Second Quarter Earnings Call
Scottish Re Group Limited
August 5, 2004
11:00 a.m.
Host: Scott Willkomm
Page 1
Second Quarter Earnings Call
Scottish Re Group Limited
August 5, 2004
11:00 a.m.
Host: Scott Willkomm
Operator: Good day, ladies and gentlemen, and welcome to the Second
Quarter Earnings Conference Call. At this time all
participants are in a listen-only mode. Later we will conduct
a question and answer session and instructions will follow at
that time. If any one should require assistance during the
conference, please press "*" then "0" on your touch-tone
telephone. As a reminder, this conference call is being
recorded. I would now like to introduce your host for today's
conference Mr. Michael French, Chairman and CEO of Scottish
Re. Mr. French, you may begin your conference.
Michael French: Thank you, operator, and good morning everyone and welcome to
the Scottish Re Group Second Quarter Conference Call. We will
begin the call with comments 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 take your questions. There will be a recording of this
call available after 3 o'clock this afternoon running through
August the 19th, and instructions on how to access that replay
were included in today's earnings release.
In addition, you can also get a replay of the call on our
website at scottishre.com. Now before we begin the financial
overview 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 that forward
looking statements are not guarantees and that the actual
results could materially different from those expressed or
implied. At this time, I'm going to turn the call over to
Scott Willkomm to discuss our financial results and operations
for the quarter, Scott.
Scott Willkomm: Good morning everyone. Scottish Re this morning reported that
income from continuing operations for the quarter ended June
30th 2004 was $27.6 million or 74 cents per diluted share as
compared to $9.3 million or 33 cents per diluted share for the
prior year period. Income from continuing operations for the
six months ended June 30, 2004, was 37.6 million or $1.1 cent
per diluted share compared to $16.7 million or 59 cents per
diluted share for the prior year period. Net operating
earnings were $17 million or 46 cents per diluted share for
the quarter ended June 30 as compared to 12.5 million or 44
cents per diluted share for the prior year period. Net
operating earnings were $33.6 million or 90 cents per diluted
share for the six months ended June 30 2004 as compared to
21.9 million or 70 cents per diluted ordinary share for the
prior year period. Net operating earnings is a non-GAAP
measurement. We determine net operating earnings by adjusting
gap income from continuing operations by net realized capital
gains and loses in the change in value of embedded derivatives
as adjusted for the related effects upon the amortization of
deferred acquisition cost and taxes.
While these items may be significant components in
understanding and assessing the company's consolidated
financial performance the company believes that the
presentation of net operating earnings enhances the
understanding of its result of operations by highlighting
earnings attributable to the normal recurring operations of
its business. However, net operating earnings are not a
substitute for income from continuing operations determined in
accordance with gap. Net income for the quarter amounted to
27.6 million or 74 cents per diluted share as compared to 7.9
million or 28 cents per diluted share for the prior year
period. Net income for the six months ended June 30 amounts to
37.6 million or $1 per diluted share as compared to 15.1
million or 53 cents per diluted ordinary share for the year
period. Total revenue for the quarter increased to 228.8
million from 129.5 million for the prior year period, which
represents an increase of 76 percent. Total revenues for the
six months
Second Quarter Earnings Call
Scottish Re Group Limited
August 5, 2004
11:00 a.m.
Host: Scott Willkomm
Page 2
ended June 30, 2004, increased to 408 million from 226.4
million for the prior year period, an increase of 80 percent.
Total benefits and expenses increased to 203.4 million for the
quarter from 120.3 million, an increase of 69 percent. For the
six months ended June 30, 2004 June 30, 2004 total benefit and
expenses increased to 371 million from 209.4 million, an
increase of 77 percent.
The increases in both total revenues and total benefits and
expenses were principally driven by the acquisition of
Scottish Re Life Corporation, which is previously known as ERC
Life. And growth in the company's reinsurance business in
North America as well a growth in investment income to the
increase of our invested asset base. ERC Life added
approximately 33 million of premium this quarter and 78
million of premium in the year to day period. The companies
total assets were approximately 6.9 billion as of June 30,
2004. The core investment portfolio, which includes cash and
cash equivalents but not including funds with held interest,
totaled $3 billion, at an average quality rating of AA minus
and effective duration of 3.5 years and a weighted average
book yield of 4.1 percent. This compares with a portfolio
balance of 2.4 billion, an average quality rating of AA minus
and effective duration of 3.9 years and an average book yield
of 4.5 percent as of December 31, 2003. Funds with held
interest amounted to $1.5 billion, at an average quality
rating of A- an effective duration of 4.9 years and an
weighted average book yield of 6.3 percent as of June 30,
2004. This compares with an average quality rating of A-. An
effective duration of 5.1 years and an average book yield of
6.3 percent as of December 31, 2003. The market value of the
funds with held interest amounted to 1.5 billion as of June
30. Investment losses, which are before taxes but include the
amortization of the deferred acquisition cost, totaled 1.7
million in the quarter and 266,000 since the beginning of the
year. The quarter and year to date impairment losses amounted
to about a $100,000 and $2 million respectively. During 2003,
the company adopted DIG B36, which requires us to account for
a modified co-insurance contracts on a fair value basis. The
change in fair value of the derivative for the quarter
amounted to a gain of 14.6 million net of related amortization
of deferred acquisition costs. The gains of the year to date
period amounted to $6 million. Changes in the value of this
derivative are caused by changes in interest rates, and/or
credit spreads.
During this quarter and the year to date, the gain has risen
principally because of the decrease or the increase in
interest rates. Going forward, we would generally expect to
experience a gain, as interest rate rise and a loss if they
fall. On a longer-term basis, the value of the embedded
derivative will trend towards zero. As discussed earlier, the
change in this value is excluded from operating earnings and
does not impact the economics of these contracts. Due to the
impact of rising interest rates and it's resulted effect on
the unrealized life loss position of our portfolio. We saw a
decline in book value per share during the quarter to $18.66
cents from $18.73 cents as of December 31, 2003. Excluding the
impact of FAS 115, book value per share amounted to 1917 per
share in comparison with 1851 per share as of December 31,
2003.
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
as to how we measure that progress. We will start with our
traditional solution's business. Our traditional solutions
business provides mortality risks transferred capacity
targeting the top life insurance companies in North America.
We are very well established in this market and currently
provide reinsurance capacity to over 75 percent of the top
North American life companies. We have excellent working
relationships with our client and are benefiting from the
scarcity of life reinsurance capacity in the market. As of
June 30, 2004, the company had approximately $298 billion of
life re-insurance in force, covering 7.4 million lives with an
average benefit per life of $40,000 in our North American
operations. As of June 30, 2003, the company had approximately
90.4 billion of life re-insurance in force in it's North
American activities, covering 1.8 million lives with an
average benefit per life of $50,000. During the quarter, we
originated approximately $14 billion of new traditional life
re-insurance from existing and new clients. On a year-to-days
basis, we have originated approximately $27 billion. Our
production goal for 2004 in
Second Quarter Earnings Call
Scottish Re Group Limited
August 5, 2004
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Host: Scott Willkomm
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the 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 favorable as well, with actual experience in
the second quarter of the year at approximately 98 percent of
expected levels. Since inception of the traditional solutions
business in 2000, mortality is at 94 percent of its expected
levels on a cumulative basis. In our financial solutions
business, we measure progress by measuring the GAAP reserves
we hold on our balance sheet.
Reserves for the financial solutions business line increased
modestly to $3.3 billion as of the end of the quarter in
comparison with $2.9 billion as of the end of 2003. As we have
said in the past, we have been selective in re-insuring
additional fixed annuity business due to the current interest
rate environment and what we perceive to be non-economic
pricing decisions that are prevalent in the primary market.
Well, there are select group of (seeding) companies and
products in the fixed annuity space that we might consider
re-insuring today. We have only in this quarter, re-insured a
new block of business in the fixed annuity space. This is the
first fixed annuity re-insurance transaction that we have
completed since last year. In addition, we have been working
to emphasize other types of interest sensitive products such
as disabled life reserves, universal life and structured
settlement products. Interest spreads earned on our financial
solutions business widened again this quarter, modestly to 167
basis points from 165 basis points last quarter and 153 basis
points for the fourth quarter of 2003. The increase in our
spread this quarter is the net effect of a three basis point
decrease in the yield and a five basis point decrease in
crediting rates on these transactions. Despite changes in
interest rates, our product selection coupled with disciplined
asset liability and investment management capabilities have
produced very stable spreads.
At this point, I would like to talk a little bit about asset
liability management at Scottish Re and the effects of changes
in interest rates on the company and it's business. From June
2001 to June 2003, the seven-year swap rate dropped from six
percent to three percent. Since then, that rate has risen to
4.7 percent and it's generally expected to rise further. With
this kind of volatility, it's important that Scottish Re do a
good job of asset liability management in order to protect the
earnings power and economic value of the company from undue
exposure to changes in the interest rates. Of our 4.4 billion
of investments, approximately four billion back liability is
generated in our re-insurance business. Our first line of
defense is managing the duration of investments to track
closely the duration target set for the liabilities. Although,
we do not control this 1.6 billion of assets under modified
co-insurance treaties, we include those assets and liabilities
in our enterprise duration management process. And as of June
30, 2004, our duration GAAP was only 0.16 years. We set
duration targets from the bottoms up. Were the portfolio
segment backing each asset intensive re-insurance transaction,
we engineer the maturity structure and sector allocation that
produces the most attractive and stable profits when combined
with the liability. The duration of that model portfolio
becomes the target duration for the portfolio segment backing
the liability. We update targets periodically for in force
business using fresh policy level data and updated interest
rate assumptions. Management of the $2.6 billion backing fixed
deferred annuities requires careful modeling of the assets and
liabilities under multiple interest rate scenarios to take the
count of interest sensitive cash flows.
Fixed annuities give customers two valuable options. One,
customers can surrender their policies for accounts value
minus a surrender charge that grades down to zero typically
over six years. As the surrender charge declines, the benefit
of surrendering rises when the crediting rate is significantly
lower than the new money rate available and a tax-free
exchange for a new annuity. As rates rise, shortening
portfolio duration is helpful because it provides funds for
paying surrenders and may provide excess cash flow for
reinvestment at higher yield. Helping preserve margins on the
business that doesn't surrender. The second option is
annuities provide a guaranteed minimum-crediting rate. Until
recently, that rate was approximately 3 percent, but many
states have lowered that requirement.
Second Quarter Earnings Call
Scottish Re Group Limited
August 5, 2004
11:00 a.m.
Host: Scott Willkomm
Page 4
As rates fall it becomes attractive to extend duration to
protect against the affect of reinvestment risk on margins.
With the prospect of continued rises in interest rates, we
revised our annuity target durations downwards during the
quarter more on annual reset annuities than on multi year
guarantee products, where we enjoy better protection against
margin erosion. We integrate asset liability management into
the origination process as well as to enforce management. As
rates dropped between June 2001 and 2003, we became
increasingly apprehensive about the risk of maintaining
margins both guaranteed minimum rates. If rates stable for
protracted period of time and the risk that business
originated when yields were very low would have trouble
sustaining margins as rates reverted to normal levels. As a
result we were extremely selective about new annuities
transactions. Limiting ourselves to clients with objectives
well aligned with ours, and strongly preparing multi year
guarantees to annual reset products.
The low level of production during the low yield period
protected us from building much exposure to the rise in rates
now in progress. With further increases in yields we will come
growth in production by current and prospective clients. We
are very well position to produce an improve volume of high
quality annuity transactions over the next two years and
competition for the time being is very limited. In order to
limit exposure to the options embedded in the fixed annuities
we have diversified our asset intensive business over the past
few years. Products with little or no surrender exposure
include, collateralize funding agreements, which are option
free agreements directly with financial institutions that are
floating rate instruments by buying LIBOR floating and very
short duration assets we minimize any interest rate risk.
Single premium immediate annuities, these products combine
longevity risk with investment risk. We are looking at a
number of opportunities in our business right now -- in demand
by (seeding) company's seems at risk. Disabled life reserves,
we avoid exposure to new claims but are willing to accept the
longevity risk of the disabled lives in run-off. Whole and
universal life, we reinsure various permanent life plans on a
coinsurance basis combining both mortality and investment
risk. Now under FAS 115 we market the investments other than
the funds with held interest through shareholders equity. And
during the second quarter, the five years swap rate rose by
109 basis point causing a 3 percent drop in the market value
of our bond portfolio as a percentage of book value. However,
under GAAP accounting we do not market the value of our
liabilities. If we did -- the swing in the net value of assets
and liabilities would be much more modest then that under FAS
115. Since assets and liability durations are well matched,
the exposure was limited to about 400 million of assets not
backing liabilities with an average duration of three years.
When the rise in rates subsided in early July, we took the
opportunity to actively hedge this exposure by entering into a
swap with a notional amount of 100 million in which Scottish
pays a fixed rate of 4.11 percent and receipts LIBOR that's
reset on a quarterly basis.
If rates continue to rise, the gain in the value of the swap
will offset part of the reduction in the value of that part of
the portfolio not backing liabilities. In summary, our
conservative approach to asset liability management is
designed to maintain the economic value of our business,
regardless of where interest rates go. In addition, a rising
rate environment should enhance the opportunity to rise high
quality financial solutions transactions. Further more, our
earnings guidance in long-term ROE expectations are built and
periodically updated with assumptions regarding the future
movement of interest rates. Accordingly, we believe that a
rising interest environment will contribute to building the
company's long-term economic value. In our international
business, premiums in the quarter were approximately $31
million, which represents a decline from 38 million in the
same quarter last year. This year-over-year comparison is
somewhat difficult due to changing from a cash basis of
accounting in 2004 for premiums earned which makes comparison
difficult. And number two, our active decision not to renew
several under performing treaties. The net result of these
activities is to improve the margins of our international book
going forward. This international business is growing very
nicely and is ready support significantly wider margins than
our North American business. In addition, the non US markets
are experiencing significant capacity constraints that we have
seen in
Second Quarter Earnings Call
Scottish Re Group Limited
August 5, 2004
11:00 a.m.
Host: Scott Willkomm
Page 5
North America which present both significant growth
opportunities as well as improved pricing conditions. The
transfer of the ERC life business to the Scottish Re platform
continues to progress on an orderly basis. Since the closing
of the transaction on December 22, 2003 several enhancements
to our organizations infrastructure have been completed to
ready ourselves for managing this acquired block.
These enhancements include an updated claims database,
accounts management system, mapping of electronic and paper
data feeds and an actuarial system to handle the individual
section business. Investment management services were moved to
Scottish control at the end of the year. Transitioning many of
the other financial administrative functions are also on or
ahead of schedule. Our expectation is that the final
transition task will be completed by mid August leaving us an
additional 45 days in the event of unforeseen events before
our agreement with ERC to provide transition services expires.
Early in the second quarter, we assumed control of the claims
processing functions and took that opportunity to ensure that
we were up to date with any processing backlogs and to adapt
the function to our systems and procedures. When we acquired
at the business of ERC we anticipated that there would be some
catch-up as we apply Scottish Re methods and procedures.
However, the financial impact of the processing backlog was
greater than we had originally estimated. As a consequence, we
are reporting operating earnings per share at the low end of
our guidance range for the quarter. Nevertheless, the
performance of this block has been consistent with our
expectations for the first six months of the year and thus is
a timing issue with respect to the ERC result. Now let's turn
our attention to the subject of CoCos. On July 1, the FASB's
emerging issues task force issued a proposal to change the
current accounting practice for contingently convertible debt
securities. Current accounting practice from it's the treasury
stock method could be used in calculating the dilutive effect
of these securities in earnings per share calculations. The
resultant impact is that these securities become dilutive only
up on reaching the contingent conversion price. The proposed
change would -- would require the if-converted method to be
used resulting in immediate inclusion of the converted shares
in earnings per share calculations. The EITF are meeting again
on this issue in September with any changes likely to be
effective in the fourth quarter of 2004. Scottish Re issued
approximately two years ago $115 million of convertible debt
securities. The current terms of these securities allow us to
settle the par value on conversion in either cash or stock.
We have previously stated our intention to settle par on
conversion in cash. And therefore, we have used the treasury
stock method in calculating EPS in conformity with current
accounting practice. The terms of the indenture of these
securities permit us to change the settlement provisions. If a
change is made such that par on conversion is required to be
settled in cash the treasury stock method would continue to
apply. The current proposal would not apply to our mandatory
convertible hybrid capital units, which we call HyCUs. Similar
to the structure for other equity unit transactions the HyCUs
are investment units consisting of an equity forward contract
and a convertible preferred. Each unit is separated into it's
constituent parts. Economically, through the equity forward
contract, Scottish owns a put option on it's own equity. Under
US GAAP, which is EITF0019, the cost of this contract reduces
paid in capital. While the cost of this contract is paid in
installments over it's life, we have appropriately recorded a
liability for the present value of these expected payments
with a corresponding reduction to equity. This liability is
reduced as payments are made for the forward contract
payments. For EPS purposes under FAS128, these securities are
accounted for under the treasury's stock method of accounting.
When we were considering issuing these convertible debt
securities in the HyCUs, and this is the case anytime we
examine issuing dilutive securities. We carefully look at the
impact that such issue ends would have on both operating EPS
growth objectives and our overall ROE growth progression.
Accordingly, we factored into our ROE expectations and
guidance, the dilutive impact of these securities.
Second Quarter Earnings Call
Scottish Re Group Limited
August 5, 2004
11:00 a.m.
Host: Scott Willkomm
Page 6
The next topic of discussion is mortality trends. Mortality as
I mentioned a little bit earlier in the prepared remarks
continues to be on track coming in at or near expected in each
of the previous eight quarters. Inception to-date mortality is
running at about 94 percent of expected levels. And we have
stated every time we have had a conference call that we
anticipate our mortality will continue to remain around 100
percent of expected levels, and we see no adverse trends
emerging. As previously stated, the projections we use to
develop our plans for earnings in return on equity progression
are based up on using assumptions that assume 100 percent of
expected mortality. And if these assumptions are realized as
we expect will be the case, we would accordingly expect to
achieve our projected returns.
We will be happy to talk in greater detail about mortality in
the Q & A section. Now let us turn our attention to earnings
guidance for the balance of the year. Our efforts to built the
business of Scottish Re in 2004 has paved the way for
substantial increases in the three key financial measures by
which we measure our successes and organization overall. One
is growth in operating earnings per share, two is growth in
book value per share and three is increasing return on equity.
And our expectations for '04 are consistent with those
objectives. I will reiterate the headline guidance that we
have given in the past. The headlines for '03 are number one,
year-over-year operating EPS growth of 70 percent over 2003's
result, 11 percent book value per share growth and number
three, expansion of our return on equity to 11.5 percent.
Let's begin by discussing our revenue expectations, some of
this will be repetitive but some of this will also update for
mid-year results. Using 2003's total revenues of 557 million
as a point of reference, we have said in the past and we
reiterate at this point in time, we would expect that Scottish
Re's total revenues for 2004 would grow approximately 50 to 60
percent to approximately $835 million to $890 million. Driving
the revenue increase is the growth in earned premiums of
approximately 54 to 56 percent over last year's $392 million
number, and growth in investment income of 55 percent over
last year's $148 million number. As you can infer from that
breakdown we expect that earned premiums will represent
approximately 69 to 70 percent of '04 revenues with the
balance represented principally by investment income.
On a year-to-date basis, premiums earned were 291 million or
48 percent of our expectations for the entire year. In
addition, year-to-date total revenue was 408 million or 47
percent of our expectations for the year. Thus when one takes
into account the seasonal pattern of premium flows that
happened to be skewed to the second-half of the year you can
see why we remain confident that our revenue expectations are
achievable. We told you on the past two conference calls that
using Moody's Credit Default Models we would expect our bond
portfolio will produce realized losses totaling approximately
7 to $10 million in 2004, which are based up on the size of
the portfolio and the weighted average Moody's default score
of the underlying bonds. While we have only reported net
realized losses of $266,000 for the first six months of '04 we
are not changing our guidance on this number. Finally, we
expect to report fee income of approximately 10 to $15 million
for 2004 with $6.1 million of fee income reported year-to-date
that expectation remains reasonable. Of the revenue we expect
to report in 2004 approximately 55 to 60 percent will be
driven by our North-American Traditional Solutions Mortality
Risk Transfer Business, probably on the high end of that
range. 20 to 25 percent from our North-American Financial
Solutions Business and 20 percent from our International
Solutions Business. We expect that in our North-American
Traditional Business we will originate approximately $65 to
$70 billion of new business, which represents an increase of
approximately 18 to 27 percent over 2003's 55 billion
origination level. Today as I've mentioned we've originated
approximately 27 billion of new mortality business or
approximately 39 percent of our objective for 2004. However,
keep in mind we are not motivated by market share objectives,
and merely use such a measure a simple yardstick. We are
focused on writing well-priced business that meets or exceeds
our risk adjusted return objectives and builds long term value
in the company. In our Financial Solutions Business, 2003's
slow growth volume is easing, as potential customers who may
not have pulled the trigger in '03 re-evaluate their
situations in light of the general change in
Second Quarter Earnings Call
Scottish Re Group Limited
August 5, 2004
11:00 a.m.
Host: Scott Willkomm
Page 7
interest rates, and pursue re-insurance solutions that were
tabled last year. This is the case with the transaction that I
referenced earlier in the -- in the conversation. However, our
expectations for growth in GAAP reserves in this product line
will be less than we had originally forecasted.
We had anticipated the GAAP reserves would increase in '04 by
approximately 1.5 billion, that production estimate we believe
now is going to be approximately 900 million. However, since
we are achieving wider margins in the Financial Solutions
business in '04 than we had assumed when forecasting the
business, we expect that this segment's contribution to '04
result will not deviate materially from what had been
expected. In addition, the strong performance in our
Traditional Mortality business more than offsets any
difference. In terms of operating expenses, we continue to
leverage our group infrastructure, and our efficient business
model so it should come as no surprise that our operating
expense to total revenue ratio continues to decline as the
company grows. In 2003, that ratio declined from -- 7.4
percent to the -- for 2002 down to 5.7 in 2003. For 2004, we
would expect that that ratio would further decline to 5.3 to
5.5 percent range. For the last 12 months ended June 30, 2004
which is the measure we use to correct for seasonally in
revenue and expense recognition patterns the Apex to revenue
ratio which excludes realized gains and losses and the change
in the fair value of embedded derivatives was 5.4 percent or
in the range that we expected for this year. Finally, the
resulting operating earnings per share that we would expect to
report for the year ended '04 will continue to be in the range
of 210 to 230 per share. And while our earnings in the
calendar year is somewhat seasonal as the company has grown
the ramp up is becoming less pronounced than what had been
observed in prior years. On a quarterly basis, as we said in
the past our '04 operating EPS should follow the following
pattern and has in the first two quarters of the year, 20 to
22 percent in Q1, 22 to 24 percent in Q2, 24 to 26 percent in
Q3 and 28 to 30 percent in Q4. So once again to summarize the
headline guidance, operating EPS growth '04 over '03 of 70
percent, a 11 percent book value per share growth and return
on equity improvement to about 11.5 percent. Our long-term
guidance continues to support 20 percent annual operating EPS
growth objectives for the next three years as well as
achieving a 15 percent ROE by 2006. Now one of the most
important drivers of ROE expansion is the company's cost of
capital especially the cost of capital that we use to back our
liabilities. One of our important objectives at Scottish Re is
to reduce the cost of capital, to that end we close a
structured financed facility with HSBC Bank, USA that provides
$200 million of collateral support primarily for regulation
XXX related products.
This facility reduces the strain on our existing capital by
providing Scottish Re US with credit for re-insurance
collateral. The trust arrangement puts in place -- put in
place for this facility will be accounted for as a variable
interest entity and is consolidated on our balance sheet in
interest sensitive liabilities. This is a five-year facility,
which includes the option to extend annually for a further
year up on the consent of both parties. At this point I'd like
to conclude our conference call by saying that, all of us at
Scottish Re are very excited about our prospects for 2004 and
beyond. And at this point we will open up for your questions,
operator.
Operator: Thank you. 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 to remove yourself from the queue
please press the "#" key, and if you are using a speakerphone
please lift the handset. Our first question comes from Al
Capra with Oppenheimer.
Al Capra: Good morning everybody. Scott, I was just hoping that
you could walk through perhaps some of those changes in
methods and procedures that you mentioned that were undertaken
this quarter ERC and how that compares to what you do with
Scottish and -- and why the -- why the blip in -- in terms of
claim process in this quarter?
Second Quarter Earnings Call
Scottish Re Group Limited
August 5, 2004
11:00 a.m.
Host: Scott Willkomm
Page 8
Scott Willkomm: One thing I'd like to clarify Al, and then I -- will
ask some of my colleagues to comment as well. There was no
change in how Scottish does things. We apply Scottish
methodology to the historic basis up on which ERC handles
claims processing. And that's something that everyone, I think
should take away from this. I think, what I would like to do
is add some of my colleagues to contribute to the
conversation, now that you know all we have done is apply our
own procedures to a block, which was done on a different
basis.
Female Speaker: Al several things happened. As Scott said in his prepared
remarks from the beginning of this quarter, almost we took
over the processing of the individual reported claim. We have
changed the method of booking those claims into our records,
from that it is previously being used by ERC. We believe that
we have reduced the back log in processing the claims and we
have changed some of the methods, and if I give you one
example, many claims, actually net claims experience against
statement and settle the amounts due or the amounts we owe to
them on a net basis. ERC had estimated the claims that are
reported in that way through prior lines. We don't -- we don't
do that. We book each individual claim as it is reported,
whether it's reported individually or whether it's a part of a
net settlement statement. So, that's one change and there was
several of that nature which means that, we have put
everything to be line with the way we currently book our
claims and we believe that in doing so we have cleared what
may have been a back log of reporting actual claims.
Al Capra: Okay, and in terms of this backlog. Was it -- were
these first quarter claims or were there even some from prior
quarters and if that was a fact, are you indemnified in some
way from GE?
Female Speaker: There would have been claims but -- in respect of
(indiscernible) we did a very careful scrutiny of the closing
balance sheet as anybody does where they acquire a company and
although there might have been one or two fairly small claims
that related to prior period. It's really a time to get
confused between January 1 and now essentially.
Scott Willkomm: And as a result Al, the six months results is for
that -- for that business is spot on with where we would have
expected it to be for the six months of this year. So, with
the timing difference in terms of when the claim was actually,
excuse me -- actually booked.
Al Capra: Okay. Just got one additional question -- you mentioned
your attempt to reduce your cost of capital, that is $200
million facility. Is this for existing business or new
business and perhaps you could expand on that, and talk a
little bit about the terms, you know, how favorable was it
versus your previous cost of capital?
Scott Willkomm: This is available to us for both new and existing
business. And, it's XXX related strain, the relevant change in
cost of capital is to reduce the cost of capital backing these
liabilities by somewhere if you took a comparable facility
that we have used in the past. Somewhere is on the order of 40
to 50 percent. So, and it is a -- it's a very attractive
facility from an economic standpoint to the company.
Al Capra: Okay. Thanks very much.
Scott Willkomm: I am trying not to give the pricing per you know the actual
numbers so that the rest of the world doesn't try to duplicate
it.
Al Capra: That's fair. Thanks.
Operator: Our next question comes from Jeff Schuman with KBW.
Second Quarter Earnings Call
Scottish Re Group Limited
August 5, 2004
11:00 a.m.
Host: Scott Willkomm
Page 9
Jeff Schuman: Good morning. Scott, I was wondering if you could identify --
I guess the dollar amount of the impact of cleaning out ERC
backlog?
Scott Willkomm: I think Jeff, we are going to -- we are going to take a second
to pull that out. But it was something on the order of $2
million after taxes.
Jeff Schuman: Okay, and when you calculated the actual to the expected ratio
for the quarter, did you exclude that or how did you -- how
did you handle that?
Male Speaker: Yeah. The actual to expected for the quarter, Jeff was done
excluding the ERC block. The ERC block is assumed to come in
about on plan. We haven't gotten that block completely rolled
into our mortality studies yet.
Male Speaker: However, the difference in terms of the year to date result
versus our plan was about only less than a $100, 000.
Male Speaker: Okay. I am sorry, I missed -- I think I missed on of your
earlier numbers. On international did you give us an earnings
comparison?
Male Speaker: We did not give an earnings comparison.
Male Speaker: Well what's the 31 versus 38?
Male Speaker: That's premium.
Male Speaker: That's the premium, okay.
Male Speaker: Yeah and there is -- there is a lot of noise in that
number, quite frankly yeah we in -- the beginning of '04 moved
from a cash basis settlement accounting approach to an accrual
based accounting approaches. There is a lot of noise in that
number. The fundamental change once you exit all that noise is
that we did not renew at the beginning of the year, a couple
of treaties that were basically stinkers and the net result is
-- has been to improve our underwriting result in that
business and obviously that will flow through over the balance
of the year.
Male Speaker: Okay. So on an earnings basis, earnings are up or down?
Male Speaker: Earning, on an earnings basis year over year,
earnings are in the quarter after -- actually before taxes was
$4.9 million in that segment. Last year with the cash basis in
there were -- there were a few other items of noise. It was
$6.2 million. A portion of which is the result of a
nonrecurring gain on recapture of a treaty.
Male Speaker: Okay. And just to be clear on the, you -- you mentioned that
your -- you know you permitted a change of the indenture --
we understand that -- that something that you will
definitely do if -- if the -- if the proposal is enacted?
Male Speaker: It's certainly something that we have looked at and
makes a lot of sense to do obviously. Since we have all along
said we would settle we -- you know our intent was to settle
in cash. So as soon as the actual accounting guidance is
solidified then we will go back and make sure that there
haven't been any changes in the guidance and you know look at
making that change.
Second Quarter Earnings Call
Scottish Re Group Limited
August 5, 2004
11:00 a.m.
Host: Scott Willkomm
Page 10
Male Speaker: Okay. And on the HSBC facility it sounds like it's
basically a five year facility, a -- a little bit longer in
nature than a credit but still as long as -- as your
liabilities, that do you have internal work to put together
some alternative longer term capital structures as well.
Male Speaker: Yeah, as -- as you -- as you may know we have been
working on this for over a year now, this being you know long
term, low cost capital to secure the long dated ordinary life
liabilities. The HSBC facility is only one of three components
that we have been working on and it just happens to be the
first to get through the gates. So and the others are quite
actively in process as we speak right now.
Male Speaker: And -- and just lastly can you maybe just speak more
broadly to that issue, obviously people keep raising concern
sort of the industry level about you know the collateral
support for these transactions and how that's going to grow
over time, I think to some of us it seems like you know you --
you get a pretty obvious sort of a regulatory arbitrage
opportunity that is likely to be closed through some means.
Are -- are you optimistic that as -- you know as an industry,
this -- this problem is going to be solved?
Male Speaker: I think that there -- there are a couple of elements to that
question and maybe we can decompose it. Number one, I think
that from the primary company stands point it is the exception
rather than the rule that the -- the leadership of many
primary companies fully grasp the future potential liability
that will evolve as XXX related products age. It is probably
well understood within you know the primary companies
actuarial team, but hasn't accepting some limited cases made
it's way up to the top floor. I think slowly our people are
beginning to get a wake up call with respect to that future
liability. I think one of the things that people have thought
is that there would be a regulatory fix, which is always a
full stream in a regulated environment such as the life
insurance industry. It took long enough to get XXX and it's
going to take probably twice as long for people to for with
it. So even if you add reasonable lapse assumptions to
determine the future reserve, the number is still rather
substantial in terms of the strain associated with long
guaranteed, dated guaranteed products. So I think that's from
the consumer side if you will.
From the reinsurer side I think you have two schools of
thought, there is one school of thought that has been
populated principally by some of our larger composite company
brethren that this is a reserve that could be funded by
364-day letter of credit facilities. The problem is that I
think a lot of people haven't dimensional zed the amount of
future strain that they are likely to confront and have not
done you know a whole hell of a lot quite frankly to address
that. I think that people are starting to slowly wake up to
that. I think on the other side there have only been a few
structure transactions done, our as being one of a very short
list of structured transactions done to secure XXX related
strain. I do expect that we will see a couple more during the
course of the second half of the year of which I would expect
we will be in one of the names on that list, but I am not sure
it's going to be a very long list. I think it presents an
opportunity for reinsurer such as ourselves who have already
gone down the past, have gone through the regulatory approval
process, have gone through all of the actuarial validations of
the reserve development by third parties the whole monarchy to
be a provider of that type of capacity to people who are just
way behind the eighth ball. So I think -- and earn a margin on
it to boot. So I think that's the state of play at this point
in time it is a -- a solvable but a significant issue and not
enough people have looked to seek to solve it. I would refer
you, there is a very good article in this months SOA
reinsurance section newsletter that projects out the industry
XXX -- the primary industry XXX strain over the next 20 years
under a couple of different basis. And it was probably one of
the best articles on the topic to date. And hopefully those
types of communications will raise the visibility and -- and
this is a meaningful issue for people to content with.
Male Speaker: Thanks a lot Scott.
Second Quarter Earnings Call
Scottish Re Group Limited
August 5, 2004
11:00 a.m.
Host: Scott Willkomm
Page 11
Scott Willkomm: Yeah.
Operator: Our next from Andrew Kligerman with UBS.
Andrew Kligerman: Good morning. Couple of questions on the ERC
business. First, could you just give a little color on the
start to finish of when a claim is reported to a reinsurer?
How long does it taking and -- and maybe give a little color
on how it happen?
Scott Willkomm: Well, our typical experience and I can't speak to other
company's experience, but we typically get claims reporting
from companies every week. As you might imagine primary
companies are incented to report those claims because we
actually settle those claims within typically a week of
receiving notice. So you know from a cash flow perspective
ceding companies would be on top of that sort of thing. So
that's you know if you will one of the Scottish methods of
processing claim. So we process them with a very short period
of being notified. I think that you know, other companies may
have different methods depending upon where their
administrative centers are relative to where the business is
originated, you know, some companies process their business
you know, far away from where the core of their re-insurance
operations may be, so I don't know what that does to you know,
the processing time for other companies. So --.
Andrew Kligerman: Okay, so Scott, so you processed it in a week and I
guess this situation implies that ERC would have taken a lot
longer?
Scott Willkomm: I am not going to make any judgments about how long it would
take ERC to process a claim --
Andrew Kligerman: Okay.
Scott Willkomm: -- processing and paying claims on the net settlement basis is
a bit different and you know, so I think, we probably will
leave it at that.
Andrew Kligerman: Okay, fair enough. Then with regard to mortality as
a percent of pricing, you indicated that you are in line with
pricing. In previous quarters you were coming in at 98 to 99
percent of -- of pricing, what -- were you actually at a 100
percent this quarter X the effects of ERC?
Scott Willkomm: Well ERC was in line. That's what I meant by saying
in line. We said on the other you know, the historic Scottish
originated block, we were at about 98, I think, it's the
number that are reported.
Andrew Kligerman: You are at 98 percent pricing?
Scott Willkomm: Yes.
Andrew Kligerman: Okay.
Scott Willkomm: And we have been for -- if we state quarters we were able to
track back through the last eight quickly here. So --.
Andrew Kligerman: And so ERC was in line and -- and Scottish was -- was at 98
percent, okay --
Scott Willkomm: Right.
Second Quarter Earnings Call
Scottish Re Group Limited
August 5, 2004
11:00 a.m.
Host: Scott Willkomm
Page 12
Andrew Kligerman: -- and -- and you know, what -- what I did is a
calculation just for modelling purposes, we -- we take a look
at benefits as a percent of earned premiums and historically
you are coming at 70 to 71 and a half percent of -- of
premium, earned premium, this quarter you came out at 78 and a
half, if I subtract the 3 million pre-tax of ERC impact in
terms of backlog even from this quarter you still sum up more
than 74, should I be modeling now going forward for a -- you
know, a higher percent of earned premiums in terms of claims?
Scott Willkomm: First of all, there are a lot of things going on in
claims and benefits. They include other types of businesses,
you know, including change in --
Andrew Kligerman: Sure.
Scott Willkomm: -- UL and that sort of stuff. So, it's kind of hard
to look at it that way, and I think, you need to look at it on
a trailing 12 months basis, because that will eliminate some
seasonal patterns --
Andrew Kligerman: Yeah, we --
Scott Willkomm: -- and premium recognition.
Andrew Kligerman: Yeah we actually did that aiming at 74 percent
versus the 70 to 71 and a half. That's -- that's why I kind of
-- may be I will come back to that with you, but --.
Male Speaker: I mean, some of that Andrew could be change in reserves.
Andrew Kligerman: Okay.
Scott Willkomm: More than -- more than half of that is changed in reserves,
yeah.
Andrew Kligerman: Okay. And then with respect to the tax --
Scott Willkomm: On our -- on our -- Andrew -- you know, if you X out
two things, if the X out ERC and if you X out new production
you know, that was booked at the end of the quarter, because
that can tend to skew your numbers favorably. Our -- our claim
-- actual claim, which is claims pay plus your IBNR as a
percent of premium has been constant at about 34 percent,
quarter over quarter, year over year for the past two years.
Andrew Kligerman: Okay, great. And then with --
Scott Willkomm: Okay.
Q -- with respect to -- Scott, you had mentioned earlier that there was some
treaties that was non-renewed. You called them stinkers or
something, could you give us a little color on what that's you
know, just a little more color on what those were and you
know, why you weren't -- non-renewed them?
Scott Willkomm: Well, those were annual treaties for the most part
that had loss ratios that exceeded our loss ratio pricing
requirement for annual business. So, you know, as we have been
doing since we bought the world wide business, we have been
re-pricing everything to our own pricing basis, this was just
consistent with that effort, and as a result has crossed our
margins in that business you know, to -- to widen and -- so
it's basically cleaning up some of the noise, some of the
drags.
Second Quarter Earnings Call
Scottish Re Group Limited
August 5, 2004
11:00 a.m.
Host: Scott Willkomm
Page 13
Andrew Kligerman: And so the world -- the worldwide -- you have the
flexibility to cancel, but for domestic there are more longer
terms, is that right?
Scott Willkomm: Well it's -- principally annual business --
Andrew Kligerman: In the worldwide.
Scott Willkomm: -- in the international that needs to be renewed and
re-priced on an annual basis. So we have always had that type
of flexibility in the US business, in the traditional
mortality business, it is a longer-term business, so you are
pricing that over the long-term result of that particular
transaction.
Andrew Kligerman: Okay.
Male Speaker: And we have no particular issues with any of the treatise in
-- in the North American business?
Andrew Kligerman: Right, and then -- then just the last question.
Taxes, you had a $2 million benefit in the quarter. Your
historic guidance I think, or at least quarter indicated a
three to five percent tax rate, what -- what should we be
thinking about going forward more benefits or -- or the three
to five or -- or --.
Scott Willkomm: It's --it's -- the three to five continues to be
appropriate Andrew, because taxes are not a quarterly item,
they are an annual item --
Andrew Kligerman: Got you.
Scott Willkomm: -- when you get, write down to it on the actual effective rate
so --
Andrew Kligerman: Right.
Scott Willkomm: -- the fact that something jumps you know, a little bit one
quarter to the next, yeah, I think the annual guidance we gave
is appropriate.
Andrew Kligerman: Great. Thanks a lot.
Operator: Our next question comes from Michael McNulty with Context
Capital.
Michael McNulty: Hi, I just wanted to clarify on the bond, the
convertible bonds issue. I think, the previous caller had said
something about having to go back and change something in the
indenture if -- if I remember correctly from -- from my past
read of the indenture, the company has the option to settle in
cash and or stock whether -- and you don't have to go back to
the indenture to do anything, you just have to tell the people
what you are doing within so many days of -- of settlement.
Can you kind of just flush out -- is there something else in
the indentures that are missing that you can go back and
modify?
Female Speaker: No, you are quite right. The indenture does say that
under current accounting guidance, just by stating that it's
our intention to settling cash means that we can use the
treasury stock method of accounting. The proposed change in
the accounting guidance, would not allow just that statement
of intention to submit that treasury stock method. So, in the
event that those guidance is changed as proposed and we wanted
to continue with the treasury stock method, we would have to
go back and change the indenture to eliminate our option --
our option to settle the par value in stock.
Second Quarter Earnings Call
Scottish Re Group Limited
August 5, 2004
11:00 a.m.
Host: Scott Willkomm
Page 14
Michael McNulty: Okay, so you would have to then go back to the
indenture and say that tentatively that you have decided to
settle it in cash --
Scott Willkomm: Right.
Michael McNulty: -- to continue to get the treasury method.
Scott Willkomm: We would effectively give up that right to settle in stock.
Michael McNulty: You would give that up, okay.
Scott Willkomm: Correct.
Michael McNulty: But, when -- when do you have to make that election?
Scott Willkomm: We can do it whenever we want.
Michael McNulty: Okay, but if --.
Scott Willkomm: It's our option, and our choice.
Michael McNulty: It's not like you have to go undo a big solicitation on that.
Scott Willkomm: That's why I said it's our option.
Michael McNulty: Okay; now I just wanted to make sure -- I wanted to
make sure. Okay, now -- now the other thing is from -- from
the -- I don't know the official terminology, but I know, when
you talked about the regulation XXX, there's been some
articles about not having enough letter of credit backing
either direct or indirect. And I know you addressed part of
this, with the previous caller, does it sound like though if
you look out in a couple of years that even with you being
able to do some of these specialty products with the HSBC's of
the world that the company will continue to need more capital
or equity oriented capital, and I just was wondering if you
can kind of talk to your needs for equity capital looking out,
let's say in the next couple of years, if you don't mind
please.
Scott Willkomm: Sure. And this is consistent with what we have said over the
past two years in fact, Michael. I think, you know, with
respect to funding XXX reserves, nobody in his right mind
would want to do that for any extended period of time, because
the relevant cost of capital just makes no sense. There is no
return on that capital, that's you know, meaningful to the
equity holder. So, and it's -- it's basically not efficient.
So, it is not our objective or intent or desire to find that
type of reserve with equity. Accordingly we have used other
types of funding instruments, the HSBC is a new one, we have
had some others which are I think less sophisticated and
perhaps slightly higher cost than the transaction that we have
just put in place but nevertheless funding with equity really
is not the way you want to go, the driver of our need for
equity as the company may grow down the road is principally
economic capital, risk based capital if you will underlying
the overall book of business, the overall balance sheet of the
company.
As we have said in the past, we did not expect that we would
need to go back to the equity markets in 2004 unless there was
perhaps a material corporate event, which obviously would be
something that everybody would know about. And at this point
in time we have no plans to go back to the equity market over
the next few quarters into 2005. However, we have in the past
said, we are going to be updating all of our capital models
for the next three years, over the next few months, has in the
past
Second Quarter Earnings Call
Scottish Re Group Limited
August 5, 2004
11:00 a.m.
Host: Scott Willkomm
Page 15
said we may need to add equity to the balance sheet based upon
the growth of the business and the mix of business growth
sometime in 2005, but I think it's pretty matured to say that
right now because there are number of other things that have
taken place in the life of the company that will influence
that timing perhaps, but we don't expect anything is going to
happen this year.
Michael McNulty: Yeah with the bonds, just on a related topic. With
the bonds probably being settled in cash now, I guess you have
to then look for -- in the bonds (indiscernible) 2006 --.
Scott Willkomm: Yeah you got about two and a quarter years.
Michael McNulty: Okay so you would --.
Scott Willkomm: The first call date.
Michael McNulty: Okay, so that would be, I guess part of your analysis,
you know going forward.
Scott Willkomm: It had always been since when we issued them the intent was to
settle in cash from the get-go.
Michael McNulty: Okay.
Scott Willkomm: That has already been based into our thinking.
Michael McNulty: Okay so you have to do another capital market
transaction either another converter or stock or something to
go with that.
Scott Willkomm: I, well actually straight that is more appealing
quite frankly, potentially, so -- but we will have to see if
that point in time, what our capital and liquidity position
would be because we may have more flexibility at that point in
time than may be evident today.
Michael McNulty: Okay great, thanks a lot.
Scott Willkomm: Yes.
Operator: Again if you have a question at this time please press the '1'
key on your touch-tone telephone. Our next question comes from
Mr. Jeff Hopson with AG Edwards.
Jeff Hopson: Hi, Scott you mentioned the capacity issue in
international markets, curious if you are talking more about
some of the traditional specialty areas you have been in or
you are going to be expanding in the traditional reinsurance
area and what markets you know you think could potentially be
new for you down the road?
Scott Willkomm: The principle new market Jeff that we have been working on now
for about 18 months time is the UK and Ireland, which are very
similar to our own US domestic markets. I think with respect
to scarcity, it's pretty much across the board except in the
assets related business such as annuity type transactions.
There seems to be some interest in asset gathering among
various composite companies for example, but in terms of you
know traditional types of mortality risk products, be they
long term or short term products, it's getting a lot tighter
in terms of capacity and is probably you know going to be as
acute a situation as we currently experience in the United
States.
Jeff Hopson: Okay, if I could follow up, in terms of your specialty
business can you give us an update on that business and how
you see that playing out over time on the international side?
Second Quarter Earnings Call
Scottish Re Group Limited
August 5, 2004
11:00 a.m.
Host: Scott Willkomm
Page 16
Scott Willkomm: Well, that business which is -- going to be a short-term
typically annual business, is still a very good business. We
have gone through and we priced virtually every thing that we
have over the past two years time to our basis as opposed to
the historic basis and accordingly has been benefiting from
lighter margins, in a business that already spots wide margin,
so we expect that will continue to contribute. It will grow
modestly; the reason I say modestly is on a relative basis.
It's a -- it's a small business be it in terms of premium or
volumes. So -- but it continues to be a very attractive
business and we expect it will continue to grow over you know,
the foreseeable near future.
Jeff Hopson: All right thank you.
Operator: Our next question comes from Mr. Leo Harmon with Fiduciary
Management.
Leo Harmon: Hi good morning.
Scott Willkomm: Good morning.
Leo Harmon: I was wondering if you guys could clarify a couple of
issues on, number one on the -- on the -- on the claim side.
You all said a claim generally run about 34 percent implanted
IBNR would be higher than normal in this current quarter you
may give in the seasonality is there something that we should
be looking for from a -- from a mixed basis is causing that as
that of a perspective change is that it -- or is that a change
from prior years that's causing that IBNR to be a little
higher than normal.
Scott Willkomm: We actual Leo, there may have been some confusion; we never
said the IBNR was higher than normal. The comment was, if you
look at our core mortality block the -- the claims -- the
premium rates your claims being the sum of you know, claims
paving cash out of the door to the receiving -- to the
receiving company plus IBNR which is the incurred but not
reported claims expectation. So the sum of the two divided by
premiums earned in the period is consistent with -- prior
quarters consistent with the year ago it's pretty steady is
what the point is. So I apologize if we caused some confusion
by throwing in a few numbers there that -- you know, sort of
may have you know, -- you know, confuse the message a little
bit.
Leo Harmon: Okay. Secondly could you talk about the credit
facility and how that affects you know, your ability to ride
business. Does it increase your capacity or does it change RBC
levels in any way shape or form? I am trying to get a better
idea of drilling down how it actually improves ROE going
forward.
Scott Willkomm: It -- it's inexpensive collateral and gives us added capacity
to fund the reserve strain related to our term business. So
you know, the -- you -- you typically would pay for
comfortable collateral facilities in the past you used to pay
anywhere from depending upon the -- the sides -- the company
and the like you could pay anything ranging from a 100 to 200
basis points and this is meaningfully less than what we paid
in the past. So that would obviously improve the margins also
in general the capacity would be improved. Hence finally we
price in a cost in excess of what the facility cost. So we
price into our premiums that are paid by our customers in
margin on top of that. So all three of those will serve to
contribute to the ROE enhancement.
Leo Harmon: Okay, and what was pricing in the quarter, year over
year and then talk a little bit about the perspective price in
environment if you could?
Male Speaker: In the -- in the pricing environment as -- as we had
mentioned in the previous few quarters as has then they are
tightening up or are we been probably over the last 12
quarters -- not 12 quarters -- 12 months -- 12 to 18 months.
We have been building in slightly higher margins in our
pricing.
Second Quarter Earnings Call
Scottish Re Group Limited
August 5, 2004
11:00 a.m.
Host: Scott Willkomm
Page 17
Scott Willkomm: If you -- you know, look at the underwriting results
for the six months of this year versus six months of last year
in our core US block. The margins has widened principally
driven by the effect that Chris has just talked about since
all of the other key performance measures are relatively
stable.
Leo Harmon: And -- and again when you -- yeah this is long term
business so pricing at higher margins means that we will you
know, that -- that -- these margins will come true you know,
over the future of this business, so just because we have been
pricing it in for the past year or so it doesn't mean it's
fully getting through into our actual results here.
Male Speaker: Okay, thank you very much.
Scott Willkomm: Yes.
Operator: Our next question comes from Xiuping Li with Tenor Capital
Management.
Xiuping Li: Yes, thank you. The first question, can you -- Scott, can you
comment on your acquisition strategy going forward? Are you
looking to -- are you actively looking to acquire
(indiscernible) as you did with ERC? Especially in the short
term as you are still in the process of integrating the ERC
--?
Scott Willkomm: Our acquisition strategy is pretty straightforward. First of
all we will have integrated ERC in about two weeks' time, but
that's sort of irrespective of you know the general approach
to acquisitions. We are principally interested in acquisitions
that are done on a creative basis to return on equity and once
that can enhance the spread of risk that the company has in
its overall book of risk. So in other words high risk adjusted
return oriented transactions. And that is our principal area
of focus. We have very limited strategic interest in
acquisitions in general except perhaps in certain markets
where we have a modest presence and the acquisition could be
complementary to our existing business. I think the general
comment about acquisition in the market that we find ourselves
in today, is that this is principally a buyers market and
accordingly is -- you know the opportunities that may come to
pass are those which are very high risk adjusted return
thresholds, so that's hopefully helpful with respect to our
approach to acquisition.
Xiuping Li: Okay that's helpful. But I also wonder if there is right
opportunities come along what do you think you are, how would
you kind of finance future acquisitions? You -- it's more
likely to use equity or issue of debt or a hybrid --?
Scott Willkomm: Depends on the size of the deal quite frankly. In some cases
we won't need you know small transaction we would probably
wouldn't need to do anything. Larger transactions, we would
want to conservatively finance the transaction and depending
upon what the relevant capital ratios are underlying that
business. It could be any of the above or a combination of the
above. I think in any such case, any potential acquisition
that we would make that would require third party financing,
obviously needs to be done on a basis that is accretive to the
value that is in the company today. However, you care to
measure it, otherwise I'm not really so certain it makes the
whole lot of sense.
Xiuping Li: Okay, last question is related to the HSBC credit facility you
disclosed, is that -- would that be on your balance sheet?
Scott Willkomm: Yes, it is an on balance sheet transaction. It appears on the
asset side in -- in fixed maturity investments and on the
liability side in interest sensitive liabilities.
Second Quarter Earnings Call
Scottish Re Group Limited
August 5, 2004
11:00 a.m.
Host: Scott Willkomm
Page 18
Xiuping Li: Okay but in terms of your liability, is that only limited to
the premiums that you put in the facility? Or in other words
it's the -- is the liability recourse to Scottish
(indiscernible)?
Scott Willkomm: It's partially recourse to Scottish (indiscernible) it's not
-- it's not a it's not an off balance sheet no re-course
facility. There is partial re-course to (indiscernible).
Xiuping Li: So you have certain thresholds like if the mortality rate is
'x' percent you need to --?
Scott Willkomm: No -- no, this is this excess reserves that we are funding.
Xiuping Li: Uh-huh.
Scott Willkomm: These are excess SSS x redundant reserves which for
statutory purposes you have to fund and you know -- but for
purposes of loss, there --there is no scenario in which there
is an expected loss on the collateral that this facility
provides us. That 's what XXX is basically, is redundant
reserves that everybody in the professional community view as
redundant and yet because it's the law you got to do it.
Xiuping Li: Okay, and can you just give a rough estimate, because you
mentioned you are looking to do more of this type of
financing. Can you just give a sense of what kind of the
ultimate size that you are? You think it's likely to occur?
Scott Willkomm: Well -- the difference facilities are different things, there
are some facilities that are non-recourse facilities and we
are working on one of those as we speak. And that would quiet
frankly be sized to the block of business that goes in it. So
it could be, you know -- you know depending upon how much
business we put in it -- it could vary in size across a wide
range. And so you know, at the end of the day -- you know, we
want to fund all of our redundant reserves with the lowest
cost form of capital available to us, and these facilities
permit us to do that. And thus further enhancing the ROE
progression in the margins, in the business overall.
Xiuping Li: But what the total kind of -- size that you can do -- for this
type of credit facility?
Scott Willkomm: Well, it depends on the size of the block of
business that support it, it could range from depending up on
how much business you are putting into it, $500 plus million
perhaps. So it really is specific to the underlying asset.
Xiuping Li: Okay thank you.
Scott Willkomm: Yeah.
Operator: Our next question comes from John Hall with the Prudential
Group.
John Hall: Yeah, just real quickly Scott, I've got two things. One,
I was wondering if you could -- on the claims that came from
ERC, were those a lot of small claims or was it -- just the
few big claims?
Scott Willkomm: No, it's a ton of small ones.
John Hall: Okay, and you --.
Scott Willkomm: It was ten boxes of them --.
Second Quarter Earnings Call
Scottish Re Group Limited
August 5, 2004
11:00 a.m.
Host: Scott Willkomm
Page 19
John Hall: -- boxes of them -- crates of them. And you mentioned
interest rates having a positive impact on -- on the business,
I was wondering if you just could offer a sort of a rule of
thumb sensitivity rates up equals what in terms of earnings?
Scott Willkomm: We -- last quarter in it and it really hasn't changed
appreciably this quarter. Last quarter we thought that on the
in-force block over the next two years the -- the rise in
interest rates wouldn't really do any thing negative to our
book of business. In terms of the new business that's coming
on in the re investment of the portfolio it's probably going
to be at least a few cents per share over the next eighteen
months. Part of that quiet honestly depends up on whether --
whether some seeding companies get motivated to do something,
the deal we close in the quarter with a deal we had quoted on
last summer and at the time the company was not particularly
inclined to pursue it. They came back to us about three to
four-ish months to go and asked us to, you know, reopen the
dialog. We have heard from a couple of other folks who were in
that position where were having those types of dialogue, so it
is -- will be principally driven by that new business
production over the course of the next twelve eighteen months
time. So could be -- could be more meaning full but probably
it is not is, you know conservative of us to -- to sort of
hold out that number out far into the future.
John Hall: Fair enough, thank you sir.
Scott Willkomm: Yeah.
Operator: I am showing no further questions at this time.
Scott Willkomm: Okay, well operator thank you and thank you every
one for joining us and we will look forward to speaking to you
over the course of the next few months, thank you.
Operator: Ladies and gentle men thank you for participating in today's
conference. This concludes the program. You may all disconnect
and everyone have a great day.