Montpelier Re Holdings Q4 2007 Earnings Call Transcript

Feb.20.08 | About: Montpelier Re (MRH)

Montpelier Re Holdings Ltd. (NYSE:MRH)

Q4 2007 Earnings Call

February 20, 2008 8:30 am ET

Executives

Tom Busher - COO

Anthony Taylor - Chairman, President and CEO

Chris Harris - Chief Underwriting and Risk Officer

Kip Oberting - CFO

Analysts

Dan Farrell - Fox-Pitt

Vinay Misquith - Credit Suisse

William Wilt - Morgan Stanley

Jay Gelb - Lehman Brothers

Keith Alexander - JPMorgan

Ian Gutterman - Adage Capital

Operator

Greetings ladies and gentlemen, and welcome to the Montpelier Re Holdings Ltd. fourth quarter and full year 2007 conference call. (Operator Instructions).

It is now my pleasure to introduce your host, Mr. Tom Busher, Chief Operating Officer of Montpelier Re. Thank you, Mr. Busher, you may begin.

Tom Busher

Thank you, Janice. Good morning, and welcome to Montpelier Re's fourth quarter and full year 2007 Earnings Call. A press release setting out our results, together with a detailed financial supplement, have been posted to the company's website at www.montpelierre.bm. The call is being webcast live, and will be available for replay until March 20th, 2008.

Our speakers today are Anthony Taylor, Chairman, President and CEO; Chris Harris, Chief Underwriting and Risk Officer and Kip Oberting, Chief Financial Officer. Anthony and Chris will give their commentary on the quarter, and then Kip will present an overview of the financial results. We'll then be pleased to take your questions.

During our discussions we may make forward-looking statements, any such statements are based on the company's current plans, estimates and expectations. Actual results could differ materially from those projected in the forward-looking statements as a result of certain risk factors disclosed previously, and from time-to-time, in Montpelier's filings with the US Securities and Exchange Commission. The company undertakes no obligation to publicly update or revise any forward-looking statements whether as a result of new information, future events or otherwise.

I would now like to turn the proceedings over to Anthony, who of course has relinquished the Presidency, Chris Harris and I apologize for that oversight.

Anthony Taylor

Good morning ladies and gentlemen, a good fourth quarter to end a good year for Montpelier. Annually, our operating income was 17.8% and comprehensive income was 19.9%. Fully converted book value per share increased by 17.6% in the year and since the end of 2005, has increased by a very significant 55.8%, both numbers being after the cost of buying out all outstanding warrants in mid-year 2007.

Our combined ratio for the year, despite the frequency of non-US mid-size events, was 61.3%, just 1% higher than last year. There was minimal movement in the net reserves from the 2004 and 2005 major events, and overall a back year release of $36.4 million. At year end, IB&R, it's 55% of total net loss reserves, which reserves are predominantly in respect of short-tail business.

We continue with our very conservative high class investment portfolio, which yielded a satisfactory 5.7% annual return. We have minimal subprime exposures, which are fully disclosed in our financial supplements. We do not write financial guarantee insurance or invest in bond insurers, nor do we write DNO. We have only minimal ENO business. We currently underwrite no casualty clash or casualty retro contracts.

In 2007, we bought out all outstanding share warrants, as well as all remaining shares held by White Mountains, one of founding investors and we initiated a share repurchase program. In total, our fully converted share count reduced by 11%, further shares have been repurchased in the New Year.

On the operations front, we were the only Bermudian reinsurer that was authorized by Lloyds to establish a brand new Syndicate during 2007. Syndicate 5151's underwriting commenced on the 1st of July 2007. Allied backed development we established a wholly -owned MGA in the USA to underwrite via binding authorities granted by Syndicate 5151 primarily short-tail property and small ticket causality business.

As we have stressed previously, the underwriting and management teams for the new operations are all people well known to us, and the business being underwritten is designed to be business in which we have historical experience. It also has limited aggregation with the peak zone catastrophe PMLs generated by our Bermuda underwritten business.

Finally, in building out our new platforms in the second half of 2007, we established Montpelier Europa Aktien (inaudible) in Zug Switzerland, which is now a Lloyd's cover holder, and accesses regional/small company European business for Syndicate 5151, and for Montpelier Re in Bermuda. Whilst in the US, we purchased the Shell company, which formed the base of our new E&S insurance company Montpelier US Insurance Company or MUSIC, which will initially concentrate on underwriting very small ticket general liability business.

Chris will expand on development and production from our business platforms. I would just stress that we fully understand the current competitive environment in our industry. We expect a major build-up in premium volume from these new underwriting centers.

Finally, during the course of the last 12 months, we have continued to widen and strengthen our management team in order to address the challenges we face in this ever-changing insurance and reinsurance world.

And with that, I hand over to Chris.

Chris Harris

Thanks, Tony. 2007 was a very successful year on the underwriting front. We produced solid returns. We added new talent, and we broadened the reach of our underwriting franchise. All of these factors should service well in 2008 and beyond.

As many other markets have already commented, rates declined across virtually all business segments during the January 2008 renewal season. We observed an average renewal price index across our portfolio of minus 10%. The US was slightly more competitive with an average of minus 11% versus an average of minus 9% for international accounts. By class we saw property cash fall 9%, property specialty fall 8% and other specialty declined by 14%.

I will comment on two trends that we observed this renewal season. First, the incumbent market did well in retaining desirable programs, as cedants stock with markets that have provided support in prior years. This was a strong positive for our Bermuda operation. We were able to leverage the Montpelier franchise to expand with our target client base and to access opportunities across the group.

Within the new US and London platforms, this trend meant most successes came from partners with whom we had past relationships, rather than truly new opportunities. Against the backdrop of the current market pricing environment, this is not entirely unexpected.

As we have said previously, our expansion is part of a long-term plan to broaden our distribution sources, and to augment our underwriting talent. It is not a get-rich-quick scheme. Investing in the right people, integrating the right tools and identifying the right business partners take time, and we will remain patient in light of current market conditions.

A second theme was flat or decreasing aggregate demand in most major cap markets. The prior couple of years were marked by solid growth and demand due to various factors, including model reversion, rating agency recalibration, and overall increased perceptions of risk within the marketplace. That cycle ended with this renewal season. Both insurance and reinsurance buyers adopted a more aggressive pricing stand.

In some open market placements, firm order terms were pitched below the lowest quote. Capacity was principal and many cedants retained more net risk, despite achieving price reductions. Along with the trend of loyalty to incumbent markets, the shrink in the aggregate demand translated into more focus on retaining existing shares.

Turning to premium, you will see a spike in Q4 casualty gross written premium. This was caused by a $13 million upward adjustment on prior year medical malpractice contracts not like current quarter writings. This was partially offset by a $6 million upward loss adjustment resulting in a net benefit of $7 million to the quarter.

I will leave the details to the accounting expert, but note that premium adjustments shows in the current quarter while a loss adjustment appears as adverse prior year development.

Total gross written premiums for January 2008 were flat, to down 5% versus the prior year. Increased signings within Bermuda and new business from the London and US platforms largely offset the impact of rate reductions, non-renewals for pricing reasons and business attrition due to larger company retention and the run-off of Blue Ocean. Absent any major changes in market condition, we would expect a similar pattern for the full year.

As noted in our press release, our quarter one 2008 property and specialty loss ratio will be impacted by several recent large individual risk losses. Based on current information, we expect to book approximately $30 million to $40 million of net losses related to these events.

One last item, in our forthcoming 10-K, we plan to update our risk disclosure to include estimated market shares for selected industry losses of certain sizes. We hope readers find the additional information helpful. With that, I will turn it over to Kip.

Kip Oberting

Thank you, Chris. Fully converted book value per share ended the year at $17.88, intangible book value per share was $17.82 including dividend our book value per share grew 5.4% for the quarter and 17.6% for the year. The $0.06 difference between book value per share and intangible book value per share rose this November with our purchase of the US license Gainsco shell for $5 million more than the GAAP value of its net assets.

Comprehensive income and operating income for the quarter, were both $88 million with investment and foreign exchange realized gains and losses being a wash. For the full year, comprehensive income was $314 million, and operating income was $280 million, the operating ROE was 17.8%.

Our loss ratio in the fourth quarter was 20.8% and our combined ratio of 52.9%, this includes $10 million of losses from the California wildfires, which was partly offset by $4 million of favorable development relating to prior accident years. For the year, the loss ratio was 31.8%, and the combined ratio 61.3%, which includes approximately $102 million of net natural catastrophe losses.

The combined ratio includes approximately $12 million of expenses that's directly related to the build out of our new US and UK platforms, of which $7 million was incurred in the fourth quarter.

Turning to investments, our portfolio continued to perform adequately through the choppy fixed income and equity markets. Return was 1.2% for the quarter and 5.7% for the full year. In terms of positioning at year end 90% of the portfolio was directly invested in cash and fixed income securities. This portion of the portfolio had an average credit quality of AA plus, a duration of 1.5 years, and a weighted average life of 2.8 years.

We'll provide some additional details on our mortgage-backed and asset-backed security holdings by sub-segments in our Q4 financial supplements.

During the second half of 2007, we committed $95 million to various funds set up to capitalize on the turmoil on the bank loans in mortgage markets. Our financial statements show about half of this has been funded at year end, and much of that was not yet deployed. We anticipate these commitments will be fully funded over the next 12 months.

On the corporate finance front, in December we amended an extended variable forward agreement with Credit Suisse, guaranteeing us continued immediate access to the present value of $90 million worth of equity capital should we chose to draw it down.

Also we have been steady buyers of our stock recently. In the fourth quarter we spent $56 million repurchasing $3.3 million shares in the open market at an average price of $16.98.

Including the repurchase of shares and warrants from White Mountains in last years second quarter, we've spent about half of our 2007 earnings reducing our fully converted share count by 11%. Further in January and February of this year, we spent an additional $35 million under our share repurchase authorization. This leaves about $1 million remaining under that authorization.

With that summary I'll now pass it over to the operator for questions and answers.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Dan Farrell with Fox-Pitt.

Dan Farrell - Fox-Pitt

Hi, Good Morning. Can you give us a little more detail on the individual risks losses that you're going to be experiencing in the first quarter? And then also, can you comment on what you think, your sense is that the overall industry loss might be from these various events?

Anthony Taylor

Okay. I'll ask Chris to answer that.

Chris Harris

Okay. Thanks Dan, I think there have been a several large individual risk losses this quarter. We think in aggregate, you're probably talking about $2 billion of industry loss, but obviously where that falls among any individual company, can be very random, because these are individual risk losses. It just depends whether or not you happen to write those specific accounts.

Dan Farrell - Fox-Pitt

Okay, thanks. And there's just one additional question, can you talk more about your expenses right now with the various new initiatives that you have, and how much of those expenses right now are sort of new start up versus ongoing expenses? And then what's your expectation for how the expense ratio will trend, as we move through '08 and you start to get more premium benefits from these initiatives?

Kip Oberting

You'll note in my script, I've mentioned that about $7 million of it is expenses, this is Kip speaking, about $7 million of expenses were incurred during the fourth quarter and these were, from what I call, directly related to new operations. And I'd say, looking ahead to 2008, we would expect general and administrative expenses to increase modestly from the Q4 run rate, but also bear in mind that for 2007 and I would expect it to continue, about a quarter of our expenses in 2007, actually more than a quarter, were related to incentive compensation. And so these do vary with performance.

Dan Farrell - Fox-Pitt

Okay. Thanks guys.

Kip Oberting

Okay.

Operator

Our next question is from Vinay Misquith from Credit Suisse. You may go ahead.

Vinay Misquith - Credit Suisse

Hi, good morning. On your gross written premiums you mentioned that on January 1, the premiums were down, flat or down 5% and this was including the new operations, would you expect that to stay at similar levels or would you expect your new operations to ramp up more towards the rest of the year? It was generating some sort of positive premium growth for you for rest of the year?

Chris Harris

Thanks Vinay, this is Chris again. In the script, I said that other than any major changes in the market, we would expect the similar pattern for the full year, similar pattern that we thought at January 1.

Vinay Misquith - Credit Suisse

Okay. Because my sense for the stamp capacity for the UK was about $250 million, so I am just curious as to whether on the rest of the business you plan to pullback that much or do you not plan to ramp up your UK operation all that much?

Chris Harris

I mean I think it's probably a combination of both a little bit, I mean again it will depend on market conditions. Again, I talked about in the script you obviously have to factor in the rate reductions that we are seeing on our core book. There are some accounts that are no longer meeting our pricing hurdle. That means premium going away, which we think will largely be replaced by some of the US and London operations.

Anthony Taylor

In addition, there are some of the businesses previously written in Bermuda which has and will transfer to the London operation.

Vinay Misquith - Credit Suisse

Sure. Fair enough.

Kip Oberting

Obviously, the capacity that you refer to, is a cap on the amount of premiums. And so, as soon as Chris noted a change in market condition that is the maximum one could write, but we would expect to write less than that.

Vinay Misquith - Credit Suisse

Sure. Okay. That's great. Second one was more of a small numbers question. The financing expense ticked up this quarter slightly and is higher in the last two quarters than it was in the second quarter. Was there anything happening in that number, $9.2 million?

Kip Oberting

Yeah, this is Kip. There is nothing material going on there. We do have some other income items relating to variable -- not variable forward but swap transaction. We did do the variable forward in 2007. We amended that. There could be some expense, but there is no real trend change. There was nothing material there.

Vinay Misquith - Credit Suisse

Fair enough. And one last question on the large individual losses. How would you look at them versus your expectations for quarterly volatility in your loss patterns?

Anthony Taylor

I think the reason that we made the point about this, there's a significantly greater frequency of large risk losses in this quarter than we've really experienced since the company started. I'm not just talking about losses we've had, but losses that there have been to the market. I remember there was a quarter about a year and half ago where there was some frequency of large risk losses. But this first quarter I think is the most frequent that we've experienced.

Chris Harris

We just felt it was worth mentioning. Certainly our long-term pricing assumptions allow for this type of events overtime. But I mean we've been writing the similar book for 25 quarters and we've effectively had kind of our three largest non-GAAP losses in this one quarter. So we just felt it was worth mentioning.

Vinay Misquith - Credit Suisse

Alright. Okay. Thank you.

Operator

Our next question comes from William Wilt from Morgan Stanley.

William Wilt - Morgan Stanley

Hi. Good morning. A few questions. The first is could you just remind me of the businesses, classes of businesses in other specialty, you said the renewal pricing index was down about 14%?

Chris Harris

Okay. I mean that's effectively anything that's not property business. So that would include casualty business, would also include engineering, some of the workers' comp cat, personal accident cat, few lines such as green aviation. In page 4 in our supplement I think breaks out some of the individual classes within that bucket.

William Wilt - Morgan Stanley

Okay. That's great. Thanks for that. Question two is that, at a high level, you touched on some of the premium going from Bermuda to London. Could you just, again high level, speak through some of the positives, negatives from a cost of capital, tax perspective writing business in Bermuda versus London as you think about the trade-off and benefits of the dual platform?

Chris Harris

Well, I think I can say that in most cases, it's probably slightly more expensive for us to write it in London and in Bermuda. But the issue here is that on a number of costs to business, we've seen the London market has got much stronger in the last two years and the business which was coming to Bermuda in 2002, 2003 and 2004 is no longer coming here. The reason we've established our platform, is to have an underwriting operation in the area where that business is being placed that we need to be close to workers and in some cases closer to the clients.

William Wilt - Morgan Stanley

Okay, great. And number three quickly, I think you said $95 million, correct me if I am wrong, $95 million committed to the new ventures further investment plans targeting distressed mortgage securities. Any color you could add, say types of residential, commercial strategies, any additional color would be great?

Chris Harris

Sure, it's about half of that $95 million is dedicated to mortgages, and as at year end, $2 million of that was invested and the managers of those two of that half are kind of household I'd say fixed income brands.

They are buying pretty simple fixed income instruments, one commentary that we heard from both of our managers here during the first quarter is, if anything, what they found is that they are buying higher quality assets than they had expected, meaning that they are not seeing the opportunities in the more distressed sectors. They are actually seeing the opportunities in the lower risk, lower spread sectors. Is that helpful?

William Wilt - Morgan Stanley

That's great. Thanks very much.

Operator

Our next question comes from Jay Gelb from Lehman Brothers. You may go ahead, sir.

Jay Gelb - Lehman Brothers

Thanks and good morning. First, I just want to follow up on the general and administrative expense line. You gave us some detail there in terms of the incremental cost for the build out. But I was actually looking maybe more for a high level view in terms of rate of growth in the dollar amount for G&A expense in 2008, if your base line was $86 million in 2007?

Kip Oberting

Yeah, this is Kip. What I've said earlier in response to the questions, we do expect that the fourth quarter run rate that for 2008, we expect some modest growth in that, so that will grow, obviously the rate of growth is going to slow significantly. But, that is the magnitude of our expenses.

My other point was to bear in mind that a significant portion of our expenses more than a quarter in 2007 are incentive comp-related, and so these will vary with performance. But, I think the hardier question answering that is that we do expect the expenses to continue to increase, albeit modestly and I'm talking in dollar term there not in terms of the combined ratio.

Jay Gelb - Lehman Brothers

Okay. That's helpful. And then, you give us the outlook for the gross written premiums, what about your ceded premiums, how should we think about the net?

Chris Harris

Well, I think, is that something we constantly review, I mean we always look at that in order to try and optimize their underwriting return. And I guess, we just say that would be sensitive on market conditions actually are. But last year is probably not a bad guide to this year as well.

Jay Gelb - Lehman Brothers

In terms of dollar amount or percent ceded?

Chris Harris

Probably in terms of percent.

Jay Gelb - Lehman Brothers

Okay. It's helpful. Thanks and then on capital management, it looks like you are going to very quickly finish up the current authorization. How is the board thinking about future capital management?

Anthony Taylor

We will find out after our next Board meeting I suspect.

Kip Oberting

We've obviously always been pretty proactive in the capital management department and Yeah I guess as Tony said we'll see what happens at our upcoming Board meeting.

Jay Gelb - Lehman Brothers

And when that's scheduled for?

Kip Oberting

A week.

Jay Gelb - Lehman Brothers

Okay. And then if you could just also update us on succession planning for the CEO position? Thanks very much.

Anthony Taylor

Yes, we put out announcement few months ago now basically saying that I will step up to Executive Chairman not earlier than the 1st of July, but that we would make an announcement well before that time of the changes in our line up.

Jay Gelb - Lehman Brothers

And you anticipate at this point that the successor to the CEO will be internal?

Anthony Taylor

I think you have to wait to see.

Jay Gelb - Lehman Brothers

Okay. Try my best. Thanks Tony.

Operator

(Operator Instructions). Our next question comes from Keith Alexander.

Keith Alexander - JPMorgan

Hi, good morning guys. I was just wondering if I can go into a little bit further detail on the large losses that could be. I wanted to talk about where they came from and how large the single biggest one is?

Kip Oberting

I think as regards to the size of the largest one and at the most we haven't got full details and there haven't been claims adjustors reports. But the largest ones are clearly hundreds of millions of dollars. As to where they've come from, there were some in the US, there is one certainly in Europe, there is a couple in Australia, there is one in South America, so it's all over the world.

Looking at the sort of industries affected, steel industry, energy, open cast mining, kind of the industries that seem to be working at 24 hours a day, supplying goods, probably for China.

Keith Alexander - JPMorgan

Okay and just one follow up question. In terms of starting your new startup operations, are people currently on the ground many people that you're not hiring?

Anthony Taylor

Yes, substantially, the majority are in both the US and (inaudible). There's a bit more filling out to do in the US, and a small amount in the syndicate Lloyd's, but substantially, they're with us.

Keith Alexander - JPMorgan

Alright, thank you.

Operator

Our next question comes from Ian Gutterman.

Ian Gutterman - Adage Capital

Good morning everyone, just a couple of questions. First, if the premium is going to be flattish, and London and the US can rate at higher leverage than Bermuda, am I correct in saying that that means you're going to be less capital intensive in '08 than '07?

Chris Harris

I think, there's a couple of ways you can answer that, but I think it probably is fair to say, if you look at our premium distribution at the end of 2008 versus 2007, you'll see a smaller percentage in the property cap market and a higher percentage within property specialty and other specialty. So that probably does mean that we would expect those buckets to be less capital intensive on average.

Ian Gutterman - Adage Capital

Okay. So I guess I wanted to oversimplify. Any earnings then would be excess capital. And I guess throughout the course of '08, your excess capital should grow by the amount of your earnings plus something for the difference in capital intensity, is that fair?

Kip Oberting

It's not such a simple answer. I mean our actual capital, kind of usage, if that's the term you want to apply to it, depends on our PMLs. It depends on our annual net operating loss, our market share analysis, what we're doing on the investment sides. So there are a lot of factors that come into play.

Clearly, from a business standpoint, I think where you're going with your question is how much capital will we look to return to shareholders? And I don't think you'll see any change in our approach. I think we'll be proactive there. But at the same time, we need to manage the risk of our company on a consolidated basis. Irrespective of whether business is written in Lloyd, the US or Bermuda, we need to look at the overall risk. We have consolidated risk management guidelines.

Ian Gutterman - Adage Capital

Okay. Fair enough. Other question is did you have any releases within the accident year, meaning a number of your peers released reserves from a lot of the earlier (inaudible), specifically Cairo and Australia I think. I was wondering if you guys have any split there?

Chris Harris

It's not something that we split out, but you would have seen some small reduction if you're talking about Cairo and UK floods that would have been within the quarter.

Ian Gutterman - Adage Capital

Okay, but nothing material.

Chris Harris

It's a reduction in the Australian floods.

Ian Gutterman - Adage Capital

Is that just procedural things, that it takes longer for you to release it, or I guess what I am trying to get at is, there were some leases larger than your competitors. I was just a little surprised that you didn't have that as well. On a minor note is that just the way your development reviews work, that would take longer to play out, or is it something you would reiterate your end of what's happened already?

Chris Harris

I mean it is something we review on a continual basis. Yeah, I think we got the number right the first time is the way we look at it. So, but it is probably on the order of $5 million if you added all of those together for this quarter.

Ian Gutterman - Adage Capital

Okay. That's good. And then just one quick numbers question. The $10 million from the wildfires, did that go into the Cat line or did some of that go into other property line?

Anthony Taylor

That was in the cat line and basically it is one program which I think I mentioned on our last call a quarter ago that it was likely that we get losses from one of the large Californian program and that is the one we got new clients from.

Ian Gutterman - Adage Capital

Okay. Thank you very much. That is all I had.

Operator

This concludes today's question-and-answer session. I'd like to turn the call over to Mr. Busher for closing remarks.

Tom Busher

Thank you all very much. If there are no further questions, that completes the proceedings from the company's point of view. So it only remains to me to thank you all very much for your participation. We hope you will join us again for the first quarter call. Thank you very much.

Operator

This concludes today's conference. Thank you for your participation.

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