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Third Point Reinsurance (NYSE:TPRE)
Q3 2019 Earnings Call
Nov 06, 2019, 8:30 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:


Operator

Greetings. Welcome to Third Point Reinsurance third-quarter 2019 earnings conference call. [Operator instructions] Please note, this conference is being recorded. At this time, I'll turn the conference over to Christopher Coleman, chief financial officer of Third Point Reinsurance.

Mr. Coleman, you may now begin.

Christopher Coleman -- Chief Financial Officer

Thank you, operator. Welcome to the Third Point Reinsurance Limited earnings call for the third quarter of 2019. 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 Dan Malloy, chief executive officer.

Before I turn the call over to Dan, 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 third-quarter 2019 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 believe 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 Dan Malloy

Dan Malloy -- Chief Executive Officer

Thank you, Chris. Good morning and thanks for joining our third-quarter 2019 earnings call. Today, I will provide the highlights of our financial results, followed by an update on underwriting strategy, other company developments and market conditions. Daniel Loeb, CEO of Third Point LLC, will then speak to the investment performance and, Chris will cover our financial results in more detail.

We will then open the call up for your questions. We reported a small net loss for the quarter resulting in a return on equity of negative 1.1%. Our year-to-date return for the nine-month period, however, is a positive 14.2%. Our diluted book value per share at the end of the third quarter was $14.76, representing a growth of 13.7% since year-end 2018.

Our combined ratio for the third quarter was 102.7%, which included catastrophe losses of $12.7 million or 6.2 percentage points. The cat losses incurred in Q3 were within our budgeted cat losses for the year-to-date period and were within expectations given the scope and scale of the events. We remain pleased with the progress we are making in expanding our underwriting platform and expect that 2019 underwriting year to be profitable. Given the catastrophe events in Japan and California over the last few months, however, we expect our calendar year reported combined ratio to drop below 100% in 2020 rather than the initially expected fourth quarter of this year.

We are very pleased to have announced last night that Joe Dowling, who serves as the chief executive officer of the Brown University investment office, has joined our board of directors. You may recall that Sid Sankaran, current CFO of Oscar Health and former CFO and chief risk officer of AIG, also joined earlier this quarter. We believe that both Joe and Sid will bring valuable insights and experience to complement the strength of our existing board and will help form our strategy designed to deliver value from both sides of our balance sheet. Now moving on to market conditions.

The build-out of our catastrophe portfolio went better than expected for 2019 based on all key planned metrics. We are pleased with our market exceptions to date, as we were signed on a number of well-priced accounts with top cedents. During the third quarter, we wrote approximately $6 million of property cat premium, bringing our total 2019 written in this class of business to $63 million. Going into 2020, we are watching the market dynamics in property catastrophe reinsurance and the retrocessional market very closely.

From what we are seeing, we expect to shape our portfolio away from retrocessional quota share treaties, which represent a little more than half of our property catastrophe premium for our 2019 portfolio toward a more retrocessional excess of loss and direct property catastrophe excess of loss portfolio, as we expect the risk return dynamics in those markets to present the most attractive opportunity for allocation of our property catastrophe aggregates. We think the shaping of our catastrophe portfolio as it enters its second year will further improve our metrics, and we also expect further improvement in the pricing of our renewal portfolio, which we also think is very likely. Our new specialty lines underwriting team that joined early in 2019 has written approximately $5 million of premium during the year. But as previously noted, their portfolio was heavily weighted toward January 1st business.

We expect this portfolio to contribute meaningfully to our goal of achieving underwriting profitability during 2020. Of note, market conditions in these lines remain stable. Our non-catastrophe business, which still represents the majority of our portfolio, continues to show evidence of improvement. We are benefiting both from primary market trends, which a number of CEOs have talked about during this earnings season, as well as improvement in reinsurance contract terms and conditions and increased demand for surplus relief transactions in the U.S.

market and capital quota shares at Lloyd's. Another theme this earnings season has been industry commentary on rising casualty loss trends in the U.S. We've been aware of the risk of increasing inflation or loss trend over the past several years and have considered that in our pricing reserving. While there is recognition in the market by some insurers that loss trends are increasing, the observed trend thus far on our own portfolio has been within pricing and reserving expectation, and we have not seen a significant acceleration in frequency or severity trends.

Additionally, our exposure to increasing loss trends is partially mitigated by the fact that much of our portfolio is proportional reinsurance of primary insurance business, where per occurrence limits are low. We also have a relatively less exposure to some classes have been more affected by the recent changes in trend, such as commercial auto and commercial D&O. After the investment changes we announced last quarter, our portfolio remains approximately one-third invested in the Third Point Enhanced fund and two-third in more traditional fixed income securities. And as discussed last quarter, this repositioning of our investments was prompted by the shift in our underwriting strategy designed to achieve our goal of delivering underwriting profitability as well as a more balanced contribution to our overall return from underwriting and investment.

We believe that we are well positioned to capitalize on underwriting opportunities, while still taking advantage of Third Point LLC's ability to outperform in managing our investments, which has always been the goal of our business model. We expect that delivering underwriting profits will build the franchise value of Third Point Re and allow us to close the gap on our discount to book value as we demonstrate the full potential of an optimized investment strategy combined with profitable underwriting. I will now hand the call over to Daniel Loeb, who will discuss the performance of our investment results in more detail.

Daniel Loeb -- CEO of Third Point LLC

Thank you, Dan and good morning. Third Point Enhanced LP, the Third Point Reinsurance investment portfolio, actively managed by Third Point LLC, was down 0.7% for the third quarter of 2019, net of season expenses. When combined with the company's fixed income portfolio, consolidated investment results for the quarter were minus 0.2%. Equity markets were broadly positive during the quarter.

The S&P 500 and MSCI World indices rose 1.7% and 0.7%, respectively. However, despite modest gains, the quarter was marked by tumultuous factor rotation, is positioned with momentum orientation, outperformed in August, but sharply reversed course in September in favor of lower quality value-oriented laggards. The funds equity portfolio and specifically its activist positions made the largest contribution to returns during the quarter, adding 370 basis points to performance. All of the funds top five winners for the quarter were active positions including Sony Corp, Baxter International, Campbell Soup, Nestle and a new position in EssilorLuxottica.

EssilorLuxottica, now the largest eye care company in the world, was the company formed in late 2018 through the merger of Essilor, the world leader in ophthalmic lenses, and Luxottica, the world leader in eyeglass frames and sunglasses. We expect this position to have meaningful upside over the next few years, as we work with management to continue an efficient and valuable merger across two best-in-class businesses. Gains in the long equity portfolio were partially offset by losses from the single-name short portfolio as the scale and suddenness of the factor rotation caught us offside in certain short positions resulting to 70 basis points in losses for the quarter. Year to date, the funds long equity portfolio is up 24% versus the MSCI World performance of 18.2% and net of its short position has added more than 900 basis points to return.

The credit portfolio cost to fund 70 basis points during the quarter, but has been a positive contributor to returns in 2019, adding 50 basis points to the fund year-to-date. Funds positioned in the unsecured debt of California utility, Pacific Gas & Electric has been a top 10 winner as bonds rallied 27% over the course of the year through September. Our largest loss in the third quarter was an Argentine sovereign debt on a surprising outcome in the August 11th presidential primary caused the panic in the capital markets, taking the bonds down approximately 50% and costing the funds 76 basis points during the quarter. Finally, our APS portfolio posted another positive quarter with an ROA of 2.5% bringing year-to-date returns to 10.7%.

At the outset of 2019, we communicated two clear objectives for the portfolio: one, a focus on alpha generation by concentrating on specialized strategies where we have an edge; two, a focus on both trade construction and portfolio construction to amplify idiosyncratic return and reduce systematic risk. As a result, our exposure has grown modestly in over the course of the year, but net equity exposure has come down. Throughout 2019, our net equity exposure for TPRE consolidated has averaged less than 30%. Despite the reduction in beta, the TPE portfolio has returned 16.9% in 2019, compared to the S&P 500 and MSCI World index returns of 20.6% and 18.2%, respectively for the same period.

The TPRE consolidated portfolio returned 10.2% for the first nine months of the year. As we look ahead, we expect to maintain consistent net exposure levels given where we are in the economic cycle and consideration of the upcoming U.S. presidential election. We believe our returns will continue to be driven by specific events in our activist portfolio as well as the spread of performance between our long and short portfolios.

We'll remain watchful for any signs of conflicting macroeconomic data that could impact our markets. We are pleased with the results so far this year. As of September 30th, the Third Point Reinsurance account represents approximately 16% of the assets managed by Third Point. Now, I would like to turn the call over to Chris to discuss our financial results.

Christopher Coleman -- Chief Financial Officer

Thanks, Daniel. For the third quarter, we generated a net loss of $15 million or $0.16 per diluted share. Our year-to-date net income was $171 million or $1.84 per diluted share. These amounts translate into a return on beginning equity for the quarter of negative 1.1% and a positive 14.2% year to date.

Our diluted book value per share at the end of the third quarter was $14.76, which was an increase of 13.7% from December 31, 2018. We generated a $5 million net underwriting loss for the third quarter and our combined ratio was 102.7%, compared to 104.9% in the prior year third quarter. As Dan noted earlier, our current quarter combined ratio included $12.7 million or 6.2 percentage points attributable to catastrophe events net of reinstatement premiums and profit commission adjustments. There were no cat losses in the prior year period.

This current period underwriting results included a benefit of $3.8 million from the net impact of favorable reserve development net of offsetting commission adjustments. The prior period included a $2 million benefit. After adjusting for the impact of reserve development and cat losses, there was a significant improvement in our core underwriting results, compared to the prior year period, as the shift in our underwriting strategy and business mix toward higher margin business is impacting the calendar year reported results. The ex-cat accident year combined ratio for the quarter was 98.4%.

Our gross premiums written for the third quarter was $95 million, which compares to $30 million in the prior year quarter. The increase in gross premiums written was primarily due to $159 million retroactive reinsurance contract written in the period. And as a reminder, retroactive reinsurance premiums are written and earned in the period of contract binding as well as recognizing a similar level of losses incurred. Those premiums written for the year-to-date 2019 was $498 million, compared to $458 million for the prior year's 9 months, an increase of 9%.

The increase in gross premiums written for the nine-month period was primarily due to $63 million of new property catastrophe business and $59 million related to one retroactive reinsurance contract. This was partially offset by contracts that we did not renew in the current year as well as the net impact of contract extensions cancellations and contracts renewed with no comparable premium in the comparable period. The net investment loss for the quarter was $3 million. Although net investment income was $221 million for the nine-month period, which reflects the returns for the period, which Daniel discussed in detail, including the impacts of investment mix shifts made during the second quarter.

The total general and administrative expenses were $9 million for the third quarter of 2019, compared to $10 million for the prior year period. The changes reflect generally offsetting amounts including a decrease in 2019 due to lower stock compensation expense and the impact on payroll of the recent departure of senior executives, partially offset by higher incentive plan accruals in the 2019 quarter from improved performance to date relative to the prior year period. For the nine-month period, general and administrative expenses were $41 million, compared to $29 million in the prior year period. The increase was primarily due to severance costs recorded in the second quarter as well as our overall higher payable-related costs due to increasing headcount to support our underwriting expansion as well as higher incentive plan accruals and share compensation expense reflecting both an increase in headcount as well as improved performance to date relative to incentive targets compared to the prior year periods.

During the quarter and thus far in 2019, we have not repurchased any of our common shares. We recognize that we've been trading at a significant discount to book value, which would suggest that repurchasing shares would be an effective tool for increasing book value and earnings per share in the short term. However, we're also mindful of the potential to significantly improve our valuation by investing in our underwriting platform, which, we believe, will drive franchise value and improve the quality of our earnings through consistent underwriting profitability, and more balanced contribution to overall returns between underwriting and investing and lower volatility of results. We thank you for your time, and we'll now open the call for questions.

Operator?

Questions & Answers:


Operator

Thank you. [Operator instructions] Our first question is from the line of Meyer Shields with KBW. Please proceed with your question.

Meyer Shields -- KBW -- Analyst

Good. Thanks. Good morning. So just a couple of quick ones.

First, it looks like cash and equivalents are about 25% of the invested asset portfolio. Is that the right level going forward?

Christopher Coleman -- Chief Financial Officer

Yes. I mean some of that -- I mean the easiest way, Meyer, to think of our investment account managed by Third Point is approximately one-third of the $2.5 billion is invested in the Third Point Enhance fund, with the remaining two-third invested in fixed income. Now depending on -- in the fixed income bucket, if some of that is in money markets and short-dated U.S. treasuries, which then end up mapping into the cash equivalent line on the balance sheet.

So some of it is just the sort of presentation difference. So it's either going forward, either expect to see some portion of that in cash equivalent, but over time, I think, you'd start to see a larger proportion of that show up within the debt securities line.

Meyer Shields -- KBW -- Analyst

OK. Yes, that's exciting. That makes sense. Can you clarify the line or lines of business in the third quarter retroactive reinsurance?

Christopher Coleman -- Chief Financial Officer

It's really just one contract, Meyer. It's with a client that we've supported in the past. And during the quarter, we had an additional reserve cover that we put in place.

Meyer Shields -- KBW -- Analyst

OK. I assume it's for something in the casualty world?

Dan Malloy -- Chief Executive Officer

It's actually primarily U.K. motor. And as you may recall, Meyer, we're not competing in the runoff space. So what this is, is a loss portfolio transfer with the motivating factor for the transaction being capital relief, where they're able to get capital credit for shifting reserves to us.

Meyer Shields -- KBW -- Analyst

OK. And then just one final question. I'm not really sure how to ask this, but how should we think about the catastrophe load associated with the property cat book and the specialty book that should start coming onboard more significantly in 2020?

Christopher Coleman -- Chief Financial Officer

Yes, I mean, I guess and I think your question was on just expectations for cat load impacting our results?

Meyer Shields -- KBW -- Analyst

Yes.

Christopher Coleman -- Chief Financial Officer

So I think probably, we've talked about the level of cat losses being -- that we've incurred year to date, being kind of roughly in line with sort of budget. And so if you quantify the impact of those cat losses over the year-to-date period, it's roughly 2.5 points. And so I would -- I think you could extrapolate that to a cat load of roughly two to three points of kind of a budgeted basis.

Meyer Shields -- KBW -- Analyst

That's perfect. Thank you so much.

Operator

Thank you. At this time, I'll turn the floor back to management for closing remarks.

Dan Malloy -- Chief Executive Officer

Well, thank you, everyone. Appreciate you listening into our call, and we look forward to talking to you in February.

Operator

[Operator signoff]

Duration: 26 minutes

Call participants:

Christopher Coleman -- Chief Financial Officer

Dan Malloy -- Chief Executive Officer

Daniel Loeb -- CEO of Third Point LLC

Meyer Shields -- KBW -- Analyst

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