SCOTTISH RE
Moderator: Elizabeth Murphy
05-10-05/10:00 am CT
Confirmation #5412793
Page 1
SCOTTISH RE
Moderator: Elizabeth Murphy
May 10, 2005
10:00 am CT
Operator: Good afternoon. My name is (Katie) and I will be your
conference facilitator today. At this time I would like to
welcome everyone to the Scottish RE First 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
then the number 2 on your telephone keypad. Thank you.
Ms. Murphy, you may begin your conference.
Elizabeth Murphy: Thank you. Good morning everyone and welcome to the
Scottish RE Group Limited's First Quarter conference call. We
will begin the call with comments about the company's
financial results and give an overview of the development of
the company's business. After concluding our prepared remarks
we will take your questions.
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Moderator: Elizabeth Murphy
05-10-05/10:00 am CT
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There will be a recording of this call available after 1:00 pm
today running through May 24 and instructions on how to access
that were included in your conference call invitation with
today's earnings release. Also a replay of the call can be
accessed on our web site, www.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.
Scottish RE reported yesterday that net income for the quarter
ended March 31, 2005 was $33.4 million or 74 cents per diluted
ordinary share as compared to $10.1 million or 27 cents per
diluted ordinary share for the prior year period. Net
operating earnings were $26.9 million or 60 cents per diluted
ordinary share for the quarter ended March 31, 2005 as
compared to $16.6 million or 45 cents per diluted ordinary
share for the prior year period.
Net operating earnings is a non-GAAP measurement. We
determined operating earnings by adjusting GAAP net income by
net realized capital gains and losses and the change in value
of the netted derivatives and adjusted for the related effects
on the amortization of deferred acquisitions 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 reinsureds business. However, net
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05-10-05/10:00 am CT
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operating earnings are not a substitute for net income
determined in accordance with GAAP.
Total revenue for the quarter ended March 31, 2005 increased
to $558.1 million from $179.2 million for the prior year
period, an increase of 211%. Excluding realized gains and
losses and the change in value of embedded derivatives, total
revenue for the quarter ended March 31, 2005 increased to
$549.4 million from $186.4 million for the prior year period,
an increase of 195%. Several benefits and expenses increased
to $524.7 million for the quarter ended March 31, 2005 from
$167.9 million, an increase of 213%.
The increases were principally driven by the acquisition of
the ING individual life business which contributed $312
million of total revenues and also the growth in the company's
reinsureds business in North America.
The company's total assets were $10.1 billion as of March 31,
2005. The core investment portfolio comprising six maturity
investments, preferred stock, and most of the cash and cash
equivalents totaled $5.4 billion at an average quality rating
of AA- and effective duration of 3.5 years and a weighted
average book yield of 4.3%. This compares with a portfolio
balance of $4.3 billion, an average quality rating of AA-,
effective duration of 3.8 years, and an average book yield of
4.2% as of December 31, 2004.
The growth in our invested assets was principally driven by
the receipt of $850 million from our (unintelligible)
offering. Funds withheld with interest totaling $1.9 billion
had an average quality rating of A and an effective duration
of 5.2 years and a weighted average book yield of 5.8% at
March 31, 2005. At December 31, 2004 this total of $2.1
billion with an average quality rating of A+ and effective
duration of 3.9 years and an average book yield of 5.2%.
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The assets backing funds withheld with interest has an
unrealized gain of $45 million at March 31, 2005. Funds
withheld with interest includes approximately $500 million
arising from the ING acquisition. At December 31, 2004 this
portfolio included a large proportion of cash which has been
invested during the quarter resulting in changes in yield,
duration, and credit quality.
Our book value per share at March 31 was $21.75 as compared to
$21.60 per share at December 31, 2004. Excluding the effects
of FAS 115 and the embedded derivatives and including the
Cypress warrants, our book value per share was $20.36 at March
31, 2005 compared to $19.80 at December 31, 2004.
At this time I'm going to turn the call over to Scott Willkomm
who will discuss our operations for the quarter.
Scott Willkomm: Thank you Elizabeth. 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.
Traditional solutions turned in a very strong first quarter
propelled by the acquisition of the ING RE individual life
business that eliminated a significant competitor from the
marketplace. In connection with our acquisition of the ING RE
individual life business, ING cancelled all open treaties in
October. During the fourth quarter of 2004 we quoted on 38
transactions that have been previously reinsured by ING.
As a result of this quoting activity, in the first quarter we
logged $49 billion of new traditional life reinsurance volume.
This compares quite favorably with
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the $64 billion we produced for all of 2004. In addition we
quoted on 62 traditional opportunities and won 42 of those
opportunities in the first quarter relative to a total of 72
wins for all of 2004 which included the flurry of activity
from the ING transaction.
We expect that quoting activity will come back to earth in the
second quarter now that the burst of new business activity in
the immediate post-ING acquisition period levels off to normal
levels. Our production goal for 2005 in the traditional
solutions business line was to originate between $100 billion
and $110 billion of new business. And as we have said in the
past, we do not sacrifice quality in return for production
goals yet we are clearly on our way to achieving those
objectives.
It is also important to note that we priced all of the new
business opportunities that came to Scottish RE as a
consequence of the ING acquisition based upon Scottish RE
pricing parameters. And all quotes that we did not win were
lost due to price.
As of March 31, 2005 the company had approximately $1 trillion
of life reinsurance in force, covering approximately 13-1/2
million lives with an average benefit per life of $76,000 in
our North American operations. This includes $714 billion of
in force in respect to the ING individual life reinsurance
business that we acquired on December 31.
As of March 31, 2004 by way of comparison we had approximately
$286 billion of life reinsurance in force in our North
American segment covering seven million lives with an average
benefit of $41,000 per life. Mortality experience continues to
be favorable with actual experience in the first quarter
running at approximately 99% of expected levels.
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Since inception of the traditional solutions business,
mortality on a cumulative basis is approximately 95% of
expected levels. And we see no adverse trends emerging and
anticipate our mortality to remain at or around expected
levels.
In our financial solutions business, we measure progress by
the GAAP reserves we hold on our balance sheet. Reserves for
the financial solutions business line increased to $3.5
billion as of the end of the first quarter in comparison with
$3.3 billion as of December 31, 2004.
During the quarter the growth in financial solutions was
driven by the completion of a closed annuity block transaction
and incremental volume that was added to a number of open
treaties. Quoting activity in the financial solutions space is
picking up after a long dry spell which was due as you may
recall primarily to low interest rates.
On a same store basis gross spreads on the fixed annuity
portion of our financial solutions business decreased to 163
basis points from 164 basis points in the prior quarter and
165 basis points in the year ago first quarter of 2004. Year
over year the spread decreased by 2 basis points.
The yield on the assets backing these transactions dropped by
6 basis points over the past year reflecting the investment of
new premium and net cash flows at market yields lower than
portfolio yields.
Credit rates decreased by 4 basis points reflecting the
benefit of reductions on renewals of annual recent annuities
offset by scheduled increases in rates on multi year step
guarantee products. These products guarantee increases of 15
or 25 basis points per year over a three to five year period
at which point the insured sets a new three or five year step
guarantee.
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While the spread on a step product declines during the
guarantee period, the average spread over the guarantee period
is comparable to that of a level guaranteed product. For GAAP
purposes, the decline in the spread is offset by amortizing
deferred acquisition costs over the expected gross profits on
the business.
In our international business premiums in the quarter were
approximately $27.4 million which is slightly less than the
$27.7 million recorded in the same quarter last year. However
total revenue in quarter one 2005 increased modestly to $30.5
million as compared to last year's result.
As you are aware, we have taken the opportunity to review the
pricing of our international business and have chosen not to
renew business that does not meet our return hurdles. And we
expect the international business to continue to grow and
support significantly wider margins than certain segments of
our North American business.
In addition the non-U.S. markets continue to experience some
of the capacity constraints that we see in North America which
presents both significant growth opportunities as well as
improved pricing conditions. And we continue to make the
investment in our international platform to tackle those
opportunities.
On December 31, 2004 we closed our acquisition of U.S.
individual life business of ING RE. The integration of the ING
RE business is progressing quite favorably and is slightly
ahead of what was anticipated by us at the time of the
transaction.
By the end of 2005 we expect to move all of our administrative
operations from Charlotte to Denver and to migrate our
administrative platform to an
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upgraded version of the ING RE administration system that was
acquired during the course of the transaction.
On September - on April 7, 2005 the company's shareholders
approved amendments to the company's articles of association
permitting certain affiliates of the Cypress Group to own up
to 24.9% of the ordinary shares of Scottish RE and the
issuance of ordinary shares to Cypress upon the conversion of
$41 million of 7% convertible junior subordinated notes due
2034. With this shareholder approval the notes were
automatically exchanged for warrants to purchase 2.1 million
ordinary shares.
On May 3, 2005 the Cypress entities received approval by the
Delaware Insurance Department and as of tomorrow will exercise
all of the warrants that are currently held by Cypress for
ordinary shares. As a result of this transaction, the Cypress
entities will collectively hold 9.3 million ordinary shares
which represent approximately 21% of Scottish RE's issued and
outstanding ordinary shares.
During the past - during this past April, (Munich) American RE
released the results of the 2004 Society of Actuaries
Reinsurance Section Life Reinsurance Survey. Scottish RE is
pleased to announce that for the year ended 2004 the company
ranked number 2 for market share in terms of U.S. ordinary
life reinsurance in force.
Our improvement to number 2 from number 6 which was our level
at 2003 is primarily associated with the ING RE acquisition.
On an organic growth basis Scottish RE would have achieved a
number 5 berth in the 2004 survey.
Let's speak a little bit about earnings guidance. I'd like to
clarify the guidance that we gave during our last quarter's
conference call. Although I
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don't see the need to reiterate all the top line assumptions
that we gave since those are the same at this point in time,
we do expect to report operating earnings per share for the
year ended 2005 to be in the range of 2.75 to 2.95 per share
as we had previously informed the investment community.
On a quarterly basis we also indicated that our 2005 operating
EPS ramp up would in our expectation follow this pattern of
20% to 22% emerging in the first quarter of 2005, 22% to 24%
in the second quarter, 24% to 26% in the third quarter, and
28% to 30% in the fourth quarter of the year.
As we also have said in the past, when we give a range of
guidance we have a very high degree of confidence regarding
two things. Number one, that we expect to report earnings
within the range and secondly, our highest degree of
confidence is around the midpoint of the range. Assuming the
midpoint of our yearly guidance of 285 and 21% emerging in
quarter one, our operating EPS guidance for Q1 at its midpoint
was 60 cents per share which is what we're reporting today.
I'd like to conclude today's prepared remarks by saying that
all of us at Scottish are very excited about our prospects in
2005 and thank you for your continued support and interest in
the company. And at this point we would be happy to take your
questions.
Operator: At this time I would like to remind everyone, if you would
like to ask a question press Star then the number 1 on your
telephone keypad. We'll pause for just a moment to compile the
Q&A roster.
Your first question comes from Jeff Schuman with KBW.
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Jeff Schuman: Good morning Scott. You put a lot of or all this ING business
in sort of out to quote and you ended up recapturing some of
it. Can you give us a sense of how - the pricing on that
compared to what it had been previously?
Scott Willkomm: Well I think it's fair to say that we looked at all the
transactions, all of the quote opportunities on the Scottish
RE basis using Scottish RE assumptions regarding cost of
capital, Scottish RE assumptions regarding mortality
development, expense allowances, etc. I think the principle
differences between how we might have looked at the business
versus how the ING team might have looked at the business at
the end of the day really I think hinges upon views with
respect to cost of capital.
Obviously we have a higher cost of capital at Scottish RE than
a large international group like ING would have so we have a
much finer point on our cost of capital assumptions. And in
some cases we found that mortality assumptions were consistent
in both environments and in other cases we found that there
were differences quite frankly in both directions in some
respects.
But I think the principle difference to your question would
have hinged on the cost of capital assumptions.
Jeff Schuman: Okay but I'm just wondering sort of magnitude wise how much do
you think the pricing improved?
Scott Willkomm: I think that our expected returns would be probably somewhere
in the range of 20% to 30% on average higher and as I say
principally driven by cost of capital factors. And in some
cases, you know, you would find greater discrepancies, in
other cases you would find less discrepancy but then - between
one pricing basis and the other.
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Jeff Schuman: And you mentioned the (Munich) RE survey. I guess what it
showed last year is that the amount of reinsurance in force
continued to increase but the amount of new sort of recurring
business assumed was relatively flat. What is your outlook for
'05 at this point for the market?
Scott Willkomm: For the market in general? I think that the overall
reinsurance market will probably grow at a rate that's
comparable to the growth in the underlying ordinary life
space.
In other words, section rates -- and I think we've mentioned
this in either conference calls or investor presentations that
we've made in the past. Section rates for ordinary life
business in the U.S. have in our opinion peaked effectively or
are at the top of the range if you will and we don't expect
that they will increase in any appreciable amount over the
near term. So that would imply that the overall growth in the
life reinsurance space would be consistent with the overall
growth in the underlying life market.
Jeff Schuman: Okay and lastly, now that you've consolidated the ING
business do you think you have any sort of market share
constraints with specific clients? Do you think there are any
clients out there constrained or, you know, your ability to
write new business because they're over exposed on a
consolidated basis or is that not an issue?
Scott Willkomm: No I don't think it's an issue for them. It might be an issue
for us vis-a-vis the amount of pool share, you know, the
percentage of the pool share we might care to take.
But I don't think we're constrained in terms of growing or
continuing to grow our market share by further deepening
relationships, numbers of individual
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treaties or different products with a variety of different
customers. I think we actually have some meaningful ground yet
to cover from that perspective.
Jeff Schuman: Okay thanks a lot.
Scott Willkomm: Yep.
Operator: Your next question comes from Andrew Kligerman with UBS
Securities.
Andrew Kligerman: Yes good morning, two questions. Scott, earlier you
mentioned you had a more favorable than expected pricing of
95% of pricing, 99% of pricing on your first quarter mortality
and that stacked up against 95% of expected for the cumulative
results. So it's quite a significant pick up. Can you speak to
the background or any thoughts behind why it kind of spiked up
in the quarter and whether you see any trends?
And then secondly, the tax rate came in at close to zero. You
had received a huge seeding commission in the ING RE
transaction which makes it difficult to generate those types
of tax benefits going forward. I know your guidance is in the
7% to 8% tax rate. Can you speak to what kind of tax rate we
should be expecting going forward?
Scott Willkomm: Yeah, with respect to the mortality, our mortality didn't
spike up in the quarter. In fact it's been consistent with the
mortality reported for the past I think 10 to 12 quarters. So
mortality has been coming in somewhere for the past as I say
number of quarters around 98% to 99% of expected levels which
is what one would expect.
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Andrew Kligerman: Scott it just looks a little odd because if I look at it on a
GAAP basis benefits as a percent of premiums it comes in at
like 78% versus in prior years it had been around 70% to 72%.
So it's just - I'm struggling to reconcile that.
Scott Willkomm: I mean, at the end of the day I think you will see that mix of
business will do that. You observed I think the same change in
the overall benefits ratio and I think you asked in fact the
same question with respect to the ERC transaction a year ago.
We would quite frankly expect mortality to come in the, you
know, 75% to 78%, 79% range, you know, using, you know, the
benefits ratio approach that you're suggesting here.
So and I realize it's a little difficult because it's one
quarter as well with such a large amount of new volume to do
something on the order of say the last 12 months which would
also pick up any seasonal discrepancy. So it's a little
difficult with the high level of growth in the quarter. So I
don't think that we've seen it, you know, pick up beyond what
we would have expected quite frankly. (Cliff) has a comment
for you too.
(Cliff): Andrew this is (Cliff). Also this, you know, first quarter has
the effect of ING in there and ING will have a little
different, you know, benefit ratio and also, you know, a
fairly large, you know, chunk of the portfolio. So you'll see
mortality coming in at about 99%, that reflects the ING block
coming in about as we had expected.
Scott Willkomm: Now with respect to your question on tax rate, what we
reported in the first quarter wasn't surprising. I think as
we've indicated we expect to have an effective tax rate in the
positive column develop for the year.
I think that as we have reviewed our numbers and our
projections especially as we've been working through the
earnings power on the ING block and how
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it influences the overall tax picture, we think that instead
of the 7% effective tax rate guidance we had given earlier,
probably comes in a little bit lean of that, probably more in
the 5% range. So a slight modification of the factor that one
would use.
But quite frankly in the first two quarters which would be
coming in about, you know, relatively similar if you look at
the seasonal patterns not only of our historic business but
our examination of the seasonal patterns on the ING business,
you're not going to have a huge tax effect in those first two
quarters.
You'll see more of that emerge in the third quarter and
especially in the fourth quarter which is a very strong
quarter for the business overall and the business that we've
acquired.
Andrew Kligerman: And the ING business as well as your existing business prior,
all of that is based in the U.S. and Ireland predominantly
where the tax rates are - the Ireland tax rate is what at this
stage?
Scott Willkomm: It's 12-1/2%.
Andrew Kligerman: Oh 12-1/2%, okay. So eventually you should be at a minimum of
a 12-1/2, would that be correct?
Scott Willkomm: That's over quite a few number of years though, that wouldn't
be obviously this year.
Andrew Kligerman: Okay, thanks a lot Scott.
Scott Willkomm: Yep.
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Operator: Your next question comes from Jeff Hopson with A.G. Edwards.
Jeff Hopson: Thanks, good morning.
Scott Willkomm: Good morning.
Jeff Hopson: In regard to the ING, you mentioned the integration is going
along well or has so far. Would you give us maybe additional
hurdles that you'll be looking toward as we go forward, the
timing of those? Any additional commentary on the mortality,
that book? I know it's early but any additional thoughts
there? And corporate expenses, other corporate expenses I
guess were up. Is that a run rate that we should expect going
forward?
Scott Willkomm: Okay. Starting first with the ING question Jeff, with respect
to the transition, we are currently - we expect that most of
the activities of the transition will take the 12 months of
2005. We are currently paying ING for services being rendered
by them under the transition services agreement, approximately
$1 million a month right now.
That is going to be ratcheting down modestly in current months
as certain services are terminated and then more significantly
as we get later in the year as we transition certain IT
services for example that are being provided through ING's
offices.
They actually happen to outsource all that to IBM but it's
provided through their master agreement. So that will be
ratcheting down in the second half of the year. So the
expenses associated with the ING acquisition will be coming
down to a slightly lower rate, a more long term run rate.
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We expect to migrate all of the Scottish RE administered
business that's currently on our own SR admin system by the
end of 2005 to the system that was acquired in connection with
the transaction. We are in the process of updating certain
elements of that system to provide certain elements of
functionality it currently does not have, also providing
additional functionality from a hardware and scalability
perspective.
That is a project that will be taking effectively the entire
balance of this year. However once that is complete we should
be able to manage incrementally on a per unit basis a growing
book of business at increasing levels of efficiency. The
development of the mortality was consistent with the expected
levels. As you do say it is kind of early. But nonetheless
it's within our expectations.
We - as you may recall from when we announced the transaction
purchased an additional incremental layer of (retrocessional)
coverage to minimize the volatility in the mortality results
to a level that we at Scottish RE were more comfortable with
and that has, you know, been in place since the beginning of
the year and will help quite frankly manage the result on the
mortality side over the course of the year and well into the
future.
So the transition goes extremely well. We're in the process
right now of completing the outfitting of permanent space for
our 85 folks in Denver which is where the operation center is
located and hopefully in October they will be moving into
those permanent quarters and we will, you know, cease to
occupy ING space as we currently do.
So that has been working out quite well. The retention of
staff has been excellent. We've lost a couple of folks around
the edges as you might do in any normal business. You tend to
lose somewhere on the order of 5% to 10%
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of staff in the normal course and we've had, you know,
excellent retention on the folks that we've brought in.
In addition we've brought in a number of folks from the ING
marketing group, the sales group in Fort Lane, and have
relocated most of that group to the Charlotte office which is
where we house our marketing, sales, and pricing and
origination functions. And we have taken the opportunity to
beef up our origination team accordingly by adding those
incremental skilled resources to our team. So that has gone
quite, you know, favorably as well.
You had another component that I have lost track of.
Jeff Hopson: Corporate expenses.
Scott Willkomm: Corporate expenses are yes, I think they're in a level that
will continue on an ongoing basis. Now the big, you know, new
line item if you will is the collateral finance that's
facilities expense, that will continue and that will continue
to be reported as a corporate expense until we push that down
to one of the operating units. This is with respect to the
sting ray contingent capital facility and that's the new item
on the list here. So anything you'd like to add on the expense
side Elizabeth?
Elizabeth Murphy: Yeah, the corporate expenses are what you should expect to see
going forward. They're pretty consistent with Q4 of 2004. They
are somewhat higher than this quarter last year due to growth
in (unintelligible) broken up internal audit departments.
(Unintelligible) legal department which is part of corporate
expenses and we do have the ongoing cost of Sarbanes-Oxley
although they were somewhat
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extraordinary in 2004 there is a continuing cost going through
2005 and all that's baked into the corporate and other costs
there.
Jeff Hopson: Okay great, thank you.
Operator: Your next question comes from Al Capra with Oppenheimer &
Company.
Al Capra: Good morning. I want to make sure I've got my hands around the
benefits expense ratio situation. And, you know, your expense
- your claims and benefits as a percentage of premiums was
about 78.6, but if I break that out between ING rates and then
Scottish stand alone, I think Scottish stand alone was about
76.6 and that averaged about 74% last year ranging like 70% to
80% and ING RE was around 79.6.
So going forward, should I be thinking about ING RE in a
particular range and is there any reason why other than
mortality being seasonally high in the first quarter that you
shouldn't average around 74% for the Scottish stand alone book
this year?
Elizabeth Murphy: A couple of things were going on in this quarter Al. First of
all you're quite right -- the increase is due to the ING
block. It was a significant contributor in the first quarter.
But we also took the opportunity in Q1 to conform accounting
estimates between the ING block, remember this is the first
quarter that came into earnings. So we conformed certain areas
of accounting estimates around establishing the reserves
between our existing block and the ING block. So going forward
you should expect the ratio to come in the 75% to 78%, 80%
range.
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Al Capra: Okay, that's a pretty wide range. I mean, I could see it
ranging that because of, you know, quarter to quarter
volatility but on average, you know, is the midpoint of that
range a reasonable range then?
Elizabeth Murphy: (Unintelligible), yes.
Al Capra: Okay and one follow-up question in terms of some of the
earning seasonality at some of your existing blocks of
business whether it's ERC, the ING RE block, and the
pre-existing Scottish block. Is there a fair amount of
seasonality weighing towards the third and fourth quarters?
Scott Willkomm: There certainly is. The ING transaction because of its
magnitude influences the seasonality of the consolidated group
in a reasonably meaningful way. Now the ING book has similar
earnings development patterns as compared to the pre-ERC
Scottish book.
So if you recall, in the first two quarters of the year the
Scottish RE sort of organic book would typically return or
produce earnings relatively comparable in Q1 and Q2, slightly
ahead of in Q2 of Q1 but not dramatically so. Q3 is clearly
ahead of Q2 and Q4 tends to be, you know, well ahead of the
prior quarters. So there is a fairly steeper ramp between Q3
and Q4.
ING's book of business was, you know, similar in terms of, you
know, the treaty of business and the development of volumes
over the course of the 12 month period that tends to push
things towards the fourth quarter.
So while pre-ING we were starting to see the seasonal slope
dampened a bit, that is no longer the case. It certainly won't
be the case for the next couple of years until we originate
enough other opportunities that would mute some of the effect
of that.
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So you're definitely going to see Q1 and Q2 relatively
similar, you know, an uptick in Q3 and then a substantial
uptick in Q4 and that's consistent with the work we have done
to dissect how the ING business develops on its own and how it
influences the overall Scottish RE book.
Al Capra: That's helpful, thanks.
Operator: Your next question comes from Sam Hoffman with Omega.
Sam Hoffman: Hello?
Scott Willkomm: Good morning.
Sam Hoffman: Scott?
Scott Willkomm: Yep.
Sam Hoffman: Yeah, I apologize. I missed the beginning of the call but I
had a couple of quick questions. The first is did you separate
out organic growth from growth from the acquisition?
Scott Willkomm: Not specifically. In some cases it's a little hard to do
because we are already quoting on some of the opportunities.
But we did get a substantial boost in the first quarter from
incremental opportunities coming from the ING business.
Sam Hoffman: Okay, the other question was UBS put out a report a few weeks
ago talking about mortality being difficult industry wide for
the first quarter. I'm wondering if you had seen any of those
trends and whether it's impacted your
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performance in the fourth quarter and kind of what you foresee
for mortality going forward.
Scott Willkomm: We - in our own experience the mortality wasn't different than
what we had seen in, you know, many prior periods. It was
relatively consistent. Quite frankly we did see some companies
report higher mortality than we might have otherwise expected.
Then quite frankly we also saw folks who reported, you know,
better mortality. I suppose it depends upon the universe of
companies you're looking at.
Since we now reinsure approximately 80% of all the major say
the top 70 to 80 life companies in the U.S., we have a fairly
broad diversified book of business so we have a reasonably
good sense that, you know, clearly some folks and I think some
were highlighted by different research firms as having higher
levels of mortality. In the same instance there were companies
coming in with much better than expected mortality experience.
And I suppose it depends on the universe of companies that you
happen to cover.
In terms of going forward, we don't see any particular trends
emerging with respect to mortality, certainly how it affects
us that we haven't factored into our pricing models already.
So as we have mentioned earlier, perhaps before you were
joining the call, that we expect mortality reported by
Scottish RE to be, you know, at expected levels or perhaps
slightly ahead of - better than expected levels as we had
reported for the past, you know, 10 to 12 quarters.
Sam Hoffman: Okay, my last question is did you give an update on capital
raising in terms of timing, size of capital raising? And also
given that the stock is trading around book value, have you
looked at alternatives to raising equity?
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Scott Willkomm: Well we have not changed our guidance with respect to timing
although I think it's fair to say that we're not happy with
where the value of the share price is now so that's an
important factor as you might imagine.
With the recent change in rating agency views on perpetual
preferred securities, we have spent quite a fair bit of time
as you might imagine looking at perpetual preferred as a
component, an important component perhaps of capital. So and
we continue to do some work on that and how that might reduce
our need for common equity.
That work is ongoing and yet I think it is quite, you know,
fair to say that with where the stock price is today we
wouldn't be, you know, happy to need to go into the market for
capital of that nature. It's - there are alternative forms
that aren't as expensive.
Sam Hoffman: So are you still thinking about some type of offering this
summer?
Scott Willkomm: We have it out there as a stake in the ground for people to
think about as they look at their models and share counts and
all that sort of stuff. But obviously we're looking at, you
know, what the share price is and more likely than not it
would be hard to see something get done before Labor Day.
Sam Hoffman: Okay and do the rating agencies care when you raise the
capital as long as it's raised this year?
Scott Willkomm: I think the rating agencies care what your ratios are at any
given point in time. So and that's obviously something that we
care about as well. So those are the types of factors that
we're looking at. And as I say, there are with some changes in
how rating agencies are looking at the in particular perpetual
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preferred that, you know, aren't as dilutive as common equity
and contribute in a very favorable way to one's ratios.
So that's why I indicate that the work is ongoing, looking at
that type of a security and also regularly monitoring where
our capital ratios are vis-a-vis the growth of the business.
Sam Hoffman: What percentage of capital could the perpetual preferred be
acceptable to the rating agencies?
Scott Willkomm: It depends quite frankly on what we have in other capital
buckets. And right off the top of my head I couldn't tell you
the number.
Sam Hoffman: Okay, great, thanks.
Scott Willkomm: Yep.
Operator: Your next question comes from David Merkel with Hovde Capital.
David Merkel: Hi, I was wondering about the seasonality in your earnings.
You know, under GAAP, aren't profits released down so you get
release from risk? Does the release of risk vary that much?
Scott Willkomm: It's - we've actually - we don't get release from risk
necessarily. We continue to be on the risk.
Man: And also for FAS (unintelligible) which is all of our
traditional business profits come in as a percentage of
premium. So (unintelligible) premium comes in you
(unintelligible) GAAP profit.
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David Merkel: (Unintelligible), very good, got it. Okay my other question,
did you see any differentiation in mortality results this
period between large and small death claims?
Scott Willkomm: Not really. Our average death claim was consistent with what
we've seen in the past. You know, we didn't have a severity
issue if that's the question.
David Merkel: That's the question.
Scott Willkomm: Yeah then the answer is no.
David Merkel: Okay thank you.
Scott Willkomm: Yep.
Operator: Your next question comes from Saul Martinez with Bear Stearns.
Saul Martinez: Hi, good morning. Questions on the seasonality of your EPS
guidance, my first question is what are you assuming in terms
of the equity offering behind that guidance? Because you're
assuming 52% to 56% of your EPS occurs in the second half of
the year and you've gone on record as saying that you will -
you're planning on doing an equity offering at some point in
the second half of the year.
So it has a pretty meaningful impact on, you know, the
assumptions behind the second half - the seasonality in the
second half. In other words because you're essentially
diluting, you're essentially increasing your share count so
substantially by our estimates your operating earnings would
have to increase by about 40% in second half relative to the
first half.
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So I guess a couple of things. One, is there an explicit
assumption for, you know, when the equity offering would take
place and secondly if you could kind of just walk us through
why you feel comfortable that your operating earnings will be,
you know, substantially higher in the second half than the
first half.
Scott Willkomm: Well we're very comfortable with operating earnings being
substantially higher in the second half. And if you observe
historically for the past six years that's been the case.
That's further, you know, per my earlier comments, that's
further influenced by the observations we have made about the
seasonality of the profit on the ING transaction which is
heavily weighted towards the latter half of the year. So the
seasonal pattern of Scottish RE pre-ING had always been skewed
if you will towards the second half of the year. The ING
transaction further cements that assumption.
With respect to share count assumptions, you may recall in our
last conference call or maybe it was two conference calls ago
we gave specific guidance that at that point in time we were
expecting that we would be doing a secondary equity offering
in the second half of the year. And obviously those shares
would be included in the denominator in the second half of the
year. So as was the share count assumption that we had talked
about.
Saul Martinez: Yeah, you know, I guess based on the guidance you guys talked
about during your investor day, you know, we were or least in
our forecasts we're assuming and you kind of backed - based on
what you said earlier maybe we have to change that.
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But, you know, we were assuming that in the middle of - during
the middle of the year there would be a $200 million equity
offering. In addition to that we have the convertible notes
from the Cypress transaction which are going to be in the
diluted share count in the second half of the year.
Scott Willkomm: They - they're in the number as of the second quarter, that's
correct.
Saul Martinez: So essentially the operating earnings in the second half to
follow the seasonal trend that you highlighted earlier would
have to be about 40% to 50% higher. So, you know, I understand
the ...
Scott Willkomm: Operating earnings -- keep in mind that our quarterly guidance
is on a per share basis, not on an operating earnings basis.
Operating earnings are, you know, as a percentage
approximately 2/3 of the operating earnings emerge into the
third and fourth quarters.
Saul Martinez: Okay.
Scott Willkomm: So that's why you would have - that's why if you look at the
guidance we have given on a percentage basis, as you say, you
know, 54% of the operating EPS emerges in the second half.
Saul Martinez: So in other words implicit in the 52%, I guess the 56%
guidance for the second half is the assumption that operating
earnings would be about - 2/3 of operating earnings would
occur in the second half. Is that (unintelligible)?
Scott Willkomm: That is correct, that is correct Saul. Yeah, so operating
earnings clearly growing faster than your share count, you
know, gets you to the result in terms of the pattern that
we've outlined for operating earnings development.
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Saul Martinez: Okay, that makes sense. Okay thanks a lot.
Scott Willkomm: Okay.
Operator: Again I would like to remind everyone, if you would like to
ask a question press Star then the number 1 on your telephone
keypad. You have a follow-up question from Jeff Schuman with
KBW.
Jeff Schuman: I just want to come back to this mortality benefit ratio issue
for a minute because I think maybe we're missing a factor
that's important here.
I thought the way the ING business worked is that it was
supposed to have a higher loss ratio as you indicated earlier
but that it was offset in terms of potentially the
amortization of the negative seeding commission which is why
we saw - if you look at the North American business we saw the
uptick in the loss ratio offset by a downtick in the
amortization line. Is that still the right way to think about
that?
Scott Willkomm: Yeah.
Man: Yeah, the amortization of the profit commission or the profit
performance is in that loss ratio.
Jeff Schuman: I'm sorry, so you're saying we should not look at it in tandem
with the amortization line or not?
Scott Willkomm: Oh you definitely - what Jeff's talking about is looking at
the claims in the acquisition cost line. If I understand your
question Jeff together relative to the, you know, premium.
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Jeff Schuman: Right, well I thought that's kind of the way the ING deal was
structured.
Scott Willkomm: Exactly.
Jeff Schuman: You couldn't change a loss ratio the way you priced the
transaction was through the negative seeding commission which
is (unintelligible) amortization.
Scott Willkomm: Right.
Jeff Schuman: On that basis if you look at them combined, on a combined
basis you get 98.9 this quarter versus 99.6 a year ago I guess
suggesting that things have sort of declined.
Scott Willkomm: Yeah.
Jeff Schuman: Okay.
Scott Willkomm: Yeah, no I think that's right. You need to look at them
together.
Jeff Schuman: Okay great, thanks.
Scott Willkomm: Yep.
Operator: Again if you would like to ask a question please press Star
then the number 1 on your telephone keypad. At this time there
are no further questions. Mr. Willkomm, are there any closing
remarks?
Scott Willkomm: We'd just like to thank everyone for joining us and we look
forward to speaking to you over the course of the quarter.
Thank you.
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Operator: This concludes today's Scottish RE First Quarter Earnings
Release conference call. You may now disconnect.
END