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Q1 2007 Scottish Re Group Limited Earnings Conference Call - Final
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| Copyright: | CCBN, Inc. and FDCH e-Media, Inc. | | Source: | FD (FAIR DISCLOSURE) WIRE | | Wordcount: | 8774 |
OPERATOR: Good morning. My name is Shawanna, and I will be your
conference operator today. At this time I would like to welcome
everyone to the first-quarter 2007 Scottish Re earnings conference
call. (OPERATOR INSTRUCTIONS).
Thank you. It is now (technical difficulty)-- to your host, Mr. Paul
Goldean. Sir, you may begin your conference.
PAUL GOLDEAN, PRESIDENT & CEO, SCOTTISH RE GROUP LIMITED: Thanks,
operator. Good morning, everyone. Thank you for taking the time to
join us this morning, and we look forward to presenting our results
for Q1 2007.
Before we begin today's presentation, let me remind all listeners
that certain statements included in today's presentation are
forward-looking statements within the meaning of the federal
securities laws, and management cautions that forward-looking
statements are not guarantees. Actual results could differ materially
from those expressed or implied in the forward-looking statements,
and we expressly incorporate the risk factors contained in our
Company's SEC filings. There will be a recording of this call
available after 10:30 AM today running through May 23, 2007.
Instructions on how to access the reply are included in your
conference call invitation with today's earnings release.
Also, a replay of the call can be accessed on our website at
www.ScottishRe.com.
Let's start with the earnings call itself. During today's prepared
remarks, we will focus on the following three areas. First, the
closing of our transaction with MassMutual and Cerberus; second, a
summary of our financial results for the first quarter ended March
31, 2007 and expectations for the remainder of 2007; and third and
finally, an update as to key business issues such as the financing of
our existing new business production and other items.
Following our prepared remarks, we will open up the phone lines for a
question-and-answer session. Let me now begin with our prepared
remarks by stating how pleased I am regarding the closing of our $600
million equity investment transaction with our new majority
investors, MassMutual Capital and Cerberus. As a brief reminder of
the specifics of the transaction, MassMutual Capital and Cerberus
each invested $300 million into Scottish Re in exchange for 1 million
newly issued convertible preferred shares, which can be converted
into 150 million ordinary shares at any time and automatically on the
ninth anniversary if not done sooner.
MassMutual Capital and Cerberus now hold a combined 68.7% of the
voting power of Scottish Re and have appointed our new Board of
Directors. The completion of this transaction provides Scottish Re
the capital and liquidity necessary to support our business on a go
forward basis and also allows us to concentrate our full attention on
re-establishing Scottish Re as one of the top global Life Reinsurance
companies.
Scottish Re will continue to be independent and trade on the New York
Stock Exchange. As noted in our press release Monday, our new Board
of Directors consists of three MassMutual members, three Cerberus
members, three independent directors, a Cypress Group designee and
myself as CEO. This new Board of Directors brings an immense amount
of business and industry expertise and will be actively involved in
the business providing the direction, support and oversight necessary
for Scottish Re to be successful in the future. Some of the key
objectives of the new board and management will be to re-establish
Scottish Re's presence in the market, create a culture of
accountability within the Company, alignment of the Company and
employee goals, and finally and probably most importantly, a focus on
operational excellence.
An important part of our future success will be the improvement in
our credit ratings over time. We believe that we have strategies in
place that will allow us to earn new business prior to regaining an A
level rating, and we are working closely with our clients to ensure
them that Scottish Re is a reinsurer that they want to do business
with. We have met with several of the rating agencies in the past
several weeks. Some of those rating agencies have already increased
our ratings, and we expect our ratings to continue to improve over
the mid-term now that the Company is well capitalized and as we
continue to demonstrate that we have the people, processes and
systems to mitigate the earnings volatility experienced in the past
year.
In closing my remarks regarding MassMutual Capital and regarding the
MassMutual Capital and Cerberus transaction, I would like to
summarize by saying we're looking forward to working closely with our
new majority investors to return the Company to its position as a
leader within the reinsurance industry and provide long-term value to
our shareholders and clients.
Now let me turn the call over to Dean Miller, our Chief Financial
Officer, who will walk you through the financial results for the
first quarter. Dean?
DEAN MILLER, CFO, SCOTTISH RE GROUP LIMITED: Thank you, Paul. Last
night Scottish Re reported a net loss available to ordinary
shareholders for the three months ended March 31, 2007 of $35.5
million or a loss of $0.55 per diluted ordinary share as compared to
net income available to ordinary shareholders of $11.6 million or
$0.20 per diluted ordinary share for the prior year period.
Net operating earnings or loss is a non-GAAP financial measure which
is net income or loss adjusted for the after-tax impact of realized
gains or losses in the change in value of embedded derivatives. The
net operating loss available to ordinary shareholders for the three
months ended March 31, 2007 was $36.5 million or a loss of $0.57 per
diluted ordinary share as compared to net operating earnings of $14.3
million or $0.25 per diluted ordinary share for the prior year
period.
As of March 31, 2007, our fully converted book value per share was
$14.81. On a pro forma basis, reflecting the $600 million equity
investment by MassMutual Capital and Cerberus, our fully converted
book value per share is $7.36.
I would now like to take a moment to review the most significant
factors impacting the first quarter. All amounts in my following
discussion are on a pre-tax basis. Premiums earned in the first
quarter of 2007 increased 2% to $458.2 million compared to $449
million in the same period in 2006. The increase is primarily related
to our international segment with the impact of new UK protection
treaties won in 2006 of approximately $9 million, partially offset by
reduced premiums on canceled business in other regions.
In addition, first-quarter 2006 international segment premiums were
negatively impacted by $9.6 million related to various client
adjustments. In our North America segment, 2007 premiums were
negatively impacted by lower new business and higher retrocessional
premiums which reduce our earned premiums. North American traditional
new business for the first quarter of 2007 was $7.6 billion compared
to $15.5 billion in the first quarter last year due to the impact of
our credit rating downgrades in the second half of 2006. 2007
represents new business mostly on open treaties and not new treaty
wins. Although our new business volumes are understandably low, we
have experienced virtually no terminations of new business or treaty
recaptures with the exception of one UK annuity treaty as a result of
our financial situation during the last nine months.
Investment income in the first quarter of 2007 increased 10% to
$141.6 million compared to $129 million in the same period in 2006.
This increase is primarily due to higher total investments from the
Ballantyne Re transaction completed in May 2006. The Company's
investment portfolio maintained an average quality rating of AA- and
increased its average book yield from 5.3% in the first quarter of
2006 to 5.7% in the first quarter of 2007.
Looking forward, investment income will increase as we invest the
proceeds from the MassMutual Capital and Cerberus transaction. Our
intention is to utilize the net proceeds of $560 million to repay the
$275 million outstanding on the Stingray Trust. The remaining net
proceeds will remain at our holding companies until required within
the operating subsidiaries in the future.
Claims and other policy benefits increased by 2% to $383.6 million in
the first quarter of 2007 from $374.5 million in the same period in
2006. Specifically North America experienced approximately $14
million of favorable net mortality.
With respect to the North America mortality, our favorable experience
is relative to our best estimate assumptions. Our current best
estimate assumptions for all traditional life blocks of business are
based on our most recent version of Summit, which is our application
for developing best estimate mortality based on all available
mortality experience dating back to 1997 for the ING Block. For the
ING Block, the current best estimate assumptions remain consistent
with those used in pricing the acquisition. For the organic and SRLC
Blocks, we have adjusted our best estimate to be consistent with
Summit and the assumption framework for the ING Block.
During the first quarter of 2007, assumed mortality for the ING Block
was favorable by approximately $26 million, representing an actual to
expected ratio of 90%. This positive experience was driven by
favorable results on large claims and as such was partially offset by
lower than expected retrocessional recoveries of approximately $16
million.
Accordingly, net mortality for the ING Block was approximately $10
million favorable for the first quarter of 2007. Experience in our
organic and SRLC Blocks contributed an additional $4 million of
favorable net mortality, bringing the total favorable mortality for
the first quarter to $14 million or a 95% actual to expected ratio.
This is a good time to highlight another initiative we have completed
to further ensure our processes and models are appropriate. In
conjunction with our new majority investors, we engaged the services
of an actuarial firm to review our 150 largest North American
traditional treaties, representing over 75% of our in force. The
recently completed results of this work concluded that there were no
material findings in the aggregate.
As you will hear later on this call regarding the impact our GAAP
models have on our earnings pattern over the near-term, having
confidence in these models is extremely important.
Interest credited decreased 17% to $35.3 million for the first
quarter of 2007 from $42.7 million for the same period in 2006 due to
the termination of four funding agreements in the third quarter of
2006 due to our rating downgrades and also due to higher lapses on
annuity treaties in late 2006 and the first quarter of 2007.
Acquisition costs and other insurance expenses increased 9% to $95.1
million in the first quarter of 2007 from $87.5 million in the same
period in 2006, principally due to our international segment in which
commission expense on UK protection treaties are incurred at a much
higher rate than our existing legacy book and also due to the cost of
the Tartan Catastrophe Bond issued in May, 2006.
Operating expenses for the first quarter of 2007 increased 11% to
$34.6 million compared to $31.1 million for the same period in 2006.
Included in the first quarter of 2007 was a gain of $2.6 million
resulting from a settlement of an indemnification provision in the
ERC purchase agreement. This settlement is unrelated to our ongoing
mediation with GE regarding the ERC purchase. Excluding this onetime
gain, the increase in expenses of approximately $6.1 million is
primarily due to higher personnel costs in our international segment
and professional fees, mostly legal and tax.
Collateral facilities expense of $73.7 million for the first quarter
of 2007 was $42.6 million higher than in the same period in 2006.
This increase is principally due to the Ballantyne Re transaction
closed in May 2006. Additional interest costs of approximately $4.5
million resulting from the drawdown of the Stingray facility in
August 2006 and increased financial guarantor cost of approximately
$3 million due to the rating downgrades.
As I mentioned earlier, we will repay the Stingray outstanding
balance in mid-June which will reduce the collateral facility expense
going forward.
Income tax expense in the first quarter of 2007 was $13.4 million
compared to an income tax benefit of $7.5 million in the same period
of 2006, primarily related to an $11 million valuation allowance
established in the first quarter of 2007 on deferred tax assets. The
valuation allowance principally relates to current period tax
benefits not being recognized as we can no longer recognize tax
benefits for certain legal entities.
An additional valuation allowance was established on deferred tax
assets resulting from estimated statutory and tax projections related
to certain legal entities.
As discussed on prior calls, our GAAP tax expense is not directly
related to our pretax GAAP earnings for several reasons.
First, our consolidated pretax GAAP earnings are the aggregation of
individual profits and losses by legal entity. This, combined with
our inability to recognize tax benefits, creates tax expense in
certain legal entities while creating no offsetting benefit and other
legal entities that have losses.
Finally, our GAAP tax expense is also impacted by the magnitude and
timing of our statutory profits and reserves as these are the primary
drivers of our gross deferred tax assets and gross deferred tax
losses, which are the basis for the calculation of any required
valuation allowance.
Effective January 1, 2007, we have adopted a new accounting standard,
FASB Interpretation Number 48, or FIN 48, which is accounting for
uncertainty in income taxes. GAAP-based financial statements must now
account for taxes under this new standard, including an analysis of
all tax positions for all jurisdictions for all open years. FIN 48
clarifies the accounting treatment of uncertain tax positions taken
or expected to be taken on any income tax returns. The cumulative
effect of adoption of this new accounting standard is accounted for
as an adjustment to the beginning balance of retained earnings. At
January 1, 2007, the adoption of this new accounting standard
resulted in a total FIN 48 liability of $78 million, which includes
$11.1 million of interest and penalties for all jurisdictions for all
prior open years.
However, since we recorded a valuation allowance for various deferred
tax assets in prior periods, the total FIN 48 liability was reduced
by $45.4 million adjustment to our existing valuation allowances,
resulting in a net retained earnings adjustment of $32.6 million.
Finally, we do not expect the FIN 48 liability to change
significantly within the next 12 months.
That concludes my remarks regarding the significant factors impacting
the quarter.
With respect to guidance for the remainder of the year, you should
view the results for the first quarter of 2007 as roughly indicative
of the next three quarters with certain exceptions.
First, we would anticipate our North American mortality returning to
our best estimate levels. Second, in addition to the impact of the
net proceeds and repayment of the Stingray debt, the closing of the
transaction with MassMutual Capital and Cerberus triggers certain
onetime expenses, as will certain other transactions to be discussed
later during this call. The MassMutual Capital and Cerberus
transaction results in a change in control which immediately vest all
outstanding stock options and restricted shares. Under GAAP
previously unrecognized expense of approximately $10 million must be
expensed in the second quarter as part of the change of control even
though the stock options are under water and the value of the
restricted shares has significantly reduced.
In addition, a new stock option program is currently being finalized,
which will result in additional immediate expense recognition with
respect to options granted to directors of 4 to $6 million.
As discussed shortly, we are in the process of completing the
transaction to finance our 2005 and 2006 new business production. We
also terminated the $100 million term loan facility which will result
in onetime expenses during the second quarter of up to $10 million.
Due to our current ratings, the new 2005 and 2006 financing facility
will have a higher cost than our existing facility and will result in
approximately $5 million of additional costs over the second half of
2007.
Finally, we anticipate severance, recruitment and relocation costs
for various management positions over the coming quarters.
The third factor impacting our future quarterly results is that we
will still experience a modest positive seasonal impact in the fourth
quarter due to higher renewal premiums in that quarter, combined with
an upward trend in our North American traditional business due to the
impact of our GAAP models as I will discuss shortly.
As you have no doubt noticed, while we had favorable mortality in our
North American segment for the first quarter, we still incurred an
overall loss for the quarter. We are projecting to incur losses for
the remaining quarters of 2007 although at a decreasing level.
I would like to spend a few minutes to explain the basis of these
projected losses and our expectations for future years.
Our ratings have an impact on our earnings in several ways. First,
our current ratings significantly impact our ability to write new
business. Although we believe the closing of the MassMutual Capital
and Cerberus transaction and the recent upgrades by certain rating
agencies will have a positive impact with our clients, we are
nonetheless projecting lower new business profits over the near-term.
As our ratings improve and we execute on our client initiatives, our
new business premium and related profits will increase over time.
This is especially true in our international segment where we have
significantly improved and expanded our management team in our focus
markets of the UK and Asia.
Our ratings also impact the cost of our Triple-X financing. Based on
our expected ratings for 2007, we will incur an incremental 13
million for all of 2007 due to higher financial guarantor costs. As
previously noted, our new 2005 and 2006 new business financing
facility will incur higher cost to our current ratings with the
estimated impact in 2007 of $5 million.
Again, as our ratings improve, these incremental costs will decrease.
As described on previous calls, we have been aggressively building
our international segment team in order to grow and diversify our
book of business in certain key markets. Due to the natural lag
between the winning of a treaty and when the premiums begin to flow,
combined with the impact of our ratings, our international segment
premiums have not kept pace with our expense structure. Accordingly,
we are projecting improving operating results over the next couple of
years in our international segment as we complete the cleanup of the
legacy book of business and continue to write more business in those
focus markets.
The last and most significant item impacting our operating results
relates to certain aspects of US GAAP which impact the emergence of
profits over time within our North American traditional business. As
brief background, FAS 60 requires assumptions to be set and locked in
for the duration of a policy or treaty. Once established, these
assumptions cannot be changed except under very limited
circumstances. The objective of US GAAP for life insurance is to
recognize profits over a level percentage of premium over the
duration of the policy or treaty.
However, US GAAP requires a provision for adverse deviation or PAD in
the reserves for which the mechanics of the release of such PADs tend
to suppress US GAAP profits in early years due to the interaction
with mortality and lapse assumptions.
While this US GAAP issue is present what all life insurers, it has a
greater impact on Scottish Re due to the newness of our book, the
impact of purchase GAAP accounting on the ING Block and the mortality
and lapse assumptions used that are unique to Scottish Re. Based on
our specific assumptions established at the inception of our models,
our profit pattern over the near-term is being adversely impacted.
With no change in assumptions, our in force book of business will
show significantly improving GAAP profits during the next five to 10
years. We start to see this improving pattern beginning in 2007,
which is one of the reasons why our North American segment operating
results will improve each quarter going forward.
I will now cover some other items of significance. As previously
announced, we entered into a $100 million term loan facility with
MassMutual Capital and Cerberus to provide additional liquidity
between the shareholder vote and the closing of the
MassMutual/Cerberus transaction if needed. We did not draw on this
term loan, and it was terminated concurrent with the closing of the
$600 million equity investment transaction on Monday.
Also, as previously announced, we have been working on a long-term
facility to fully fund up to the peak reserves our 2005 and 2006 new
business production. We anticipate closing this facility within the
next 30 to 45 days. Upon the completion of this facility, we will
have fully financed virtually all of our Triple-X business.
That completes our prepared remarks. At this point we will open up
for questions. Operator?
OPERATOR: (OPERATOR INSTRUCTIONS). Ann Maysek, Deutsche Bank
Securities.
ANN MAYSEK, ANALYST, DEUTSCHE BANK SECURITIES: One question. On the
Stingray Trust, you mentioned that you were repaying the $275 million
that remained outstanding. I am assuming that means that the trust
will remain available to the Company as the liquidity facility going
forward, or are you simply closing out that whole facility?
DEAN MILLER: Yes. When we repay the 275, that 275 will then be
available for either future letters of credit usage or cash
drawdowns. So there's no impact on our ability to use that going
forward.
ANN MAYSEK: Got it. And then secondly, you mentioned that you had
strategies in place to win business absent better ratings. Can you
expand on that at all, or is that too much of a competitive question
to ask?
PAUL GOLDEAN: Yes, we can talk about that. First of all, this is not
new. This is something we have been working on over the last several
years, especially after the acquisition of the ING business which
brought lots of talent people, systems and capabilities. It is the
evolution of Scottish Re from its early years as really a low-cost
provider to a full-service provider. And areas that we have been
dealing with the last couple of years and are a key focus this year
would be like the Mortality Research Center, which we have a big
investment in which not only does it provide us with invaluable
information about the mortality experience of our book of business,
but also it provides us an opportunity to provide services to our
clients that not all reinsurers offer, and it gives us a competitive
advantage.
Other areas is clients rely on Summit, for example, which I briefly
mentioned, which is our mortality application system. Our clients
will use that to set their own pricing and best estimate assumptions.
We have an underwriting manual that is called [Ascent]. That was very
well-regarded and a big value-add for clients. We're investing time
and money in just further enhancing that. So the clients get the most
of that.
So its those types of value-added services that the clients need and
want that not all of our competitors offer that will help us remain
competitive. The one thing we will not do is we're not lowering our
profit margins by attempting to win new business. We are going to do
it through the value-added services and demonstrating that Scottish
Re is financially stable, we will be here in the future and is the
reinsurer that can meet their needs.
OPERATOR: Richard Sbaschnig, Oppenheimer.
RICHARD SBASCHNIG, ANALYST, OPPENHEIMER: Just to kind of follow-up to
that strategy as to win new business, won't you need to post
collateral or set up other types of facilities to try to actually
close on new business with the lower rating?
PAUL GOLDEAN: Well, not necessarily. Part of it is depends on the mix
of business. Coinsurance versus YRT can have an impact, and we're
definitely seeing a shift -- it is not us; it is the whole market --
a shift towards YRT, which then the ceding Company has less credit
exposure to the reinsurer. Secondly, our intent is to demonstrate
through improving ratings, the financials of the Company and so
forth, that we are not a credit risk to the Company.
Now we are working on, are there ways in which we can provide
collateral or maybe some form of a cut through? We're thinking
through those. We are working on that. But that is not the primary
focus. The focus is, again like I said, is the value-added services.
It is filling a capacity need in the market and just demonstrating
the financial strength of the Company.
So yes, we might look at some things like that, but that is not at
the top of the agenda.
RICHARD SBASCHNIG: Just to expand on kind of your strategy going
forward, it seems like there is no major strategic shift after this
deal. But if I understand your comments, there seems to be a little
bit more of a focus on international. I'm just wondering if you could
maybe provide more color on that.
PAUL GOLDEAN: This is Paul Goldean. We have always been focused on
our international segment. We just, I think if you heard us talk in
the past, we did not execute effectively on our strategic plan. And
now, as we come through the last nine months, we will engage our
international segment team to actively pursue the goals and
objectives that they have put in place. We're very happy with our
international segment team, and the new investors are very happy with
them, and we expect them to go out and execute on a strategy that we
were thinking of at least three years ago. (multiple speakers). I
expect you would see increasing improvement in our international
segment.
RICHARD SBASCHNIG: Okay. Another question is, in terms of you briefly
touched on these, but what steps -- maybe if you can elaborate more
on steps you have taken to prevent any types of any potential future
blowup with regard to the financials and operations.
DEAN MILLER: Well, first of all, I think we have got to put 2006 in
perspective. It was a difficult year, but if you really break down
the some of the root cause of what created the volatility, first of
all, you go back and you say, okay, growth by acquisition, and then
we went through the second half of '05, first half of '06 of building
the team, the infrastructure. There's a lot of new people we have
talked about. A big part of what happened in 2006 was the right
people with better data and better systems.
For example, putting all of our retrocession business, cleaning up
all the data and putting it onto a proper system is a great proactive
initiative that we undertook. Unfortunately it uncovered some things
that were not administered properly in prior years.
So a lot of what happened in 2006 was driven by things that we did
proactively. You combine that with some variability and some lapses
in mortality like the shock lapse on the one annuity treaty that hit
its five-year term or -- see then that. So what we did proactively
combined with some kind of volatility then creates the deferred tax
asset. Because what it did, is it then had the issue of we could not
finance. The rating agencies got nervous and downgraded us which
closed off the Capital Markets, which, as you may recall, we were
literally a week away from closing any collateral finance facility
deal, a debt offering that would refinance the convertible notes.
Once the ratings went down and you lost access to those facilities,
then we had the liquidity crisis.
So I'm not saying that things did not go wrong. But it was kind of a
snowball effect of things that we did combined with things outside of
our control which led to the deferred tax asset, which led to the
ratings, which led to the Capital Markets, which ultimately led to
the sale. Now if you sit and say, okay, so where are we today? To
really get back to your question, first of all we have been through
tremendous due diligence for the last six months. The team that was
in place in the latter half of '05 and the first half of '06 now have
almost a year under their belts.
We have continued to do the things we were doing. Something that I
talked about briefly was the review of the top 150 treaties. That was
all multimode effort with a significant amount of involvement from an
external actuarial firm to really tear apart the models, and that's
75% of the in force.
So our focus right now is some automation, better process. We feel
that we have largely taken the steps in '06 which unfortunately
created some of the issues. So we are always going to have volatility
and mortality and to a lesser extent in lapses. That is the business
we're in, and we are always going to have clients that are going to
change systems and report things. And typically those aren't -- that
is significant. But if we are the size of a company like Scottish Re,
one client reports 5 million. That is significant to our earnings in
a quarter.
The other thing that throughout this whole process last year was the
focus on liquidity. When liquidity gets very tight, you implement a
lot of procedures to track and monitor it, and we feel that we have a
very robust liquidity analysis that is updated weekly, that is
integrated with all aspects of the business. The key for us and the
key for the rating agencies is, as we begin to write new business, to
make sure that we have got the financing facilities and the capital
in place before it builds like it did before. We cannot have the
dependency on the Capital Markets that we had before. And that is
something that the new board, the new investors and management will
ensure does not happen.
RICHARD SBASCHNIG: So, in terms of those processes, you're basically
-- in terms of your own processes, you are basically done with those?
DEAN MILLER: Well, you are never done. We have a list of company
initiatives that any company would have and always improving. But the
answer is we do not have a laundry list of things that we think we
need to work on to avoid or mitigate volatility.
RICHARD SBASCHNIG: That is basically my question. In terms of some
numbers questions, the stock option expense, the 4 to $6 million, is
that an annual or is that a quarterly number?
DEAN MILLER: Well, what that relates to is we are finalizing right
now the stock option program, you know the number of shares and who
gets them and the strike price and so forth. A portion of those stock
options will be granted to directors. And under FAS 123R, directors
are not employees, and therefore, the total projected expense under
your Black-Scholes method has to be expensed immediately at grand
date.
Now all the other employees you will calculate the total expense, and
you amortize it over the five-year vested period. So that 4 to $6
million that I mentioned, it is a range because we don't know exactly
what the strike will be and how many, but that relates to the
directors on the date of grant, which we anticipate happening in Q2.
And it is a onetime expense. So there will be no further expense for
those options related to those directors.
OPERATOR: David Havens, UBS.
DAVID HAVENS, ANALYST, UBS: Maybe you could just spend a minute on
your ratings and maybe tell us what you're thinking in terms of
ratings as sort of being an integral part of your strategy and what
your goals are in restoring competitive ratings?
PAUL GOLDEAN: Well, we have met with most of the rating agencies
during the past two weeks. It is kind of the time of year when you go
through the annual process anyway. But it was especially timely for
us given the close of the transaction. So we have very -- you know,
MassMutual service were in attendance. We did the normal review of
operations, the plan and so forth. And, as you can see, each rating
agency -- some had the transaction included in the rating. Others did
not. But all of them have either upgraded us or put us on positive.
They are still in the process of running their capital models now
that they have the plan, digesting everything that we told them.
But the key for us is transparency, good communication with the
rating agencies, delivering upon what we promise, and at the end of
the day, they really want to see two things.
They want to see one, execution and lower volatility in our earnings.
And secondly, they want to see that we have a valid new business
franchise.
Now what does that mean? Well, part of it is treaties that are open
for new business aren't terminated, which we have been very
successful in working with our clients and not having open treaties
terminated. It is not having recaptures, which we've had virtually
none. And it is also, it is a little bit of a chicken and egg issue,
but it is also demonstrating that the clients view Scottish as a key
member in the market and want to do business with us. And it is not
really -- I don't think so much the actual volume of new business
that we have. It is that we have a volume of new business with
clients and that we are in the market.
So that new business franchise and the execution are they keys, and
that's not going to happen overnight. We are in a prove it mode to
some extent, and they are going to watch us closely over the
following three or four quarters and see how things go and go from
there.
DAVID HAVENS: I guess common wisdom is that you kind of need to be in
the A category from a claims paying perspective. Is that the goal?
PAUL GOLDEAN: Oh, absolutely. It is getting back to A- or A is the
goal. But like we mentioned before, we do have a lot of initiatives
and especially with the new team in the international segment a lot
of momentum that we are cautiously optimistic that we will win some
level -- I mean don't overstate it. It is not going to be big
volumes, but we will have a flow of new business pre-A-. And right
now the clients have been very supportive sending us quotes. We are
not winning much, although real positive news flows. We have won a
couple of smaller treaties in the US in the last month and also in
the UK in the international segment.
So what the unknown is, as supportive as the clients have been, the
question is, now that the deal is closed and the rating agencies have
come out and will continue to come out, will that -- how much will
that free them up? They have all got risk committees and policies
about who they can do business with and so forth, and each client is
a little different. But like I said, I guess the summary is be
cautiously optimistic, but not putting into our projections
substantial new business volume.
OPERATOR: Chris Cook, Zazove Associates.
CHRIS COOK, ANALYST, ZAZOVE ASSOCIATES: I was curious as to given all
the near-term noise if you guys could provide some window into what
you expect the returns on your existing book of business to be sort
of on a return on equity basis, as well as any new business you might
put on in the next year or two, what kind of returns you're seeing in
the marketplace on that book of business or that you're estimating
you are seeing when you look at new books?
DEAN MILLER: Let me answer the new business piece first. The market
in North America in particular has been very stable over the last
several years, and we have not really seen any shift in just general
pricing better or worse. As we mentioned before, we are not going to
win new business by lowering our margins.
So the simple answer is, our margins will be consistent with what
they have been in the past but at a much lower rate of volume.
So over the next -- 2007/ 2008 new business is not going to be the
driver of our results. While we hope to win treaties and grow the
business and do well, it is not going to be the main driver. The in
force is what will drive the book the remainder of this year and a
large part in '08.
Now return on equity in the in force is difficult because well, first
of all, we have losses. We talked about some of the issues that
create short-term losses. Secondly, it is difficult. What is E in
equity when you're trying to look at a segment? So it is difficult.
And we look at return of equity on a company as a whole, and as a
company as a whole, it is going to be as we said we're projecting
losses for the remainder of 2007.
But if you were to look at the underwriting margin, and again that is
difficult. One, because again relative to equity because we don't
allocate equity down to treaties or lines of business. And then
secondly, we have got this phenomena of the short-term suppression of
the GAAP profits because of the mechanics of the way our models and
our assumptions and the interplay of those on our US GAAP and our
organic and the ING Block.
So having said all that, what I would say is the in force the margins
will be suppressed for a short period but increasing over the
near-term and continuing out in the 5 to 10 year period.
PAUL GOLDEAN: This is Paul Goldean. I just thought that I would add a
couple of points. First is, you have been on our calls in the past.
We have been accused of overpromising and under-delivering. So the
goal is to make sure that we make a promise to our shareholders and
other third parties and we stick to that promise.
So when we talk about these items, we don't project out things like
acquisitions or big wins or things of that nature. We are going to
give you exactly what comes off of our models and what our best
estimations are given where we are in the ratings environment. That
is number one.
Number two, the new investors have been fully aware of what our plan
is on a go forward basis. And I think they understood it enough and
they still continue to close the transaction. I think it is an
important note for the rest of the investors out there, and that is
pretty much all the comment I have on the two points.
Is anyone still on?
OPERATOR: Does that answer your question?
CHRIS COOK: Not particularly, but thanks anyway. I understand your
answer.
OPERATOR: (technical difficulty)--
UNIDENTIFIED PARTICIPANT, ANALYST: Most of my questions have been
answered, but I did have one on the facility you're putting in place
to finance all your '05, '06 Triple-X production. Is that more of a
credit line type of facility, or is it more like a securitization
shelf?
DEAN MILLER: Yes, this is -- when we announced the transaction back
on November 26, 27, we indicated at that time that we had a
commitment from Citigroup and Calyon to provide a facility. What we
have been -- so that was a full commitment.
What we have been doing since then is working on the structure, the
pricing and so forth. As I mentioned, we're maybe a month or roughly
a month away from closing.
So basically it is similar to the HSBC type facilities, which is a
bank facility than it would be our Orkney or Ballantyne. It is a
15-year committed committed line up to the full 550 million peak
reserves. So it is not a Ballantyne REIT type structure.
OPERATOR: Jeff Bernstein, Schroder's.
JEFF BERNSTEIN, ANALYST, SCHRODER'S: My question has been answered.
OPERATOR: [Dru Newton], Jefferies.
DRU NEWTON, ANALYST, JEFFERIES: Thank you. My question has been
answered as well.
OPERATOR: Richard Sbaschnig, Oppenheimer.
RICHARD SBASCHNIG: Just a quick question, some numbers questions.
First of all, on the severance and relocation, I guess we can expect
to see some management changes over the next couple of quarters?
PAUL GOLDEAN: Richard, is that your -- we broke up a little bit at
the beginning. So you're asking us about management changes and
severance that we announced?
RICHARD SBASCHNIG: Yes.
PAUL GOLDEAN: The answer is like any transaction of this magnitude
you would expect to see some level of change in the management
structure both exiting and coming in. And what those are at this
point, we just don't have all that information, but we know it is
going to happen.
DEAN MILLER: The only comment I would make, Richard, from an
accounting perspective is, it is difficult to both quantify the
amount and to put the timing of which quarter it will play into. So
there is a lot of variables in those types of subjects. So some Q2,
maybe Q3, Q4 -- I'm not picking any pegging any particular amount or
quarter.
RICHARD SBASCHNIG: Got it. Okay. That makes sense. The other question
ahead, with regard to your Orkney I transaction, I remember you had
this issue of stat versus GAAP accounting on it, and some potential
tax assets that might be coming through on those. I was just
wondering if there has been any change with regard to that and if you
expected any?
PAUL GOLDEAN: This is Paul Goldean. There are two elements there.
First is, we have successfully redomesticated Orkney I into Delaware
from South Carolina. In doing so, we have been given certain
treatments that allow us to avoid significant tax impact on the
structure. What we do with Orkney I in the future will be a business
decision on whether we restructure it into another domicile or keep
it as is. But the key point here is yes, we have moved Orkney I into
Delaware, and we have been given the treatment that we were looking
for.
RICHARD SBASCHNIG: And to my understanding, I guess there was some of
the valuation allowance on the deferred tax asset was tred to the
original issues I guess with Orkney I. I guess those are expected to
reverse?
DEAN MILLER: No, no, all we have really done with the redomestication
is just that, is redomesticate, and there is different treatment of
the reserves. But the tax planning strategy that supported the
deferred tax asset of Orkney I that has not changed. And so again,
like all the valuation allowances we set up, we set those up because
we cannot take credit for the profits that are projected to come
through the book of business. Because we don't have a history of
profits, especially in a new securitization.
So there is no change. We cannot reverse the valuation allowance, but
to the extent the projected profits in the models do come to fruition
over the long-term, we will get those tax benefits back over time. So
there is no -- there's nothing -- there is no tax planning strategy
or change in our circumstances in how we recognize deferred tax
assets to allow us to reverse that valuation allowance.
The other comment I would make on Orkney I with the redomesticated is
it has no impact on the securitization transaction itself. The cash
flows, the debt to the third parties, everything is unchanged with
respect to that piece of it.
RICHARD SBASCHNIG: Okay. Do you get a little bit of help on your stat
capital -- (multiple speakers)?
DEAN MILLER: Sorry. That was the other point I wanted to make. No, we
won't. It is part -- even though we're going to GAAP reserves, there
are still provisions within statutory accounting that Delaware is
saying, hey, we're not going to give you stat accounting treatment.
So that extra whatever it was, maybe 40 to $60 million of capital
boost that we thought we might get when we were trying to do some
other things last year, we're not going to get.
OPERATOR: [Si Lund], Morgan Stanley.
SI LUND, ANALYST, MORGAN STANLEY: As far as the guidance for the
balance of the year, you said you're projecting losses but at a
decreasing level. What do we use as the starting point there? Should
we use net income or the net loss in the quarter as a starting point
for that?
DEAN MILLER: Well, you always should start with operating, back out
the realized gains and losses in the embedded derivatives. So that is
-- I forget what that is now -- 36.5 would be the net operating.
Now, I guess at a very macrolevel, if you were to kind of roll
forward to Q1 from that 36 if you've got the mortality piece, which
best estimates come back, you would have that. Q2 we had the things I
walked through with the onetime transactions with the stock options
and so forth.
So what you are going to have is Q2 is going to have a fair amount of
extra onetime expenses that won't recur later. You have got the
mortality. And then -- well then, this GAAP model impact that we
talked about, which actually impacts North America each quarter
starting in Q2 a little bit. So having said that, if you look at
North America and put aside any expenses on the onetime, what you
will see is it goes down a little bit if mortality goes to where we
expect, but goes up some with the GAAP models and then up a little
bit more in Q3 and up a little bit more in Q4.
And international I would say is roughly going to stay kind of where
it is for the remainder of 2007. Because while we are hopeful to win
new treaties, the lag will be if we win them today, we probably won't
see any premium until six months from now. So -- and the premiums
that are coming in on the treaties we won last year are at a
relatively flat level. And the nuance for that is the product that
was underlying some of the big treaty wins we had in the UK about
this time last year was related to what is called a pension term
insurance product, which had some tax benefits under the UK tax
regime. They repealed that in the first quarter of this year. So all
the new business flow under that product just stopped around
February/March this year and kind of -- so that has an impact. So we
will be about flat in international.
And in corporate, to round off the segments, again you've got to put
aside the proceeds on the transaction and the collateral facility
expense and paying down Stingray. But absent those items, what you
will see is pretty much status quo, except we had a little bit higher
operating expenses because we had some tax consulting around FIN 48
and the transaction, some extra legal and some audit spillover. So I
would expect OpEx to go down a little bit going forward and
everything else about the same.
SI LUND: Okay, thank you. And then on the actuarial review, did that
include a review of the DAC asset on the balance sheet?
DEAN MILLER: Well, it is a review of the cash flows in the models.
And those cash flows in the models are what underpin all of your GAAP
reporting, statutory reporting, cash flows for stat and so forth. And
so that was really the focus is, are the underlying cash flows
appropriate, and then those cash flows feed into lots of different
applications to do whatever GAAP or stat reporting you're doing.
SI LUND: Okay. And then a final quick numbers question. As far as
cash at the holding company before the proceeds from the investment,
do you have a number for that, or can we sell through higher or lower
than what we saw in the 10-K?
DEAN MILLER: I'm not sure we disclosed the number in the 10-K. Well,
you have got to be careful. If you're looking at cash on the balance
sheet, that can be misleading. Because there is a lot of cash that is
encumbered and not available.
The way we look at liquidity is how much liquid cash do we have at
our two holding companies, SRGL and SALIC, that can either be put
into trust funds to support our offshore reserves, which is almost
greatly mitigated and eliminated with the new financing structure we
just talked about, or if we need to put capital in for risk capital
purposes.
Now that number is what was driving the issues last year with the
liquidity. And, as we talked a lot in the 10-Qs and the 10-K, that
liquidity was extremely tight, and if the transaction did not close,
we would be in big trouble.
Now pre-close liquidity is very tight, and that's why we put the $100
million term loan in in case the deal got postponed or delayed
slightly. So I guess long answer but the short answer is, liquidity
pre-close is very tight as it was before but very sufficient
post-close.
OPERATOR: At this time there are no further questions. I would now
like to turn the call back over to Mr. Paul Goldean.
PAUL GOLDEAN: Well, once again, thanks to everyone for spending time
with us on our Q1 results. We look forward to better things at
Scottish Re on a go forward. Appreciate it. Thanks.
OPERATOR: Thank you. This does conclude today's Scottish Re
first-quarter 2007 earnings conference call. You may now all
disconnect, and have a great day.
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