SCOTTISH RE
Moderator: Scott Willkomm
11-04-05/10:00 am CT
Confirmation #1419708
Page 1
SCOTTISH RE
Moderator: Scott Willkomm
November 4, 2005
10:00 am CT
Operator: Good morning and welcome to the Scottish RE Third Quarter
Earnings Release conference call. My name is (Tasha) and I
will be facilitating the audio portion of today's
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SCOTTISH RE
Moderator: Scott Willkomm
11-04-05/10:00 am CT
Confirmation #1419708
Page 2
At this time I would like to turn the show over to Mr. Scott
Willkomm. You may begin your conference.
Scott Willkomm: Thank you (Tasha). Good morning everyone and welcome to the
Scottish RE Group Limited Third Quarter conference call.
This morning I'd like to take this opportunity to introduce
(Dean Miller) who is our new Chief Financial Officer.
As many of you may know, (Dean) joined the Scottish RE
senior management team in August after having spent five
years with Swiss RE as Chief Executive of their Admin RE
unit in London and before that as Chief Financial Officer of
their global life and health unit. Before joining Swiss RE
(Dean) was a partner with Ernst & Young in New York.
At this point (Dean) will walk you through our prepared
comments for the third quarter. (Dean)?
(Dean Miller): Thank you Scott. Good morning everyone. As a slight
departure from the approach on previous calls, we will take
the earnings release as read and focus our prepared comments
on highlights on our financial results and business
operations for the quarter. After concluding our prepared
remarks we will take your questions.
There will be a recording of this call available after 1:00
pm today running through November 18. Instructions on how to
access the replay are 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 quarter overview please keep in mind
that certain statements that we make are forward-looking
statements within the meaning
SCOTTISH RE
Moderator: Scott Willkomm
11-04-05/10:00 am CT
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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.
I'd like to begin with a summary of some of the more
significant financial highlights for the quarter. Last
evening Scottish RE reported net income available to
ordinary shareholders for the quarter ended September 30,
2005 of $31.9 million or 66 cents per diluted ordinary share
as compared to $11.6 million or 31 cents per diluted
ordinary share for the prior year period.
Net income available to ordinary shareholders for the nine
months ended September 30, 2005 was $66.9 million or $1.42
per diluted ordinary share as compared to $50.3 million or
$1.35 per diluted ordinary share for the prior year period.
Net operating earnings available to ordinary shareholders
was $32.6 million or 67 cents per diluted ordinary share for
the quarter ended September 30, 2005 as compared to $18.8
million or 51 cents per diluted ordinary share for the prior
year period.
Net operating earnings were $79.3 million or $1.68 per
diluted ordinary share for the nine months ended September
30, 2005 as compared to $53.5 million or $1.44 cents per
diluted ordinary share for the prior year period.
Net operating earnings available to ordinary shareholders is
a non-GAAP measurement. We determine net operating earnings
by adjusting GAAP net income available to ordinary
shareholders by realized gains and losses in the change in
the value of the embedded derivatives as adjusted for the
related effects on the amortization of deferred acquisition
cost and taxes.
SCOTTISH RE
Moderator: Scott Willkomm
11-04-05/10:00 am CT
Confirmation #1419708
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While these items may be significant components of
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 reinsurance business. However, net operating earnings
are not a substitute for net income determined in accordance
with GAAP.
On a quarter to quarter basis premiums earned increased to
$467.9 million in Q3 2005 from $438.6 million in Q2 2005. In
our North American traditional solutions business, new
business production is at $106 billion year to date compared
to a plan of $100 billion to $110 billion.
Our international segment premiums increased by $15 million
over the prior quarter including the impact of updated
reporting from a Lloyd's of London syndicate and a one time
$9 million increase to premiums which was largely offset by
a similar increase to total benefits and expenses.
As discussed at the last earnings call, the impact of the
ING acquisition and the related purchase accounting
adjustments that were made to that block make it difficult
to accurately analyze the company's benefits and acquisition
ratios. This has been especially difficult due to the
accounting implications at the new business production split
between 2004 and 2005.
Consistent with the prior quarter we have received further
client reporting of actual new business production and
completed our purchase accounting adjustments for this new
business in the third quarter.
SCOTTISH RE
Moderator: Scott Willkomm
11-04-05/10:00 am CT
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Also on our second quarter conference call, we gave guidance
with respect to our benefits and acquisition expenses ratios
excluding the acquisition accounting noise.
On a normalized basis we would expect our benefits ratio to
range from 73% to 75% for the full year and our acquisition
ratio to range from 20% to 22%. The sum of the two ratios
should range from 93% to 96% for the full year 2005. Our
quarterly and year to date ratios adjusted for the impacts
of the purchase accounting are very close to these expected
ranges.
On a reported basis our benefits ratio was 76.1% for the
third quarter and on an adjusted basis for the acquisition
accounting adjustments it was 74.6%. The benefits ratio for
the nine months ended September 30, 2005 was 75.1%. The nine
months figure evidences where this ratio is heading when one
turns off the acquisition accounting noise in individual
quarters.
On a reported basis the acquisition expense ratio for the
quarter was 15.9% and on an adjusted basis for acquisition
accounting adjustments was 17.1%. For the nine months ended
September 30, 2005 the acquisition expense was 18.8%. Once
gain a better indicator of the ratio at the acquisition
accounting noise in individual quarters is dampened over the
course of the year.
Our operating expense ratio which is the ratio of operating
expenses to total revenues excluding realized gains and
losses and the change of value of embedded derivatives for
the last 12 months ended September 30, 2005 was 5.5%.
Operating expenses for the third quarter were approximately
$6 million higher than the prior quarter. This increase is
primarily attributable to professional fees incurred in
connection with Sarbanes-Oxley. Costs incurred for
SCOTTISH RE
Moderator: Scott Willkomm
11-04-05/10:00 am CT
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Sarbanes-Oxley for the third quarter were almost $4 million.
The higher than normal costs relate to the need to fully
document and test the ING operations for the first time.
As we are in the process of migrating all of our back office
operations to the ING platform, we feel that the
Sarbanes-Oxley work was a valuable investment in ensuring
that our future platform for our North American business is
robust and well controlled.
We have also spent considerable time and effort addressing
the issues related to the material weakness in our UK
operations identified by management at the end of 2004.
While there is still some work to be completed during the
fourth quarter, we are very pleased with the progress made
and feel confident that the internal control deficiencies
identified have been fully addressed.
We also incurred higher costs in the third quarter as we
continue to expand our corporate infrastructure in response
to our recent and anticipated future growth. This includes a
significant investment in depending our senior management
bench in the U.S., Bermuda, and Windsor as well as a
meaningful investment in enhancing enterprise risk
management disciplines. Interest expense for the third
quarter was higher than the second quarter resulting from an
increase in interest rates impacting our floating rate debt.
As discussed in the last earnings call, on July 6 we issued
125 million non-cumulative perpetual preferred stock with a
fixed rate dividend of 7.25% for the initial five year
period.
During the quarter the company declared a per share dividend
which is comprised of two components -- the stub period
between July 6 and July 14 and the regular quarterly
dividend of between July 15 and October 15. This
SCOTTISH RE
Moderator: Scott Willkomm
11-04-05/10:00 am CT
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preferred dividend of approximately $2.5 million is a
reduction of shareholder's equity but must be deducted from
net income and net operating earnings per share for earnings
per share calculations.
That completes my prepared remarks on the financial results
of the company. I would now like to turn it over to Scott
who will provide a more in-depth analysis of our business
operations during the quarter.
Scott Willkomm: Well thank you (Dean). In our North American traditional
solutions business as (Dean) mentioned, year to date new
business production is about $106 billion which is on target
for our '05 plan of between $100 billion and $110 billion.
This also compares quite favorably with the $64 billion
we've produced in all of 2004.
New business in the quarter exceeds about $18 billion. And
since the beginning of the year our in-force portfolio risk
has grown by approximately $35 billion net of lapses in
claims.
We quoted on 28 traditional opportunities and won 10 in the
quarter. On a year to date basis this brings total quotes to
149 with 71 wins and compares well to last year in which we
had 72 wins for the entire 2004 year.
Quoting activity has stabilized now that the burst of new
business activity in the immediate post-ING acquisition
period has returned to normalized levels. On a year to date
basis we have declined to participate in 41 quoting
opportunities and substantially all of our 37 losses were a
result of price.
In terms of mortality experience in the quarter, mortality
experience was consistent with our expectations on both the
claims count basis as well as the average claim amount
basis.
SCOTTISH RE
Moderator: Scott Willkomm
11-04-05/10:00 am CT
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As (Dean) alluded to, the integration of the ING RE
acquisition continues to progress with great success. As we
speak our Denver team is in the process of moving into
permanent quarters in downtown Denver and we are well on the
way to migrating all of the company's North American
traditional life, RE, admin, and operations functions from
Charlotte to Denver. It is anticipated that most of this
migration will be completed by mid-December.
In addition we are in the latter stages of merging the old
Scottish RE admin system into the newly enhanced Sage admin
system that was acquired in connection with the ING
transaction. Our IP and operations teams have worked
tirelessly over the past six months to enhance the Sage
platform and prepare it for this migration.
In Sage we have one of the most sophisticated life, RE,
admin systems in production today. And we anticipate that by
merging the old Scottish RE system into Sage we will not
only have enhanced admin capabilities but we will have a
platform upon which we can scale our business in the most
efficient fashion.
In connection with the integration of the ING acquisition,
we did spend approximately $3 million on Sarbanes-Oxley
implementation. This is largely a non-recurring expense that
is non-operating in nature since it was specifically tied to
the acquisition of the ING business.
Since we are building our operations center in Denver we
also thought it was important to go beyond the mere letter
of the Sarbanes requirements and instead invest in building
a world class internal control structure.
SCOTTISH RE
Moderator: Scott Willkomm
11-04-05/10:00 am CT
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Finally, our dedicated securitization team is hard at work
on a series of transactions that will enable us to refinance
the XXX reserve facility that ING provided the Scottish RE
in connection with our acquisition of that block.
No new business was written in the financial solutions line
this quarter and our GAAP reserves in that business remain
unchanged from last quarter at approximately $3.5 billion.
The outlook for interest rate in the U.S. however is
changing the likelihood that our customers will seek
reinsurance for their asset sensitive products. We
anticipate that as rates rise another 50 to 100 basis points
over the next few quarters, activity in this product line
will increase.
Yet despite the meaningful change in rates this quarter our
disciplined asset liability management approach has been
effective in allowing Scottish RE to maintain growth spreads
on our fixed annuity book of business. On a same store basis
growth spreads on fixed annuities which is the largest part
of our financial solutions business decreased to 1.61% from
1.64% in the prior quarter and 1.65% in the second quarter
of 2004.
Over the past year the yield on the assets backing these
transactions dropped by eight basis points reflecting the
investment of new premiums and net cash flows at market
yields that are lower than portfolio yields. By the same
token crediting rates decreased by four basis points.
In our international business premiums in the quarter were
approximately $42.9 million which is an increase from the
$27.9 million recorded in the prior quarter. As (Dean)
indicated, the third quarter figure includes an adjustment
related to our Lloyd's of London syndicate.
SCOTTISH RE
Moderator: Scott Willkomm
11-04-05/10:00 am CT
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While it's taken longer than we would have liked we are
building earnings power in the international segment once
again with some of our new business activities. During the
third quarter we started realizing the beginnings of this
growth as we wrote several significant UK protection
treaties and the current pipeline is very strong.
While this new business production is a few quarters behind
the expectations we had in our 2005 plan, we are very
encouraged about our market prospects as we go into early
2006.
On October 20 Scottish RE announced that it had been granted
a license to establish a rep office by monetary authority of
Singapore. In addition we announced on that date the
appointment of (Andrew Linput) as Asia Pacific Regional
Director.
You will note that this is Scottish RE's first step in
establishing a physical presence in the Asia Pacific region.
For several years now we have provided life reinsurance
capacity to clients in Asia through the London market.
And with this enhanced commitment to the region we expect to
enhance our ability to service existing clients while
providing Scottish RE with access to an expanding universe
of high quality business opportunities in one of the world's
fastest growing life reinsurance markets.
Singapore will serve as Scottish RE's Asia Pacific regional
hub, focusing on life reinsurance business in principal
markets such as Japan, China, India, Korea, and Australia.
Now let us turn our attention to earnings guidance. Our
guidance for fiscal '05 had historically been $2.75 per
share to $2.95 per share for the year.
SCOTTISH RE
Moderator: Scott Willkomm
11-04-05/10:00 am CT
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While higher than expected claims in the second quarter
negatively impacted our earnings in the quarter to the tune
of 24 cents per share, as we indicated last quarter there
has been no change in the underlying fundamentals of our
business in earnings power of the company.
Accordingly we did not and we do not expect to change our
outlook for growth in new business profitability.
Furthermore, other than adjusting for that mortality
shortfall last quarter we don't expect to adjust our
guidance range and we aren't doing so. In other words, our
revised guidance for fiscal '05 remains at 251 to 271 as we
mentioned to you on our last call.
Since the company's reported net operating earnings of about
$1.68 per share for the first three quarters, we expect that
the company will earn between 83 cents and $1.03 per share
in the fourth quarter of 2005.
We look forward to seeing many of you next week at the Bear
Stearns mid cap conference in New York. Information about
joining our presentation which is scheduled for Monday
afternoon via web cast will be posted later this afternoon.
I'd like to conclude today's prepared remarks by saying that
all of us at Scottish are excited about our prospects for
the rest of the year and beyond. In addition to a very
strong showing in terms of our net operating earnings per
share this quarter, we're very pleased with the continued
growth in fully diluted book value per share and return on
equity which is some of the most important financial metrics
of our long term success.
And we thank you for your continued support and interest in
the company. At this point we will open up for questions.
Operator?
SCOTTISH RE
Moderator: Scott Willkomm
11-04-05/10:00 am CT
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Operator: As a reminder, to ask a question press Star 1 on your
telephone keypad. We will pause for just a moment to compile
the Q&A roster.
Your first question comes from Saul Martinez of Bear
Stearns.
Saul Martinez: Hi, good morning. Thanks for the plug on the Bear Stearns
small cap conference Scott. But I have a couple of
questions. One, on your capital plans, how are you looking
at the question of hybrids versus common equity and what do
you think your capital needs will be going into '06?
And then secondly I wanted to drill down a little bit on the
new business production in the quarter. Obviously year to
date it's been stronger than what you guided to last year
but it was, you know, by my - I think you said it was $18
billion in the third quarter which is down. You won 10 of 28
opportunities and the portion of business you quoted on that
you won came down.
Can you talk a little bit about how we should look at that
number going forward? Is $18 billion a better run rate on a
normalized basis or do you think that's a little bit light
given what you expect going forward?
Scott Willkomm: Okay maybe we'll start with the capital question first and
the use of hybrids versus other forms of capital. As you
know we have been an active user of hybrids as I guess many
other companies have been over the past couple of years.
When we look at capital we look at a couple of things. We
look at obviously our new business growth and the necessary
consumption of capital to support that new business growth.
We also look at as measurements both our capital
SCOTTISH RE
Moderator: Scott Willkomm
11-04-05/10:00 am CT
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ratios be it on various debt to capital levels, risk based
capital levels and the like.
But we are also very focused on other ratios as well such as
interest coverage ratios which I think are very important.
And we try to balance between the two and achieve targets
that we set for ourselves internally or that rating agency
expectations may, you know, may be.
So when we look at using hybrids, one of the most important
factors is looking at the interest coverage ratio and the
impact of the use of hybrids on that number.
I also think that - my sense is that while the rating
agencies have always focused on both capital ratios in terms
of leverage but also focused on interest coverage ratios,
more recently with the prolific I guess use of hybrids there
has been more focus on coverage ratios especially in the
aftermath of Hurricane Katrina where I think many companies
at least contemplated -- may not have actually gone down the
path -- but many companies contemplated addressing their
capital shortfalls via the use of hybrids.
And I believe, and I think it's probably shared by some of
our compatriots in the industry both in the life and the
non-life industry that we and the rating agencies
collectively are looking more strictly perhaps or with a
greater focus on coverage as well as on leverage.
So that's a long way to say that from our point of view we
think that the use of incremental hybrids today is probably
not the most appropriate capital instrument, you know, just
by itself, perhaps in conjunction with some other forms of
capital that may be an appropriate mix.
SCOTTISH RE
Moderator: Scott Willkomm
11-04-05/10:00 am CT
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So when we're looking at our capital plan which we're in the
process of finalizing over the next several weeks for the
2006 year, we are looking at obviously most importantly our
new business activities and the capital needs that will
drive. But also the mix of capital comes out of our analysis
of coverage and leverage.
And as we look at it today, and I think this is a little bit
different than what we've said in the past in one respect, I
think that our view is that we would anticipate using less
hybrids than we had thought about in the past because of
this I think more heightened scrutiny that's being placed on
interest coverage or cash coverage if you will.
Now that does not change what we've said in the past about
equity. We have always said that equity was in our near
future and we even sort of rolled back the clock to last
year, this time last year, the beginning of the new year. We
articulated a capital need for '05 of somewhere on the order
of $200 million. To date we have raised $125 million in a
hybrid fashion which counts effectively as about $100
million because of the capital credit one receives.
We clearly have some excess capital on the balance sheet and
we've been putting that to use. And as we look at some of
our year end activity and first quarter activity we're
trying to sharpen our pencils on the finer points of the
capital raise. But I think we've been very clear that it is
a timing issue for us as opposed to a yes or no issue, do
you raise capital or not.
It's clearly the case that we've grown significantly during
the course of this year. And as you can see we're growing on
a pace that is faster than what we had originally
anticipated and doing that at attractive margins. So from a
capital perspective that's - those are all the factors that
we take into account.
SCOTTISH RE
Moderator: Scott Willkomm
11-04-05/10:00 am CT
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With respect to the new business activity, clearly we had --
and I think we've mentioned this on a number of occasions --
in the beginning of the year most notably the first quarter,
a little bit in the second quarter as well. We had, you
know, a waterfall of business that came to us in the
aftermath of the ING transaction.
Our originally anticipated expectation if you will for just
regular way new business ex-ING would have been something
probably in the $80 billion to $85 billion range. So when
one looks at the $18 billion in the quarter, first of all
I'm not sure that says anything quite frankly per se about
new business production since the fourth quarter tends to be
the most robust period, you know, ex sort of this
acquisition effect.
But I think that we just in terms of underlying growth would
have anticipated seeing something that would have suggested
that $18 billion is at least on track if not ahead of track.
So that looks like we're going to be probably pulling in
somewhere close to $120 billion to $130 billion for the year
which is at least 20% more than our already inflated or, you
know, acquisition inflated number.
So with respect to quoting activity, at the end of the day
the key thing for us in terms of winning quotes is achieving
our pricing objectives and our, you know, risk appetite if
you will for that business. So we are not going to chase
business for volume. We will pursue business that yields the
most attractive return on capital with the most appropriate
- within our risk appetite if you will.
So one quarter's volume, you know, I'm not sure is
particularly indicative of anything in terms of quoting
activity. Most of the quotes we win quite frankly this year
we will only see production for, you know, in the next 12
months
SCOTTISH RE
Moderator: Scott Willkomm
11-04-05/10:00 am CT
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time. That doesn't really even impact this year's - this
quarter's activity. So is that helpful?
Saul Martinez: No that's very helpful Scott. It's a very thorough answer.
Just going I guess back a little bit to the capital plan,
you know, it sounds - as you indicated it sounds like maybe
you're more disposed obviously to common equity as opposed
to hybrid securities for the reasons you said. It sounds
like you have less capacity for hybrids given the focus on
interest coverage.
But I guess, I mean, in terms of timing of getting those
capital plans, is it fair to say, I mean, you're sharpening
your pencils. Is it fair to say next quarter we'll have a
little bit more clarity on what exactly those might be?
Scott Willkomm: Well I think so, even with greater clarity than that. I
think as we've indicated in the past, it would be highly
surprising to I think us and probably highly surprising to
the investment community that we would not be in the capital
market at the latest by end of Q1, you know, timeframe.
So, you know, between now and then quite frankly as we
sharpen our pencil and look at what our new business
production is both our year end activity, occasionally
there's a lot of year end activity that either comes in
December or January as the case may be. As we get a very
good sense of where that's coming in, it will really drive
timing.
And you're absolutely right on the common equity front.
That's where we've always been angling if you will. Not
angling I should say but focused. Core capital, we had the
opportunity on a couple of occasions over the course of the
past few years including this summer to do hybrid capital
that had a lower cost of capital than equity.
SCOTTISH RE
Moderator: Scott Willkomm
11-04-05/10:00 am CT
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In fact you might note that our perpetual preferred offering
was the most efficient in terms of dividend level for any
company I think of any rating almost other than perhaps the
Met Life guys.
So, you know, we will take advantage of managing the
progression of our return on equity as well as book value
per share and of course earnings into those thoughts.
Saul Martinez: Okay, all right, thanks a lot Scott. It was a very complete
answer.
Operator: Your next question comes from John Nadel of Fox-Pitt.
John Nadel: Hi Scott.
Scott Willkomm: Good morning.
John Nadel: Just a question on the - I've got a couple of questions but
the question I guess to start on the guidance. I guess it's
a pretty wide range for the fourth quarter. And just
thinking about, you know, the movement of the tax rate and
how that impacted things this quarter or maybe even this
year relative to, you know, original thoughts as '05
guidance was kind of played out.
Can you give us a sense for maybe what you're thinking about
with respect to or what we might expect on the tax rate for
not only maybe just the fourth quarter but also, you know,
thinking about that going forward too?
Scott Willkomm: Sure. I think that ...
John Nadel: I know it's a tough one.
SCOTTISH RE
Moderator: Scott Willkomm
11-04-05/10:00 am CT
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Scott Willkomm: Yeah, no that's okay. I think there are actually two
questions that you're asking in some respects. The first
question at least that I heard was, you know, yes you're
absolutely correct. The range is relatively wide. And I
think the reason it is wide, one of the key drivers of why
it is wide is because we have a lot of pending activity in
the securitization of some of the ING risk. And that can
have some meaningful impact on the result for the year.
John Nadel: And when you say Scott, that can have some meaningful
impact. That's positive impact, correct, because
(unintelligible).
Scott Willkomm: That is correct, that is correct. That allows us to drive
towards the higher end of that range as opposed to - yeah.
And so that's - and quite honestly, you know, that is, you
know, there are a lot of moving parts involved in those,
many beyond our control, you know, putting regulators
calendars and the like.
John Nadel: Understood.
Scott Willkomm: So we're not letting grass grow under our feet there but,
you know, that is just a matter of fact that bakes into the
Q4.
John Nadel: No that's very helpful, absolutely.
Scott Willkomm: Yeah so, you know, with respect to the tax rate, it is - I
understand it's challenging quite frankly for one to project
the tax rate in any given quarter. And in some respects it's
difficult for us to do.
As we prepare our business model for a given year we build
in certain assumptions. But that can change obviously as
certain circumstances change in some of our higher tax
subsidiaries, most notably the U.S., to a certain extent the
UK, and to a lesser extent in Ireland.
SCOTTISH RE
Moderator: Scott Willkomm
11-04-05/10:00 am CT
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For example, losses on mortality for example in the second
quarter drove the benefit a bit up if you will in the North
American space. That had clearly an influence on where the
tax rate came out on a Q2 basis and even quite frankly how
it influences us on a year to date basis.
I think it's probably fair to say based upon what we see
right now, once again the securitizations can, you know,
influence the tax outcome as well as one is in effect
recapturing business from different parts of our
organization with different tax rates and then effectively
reallocating them to different jurisdictions with different
tax rates.
We saw that for example on the first quarter with our
(unintelligible) RE transaction where we took business from
higher tax rate environments in part or lower tax rate
environments rather, recaptured them into a higher tax rate
environment.
So that being the case, all that being the case, we would
anticipate that there will be a modest tax benefit coming
through the end of the year that could be impacted to a
larger extent by the securitization activity that runs
through the fourth quarter. So those are somewhat going hand
in hand.
The - in terms of '06, the tax benefit if you will as a - on
an operating basis when one takes out the impact of things
like the (Digby) 36 adjustment, realized gains, losses on
securities and the like, has been in general coming down. In
other words the benefit has been getting smaller relative to
pre-tax income. And we would anticipate that continuing to
be the case.
We had thought that we would be perhaps in a slight positive
position in terms of positive tax rate in 2005 but we were
able to more effectively structure the
SCOTTISH RE
Moderator: Scott Willkomm
11-04-05/10:00 am CT
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ING transaction from a tax perspective than we had
anticipated when our original models were prepared. So
taking advantage of those opportunities made a lot of sense
to us because that's real economic savings for the company.
The key thing for us is how much business is originated into
different tax jurisdictions. And as our international
business is growing, you know, relative to the organic
growth in the U.S., granted it's much smaller but it's
growing at a faster rate. A lot of that business is getting
written into lower tax jurisdiction entities such as our
Irish operations. So that will have an influence as well.
At the end of the day it's profitable business that we're
writing so in many respects we would anticipate the tax
benefit at some point decreasing to where it turns to a
positive tax expense although it has not happened as quickly
as we would have originally forecast.
John Nadel: That's extremely helpful. Thanks for that. And then just
following up maybe on one of Saul's questions on the quoting
activity Scott. You know, in terms of your comment about
achieving pricing objectives, I guess if - I could interpret
that or one could interpret that to mean that perhaps it's
getting a little bit more competitive.
Scott Willkomm: No not necessarily. You know, anecdotally in a given quote
you might see a slightly greater degree of competition from
one of your competitors than, you know, you would see in
another quote. And some of that may be based upon historic
relationships and the like.
So I think one of the nice things that we have experienced
and I'm sure our competitors have experienced as well over
the past couple of years, recent
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Moderator: Scott Willkomm
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years, has been a relatively high level of consistency among
reinsurance pricing. It's not as irrational perhaps as some
pricing was at the end of the 90s and even the first couple
of years of this decade.
We also have a - and I know that some of the direct
companies have suggested that they're not very happy with
this. But there's been a much greater consistency and rigor
if you will in things - in the context of terms of trade of
reinsurers. And it's probably overdue in many respects
although I know our customers are probably not totally
enthused with some of those initiatives.
Our view on pricing is it's robust across the industry. It
is consistent, it is informed by, you know, ever increasing
better data sets that we all have in our possession. And,
you know, really no complaints per se about the pricing
environment whereas had you asked the question four or five
years ago you would have probably gotten some different - a
different answer.
John Nadel: Understood. All right, thanks very much Scott. Thanks for
the complete answers. I'll let somebody else take a shot.
Thanks.
Scott Willkomm: Thanks.
Operator: Your next question comes from (unintelligible).
Man: Hi good morning. Could you update us on I guess the year to
date actual to expected mortality? And in the Asian
operations, you know, how significant is the up front cost
here, how quickly can you, you know, offset that with
ongoing premiums and revenues? And any thoughts about
ongoing concern of aggressive underwriting by primary
companies in this market?
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Scott Willkomm: I think maybe back to front Jeff. I think that, you know,
we're always being very diligent about underwriting, you
know, trends, standards, etc. by primary companies. We are
very, very active, you know, emphasize this -- very, very
active in auditing our customers. You know, our underwriting
and claims audit teams are effectively road warriors who are
out spending time in our customers' shops reviewing the
activity.
And quite frankly before we quote on business they're
evaluating the quality of the underwriting shop. And we
score those internally, we rate them effectively internally,
and that is a factor in how we look at pricing the economics
of the transaction. So we're very, very focused on that for
the reasons that your question implies.
With respect to the Asian operation, we are - we're not
spending a ton of dough although I will note that we already
generate a reasonable amount of premium from Asia that comes
through the London market. And some of the servicing of that
premium will be migrating to Singapore from London and that
will have some incremental efficiency over the not very long
term.
Secondly we are - even though we're not, you know,
officially opening our doors until the first of the year, we
are already actively looking at some very attractive new
business opportunities. And we are leveraging the
infrastructure that we have throughout the group such that
we can do our expansion into that market in a very, you
know, productive and profitable fashion.
With respect to the year to date mortality, (Cliff), do you
want to make a comment or two here?
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(Cliff): I have to say that, you know, as Scott mentioned before, the
quarter to date mortality is in line with expectations.
Unlike quarter two we did not experience the large number of
very high claims in the third quarter that we did in quarter
two. So again, you know, mortality is pretty much in line
with expectations.
Man: Okay and Scott if I could follow up on the underwriting
issue, as you've done the auditing, you know, how many
situations have you found where there's reason for concern?
Is there any overall trend or, you know, any issues
(unintelligible) by company basis?
Scott Willkomm: I think - obviously Jeff we're not going to drag out
individual companies' dirty laundry in this forum. But there
are only a very small - you can count them on one hand of
companies where we have identified in our - in the context
of our audits, you know, some things that we weren't too
keen on. Quite frankly I think in almost all cases those
companies are seeking to remedy those deficiencies.
You know, the way our audit process works, and this is the
same for our competitors I think as well, our team will go
in, they'll do their evaluation. They will then prepare a
report, sit down with the customer and their representatives
and go through it sort of like an exit interview process.
The customer will have the opportunity to respond to some of
the comments we're making.
Occasionally we find some things that need to be rectified
just, you know, sometimes you find out people aren't dead
who you thought were. Or, you know, something may have been,
you know, done just accidentally and those can just get
corrected in a rather quick fashion.
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I happened to read on the plane the other day the audit of
one company who's an excellent organization. There was a
$2000 difference on a very, very large (Trevy) relationship.
And, you know, so but we try to get down into the details
there and we try to audit, you know, the vast majority by
volume of our business in a given year.
And I think our customers find value in that because quite
frankly many of them are on the risk to a certain extent as
well. And, you know, in this concentrated environment of
short number of reinsurers, you want to maintain a high
level of candor with your business partners.
Man: Okay great, thank you.
Andrew Kligerman: Hello?
Scott Willkomm: Yes please?
Andrew Kligerman: Oh okay, you've got it. The operator didn't come through,
it's Andrew Kligerman. First Scott on the tax benefits, I'm
still not 100% clear on it because it added about 20% to
pre-tax income. So maybe at a later date maybe you could map
this out or graph out what exactly is going on. So that's
part one. Part two -- just a request there.
Part two, just want to get a sense of where you are on
capital. At year end your RBC or your S&P CAR ratio or
actually maybe even more recently, you've got about $1
trillion in force. You've got over $7-1/2 billion in assets.
Could you give a sense of RBC and the S&P CAR ratio?
Scott Willkomm: Well we don't do any IC RBC for other than our operating
subsidiaries that operate in the U.S. And those are both as
of the two major subsidiaries in the
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11-04-05/10:00 am CT
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U.S. were in excess of 250 RBC as of September. With respect
to the S&P ratio, we're well in excess of the S&P ratio. One
of the things that ...
Andrew Kligerman: Which ratio?
Scott Willkomm: The S&P ratio which is a customized ratio specific to the
organization that takes into account ...
Andrew Kligerman: You know, just - what would your - in excess of what number
on S&P CAR?
Scott Willkomm: Well the point is the S&P ratio that is used for us is a
customized ratio. It's not the standard ratio because there
are certain factors taken into account for our overseas
business as well as the unique animal of our negative
seeding commission which has the effect of counting as
capital. And so that would be - it would be hard to draw a
comparison to their published ratios because it is in
(unintelligible) same animal.
Andrew Kligerman: Got it, and then on the RBC then, your excess of 250. But I
think a lot of AA companies have 350 so is that what you're
aiming for, 350?
Scott Willkomm: Well the minimum we maintain in our regulated subsidiaries
in the U.S. will be around the 250 level. That's the minimum
that we maintain. We may end up having greater amount than
that of course but that's the minimum that we maintain. And,
you know, so that - we don't in an individual regulated
subsidiary necessarily have a target other than to be in
excess of the minimum.
Andrew Kligerman: Okay and then just shifting over to the ratios because they
kind of threw me off a bit this time again because I thought
that the - let me first start with the ING accounting issue.
Can you refresh us on what exactly happened in
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Moderator: Scott Willkomm
11-04-05/10:00 am CT
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the second quarter and why maybe to some degree it recurred
in the third quarter which is what I understand your new CFO
was just saying?
Scott Willkomm: I think that you're mischaracterizing this as an accounting
issue. The key factor, and it's the same thing we explained
last quarter, is allocating the new business premiums
between those that were issued - underlying policies that
were issued prior to the date of acquisition which was
December 31. So anything issued in '04 versus anything
issued in '05.
We at the beginning of the year made an estimate of the
premium that was issued in '04 versus '05. '04 is accounted
for under purchase GAAP accounting rules.
As we received increased information from our customers on a
policy level basis we got more info in the second quarter
and we made an adjustment for the allocation between '04
issues versus '05 issues which is a geographic issue on the
income statement. And that was roughly in the aggregate
something on the order of about a $15 million reclass.
In the third quarter we had some stragglers vis-a-vis giving
us some detailed information so we had about a $7 million
reclass. At the end of the day it's reclassification between
'04 issue year and '05 issue year. So if you do one of two
things, and you can take two analytical approaches here.
One which is difficult obviously for folks on the outside
world to do is to, you know, make these reclasses unless we
sort of walk them through with you to give you a sense of
what the normalized ratio is. Quite frankly the easier way
is looking at the past nine months ratio which is going to
remove some of that noise in terms of what's allocated on an
individual quarter basis.
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So if you look at the benefit ratio for the quarter, it's
75.1, more consistent if you will with the type of guidance
at the high end of the guidance we gave. But then again the
acquisition expense ratio is a little bit below the
guidance, about 18.8 on a year to date basis.
And if you look at the normalized numbers quite frankly,
normalized in the quarter was 74.6 on benefits and 17.1 on
acquisition expense. Comparing that to the nine months,
relatively consistent with where the nine months is coming
out.
So one of the great things will be after the end of this
year we won't have that type of noise from P-GAAP, from
purchase accounting. So we understand the frustration with
the analytical side of this if you will, but, you know,
trying to give some guidance and explain why there's noise
in that particular number.
Andrew Kligerman: Maybe Scott you could help me, you mentioned the Sage
administrative system and how efficient it is. Could you
maybe talk about how that might help avoid these errors?
Scott Willkomm: These are not errors Andrew. I think ...
Andrew Kligerman: (Unintelligible).
Scott Willkomm: These are not errors. The Sage quite frankly is dependent
upon, as any admin system is, the information that comes in
from customers. So when customers give us information
initially it's done on a summary basis. At a latter date we
will get electronic policyholder level data. We have upwards
of 14 million individual policy records for each of the
underlying pieces.
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So as we get that data from the customers we can update
these - the estimates that we make from the summary data
that they provide us. So the Sage is an admin system that is
dependent upon the information that comes from our customers
so it is not the oracle.
(Dean Miller): This is also a very unusual circumstance in trying to
predict a split between one year and the other year at the
very beginning after a recent acquisition. And typically
that split between issue year doesn't matter because it goes
into the same categories. But the P-GAAP was just a very
unique, one-time circumstance.
Andrew Kligerman: Okay, I mean, it - I guess in the end it's - you're
dependent on some of the volatility in your clients and
their reporting regardless of what system you have. And I'll
keep my eyes on the mortality going forward when the numbers
are clear. Thank you.
Scott Willkomm: Yeah, well I think also Andrew your comment on mortality, we
have to remember that the benefits ratio, one of the largest
pieces is change in reserves which isn't necessarily
directly driven by changes in mortality. So unfortunately,
you know, our reported benefit ratio in the second quarter
in our worst mortality month was low. A lot of that has to
do with somehow - the effect of the reserve change.
So but yes, we are and I think we've talked about this in
the past in public forums and the like, we are dependent
upon data from customers. As (Dean) mentioned it's usually
never an issue except in the context of an acquisition where
one needs to allocate between one basis of accounting and
another basis of accounting. So but we appreciate your
attendant eye on this.
Andrew Kligerman: Okay, talk to you soon.
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Moderator: Scott Willkomm
11-04-05/10:00 am CT
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Scott Willkomm: Okay.
Operator: Your next question comes from Al Capra of Oppenheimer.
Al Capra: Thanks, I'll try to be quick here. Just in terms of the
international business, I mean, that really appears to be
one of your future growth engines. Do you see any catalysts
in the near to intermediate term that can really get that
engine started?
Scott Willkomm: Yeah well I think there are two major catalysts Al and we
talked about it a little bit in our comments. One, the UK
market is really quite important to us. And we haven't
publicly announced it just yet but because literally we
haven't had the time to write the release and we will do so.
We have recently added a deputy CEO in the UK. (Dave Hal)
joins us from Swiss RE where he was in charge of pricing for
Swiss RE out of Zurich. (Dave) is, you know, extremely well
known also in the UK market where he spent quite a fair bit
of his career before moving to Switzerland. Eight years in
total in that market running the pricing shop at Swiss RE
who is the market leader. So we are very happy to have
(Dave) join our team.
The UK as is the case with all of the key markets in which
we see great opportunity, is influenced - the big catalyst
is regulatory change. Most recently the regulatory change
that's impacted the UK was the introduction of the
individual capital assessment framework, effectively an
economic capital framework for looking at one's statutory
solvency.
And it was introduced last year. It will be phased in
effectively over a period of years. Companies are now
looking at the relevant capital and reserving
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11-04-05/10:00 am CT
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bases under this new framework and that is changing how
companies look at the utilization of reinsurance.
Secondly, in the very near term in that market there are
basically nine guys in the market competing including
ourselves of which four are some of our principally non-life
brethren who have been actively pursuing the - some of the
annuity business and some of the protection business.
With the opportunities in the non-life space and the
post-Katrina market or post-Katrina non-life market, it
would not be entirely surprising to us to see some of our
competition in that market a little bit more focused on
their non-life book of business.
The other key thing - theme that's coming through is the FSA
is beating the pots and pans regarding diversifying counter
party exposure, specifically with respect to the use of
reinsurers. And historically business in the UK was done,
maybe there was one reinsurer, maybe there was a second one
taking a small sliver.
But now the FSA -- well actually for some time this has been
an under current in the market -- have been encouraging
diversification and have been providing some guidance to
that effect. So there are a lot of regulatory catalysts
helping to drive activity in that market and we have
enhanced our capabilities in terms of personnel in that shop
to pursue those activities.
The other piece is Asia. We already do a fair bit of
business in Asia through the London market. I think we all
know what's going on in Asia from an economic catalyst
standpoint. We also have regulatory catalysts. In Japan
which is the biggest life insurance market other than the
U.S., there's only a 1% session rate.
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11-04-05/10:00 am CT
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However we have some significant changes going on. You've
been reading in the paper recently about the privatization
of the (Compo) which is the postal service financial scheme
which includes half of all life insurance that is sold in
Japan. This governmental entity is being privatized. It's a
big cause, celeb for U.S. life companies who are active in
the primary market we believe will create incremental
opportunities for reinsurers in that market.
Secondly there are the regulation of - the unregulated
mutual sector in Japan which is called the (Keusi) sector.
That is rapidly progressing opportunities in the market. As
well as a market that we don't specifically play in but is
once again influencing capital utilization is the reserving
for variable annuities that have been sold in Japan.
We see similarly the evolution in China of a regulatory
regime that is, you know, currently relatively closed to,
you know, to western reinsurers but is rapidly opening up if
you will. So we think it's very important to be on the
ground in the market as these opportunities develop. We've
exhausted in many respects our ability to generate this
through, you know, the London market channel.
And longer term probably more on a three year horizon with
the roll out of Solvency II in Europe, we anticipate that
markets such as Germany, France, Spain, and Italy will be
quite attractive markets for many types of financial
services providers.
You can read in the paper today about how the private equity
guys are very active in Germany in the financial services
and insurance sectors today. Inevitably we will see the same
type of activity come through the reinsurance
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11-04-05/10:00 am CT
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space as well as probably general capital markets activity
as Europe puts the insurance industry on a new capital
footing.
So regulatory catalyst is one of the principal drivers here
and that's just a flavor of some of the ones that we
anticipate coming down the pike.
Al Capra: That's great, great color, thank you.
Operator: Your next question comes from Jeff Schuman of KBW.
Jeff Schuman: Just a clarification -- I think I followed most of your
answer to John's tax question but I wasn't quite sure if we
got to a bottom line for '06. Is the '06 you think going to
be positive or negative?
Scott Willkomm: I think Jeff it's - in some respects it's difficult to tell
right now but I think it will be probably a slight benefit.
A lot of that will be driven by some securitization activity
I think at the end of the day.
Jeff Schuman: A slight benefit in '06?
Scott Willkomm: Right.
Jeff Schuman: Okay and then on - back to the capital issue, obviously
you're still working on your capital plan. But in terms of
an equity raise, should we think of sort of $100 million
maybe as being the floor and that it could be larger to the
extent that you see a lot of growth opportunities? Is that
kind of the right way to think about it?
Scott Willkomm: Yeah, I think - in all candor, I don't think anyone gets out
of bed for less than $100 million these days.
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11-04-05/10:00 am CT
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Jeff Schuman: (Unintelligible).
Scott Willkomm: The - I think that would be the, you know, the sub-floor
probably.
Jeff Schuman: Okay so, I mean, would it take $100 million just to kind of
fill out the balance sheet for growth that you've already
realized or would that actually finance any additional
growth?
Scott Willkomm: I don't think it would finance a ton of additional growth
Jeff. I think I would be definitely looking something more
to the tune of the 200 mark, you know. And then it's really
a question of the growth outlook quite honestly.
Jeff Schuman: Right, right. Okay and then I was wondering, kind of an
ongoing issue, if you can give us your latest take on
primary company behavior. I think some of your competitors
are still holding pretty firmly to the view that primary
retentions aren't changing very much. Sometimes we get a
different perspective from the primaries. What's kind of the
- your up to the minute take on retention strategies?
Scott Willkomm: The up to the minute take. We do believe that in general
primary companies are retaining more risk. I'm not sure it's
going to be, you know, I mean, we have some, you know,
different outlooks here and there and everywhere because a
lot of this is anecdotal evidence.
You know, we've spent a lot of time talking with our sales
guys who are obviously out in the field. We've spent a lot
of time talking with some of our competitors, you know,
casually about their views with respect to this.
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Moderator: Scott Willkomm
11-04-05/10:00 am CT
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I personally think we're going to see companies retain more
risk in the near term. Some will do it under the, you know,
sort of guise of, you know, they have excess capital,
reinsurance rates are high, they can incrementally leverage
that excess capital for a period of time.
The second piece is some companies are thinking about there
may be alternative means a la securitization and other types
of things that they can access directly. We've seen a few
anecdotes of that. And inevitably we will see a few more of
those. There are enough investment bankers running around
the industry today that I would hope that there would be a
bit more to show for their effort.
Thirdly, I think that we have probably a situation where the
life companies are actually starting to pay more attention
to the life insurance business again. So I think that as
companies look at their longer term role as financial
services providers, you see some companies actually starting
to pay more attention to actual life insurance risks than
some of the other businesses that have been their areas of
focus for the past.
Now I think some interesting developments we see going
forward as well, I think this may be somewhat of a temporary
phenomenon for a couple of reasons. Let me give you a few
that we're observing.
One, I think we might all agree that we are going into a
credit crunch over the next three years. If you look at a
variety of prognostications out there, we are coming through
probably one of the most rosy credit cycles and starting to
go, you know, back up the hill to where credit will get more
expensive and more difficult to obtain.
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So the means of financing things like XXX reserves using
lesser expensive letters of credit or similar types of
facilities is going to get more expensive and there may not
be as much capacity out there as the banks start to pull in
their horns. We've seen that happen in the past through
other credit cycles.
Second, the likelihood of companies retaining more risk also
exposes them to a greater degree of mortality volatility.
And I think we all know that direct companies have not had
to contend with significant amounts of mortality volatility
for a very long time because they have seeded very large
portions of their term business over the years.
And we've anecdotally seen at least one company that had
retained more risk in recent history experience some
challenging mortality periods and seek to lay off some of
the business of the market.
Thirdly, as securitization becomes more efficient in terms
of cost and structure for reinsurers, eventually we may be
able to pass on some of those cost savings to our customers
and be even more competitive on a pricing basis than, you
know, as an industry were in the past.
So, you know, we in our experience see securitization slowly
but progressively getting a bit more efficient from a cost
perspective. And over the next 18 to 24 months that's likely
to, you know, continue.
So you have a number of different factors coming together to
I think change what is probably a short term phenomenon. But
we actually think people are retaining more risk. More guys
are going to an excess basis. We see changes in retentions.
Yet on the flip side we've been able to grow our business
quite substantially in that type of a marketplace.
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11-04-05/10:00 am CT
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Jeff Schuman: Okay, thanks a lot.
Operator: ... then press Star 1 on your telephone keypad. At this time
there are no questions.
Scott Willkomm: Well at this point we would like to thank everyone for
joining us today and we look forward to speaking with you in
about three months. Take care.
Operator: Thank you. Ladies and gentlemen this concludes today's
Scottish RE third quarter earnings release. You may now
disconnect.
END