Montpelier Re Holdings Ltd. Q2 2008 Earnings Call Transcript

Jul.23.08 | About: Montpelier Re (MRH)

Montpelier Re Holdings Ltd. (NYSE:MRH)

Q2 2008 Earnings Call

July 23, 2008 8:00 am ET

Executives

Jonathan Kim - General Counsel and Secretary

Chris Harris - President and CEO

David Sinnott - Chief Underwriting Officer

Mike Paquette - CFO

Analysts

Matthew Heimermann - JPMorgan Securities

Rohan Pai - Banc of America Securities

Bill Wilt - Morgan Stanley

Chuck Hamilton - FTN Midwest

Ron Bobman - Capital Returns

Operator

Greetings, ladies and gentlemen, and welcome to the Montpelier Re Holdings Ltd. second quarter 2008 conference call. (Operator Instructions).

It is now my pleasure to introduce your host, Mr. Jonathan Kim, General Counsel and Secretary of Montpelier Re. Thank you, Mr. Kim, you may begin sir.

Jonathan Kim

Thank you. Good morning and welcome to the Montpelier Re second quarter 2008 earnings conference call. A press release setting our results together with a detailed financial supplement has been posted to the company's website at www.montpelierre.bm. This call is being webcast live and will be available for replay until August 23, 2008.

Our speakers today are Chris Harris, President and CEO, David Sinnott, Chief Underwriting Officer and Mike Paquette, Chief Financial Officer. Chris and David will give their commentary on the quarter and then Mike will present an overview of the financial results. We will then be pleased to take your questions.

During our discussion this morning 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 any forward-looking statements as a result of certain risk factors disclosed previously and from time to time and 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 Chris. Chris?

Chris Harris

Good morning, ladies and gentlemen. A solid quarter for the Montpelier Re group Operating income of $63 million, fully converted book value per share growth of 3.1% and a combined ratio of 58%. Both underwriting and investment teams performed well in tough market conditions.

David and Mike will provide more detailed commentary on the underwriting environment and the financials. I will make few comments about the loss activity for the quarter.

While the quarter was an active one in terms of both PCS catastrophe losses and commercial property individual risk losses, we saw much less activity in our portfolio than in the prior quarter. For the current quarter, we booked $15 million of net loss in respect to the various US weather events, which includes an IBNR provision for some multi-event protection as well as our crop book. While we continue to see increased claims frequency in the property individual risk area as compared to prior years, we avoided most of the larger market losses this quarter. Our results do include $6 million of net loss from one risk claim.

Reductions in prior year losses provided a $28 million benefit to the quarterly results. $8 million of the benefit resulted from subrogation on a previously paid claim. The remaining $20 million of reserve release was driven by continued favorable development across the storms of '04, '05, and '07, and a case reserve reduction on a single risk loss. Across our entire portfolio, the IBNR its total reserve ratio increased to 55% with a casualty component at 74%.

Turning to our new operation: July 1st marked the one-year anniversary of our launch of Syndicate 5151. Although we still have a lot of work to do, we are pleased with our progress in establishing both the London and US operation. Notably, the London operation turned an underwriting profit for the first time this quarter and in total, the new platforms account for 16% of year-to-date written premium. Key hires, infrastructure and regulatory approvals are in place, and the focus is squarely on finding profitable business.

Our expense ratio this quarter reflects the impact of all of the investments in our new operation. There is a cost to attract talented people, but we consider it money well spent. In regards to fixed G&A expenses, we estimate our expense ratio is nearing an inflection point and premium for the new operation should begin to earn at a quicker pace.

Lastly, our peak PML are down slightly as compared to the prior US wind season. We remain comfortable with our capital position. At current valuation and at the right time, we believe stock buyback remain a compelling option against, which we will measure other opportunities.

With that I will turn it over to David.

David Sinnott

Thank you, Chris. The general patterns of price erosion observed in the first quarter of this year continued into the second quarter, for the underwriting year-to-date for all regions and all segments of our operations. The property catastrophe renewal price index has declined 9%. Property specialty is off 11%, other specialty is down by 12% and casualty is off 6%.

The RPI for property specialty masks some discrepancy between subclasses, whereas property risk excel and property pro-rata have declined by 7% and 10% respectively, property direct and facultative is down 15%.

Despite steady price declines in all lines underwritten by Montpelier Group, we are beginning to see some evidence of a slowdown in the rate of deterioration in certain segments. While it is premature to characterize this trend as a market hardening, rate stabilization may be beginning to emerge.

In our direct and facultative property line, the mining sector has experienced significant increases following its recent run losses. The impact of which is also starting to be felt in other heavy industrial classes such as steel and energy.

In US property catastrophe, where we still see a relatively disciplined market, we have served some shrinkage in supply for US wind exposure at mid-year brought on by one, reinsurers assuming more risk on June 1st (inaudible) programs and two, a tightening of terms in the retrocession market, the combination of which lead to a number of shortfalls and price renegotiations.

The extent of catastrophe losses in the US during the first half of 2008, the incidents of which will fall most heavily on primary carriers, could provide some further impedance for slowing the downward slide in original raise. In the Florida market at June 1, rate declines of 10% to 15% were in line with our expectations, following the decision by the FHCF not to reduce its risk exposure for the coming year. Rate declines were mitigated to some extent by one, new company demand, which grows at steady clip as national writers continue to reduce exposure in the State;; two (inaudible) decision to purchase the modest amount of reinsurance from the open market; and three, some expansion in capacity and demand on existing treaties.

Turning to premium, total gross written premium for the second quarter was nearly flat at $187 million as compared with $188 million in the prior year. Through the first half of the year, gross written premium came in at $445 million versus $449 million in 2007, a difference of 1%.

From a class of business perspective, the reduction in writings in property specialty written in Bermuda mainly in the property direct and facultative line were offset by gains in the property catastrophe line, where we expanded our book of business in Florida and the continuing build up in property and other specialty lines written by our Lloyd's and US agency platforms.

Net written premiums for the first half of the year amounted to $376 million versus $356 million in 2007, a gain of 4%. For the second quarter, net written premiums registered at $154 million versus $167 million a year ago. The 8% decline is attributable to the deferral of certain reinsurance purchases made in the first quarter of 2007 to the second quarter in 2008. We have now substantially completed our outwards reinsurance buying for this year.

At this point, I will now hand the proceedings over to Michael Paquette, who will comment on the financials.

Mike Paquette

Thank you, David. Our fully converted book value per share ended the quarter at $18.24 including dividends; this represents an increase of 3.1% during the quarter and 15.7% during the past 12 months.

Operating income, which excludes investments and foreign exchange gains and losses, income taxes and extraordinary items were $63 million or $0.73 per share. Comprehensive income was $44 million in the quarter or $0.51 per share.

During the period, we acquired 100% of Blue Ocean for $30 million in cash. This transaction resulted in an extraordinary gain to us of $1 million. We intend to keep Blue Ocean in good standings for future opportunities.

Net premiums earned during the quarter were down $10 million or 8% from the second quarter of 2007. The quarter was impacted by two non-recurring items; one, a drop in reinstatement premiums; and two downward adjustments on several proportional treaties. In addition, a shift in written business towards proportional business added to the decrease. Earned premiums from our new operations will soon begin to earn more heavily through the income statement as Syndicate 5151 have now been up and running for one year.

General and administrative expenses for the quarter were $5 million higher than that of the second quarter 2007 substantially all of this increase can be explained by costs incurred in relation to our new operations.

Net investment income for the quarter was $22 million versus $34 million in the second quarter of 2007. The decrease is largely the result of lower yields being applied to less flows. The consolidated investment returns net of these and withholding tax for the quarter was a positive 0.1% that net investment income of $22 million was nearly offset by $20 million in net realized and unrealized investment in foreign exchange losses.

In terms of investment [provisioning], we have been steadily rebalancing a portion of our portfolio away from fixed maturities and towards alternative investments and cash. Our highly liquid fixed income portfolio currently has duration of 1.5 years and an average credit quality of AA+. In addition, we have modestly added to our commitments the managers and risk classes such as equities and private investment funds.

During the quart quarter, our Cat Bond Swap facility was terminated and we purchased the $72 million in Cat Bond's previously held within that facility. As a result, these bonds are now carried on our balance sheet and are shown as other investments. Following the recent market concerns of Fannie and Freddie, let me give you some general details on our exposure.

At quarter end, we held agency securities totalling $85 million in Fannie and $10 million with Freddie. We continue to be steady buyers of our stock, repurchasing more than $2.3 million shares during the quarter at an average price of $16.05 per share.

Through June 30th 2008, our aggregate purchases over the past two accounts of just under $11 million shares has increased our fully converted book value per share by $0.52 or 3.4%. Since the end of the quarter, we have purchased a further 700,000 shares at an average price of $14.87 leaving us with $111 million of share repurchase authorization. From a total capital perspective, we remain comfortable with our current level of $1.65 billion, which includes $89 million of contingent capital.

And with that summary, I will now pass it over to the operator for Q&A.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question is from Matthew Heimermann with JPMorgan Securities. Please proceed with your question.

Matthew Heimermann - JPMorgan Securities

Thank you. Good morning everyone. Couple of questions. First could you just quantify the impact on the premium this quarter, lack of reinstatements as well as the quota share reestimation?

Chris Harris

Okay. Did you have another question?

Matthew Heimermann - JPMorgan Securities

I do. Do you want me to rattle them all off?

Chris Harris

Sure, go ahead.

Matthew Heimermann - JPMorgan Securities

Okay. The other one was going to be just on the $15 million of losses this quarter, if you could just opine on what was insurance versus reinsurance? And then the other question I had was on the G&A expense. I appreciate the comment that the earned premiums should start to help the ratio, but my question was on in absolute terms, it looks like sequentially declined and I don't know, if there was any noise in that or not?

Chris Harris

Okay. Thanks, Matt. I will take a stab at the first two and I think I will leave the last one for Mike. In terms of premium impact this quarter, reinstatement premium was about minus $5 million impact. Again, we think that's probably a quality problem. That obviously arose because we had some takedowns, some large losses in prior years, so we saw that on the loss side, but then we gave back the reinstatement premium as well. And then in terms of proportional treaties, as I said, we had a couple of large ones, where we reviewed the premium estimates and that would have been about another $5 million in that category as well. So probably $10 million between those two items.

Matthew Heimermann - JPMorgan Securities

Okay.

Chris Harris

Then in terms of loss for the quarter: The $15 million of weather related loss that would all be reinsurance related. Then I think the last one, maybe for Mike, about the G&A?

Mike Paquette

There is a little bit of noise in the current quarter but it's not much. We hit the point within our share based compensation cycle where it was prudent for us to revisit our forfeiture assumptions and our forfeiture assumptions were a bit greater than our actual experience, so we took down that accrual, kind of retroactively by about $0.8 million. Other than that, there really wasn't any other noise within G&A for the current quarter.

Matthew Heimermann - JPMorgan Securities

Okay. Extremely helpful. Thank you guys.

Operator

Our next question is from Rohan Pai with Banc of America Securities. Please proceed with your question.

Rohan Pai - Banc of America Securities

Hi. Good morning. Just a quick question: I was wondering what was the level of crop losses that you put up as a percent of the overall losses here?

Chris Harris

Of that $15 million, crop represents about half.

Rohan Pai - Banc of America Securities

Okay. And what was the crop premiums that that you booked in the quarter?

Chris Harris

If you're looking at our soft limit, that would tend to fall under the miscellaneous category. We don't have the breakout by line of business there.

Rohan Pai - Banc of America Securities

Okay. I will look into that. I guess the second question was, if you could give us some more detail on the nature of the individual risk losses, I guess they continued from the first quarter, are many of these still mining and heavy industry related losses that you were seeing?

Chris Harris

Well, again, I think it's a mix. Certainly, a couple of those industries have seen a few losses this year, but there's just been general fire losses as well, it's been really across the board. We tend to write excess layers. So when we suffer a loss with the miss factor, there's a relatively high miss factor, but we don't see quite as big a frequency as some writers. But even in the excess layers, we've noticed just more losses coming into the market over the last 12 months than previously.

Rohan Pai - Banc of America Securities

Okay. Thanks. I guess my last question was just on the investment income. The yields have been declining. If you could tell us what the alternative asset returns were in this quarter and also just a sense of, you've been reallocating more towards alternatives and cash. If you can just help us project the yields a little?

Chris Harris

Why don't I take that? If you take a look at page seven of our investor supplement, you'll see why the yields are coming down. It's most pronounced if you take a look at where we were at June 30th of 2007 last year versus where we are today, and you'll see that our fixed maturity portfolio is down quite a bit. There's a lot of noise there. We've had couple of hundred million dollars of Blue Ocean distribution. We've repurchased a lot of shares since then; we've made additional investments, as you indicated, into the alternative investments.

We've put more into our cash and cash equivalents for dry powder into funds committed, but unfunded future investment opportunities. The alternative portfolio did relatively well this quarter, yielding about 2.5%. I don't really want to get into what comprises our alternative investment with the exception that it's geared pretty heavily towards mortgage instruments, particularly distressed mortgage instruments.

Rohan Pai - Banc of America Securities

Okay.

Chris Harris

Does that answer your question?

Rohan Pai - Banc of America Securities

Yes. This is helpful color. Thank you.

Operator

(Operator Instructions). Our next question is from Bill Wilt with Morgan Stanley. Please proceed with your question.

Bill Wilt - Morgan Stanley

Thanks. Good morning. Mostly numbers and investments questions: The Fannie Mae and Freddie Mac securities I guess $95 million in total, what types of securities are those?

Chris Harris

We have about $206 million of agency securities, and I only quoted Fannie and Freddie, because they're the ones that are hitting the headlines now. The others are, Farmer Mac, Federal Farm Credit, Federal Home Loan Bank, but they're basically agency debentures. That's what we have quoted, $84 million for Fannie, and $10 million for Freddie.

Bill Wilt - Morgan Stanley

Okay. Thanks. So, senior unsecured debt issued by those entities?

Chris Harris

Correct.

Bill Wilt - Morgan Stanley

Got it. Thanks. Sticking with the investments theme, your investment parameters, your broad tolerance for equities plus alternatives, however you might define, risk assets as a percentage of either cash invested assets, percentage of net worth, what investment parameters are you operating with?

Chris Harris

Our investment parameters are approximately 50% of shareholders equity, but we're not there now and may not get there. But that's the bright line test internally.

Bill Wilt - Morgan Stanley

Okay. Thanks for that. Then looking at page seven, with as much specificity as you care to, but even just generally, the line equity securities versus other investments, how would you characterize those equity securities? Is that all publicly traded equities and other investments is where you place alternative investments, or how would it be defined?

Chris Harris

That's absolutely correct. Also included in other investments for the quarter, as I said previously was $72 million of Cat Bonds. We used to own the economics of the Cat Bond through a swap facility that was terminated during the quarter and we bought the underlying assets. So where we used to hold the derivatives net, we now hold all of the Cat Bonds growth on our balance sheet. The balance are the alternative investments and those are as I explained earlier.

Bill Wilt - Morgan Stanley

That's great. One more quick one, if I may. Then a Syndicate 5151, the premiums in the second quarter as soon as you get back into it, I heard you mention that 16% of year-to-date premiums come out of Syndicate 5151. Is that of gross premiums or of net premiums?

Chris Harris

Its gross premiums. The syndicate rose roughly $30 million for the quarter.

Bill Wilt - Morgan Stanley

And that's gross, net, or gross equals net?

Chris Harris

That would be gross-gross.

Bill Wilt - Morgan Stanley

Gross-gross. Okay, thanks very much.

Operator

Our next question is from Chuck Hamilton with FTN Midwest. Please proceed with your question.

Chuck Hamilton - FTN Midwest

Hi good morning. Thank you very much. A couple of questions this morning. In terms of the favorable loss development of $27 million, $28 million I think you cited that $20 million of that came from '04, '05 and the '07 storm development. I guess in terms of your '04 and '05 years, what fraction of that $20 million do those two years represent, if you can tell us please?

Chris Harris

It's about a third.

Chuck Hamilton - FTN Midwest

Okay. How much is still remaining in loss reserves at this point, or conversely, what's the amount or percentage that's been paid out of the total reserve so we have a sense of future potential for favorable developments from those two years?

Chris Harris

I need to take a look. We could look those numbers up, but we'll probably need to get back to you on that one. I don't have that handy.

Chuck Hamilton - FTN Midwest

Okay. Great. Second question. In terms of the realized and unrealized capital loss this quarter, $16.5 million, is there a breakdown between the alternative investments or the fixed income or the equity portfolio so that we can get a little more color on?

Chris Harris

Sure. I'm sorry; you're talking quarter or year-to-date?

Chuck Hamilton - FTN Midwest

Just the quarter where we had the $16.5 million realized and unrealized loss, I'd just like to get to know how that breakdowns between the different asset classes?

Chris Harris

What we've got is about $17 million loss on fixed maturities, about a $2 million loss on equity securities, $2. 3 million gain in other investments and a small gain on securities lending.

Chuck Hamilton - FTN Midwest

Okay. Great, thank you.

Chris Harris

That number, Chuck, on '04, '05, net reserves you will get about $210 million.

Chuck Hamilton - FTN Midwest

Still outstanding?

Chris Harris

Correct.

Chuck Hamilton - FTN Midwest

All right. My last question then I'll let somebody else take the floor. In terms of the timing difference on the purchase of your reinsurance getting from gross to net written premiums, it was about $20 million. It appears, just a quick off the top of my head calculation, in second quarter '07 versus, maybe you can just clarify the difference in the seating premiums year on year, second quarter '08 to second quarter '07?

Chris Harris

Sure. I think we talked about that a little bit last quarter. We did defer some of our purchases from the first quarter until the second quarter, so that's why you're seeing the spike this year versus last year. I think David mentioned in his comments as well that we're substantially complete for the year. You'll see a little bit more come through in Q3, but I wouldn't expect any dramatic changes as compared to last year in that regard.

Chuck Hamilton - FTN Midwest

All right. Was there any significant difference in terms of the amount of reinsurance purchased year-to-date this year against last year?

Chris Harris

I guess the only comment I would make is we probably bought a little bit more excessive loss protection in the prior year. We did purchase some proportional protection this year. Effectively everything was excessive loss and was probably targeted a little bit more at some of the medium to larger size industry losses than previously.

Chuck Hamilton - FTN Midwest

Okay. Great. Thank you very much.

Chris Harris

A little bit more limit for the same spend.

Chuck Hamilton - FTN Midwest

All right, great. Thank you.

Operator

Our next question is from Ron Bobman with Capital Returns. Please proceed with your question.

Ron Bobman - Capital Returns

Hi. Good morning, congrats. We don't hear subrogation mentioned all that often as a mover of the dial, so I'd be curious to have a little bit some more info as to the nature of the subrogation gain or return, maybe the timing of the related loss that presumably you suffered in the past associated with that policy or treaty or whatever it was? Thanks.

Chris Harris

Sure. Thanks for the question. I really don't want to get into discussing individual cases or individual claims. I guess I will say this was an event from a couple of years ago and just we had paid on it. They were able to collect from another party and we got our money back, but at 8 million we disclosed what the amount was, but I don't want to discuss anymore details than that.

Ron Bobman - Capital Returns

Okay. Then I have a second question. I don't know if you still do this, but do you write any retro, sell any retro cover?

Chris Harris

I didn't hear your description?

Ron Bobman - Capital Returns

Do you sell retro reinsurance?

Chris Harris

We do.

Ron Bobman - Capital Returns

I'm just curious to know what sort of the current market dynamics are as far as rates for that product line right now?

Chris Harris

David? Do you want to comment on that?

David Sinnott

Yes sure, this is David. We've seen a gradual tightening in that segment of the marketplace, and we expect that that's probably going to continue to tighten as we move through the winter season. We did write some retrocession a year ago at this time, but we don't expect that's going to be written for the third quarter of 2008. So we're effectively not really looking for opportunities in that space. Having increased some of our Cat exposure on our traditional business, namely in Florida, we're pretty much at capacity or where we want to be in terms of our wind exposure.

Ron Bobman - Capital Returns

Okay. Understood, thank you very much.

Operator

There are no further questions at this time. Mr. Kim, please proceed with your closing remarks, sir.

Jonathan Kim

Thank you. That concludes the proceedings from the company's point of view. Please note that Bill Pollett, our Treasurer, whose number appears on the front of the financial supplement posted to the company's website, will be available to take additional questions following the conclusion of today's conference call. So it only remains for me to thank you all very much for your participation and we hope you will join us again at our third quarter earnings call. Operator?

Operator

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

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