SiriusPoint Ltd. (SPNT) Q4 2017 Earnings Report, Transcript and Summary

Greetings, and welcome to the Third Point Reinsurance Fourth Quarter 2017 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your hosts Chris Coleman, CFO. Please go ahead, sir.

Thank you, operator. Welcome to the Third Point Reinsurance Limited Earnings Call for the Fourth Quarter of 2017. Last night, we issued an earnings press release and financial supplement, which is available on our website, www.thirdpointre.bm. Leading today's call will be Rob Bredahl, President and CEO. But before we begin, I would like to remind you that many of the remarks today will contain forward-looking statements based on current expectations. Actual results may differ materially from those projected, as a result of certain risks and uncertainties. Please refer to the fourth quarter 2017 earnings press release and the Company's other public filings, including the risk factors in the Company's 10-K, where you will find factors that could cause actual results to differ materially from these forward-looking statements. Forward-looking statements speak only as of the date they are made and the Company assumes no obligation to update or revise them in light of new information, future events or otherwise. In addition, management will refer to certain non-GAAP measures, which management believes allow for a more complete understanding of the Company's financial results. A reconciliation of these measures to the most comparable GAAP measure is presented in the Company's earnings press release. At this time, I will turn the call over to Rob Bredahl. Rob?

Thanks, Chris. Well we had a strong fourth quarter and a terrific full year. In the fourth quarter, we generated net income of $44 million, a return on equity of 2.8%. And for the full year, we generated net income of $278 million and return on equity of 20.1%. The strong results were particularly gratifying given that they allowed us to highlight the strengths or at least the uniqueness of our total return business model. In a year with record cat losses and poor industry results, we had stable underwriting results and a 20% return on equity, among the very highest in the industry. Chris, will go through the details of our results in just a minute. From our inception six years ago, we have focused on generating stable long-term flow and minimizing underwriting risk by focusing on quota share contracts of less volatile lines of business. Now that we have stable long-term float, have increased surplus by $1.1 billion over six years and are fully connected with producers, we plan to increase our expected underwriting returns by incrementally, and I stress incrementally, increasing the risk profile of our reinsurance portfolio. We plan to increase our rating of specialty lines, rate lower layer excess coverage in addition to quota share and raise some shorter tail event type covers. We're off to a strong start in 2018 having already written more than $325 million premium and at improved pricing levels to the transactions we booked early last year. We believe that in the years leading up to 2017, when there is much less cat activity and the modeled expected activity, reinsurers earn outside profits, which masked the poor pricing in non-cat lines. Recent cat events have shined the light on this poor pricing and we've seen 300 to 400 basis point improvement in the composite ratios of the quota share contracts we renewed at 1:1 through a combination of improved underlying insurance pricing and reinsurance terms and conditions. Now I would like to take a few minutes and talk about the potential impact of U.S. tax legislation passed at the end of 2017. To start and to be very clear, we do not believe the new tax legislation will have a material impact on our financial results. The tax legislation is enormously complicated and there are really two pieces of the Tax Act that could impact us. The first is the base erosion and anti-abuse tax or BEAT. This is a tax on certain payments from U.S. taxpayers to their foreign affiliates. For many reinsurance companies, there will be faced-in 10% tax on gross premium seated under intercompany quota share arrangements. This has caused many offshore reinsurance companies to eliminate or restructure these agreements and to increase the capitalization level of the U.S. affiliates. For our Third Point Re, there'll be no change to our intercompany quota share arrangement and will not be subject to any BEAT tax. The tax applies to entities where the gross receipts under U.S. tax paying subsidiary exceeds $500 million. Our U.S. tax paying subsidiary is under this threshold and we expect it will be so for the foreseeable future and therefore, the BEAT Tax should not apply to us. The other part of the tax bill that will impact us, at least indirectly, is the test for determining a Passive Foreign Investment Company or PFIC. If we're deemed a PFIC, our U.S. taxpaying investors will be required to pay taxes on current taxable income of the company. To be clear, our financial results are not impacted by the PFIC rule, just for investors after tax returns. But of course, any negative impact to our investors is concern to us, especially since it will affect our share price and our access to capital. So we will be taking certain steps to ensure we are not a PFIC. The Tax Act modifies the active insurance exception to PFIC status by adding a requirement that reserves, but generally constitute more than 25% of the Company's total assets for the relevant year. However, the tax law uses an odd definition of reserves. Only loss and loss adjustment expense reserves are used in the formula and not UEP reserves. Our loss and loss adjustment reserves are currently less than 25% of our total assets as they are, by the way, for almost half the P&C market. One of the factor working against us is the structure of our investment account. Instead of investing through a traditional limited partnership arrangement, where only the net asset value of our portfolio managed by Third Point LLC, would be presented in our balance sheet, our investments are managed through a separate account with the gross asset and the gross liabilities related to our investment activities reflected in our balance sheet. Under our current investment account structure, our gross assets exceed the net asset value of our investment portfolio by more than $1 billion. We plan to restructure our investment account, so that we will present only its net asset value on our balance sheet and thereby reduce our total balance sheet assets by the $1 billion, while preserving similar economic exposure to Third Point investment strategy. Once, we’ve completed the investment account restructuring, we are confident that we will clear that 25% threshold by year-end. I will now hand the call over to Daniel Loeb, who will discuss our investment results in greater detail. Daniel?

Thanks, Rob and good morning. The Third Point Reinsurance investment portfolio managed by Third Point LLC returned to 2.7% in the fourth quarter of 2017, net of fees and expenses. The account returned 17.7% in 2017, net of fees and expenses, versus returns for the S&P and CS Event Driven Indices of 21.8% and 6.3%, respectively, for the year. The Third Point Reinsurance account represents approximately 15% of assets managed by Third Point LLC. In 2017, many factors combined to create a favorable environment for our opportunistic equity investment style. 93% of returns came from the equity portfolio and these were driven by strong stock selection and event driven situations, several constructive investments, strength in that tech sector, successful short selling efforts and maintaining a well balance portfolio across sectors with equal exposures to cyclical and defensive stocks. Our equity book generated a return of nearly 30% on invested assets for the year. While the portfolio was mostly U.S. focused, we had more ex-U.S. exposure than in recent years and international investments generated 25% of 2017 returns. In Q4, equities continued to drive profits with industrials, consumer and financials as the top-performing sectors. Energy, TMT and healthcare were flat for the quarter. The total equity portfolio returned 5.2% on average exposure during the quarter. Credit exposure remains modest in an environment with tight spreads and many participants chasing the same opportunities. We continue to monitor the impact of a rising rate regime and will adjust exposures accordingly. Corporate, structured and sovereign credit debt returned 3.2%, 1.4% and 60 basis points respectively for the quarter. Our portfolio remains concentrated in equities and balanced across sectors with a focus on U.S. investment opportunities. We will continue to monitor economic data closely and adjust our portfolio exposures to changing market conditions. Now I'd like to turn this call over to Chris to discuss our financial results.

Thanks Daniel. As Rob noted, 2017 was an excellent year for Third Point Re with the market-leading return on equity exceeding 20%. Our diluted book value per share ended the year at $15.65, which was an increase of 2.8% for the fourth quarter and 19% for the full year. The key driver of our results was the excellent investment returns that Daniel just discussed in detail. For the fourth quarter, we generated net investment income of $67 million, bringing the full year to $392 million. Related to our underwriting results, we've continued to reshape the portfolio and based on these changes, as well as some improvement in overall market conditions that Rob discussed earlier, we expect continued improvement in our underwriting results over the next 12 to 24 months. Related to movements in gross written premium, just a reminder that given our focus on large contracts that in some cases may not renew or may renew in non-comparable periods. We will not overly react to premium movements in any given quarter. Having said that, our gross premiums written increased by $83 million or 103% to $164 million from $81 million in the prior year's quarter. Gross written premium increased by $24 million or 4% to $642 million from $617 million in 2016. The increase during the fourth quarter was primarily due to the renewal of two contracts. One of which was a two-year contract written in 2015, which renew this year and the second was a contract previously written for one year in 2016 where we renewed for a two-year period in 2017. As Rob mentioned earlier, these were two examples of contracts where improvements in pricing terms and conditions resulted in us writing contracts that we would not have expected to renew earlier in the year. The modest increase in premium for the full year reflects several moving parts, but includes $286 million of new premium written during 2017, partially offset by non-renewals and other timing differences. Movements in net premiums earned between periods reflect the timing of earnings in our in-force portfolio, but was also impacted for the full year of 2017 by $109 million of new retroactive reinsurance contracts written in the second quarter, which are fully earned when written. We did not write any retroactive reinsurance contracts in 2016. We generated a $9.2 million net underwriting loss for the three months ended December 31, 2017, compared to an underwriting loss of $9.5 million in the prior year period and our combined ratio was 107.1% compared to 105.0%. For the 12 month period, we generated a $43 million net underwriting loss compared to an underwriting loss of $50 million in the prior year period and our combined ratio was 107.7% compared to 108.5%. We did not record any catastrophe losses in the fourth quarter and we maintained our $5 million estimate of cat losses for the full year of 2017. The cat losses in 2017 accounted for one point on the full year combined ratio. During the fourth quarter, we recognized net prior year's favorable reserve development of $2.5 million. As we did not have any net reserve development in the prior quarters, this was also the amount impacting our full year's results. As a reminder, our reference to the net impact of reserve development reflects the impact of changes in loss reserve estimates as well as any offsetting impact of acquisition cost. Federal and administrative expenses for the fourth quarter of 2017 were $14 million compared to $5 million for the prior year period. General and administrative expenses in 2017 were $53 million compared to $39 million for 2016. The increase was primarily due to an increase in our annual incentive plan compensation accruals reflecting the performance of the company year-to-date. In the fourth quarter of 2016, we reversed our bonus accruals based on performance, which lowered the expense in that period. The increase in income tax expense for the 12 months ended December 31, 2017, compared to the 12 months ended December 31, 2016 was primarily due to higher taxable income generated by our U.S. subsidiaries. As a result of the change in tax rate, we reduced our net deferred tax liability during the fourth quarter, which resulted in a gain of approximately $800,000. We do not expect any material impact to our effective tax rate as a result of the changes from recent tax legislation, which Rob discussed earlier. Finally, as noted in our earnings press release, we have increased the authorization on our share repurchase plan to $200 million. We intend to buyback shares when our share price is 95% of diluted book value per share or lower, subject to market conditions, rating agency capital considerations and other factors. I will now hand the call back over to Rob.

Thanks, Chris. We had a great year in 2017 with market-leading returns and we're able to showcase the strengths of our total return business model. After building up stable long-term float by focusing on less volatile, cash rich quota share contracts and reserve covers, we plan to incrementally shift more risk-taking to improve our underwritten results. Recent cat events have contributed to some improvement in pricing and we're off to a strong start in 2018. I will now hand the call back over to the operator, who will open the call up for questions. Thank you.

Thank you. We’ll now be conducting a question-and-answer session. [Operator Instructions] Our first question today is coming from Kai Pan from Morgan Stanley. Your line is now live.

Thank you and good morning. First a few questions for Dan. Dan, in your letter in January, you identified that inflation as a key issue you closely watch. Since then, the market has experienced a period of heightened volatility. Do you think that will continue? And how do you position the portfolio?

Hi, yes, I think obviously, inflation goes hand-in-hand with interest rates and that's been – and that's obviously been something that we, along with everyone else has been focused on. I think we also need to just look at growth expectations. And I'm not saying that growth is a problem, but it's definitely an issue that we're looking at and I think getting past sort of the concerns about interest rates and inflation. I think, that there may be more pressing issues going to be whether the rosy assumptions that everybody has about earnings growth this year and next year will be net, I'm not saying there won't be net, but it's definitely something given some of the recent economic data, which tends to be noisy, we need to keep an eye on. As far as positioning the portfolio, we've been in process of reducing both gross and net to be more nimble in what we think will be more of our range bound market this year. Still one with a lot of great opportunities, but probably won't have the same tailwinds that we had last year in terms of low volatility and steady up into the right market that ended up over 20% for the year.

Okay. And then my second question on the tax reform. If you step back and think about it, is that -- does it take away or blunt it – blunt one of the key competitive advantage for the Third Point Re business model?

I'll let Rob answer that one.

Yes, I can – this is Chris. I'll start that and certainly Rob can chime in. So, I mean, I guess to your question, Kai, we don't intend to be a PFIC at the end of the year. Clearly, if we were deemed a PFIC that would blunt the advantage of investing in Third Point Re in terms of the tax considerations of investing in a corporation. As Rob laid out in his initial remarks, our plans to address the PFIC – and there's really two parts to how we intend to ensure we're not a PFIC entity at the end of the year. As Rob mentioned, due to the structure of our investment portfolio as a separate account rather than an LP investment, our balance sheet is closed up by the underlying investment assets and liabilities. We plan to restructure our investment account to more of an LP-type structure in a manner that achieves the balance sheet presentation that helps on the PFIC ratio, while preserving the same investment exposure and expected investment returns to our shareholders as they would have under the existing structure. And based on the information you would see in the earnings release and financial supplement, by doing that, it would bring our ratio for purposes of the PFIC test, from 15% to 21%. And so that would leave us about $200 million of loss reserves under the required 25% ratio, and we expect to be able to close that gap in the normal course of business, including writing additional reserve covers, which as you know, is already a core part of our underwriting strategy.

And also, Kai, although we don't like the measurement, there's now a bright line test. So everybody knows what they have to achieve to be considered not a PFIC. And I – there's always been a cloud over Bermuda reinsurers with respect to PFIC, and so I view that as a positive.

Okay, that's great. And back to Dan. You talked about your data science team in the letter. Can you give us more detail about how's the team helping the investing process?

Yes. I mean, it's early days in terms of data science, but they've already had a very strong influence on us in terms of using machine learning and artificial intelligence and applying that to the data that we've got, both from our developing some quantitative screens that we use, especially on the short side and also on helping to supplement the fundamental work that our various industry teams do in terms of better understanding consumer behavior or what's going on in sales channels and other things. So it's a very exciting thing. We spent a lot of time and energy on it. But this is something that is going to be – is going to require a lot of time and resources and this is a multi-year project. It's basically embedded in our organization at this point and will be there and we're just starting to see the first fruits of that effort. But I don't think you can be in any business today that's reliant on information and requires people to make decisions based on data without having a sophisticated approach to accessing and analyzing that data, whether you're a hedge fund or an operating business. And we're certainly making the commitment and the investment in that area. So we stay up to date.

Great. Last one for you, Dan. What's your take on the media report of potential investment by Softbank in Swiss Re?

I have no real opinion about it. They've made some unusual investments in the financial services area and I don't know – I don't really have an opinion on this one. Unusual and they're unexpected for a tech company with a focus investment in this investment. You will have to ask Masa Son on that question.

Okay, great. And then switch to Rob and Chris. I have a couple for you. Number one, Rob, you mentioned that you're gradually increasing the risk profile of the underwriting. Is that – will help the combined ratio profile to lower? And – but at the same time, will that increase volatility of the underwriting results? Will the rating agency be comfortable with that?

Well, the combined ratio is going to improve our core book of business. We're just seeing improved pricing. We're already right in some specialty business through quota share contracts. And so Kai, it's really an extension or maybe a slight acceleration of what we've been doing. And we've retained a lot of earnings recently. So from a rating agency standpoint I think we're just fine.

Okay. Last one on the buyback. You increased also utilization and also since it sounds like to me, if I remember correctly, you have threshold about 90% before and now it's 95%. Is that the change?

Yes. I mean, you're right. I mean, previously we had announced a threshold of 90% and now we've just announced a threshold of 95%. And it's a little bit of an increase. Clearly, as we said in the past, buying back our shares below book is immediately accretive to shareholders on future earnings. And given the – as Rob just pointed out, the additional earnings that we've retained over the course of the year and the strengthening of our capital position, we've made the decision to move that dial out slightly.

Kai, our gross premium really hasn't changed so much in three or four years. And now we're up to $1.7 billion in surplus, which is $500 million or so more than we were a few years ago. So we have room to take a little bit more risk and buyback shares.

Great. Well, thank you so much for all the answers.

Thank you. [Operator Instructions] Our next question today is coming from Meyer Shields from KBW. Please proceed with your question.

Great, thanks. Good morning. Rob, again, touching on the incremental increase in underwriting risk. I guess, two questions. Should we expect some measure of capacity risk? And will the receipt rate on this enhanced risky portfolio be longer than the current liability duration?

I guess first on property cat. We're unlikely to write any meaningful amount of property cat this year. We're looking at how the market is shaping up, pricing. I'm very interested in what goes on at 6.1 and then we’re going to look at cat activity during the year. And so that's something that's under consideration. And the second question is, are we're going to stretch out the tail? Was your – the second part of your question more just sort of expectations on liability duration as result of shaping – reshaping the portfolio?

Yes.

I think it comes in a little bit. Just the more event-driven type risk that we're looking at, we're bringing in slightly. You're probably not going to notice any meaningful change this year.

Yes, that’s right.

Okay, that's very helpful. And then, this is just an ignorant question, but does the restructuring of the investment accounts into an LP require any external approvals?

No, it doesn't require any external approvals. Of course, any time you're making changes like this, we'll be working closely with our regulators and with the rating agencies to ensure they fully understand what we're doing. But as I said before, the intention is to restructure things in a manner that results in a different balance sheet presentation, but retains very similar, if not the same investment exposure and expected investment return.

And we currently have a separate account, maybe a more traditional way for reinsurers to invest in hedge funds is through an LP structure, but both approaches are widely used.

Okay. Yes, I just didn’t notice any restriction on that, particularly to understand what you're doing. Thanks so much.

Yes.

Thank you. We’ve reached the end of our question-and-answer session. I’d like to turn the floor back over to management for any further or closing comments.

Well, thanks, everybody, for joining us. We look forward to talking to you next quarter. If there's any questions in the interim, please give us a call.

Thank you. That does conclude today's teleconference. You may disconnect your line at this time and have a wonderful day. We thank you for your participation today.