Transatlantic Holdings, Inc (NYSE:TRH) Q3 2011 Earnings Call October 27, 2011 ET
Tom Cholnoky - SVP, IR
Bob Orlich - CEO
Mike Sapnar - President
Steve Skalicky - EVP & CFO
Josh Shanker - Deutsche Bank
Ron Bobman - Capital Returns
John Hall - Wells Fargo
Good day and welcome to the Third Quarter 2011 Transatlantic Holdings, Inc. Earnings Conference Call and Webcast. All participants will be in a listen-only mode. (Operator Instructions) After today’s presentation there will be an opportunity to ask questions. (Operator Instructions) Please note this event is being recorded.
I would now like to turn the conference over to Tom Cholnoky, Senior Vice President, Investor Relations. Mr. Cholnoky, please go ahead sir.
Thank you. Good morning and welcome to Transatlantic Holdings’ earnings conference call to discuss results for the third quarter ended September 30, 2011. You can access a copy of our press release and accompanying financial supplement on the Investor Information page of our corporate website at www.transre.com.
Leading today’s call will be Bob Orlich, Chief Executive Officer; Mike Sapnar, President and Steve Skalicky, our Chief Financial Officer. After prepared comments, we will open the call for questions.
Before we begin, I note that we will refer to certain non-GAAP financial and operating measures on today’s call. We provide reconciliations of those figures to their most directly comparable GAAP measures in our press release and supplement. In addition, comments made on today’s call may contain forward-looking statements. These forward-looking statements are based on current assumptions and opinions concerning a variety of known and unknown risks. Actual results may differ materially from those contained in or suggested by such forward-looking statements.
Transatlantic’s filings with the Securities and Exchange Commission contain a description of the business environment in which Transatlantic operates and the important factors, risks and uncertainties that may affect its business and financial results.
With that, I will turn the call over to Bob Orlich.
Thanks, Tom, and good morning everyone. Before we discuss our third quarter results and our outlook, I want to briefly comment on our strategic review process. On September 16th, we announced the Transatlantic and Allied World mutually terminated our merger agreement. Although the Allied World merger offered strategic and financial benefits, ultimately it became clear that our stockholders would not approve this transaction.
We have said that we will entertain and evaluate any serious proposal or opportunities that offer our stockholders full and fair value. We have entered into confidentiality agreements and discussions with Validus and two other parties regarding potential alternative transactions. We appreciate the dialog we’ve had with our stockholders over the pass few months and want to emphasize that our Board is committed to delivering enhanced value via true transaction or on our standalone plan.
We continue to strongly believe in our standalone prospects and believe that we can deliver significant value by executing on our business plan. To that end, we announced on September 16 that our board approved $600 million share repurchase program, which added $455 million to the company’s then existing share repurchase authorization. Our plan calls for repurchasing $300 million worth of shares through December 31 and the remaining $300 million during 2012. Through October 21st, we have repurchased about a $165 million of our common stock under the new authorization.
We continue to be actively involved in the strategic review process, though there can be no assurance that the discussions currently under way will result in a proposal or a transaction. While we continue to be diligent and throughout our discussions we are also fully committed to reaching a conclusion to this process expeditiously.
With or without a transaction, we have a business to run and the January 1 renewal season is the most critical business period for any reinsurance company. Our teams in New York and on the grounds throughout the world are sharply focused on the job of serving our clients and partners, as always, and I want to thank everyone for their patience and professionalism during this period.
With those comments, we are now going to turn to the purpose of today’s call, we chose to discuss Transatlantic’s third quarter earnings results. After we have completed our prepared remarks, we ask you that you please limit your questions to our financial results. Thank you for your understanding.
Our results for the third quarter were largely in line with the ranges we pre-announced in mid September. The third quarter included a couple of important developments that significantly impact reported results. These include cost related to our strategic activities in the quarter including the termination fee and expense reimbursement paid to our growth as well as the arbitration settlement with the United Guaranty Company. That settlement is included in our underwritings results for the quarter and Steve will detail the impact in his comments.
Notwithstanding these developments, the quarter was generally solid in light of the active catastrophe environment and softer pricing conditions in other parts of the market. Book value per share at September 30 stood at $69.67, up about 3% from June 30 and up 1% from the year-ago third quarter.
We wrote over $950 million in net premiums and produced net operating income per diluted share of $0.93. Our annualized operating ROE was 5.5%. Our combined ratio for the quarter was 94.3, roughly flat with the year-ago third quarter. As we get into the busy 11 renewal season market conditions and rates remain relatively consistent with the trends that have been in place throughout the year. Mike will speak to the underwriting climate in more detail, but overall it remains a challenging market that requires focus, discipline and strong underwriting expertise.
Our people on the ground in 24 key insurance and reinsurance markets worldwide are doing what they always do, applying the collective strength of what we think is the best global underwriting team in the business. This team is the core of the reinsurance franchise that has produced consistent records of book value growth through every kind of market cycle over our 30-year history and it is a group that I’ve been proud to serve as CEO for the last 17 years.
As announced last month, I am planning to retire at the end of the year. I want to take this opportunity to thank everyone who has supported the company and me over the years, most particularly our 600 plus employees around the world, many of whom aren’t just colleagues but close friends. I also want to congratulate Mike Sapnar. Transatlantic will be in terrific hands under his leadership. That concludes my comments and now I will turn it over to Mike.
Good morning everyone and thank you Bob for the kind comments. It’s difficult to put in words just how much Bob has contributed to building the company over the years, and he is a great mentor and friend. We look forward to Bob’s continuing contribution as a member of the Board.
I’ll start with a review of catastrophe costs in the quarter. Pre-tax cat costs were approximately $71 million, less than half of this amount stem from the third quarter event, with the Danish floods at about $18 million and Irene at about $40 million.
The balance reflected increased costs primarily first quarter 2011 event including an additional $21 million in New Zealand and $8 million in Japan.
Net premium volume of $956 million in the third quarter was down year-over-year by about 5%, reflecting overall market conditions and our desire to remain selective. The decrease is primarily in our domestic book of business and was somewhat offset by higher premiums internationally. Looking more closely at the property market, US property has seen rate gains driven by the impact of RMS 11 and regional cat activity in 2011.
Areas of strength include personal lines, particularly in Florida where the market has seen its second round of double-digit rate increases in the last year. Onshore energy has also seen a positive rate trend.
That said, the tough economy is making it somewhat difficult to sustain rate increases, particularly in areas like California earthquake cover where there's significant capacity. Overall our US cat book has seen modestly higher risk-adjusted rates heading into January 1 and stable terms and conditions giving us a positive outlook on the margins associated with this business.
As we've discussed for much of the year, catastrophe and direct property rates in quake-affected zones remained strong. Rates in both New Zealand and Australia are up well into double digits with more increases possible in light of losses that have crept up throughout the industry. Our rate experience in Japan is similar and we are seeing higher wind and flood cat rates in addition to quake.
Marine, haul and cargo have also increased sharply following the Japanese quake. Though outside of Japan these lines remain generally flat. In Hong Kong which is unaffected by significant activity this year, rates have been muted across most lines, but we are seeing good underwriting performance.
London and Continental Europe catastrophe and traditional property rates are generally unchanged except for loss affected zones and finally Latin America remains active with modest expected increases in property rates at 11 but the market continues to be competitive.
Turning to specialty casualty. D&O and E&O both remained very competitive globally. Looking first to D&O. Market volatility and the sovereign debt crisis are reversing the trend of recent rate pressures on the financial institution side. The pristine accounts are renewing at or close to expiring but more challenged accounts are seeing significant rate increases.
Rates are less favorable on the commercial side including A side covers with good accounts still getting 5% to 7% rate decreases. Security class action suits filed in 2011 are flat with last year and remain below 10-year averages.
Errors and omissions coverages remain a tale of two markets, where a lot of capacity is facing the smaller risks, the exceptionally small law firm business. We’re seeing flat to higher rates for more complex risks. We think this offers us opportunity given our historic strength in the category. Overall, E&O remains profitable despite the competitiveness although economic conditions have led to increased frequency with severity remaining stable.
Competition is probably in medical malpractice as well, but the visits remains attractive from a margin standpoint particularly on the physician side where we specialize. Frequency trends remain favorable and severity trends remain below expectations.
That said, we look more positively on domestic opportunities at present and have reduced exposures selectively in Europe. Overall rates are down in the low to mid single digits. Rate pressure is more prevalent on the hospital side down in the 10% range on renewals.
Accident health rates are keeping pace with claims trends and while the business is competitive results have been good and it continues to be in area that view favorably. The trade credit market remains very disciplined on the underwriting side, but we are seeing some competition for the best quality business. Political risk underwriters remain disciplined in an uncertain environment with exposures down on improved rates.
Our domestic surety book continues to perform well. Our global general casualty business remains mixed. International general liability umbrella is still highly competitive and generally unattractive. Domestically, these lines continue to perform well and we are beginning to see some modest upward rate movement particularly on regional business and to a lesser extent umbrella business.
So I would summarize by saying the overall market conditions remain mixed moving toward one-one, but with health and positive activity in the number of various where Transatlantic is well-positioned. Cat rate environment has unfolded largely as expected over the year and response to significant losses and the difficulty of adjusting to drastic model changes. Our specialty casualty business remains solid while early signs of improving general casualty trends domestically can only be a plus.
I’ll turn the call over now to Steve for the financial discussion.
Thank you, Mike. As Bob mentioned earlier, three significant items are reflected in the results of the third quarter and I would like to call those quickly.
First, after-tax catastrophe cost of $46 million which is net of $25 million of the tax benefit. I would note that in the year ago period, we recorded after-tax cash catastrophe cost of about $7 million.
Second, merger and strategic review related costs of $57 million which included $48 million in termination fees and expense reimbursements paid to Allied World. Given that the strategic review process is ongoing, the great majority of these costs have been treated has non-tax deductible at this time. If no qualifying transaction takes, place additional tax benefits of $21 million related to those costs that are not presently deductible will be recorded in the future periods.
And third, the negotiated settlement of arbitration proceedings with United Guaranty Company’s which resulted in a pre-tax benefit of $45 million. The settlement impacts are underwriting results by reducing losses incurred by $61 million and reducing net written and earned premiums by $19 million and commissions by $3 million.
Turning to the results, the third quarter net operating income totaled $59 million or $0.93 a share on a diluted basis. Year ago net operating income was $127 million or $1.97 per share.
Net income in the third quarter was $68 million or $1.06 on a diluted per share basis down from net income of $134 million or $2.08 per share in the year ago period. Our combined ratio was $94.3 for the quarter versus $94.0 in the year ago period.
Our underwriting performance in the current quarter included $83 million of net favorable reserve development including a $61 million rising from the UGC settlement. Third quarter 2010 results contain $13 million of favorable reserve development. The nine month period favorable reserve development totaled $110 million in 2011 compared to $35 million in 2010.
Net premiums written in the third quarter, we’re inline with our expectations at $956 million. Operating cash flow in the quarter was $156 million reflective of a high level catastrophe loss payment principally from the Japan earthquake and merger cost most of which were paid during the quarter.
Net investment income was $118 million versus a $124 million for the same period in 2010 as a result of a decrease in income from alternative investments. At the end of the quarter, 93% of our investment portfolio was invested in fixed maturities with approximately 96% of such securities rated A or better, 72% AA or better. Our fixed income portfolio has an average duration of approximately 3.1 years.
Taking a quick look at the balance sheet, we ended the quarter with total assets of $16.6 billion, loss reserves of $9.7 billion and total stockholders equity of $4.3 billion. Book value per share increased approximately 3% in the quarter to $69.57 at September 30th. This includes an increase of $48 million of unrealized depreciation of investments, net of tax due to the reclassification of bonds in the held to maturity portfolio to available for sale. The change will allow a greater flexibility in managing our investments in future periods.
On September 16, we announced a $600 million share repurchase program with the commitment to repurchase $300 million of our shares through the end of 2011 and the remaining $300 million in 2012.
As the market closed last Friday, October 21, we had utilized approximately $165 million of the repurchase authorization, including $41 million prior to the close of the third quarter.
With that, we’ll open up the call for questions, Operator?
Thank you, sir. We’ll now begin the question and answer session. (Operator Instructions) And the first question we have comes from Josh Shanker of Deutsche Bank. Please go ahead.
Josh Shanker - Deutsche Bank
I (inaudible) talking on your -- I realized that you may dampen the conversation a little bit but, but this whole story, the striking storyline on the M&A front got started when you and Allied World thought it would be agreeable to come together. To what extent is your desire to go alone, if need be, stronger – so what is there -- are you looking for a partner?
No. I think we’ve been fairly clear with what we expect out of any transaction. I would like to say Josh that we are pretty much prepared to discuss what we are able to discuss because of confidentiality agreements, we’ve already discussed it you know at the beginning of the call.
Josh Shanker - Deutsche Bank
Yeah, I just wanted to understand your appetite in general, do you desire to do a deal?
Our appetite in general is if it improves shareholder value and shareholders get fair and reasonable value, we’ll entertain any transaction that comes our way. I can’t elaborate you on that.
Josh Shanker - Deutsche Bank
Okay. Okay. And in terms of -- I am wondering if you can give some discussion on what you are hearing about our yearend renewal prices. There is a lot of feedback which I have been finding sort of surprising out of [Baden-Baden] and what not, maybe you have some thoughts there?
I think for January 1 we are expecting loss affected cat business to have meaningful rate increases. I am not sure internationally that we are going to see big rate increases in non- loss affected zones, but there are model changes going on throughout the international book as well that will continue to change some of your modeled output. You know Europe has had a pretty decent run in the peak zones. It’s been really non-peak zones where there has been loss activity.
I think anything with a multi-zone or non-peak area is going to have upward rate increases on the property cat side. In the US book, there are -- we are expecting, you know, as we’ve said really around 10% on average again depending the regional businesses had more loss activity than some of the national accounts. Homeowner’s business is getting rate in general in the US and specifically in Florida. So we think that’s a positive movement.
The version 11 of RMS is not fully played out. It has been slow to make its way through portfolio loss estimates -- projected loss estimates and even into reinsurance programs. So I think that will continue to be a headline feature at one-one and beyond. In general, we think the overall cap up will be up although the problem we -- varied in different areas.
The casualty made a pretty mix bag. It depends on what part of the world and what line of business. Some of the motor rates in Europe particularly in the UK have gotten significantly price increases, but on the comments that’s been not the case. To delve internationally, we don’t see really much signs of improvement from what we said.
Specialty casualty business has had some improvement on some of the smaller business ironically like the non-profit DNL in the US where there has been a lot of EPL claims, but the larger accounts especially the commercial accounts still remain pretty competitive. You know it remains a mix bag. We don’t see any areas where there is significant downward pressure, but the meaningful upward pressure has been selective.
(Operator Instructions) The next question we have comes from Ron Bobman of Capital Returns.
Ron Bobman - Capital Returns
Good morning. I got on the call late. I am sorry I surely missed the long ceremony and congratulatory statements and pomp that I am sure, Bob. But probably going to have 90 days for that, I would imagine. In any event, I assume this is your last call, Bob. Thanks a lot for all the help and beautiful business you build and grown over the years?
You quite welcome thank you. Thanks.
Ron Bobman - Capital Returns
I just had one question. The various frequency of cats that hit the U.S. this year with the tornadoes and Irene, I am curious when you look at the losses that have come from that, and not for your book really but for the industry, how would you say RMS 11 estimated those in the sense, did this -- the cat events and the losses that came from it in any way validate portions of RMS 11 or is it not in indicative, it’s not like a fair question, any sort of thoughts as far as the loss activity put up against RMS 11? Thanks.
Sure, it didn’t – now the tornado losses really are modeled events. So it’s hard to look at those against RMS 11 and flood is not really a modeled event. So, I am not sure that the frequency that we saw on the regional business really is manifest or I guess captured within RMS 11 in my view.
What is interesting to me is just living in the northeast and sitting in my house for Hurricane Irene, well which turned out not to be a hurricane, but still if you still saw the damages and the flooding and what happened in certain areas, you have to say that maybe RMS version 11 is probably more accurate than before based on the values, some of the older construction and the damage that was done just from a tropical storm that passed its way through the northeast.
So there are not a lot of recent storms to test the model the way we have through Ike and Katrina and some other things and even some Florida losses. So I think the Northeast remains a very big question mark and certainly the increase in expected loss inland in the Northeast is probably something that’s really worth considering.
Ron Bobman - Capital Returns
Okay. Thanks a lot for your thoughts. I’ll ask another question. I asked D&Os this -- a bit senior thoughts and make sure if you any sort of changes to your action plan, public company D&O rates have been stubbornly declining, and I am wondering why you think that is the case and I also believe that trends like has been a pretty consistent supporter of some -- some of the best writers in that business. Do you have any plans to change the magnitude of your support for that line?
Well, we’ve been changing our involvement in that line, if the domestic premium decrease in the quarter which was pretty significant is largely driven in the D&O area. And it’s really twofold. It’s actually, probably three-fold. The first is clients retaining more because the business has been good. The second reason is we’ve cut back as we’ve become concerned with some rate decreases that have been continuing. And the third is the clients have, at least our clients have cutbacks. So, the ceded premium to the treaties has gone down, relatively, meaningfully. So, you can’t have three drivers that have pushed that down.
Ron Bobman - Capital Returns
I sort of guess, that it’s not going to change because like you start up by saying the results have being good?
We would say that that trend for Transatlantic in terms of cutting back that book is expected to continue, absent any sort of major change in the market. We’ve had frequency that is better than expected in terms of class action suits. And that drives well over 75% of the loss cost for the public D&O sector.
D&O is really more similar to cat business than it is to other casualty business. It’s kind of like, you know that your loss pick is never going to be spot on. You are either going to be probably significantly below or significantly above depending on the class action suits and the market cap drops.
So, you can get fooled into thinking that it’s very good business just because there are no ‘cats’, just like you really don’t know how good your cat portfolio is until the loss happens because otherwise it’s all margin. It’s similar that way on D&O in our view. We think frequency and severity have been down because there's a lot of different reasons including attorneys, it’s harder to bring new things anymore. They are very costly, people don't have the money, they are just throwing suits and make them go away.
They are saying basically how about it. That makes it a more of a speculative venture as opposed to just a continual churning of D&O suits. Market cap has been down from the peaks and I think for the financial crisis what you saw is that everybody kind of wound up beaten up, nobody stands out and then it’s harder to prove where you’ve made bad business judgments that have contributed to losses or you know center which shows intent.
So I think those are all reasons why the D&O business has performed well, I think like a lot of casualty business. Nobody would sit there and look and say this is really great priced business, greatly priced business but against the loss cost trends it’s performing. At some point that changes.
And the next question we have comes from John Hall of Wells Fargo. Please go ahead.
John Hall - Wells Fargo
But the question that I have has to do with property reinsurance and specifically on reinstatements. It seems that out of New Zealand and perhaps other cat seasons you are seeing events coming on top of each other, I just wanted you to comment or just share your views on whether reinstatement premiums are actually being priced appropriately or given away in the context of property cat coverage?
I don’t think they’re necessarily being given away. I guess you have to look at frequency and when you have it similar almost to the – again I'm going to draw another analogy between and D&O and [CapEx] you know, in the soft market in 90s D&O policy started offering free reinstatements on the aggregate limit because D&O was not viewed as a frequency cover, much like cat business is not viewed as a frequency cover.
So when you get sort of this period of increased frequency, it’s unexpected and it might be undervalued in that standpoint if you think you’re going to have multiple earthquakes or multiple hurricanes in the same spot.
It’s hard with New Zealand because they can't even get into the central business district yet and who knows what part of the loss is coming from what event at the end of the day. The reinstatement premium is generally all priced in based on model expectations. If you miss those expectations that look underpriced, but I am not sure they’re being given away.
The more interesting thing of the aggregate covers which is also a frequency type of a cover that typically come in below [suitors’] core programs. And I think a lot of people are out there looking to buy or have bought aggregate covers and those tend to be difficult to price and in some cases in our view are given away. So it’s…
Well it appears that we have no further questions at this time. We’ll go ahead and conclude our question-and-answer session. I will now like to turn the conference back over to Bob Orlich for any closing remarks. Mr. Orlich?
Well thanks operator and now its time for me to thank you. You know in closing, I would like to say thanks again to everyone on the call for their support of Transatlantic in my time here. It really has been a great ride and whatever the future holds this is a remarkable company with a terrific franchise and is in a really strong position to deliver for its clients, partners and stockholders. Now with those comments I wish everyone a good day. Thank you very much for joining us.
And we thank you sir and we thank you to the rest of management for your time. This will conclude today’s conference call. We thank you all for attending today’s presentation. At this time you may disconnect your lines. Thank you.
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