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Third Point Reinsurance (TPRE 0.83%)
Q4 2019 Earnings Call
Feb 28, 2020, 8:30 a.m. ET


  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:


Greetings, and welcome to the Third Point Reinsurance fourth-quarter 2019 earnings conference call. [Operator instructions] Please note, this conference is being recorded. I will now turn the conference over to your host, Chris Coleman, chief financial officer.

Chris Coleman -- Chief Financial Officer

Thank you, operator. Welcome to the Third Point Reinsurance Limited earnings call for the fourth 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, our 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 earnings press release and the company's other public filings, where you will find risk factors that could cause actual results to differ materially from these forward-looking statements. In addition, management will refer to certain non-GAAP measures, which management believes allows for a more complete understanding of the company's financial results.

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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. I'm glad you can join the fourth-quarter 2019 earnings call. Today, I will provide the highlights of our financial results, followed by an update on the transition of our business model to a specialty reinsurer and conclude with a discussion of market conditions.

Following my talk, Daniel Loeb, CEO of Third Point LLC, will speak to our investment performance; and Chris will cover our financial results in more detail. We will then open the call for your questions. To start, we are very pleased with our results for the fourth-quarter and full-year 2019. For the 2019 fourth quarter, we generated a net income of $30 million, and our return on equity was 2.1%, bringing our full-year net income to $201 million and return on equity to 16.7%.

Our diluted book value per share at the end of the fourth quarter was $15.04, representing a growth of 15.9% since year-end 2018. Our combined ratio for the fourth quarter was 104.8%, which included property catastrophe losses of $16 million or 8.2 percentage points. We reported a small benefit from favorable reserve development in the quarter, and the fourth quarter of 2019 is now our 14th quarter in a row with no prior-year adverse reserve development. Our full-year 2019 combined ratio was 103.2%, an improvement of almost four points from last year.

We are encouraged by these results and the evolution of our business model, and 2019 was an important year of transition. Our new underwriting initiatives continue to benefit results, and we remain on track to deliver underwriting profitability in 2020. Over time, our goal is to deliver a combined ratio in the mid-90s, as we work to deliver value from both sides of our balance sheet by taking a prudent mix of underwriting and investment risk. As we deliver more consistent results over time, we expect to close the persistent discount that our shares trade to book value and our peer group.

Now let me turn to an update on the underwriting and current market conditions. The buildout of our property catastrophe portfolio went according to plan for 2019, and we recently completed a successful January 1 renewal cycle where we made further refinements to our property catastrophe book, resulting in an increase in expected profitability without assuming more aggregate catastrophe exposure. We have reshaped our portfolio away from retrocessional quota share treaties, which accounted for approximately half of our property catastrophe premium in 2019, toward more retrocessional occurrence excess of loss contracts as the risk-return dynamics in that segment of the market presented the most attractive opportunity for the allocation of our property catastrophe aggregate. Looking forward, we expect the catastrophe market to provide meaningful rate increases on April 1 and June 1.

Our new specialty lines underwriting team that joined during 2019 is now fully integrated and is contributing to our goal of achieving underwriting profitability in 2020. Their specialty catastrophe market is broadly flat, so we are proceeding conservatively in the buildout of this portfolio. It is worth noting that we do not have significant exposure to coronavirus as a result of this prudent buildout. Our noncatastrophe business, which still represents a majority of our reinsurance premium, continues to show improvement.

Since most of this business is pro-rata, we are benefiting both from primary pricing trends and from an improvement in specific reinsurance contract terms and conditions. We continue to reposition the noncat portfolio away from float generating, low-margin contracts toward business, which offers increased profitability and improving market segments. This shift in the mix of our noncat portfolio has and will continue to contribute to improving underwriting results. A continued theme this quarter has been industry commentary on rising casualty loss trends in the U.S.

We have been aware of the risk of increasing inflation or loss trend over the past several years and have considered that in our pricing and reserving. While there is recognition in the market that loss trends are increasing, and some firms have booked adverse reserve development as a result, the observed trends thus far in our portfolio have been within our pricing and reserving expectations. As we noted last quarter, our exposure to these loss trends is partially mitigated by the fact that much of our portfolio is proportional reinsurance of primary business where per occurrence limits apply. We also have relatively less exposure to some classes that have been more affected by the recent changes in trend, such as commercial auto and D&O.

I will now hand the call over to Daniel Loeb, who will discuss the performance of our investment results in more detail.

Daniel Loeb -- Chief Executive Officer

Thank you, Dan, and good morning. Third Point Enhanced LP, the Third Point Reinsurance investment portfolio actively managed by Third Point LLC, was up 5.1% for fourth-quarter 2019, net of fees and expenses, bringing 2019 returns to 22.9%. When combined with the company's fixed income portfolio, consolidated investment results for the quarter were up 2.4%, bringing the full-year return to 12.8%. In 2019, Third Point reoriented its investment strategy with an enhanced focus on portfolio construction.

We reduced net and increased gross equity exposure through thoughtful trade construction in activist positions and by increasing both individual shorts and portfolio hedges to dampen volatility and amplify idiosyncratic returns. Efforts to optimize portfolio management led to more alpha generation and less market exposure. We also focused on our core strengths, including activist investing and acquiring stakes in high-quality companies during significant market sell-offs. Activism, which is now over 50% of equity exposure, has been a source of outsized returns for Third Point's 2011 and has become a more valuable strategy in a changing market environment.

In 2019, the firm allocated additional internal resources to sourcing and implementing activist ideas and increased exposure to the highest level in the firm's history. We initiated three new activist investments in 2019, specifically, Sony, EssilorLuxottica, and Prudential. The top five performers for the year, Sony Corp, Baxter, Campbell Soup, United Technology, and Nestle, were all active as positions. And collectively, the activism portfolio accounted for over half, or 24.5%, of Third Point Enhanced total gross long equity returns of 41.9% for the year.

Within equities, strength on the long side was partially offset by losses in the short portfolio. Shorting was challenging in 2019 given the sharp rise of the stock market. Factor moves in the fall reversed alpha generated earlier in the year. Losses in shorting were roughly as expected, considering market performance, but the efforts succeeded in reducing overall volatility, data and correlation.

Credit investing has been an essential part of Third Point's investment strategy since its inception. The credit portfolio contributed 20 basis points to overall fund returns for the quarter but attracted 80 basis points from fund returns for the year. Losses from an outsized position in Argentine government debt offset gains in Pacific Gas and Electric corporate debt. Third Point had a good year in structured credit, specifically in RMBS securities that gave back some profits in marketplace lending.

Structured credit offers an important source of diversification and continues to generate strong risk-adjusted returns for Third Point. Looking at the year ahead, friendly monetary conditions and a benign economic backdrop drove the market higher in the early weeks of the year. These benign conditions quickly reversed themselves with the spread of the coronavirus. While we expect the market to normalize, for now, volatility will remain with us, so long as the corona situation is unresolved.

We remain focused on bottom-up fundamental investing, and we'll continue to monitor both the corona situation, as well as the upcoming elections. The portfolio remains more defensively positioned with lower net exposures when compared to historical exposure levels. In the meantime, the TPRE investment portfolio has defended well amid the recent volatility introduced by the coronavirus. As of December 31, the Third Point Reinsurance account represents approximately 6% of the $13.6 billion of assets actively managed by Third Point.

Please note that assets actively managed by Third Point include the main hedge funds, SPVs, and a drawdown vehicle, but excludes fixed income and collateral assets managed for TPRE. Now I'd like to turn the call over to Chris to discuss our financial results.

Chris Coleman -- Chief Financial Officer

Thanks, Daniel. For the fourth quarter, we generated net income of $30 million or $0.32 per diluted share. Our year-to-date net income was $201 million or $2.16 per diluted share. These amounts translate into a return on beginning equity for the quarter of 2.1% and 16.7% for the year.

We generated a $10 million net underwriting loss for the fourth quarter, and our combined ratio was 104.8%, compared to 111.6% in the prior-year fourth quarter. After adjusting for the impact of favorable prior-year reserve development and cat losses, our combined ratio for the quarter was 97.2%, compared to 98.4% in Q3 and 101.2% in Q2, which demonstrates the continued improvement in our core underwriting results as the shift in our underwriting strategy and business mix toward higher-margin business is reflecting in our reported results. As we head into 2020, we would expect to report underwriting profitability in the first quarter of 2020, subject to catastrophe losses exceeding expectations. As our underwriting strategy shifts, we expect underwriting to become a meaningful contributor to overall returns, more in line with our peers.

As Dan Malloy mentioned earlier, we believe this will drive a more balanced return contribution from underwriting and investment activities, which we believe will make our business model more attractive to investors and ultimately improve our valuation. Our gross premiums written for the fourth quarter were $134 million, which compares to $120 million in the prior-year quarter. The increase in gross premiums written was primarily due to $86 million of new premium written in the quarter, partially offset by the net impact of contract extensions, cancellations and contracts renewed with no comparable premium in the current quarter. Gross premiums written for 2019 was $632 million compared to $578 million for the prior year, an increase of 9%.

The increase in gross premiums written was primarily due to $93 million for two retroactive reinsurance contracts written in the period and $68 million of new property catastrophe business. This increase 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 that comparable period. Net investment income for the quarter was $62 million and was $283 million for the year, which reflects the returns for the periods, which Daniel discussed in detail, including the impacts of investment mix shifts made earlier in 2019. Total general and administrative expenses were $13 million for the fourth quarter of 2019, compared to $8 million for the prior-year period.

The increase primarily reflects higher incentive plan accruals in the 2019 quarter from improved performance to date relative to the prior-year period. For the 12-month period, general and administrative expenses were $54 million, compared to $36 million in the prior year. The increase was primarily due to severance costs recorded in the second quarter, as well as overall higher payroll-related cost due to increased headcount to support our underwriting expansion, as well as higher incentive plan accruals. Adjusting for normalized compensation and other unusual expenses impacting 2019, we would expect our G&A run rate per quarter going forward to be approximately $12 million to $13 million in total, split $7 million per quarter for G&A allocated to underwriting and included in the combined ratio, and $5 million to $6 million of corporate expenses.

The foreign exchange losses in the current quarter were primarily due to the revaluation of foreign currency loss and loss expense reserves denominated in British pounds, where the U.S. dollar weakened in the current period compared to the prior-year period. Although we have minimal net exposure to foreign currency movements from our foreign currency reinsurance contracts as we typically have collateral accounts with a similar amount of foreign currency investment assets as the net reinsurance liabilities, these generally offsetting FX gains and losses flow through net investment income and the reported investment returns. Turning to capital allocation and share repurchases, we did not repurchase any of our common shares again this quarter.

As we've stated throughout 2019, we recognize that we've been trading at a significant discount to book value, which would suggest that repurchasing shares could be an effective tool for increasing book value and earnings per share in the short term. However, we have chosen to invest our excess capital into improved underwriting performance, which we believe will drive franchise value and an improvement in the quality of our earnings through consistent underwriting profitability, a more balanced contribution to overall returns between underwriting and investing and lower volatility of results. We believe that these investments of our capital will ultimately improve our valuation and shareholder returns. We thank you for your time, and we'll now open the call for questions.


Questions & Answers:


Thank you. [Operator instructions] There are no questions at this time. I will now turn the call back over to management for any closing remarks.

Dan Malloy -- Chief Executive Officer

Thank you for listening to our fourth-quarter call, and we look forward to talking to you next quarter.


[Operator signoff]

Duration: 20 minutes

Call participants:

Chris Coleman -- Chief Financial Officer

Dan Malloy -- Chief Executive Officer

Daniel Loeb -- Chief Executive Officer

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