Newswires

October 29, 2012 Newswires

VALIDUS HOLDINGS LTD FILES (8-K) Disclosing Other Events

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ITEM 8.01 Other Events.

On October 26, 2012, Validus Holdings, Ltd. ("Validus") hosted a conference call for analysts and investors to discuss Validus' third quarter 2012 financial results and related matters. During the conference call, representatives of Validus made certain statements relating to the pending Agreement and Plan of Merger, dated as of August 30, 2012, by and among Validus, Validus UPS, Ltd., Flagstone Reinsurance Holdings, S.A. ("Flagstone"), and Flagstone Reinsurance Holdings (Bermuda) Limited. A transcript of the conference call is set forth below.

    CORPORATE PARTICIPANTS

Jon Levenson Validus Holdings, Ltd. - EVP

Ed Noonan Validus Holdings, Ltd. - Chairman & CEO

Jeff Consolino Validus Holdings, Ltd. - President & CFO

Jeff Sangster Validus Holdings, Ltd. - EVP & CAO

CONFERENCE CALL PARTICIPANTS

Jay Cohen BofA Merrill Lynch - Analyst

Matt Heimermann JPMorgan Chase & Co. - Analyst

Ian Gutterman Adage Capital Management - Analyst

Ryan Byrnes Langen McAlenney - Analyst

Amit Kumar Macquarie Research Equities - Analyst

Michael Nannizzi Goldman Sachs - Analyst

Mike Zaremski Credit Suisse - Analyst

Brian Meredith UBS - Analyst

Matt Carletti JMP Securities - Analyst

  PRESENTATION  Operator

Good day, ladies and gentlemen, and welcome to the third quarter 2012 Validus Holdings Limited earnings conference call. My name is Shantalay and I will be your facilitator for today's call. At this time, all participants are in listen-only mode. We will be facilitating a question and answer session towards the end of this conference.

(Operator Instructions)

As a reminder, this conference is being recorded for replay purposes. I would now like to turn the call over to your host for today, Mr. Jon Levenson, Executive Vice President, please proceed.

Jon Levenson - Validus Holdings, Ltd. - EVP

Thank you. Good morning and welcome to the Validus Holdings conference call for the quarter ended September 30, 2012. After the market close yesterday we issued an earnings press release and financial supplement, which are available on our website located at ValidusHoldings.com. Today's call is being simultaneously webcast and will be available for replay until November 9, 2012. Details are provided on our website. Leading today's call are Validus Chairman and Chief Executive Officer, Ed Noonan; Validus President and Chief Financial Officer, Jeff Consolino; and Validus Executive Vice President and Chief Accounting Officer, Jeff Sangster.

Before we begin I would like to remind you that certain comments made during this call may be deemed forward-looking statements as defined within US federal securities laws. These statements address matters that involve risk and uncertainties, many of which are beyond the Company's control. Accordingly, there are or will be important factors that could cause actual results to differ materially from those indicated in such statements and therefore you should not place undue reliance on any such statements. More detail about these risks and uncertainties can be found in the Company's most recent annual report on Form 10-K and quarterly report on Form 10-Q, both as filed with the US Securities and Exchange Commission.

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Management will also refer to certain non-GAAP financial measures when describing the Company's performance. These items are reconciled and explained in our earnings release and financial supplement. With that, I turn the call over to Ed Noonan.

Ed Noonan - Validus Holdings, Ltd. - Chairman & CEO

Well, thank you, John. And thank all of you for taking the time to join us today.

It's been another outstanding quarter for Validus Group, reflecting both light catastrophe activity and the fundamental strength of our business model. We are very pleased to report an annualized return on average equity of 23.3% and a 19.2% annualized operating return on average equity during the quarter, as well as growth in book value per share including dividends of 6.1%. Our net income for the quarter was $207 million bringing our net income for the first nine months of the year to $499 million. Each of our operating businesses had excellent performance. Validus Re had a 51% combined ratio for the quarter and Talbot 83.2%. We benefited from a quiet catastrophe environment and a lower level of individual risk losses during the quarter, as well as $24 million in favorable development to Validus Re and $26 million in favorable development to Talbot. There was nothing out of the ordinary in our reserving activity and releases are in line with prior years.

Our AlphaCat subsidiary continued to gain traction in the market. Written premium was relatively light in the quarter, but investor response continues to be quite good. While this was a quarter with light catastrophe activity, our results are not simply the result of chance. We have positioned ourselves to be a significant player in the best price risk classes and are benefiting from two industry leading franchises we've built, along with people, platform in the technology to outperform in both good times and bad.

The other big development in the quarter is our announcement that Jeff Consolino will be stepping down as President and CFO effective February 15 of next year to join American Financial Group. Jeff has been a great partner in the development of our business and while I will miss his daily council, he will continue to provide his insight and advise as a member of our Board of Directors effective from our meeting next week. We will bifurcate Jeff's responsibilities with Jeff Sangster assuming the role of CFO. Jeff has been with us almost from the start and has been grooming for the CFO role over the last year as part of our normal succession planning. Many of you know him already from his investor relations work and our finance function will not miss a beat with Jeff's leadership.

John Hendrickson will join us as a Director of Strategy, Risk Oversight and Corporate Development. John has been a part of Validus since before we even wrote the plan to raise capital for the Company and has chaired our Audit Committee since our founding. John started his career as an investment banker to the industry, spent nine years with Swiss Re, including five on Swiss Re's Executive Management Board and founded his own merchant bank and advisory firm SFRi. John Hendrickson will also remain as our Board of Directors. We're very pleased to make these two appointments from within our Company, as it's a good indication of the depth and quality of management across the organization.

With John and Jeff Sangster we will continue to charge ahead with the same entrepreneurial culture and disciplined financial management that has made us successful. So, with that I would like to turn the call over to Jeff Sangster and Jeff Consolino to review our recent results in more detail.</p>

Jeff Consolino - Validus Holdings, Ltd. - President & CFO

Thank you, Ed. This is Jeff Consolino. As always, I'm pleased to be here to share our financial results with you. Before I introduce the customary discussion of our financial results, which again this quarter were superb, I also want to address the other press release from last evening, describing our planned CFO transition. As announced last evening and as described by Ed, in February, 2013 I intend to step down my role as President and Chief Financial Officer at Validus and transition my role at Validus from being a member of Executive Management to one of being a Board member.

I've been involved with Validus for over seven years. Ever since we commenced raising $1 billion in support of a business plan designed to bring much needed capacity to a market reeling from the losses of hurricanes Katrina, Rita, and Wilma. In this period we've gone from that business plan to the point where I parochially believe that we are the very best Company in our industry segment.

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This career decision for me is a profoundly personal one. Bermuda has been a wonderful place for my wife and I to raise our young family. However, when faced with the opportunity to relocate to the United States and work with another company that I have a very long history with, setting the Validus CFO succession plan into motion made the most sense to us. Most of you on this call know Jeff Sangster and many will know John Hendrickson. With this transition effected, I am confident that Validus will continue moving forward seamlessly.

Now onto the quarter. I'm going to review our financial results at the bottom line level. And then Jeff Sangster will provide the details of our results of operations and financial position. Our third-quarter net income available to Validus shareholders was $207.3 million. This is $2.11 per diluted common share. Net operating income available to Validus was $170.6 million or $1.74 per diluted share. Diluted book value per share at quarter end was $36.27. After considering the $0.25 per share dividend in the quarter, we grew by 6.1% from the second quarter diluted book value per share of $34.43.

Examining our shareholder value creation over a longer time frame, we've grown diluted book value per share plus accumulated dividends by 13.8% annually since formation and 13.4% annually since our July 2007 Initial Public Offering. Let me now transition this financial discussion to Jeff Sangster, who will share further details. Jeff, you are in.

Jeff Sangster - Validus Holdings, Ltd. - EVP & CAO

Thanks, Jeff. Speaking of more detail to the quarter's results of operation, full managed gross written premium increase by 2.1% to $399.5 million from $391.1 million. This is an increase of $8.3 million for the prior year's quarter in dollar terms. The increase is a result of increased gross premiums written in the Talbot segment offset by a reduction of managed premiums in the AlphaCat segment. Net operating income for the AlphaCat segment of $17.9 million increased by approximately $5.4 million or 43.7% from $12.4 million in the prior year quarter. The $12.4 million represents the Validus share of the total net operating income from AlphaCat Re 2011 in that quarter.

Both AlphaCat Re 2011 and AlphaCat Re 2012 contributed meaningfully in the quarter to the growth of our client franchise and they also contributed fee income to our bottom line from managed third party capital equal to $6.7 million per quarter. Our quarterly combined ratio was 69.9% including a loss ratio of 32.7%. During the quarter, we incurred two notable loss events. US drought of $22 million, representing 4.6 percentage points of a loss ratio, and hurricane Isaac of $15.2 million, representing 3.2 percentage points of a loss ratio. Accident year loss ratio excluding catastrophes and change in prior accident year was 35.4% compared to 51.3% in Q3 2011. Favorable development in the quarter was $49.8 million, which benefited the loss ratio by 10.5 percentage points.

Our gross IBNR at quarter end stands at $1.16 billion and our net IBNR at $1.05 billion. We allocated $13.7 million from the reserve for potential development on 2010 and 2011 events to Deep Water Horizon, the Tohoku earthquake, and Christchurch earthquake. As a result of the Deep Water Horizon allocation, the 2010 RDE balance had been fully allocated and we expect no future activity on the 2010 RDE. Our IBNR now stand at 46.8% of our $2.25 billion net loss reserve.

Beyond underwriting results, I am going to comment on our quarterly investment results, including the noncontrolling interest and our balance sheet. Our consolidated investment portfolio is $6.69 billion at September 30. This includes the consolidation of PaCRe's investments, for which there is an offsetting 90% noncontrolling interest. Net investment income for the quarter was $25.5 million for a quarterly annualized effective yield of 1.68%, a decrease of 1 basis point from the Q2 2012 annualized effective yield of 1.69%. In the quarter, we realized $9.1 million$86.3 million on a consolidated basis. This was driven primarily by the PaCRe investment portfolio, which contributed $62 million to the unrealized gain on a consolidated basis. The amount of PaCRe net unrealized gain, which was attributable to the noncontrolling interest, was $55.8 million, leaving a net bottom line gain attributable to Validus of $6.2 million. The duration of our investment portfolio continues to be short at 1.61 years as of September 30.

Our total stockholders equity at September 30 is $4.1 billion dollars and total capitalization is $4.64 billion. Our financial leverage remains very low with debt to capital at quarter end of 5.3% and debt and hybrids together as a percentage of capital of 11.6%. From June 30 through October 23 we have repurchased an additional 1,174,628 shares for an aggregate purchase price including commission of $38.4 million. We have $122.3 million remaining under our authorized share repurchase program as of October 23.

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We are on schedule to close the Flagstone transaction in the fourth quarter and plan to be back in the market with repurchases after closing. We will reassess our capital position after the close of the Flagstone transaction and the January renewal season. As our track record has shown, we will prudently manage capital, while maintaining the capital buffer and flexibility to pursue the market opportunities which may present themselves in 2013. Now, back to Ed.

Ed Noonan - Validus Holdings, Ltd. - Chairman & CEO

Thanks, Jeff. Let me give you some further color on our business, as well as the Flagstone integration, after which we'll be happy to take any questions you may have. Starting with Talbot, we continued to be in a good pricing environment, although by no means a hard market. Year-to-date we have generated rate increases across our portfolio of 3.3%. In general, classes that have sustained losses over the last few years are the best performing, with international property and onshore energy up by over 11%. Competition is not excessive in the short tail classes at Lloyd's, as our overall level of rate change by class ranges from negative 2% to positive 12%.

Given the general competitive environment and the state of the global economy, most of Talbot's growth in the quarter has come from rate increase activity. The global economic downturn has had a meaningful impact on shipping and commerce, consequently, there's less new business coming into the market. At the same time, Talbot's renewal retention ratio has increased materially. Our view of rate levels has caused us to be underweight direct and facultative property business for several years, particularly for US risks. We see rates now reaching attractive levels in some major markets. We would expect this to be a key growth area for Talbot going forward. We'll also continue to see growth from our emerging markets through our Miami and Singapore offices.

Turning to Validus Re, it was obviously an outstanding quarter, as you would expect, given the absence of CAT losses. We're very proud of our ability to generate underwriting profits in the worst of years, while delivering excellent results when CAT losses are low. Regarding loss activity in the quarter, Validus is not a major player in the crop market. We write a high layer excess of loss account, which is well diversified by state and peril. Our crop loss of $22 million was in line with our expectations and we believe we may see the chance to grow this book next year.

We are in the process of integrating the Flagstone portfolio as we speak. The integration is going very nicely, in large part due to the professionalism and cooperation of Flagstone's management. We will be renewing all businesses Validus Re starting at January 1. And I wanted to take a minute to describe the process by which we are building the combined portfolio. Our VCAPS system allows us to run our optimization routines across the combined Validus and Flagstone portfolio. Our goal is to maximize our underwriting profit relative to our risk constraints. This process yields the optimal portfolio by client and by layer and moves us out toward the efficient frontier. We know that as we go into the live market our outcomes will vary, but by having disciplined targets at such a granular level, our underwriters will be able to achieve the best possible outcome.

Toward this end the reaction from clients and brokers has been very gratifying. The thing we hear most often is clients desire that we keep our combined lines on their programs. Combining our deep research and analytic skills with responsive underwriting and a $5 billion plus capital base, makes us one of the most important markets for catastrophe risk in the world. Our ability to integrate our sidecars and top layer facility into customer solutions makes us a go-to market for clients and brokers. Finally, our dual rating upgrade this year reinforced the strength of our franchise.

As you know, we were significantly underweight AustralAsia earthquake risk before last year's events, as our geoscience research caused us to view rates as significantly inadequate. It's gratifying to see the industry come around to our view and adjust rates appropriately. We would observe, however, that the market does not seem to fully understand the change in seismicity arising from last year's events. This informs both our pricing and risk-taking and has caused us to make significant changes in our portfolio construction.

Despite being underweight in Asia, we enjoy excellent relationships with the major Japanese customers based on long-standing personal relationships, the quality of our analytical research and the consistency of the capacity we do provide. I spent some time in Asia over the last few weeks and thought it would be helpful to share some thoughts on the Asian market and our position there. Our Asian operations for both Validus Re and Talbot are based in Singapore, with catastrophe risk predominantly underwritten in Bermuda. Both operations are four years old and we have well-developed infrastructure with excellent people. Premium information is dominated by the Japanese and Australian accounts, although Southeast Asia and China are growing rapidly as you would expect.

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There is still a great deal of pro rata reinsurance bought in Asia and this is not typically a good fit with our appetite. Today, pricing in the Japanese market is generally quite sound. The Japanese ceding companies behaved exactly as one would've hoped post-event and reinforced the long-term nature of their relationships. Our position in Japan is quite strong, as we have paid our claims very quickly and we did not run from the market post-event like some other major reinsurers. Rather, we increased our capacity in Japan post-event. Across the Asian market, there is ceding companies whose claims from last year's event are not getting paid. The problem is predominately with local Asian reinsurers. As a result, there is growing concern over willingness to pay on the part of reinsurers. That benefits companies like Validus. Our size and claims paying performance make us a very attractive market.

Australia is the other well developed market in the region. This is much more of a trading environment and while prices are currently very good, Australia always seems to be prone to major reinsurers doing odd things with big capacity that tends to cap the prices in the market. In the past it was predominantly European reinsurers. However, the reinsurance market de jeur is one of the largest American-based reinsurers. Consequently, our Australian portfolio is more likely to be an accordion based on the competitive environment. Flagstone was also active in AustralAsia and we have ample capacity for the combined portfolio.

We broadly see a better rating environment than Asia, with the Chinese market continuing to develop and we will continue to grow our presence in the region through both Validus Re and Talbot of Singapore. More broadly, as you've heard us say before, we are firm believers in size and scale in the catastrophe business.

We see the catastrophe market undergoing structural changes that will make it significantly harder to compete as a generalist or smaller player. The Flagstone portfolio gives us the ability to meaningful grow our business in a period of sound pricing in an otherwise crowded market. We think all of this adds up to significant competitive advantage and will continue to yield superior returns to our shareholders.

Lastly on a more topical subject, I'd like to touch on hurricane Sandy and our best current view of potential outcomes. Any coastal landfall is likely to be in the form of a strong tropical storm or mild category one hurricane. There are a few factors that make this a potentially significant event. First, ocean temperatures off the eastern seaboard are a few degrees above normal for this time of year. Second, Monday is a full moon with astrological ties at their high level for the month. And finally, the energy associated with the complements of a very large storm interacting with a Canadian low-pressure system could yield extraordinary amounts of precipitation, mostly in the form of rain. These factors suggest potentially higher storm surge and beach erosion.

At this point the damage potential will arise from downed trees and loss of power, inundation along the coastline, and moderate levels of wind damage, with potentially serious flooding affecting commercial risks. As far as residential risk, we would expect losses to have similar attributes to hurricane Irene, some wind damage but with much of the residential loss not covered by private insurance due to loss from flood. One caveat is that like Irene, there's the potential for extracontractual exposure arising from governmental involvement in interpretation of insurance coverage, particularly as regards deductibles.

Our meteorological team views the likely landfall as being the Delmarva Peninsula. However, I would caution that there's a 200 mile margin of error for forecasts four to five days out, so the entire Northeast corridor is still in play. Using the best historic storm path proxies, we would expect that Sandy is unlikely to be a large economic event to the industry. And in the absence of other information between now and landfall, we'd expect it to be measured in the low to mid-single digit billions of insured loss.

Before taking your questions, I'd like to observe that this is Jeff Consolino's penultimate earnings call, so I'll wait until next quarter to fully pay him tribute. Therefore I'd ask that you refrain from spontaneous applause during Jeff's answers to your questions. Operator, with that we'll be happy to take any questions.

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QUESTIONS AND ANSWERS  Operator  (Operator Instructions)   Jay Cohen of Bank of America

Jay Cohen - BofA Merrill Lynch - Analyst

Thank you. A couple of questions. First one in Talbot, the acquisition costs ratio was quite a bit higher than it had been. I am wondering what's going on there?

Jeff Sangster - Validus Holdings, Ltd. - EVP & CAO

Hi, Jay, is Jeff Sangster. By way of background, Talbot receives their premium net of acquisition costs and during the quarter we re-examined our approach to estimating the gross up that we apply and in that process we applied a higher degree of precision, doing so at a contract level rather than at a line level. So, the result was a gross up of gross premiums written and acquisition costs in the quarter of $14.8 million.

This is a one-time only adjustment and has no bottom line impact. Impact on a forward basis the acquisition ratio impact should be minimal, as the re-estimation applies to several years. So, the $14.8 million over a period of about five years is relatively minimal and don't anticipate that changing estimations going forward.

Jay Cohen - BofA Merrill Lynch - Analyst

That's helpful. The second question, you look at the premiums written in Validus Re, and the growth rate has been pretty volatile. This was a bigger drop this quarter than we had expected. I'm wondering if you can give us some color behind that?

Ed Noonan - Validus Holdings, Ltd. - Chairman & CEO

Jay, our job is to construct a portfolio to maximize our expected returns relative to the acceptable level of volatility and some quarters that translates into very significant premium writings. Other quarters there's not as much business that hits our screens.

I wouldn't interpolate that into any particular trend line, so much as just the movement at July 1. Specifically, as we looked at our portfolio, we really started to back off just a bit on some of the national accounts types business in terms of its efficiency and utilization of capital across our whole portfolio. So, I wish I could tell you that I could give you a good kind of trend line to work from, but I think Validus Re is prone to having a bit of a lumpy business from time to time.

Jay Cohen - BofA Merrill Lynch - Analyst

 Got it, thank you.    Operator

Matthew Heimermann, JPMorgan

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Matt Heimermann - JPMorgan Chase & Co. - Analyst

I guess there weren't as many people standing in line to give Jeff props as I thought. (laughter) A question on Flagstone, Jeff. Can you give us a sense of how you might tweak that portfolio. My working presumption/assumption would be that they probably had more European exposure then you'd probably like to keep. . . .

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