AXIS Capital Holdings Limited (AXS) Earnings Call Transcript & Summary

Great and thanks to everyone for joining our virtual fireside chat with AXIS Capital at the Deutsche Bank Global Financial Conference. I'm Phil Stefano, the insurance analyst here at Deutsche Bank. We're very excited to have with us today, CFO, Peter Vogt. Just as a quick background, AXIS is a Bermuda-based specialty insurance and global reinsurance company. Mr. Vogt was appointed CFO in January 2018, having held various roles of increasing responsibility since joining AXIS in 2010. Previously, he held various financial and actuarial roles in the insurance industry. It would also be remiss of me if I didn't note that Peter is a fellow of Temple University alumni. So we'll start out with some questions of my own, but I'm also going to leave some questions for the participants. And just a quick instructions on that, you can ask a question via the web portal or you can e-mail me at [email protected], whatever is easy for you. So Pete, again, thank you for being with us today.

Thanks for inviting us, Phil.

And we're going to kick off -- yes, of course. So we're going to kick off the questions with the first question that we've asked everyone thus far. On the first quarter earnings call, you discussed your approach to setting reserves for COVID and most companies did discuss this methodology to some extent or another. I was just hoping you could remind us what's encompassed in your first quarter charge? To what extent should we think about them as an ultimate? And maybe some thoughts around the extent to which estimates include potential legal expenses as well?

Well, thank you, Phil. And again, thanks for inviting us for the opportunity, and I hope everyone is staying well and their families -- with their families and everyone staying safe also. If we go back to the first quarter, 2 things I'd want to -- a couple of things I'd point out is, one, I would remind everybody, we did take a $10 million write-down for our portion of the World Health Organization pandemic swap that was out there. And that negative $10 million is actually run through our other income line on the income statement. But on the loss provisions, we did take loss provisions of $235 million. Really focused on 2 assumptions that drove that number: One is, it assumes a shelter in place to July 31; and two, with that assumption, it's really focused on, I'll call it, the short-tail lines. And so we put up the losses that we felt were appropriate for the property BI, which was just about 80% of the reserves that we put up in virtually all IBNR, but also to the extent we had some event cancellation and some A&H, where we had some medical expense and some travel losses. So the number encompasses all those short-tail lines. So most importantly, what we didn't put anything up for would be any of the long tail lines to the extent we think COVID-19 could create, we'll call it, trade credit losses or professional lines D&O losses, E&O losses or anything like that. Those are claims that if they come due to COVID-19, we won't see those until later this year or even into next year. So we did not put up reserves for that. But it was very much a bottoms-up view of our property book to look for BI on the insurance side and the reinsurance side. We looked at all the underlying contracts, looked at it by region, mostly in the U.S. versus U.K. versus rest of world and made sure we had a good understanding underlying contracts and then assumed a shelter in place to July 31. I would say in our reserves on the U.S. side, where we have a lot of protections in the wordings, we did put up some amount that includes some amounts for legal expense. And so that was included in the U.S. numbers.

Great. And you had mentioned the July 31 date. I guess, when I think about the various ways that companies reported their estimates for COVID losses, it felt like yours is probably the more comprehensive or precise end of the range, just given that specific time line. I mean, maybe you can help us think about the sensitivity of losses around that date and the extent to which that date came to be as your -- part of your reserving process?

Yes. We started, when we saw COVID coming on, with an exposure group led by our Chief Risk Officer that kicked off the last week in February actually. And I'd say at the same time, we had our Chief human resources person kick off, I'll call it, an internal view of making sure that all employees were able to work from home, and operationally we were still going to be up and running to the extent we would have to go work from home, which we did starting in the second -- actually, it was the beginning of the third week of March, like March 14th, I believe, or 15th is when we started working from home. And starting the exposure analysis that early gave us a really good view to be able to pull all our data together to see where we thought we had exposures. And to the extent that you're going to make any assumption on property BI, typically where we had it, we saw sublimits in place. So then the question was, well, how long would the sublimit go? And then on most BI claims, the question is, well, how far out does it go? And so we felt it would be prudent, given things looked, I'll call it, very bleak in the latter half of March, even the beginning of April, but how long this could go, we felt taking a 4-month view out would be an appropriate time frame because that would get us through the second quarter. And to the extent that we saw anything new coming, we would know it by the end of the second quarter. We didn't want to be able -- we did not want to take a charge in the first quarter that only envisioned a shelter-in-place stay till the end of April or the end of May, and then have to take another charge in the second quarter. So given all the rhetoric that was going on, we thought it was prudent to go to July 31, that's why we did choose that date. Beyond that, we did do scenario analysis that looked out, well, what could happen if it goes 6 months out, if it goes into 2021, to give us an idea of what are all the pressure points that we need to make sure we keep a view on and that we get weekly reporting on to make sure things -- that we can track things through -- as we go through this event.

Yes. Understood. Look, one of the things I've been struggling with myself is just given the uniqueness of this event, and people have talked about various reserving methodologies, whether it be top-down or bottoms-up, it felt like you lean towards the latter, but do -- is the reserve process in place? Do you need to revisit your reserve process moving forward as information becomes more available or at least there's some clarity around the losses as they crystallize?

Yes. It's a great question. I'd say the process we put in place is very well structured. Now what we're watching right now every week and as we go towards the end of the second quarter is filling in the assumptions through that process. So building the structure of what the pressure points are, what are the variables, what are the assumptions we need to make. As those assumptions now become clearer, such as duration of the event and where we're going to see pressure, say, on the reinsurance portfolio, where I think it's going to be very client specific. Well, again, we had -- as you mentioned, on the reinsurance side, we did a bottoms-up, we also had to do a top-down there because we're 1 step away. And we're getting information from our clients, but not enough information in all places. So we actually did a top-down and bottoms-up on the reinsurance side. And as time goes on, and we're getting more and more information, we know the information we want, and it starts to give us some more clarity on are our assumptions accurate? Are they more prudent? Or are they too liberal? And we'll use that to adjust ourselves as we go forward. But it doesn't need to be another bottoms-up approach, if you know what I mean, Phil. We'll be able to actually take the models we have and just keep updating our assumptions.

Got it. Okay. And I will switch gears a little bit to get away from COVID because I think it's easy to beat that over the head if we want to. But looking at the underwriting portfolio optimization, so the company has made a lot of progress in shifting the portfolio with the intent of delivering higher and more stable earnings. Over the past several years, this has involved exiting a number of lines while investing in more attractive markets. What inning are we in for the optimization plan? And to what extent should we think about there being material work left to be done?

Yes, that's a really good question. I would say that we are very much in the later innings when it comes to the optimization. We did a lot of work in '18 and '19, and it started really in the latter half of '18 all through '19, exited a number of businesses, mostly on the insurance side. And today, we're seeing, I'll call it, the better portfolio results come out from a lot of those businesses now actually being run off. So at this point, I'd say we're at the latter stages of the game. But now it's really just fundamental underwriting. I mean, every underwriter every year has parts of their portfolio that they're going to want to exit, and parts of their portfolio they're going to want to grow. And as we're moving into these really, especially nicely priced attractive markets, they're looking at where do they want to grow certain parts of their portfolio. But as for exiting lines, I think we said it at the end of the year, that really the only other line that we've got our eyes on, on the insurance side, is the airline business. And while that's getting good rate right now, that's a business that does need, I'd say, at least 2 years of really solid double-digit rate increases. And that would be the 1 business that I still would say that's a "business line" that has to perform this year and get rates in terms and conditions the way we expected or that could be one we'd leave. But other than that, that's why I say we're in the latter part of the game here. And it's starting to show in the numbers.

And is there an impact that's remaining on the income statement or what we see in the underwriting results from the business lines that have been exited? And when should we think about the burn-off of these exited lines kind of being complete and the clean new AXIS book, so to speak, being example moving forward?

Yes. So the -- so on the insurance side, again, the exit lines of business hit the ex-cat loss ratio for insurance by just under 1 point this first quarter. So what that would mean is if we didn't have that business, the ex-cat loss ratio for insurance would have been improved by a little less than 1 point. So that business has got about $30 million of unearned premium to earn on it. That will earn-out the rest of this year, probably through the final 3 quarters in a $15 million, $10 million, $5 million kind of fashion. But that's the last of the unearned premium we have for exited businesses on the insurance side. So we think that it did hurt us a little bit in the quarter, but the rest of the book's been performing well that we still actually were at mid-50s ex-cat loss ratio there. On the reinsurance side, they've continued to work their portfolio. They've looked at the profitability. And again, we think that they should be running at an ex-cat loss ratio in the low 60s. They had that in the first quarter. They got hurt in the fourth quarter with the agriculture losses. And as we mentioned, we fundamentally reengineered the agriculture book in the first quarter with one of the big treaties we had where we restructured ourselves way down, so a $100 million drop in gross written premium in the agriculture side. So we feel much better about where that's going to perform going forward.

Okay. And look, one of the -- in my mind, one of the things for the optimization plan was to help limit volatility moving forward and thinking through, how should we judge the underlying performance of the results moving forward? And what's the measure of volatility that we should be contemplating outside of catastrophe losses, right? Because that provides obvious volatility for the industry. But to the extent there are no catastrophes, there's really no tests of the new book moving forward. I mean how should we think about that? And what should we be looking at as the proof-of-concept that this book has truly been improved and sustainable?

Yes. I would say, if you just talk, especially ex-cat, what we've done is reduced our line sizes. We brought the gross lines down. We brought the net lines down. And as we've exited, I'll call it, some of those volatile lines that weren't appropriately priced, we should be able to see the ex-cat -- I'll call it, the ex-cat loss ratio in, especially insurance but also reinsurance, behave less -- behave more structurally sound. Now we're in the specialty business, so you're always going to see some volatility can happen. I mean that's where we are. We're not a standard lines carrier. But given the new structures of our line sizes, it's not going to be as volatile as it was in the past. And so kind of watching that over time, that ex-cat loss ratio and making sure that it behaves within a range that's reasonable is something that you should keep an eye on.

Okay. Understood. Maybe switching gears a little bit to talk about the expense programs that have been in place. So there are $30 million of remaining expense improvements that are to be realized this year from a prior transformation program and also the Novae synergies. To what extent should we contemplate there being a difference between gross expense savings and net expense savings, i.e., should we think about any of this $30 million needed to be reinvested in technology or some other avenues of growth for AXIS as we move forward.

Yes, it's a good question, Phil, just because we set that program out 2 years ago at this point. But when we announced the transformation initiative as well as the Novae savings adding up to $100 million off of that 2017 run rate, that was based on net savings. So that $30 million is a net number. So gross savings are actually higher than that, and we've contemplated where we want to make investments. To bring it down to that $30 million. So that $30 million is a net number, and that's off that 2017, what I call an inflation-adjusted run rate that you'd expect to see. And we have every confidence we can see the numbers and where that's coming from. And that came from some investments we've already made now paying off for us this year, and we do expect to see that.

And on top of that, there was, on the first quarter earnings call, a conversation around an additional $50 million of expenses that are going to be removed this year. Maybe you could talk to us about what are these expenses comprised of? What's the patterning of their removal? It sounds like, in my mind, it was a bit of a onetime just given the nature of the world that we live in today. How should we think about the extent to which these expenses come back next year as operations return to something a bit more normalized?

Yes. I would say that much of it is -- not much of it, there's a chunk there that's driven by the new world we live in. So I'd say about 30% of that $50 million is just lower G&A. We've canceled conferences. We're not going to conferences. I'm doing this conference from my home versus actually traveling to go do it somewhere else. So we expected about 30% of the number come from G&A. The rest really comes from, I'll call it, delayed hires for any of the new ventures we're thinking about doing as well as, I'll call it, restructuring and reprioritizing some of our IT projects. And again, those are things that we'll have to make decisions at the end of this year. Do we want to actually bring in additional headcount? Where do we want to bring it in? It may be different in a post-COVID environment than it was a pre-COVID environment, meaning the lines of business we think that are going to be much more attractive may be different. And what projects are actually going to drive, I'll call it, growth in the right areas quicker, we may adjust that. That's why I say I think this year, a lot of that $50 million is for this year, which is why I wouldn't build it into a run rate long term. But there will be changes coming out of our view. I'd say as a management team, we're committed to continuing to drive our G&A ratio down. We are still looking at those targets we had put out that had a low 14s this year and a mid-13 s next year. And our other worry about COVID-19, obviously, is with the slowdown in the global economy, we could see pressure on top line. So we'll be looking a hard look at that savings we're getting this year and trying to decide what do we actually put in our pocket to continue our track towards our G&A goals for the long term.

Okay. And that leads into a question we just had come through talking about the potential for top line pressures versus expenses moving forward. Is inflation the right benchmark to use for expenses moving forward? Does it largely track premium growth? In my mind, there's been remixing of the book of business, which has moved around the expense ratio components. How should we be contemplating the forward expense ratio and even nominal dollar expense growth?

Yes. I would say that right now, as we think about expenses on a go-forward basis, if you wanted to use growth as a rate, we have -- with the installation of a couple of the platforms we've done, most notably on the insurance side, where the greatest expense ratio is in the London market as well as in the U.S. with the new platforms that the teams have put in over the last couple of years, there is some real operational leverage there. So to the extent we're growing our top line, you will not see a dollar-for-dollar expense growth, therefore, even at the same, I'll call it, rate of expense growth. So we have operational leverage there. We can see it in the new platforms we've put in. So my expectation would be, as we think about growth on a go-forward basis, that there is operating leverage there that can handle it such that we should get a gain on our G&A ratio, especially in the insurance segment. On the reinsurance side, we're already very competitive on the G&A ratio. So I think this is really a focus on getting the insurance team to be more focused on using the leverageability they have with the new platforms that they've built over the last 5 years.

Got it. And as we think about new business momentum and the potential for premium volumes there, I guess to what extent is pricing contributing? To what extent is potential exposure shrinkage, because of the macroeconomic environment, a headwind? And how should we think about these 2 things kind of balancing to drive forward premium volumes?

Well, you hit the 2 big ones, right? So we are getting more rate today. So even in the first quarter, we saw the insurance team was up 11% on GWP, but their renewal rate was up 10%. So it did not drive a ton of exposure change there, just really drove a lot of rate, when you looked at it at a complete macro level. But I think on a go-forward, we're going to see more pressure on some lines of business that are really driven by the size of the economy. So the credit lines, credit and political risk, we may see aviation come down, and we may see marine come down. So we're going to see some pressure on all those lines of business. To offset that in many of the other lines of business, we're seeing really good rates. So as we mentioned in the first quarter, when I think about rate, the insurance team had over 15% rate on E&S property, over 20% rate on excess casualty. So those rate increases will help offset some of that. What the extent is of each? Will they completely offset? It's going to be a function of it's going to be a function of how well the slowdown lasts and what the impact is going to be to some of those -- really those lines of business written driven by GDP. But as we look at our portfolio, we do think there's going to be some impact. And while we're expecting growth this year for insurance, we could be flat to even down from last year a little bit depending upon how long the shelter in place holds. And that would be on top of really good rate increases. So it's hard to actually model it all out knowing exactly what's going to happen with GDP and the economy in the rest of the year. But it is something we have our eye on. It's the reason we've delayed hires and taken some of the expense actions we've had that we can actually sort of keep our powder for next year to the extent there actually continues to be any pressure on top line due to the economy.

Yes. No, it's -- the crystal ball for 2020 has been cloud EFS. So even looking out further than that, it's been interesting. Does it feel like business is moving out of the standard market and towards E&S and has that helped terms and conditions, in addition to pricing in any material way?

I would say yes to both those questions, Phil. We have seen an uptick in business moving from standard lines into E&S, and it's given our underwriters the opportunity to really put good terms and conditions, better terms and conditions as well as get rate that they've needed on a lot of these renewals that they're seeing.

And thinking about the impact of pricing to underlying underwriting performance, most companies talk about, and I think AXIS is -- has similar verbiage about being quick to recognize the bad news and slow to recognize the good news. Should underlying underwriting improvements be evident, given the pricing that we have? Or should we think about loss picks being a bit sticky around current levels, and we'll see how the business unfolds just given the uncertainty that we have?

I would say that what you just mentioned, I think, is a prudent approach because if you remember just even 3 to 4 months ago we were talking about social inflation and the impact of social inflation on our long-term, like our liability portfolio, so the professional lines and the casualty, excess casualty. So I would think that on those longer tail lines, it's going to be a while before we actually take all the rate we're getting and start showing it in the loss picks. On the short-tail line, so if you're thinking about A&H or property, we'll see the results fairly quickly. And by that, I'll say, within a year, because those are short-tail lines, we'll know if we got the right price or excess price, and that will flow through a lot quicker. So when you're looking at it on the income statement, it depends on how the mix of business is going, but I would think that we're going to see -- we're going to be more prudent on the long-tail lines, especially with the uncertainty around COVID as well as still continued worries about social inflation.

Yes, we actually had a question come in about social inflation. To what extent does COVID and the uncertainty around that impact social inflation? And does it accelerate or decelerate the momentum that we've seen?

That's a really good question. We've debated that. It could be that the plaintiffs' bar who were kind of driving a lot of the social inflation and the fact that the courts have been shut down would decelerate it a bit. And what you're going to see is those folks now focus on, I'll call it, property BI and suits around property BI coverage or whatnot. But I do think that it's not going to go away. So it wasn't a 1 quarter phenomenon. It's something that we've been seeing come through claims as an industry for the last couple of years. And so it's not going to go away in 1 quarter. So we still need to continue to price for it. We still need to continue to underwrite for it, and we still need to reserve for it.

Got it. Understood. Switching gears a bit and just thinking about life post or with COVID and the fallout from this. We've got a couple of questions about the potential for consolidation underwriters, and just maybe the opportunity the current valuations present to the extent that there could be consolidation. Do you have any thoughts around inorganic opportunities, maybe not just for AXIS in particular, but broadly, how we might see the market unfold over the coming quarters?

Yes. It's a pretty interesting time mostly because of what's happened with the stock markets and what it's done to folks' valuations. Because in a normal time with a market that is accelerating rate and getting firmer, I would expect to see little M&A because management teams are going to want their underwriting teams focused on the markets, generating quotes and getting rate and driving to a better book of business and not having anyone distracted by talk of a merger or an acquisition, and then you've got a lot of senior underwriters wondering, will I have a job? Will I win the job? Will it not win the job? And that uncertainty would take their eye off the ball, which is really driving a good portfolio and increasing growing portfolio with good rate and good terms and conditions. I still think that will hold in the near term even though valuations are where they are. I think as COVID sort of clears up a little bit and valuations start to remove some of the uncertainty associated with COVID to the extent we can get there, you'll see valuations go back up a bit, and then we'll have, I'll call it, normal valuations, and we're in a hard market, which usually, you don't see the M&A activity. Usually, you see it towards the end of a hard market where people want to still grow and the best way to do it is inorganically. So I guess right now, I'd say our view is we're having our teams and our underwriters focus on growing inorganically. It's a good market out there. It's got some good sectors that are growing and have firming and some markets here even say pockets are hard, that that's the best way to grow versus trying to do another acquisition where you're just going to distract everybody for an extended period of time.

Understood. Now thinking about the potential for consolidation from another perspective, there's clearly been consolidation in the distribution side of the house of the brokers. Has that been disruptive in any way to AXIS and as we think about renewals in 2020 or have you felt an impact from consolidation among the brokers?

We haven't felt it yet. I think the big consolidation that's happening with Willis and Aon is still in -- they've still got to get a number of approvals. It's kind of still in the planning phase. And so from what I could tell, most of the brokers are -- they're out there doing their job, and they haven't come down to that time yet where they're wondering what the combined group looks like. So day-to-day, right now, it's more been, can everyone do their job virtually? Can everyone get the flip side, get the terms and conditions out? Can we actually respond appropriately when it comes to the current environment we're working at with less worry about without acquisitions, at least right now? And in that vein, I'd say we're all performing really well. We've actually heard from the brokers that our underwriters are even easier to get a hold of because none of them are traveling now. So they know where they are every day, and they can get them on the phone every day. So it's kind of an interesting phenomenon of the shelter in place as everybody knows where everybody is. But overall, it's not impacting us yet. And on a go forward, I think that we have great relationships with the leaders of the firms. And we think that our relationship will be positive on a go-forward with a combined Willis Aon. And we don't have any worries there. That may be more of an impact to the reinsurance market, and our reinsurance team has done a very good job at actually getting close to their clients, keeping the brokers involved, but getting close to the clients, and so that they have a very good relationship. We have a good relationship with our top clients as well as the brokers as the intermediary between.

Understood. Okay. And we had a question come in over the line talking about the impact of rating agencies and the actions that they have taken recently. And look, in my mind, again, it's a bit disappointing because as it feels like we're starting to see the tangible results of the remix and the business optimization come to fruition is the exact time that the rating agencies took the actions that they took. Do you have any thoughts on how those conversations went? Or any feedback you can kind of give from that perspective?

Yes. I'd say I agree with your sentiment there, Phil. First and foremost, we take accountability for, I'll call it, the lack of stellar performance the last couple of years. The performance was not great. We were overweight property in the exact part of the cycle. We did not -- we should not have been overweight property. So that second half of '17, '18 and '19, as we were changing the portfolio in '18, '19, we still had the hangover of those claims coming through as we readjusted the property portfolio. We explained that the rating agencies. They're very open about it, but especially AM Best said, "Well, it's been 2 years, we've seen you've now had 2 good quarters in a row, but that's not enough of a trend for us to feel that you've made the complete turn," And they had to make a decision moving from A plus to A, AM Best hasn't hurt the business at all. The business guys have been well on the front lines with their producers and their distributors and their clients and that hasn't hurt. The more interesting thing is all the rating agencies when they did their write-ups, they acknowledged, one, our capital position is very strong, strongest rated by AM Best as well as S&P back to strongest position there. So where our capital base was good, it was all about the backward-looking performance. And again, I have to acknowledge the backward-looking performance the last 2 years was not stellar as we continue to remediate the portfolios. But as we sit here today, and we see the moves we've made, the lines of businesses we've exited, and the go forward, we feel really good about the go forward. And now we actually have, due to various reasons, one, the underpricing in the market that was alive well before we got to COVID-19, still driving rate, we actually feel pretty good about our go-forward performance. But they did, I'll call it, a backwards-looking view, and we have to accept accountability and responsibility for that. Hopefully, in 2 years from now, they'll look at it and say, "Geez, you did turn around the portfolio. We've now seen it in 2 years of results," and take a positive action.

Well, Pete, we have about 1 minute left, so I think we'll probably just cut it here. But I look forward to the next couple of quarters as well and thinking about the go-forward of the business and how that's going to unfold. And the past 2 years are the past 2 years, and we'll take it from here. So thank you so much for the time and for all the thoughts today, and hope you and all yours are well.

Thank you very much, Phil. Same to you. I hope you and your family are doing well, and enjoy the conference.

All right. Do well, everyone. Thanks, and have a good day.

Thank you.