Endurance Specialty Holdings Ltd. (NYSE:ENH)
Q4 2015 Results Earnings Conference Call
February 4, 2016 9:00 a.m. ET
Gregg Schroeder - Senior Vice President of Investor Relations and Corporate Development
John Charman - Chairman and Chief Executive Officer
Mike McGuire - Chief Financial Officer
Ryan Byrnes - Janney
Mike Zaremski - Balyasny Asset Management
Good morning everyone and welcome to the Endurance Specialty Holdings' Fourth Quarter Earnings Results Conference Call. This call is being recorded. Your lines will be in a listen-only mode during today's presentation. You will have an opportunity to ask questions after the presentation and instructions will be given at that time.
I would now like to turn the call over to Gregg Schroeder, Senior Vice President of Investor Relations and Corporate Development. Sir, please go ahead.
Thank you, Lisa and welcome to our fourth quarter call. John Charman, Chairman and Chief Executive Officer and Mike McGuire, Chief Financial Officer will deliver our prepared remarks.
Before turning the call over to John, I would like to note that certain of the matters that we will discuss here today are forward-looking statements. These statements are based on our current plans, estimates and expectations and include but are not necessarily limited to various elements of our strategy, business plans, growth prospects, market conditions, capital management initiatives and information regarding our premiums, loss reserves, expenses and investment portfolio. Forward-looking statements are based on our current expectations and assumptions regarding our business, the markets in which we operate, the economy and other future conditions and involve inherent risks and uncertainties. A number of factors could cause actual results to differ materially from those contained in the forward-looking statements and we therefore caution you against relying on any of these forward-looking statements.
Forward-looking statements are sensitive to many factors, including those identified in Endurance's Annual Report on Form 10-K and Quarterly Reports on Form 10-Q that could cause actual results to differ materially from those contained in forward-looking statements. Forward-looking statements speak only as of the day on which they are made and Endurance undertakes no obligation publicly to update or revise any forward-looking statement, whether as a result of new information, future developments or otherwise.
In addition, this presentation contains information regarding operating income and other measures that are non-GAAP financial measures. For reconciliation of these items to the most directly comparable GAAP financial measures, please refer to our press release which can be found on our Web site at www.endurance.bm
I would now like to turn the call over to John Charman.
Thank you, Greg. Ladies and gentlemen, a very good morning to you all and welcome to our fourth quarter earnings call. Endurance delivered exception fourth quarter and full year 2015 financial results despite the backdrop of increasing global competition and an extremely challenging investment environment.
Our fourth quarter operating income excluding Montpelier related expenses was $121.9 million with an annualized operating ROE of 11.1%. On the same basis, for the full year 2015 operating income was $408.6 million with an operating ROE of 12%. Our combined ratios were an excellent 76.2% and 82.9% for the fourth quarter and full year respectively. These strong underwriting results reflect the high quality of our underwriting and risk management. They clearly show the benefits of the investments and improvements we have made with Endurance over the last four years.
The profile of our global businesses showed substantial improvements in 2015. The acquisition and successful integration of Montpelier provided great strategic and financial benefits to Endurance, including a good sized and scalable Lloyd's syndicate, a high quality enforced catastrophe portfolio and an established third-party capital platform.
Our total gross written premiums exceeded $3.3 billion in 2015, up over $770 million or 32% from 2012, mainly driven by a strong organic growth in our insurance segment. Our insurance business exceeded $2 billion in gross written premiums in 2015, up over $650 million or 46% from 2012. Our portfolio is now much more balanced and diversified across products and geographies and with the scale that we are beginning to achieve, we are starting to deliver insurance accident year combined ratios below 100%. Importantly, the investments we have made to expand our global insurance franchise are durable and sustainable and we have great momentum in the market.
Within our reinsurance segment, despite significantly re-underwriting and rebalancing our portfolio, we have grown our gross written premiums by 10% since 2012. As an example, professional specialty lines now represent 43% of the portfolio compared to 16% in 2012. The investments we are made in market-leading underwriting teams have significantly improved the quality and sustainability of our overall reinsurance business.
Our view almost 3 years ago was that market conditions would continue to deteriorate, competition would intensify and market consolidation would accelerate. These disruptive forces have been embedded in our business plan since 2013. Our targeted and deliberate product and geographic growth led by our expanded market leading underwriting capabilities with a strong reinsurance support has allowed us to profitably grow our business while navigating these extremely challenging market conditions.
Later in the call, I will provide some specifics on market conditions and our first of January renewal activity. First though, I will turn the call over to Mike to provide more detail on our fourth quarter results. Mike?
Thanks, John and good morning everyone. In the fourth quarter, Endurance generated net income to common shareholders of $91.4 million and $1.36 per diluted share which included $8.1 million of expenses related to the acquisition and integration of Montpelier. Full-year net income to common shareholders was $311.3 million and $5.73 per diluted share and it includes $76.6 million of expenses related to the acquisition and integration of Montpelier.
We expect to recoup these expenses in full through annual expense synergies starting this year. Excluding these costs, full-year operating income was $408.6 million and $7.52 per share representing an operating ROE of 12%. Our fourth quarter results benefited from improved underwriting profitability in both segments. Our overall combined ratio was 76.2% in the current quarter, an improvement of seven points compared to a year ago. This improvement was primarily from a lower loss ratio and our agriculture insurance business and light catastrophe losses in our reinsurance segment.
Within our insurance segment the fourth quarter combined ratio was 85.9%, an improvement of 11.9 points from the fourth quarter of 2014. Loss ratio improvement reflected more normalized results within agriculture insurance as 2013 and 2014 were impacted by our previously higher crop hail loss retentions and material declines in commodity prices.
The insurance segment's general and administrative expenses ratio increased 3.7 percentage points, reflecting lower net earned premiums on a slightly higher expense base in our agriculture line of business. This increase was partially offset by additional seeding commissions and increasingly scale in our other insurance lines of business. Overall, we expect our insurance segment's G&A ratio to continue to show marked improvements over the next two years. The insurance segment acquisition ratio was modestly higher than a year ago as a greater portion of earned premiums were from lines of business with higher acquisition costs. This increase was partially offset by the benefit of Montpelier premiums earned with no acquisition costs as they were written off under purchase accounting.
In our reinsurance segment the fourth quarter's combined ratio was 63.7%, 2.1 points better than the 65.8% reported a year ago. The reinsurance segment's loss ratio improved 2.6 points compared to last year as a result of very low cat losses and improvement in the specialty lines of business. The acquisition ratio improved modestly, primarily due to Montpelier acquired earned premiums that had no acquisition costs. The reinsurance segment's G&A expense ratio was two points higher in the current quarter due to higher year-end incentive compensation expenses as well as additional staff costs related to new employees from Montpelier.
Overall, gross premiums written in the fourth quarter were $515.6 million, an increase of 22.5% compared to the fourth quarter last year. The acquisition of Montpelier enabled us to write approximately $70 million of gross written premium in the quarter, split $50 million in insurance and $20 million in reinsurance. Of the $98 million of gross written premiums that Montpelier wrote in the fourth quarter of 2014, around $10 million was not up for renewal. So our retention rate was approximately 80% as we re-underwrote the portfolio. Overall, we expect to ultimately renew 60% to 70% of the total acquired [in force] [ph] book as we complete the renewal and re-underwriting of the portfolio due to first half of this year.
Within our insurance segment, gross premiums written were $432.3 million, an increase of $110.3 million or 34.2% from the fourth quarter of 2014 due to strong growth in our expanding U.S. and London insurance operations coupled with the addition of a Lloyd's franchise. Excluding agriculture, fourth quarter gross premiums written in insurance increased $124.5 million or 49.3% compared to a year ago. Agriculture insurance gross premiums written of $55.4 million, were down $14.2 million primarily due to commodity price reductions. On a net basis, non-agriculture insurance premiums written grew $85.4 million or 75.9% in the current quarter due to the increase in gross premiums and slight increases in retentions, mainly in professional lines.
Our increased total account coverage reduced the need for some of our individual product treaties. For the full year, insurance gross premiums written were $2.1 billion, an increase of 21.5% and our insurance premiums accounted for over 60% of company-wide gross premiums written. Excluding agriculture insurance, gross premiums written increased 46.5% over 2014. Within the reinsurance segment, fourth-quarter gross premiums written were $83.4 million, a decline of $15.6 million compared to a year ago. The decline was predominantly driven by reductions in catastrophe, property, specialty and professional lines. The reduction within property and catastrophe was largely driven by targeted non-renewals and deliberate and material line size reductions due to unacceptable deterioration in terms and conditions on a few contracts.
The reductions in specialty and professional lines were largely driven by premium adjustments, mainly in specialty as a result of worldwide commodity price reductions. These reductions were partially offset by renewals of previous Montpelier business. For the full year reinsurance gross premiums written of $1.2 billion increased $57 million or 4.8% over 2014 as growth in casualty, specialty and professional lines offset declines within catastrophe and property lines of business.
Why John will provide more details about our  [ph] renewals, we have successfully integrated and renewed the desired parts of the Montpelier business and maintained a balanced portfolio of catastrophe exposures while growing our market profile. This careful focus on the risk reward characteristics of our portfolio, in particular on our catastrophe line, is illustrated by the stability of our largest one in 100 year event PML as a percentage of equity which has remained largely unchanged from 2015 and 2014.
Moving to investments. Our net investment income was $23.2 million, down $2.7 million from a year ago due to negative returns on our alternative assets. Alternative asset returns were stressed by global equity market volatility and wider high-yield credit spreads where evaluations were hurt by poor market liquidity. The decline from alternative assets was partially offset by increased interest in dividend income from the addition of Montpelier's investments. Our portfolio's total return was negative 52 basis points on the fourth quarter but for the full year of 2015 was positive six basis points. While some markets face fundamental issues, valuations in many sectors are reaching levels where we are starting to see more attractive investment opportunities.
Our investment portfolio continues to be conservatively positioned with high quality assets on a relatively short duration of 2.7 years. Turning to capital. We ended the fourth quarter with nearly $4.9 billion of shareholder's equity available to the company and total capital of $5.6 billion. Book value per share was $65.48 which when adding back dividends paid was up 1.2% in the quarter and 9% from year-end 2014. As I mentioned on last quarter's call, early in the fourth quarter we repaid $198.5 million of maturing senior notes, reducing our leverage and lowering our ongoing interest expense. Also during the fourth quarter, we redeemed $200 million of our series A preferred securities with a dividend yield of 7.75% and issued $230 million of new series C preferred securities with a dividend yield of 6.35%.
We start 2016 with exceptional financial strength and flexibility and our balance sheet is as strong as it has ever been. With that, I will now turn the call back to John for some additional comments.
Thank you, Mike. Turning to current market conditions and renewal activity. Industry excess capital and favorable loss trends throughout the insurance and reinsurance continued to push pricing down through the fourth quarter and at the first of January. Insurance pricing and conditions are generally stable with our overall pricing being down in low single digits. We expect these favorable conditions to continue in 2016.
Due to the emerging negative experience and corporate disruptions being faced by significant participants in our industry, we anticipate broad ranging opportunities to develop for Endurance. Within reinsurance, North America short tail lines continue to be soft but moderating although we found some new business opportunities within regional and professional lines of business. In Asia Pacific, while competition remains fierce, our unique specialty capabilities enabled us to partner with [cedents] [ph] resulting in strategic growth opportunities in both agriculture and other specialty lines. At the same time we reduced Asia Pacific catastrophe exposures as the market softened.
Europe was modestly more competitive than we expected as some competitors were fairly aggressive during [indiscernible] renewals. European property and casualty rates overall were flat as non-loss impacted accounts experienced 5% to 10% rate decline while impacted accounts saw up to 15% rate increases. Overall, we have an extremely successful first of January renewal season for our reinsurance business. Pricing was competitive as expected and our overall rate change was down approximately 9%. Our speedy integration of Montpelier allowed us to complete our first of January renewals seamlessly as one integrated team with no market disruption.
We continue to gain share with our key clients and expand within specialty lines of business while prudently managing our short tail exposures and maintaining our underwriting and pricing discipline. Our first of January combined reinsurance renewal base was $683 million, including $171 million of expiring Montpelier premiums. As of first of January 2016, we wrote $702 million of gross written premiums. This represented an increase of $19 million or 3% compared to the combined first of January renewal base and $190 million or 37% increase compared to Endurance existing book of business.
I am very pleased with our targeted execution of the portfolio. We were able to retain the renewal positions we wanted. We rationalized our combined portfolios in order to keep our net risk exposures in line with our prudent historic averages and we grew within casualty and specialty lines. Our insurance segment gross premiums reached $2.1 billion in 2015, nearly 46% higher than 2012. This growth was driven by the continued expansion of our U.S. specialty business, the successful launch of a London based insurance platform and our strategic acquisition of the Lloyd's franchise.
Importantly, our insurance businesses are reaching relevant scale. We expect continued strong growth opportunities to carry forward through 2016 and 2017. Indicative of that, we were delighted to announce our strategic partnership with W. Brown Insurance Services for general aviation which will start in the second quarter. We also expect to substantially expand the underwriting activity and capacity of our Lloyd's business. Our willingness and proven ability to attract and make continued substantial investments in high quality underwriting talent positions us well to take advantage of the stresses and fractures already emerging from many of our major peers.
Within our reinsurance business, our transformation efforts over the last three years have focused on building a strong broad-based relationships with key cedent partners around the world which has enabled us to increase the profitability, quality and diversification of our book of business. Overall, our current portfolio is much more balanced and less volatile then it was in 2012 with a much greater percentage of specialty and professional lines business. The improved underwriting profitability has been evident in our results.
As I mentioned earlier, 2015 was a critical year in Endurance's transformation as the extensive efforts successfully completed over the last three years began emerging more fully in our underwriting production and profitability. We start 2016 with great momentum. Whilst other are only just now starting to react to the current softening markets, we started taking significant steps in 2013 to position Endurance to outperform in very challenging market conditions. Our underwriting quality, risk selection and strong risk management, remain critical in delivering the differentiated performance we expect to achieve. I am firmly convinced that the path we are on to increase our scale and relevance while enhancing our market position and building market-leading capabilities, will lead to superior under-writing profitability and returns.
With that, Lisa, we are now ready for questions.
[Operator Instructions] And we will take our first question from Ryan Byrnes from Janney.
Just wanted to ask a question about your philosophy of, I guess, taking property and catastrophe risks. Clearly, the past couple years, you've kind of de-risked your reinsurance book from property and cat but you're adding property in the insurance line. Just wanted to figure out, geographically where those risks are and I guess why that change in strategy.
I am not sure we have de-risked, just coming back to your point. We have de-risked our reinsurance portfolio. I think what we had done is made our reinsurance portfolio much more focused on cedents that we believe have high quality underwriting capability within those lines of business. So what we have done is that we have actually made it much more focused and much more selective. It's a slight difference between de-risking. But we have also very carefully on the reinsurance side taken into account the risk-reward characteristics of portfolios in today's market conditions and that’s why we have made the comments that we made about our PMLs and those exposure zones. And we are very very mindful of making sure that the PML exposures reflect the risk-reward characteristics of the portfolios that are available to us.
As far as reinsurance business is concerned, we had hardly any of that business. And so what we have been able to do over the last two years is to bring in highly high quality leading market underwriters who have long experience of writing international exposures for those short tail lines. And those people have been working for either Jack Kuhn or myself in our previous businesses. Have great reputations, have great market following. And regardless of how much pressure there is on the global short tail insurance marketplace, they have the capability and the standing within the market to access the better end of that business. And we will continue to grow out that business and I reiterate, we are growing it up from pretty well nothing. And we will grow it out very carefully, very cautiously with the clients we have known over many, many years and we will also mitigate the volatility by our efficient use of reinsurance with our reinsurance partners.
Great. I was going to ask a question about the retention within that insurance segment. If I back out ag, there is kind of a nice steady increase in your retention. It went from mid-40s all the way a little above 50% this year. Is that a result of the growth in property which may have less reinsurance coverage, or just a change, or fundamental change, in retaining more business going forward?
Brian, it's Mike. There is really no fundamental change in our approach to retention. If you look at the details of our gross to net, outside of agriculture, the retentions did pick up very modestly. But that was largely in our professional lines if you look at the fourth quarter last year, our retention ratio was only about 33% and that is a result of the fact that we had that individual product treaties in place for many of our individual insurance lines. At the same time we have been overlaying broad whole account reinsurance protection across all of our insurance businesses. Some of those treaties had different renewals dates and so there was a period of time last year where we essentially had doubled up on some of the reinsurance coverage. And as those individual product treaties came up for renewal, given the expansion of our whole account coverage, we reduced some of those individual product treaties.
In general, though, I would say that retentions in the 50% range, give or take, depending on the line, is the right way to think about our retention levels in our insurance business.
We have a long-term strategic objective of those short of numbers, Brian, in our insurance portfolios.
Okay. And then just two numbers questions, if I can. The other income line in the reinsurance segment was $8 million loss. Is that weather derivatives? I know a competitor had a loss that was a weather derivative related loss. Just want to see what that was.
Yes, Brian, we do have a weather insurance team, risk management team. It was one of the market-leading teams and we did have some exposure to a very warm Europe and that did result in some weather losses. I think the differential performance on our end was that we have a significant portion of that reinsured and so our net exposure was much less than what I would call our market standing in that industry.
Yes. And that’s a long-standing reinsurance approach for our weather guys who are excellent and they have a lot of market support for them. So the impact was much much less than we have seen elsewhere in the marketplace.
Okay, great. And then my last numbers one was, the tax rate ticked up a little bit, at least on a net basis. Just wanted to see if you guys had any color there.
The tax rate actually, we had actually a modest tax benefit coming through in the quarter. From a tax perspective we have been maintaining a pretty meaningful valuation allowance against some of our deferred tax positions in the U.S. As our emerging profitability is starting to come through, there was a modest decrease in some of those valuation allowances which found their way into an income tax benefit in the quarter. So I am not sure where you are seeing a tick up in the tax rate because it was actually a benefit.
[Operator Instructions] And we will take our next question from Mike Zaremski from BAM.
I think you touched on it in the prepared remarks -- regarding the expense ratio, I think there was some noise due to crop that you alluded to in the prepared remarks. Can you kind of go through if there were any abnormalities and how to think about some of the tick up? It looks like there could be some seasonality as well in 4Q G&A?
There is a couple of different things going on in the G&A line. With respect to our crop insurance business we did see a tick up in the expense ratio. There is a little bit of noise between the expense ratio and the acquisition ratio. The year prior in 2014 we received an additional amount of expense reimbursements from our business in some states where loss performance was pretty rough. As part of the federal programs we do receive supplemental expense reimbursements when underwriting losses exceeded certain thresholds. We did receive some of those additional benefits in the fourth quarter last year and this year was a much much better crop insurance year. So we did not receive those additional expense reimbursements. In addition, and probably the more important driver in our crop business is that our net earned premium base has gone down a decent amount as we bought a simply higher amount of reinsurance. So that has pressured a little bit the expense ratio as our G&A levels have been relatively flat. And so that was the main driver there.
Outside of our crop insurance business, the actual G&A ratio is in our -- other insurance lines have actually shown continued very strong improvements and as I said in my prepared remarks, overall, we do expect to see continued benefit rolling through this year and next year in our expense ratio from our current levels as our businesses continue to benefit from the scale we have built in.
Okay, got it. As to crop, is there -- has that been trued up for the 2015 action year or is there still a bit of uncertainty in IBNR left and you guys would have the final conclusion on that next quarter?
I think we feel pretty good about our crop insurance results as we ended the year. I would say, we prudently established our loss reserves for our crop business. 2015 was a pretty good year and so far through the end of January, we have seen continued favorable trends related to last year. And so we would do any final true ups to that favorable moves in the first quarter.
But we don’t expect them to be material if they arise, at all.
Got it. And lastly, regarding the weather derivative losses. Can you comment on whether January, if the mild weather persisted in Europe?
Let's say, it's too early to tell on the weather business for January. There was a cold snap and then it warmed up again. So we will have to see how the individual per metric coverage has come through and what the measurement points were. But again that part of our business activity isn't a material driver. So the bulk of that exposure would have been reflected in our fourth quarter results.
And ladies and gentlemen, this will conclude today's question-and-answer session. I would like to turn the conference back over to John Charman for any additional or closing comments.
Thank you, Lisa. Thank you all again for joining us on our call today. But before closing the call, I would like to take this opportunity to mention that Jerome Faure, more commonly known at Endurance by his nickname, Lafayette, retired as the Head of Endurance Reinsurance at the 31st of December last year. Jerome joined the company in the spring of 2013 and was responsible for driving the transformation of our global reinsurance business to the high quality, diversified and profitable business we have today. Jerome has been a much valued and well liked and much respected colleague. We all wish he and Julie the very best for the future. And with that operator, this concludes our call. Thank you, everyone.
And ladies and gentlemen, this does conclude today's conference. We do thank you for your participation. Have a wonderful rest of your day.
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