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RICHARD BRINDLE, CEO, LANCASHIRE HOLDINGS LIMITED: Good morning
everybody thank you very much for coming to the Lancashire annual
results presentation. I'm Richard Brindle, Chief Executive and Chief
Underwriting Officer; to my left Simon Burton, Deputy CUO and Chief
Operation Officer, and Ian McConachie, Chief Financial Officer.
Starting at page 3, I think probably what we're most pleased with,
because to be candid with your pretty much everybody in our world had
a very good year last year, is how we feel we're now a proper
company. This time last year we had a handful of people, it was a
real struggle just getting through the day and we're still working
[expletive] hard, but it now feels like a proper company. We're fully
staffed -- pretty much fully staffed in both London and Bermuda,
we're about to open in Dubai, we have 57 people in place currently
and I think there's a few hires in the pipeline, but it's going to
be, I guess, in the low to mid 60s when we settle down, and that's a
great feeling for us.
The other factor that's particularly pleased all of us is the way
that we've been received by the brokers and the clients. We had to
fight in the early days against a perception and we haven't entirely
conquered this perception yet. I realize that that we were a very
sort of short animal just coming in to cream off a couple of year's
of good results and then head for the hills. And funnily enough I've
been spending a lot of time with clients this week and we saw one of
our biggest energy clients yesterday and I was delighted when they
said that that's a perception which they feel is now fundamentally
changed.
Because the argument I always use with people is not only is it an
incorrect way to behave, I wouldn't go out and hire 60 people and
then fire them all two years later; it's just not a good way treat
human beings. But people kind of roll their eyes when you talk about
morality in this business. But just for narrow financial self
interest, if we want to achieve a decent multiple to put value in
this company over time, we've got to demonstrate that we are
long-term players. I've always been a long-term player, I've
demonstrated it in my previous career, but just to re-emphasize, we
are building for the long term here. So I'll hand over to Neil on
side 4.
NEIL MCCONACHIE, CFO, LANCASHIRE HOLDINGS LIMITED: Thanks. Morning
everyone. Slide 4, financial highlights, we'll go thorough in more
detail, but just to read them out.
We had an ROE of 17.5%; the way that we look at ROE is growth in
fully converted book value. Net operating income of $180 million,
that excludes realized gains and losses, foreign exchange and one-off
warrants given out at the IPO, it does include options. Net profit of
159, gross written premiums 626, very low loss ratio of 16% and
combined of 44% and we are not paying a dividend and we'll tell you
why later on.
Let's turn over to page 6. Just first of all a couple of things to
think about for going forward. We are going to start doing quarterly
earnings announcements. We will issue a press release, it will have
some comments from management and some discussion on the numbers, it
won't be as long as an annual press release, it will be more of a US
sort of length. It will have summary financial statements in there
and we will do an earnings call once a quarter.
We're also publishing, for the first time, our financial supplement
which is on our new and improved website; we finally got rid of our
embarrassing old website as of midnight, and there's lots of good
stuff in there. If you haven't looked at the financial supplement
there's loads and loads of good stuff, lots of detail, lots of
breakdowns; it's a riveting read. So that's something that's going to
come out each quarter as well and hopefully it's pretty helpful. It
won't tell you how much money we're going to make, you still have to
make that up yourself.
So okay, page 6 just to run through some of the numbers here, gross
written premiums 626; we had previously come out with a range of 615
to 625. Outwards reinsurance, mostly purchased in the second quarter
so the number hasn't changed too much since the half year because
essentially we're buying reinsurance for US wind storms.
Net earned premium as a ratio of net written premium, the ratio is
only 44% in the first year. We obviously started 2006 without any
unearned premium reserve; we're starting 2007 with 307 million of
unearned premium which will flow through this year. There's actually
quite a bit of premium in there that was for US wind storms, so
hopefully that flows through [inaudible].
Moving down, very low claims, $39 million of claims; as Richard said,
a lot of people have had a good year. We are not however at pains to
point out, the same as many of the Bermuda property cut reinsurers,
we're an insurance company, a direct writer; we've got a much more
diversified book of business. Half of our business is not exposed to
property cut events, in fact this year the majority is non-elemental.
So yes, mother nature was kind last year, but obviously a lot of the
stuff that we do does come down to risk selection and hopefully the
fact that we had a good result in the rain and areas of energy and
property is testament to the skills of the underwriting team.
Operating income we talked about, we do think that's the best way of
thinking about the run rate of earning power, whether it comes to PE
ratios, whatever it might be, that's the figure we think is most
appropriate. And then ROE as we said 17.4%, not too bad for the first
year.
Turn over to page 7. Cash and investments went up 29% in the year,
flow is building steadily. It didn't build as much as we thought
because we didn't have as much claims as we thought, but that's --
there's good flow and bad flow and so the flow we do have is good
flow. Cash flow was $314 million in the first year, that may
approximately double in 2007.
OSLR only $1.2 million out of the $39 million of total claims, but
the majority is IBNR. That could be perceived as aggressive
reserving; I'd argue it's complete the opposite. There's a number of
classes of business where nothing has happened, we know nothing has
happened, there hasn't been a Manhattan terrorism event, there hasn't
been a retro event, there has not been a plane driven into a
building. We cannot reserve anything for that, it's inappropriate,
the auditors would not like it. So we reserve zero and it should not
be seen as aggressive reserving, it's entirely appropriate.
Shareholders' equity has grown $190 million in the year; $180 million
is operating profit, $9 million is unrealized gains on our investment
portfolio and then $1 million of miscellaneous other stuff.
Okay, let's turn quickly to page 8, investment performance. We are an
insurance company, we're not an investment management company, we
don't take big risks on our investment portfolio, we'd probably do a
pretty bad job if we did. So we keep durations very short, credit
quality very high, but actually quite pleased with the result that
was achieved in 2006. The strategy is not likely to change much, the
proportion of equities in not likely to change much. We definitely
prefer not to lose money as opposed to shooting the lights out as far
as investments are concerned.
Page 9, a lot of detail in the financial supplement on this, much
more broken out than we've got here. But briefly if we look at
property and energy, both about 40% of our premium, marine and
aviation something around about the 10% level. We buy reinsurance for
property and energy, we do not buy for marine and aviation, so that's
why you don't see anything there. Loss ratios we kind of touched upon
there, aviation for instance we do not do general aviation, we don't
like it. Our aviation book has a very specialized third party
liability carve out book and there hasn't been any events, and that's
why the loss ratio is zero.
Page 10, we made a 17% return in 2006, that's a nice return. Over the
cycle, over many years we would hope to make a 15% return at least
for investors, that's something we've said before. In a hard market
we should be making more than 17% quite honestly, but in the first
year obviously there's technical reasons that make it difficult to
make much than that. And what these graphs are hopefully
demonstrating is that the earning power of the business grows quite
dramatically once you're past that first year. The ramping up does
take some time, you can see, any one of those four graphs there how
it's really growing quite quickly. If we look at the fourth quarter
last year, the annualized ROE was into the mid 20s and that -- the
sort of ratio of earned premium to written premium is still growing.
So if you're thinking about what our book value might be in the first
quarter for instance you should factor in that kind of ramping up
impact.
That's it from me.
RICHARD BRINDLE: So slide 12, I think you're familiar with our [firm
bites] and I don't want to bore you by keeping banging on about them,
but we are an underwriting company, we believe in maintaining a
strong balance sheet, we will manage capital through the cycle and
we'll be nimble. We're not interested in global domination and we
will never put pressure on underwriters to achieve top line growth at
the expense of risk selection and underwriting profitability. Sounds
like a bit of a truism, but probably as you know it's not always the
case in our industry. Investment criteria are extremely conservative
and there's an awful lot of diversification for the sake of it these
days, which again runs completely counter to our primary focus on the
growth underwriting profitability.
SIMON BURTON, DEPUTY CUO AND CEO, LANCASHIRE HOLDINGS LIMITED: I
think it's fair to say that these concepts are nothing new for
Lancashire; this is something you've seen before. But one year in we
can confirm that Richard and I still spend a large majority of our
time underwriting, assessing risk. Underwriting comes first, it is
rule number one, it overrides everything else.
RICHARD BRINDLE: Yes, it's a good point. The daily conference call is
absolutely paramount to the way that we operate; I don't think I've
missed a single call since Lancashire was launched, wherever I've
been in the world. Simon has missed a handful and this is an
absolutely vital point to emphasize.
Slide 13 shows the business mix; again we've been over these a number
of times. What it does show for '07 is the non-natural catastrophe
exposed business powering ahead to well above 50% and again that's a
perception we need to keep working on, that we're not a property cat,
but [a media] only reinsurer.
Do you want to talk about slide 14 Simon?
SIMON BURTON: Sure, two main themes that we've mentioned at the
outset. As you're well aware we are a direct writer primarily and
it's short tail specialty lines, it's the lines we understand. There
are several reasons why we prefer the direct business to the
reinsurance world. We do write some reinsurance products, but it is
rather more of an opportunistic marketplace. You just simply don't
build the same broker and client stickiness if you like through the
cycle with reinsurance products that you do with direct lines.
So we have built out those strong relationships with our brokers and
clients. Indeed we're one year old, but you have to remember that
collectively as management and senior underwriters we have
longstanding relationships that we've brought to the company and
these are certainly bearing fruit. So in terms of the stickability if
you like of the portfolio of risk that we've built in a hard market
through the cycle, we think we're very well positioned as the market
inevitably becomes a little more challenging.
RICHARD BRINDLE: We are extremely broker and client focused and I
always tell the joke as far as our London operation is concerned,
that a broker came to see me, a very senior broker, this was when we
were in our temporary office at the, I guess it's the western end of
Cornhill away from Lloyds where he is accustomed to spending his
days, and we were probably 200 meters from the Lloyds building and he
printed a map off the Internet in order to show him how to get to us.
And I think it's quite revealing about how the narrow geographical
orbit in which these guys operate and that's one of the many reasons
it was just so vital to get our London license; it's made a big
difference.
SIMON BURTON: Another concept here is of course risk selection, this
is exactly why Richard and I spend so much of our time underwriting.
We are in a class of business that we understand, they are specialty
lines, they're often difficult lines to underwrite. We have a lot of
experience and we believe our ability to risk select is superior, and
we think we've demonstrated that as you can see from our results from
2006. That does create a competitive advantage.
The reinsurance sector we do hedge some of our risk via the
reinsurance market. I think conditions for '07 are looking relatively
favorable compared to the direct business. Of course through the
cycle that trend can reverse, it can move in all sorts of directions,
but for the short to medium term that plan is looking quite good for
us. Preferring short tail over long tail we've always said that's our
expertise, we don't have aspirations to diversify into lines of
business that we don't understand, that we feel just don't offer the
same ability to add shareholder value.
And specialty lines over general lines, again this is all about the
ability to risk select and get close to the clients and broker and
understand the risks as opposed to the commodity products we often
see in the general lines business.
RICHARD BRINDLE: So slide 16, trading conditions. I think it's fair
to say when I was out raising money for this company at the end of
'05 we talked about '06 being a fantastic year in terms of rating, in
terms and conditions and '07 being at least as good. And I'm pleased
to report that at least for our portfolio, which was selected with
some deliberation, that remains the case. There's a lot of
speculation I know, and perhaps Simon will talk about Retro and
Florida in a minute, but there's a lot of speculation that these core
lines of business are under a lot of rating pressure this year. I can
tell you our portfolio is not. I would estimate that overall rating
and terms and conditions are at least as good as '06 which is a great
position for us.
SIMON BURTON: Our book of business is relatively resilient to the
changes that we have seen, specifically in Florida in recent months,
partly because the proportion of business that is reinsurance or
retrocessional is relatively smaller. And yes, there has been an
impact in our line of business, although we knew a substantial amount
of that prior to the legislative changes that we're extremely happy
with and we do expect to see continuing opportunity through the year.
Perhaps not at the same rate of return that we might have expected
absent the changes in Florida, but again it's a relatively smaller
part of our book. It's not something that we rely on as a cornerstone
of the shareholder value; it is an opportunistic line.
RICHARD BRINDLE: And we don't write property cat.
SIMON BURTON: We don't write property cat so there's no direct impact
from this legislation on our book. It's all indirect, it's all about
potentially our clients having less demand for the Retro product that
we're starting to see. And --
RICHARD BRINDLE: But again on a risk weighted basis I think there
will be opportunities where our own return will be enhanced because
of the lack of underlying portfolio risks for us to reinsure.
SIMON BURTON: That's correct. It's certainly not clear that the
changes in Florida are a net negative to Lancashire for '07.
RICHARD BRINDLE: Because, of course, it will make our own reinsurance
cheaper. D&F is well ahead of where it was this time last year.
It's probably fair to say rates probably peaked in the third quarter
last year after the model change, but the encouraging thing is the
markets are benchmarking off that rather than what the pricing was
this time last year.
We continue to -- maybe you could talk about the marginal pricing
approach to modeling which I think is a key differentiator with us.
SIMON BURTON: We are a little unique as a direct writer that we
employ some of the generally accepted skills and disciplines of the
reinsurance world to a direct portfolio. In the reinsurance world I
think everyone is used to hearing about marginal pricing and capital
allocation, return hurdles etc. This discipline is not generally
applied to direct business, primarily because of the transactional
nature; there's a far greater risk count for a direct portfolio. It
can be done, so we execute that. The reason we're able to execute
that is because we've streamlined our systems enormously. So we are
in fact able to, for any risk that is cat exposed for certainly the
peak zones and a large majority of zones throughout the world, we are
able to model these risks in advance of quoting and determine the
capital required to support the risk and essentially the ROE hurdles
that we're achieving with the pricing offered. So --
RICHARD BRINDLE: And the incremental difference, the addition of that
risk to our portfolio will make to our P&L.
SIMON BURTON: That's correct. So we find that we're leaving '06 with
a portfolio that, despite being a first year portfolio of risks, is
relatively highly optimized. Because we've employed this discipline
of pre-modeling, pre-allocation of capital, understanding the impact
on P&Ls for each individual account prior to quoting. We haven't
made any underwriting decisions that in retrospect look outliers for
the portfolio.
RICHARD BRINDLE: Yes, terrorism rates are coming off and there's a
lot of competition for the business, less so for iconic buildings in
Manhattan. But the good thing is again now with the London team in
place we're able to get a far better spread of this class of business
than we were this time last year when we were -- when it was tough to
handle the deal flow. Energy Gulf of Mexico is a key area for us. The
good thing is that there are very few new entrants to this market
this year. I'd be lying if I said I hadn't been concerned that there
might be a flood of new capacity into this sector; it hasn't
happened. There are various reasons for that.
Certainly the Lloyds market has, apart from pretty stringent internal
reporting hurdles within Lloyds which limits their ability to write
particularly large lines on this business. Either markets have huge
amounts of capacity, but are not particularly user friendly with the
brokers. This is business which is dominated by London based
wholesale brokers; I'm not being jingoistic, it's just fact. And
again the relationship with these guys is absolutely paramount. There
are a handful of wholesale houses who really control the bulk of this
business, certainly the drilling contractor business, the exploration
and production companies; it tends more to be the big three. We enjoy
excellent relationships with all of them.
And I also -- where we need to be intelligent is, I saw a client
yesterday who has drill ships and other deepwater mobile units right
out in the middle of the Gulf and these things actually suffered no
damage at all from Katrina and Rita. They're basically ships and if
there's a hurricane coming, there's a very well rehearsed and
detailed hurricane preparedness plan, they will do everything they
can to secure the vessel if necessary, they'll take the crew off, but
they'll also move the vessel out of harms way. These things can do 8
to 10 knots, you'll normally get at least 36 hours' warning. So
that's plenty of time to get out of harms way down to the Bay of
Campici or wherever.
Now this is the way we like to underwrite this risk intelligently,
look at different types of assets. If you have a jack up rig, without
boring you too much with the minutiae, a jack up rig which is
essentially a fixed structure sitting in shallow water, these things
provided the bulk of losses in the '05 storms. And we're not saying
we won't underwrite those, but we're also very mindful of risk
differentiation towards the more deepwater assets which it proves
with seven major storms in a two year period that they sustained
dramatically lower loss ratios. So that's the kind of way we go about
the stuff.
We're also very sensitive to clients. I met a client yesterday with a
market cap of over $20 billion, and they look at insurance entirely
differently from a private company with nothing like that asset base
and we have to tailor our products accordingly. In the former case
it's a matter of balance sheet protection. We can -- they are happy
to run a deductible of potentially hundreds of millions of dollars
and then we come in providing a really meaningful amount of cover
which is a meaningful balance sheet protection for a $20 billion odd
public company. On the other hand the smaller guys, we've got to
offer an entirely different product. So it's not a commodity, it's
absolutely about broker and client relationships; these guys are in
and out of our offices in both locations on a weekly basis.
I might add on that note, we probably have half a dozen clients in
and out of each office daily, now I would say which is fantastic
because it is a client and broker business. It's not a commodity, you
have to win hearts and minds so that when the market softens people
still want to do business with you. And that's why that is such a
huge focus for us.
Offshore, the rest of the world conditions are still sound, I'm
conscious I'm probably talking too much. Onshore Gulf of Mexico
pricing strong, not as spectacular as the offshore, and onshore rest
of the world conditions remain good.
Marine, as you all know we took the view last year that the excess of
loss sector was too soft and too cheap so we didn't write any. There
was a lot of speculation about why our top line numbers were lower
than they were in the IPO business plan and that was the principal
reason. And I would strongly defend our decision to do that and the
consequence it had on our earnings, because we are underwriters and
we must never be slaves to any business plan. We must remain nimble
and adapt to market conditions and not slavishly follow a preordained
methodology.
That's one of the reasons that we don't have class underwriters in
Lancashire; I've always opposed class underwriters throughout my
career. We've got to be business men and women and we've got to be
looking at return on capital, we've got to be agnostic about where
the returns come from and trade accordingly. Otherwise you have this
big bureaucracy, this big sort of pantechnicon that chugs along with
people ideologically addicted to their class of business regardless
of whether they can make any money or not, which does not make sense.
On the Marine just briefly, on the direct side there are some
acceptable risks. We're pretty selective to put it mildly, but we do
write some direct Marine contracts. We like AV52 very much, it's a
very remote and cataclysmic chain of events which will give rise to a
loss, God forbid it should happen, and we like that a lot.
So just to summarize, we like 2007 rates, we think they are
absolutely what we thought they'd be. I think we're all realists, if
there's another year even approaching the benign nature of '06 we're
going -- all the rates will come under pressure in '08 and we should
not be afraid of saying that to you. Back to you Neil and [inaudible]
SIMON BURTON: I'll take the modeled loss scenarios.
RICHARD BRINDLE: Yes, sorry.
SIMON BURTON: This is a slide you've seen before, actually we've not
changed the format or content of the slide in any way since mid year.
This demonstrates the exposure to specific events under certain
return periods that we have identified as critical to our risk model.
So principally that's 1 in 100 Gulf windstorm events and the 1 in 250
US quake, CalQuake event to remain within 25% impairment of capital
at the time of that scenario. And you can see from the two bars on
the left of the graph that's exactly where they are. On a gross basis
the wind storm was a little higher, but we bought [inaudible]
reinsurance to mitigate that loss.
You can also see the as if events. Katrina, Rita a combination of
Katrina, Rita, Wilmer 2004, Andrew and Northridge all well within the
1 in 100, 1 in 250 events that you see on the left. And this is all
prepared using the industry accepted RMS version 6 model which we
strongly believe to be by far the most conservative model available.
We have performed extensive testing of the various models available
to us and RMS has consistently exceeded the others in terms of
conservatism. So we are very comfortable with these numbers.
NEIL MCCONACHIE: I'll just talk capital for another minute. 25%
impairment is more or less the level of ROE that we're looking at for
2007; we're projecting 20% to 25% ROE. The ROE includes a mean or
average amount of losses done over 100,000 a year or so scenario. So
we'd include things like 1 in 100 year events or on the curve include
1 in 100 year events. But what I'm basically saying though is if we
had a 1 in 100 we're not looking at making a big loss for the year,
we might still beak even.
I don't really have too much more to say on capital management. We'll
come back on and talk about the dividend at the end.
RICHARD BRINDLE: Middle East operation. We've never been into
expansion for its own sake and you'll never find us sitting here with
50 offices around the world, it's just not going to happen. But if we
do decide to make a move such as this we do it, we think, for very
sound reasons. The Middle East is an area I particularly have done
business in for many years, particularly the Gulf region, the Gulf
states surrounding the Arabian Gulf, Persian Gulf whatever you want
to call it. The growth in those countries is unbelievable. I think a
third of the world's cranes are currently working in the United Arab
Emirates between Abu Dhabi and Dubai. Qatar is absolutely booming as
well, Kuwait, Oman, Bahrain, to some extent Saudi, the economic
growth is phenomenal, obviously powered by high oil prices.
The business that that spawns happens to hit our sweet spots right
across the board because it's on and offshore energy, it's onshore
property, onshore engineering, it's gleaming big new boats, it's
lovely big gleaming new airplanes, it's exactly what we underwrite.
It is as [inaudible] fantastically well with managed business, the
culture is not a litigious, claim seeking culture, the engineering of
the business is probably the best in the world and knowing their
natural perils in the region.
So for a number of reasons we think it's absolutely a place we need
to be. Very few of our peer group are there, if any. You may be
familiar with the Dubai International Financial Centre which is
essentially a very lightly regulated English law and practice enclave
within Dubai which has been a phenomenal success in many, many
different sectors. Not that many London/Bermuda insurance operators
are there and we think it's key. We've employed a guy whose been in
the region, he's actually Iraqi born, has worked between Abu Dhabi
and London all his life and knows absolutely everybody. And we have
preliminary authorization from the [DISE] I should stress -- from the
DFSA sorry more correctly, and I should stress we're not taking
anything for granted, but we should get the formal authorization
within a couple of weeks. And then John Melcon, who's our guy there,
his job will be basically to work all the relationships. We are
crucially not devolving underwriting authority to John or the Middle
Eastern office; it's a marketing office.
I think I've bored you all before with my strong belief in
centralized underwriting decision making. I think a lot of companies
start to go wrong when they start to delegate underwriting authority
around the globe. You often even find the kind of crazy situation
that one office within a group quotes against another group for the
same piece of business; it's just madness. We remain -- we retain
control within the mother ship. The mother ship is piloted by the
daily conference calls and that's not going to change. But we're
excited about it, very early days. I guess -- do you want to do this
Neil, 22 or -- I mean, we're kind of repeating ourselves aren't we
really?
NEIL MCCONACHIE: Let's [start] with the dividends just for the
minute.
RICHARD BRINDLE: Dividends, good idea.
NEIL MCCONACHIE: Lack thereof.
RICHARD BRINDLE: Lack thereof.
NEIL MCCONACHIE: Decided not to do dividends, and tried to explain
the reasons for that in the press release, but just to do it here, I
mean, it's quite simple. We are looking a healthy amount of
opportunities ahead of us, looking at trading conditions which are
very good, looking at submission counts which are multiples --
RICHARD BRINDLE: I should have mentioned that.
NEIL MCCONACHIE: Multiples of where they were in the first couple of
months last year.
RICHARD BRINDLE: What are we Simon? Is it something like -- what's
the multiple on the submission count there?
SIMON BURTON: For January, February, year-on-year it's about 500%
increase.
NEIL MCCONACHIE: Yes, it' massive. Full team of underwriters, there's
a great deal of optimism for 2007. So when we look at our capital
base, we feel confident we can make a return on that capital which is
above the hurdle rate of return that we think equity investors would
want from us. We're looking at returns in the low to mid 20s on a
mean loss basis, which is obviously losses a lot higher than 2006
losses. So we are going to keep all of the capital.
We're not going to -- well, let me step back. Absent any major
losses, we're not looking at any imminent capital actions either
raising or giving back for the majority of 2007. When we get to end
of 2007 we will know if the market has had a lot of losses, we'll
know where the market is likely to go in 2008. We'll obviously know
how much money we have made, and we'll be in a better position then
to look capital. I think we, as a management team, are comfortable
saying that over the cycle we would expect to give back meaningful
amounts of capital.
[inaudible -- technical difficulty]
OPERATOR: Please continue to stand by while we reconnect your
speaker.
NEIL MCCONACHIE: [inaudible -- technical difficulty] that kind of is
our buffer and that's why we've got that in there so we don't lose
too much.
UNIDENTIFIED AUDIENCE MEMBER: And about terror?
SIMON BURTON: Sure, on to terror. The TRIA backstop is something that
we don't [inaudible -- technical difficulty]
OPERATOR: Please continue to stand by. Your speaker will join you
momentarily.
SIMON BURTON: it's a global book of terrorism. We see a very large
number of extremely attractive risks outside of the US. Manhattan is
obviously the headline for a terrorism portfolio, but for us we think
about this as a global book. This is not a two legged store.
ZENON VOYIATZIS, ANALYST, MERRILL LYNCH: Hi. It's Zenon, Merrill
Lynch. I just have one question if I may? And I just wanted to
explore capital management a little bit deeper just to see if my
understanding is right. You're talking about this year, under
normalized conditions, looking to achieve 18% to 22% ROE or growth in
fully diluted book value. Given what trading conditions are at
present, I would have thought that the capital that you would be
needing at the end of the year will not be dissimilar to at the
beginning of the year. Given your comments made about your capital
management, am I right to -- how should I think of capital returns
for 2008? Would it be fair to assume that a substantial amount of the
earnings that will be delivered over 2007 will return to the
shareholders, assuming no -- assuming average losses?
NEIL MCCONACHIE: Do you want me to -- ?
RICHARD BRINDLE: Yes.
NEIL MCCONACHIE: Yes. The projected ROE is 20 to 25 for this year and
that's on a mean loss ratio. Mean loss ratios are always wrong,
that's the only thing you know about them; they're either too high or
too low. Most of the time they're too high and occasionally they're
quite a lot too low. So let's just see how it plays out.
You know, in broad terms if every class of business doesn't have a
major loss, then probably every class of business is going to soften.
I think it's unlikely you're probably going to have a marine loss,
you're probably going to have a big energy loss wherever it might be.
And, as Richard was talking about before, we don't -- we are agnostic
to different classes of business. It may be that Retro softens and we
pull back quite a bit on that, but we discover that our Dubai
operation is fantastic and energy is great. So I don't think we can
make broad brush statements on where our premium is going to go.
If you're looking at general trends, and I would caveat this to say
that this is just general trends, then we would imagine, as the
market softens that we would decrease the proportion of elemental
business over time. That's the business that's priced very highly
right now and I would prefer this to come down, but we have the broad
book and we can move around. But the elemental business is the
business that does need a bit more capital to service.
I haven't really answered your question, deliberately. But yes, we
are committed to give back capital, if it's excess capital; we're not
going to hold on to it forever. If we can't make a good return on it
we'll give it back after talking to rating agencies, after looking at
all stakeholders. That's very important. But no, there will be times
it's appropriate to give it back. But there's no clear answer on it
at this stage.
RICHARD BRINDLE: And I think if we tried to give you clear answers,
Zenon, we'd be making unwarranted assumptions about the future which
would insult your intelligence.
NEIL MANSER, ANALYST, FOX-PITT KELTON: Neil Manser, Fox-Pitt. Can I,
just on that, can I push you slightly and say are you effectively
saying that you don't see this company paying a ongoing dividend, but
you will effectively limit your capital management to more active
measures such as a [special] or buyback?
NEIL MCCONACHIE: No, I don't think that's the case. I think we could
see a scenario where an ongoing dividend does make sense. Those kind
of measures work in my opinion, this is not the opinion of any one
else, better in soft markets than hard markets. I wouldn't like to be
absolutely committed to having to pay a dividend through every cycle
hard and soft. I think there's times where keeping all the capital is
appropriate. But I think an ordinary dividend is -- it is, we've
talked about it, we've concluded at this time not to do it, but it's
on the agenda. It's on the agenda.
RICHARD BRINDLE: And the whole point Neil is that we are, and
certainly we're not slaves to any rigid underwriting policy, we're
not slaves to any rigid dividend policy. We have to be using our --
utilizing our skill as underwriters to take maximum -- make maximum
hay out of hard market conditions and the dividend policy will come
second to that consideration.
NEIL MCCONACHIE: The most important thing is making a nice attractive
return for shareholders in the long term. Some of that return will be
growth in share price driven by growth in book value, and some of
that will be dividends. As for the mix of those two, it's not clear
at this stage where it's going to come from. In 2007, the majority we
think is going to come from growth in book value and hopefully growth
in share price. As we move into the soft market a greater proportion
will come from dividends and things like share repurchases.
NEIL MANSER: Can I just ask one more actually? You're talking about
the mean loss ratio as being your basic premise for your ROE
calculation. How far away is your [median] loss ratio from your mean
loss ratio given the severity nature of your book of business?
NEIL MCCONACHIE: Again we're a mix. We're not all severity and we
must stress that point. So it's not as big a difference for us as it
might be for some of the more focused Bermuda reinsurers. But yes,
there's a few points of difference. Simon?
SIMON BURTON: Our [median] loss ratio is not zero as it may well be
for a mono line cat reinsurer frankly. The mean loss ratio is going
to exceed the [median], but as Neil said, by a lesser margin than
you'd see for a mono line.
OPERATOR: Excuse me this is Jenny the operator. We have a telephone
question from Frank [Cawood].
RICHARD BRINDLE: Any questions from here or if not shall we just go
ahead with the calls?
SIMON BURTON: Are there any questions on the telephone bridge?
OPERATOR: Yes, there are sir. There's a question from Frank [Cawood].
Please ask your question Mr. [Cawood].
FRANK CAWOOD, PRIVATE INVESTOR: Yes sir, can you hear me?
RICHARD BRINDLE: Yes.
FRANK CAWOOD: I have a couple of -- one statement, we would much
prefer that you keep your money and invest it wisely if you've got
good underwriting discipline and good markets and pay dividends. So
that's our opinion and it's a very strong one.
I have a number of questions. Well actually just one, but I am not an
insurance professional, I'm a private investor and I would like to
understand a little more detail about exactly what sort of property
you insure in the different categories like energy, marine. I think I
know your focus on the terrorism insurance, but that may be changing
with your opening of the branch in Dubai. But if you could give me a
little more detail about the types of property.
And particularly, I have a question, I know there's a company called
FM Global I believe, that insures plants that are perhaps in some
super cat areas and others that are not. And I was very impressed
that, during the Katrina period, they had an outstanding combined
ratio of about 80, which was very profitable even in that area. So
that seems to be a particularly profitable area. Are you in that
area, as well as some of the others, is that included in some of your
areas? But just more detail please?
RICHARD BRINDLE: Okay, no problem, Frank. On the first part, the kind
of assets we insure, we've always said that Lancashire is the kind of
company that, if we have a big claim it's going to be on the front
page, or at least in the first few pages of the newspaper. Of course
that depends on which newspaper you read, but if it's one of the
broadsheets as we call them over here. But energy we're looking at
semi-submersibles, we're looking at drill ships, we're looking at
jack ups, we're looking at floating productions and storage
operations, FPSOs as they're called. We're looking at the big stuff.
And the same goes for ships. We're looking primarily at large cruise
liners and big liquefied natural gas carriers, which are two of our
prime areas of focus. Property, we're not doing personalized
residential stuff. It's commercial and industrial business, tending
towards the larger stuff.
On FM Global, I have to say they're an excellent company and I
thoroughly endorse your view on how they came through '05, Frank. And
they are a big beast, they've got a big market share. We sometimes
compete with them, but more often actually co-insure with them, and
we think that they're very good at what they do.
FRANK CAWOOD: Yes. That was my thought that you could almost tag
along because of their underwriting discipline. If they've
underwritten something you could almost consider that's a seal of
approval and tag along. Is that a possibility?
RICHARD BRINDLE: It's an interesting point and, no offence, but I'm
pleased to say no. And the reason I say that is whilst, if FM are on
a program that ticks one of the boxes if you like, we were talking
earlier, I know it's all a bit sort of arcane, but we were talking
about our marginal pricing analysis, how we pre-model risks. A risk
may work for FM, because they may not have a concentration of
exposures in a particular county, in California or Florida for
example, but we may have such an accumulation. So a given risk may
work for them and not for us and vice versa. So certainly their
presence on a program is a source of comfort to us, but it's not
sufficient for us to get involved necessarily.
FRANK CAWOOD: Yes. One other observation on FM. I've read recently
from their statements that because of their clients investing
something like $2.5 million in reinforcing their property, it saved
them $500 million in claims when Katrina came. So that was a very
interesting observation about having clients who are willing to do
that and work with their insurers.
SIMON BURTON: We are seeing that effect more and more that there is
an awareness from the risk managers of the corporations that we
insure that the pricing is heavily model driven, often the RMS model
or AIR. And these models take consideration of things like
construction type and number of storeys, all sorts of information
with respect to any given risk. And the risk managers are waking up
to this fact and investing some money on improving the underlying
risk.
One example is in the past, going back a number of years, you may
have seen substantial flood losses from operations like hospitals,
for example, where the equipment used to reside in the basement, all
of the big machines, the heavy equipment used to be in the basement.
Now they've shifted it up a floor or two and if the flood were to
repeat the loss would be minimal. That's just one example, but
there's certainly a trend to improving risk management at the
customer end.
FRANK CAWOOD: When you work with your brokers and clients do you get
into that sort of detail or do you just go on their past track
record?
SIMON BURTON: No, absolutely. That's part of the underwriting
discipline. Historic losses, bear in mind that for most of the
clients that we insure, the historic losses may well be zero for many
decades. So there's very limited credibility on loss data for the
large majority of our clients. It is an underwriting exercise
understanding the risk.
FRANK CAWOOD: Thank you very much. I think I do understand a little
more about the details of your underwriting. So it's a fascinating
business.
SIMON BURTON: Thank you.
RICHARD BRINDLE: Well it's fascinating sometimes, at other times it's
very frustrating. Fascinating at the moment. Anybody else? Okay.
Thank you very much. Thanks everybody for coming.
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