Kestrel Group, Ltd. (KG) Q1 2016 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Maiden Holdings First Quarter 2016 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. I would like to introduce your host for today's conference, Mr. Noah Fields. Sir, you may begin.

Good morning, and thank you for joining us today for Maiden's first quarter 2016 earnings conference call. Presenting on the call today we have Art Raschbaum, Maiden's Chief Executive Officer; along with Karen Schmitt, our Chief Financial Officer. Also in attendance today is Pat Haveron, President of Maiden Reinsurance Limited. Before we begin, I would like to note that the information presented here today contains projections or other forward-looking statements regarding future events or the future financial performance of the company. These statements are based on current expectations and future events, and are subject to a number of risks and uncertainties that could cause actual results to differ materially from these expectations. We refer you to the documents the company files from time-to-time with the Securities and Exchange Commission, specifically the company's Annual Report on Form 10-K, and our Quarterly Reports on Form 10-Q. Some of our discussions about the company's performance today will include reference to both non-GAAP financial measures and information that reconciles those measures to GAAP, as well as certain operating metrics that may be found in our filings with the SEC and in our news release located on Maiden's Investor Relations website. Please also note that unless otherwise stated, all references to common share data in today's discussions are on a diluted share basis, and comparative comments will refer to Maiden's results in the first quarter of 2016 relative to the corresponding period in 2015. I will now turn the call over to Art.

Good morning, and thank you for joining us for our first quarter 2016 earnings call. On this morning's call I will be providing an overview of strategic and operating developments, while Karen Schmitt, our Chief Financial Officer, will focus on the detailed financial results from the first quarter. While the global reinsurance marketplace remains competitive, our highly differentiated business model continues to serve us well. For Maiden, our focus on serving the long-term capital needs of our regional and specialty insurer clients remains unchanged. Importantly, whether it be continued profitable growth from our significant strategic quota share with AmTrust, organic growth from our existing client relationships in our Diversified segment, or expansion emanating from our European and US new business initiatives, we believe that we're focused on intelligent and disciplined business development. For the quarter, Maiden reported net operating earnings of $28 million, or $0.37 per diluted common share, compared with $27 million or $0.35 per diluted common share. Underlying these favorable results was continued growth in investment income and investable assets, profitable underwriting, and lower expense relativities. Importantly, Maiden's annualized operating return on equity for the quarter was 12.3%, notwithstanding strong growth in book value of over 12% in the first quarter versus year-end 2015. Book value growth reflects significant favorable movements in our fixed income investment portfolio, as interest rates fell during the quarter. Maiden's first quarter 2016 gross premiums written increased 3.6% to $864 million, compared to $834 million. In our Diversified Reinsurance segment, gross premiums written were up 3.4% compared to the first quarter of last year. We benefitted from organic growth of US diversified clients, while maintaining a retention ratio of nearly 90%, despite the non-renewal of several underperforming accounts. In Europe, our Solvency II oriented capital solutions business has successfully added new clients year-to-date, and the team is exploring a healthy and growing pipeline of new opportunities. Gross premiums were consistent with our expectations, and we're very encouraged by the reception we're getting from the market. Following the implementation of risk-based capital rules in Europe, Maiden has developed a continuum of capital solutions that range from traditional reinsurance to subordinated debt. And we're actively helping customers meet the new capital standard. We're very gratified as well with the significant broker support we're receiving for this important initiative. Growth in our auto manufacturing focused Maiden Insurance Partnerships business continues to move forward with opportunities to partner with major auto brands and insurers to develop and deliver consumer insurance products. While the quarter does reflect the benefit of some of our new manufacturer branded auto insurance relationships, it does not yet reflect any of the expected growth from our payment protection insurance joint venture with Allianz. We expect a slow ramp-up of this business, as new opportunities move to implementation throughout the next several years. Turning now to the AmTrust Reinsurance segment, we had gross written premium growth of nearly 4% compared to the first quarter of last year. Our AmTrust segment growth was dampened somewhat due to the commutation that was implemented in the fourth quarter of 2015, as well as the completion of the onboarding of the new Tower Group premiums last year, which boosted comparative period premium volumes. That said, we believe that AmTrust remains well-positioned to continue its profitable growth. Overall, Maiden's combined ratio was within expectation, at 98.9%, above the 98.2% reported in the first quarter of 2015, but an improvement compared to the fourth quarter and full-year 2015 results. In the AmTrust segment, we continue to see strong underwriting results. Our combined ratio for the quarter in this segment was 95.3% versus 94.6% in the first quarter of 2015. While loss ratios and combined ratios for the quarter are modestly higher, this reflects a combination of business mix changes and a higher initial booking ratio. The Diversified Reinsurance segment combined ratio was at 102.9%, above the 101.1% combined ratio in the first quarter of last year, but slightly improved versus the fourth quarter of 2015. Within the Diversified segment, results for the quarter reflect net adverse prior-year development associated with the commercial auto line, and to a lesser extent the impact of US weather-related losses, which exceeded our expectations. Focusing on commercial auto, we've seen a significant level of adverse development from this line over the last 12 months, particularly from our excess of loss portfolio. While adverse development slowed significantly in the last quarter, in the first quarter the adverse movement was less expansive, and the vast majority emanated from one terminated account, which experienced further case reserve strengthening and a corresponding increase in IBNR reserves. We'll continue to maintain our focus on addressing underperforming accounts promptly and effectively, and ensuring that our results reflect that impact. Importantly, our commercial auto book is significantly smaller than it was at the same time last year. We do believe that our current pricing, risk selection, and terms and conditions reflect the influence of this adverse activity. We've seen many clients who've successfully increased their rate levels and enhanced their risk selection criteria. And we're also working to introduce new underwriting tools that will assist our clients to strengthen their underwriting performance in this line. Absent the adverse impact from the commercial auto line, the balance of Diversified segment results were solidly profitable. Improving Maiden's underwriting profitability remains a key focus for our underwriters and our management team. I'd like to now turn the call over to our Chief Financial Officer, Karen Schmitt, to review the first quarter results in greater detail. Karen?

Thank you, Art, and good morning. As Noah said earlier, unless otherwise stated, all references to common share data are on a diluted share basis, and comparative comments will refer to Maiden's results in the first quarter of 2016 relative to the corresponding period in 2015. Maiden reported first quarter 2016 net operating earnings of $26 million, or $0.37 per share, compared with $27 million or $0.35 per share. Net income attributable to common shareholders was $27 million, or $0.35 per share, compared with $32 million or $0.41 per share, due to lower foreign exchange gains in 2016 versus 2015. Net premiums written totaled $793 million in the first quarter of 2016, a decrease of 0.5%. During the first quarter, the change in net premiums is lower than the change in gross premiums, due to the corporate retrocessional program which had a much greater impact in 2016 versus 2015. The Diversified Reinsurance segment's net premiums written totaled $286 million, a decrease of 3%. In the AmTrust Reinsurance segment, net premiums written increased by 0.8% to $507 million. In addition to the retrocessional impact, the AmTrust Reinsurance segment growth rate was muted by the commutation announced in the fourth quarter, and the completion of AmTrust's absorption of the new business following the acquisition of the Tower Group. Net premiums earned of $616 million, increased 7%. In the Diversified Reinsurance segment, net premiums earned decreased 11% to $172 million. The AmTrust Reinsurance segment net earned premiums were up 15% to $444 million. Net, written, and earned premium comparisons are distorted by the significantly larger impact of our corporate retrocessional program in 2016 versus 2015. Net loss and loss adjustment expenses of $404 million were up 7%. The loss ratio of 65% was slightly higher than the 64.8% reported in the first quarter of 2015. Commission and other acquisition expenses increased 9% to $195 million in the first quarter of 2016. The expense ratio increased from 33.4% to 33.9% for the first quarter, reflecting changes in business mix. General and administrative expenses for the first quarter 2016 decreased by 4% to $15 million. The general and administrative expense ratio was 2.5% in the first quarter, compared to 2.8%. The combined ratio for the first quarter of 2016 totaled 98.9%, compared to 98.2% in the first quarter of 2015. Due to the volatility Maiden experienced in 2015, a higher booking rate is reflected in the combined ratio relative to the same quarter last year. But we also experienced continued adverse development in commercial auto. The Diversified Reinsurance segment combined ratio was 102.9% in the first quarter of 2016, an improvement of 1 point from Q4 2015, but up from the 101.1% in the first quarter of 2015, due to the adverse development. Additionally, weather losses exceeded our expectations for the quarter, and added 0.6 points to the combined ratio. The adverse development for Diversified segment increased losses by $8.6 million, and added 4.9 points to the first quarter Diversified combined ratio. The AmTrust Reinsurance segment reported a combined ratio of 95.3% in the first quarter, compared to 94.6% in the first quarter of 2015. The increase was due to a higher booking rate, slightly offset by changes due to business mix. Additionally, the overall combined ratio in the first quarter of 2016 includes $2.8 million of non-operating development in the other category due to adverse development in a few remaining superstorm Sandy claims, which if excluded would have resulted in a 98.5% combined ratio. Absent adverse development, and as we have indicated previously, we expect to maintain a more conservative booking loss ratio across our portfolio for the balance of the year, in light of market conditions and continued loss cost volatility. Net investment income for the quarter was $36 million, an increase of 29%, and reflects an increase in investable assets to $4.72 billion, compared to $4.17 billion at March 31, 2015. The average yield on the fixed income portfolio, excluding cash, is 3.41% with an average duration of 4.72 years. The new money yield on fixed maturities in the first quarter was 3.32% with an average duration of 5.48 years. Including cash, the average duration is 4.47 years, versus an average duration of liabilities of 4.17 years. The settlement of the fourth quarter AmTrust commutation lowered operating cash flow by $107 million. Operating cash flow for the quarter was $9 million, a decrease of $161 million compared to the first quarter of 2015. Despite the lower cash flow, cash and cash equivalents were $231 million as of March 31st, as compared to $333 million at the end of 2015. During the first quarter, we maintained our historical investment approach with purchases of $269 million of high-quality fixed income securities. Total assets increased 7% to $6.1 billion at March 31, 2016, compared to $5.7 billion at yearend 2015. Common shareholders' equity was up 13% compared to December 31, 2015. Book value per common share was $13.23 at March 31st, or 12% higher than December 31st, due to the increased value of our fixed income security portfolio, as interest rates were lower at quarter end. We consistently evaluate our capital position and continue to feel confident that the current capital levels are appropriate for the business opportunities we anticipate. Later this quarter we will have the opportunity to call our $107.5 million of 8.25% 30-year notes, and Maiden's 7.25% mandatory convertible shares will convert to common equity in September. In addition to the capital markets, Maiden has benefited from the purchase of retrocessions, and could utilize additional amounts of this tool should the need for additional capital arise. As always, any capital management will be conducted in the most shareholder-friendly way possible. I will now turn the call over to Art for some additional comments.

Thank you, Karen. As I mentioned earlier, we're operating in a highly competitive environment. The soft market does not show any signs of abating despite continued low interest rates. And while commercial auto has been challenging, we're adjusting terms, conditions, and rates to ensure that premiums are appropriate for the risk we assume. In the US, we're still seeing strong margins in our other liability lines, including umbrella, worker's comp, general liability, and our individual risk facultative casualty segment. Beyond the goal of improving the underwriting performance of the Diversified Reinsurance segment, we remain focused on profitably expanding our business. In the US we anticipate continued growth from existing client relationships, while continuing to add new clients to the portfolio. We've constantly found that developing and providing new products and services for our clients helps to enhance retention and increase revenue opportunities. To that end, in the first quarter we rolled out our new equipment breakdown boiler machinery reinsurance offering. We'll also continue to focus on our highest-margin business, while calling underperforming contracts. Internationally, where we believe the most significant growth opportunities lie, we see continued opportunity to expand our highly differentiated capital solutions business, leveraging the sub-debt capabilities of insurance regulatory capital and the underwriting expertise of the entire Maiden Capital solutions teams in Bermuda and Europe. And finally, at Maiden Insurance Partnerships, our unique auto manufacturer branded consumer solutions business, we see continued opportunities to expand our business through new manufacturer relationships, and by implementing our Allianz payment protection insurance joint venture. Importantly, we also expect to see continued growth in the AmTrust segment. Beyond our underwriting activities, we see continued opportunity to strengthen our earnings run rate with a continued increase in our investable and invested asset base. We also believe there are several opportunities to reduce our cost of capital as we move to refinance our current debt over the next several years. Our lower-volatility reinsurance portfolio, our highly efficient operating platform and balance sheet, and our conservative investment portfolio position Maiden well to continue to generate double-digit returns, while rewarding shareholders with a substantial quarterly dividend. Finally, I'd like to close this morning's prepared remarks to express our sincere and deepest sympathy and condolences to the family of Michael Karfunkel. As you may know, Michael was an original founder of Maiden Holdings. And while Michael did not serve on our Board or our management team, nevertheless, his vision, his unwavering support, and his wise counsel were invaluable to the formation and the continued success of Maiden Holdings. His energy and his enthusiasm for the business were boundless. All of us at Maiden were truly blessed to have known and learned from Michael. And we'll miss him a great deal. We're committed to honoring Michael's memory by focusing on delivering exceptional value to our customers, and exceptional returns to our shareholders. Thank you. This concludes our prepared remarks. Operator, could you please open the lines for questions and answers?

Thank you. [Operator Instructions] And our first question comes from Ken Billingsley from Compass Point.

Good morning. Thanks for taking my questions. What I wanted start with is specifically on the Diversified Re loss ratio was a little bit better than we expected. And looking at the trend in the last three quarters of 2015, can you just maybe infer, was this better than expected, or should we see some seasonality trends still come through with those segments and maybe see some elevated loss ratios through the last part of 2016?

Yes, Ken, we think and we've talked about this a little bit before. We think it's really important to look at combined ratio rather than loss ratio, because our mix of pro rata and excess is really going to distort looking at just the components separately. And with the combined ratio that we reported in Diversified, it's definitely higher than we expected or wanted. And that was due to the adverse development in commercial auto.

And I just want to verify that number. The 0.6 points - I'm sorry - the $8.6 million, that was all just for Diversified, correct?

That was Diversified, correct.

Okay. But mix-wise, are we still expecting to see it maybe still be elevated? Or I mean, I knew there was some business mix change overall, and our assumption is the expense ratio may come down going forward, if we looked at as a whole. But from a net basis, is there still going to be a seasonal pattern?

I think expense is always a more challenging one. Again, as we've always said, we look at the blend of loss and expense ratio to produce combined ratio. And our G&A is improving consistently. So that does benefit us. But I think the more important focus is on the combined. And I'd say, certainly it's our hope and focus and effort to try to reduce the combined ratio in the Diversified segment. Nevertheless, I would expect a higher booking rate, as we've talked about before, just recognizing some of the volatility we've seen. But hopefully the Diversified combined ratio will be muted over time throughout the year.

Okay. And I didn't quite catch the commentary on the weather. I did get it was 0.6 points. Was that across the whole book, or just one segment?

That was for Diversified, Ken.

Just Diversified, okay. And then in that, was that mostly Sandy claims? I believe that was some commentary you made.

No, the Sandy claims was the adverse development in the other segment. The weather claims were from thunderstorms in California. And I mean, we're not a cat writer, and we have a very small amount of actual catastrophe in the book. But we do have some weather claims that just come from our property book. And we have an expectation of what those will be every quarter. And some quarters we run a little higher, and some a little lower. This quarter we ran a little higher.

The Sandy claims were related to the discontinued—we actually sold the former E&S property business. And so that's all - we'll see a bit of noise as those claims kind of pay out in the tail.

Now, there - is this not - so that's not related to an existing primary company that you currently reinsure that had -

No.

-- had high exposure. So it's not new development from a current customer?

That is correct. That is correct. It's from a business that we're no longer in that we sold.

Okay, E&S sold business. And then lastly, to turn it over to someone else to ask the question, this is kind of a two-part. Looking at some recent AmTrust acquisitions, is there any lines of businesses from recent acquisitions that they've either completed or announced that you are not interested in? And then I'd also like to get some color on the MI business. A number of reinsurers have deployed capital there. Is that someplace that you would be interested in doing more work with, given AmTrust is looking to acquire a European MI company?

Yes, I think a couple of things. One of the criteria that we use in evaluating opportunities at AmTrust is really that one, we believe that kind of the risk profile fits with our kind of focus; and importantly that we have some competency to underwrite and evaluate the business. So we've said before, I think, Republic fits nicely. It conforms to the three main segments that were initially part of the quota share. Anything that's outside of that, we do evaluate. Typically if they're kind of outside of our underwriting focus, we do not include them. So we have the surety business. We currently do not reinsure some surety lines. We have the MI business - or excuse me - we have the mortgage insurance in Europe. That we don't anticipate supporting at this point as well. So we look at them as they're presented to us. And at this point, they've not been presented to us.

[Operator Instructions] And our next question comes from Alex Combs of FBR Capital Markets.

Hi. Good morning. Can you guys give us an update on business that you're doing through the IRC subsidiary? And I guess to date, have you done any subordinated debt deals? And are any of these on your balance sheet?

No. At this point, we've entertained a significant number of transactions. It's kind of interesting because as we talk to companies in the European market that are dealing with Solvency II, the dialog many times begins with discussions around subordinated debt. But for a lot of these companies, the more natural source of capital support and the more historical source has been reinsurance. In most of the transactions that we've entered into, most of the new clients, there is an ongoing expression of interest to consider subordinated debt and we anticipate being able to deliver solutions to them as their needs develop. We've also seen some transactions that didn't meet our criteria. But I would say unequivocally, the ability to offer sub debt has been one of the driving differentiators for us to create deal flow opportunities. So, we are anticipating that we will see some transactions this year. In terms of our participation, we don't intend - it's not our expectation to put a large amount of sub debt on our balance sheet. We may support some of the transactions and we do have some authority from our Board to do so, but a very modest level. More importantly, we think that there are other capital providers and we have several that have already been identified that have expressed an interest in this business. And so for us, we largely see IRC as a fee business, something that delivers value to our customers; something that we may provide supporting participation on. But to a large extent, we'd really like to build a universe of capital providers that we bring to our client base.

Okay, great. That's very helpful. And then moving back to commercial auto, and sorry if I missed this. So you said the $8.6 million, was that all auto-related development in the Diversified Reinsurance book?

It was. And the majority of it emanated from one client that was terminated.

Okay. And can you give a breakout of accident year there, by any chance?

Mostly, a lot of this focused on the 2013 underwriting year.

Okay.

We did also modify, in the case of that account, our kind of forward expectation on the subsequent underwriting years. We haven't done that on all accounts, because in a lot of accounts we're comfortable with the pricing and the risk selection changes that are taking place. But in the case of this account, we thought it was prudent to also change our forward picks.

Okay, great. And then one last one if I could; so as you guys mentioned, this is the fourth quarter in a row of continued adverse development for commercial auto. And rough math here, I think it's over like $25 million of auto charges over the past four quarters. Our view of scheduled P data shows the 2015 accident year is pretty elevated. So can you just give some broad commentary on where you see the industry going, and what inning do you think we are here?

Well, I mean that's a great question. I mean, when you look back at the catalyst for this, I mean people have pointed to a lot of kind of interesting factors that may be driving it. I think fundamentally you look back on it, and obviously pricing wasn't strong enough. So I think it depends on the sector and the geography. But we do believe and we do see our clients strengthening pricing across the board. And I think there are some opportunities, that said, are developing in that sector as well. I guess my - certainly my hope - and importantly, there have also been companies that have continued to operate effectively in that market regardless of that issue. So we believe that to some extent risk selection and underwriting has to change. There are different factors that are driving loss costs today that maybe historically have. But we do believe that at least many industry participants have taken the right track, and stepped up, and strengthened reserves. And as far as our forward look on this business, we still entertain the business. We don't write as much of it today as we did even 12 months ago. But we're still looking at it. And under the right terms and conditions, we're happy to entertain it. I wouldn't say universally all companies have altered their pricing and their risk selection. But we think a lot of companies have. And I think that's a good sign.

And I'm showing no further questions at this time. I would like to turn the call back over to Mr. Noah Fields for closing remarks.

Thank you, everyone, for joining us today. I know it's a busy day for calls. And we look forward to speaking with you in the future. Have a great day.

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program. You may all disconnect.