One Beacon Insurance Group Q4 2008 Earnings Call Transcript

| About: OneBeacon Insurance (OB)
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One Beacon Insurance Group (NYSE:OB) Q4 2008 Earnings Call February 6, 2009 10:00 AM ET


T. Michael Miller – Chief Executive Officer, President

Paul H. McDonough – Chief Financial Officer

Todd Mills – Treasurer and Vice President of Investor Relations


John Fox – Fenimore Asset Management

[Sarah Dewitt] – Barclay’s Capital


Welcome to the OneBeacon Group's Fourth Quarter and Full Year 2008 Financial Results webcast. This call is being recorded at 10 am Eastern Time, Friday, February 6, 2009. All participants are in listen only mode.

At the conclusion of the prepared remarks, we will host a question and answer session. Now let me turn the call over to Todd Mills, OneBeacon's Treasurer and Vice President of Investor Relations.

Todd Mills

Thank you and good morning. On behalf of OneBeacon's management team, welcome and thank you for joining us as we review our fourth quarter and full-year 2008 financial results.

Today's call is being hosted by Mike Miller, our Chief Executive Officer and Paul McDonough, our Chief Financial Officer. I'll be joined during the Q&A by other members of senior management.

We released our fourth quarter and full year results earlier this morning. Our press release, today's slide presentation and our financial supplement are available on the Investor Relations section of our website, An audio replay of today's webcast will be available on our site following this call.

Turning to slide two; let me remind you that any statements we make during today's call that are not historical facts constitute forward-looking statements. These statements are made based on certain assumptions and analysis made by OneBeacon, in light of our experience and perception of historical trends, current conditions, and expected future developments, as well as other factors. However, actual results may differ materially from expectations.

Please refer to the summary of risk factors at the end of our earnings release, as well as the detailed list of risk factors contained in our annual report filed on Form 10-K for the fiscal year ending December 31, 2007, filed on February 29, 2008. In addition, any forward-looking statements represent our views only as of today, and should not be relied upon as representing our views as of any subsequent dates.

Slide three; during this call we will refer to non-GAAP financial measures. These non-GAAP financial measures are not prepared in accordance with generally accepted accounting principles. A reconciliation of the non-GAAP financial measures, for the most directly comparable GAAP measures, accompanies the press release financial statement, and is provided in the financial supplement posted on our website.

Now I can turn the call over to Mike.

T. Michael Miller

Thank you, Todd and good morning everyone. We were disappointed by the decrease in OneBeacon's book value for both the quarter and the year, which was primarily driven by our investment losses. This outcome reflected the unprecedented downturn of the capital markets during the second half of the year.

As we noted on our last call, we have successfully repositioned our portfolio through the sale of equity holdings, which Paul will discuss in some detail later.

We did have a very solid underwriting year, our underwriting results from all of our businesses, delivering a combined ratio of 86% for the quarter and 95% for the full year. All in all, I'm very pleased with our operating results and confident that we're well positioned for 2009.

Turning to slide five; our fourth quarter and full year non-CAT accident year results were quite good. CAT losses for the year included our Gustav and Ike claims from the third quarter, but our solid, full year combined ratio includes about a half point higher than normal CAT losses. Again, overall a very good result.

We continue to see favorable development on prior accident year losses, particularly in our professional liability book of business.

There has been no meaningful change in our overall trends regarding frequency and severity that we talked to you on each of our calls in the past. Our expense ratio continues to trend at roughly 35%, consistent with our expectations. We have reduced our OUE expenses over the past two years, but our mix shift, most notably the collector car business, has driven higher acquisition costs.

On slide six, a highlight for us was the strong growth we experienced throughout the year due to our specialty focus. Our specialty lines businesses grew by an outstanding 63% in the fourth quarter, and 41% for 2008, with a significant amount of that growth coming from our collector car and boat business that we talked to you about in the past. Other specialty lines grew by a healthy 35% for the quarter, and 16% for the year, net of that collector car business.

Our commercial lines premiums were down 2%, as we selectively elected to de-emphasize new business due to unsettled market conditions, and our view that many new accounts were underpriced.

In personal lines, almost half of our shrink was driven by the decreasing volume of involuntary business written through AutoOne and premiums associated with our former territories outside of the Northeast.

Turning to slide seven; specialty lines had a terrific quarter, with a low level of non-CAT losses, which helped full year results as well. We saw favorable development, as I mentioned, at OneBeacon Professional Partners on the prior accident year claims that continue to perform better than we expected.

The expense ratio continues to reflect our investments in new businesses, with the majority of the increase driven by higher acquisition costs which I mentioned on our new MGA relationships, but the overall combined ratio for this business, including that expense ratio, remains outstanding.

Turning to slide eight; we saw a meaningful improvement in the renewal pricing at OneBeacon Professional Partners in the fourth quarter. Remember as you look at the chart, that the third quarter, excluding a couple of large accounts, was roughly minus ten on the pricing.

For our marine business, rates remained flat. IMU was challenged this past year, but remains disciplined in what proved to be one of the most competitive for the marine insurance marketplace. Our retentions held steady with prior periods, trending in the mid-80s for OBPP, and the mid-70s for IMU.

New business continued to be the story for our specialty lines, with impressive growth in these target segments. The collector's car program brought in $110 million over nine months, with most of the business written in the second and third quarter consistent with the historical seasonality of this business.

Our emerging specialty businesses such as accident and health, Entertainment Brokers International, and OneBeacon Government Risks, also contributed nicely to that growth.

Turning to commercial lines; commercial lines delivered strong non-CAT per an accident year results for the quarter, reflecting the strength of the underlying book of business that continues to perform very well.

Full year results, although very solid, were impacted by the weather-related losses experienced during the first quarter and the third quarter, but compared to last year – remember that in 2007, we had an unusually low level of large losses. We are quite pleased with the 58% non-CAT accident year loss ratio.

We saw favorable prior year development again this quarter, reflecting strong and conservative historic reserving practices. Expenses are showing improvement, based on actions taken over the past year.

Turning to slide ten; pricing is beginning to show very gradual improvement, a trend that we expect to continue. On a pure rate basis our middle market pricing was down 4% for the quarter, and 6% for the year, while small business pure rate was down 2% for the quarter and 3% for the year.

Due to our confidence in our current book of business, we have focused on keeping our best accounts, and we're pleased to see improving levels of retention in the quarter. As previously mentioned, we are comfortable with our declining new business level in the fourth quarter, which is completely based on price level adequacy decisions.

Turning to personal lines on slide 11, the First Alliance current accident year non-CAT results were good, especially given the market conditions. 2008 for our Northeastern personal lines book was a relatively quiet CAT year. We also continued to drive expense ratio improvements as you can see, as a result of our repositioning personal lines to a Northeastern only business, which will allow us to be more competitive going forward.

Turning to slide 12; in personal lines the market remains competitive. Our pricing trends held steady with prior quarters, and we continue to benefit from rate increase filings in the majority of our territories. Retentions remained on track, and the lower policies in force for Pip counts continued to reflect our exit from the homeowners' surplus lines business in states outside of the Northeast.

In the fourth quarter, we saw an improving flow of new business related to our enhanced package product launched in New Hampshire, New Jersey and Rhode Island. We will be introducing this package product in Massachusetts in 2009.

Now with that, let me turn it over to Paul who will discuss our investment results and capital management.

Paul H. McDonough

Turning to investments then, as outlined on slide 13, our investment portfolio generated an after-tax loss of $210 million in the fourth quarter. Most of this loss was driven by other than temporary impairment and other net realized losses on our equity investments.

It also reflects additional unrealized losses in our fixed income portfolio, driven by general spread widening during the period. Net investment income in the quarter was adversely impacted by the inflation adjustment related to our inflation-indexed treasury securities.

This adjustment has ranged from a positive half a million in Q1 '07 to a positive $7 million in Q3 '08 and has averaged a positive $3.5 million over that period. In the fourth quarter of this year it was a negative $5 million.

Regarding OTTI, our investment securities are regularly reviewed for impairment, based on criteria that include the extent to which cost exceeds market value, the duration of the market decline, the financial health of and specific prospects of the issuer and our ability and intent to hold the investment to recovery.

As a result of this review in the fourth quarter, we impaired a number of equity investments, but virtually no fixed income securities due to the high credit quality of our fixed income portfolio and importantly, our ability and intent to hold these securities until recovery.

For the full year summarized on slide 14, our investment portfolio generated an after-tax loss of $390 million. The biggest driver of this loss was the change in the net on realized gain or loss position. Impairment and other net realized losses also contributed significantly to the loss for the year, again heavily weighted towards equity.

Turning to slide 15, relative to the Barclays U.S. Aggregate Index our fixed income investments under-performed in both the quarter and the full year driven primarily by our being underweight in U.S. Treasuries, which were far and away the place to be during the period.

Treasuries represent roughly 25% of the Barclays Index, as compared to only 19% of our portfolio. In addition, treasuries in the Barclay's Index are conventional treasuries, which were up 6.5% in the quarter and 11% for the year, while our treasuries are primarily inflation indexed, which were down over 5% in the quarter and 1% for the year.

Our corporate bonds which at year-end represented 41% of our fixed maturity investment, excluding cash and short-terms, generated negative returns in both the quarter and the year reflecting general spread widening, but performed reasonably well in relative terms and importantly avoided any significant credit losses.

Our structured product portfolio, which represented 35% of fixed maturity investments at year end, also performed well in relative terms with no sub-prime, no CDOs, no CLOs and very limited [All Bay] securities.

On the equity side we under-performed the S&P in the quarter and year-to-date, driven by the performance of our common stock holdings with convertible bonds and alternative investments out-performing the index.

The under-performance in common stocks for the full year was driven primarily by our overweight position in materials, primarily gold stock, which historically had performed well in bear markets, but which simply did not perform well in 2008, and to a lesser extent our stock selection in the energy and utility sectors.

We also sold down a portion of our common stock holdings in the fourth quarter that was later proved to be near the lows for the quarter and the year. This appropriately reduced our risk going forward, more on that in a moment, but adversely impacted our returns versus the index in the period.

It's worth noting that excluding this impact, the portion of our investment portfolio managed by Prospective Partners, which includes most of our common stock and convertible bond holdings actually out-performed the S&P in 2008 by several hundred basis points, and over the last five years their portfolios have generated average annualized returns of roughly plus 8%, as compared to about minus 2% for the S&P.

Turning to slide 16; on the third quarter earnings call we indicated that we would reduce our equity holdings in the context of continuing economic uncertainty and continuing volatility in the equity market.

During the fourth quarter, we in fact sold and redeemed approximately $361 million of common stocks, convertible bonds, and hedge funds. This reduced our equity holdings from about $1.4 billion at September 30, to about $715 million at December 31, which reduced equities as a percentage of our total investment from 32% at September 30 to about 19% at year end, as outlined on slide 17. Our six maturity investments continue to be very high quality and relatively short in duration.

Turning now to capital management on slide 18, our shareholders' equity declined in 2008 by about $750 million. This reflects $195 million of special dividend and $69 million of share repurchase in the first half of the year, comprehensive net loss we reported in the second half of the year, driven by investments, and our ordinary quarterly dividends.

The decline in equity effectively took us from a fairly significantly over-capitalized position at the beginning of the year, to a more appropriately capitalized position at the end of the year.

Our stat surplus remains above rating agency requirements and our RBC ratios remain consistent with 2005 levels and actually better than 2002 levels. Having said that, we have less margin for errors than we did a year ago and so we have taken meaningful steps to reduce risks.

As already mentioned on the investment side, we significantly reduced the size of our equity investments. On the underwriting side we entered into a quota-share on approximately 27% of our northeastern U.S. homeowner's book, which significantly reduces our exposure to catastrophe losses.

With respect to our consolidated leverage, it's certainly higher than we'd like due to the decline in shareholders' equity, but we will work to reduce it going forward.

In the meantime we have plenty of liquidity. Our fixed charge coverage remains in line with our rating and with a coupon of 5 7/8 our senior notes represent a very cheap source of debt capital.

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

T. Michael Miller

Like many of you, we are happy to close the book on 2008, a year of unprecedented economic turmoil. Our investment results for the first time in our history were disappointing. Our investment partners anticipated things would get difficult, but we under-estimated just how bad.

In hindsight there were a few places to hide and we weren't in there. Until more stable footing is evident, we have de-risked our equity portfolio but believe better times will come. We're just not sure how soon.

Our underwriting businesses are performing well. We are appropriately capitalized and expect gradual pricing improvement throughout 2009, but many of our customers will be tightening their belts, which will be a counter-force.

We like our positioning in the specialized segments and our northeastern personal lines of business and stand ready for 2009.

And with that, operator, we would be happy to take questions.

Question-and-Answer Session


(Operator instructions) Your first question comes from John Fox – Fenimore Asset Management.

John Fox – Fenimore Asset Management

Good morning everyone. I have a number of questions; one on the investment portfolio, could you just go through the major holdings in the ABS area, which you said is about 1/3 of the portfolio?

Paul H. McDonough

Total ABS at the end of the year was about $759 million. The biggest piece of that is our mortgage backed securities, which is about $719 million. Most of that is in agency securities. The non-agency piece consists of about $112 million residential and about $127 million commercial, and then we have very little in the way of other asset backed, we've got about $40 million in credit card and nothing in auto.

John Fox – Fenimore Asset Management

Okay and could you talk about the hedge funds, what are the major strategies that you ran?

Paul H. McDonough

They're primarily equity-based strategies and for the most part don’t involve a great deal of leverage.

John Fox – Fenimore Asset Management

Do you have any short? Is any of it short or is it you guys running long-short in one fund or?

Paul H. McDonough

They're mostly long-short.

John Fox – Fenimore Asset Management

Okay and then I was just curious on the slide of the investment results, obviously I understand OTTI, you have other net realized losses of $144 million, is that just stuff that you sold at a loss?

Paul H. McDonough

That's exactly right.

John Fox – Fenimore Asset Management

Okay and then in terms of, you mentioned capital and you're, I guess, not where you want to be on leverage and that type of thing. You have a pretty high dividend payout, so how are you thinking about the dividend at this point?

Paul H. McDonough

We think about the dividend on a quarterly basis with our board. We think about it perhaps more frequently ourselves, and obviously, there are lots of trade offs associated with it and it is always subject to change.

T. Michael Miller

I would just say that clearly, given what happened on the equity side, the yield is quite high and that’s clearly a discussion that people are raising. We understand that and agree with that; having said that, we don’t expect to be at this position forever.

So at the moment in time that we look at it and it's part of our overall capital management and as we noted in the call, we feel that we’re appropriately capitalized and in a good position, relatively speaking on the business. So we’ll consider all aspects of the best thing to do with the capital.


(Operator Instructions). Your next question comes from the line of [Sarah Dewitt] – Barclays Capital.

[Sarah Dewitt] – Barclays Capital

I was hoping you could expand a little bit more on your comment that you think the capital position is adequate. Debt to cap is approaching – is about 39% in the quarter, could you talk about your comfort level on that and what the feedback from the rating agencies has been?

Paul H. McDonough

Sure, good morning. Yes the leverage is clearly high. It’s higher than we’d like. It’s higher than the rating agencies would like, but it is, nevertheless, one metric among many metrics and is not the single determinant of our rating.

At the operating company level, the capital inside the operating companies is above the capital required for our ratings, and so what I can tell you is that based on our capital position in its totality and based on our recent discussions with the rating agencies, including in the last week, the leverage by itself does not cause us to need to do anything in the very near-term to support the ratings.

[Sarah Dewitt] – Barclays Capital

Okay great, thanks and then could you talk about why you moved some of the reserves to runoff? What type of claims was this on and why it didn’t just run through the incurred?

Paul H. McDonough

[Sarah], I think you are probably referring to the reserve re-balancing that we did at the end of 2007.

[Sarah Dewitt] – Barclays Capital

Okay, that wasn’t in this quarter?

Paul H. McDonough

There was nothing in this year; we went through it in the press release, only to make a comparison to the prior year.

[Sarah Dewitt] – Barclays Capital

Okay great, thanks and then finally, could you just update us on what the investment performance has been so far year-to-date in 2009?

T. Michael Miller

Sarah, what I would say is so far in '09 early on, again we don’t have all the results in their totality, so I want to be a little careful on how specific you get, but I would say all in return is somewhere around flat.


At this time, there are no more additional questions in queue. I would now like to turn the call back over to Mike Miller for closing remarks.

T. Michael Miller

Okay, thank you all for joining us and we’ll look forward to talking to you next quarter.


Ladies and gentlemen, this concludes the presentation. You may now disconnect. Thank you and have a good day.

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