Validus Holdings' (VR) CEO Ed Noonan on Q1 2016 Results - Earnings Call Transcript

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Validus Holdings, Ltd. (NYSE:VR) Q1 2016 Results Earnings Conference Call April 29, 2016 10:00 AM ET


Jon Levenson - EVP

Ed Noonan - Chairman and CEO

Jeff Sangster - CFO


Matt Carletti - JMP Securities

Amit Kumar - Macquarie Capital

Michael Nannizzi - Goldman Sachs

Jay Cohen - Bank of America

Ryan Byrnes - Janney

Ian Gutterman - Balyasny Asset Management


Good day, ladies and gentlemen, and welcome to the Validus Holdings First Quarter 2016 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions] As a reminder, today's conference is being recorded.

I would like to introduce your host for today’s conference, Mr. Jon Levenson, Executive Vice President. Sir, please go ahead.

Jon Levenson

Thank you and good morning, and welcome to the Validus Holdings conference call for the quarter ended March 31, 2016. After the market closed yesterday, we issued an earnings press release and financial supplement, which are available on our website located at Today’s call is being simultaneously webcast and will be available for replay through May 13, 2016. Details are provided on our website.

Leading today’s call are Ed Noonan, Validus Chairman and CEO and Jeff Sangster, Validus Chief Financial Officer. Before we begin, I would like to remind you that certain comments made during this call may be deemed forward-looking statements as defined within U.S. Federal Securities Laws. These statements address matters that involve risks and uncertainties, many of which are beyond the company’s control. Accordingly, there are or will be important factors that could cause actual results to differ materially from those indicated in such statements and therefore you should not place undue reliance on any such statements.

More details about these risks and uncertainties can be found in the company’s most recent Annual Report on Form 10-K and Quarterly Report on Form 10-Q, both as filed with the U.S. Securities and Exchange Commission. Management will also refer to certain non-GAAP financial measures when describing the company’s performance. These items are reconciled and explained in our earnings release and financial supplement.

With that, I’ll turn the call over to Ed Noonan.

Ed Noonan

Well, good morning and thank you for taking the time to join us today. I am pleased to report an excellent first quarter for the company. We generated $166.8 million in net income, $117 million in net operating income. We had an annualized return on equity of 18.1% and most importantly grew our book value per share including dividends by 4.8% in the quarter.

Our underwriting businesses performed well with Validus Re and Talbot Underwriters both producing strong underwriting income. Western World continues to make good progress in reshaping their portfolio with a 10 point improvement in loss ratio relative to the first quarter of last year, despite 3.3 points of catastrophe losses in the quarter.

All the catalysts have performed well with assets under management down slightly at $2.3 billion due to the expiry of sidecar vehicle. Our investment portfolio performed exactly as we would expect in the quarter with a very slight decrease in investment income more than offset by strong unrealized gains both emanating from the declining yields in the quarter.

Our loss reserves continue to be source of strength with $54 million of favorable development without weakening our reserve position.

With that, I would like to turn the call over to Jeff Sangster to provide more detail on our financial results after which I’ll provide more color on our business. Jeff?

Jeff Sangster

Thanks, Ed. Thank you all for joining the call today. The first quarter produced a strong financial result for Validus, driven by strong results at each of our segments. Particularly Validus Re, which benefiting from the lack of significant Cad capacity.

Our book value growth was further boosted by the performance of our investment portfolio for our short duration fixed income buyer resulted in significant unrealized gains. Net income available to Validus common shareholders was $166.8 million or $1.98 per diluted common share.

Net operating income available to Validus common shareholders was $117.4 million or $1.39 per diluted common share. Annualized return on average equity for the quarter was 18.1% and annualized net operating return on average equity for the quarter was 12.8%. Book value per diluted common share was $44 at March 31 an increase of 4.8% from December 31, 2015, inclusive of dividends.

Speaking more details about the quarter's results, total gross premiums written were $1.7 billion for the quarter, an increase of $53.6 million or 4.8% from Q1 2015. The increase in premiums is driven by the AlphaCat and Western World segments, offset by a decrease in premiums in the Validus Re, Talbot segments.

Gross premiums written on behalf of our AlphaCat variable interest entities increased by $65.5 million over the prior year's quarter to $167.3 million from $101.8 million due to increase in the AlphaCat IOS funds capital base.

Gross premiums written in the Western World segment increased by $7 million over the prior year's quarter to $64 million from $56.9 million. Growth in Western World's Contract GR business has offset reduction in programs and brokerages which have been reduced in favor of better performing lines.

The net increase over Q1 2015 was primarily driven by a $6 million increase in the property lines. Q1 premiums were $7.2 million lower than Q4 2015 premiums of $71.1 million due to the seasonality of Western World’s business whereby the first quarter historically produces the lowest level of quarterly premium.

Offsetting the increases in gross premiums written at AlphaCat and Western World were decreased in the both Validus Re and Talbot segments. Gross premiums written in the Validus Re segment decreased by $20 million over prior year’s quarter to $691.7 million from $711.7 million.

The decrease was primarily driven by decreases in both the property and marine lines of $27.2 and $26.8 million respectively offset by an increase in the specialty lines of $34 million.

The decrease in the property lines was driven primarily by reductions in our participation on various catastrophe excess of loss contracts, offset by an increase in proportion of business due to a new quota share arrangement.

Our cat loss business had decrease due to reductions in our participation and non-renewals in various programs due to current rate environment and utilization of third party capital.

The decrease in the marine lines was driven by a decrease in our participation and proportional business along with challenging energy market conditions. The increase in specialty was driven primarily by new casualty business of $23.6 million written during the quarter. Additional increases occurred in the financial, trade credit and composite lines.

Offsetting these increases are decreases in other lines primarily agriculture. The decrease in agriculture lines was driven by a significant reduction in our participation on a contract with the underlying premium was reduced in accordance with client needs. The crop business recorded in Q1 was booked to a 100% combined ratio as has been our practice historically.

The Talbot segment decreased by $3.8 million over the prior year's quarter to $266.3 million from $270.1 million. The decrease was driven primarily by a decrease in the marine lines of $22.1 million offset by an increase in the specialty lines of $20.3 million. The decrease in the marine lines of $22.1 million includes an increase in premium estimates of $6.5 million.

After the impact of this change, the decrease of $28.6 million was driven primarily by a decrease in the upstream energy lines, but also in cargo and marine and other treaty lines due to the timing of renewals of certain policies and ongoing market conditions.

The increase in specialty lines of $20.3 million includes an increase in premium estimates of $15.8 million. After the impact of this change, the increase of $4.5 million was driven primarily by new business in the political lines by us and prior period amendments on the contingency class.

The premium estimate increases in Talbot Marine and specialty lines affect gross premiums written only and do not have any effect on earned premium.

Shifting discussion of losses, our quarterly combined ratio was 75.1% including a loss ratio of 39.3%. We do not incur any notable or non-notable loss events during the quarter.

Net favorable development from prior years was $53.7 million equal to $9.4 loss ratio points. Our favorable developments primarily from non-event reserves in the amount of $71.4 million.

This was offset by unfavorable development from prior years on event-specific reserves of $17.7 million, driven by a potential claim on a 2015 marine policy, which Ed will discuss in his remarks.

The net favorable development by segment was Validus Re $25.7 million, AlphaCat $0.9 million, Talbot $22.7 million and Western World $4.4 million. The overall accident year loss ratio excluding notable and non-notable loss events unchanged in prior accident years for the quarter was 48.7% compared to 53.7% in Q1 2015.

Beyond the underwriting results, I'll comment on the AlphaCat contribution to earnings, the quarterly investment results and our capital position. AlphaCat had total assets under management of $2.3 billion at April 1, $2 billion of which is managed by third parties. AlphaCat contributed $8.8 million of income in the quarter, net of non-controlling interest, which is comprises of the following components.

AlphaCat earned management fees of $5.6 million in the quarter of which $0.9 million were earned from other parties, offsetting the fees or expenses incurred by AlphaCat Managers $2.4 million. Expenses decreased by $4.6 million from $7 million in Q1 2015, primarily as a result of reduced placement fees incurred in relation to raising new capital.

Including investment income from the AlphaCat sidecars and ILS funds of $5.6 million, AlphaCat contributed $8.8 million in the quarter.

Our consolidated investment portfolio including cash and cash equivalents and restricted is $8.6 billion at March 31, 2016. Of this, our managed portfolio is $6.4 billion and the non-managed portfolio is $2.2 billion.

Our consolidated net investment income for the quarter was $29.5 million, excluding the non-managed investment component, managed net investment income of $27.9 million, contributed to a quarterly annualized effective yield of 1.79%, a decrease of 11 basis points from the Q4 2015 effective yield of 1.90% and a decrease of four basis points from the Q1 2015 annualized effective yield of 1.83%.

The lower yields from prior quarter and prior year was primarily caused by a single fixed income fund that is booked at one month lag. The volatile markets early in the year resulted in a lower return at the end of February. However, the fund recovered substantially in March, which will be reflected in the second quarter results. Duration of the portfolio is 2.15 years at March 31, which is unchanged from December 31.

Net of our non-managed portfolio, we recorded $1.1 million in realized investment losses and $47.1 million in unrealized investment gains in the quarter. Total shareholder's equity available to Validus at March 31 of $3.72 billion and total capitalization available for Validus at March 31 is $4.51 billion.

Excluding non-controlling interest, debt-to-capital at quarter end was 5.4% and debt and hybrids together as a percent of capital were 17.4%.

Our 1:100 U.S. windstorm PML is 15.9% of total capital, excluding non-controlling interest and has decreased by $46.1 or 6% from Q4, due to the purchase of additional upwards reinsurance at the top of our aggregate program and increase business ceded to AlphaCat. Our peak zonal aggregate is 55.3% of Validus Re capital.

During the quarter, we repurchased 1,356,636 shares an average price of $44.50 per diluted share for a total of $60.4 million. As of the market close on April 27, we had purchased no shares in the second quarter leaving $472.3 million remaining in our share repurchase authorization.

Our level of repurchase in Q1 reflects a conservative view taken at the start of the year and as our actual results developed during the year, we will adjust our expectations and prudently manage capital accordingly.

And with that I'll turn the call back to Ed.

Ed Noonan

Thanks Jeff. Let me begin by giving you more color on Western World. We're seeing very strong progress at Western World as a result of their shift in portfolio of mix as well as growth in their core product, the contract binding authority.

Since a quarter in Western World management has aggressively addressed underperforming classes, exiting a significant amount of business and re-pricing other parts of the portfolio. As a result, we continue to see very strong improvements in the company's loss ratio with a trend line that suggest there is more improvement to come. Overall, our rates were up 2.8% at Western World in the quarter.

As a result of shrinking their portfolio over time, any addition of new underwriting teams and offices, Western World currently has an elevated expense ratio. Management has done a good job of managing cost, including the difficult decision to reduce staff by 5%.

We're nicely positioned to improve the expense ratio in a few grown areas. The first is basic timing. The first quarter is historically Western World's lightest premium quarter and we think the annualized run rate on expenses is currently around 41%.

The secondary improvement will come from growth in contract binding authority business, in which the company is close to perfectly scalable. We have added a significant number of new binding authority contracts over the last six months and with the addition of our Scottsdale-based team, we'll continue this trend.

Earned premium lags on new business and the benefit will merge over the course of the year. Our technology the WIP system has a distinct competitive advantage due to its ease of use for producers and our use of automation is the biggest driver of our scalability.

The third core area of growth for the company is the addition of new products and underwriting teams. Our property product is doing very well despite a couple of million dollars of Cap losses in the quarter. Our Flood product continues to gain traction and is a high margin class for us.

We continue to expect the expense ratio run rate to trend down to 38% to 40% by the fourth quarter and continue to decrease with the company's growth. We also expect a loss ratio to continue to trend downward over the course of the year.

At current prices we see binding authority business generating loss ratios in the 58% to 60% range and our short-tail business in the mid 50s loss ratio. Short-tail products have already grown to 21% of Western World's business.

So when we added up, we expect to see the run rate on Western World's expense ratio to be down to 38% to 40% and the loss ratio down to around 58% to 60% by the fourth quarter on a run rate basis based on the current competitive environment.

Over time, as short-tail products continue to grow as a percentage of our business, we would expect to see loss ratios continue to decline and growth on a scalable platform will continue to reduce the expense ratio.

The recent flooding in Houston presented another opportunity to validate our flood level. Based on our proprietary selection criteria, we wrote 864 policies in the affected area and despite over 10 inches of rain and significant flooding, to date we've had 17 crimes reported.

In terms of underwriting teams, we're not willing to add lots of expense ahead of revenue at this stage in the underwriting cycle. There is a time when that makes sense, but we're not there today and so we're very judicious in adding small teams that can be self supporting within a year or two at most.

We've also created a brokerage unit, not with the specialty underwriters that we'll underwrite on behalf of both Western World and Talbot in the U.S. This will be a key driver of growth. This model has worked well for us in building Talbot's U.S. book and we see good opportunities to accelerate this process.

Premiums are up at Western World 12.3% over the first quarter of last year, but this underestimates the underlying run rate as we are still in the process of restructuring our portfolio last year. So the story remains the same. The combination of growth from our loss ratio products is the path of making Western World a high performing company for us.

Turning to Validus Re, we had an excellent quarter with underwriting income of $98.3 million. We saw more competition on Japanese renewals with rates up 7% to 9% and commissions up as well. Pricing for Japanese risk remains strong however due to the strength of underlying pricing in the Japanese market.

There was a bit of a battle for signings in Japan, but as always we performed quite well. The rest of Asia remains overly competitive and we reduced shares on non-renewed programs as a result.

The treaty market also continues to be losing its discipline in providing terrorism coverage. We saw one catastrophe program from a very large U.S. company with heavy major city exposure get placed with the full terrorism including nuclear biological and chemical coverage.

Lots of markets seem to think of terrorism as free premium, but then again lots of market thought that way before 9/11 as well. We apparently have a longer memory.

The marine treaty market remains very competitive with commissions going up despite rate decreases on the underlying business. This, coupled with plummeting energy rates has caused us to reduce our writings by 20% and shift more of our aggregate into composite programs for Lloyd syndicates where we see much less competition.

In our profit count we expect to see industry-wide agricultural premiums down 2% to 4% this year as a result of lower commodity prices, partially offset by the inclusion of 2012 losses in the MPCI pricing model.

Our casualty reinsurance book continues to make progress. We're in the building stage and are taking a very conservative stance, but nonetheless making good progress in the market. We saw additional demand come into the market from global companies, which we decline to participate in.

Some of these business struggled to get done, which we take is a positive indicator of market behavior. We will continue to reserve this business very cautiously and let the good news come out slowly over time.

Looking ahead to Florida, we expect to see net new demand of roughly $1 billion based on what we know at this point. While citizens are reducing their placement much of their business has migrated to more reinsurance dependant companies, which should materially offset the decline. We offer no commentary on rate expectations at this point.

I wanted to spend a minute on the construction of our catastrophe portfolio and how it increases the ability to generate good returns even in an otherwise weak environment. We optimize returns in our catastrophe portfolio in three ways. The first is the basic construction of the book, which risks we choose to write to maximize our return relative to our risk appetite. This process is deeply informed by our research and analytic capabilities as well as our own proprietary view of risk.

The second step in our process is the purchase of retrocession to both manage risk absolutely, but also improve our return on equity by reducing the capital required to support our business and importantly accessing markets in the events of lower cost of capital for the risk. Our retrocession purchasing typically adds 150 to 300 basis points to our expected return.

The final step in our process is harmonizing our portfolio in conjunction with AlphaCat's third party investors. We write a very attractive book and generating business for AlphaCat investors is part of our underwriter's charge in all aspects of our process.

We specifically work with AlphaCat as the last step in our portfolio management process to identify business in which their investors have both appetite and a lower cost of capital. Typically this is peak risk U.S. business. This part of our process adds an additional 150 to 200 basis points for our expected return.

The ability to manage risk and capital efficiently gives us the ability to outperform the market through all stages of the cycle while generating attractive portfolios for our AlphaCat investors. This model has proven particularly valuable during the competitive phase of the market which is reaching its bottom.

We can't turn weak rates into strong rates but we use every tool available to us to protect returns across the cycle. It was a very quite quarter from a loss standpoint for Validus Re and the year is off to a strong start.

As from more recent events based on what we know and client reporting, we would now expect the Texas Hailstorm Ecuador and Japanese earthquakes to reach our event threshold. But I would caution as regard to earthquakes that there is always the potential for material volatility around claims estimation. We will be in a much better position to provide insight at the end of this quarter.

Talbot reported another strong underwriting quarter with net underwriting income of $20.3 million. Premiums were down slightly year-on-year, which reflects the ongoing competitive dynamic at Lloyds.

Our property portfolio performed very well due to the low incentive losses around the world although pricing pressure is very high. Likewise our specialty portfolio had a good quarter due to low claims activity.

Our political risk accounts had a subpar quarter, as we continue to see heightened frequency of political risk losses arising from uneven global economic conditions. Rates in our portfolio were up 4.6% year-over-year with energy being the worst performer ranging from 9% to 15% off.

Talbot's results continue to benefit from their diversification across 23 classes as well as their leadership position on a very high percentage of the business in their key classes.

We've spoken repeatedly about the competitive dynamic in Lloyd's specifically the impact of broker facilities and Lloyd's willingness to allow passive underwriting on a broad scale. Interestingly Lloyd's has begun to take notice of the devastating impact on rates some of these utilities lead to as well as the problem of passive following markets with little or no underwriting skills in the business they're taking on.

We've long been of the belief that this passive underwriting violates multiple tenants of solvency too and it’s encouraging to believe that it's at least stating to notice.

At the same time U.K. regulators have turned their attention to these facility arrangements and are beginning to add some very powerful questions about the value of data and access to business over time. I wouldn’t yet conclude that there is C change, but at least a few ways of beginning to reach the shore.

Our reserve position continues to be extremely strong with no material change relative to our actuaries estimates during the quarter despite the continued favorable development. We did have modest adverse development in our marine line for 2015, which I would like to address.

Our marine account is performing perfectly in line with our expectations including for 2015. However, we received a loss advice during the quarter on a policy written late last year with an alleged loss date in 2015. The alleged claim is rather murky and we're in the process of trying to ascertain whether an actual claim took place and if so whether it was even covered by our policy and if so whether there is subrogation against third policies and finally if all that's true, what reinsurance would we expect to recover.

For estimation purposes, we looked at a range of outcomes including a meaningful probability of a zero loss. However as you know, we prefer to be very prudent in our reserving and so for the time being we have held back to 2015 IBNR that would have otherwise been released in the range of $20 million to $30 million across Validus Re and Talbot. Claim advices of this nature often end up with litigation and so we're limited in our ability to provide too much commentary.

AlphaCat continues to perform very nicely. We saw modest decline in assets under management in the quarter and while we don’t anticipate major growth in assets in light of market returns, we may increase AUM by 10% or so during the second and third quarter.

In closing it’s always nice to start the year with a strong quarter and we expect the first quarter to be a low loss period. We feel like we've built a very solid business model. We've resisted the trend to grow too quickly in new markets and classes.

We've adopted a defensive positioning in classes under too much competitive pressure and we invest in set reserves very prudently.

With that we'll be happy to take any questions you may have.

Question-and-Answer Session


Thank you. [Operator Instructions] Our first question comes from the line of Matt Carletti with JMP Securities. Your line is open. Please go ahead.

Matt Carletti

Okay. Thanks, good morning.

Ed Noonan

Good morning, [Danville].

Matt Carletti

Couple of numbers questions then a little just higher level question. Net investment income, you commented on is just a little came down a little bit in the quarter around 30 million given where yields are that feel like a good quarterly run rate or is there anything in the quarter that was more kind of a onetime remark that flowed through there that has reversed or might not be there in future quarters?

Ed Noonan

So Matt if you look at the managed component, which was just under $28 million, that was what would we expect to be around $30 million or slightly above $30 million on a run rate basis. So that was down slightly from our expectations and that was the single funds that had a downtick at the end of February as a result of us booking that on a month lag.

We didn’t get the benefit of that fund bouncing back in March. So a little bit timing issue that will flow through in the second quarter and we'll expect it to be back at the level as you suggest around $30 million.

Matt Carletti

Okay. Great and then another numbers questions, GNA expenses including share comp at Talbot looked a little elevated, was there anything one time in there? Does that kind of look like a good run rate as we look forward?

Ed Noonan

Yeah, two things going on there, one is a one time on Lloyd's expenses. They are up about $1 million year-on-year and I would expect that to be non-recurring. There is also a bit of a higher allocation of IT and research expenses going into Talbot, but that would be recurring. So I would say split the increase there about 50-50 or half as recurring and assets at one time.

Matt Carletti

Okay. And then just higher level. I noticed the RDS is looks like Lloyd's has added a new one a cyber event, which makes a lot of sense. And you guys always do a lot of research and have really good perspective on in both your own risks and the industry.

So I just curious, are there other risks out there that I don't know maybe not as far as keep you up at night, but that you think are significant and that you keep an eye on and maybe you worry about for the industry or for you anything from like trade credit book the impact of a Braxton occurring or something completely in the field like a sharp needle.

Ed Noonan

Actually Matt, our research team has spent a lot of time on the sharp NATO exposure will probably enhance our disclosure to include that at some point. In terms of thing that might keep us awake, actually you raised an interesting one in [breaks], we haven't seen any good work come out of Lloyds at this point and candidly I don't know that we have unique insights on that issue as it may be an area that you're highlighting and we ought to be spending time.

I've been comfortable that any exits that actually if we can go back to Norway it took them seven years to leave the union and so there should be ample time to deal with it, but I think that’s reasonable one.

That other one that I do worry about a little bit is the electromagnetic pulse and that can come obviously from solar flares or even manmade and that affects electric grids all over the world, technology all over the world. That certainly affects satellites.

And so that's on the one hand you say, well that sounds like an end of the world scenario. On the other hand, you say well is it still something that we have an exposure to and we have to figure out a good way to track. Can't claim that we've come up with a great way to track that yet other than just tracking the individual classes on our aggregates there. So that's one that we think about.

Matt Carletti

Okay. Great. Thanks for the answers and congrats on a good start to the year.

Ed Noonan

Thanks Matt.


Thank you. And our next question comes from the line of Becky Kumar with Macquarie Capital. Your line is open. Please go ahead.

Amit Kumar

Ah ha, I see what you did there.

Ed Noonan

Amit was that a mistake, or have you solved the mystery.

Amit Kumar

Oh my God. The beehive is coming after me now.

Ed Noonan

Amit it's understandable. You have such a good hair. I can understand.

Amit Kumar

Never emitting you before, but just very quickly, the first question goes back to the discussion on the marine policy. And maybe you can educate us a bit here. I understand the discussion relates to the statute of limitations and if that has run out or not. How should we think about the timeline on all of that?

Ed Noonan

So first Amit, it really doesn't refer to statute of limitation and this is a very standard plain Vanilla Marine policy. There is nothing unique about it there is no political risk associated with that. The claim that has been reported to us I described as very murky and the more questions that we ask the murkier it seems to get.

So I don't know, it could well be that over time we'll as we complete the adjusting process we'll conclude. Jeff do you have to cover claim but there is so many open questions and so much murkiness around it that at this point it's hard for us to reach any conclusion.

It may depending on the outcome of that adjusting process you could envision an scenario where this drag is gone for an extended period of time and perhaps ultimately in litigation and things like that and that just drags things out.

So yeah we'll stay on top of it because there is the potential for dispute is there we probably have limited ability to provide too much commentary but certainly if there are any material movements than we would disclose them.

Amit Kumar

Yeah that's helpful. The other question I had was I think Jeff was talking about capital management and why it was lower than the operating income this quarter. Is that signaling that there could be some catch up down the road or did I read too much into that comment?

Jeff Sangster

Amit I think if you look at what we did last year in terms of capital management and sequencing, you're seeing the same pattern. While we don't want to get ahead of ourselves and it's hard to play catch-up in Q1 and so slightly lighter in Q1 is where we take a conservative view but with our goal of managing total capital including dividends in an amount equals to earning, obviously we would over the course of the remainder of the year we would need to catch up to achieve that goal.

Amit Kumar

Got it. That’s helpful and final question, just going back I think Ed was talking about the loss ratio and addressing the expense ratio issues with Western World and if you do the math it ends up between 96 and 100.

On the last call you had -- you sounded more confident regarding the profitability in the second half of 2016, has anything changed on that front or are you just putting ranges -- specific ranges around it this quarter versus last quarter?

Ed Noonan

Yeah, nothing has changed Amit. We still think the run rate on the business by Q4 should be underwriting breakeven or better and I was just trying to provide more detail by giving you our expected loss and expense ratio ranges and the path that we see to accomplishing that.

Amit Kumar

That’s all I have for now. Thanks for all the answers and good luck for the future.

Ed Noonan

Thank you, Amit.


Thank you. And our next question comes from the line of Michael Nannizzi with Goldman Sachs. Your line is open. Please go ahead.

Michael Nannizzi

No reference for me?

Ed Noonan

Michael, before you leave the call, we are interested in opening a savings account. If you can put us in touch with the colleague at Goldman, we can do that. That would be helpful?

Michael Nannizzi

I look into it. So couple of questions. One thing, so the income from affluence line I guess with PaCRe wanting that, that should basically run where -- close to zero where it showed up this quarter, is that fair. There is no nelson in there, is there?

Jeff Sangster

The income affiliates also includes one private equity investment that we have with a private equity fund that facilitates through our Board. So that’s the one component that remains there.

Michael Nannizzi

Okay. So is that in your disclosure in terms of how large that investment is of is there a way we can figure that out?

Jeff Sangster

It is, even that's a related party, that's what we disclose in our related party notes. So you can go back to that, our full commitment and the amount that’s been funded is disclosed.

Michael Nannizzi

Okay. And then sorry just a could ones and then if I can real quick, other income bounced around a lot. I think there some of the performance fees are in there. Can you remind us what’s in that line item and just how we should be thinking about that?

Ed Noonan

So that’s exactly, is the fees related to AlphaCat and so that includes both management fees and the performance fess. The management fees is reasonably stable because that's calculated off the AUM. The performance fees do bounce around a little bit and obviously on the underlying performance of the funds and will be heavier -- more heavily weighted into the back half of the year as there is seasonality in the risk related to those funds mostly GAAP and U.S. wind exposed.

And so you would expect to see the performance funds if it's a quite cat year, quite Atlantic windstorm season you expect the performance funds to show up more predominantly in Q3 and Q4 and ultimately if there is a stronger effects to funds then that line would drop off in the second half of the year.

Michael Nannizzi

Got it. Okay. So the patterning here with 600 change in the first quarter, that's just, that's more of a function of the patterning of the earning of the revenue as opposed to any other offsets that might be in that line item that we don’t know about?

Ed Noonan

Yeah I think that’s right.

Michael Nannizzi

Okay and then in Validus Re the underlying loss ratio it seems like the property ran at a negative loss ratio obviously the development was probably a factor there, but where should that typically run on an underlying basis that property or even if you don't want to say where should it, where has it historically run just to give some context for the first quarter?

Ed Noonan

Yeah sure. So that is abnormally low in term -- obviously that’s a negative numbers not what we expect there. So I think the drivers there will be obviously the level of prior period developments, which has historically come true there.

And I'll let you make your own assumption of that and then the quick cat losses, outside of the headline notable or non-notable losses we've also indicated in the past that we would expect in a given quarter there to be approximately $30 million is a rough estimate of below the $15 million type of losses.

None of those showed up this quarter absently the one claim that Ed referred to and so that resulted in the negative loss ratio. And I think if you go back a year and look at on Page 13, you look at a mid-teens loss ratio that's a pretty typical loss ratio for the first quarter and on the Valery Property line.

Michael Nannizzi

Okay. Great. Thanks for that. And then just really last one maybe Ed, you mentioned the storms in Texas in the second quarter and Valery, how do you think that that loss obviously you guys have a ton of data and your analytics provide you with great lengths into when these events occur.

How are you looking at that shaping up relative to first quarter Texas losses either the flooding in Huston or the hailstorms outside of San Antonio? Thanks.

Ed Noonan

So the flooding I think because most of the flooding is residential that's mostly covered by the National Flood Insurance Program we're one of the few private flood insurers for residential business. As I mentioned we have 17 claims out of 800 odd policies. So we're feeling pretty good about that.

The hailstorms are likely to be a bigger event to the industry, not a big event, but a bigger event to the industry that will also likely to be absorbed by the big primary companies who tend to dominate the personal line space and as a result we're not expecting those companies to have a big enough loss to get into the reinsurance market.

There are some regional companies as you think about the Farm Bureau in Texas that we would expect may well have a claim as a result of this but even that isn’t likely to be terribly material event. So I'm not sure whether this is $1.5 billion event or $2.5 billion event, but we think of it in that range at this point.

Michael Nannizzi

Okay. Great. Thanks so much.

Ed Noonan



Thank you. And our next question comes from the line of Jay Cohen with Bank of America Merrill Lynch. Your line is open. Please go ahead.

Jay Cohen

Thank you. Just a couple of questions on Western World, first at the loss ratio view that you gave for the entity are you assuming that's kind of a reported loss ratio not necessarily just the accident year?

Ed Noonan

No that's a run rate. So that will be more accident year or underwriting year depending on how you think about it. I actually think that it's closer to underwriting year but that we're not talking about PPD in that.

Jay Cohen

So that number has been high 60s, low 70s last three quarters, as you think that could be in the low -- in the high 50s?

Ed Noonan

So again going back to the Contract Binding Authority business, we think the normalized loss ratio in that our business in this environment is around 58% to 60%. And we expect that we should be around there on a run rate basis in Q4.

We've had a lot of growth in the binding authority business, We've added a significant number. Historically what's enrolled put very strong caps on how the number of binding authorities that have, they changed that practice and so we've added in the last six months, probably 20 or 25 binding authorities and we've got another eight already in the pipeline for the second quarter.

So as that business comes on, it moved all over and obviously by the fourth quarter, but the run rate on that business, we think from a loss ratio perspective is 58 to 60.

The property in other short-tail business that we're adding and that's in the brokerage space predominantly that includes the flood product, we think that runs in loss ratios in kind of the low mid-50s. So if you think about you pick the number of 55 or 54 or 56 whatever you think, that's currently 21% in the book and we think that percentage will either remain constant or grow over the course of the year.

And so with the improvements we expect to see a loss ratio which again normalized right now if the run rate is about 41% and as we scale up the business more that will come down. We expect run rate underwriting break even or better in Q4.

Jay Cohen

It seems as if you've had some fairly consistent favorable prior year development for the past five quarter. If that continues then your reported results really will look really quite good?

Ed Noonan

That happens will party like 1999.

Jay Cohen

Very good. Second question on Western World, I guess your comment suggest that the growth rate in gross or net premium should accelerate from the first quarter, is that a fair assessment of what you said?

Ed Noonan


Jay Cohen


Ed Noonan

Yeah, the underlying growth rate in the first quarter of last year was still running off non-renewed business. We hadn’t really ramped up on scale of binding authority growth now for that matter even the property and other short-tail product growth.

So yes, we would expect to see that growth rate continue to accelerate. Remember we're starting from a pretty small base here. It’s a competitive market out there and we're not willing to go whole hog on it, but given the base we're starting from, it doesn’t take big daring bets to grow the portfolio at a pretty good rate.

Jay Cohen

Got it. All right. Thank for the answers.

Ed Noonan

Okay Jay. Thank you.


Thank you. And our next question comes from the line of Ryan Byrnes with Janney. Your line is open. Please go ahead.

Ryan Byrnes

Thanks guys, good morning. Just had a clarification question on the second quarter events not reaching your threshold; is that the cat threshold of $30 million per event or is that also the non-notable which I believe is at $15 million?

Ed Noonan

Yes obviously each individual event is assessed on its own, but to what we know right now there is nothing that we would expect to reach the notable threshold of $30 million. So assessing all the events and probably wouldn’t go out and say that we're 100% confident they're not going to reach the non-renewable threshold at this point.

Ryan Byrnes

Okay. Great. Thanks. And just the underlying loss ratio in Validus Re was better than last four quarters, were there any only one timers and are you thinking of maybe a crop true up for the 2015 year?

Ed Noonan

No one timers in there. Obviously the prior period development had favorable impact. We booked the crop for 2015. We didn’t move that. We booked at the same level as we did in Q4. So nothing that I would identify as a onetime that you would want to take out and normalize that.

Ryan Byrnes

Okay. Great and then my last one. Just wanted to make sure I understood that you guys non-renewed I guess the retro sidecars that you guys have been doing the last couple of years, just wanted to make sure I understand the though process there, is it just lack of opportunity?

Ed Noonan

Yeah that’s just actually a bit of form over substance. We've actually shifted those risks into a fun format and that’s what the investors were telling us they preferred as opposed to the sidecar, the annual sidecar.

So what you'll see there is an uptick in what we're referring to as the higher risk funds in AlphaCat and that’s the shift largely of the sidecar into a fun format and so the sidecar form per se was discontinued, but that risk category has been continued just in a different format.

Ryan Byrnes

And is your participation in those -- is that at similar levels as previous or that be I guess similar to your other I guess funds I guess?

Ed Noonan

Yes, similar level of participation as we've previously -- we don’t give our participation by fund across the entirety of the AlphaCat's funds. 15% would be a good round number to use.

Ryan Byrnes

Okay. Great. Thanks guys.

Ed Noonan

Thanks Ryan.


Thank you. And your next question comes from the line of Ian Gutterman with Balyasny. Your line is open. Please go ahead.

Ian Gutterman

I couldn’t even understand what that was. So I want to get…

Ed Noonan

Ian you're going by -- Ian you're going by Bobby.

Ian Gutterman

I don't even know who that is. I am not as closely relevant as you are Ed, I am afraid. So first I guess, I was confused on the vague loss you're talking about at marine, is that what was the adverse event that you described or is that an additional event?

Ed Noonan

No, that's the event. I am not really -- not trying to be vague about it. It's just the circumstances it's an ordinary marine policy and it's written across the entire market, but as we've gotten the details of the claim, so far nothing seems to add up and so we're treating it, we're treating it with I guess a great degree of caution.

But as I say, first we need to identify whether there was in fact a claim, whether it was covered under our policy, whether we have recoveries against third parties, all of which are active issues involved in this and then what reinsurance might recover some.

Our view of that is that whether or not we think it will ultimately be a zero loss or not, we just assume we try to be safe and sorry and hold back might be in all leases because the general level of incurred but not reported probably is up a little bit because of this one.

Ian Gutterman

Actually a couple of things I am still confused on. First, you said $20 million to $30 million of IBNR, but the press release said $13.7 million. so I guess I am confused on why the numbers are different?

Jeff Sangster

Ian, the $17.7 that is our net event related prior period and so that's netting our typical level across all events and so that wasn’t specifically referring to that single event. That was all in. So obviously there was, there was positive development.

Ian Gutterman

Okay. Got you. Got you. Okay. And then secondly…

Jeff Sangster

None of which big enough to note, but…

Ian Gutterman

Right. Okay. That makes sense. And then secondly what was related to a large loss in Mexico, you called that last year or is this a totally different thing.

Jeff Sangster

No, no.

Ian Gutterman

Okay. So you didn't have anything. Okay. So you didn't have any…

Jeff Sangster

It was a policy written in the fourth quarter, very late third quarter or fourth quarter I forgot where we got a report during the first quarter on it. So not related to anything else in the past.

Ed Noonan

So Ian just to be clear, while we book it in development because the event happened in '15. It wasn’t an event that we recorded in the previous year. It's a new event in '16, but because it's an '15 event it's recorded as PPD.

Ian Gutterman

No. That makes sense. That makes sense. What confuse me is I guess in the press release last night, I guess it was I thought just given that Pamex notified the market of a higher loss during the quarter and you guys took a large loss for that last year and I think you gave a market loss estimate at the time that was below whether your advisor would have though you would have had to true up the Pamex this quarter.

Ed Noonan

So that's interesting Ian. Your recollection is exactly right. We had reserved above market originally and it wasn’t a revised advice. The market has treated that revised advice as an interesting piece of fiction, but more likely part of a settlement negotiation than an actual adjustment of the claim.

We're in the interesting position of -- we reserved $850 million market loss. If the market loss in fact hits $1 billion, we have ILWs to kick in that cause our loss to plummet, our net loss to plummet. And between $850 million and $1 billion, we have exposure just more than $10 million.

So we're in the odd position of rooting for the claim to be bigger than we originally thought, but we don't want to see all of our competitors get hurt either. So maybe a little bit bigger.

Ian Gutterman

Got it. Got it. Okay. That makes sense. So that I just read it. I made a bad guess last night. Okay. So moving on, Western I guess a couple of things, I was just wanted to clarify too on the commentary, first you talked about doing things to improve expenses there aside I think you said some layoffs and so forth.

When I look at the G&A, second half of last year it was running about $9.5 million a quarter and this quarter pops a $12 million. So it seems like your expenses are going up in the near term.

Jeff Sangster

Yes, so a couple of things there. You're right, there is two things driving that up. One is the addition of underwriting teams that we've added over the second half of 2015 and early in '16. So as those underwriting teams come on and ramp up, there is additional expense there and also some of the support that the broader group is providing in terms of research and those types of expenses are following through as well.

The reduction of expenses that Ed referred to in terms of reducing the staff commensurate with some of the line that we've exited, that departure just happened earlier in April. And so we would see expenses related to that coming through Q2 and then we have better run rates in Q3 normalized.

Ed Noonan

Okay. Okay. I would offer that Western World has about 200 employees and per the insurance company actually a relatively small number of employees. More than greater tractions at the company is that each binding authority think of it as kind of a miniature treaty reinsurance agreement although its obviously direct insurance.

The variable cost associated with that are very, very low. So we don’t think the past to greatness at Western World is shrinking the employee count 200 to 180. We think using that employee base and the scalability of the business to grow it and we feel like we’re making really good progress there.

Ian Gutterman

Okay. So where I was going with this maybe you might have and I was about to ask maybe I am thinking about it wrong but I guess I was modeling that on a technical ratio basis and trying to get the dollars of G&A right and assuming that the acquisition ratio will be fairly consistent and has been fairly consistent and has been the low 20s.

Are you seeing that things are doing can lower the acquisitions ratio in some way that they're putting some non-commission loss in the acquisition ratio or because I guess what I’m looking at is if the acquisition ratio was 23 then they get to 38 to 40 implies 15 plus of G&A, which at current level means like $90 million earned if I’m doing that correctly on a napkin.

Ed Noonan

So from my -- the acquisition ratio on the binding authority business isn’t likely to change, but however on the brokerage business, we wouldn’t expect to see acquisition cost anywhere that high. So as the rest of the business grows, the acquisition ratio will come down.

We'll see that taking place but that’s part of a long term effect of change in product mix as well and so in the near term, acquisition cost will still be probably elevated because contact binding authority which is a nice class of business is growing. It’s a bigger part of the business and so it will be the driver of the acquisition cost.

The G&A will come down, as a ratio again just because of our ability to scale up the business.

Ian Gutterman

Sure, sure. Okay. And then just big picture on competition, is sounds like I guess really across the Board and insurance and reinsurance, seem like they're getting a little tougher year-to-date, how concerned are you about your ability to be able to do what you like to on the growth on the Westerns side if market condition deteriorate faster.

Has that changed the plan and similarly on Lloyds how closer are we to the point where you say we really got to start shrinking this thing in a more meaningful way just because it's too tough?

Ed Noonan

Yeah, so great question. First I don’t feel like the market is somehow accelerating downward. I’m actually a little bit surprised by some of the commentary around that. We've been right now uncomfortable for couple of years with rate decreases and I'll answer your question in reverse order.

Talbot, we have been shifting business around between classes. There are some classes that candidly are better able to withstand rate decreases than others and so our portfolio tends to align that way and the shifts in our portfolio tend to align that way.

But Talbot had been a pretty rapid growth business and you saw that level off and now it’s trickling down a little bit. That reaction to the competitive environment, if we come up with some great idea and find some niche that we are not in that makes sense, maybe that growth will resume in the near term.

But otherwise in the near term, we would expect flat to down to be kind of the order business at Talbot and Western World I think the binding authority business is interesting in that one of the attractive attributes of it is that the average policy premium was about $2,000 underlying insurance.

And so you're just not seeing people come in and say hey we'll write it for $1500. The cost base associated with writing small commercial policies is pretty high and so on that level, Western World rates are still up 2.8% year-to-date and that's virtually all binding authority business.

Not saying that rates will continue to trend upward, you see more people looking to get into the SME business. But this is really the heavy end of the SME business. These are in $25,000 and $50,000 account. These are mom and pop businesses. So there is meaningful competitive installation there.

In distribution there is competitive installation that arises from inertia. Business tends to be very sticky in the binding authority space. We have renewal retention ratios much higher than in say brokerage G&S business and so that's helpful. There just isn’t the impetus to go and shop a $2,000 policy on the part of an agency each year. It's expensive, time consuming in that.

And as we offer broader products to our wholesalers and the addition of a property product has really been a big uplift for us to world as we offer broader products that also makes us a more attractive market and helps us expand those binding authority business.

So by no means immune to competition, but yes there is a couple of players of installation there that cause us to like that business particularly in this part of the cycle more than some other things.

Ian Gutterman

Got it. It makes sense. Very thorough. Appreciate it and I will try next call to be more prepared in my culture references.

Ed Noonan

Thank you, Ian.


Thank you. And I’m showing no further questions at this time. And I would like to turn the conference back over to Mr. Ed Noonan for any closing remarks.

Ed Noonan

Thank you very much operator and thank you all for your interest. We recognize we’re in a very competitive market and this quarter stands out as particularly good quarter. We will be whistling past the graveyard to say that every quarter will be as good, but we have our hopes. But we look forward to catching up with you in another three month's time. Thank you.


Ladies and gentlemen, thank you for your participation in today’s conference. This does conclude the program and you may all disconnect. Everyone have a great day.

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