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OneBeacon Insurance Group, Ltd. (NYSE:OB)

Q1 FY08 Earnings Call

May 02, 2008, 10:00 AM ET

Executives

Todd Mills - Treasurer and VP of IR

Mike Miller - President and CEO

Paul McDonough - CFO

Analysts

Jay Gelb - Lehman Brothers

Bob Glasspiegel - Langen McAlenney

Gary Ransom - Fox-Pitt Kelton

Rohan Pai - Banc Of America Securities

Operator

Good morning and welcome to OneBeacon Insurance Group's First Quarter 2008 Financial Results webcast. This call is being recorded at 10 AM Eastern Time Friday, May 2, 2008. All participants are in a listen-only mode. At the conclusion of the prepared remarks we will host a question-and-answer session. Now, let me turn the call over to Todd Mills, OneBeacon's Treasurer and Vice President of Investor Relations for opening remarks and introduction. Please go ahead Sir.

Todd Mills - Treasurer and Vice President of Investor Relations

Thank you and good morning. On behalf of OneBeacon's management team welcome and thank you for joining us as we review our first quarter 2008 financial results. Today's call is being hosted by Mike Miller, our Chief Executive Officer and Paul McDonough, our Chief Financial Officer. They’ll be joined during the Q&A by other members of senior management. We released our first quarter 2008 results earlier this morning. Our press release, today's slide presentation and, our financial supplement are available on the Investor Relations section of our website www.onebeacon.com. An audio replay of today's webcast will also be available on our site following this call.

Turning to slide 2. Let me remind you that any statements we make during today's call that are not historical facts constitute forward-looking statements. These statements are based on certain assumptions and analysis made by OneBeacon in lot of our experience and perception of historical trends, current conditions, and expected future development, as well as other factors. However, actual results may differ materially from expectations. Please refer to the summary of risk factors at the end of our earnings release as well as the Safe Harbor provision of risk factors contained in our Annual Report filed on Form 10-K for the fiscal year ending December 31, 2007 filed on February 29, 2008.

In addition, any forward-looking statements represent our views only as of today and should not be relied upon as representing our views as of any subsequent date. During this call we will refer to non-GAAP financial measures. These non-GAAP financial measures are not prepared in accordance with Generally Accepted Accounting Principles. A reconciliation of the non-GAAP financial measures to the most directly comparable GAAP measures accompanies the press release financial statements and is provided in the financial supplement posted on our website.

Now, let me turn the call over to Mike.

Mike Miller - President and Chief Executive Officer

Thank you, Todd, and good morning, everyone. Thanks for joining us to discuss our first quarter results. First quarter 2008, let’s begin on page four, was a challenging quarter for us at OneBeacon, driven principally by combination of the difficult losses in our Commercial Lines segment mostly driven by adverse weather including CATs and a challenging investment climate, which you are all aware and have discussed previously on other calls.

As you can see on page 4, our GAAP combined ratio for the quarter was 100% and our total return on invested assets was zero leading to a slight decline of 1% in our adjusted book value per share at the end of the quarter, including dividends and that also includes our special dividend that we paid in March of this year. Over the last 12 months as you can see our growth in adjusted book value is 10%.

Turning to page 5, this is an overview of our primary insurance operations combined ratio results. As you can see in the first quarter of 2008, our current reported Accident Year was 65.2%. That is driven adversely by 3.5 points of large property losses mostly weather. As well you can see our CAT losses for the quarter were 3.7% compared to 0.5% last year and those were CAT losses in the southeast United States. On a prior Accident Year basis, our results are similar to last year's first quarter with the prior year positive development of 2.8%. Our expense ratio is beginning to show the benefits of the actions that we took last year to reduce our expenses overall. However, there were some one-time benefits in there and our view is that run rate on the expense ratio is roughly 35%.

Turning now to slide 6, our net written premium overview you can see that our Specialty Lines grew by 16% in the quarter, an excellent result. Commercial Lines at minus 1%, we believe is a solid result in a competitive marketplace. Our Personal Lines group shows results of minus 16%. Recall that this is made up of our AutoOne and voluntary business, which shrank by 11%, indicative of the continuing decline in the involuntary market most specifically in New Jersey and New York, and minus 17% on our Traditional business. The Traditional shrink is driven by combination of actions that we took during the quarter to focus our business primarily on the northeast where we have a significant presence and as well by coastal CMO management actions, as well as a competitive marketplace.

Turning to page 7, this is an overview of our Specialty Lines results. As you can see our non-CAT Current Accident Year loss ratio is 57.2%, an excellent result. Comparing it to last year, recall that last year in the first quarter we had over six points of Agri losses and we are no longer in the Agri business and sold that in 2006. So on a continuing basis, our Specialty Lines results continue to be outstanding with non-CAT Accident Year loss ratios in the mid-to-high 50s. On a prior Accident Year basis you see that we have continued positive development of 3.2% compared to 6.1% last year and all in, a GAAP combined ratio of 87.2%, an excellent result.

Turning to page 8, you see here the breakdown of our premium renewal changes. On the top part, the rate change for OneBeacon Professional Partners at minus 11% is consistent with recent quarters. We still are confident that the business that we are renewing at those pricing levels is at a profitable level. At IMU you will see that the rate increase for the quarter remains positive and encouraging some [ph]. As you move down the retention line, you see at OBPP that our retention remains consistent with previous quarters on a very sound business. At IMU you see that our premium retention level dropped 76% indicative of the fact that the market is becoming more competitive and we referring back to the rate change are holding the line on price and is having some impact on our renewal retention. As you move down to new business you see our level is consistent with previous quarters for both OBPP and IMU and you see Other Specialty driven by our new segments most notably accident and health and government-risk solutions. At the end of the quarter we also launched our Hagerty relationship on collector car and wind boats that will begin to have impact next quarter. So all in, by any measure excellent results on our Specialty Lines business for Q1 2008.

Turning to slide 9 for Commercial Lines, we had a challenging quarter. Our non-CAT Accident Year loss ratio of 69.2% is principally driven by higher than normal large property losses mostly weather-related, a full 9 points driven in that number. As well, you see our CAT impact specifically driven by the southeastern CATs that occurred in the first quarter and our impact was in the state of Tennessee and Georgia, a full 4 points above expectations. After reviewing all of our large losses in the quarter, we are very comfortable that our business remains in good shape and we expect to go forward and produce better results.

Our prior Accident Year results you see continued positive development. On a non-CAT basis slightly less than last year and obviously a positive prior year CAT development, which is driven by a recovery and release related to the 2005 events KRW. So all in, a 110.3%, clearly not a result that we are pleased with. When understanding the dynamics inside of it we believe that the overall book is in good position.

Turning to slide 10, our renewal price change in middle market was minus 2% for the quarter, consistent as you can see across a slide pricing levels in previous quarter. Our middle market fuel rate was down 6% again consistent with the numbers we've shared with you in prior quarters. Small Business showed renewal price change of a positive 1%, slightly down from the previous quarters indicating a continuing competitive marketplace. That's still positive. Premium retention as you can see in middle market came in at 80%, down slightly when compared to previous quarters and again we believe indicative of a more competitive marketplace that we are in today. You’ll also recall that in combination, our renewal price change of minus 2 and our overall retention level at 80% that in fact the exposure increases that we are getting are less indicative of a weakening economy and our renewal retention at 80%, we believe being impacted slightly by all in [inaudible] pricing. As you look at new business you see consistent levels of new business written premiums in our middle market operation and is principally driven by a combination of our new segments that we've added in the last year, as well as new territories that are beginning to kick in.

Turning to slide 11 on Personal Lines. With a solid profitability quarter especially when you consider that our Personal Lines business is driven and focused on the northeast, which is often impacted by adverse weather. So, we are very pleased with the non-CAT 64.3% Current Accident Year loss ratio. Our loss trends overall in this business really are unchanged from previous quarters. Frequency remains flat and severity is up mid-single digits. Our expense ratio is beginning to show the impact of aggressive expense actions last year, having said in the 30.8% reported, there are a number of one-time benefits that are in there, the run rate is 33% still improved over the prior quarter last year.

Turning to page 12, you can see that our renewal price change in Auto was 3%, up slightly over previous quarters. We would also update you that we have filed for rate increases in four states on our automobile rates. The premium retention at 80% and includes the price increases that we have begun to see at a consistent level of overall premium retention inside the book of business. Our policy-in-force growth was flat for the quarter not as consistent of what we've seen over the previous quarters and again indicative of our competitive marketplace. Our new business is down somewhat and added the combination and actions that we have taken, I mentioned previously regarding focusing on the northeast and the lack of premium that we had in previous quarters in our business that was outside of the northeast. So, our Personal Lines business overall had a very good quarter profitability-wise in a challenging and marketplace that is putting pressure on growth.

With that I will turn it over to Paul to talk about the investments.

Paul McDonough - Chief Financial Officer

Thanks, Mike and good morning. Turning to investments as Mike mentioned the total return on the portfolio in the quarter was an underwhelming 0%. In absolute terms we are certainly not thrilled with that outcome. In relative terms though the portfolio actually performed quite well. As illustrated on slide 13, our fixed maturity portfolio with a 1.3% return underperformed relative to the Lehman index which reflects it being underweight in treasury and shorter in duration but importantly it avoided the major landmines of the current credit crisis.

On the equity side, our portfolio of common stock and convertible bonds was down roughly 3% in the quarter, which compares very favorably to the S&P 500, which was down over 9%. Now, other investments, which consist primarily of equity-focused hedge funds, were also down about 3% in the quarter again an excellent result in relative terms.

One might ask whether quarter such as this one where a third of our portfolio of the common stock, convertible bonds, and other investments was down 3% that causes to rethink our asset mix, and the simple answer is no. We remain committed to a philosophy of investing to maximize the risk-adjusted total return of the portfolio and we believe our current asset mix as illustrated on slide 14 is about right… relative to that philosophy and that objective.

Turning now to capital management on slide 15, we paid roughly $215 million in dividends in March which included the $2.03 per share special dividend and a $0.21 per share ordinary quarterly dividend. We also repurchased approximately 2.5 million shares in the first quarter for about $53 million which brings the inception to-date share repurchases to about $87 million and leaves approximately $114 million remaining under our current share repurchase authorization. As you would expect, one impact of the special dividend and share repurchase in the quarter has been to increase our financial leverage which now stands at about 32%. Though our target leverage is between 25% and 30% and we will manage to that target over time, 32% is not out of line relative to our single A financial strength rating and is actually where we were when we went public back in November of 2006.

Finally, just as a reminder, we will redeem the remaining preferred stock for its retention value of $300 million later this month using assets from the grantor trust that was established for that purpose.

And with that, I'll turn it back to Mike.

Mike Miller - President and Chief Executive Officer

Thank you, Paul. So finally just to close the quarter with a few comments. As we talked about our book value declined by 1% in the quarter, driven by a breakeven underwriting results and flat investment returns, a combination of large non-CAT property losses and unusual CATs above normal, well above normal in Commercial led to a challenging quarter in Commercial Lines only. After a thorough review, we are very comfortable with the book-of-business we have and the underwriting related to that. Specialty and Personal Lines delivered strong profitable results. We do anticipate that the market conditions will continue to soften and we of course will continue to focus on underwriting. We expect to deliver better underwriting and investment results in the coming quarter.

And with that we are happy to take your questions. Jasmine?

Question and Answer

Operator

[Operator Instructions]. And your first question comes from Jay Gelbs, you may proceed.

Jay Gelb - Lehman Brothers

Thanks and good morning. It's Jay Gelb from Lehman. I was hoping you could…

Mike Miller - President and Chief Executive Officer

Hi, Jay.

Jay Gelb - Lehman Brothers

How are you? I was hoping you could hone in a bit on the Commercial Lines business which even ex-CAT and prior development show some pretty significant deterioration in the underwriting results, year-over-year. Was there anything else in there that was sort of one-time in nature and what... how come we can get a sense that, that’s going to improve over time?

Mike Miller - President and Chief Executive Officer

Jay, I would comment that 9 points of that non-CAT Accident Year was from higher than normal large property losses mostly weather driven in the quarter. And we went back and looked at the previous 6 to 8 quarters and it clearly sticks out as unusual. Now again it's weather driven and those things occur, it does stick out as unusual and having gone through those losses from an underwriting perspective, we are very comfortable with the book and obviously would hope for better results in the coming quarters. But it's 9 points in that non-CAT number.

Jay Gelb - Lehman Brothers

So even with the 7 points of CAT there's an additional 9 points of sort of...

Mike Miller - President and Chief Executive Officer

That's correct.

Jay Gelb - Lehman Brothers

Unusually large weather, okay. The second thing I want to touch based on separately is the Financial Institutions business, what is that for OneBeacon?

Mike Miller - President and Chief Executive Officer

The Financial Institutions business is a combination of the Community Banks that we talked about that we started about a year-and-a-half ago, as well as the Package business that we write for financial institutions overall. So, it's a combination of the Community Banks on the professional side and the Package business on a commercial side.

Jay Gelb - Lehman Brothers

What’s the environment like for the community banks on the professional side given that the credit crunch related issues and subprime?

Mike Miller - President and Chief Executive Officer

There is very little impact on the subprime. Clearly, the overall economy has impact on the Community Banks but we have not seen any unusual loss development coming out of any of those events. We do in fact underwrite the business on the professional side looking for those exposures and as you recall on the community banks side, the average asset size of the banks that we target is less than $3 billion and it’s been a very profitable segment, one that we will continue to watch and manage.

Jay Gelb - Lehman Brothers

Right. And what's the average limits for that professional liability?

Mike Miller - President and Chief Executive Officer

The average professional liability limits are $2 million.

Jay Gelb - Lehman Brothers

Okay. That's helpful. Thanks.

Mike Miller - President and Chief Executive Officer

You're welcome.

Operator

And your next question comes from Bob Capalli [ph] of Langen McAlenney

Bob Glasspiegel - Langen McAlenney

Bob Glasspiegel, Langen McAlenney that was a great job. Help me out on Specialty please, I know there has been some management changes both in and out, and maybe how we should think about the implications of that... the premium trends and underwriting trends as we look to '08, '09?

Mike Miller - President and Chief Executive Officer

On Specialty, Bob, what I would say is that again a combination... you're talking about a number of different segments in there, OneBeacon Professional Partners, which I think you're alluding to, as well as IMU, Accident and Health, Government Risk Solutions. So, there are a number of segments in there now. In the quarter, we did have management turnover at OneBeacon Professional Partners. We have a very seasoned experienced management team in place at OneBeacon Professional Partners after that and we are very comfortable with that management team and the future of that business and we remain very committed to it and we are focused on the business and on the market.

Bob Glasspiegel - Langen McAlenney

Okay. You don't want to answer the specific questions then as far as, did you move up or down your premium growth forecast internally, may be that’ll be a better way to ask it?

Mike Miller - President and Chief Executive Officer

Now. We didn't make any adjustments there Bob.

Bob Glasspiegel - Langen McAlenney

Do you think your business plan is still intact for '08 as it was before?

Mike Miller - President and Chief Executive Officer

We certainly plan on that.

Bob Glasspiegel - Langen McAlenney

Okay. With the start for the first quarter, remind me... you seem to have a double-digit growth in asset value with dividends included as your business plan were off a to rough start with the macro environment, is it still possible to executive it this year or should we think in terms of a longer-term double-digit growth as an objective?

Mike Miller - President and Chief Executive Officer

I'm sorry, growth in book value, Bob?

Bob Glasspiegel - Langen McAlenney

Book value plus dividends, I think is your goal, right?

Mike Miller - President and Chief Executive Officer

That’s right. And I would say that... again we do talk about that being long-term and over the long-term and clearly the first quarter was a challenging environment. And obviously we would expect that if you just look at our history there of our investment returns to obviously do better than 0% on a relative basis as Paul talked about. That was not a bad performance at all. In fact on the equity side, it was a good performance relative to the S&P. So, I would expect the returns to be better than they were in the quarter but obviously we will operate in the marketplace, the investment market place however it is. But I... our focus is still to return the 13% to 15% growth in book value over the long term.

Bob Glasspiegel - Langen McAlenney

Okay. Last question, you gave 3% as your Auto rate increase, ex-Mass [ph] in Q1. What would be the Auto rates with Mass, all in?

Mike Miller - President and Chief Executive Officer

Hold on. We'll try to get that for you, Bob. Again the…

Bob Glasspiegel - Langen McAlenney

Well, you just give me the ... what the rate cut in Auto and Mass auto and then I can sort of work backwards?

Mike Miller - President and Chief Executive Officer

Yes, it's roughly 7% Bob.

Bob Glasspiegel - Langen McAlenney

And that's 40% in the total roughly or I can't remember exactly.

Mike Miller - President and Chief Executive Officer

Up Mass of the total Auto?

Bob Glasspiegel - Langen McAlenney

Yes.

Mike Miller - President and Chief Executive Officer

In Personal I think you are in the range.

Bob Glasspiegel - Langen McAlenney

Okay. That's enough. You don't need to do the work I can do it from there. Thanks.

Operator

And your next question comes from Gary Ransom from Fox-Pitt Kelton. You may proceed.

Gary Ransom - Fox-Pitt Kelton

Yes, good morning. I just want a little bit more clarification on the large losses in Commercial. Did you say that they were all weather and property related or were there any liability components to that?

Mike Miller - President and Chief Executive Officer

They were... Gary, good morning... they were property and they were all property and they were mostly weather driven.

Gary Ransom - Fox-Pitt Kelton

Okay. Thanks. And just another question on loss trends and maybe this is a multiple part question because they're... probably are different in the different segments but could you just talk about what changes you are seeing in Auto and then Commercial Lines generally and maybe if you can talk about some of the Specialty areas that would be great too?

Mike Miller - President and Chief Executive Officer

Sure. The… what I would say just overall, is we really have not seen a significant change in loss trend overall. We've talked about now for a number of quarters across the entire company about frequency being flat and severity being mid single-digits. I talked specifically about in Personal Lines that continuing to be the case. I know others have talked about some other things that they've seen. We have not seen that in our book. As you look at the Other business lines, I would include in Commercial and again then for a minute I will comment on Specialty. In Commercial, I would say the same general statement and we have not seen any significant deviations from that at this point. And then on Specialty again as you get into different lines of business, obviously you'd have some different frequency and severity numbers but they're inside of each of the segments, we have not seen any significant shift on a difference between frequency or severity.

Gary Ransom - Fox-Pitt Kelton

Okay. Thank you very much.

Mike Miller - President and Chief Executive Officer

You're welcome.

Operator

And your next question comes from Alain Karaoglan of Banc Of America Securities. You may proceed.

Rohan Pai - Banc Of America Securities

Hi good morning, it's actually Rohan Pai on Alain’s behalf. The first question we have... I was following... I wanted to follow up on Gary's question on the Commercial Lines large losses. If you can give us a little color maybe one these losses both geographically and what kind of Commercial losses these were?

Mike Miller - President and Chief Executive Officer

Sure they were, as I have mentioned they were property, you had a combination of weather losses in the northeast that were driven by northeastern weather that is non-CAT, significant snowfall for example off in Maine was a major driver for us. And then as well, we had some other large property losses inside of that, that were non-CAT and some of those were weather as well. And we had a one loss that was not weather driven, that was significant, it was still a property loss and… but it was not a cause of weather.

Rohan Pai - Banc Of America Securities

Thanks. And another question on Personal Lines, I think the reciprocals had a pretty significant decline relative to your traditional personal auto... I mean, Personal Lines, is the strategy still in place to grow the reciprocals, that going to be still the focus?

Mike Miller - President and Chief Executive Officer

The answer is, yes. That strategy is still in place to continue to leverage the reciprocal structure inside our Personal Lines. The 31% that you're referring to on the shrink that is in our supplement. As I mentioned to you, we began to focus on the northeast only, Houston General, which is one of our reciprocals doing business that we are doing business outside of the northeast we are no longer writing that business. So, that's the most significant impact inside of the reciprocals, as well on at Adirondack in the State of New York we purchased additional CAT cover. So, there were a few different factors there that are impacting that growth number. We are still committed to it and will be so going forward.

Rohan Pai - Banc Of America Securities

Good. Thank you for the detailed answers.

Mike Miller - President and Chief Executive Officer

You're welcome.

Operator

[Operator Instructions]. And at this time, you have no questions. I would like to turn it back to management.

Mike Miller - President and Chief Executive Officer

Thank you, Jasmine. Thank you everyone for joining us. We are... it was a challenging quarter as I mentioned, but we're very comfortable with the underlying book of business and where we're going and excited in the next quarter too. We'll talk to you soon.

Operator

Thank you for attending this conference. This concludes your presentation. You may now disconnect. Good day.

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