IPC Holdings, Inc. F2Q08 (Qtr End 06/30/28) Earnings Call Transcript

Jul.25.08 | About: IPC Holdings (IPCR)

IPC Holdings, Inc. (IPCR) Q2 2008 Earnings Call July 25, 2008 8:30 AM ET

Executives

Sean Symons – Sr. VP & Controller

Jim Bryce – President & CEO

John Weale – Sr. VP & CFO

Analysts

Joshua Shanker - Citigroup

Mark Dwelle – RBC Capital Markets

Susan Spivak - Wachovia

Jay Cohen - Merrill Lynch

Ron Bodman - Capital Returns

Operator

Good day ladies and gentlemen and welcome to the IPC Holdings’ second quarter 2008 earnings conference call. (Operator Instructions) I will now turn the call over to turn the call over to Mr. Sean Symons; please go ahead sir.

Sean Symons

Good morning ladies and gentlemen and welcome to the IPC Holdings second quarter 2008 conference call. My name is Sean Symons, Senior Vice President and Controller of IPC, and with me this morning our Jim Bryce, President and CEO, and John Weale, Executive Vice President and CFO.

During our discussions this morning we may make forward-looking statements and while these statements represent our best current judgment on what the future holds they are subject to risks and uncertainties that could cause actual results to differ materially. As always, we recommend that you refer to our public filings including our Annual Report on Form 10-K for the year ended December 31, 2007 and our soon to be issued Form 10-Q for more details on the risk factors.

And now I'll hand you over to Jim Bryce who will talk about the second quarter earnings.

Jim Bryce

Thank you Sean, IPC’s 2008 year began strongly. The good results have continued throughout our second quarter and we are very pleased to announce strong and solid six month results.

Second quarter cat activity in the US is currently estimated at slightly over $6 billion by PCS. This makes it the second worst second quarter in the last 20 years. As similar with the first quarter of 2008 only one single event in the second quarter was greater than $1 billion. There were actually 16 PCS events in the quarter.

We fully expect that the majority of these losses will fall upon our insured’s and this is being borne out in the second quarter numbers that we see being published. The terrible earthquake in Chengdu, China on the 12th of May took 70,000 lives and injured 350,000 more. However it does not appear to be other than a major tragedy but a major reinsurance event. The fire loss in the second quarter at the Universal Studios continues the spate of major risk losses we have also seen develop in the first quarter of 2008.

The continuing build up of capital is still causing pressure on rates but generally market conditions are still very healthy for property catastrophe reinsurance business. Weakening balance sheets of primary companies driven in some cases by the turmoil in the credit markets, created an increase in demand for our products in the second quarter. In addition some national carriers in Florida-only riders went into the market seeking spike covers late in the quarter and this surge in demand caused a mini hard market for industry loss R&T covers at July 1st.

We are pleased to confirm we were able to take response and take advantage in satisfying this spike in demand. Commissions outside the US are also showing continuing signs of weakening with the exception of Japan. This market had a spate of risk losses before going into renewals at April 1, 2008 and this had a positive impact on pricing per cat coverage as mentioned on our first quarter conference call in April.

Premiums in the quarter and the six months to date are down primarily due to retired lines in the USA and reduced reinstatement premiums in line with our reduction in losses. Our experience from the July, 2008 renewals points to a healthy marketplace. Catastrophe premiums are moving in line with original exposures of our clients and in addition the significant retention increases of our clients in the past few years is beginning to insulate reinsurers from the attritional loss activity which we had been seeing and paying in the past.

I will now hand over to John who will give us some comments on the financials.

John Weale

Thanks Jim and good morning ladies and gentlemen. Following are my brief remarks regarding some of the financial aspects of our second quarter 2008 results.

Once again our investment income for the quarter suffered a notable decline in comparison with the second quarter of 2007 primarily due to the lack of a dividend from the fund of hedge funds that we have invested in. In the second quarter of 2007 we had benefited from a dividend of $6.7 million. Similarly in the six months ended June 30, 2007 we had received dividends totaling $14.6 million.

In addition to the lack of such dividends investment income is also down due to the continued reduction in the yield on the fixed income portfolio. Clearly one of the disappointments of the quarter was the net loss on investments which represent the change in fair value of the portfolio during the quarter together with any realized gains and losses from the sale of investments.

As noted in the press release this was comprised of a $50.1 million loss from fixed income securities and a $0.8 million loss from our investment in a number of equity funds. Actual realized gains from the sale of investments in the quarter were $8.4 million. We again benefited from a relatively low level of incurred losses which Jim has just mentioned.

The few losses that did occur during the second quarter 2008 that impacted us were more then offset by some additional reductions for several of the events that occurred in prior years as our cedents continue to reevaluate their estimates of their exposures to those events. Our net paid claims in the second quarter of 2008 were approximately $38 million compared to approximately $93 million net paid claims in the second quarter of 2007.

Approximately $15 million of our paid claims in the second quarter of 2008 related to KRW and $19.5 million with respect to the major events of 2007. Our net operating cash flow in the second quarter of 2008 was a positive $47.9 million compared to $5.9 million in the second quarter of 2007.

During the quarter we used $179 million to pay dividends and to buyback shares. This was financed in part by the drawdown on our syndicated revolving credit facility in the amount of $150 million which occurred in the early part of June of this year.

Fully diluted book value per common share was $34.48 at June 30, 2008. As Jim commented in the press release during the second quarter of 2008 we had bought back 5.7 million shares and we have continued to buyback our shares at prices well below book value. As of this week since June 30, 2008 we have purchased a further 1.9 million shares for a little over $52 million.

Our operating returns i.e. operating income less preference dividends on our weighted average common shareholders fund for the six months ended June 30, 2008 was 19.6% on an annualized basis.

Yesterday The Board of Directors declared a quarterly dividend of $0.22 per common share. This amount will be paid on September 19, 2008 to shareholders of record on September 3, 2008. In addition The Board also declared a third dividend of $0.475781 per preferred share payable on August 15, 2008 to shareholders of record on August 1, 2008.

I’m going to hand it back to Jim who will open the Q&A session.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Joshua Shanker - Citigroup

Joshua Shanker – Citigroup

I wonder if we can go through the mark-to-market on the investment portfolio and talk a little bit about FAS 159 what advantage do you see it as marking items that you see as held to maturity through the P&L. Obviously it secures your numbers a little bit for some investors, I just wanted to talk through your thinking on that.

John Weale

We adopted FAS 159 early, we adopted it January 1, 2007 and its been accounting for our investment portfolio, in particular our fixed income portfolio pretty much as a trading portfolio rather then either available to sale or held to maturity. We felt that the benefit of doing so—one of the benefits of doing so, was that we didn’t have to take other than temporary impairment charges on only certain portions of the portfolio. So now movements both up and down within individual securities are all treated the same whereas we treat—if you have to take other than temporary impairment charges you only take the negative charges you don’t get the benefit of securities rising.

Joshua Shanker – Citigroup

Okay, and in terms of the impact on this quarter the mark-to-market they’re interest rate driven mostly?

John Weale

Yes absolutely and we saw treasury yields between the end of March and the end of June treasury yields on two year securities for example went up over 100 basis points and on five year securities it was around 90 basis points. Unfortunately that did have an impact on our, even though we have a very high quality short duration bond portfolio when yield spreads move that dramatically it does have an impact on even the best of the portfolios and we did suffer a 2.7% decline in the value.

We’re still showing net unrealized gains at the end of the period, its just the gain isn’t as big as it was at the end of March.

Joshua Shanker – Citigroup

And are you making any portfolio changes to take advantage of where interest rates are?

John Weale

One of the things we are doing which you may have seen in our 8-K a little while ago that we issued that we are about to put a small allocation to predominantly agency issued MBFs and those are AAA rated MBFs. So that’s a small allocation that we’ll be doing shortly. We had planned this actually though its been in the works for well over a year but clearly with the credit crisis that took place last June and all the headline risks surrounding mortgage-backed securities we’ve kind of been holding off for awhile and of course even more recently with Fannie Mae and Freddie Mac again headline news we deferred it even a little longer.

But we’ve come to the conclusion it’s a good investment. The primary reason we’re doing it is to add further diversification to the portfolio and clearly with spreads where there are at this point in time we think it’s a good play.

Operator

Your next question comes from the line of Mark Dwelle – RBC Capital Markets

Mark Dwelle – RBC Capital Markets

Just in terms of the market pricing environment would you say that pricing has now retreated back to pre-Katrina levels or are we still—prices still at a premium to where they were ahead of that timeframe?

Jim Bryce

I think the biggest change in the post KRW world was really not just the pricing but the retention levels and retention levels have gone up literally billions of dollars before they’re impacting reinsurers. I think we’re really looking at for regional carriers, somewhere in the area of maybe $2.5 billion to $3 billion as a flashpoint for reinsurers to get a major involvement in a loss.

National accounts you’re probably looking at a flashpoint of $7.5 billion to $8 billion and I guess we’ve seen it, as I said in my comments, evidenced in the quarter that the small losses and really kept by the ceding companies and that’s really where they should be. I think the pre-Katrina world we were allowing the cat covers to protect not just balance sheets but income statements and now we’re reverted back to the way it should be, we’re protecting balance sheets, the income statement in the main is unprotected and that’s the way that the reinsurance cat products should work.

Prices as I said again during the call they’re pretty much following exposures. With these higher retentions our clients are much more risk adverse because the low level of loss where we have the greater frequency that’s all kept net on their balance sheets so they are reducing exposures. We are in cases recognizing a reduction of exposure prices will come down. And conversely where we think exposures have gone up, prices will go up. And that’s really what we meant by the prices are really following exposures. It’s a very rational marketplace. I guess the use of the models help us to track these exposures more accurately. And I think we’ll still get premium pricing at very reasonable levels.

It has come off a bit with the builder per capital but that’s a supply/demand market characteristic that will always be there.

Mark Dwelle – RBC Capital Markets

So I guess with that in mind, there’s constantly chatter about whether it’ll be an active or inactive Atlantic weather season or not, I guess with that in mind we would need to see a season that was more characteristic of like a 2005 with larger events to produce any type of tightening in rates or real change in the trend line of the market as compared to say a year more like a 2004 where there was a frequency of events but they were unbalanced, smaller in terms of industry loss.

Jim Bryce

I’d agree with you with the exception of Florida because Florida is probably still what I would consider the underbelly for reinsurance market change and these extreme events are really [out wires]. What we would probably see is just a normal frequency of low to medium severity and in the case of Florida if we had a similar situation 2004 that could very much impact the marketplace. The reinsurance market on the bottom end, we’re not big players there but reinsurers are still playing very heavily there. I think it has started out to be a higher frequency, it started very early.

I think that’s just a given we have a higher frequency but the real spot is I think is if Florida gets hit with even a low to medium severity, you’ve got a whole domino affect, its not just the reinsurers but does that impact the funds, the loss paying ability, the issuing of the bonds, it’s a dynamic that really could be quite a significant event from just a very small catalyst.

Operator

Your next question comes from the line of Susan Spivak - Wachovia

Susan Spivak – Wachovia

Just following up on that last question, what happens to rates if we don’t have any wind blow through the season at January 1?

Jim Bryce

Oh you would pick the worst possible scenario. If nothing happens—we have had losses already, we’ve had I guess as I said $6 billion and we had about $8 billion, so we’ve had over $10 billion in losses. I guess—it hasn’t impacted reinsurers significantly. I think if we have no losses at all and capital continues to grow it will have additional pressure on rates. That is not the scenario we want to see. Normal loss activity, we will have loss activity and I think it’s just a question of how does it impact reinsurers. But we would prefer as IPC to see a similar situation 2004 in terms of the low to medium hitting Florida. That would be the most advantageous for us.

I guess in terms of the marketplace Florida is unfortunately surrounded by water on three sides. It’s probably not a very good place to build a home. The standards have been improved. I guess the fact is that that’s probably the most vulnerable state in terms of wind.

Operator

Your next question comes from the line of Jay Cohen - Merrill Lynch

Jay Cohen - Merrill Lynch

I’m looking at the numbers and you have a negative loss ratio because of the favorable development so but then you look down at the ROE and it’s 18%, 19% when you have negative losses. Now clearly you have a lot of capital and there’s a lot less operating leverage, and so if you could explain and clearly you bought back a lot of stock, how do you see that capital management going forward. Is it just a matter of keep buying back stock at this pace, and then related to that, will you continue to buyback more than you earned meaning get rid of what is excess capital now.

John Weale

I think that the short answer is yes to your last part, we will continue to buyback stock, try to at least maintain either the same level of capital or even reduce it. Obviously we have to be mindful of rating agency constraints over with SMP having an A minus, that’s less of a constraint then it was probably previously. But we do have to be mindful of our A rating of [AM Best].

But yes we will continue to buyback stock. One of the other things that we have in mind to do at some point if maybe the credit markets will start to settle down a bit is maybe introduce a little bit of debt type leverage onto our balance sheet and thus take down the common shareholders fund further. But that’s the plan.

Jay Cohen - Merrill Lynch

I guess in the past you’ve used special dividends but of course the ownership structure was a little bit different and with the stock where it is, is it fair to say buybacks are simply more economically attractive then paying a dividend at this point?

John Weale

At this point while we have the [inaudible] convertible preferreds there would be an impact on the conversion rate if we were to start paying special dividends. So that’s been one of the factors we’ve had to be mindful of during the past 15 months while we’ve been buying back stock. But yes, going forward once those convertibles convert which takes place in November of this year that option will be back open to us as a possibility.

Jay Cohen - Merrill Lynch

I didn’t realize that was a constraint. The events of 2007 loss events, initially you showed up a one of the ones with the bigger losses, probably the biggest loss on that, but since then of course you’ve had this favorable development, can you give us a sense of what the losses looked like from those events relative to where you had initially booked those reserves?

Jim Bryce

I guess the development really reinforces the fact that we’re reserving on a very conservative basis and quite frankly a welcomed positive surprise is that we’re going to look very, very partially at negative surprises. In terms of the loss events last year we took a stance of establishing reserves based on very little information. It was based on market information, very limited advices received and if you want to run down the losses, last year [inaudible] we had originally estimated at $47.5 million, that’s currently standing at an incurred of $29 million.

The Australian floods we had reserved at $47 million and they’re now standing at $18 million and then the July and June floods as we said in the conference call last year, the losses were both estimated at $75 million and $75 million. And those losses are considerably down.

John Weale

The July flood was initially estimated at gross $65 million, net $59 million. And the Australia storm was estimated at a net $50 million.

Jim Bryce

The biggest reduction is really the Australian events.

John Weale

The Australian one in particular we had one cedent in particular who in the middle of July of last year as we were finalizing our results increased their estimated loss by threefold and then subsequently reduced it to about 40% of that number so it’s been—

Jim Bryce

And that actually cost us to initiate a review of the losses. We had people locally employed to go in to look at those reserves and they were found to be too high. But as I’ve said before we—positive surprises are welcomed, negative surprises are not and I guess we have been trying to be as conservative as possible. I guess five, six, seven, eight, we’re trying to do the best we can and if we overshoot it I’d rather do that then undershoot it.

Operator

Your final question comes from the line of Ron Bodman - Capital Returns

Ron Bodman - Capital Returns

I was curious to know the ILW demand spike that you mentioned that had an impact on July 1, has that persisted or has the demand abated?

Jim Bryce

The demand was there. It was really for about a 10 day period, not even two weeks. As I said it was a spike. It was brought on by—I guess the national carriers buying more cat cover as I alluded to on the call that they’re weakening the balance sheet because of the credit situation did take some CEOs and CFOs I think by surprise. They wanted to insulate themselves by buying more cover because then it reduced net worth.

That and the Florida situation it really as I said spiked it but it very quickly disappeared because there is abundant capital. I guess the area is really national and Florida that’s probably still a very fine line between supply and demand and again we were able to satisfy it at prices we thought were returning to the good old days of last year. I guess with the advent of some of the funds coming that’s really where the market has come down in pricing the most and that’s not really underwriting, that’s really just looking at a grid, looking at a price, looking at a peril, looking at attachment point and its really just the numerical exercise of getting to your minimum price and if you want more business you reduce your minimum price and that’s what’s been taking place up until just recently during this mini hard market.

Ron Bodman - Capital Returns

Some time has passed, I don’t know if its been 15 months or so since the SMP downgrade, it looks like from your writings, its not really had a material impact but obviously we don’t have a look into the underlying components of your book, would you comment on that whether its had any impact on at the [cede] level, allocation sizes or you really haven’t seen anything.

Jim Bryce

We are allocating more capital in line with their wishes. The rating agencies, in terms of the models we are using the models and the models are asking us to put up a little bit more capital.

Ron Bodman - Capital Returns

I was really asking about your counter parties, are your counter parties--?

John Weale

The only client that we know for sure that we lost through the downgrade was an insurance subsidiary of a European bank. That’s pretty much been it in terms of a loss of business and in terms of impact on signings it would say it’s been pretty negligible. Obviously that’s a harder one to tell.

Jim Bryce

The loss of premium was about $100,000 so it was not significant and I guess ironically we had a relationship with the bank which was generating more to them in fee then we were getting in premium and that’s no longer there. It was actually a net loss for the bank.

Ron Bodman - Capital Returns

What’s the balance on the buyback after the incremental numbers that you provided us for July 1, third quarter to date when you subtract those actions, how much do you have left authorized?

John Weale

We’ve got just over $50 million to go on the $300 million authorization that was provided to us by The Board in February.

Ron Bodman - Capital Returns

I was curious whether you participated in any meaningful fashion on the Citizens Program?

Jim Bryce

We took a pass on that one.

I would just like to thank everyone for your time and your interest and I wish you all to have a good day and possibly if I could also congratulate both Mr. Weale as our new EVP and Mr. Symons as our new Senior Vice President. I’m a little surprised people didn’t pick up at that. I’m sure John is very disappointed but I just wanted to say well done to both of these gentlemen and again thank you and have a good day.

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