Lancashire Holdings Ltd
LSE:LRE
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Lancashire Holdings Ltd
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Good day, and welcome to the Lancashire First Quarter 2018 Results Conference Call. Today's conference is being recorded.At this time, I would like to turn the conference over to Alex Maloney, Group Chief Executive Officer. Please go ahead, sir.
Okay. Thank you, everyone. Thank you for calling in for our Q1 call. I'm delighted with our first quarter results. Our underwriting portfolio has seen little loss activity in the quarter coupled with strong reserve releases mainly from the 2016 accident year. We have top line growth driven by the improved underwriting environment. And lastly, our hedging strategy has mitigated are mark-to-market investment loss as interest rates increase. We are, therefore, satisfied that strategic decisions we took coming into this year were the correct ones and the insurance markets and investment markets are where we thought they would be. It's pleasing to see top line growth, which is partly driven positive rate movements and partly driven by new business across the majority of our portfolio. Even where rates are not positive, such as terrorism, we have seen more rating discipline in the terrorism market than we have seen in many years.We have commented before that we hope to achieve more rates across our underwriting portfolio, but as others have also commented, the underwriting environment is not currently there to push for more rates. But our portfolio is generally more profitable than the market average so any positive change is accretive and margins are improving.We see daily evidence of carriers taking corrective action to improve the profitability of their underwriting portfolios. Not a day goes by where a headline doesn't pop up with another carrier closing another product line. These are small signs of the changing underwriting environment. We are yet to witness material rate improvements from this action, but this is another clear indicator to us that we are finally off the bottom of the market. This very much feels like the year 2000 all over again. We will continue to demonstrate the underwriting and capital discipline that we have always demonstrated. We are witnessing for the first time in years pretty much everything pulling in the right direction. We will adjust quickly if the current direction of travel accelerates, which we believe could happen if we see further loss activity or loss creep from the 2017 events. It's a finely balanced market that just has to improve. It simply has to.So in summary, we're in excellent shape as a business, probably the best we have been in years. We have maintained our underwriting discipline during a prolonged soft market. We have no need to review any product lines, and we have the flexibility of our 3 underwriting platforms to navigate through the next stage of the cycle. We have a supportive long-term shareholder base, which we thank for their patience, and one which we believe we will be able to provide the risk-adjusted return they require.I will now pass over to Paul.
Thanks, Alex. Following the loss frequency and severity of the last 2 quarters, the first quarter of 2018 has been very benign. Those losses that have occurred during the quarter, such as U.S. and European winter storms, are relatively minor in nature and, as such, have a limited impact on our underwriting results. Given this loss environment, the group has been able to generate a respectable combined ratio of 65.2% for the quarter. As we highlighted last quarter, we anticipated the majority of the group's portfolio to be exposed to positive rate movement, and this has transpired. Rate movements were in line with our previously communicated expectations. Catastrophe-exposed lines, such as retro, property cat and property D&F, all saw rates moving positively. In addition to this, the energy market has also seen rate rises, and other lines, such as terrorism, have flattened. The group's overall portfolio saw a rate improvement of approximately 5% year-on-year. Rate improvements is certainly a positive for us as a group, especially given that they are focused in the areas in which we specialize. In addition to this, there are other areas of optimism.In the property catastrophe classes, there were some small pockets of opportunity to write some new business with both existing and new clients. Some of this is post-loss opportunities, and others were opportunities to expand relationships at slightly improved rates. The energy market is also showing the first green shoots of recovery. With a more robust oil price, our clients are cautiously optimistic about the future, and we should start to see demand slowly coming back into the energy market should the oil price remain close to its current level. As a group, we're well placed to capture any increased premium flow to this market and have plenty of room to expand if conditions become favorable. Our 2017 premium income was approximately 50% of its all-time high. Our new downstream energy classes made a good start for 2018, securing new business for the group, and our new power team will commence underwriting during the latter part of the second quarter. Once these product lines are fully established in 2019 and beyond, we'd expect them to generate approximately $20 million to $25 million of gross written premium combined, assuming, of course, stable market conditions. Kinesis grew limits deployed at 1st of January by approximately 28% and premiums written by approximately 33.5%, managing to grow with both existing and new clients. For the first time in many years, the overall trajectory is upwards. Rates have improved, and there have been some small opportunities for new business. As a result, our gross premium has grown modestly year-on-year. Gross premiums grew by 9.8%, and total premium under management grew by 15.3%, reflecting the modestly improved environment.As we previously explained, any growth will be driven by the underwriting opportunity. If the risk-return metrics make sense, then we're happy to deploy capital. Whilst the rating environment is positive, we are coming from a base that is historically low given years of rate reductions. As such, our growth is broadly in line with the rate improvement plus the small amount of new business. The group's risk levels did not materially increase, producing a portfolio with a better risk-adjusted return year-on-year. From an underwriting perspective, the first quarter is positive: the rating environment for our portfolio has improved, combined ratio is very respectable, premiums have grown modestly, and risk levels have been managed appropriately. As the group progresses through 2018, the underwriting philosophy will remain constant. We underwrite our portfolio based upon risk and reward and have the discipline to hold our nerve should the risk-reward metrics not transpire due to market dynamics. But also, when viable opportunities do manifest, we have the capital, platforms and people to maximize these.I'll now pass it over to Elaine.
Thanks, Paul. While we hedge our interest rate risk with yields at the front end of the curve rising by 30 to 40 basis points in the quarter, our investment portfolio had a loss of 14 basis points. Our underwriting results were strong, and we had some releases on our prior accident years. That resulted in a loss ratio of just 12% for the quarter and an ROE of 2.9%. This is the first quarter in many years we have shown growth in our top line. However, that's the combination of the rate increases we expected following last year's cat events, plus the new business was also less of an impact this quarter from the timing of multi-year contracts.As Paul has said, pricing has improved across most of our portfolio, just not as much as we would have hoped for following last year's events. But as we said before, we're well-positioned to take advantage of the increases that are there and any other opportunities that may arise. We also saw the impact of rate increases in our reinsurance program. While there are a few moving parts, we bought largely the same program. Our overall spend for the year will be a little bit higher than last year though because of the rate increases and a couple of new quota share deals we added this year. Our acquisition cost ratio looks a little higher this quarter driven mostly by some adjustments in the energy construction book. I do expect the ratio to normalize over the year to around the 27% level we've been running at.On losses, we've had very few losses reported this quarter. Our attritional ratio is, therefore, comfortably in the mid-30s. We also had a 2016 accident year energy claim develop in our favor, a little bit of favorable development on last year's cat events, plus some general IBNR releases due to lack of reported claims coming through. Overall, we had net favorable development for the quarter at $25.2 million, helping us produce that low loss ratio of 12%. As I mentioned, investments produced a 14 basis point loss for the quarter driven primarily by the mark-to-market impact of yields increasing. Our interest rate hedge and our risk assets did what they're meant to do by adjust the downside impact of the increase in yields. While we expect volatility to continue and further rate increases this year, we remain well positioned for both of those. We will also have the benefit of reinvesting at higher rates in the future, and we will gradually increase our duration and, thus also, take advantage of those higher rates. There's a reduction in other income this quarter due to reduced profit commissions from Kinesis. As I said last quarter, with the loss events for 2017, there's trapped collateral at Kinesis and no PCS on the 1/1/17 cycle. As Paul has said, we wrote about 28% more limit in Kinesis for the 1/1/18 cycle. If there are no losses on that cycle, profit commissions could be about $9 million, but the earliest we would receive that would be Q1 2019. There's a very small uptick in our G&A this quarter that's largely driven by the increase in sterling in the quarter. We do hedge our currency exposures. We took advantage of lower sterling rates last year, given our sterling costs for our U.K. operations, and we're slightly low on sterling just now. You can see the impact of that in our FX line in the income statement. While there are reduced vesting expectations in employee stock compensation awards, which reduces the expense we record on those, the Q1 2017 charge was significantly impacted by lapses due to the departures of some Cathedral employees. We have small gain this quarter on the mark-to-market of our interest rate swaps but also a slight increase in our unhedged subdebt cost given rising rates. We also have more LOC costs coming through as we continue to fund some of our [ final ] Cathedral [ biannual fee ]. Ignoring this LOC, mark-to-market and any one-off costs, our financing costs are now running at around $4.5 million to $5 million a quarter.Lastly, on capital, we continue to be comfortable that our current level of capital will more than adequately support the [ bit ] we hope to write this year. As ever, we will monitor underwriting opportunities and adjust our capital accordingly.With that, I'll now hand over to the operator for questions.
[Operator Instructions] We will now take our first question from Thomas Seidl from Bernstein.
First question on pricing. There seems to be a healthy debate right now whether we have seen the peak of pricing already internally or whether there's another peak to be expected about midyear. I wonder what you see in the market in terms of supply-demand dynamics and how those shapes up to H1 and probably, also, beyond. Secondly, capital, Elaine, you just mentioned, you have enough capital for 10% growth. Can you give us some color how much capital buffer you have in terms of further growth? Let's say, if you go to 15%, 20% growth, is the capital base still then comfortable? And thirdly, on nat cat, you started to release, I think, $8 million of reserves. And last year, you mentioned the big uncertainty about those reserves, and I just wonder how so far loss emergence has been coming in versus the assumptions you did back then.
Thomas, thank you for your questions. I think, on rate, there is a debate. Our view into our book, I don't think rate gets stronger from here unless there's any loss activity or anything changes, but equally, I don't think it goes backwards. Florida property cat market is not a huge market for us. So you're probably better off listening to the RenRes of the world. But for our portfolio, we don't see rates going backwards. Equally, we don't see big changes in rates hardening from here. And if you think about our portfolio, most people's portfolio, you've got the run-in now to the winter season, and most people would have written their income by the 1st of July. So we don't expect any real changes. So we're quite comfortable with where we're at on that basis.
Thomas, on the capital buffer, we're pretty happy with where we are. We think we got plenty to handle growth. When you look at capital, we normally work at what we need, run a stress on that, and then put a buffer on top of that so that there's more than adequate capital there to handle the -- our growth expectations. And on the nat cat, we did have a small release this quarter. We're not really expecting to see an awful lot of movement on those reserves until later in the year. Now it's still relatively early days. Most of the release so far has come from Harvey, which you may expect. By memory, you're going to take a bit more adjusting.
On Harvey, I mean, this was a -- there's in-line flat stuff and commercial line stuff, so how is the actual losses coming in versus the expectations there?
I think it's slower than we would normally expect for these kinds of events.
Okay, but you still feel comfortable and, hence, you started releasing reserves.
Yes, I know. Put in context, it's a pretty small release.
We will now take our next question from Kamran Hossain from RBC.
First question is just on, I guess, pricing and kind of what it's done to your book. So looking at your RPI, you've talked about 5% up in the call and, actually 6% up at Cathedral. Obviously, there's renewal business -- sorry, new business as well which doesn't get increased in that calculation. Could you get -- maybe give an indication of whether kind of the new business on an implied basis kind of has either higher pricing than the renewal book? That's the first question. And second question, just on the, I guess, increasing energy demand. Is this construction or kind of -- which part of the energy market do you see picking up very strongly?
Paul, do you want to start on that question?
Yes, so on new business, Kamran, I'd almost split it into 2 parts. There's been some new business where we've grown with existing clients, and that's going to be broadly in line with the RPIs you're seeing in our statements. And then there's another pocket, which is what I'd call your post-loss opportunities, which -- there's been some of it, not lots but there's been some. And that, by nature, is likely to be paying RPIs that are in excess of those RPIs that we're seeing here but, obviously, probably starting from a slightly smaller base. So that -- hopefully, that answers that question. And then on the energy piece -- sorry, Kamran, was your question around where we expect to see the demand come from?
Yes, is it neutral, and is it kind of existing assets where you see the new demand coming from?
Yes, so it will be from a number of areas. First of all, as oil price kind of stabilizes, you'll see insured values themselves start to edge up. You will then see some of our clients starting to basically conduct more activity. So energy contractors will be employed more and start going [ drilling wells with ] people, and operators will start employing those contracted to drill wells, and that just brings premium back into the market. And then there is the construction side of the portfolio. That's probably -- we got a bit more of a time lag on it. People won't start putting big construction projects out here until they really are comfortable that oil prices are stable, but we have just started to see new projects come to market. None of this will -- you're not going to see all of this in '18. It is going to be a slow burn, but we are starting to see the first green shoots of all those things starting to happen. And if you want to put in context, the kind of 2017 upstream energy premium was about half of its peak of 4 to 5 years ago. So the energy market has room to grow if oil prices are stable and...
It sounds like...
Yes, for us, we are uniquely placed in that market, so that is positive, but oil prices do move around, obviously. But where they are at the moment, that gives us some room for optimism.
Yes, on that, Kamran, just to give you a bit more flavor. If you think about some of our property D&F book at the Syndicate, you can see a renewal found in the U.S. that's paying a rate increase, but you kind of sit on it and think that the rate increase you would hope for would be more, and then you'll see something in the Caribbean where you can charge an awful lot of money that, quite frankly, you just haven't written for 2 or 3 years. So our property D&F guys are writing some business that they haven't seen for 5 years or even longer because it's been completely underpriced. And again, this is why the market's so patchy, and you have to just -- you have to have the right underwriters to sort of -- to work your way through the market. You can see some U.S. business where you think that's quite a business that should be paying. It's in Florida. It should be paying a sensible rate increase, and when the rate increase comes, then you're disappointed. And then you something in the Caribbean that you haven't seen for 5 years, and you can charge double the price. So it's just patchy, so you just need to make sure you got the right people to sort of sift through an evolving story. It's a bit all over the place, quite frankly.
We will now take our next question from Jonny Urwin from UBS.
Just 2, please. So firstly, on the energy book again. You mentioned that the current premium levels are approximately 50% below peak. So at the current oil price, could you see yourself taking the book back over like USD 200 million, or does the oil price need to go higher from here for that to happen? That's the first question. And secondly, the comments around trapped capital in Kinesis. Can you give us an idea of how long you expect that to be trapped for, how much capital is trapped and just whether that your experience is indicative of the broader market? That will be very interesting.
Paul, do you want to start on energy?
Yes. Jonny, so I think Brent this morning was around $73. So -- and our premium in energy was obviously significantly below $200 million last year. So my honest opinion is that $73-ish oil and rates increasing at the level that they're currently increasing in, which is just kind of like mid-single digit, it would be a stretch to get to $200 million. That said, if only the oil price remains stable for a period of time at these kind of levels, demand will come back in. So you can certainly start adding premium to that portfolio quite quickly. I think, when we were north of $200 million, you were sort of looking at sort of a world of $100 oil. So we've got way to go to get there, but all the signs are encouraging, and if stays around the $75 mark for a period of time, you'll definitely see demand coming back into the system.
Yes, and on that, Jonny, as well, we also got a bit of a broader footprint as well, so we do have an on-shore energy book as well now, and we will have a power book. So it all starts moving in the right direction. We do have a sort of a broader energy footprint than we had in the past. But as Paul said, $100 oil, there was a lot of business, but it definitely feels like our energy customers have turned the corner. And when they're in London and meeting our underwriters, it's much more positive. As Paul said, construction works are coming back on track, but that is a '19 story for us as opposed to an '18 story. But again, weirdly similar to the insurance and reinsurance market, those guys are sort of dragging themselves off the bottom, and everything is looking more positive. So that's a good story for us.
Jonny, regarding the question on trapped funds. I mean -- quickly, I mean, Kinesis has approximately 30% trapped. Regarding when we'd expect that to be released, I wouldn't expect to see any of that until about after the third or fourth quarter this year, more likely the fourth quarter. Just as a general comment on the market overall, you have buffer loss tables that would dictate when that's released. I would imagine, on average, higher-risk funds would have larger amounts trapped in that, but it depends what they've told their investors. The losses are -- but we don't count trapped funds as assets under management either, some others do.
We will now take our next question from Ben Cohen from Investec.
I wanted to ask 2 things. Firstly, just stepping back. I think at the full year you were indicating in broad terms that, because of some of the headwind from multiyear contracts in prior periods, that you would expect roughly top line to be flattish to maybe slightly up this year. After the growth that you had in the first quarter, does that make you more bullish for the full year, or are there some other seasonality effects that we need to be aware of in terms of timings? And then just on the investment portfolio. You said, Elaine, that you were going to maybe take out the duration at some stage. I just wonder, what is the rate that you're investing in it at the moment, and what sort of instrument are most of interest to you with what sort of yield?
Ben, I'm going to let Denise answer your second question. On the first one, we did mention the multiyear impact on the Q4 earnings call, and we said it was about $65 million last year and expected the same this year. We didn't give quarterly guidance on that. It's very difficult to do that given contracts can extend or cancel and replace. So although we've had growth in this quarter, there was a bit more of a multiyear impact in Q1 2017, and so -- and less of an impact in this quarter, so you can still expect to see a multiyear impact on other quarters going out this year. It's not a linear thing.
Ben, Denise O'Donoghue. Yes, right now, we're obviously very short at 1.7 years. So with looking at sort of 8 to 9 fed hikes over the next 2.5 years, we're probably sort of midway thinking about increasing duration by taking our hedge off. That will be sort of our first mode of attack. And that's sort of the next 12 to 18 months. And then we'll slowly try to increase it a little bit more to take advantage of the higher rate. So sort of thinking halfway through the hike cycle. That's what we're anticipating.
Right, right, and the -- sorry, the investment yield on new investments at the moment?
Right now it's 2.5%. So yes, [ after that ], the last couple of quarters.
We will now take our next question from Darius Satkauskas from KBW.
Just one. You've reduced the loss estimate for HIM and California wildfires by $8 million. How much of that is in that $25.2 million prior year development you reported?
I think that question was how much of the $25 million is HIM related is our releases.
So within our press release, if you have a look at the loss reserves section there, you'll see the movement in there's about just under $8 million. That's the release on those reserves there. But you can into the factor that into the property book in prior year movement.
[Operator Instructions] We will now take our next question from Thomas Fossard from HSBC.
Two questions on my side. First one is related to the GWP growth in the large segments, so plus 18% in Q1. Could you give us a bit more granularity on what is driving this growth? You're pointing to property in aviation and new business. But I mean, I can understand where the growth is coming from on the property side. Aviation, I'm struggling a bit more to understand where you're finding I would say attractive opportunities at the present time. And the second question, related to your cat protection program. So actually, you mentioned slightly increase in the money spent. And I think that you've made some small changes on the side. Just to make it clear, can you tell us if we had a return of HIM this year? I mean, how much of the net loss incurred, which end? Would that be completely stable? Or should we expect some slight improvement?
Thomas, on the cat reinsurance program, we made a point on the last call saying that we decided, when we came into this year, to buy exactly the same cat reinsurance program that we had for last year. So we didn't feel the need to take any more net exposure. We've got exactly the same program. But if we -- we did buy a slightly enhanced program, and we did buy a bit of a retro quota share, so there may be some; slightly -- if you had exactly the same as HIM, which is unlikely, but if you had exactly the same pattern, we definitely wouldn't have any more risk. We'd probably have a slightly reduced exposure to what we had in '17, but obviously, these things are impossible to predict. But as a business, or as a shareholder, we'll get more rate in the front door for no more additional net risk. And that was the point we were trying to make at the last call, and we think that's the right way to the position the underwriting portfolio for the '18 year. And one thing we've always said is, if rates get a lot more -- if rates harden, for whatever reason, a lot more, we'll look at that position again, and we're more than happy to deploy capital if we think we're getting substantially more rate. As we've seen this year where rates have gone, we're happy with the position that we took to buy the same reinsurance program.
On the increase in the Lloyd portfolio, Thomas, as you said, there's some increases in the property insurance lines, which predominantly rate driven. In direct and fac property, again, there's some good growth there that is both rate and new business, and Alex alluded to where we're seeing some of that new business earlier on in the call. On aviation, which you mentioned, there's 3 things there. There is a little bit of rate improvement. Not huge, there is a little bit of new business, but there's also some timing around certain contracts, and also, that's coming from a reasonably -- percentage increases is big, but it's coming from a reasonably low base. And then on the other lines, marine and energy, you're also seeing some growth there. Again, that is small amount of rate but also some increased demand, new business in those lines, albeit the dollar amounts are relatively small.
There are no further questions from the telephone. We have a next question, a follow-up from Ben Cohen from Investec.
Sorry, I just wanted to ask 2 things. On the Lloyd's business, it looks like there's quite an improvement in margin there, if you look year-on-year. Presumably, that's driven by the price. I was just wondering if you could say a bit more about how much you're looking to grow the business through the year and the impact that you think the price increase should have on the margins that you want? And the second thing, more generally, the price increases that you're getting through at the moment, do you think they should start to have a meaningful impact on your attritional loss ratio, if we look into 2019?
On that, Ben, we will grow the business as much as we can according to where we think the rates are. So we have seen some good opportunities in Cathedral. We have cleaned up some of the book. So one of the first years when we really decided to sort reunderwrite the portfolio for that, hopefully, should improve the ratios over time. Obviously, only time will tell. But we have cleaned up the book. Again, they're taking no more risk. So the margin improvement is obvious, and we will grow as hard as the opportunity allows us. But as I said, we think the growth we've put on is sensible to the opportunity. And as I said, we have reunderwritten some of that book and taken out, hopefully, some of the more attritional accounts. And it's one of the -- I mean, '17 was a year where, because of the cat activities, it was very difficult to sort of reunderwrite the book. But the start of '18, as I said in my comments, as a business, we've probably never been in such good shape. Cathedral is in brilliant shape. Their new underwriting team has been there a long enough period now to really kind of change that business over time. And as the market opportunity improves, we will continue to grow Cathedral accordingly. And I just think -- another thing I mentioned earlier, about the small things that we see, the market cannot go backwards from here, and everything we see, particularly Lloyd's, with people shutting down product lines and all the necessary behavior that we are finally seeing, leads us to believe that this market has changed. It's getting there slowly, and that's frustrating for everyone including ourselves. But I think you're seeing now the sins of the past all coming back to haunt people. For our point of view, that's good. And we don't really have to do much to clean up our book, really. So hopefully, it's one-way traffic from here. But as usual, we will stay disciplined, and we will only match our underwriting to the opportunity, and quite frankly, that's why this company has had the results it's had for such a long period of time. So it is an evolving story. We will grow as much as we need to or as much as we can. But I do think I just can't see how the market goes backwards from here.
Ben, on the attritional guidance. I mean, we're still pretty happy with where we're guiding. And it's obviously getting too early change that. There is going to be a lag off of lower-rate businesses to this year. But you're right, [ areas ] of new business and businesses renewing at higher rates will [ err ] more into 2019. If you feel like pricing adjusting the attritional loss ratio, feel free, but it wouldn't really move it that many points at this stage because we're looking at kind of 5%-ish rate changes.
There are no further questions from the telephone.
Okay, thank you for your questions, and we'll talk to you next quarter.
That would conclude today's conference call. Thank you for your participation, ladies and gentlemen. You may now disconnect.