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Third Point Reinsurance Ltd  (NYSE:TPRE)
Q4 2018 Earnings Conference Call
Feb. 28, 2019, 8:30 a.m. ET

Contents:

Prepared Remarks:

Operator

Greetings, and welcome to the Third Point Reinsurance Fourth Quarter and Full Year 2018 Earnings Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. (Operator Instructions) As a reminder, this conference is being recorded.

I would now like to turn the conference over to your host, Mr. Chris Coleman, Chief Financial Officer, for Third Point Reinsurance. Thank you. You may begin.

Christopher S. Coleman -- Chief Financial Officer

Thank you, Operator. Welcome to the Third Point Reinsurance Ltd. earnings call for the fourth quarter of 2018. Last night, we issued an earnings press release and financial supplement, which is available on our website, www.thirdpointre.bm.

Leading today's call will be Rob Bredahl, President and CEO. But before we begin, I would like to remind you that many of the remarks today will contain forward-looking statements based on current expectations. Actual results may differ materially from those projected as a result of certain risks and uncertainties. Please refer to the fourth quarter 2018 earnings press release and the Company's other public filings, including the risk factors in the Company's 10-K, where you will find factors that could cause actual results to differ materially from these forward-looking statements. Forward-looking statements speak only as of the date they are made, and the Company assumes no obligation to update or revise them in light of new information, future events or otherwise.

In addition, management will refer to certain non-GAAP measures, which management believes allow for a more complete understanding of the Company's financial results. A reconciliation of these measures to the most comparable GAAP measure is presented in the Company's earnings press release.

At this time, I will turn the call over to Rob Bredahl. Rob?

J. Robert Bredahl -- President and Chief Executive Officer

Thanks, Chris. This morning, I would like to briefly review our results for the fourth quarter and full year 2018, and then spend time discussing market conditions and honoring initiatives that we are implementing to improve profitability. Danny will then discuss our investment results and Chris will cover our financial results in more detail. We will then open the call up for questions.

The fourth quarter of 2018 was a disappointing quarter. We generated a net loss of $298 million in the quarter, driven by a negative investment return of 11.4%, which resulted in net investment loss of $277 million. In addition, we incurred $18 million of cat losses related to the California wildfires and other fourth quarter events. For the full year, we generated a net loss of $318 million.

Now moving to market conditions. Although the industry experienced significant losses in 2017 and 2018, there continues to be significant underwriting capacity available, and market conditions remained challenging. While many market participants were hopeful that the significant cat losses over the past few years would lead to more attractive cap rising, improvements have been modest. We believe that cap rising on loss-impacted programs has improved, while pricing on other non-loss impacted contracts has remained broadly flat.

Outside of property cat reinsurance, in housing lines and where capital relief reinsurance structures are employed, we are seeing some improvement. Most reinsurers have been living off of cap profits during a long string of benign cat years. When cap portfolio results reserved over the past two (ph) years, reinsurers have been pushing for improvements across their entire portfolio. And interestingly, they seem to be sticking more in the non-cat areas versus the cat-related lines of business.

As we talked about for several quarters, we continue to build out our underwriting platform and gradually shift our underwriting portfolio to higher-margin business to help drive down our combined ratio below 100. As previously mentioned, we started rating property cat at January 1, 2019, and we had already expanded our ratings at various high-margin specialty lines in 2018.

In our cat portfolio, we are targeting $45 million to $50 million of premium this year, 2019, and we'll concentrate this premium on the higher-margin peak exposure zones. We've already written $40 million of premium at January 1, and we expect to add some additional for (ph) the cap premium at June 1. The execution of the plan has gone very well with our access to business, portfolio metrics and premium written all better than we expected.

During 2018, we added experienced senior underwriters with strong market relationships to our team, and we've recently hired a specialty lines underwriting team in Bermuda that will join us mid-year 2019 to accelerate our shift to higher-margin business.

Please note, however, that we would still expect that our total risk limits, PMLs and underwriting volatility to remain lower than many of our reinsurance company peers.

The last item I'd like to touch on is our developing strategy to make small investments in insurance companies and managing general agents in exchange for access to attractive reinsurance premium. This approach has proven to be a great way to leverage our underwriting and capital markets expertise to structure and offer capital alternatives in numerous forms and combinations. These include equity, debt and reinsurance offerings.

We made one small investment in an auto company in the first quarter of 2019 in exchange for a ROFR, a right of first refusal, on the reinsurance program at several other conversations that, we believe, will lead to improved access to profitable books of reinsurance business.

Before I hand off the call to Daniel to update you on the investment results, I wanted to first reaffirm our belief that Third Point LLC is an excellent partner and although the returns have not been what either of us have come to expect, we continue to work closely with Third Point LLC to improve our financial results.

We announced last night with our earnings release that we have amended our limited partnership agreement with the Third Point Enhanced fund to lower our management fees from 1.5% to 1.25%.

In addition, we are working with Third Point to possibly reallocate investable cash to Third Point affiliated credit funds that recently have been formed or soon will be formed. We believe these new funds will help diversify our investment portfolio, lower the volatility of our results and free up some risk capital for our underwriting activities.

I will now hand the call over to Daniel Loeb who will discuss our investment results in greater detail.

Daniel S. Loeb -- Chief Executive Officer

Thanks, Rob, and good morning. The Third Point Reinsurance investment portfolio managed by Third Point LLC was down 11.4% for the fourth quarter of 2018, net of fees and expenses, bringing year-to-date returns to minus 10.8%. In comparison, the S&P 500 was down 13.5% and 4.4% over the same periods. The Third Point Reinsurance account represents approximately 16% of assets managed by Third Point.

Performance for the year and quarter were just disappointing. This was the fourth time in 24 years that we lost more than 1% at calendar year and only the second time that we have lost double digits. We took the opportunity to learn from our mistakes and have made improvements to portfolio and risk management, optimize some of our processes and restated our competitive advantage as investors in today's markets. We have invested for long enough to know that years like '18 plant the seeds for innovation and new investment opportunities and are usually inflection points in this business. With 2018 behind us and the balanced portfolio of securities that we think have embedded catalyst-driven value, we expect to deliver better results.

In 2018, too much exposure to unhedged, long cyclical equity investments, especially heading into the fourth quarter, and one large miss in merger arbitrage accounted for substantial portion of our negative returns. Given our domestically concentrated portfolio, we were perhaps too focused on the fed and US data and missed signs of a potential turn in the business cycle prompted by weakness outside the US.

In Q4, our equity book was down 18.8% on average exposure. Negative performance was driven by a sell-off in many core equity long positions. Our dedicated single-name short portfolio generated an ROA of 20% last year. The exposures were too modest to materially offset the declines in our long book. We've added new team members dedicated to shorts over the last 12 months and expect us to continue to be a core area of focus and increased exposure moving forward.

In credit, performance for the year was mixed as gains from our structured and sovereign portfolios were offset by losses in corporate credit. Our corporate credit portfolio was down 12.1% on average exposure in Q4, largely driven by a dislocation in energy. Our sovereign credit portfolio returned positive 1.6% and 12% for the quarter and year, respectively. Finally, our structured credit portfolio detracted modestly in Q4 with returns of minus 1.4%, but generated an ROA for the year of nearly 10%, approximately 8% more than the HFN mortgage index return for 2018.

Investors have asked us two questions often in the past few months. The first is whether last year was a blip in the market or the end of an era, despite this year's run-up. We think it marked a beginning in markets as QE comes to an end. While QE drove risk assets steadily upward, many investors, including us, initially missed the meaningful shifts in markets that were happening under the surface. In an ETF and quantitatively driven world, fundamental investing still has an important place, but it has to be done differently. Over the past three years, I've invested more on our business than ever before. We brought on teams in dedicated shorts, as I mentioned, and in data analytics, risk management and portfolio structuring. We recently hired a capital markets specialist. Each of these areas provide essential information in evaluating both individual investments and portfolio construction.

Investors have also been curious about our views on the potential for an implosion in corporate debt. The stress credit investing has been enormous profit center for Third Point since our inception, and we're eagerly awaiting the next credit cycle. We see a few areas of potential future opportunity today, mainly in BBB securities and CLOs, but there's nothing to suggest massive defaults are imminent. Our flexible investment style and team of asset class specialists allows us to deploy capital rapidly when we see attractive opportunities. We have added over $0.5 billion of credit exposure during the first few weeks of this year. We expect to have more one-off chances to add to corporate credit, some additional opportunities in sovereign bonds and additional gaps to take advantage of -- in structured credit this year. And when bonds sell off, we are ready for it.

Looking forward, we believe that our current more moderate positioning is appropriate for this market. We expect volatility will reemerge and we plan to benefit from being providers of liquidity during despair and euphoria, something we have done well throughout our history. We remain focused on Third Point's competitive advantages that can generate alpha where machines cannot, including identifying mispriced intrinsic value securities, short selling, activism and investing across the capital structure and into credit opportunistically.

Now I'd like to turn the call over to Chris to discuss our financial results.

Christopher S. Coleman -- Chief Financial Officer

Thanks, Daniel. As a result of the net loss that Rob mentioned earlier, our diluted book value per share ended the year at $12.98, which was a decrease of $2.62 or 16.8% from September 30, 2018, and a decrease of $2.67 or 17.1% from December 31, 2017. The result of the net investment returns discussed by Daniel was an investment loss of $277 million for the fourth quarter and $251 million for the year.

Our gross premiums written for the fourth quarter was $120 million, which was a decrease of $44 million from the prior year's fourth quarter. Gross written premium for the full year decreased by $63 million or 10% to $578 million from $642 million in 2017. The lower gross premiums in the fourth quarter primarily related to certain contracts written in the prior year period on a multi-year basis with no comparable premium in the current year period. This decrease was partially offset by new contracts bound in the current year period, including one reserve cover for $70 million that was written and earned in the fourth quarter.

We generated a $24 million net underwriting loss for the fourth quarter, and our combined ratio was 111.6%, compared to 107.1% in the prior year fourth quarter. We recorded $18.5 million of cat losses or 8.8 percentage points on the Q4 combined ratio related to the California wildfires and other catastrophe events compared to no catastrophe losses in the prior year period. Although we have not specifically written property catastrophe contracts in 2018 or in prior years, we were exposed to California wildfire losses through liability reinsurance of the utilities in California. Based on the information we have available, we recorded $11.3 million of losses related to the liability exposure from the California utilities, representing our full limits exposed on the effective contracts.

The remainder of the catastrophe losses related to exposure on two Florida homeowners' contracts related to Hurricane Michael and two whole account reinsurance contracts. There was a small favorable impact of prior year reserve development in the quarter and year-to-date on our net underwriting results.

As Rob mentioned earlier, we expect our combined ratio to gradually improve, primarily due to a shift in business mix beginning in 2019. We expect that our 2019 underwriting year combined ratio will be below 100% and that our calendar year combined ratio will continue to decrease as the earnings from the property cat portfolio and other higher-margin business written in 2019 earned through our financial results.

Total general and administrative expenses for the fourth quarter of 2018 were $8 million, compared to $14 million for the prior year period. Total general and administrative expenses in 2018 were $36 million, compared to $53 million for 2017. The decreases were primarily due to lower annual incentive plan compensation expense accruals, which is based on a formula derived from certain financial performance metrics, partially offset by higher stock compensation expense and professional fees. The increase in professional fees was primarily due to legal and accounting fees incurred in conjunction with the investment restructuring.

During the quarter, we reduced the amount of share repurchases, given the significant net losses and reduction in our overall capital position. As a result, we purchased only 526,000 common shares in the open market for approximately $5 million at an average price of $10.13 per share. We continue to believe that buying back shares below book can be an effective use of our capital, subject to maintaining an appropriate level of capital and other risk management considerations. We currently have $61 million remaining under our current authorization.

We thank you for your time, and we'll now open the call for questions. Operator?

Questions and Answers:

Operator

Thank you. At this time, we will be conducting a question-and-answer session. (Operator Instructions) Our first question comes from the line of Michael Phillips with Morgan Stanley. Please proceed with your question.

Michael Phillips -- Morgan Stanley -- Analyst

Thank you, and good morning, everybody. Rob, just a quick first one for you. I think you said in the property cat business for 2019 around $45 million to $50 million, and this could be from running (ph), but that sounds a little bit higher than what you said previously. Is that running? Or is that intentionally a little bit more than what you were thinking earlier?

J. Robert Bredahl -- President and Chief Executive Officer

Yes. I think we said $40 million to $50 million a couple of earnings calls ago. And so it's coming a little bit higher, but still within the range I indicated.

Michael Phillips -- Morgan Stanley -- Analyst

Okay. So nothing more aggressive there given your comments of the expected pricing going on there?

J. Robert Bredahl -- President and Chief Executive Officer

No. I would say that our access to the market was better than we expected. The deal flow was pretty good. And of course, some of that had to do with the losses in the fourth quarter. Also, we heard often that companies are pushing back from the collateralized markets. They just prefer rated paper where they don't have to deal with collateral and collateral leases and dealing with tail risk. And so that was somewhat of a pleasant surprise.

Michael Phillips -- Morgan Stanley -- Analyst

Okay. Okay, thanks. Given all the changes in kind of a mix with the excess of loss in the property cat and the specialty business that you're looking to get into throughout the year, what impact do you see on -- I guess, going forward on your acquisition ratio?

J. Robert Bredahl -- President and Chief Executive Officer

Yes. Why don't you take that, Chris?

Christopher S. Coleman -- Chief Financial Officer

Yes. I mean, I think as we've talked about a number of times in the past, we don't typically overly focus on the component parts of our composite ratio. And as we look at our business, it's really driven more from an aggregate composite ratio. And again, in the opening remarks, we made the point that, as the earnings from the new cat business and the other higher-margin business that we expect to begin writing in 2019, we expect our overall composite and combined ratio to come down on an underwriting year below 100.

Having said that, certainly, the property cat XOL business that we expect to write will have a more typical 10, 11 point type acquisition cost ratio. So you may see over time the acquisition cost ratio component to drift down based on a mix of business with more XOL.

J. Robert Bredahl -- President and Chief Executive Officer

Yes. And Michael, so the quarter share contracts that we focused on primarily up until recently had ceding commissions that probably average 30% to 32%. Excess treaties are more like 10%. And so the acquisition costs should come down as we shift the portfolio away from quarter share and more to excess.

Michael Phillips -- Morgan Stanley -- Analyst

No. Great. Thanks. I appreciate that. And I guess, lastly, if you -- as you shift and try to write more of the excess of loss business, can you provide just a little bit more color on kind of maybe the type of warrants you're looking at there and what you're seeing from the primary folks and what they're doing what the pricing and loss trends are like in those lines you're focusing on?

J. Robert Bredahl -- President and Chief Executive Officer

Sure. Maybe I'll start with the sort of lines we plan to write going forward. I've mentioned, well, I guess, in the earnings script as well as in our numbers release last night that we hired a specialty underwriting team in Bermuda. And they write a relatively eclectic portfolio. So it's workers comp cat, some cyber, some terrorism political risk, some class, some personal accident insurance. So we expect that group to write $20 million to $30 million of premium next year. Most of their business is January 1.

And then I was looking through our recently completed deal list and work in process list, and we have all sorts of different forms of transaction liability. We wrote some title insurance, some RBI. We wrote some of our first surety treaties, very small. We're looking at commercial auto. There's been a big price adjustment in commercial auto. We're not sure if it's big enough yet, but we're looking at it. Some Marine.

So it's a big list of true specialty lines and a lot of that's new, lot's growing. And then you ask what are we seeing from our clients. Still, despite that long list, most of our business is still in the form of casualty treaties. And there's really two layers to my comments on pricing and terms and conditions. On the underlying business, where the primary companies are writing, they're getting rate and you've seen that in the earnings release. They are getting rate. The question is, are they staying ahead of loss trends? They think so. We think maybe probably. But then, there's another layer of pricing and it's the reinsurance terms, which sit on top of that.

And reinsurance ceding commissions, that's the price variable on quota share contracts, went up for many years in a row, but they've come down over the last couple of years. And so the combination of maybe some improvement on the underlying with an improvement in the closure terms, we believe, gives us improvement of 1 or 2 points on those closure deals.

Michael Phillips -- Morgan Stanley -- Analyst

That's great. I'll wrap. Thank you very much for the color. Appreciate it. That's all I have for now.

Operator

Thank you. (Operator Instructions) Our next question comes from the line of Meyer Shields with KBW. Please proceed with your question.

Meyer Shields -- KBW -- Analyst

Great. Thanks. Good morning, all. Rob, can you give us a sense as to your PML as of January 1?

J. Robert Bredahl -- President and Chief Executive Officer

We're not going to be super specific in handing out PMLs. Our PML, as we benchmark against traditional companies and as we plan and project it, we believe, will come in to be about half of the average reinsurance company.

Meyer Shields -- KBW -- Analyst

And that's as a percentage of tangible equity?

J. Robert Bredahl -- President and Chief Executive Officer

We're looking at it as a percentage of tangible equity.

Meyer Shields -- KBW -- Analyst

(multiple speakers)

J. Robert Bredahl -- President and Chief Executive Officer

And the data that's out there is typically the one in 100 PML worldwide per occurrence, and that's where we're benchmarking against.

Meyer Shields -- KBW -- Analyst

Okay. You talked a little bit -- I think (inaudible) my question about ceding commissions. Was there another step-down at January 1?

J. Robert Bredahl -- President and Chief Executive Officer

Yes. We saw continued improvement. We saw a little bit of improvement last year. And I want to moderate my comments; a little improvement. I don't think we had a ceding commission go up on a renewal. I'm looking around the table at some of my senior underwriters. And so no ceding commissions went up. Some of them came down slightly.

Meyer Shields -- KBW -- Analyst

Okay. So that's hobbled in the right direction. And then final question. Can you give us a sense as to the tail on the retro contract written in the fourth quarter of last year?

Christopher S. Coleman -- Chief Financial Officer

I mean, I think, in detail, in terms of the loss reserve kind of estimated duration of those reserves?

Meyer Shields -- KBW -- Analyst

Yes.

Christopher S. Coleman -- Chief Financial Officer

I would say, on average, about five years, and that's probably pretty representative of the reserve covers that we've written in the past. They typically end up with an average liability duration of about five years.

Meyer Shields -- KBW -- Analyst

Okay. Excellent. Thank you so much.

Operator

Thank you. (Operator Instructions) Mr. Bredahl, there are no further questions at this time. I'll turn the floor back to you for any final comments.

J. Robert Bredahl -- President and Chief Executive Officer

Thanks, everybody, for your time. We look forward to talking to you next quarter. If there's any questions in the meantime, please give us a call. Bye-bye.

Operator

Thank you. This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.

Duration: 27 minutes

Call participants:

Christopher S. Coleman -- Chief Financial Officer

J. Robert Bredahl -- President and Chief Executive Officer

Daniel S. Loeb -- Chief Executive Officer

Michael Phillips -- Morgan Stanley -- Analyst

Meyer Shields -- KBW -- Analyst

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