Aspen Insurance Holdings Limited (NYSE:AHL) Bank of America Merrill Lynch Insurance Conference Call February 13, 2013 4:40 PM ET
Chris O'Kane – Chief Executive Officer
Jay Cohen – Bank of America Merrill Lynch
Jay Cohen – Bank of America Merrill Lynch
Okay, last presentation of the day. We’ve had several CEOs at this Conference who were fully architects of their business and of their companies since the founding. And our next speaker certainly fits this description; Chris O'Kane is CEO of Aspen Insurance Holdings. He has spent 20 years of working in the industry before he started Aspen in 2002, and so his experience is clearly extensive. Aspen is now a broad based insurance and reinsurance company, several different underwriting platforms. And so, Chris is a great addition to our conference this year, Chris O’Kane.
Well, thank you, Jay. Thank you for the opportunity to come and talk to you guys and for you, I’m sure you’ve listened to a lot of speakers I’ll do my best and make this uplifting, exciting, entertaining and rousing for the end of the day. As Jay said, I am not just a CEO, but also the Founder of Aspen, the good part about that is I know the business very well, the bad part is I’ve got nobody to blame but myself, everything, when you’ve been in-charged you’ll be getting you can claim credit for the good biz, but you certainly have to worry about the rest.
As Jay said, I have been around about 11 years of business, (inaudible) 2001 type of company. A couple of years ago really it was common to say a lot of mid-teen kind of ROE business, 15 and I said to the several people in our private equity days. One of the Blackstone guy is actually said to me, if you present the business plan for less than 15 ROE, I am rejecting it, I’m going to carrying on rejecting until you give me a business plan for 15 ROE those are the days, those days we were investing new money at around about 500 basis points and we had real pricing plan in almost every line of business regrettably, that just isn’t the case today investment returns are what they are and they are pretty anemic and there is a better underwriting market than there has been for some time, but that’s not a hard market, that’s not a great market.
Some of those things in your life that stick in your mind, few years ago there was a film called Network I think it was Peter Finch stared in it and he was a kind of a television news anchor who just went kind of crazy and at some point he said “I’m mad as hell and I’m not going to take it anymore” And he encouraged everybody open the window nice and shout, I’m mad as hell and I’m not going to take it anymore. And as I looked at our performance in 2012, which was an 8.5 ROE operating ROE and I think it’s quite respectable and in November put the three year plan in front of our board saying the sort of money I thought we could make for the first time in my life I said to them, what I, this is what we can do unless we do something very different.
And I think we go to think quite radically I’m mad as hell and I’m going to take it more which meant that we then went into a further standing run, which concluded last week with a board meeting and then we do that. And I want to say really our business is a great business it’s operating in a field P&C insurance, reinsurance works very hard to make a decent return. But we are mad at, so we won’t take anymore, we wanted to do something squeeze more value out of business. And that really is the theme of this presentation.
And why, why now, I guess, I think I’ve said already, we just need more and the market is not really often, so we’re going to change our performance by things we do ourselves to our business will make us better. So we think two things matter increasing book value per share, include dividend cost and have a decent ROE. We’re not a company that tries of the highest possible ROE, we like to limit volatility. We believe the shareholder value will be created not just by a good return on equity, but some stability around that return on equity. That said we are P&C insurer, reinsurer and there will always be some volatility. We thought that were three things that we ought to be doing, first of all optimizing the business portfolio mix. Every year we take a long-haul look at every line of business, everybody is going to earn the right to capital reallocated again.
We’re not self-intended, we don’t do for living what you do for living, there are the considerable regulatory cost and setting up business platform, you have to stay in a business if you expect to be able to make money in it over time, you don’t have to stay in the same scope, it’s tough to actually liquidate the position, sometimes we do that, not very often.
More often, we are saying, we’ll do more or will do less see the response, you need to see the opportunity coming. Three or four years ago, we came across the team that did some kidnapping around some business, and we saw an emerging risk piracy in Somalia. We had those guys do $15 million of premium or exceeded over 40 in the first year and more in the second year and more again in the third year. Their returns was off spectacular that is what I call spotting opportunity, you also have to spot when they’re going wrong, when you don’t want to be the last guy to notice the business and what it was.
We do that anyway and then I thought after the two anemic ROE we’re putting in front of our board last November. We’ll take another look and essentially I concluded and board concurred that U.S. property insurance with CAT exposure it’s just not the most efficient place to put your capital.
In our case, we can do two other things and maybe all the things beyond these two evolved. But there are two things we can do to hat represent more value opportunity, value creation opportunity, one is the buyback of shares gets us counter book that is retty clear equation. The other is actually the property CAT reinsurance business would give a better reward and a more stable award than the CAT exposde property insurance business. So over the course of the next two years we’ll withdraw $140 million from the property reinsurance business in the U.S. by reducing CATs of using wind and CAT quite exposure and maybe over $200 million ultimately when that purchase is finished.
That’s going to change share part of business a little bit,are there are other things we did not talk about on the call, but look every target kicked and kicked repeatedly it’s a very comparative view and there will be more to talk about on future calls. Improving capital efficiency, we are quite conserved people and that is the right disposition from which to run a P&C insurance company. However, it is inefficient to carry too much capital, we’ve got a great Risk Committee of the board, we have some great capital modeling accessories. I have felt increasing it for sometime though that we expanded to just be holding too much capital, beyond the natural safety margin. So, few things have happened that will allowed us to conclude, that we can reduce the technical amount of capital we need in the business by about $100 million.
In addition to which we’ve identified some $250 million of excess capital currently. In addition to that, there is a $140 million in two years to be freed up from running down CAT exposed property insurance in U.S. In addition to that, we’re making a clear statement that the majority of our earnings in the future will if our business plan goes away (inaudible) will be used to buyback shares in the company.
If the world changes, if underwriting opportunities and other opportunities emerge that would reward dedicating capital to it of course, we’ll look at that we just don’t think that’s very likely to happen in the next two or three years. Well, I say most stuff, we haven’t been specific, but more than half probably less than three quarters is going to be used for those purposes, so that cause us to announce a $500 million increased share buyback authorizations say that we expect to buy more than $300,000 million worth of our shares back in the next 10 months.
So, the first example is about being in a better underwriting business, the second, is about being a more capital efficient business. And then the third, investment returns, I spend and probably you as a guy who grew up as an underwriter, choosing individual reinsurance risks. Later in my career somebody said maybe you could manage all the people doing that, that’s mostly what I do these days. I am not a finance guy, I am not an investment guy and I am not service sophisticated in these things. So we employ people around and we advised a couple of year ago was short-term dip in the investment returns will be a quick reversion to the mean. Well, it’s not a quick reversion to the mean we don’t know when that reversion to the mean is something about. But we did, we did essentially hold a lot of cash, hold a lot of short duration investments, expecting to have the opportunity to reinvest and improve yields.
And I guess, we come to the opportunity with the conclusion that opportunity is long a way off, if we just wait. Credit market, the bond market is not an attractive place and I’ll be not likely to be [interacted] with for a long-time. However, we we’re an insurance company, we’re a P&C insurance company, we’re not a hedge fund, we’re not a Fund Manager. We are not, we don’t view our mission in life as to manage your money for you in a financial investment sense, our mission is really to underwrite successfully and use the float that underwriting producers to invest sensibly and preserve capital. To get a fair award for preserving that capital, but essentially preserve capital.
We have nevertheless decided that our portfolio could do with a little bit more risk. And we looked at and have in fact increased store exposure to equity from $200 million last year to $400 billion now. And the question is on the review whether we would further increase our explore to equity?
The capital model would say 10% for an $8 billion portfolio investing in equities is probably the maximum possible limit, where is still efficient after that point equities are going to attract capital charges that make the dilutive return too much. This is not a prediction that we will go to 10, it’s just to give you some color that the issue is still on review. We’ve looked at bank credit, we’ve looked at managing markets that, we’ve looked at lower grade securities and we’ve made some moves in that direction these are important considerations not because they are going to increase our investment return, it’s rather that they gain to avoid a further reduction investment return, four, five years ago new money was being invested at 480 basis points, I think was our peak, today it’s not much more than 100 basis points, that’s a very big difference, if you understand as I know you do the financial model of P&C insurance that is very important.
It would seem sensible to us and logical that any industry faced with such a drain on its earnings, cost and the investment side, would say on the underwriting side, let’s get more money, let’s increase underwriting prices. That cry is being heard, that cry is going out, the impact is very muted.
Pricing is better than it was year ago, pricing is one, one across our whole book was up on average between 1% and 2%, but on the freight underwriting pricing going out 1% to even 5% to 7.5% is not going to compensate for that huge reduction in the investment side.
So my own private equity friend just says 15 ROE is the minimum that I’ll accept and you can just resubmit your plan until you get to 15 for the rest of your life, it would be the rest of your life today because I don’t think 15 is the way that we’re broadly based companies that don’t want to take excessive amounts of risk.
So we announced on the call a goal with 10% ROE in 2014, that’s what we expect to do. We continue to be the same people who have always been that prudent, conservative and not given to statement, so we make a statement like that with consumer confidence, we wouldn’t be standing, I wouldn’t be saying it unless our growth eminently achievable. So I really come to the chase there because that was the up-to-date key story about Aspen, I recognized a number of people who really know the company quite well, I don’t recognize other faces, so by sort of some general background at this point and then we’ll get later on to an opportunity for Q&A if there is any.
Bermuda-domiciled, I would like to say we’re a specialty insurer and a specialty reinsurer, what does that mean Specialty? It means special, the risk we want to write off always got something about them that means they needed to be underwritten, cookie cutters don’t help us, we do trade in some commoditized business in fact I would say all business are commoditized to some extent, but the mass market commodity stuff was successes about the chief operating platform and a carefully manufactured product sold a very little underwriting determination that is not our model.
We have very smart, very well paid people looking at some of the most complicated risks in the world, they may be financial risks, they may be offshore energy risks, they may be on the reinsurance side, complex casualty, questions they may just be on the CAT side where the best place in the CAT business these days are the people who are the best models and use them and update that most frequently, it is a lot of intellectual effects staying that we are a social company.
Balance sheet is, in my opinion extremely strong I think the rating agencies give us A ratings they will probably confirm, okay. We talked about a multiplatform approach, the origins are in the London market and we have a very strong presence in the London market doing the source of specialty insurance lines, Lloyd’s vision has been good at.
We in the early days opened in Bermuda at both our headquarters, operating headquarters but also it’s a center for our property CAT, for most of our property CAT underwriting as you know Bermuda has about its 65% market share were like property CAT and is the best place in the world to do it that’s why we do it there. And the third major platform is the U.S. where we have both insurance and reinsurance operations, the reinsurance operation is extremely successful and goes back about nine years, the insurance operation is smaller and has been a subject of considerable investments in the last several years.
Diversification matters a simple values about that if a risk is available to you at a premium that does not cover the cost of claims then it has no place in your portfolio. However diversifying it makes no sense to lose money. If the risk is entirely diversifying, so that you don’t need to hold incremental capital by riding that risk because it presents a quite different risk in [every answer] then as long as it more than count the cost of claims, you might consider to accept it into your portfolio.
If you think about this logically, you become more efficient as a company, if you think about this logically it will enable you to write a broader base portfolio with better leverage, one of the things that enable us to say what we just said, what I said about capital buyback and ROE is today we have a diversified model, where we have growth and the growth is self-funding out of earnings and the reason for self-funding out of earnings and the amount of earnings is actually we need this quite modest is that we are diversified where we are growing is in ways that are different from our peak exposures, it’s a very powerful tool used correctly, used badly I just want to show, I know what using it badly means, using it get badly means getting into lines of business you don’t have to spend, risk with limited transparency, finding exposure you didn’t know who are that and getting losses. There is a reason why, why I would like to say, it’s not diversification, it’s diversification, but really that’s too simplest to get inside.
Having a little trouble with this, so reinsurance is the business that we’ve been known for longer. I talked about our main platforms, but reinsurance we see growth opportunities in the high growth markets of Latin America and Asia primarily in the last five or three years we’ve opened Aspen Re in Zurich, in Singapore and Miami, Miami obviously servicing the Latin American market.
The deep understanding, deep expertise and understanding plan exist those would make them, they make and I urge you to believe that they are not. Generally speaking especially in the property CAT business submissions come in and they are complicated and they are put together by people with a lot of technical expertise. Smaller less well funded companies in these smaller but high growth markets don’t have the same expertise.
The underwriting information they give you will not be as complete. And if you underwrite promotions based on that the chances are you will make the wrong decisions because you won’t understand the totality of the risk presented. So you need people who operate in that market, in that language, in that culture, in that time zone who know the good guys and bad guys, who know what’s contained in the information and what’s likely not contained in the information.
We also have the advantage by knowing these companies, these are small companies they don’t have the range of specialized product knowledge that major European, American companies do have, so one of the things you can do with them let’s say, are you selling this product? No, we’re not, we’d like to, but we don’t know how to. Well, we know how to, because part of our New York and London market operations were actually very success really, so we can say to a smaller company in Asia, in Lain America. Let us show you how to sell the product, we’ll reinsure up to 100% limit, we’ll show you how to do, you do the local distribution and we’ll do the manufacturing, and we’ll provide as much capital is needed, not many of our competitors are doing this. We are fortunate in having some very experienced capable people. In our international reinsurance operations, we’ve been doing this very long time, and it’s still quite notable.
I feel relatively comfortable talking in this audience, I might not even talk about this on an earnings call, although I understand, what I say is probably, because one doesn’t wants to draw the attention of competitors to these ideas. Very often what is notable doesn’t appear to be all that uniquely different, it just does retro par and that’s one of the things I like about our reinsurance operation, it’s on the ground and it’s growing intelligently, that also helps it avoid some of the bad things that are going on, we do learn from our mistakes, we used to write a lot of New Zealand earthquake business. It was stuff, we didn’t know about the South Island now we do, we’re writing very little on the earthquake in the south part pf New Zealand I think is today more less our regret to say in uninsurable risk, certainly it ending like the price, which is available, we learn that in a hard way by occurring the losses.
Final point especially on reinsurance is the credit facility agriculture, the energy, the, again these smaller companies who don’t have of products the bigger clients have, don’t just want us for capital and capacity to help compete in major CAT program. They want us to help their positioning in the surety bond market for example in Latin America. We commenced and then they commenced (inaudible) that is a record growth area for reinsurance, casualty reinsurance not rather growth, it’s great business we’ve done very well out of it. But between the investments return slightly on pricing we’re actually shrinking it, not growing it. And property CAT reinsurance is truly successful line for us, it’s the area that expose our capital to the most and consequently we don’t want more CAT risk on the balance sheet, we’ve got what we want.
Now I’ll cover that, so moving to insurance, there are five product groups, but we also think about this business in terms of the U.S. operation, which is relatively immature and the London operation which is quite mature.
The first couple of product groups, I’ll describe is truly global. For example in London we’ve got a lot of marine energy, the risks may well be American risk and maybe got Mexico risks. If it’s energy or marine construction it maybe The Port Authority of New York, it maybe a project in this country, it is switched to London because that’s where the expertise is and that is the distribution chain historically to take a lot of London. If our customers wanted us to underwrite that in New York rather than London, we will be classified of doing that willing to do it typically or achieve way to do it.
So global, similarly the financial professional stuff a lot of that is global risk managed from London and New York with global risk. And those first two areas were I think we are increasingly market leaders. In complex energy liability risks focused come to Aspen for solutions. Increasingly in professional lines, in London and in New York, they look to our people for market leadership and I’m very pleased with our financial performance there. Property insurance as mentioned once already in this bulletin because we really have changed direction in U.S. property, we just embarking on the change. We’ll still sell U.S. property and we will give some CAT cover with the property particularly in the context of program business, but standalone E&S with a prime aspect of the risk is earthquake, wind or flood is an area we will as rapidly as possible exit down too quickly.
UK property highly committed market very successful, these guys, I don’t really know how they do it, I have an inkling but in a market that tens to hundred combine these guys just keep producing 80 combines for us and 80 combined in this bulk of UK properties is the one who result.
Casualty bigger and more complicated some newly specializations like environmental liability U.S. excess casualty, UK regional liability, other areas like UK liability that’s been about 40 plus ROE business for us in the history of the company, it’s been fantastic. Not smaller these days, because the market is competitive. Final, comes on insurance, our London platform is mature, successful, profitable. Our U.S. platform has completely satisfactory loss ratios, but is in the investment phase, we spent a lot of money building brand, establishing a limited market company, getting the right IT systems, hiring the right risk managers that write actually these things are expensive if you can to do them well, but if you are not going to do them well, you may as well not be in the business.
And therefore, I think it wouldn’t be that U.S. insurance will be, has been a loss making in fact because of the expense side rather than the loss side of the combined rates equation and is projected to be breakeven probably towards, again probably next year, with the better underwriting market will be faster with the worst that might be a little. So, but I don’t think longer than the end of 2014. What else then I want to touch on, well, really I don’t see there is enough a lot of point to me reading et cetera and numbers that you can read for yourself. I told that for full year 2012 an operating ROE of 8.5% is less than we hope to do that’s we can achieve. $25 billion or $28 billion depending new list of Sandy loss, cost (inaudible) at the beginning of the year, pretty poor investment returns and underwriting pricing is getting better, but if by no means of our market those things make be say 8.5 into [savvy].
I think, I’m going to wind up and say really I am running a company that knows how do better than 8.5, and it’s going to be doing better 8.5. And if that’s okay with Jay, I am going to leave it there and move to questions.
Jay Cohen – Bank of America Merrill Lynch
Of course it sounded, as if you wanted to start a bit of a blank slate and say let’s really think about this business differently. And I could see some of the changes that you’re planning to get to that 10% ROE. Once you did mention was M&A and whether it’s buying someone merging with someone else that’s a bit more out of the box, does that come up at all in the conversations with your executive team?
It does come up, the first improved reality here is we have been trading at a substantial discount to book value for sometime. So, I think you look at M&A and look in a strategic way and you look at the financial way. And I think if you trading at 0.7, we’re a bit better now we’re 0.85 or so and all of that but that points I said [in the book] you destroy value by making acquisitions probably, we’re not in business to do that, so it kind of stays off the table. If you have a strategic debate it’s a little different, I think I have said enough just now this day, we have a London market platform, it’s scaled, it’s sensible, but there are, our market share and some of those things we really like in London is quite small, how would we win more of that business, I don’t think it would be easy. In fact, it would be very tough to win it from competitors by being cheaper; we don’t want to do that. So, actually acquisition is interesting, so we constantly look at smaller Lloyd's syndicates, where we think cost to compliance is going up solitude, I wish, I can have to mention solitude, it is completely not a piece of shareholder friendly regulations, it is I don’t even know it is consumer friendly actually.
But you guys see and this is going to pay for it and the cost of it is recons would be €3 billion, €4 billion and up, small companies, all companies are suffering, small company suffer even more, because it’s not really scalable with the expertise, so we just wonder whether there is some guys who will be better often part of us, we got the infrastructure to do that. Elsewhere strategically speaking, we’re building U.S. specialty insurance business, we’re building in parts, if there were parts that we could acquire not small $100 million acquisition that sort of thing that would accelerate the path we want to go down I think that’s interesting.
And then finally, on the reinsurance side, I think I had cover the U.S. but I said growth in the growth markets, if we can find small company, small reinsurance with a local franchise with some quality that’s of interest to it, there are not too many of those out there.
Jay Cohen – Bank of America Merrill Lynch
One of the observations we had during the renewal season was that the pricing in the U.S. seems to be responding better to the ROE pressures than we see in London. First of all, do you agree with that and secondly if that’s true what do you think that is. Do you have a kind of unique perspective here?
I think it is certainly true, look what I might do is not such contract with the U.S., London as the U.S. with the Europe, because if London looks at a wide range of international. It is true, I mean, I don’t want to give bad news at the end of your day, but the rate reductions in property CAT reinsurance in Europe is one, one. At the same time Sandy influenced, going up I thought was very disappointing.
Why that first of all, I think European pricing never went up as much as U.S. pricing did in the 2001, 2004 period. When the U.S. started falling, it fell very fast U.S., Europe we didn’t pull quite as fast. In fact, I’d say probably it didn’t we know that it didn’t. Now I think that some, the some feeling in the U.S. we’re going to get back some of that currently loss just in underwriting sense as well as compensating for the lack of investment income.
And Europe forfeiting is we haven’t got such a big problem now that maybe part of it. I’ll tell you another low storage is very briefly somebody it influenced me in my life was Founder of McKinsey, Marvin Bauer and he said you would ask question, why are U.S. companies more successful than European companies. Are you U.S. capitalism at that time (inaudible). He said in America, we just get things done. In Europe we form a committee to think about it, debate it and after couple of years of consideration you might decide to do it or you might move on to the next committee. And I think there is that kind of this attitude in America is pretty much, we got a problem let’s address it, let’s fix it like that. And the European attitude is little bit more, we have a problem, let’s examine and wait and see mix kind of maybe cultural, I don’t think it’s very profound it’s about best practicing I can do.
Jay Cohen – Bank of America Merrill Lynch
Going back to the exposure reduction, could you explain it in terms of the change in your PML, say one in a 101 to 250, what percentage of capital of our shareholders equity will it consume before the change and after the change and then second, how quickly will you implement this process of reducing your exposure?
Okay, I’ll give, these are bit of your question in second, but I’ll do that first, short answer as quickly as possible, but that’s not necessarily very quick, because the same brokers that we’re not going to providing property policies for in the future of the same guys some extent to bringing this products that we do, that we do want to sell, selling price, selling on the liability side, on the professional manger liability in the marine. So we’re going to treat careful cautiously. On the call, we said about $140 million capital released in the two year period bit more on top of that in the first year, we said about $200 million or actually over $200 million of PML reduction of capital released ultimately that would be, that will be completed.
It’s about dollar for dollar, you take our $200 million PML, you take out $200 million of CAT is about the same thing. So, the question therefore is what they do to our overall PML, but we’re giving you a I think, hopefully not a, and hopefully settlement, but when we trading at 0.7 of book and U.S. CAT pricing a few years ago was quite low, it was very clear what the economically superior thing to do was buyback shares. Since then, property CAT, especially U.S. property CAT has become rather better priced. And our share price has also moved up, so you got to review around the numbers, you’re going to think what’s the economic benefit of the share buyback, what’s the economic benefit of investing capital in the business, some of that 200 plus million, it might be more sensible to redeploy in similar payrolls, but on the reinsurance side. Obviously, if we did all of that, I don’t think we will, then there would be no P&L impact at all in the company.
We just would be selling the same amount of capital in the same way. What actually I think, I think it’s less likely, but I think probably some of that 200 plus will get redeployed into another area of the business, property CAT reinsurance and the majority will come out of the business and whatever comes out, less than 200, but say way more than a 100 to 150, we’ll use to buyback shares, now that comes straight of the P&L, and then the P&L percentage is really expressed on smaller capital base. Long answer, but the reason for longer answer is you actually have to do the sums every quarter to see which is the better way to proceed on that.
Jay Cohen – Bank of America Merrill Lynch
That’s all we got. Thanks.
Very good. Well, thanks for listening. Thank you.
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