AmTrust Financial Services Inc. Q1 2008 Earnings Call Transcript

May.27.08 | About: AmTrust Financial (AFSI)

AmTrust Financial Services Inc. (NASDAQ:AFSI)

Q1 2008 Earnings Call

May 6, 2008 11:00 am ET

Executives

Hilly Gross – Vice President, Investor Relations

Barry D. Zyskind – President, Chief Executive Officer & Director

Ronald E. Pipoly, Jr. – Chief Financial Officer

Analysts

Bijan Moazami – Friedman, Billings, Ramsey & Co.

Dan Schlemmer – Fox-Pitt Kelton

Kenneth Billingsley – Signal Hill Group, LLC

Adam Klauber – Fox-Pitt Kelton

Operator

Welcome to the AmTrust Financial first quarter 2008 earnings conference call. (Operator Instructions) At this time I’d like to turn the conference over to Hilly Gross, Vice President of Investor Relations.

Hilly Gross

Good morning and welcome to our first quarter earnings conference call. Before I introduce you to President and CEO of AmTrust, Mr. Barry Zyskind and the Chief Financial Officer of AmTrust, Mr. Ron Pipoly who are both here with me this morning I would read into the record a mandatory paragraph on forward-looking statements.

Since this morning’s conference calls contain forward-looking statements which are made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995 these forward-looking statements are based on the company’s current expectation and beliefs concerning future developments and their potential effects on the company. There can be no assurance that actual developments will be those anticipated by the company.

Actual results may differ materially from those projected as a result of significant risks and uncertainties including non-receipt of the expected payments, changes in interest rates, effect of the performance of financial markets on investment income and fair value of investments, developments of claims and the effect on loss reserves, accuracy in projecting loss reserves, impact of competition in pricing environments, changes in the demand for the company’s products, the effective general economic conditions, adverse state and Federal legislation, regulations and regulatory investigations into industry practices, developments relating to existing agreements, heightened competition, changes in pricing environments and changes in asset valuations. The company undertakes no obligation to publicly update any forward-looking statement.

Having dispensed with that I now take great pleasure introducing to you AmTrust’s President and CEO, Mr. Barry Zyskind.

Barry D. Zyskind

I am pleased to report that AmTrust had a strong first quarter and is continuing to achieve both top line and bottom line growth. Gross written premium for the first quarter was approximately $235 million an increase of 24% over first quarter 2007. Our net income was $22.3 million for the first quarter in 2008. Additionally our operating earnings continue to grow and for the first quarter of 2008 was $25.7 million an increase of 48% over the first quarter in 2007. This increase was attributable to both organic growth in our Specialty risk segment and Specialty Middle Market segments as well as the successful integration of our 2007 acquisition.

Our three business segments continue to perform very well. We continue to demonstrate discipline in both pricing and risk selection in our Workers’ Compensation segment as this segment experiences increased competition. Gross written premium in this segment remained relatively flat as we wrote approximately $90 million in the first quarter of 2007.

As mentioned in previous calls because we operate in small niche markets our renewal rates continue to remain very high above 85%. This has benefited AmTrust during this time of increased competition. I cannot state strongly enough that we have made a strategic decision not to chase premiums at prices which would loosen our disciplined underwriting standards and may not be as profitable to the company.

What we are doing is implementing a series of technology and marketing initiatives with the anticipated completion of the Unitrin business insurance acquisition our Small Business Workers’ Compensation unit will become a small commercial package unit enhancing our product offerings to our network of agents and brokers as well as expanding our geographic reach.

In addition we continue to see an excellent loss ratio in this segment which underscores the effectiveness of our discipline conservative underwriting standards. Our Specialty Risk and Extended Warranty segment continues to grow. In the first quarter of 2008 we wrote $88 million in premium an increase of 83% or $40 million over the first quarter in 2007. This segment growth is attributable to both organic growth as well as acquisitions. This segment is extremely specialized and less prone to the pricing cycles of traditional insurance businesses. We continue to leverage our unique expertise, we are benefiting from being a diversified company capable of allocating resources in response to growth and market opportunities.

We are quick to adjust resources to take best advantage of changing market opportunities in our business segments in order to achieve maximum returns for our shareholders. We are extremely proud of this segment which continues as our fastest growing division. We continue to push for growth both in new products and geographic regions throughout the United States and Europe and are confident that we will continue to see strong prospects for this segment for the remainder of the year.

Our Specialty Middle Market segment continues to grow organically through existing and new programs. In the first quarter of 2008 we wrote approximately $58 million in premium an increase of 11% or nearly $6 million over the first quarter 2007. We are now in our third year with this business segment and are in a position to continue to grow and develop our activities. We see growth from the addition of new programs and managing general agents as well as the re-establishment of customers who previously had relationships with Alea prior to the AmTrust acquisition of this division.

In all segment lines as we successfully grow our business we remain focused and disciplined. We look forward to the closing of the Unitrin transaction and have continued with integration activities. We anticipate Regulatory approval during the month of May and the closing of the acquisition in the beginning of June and this will be a second quarter activity. As mentioned in our press release our quota share agreement with Maiden Insurance Company effective July 1, 2007 continues to be accretive to AmTrust. We anticipate that our arrangement with Maiden will enable us to continue to leverage our balance sheet, increase our writings, decrease our expense ratio and most importantly increase our return on equity. In these times when capital can be difficult to come by we benefit from being strongly capitalized as is our strategic partner, Maiden. We feel that this strength provides with the ability to grow our business, seek further acquisitions and in general retain the flexibility to take advantage of opportunities as they arise.

We are pleased to report that the acquisitions which took place last year are producing very good results and return on capital. We are seeing a healthy deal flow in the marketplace and will continue to seek opportunities for strategic acquisitions that can provide similar returns and are consistent with our objectives. As we previously mentioned we have no exposure to sub-prime mortgages and we carefully monitor our investment portfolio. Of our $1.4 billion portfolio we have approximately 94% in bonds, cash and short term investments. 56.4% of our bond portfolio is AAA or US government and 90% is A rated or better.

As you know the past few months have been a difficult time in the investment marketplace and our book value has not grown at the same pace as our earnings. 65% of the temporary market value decline experienced during the first quarter came from the reduction of bond prices. This impacted us because we keep the majority in our available for sale category. I am pleased to report that already at the end of April a substantial portion of these bonds have increased in value. We expect this to stabilize and for our book value to continue its growth in line with our earnings going forward. Our investment income continues to increase and we feel confident in our portfolio. Our portfolio is managed in house by a team of experienced professionals who focus on high quality investments.

As our operating income continues to grow we have successfully achieved economies of scale in all lines and continue to reduce our expense ratio. We feel very good about the prospects of all three segments in our profitable underwriting activities as we benefit from being a diversified company operating in multiple lines of business and varied geographic regions. We maintain our focus on specialized areas of business, we can maintain consistency as a stable and disciplined company while avoiding volatility during both the hard and soft cycles of the insurance marketplace.

As we mentioned previously we projected to grow our premiums by at least 15% organically in 08 over 07. We still stand by that and feel very good about the prospect of our business going forward. We look to continue our success through adherence to carefully managed growth, disciplined underwriting and pricing, strategic acquisitions and diligent cost control.

And now I’d like to turn the discussion over to our Chief Financial Officer, Ron Pipoly to report on our first quarter results.

Ronald E. Pipoly, Jr.

As Barry previously mentioned the first quarter of 2008 was a very strong quarter for AmTrust in terms of both the increase in written premium as well as net operating income. Gross written premium for the quarter increased by $45.1 million or 23.8% from $189.7 million to $234.8 million. Small Business Workers’ Compensation had a slight decrease in written premium from $89.8 million for the first quarter of 2007 to $89.3 million.

This decrease was not unexpected as the company had a one time event in that it was required to process rate reductions on its in force book of New York business. In addition there was a rate reduction in Florida. The effect of this rate reduction when comparing the first quarter of 2007 to 2008 was a 16.2% reduction. However we are very encouraged by the premium numbers in this segment for April. As Barry mentioned earlier we continue to be disciplined in both risk selection and pricing.

The Specialty Risk and Extended Warranty segment grew by 83.1% or $39.8 million from $47.9 million to $87.7 million. The growth in this segment was driven organically by new programs as well as expanding programs within our existing customer base. Our specialty middle market segment grew by 11.2% or $5.8 million from $51.9 million to $57.7 million. This growth was fueled by our ability to generate additional policies from existing programs as well as successfully adding additional programs.

Our net written premium for the quarter declined from $160.6 million for the first quarter of 2007 to $117.4 million for 2008. This decline was the result of $82.9 million of seated premium to Maiden Insurance during the first quarter of 2008. The Maiden Treaty was entered in to on July 1, 2007. Net earned premium also declined from $118.7 million for the first quarter of 2007 to $97.4 million for 2008. The decline in earned premium was the result of seating $63.8 million of earned premium to Maiden during the quarter. We earned $20.2 million of seating commission revenue from Maiden during the quarter.

Our overall combined ratio for the first quarter was 77.2% compared to 89.1% for the first quarter of 2007. In terms of the components of our combined ratio, the loss ratio for the first quarter was 56.5% compared to 62.8% in the first quarter of 2007. The expense ratio for the first quarter was 20.5% compared to 26.3% for the first quarter of 2007. Our expense ratio in the first quarter of 2008 without the effects of the Maiden seating commission was 24.9%. As you can see, we continue to leverage down our expenses.

We also continue to see favorable trends in our losses. Our combined ratio of our Workers’ Compensation segment was 76.3% which was made up of a loss ratio of 53.1% and an expense ratio of 23.2%. The combined ratio of the specialty risk and extended warranty segment was 71.9% which was made up of a loss ratio of 60.5% and an expense ratio of 11.3%. The combined ratio in the specialty middle market segment was 86.4% which was made up of a loss ratio of 59% and an expense ratio of 27.4%.

Fee income was $6.3 million which was an increase of $1.8 million from $4.5 million for the first quarter of 2007. For the quarter net income was $22.3 million or $0.37 per share. Net operating income was $25.7 million or $0.43 per share. For the first quarter our investment income was $13.5 million and realized losses were $5.2 million. Our average rate of return on fixed maturities, cash and short term investments was 5.3. Our annualized return on equity was 22.6.

The company generated over $40 million of positive cash flow from operations. Total shareholders’ equity was $396 million which represents a book value of $6.60 per share. We paid a quarterly dividend of $0.04 per common share during the quarter. Total assets as of March 31 were $2.6 billion. Our total invested assets were $1.46 billion. Fixed maturities comprised 65% of the portfolio, cash and short term investments 29%, equity securities 4.7% and other investments 1.3%.

Hilly Gross

Both Mr. Zyskind and Mr. Pipoly have indicated that they would be pleased to entertain question that you in our calling audience may have.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Bijan Moazami – Friedman, Billings, Ramsey & Co.

Bijan Moazami – Friedman, Billings, Ramsey & Co.

Could you give us an update on the Unitrin business insurance, when you’re going to be closing on that transaction? What is the amount of premium that you expect to be generating out of that business? And also, what are you at in terms of the integration of that business?

Barry D. Zyskind

We are planning to close that as I mentioned in my remarks, we hope to get the final regulatory approval in this month, in May and we hope to close it at the end of the month, the beginning of June. It’s somewhere in the next few weeks. In terms of integration we were expecting to close April 1 so we were ready from April 1 to close this transaction from a technology standpoint and an integration standpoint, back office so we’ve done a lot of work. We feel we’re in very good shape and having the additional time has just allowed us to test our systems and make sure we’re in good shape. In terms of premium we feel conservatively from when we close the book will be somewhere between $150 to $165 and $170 million in gross written premium.

Operator

Your next question comes from Dan Schlemmer – Fox-Pitt Kelton.

Dan Schlemmer – Fox-Pitt Kelton

On the Unitrin can you clarify what the delay is or what progress has been made since the last time you discussed it. Also, as that gets pushed off my understanding is that it’s pure regulatory hurdle, does that impact the agents and therefore your ability to convert that premium? Can that become a problem?

Barry D. Zyskind

In terms of it’s only up to the regulatory process, there’s three states that we have to get regulatory approval. We have regulatory approval from two out of the three we’re just waiting for the one state to give us regulatory approval and we feel that we’ll get it this month. It’s been a little bit delayed.

In terms of agents and the book of business, we have been monitoring that very carefully and as I mentioned previously our team has been going out on road shows consistently meeting with the Unitrin agents and the Unitrin people running the division have done a very good job. And again, their business with similar characteristics of our business has very high renewal rates and we’ve been monitoring that and it seems to be doing very well and we’re keeping a close eye on it. We feel very good that we’re not going to lose really anything that’s material because of a month or two delay.

Dan Schlemmer – Fox-Pitt Kelton

On the loss ratio, the overall 56.6 and I know you ran through the individual segments, can you just clarify how much of that, if any, is favorable or adverse development? Or, if it’s just a pure accident year ratio?

Ronald E. Pipoly, Jr.

The loss ratio in terms of reserve releases, we did not have any reserve releases. Again, the loss ratio again was just a reflection of where we are in terms of our cycle and where our loss trend are headed.

Dan Schlemmer – Fox-Pitt Kelton

The trends you’re talking about there, can you give a little more granular detail on the segmentation on where you’re seeing that? I mean, it’s obviously a very impressive loss ratio and I just want to understand how you got there from where you were a year ago, in particular on a segment basis.

Ronald E. Pipoly, Jr.

Really, there’s been improvement across all three segments in terms of the loss ratios and again, it’s just a product of our loss development factors and some of the actuarial techniques that we use in terms of our experience in these particular lines and our loss development factors pointing to better ultimate loss ratios and us having more confidence and putting more weight towards our development factors. So, really what we’ve seen is continued improvement really in all three segments in terms of loss rations.

Dan Schlemmer – Fox-Pitt Kelton

Is it more frequency? Severity? And, how much is pricing I guess maybe giving away on that?

Ronald E. Pipoly, Jr.

I think it’s a combination of all three. As Barry mentioned, from a workers’ compensation segment perspective the one thing we have not compromised is our pricing underwriting guidelines and I think that bares out in the improvement of the loss ratio. But, I wills say that from an actuarial perspective we are still very confident that when it comes to setting ultimate loss picks that we are still very conservative. We have not abandoned any of those kind of core competencies when it comes to setting loss reserves.

Dan Schlemmer – Fox-Pitt Kelton

Talking about the actuarial piece and the reserving there, if you’re seeing favorable experience on the current year does that point to the potential for favorable development on prior years? Or, how are you evaluating that?

Ronald E. Pipoly, Jr.

We will continue to evaluate it quarter-to-quarter. Again, suffice it to say that we continue to see positive trend and we will evaluate prior accident years on a quarter-by-quarter basis.

Operator

Your next question comes from Kenneth Billingsley – Signal Hill Group, LLC.

Kenneth Billingsley – Signal Hill Group, LLC

On the policy acquisition costs, those seemed to jump up, was there anything specific or unique in the first quarter or is this going to be a new run rate?

Ronald E. Pipoly, Jr.

It did jump up a little bit in the first quarter. I think that the business mix change had a little bit to do with it. I do think that in terms of the policy acquisition cost you’ll probably see a decline in the following quarters and really that increase in acquisition cost had to do really with the mix between where the business was coming from. The European specialty risk business tends to have very low acquisition costs where the US relative to Europe has more acquisition costs and we saw more business being produced in the US as a percentage of the overall segment. But again, I’m confident that will decline in the second quarter.

Kenneth Billingsley – Signal Hill Group, LLC

But, normalized would you expect it to be down to like 14% for the year? Or, do you think overall that it’s going to start ticking up in to the 15%, 16%?

Ronald E. Pipoly, Jr.

No, I would think for the year we’d be somewhere between 14% and 15% for policy acquisition costs for the year.

Kenneth Billingsley – Signal Hill Group, LLC

On the other insurance expense ratio can you talk about just in comparison maybe to prior year, is there anything specific that has it rolling forward up to almost $10 million? It’s down below from fourth quarter 07 but is there a fixed cost component to that?

Ronald E. Pipoly, Jr.

No. The biggest major component of those types of costs would be premium audit expenses, federal excise tax, some of the other taxes. I think that the run rate we’re on for the first quarter I would consider to be fairly normal what I would expect it to be relatively level for the year.

Kenneth Billingsley – Signal Hill Group, LLC

And, on the investment yield, it fell pretty significantly, are you expecting that to be a run rate? Are you shifting some of your fixed investments and is that causing it to become lower? I noticed that the tax rate was dramatically lower as well?

Barry D. Zyskind

Obviously, you know with the Fed lowering the rates between the later part of last year and beginning of this year and us keeping a lot of cash in short term, you’re going to see some of that return coming down. Naturally, we’re looking at it and we’re constantly evaluating the portfolio and at the right time we’ll put more to fixed to get the yield we need and invest some of the cash but that clearly has had an effect. We feel good about where the rates are right now and the yield that we’ve got the first quarter that we’ll be able to continue in to somewhere between I’d say 5.2% and 5.6% on an annual basis.

Kenneth Billingsley – Signal Hill Group, LLC

So you still think future investments will be at the 5.2%, 5.6% is what you’re looking at?

Barry D. Zyskind

I mean depending. There are some good corporate bonds right now that yields and some of the agencies you can do better than that. It’s all really on how much we keep in cash and where the rates continue going but it’s something that we monitor all the time.

Kenneth Billingsley – Signal Hill Group, LLC

So this was not a case of what you were investing in, it’s more sitting on the sidelines?

Barry D. Zyskind

Some of it yes. I mean, if you look at it we had a big portion in cash and last year cash was earning a lot more than it’s earning now.

Kenneth Billingsley – Signal Hill Group, LLC

On the tax rate was there anything you did that’s going to continue to have a tax rate sub say 30%? Or, was this an anomaly for the quarter?

Ronald E. Pipoly, Jr.

I think in the past our effective tax rate has fluctuated somewhere between 27% and 29% and really I think it’s a function of where the revenues and the income were earned. We had some more income earned offshore which helped to drive down the effective tax rate. But again, I think for a year basis I think we’re comfortable saying that the effective tax rate will be somewhere between 27% and 29%.

Kenneth Billingsley – Signal Hill Group, LLC

The last question and then I’ll re-queue here, on just the realized losses and then other investment losses can you just walk through what was going on there? And then, for the last three quarters we’ve seen $6 and $7 million there, is this something that we’re likely to see immediately from the other investment side? Or, can you just talk a little bit more of what’s in there?

Ronald E. Pipoly, Jr.

Other investment gain or loss on managed assets, the presentation may be a little awkward. Those assets are third party assets that we manage and the losses, that $2.9 million represents the investment activity on those managed assets for the quarter. Further down on the income statement you’ll see a $2.9 million reduction in expenses if you will. So, that $2.9 million doesn’t affect our bottom line because it’s offset by a minority interest so that’s income associated with managed assets. In terms of the realized gains, as Barry mentioned, the markets have been rough and in terms of realized activity I think what we’ve seen through April is that we have probably some additional opportunities to maybe have some gains in the quarter but we’ll see.

Barry D. Zyskind

Just to add, I think if you look at the historic, some of the realized losses that we’ve taken and us taking a position where we don’t think is going to come back and selling it and taking a loss and moving on. But again, like we mentioned before we think April what we’re seeing now is things have stabilized, bonds have come back and as we have grown and gotten bigger we have purposely kept equity as a much smaller percentage of our assets and historically most of the gains and losses have come from the equity and going forward that should be a smaller percentage of our assets. We feel that most of it is behind us in terms of losses and that we should not be seeing a lot of realized losses going forward.

Kenneth Billingsley – Signal Hill Group, LLC

Just to confirm something you said I think to Bijan regarding Unitrin, was the $150 to $165 was that your expected gross premium written?

Barry D. Zyskind

Yes.

Operator

Your next question comes from Adam Klauber – Fox-Pitt Kelton.

Adam Klauber – Fox-Pitt Kelton

The warranty business, is the economy impacting, with the economy slowing down a little is that affecting the business?

Barry D. Zyskind

I’ll tell you Adam what we’re seeing first of all is we’re seeing a lot more opportunities in the marketplace and it’s somewhat counter defensive because what happens is that retailers and other manufacturers in this type of slowing economy tend to look for more revenue sources. So, companies that have been on the sidelines that maybe had not sold warranties suddenly decided that it’s a good way for them to increase their bottom line.

And also in addition, companies that are already selling it because they’re selling less product will have higher attachment rates. So, it’s a line of business that even in this market we feel very bullish about and we think that it’s something again, as we mentioned, we have a lot of expertise and we’re somewhat unique in the marketplace on this line that we’re going to see good growth on this for the foreseeable future.

Adam Klauber – Fox-Pitt Kelton

In the workers’ comp segment that’s obviously become more competitive over the last 12 months, are you having to raise your loss picks there or can you keep those pretty consistent?

Barry D. Zyskind

I think going back to what Ron mentioned is what we have purposely have done is we know we have a very strong renewal book and we looked at where rates are and we purposely are not taking our rates down because we’ve made a strategic decision that we’re going to try to capture as much of our renewal business, still write new business and even though we’ll write less new business but by doing that we’re able to keep very good returns.

And, as you know, if a bigger percentage of your book is renewal, you have a much better loss ratio. So, we think that even though we may give up some growth in that segment, from an earnings standpoint it has a very good prospects for us because if anything, the loss ratio may even trend down like we’ve been seeing the last couple of quarters.

Adam Klauber – Fox-Pitt Kelton

Finally, acquisitions, it seems like it’s flipped to much more a seller’s market. Can you still find the deals like you have been able to in the past?

Barry D. Zyskind

I think we actually are seeing a fairly healthy deal flow. Again, we try to look for sort of things that are not typical, we’re not looking to buy big companies, we’re looking to find unique opportunities and there’s a couple of opportunities on our plate right now that we feel good about in the marketplace. So again, we’re sort of niching what we’re looking for and the typical big stuff that’s on the market that’s probably not something we’re going to go after. But, the things that make sense for us we’re going to definitely go after and we’re seeing a nice flow of opportunity.

Operator

That concludes our questions for this time.

Hilly Gross

Thank you Barry, thank you Ron and thank you our audience for joining us this morning.

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