Scottish Re
Scottish Re Group Limited
2004 First Quarter Earnings Call
May 6, 2004
011:00 a.m. ET
Host: Scott Willkomm, President
Michael French: Good morning, everyone. Welcome to the Scottish Re Group
Limited 1st quarter conference call. We are going to begin
the call. A comment about the company's financial results
and give an overview of the development of the company's
business. And after concluding our prepared remarks, we will
be happy to take your questions. Now there will be a
recording of this call available after 3 pm today. Running
through may 20th and instructions on how to access that we
are in the earnings released this morning. Also a replay of
the call can be accessed on our web-site scottishre.com.
Before we began the financial over view, please keep in mind
that certain statements that we make are forward looking
statements within the meaning of the Federal Securities laws
and management cautions the forward looking statements are
not guarantees and that actual results could differ
materially from those expressed or implied. At this time I
am going to turn the call over to our President Scott
Willkomm to discuss our financial results and our operations
for the quarter -- Scott?
Scott Willkomm: Good morning, everyone. Thank you, Mike. Scottish Re this
morning reported that income from continuing operations for
the 1st quarter ended March 31, 2004 was $10.1 million or 27
cents per diluted share, as compared to 7.4 million or 26
cents per diluted share for the prior year period. Net
operating earnings were 16.6 million or 45 cents per diluted
share for the quarter as compared to 9.4 million or 34 cents
per diluted share for the prior year period. On a per share
basis net operating earnings per share for the quarter
increased by 32 percent over the last year. Net operating
earnings is a non-GAAP measurement and we determine net
operating earnings by adjusting GAAP incomes from continuing
operations by the net realized capital gains and losses and
the change in the value of embedded derivatives as adjusted
for the related effects upon amortization as deferred
acquisition costs and taxes. While these items may be
significant components in understanding and assessing the
companies consolidated financial performance the Company
believes that the presentation of net operating earnings
enhances the understanding of it's results of operations by
highlighting earnings attributable to the normal recurring
operations of it's business. However, net operating earnings
are not a substitute for income from contributing operations
determined in accordance with GAPP. Net income for the
quarter amounted to 10.1 million or 27 cents per diluted
share as compared to 7.2 million or 26 cents per diluted
share for the prior year. Total revenue for the quarter
increased to 179.2 million from 96.8 million for the prior
year period which represents an 85 percent increase. Total
benefits and expenses increased to 167.9 million for the
quarter up from 89.1 million which is an increase of 88
percent. The increases were principally driven by the
acquisitions of the ERC life which is now renamed Scottish
Re Life corporation although through out this call I would
refer to it as ERC Life. And growth in the companies
reinsurance business in North America and internationally as
well as growth in the investment income due to the increase
in our invested asset base. ERC Life added approximately 45
million of premium to our results in the quarter. Let me
offer some comments at this point regarding operating
expenses. In the quarter operating expenses were up
significantly on an absolute dollar basis as compared to the
4th quarter of 2003. As you may recall on last quarter's
conference call we explained that operating expenses in the
fourth quarter were a bit lower than expected due to year
end clean up of accruals and favorable foreign currency
movements. We also mentioned that for a comparative purposes
Q3 2003s expense level of 8.8 million was a more appropriate
basis for a comparison. Using the Q3
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expense level as a basis for a comparison much of the
increase in our opex and Q1 04 was due to number one the
increase in the overall expenses as we took on the ERC Life
business as of the end of 2003. Number 2 about one cent per
share of increased opex due to foreign currency fluctuations
in the quarter and 3 expected increases in operating
expenses due to the growth of the Scottish Re enterprise
overall. We view the ratio of operating expenses as a
percentage of total revenues on a trailing 12 month basis as
the most informative ratio for judging relative opex levels.
Since it eliminates any seasonality in revenue in opex
patterns on that basis our opex to total revenues for the 12
months ended March 31, 2004 was 5.63 percent which is less
than the ratio for all of 2003 which was 5.7 percent. This
decreasing trend in the opex ratio was consistent with our
guidance that we gave on our last conference call. The calls
for an opex ratio for 2004 in the 5.3 to 5.5 range. The
company's total assets were 6.4 billion as of March 31, '04.
The core investment portfolio which includes cash and cash
equivalents but does not include funds with held in interest
-- total $2.7 billion -- at an average quality rating of -AA
minus and effective duration of 3.8 years and the weighted
average book yield with 4.4 percent. This compared with the
portfolio balance of 2.4 billion an average quality rating
of -AA minus, an effective duration of 3.9 years and an
average book yield of 4.5 percent as of December 31, 2003.
Funds withheld at interest amounted to approximately 1.5
billion, had an average quality rating of -A and an
effective duration of 4.9 years and a weighted average book
yield of 6.2 percent as of March 31, 2004. This compares
with an average quality rating of -A an effective duration
of 5.1 years and an average book yield with 6.3 percent as
of December 31, 2003. The market value of the funds withheld
in interest increased to approximately 1.6 billion as of the
end of the quarter. Investment gains which are before taxes
but include the amortization of deferred acquisition costs
totaled 1.4 million in the quarter. These gains are stated
net other than temporary impairment loss of 1.9 million that
we took in the quarter. During 2003 we adopted the world
famous DIGB36, which requires us to account for our modified
co-insurance contracts on a fair value basis. The change in
the fair value of the derivative for the quarter amounted to
a loss of $8.6 million. Net of related amortization of
deferred acquisition costs. Changes in the value of this
derivative are caused principally by changes in the interest
rates and our credit spreads. During this quarter the loss
has risen principally because of the decrease in rates
during the quarter. On a go forward basis we would generally
expect to experience a gain as interest rates rise and a
loss as they fall. On a longer term basis the value of the
embedded derivative will turn towards zero. And as discussed
earlier in this call and actually in prior conference calls
changes in this -- the value of the embedded derivative are
excluded from operating and do not impact the economics of
these contracts. We continue to build book value per share
during the quarter with the company's book value the top --
per share toping $19.79 cents per share as of March 31,
2004. As compared to $18.73 as of the end of 2003. Excluding
the impact of FAS 115, which is the market to market on our
bond portfolio -- book value per share amounted to $19.1
cent as compared with $18.51 cents as of December 31, 2003.
At this point I would like to take a moment to give you a
brief over view of the progress we are making in our
business. And some guidance a to how we measure that
progress. And we will start by talking about our traditional
solutions business. One measure of success in our
traditional North American business is the annual Society of
Actuaries (MunichRe) Survey life reinsurance. In 2003,
Scottish Re advanced to the number 6 provider of life
reinsurance in United States, with 5.42 percent of the
market for recurring life reinsurance business. In addition
we rank number two in over all US ordinary life reinsurance
assumed with a16.7 percent market share, (driven)
principally by our acquisition of the ERC life. As you all
know our traditional solutions business provides mortality
risk-transfer capacity to the top life insurance companies
in North America. And we are very, very well established as
you can tell from the Munich's survey. In this market we
currently provide
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reinsurance capacity to over 75 percent of the top 60 to 100
North American Life companies. We have excellent working
relationships with our clients, and are very much benefiting
from the scarcity of life reinsurance capacity in general.
As of March 2004, the company had approximately $286 billion
of life reinsurance in force covering $6.9 million lives
with an average benefit for life of $41,000 in it's North
American operations. This includes about 153 billion of Life
reinsurance in force in respective of the ERC life business
that we acquired at the end of 2003. As of March 31 2003 by
comparative purposes the company had approximately 74.3
billion of Life reinsurance in force and covering 1.5
million lives with an average benefit per life of $51,000.
During the quarter we originated approximately 15 billion of
new traditional life reinsurance from existing and new
clients. Our production goal for 2004 as you may recall in
this traditional solutions business line was to originate
between 65 and 70 billion of new business, and we are well
on our way to meeting this goal. Mortality experience
continues to be quite favorable with actual experience in
the first quarter of the year at approximately 98 percent of
expected levels and since inception on a cumulative basis of
this particular traditional solutions business our overall
mortality is 93 percent of expected levels. In our financial
solutions business we measure progress by measuring the gap
reserves we hold on our balance sheet, and reserves for
financial solutions -- for the financial solutions business
line increased modestly to 3.2 billion as of the end of the
March quarter in comparison with 2.9 billion as of the end
of 2003. As we have said in the past and we continue to
reiterate we have been very selective in reinsuring
additional fixed annuity business due to the impact of the
current interest rate environment and what we perceive to be
non economic pricing decisions that have been prevalent in
the primary market. While there are a select group of ceding
companies and products in the fixed annuity space that we
might consider reinsuring today. We have been working to
emphasize other types of interest sensitive products such as
disabled life reserves, universal life and structured
settlement products. Nevertheless the number of high quality
opportunities in our pipe line highlights that we can
successfully add to this business line profitably and
successfully in a challenging interest rate and product
design environment. At the same time we continue to decrease
our concentration overall in the fixed annuity product. As
always this is part and parcel of our philosophy -- focusing
on quality opportunities rather than merely the quantity.
Interest spreads earned on out financial solutions business
were 165 basis points for the quarter, as compared to 153
for the fourth quarter of the last year. This increase in
our spread is due principally to a reduction in crediting
rates on our overall bulk fixed annuity business. Despite
changes in interest rates throughout last year, our product
selection coupled with asset liability and investment
capabilities have produced very stable spreads. In our
international business premiums in the quarter were
approximately 28 million up from 25 million in the same
quarter last year. Out international business is growing
very nicely and supports significantly wider margins than
some of out North American businesses. In addition the non
US markets are experiencing some of the same capacity
constraints that we see in North America, which we believe
present significant growth opportunities for us, as well as
improved pricing and terms in the market. The acquisition of
the business we acquired from ERC late last year performed
from a financial point of view in line with our expectations
for the quarter, and the transfer of the ERC Life business
to the Scottish Re platform continues to proceed on an
orderly basis. Since the closing of the transaction on
December 22 2003, several enhancements to our organizations
infrastructure has been made to accommodate this additional
book of business. These enhancements include an updated
claims data base and account management system, mapping of
electronic and paper data feeds from ceding companies and a
new actuarial system to handle specifically individual
session business that came with the ERC life block.
Investment management services were moved to Scottish
control at the end of December last year, and transition of
claims processing occurred to the Scottish platform as of
the first of April 2004. Transition of many of the other
financial administrative functions
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are also on or ahead of the schedule, and our expectation
that the final transition task will be completed by mid
August which we asses, in additional 45 days in the event of
unforeseen events before agreement with ERC to provide
transition services expires.
Now lets turn out our attention at this point to earnings
guidance for 2004. Our efforts to further build the business
of Scottish Re in 2004 will continue to pave the way for
substantial increases in the three key financial measures by
which we measure our success as an organization. Those are
our growth and operating earnings per share, growth in book
value per share and increasing returns on equity. And as you
may know, our expectations for 2004 are consistent with
those objectives. The headlines, just to remind you for 2004
are, year over year Operating EPS growth of 70 percent, a 11
percent year of year book value per share growth and
expansion of our return on equity to a 11.5 percent. A
comment that I would like to make with respect to the
principle differences between the consensus as to make a 46
cents per share for this first quarter and our published
number of 45 cents are, number one, slightly higher actual
diluted share account -- account it for about one penny of
difference between the consensus and what we reported. And
number two, higher opex due to foreign currency fluctuations
during the quarter accounted for one penny as well. Now let
me come back to some of the details driving the headlines of
our earnings guidance. Let's begin by looking at our revenue
expectations for 2004 again. Using -- the 2003 total revenue
of 557 as a point of reference, as we told you in the past,
we expect that Scottish Re's total revenues for 2004 would
grow approximately 50 to 60 percent to approximately $835 to
$890 million. Driving the revenue increases the growth and
earn premium of approximately 54 to 56 percent over 2003 is
392 million value and growth and investment income of 55
percent over 2003's number. As you can infer from that break
down we expected our earned premium would represent
approximately 69 or 70 percent of total `04 revenue with
approximately 29 to 30 percent represented by investment
income. Using Moody's credit default models, we expect that
our bond portfolio will produce realized losses in the range
of seven to ten million dollars which is based on the bond
portfolio size and the weighted average of Moody's default
score that ties out to our various bonds. It's been
obviously a little bit different in this quarter where we
had a net gain but nonetheless this is the guidance that we
continue to provide. While, this number that we are
providing -- it's greater than the 4.4 million realized loss
on investments that we reported in 2003 relative to the size
of the investment portfolio these expected bond losses are
trending you know, it's much lower relative to `02 and `03
results. We expect also to report the income of
approximately 10 to 15 million for 2004. Of the revenue
growth we expect to report in 2004 approximately 55 percent
of the total revenue be driven out of our North American
traditional solutions mortality risk transfer business. 24
percent from our North American financial solution business
and 20 percent from our international business. For those of
you who have followed us for sometime are typical business
contributions put in the past, it's been a long line of 35
percent from traditional, 35 percent from the financial
solutions business with the balance coming from the
international business. However our acquisition of ERC Life
along with many of the opportunities we see in the
traditional mortality business are skewing our source of
earnings for 2004. However, we do expect that our
international business will continue to grow over the next
three to five years and represent approximately 50 percent
of the group profits over that time frame. We expected our
North American traditional business will originate as I
mentioned before 65 to 70 billion of new business which
represent an increase of about 18 to 27 percent over 2003's
originations. In our financial solutions business, we have
also indicated that we expect 2003 slower growth volume
would not necessarily persist as some potential customers
who may not have pulled the trigger in 2003, we evaluate the
situations and pursue reinsurance solutions that were tabled
in 2003. We expect that GAAP reserves in this product line
will increase during the course of `04 by approximately 1.5
billion which represents an increase of approximately 15
percent over the 1.3
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billion of growth in our financial solutions GAAP reserves
in 2004. In addition it's important to know that our largest
financial solutions relationship continues to decrease as
our percentage of our total GAAP reserves and in the past
six months this relationship has decreased from 60 percent
of our overall financial solutions reserves to less than
fifty percent of our financial solutions reserves as of
March 31, 2004 and we fully expect that decrease will
continue throughout the year. In terms of operating expenses
as we mentioned before we continue to leverage our group
infrastructure in our efficient business model, so it really
should come as no surprise that our opex to total revenues
ratio will continue to decline as the company grows. If you
recall the trend that we have exhibited over the past few
years, has gone from an opex ratio in 2002 of 7.37 percent
to 5.7 percent in 2003, to 5.6 percent for the trailing
twelve months ended march 31, 2004. And we fully expect
that, that ratio will continue to slowly decline to a range
for the year of 2004 -- a range of 5.3 percent to 5.5
percent for the year 2004. Finally the resulting operating
earnings per share that we would expect to report for year
ended 2004 has not changed and continues to be in the range
of 2.10 to 2.30. So we are reaffirming guidance. Well our
earnings in the calendar quarter -- is so much seasonal as
the (indiscernible) has grown -- the ramp-up in seasonality
is becoming less pronounced than was observed in the prior
years. And on a quarterly basis, our 2004 operating EPS
ramp-up should follow the following pattern. For Q2, twenty
two to twenty four percent, twenty four to twenty six
percent in Q3 and twenty eight to thirty percent in Q4. Once
again just to summarize all of that extensive guidance.
Operating EPS growth of seventy percent year over year.
Eleven percent book value per share growth, year over year
and return on equity improvement to 11.5 percent. And our
long term guidance continues to support a minimum of twenty
percent annual operating EPS growth for the next three years
as well as achieving a fifteen percent return on equity by
2006. I would like to conclude the prepared remarks on
today's call by saying that all of us at Scottish are very
excited about the prospects for 2004 and beyond. And the
quality of the results that we have reported today reflect
the enhancements we continue to make in our business model
our professional team and our commitment to building overall
shareholder value. And now at this point we will open up for
your questions -- operator? Operator we can open up for
questions.
Operator: Okay, thank you.
Scott Willkomm: Thank you.
Operator: If you have a question at this time please press the "1" key
on your touch-tone telephone. If your question has been
answered or you wish remove yourself from the queue. Please
press the "#" key and if you are using a speaker phone
please lift the hand set. I am showing our first question
comes from Al Capra, with Oppenheimer.
Al Capra: Good morning everybody. We usually talk about mortality
trends a lot but not persistency or (lapsations) -- so
curious to know how your -- your lapses have been versus
pricing -- both this quarter and historically.
Scott Willkomm: Al, I am going to ask Cliff Wagner our group Actuary could
give you a little color on that point.
Cliff Wagner: Yeah well. As far as our persistency goes on the book --
it's right above what we have expected it to be. I mean it's
still fairly early in the block of business to feel out of
movement -- in -- in persistency but -- but it's trending
along about as expected.
Al Capra: Okay and just one quick follow up -- or additional question
and that is, could you talk about -- what sort of business
you wrote this quarter. Perhaps a touch on the pipe line and
any new clients that you might have added thus quarter.
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Scott Willkomm: You know, it's funny because when we are sitting around the
other day putting this -- our comments for the call
together. We have actually stopped counting the number of
new clients because since we acquired ERC we are now
reinsuring, -- really substantially all of our major target
companies -- if you will in -- in the top sixty North
American companies. So we -- we added a handful of new
clients. New names in the first quarter but less of the
growth is driven by adding new clients, more of the growth
is driven by deepening the relationship with existing
clients. So part of that is increasing the number of
programs or pools that we might be included in -- and in
some cases changes or shifts in pool size. We have been
doing a lot more (YRT) business, than co-insurance business
over the recent period. And that's probably something we
would expect to continue -- you know, it's not -- I don't
think it's an episodic type trend, and that's -- I think the
principle -- you have difference if you have long term sort
of trending difference that we would see in the types of
products that we are writing. So, the products that we are
writing now are virtually identical in other than that --
you know, shift -- slight shift towards more YRT than
co-transactions -- you know, that types of products are
pretty much the same. There is not a whole lot of innovation
in the term life business right now.
Al Capra: And just in terms of the shift to YRT from some of the
co-insurance agreements -- what implications does that --
that have on the business you write in terms of the capital
needed to support it -- in turn some of the returns you
generate?
Cliff Wagner: Now, the -- this is Cliff, the returns we expect on the
businesses are pretty much the same for the YRT as it is
with the co-insurance but, the capital required -- you know,
from a risk based capital level are the same to the reserves
-- you know, clearly they aren't the -- you know, the high
statutory stream.
Scott Willkomm: In general, more -- YRT tends to be more capital efficient.
But, the RBC underlying it is the consider --. Cliff Wagner:
Right, as this states mostly on the net amount at risk and
then move toward the -- the YRT I mean, it's a relative move
towards YRT that is to happening as companies have been
re-pricing their -- their permanent portfolios where we
don't take any of investment risk and but we will -- but we
will reinsure the mortality component on a (YRT) basis.
Al Capra: Okay. Thank you .
Cliff Wagner: Welcome.
Operator: Our next question comes from Andrew Kligerman with UBS
security.
Andrew Kligerman: Thanks a lot, Good morning. I just kind of have a few
questions. At first I just want to make sure I understand
the opex ratio, is that the operating expense line on page
six and seven divided by the total revenues?
Scott Willkomm: On a trailing 12 month basis.
Andrew Kligerman: Okay. If -- if I just look at it for this specific quarter
in time and it looks like it's -- you know, north of seven
percent in the quarter. If there is -- was there something
unusual that I missed that -- that would drive it up a lot
on a one time basis or is it just accruals and so forth from
time to time that cause it to jump around?
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Elizabeth Murphy: I think that -- you are probably calculating that including
in revenue would be impact of DIGB36. If you take that out
the percentage does pull to I think marginally below a 7
percent.
Andrew Kligerman: Right.
Elizabeth Murphy: I'm just also remember that our revenue does tend to ramp up
half past of the years from quarter to quarter with Q1 being
the lowest revenue.
Andrew Kligerman: I see.
Scott Willkomm: Yeah, that's why Andrew when -- because we do have that
seasonality element. And there is a some seasonality in the
pattern of opex that some expenses are accrued -- you know,
straight line over the year, as opposed to input, -- you
know, reference to the growth in revenue. So, that's why we
always tend to look from a -- management reporting and
measurement stand point on a trailing 12 months basis.
Andrew Kligerman: That makes sense.
Scott Willkomm: Truth be told, last quarter and in prior quarters we didn't
have the expenses associated with ERC. Yes, that is the one
item we did have about a penny of share -- less in operating
earnings because, both the Dollar-Euro and Dollar-Sterling
relationship slid significantly from December through the
end of the quarter as well. So, -- so we -- as I say in my
earlier comments we left about a penny you know, from
foreign exchange fluctuations there as well. And I think
that it's probably fair to say though, that on a go forward
basis there were a handful of expenses in the quarter and
nothing you know, to write home about that -- are probably,
I wouldn't characterize them as non recurring but there is
some what episodic and on a go forward basis the -- the 12
million level is -- something that I had -- we reasonably
expect to see throughout the course of the year. I think the
key thing for us is opex on a relative basis. And that I
think is where we continue to add margin points, as we
manage opex on a relative basis.
Andrew Kligerman: So -- it's twelve million. You know I mean, want to look at
the ratio but twelve million is probably a consistent number
to expect.
Scott Willkomm: Yeah, I think that's probably fair to say.
Andrew Kligerman: And anything worth noting on that sort of episodic expenses
or just -- a lot of little stuff?
Scott Willkomm: No, it's little -- drifts and drags like quite frankly --
yeah, we added a couple of new folks to our teams through
out the organization first of the year. Folks we had been
seeking to hire in late `03 but they started effectively,
the beginning of `04 -- you know, truly -- you know sort of
little bits of drifts and drabs.
Andrew Kligerman: And then the tax, the tax rates. It jumped up to a little
more of a seven percent versus what we would had felt was a
run rate of three or four percent. Can you -- can you talk
about the -- (indiscernible).
Scott Willkomm: Yeah, the principle -- the principle relationship with the
tax rate is ERC -- because we think we are accruing tax at a
about thirty five percent of rate in the first quarter for
ERC. There -- there are some, you know what tax planning
initiatives that we will be implementing over the course of
the next couple of quarters. And I think on an annual basis,
you will probably see that overall number come down. So I
think what we have there is a timing difference.
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Andrew Kligerman: Okay, and then lastly just an -- interesting observation --.
We have been looking at this annualized premium -- relative
to average enforced was 37 -- basis point for
(indiscernible) was the employers re-transaction, it's come
down to twenty six basis --. It was just interesting in that
-- besides ratio potentially, tell me that you got younger
lives with this ERC transaction or is the ratio not that
useful --.
Scott Willkomm: I am not sure in all candor, I am not sure it's terribly
just positive because the mix of business -- yeah, when you
look at premiums overall. I am not certain exactly how you
are preparing that number. But premiums overall are
influenced not merely by US mortality block but also by our
non US block which has an entirely different basis. And also
the mix of business in the mortality block in the states.
Cliff Wagner: The ERC block if you remember was primarily pre XXX business
-- that would have been priced that low premiums for
(indiscernible) any way.
Andrew Kligerman: Uh-huh..
Cliff Wagner: And a lot of way (indiscernible) business.
Andrew Kligerman: I see. But no demographic really that difference.
Cliff Wanger: On a demographic (indiscernible) on the business that were
writing today -- a new business looks a lot likely
(indiscernible).
Andrew Kligerman: The ERC.
Cliff Wagner: It looked alike -- like what we have been writing -- for the
last couple of years.
Andrew Kligerman: Okay, thanks Cliff. Take care thank you.
Scott Willkomm: Thank you.
Operator: Our next question is from Jeff Schumann, from KBW.
Jeff Schumann: Good morning. First let me talk a little bit about SOPO3 --
did it impact your financial at all. And does it trade
market opportunities for your (indiscernible) -- the primary
companies reports this quarter -- some of them that haven't
re-insured secondary guarantees. You know, that kind a
negative impact on other companies and other companies you
know, had used reinsurance to really avoid any impact and
were pretty glad that they did. So what -- is that an
opportunity for you?
Elizabeth Murphy: It certainly didn't impact our quarter, Jeff. We didn't
refer to it in our 10K. But we didn't expect it to have a
material impact -- and it hasn't.
Jeff Schumann: Right.
Scott Willkomm: And we really don't like the secondary guarantee business,
Jeff.
Cliff Wagner: Now we currently don't -- don't re-insure or any of the
secondary guarantee business.
Jeff Schumann: Is that a capital issue or a risk issue a profitability
issue or --.
Scott Willkomm: Only about is it true that we (sold) all the above in many
respects.
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Jeff Schumann: Fair enough, and I didn't catch -- what you had given for
the international premium comparison, it was 28 versus what?
Scott Willkomm: 28 versus 25.
Jeff Schumann: 28 versus 25, okay. So that has slowed I guess a little bit
from -- from the early --.
Scott Willkomm: Actually I wouldn't say it's slow Jeff you know, a couple of
things on the fourth quarter was, you know quite a
substantial quarter for a number of reasons. Secondly, and
probably more importantly, we have been working over the
past years to call the portfolio little bit and get out some
of the -- under performing transactions which since it --
most of the book is you know, annual business, we have been
able to do that, and this is the first quarter in some cases
where you have seen that because there is couple other
things that -- couple of transactions that we didn't like
the pricing on, we requested pricing increase and the ceding
company was not willing, so they pursued other routes. Then
you see obviously the premium decline as a result of that.
So, rather not take on -- you know, business without the
proper pricing increase as necessary. So, I think that's
your principle difference there. So, the quality of the
earnings goes up although you know, I mean we don't mange
our business on a top line basis, we manage it on a
bottom-line basis.
Jeff Schumann: Got you. And lastly, I was wondering about you know, how you
would suggest when we think about securitization at this
point. There is one large primary company that has completed
a securitization that's probably -- its going to be more
visible in the next couple of weeks. Is that something you
view as an opportunity because it creates kind of new
financial opportunities, source of capacity for you or is
that a threat?
Scott Willkomm: I think -- you know, I think there are couple of ways to
view it. First of all, it's no secret that you know, for a
good portion of 2003, we have spend a lot of internal time
and work with some external experts as well to
dimensionalize the characteristics of our book of business
and you know, looked at a number of different ways as you
can imagine every investment banker in town has been to
visit us at least a few times to talk about alternative
forms of securing statutory strain deed on XXX on some other
you know, source of strain. So, you know, we have actually
invested an awful lot of time looking at that in 2003. I
think you know, generically speaking, it allows us to be
substantially more efficient in terms of how we utilize our
core capital be at equity and near equity and indebtedness.
And when we talked about being more efficient it brings our
overall cost of capital down in the light so, suffice to say
we are looking at a lot of those things pretty actively.
These are not types of transactions that happen everyday
although I think we will see you know, over the course of
the next 12 to 18 months in general maybe about half a dozen
to a dozen at the outside happening be it in a primary or in
the reinsurance phase. So, I think it does provide some
opportunities to enhance margins, if you can bring down, you
know, the incremental cost of capital. So, that obviously
when we see opportunities like that we invest time and
energy to pursue them if they are appropriate for us.
Jeff Schumann: Okay. Thanks a lot Scott.
Scott Willkomm: Yeah.
Operator: Our next question is from John Hall from Prudential.
Roger Smith: Hi, this is actually Roger Smith in. I just got a couple of
questions. Can you talk -- I mean demands for the product
still seems very strong. Could you tell us -- do you think
that demand is accelerating or kind of staying the same that
you have seen in the last couple of years. And then it seems
like it's really strong on the traditional side, do
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Scottish Re
you think that financial interest side is going to pick up
and then lastly do you see any reasons why or new products
that would cause the demand to increase it that weren't in
your thinking maybe last year?
Scott Willkomm: With -- you know, with respect of the demand on the
traditional side. We -- I think traditional demand is strong
although traditional demand is not growing nearly as that as
I did say. If you look -- you know, eight years in the past.
Because you had both the combination of overall growth with
the ordinary life business but also the amount or the
cession rates if you look at the percentage of new business
that was reinsured increased dramatically during that
time-frame. I think that -- you know, it's fair to say we
will see some modest growth -- it will probably track the
overall growth of the overall ordinary business -- maybe a
little bit ahead of that cause some penetration, cession
rates may modestly change over the course of the next few
years which I think more pronounce Roger is the -- excuse
me, the supply side of the equation, the life reinsurance
business on a global basis clearly in US is a consolidating
business. I think that we are witnessing that and we will
continue to witness that for a period of time. So, I think
you are going to see more concentration in some respects of
market share in the top five reinsurer serving the market
and most everyone else will be participating sort of in
modest amounts. So, I think what we are seeing is that a
significant contraction in the near term of available
supply, will there be some new entrants? No question. There
will be come new entrants. Although I am very confident that
the likely new entrants and I am not saying there -- you
know, half a dozen, I think it might be something you count
on -- you know, couple of fingers, will come into the market
in a fairly disciplined pricing and capital utilization
faction. So, it won't be -- you know, driving pricing and
risk acceptance in adverse direction. I think with respect
to financial solutions -- I mean I think it's fair to say
that we are not as fond of the pure spread business --
stereotypically speaking because many of the behaviors of
ceding companies have been inconsistent with earning a
proper return on the capital of risk in that business. So,
if you see we have done very, very little bit of that. I
think that as we see -- you know, interest rates trending
upwards you may see the opportunity of more interest
sensitive in force blocks coming -- you know, to the floor
if you will. But, you know, I don't think sort of a new
business side of things will be -- you know, an outrageous
driver and we have quite frankly been trying to balance or
moderate the amount of spread with we have relative to the
over all mortality risk that we have. So, and at this point
in time, you know, while there are a lot new products that
create opportunity to reinsures, most of them in all candor,
we are not too fond of, the ones that will produce
potentially high volumes like long term care products -- you
know, for example comes to mind and some of that has to do
the manner in which the products are designed, the manner in
which they are sold and you know, quite frankly there is a
lot of fogginess with respect to risk assessment in terms of
-- you know, a reinsurer taking on that type of risk in
recent out opinion so, those types of things have not been
factored into our thinking in terms of providing near term
and longer term values. Quite frankly there is enough
growth. Our opportunity both top-line and bottom line
opportunity in the core businesses that we currently
participate in.
Roger Smith: Great, thanks and then I have one follow-up -- I -- on the
supply side, I agree significant contraction but, what would
cause a lot of new entrants into the business and what do
you think would happen to cause in to be irrational. I mean
what could possibly disrupt --
Scott Willkomm: A lot of new entrants come into the business when life re
gets paid five times book and I think that quite honestly
that was a driver, some of the -- the multiples that were
paid in contacts and merger and acquisitions activity in the
late 1990's was some what of a motivating influence, I think
that most of the companies that came into the market in the
late 90's were doing so, a little bit sort of mortgaging
their future in some respects.
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Scottish Re
Most of the companies that came into the market were non US
companies, who could, through their corporate structure,
secure a lot reserves strength to short term (indiscernible)
credit facilities, which is something we have not done
(indiscernible) a period. We don't believe that, that's
prudent asset liability management. But, I think what would
happen -- what would need to happen today would be quite
frankly -- you know, to -- get a lot of people to come into
the market is -- you know, I think it would be a more
(indiscernible) to the life re-experience which in all
candor I don't think it's necessarily what's in the cards
over the near term at Vegas, I think that what always causes
a rational pricing is too much capacity. It's the case in
the life business, it's the case in the (P&C) business. And
I think the difference between and life and P&C it was
(indiscernible) and the magnitude of capital needed to
secure the risk that are taken in the light business, long
duration was is entirely different from what most of the
potent P&C business are confronted with. And you'll see a
couple of, I think, thoughtful competitors and that's not a
wishful thought. That -- that's somewhat of an informed
thought. People coming into the market are not interested in
riding business at an 8 or 9 percent IRR. People are coming
into the market today or writing the business today at
proper IRRs, that whether they return to shareholders or
just return to the overall enterprise, the types of returns
that this risk demands. And as you know we've always used a
15 percent level as a -- you know, as a hurdle rate for us
to try to get over as we look at business. And I think
that's, you know, a prudent type of approach to takes. So
I'm not sure if that answers your question entirely, but
it's somewhat of a subjective view of why people enter
markets.
Roger Smith: No, Scott. That's was great. Thanks very much.
Operator: Our next comes from Ned Davis from (indiscernible).
Ned Davis: Yes, good morning. Scott, I know you sort of touched on this
indirectly, but if you hit your guidance for this year of a
mid point or so of your guidance, could you just sort of
outline again what you think the capital structure would
look like at the end of the year in terms of you know, the
different sources you would tap including your excess
capital today? Give us an update on that?.
Scott Willkomm: Yeah, well, I think that -- as we've said in the past, we
didn't expect based upon where we see the company go, we
didn't particularly expect to see ourselves in the equity
market in 2004. We -- you know, we made to the extent
appropriate within our -- with our -- within our leverage
guidelines incrementally add to our -- you know, to our
capital structure by adding perhaps some indebtedness. And
as you may recall, we try to manage around a 20 percent
debt-to-cap level overall, which is probably a little bit
more conservative than some of our competitors. So, you
know, our -- I would think that, you know, based upon, you
know, sort of the question you're asking, the capital
structure doesn't look terribly different than the capital
structure that we have today, other than perhaps some
incremental additions on the fixed income side of the
capital structure. And, yeah, I think it's pretty
straightforward. Our need or desire to raise equity or near
equity, if you will, is something that will likely be event
driven. And you know, with all of the consolidation going on
in our business right now, it would not be entirely
surprising that an event does come to roost, but that would
be the catalyst and at that point in time obviously
shareholders would have the opportunity to judge whether
they thought it was an appropriate utilization of capital,
so.
Ned Davis: Okay. One other thing. You've set this sort of goal for `06,
I think it is a 15 percent return. Is that -- that's on
beginning equity or average equity?
Scott Willkomm: They would be at average equity.
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Scottish Re
Ned Davis: Average equity. And I'm just asking you, I guess, what's
implicit in that with regard to two of the variables? One,
the operating expense ratio approximately and secondly, the
tax, the effective tax rate for GAAP --
Scott Willkomm: Implicit in that is -- we've -- I think we've given a little
bit of guidance on this in the past, but just to re-mention
that, OPEX ratio will probably be somewhere in the high
fours, all things being equal. Eventually, you get to a
diminishing return where you're penny wise and pound foolish
in all candor. Tax rate will probably trend up, not
necessarily from where it is right now because I think that
we may have explained it's a little bit higher due to some
effect of the ERC transaction in the first quarter, but we
would certainly expect that that would trend higher to the
higher single digits which we think is a reasonable long
term sustainable level for us based upon how we ride our
business and the overall corporate structure of the
enterprise.
Ned Davis: Okay, thank you.
Scott Willkomm: Yeah.
Operator: Again, if you have a question, please press the one key on
your touch-tone telephone. I am not showing any further
questions at this time.
Scott Willkomm: Well, thank you, everyone for joining us today and we look
forward to speaking with you over the course of this quarter
and in three months' time. Thank you very much.
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