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October 31, 2008

OneBeacon Insurance Group Q3 2008 Earnings Call Transcript

Filed under: Conference Call Transcript — Tags: — admin @ 12:00 am


T. Michael Miller – Chief Executive Officer, President

Paul H. McDonough – Chief Financial Officer

Todd Mills – Treasurer, Vice President of Investor Relations


Robert Glasspiegel – Langen McAlenney

Jay Gelb – Barclay’s Capital

Jim Bradshaw – Bares Capital Management

Jay Cohen – Merrill Lynch

OneBeacon Insurance Group (OB) Q3 2008 Earnings Call October 31, 2008 10:00 AM ET


Good morning and welcome to OneBeacon Insurance Group third quarter 2008 financial results webcast. (Operator Instructions). Now let me turn the call over to Todd Mills OneBeacon’s Treasurer and Vice President of Investor Relations, please go ahead sir.

Todd Mills

On behalf of OneBeacon’s management team welcome and thank you for joining us as we review our third quarter 2008 financial results. Today’s call is being hosted by Mike Miller, our Chief Executive Officer and Paul McDonough, our Chief Financial Officer. I will be joined during the Q&A by other members of senior management.

We released our third quarter 2008 results earlier this morning. Our press release, today’s slide presentation and our financial supplement are available on the investor relations section of our web site an audio replay of today’s webcast will also be available on our site following this call.

Turning to slide two, let me remind you that any statements we make during today’s call that are not historical facts, constitute forward looking statements. These statements are based on certain assumptions and analysis made by OneBeacon in light of our experience and perception of historical trends, current conditions and expected future developments as well as other factors.

However, actual results may differ materially from expectations. Please refer to the summary of risk factors at the end of our earnings release as well as a detailed list of risk factors contained in our annual report filed on Form 10-K for the fiscal year ending December 31 2007 filed on February 29th, 2008. In addition any forward looking statements represent our views only as of today and should not be relied upon as representing our views as of any subsequent date.

Slide three, during this call we will refer to non-GAAP financial measures. These non-GAAP financial measures are not prepared in accordance to generally accepted accounting principles. Our reconciliation of the non-GAAP financial measures and most directly comparable GAAP measures accompanies the press release financial statement, and is provided in the financial supplement posted on our web site. Now let me turn the call over to Mike.

Mike Miller

Beginning with slide four, clearly this was a challenging quarter as evident by the adverse change to our book value, down 13% to $14.44 per share. Investment results were the primary driver, reflecting of course the unprecedented market volatility of recent months.

Our 99.8 GAAP combined ratio for the quarter, includes six points or $28 million of CAT losses, primarily from Ike and Gustav and two points through nine months overall in line with our expectations. Investments for the main event however, and we will have a deeper discussion on this topic when we review our investment slides with you briefly.

Turning to slide five, third quarter and year-to-date non-CAT accident year results were solid. The third quarter was impacted by a few large IMU losses in year-to-date by first quarter large property claims. Our third quarter CAT results, as I mentioned, totaled $28 million and was concentrated in our commercial and marine businesses.

We continue to see favorable development in prior accident year loss results for those specialty and commercial lines as evidenced by the 4.4 points of favorable development. There has been no change in our overall views as regarding frequency and severity from the previous quarters and our underlying businesses continue to perform well. And our 35% expense ratio run rate remains on track with our expectations.

Turning to slide six, our top line growth continues to be driven by specialty lines, especially so with our new collector car and boat business. Excluding the collector business, specialty still grew by 11% in the quarter and year-to-date.

In commercial lines middle market we held our ground on price reduction levels. Commercial lines pricing was highly competitive on new business and we passed on more opportunities this quarter given our view of pricing levels. Small business, where pricing remains more reasonable, continues to grow although at a slower rate than prior quarters. And our personal lines results reflect continued competitive auto market conditions and less new business versus Q3 of ’07 due to our retrenchment to northeast only writings.

Turning to slide seven, this was an unusually challenging quarter for our marine business. The current accident year results impacted by an unusual level of non-CAT large losses as well as the CAT losses from hurricanes Ike and Gustav. Remember our marine losses would be boats and marinas not offshore energy like others may report.

At OneBeacon Professional Partner we continue to see favorable development consistent with prior quarters reflecting lower severity. Slight but favorable changes in prior year severity we have not adjusted our severity assumptions for the current year loss base. Expense ratio reflects investments in our newer businesses with our run rate holding steady at roughly 35%.

On slide eight OBPP/s favorable pricing variance was driven by a few large provider access accounts and long-term care accounts. Otherwise the pricing levels were consistent with prior quarters but IMU rates remain flat.

The retention remains in the mid 80s for OneBeacon Professional Partners while the marine retention rates reflect increasingly challenging market conditions across the board. New business levels were solid for both groups and our specialty businesses delivered good growth with overall results again bolstered by the exceptional growth in the collector car and boat business.

In July we announced the acquisition of Entertainment Brokers International, a managing general agency specializing in sports, leisure and entertainment business. We’re very excited about this new opportunity and the highly experienced team of specialists. On an annualized basis EBI will produce roughly $50 million of net written premiums.

Turning to slide nine in commercial lines, we were pleased with the commercial line results with solid non-CAT results and Caps within our expectation levels. We saw a favorable prior year development again this quarter which increases our confidence regarding the underlying strength of this book of business. For nine months results reflect the first quarter’s winter storms as well as the late summer hurricanes; overall the results are fine.

On slide 10 our renewal pricing for middle market is consistent with prior quarters. Middle market’s pure rate change was down 6% for the quarter and is running at 7% through nine months, while small business pure rate was down 3% for both the quarter and a year-to-date basis.

Middle market and new business pricing in the third quarter still showed an aggressive market and in our view an adequate pricing on many accounts, prompting us to behave prudently and scale back our new business writings as you can see. We are satisfied with our renewal retention levels and will continue to focus on keeping our best accounts. In small business we continue to see strong growth from our affinity groups with new business up slightly over prior year.

Turning to slide 11 and personal lines, the personal lines current accident year non-CAT results were solid within the competitive marketplace. The third quarter non-CAT variance was influenced by our involuntary business results. The expense ratio continued to improve reflecting the actions taken last fall to address personal line deficiencies. Keep in mind that Q3 2007′s expense ratio was favorably impacted by nearly eight points of non-recurring items.

Turning to the statistics on slide 12, throughout year we have successfully filed rate increases in all states we’re running business except Massachusetts, which as you know is transitioning to a managed competitive environment. Retention levels are holding steady where variants in our PIF counts reflects our exiting the surplus lines homeowners business as well as limiting our focus to the northeast for all personal lines.

New business levels were in line with our recent quarters. And with that let me turn it over to Paul to review our investments and capital management.

Paul McDonough

Turning to investments on slide 13, the total return of the investment portfolio in the third quarter was negative 7.1%. The majority of the investment loss in the quarter was from the change in unrealized gain and losses which is primarily a reflection of market trends.

In particular general spread widening in fixed maturity investments and a general deterioration in equity market valuation. We did record $63 million of other than temporary impairments or OTTI in the quarter. With respect to the headlined credit event exposure the $63 million of OTTI included $10 million of Fannie Mae and Freddie Mac preferred stock, $8 million of ILST bonds, $1 million of AIG common stock and nothing Lehman Brothers related.

But we sustained relatively minor losses in those credit events, reflecting our modest exposure. The balance of the OTTI in the quarter was from various securities in the financial material and energy sectors.

Looking at our relative performance on slide 14, consistent with recent quarters our fixed income portfolio modestly underperformed relative to the Lehman U.S. aggregate index due primarily to being underweight in U.S. Treasury securities during a general flight to quality, coupled with the fact that our U.S. Treasury investments are primarily in inflation indexed treasuries which were down approximately 2% in the quarter, while intermediate fixed rate treasuries were up about 2%.

Going the other way our corporate bonds were down 3% in the quarter but significantly outperformed the Lehman Corporate Bond Index. And our structured product which has no CDO, no CLO and no sub-prime residential mortgage backed securities, was up about 20 basis points in the quarter.

On the equities side where we have historically outperformed the S&P particularly in a down market, the portfolio significantly underperformed the S&P in the third quarter. The underperformance is primarily driven by the fact that in our common stock portfolio we were overweight in utilities and gold stock. Both of which had historically served as effective defensive positions in a bear market, but in the third quarter they significantly underperformed the broader market and our particular securities within those sectors underperformed the sectors themselves.

On a year-to-date basis consistent with our historical performance, we continue to outperform the S&P driven by significant outperformance in the financial and energy sectors.

Turning to the asset mix on slide 15, our equity oriented investments accounted for 32% of the portfolio at December 30, compared to 36% at June 30 reflecting the mark-to-market during the period. Our short-term investment increased by over $100 million during the third quarter representing 13% of the portfolio at December 30, up from 9% at June 30.

While there is no change to our overall investment philosophy we will further reduce equities as a percent of the total portfolio during the fourth quarter before any impact from-mark to-market, reflecting a decision to reduce the risk profile of the portfolio given the extraordinary volatility of current markets.

Finally regarding capital structure and capital management, on slide 16, during the third quarter we repurchased roughly 400,000 shares that were roughly $7 million, bringing inception to date share repurchase which began in Q3 of ’07 to 4.9 million shares and roughly $102 million. This leaves $98 million of share repurchase authorization outstanding but at the moment we are not actively buying back shares due to the volatility of current markets and the potential for emerging opportunities on the business side.

Our leverage at December 30 of 34.8% is certainly higher than our long-term target of 30% but nevertheless manageable. In the quarter we did repurchase approximately $24 million PAR value of our senior note which reduced our leverage ratios by 70 basis points.

And with that I’ll turn it back to Mike.

Mike Miller

Thank you Paul, let me make a few closing comments before we turn it over to your questions. On the underwriting side, all of our businesses are in good shape, and positioned to do well in an improved pricing market, which we now have hopes and belief could occur in 2009.

Until then we will remain disciplined as evidenced by our new business decisions that I just shared with you during this past quarter. On the investment side we continue to have a high quality portfolio on both the equity and fixed income side. But as we’ve learned even that doesn’t make you immune from the down draft of recent months.

We are continuing to move our investments thoughtfully to an even more defensive position as we navigate through these unprecedented times. Our capital position remains strong and we continue to look at the future with our opportunistic approach to our teams, segments and quality new business.

And with that operator I’ll turn it back to you and we’d be happy to take your questions.

Question-and-Answer Session


(Operator Instructions) Your first question comes from Bob Glasspiegel – Langen McAlenney

Bob Glasspiegel – Langen McAlenney

Your press release indicates that you’ve had some further hits in the fourth quarter with respect to bonds. Anything you could quantify?

Paul McDonough

I’ll give you some context for it, the S&P 500 portfolio through yesterday in the quarter was down about 18%. Our portfolio of common stock and convertible bonds was roughly in line with the S&P through yesterday.

Bob Glasspiegel – Langen McAlenney

And bonds any specific hits?

Paul McDonough

Not specific hits, but certainly we’ve experienced some additional spread widening in the quarter.

Bob Glasspiegel – Langen McAlenney

That would suggest your debt-to-capital ratio will be higher at year-end, unless there’s some other offsets that I’m missing. Is there an upper bound range that you would get nervous about the dividends?

Paul McDonough

I would say that our leverage at 34.8 is approaching an upper bound. I think that we could, strictly looking at the leverage, I think we could manage with maybe a couple of points higher. But certainly our objective is to manage the leverage ratio down and we’ll continue to look for and evaluate opportunities to do that, along the lines of the debt repurchase that we did in the third quarter.

With respect to the dividend which is I think the second part of your question, the leverage ratio and the dividend certainly are somewhat tied. I think ultimately any decision that we make with respect to the dividend will have other considerations to it as well.

In November when we meet with the board as we do every quarter, we will again consider whether the dividend level is appropriate in the context of our capital position and also in the context of the yield bonded dividend relative to our peers. And that is something that we look at every quarter.

Bob Glasspiegel – Langen McAlenney

Mike you’re an esteemed veteran of the industry and some of your fellow experienced CEO’s have offered some sort of crystal ball commentary of more clarity, sort of on what they expect the third quarter hostile environment might do to the market going forward. Your comments seem to be a little bit more soft cycle strategy than highlighting a sizeable change in the environment. I was wondering if you could clarify, sort of where you stand and where you think things are going?

Mike Miller

What I would say is my comments relative to the third quarter was that clearly we didn’t see the transition that you’re alluding to in the third quarter. What I would say though, and I think I said in my prepared comments, was that I do believe that a number of factors are in place that would point to an improving pricing market as we head into 2009. I think that should happen, and I think clearly there’s a lot of discussion about that in the industry and rightly so.

The capital position in the industry has been significantly hit. And I think there will be impact, so I’m optimistic but we obviously manage the business everyday transaction to transaction. And as you saw in my comments as well, in the third quarter we believe that some of the pricing specifically in the middle market new business area, was actually pretty aggressive and so we backed off some of that.

I think we see an overall flattening if you want to call it that at the price levels we’ve been running at for the previous couple of quarters. Which I think is generally the first indicative sign that things are flattened out and may begin to head out the other way and I’m somewhat optimistic and expect that that would be the case. And I think it should be

Bob Glasspiegel – Langen McAlenney

So you’re sure of late ’09 early ’10 things should be a lot better?

Mike Miller

Well you know, I’d love to see it happen sooner, Bob, and I think there are a lot of reasons that it should, but our job is to manage through it either way. But I think in ’09 pricing clearly should improve over ’08.


The next question is from Jay Gelb – Barclay’s Capital

Jay Gelb – Barclay’s Capital

Paul on the investment portfolio given how much of the, given the majority of the portfolio is in fixed income, I don’t know if you just have the ability to tell us how far down the overall portfolio may be to October?

Paul McDonough

I can’t give you a number Jay. But it will perform as you would expect it to given the positioning and given the short duration. So certainly there’s been an impact given the spread widening but it’s a very conservative and defensively positioned portfolio.

Jay Gelb – Barclay’s Capital

And then on the personal lines business can you talk about how that’s being viewed strategically? Mike?

Mike Miller

Sure what I would say is the business is performing well, we, one of the things I referred to Jay was last fall as we told you, our core book of business has always been the eight northeastern states. And we were involved with some events trying to expand outside of that given the market conditions at the time, we thought it made more sense to point the resources more to the northeast and we’ve done that.

And I’m pleased with the results of the business. And we’re managing it going forward, investing in new products and new pricing tools. And I think it’s really the northeastern book of business is a real franchise for us.

Jay Gelb – Barclay’s Capital

And then finally on the expense ratios, year-to-date if I’m looking at the right page in the supplement, it looks to be up about a point to almost 35% year-to-date even though, premiums up in the single digits so can you give us a sense of when that trend may reverse on the expense side?

Paul McDonough

The run rate remains at about 35% and year-over-year that has been consistent. On a normalized basis we had some non-referring items in ’07 that produced reported expense ratio. The ’07 run rate was about 35% it remains 35% through ’08.

There is a difference in the pieces if you decompose it into acquisition and OUE. We’ve actually made some progress on the OUE with our expense management. We have given all of that back on the acquisition side, mostly due to mix. And so the run rate is at 35% from where we sit today.


Next question is from Jim Bradshaw – Bares Capital Management

Jim Bradshaw – Bares Capital Management

You mentioned taking down the percentage of equities in the portfolio I wonder if you have a percentage you were looking to reduce that to?

Paul McDonough

Yes rough numbers directionally I would expect that we would take the total equities of common convertibles and other investments down in the neighborhood of 15% to 20%.

Jim Bradshaw – Bares Capital Management

And as far as in the future bringing that back up is that going to be driven more by when the market’s volatility has kind of settled or what do you think will drive that?

Paul McDonough

It will be, somewhat opportunistic, so short answer yes.

Jim Bradshaw – Bares Capital Management

As far as what you’re seeing in the insurance market as well as in environment I guess, as well as the current economic environment, are you seeing any opportunities increasingly for specialty lines and adding lines or anything like that? Could you speak a little about what you’re seeing there?

Mike Miller

What I would say is I do think that there, we continue as always as we’ve talked about in the past we’re always looking to add new teams and new segments that we make. Offers with returns over time that we believe are extraordinary. I mentioned to you we added DBI in the quarter which was a nice opportunity for us.

And we’ve started a new energy segment and so we’re, and that’s a team of people that we brought over. We just brought over a new leader for that business so my answer to you would be yes, we, there are going to be opportunities, there still are. I would expect that there will be some increasing opportunities given the overall economic climate that we will be interested in looking at.


Your next question comes from Jay Cohen – Merrill Lynch

Jay Cohen – Merrill Lynch

I want to ask about your own reinsurance buy. I guess two questions. How do you see your, say in the CAT side as an example, how do you see your retentions changing? And then secondly what kind of message are you getting from reinsurers or reinsurance brokers as we head into the one-run renewals. I forget exactly when your CAT contract renews but kind of what’s the word out there?

Mike Miller

Couple of comments, relative to what we’re hearing and what the market is saying, there’s discussion obviously about the overall market pricing. There’s speculation obviously that there’s generally property and property tax, historically have moved first towards pricing increases. And I don’t have any reason to suggest that wouldn’t necessarily be the case here.

We’re we’ve not had specific discussions with anyone yet, regarding our placement in that regard. What I would tell you, which relates to your first question a little bit, we’ve relative to how we look at buying the reinsurance we look at the CAT cover really as balance sheet protection, always have. And that’s something relative to our own view on it.

Clearly there are times given the overall capital issues in the industry if you look at it as a balance sheet item like we have today that obviously we take a look at. But our overall philosophy is we’re pretty committed long-term significant line underwriter. But it’s clearly something that we will take a look at as time goes forward and we’ll do so.


(Operator Instructions). And we have a follow-up question from Bob Glasspiegel – Langen McAlenney

Bob Glasspiegel – Langen McAlenney

Just a follow up on the acquisition analysis, you seem to be talking in terms of niche stuff. If there was something a little bit bigger that was intriguing to you, what sort of financing options would you be able to use> Would you work with White Mountains together or I mean there are obviously a lot of things out there that would in the more normal world be interesting to you?

Mike Miller

I think your assessment Bob of the things we’ve done have been niche oriented and that’s – we continue to do that. On a larger more broad scale basis we consider partnering with a variety of different options. Clearly you mentioned White Mountains which would be one and an obvious one, and in addition to that obviously other partners as well, private equity, etc. So to the extent we really felt there was an opportunity that was much wider, we’d look to try to construct a consortium to make it happen if we thought it made sense.

Bob Glasspiegel – Langen McAlenney

Do you have an acquisition team in place today or is it just management?

Mike Miller

We have a group of people that are continually working and looking at that opportunity yes.


You have no further questions at this time. I would now like to turn the call back over to Mr. Mike Miller for closing remarks.

Mike Miller

Thank you very much for joining us, and we look forward to talking to you next quarter, thank you.

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