SCOTTISH RE
Moderator: Michael French
11-04-04/10:00 am CT
Confirmation #1298568
Page 1
SCOTTISH RE
Moderator: Michael French
November 4, 2004
10:00 am CT
Operator: Good morning, my name is (Mary Ann). And, I will be your
conference facilitator. At this time, I would like to
welcome everyone to the Scottish Re Group Limited Third
Quarter Earnings Release Conference Call.
All lines have been placed on mute to prevent any background
noise. After the speaker's remarks, there will be a question
and answer period. If you would like to ask a question
during this time, simply press star then the number one on
your telephone keypad.
If you would like to withdraw your question, press star then
the number two on your telephone keypad. Thank you. I would
now like to turn the conference over to 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. Welcome to
the Scottish Re Group third quarter conference call. We'll
begin the call with comments about the company's financial
results and give an overview of the development of the
company's business.
SCOTTISH RE
Moderator: Michael French
11-04-04/10:00 am CT
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And, after concluding our prepared remarks, we'll take your
questions. There will be a recording of this call available
after 1:00 today running through November 18 and
instructions on how to access that are included in today's
earnings release.
Also, a replay of the call can be accessed on our web site,
scottishre.com. 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 actual results could differ
materially 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 our operations for the quarter.
Scott.
Scott Willkomm: Good morning, everyone. Scottish Re reported this morning
that income from continuing operations for the quarter ended
September 30, 2004 was $12.8 million or 34 cents per diluted
share as compared to $1.8 million or 5 cents per diluted
share for the prior year period.
Income from continuing operations for the nine months ended
September 30 was $50.5 million or $1.35 per diluted share
compared with $18.5 million or 60 cents per diluted share
for the year ago period.
Net operating earnings were $20 million or 54 cents per
diluted share for the quarter ended September as compared to
$800,000 or 2 cents per diluted share for the prior year
period.
SCOTTISH RE
Moderator: Michael French
11-04-04/10:00 am CT
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Net operating earnings were $53.7 million or $1.44 per
diluted share for the nine months ended September 30 as
compared to $22.7 million or 74 cents per diluted share for
the prior year period.
As you know, net operating earnings is a non-GAAP
measurement. We determined net operating earnings by
adjusting GAAP income from continuing operations, by net
realized capital gains and losses, and the change in value
of embedded derivatives, as adjusted for the related affects
upon the amortization of deferred acquisition costs 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 results 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 U.S. GAAP. Net income for the quarter amounted to $12.8
million or 34 cents per diluted share, as compared to $1.6
million or 5 cents per diluted share for the prior year
period.
For the nine months, net income amounted to $50.5 million or
$1.35 per share as compared to $16.7 million or 55 cents per
diluted share for the year ago period. Total revenue for the
quarter increased to $198.1 million from $134.6 million for
the prior year period which represents an increase of 47%.
For the nine months, total revenue increased to $606 million
from $360 million for the prior year period which is a 68%
increase. Total benefits and
SCOTTISH RE
Moderator: Michael French
11-04-04/10:00 am CT
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expenses increased to $189.5 million for the quarter from
$140.9 million which is a 34% increase.
And, for the nine months ended September 30, total benefits
and expenses increased to $560.8 million from $350.4 million
which is an increase of 60%. The increases in both the total
revenue and total benefit and expense were principally drive
by the acquisition of Scottish Re Life Corporation which was
previously called ERC Life and growth in the company's
re-insurance business in North American, as well as, growth
in its investment income due to the increase of its invested
asset base.
ERC Life added approximately $30 million of premium this
quarter and $108 million in the year to date period. ERC
Life is currently performing in line with our initial budget
for the quarter, as well as, for the nine months.
The company's total assets were $6.9 billion as of September
30, 2004. Our core investment portfolio which includes cash
and cash equivalents but not including funds with held in
interest totaled $3.1 billion at an average quality rating
of double A minus and effective duration of 3.3 years and a
weighted average book yield of 4.3%.
This compares with a portfolio balance of $2.4 billion,
average quality rating of Double A minus, effective duration
of 3.9 years, and an average book yield of 4.5% as of
December 31, 2003.
Funds with held in interest amounted to $1.5 billion, had an
average quality rating of A minus, and an effective duration
of 4.8 years and a weighted average book yield of 6.2% as of
September 30, 2004.
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11-04-04/10:00 am CT
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This compares with an average quality rating of A minus and
effective duration of 5.1 years and an average book yield of
6.3% as of December 31, 2003. The market value of the funds
with held at interest amounted to $1.5 billion as of
September 30.
Investment losses which are presented before taxes but
include the amortization of deferred acquisition costs
totaled $3.4 million in the quarter and $3.7 million since
the beginning of the year.
Losses for the quarter and year to date include $2.2 million
arising from the mark to market of an interest rate swap. We
entered into this swap to mitigate the impact of rising rate
on certain of our assets not supporting re-insurance
liabilities.
This interest rate swap has not been designated as a hedge
and accordingly, the mark to market runs through the income
statement. The quarter and the year to date impairment
losses amounted to $1.2 million and $3.2 million,
respectively.
During 2003, we adopted (Digby) 36 which requires us to
account for our modified co-insurance contracts on a fair
value basis. The change in fair value of the derivative for
the quarter amounted to a loss of $5.5 million net of
related amortization of deferred acquisition costs.
The gain for the year to date period amounts to $456,000.
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 arisen
principally because of the decrease in rates.
SCOTTISH RE
Moderator: Michael French
11-04-04/10:00 am CT
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Going forward, we would generally expect to experience a
gain as rates rise and the losses they fall. On a longer
term basis, the value of the embedded derivative will trend
towards zero.
As discussed earlier, changes in this value are excluded
from operating earnings and do not impact the economics of
these contracts. Our book value per share as of September 30
amounted to $20.08 compared to $18.73 as of the beginning of
the year.
Excluding the impact of FASB 115, book value per share
amounted to $19.68 per share in comparison with $18.51 per
share as of December 31, 2003. I'd like to take a moment to
give you a brief overview of the progress we're making in
our business and some guidance as to how we measure that
progress.
We'll start with our traditional solutions business in which
we provide mortality risk transfer capacity for the top life
insurance companies in North America.
As of September 30, 2004, the company had approximately $307
billion of life re-insurance in force covering approximately
7.5 million lives with an average benefit per life of
$41,000.
As of December 31, 2003, the company had approximately $275
billion of life re-insurance in force in its North American
segment covering 6.2 million live with an average benefit
per life of $43,000.
During the quarter, we originated approximately $16 billion
of new traditional life re-insurance from existing and new
clients. On a year to date basis, we originated
approximately $43 billion.
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Our production goal for this year in the traditional
solutions business has been to originate between $65 and $70
billion of new business. And, we're well on our way to
meeting this goal.
Mortality experience continues to be favorable as well with
actual experience in the third quarter of the year running
slightly below expected levels. Since inception of the
traditional solutions business line, mortality is
approximately 95% of expected levels on a cumulative basis.
We anticipate our mortality to continue to remain
approximately around 100% of expected levels and we see no
adverse trends emerging. And, as previously stated, the
projections we use to develop our plan and long range
forecasts are based on 100% of expected mortality.
Also, during the quarter in connection with some of our
efforts to secure ties, our regulation Triple X reserves, we
performed a (Seriadam) Mortality Study that was validated by
a leading independent actuarial consulting firm and supports
the information that we've presented.
In our financial solutions business, we measure progress by
measuring the GAAP reserves that we hold on our balance
sheet. Reserves for the financial solutions business
increased modestly to $3.3 billion as of the end of the
quarter compared to $2.9 billion as of the beginning of the
year.
As we have said in the past, we've been very selective in
re-insuring additional fixed annuity business due to the
current interest rate environment in what we perceive to be
non-economic pricing decisions that prevail in the primary
market.
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11-04-04/10:00 am CT
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On a same store basis, spreads on the fixed annuity
portfolio remains unchanged at about 165 basis points from
the prior quarter but increased by 11 basis points from the
third quarter of 2003.
Relative to last quarter, a three basis point decrease in
average investment yield was offset by a three basis point
decrease in the average crediting rate. In relation to the
third quarter of 2003, yields dropped 15 basis points while
the average crediting rate dropped by 27 basis points.
Over both periods, the decline in yields rose mainly from
the employment of new money yields lower than the average in
force yield on the related portfolios. Most of our three and
five year guaranteed products have scheduled increases of 15
or 25 basis points at each policy anniversary.
On annual reset products, however, our clients have been
taking advantage of low new money rates to reduce crediting
rates on annual renewals. In our international business,
premiums in the quarter were approximately $29.5 million
which is a slight decline from the $30.2 million that we
reported for the quarter, third quarter of last year.
This year over year comparison is due to, first of all,
changing from a cash basis of accounting for premiums
earnings which makes the comparison somewhat difficult.
And, two, our decision not to renew several under performing
treaties. The net result is to improve the margins of our
international book going forward. We expect the
international business will continue to grow and support
significantly wider margins than our North American
business.
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11-04-04/10:00 am CT
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And, in addition, the non-U.S. markets are experiencing many
of the capacity constraints that we see in North America
which presents in our opinion both significant growth
opportunities, as well as, improving pricing conditions.
As you all may know, on October 18, we announced that we had
agreed to acquire the U.S. individual life re-insurance
business of ING Re. We will re-insure the liabilities of all
of ING Re's individual life business through a co-insurance
transaction.
ING Re will transfer to us assets equal to reserves of
approximately $800 million and will pay us a seating
commission of $560 million. These assets will be held in
trust to secure the reserve obligations of the business that
we're assuming.
In addition, ING Re will transfer certain operating assets
associated with the business that are principally computing
systems. Following the acquisition, Scottish Re will have
approximately $1 trillion of life re-insurance in force;
$8.8 billion in total assets; approximately $2.1 billion in
revenue; and a capital base of approximately $1.3 billion.
Scottish Re and ING Re have complimentary broadly
diversified books of traditional mortality business with
minimal overlap. This transformational transaction will
allow Scottish Re to further increase its new business
production while also giving Scottish Re the opportunity to
further enhance its operational infrastructure and achieve
economies of scale.
In addition to the assets to be transferred by ING Re, we
will raise an additional $230 million of capital to satisfy
the capital requirements to support the acquired business.
This new capital includes $180 million to be provided
SCOTTISH RE
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11-04-04/10:00 am CT
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by The Cypress Group which is a private equity firm and
approximately $50 million of additional trust preferred
securities.
Scottish Re, Cypress, and advisors which included Accenture,
Bear Stearns, Ernst & Young, Merrill Lynch, and Tillinghast
performed extensive due diligence on the acquired business.
We arrived at our valuation through extensive actuarial and
economic analysis and by effectively re-pricing the business
to meet our group's return hurtles. Let's talk about the
integration of ERC Life which we have recently completed the
transfer of the ERC Life business to the Scottish Re
platform.
Since the closing of the transaction on December 22 of last
year, several enhancements to our organizations
infrastructure has been made to better manage this acquired
block of business.
These enhancements included an updated claims database,
account management system, mapping of electronic and paper
data fees, and an actuarial system to handle the individual
session business.
For the quarter and the nine months, as we mentioned, the
ERC block of business has been performing consistent with
our pricing expectations. Let's return in some respect to
our attention to the subject of (Cokehauser), contingent
convertible debt instruments.
During the quarter ended September 30, 2004, EITF04-8 the
effect of continually convertible debt on diluted earnings
per share was issued by the FASB. EITF04-8 requires that
instruments with embedded conversion features that are
contingent upon market price triggers be included in diluted
SCOTTISH RE
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11-04-04/10:00 am CT
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earnings per share calculations regardless of whether the
contingency has been met.
Scottish Re's 4.5% senior convertible notes are convertible
on the basis of a market price trigger. On October 26, 2004,
we amended the terms of these notes so that we are required
to settle the principal amount of $115 million in cash.
As a result, we shall continue to apply the treasury stock
method in calculating diluted earnings per share for amount
in excess of the principal of $115 million.
We're pleased to announce as well that our board of
directors has named Jean-Claude Damerval as the Director of
Scottish Re Group Limited. Jean-Claude will be taking the
board seat vacated by (Contron) who stepped down during our
- following our last board meeting.
Throughout his career, Mr. Damerval has been actively
involved in supporting corporate finance operations within
the insurance industry including mergers and acquisitions to
mutualizations, joint ventures, strategic alliances, and
capital restructurings.
Mr. Damerval brings with him a proven track record in
complex negotiations which occurred all around the world.
We're delighted that Mr. Damerval has agreed to serve as a
Director of Scottish Re. And, we look forward to benefiting
from his more than 30 years of experience in the finance and
insurance industries.
Mr. Damerval is experienced in the industry and included
leadership roles in many international transactions and
organizations. From October 1994 to
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Moderator: Michael French
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March 2003, Mr. Damerval represented the interests of
Artemis in connection with it's investment in management
over sight of Aurora National Life as both a director and
executive committee member.
Between July 1997 and late 1999, Mr. Damerval served an
active role in projects associated with Price Waterhouse
Coopers in the UK, France, and Japan.
Mr. Damerval's significant role in the insurance industry on
an international scale has also included leading the
national mutual negotiations in Australia on behalf of AXA
from September 1994 to October 1995, as well as, being the
lead executive in charge of the acquisition and sponsored to
mutualization of the equitable.
Over the course of his career, Mr. Damerval had served on
the board of directors with a number of prominent insurance
companies including AXA, (Occidalitalia), Artermis,
(unintelligible) Life, CX Re, and IMA, Italy's foremost
composite insurer. We welcome Mr. Damerval to our board.
Now, let us turn our attention to earnings guidance for the
balance of 2004 and then we'll turn to preliminary earnings
guidance for 2005. Our efforts to further build 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 in organization, growth and operating
earnings per share; growth in book value per share; and
increasing returns on equity.
And, our expectations for 2004 and the balance of the year
are consistent with those objectives. Let's discuss by
reviewing our revenue expectations. We have used 2003 total
revenues of $557 million as a point of reference.
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And, we would expect that Scottish Re's total revenues for
the year ended 2004 would grow approximately 50 to 60% over
that number to between $835 million to $890 million and
driving the revenue increases the growth in earned premiums
of approximately 54 to 56% over 2003's value and the growth
in investment income of 55% over 2003's number as well.
And, we expect that earned premiums will represent
approximately 69 to 70% of total revenue with approximately
29 to 30% represented by investment income. On a year to
date basis, premium earned was about $440 million, a 73% of
our expectations for the year.
In addition, year to date total revenue was $606 million or
70% of our expectations for the year. Thus, one takes into
account the seasonal pattern of premium flows that happen to
be skewed towards the second half and particularly the
fourth quarter of the year; you can see why we remain
confident that our revenue expectations are achievable.
Using Moody's Credit Default models, we expect that our bond
portfolio will produce realized losses totaling
approximately $7 to $10 million in 2004 based on the
portfolio's size and weighted average Moody's Default Score.
While we have only reported net realized losses on a year to
date basis of $3.7 million, we have not changed our specific
guidance with respect to this number. Finally, we expect to
report fee income of approximately $10 to $15 million for
the year with $8.7 million of fee income reported year to
date that expectation remains reasonable.
Of the revenue, we expect to report in 2004 approximately
60% will be driven by our North American mortality risk
transfer business; 20% from our North
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American Financial Solutions business; and approximately 20%
from our international solutions business.
And, we expect that our North American traditional business
will originate approximately $65 to $70 billion of new
business which represents an increase of 18 to 27% over
2003's level.
And, to that - and to date, we have originated approximately
$43 billion of new mortality risk business which is
approximately 61% of our objective for 2004. However, keep
in mind, we're not motivated by market share objectives and
merely use such as a simple yardstick.
We're focused on writing well priced business that meets or
exceeds our risk adjusted return objectives and builds long
term value in the companies. In terms of operating expenses,
we continue to leverage our group infrastructure and our
efficient business model.
So, it should come as not surprise that our operating
expense of total revenue ratio continues to decline as the
company grows. For 2004, we would expect that ratio to
decline to a range of 5.3 to 5.5%.
For the last 12 months, which is a measure we use to correct
for seasonality and revenue and expense patterns, the
affects to revenue ratio was 5.5%. Affects in the third
quarter was a bit higher than expected due to additional
professional fees and costs related to the implementation of
Sarbanes Oxley Section 404.
That incremental cost adversely impacted net operating
earnings per share by approximately 2 to 3 cents. Estimated
Sarbanes Oxley implementations costs is difficult to say the
least. But, it's appropriate to expect that we may see our
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affects adversely impacted in the fourth quarter to the tune
of 3 to 4 cents as we come to the end stages of this
implementation project.
Favorable results elsewhere in our business may offset that
impact but it's important for shareholders to know that
implementation costs are running higher than expected.
Finally, the resulting operating earnings per share range
that we would expect to report for the year continues to be
at $2.10 to $2.30 per share range. And, while earnings in a
calendar year are somewhat seasonal, as the company has
grown, that ramp up is becoming somewhat less pronounced,
although, that has been somewhat aggravated by the seasonal
patterns of ERC's premiums as they come online.
And, on a quarterly basis, our 2003 operating EPS ramp up
should see 28 to 30% of earnings appear in quarter four.
Now, let's turn ourself to preliminary guidance for 2005.
This guidance includes the affect of our pending acquisition
of the individual life re-insurance business of ING Re that
is expected to close by the end of the year. As we mentioned
on our conference call announcing the acquisition, we will
continue to update you regarding guidance periodically and
would expect to provide additional information shortly after
the closing of the transaction.
On the revenue front, we would expect to earn for the full
year of 2005, total revenue in the range of $2.1 to $2.3
billion driven by earned premium in the range of $1.9 to
$2.1 billion; investment income in the range of $275 to $350
million; and fee income in the range of $10 to $12 million
for the year.
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Operating expenses for the combined operations are expected
to be in the range of 4.9 to 5.2% of total revenue which
represents the further achievement of operating leverage in
our organization.
Finally, the resulting operating earnings per share that
we'd expect to report for year ended 2005 would be in the
range of $2.75 to $2.95 per share which represents an
increase of approximately 30% over 2004's guidance range of
$2.10 to $2.30.
That breaks down into approximately 20% derived from organic
operating EPS growth in the year plus approximately 10%
earnings accretion from the ING Re acquisition.
Finally, and perhaps most importantly, these earnings
expectations result in a return on average equity of 15% for
the full year ended 2005 which is one year earlier than our
long held objective which was originally 2006.
I'd like to conclude today's prepared remarks by saying that
all of us at Scottish are very excited by the prospects for
the remainder of 2004, for 2005, and beyond. And, thank you
for your continued support and interest in the company. And,
at this point, we will open up for questions. Operator.
Operator: At this time, I would like to remind everyone, if you would
like to ask a question, please press star then the number
one on your telephone keypad. We'll pause for just a moment
to compile the Q&A roster. We are continuing to pause to
queue the roster. One moment please. Your first question
comes from Al Kapra of Oppenheimer and Company.
Al Kapra: Good morning. What I was wondering is, given the amount of
consolidation we've seen in the life re-insurance based over
the past two years and, you
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know, with the ING Re deal coming up. Are you seeing any
changes in how the primary companies are reacting to the
market place? I mean, is it creating dislocations? And, if
so, you know, has that been beneficial or not for you?
Scott Willkomm: That's a very good question, Al. I think, that the
consolidation trend, I think, has been a very powerful trend
in terms of how it impacts both our business directly, as
well as, how it impact the decision making of our customer
or potential customer universe.
I think, that we've seen somewhere on the order of 35 to 40%
of the capacity that was available, you know, say in the
past two to three years get acquired by other parties. RGA
acquired Aviance. Swiss Re acquired Lincoln Re.
We acquired a portion of ERC and now ING Re. And, there have
been a number of transactions as well that have taken place.
And, the concentration of capacity has caused, first of all,
I think, people to reevaluate what the true cost of capital
is supporting the re-insurance business.
And, perhaps it could be suggested that there was some
capital and capacity in the market that was under priced
relative to what one would consider true cost of capital.
And, I think, that discipline is clearly changing the key
leading companies in the industry, I think, have a fairly
rigorous approach to allocating capital and costing that
capital.
That has, in many cases, caused some of the costs of
re-insurance to increase for seeding companies. Some seeding
companies, we know, have reduced the amount of reliance on
co-insurance and have put some of their business into an
excess model which was how business was predominantly
written 15 years ago.
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That hasn't particularly impacted the re-insurers because of
the great degree of concentration. But, I think, it is
causing direct companies to think about their relationship
with the re-insurer on an economic basis.
So, I think, it creates great opportunity for those of us
who are leading participants in the life re-insurance
market. And, that list is becoming shorter, you know, in
recent years certainly. But, I think, it's also creating a
discipline in terms of how risk is accepted and priced. Does
that answer your question?
Al Kapra: It does. Just one follow up, since we were talking about
cost of capital. Where is the industry at this point in
terms of coming up with a even longer term securitization
solution for some of the excess reserves tied to Triple X?
Scott Willkomm: Well, I think, speaking just somewhat anecdotally, I think,
that there are clearly efficient mechanisms or structures to
securitize the redundant reserve exposure generated by
regulation Triple X.
I anecdotally believe that there are a number of
transactions that are being worked on as we speak by
re-insurers and by some of the large direct writers. And, I
would expect that we will see a hand full of these before
the end of the year and into the first quarter.
Keeping in mind, however, that the gross exposure to
regulation Triple X over the next 10 years is quite dramatic
relative to where it is today. So, I think, that re-insurers
in particular are well suited to provide securitization
capacity, if you will, to direct companies.
Because, we have a more diversified spread of risk across
multiple companies, many, many companies which makes for
volatility the performance of the block generally, you know,
quite benign relative to an individual company's
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performance where they have exposure to systematic
underwriting risks and demographic risks and the like.
So, but I think, that a lot of people have talked about
securitization for a long time. I think that most of what
you heard in 2002/2003 was just that, talk. I think, that
the latter half of 2003 and certainly through 2004 and into
2005, I think, we're seeing a lot of traction and the
structures that are being developed and pursued by firms are
meeting regulatory and rating agency criteria, you know,
thoughtfully. So, I think, it's, you know, a long way from
getting to a mature structure and process. But, it's
certainly no longer just talk.
Al Kapra: That's helpful, thanks a lot.
Operator: Your next question comes from Jeff Schuman of KBW.
Jeff Schuman: Morning Scott.
Scott Willkomm: Morning.
Jeff Schuman: I was wondering if you could repeat one statistic that I
missed. What was the traditional solutions new business
production in the quarter?
Scott Willkomm: Sixteen.
Jeff Schuman: Sixteen okay. And, do you have a traditional solutions
production goal for 2005?
Scott Willkomm: Yes, we do Jeff. I didn't mention that quite frankly. We
would anticipate with the ING Re transaction writing on the
order of around $100 billion of new business.
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Jeff Schuman: About $100 billion. And, can you just give us a little bit
better understanding of kind of how you kind of market going
forward with the ING? In other words, when you assume
control of that company, are there - do you have the
discretion to re-price or re-negotiate some of the open
treaties?
And, are you going to do that? And, you know, how much of
their, I guess, sort of new business origination platform
are you taking on? Are you taking on kind of all their sales
and marketing people? Or, how is that going to work?
Scott Willkomm: Well, with respect to re-pricing existing or open treaties,
the answer is, you know, we don't, you know; sort of
stereotypically don't have the opportunity to re-price them.
That was built into the transaction and the pricing of the
block as a whole in the trade we're doing with ING if you
will. Restructuring or re-pricing those with individual
seeding companies is highly unlikely. So, that was built
into the pricing of the transaction.
Jeff Schuman: Okay.
Scott Willkomm: With respect to new business origination platform, you know,
we anticipate welcoming a number of the team from ING to the
Scottish team. Although, it is unfortunate but there are
redundancies in terms of how we cover the market as a
combined organization.
So, we will be taking on a rational element of the
origination team. But, inevitably we will not be able to
accommodate all of the people on the origination team.
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Jeff Schuman: And, I mean, looking at the increase of 70 as a production
issue to 100 next year. I mean, are you going to be able to
attempt any kind of new market segments? Or, is this really
just a penetration opportunity?
Scott Willkomm: Well, actually there's very little over lap between our book
of business sort of on a dollar weighted basis. I mean,
we're in some of the same accounts. But, the amount of or
the magnitude of the relationship that we have with some of
the companies is relatively modest relative to ING.
When you sort of do a side by side, you know, the ING group
has, you know, much greater breadth and depth, as you might
imagine, from the size of the book of business that they're
acquiring.
We're very familiar with these accounts. We have quoted on
these accounts. Haven't won all of the accounts but have
certainly a lot of experience with them. So, the nice thing
is there's - the books of business are quire complimentary.
So, incremental opportunities, I think, are going to be
pretty attractive.
Jeff Schuman: So, they're not really different markets. But, they've
penetrated a number of different accounts that you haven't
historically penetrated. Is that the right way to think
about it?
Scott Willkomm: Yes, I think, that's a good way to think about it.
Jeff Schuman: And, as we're thinking about the EPS guidance for next year,
can you talk a little bit about the quarterly ramps.
Obviously, there's some, I guess, there's some
(unintelligible) about the exact point at which you close
ING and obviously some kind of a trajectory in terms of kind
absorbing that.
SCOTTISH RE
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11-04-04/10:00 am CT
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Scott Willkomm: Right. The funny thing is I intentionally didn't give a
quarterly ramp. Because, we are - as we speak, you know,
working on, you know, mapping out all of the sort of monthly
and quarterly premium and claims patterns so that we can be
very confident in giving that guidance.
As you may recall, when we took over ERC, we had very good
annual data not very good granular, monthly, or quarterly
data. So, you know, I think, our objective is to and we have
certainly the time to do that over the ensuing couple of
months before we close.
We expect to close December 31, by the way. So, the impact
of ING's contribution to earnings will start effective the
first of the year. So, there won't be sort of a partial
period, if you will.
But, we'll be giving more guidance, Jeff, as we you know
further, you know, verify and validate the monthly and
quarterly premium patterns. So, I appreciate the question
and understand why you ask it.
Jeff Schuman: Okay, just directionally, would it be prudent at this point
for us to kind of back end load that a bit?
Scott Willkomm: It's always back end loaded. I think, the experience,
however, we had with ERC is that core to core tends to be
the big quarter. Quarter one is next. Quarter two is third.
And, actually quarter three tends to be the lightest
quarter.
A lot of it has to do when policy anniversary dates occur
depending upon the actual nature of the underlying policy.
So, I think, it's fair to say that it tends to be in the
industry a back end loading however.
SCOTTISH RE
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11-04-04/10:00 am CT
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So, I think, if you're contemplating taking a stab at that
ramp, I think, that's probably a fair approach. But, I would
just caution you that as we provide more guidance, we may
want to help sort of guide the relative ramp a little bit.
Jeff Schuman: Okay, that's helpful. Thanks a lot. You guys actually had a
nice quarter.
Scott Willkomm: Thank you.
Operator: Your next question comes from Jeff Hopson of AG Edwards.
Jeff Hopson: Hi, good morning.
Scott Willkomm: Good morning.
Jeff Hopson: A couple of questions here. We've heard about aggressive
placing in the primary markets for secondary guarantee
products. How are you approaching that type of environment?
And, then two, you might have said this, but the ERC block,
how did that perform in the quarter?
Scott Willkomm: Yes, to answer your second question first, Jeff. I did
mention, but ERC performed well in the quarter and on a year
to date basis. It's contributing to operating earnings what
we expect, so. It performed in line with what we had
advertised.
With respect to item one, we don't actively pursue
opportunities in the secondary guarantee space. And, don't
have, you know, any particular direct knowledge because we
intentionally do not write that business.
SCOTTISH RE
Moderator: Michael French
11-04-04/10:00 am CT
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Jeff Hopson: Okay. And, then on the ING acquisition, how does - you're
going to, I guess, maintain the Denver location. How will
different functions be divided, I guess, so that you get the
maximum amount of expense leverage?
Scott Willkomm: Yes. We anticipate that Denver will be an administration and
operation center for us. And, you know, we're going to
develop it accordingly and in fact we're going to be moving
one of our senior executives from Charlotte to Denver in the
early days post closing to provide, you know, on the ground
leadership in Denver.
So, we are initially going to run the ING book on its
existing administration platform. And, we will continue to
run the Scottish Re platform on its own administration
platform.
We have brought in to work with our transition team the guys
at Accenture to help us evaluate the unification of those
administration systems over a fairly short period of time up
close to closing, such that we will be able to further
achieve more expense leverage operating leverage, if you
will, in the operation.
All of our offices are connected by wide area network
facilities. So, to the extent we have administration/staff
in Charlotte and administration/staff in Denver, we don't
believe that there will be any redundancy in terms of costs.
We actually have a relatively modest size group in Charlotte
relative to the team in Denver. And, with the amount of
business that we're taking on, the amount of the - the size
of the book of business, the team in Denver actually will be
quite fully employed as it is.
SCOTTISH RE
Moderator: Michael French
11-04-04/10:00 am CT
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So, and as you think about, as we anticipate our general
production to be at levels greater as a result of the
transaction than they would have been had we just - had we
not done the transaction, we actually will get additional
unit cost leverage out of the operations side of the house.
Jeff Hopson: That's it, very good. Thank you.
Scott Willkomm: Thank you.
Operator: Your next question comes from Andrew Kligerman of UBS
Security.
Andrew Kligerman: Good morning, just a quick one and then I have a follow up.
With regards to your cash position, it seems to have dropped
by about $80 million in the quarter. Could you clarify why
that went down?
Scott Willkomm: Yes. I will do that. (Elizabeth) can you click on there?
We're in different locations, so.
Andrew Kligerman: Oh okay.
(Elizabeth): There's no particular reason for that. As you can see, the
investment portfolio has gone up. And, part of that cash
position does represent a short term investment within our
investment portfolio. So, it would just be additional
investment of cash within the investment portfolio.
Andrew Kligerman: Okay. And, then shifting over to - let's assume that, you
know, we're at December 31 and the ING Re transaction has
closed. Could you outline for us your debt to capital level
at that time, your RBC levels, and whatever excess capital
you might have? And, then maybe take us out to when you
might expect to do a capital raise?
SCOTTISH RE
Moderator: Michael French
11-04-04/10:00 am CT
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Scott Willkomm: Well, as you may recall, Andrew, we said when we announced
the deal that we anticipated as we've been saying for three
years now that we would likely be raising somewhat on the
order of $200 million during the course of 2005 which is to
support the ongoing growth of the business away from the ING
acquisition which is for all intents in purposes funded by
the negative seeding commission and the incremental capital
that we're raising in connection with the deal.
So, the - and, we've, you know, factor that into all of our,
you know, return and guidance calculations as well. So, when
we give the guidance, it includes that, you know, factor.
So, we - in terms of estimated capital, we would expect to
have at the end of 2005, in terms of equity, exclude if you
will the $200 million that we just referred to slightly in
excess of $1 billion in equity.
Total capital on the order of, when you add in our trust
preferred and mezzanine equity, that adds approximately
another $390 million to the total capital base. So,
effectively we'll be at about $1.4 billion of total capital
sans the additional capital that I referred to which is a
very high level relative to be it any IC models or any of
the rating agency models, so.
Andrew Kligerman: Would it be above 300 RBC?
Scott Willkomm: Yes.
Andrew Kligerman: Okay. And, debt to capital?
Scott Willkomm: Debt to cap, I'm just trying to look on a sheet here. It's,
you know, it's going to be - I'm just trying to find a page
here. I'll be approximately 19 to 20% which is the measure
that we use.
SCOTTISH RE
Moderator: Michael French
11-04-04/10:00 am CT
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Page 27
Now, if you include the additional $200 million, it'll be
about 17% and that's at the end of 2005. So, at the
beginning of the year at the closing, if you will, at the
end of 2004, it'll be about 20% which is the number we
generally manage to.
Andrew Kligerman: And, so if X the $200 starting out the year, I mean, how
much cushion do you have where you need to ride it? Like how
much capital, excess capital, will you have after the $200
million starting on January 1?
Scott Willkomm: We'll actually have a fairly substantial amount of excess
capital quite frankly. So...
Andrew Kligerman: Do you feel...
Scott Willkomm: Yes, I mean, I think, the key thing to keep in mind, we
start out the year of 2005 with about, you know, a very
large in force block which generates significant cash flows.
However, it doesn't generate all that cash flow in the first
quarter or first two quarters of the year. So, I think, as
you look out at the company over multiple years, you see
significant internal capital generation that reduces
significantly, you know, our historic dependence on periodic
new capital raises.
However, because, you know, the transaction and the cash
flow from the in force book of business has (unintelligible)
in the first, you know, three to six months of the year, we
have continued to plan and we will obviously evaluate our
capital position as we get into the new year.
SCOTTISH RE
Moderator: Michael French
11-04-04/10:00 am CT
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Page 28
But, we have continued to plan and continue to guide the
investment community to the previous expectation that we've
had out there for a number of years now.
Andrew Kligerman: Okay, thank you.
Scott Willkomm: Thank you.
Operator: Again, I would like to remind everyone, if you would like to
ask a question, please press star then the number one on
your telephone keypad. Your next question comes from Bin Yu
of Eagle Capital Management.
Bin Yu: Good morning, Scott. I have a couple of questions. One is,
could you just give us a bit more color around international
re-insurance business on you mentioned earlier the year
giving your (unintelligible) that's one area that you are
looking to growth organically. I wonder how that effort is
going and what are the trends in that market.
Second, just to help us think about the company, what the
company will look like a couple of years down the road. In
terms of priority, where do international and also the
financial guarantee business rank in the grandeur scheme of
things.
Scott Willkomm: Okay, sure. And, remind me if I don't remember all the ones
you just asked. With respect - first of all, we don't
financial guarantee business, just to correct a point. Our
financial solutions business is the re-insurance of interest
sensitive liabilities.
It's a spread business. So, we're not guaranteeing
performance of bonds and stuff like that. So, I don't know,
that may have just been a mix of words. The
SCOTTISH RE
Moderator: Michael French
11-04-04/10:00 am CT
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international business continues to be a very important part
of our overall organization.
The, you know, the key management in our international team
continue to feel as if we're raising the bar on them because
we've significantly increased the size of North America
through acquisition and expect them to maintain a fairly
aggressive pace of growing organically our non-U.S.
business.
We continue to have that focus. The markets are very, very
favorable to a market participant like Scottish Re. We've
invested significantly in the platform, in the people, in
our Windsor office to generate that business.
We have - we're, you know, when we first bought the business
two and a half years ago, three years ago, we wrote very
little business actually in the UK. Most of the business
written in the international group there was written in
other parts of the world.
We've had an active focus on the UK since the beginning of
this year, UK and Ireland. We've actually had some very
successful opportunities come to us in those markets. We
continue to actively mind and cover those markets and expect
that that will contribute attractively to the overall
business.
We've also been looking very closely at continental Europe
as well. And, we have participated in certain portfolio
closed block transactions to date. We're looking at some of
the new business opportunities, the enhancement of our
marketing team to focus on that particular segment of the
market.
So, it's - while it is small, it has gotten small quite
frankly because of the acquisition climate in the U.S.
market which is somewhat short lived at the
SCOTTISH RE
Moderator: Michael French
11-04-04/10:00 am CT
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end of the day. So, it's a significant focus for us as a
group, as a management team, and as an organization overall.
Financial solutions continues to be an important product for
us. We have intentionally viewed financial solutions as a
complimentary to our mortality risk transfer business.
We are principally first and foremost a mortality shop.
However, but financial solutions continues to be an
important contributor. And, if you think about some of the
guidance comments that were made, it contribute somewhere on
the order of 20% of our operating profit.
And, we think that's appropriate, an appropriate level
relative to our enterprise capital allocations. So, 20% of
the overall business in the organization coming from that
space. Is that helpful?
Bin Yu: Yes, thank you.
Scott Willkomm: Yes, thank you.
Operator: Again, if you would like to ask a question, please press
star then the number one on your telephone keypad. Your next
question comes from Jeff Schuman of KBW.
Jeff Schuman: Beat this to death a little bit, I guess, I'm going to go
back to guidance, just getting a clearer stint of how the
expectation of an equity raise intersects with your 2005
guidance. Is that in the 2005 guidance?
Scott Willkomm: Yes, it is Jeff. It's - we assumed it was a mid year, you
know, use the mid year convention. So - which is probably
consistent with what likely timing
SCOTTISH RE
Moderator: Michael French
11-04-04/10:00 am CT
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Page 31
expectations would be. So, it's in the denominator on both
the ROE calculation as well as on the operating EPS
calculation.
Jeff Schuman: Okay. And, then you spoke to this a little bit. But, I was
hoping you'd come back to a little bit. Because, I know,
it's an issue that's going to come up probably in the next
few months.
And, that's the issue of, you know, the Triple X
securitization solution and your view on the extent to which
it represents, kind of, you know, a very helpful tool for
Scottish, another re-insurers versions potentially, I guess,
a threat in the form of a (unintelligible) type of capacity.
Scott Willkomm: Sure. Yes, no that's a very good question. In fact, I spoke
on an S&P conference two weeks ago or it actually, I think,
it was last week on the very topic.
We view Triple X securitization as, you know, an important
tool as you say for us. We do not see it as being very
competitive with our business. In fact, what we have
observed to date and, of course, there aren't a whole lot of
data points out there.
There is a lot of conversation, however, going on. From a
direct company standpoint, there are very few - it's a
fairly short list of direct companies who have the size of
in force portfolio on their balance sheet today who could
execute, you know, an efficient securitization of Triple X
related risk.
If you remember that most of the large term writers
re-insure upwards of 80 or 90% of their books of business
especially the post Triple X risk. It's already in the hands
of the re-insurers such as Scottish Re and others.
SCOTTISH RE
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11-04-04/10:00 am CT
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So, we are important and intrical parts of and parties to
that transaction. The way that some companies, direct
companies have approached it, they still don't want the
mortality volatility.
So, some people have contemplated, you know, stripping out
the Triple X risk which is a cost of capital issue and
perhaps if you're a very large organization, you may be able
to achieve efficient execution and lock in that cost, if you
will.
But, many direct companies are contemplating seeding the
mortality risk premium on a YRT basis for example to the
re-insurer to minimize their exposure to mortality
volatility.
So, that's a construct that we have seen and have heard
about companies considering. The other thing, though, our
view is that the very powerful tool. Because, at the end of
the day, our view is that the model of life re-insurer is no
longer a traditional under writing, medical under writing
model.
It's a capital and risk management model. And, cost of
capital is one of the critical components to success in that
space. We believe that re-insurers because of our spread of
risk, our mortality expertise, our diversified portfolio of,
you know, risk can be more efficient securitizers from a
cost basis of the product.
And, we have been informally contacted, you know, by one or
two I understand from our sales team directly companies who
would be inclined to seed business to us and work with us on
Triple X securitization.
SCOTTISH RE
Moderator: Michael French
11-04-04/10:00 am CT
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However, we have the talent and the team, if you will, who
are ready, you know, have been through the exercise. They
know how to do it. We know how to get regulatory approval.
It's a fairly arduous process at the end of the day working
with all the constituencies involved. So, our view is it's a
fantastic pool in terms of reducing cost of capital,
mitigating risk, and is a powerful, competitive product, if
you will, as we factor it into our approach to the term life
market.
So, and quite frankly, the magnitude of Triple X exposure
over the next 10, 15 years is so dramatic, that there's
going to be an awful lot of variations or alternatives that
people will need to pursue.
The depth of this new securitization market is limited. It
may grow. But, it's currently limited. And, it certainly
cannot accommodate - it is not the Holy Grail at this point
at least to accommodate the gross amount of Triple X strain
that will develop over, you know, the next 10 years.
Jeff Schuman: Thanks a lot.
Scott Willkomm: Thank you.
Operator: At this time, there are no further questions. Mr. Willkomm,
are there any closing remarks?
Scott Willkomm: Yes, I'd just like to thank everyone for joining us today.
And, we look forward to speaking with you shortly after we
close the ING transaction at the end of the year and then in
February on our year end conference call. Thank you very
much.
SCOTTISH RE
Moderator: Michael French
11-04-04/10:00 am CT
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Page 34
Operator: Thank you. This concludes today's Scottish Re Group Limited
Third Quarter Earnings Release Conference Call. You may now
disconnect.
END