Allied World Assurance Company Holdings' (AWH) CEO Scott Carmilani on Q1 2016 Results - Earnings Call Transcript

| About: Allied World (AWH)

Allied World Assurance Company Holdings, AG (NYSE:AWH)

Q1 2016 Earnings Conference Call

April 20, 2016 8:00 AM ET

Executives

Sarah Doran – Senior Vice President-Strategy, Investor Relations and Treasurer

Scott Carmilani - President and Chief Executive Officer

Tom Bradley – Chief Financial Officer

Analysts

Amit Kumar – Macquarie

Dan Farrell – Piper Jaffray

Charles Sebaski – BMO Capital Markets

Ian Gutterman – Balyasny

Operator

Welcome to the Allied World Q1 2016 Earnings Call. My name is Jason, and I will be your operator for today's call. At this time, all participants are in a listen-only mode. Later, we will conduct the question-and-answer session. Please note that this conference is being recorded.

I will now turn the call over to Sarah Doran, Senior Vice President-Strategy, Investor Relations and Treasurer. Sarah, you may begin.

Sarah Doran

Thanks, Jason. Good morning, and welcome to Allied World's discussion of our first quarter 2016 results. Hopefully, all of you have seen our press release, financial supplement, and 10-Q, which were released last night after the market close. This call is being webcast and the webcast replay will be available later today and for the next month. All these materials can be found on our website at www.awac.com under the Investor Relations section.

Scott Carmilani, President and CEO; and Tom Bradley, Chief Financial Officer will deliver our prepared remarks. Also with us to assist with your question are Marshall Grossack, Chief Actuary; and John Gauthier, Chief Investment Officer.

Before I turn it over to Scott, I'd like to note that our presentation today may include forward-looking statements within the meaning of the U.S. Federal Securities Laws. The company cautions investors that any forward-looking statement involves risks and uncertainties, many of which are outside of our control and is not a guarantee of future performance. Actual results may differ materially from those projected in the forward-looking statements due to a variety of factors. These factors are described in the company's filings with the SEC.

We're not obligated to and do not undertake any obligation to update or revise forward-looking statements, which speak only as of the date on which they're made. Also, in our remarks and responses to questions, we may mention some non-GAAP financial measures within the meaning of U.S. Federal Securities Laws. Reconciliations are included in our earnings press release and financial supplement.

And now, Scott Carmilani.

Scott Carmilani

Thank you, Sarah, and good morning everyone, and thanks for joining our first 2016 earnings conference call. I'll go through the performance of each of our three segments, and Tom will give you more color. The catastrophe environment has been quiet for some time now, and that has continued through the first quarter of this year with no catastrophe losses to report for the quarter. Market conditions remain very competitive on both rate and coverages across all three of our underwriting segments.

Even though there are signs of rate change and need for change to market conditions. The rate environment continues to be challenging. That said, we do see some attractive opportunities within our mix of our businesses, and remain focused on hunting for those opportunities and clients, while maintaining discipline in other businesses that show signs of pressure.

For the first quarter of 2016, our top-line decreased modestly overall by 1.9%, for the same quarter from last year, in gross written premiums. Our net premiums decreased further as we affected strategies to lay up more volatility during these market conditions.

Turning to the segments for our specific movements within the portfolios, the reinsurance segment declined by 16% quarter-over-quarter, driven by a number of factors, all pointing to underwriting discipline by management. We reduced line sizes and acceptance of renewals, seasoned companies changed structures and assumed more risk and we reduced clients and volatility to our cat treaty participations as we seek risk reward, where it makes sense and a pullback where we see deteriorated both on the internally and externally managed portfolios.

In the North American insurance platform, the top-line was essentially flat. There was growth in our environmental and programs units, offset by declines in businesses, where we less favorable rates of returns like the real estate casualty class, healthcare and some property classes. In the Global Markets Insurance business, as most of you know, we've been growing rapidly in the Asian markets with the addition of our acquired business last April.

This was the final quarter to include the roll-in of the results from those acquisitions, making future references by quarter more comparable to prior years. So, all-in, we grew by 91% for the quarter in this segment. I am pleased with the overall progress we continue to make as we integrate these operations and combined efforts to get those businesses running towards full potential.

There's work still to be done by focusing on the capabilities and the efficiencies is definitely a focus of this investment while maintaining our goal to bring expenses in line with our distribution and the profit and business opportunities. Beyond the segment results, let me provide some more contexts on the current market rate environment. On average, rates across our insurance portfolios continued their downward trend in the quarter, although those in property more so than our larger casualty business.

The U.S. remains as strong as rate environment globally with overall rates down around 2%. Property rates down in the mid-single digits and casualty rates closer to flat when you factor in managing rate increases to some line and decreasing renewal pricing. The international rate environment is a bit more challenging both in the London specialty wholesale market and the rest of Europe and Asia as well with new opportunities appearing to be more competitive than the renewal pricing.

As always, the rate environment is just one piece of the pie. In many lines of business, the loss cost trends have remained within our expectations or below. I think fueling competition, but also providing decent returns from many parts of the market where we compete for business. It certainly is a complicated market today, where we don't see loss cost staying in line or where rates have deteriorated below where we think we should get acceptable margins in the near or mid-term. We are working very hard to maximize return by applying underwriting discipline to any underperforming businesses and also effecting efficiency and expense savings wherever and whenever possible. We are taking swift action to push these variables in the right direction.

And with that, I'm going to turn it over to Tom, our CFO. Tom?

Tom Bradley

Thanks, Scott, and good morning, everyone. For the first quarter of 2016, Allied World generated underwriting income of $23 million, operating income of $59 million, and net income of $74 million. Our results benefited from $72 million of investment returns, and $25 million of net favorable loss development on prior-year reserves.

Our reported loss ratio for the quarter was 64.2%. This includes 4.4 points of net benefit from those reserve releases. The accident year loss ratio was 68.6%, which is in line with the 68.4% of the prior year quarter. Notably, the accident year loss ratio for the North American insurance segment was 68.4% for the quarter, an improvement of 2.2 points as compared to the prior year quarter. Included in the current accident year for the quarter, the company recorded $8.6 million of losses in the global markets insurance segment, primarily from the impact of a property loss in February and a March aviation loss.

Following the work we completed on the healthcare, medical malpractice reserves last quarter, this line is performing as expected and we continue to believe that we have put the reserving issue behind us. For the quarter, the company's expense ratio increased to 31.8% from 30.9% in 2015, driven entirely by the acquisition ratio. This was a result of higher acquisition cost across each of the three segments, most notably within the acquired Asian operations due to the nature of that business.

The G&A component of the ratio improved by 0.5 points from the prior year quarter as a result of the reduction in compensation expenses including the impact of our stock price on those expenses. Going forward, rest assured that we will carefully manage our operating expenses in this low growth environment to maintain our historical expense advantage.

Operating cash flow was $347 million in the quarter compared to $318 million in the prior year quarter. This increase was driven by the receipt of funds from prior underwriting years related to our participation in the Aeolus collateralized property catastrophe reinsurance program.

Turning to investments, the total return on the overall investment portfolio was 80 basis points or $72 million in the first quarter driven by $53 billion of net investment income and $19 million of net realized gains.

The net investment income is a 20% increase over the prior year quarter and was driven by higher returns from fixed income assets and the improved performance of Allied World financial services.

We continue to dynamically manage our investment portfolio and capital. During the quarter, we reduced our non-core allocation to 19%, down from a peak of 30%, in part by decreasing our public equity exposure to 2%, down from a peak of 10%.

Turning to capital management activity, we've restarted our share repurchase program at the beginning of the year, and at least purchased $67 million of common stock year-to-date at an average price of $34.42 per share.

We're also happy to announce that at yesterday's Annual Shareholder Meeting, shareholders approved another four quarterly dividend – dividends equal to $0.26 per share and a new two-year $500 million share repurchase authorization.

As you can see on page 16 of our financial supplement, our PMLs have declined from previous quarters due to underwriting actions across our property portfolios. Each PML decreased this quarter to the lowest amount as a percentage of total capital in the last three years. While the PMLs declined materially this quarter, we do expect them to slightly increase in the second quarter, as our corporate CAT cover renews and we're able to optimize that purchase.

Finally we ended the quarter with shareholders equity of $3.5 billion, flat from year-end but a 90 basis point increase in book value per share. Our total capital was $4.8 million, which includes the recent $500 million 4.35% senior notes that were issued in October to refinance the existing 7.5% senior notes that mature on August 1.

For the quarter, interest expense on the 7.5% notes was $9.4 million, which will obviously go away upon repayment of those notes this summer as well as the additional cash we're holding to fund that maturity. Adjusting for the double leverage, financial leverage was 18.8%, unchanged from year-end, premium leverage was 0.67 times.

With that, I'll turn the call back to Scott, for closing remarks.

Scott Carmilani

Thanks, Tom. I'm pleased with our first quarter results, as Allied World was off to a strong start for 2016. We continue to see strong momentum in our key markets. With a solid underwriting and investment results to start the year, we're confident that the businesses that we have and continue to build will be profitable, sustainable, and accretive to our franchise.

And with that, I'm going to open up to questions from the group. Thank you very much. Operator? Jason?

Question-and-Answer Session

Operator

Thank you. We will now begin the question-and-answer session. [Operator Instructions] And our first question comes from Amit Kumar from Macquarie. Your line is open.

Amit Kumar

Thanks and good morning, and congrats on the beat. Just a few questions. The first question obviously relates to our discussion on the reserve moments. There were some confusions regarding the re-bucketing of the segments, where you've moved the healthcare management liability line into the provisional liability line, was there – first of all, if you could explain the re-bucketing? And second of all, was there any movement in the healthcare management liability reserves this quarter?

Tom Bradley

No. Amit, let me handle that. We in the past or what we've defined is that, healthcare line of business, included both healthcare or medical malpractice liability and management liability, and healthcare E&O for that sector. In 2015, we've changed the management responsibility for the professional lines part of the healthcare business to be in sync with the professional lines or other professional lines businesses within the North American segment.

So for the first quarter of this year, we've moved the premiums, the losses, the reserves and results into the professional liabilities line for that part of it. What you see on healthcare line is the medical malpractice, medical liability reserves only. And as you can see, no movement in those reserves this year and we remain content with the actions we took in the fourth quarter.

Amit Kumar

And what about the healthcare management liability piece?

Tom Bradley

Again it's just bolted in to the professional liability, nothing really to talk about it. So we operate it as a separate business and we will kind of continue operate it as part of that team.

Amit Kumar

No, the question was, was there any reserve movement in the healthcare management liability line?

Tom Bradley

Nothing material.

Amit Kumar

And what's the threshold of materiality?

Tom Bradley

Nothing that I – I thought necessary to mention it in these comments. There is some movement you can see on the professional liability line, some bunch of years went up, bunch of years went down we net took down to $5 million overall in professional lines for the quarter.

Amit Kumar

Okay. Fair enough. I'll move on and maybe come back. The second question relates to the discussion on capital management and obviously the return to capital management, how should we think about the level of buybacks sort of going forward? Does it equate earnings? Is there some sort of rule of thumb you're using for 2016 on a capital management?

Tom Bradley

Yeah, I would say it's less related to earnings and more about the pace of buybacks, particularly given where the stock is now. You saw we authorized $500 million for two years, given us the ability to do call it $250 million a year, $50 million in the first quarter, considering it's a 10b5 plan is kind of the thread we will look for. So, managing the capital as a way of returning that amount kind of separates from the amount we'd expect to earn this year. As you remember last year, we've returned a multiple of what we earned in repurchases.

Amit Kumar

Yeah. You had the Exor buyback. Final question for Scott, and then I'll re-queue. Scott, when you look at the stock price and you look at the book value, obviously you're an outlier, if you look at the group. I'm curious is there some sort of – I guess a self created exam where you're saying to yourself that if the stock does not reflect the value creation of the franchise, perhaps it's time to consider other options including the sale of the company?

Scott Carmilani

No.

Amit Kumar

Okay. Okay. I will re-queue for some other question.

Scott Carmilani

Thanks, Matt.

Amit Kumar

Thank you.

Operator

Thank you. And, our next question comes from Dan Farrell from Piper Jaffray. Your line is open.

Dan Farrell

Hi, and good morning.

Scott Carmilani

Good morning, Dan.

Dan Farrell

First, just a question on trend of expense ratio. I think both G&A and the acquisition expense ratio. We have seen an uptick in the acquisition expense ratio; I think a lot of companies have. Is this sort of the level that you think it is going to be at? Is there anything from reinsurance buying standpoint over time that can impact that? You have obviously been active in purchasing some more reinsurance, but not sure if that will be having an impact there.

And then I would also love to get a sense of your view of how quickly we can see progression of the expense ratio, the improvement in the global segment. Thank you.

Tom Bradley

Yes. As far as the acquisition costs the reinsurance buying is certainly a lever to help manage that, the brokers are demanding more on the primary end, but we do have the ability to achieve additional seating commissions in our reinsurance purchases and we are utilizing that as a tool. So, I think that'll have some impact in the second half of the year.

On the operating expense side, and particularly expenses as it relates to global markets, I think we talked about it’s probably 2017 before you get good visibility into the initiatives there. The integration is going on plan, we're still spending on systems related integrations, the number of the systems have gone in, actually our specialty, causality underwriting system, I think the last line of business just went up this month. Some of our expense reporting systems are in. We're looking for the first lines of the new retail system and product to go in by the end of the year. So, still investments being made there, but, I think it's really 2017 before you get a lot of visibility into that.

Dan Farrell

Okay, great, thanks. And then just a question again on the removement of the reserving between segments. If I recall, I think the disclosure in the supplement had some difference with the disclosure that you put in your Global Triangles in terms of the bucketing. Does this change that you have made to the supplement actually make it more consistent with what you report in the Global Triangles?

Tom Bradley

Great question and thanks for reminding me that, that does make it consistent with the global triangles, where the management liability part of healthcare had been reported in the management – in the professional liability triangles, this now aligns with the GLT presentation.

Dan Farrell

Okay, great. And then just one last question. While it has been a lower cat quarter, I mean there has been some weather activity, particularly in North America. Was there any weather impact there in the quarter that may not get reflected or hit a threshold from a cat perspective given that you had zero cats?

Tom Bradley

Yes we really – no impact on our current accident year in the first quarter in North America for that type of thing.

Dan Farrell

Okay.

Tom Bradley

Obviously, we would have seen some activity, but nothing that made us want to change our view of the accident year. Very minimum.

Dan Farrell

All right, great. Thank you very much.

Tom Bradley

Sure, Dan.

Operator

Thank you. [Operator Instructions] Our next question comes from Charles Sebaski from BMO Capital Markets. Your line is open

Charles Sebaski

Good morning. Thanks for getting me in.

Tom Bradley

Sure, Charles.

Charles Sebaski

I guess the first question is on the North America segment and obviously the top line is staying flat, but the net has come down pretty big in the quarter, 10%. Just wondering is it just the reinsurance buying opportunity or what is the thought process on increasing the fee relative to last year?

Scott Carmilani

It's a combination of things. Yes, that's part of it where we've bought global treaties for specific lines of business and there is different ceding structures and different ceding commission structures that Tom alluded to in his earlier comment. But also the mix of the business has changed little bit, which has put us in a position to have a little bit less net written versus gross written on a couple of lines of business.

Tom Bradley

Yes and particularly it's been a tool that we've used for additional protection on some of the lines that have had more volatility recently, some like medical malpractice and primary casualty. We have increased sessions on those businesses to provide some air cover as we do the underwriting actions.

Charles Sebaski

All right. And then I would like to just talk about the Reinsurance segment reserves a little bit. Obviously you had a big property takedown in 2015. Was that a large single event? Was that a multitude of events? And is there – it just seemed the size of it, nearly $20 million of 2015 is nearly 5% of the losses in that year, accident year losses.

So curious on that. And then also any commentary on – the 2011 to 2015 accident years seem to be maybe a little bit pressured relative to the historic and interested in your thoughts or any concern on how those are developing and what might be in the pipe from cedents.

Tom Bradley

Sure. On the property question, that really is just a takedown of bulk reserves that we had for the 2015 accident year for like reporting of any losses that might come in on that line, and not really held back on any specific claim that we released but just based on the runoff of the 2015 accident year cat business in the first quarter, and likely in the some couple of quarters into the future.

Charles Sebaski

Okay. And then any thoughts on what is developing in the 2011, 2012, 2013 years? You guys have any concern on looking at the casualty reserves and reinsurance on what is going on there?

Scott Carmilani

Yes, we've had concern and that's why the reserves have gone up in the most recent period. We've taken serious underwriting action to that portfolio since the end of 2012, and that portfolio has gone from, circa $200 million to circa $40 million in written premium, where we've reduced the line sizes or gotten off accounts altogether. So, there has been a quite a bit of underwriting action, we don’t expect to continue from that portfolio. It’s casualty business and reinsurance casualty business has a bit of a tail to it. It performed a little bit worse than we had expected.

Charles Sebaski

Okay. And then just finally on the global markets, wondering if you could give any thoughts on what the growth has been or commentary on organic growth of that RSA business. I guess obviously there is a roll-in this quarter and the last few as you get to a normalized state of getting that book involved. But I guess I would appreciate what is going on from a growth perspective on policy count relative to what the book looked like at acquisition.

Scott Carmilani

There hasn't been much growth at all. This is a transition of that business that we didn't sign up or finalize until last April. So, what you're seeing this quarter is a first year – first quarter results from their book from last year. There’s not a lot of organic growth in at all in fact just the opposite, we've taken some action on some of the book that we inherited from there, and we underwrote some of them.

Charles Sebaski

All right. Thank you. Thank you for the questions – or for the answers, excuse me.

Scott Carmilani

All right.

Operator

Thank you. And, our next question comes from Ian Gutterman from Balyasny. Your line is open.

Ian Gutterman

Hi, thanks. I guess maybe I will continue some of what Dan was asking on the development moving to insurance. One pattern I noticed is most of the, I think all the releases this quarter and kind of in the past two quarters have been 2010 or 2011 and prior and sort of the 2012 to 2015 is flat or a little bit adverse. But yet your overall range I believe over the median is relatively consistent with where it has been in prior years. Does that suggest that the 2012 through 2015 you guys expect at some point will switch to releases or is most of the redundancy as you are above the range in the 2011 and prior?

Scott Carmilani

It's too early to say that categorically or specifically. The range is actually increased slightly in relativity and reserves have grown as the company has grown.

Tom Bradley

Yes, I think if you went back a year ago or two years ago, three years ago, you would have seen the most three, four, five accident years basically have more bias to upward movement than downward movement and years five, six, seven, eight in arrears having most of the take down, and I think that's been pretty consistent story. So, I think this is more the same. As Scott mentioned, our view of the reserve position is good or better than it was as of the end of December.

Ian Gutterman

Okay, guys. I just wanted to confirm that because I think people look at the adverse for the past four years and think that means something different than it used to mean. Then Tom, to follow up on your comment about the global, seeing the expense savings more in 2017. I know you have talked about where that gets ultimately, but can you give us any sort of sense just what your trajectory is I guess? I mean will it be that sometime in 2017 there is going to be sort of a step drop and it is going to be several points noticeable right away or is it more gradual that it is going to be X percent, X basis points each quarter and just kind of grows from there? Just how is the right way to kind of model that?

Tom Bradley

I think, there'll be modest improvement over the full course of 2016 and into 2017 and hopefully continue to improve in 2018. But in terms of getting the operating model to where we want the pieces to fit, that's probably not all in place until 2017. But again, even properly overall, I would expect to be able to demonstrate some modest improvements each quarter.

Ian Gutterman

Okay. I guess what I am trying to get to is whatever operating plan you guys have to get these out, is there something that, in a certain quarter of 2017, we are just going to see a big drop at one time because whatever plans you are planning on get executed and then those costs are gone or is it more sort of spaced out?

Scott Carmilani

Yes. It rarely works like that with expenses. It works its way in

Ian Gutterman

Okay.

Scott Carmilani

We're just trying to be cautious to make sure, we don't – you don't get ahead of the curve, in terms of where we get there.

Ian Gutterman

Got it, okay. I just didn't know if there was some kind of regulatory thing that one quarter $10 million is going to fall out or something like that. So, okay, and one more thing before the buyback. I am drawing a blank, so I will come back to it. So on the capital, I think ISS was being a little difficult about the size of the buyback, which seemed a little ridiculous to me frankly, but is there any color just sort of what you did the two-year $500 million? Could you have done one year of $300 million and then $300 million next year to get around that or what was the philosophy of doing it especially given you got some pushback on it?

Scott Carmilani

Yes. The 10 year fits within the Swiss governance framework that we operate under realizing ISS as a formula, which gives them the answer that they have, obviously our shareholders agreed with us in authorizing the repurchase.

Ian Gutterman

Okay, got it. So I know you sort of suggested it would be – maybe the base case for it is $250 million each year, but is that something that the Swiss regulations require in any way or if you wanted to do – just to make up a number – $400 million this year and $100 million next, is there anything that prevents you from doing that?

Scott Carmilani

No. It's 500, anytime between now and May of 2018.

Ian Gutterman

Got it, okay. That’s why I wanted to check on. And given the – obviously it is a big number. Without doing the math, I think it is somewhere around a full 100% of street earnings, but given the capital freed up from the reduction in the investment portfolio and the reduction in the Aeolus I think is several hundred million. Is there a reason why – it feels like net-net even with this program at the end of 2017 you are going to have more excess capital than at the end of 2015. Is that correct?

Tom Bradley

Yes. I don't know, if I would say that, but...

Ian Gutterman

But it depends.

Tom Bradley

Yes. These other capital actions are among the reasons that we can – we were in 2015 and in 2016, as necessary we could do capital returns in excess of earnings because of the – our capital position.

Ian Gutterman

Got it, okay. Got it, okay, fair enough. I guess I just wondered it seemed like you are doing a lot of action that in the near-term are freeing up capital on the cat side and the investment side. I don't know if that would lead to any sort of – I guess what I was trying to say is just the capital generation may be front-end-loaded because of that right because you are getting these sort of upfront and the earnings obviously come in ratably. If that suggests maybe you try to buy back faster because you have this capital being freed up very quickly.

Tom Bradley

Remember the buyback is on an algorithm to 10b5 program.

Ian Gutterman

Yes. Okay. Good point.

Tom Bradley

And it maters where the stock is trading and also matters where the other business opportunities are.

Scott Carmilani

Yes. If you can never time it exactly in terms of release the capital and use the capital. But we want it, we certainly want to have the flexibility to be able to do that given the authorization we have and potential opportunity.

Ian Gutterman

Got it, okay. I remember what the other last thing was just real quick. The decrease in the non-core investments to 19%, is that sort of where you guys think is the bottom or do you think you will continue to bring that number down?

Scott Carmilani

I think it's based on our – let's back to the capital question. We kind of do our risk base allocation of where to put the capital. We've been applying much more to investment portfolio is the non-core portion went up as high as 30%. So it's really more capital based that to drive that as proposed to specifically in an individual investment decision but again as other opportunities became available we still have the capital flexibility to pivot back. If we thought that was the best economic use of the available capital.

Ian Gutterman

Got it. Thanks so much.

Operator

Thank you. [Operator Instructions] And we have Amit Kumar from Macquarie again. Amit, your line is open.

Amit Kumar

Yes. Thanks. One quick question I had, do you have a staggered Board of Directors?

Scott Carmilani

No. Everybody is elected annually.

Amit Kumar

Okay, got it. That is all I had. Thanks for that answer.

Scott Carmilani

Thanks, Amit.

Operator

And we have no further questions. I'll now turn the call back to Scott Carmilani for final remarks.

Scott Carmilani

I'd just like to wish everyone a nice rest of the week. And thank you very much for participating in the call. Have a good day.

Operator

Thank you, ladies and gentlemen. This concludes today's call. Thank you for participating. And you may now disconnect.

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