SCOTTISH RE
Moderator: Scott Willkomm
02-17-05/10:00 am CT
Conference #3500149
Page 1
SCOTTISH RE
Moderator: Scott Willkomm
February 17, 2005
10:00 am CT
Operator: Good morning. My name is (Christie) and I will be your
conference facilitator today. At this time I would like to
welcome everyone to the Scottish Re Fourth Quarter Earnings
Release conference call. All lines have been placed on mute
to prevent any background noise.
After the speakers' 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 1 on your
telephone keypad. If you would like to withdraw your
question press star and the number 2 on your telephone
keypad. Thank you.
I would now turn the call over to Mr. Mike French. Please go
ahead.
Mike French: Thank you, operator, and good morning, everyone. Welcome to
the Scottish Re fourth quarter conference call. This is Mike
French, the chairman of the company.
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. And after concluding our prepared
remarks we'll take your questions.
SCOTTISH RE
Moderator: Scott Willkomm
02-17-05/10:00 am CT
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There'll be a recording of this call available after 1 pm
today running through March the 3rd and instructions on how
to access that were included in the conference call
invitation and today's earning 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, President and Chief Execution Officer of the
company, to discuss the financial results and our operations
for the quarter. Scott?
Scott Willkomm: Thanks, Mike. Good morning, everyone. Scottish Re reported
this morning that income from continuing operations for the
quarter ended December 31st, 2004, was $19.5 million or 52
cents per diluted share as compared to $30.3 million or 82
cents per diluted share for the prior year period.
Income from continuing operations for the year ended
December 31, '04, was $69.8 million or $1.86 per diluted
share compared to $48.8 million or $1.51 per diluted share
for the prior year period.
Net operating earnings were $26 million or 69 cents per
diluted share for the quarter ended December 31,'04, as
compared to $18.3 million or 50 cents per diluted share for
the prior year period.
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02-17-05/10:00 am CT
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For the year net operating earnings amounted to $79.6
million or $2.12 per diluted share compared to $41 million
or $1.27 per diluted share for the prior year period.
Net operating earnings is a non-GAAP measurement and we
determine net operating earnings by adjusting GAAP income
from continuing operations, by net realized capital gains
and losses, the change in the value of the imbedded
derivatives as adjusted for the related effects of the
amortization of deferred acquisition costs, due diligence
costs and taxes related to these items.
While these items may be significant components in
understanding and assessing the company's consolidated
financial performance, the company believes that the
presentation of new operating earnings enhances the
understanding of its results of operations by highlighting
earnings that are 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 GAAP.
Net income for the quarter amounted to $19.3 million or 51
cents per diluted share as compared to $10.5 million or 29
cents per diluted share for the prior year's period. Net
income for the year was $69.6 million or $1.86 per diluted
share compared to $27.3 million or 85 cents per diluted
share in the prior year.
Total revenue for the quarter increased to $215 million from
$196 million for the prior year period which represents an
increase of approximately 10%. Excluding realized gains and
losses and the change in the fair value of the imbedded
derivative total revenue for the quarter increased to $216.9
million from $182 million for the prior year period which is
an increase of about 19%.
SCOTTISH RE
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Total revenue for the year ended December 31, '04, increased
to $816.6 million from $557.4 million for the prior year
period which is an increase of 47%. Excluding the realized
gains and losses and the change in the fair value of the
derivative, total revenue for the year increased to $821.2
million from $547.9 million which is about an increase of
50%.
Total benefits and expenses increased to $202.4 million for
the quarter from $169.2 million which is an increase of 20%
over the prior year's period. For the year total benefits
and expenses increased to $759.1 million from $519.6 million
which is an increase of 46%.
The increase in both total revenue and total benefits and
expenses were principally driven by the acquisition of
Scottish Re Life Corporation which was previously ERC Life
and growth in the company's reinsurance business in North
America.
The company's total assets as of December 31, '04, were $9.4
billion. The core investment portfolio comprising fixed
maturity investments, preferred stock and most of the cash
and cash equivalents on our balance sheet totaled about $4.3
billion. Had an average quality rating of `AA-`, an
effective duration of 3.8 years and a weighted average book
yield of 4.2%.
This compares with a portfolio balance of $2.4 billion, an
average quality rating of `AA-`, an effective duration of
3.9 years and an average book yield of 4.5% as of December
31, 2003.
Funds withheld at interest totaled $2 billion and had an
average quality rating of 'A+', an effective duration of 3.9
years and a weighted average book yield of 5.2% at December
31, 2004. This compares with a total of $1.5 billion with
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an average quality rating of 'A-', an 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 withheld at interest amounted
to $2.1 billion as of December 31, '04.
Realized losses which are before taxes but include the
amortization of deferred acquisition costs, totaled
approximately $5.5 million in the fourth quarter. This
includes impairment losses totaling approximately $6 million
that the company chose to take in the fourth quarter.
During the quarter we issued an additional $230 million of
capital to support our acquisition of the ING Re block. This
$230 million included $180 million of equity securities to
The Cypress Group which is a private equity firm and $50
million of trust preferred securities.
Our book value per share at December 31, '04, was $21.58 per
share as compared to $18.73 per share a year ago. Excluding
the impact of FAS 115 book value per share amounted to
$21.35 per share in comparison with $18.51 for a year ago.
Now 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.
Now first we'll start with our traditional solutions
business which is, as many of you know, how we provide
mortality risk transfer capacity to the top life insurance
companies in North America.
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As of December 31, 2004, the company had approximately $1
trillion of life reinsurance in force covering approximately
14 million lives with an average benefit per life of
$73,000. Excluding the business acquired from ING, we had
approximately $309 billion of life reinsurance in force
covering 7.3 million lives with an average benefit for life
of $43,000.
As of December 31, '03, the company had reinsurance of
approximately $275 billion of life reinsurance in force on
6.2 million lives and an average benefit per life of
$43,000.
During the quarter we originated approximately $16 billion
of new traditional life reinsurance from existing and new
clients. And on a year-to-date basis we originated
approximately $65 billion.
Mortality experience continues to be favorable as well with
actual experience in '04 running at approximately (95) per
expected levels for a Scottish Re originated business. Since
inception of our traditional solutions business mortality
has been at approximately 95% of expected levels on a
cumulative basis.
We see no adverse trends emerging in our mortality and
anticipate it to remain at or around expected. And as we
have stated on many cases in the past, that the projections
we use to develop our guidance and forecast are based on
100% of expected mortality. In addition, mortality from the
Scottish Re Life Corp block is performing as anticipated in
our pricing of that block.
In our financial solutions business we measure progress by
measuring the GAAP reserves we hold on our balance sheet.
Reserves for financial solutions business increased modestly
to $3.4 billion as of the end of the year in comparison with
$2.9 billion as of the end of '03.
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As we've said in the past, we've been very selective in
reinsuring additional fixed annuity business due to the
current interest rate environment and what we perceive to be
non-economic pricing decisions that have prevailed in the
primary markets.
On a same-store basis spreads on the fixed annuity portion
of our financial solutions business increased to 1.66% from
1.65% in the prior quarter and 1.53% in the fourth quarter
of 2003. Year-over-year the spread increased by 13 basis
points. The yield on the assets backing these transactions
dropped by 9 basis points over the past year reflecting the
investment of new premium and net cash flows at market
yields that are lower than portfolio yields.
By the same token, crediting rates decreased by 21 basis
points reflecting the benefit of reductions on renewals of
annual reset annuities which are offset by scheduled
increases in rates on multiyear step guarantee products. The
latter products guarantee increases of 15 to 25 basis points
per year over a 3- or 5-year period at which point the
insurer sets a new 3- or 5-year step guarantee.
In our international business premiums in the quarter were
approximately $39 million which is a decrease from the $67
million we reported in the same quarter of last year. As we
mentioned on prior calls, this year-over-year comparison is
due to two major reasons. One, changing from a cash basis of
accounting for premiums earned which makes comparisons
somewhat difficult on a '04 to '03 year basis and our
decision not to renew several underperforming treaties that
produce significant premium but not a whole lot of operating
earnings.
The net result has been to improve the margins of our
international book on a go forward basis and we expect this
business will continue to grow and
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support significantly wider margins than our traditional
North American business.
In addition, as we've also talked about the non-U.S. markets
are experiencing some of the capacity constraints and other
changes that we've been seeing in North America which
present significant growth opportunities as well as
attractive pricing conditions.
As everyone probably knows on December 31st of 2004 we
announced that we closed our acquisition of the U.S.
Individual Life Reinsurance business of ING Re. Although our
integration is still in its early stages, the early returns
suggest that it's progressing quite favorably.
Effective with the closing we hired approximately 100
employees from ING Re with the majority remaining in Denver
which is where ING Re was headquartered where we opened a
new office on January 3rd. And in addition, a small number
of staff relocated or are relocating to our Charlotte office
at this point in time.
Let's talk a little bit about regulation XXX reserves. At
Scottish Re we've been talking with analysts, investors and
rating agencies about XXX since 1998. In fact our original
IPO slideshow had some points on XXX in that presentation.
However in the past year or two the regulation XXX reserve
requirement has started to receive some more focused
attention from various industry observers.
As many of you may know, XXX is a regulation that was
adopted by the insurance departments of most of the states
in the U.S. in late 1999 and into early 2000. It
prospectively, not retroactively, changed the reserving
basis for term life policies that have long-term premium
rate guarantees.
SCOTTISH RE
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With XXX the statutory reserve grows over time and in the
case of Scottish Re's business it peaks approximately 10 to
11 years from the date of issue and then declines to zero
over time. Approximately 75% of the life business reinsured
by Scottish Re since 2000 is subject to this XXX reserve
requirement. I would also note that the ERC block that we
acquired is pre-XXX business and approximately half of the
ING Re block is pre-XXX paper.
Many life insurers and reinsurers currently use letters of
credit or other types of short-term funding mechanisms to
secure or back their XXX strain. We believe that funding
long duration liabilities with shorter-term funding
facilities is not suitable or sustainable in many respects
from a prudent asset liability management perspective
because it creates significant refinancing or rollover risk
every year. And you've seen some of the rating agencies
having highlighted this potential risk in comments that
they've published during the course of the past year.
Historically we at Scottish funded our XXX reserve strain
using a variety of capital resources including equity and
debt on the balance sheet as well as a number of funding
facilities including various collateral and surplus relief
facilities. We have historically not relied on letters of
credit however to secure our XXX reserves as we believe that
the duration mismatch was inconsistent with our firm's risk
management philosophy.
Some of you may have noticed that last week Scottish Re
closed an $850 million 30-year securitization from our newly
formed wholly owned subsidiary which we call Orkney
Holdings, LLC. Proceeds from this innovative transaction
will fund XXX reserves associated with business written by
Scottish Re U.S. between January 1, 2000, and December 31,
2003. This securitization successfully matches the long-term
requirements
SCOTTISH RE
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02-17-05/10:00 am CT
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imposed by Reg XXX at a cost comparable to 364-day letters
of credit for a company with our ratings. In other words we
have 30-year paper at 364-day effective pricing.
This is the first securitization of excess reserves arising
from XXX to be completed for a reinsurance company and the
first to lock in certainty of availability in cost of future
funding.
In addition, in January we closed another capital markets
collateral facility which was called the Stingray
Pass-Through Trust which totaled $325 million. The Stingray
facility may be used to collateralize XXX or quite frankly,
any other type of business need that Scottish Re may have
over time. And Scottish Re's per annum cost for this
collateral facility is approximately 170 basis points and
the facility has a 10-year maturity.
In addition to the collateral provided, the facility allows
our Cayman Life Company, Scottish Annuity and Life Insurance
Company (Cayman), to issue funding agreements at a
predetermined price without any conditions and at any time
in exchange for the assets in the portfolio at Stingray.
The facility we closed with HSBC Bank, USA, in June, '04,
provides $200 million of collateral support primarily for
XXX related products. This facility reduces the strain on
our existing capital by providing Scottish Re U.S. with
credit for reinsurance collateral.
The trust arrangement put in place for this facility is
accounted for as a variable interest entity and is
consolidated on our balance sheet and you've seen it in the
past. This is a rolling five-year facility which includes
the option to extend annually for a further year upon the
consent of both Scottish Re and
SCOTTISH RE
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HSBC. Scottish Re's per annum cost of this facility is less
than 100 basis points.
In December Scottish Re announced a $175 million credit
agreement with a syndicate of lenders. This agreement is an
unsecured 364-day facility that allows Scottish to issue
letters of credit and borrow for working capital, capital
expenditures and other corporate purposes. While this new
credit facility could be used to fund XXX reserves we do not
have plans to use this facility as a long-term XXX solution.
Taken together, these facilities provide a framework to
efficiently and effectively manage the strain of new
business. The Orkney transaction represents a solution that
addresses the cost and availability of collateral for the
life of a block of business. It is a solution that best fits
a closed block of business and requires considerable
modeling effort and data.
The Stingray Trust and HSBC structures represent valuable
medium-term structures that provide prearranged availability
and cost of collateral for a certain period while also
providing the flexibility to warehouse the strain created
from several years of new business production.
As these new business blocks reach an optimum size they can
be moved from the warehousing structures into another
permanent type of structure like Orkney, thus renewing our
capacity to warehouse future years' production.
Lastly the syndicated credit agreement allows not only
working capital but also the ability to efficiently manage
any short-term XXX timing issues that may arise from the
normal course of doing business with quarterly reporting.
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Finally in connection with the ING Re acquisition all of the
collateral for the XXX reserves related to that business are
provided for by ING for the life of the business at agreed
upon prices that we included in the valuation of the ING Re
business.
This unique transaction structure significantly increased
the value of the transaction from our perspective by
eliminating exposure to the XXX reserve development related
to the block of business that we acquired from ING Re.
We do anticipate sourcing our own sources of permanent
collateral for this business within the near future which
could improve the overall return on that transaction.
Let's talk a little bit about our acquisition philosophy. We
evaluate in-force blocks of business based upon our own view
of mortality, persistency, cost of capital and return
requirements. And it's this discipline that we used in
acquiring the ING block, the ERC block, as well as other
in-force blocks of business that we look at from time to
time.
Our view of assumptions takes into consideration all
currently available historical data. Assumptions may or may
not be consistent with the assumptions used in the original
pricing of the business and generally are in practice quite
different.
At purchase updated assumptions are also used in setting the
reserves that are posted to assure that future liabilities
are properly accounted for. The economics to Scottish Re in
these transactions are fully expected to meet our
shareholder return requirements.
SCOTTISH RE
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Want to talk a little bit about retention, catastrophe and
clash covers and to point out that we did not have any
claims related to the Asian Tsunami event. As part of our
ongoing risk management process and given the growth of our
in-force book of business, we have evaluated our corporate
retention limits as well as our catastrophe and clash cover
limits.
As you may recall if you've been following Scottish Re for
some time, our corporate retention has been $1 million since
we started the business but when we started writing
mortality business in the U.S. we limited our retention to
$500,000 per life until the block grew to a sufficient size.
With the growth of our organic business as well as the ERC
Life acquisition and the ING Re acquisition our block of
business is now sufficiently broad enough to comfortably
support a higher per life retention. As a result, effective
January 1 of 2005 our per life retention for new fully
underwritten business has been moved to $1 million. That
remains the lowest of all of our competitors in the
industry.
The retention on the Scottish Re Life Corp, the former ERC
block, is also set at $1 million. The in-force business
acquired through the ING Re transaction has been - will have
a $2 million retention which has been reduced from $5
million through the purchase of special retrocession pools
that have been put in place to (cede) off any risks in
excess of our stated retention on the blocks.
Our catastrophe reinsurance cover covers multiple deaths,
that's typically defined as three or more deaths from a
single event. As you may know, we have had catastrophe
coverage before there were catastrophes recognized by many
people in the life insurance and reinsurance business. The
events that we cover under our CAT cover include but are not
limited to crashes, fires, earthquakes, tsunami, natural
disasters of other types, terrorisms, nuclear,
SCOTTISH RE
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biological and chemical events and a fairly long list quite
frankly of various coverages.
Beginning January 1, 2005, we have increased our coverage to
$50 million. You may recall that we had upped it a little
bit last year during the course of the year and it had
increased steadily from $10 million to $20 million now to
$50 million. This catastrophe layer attaches when claims
from a single event exceed $10 million.
Clash coverage as well is our reinsurance on unknown
accumulations which we've had for a number of years with
respect to any one individual life. This is important when
one is acquiring in-force blocks of business and protecting
oneself from data integrity issues that come through those
transactions. Our new Clash cover limits have a $3 million
attachment point and provide a $7 million layer of coverage.
As with our CAT coverage, Clash cover covers all of the
Scottish Re group business regardless of where it's written.
Let's go and talk a little bit about guidance and inevitably
we'll answer some additional questions in the Q&A period.
Our efforts to further build the business of Scottish Re in
2004 has paved the way for substantial increases in three
key financial measures that we use to measure the success as
an organization - growth in operating earnings per share,
growth in book value per share and increasing returns on
equity and our expectations for '05 are consistent with
those objectives.
On the revenue front as we mentioned last quarter, we expect
to earn for the full year 2005, total revenue in the range
of $2.1 billion to $2.3 billion. That is driven by earned
premium in the range of $1.9 billion to $2.1 billion,
investment income in the range of $275 million to $350
million and fee income of approximately roughly $8 million
to $12 million for the year.
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Of that earned premium figure, approximately $1.8 billion to
$2 billion is expected to be generated by our North American
operation and $165 million to $175 million is expected to be
generated by our international team.
With respect to production assumptions we are assuming and
expect to produce approximately $100 billion of new
traditional solutions business, that's our mortality risk
transfer business, in our North American markets in 2005.
That's an increase of approximately $35 million over the $65
million we did in '04.
We anticipate based upon where we are with respect to
interest rates, deferred annuity production of approximately
total $500 million. And based upon business that we've done
in the early part of the new quarter here, we think that
we're reasonably on our way to that level.
We also anticipate as I mentioned, fee income of
approximately $8 million to $12 million and we anticipate
producing approximately $500 million of single premium
immediate annuities in addition to our deferred annuity
production.
Operating expenses for the combined operation are expected
to be in the range of 4.9% to 5.2% of total revenue which
represents further achievement of operating leverage in our
organization.
As we have also mentioned in the past, we have always
expected that our effective tax rate would increase as the
company matured and the block of business matured over time.
With the acquisition of ING Re that has accelerated that
effect and as we have guided people in conversations we
would anticipate having reporting an effective tax rate in
2005 in the range of 7% to 8-1/2% of pretax operating
earnings.
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Finally when you sort through it all the resulting operating
earnings per share that we expect to report for year ended
'05 would be in the range of $2.75 to $2.95 per share which
represents an increase of approximately 30% over the
guidance range we gave for 2004. That breaks down into
approximately 20% in organic operating EPS growth plus
approximately 10% of earnings accretion from the ING Re
acquisition.
While our earnings in a calendar year is somewhat seasonal,
as the company has grown the ramp up in quarter-to-quarter
earnings is becoming less and less pronounced than what was
observed in prior years. On a quarterly basis our '05
operating EPS ramp up should follow the following pattern.
We would approximately see 20% to 22% emerge in the first
quarter of '05, 22% to 24% in the second quarter, 24% to 26%
in the third quarter and 28% to 30% in the fourth quarter.
Now let me state very clearly that this is our expectation
for quarterly earnings today. The ING Re block of business
is quite large and although we have a very good picture of
the premium and earnings patterns that we expect to emerge
from this block of business, it will take us a full 12
months - all of '05 - to fully integrate the business into
Scottish Re. As a result, the block does have the potential
to slightly distort this quarterly earnings pattern.
As we come back to you to report earnings throughout 2005 we
will update our quarterly guidance progression along the
way.
These earnings expectations ultimately 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 had been
2006.
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One last comment on guidance. When we give a range of
guidance we have a high degree of confidence regarding two
things. Number one, that we expect to report earnings within
the range and number two, that our highest degree of
confidence is around the midpoint of the range.
The Street obviously needs to do their own work and derive
their own numbers but we would expect that the conclusion
that analysts reach when calculating earnings estimates are
closer to the midpoint of our range than the high end.
I'd also like to mention we'd like to announce today that we
will be hosting our annual investor day in New York City on
March 15th. Invitations and further information regarding
that day will be sent down and posted on our Web site next
week so please look for it.
Finally I'd like to conclude today's conference call by
saying that all of us at Scottish are very excited about our
prospects 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 in order to ask
a question please press star 1 on your telephone keypad.
We'll pause for just a moment to compile the Q&A roster.
Please continue to hold for your first question.
Your first question comes from the line of Al Capra with
Oppenheimer.
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Al Capra: Good morning, everybody. My first question is
mortality-related and if I look at the quarter and I look at
the trailing 12-month benefits ratio it was around 72.3% and
a year ago it was at 70.4%. And I would guess that maybe ERC
has some impact on that so number one, I was just hoping you
could reconcile that for me but more importantly, you know,
is that 72.3% sort of a normalized number or was there any
noise in there?
Scott Willkomm: Well, I think, Al, you are correct that the complexion of
the book of business has changed in large part in '04
because of the acquisition of ERC which had, you know, A)
was a different block of business, it was a pre-XXX block,
had different dynamics to its performance overall. So that
is a very good conclusion to reach.
We would expect that the benefits ratio albeit, you know,
it's a little bit of a crude measure but it's what you have
to work with, will change a little bit a well with the ING
block but not appreciably because that block of business for
the most part is quite similar to the Scottish Re
"originated business." And if you look at the relative
distribution the loss ratios should be relatively similar.
They will probably be marginally higher than the numbers
that you mentioned but that would be I think only at the
margin quite frankly because the blocks are, you know, I
think in the aggregate somewhat similar.
Al Capra: And the expense ratio in term on the ING block should be a
little bit lower then?
Scott Willkomm: A lot lower, yeah. A lot lower.
Al Capra: Okay. And then just, you know, as it relates - it sounds
like mortality was sort of right in line this quarter and
under that assumption, you know, we talk
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about actual to expected being around 95% and what I was
curious about is having gone through the whole due diligence
process on the securitization you obviously got to look back
and revisit what the block's been doing from your '01 and
'02 and '03 underwritings. Where there any notable trends
that came out of that exercise?
Scott Willkomm: Nothing that we, you know, there were no observations quite
frankly that we didn't, you know, that we weren't aware of
or didn't expect I guess. In connection with the
securitization, you know, our internal team did quite a fair
bit of extensive modeling as you might imagine as did, you
know, the various consulting firms who were representing us,
MBIA, you know, Goldman and the underwriters as well as the
states of South Carolina and Delaware.
What I think the ultimate conclusion and as you might
imagine in the securitization, this is the conclusion that
comes out, is that the assumptions underlying the block and
the cash flows coming off of the block are sufficient - in
fact more than sufficient - to support the issuance of these
securities. So that's sort of a long winded way of saying
that the underlying assumptions used in pricing the block
were determined to be quite sound for the 30-year duration
of the securitization.
So I think that, you know, as I say there wasn't anything in
the work that was done that we weren't aware of. In fact,
quite frankly it confirmed what we've been saying all along.
Al Capra: Okay. That's helpful, thank you.
Operator: Your next question comes from the line of John Hall with
Prudential.
John Hall: Good morning.
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Scott Willkomm: Good morning.
John Hall: Hey, Scott, I was just wondering if you could - I've got
several questions - I was wondering if you could just sort
of run through the composition of due diligence expenses a
little bit.
Also the negative (seeding) commission on the ING
transaction, how's that being treated and I was wondering if
you could also discuss what the repercussions are as you see
them to a player like Met Life selling its stake in RGA?
Scott Willkomm: That's quite a list. I wonder if we have the rest of the
day. Elizabeth, do you want to hit the negative (seeding)
commission? I think that's a pretty straightforward one
there and then we can sort of hit all the other points as
well.
Elizabeth Murphy: The negative (seeding) commission has no impact on our
earnings for the quarter or the year. The negative (seeding)
commission will be used as part of the reserve on the block
of business. As you can see, our policy benefit reserves
have increased significantly and about $1.6 billion of that
is attributable to the ING block of business that does come
onto our balance sheet at 12/31. So essentially when we
evaluate the reserves required on that business we take the
negative (seeding) commission in amongst that reserve line.
John Hall: And that's net of cash?
Scott Willkomm: Yes, that would be.
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Elizabeth Murphy: Well, taxes will be shown separately in the balance sheet.
It's not net of tax. It's all part of the reserve and our
tax liability will be shown in the tax liability line.
John Hall: Okay.
Scott Willkomm: You know, with respect to the due diligence expenses, those
are expenses such as actuarial consulting fees, accounting
due diligence, legal consulting fees that we determined not
to capitalize and carry on the balance sheet. So we chose to
expense it our whole objective being that, you know, it
effectively allows us to have a noiseless 2005, you know,
earnings result which I think everybody would certainly
relish.
The last point with respect to Met Life's announcements and
the speculation with respect to RGA I think at the end of
the day that, you know, any activity be it
acquisition-related and otherwise in the life sector in
general or in the life reinsurance sector creates
opportunities for all of the, you know, participants in the
market.
And if you think about some of the basics behind uses of
life reinsurance, life reinsurance has been used to help
contribute to the overall either the financing plan for
acquisitions or alternatively, the post-acquisition
rationalization of capital within companies. It can be used
occasionally to sell or release capital underlying
businesses that are no longer germane to the combined
company.
I think when push comes to shove, the simple answer is it
creates many opportunities for participants in the life
reinsurance business in general. And, you know, with respect
to RGA I think that it no longer being part of the Met Life
organization is probably quite beneficial for RGA in the
long-term and will allow them to explore avenues that they
may not have been able to
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explore from a strategic standpoint because of, you know,
broader corporate objectives.
So I think net/net change is good. We're seeing dramatic
change in our industry both how it effects the domestic U.S.
market but also how it effects the global markets as well.
There's a lot of regulatory change afoot, less so in the
U.S., more so in places like Europe and in Japan and as many
people have heard us say in the past, the long-term organic
growth in the international markets is very, very
attractive.
Obviously that's why we invested in a platform three years
ago and have been looking to develop that platform so that
we can participate in that overseas expansion as well. So I
think the punch line is, net/net change I think such as what
the Met folks have announced will be beneficial to companies
like Scottish and many of our competitors not only in the
near-term but I think it actually may have a longer-term
impact as well.
John Hall: Thank you very much.
Scott Willkomm: Thank you.
Operator: Your next question comes from the line of Jeff Schuman with
KBW.
Jeff Schuman: Good morning, Scott.
Scott Willkomm: Good morning.
Jeff Schuman: A couple of things. I was wondering if you could just give
us a little more color on the ING integration first of all
with respect to just kind of how it's
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playing out in the marketplace. You've mentioned retaining a
number of their employees. Have you retained a lot of the
marketing staff?
And as sort of add new business comes to market from those
existing ING clients are you kind of holding your market
share or how is that sort of playing out at this point?
Scott Willkomm: Yeah. I think to actually on the market share point we're
adding to market share in a meaningful way, Jeff. The fourth
quarter, and I'll come back to the other points on your
question, the fourth quarter quoting activity around our
U.S. business was about as active as it has ever been. I
don't have the quote report right in front of me but as of
the end of the third quarter we had won approximately 42
quotes which is about on pace for what you would expect in a
normal fiscal year.
By the end of the fourth quarter we had added at least
another 30 quotes and the fourth quarter tends not to be,
you know, just a barnburner quote quarter, the reason being
is we were requoting on many pieces of the ING business.
Now mechanically what happened is, you know, ING notified
all of their cedants in October about the time of the
announcement of the transaction that they would no longer be
accepting new business on those treaties.
So typically your garden variety treaty will have a 90- to
120-day cancellation provision in it and during that 90- to
120-day period which ended, you know, effectively two days
ago for all intents and purpose we worked with many of the
companies that had been customers of ING to, you know, to
work on new quotes and new treaties.
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And actually the pricing team now was sort of back to normal
pace if you know what I mean so the fourth quarter was a big
quarter in terms of quoting activity so I believe you'll see
that translate into market share when the market share data
for 2005 results are published.
Jeff Schuman: I'm sorry, just to be clear, you actually repriced open
(cedants) actually.
Scott Willkomm: Well, effectively they closed and reopened in so many words.
Jeff Schuman: Right, okay.
Scott Willkomm: Yeah. We needed as did ING, we needed as an acquirer to
limit in some respects any future production because that
could potentially change, you know, based on the old pricing
basis, that could have changed our view of value. And both
we and ING did not want to have sort of that open item out
there that would result in, you know, adjustments down the
road perhaps.
So we decided collectively that sort of stopping the new
business made a lot of sense. You know, ING was prepared to
run off the business if they hadn't negotiated a deal to
sell the block so they were prepared to do that regardless.
It made a lot of sense for us in terms of limiting our
exposure to things that weren't priced, you know, to the
Scottish approach.
And then we've gone back and worked with many, not all, some
cedants went elsewhere. We did not win everything we quoted
on but we certainly were very successful in a large volume
of quotes in working through with the cedant companies. So
very active but yes, effectively we requoted on many of the
treaties there.
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With respect to the integration activities, as I mentioned
in the prepared remarks, the early returns are quite good.
The ING Re team that we hired in Denver is largely allocated
to operations and administration staff which allows us to
leverage our operating infrastructure across the U.S.
organization very, very effectively.
In addition, we did bring on a number of - not a very large
number but a number of the marketing, sales and a couple of
the pricing actuarial team as well to supplement our
existing origination efforts. And in addition on the
financial reporting and the valuation actuarial side, we
brought on a number of very talented folks as well.
Finally we brought on - a number of the folks we brought on
were part of the famous ING mortality research center which
you may recall had been the Lincoln Re mortality research
center before that. So we have brought on, you know some of
the folks from that team who have done extensive studies on
various mortality related topics and that is very, very
helpful. Something we had planned to do and develop at
Scottish as we grew, however this was a more efficient way
to do that and they have brought with them a number of very
helpful tools that we are working into our business
processes around the organization.
We had a very successful start in Denver on the third of
January when we turned on the lights and everything worked.
And, you know, touch wood - the early returns are very, very
good. I think one of the important things that we talked
about when we announced the transaction is we were seeking
to minimize execution risk and in doing that we brought on a
very talented team of life reinsurance professionals who are
allowing us to leverage our existing team and infrastructure
appropriately.
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Jeff Schuman: Okay, thanks a lot, Scott.
Scott Willkomm: Thank you.
Operator: Your next question comes from the line of Greg Mason with AG
Edwards.
Greg Mason: Hi, this is Greg Mason on behalf of (Jeff Hobson). Just a
quick question. On your Sarbanes-Oxley expenses here in the
fourth quarter were any of those one-time expenses in terms
of a ramp up in compliance or do you expect most of that
increase to be ongoing?
Scott Willkomm: Actually that's a very good question. The Sarbanes-Oxley
cost that we talk about first of all are external costs.
They do not include the internal costs of our people who've
been dedicated to the implementation of the 404 compliance
regime.
Second, we have built into our expense budget the ongoing
what I would characterize as maintenance costs if you will
throughout the organization of, you know, the various
processes and documentation needs. So what we're talking
about in our news release here is the consulting fees, the
incremental auditing fees, basically all of the generally
non-recurring implementation fees as opposed to the ongoing
maintenance fees.
And I would add, as much as we all and I would characterize
myself as being in this camp from time to time, we all love
to complain about Sarbanes-Oxley, how much it's costing and
how much it has the potential to distract from the business,
at Scottish we were already doing a number of these things
as just the part of a growing business and developing the
internal controls to sustain the business and control the
business as it got larger. We were already doing
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process mapping of various parts in part to make sure that
we were doing things well and efficiently.
Would we have gotten it all done in a year? Probably not; it
would have taken multiple of years. So I think I would say
that while there are some elements of Sarbanes-Oxley that
were somewhat pedantic and the rules changed throughout the
course of 2004, the vast majority of this investment I think
is something that we all as shareholders can be confident
will allow the business to sustain itself in a very prudent
controlled environment.
So we can do all the SOX bashing we want to but there is a
very large percentage of the effort that was very, very
valuable and should in the long-term add value to certainly
a company like Scottish which was growing rather quickly.
Greg Mason: Great. Thank you very much.
Scott Willkomm: Thanks.
Operator: Your next question comes from the line of Ernest Jacob with
Longnook Capital Management
Ernest Jacob: Thank you. Good morning, Scott. I was just wondering if you
have filed a registration statement or any other type of
document regarding the recent securitization that we could
read just to get a better understanding of the thing?
Scott Willkomm: No, we haven't. It was a private placement, Ernie, so there
is no registration statement related to it. We did file, you
know, an 8K but I know it's pretty short which is what the
lawyers under Reg FD limited us to. So we'd be happy
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to talk through with you - it's probably a lot easier
offline because it is pretty thick stuff, you know, some of
the details but we don't have a registration statement
related to it since it was a private transaction.
Ernest Jacob: Okay, I'll give you a call then.
Scott Willkomm: That's great, thanks.
Operator: Your next question comes from the line of Andrew Kligerman
with UBS Securities.
Andrew Kligerman: Great, thanks a lot. I have a bunch of questions so let me
just ask one at a time. With regard to the tax rate at north
of $6 million, it increased your earnings by over 50% which
is fantastic. What went into that tax benefit?
And you mentioned that you were expecting 7% to 8-1/2% I
think going forward. I think you expected 4% or 5% going
through '05. What happened and why should we actually expect
the guidance on your tax rate?
Then I'll have a follow up.
Scott Willkomm: Well, I think, Andrew, as you may recall we for some time
have expected as our business grew and the block of business
got larger and the rate of growth of new business because
the denominator grew larger, you know, the delta got smaller
over time, that we would expect to see an increasing
effective tax rate.
Now it is absolutely true and I think you've pointed it out,
in fact I think you expected a higher tax benefit this
quarter. In the last note I saw that we do a lot of year-end
tax planning and some of the year-end tax planning that we
did in the fourth quarter was in advance of the ING block
coming on. And so that
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would have attributed to the benefit being a little larger
than it perhaps would have been otherwise. So there was some
planning we did in advance of the ING closing that resulted
in some benefit.
All in all though, the ING block is two times our non-ING
block if you will or our pre-ING block. It is a very
profitable book of business, profitable on a statutory and
tax basis the way we priced it. We can do some, as I
mentioned, we've done some extensive tax planning so we can
reduce the overall amount of tax that we will have to pay on
that. But we think it's reasonable to believe and we have
modeled it in our own internal models, in that range of 7%
to 8-1/2% effective rate.
That makes a lot of sense if you think about, you know, a
portion of the business is held in the U.S. entities not
only in Scottish Re U.S. but in one of our Bermuda 953
companies which are U.S. taxpayers. But also a large portion
of the business, you know, may be ceded to our Irish
operation which has a tax rate of 12-1/2% on a marginal
basis. So when you pull all that together we believe it's
reasonable and we've stated that an effective tax rate in
the range of 7% to 8-1/2% is appropriate.
We would have expected to get there over time. Obviously
we've been doing some tax planning over the past few years
that has in some respects allowed us not to get there as
quickly which has probably been helpful one way or the other
along the way. But your observation that you would expect,
you know, us not to be able to sustain tax benefits in
future periods is true and that's in large part in the
near-term driven by the ING block.
Andrew Kligerman: And then with regard to your operating expense ratio at I
believe you're projecting around 4-1/2% to 5%, correct?
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Scott Willkomm: Yes.
Andrew Kligerman: And last year I think it was expected in the 5%...
Scott Willkomm: It was supposed to be 5.3% to 5.5%. You're right. It was
higher.
Andrew Kligerman: Yeah, this quarter - so what went into the - I think it was
sequentially up about $9 million so maybe you could give
us...
Scott Willkomm: The fourth quarter was really a barnburner as opex goes,
you're absolutely right. In addition to the (Sarbox)
expenses which we've talked about, you may recall we raised
$50 million of trust preferred in the fourth quarter that
was done at the beginning of November and we would have had
interest expense related to that but obviously not the ING
block that it was backing, you know, since that didn't close
till the end of the year.
We also because we set ourselves up in a way with respect to
ING such that we started the transition before we closed. We
had a high degree of confidence that the transaction would
close as expected on 12/31 and as a result, we began working
on the transition. We added some staffing resources, there
were some IT-related costs such that on January 3rd when the
folks showed up at their desks all they had to do was turn
on their computer and they were linked into all of
Scottish's systems. And that was also in that number as
well.
So, you know, we also had in the quarter some foreign
exchange because quite frankly when we did our earnings
guidance at the beginning of the year the dollar sterling
and dollar Euro level was much, much lower than it is today.
And on an economic basis we're still ahead because our
sterling assets
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are worth substantially more but that doesn't go through the
income statement. That just hits the balance sheet.
However the currency, you know, the difference between what
we had planned for and what the currency exchange rates have
turned out to be have dogged us not only in this quarter but
in prior quarters as well so there was some noise in there.
Now with respect to planning on a go-forward basis, $1.85
sterling type relationship is probably going to be where
it's at and we've looked at it and planned on that basis. So
to the extent that there's some upside in that, yeah, that's
great. That may be helpful in opex on a go-forward basis.
So we've talked a little bit answering one of the questions
of one of the earlier callers on the Sarbanes expenses and
obviously if we started spending a little bit on the
transition in the fourth quarter of '04 and didn't have the
ING block, we had really nothing appreciably to offset that
against.
And I think that this year was just a very difficult year
for opex for a number of reasons. Not making excuses or
anything, it is what it is and I think that we have done a
very good job in looking at opex on a go-forward basis and
have tried to address that concern.
Andrew Kligerman: Thanks. Shifting over to your balance sheet I saw that the
reinsurance recoverable increased by about nearly $500
million to $1.1 billion. Can you give a little color on what
went into that increase in the reinsurance recoverable?
Scott Willkomm: The simple answer and I'll let Elizabeth give you a little
more detail, the simple answer on all the material changes
in the balance sheet are related to
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the closing balance sheet of ING. So all of the major
changes including the increase in the (modco) because some
of the - remember ING was a reinsurance transaction. Some of
the business that was ceded to us was on a funds withheld
basis even though we actually managed the money ourselves on
behalf of ING as our cedant.
But Elizabeth, if you want to, you know, give any more color
on the reinsurance receivable line?
Elizabeth Murphy: Yes, the reinsurance recoverable line, the increase - the
(unintelligible) you said is entirely due to the ING
business and its amounts recoverable from reinsurance in
respect to paid and pending claims and (IBNR).
Andrew Kligerman: Okay, and then your net - you gave us gross in the press
release. What is your net in-force reinsurance?
Scott Willkomm: (Cliff), I don't know if you have that handy. I think on the
back - off the top of my head quite frankly, (Cliff) may
have a better number in front of him there. We're not
sitting in the same location. We would probably, you'd
probably subtract about $75 million from the gross number.
(Cliff): Yeah, I think that's about right.
Andrew Kligerman: Okay, great. And then just lastly on the mortality at 95% of
expected. I noticed just that industry-wide mortality was
very favorable this quarter. Any added thoughts on why you
came in at 95% in the quarter?
Scott Willkomm: Hey, (Cliff), do you want to answer that?
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(Cliff): Yeah, let me back up and re-answer the question before. You
know, for the Scottish Re organic business and the ERC
business, I think about $70 million is the right number for
retro ceded business. If you add in the ING block then we've
got another about $47 billion of business that's retro ceded
out to the excess pools. So the total, you know, the total
retro ceded business comes out to about $130 million or so -
or a billion or so.
Then could you repeat the question on the mortality?
Andrew Kligerman: Yeah just, (Cliff), I'm just kind of curious, you know, I
was thinking that mortality was very favorable across the
whole industry this quarter and you guys also exhibited
that. Any thoughts on why you came in at 95% of pricing? Any
other color that I'd just be interested in.
Scott Willkomm: We're trying to be helpful on that point for you
(unintelligible) in some respects. (Cliff), you probably
have a more serious answer than that though.
(Cliff): No, I mean it's been a consistent year for us and we've come
in probably the same as - we should come in pretty much the
same as all the other reinsurers on our base block of
business. Again, the ERC block is coming in at about what we
expected but there's no real trending for the quarter I
don't think on the organic block of business.
Andrew Kligerman: Okay. Thanks a lot.
Scott Willkomm: Thank you.
Operator: Once again if you have a question or comment please press
star 1 on your telephone keypad.
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Please hold for your next question.
Your next question comes from the line of Sam Hoffman with
Omega.
Sam Hoffman: Hi. Can you explain why book value per share increased from
$19.68 to $21.35 in the fourth quarter and specifically what
we can expect in terms of share count going forward?
Scott Willkomm: Elizabeth, can you walk through the book value per share
change with Sam?
Elizabeth Murphy: Yeah. Part of the book value per share is change in the
comprehensive income which is from FAS 115, unrealized gains
and the foreign exchange component of our UK operation. And
the other book value per share growth is obviously in our
earnings for the quarter together with the additional
capital that we have raised during the quarter as well.
Scott Willkomm: Now to your second point, Sam, with respect to shares
outstanding in terms of a point in time, you know, balance
sheet number as opposed to an average, as of the end of the
year we had 39.9 million shares outstanding. You may recall
that two components of the Cypress investment were in the
form of a warrant and a convertible security which upon the
approval of some changes in our charter, will convert into
shares. And we've sort of always viewed them as in the
denominator.
That would add approximately - well, that would add
approximately an additional 5.7 million shares to that
number and so the total shares that Cypress would have are
approximately 9.2 million. I think there's just a little
over 3 million, 3-1/2 million in the number as at December
31, '04, for that very point in time.
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Now on a weighted average share basis we have some dilutive
securities as well and we anticipate that the weighted
average shares during the course of the year would be
approaching somewhere around the $50 million to $52 million
number based upon what the share price for Scottish is
during the course of the year because some of those are -
well, most of those are convertible and the like at various
prices.
Does that answer your question?
Sam Hoffman: Would that $50 million to $52 million include your $200
million equity offering planned for the middle of the year?
Scott Willkomm: Yes, it would.
Sam Hoffman: Okay, thanks.
Scott Willkomm: Yeah, it does. We've assumed that in our guidance numbers as
well.
Sam Hoffman: Okay.
Operator: Your next question comes from the line of Al Capra with
Oppenheimer.
Al Capra: Scott, just in terms of the acquisition-related growth you
see for '05 in the ING Re block, is that at all dependent on
you viewing the securitization of those reserves to lower
the reserve strain costs?
Scott Willkomm: No, it's not. Not that we won't do that but it is not. Just
to sort of cover a couple of points I think we've made, the
way that the XXX relationship with ING works is ING has
agreed to provide the XXX reserve strain on the block that
we bought for the duration of the block. And that reserve
strain grows
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with time and then obviously comes down sort of has that
humpback effect and that has been agreed as well as what the
cost is.
And in negotiating our transaction with ING we factored that
change in the amount of reserve that they would be providing
as well as the price because that does change with time,
into our pricing model. So we have focused on pricing that
into our view on the business.
To the extent that we are able to finance that in a more
cost-efficient fashion, there is obviously, you know, the
opportunity for enhancement of the returns on the
acquisition of that block and it is our intention to do
that.
We were first focused as you might imagine on our own block,
that which we knew the best. We had been working on it for
some time well before ING was in conversations with us. But
we do have plans to securitize or refinance if you will, you
know, a large portion if not all - that's not all going to
happen overnight because these things do take a little while
but a large portion of the reserves strain related to the
XXX component on that block of business just like you'll see
us do it on the production that we write so the new business
production.
So this is not a one-off. The securitization or, you know,
structured financing if you will of reserves, not merely XXX
reserves, is a very important component of our view on where
the industry is going. But the simple answer is that we
would anticipate it. It is not included in any of our
guidance so, you know, that could be additive not
immediately; it would be in the longer-term over the ensuing
couple of years.
Al Capra: And then very quickly, I know this is running long, but now
that we've got the (emergencies) securitizations and given
your past dependence on having to
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fund your growth via the capital markets, you know, equity
raises, does this have any impact on your dependence on
equity raises in terms of these securitizations?
Scott Willkomm: In a major way, it does. I mean I think in some respects the
reason Scottish Re was the first life reinsurer to not only
do one securitization but we've done now three structured
financing techniques in some respects because we were
smaller, had a smaller balance sheet, we needed to focus on
ways to reduce cost of capital which at the end of the day
is our principle cost of goods sold as a financial
intermediary.
What we have in effect created over the past 12 months is a
factory that can through the HSBC facility warehouse
XXX-related production and allow us to build a proper
diversified block, permanently finance it through an Orkney
Re structure and when the capital markets are closed and we
all know they close from time to time, we have the Stingray
structure which is a contingent capital facility that can be
used not only for XXX but really any other type of reserve
need within Scottish Re.
And then the final piece of this building blocks of capital
is our unsecured credit facility which allows us at the end
of a quarter to true up our various accounts in various
locations and our reserve credit trust and the like in an
efficient fashion, never used as a long-term strategy for
financing.
So the punch line is, out of this, this allows us to
increase the velocity of our core capital, our basic debt
and equity, and significantly reduces the level of
dependency if you will, the level of perhaps frequency that
we would be needing to visit the capital markets on a
go-forward basis than we have in the past.
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Another important thing to note is we have a very large
in-force block of business today that's very well priced and
is performing well and that is a large cash flow generation
engine that we didn't have two years ago. So I think when
you take all of these factors together, this has been a
transformational year for Scottish Re in many ways, not
merely the acquisition but the financing techniques that
we've put into place and the go-forward ability to generate
a very attractive returns on our capital base and continue
to build long-term value in the business.
Al Capra: That's usually helpful. Thank you.
Scott Willkomm: Thanks.
Operator: Your next question comes from the line of Michael McNulty
with Context Capital.
Michael McNulty: Hi, thanks for the call. I just wanted to ask you a couple
of questions. One on the tax rate - I'm trying to reconcile
the benefit that was actually reported versus the benefit
that analysts and folks thought would be in there vis-a-vis
the earning estimates. I thought I heard someone say that it
was more than expected and I'm just trying to figure out on
an apples-to-apples basis how much of an effect did that
have on your EPS. Was it a nickel or 6 cents or, you know,
versus where expectations were?
Scott Willkomm: I don't know where all the analysts were, Michael, but with
respect to where we saw things emerging before we did some
tax planning for the ING, it may have added, you know,
something on the order of 3 cents to 4 cents to the overall
mix at the end of the day.
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Michael McNulty: Okay and that would certainly still be well within range and
near the high end. Okay, great. That's what I thought; I
just wanted to check.
Also a housekeeping question. As you start to generate more
cash what's your thoughts on raising the dividend? It's been
a nickel for a long time per quarter. I didn't know if you
had any thoughts there?
Scott Willkomm: We have thoughts. We've talked about it in the past but
obviously as we were growing the business, you know, it was
important for us to retain, be a net retainer of capital. We
will continue to be so. It's a conversation that we've had
at our board a couple of times and are reviewing that as we
speak.
You may recall that we have had a dividend of 5 cents per
quarter since we took the business public and, you know, now
with the change, the dramatic change over the past few years
and the company's scope and size and capital resources it's
appropriate for us to review that again.
At the end of the day we still are a growing company so we
need to be conservative about that. We have, you know,
ratings objectives that need to be supported as well but
it's on the agenda.
Michael McNulty: Okay. And then just kind of an overview question. On the one
hand you see GE and ING selling their business to someone
like yourself and now Met Life on the RGA side and so you
have certain people kind of, if you will, exiting the
business in a large way. And then on the other hand you have
someone like Marsh increasing their commitment to the area.
Can you just kind of talk about what your thoughts are for
why you see so many people getting out of the business and
why it's presenting the
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opportunities in the market that it has been? And also I
understand pricing is up too.
Scott Willkomm: Sure. Yeah. Well, I think if you look at some of the history
of the industry on the provider side, on the reinsurance
side, for many years many very large diversified, often
European but not always, financial conglomerates were
actively engaged in expanding or buying into the life
reinsurance business principally in the U.S. which is the
vast majority of the global market but also in other markets
around the world.
We then, you know, as a student of the markets you'll know
that the global capital markets on a value basis started to
decline around the beginning of 2000. With the 9/11 incident
that sort of further accelerated and exacerbated the decline
in the market value of capital securities in the markets and
the excess capital that was available to many of these
larger firms became a bit more scarce as a result.
And they also had a number of other issues in terms of
adverse loss development trends. Not only were there the
claims from 9/11 that were paid but there were things like
asbestos, other types of sales practice issues, European
flood issues, a whole litany - you know, (GMGB) reserves
changes as equity markets changed, revaluation of pension
liabilities in markets like the UK and elsewhere.
So another significant amount of strain was placed on the
capital base of many of the significant capital providers to
the industry. And I think companies sort of found themselves
into a couple of categories. A company like GE which had I
think as (Bill Gross) was the one to point out, been
effectively borrowing short and lending long in their GE
Capital business, doing the same in the insurance business.
So they've not only gotten out of life reinsurance;
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they spun off Genworth, they sold (Unintelligible) Insurer
and, you know, they've been progressively getting out of
that business. They must have made a decision internally
that they were going to focus elsewhere.
ING had a new chief executive come into office in April and
they had completed, the firm had completed a strategic
review of the businesses they wanted to be in on a global
basis and they don't want to be in the life insurance and
reinsurance businesses is what I understand one of the
conclusions was.
They would like to be in your business, the wealth
accumulation and management business. So that was a
strategic decision for them and they've made I know a number
of other both acquisitions at ING on a corporate basis as
well as divestitures that fit with that strategic direction
they've taken.
And some other companies quite frankly have, you know, had
difficult times, difficult results that impaired their
capital to a point where they are no longer active in
writing new business. And there were a few companies who
sold, who were under B ratings and capital pressure who sold
various businesses not only the life reinsurance business
but other financial businesses in order to reduce their
exposure to certain things, reduce liabilities and raise
capital.
So a lot of different people were moving out of the industry
for unique reasons. I think also it's fair to say that this
is a consolidating market. This is a market where the
economic model really requires scale in order to generate
the types of returns that are credible to equity and debt
holders.
Michael McNulty: Right.
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Scott Willkomm: And we have been working very hard to achieve scale at
Scottish Re. Quite frankly we were very fortunate that we
were able to put a very attractive deal together with ING
that allows us to achieve a level of scale that would have
taken us a God-awful long time to achieve otherwise. And it
allows us to perfect our economic model.
When you throw into the mix, the securitization work that
we've done to reduce our principle cost of goods sold which
is cost of capital, I think we have gone a very long way to
really tune up and tighten up the economic model that I
think will produce a lot of benefit over the ensuing five
years.
So on the flip side you do have new market entrants so we're
not sort of the last man standing. We're not the captain
going down with the ship.
Michael McNulty: Right.
Scott Willkomm: There are a lot of people who've been trying to do this. It
is not easy. You know, (Chris Straup) with the backing of
Marsh and a number of others has set up (Wilton Re). (Chris)
is one of the most capable executives in the life
reinsurance business and it's a short list of folks who
could really I think do this successfully. There aren't that
many people in this small fraternity in the life reinsurance
business and I think that this is a long-term business.
Equity providers have been very patient with us as we have
been building return on equity over the past six years since
we really got into business here and that has paid off. I
think in many respects though that it's that patience is
something that we're very grateful for but in this day and
age as we all know, you know, it's what have you done for me
lately.
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And while I think people have done very well in buying
Scottish stock over the years, if you were to do a new say
public start-up today the amount of capital you would need
in order to get proper ratings would leave you with a lot of
redundant capital that would take many years to properly
leverage and unfortunately there have been situations in the
industry where people have raised capital and have not been
as successful and they've put a lot of capital and it really
didn't do the trick.
So I think that those are some of the features that you see
going on. You've heard Partner RE, you've heard Brian O'Hare
at XL recently. You've heard a number of other market
participants talk about opportunities in the life
reinsurance business being very attractive and I think we
believe that they are. And we've solidified a market-leading
position, number three in the U.S., number five in the
world, that allows us to compete very effectively with any
new market entrant that comes along. This is all we do;
focus is critical I think to doing this business well.
And you look at the guys who've done well in this business.
Forty-five percent I believe of Swiss Re's global business
is life reinsurance. RGA is solely in life reinsurance and
so are we. I think so many of our competitors have been in
multiple lines of business and just, you know, I think focus
and discipline is really important.
So I think that hopefully answers some of the broader
questions that you were posing there.
Michael McNulty: No, no, that's great. I just was seeing competing trends and
I appreciate you summing that all up. It was very helpful.
Scott Willkomm: Thanks.
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Michael McNulty: Take care, Scott.
Scott Willkomm: Yep.
Operator: Your next question comes from the line of Frank Strezo with
Deep Haven Capital Management.
Frank Strezo: Hi, just actually one of my other questions has already been
answered but just a quick question with respect to the
Sarbanes-Oxley costs. Can you tell us, give us a sense of
when you expect those costs to subside, the external costs?
Thanks.
Scott Willkomm: I think, Frank, two things. One, the issue with
Sarbanes-Oxley costs have a lot more to do with when we plan
for the process, you know, a little over a year ago I think
we and many other people did not completely have a full view
of what the scope would be and what would be required. In
fact, considering that, you know, the SEC and the accounting
profession was working well late into the summer putting out
guidance, I think nobody really knew. So it was very
difficult to estimate and as things often are, it's become -
it's sort of grown upon itself or sort of mushroomed in some
respects.
So we expect that many of those costs will not continue in
future periods. As I mentioned I think in response to a
question asked by an earlier caller, we have already built
into our guidance and our models for '05 the ongoing costs
of keeping the Sarbanes-Oxley regime alive and current
throughout our organization.
So I think a lot of the cost, it was unexpected. I think
you've probably seen that from many companies. I think
Business Week has reported that the
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average company is spending at least $5 million to implement
Sarbanes-Oxley. Unfortunately for a small company where
$350,000 is a penny a share, we're going to see it.
Frank Strezo: Thank you.
Scott Willkomm: Thanks.
Operator: Your next question comes from the line of Xiuping Li with
Tenor Capital Management.
Xiuping Li: Yes. I just want to ask about the dividend question the
other people asked. You were mentioning you were evaluating
your dividend policy. I was just wondering if you can give
some guidance in terms of how you think about your dividend
(unintelligible) in the long-term, you know,
(unintelligible) you only had there is RGA which is paying
very little dividends. So I was just wondering based on your
current review if you're going to change your dividend, what
kind of level you want to be in the long-term.
Scott Willkomm: Well, I don't think we're to a point where I could say what
we're going to change it to. I think a lot of that obviously
has to do with the key constraints we managed to; A.) we're
trying to work to improve our capital base and improve our
ratings progression. So we don't want to do anything with
respect to dividends that would be viewed by our rating
agencies as detrimental not only to maintaining ratings but
progressing ratings in a positive direction. So that's a
very important issue for us.
Second, you know, I think returning capital to shareholders
is an important element in the evolution and, you know, an
important factor for companies. That's why we're looking at
it again. Quite frankly, we as a brand-new and
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growing company probably shouldn't have paid a dividend at
all from the beginning but, you know, in connection with our
initial public offering it was, you know, it was advised
that we should be paying a modest dividend in order to open
the offering to a broader spectrum of investors since some
investors are motivated by even a small dividend, a dividend
nonetheless.
So it's something we're looking at and, you know, I think
net/net those are some of the constraints but I think
philosophically returning capital to shareholders either in
the form of dividends, in the form of buying back stock and
the like, are things we've always been open to. It's just
not we've been in a position where we could comfortably and
prudently to it.
At this point in time with the growth the company has taken
we think it's a conversation worth having around the board
table as well as with folks at the rating agencies and other
people whose opinions about the capital position of the
company are very important.
Xiuping Li: Okay, so because that doesn't sound like you'll be in a
position to change your policy I guess even short-term,
right?
Scott Willkomm: We also are a facile company too so, you know, it doesn't
take years to make decisions either. I think whatever we do,
we want to make sure that it properly and prudently
addresses the near-term and longer-term capital development
of the company and it's consistent with the message that we
are trying to deliver to our counterpart, our credit
counterparties, and the rating agencies who are a very
important factor in how credit counterparties view us.
Xiuping Li: Okay. And also I guess I just don't see the reason for you
to increase your dividend just given the company has been
positioned as a growing company. And also you have the
convertible bond which is (putable) in 2006. So I figure
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you guys take that into account as well when you think about
your capital needs going forward.
Scott Willkomm: Oh, sure. Absolutely. Without question. That's why, you
know, in response to the earlier question, my point was
saying it's on the agenda, it's a conversation that we are
having - a serious conversation we are having but we are
also very cognizant of the capital structure of the company
and its capital needs. These are all things that we are
looking at - well, we looked at them long before even
considering putting a conversation about the dividend on the
agenda.
Xiuping Li: Okay. Thank you.
Scott Willkomm: Sure.
Operator: Your next question comes from the line of Trevor Petch with
Insight Investments.
Trevor Petch: Hi. Can you hear me?
Scott Willkomm: Hello?
Trevor Petch: Hi. Yes. Obviously the ING transaction was a really
significant one both in terms of its size and capital
requirements and so on. I wonder if you could say something
about how long you looked at it all before you agreed in
principle to the transaction and how long it took to
structure the contracts and how long you had to do due
diligence and things like that?
Scott Willkomm: Trying to remember when the first - I mean we've known it's
been out there for a while. This is a small world quite
frankly. And we're reasonably familiar
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with the business because there aren't a whole lot of us and
we do know what our competitors are up to.
We received the official offering document from the bankers
on Memorial Day so that would have been in May and we
announced the transaction middle of October so from that,
you know, Memorial Day receipt of the due diligence book and
the actuarial appraisals and the like to October we were
working both on due diligence as well as structuring the
transaction and, you know, so in many respects in parallel
throughout that period of time so, you know, it was a
reasonably extensive period of time.
Trevor Petch: May I ask which were the parts of it that you said you found
the most challenging?
Scott Willkomm: I think the most challenging parts were two things. One, how
do we address the XXX strain and the way we did that was a
structure where ING is retaining that risk and that was a
very important element to the negotiation and structuring of
the transaction.
And quite honestly the second - maybe not - actually
probably the most important thing was, you know, in order to
make the transaction successful in terms of executing and
managing the block was the acquisition of staff and making
sure that we did the human potential element in as
thoughtful a fashion as possible in terms of, you know, we
knew the senior folks but there were quite a fair number of
mid-level and junior folks who we did not have access to in
the first half of the period and had access to after we got
into an exclusive conversation with ING late in the game.
So we had a lot of work to do in terms of evaluating the
people. We interviewed every person who worked for the ING
Re organization, looked to
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see how they fit within our post-acquisition Scottish Re
organization and I think that was the toughest because at
the end of the day, you know, we are a people business and
our assets go home at night.
Trevor Petch: Thanks a lot.
Scott Willkomm: Sure.
Operator: At this time there are no further questions. Are there any
closing remarks?
Scott Willkomm: No, at this point I would just like to thank everyone for
joining us on this conference call this morning and we look
forward to seeing many of you at investor day in New York on
March 15th. Please check our Web site and we will endeavor
to email to many of you information in the course of the
next week as to venue and agenda for events.
Thank you very much.
Operator: Thank you. This concludes your conference. You may now
disconnect.
END