Conduit Holdings Limited (CRE) Earnings Call Transcript & Summary

Good afternoon, and welcome to the Conduit Holdings Limited Investor presentation. [Operator Instructions] Before we begin, we'd like to commit the following call. I'd now like to hand you over to Neil Eckert, Executive Chairman.

Good afternoon, Paul. And ladies and gentlemen, I shall start with the presentation, which what we do is we start with a very basic explanation of what reinsurance is, Conduit Holdings is a reinsurance company. So reinsurance is effectively insurance for other insurance companies. It's the principle of putting the losses of the few into the pockets of the many, which is what insurance is. Insurance companies that insure either commercial risk or the general public can quite often face dangerous accumulations. In the U.K. market, it could be a Thames flood or a hurricane. And they can't take the levels of volatility that are potentially out there for large losses. So they go to the reinsurance market, and they try and lay off the peak catastrophe potential. Typically, placements are syndicated amongst many people. The global reinsurance market has about $700 billion of capital. And it probably issues about $400 billion of limit across Europe, America and on a global basis. The job or our goal is while we're taking exposure, we also want diversification and we want to manage the volatility in our own portfolio. And I will come on to that during the presentation. Reinsurance is important. It oils the wheels of commerce. Without insurance, it's impossible to borrow money. It's impossible to drive a car. It's a fundamental part of the global financial system. And with climate change, increasingly, society is facing new threats, increased hurricane risk, increased flooding risk, wildfires, secondary perils. Reinsurance comes in 2 forms. One is what we call proportional where the reinsurer takes a pro rata share of each risk from the direct insurer. So that's effectively renting our balance sheet. And insurance companies buy that type of coverage in order to defray their expense base. So they will charge the reinsurers what's known as the ceding commission. We take a share. We pay a pro rata share of the claims. We take a pro rata share of the premium, but we pay them the ceding commission, usually between 25% and 30%. And that covers the cost of their claims adjustment, running their offices, marketing distribution. But we're taking aggregated portfolios, and it's a very efficient way of us doing that. There's then nonproportional and those coverages are volatility covers. And what we will typically do is someone -- I mentioned before the example of the Thames flood, someone will decide that they've got a high concentration of property risk in London. They will come to the market and say, we've never had one event that cost us more than $50 million. We will price a coverage in excess of that number. We will look at loss returns, we'll model it, we'll look at the potential and we'll charge a premium. And that gets the volatility off their balance sheet. Our job then is to manage and diversify our own portfolio. We are able to write reinsurance whilst having a limited catastrophe profile ourselves, and we'll come on as to how we manage risk. We only underwrite P&C, Property & Casualty. Casualty is liability coverage. We do not write life of health. Insurance is a cyclical market. And the key to making money in insurance is understanding the cycle. Industry vernacular for profitable is hard. It's when rates are hardening as opposed to softening. And we showed the insurance cycles here since the year 2000 -- well, '99. What triggered that first half market was the tragic event of 9/11, which was a $50 billion claim. It was an unmodeled event. And it drove rates up significantly. I was running Brit Insurance at the time and our account grew. We went from about a $300 million to a $1.3 billion market cap during the early 2000s. After a while, people -- at the top of hard markets, insurers become very profitable and make good returns on equity. And then gradually, capital flows back into the market, as you can see there, which will drive pricing down. And that's what occurred from [ 2013 ] through to 2018. We then had some serious hurricanes. We then had COVID in 2020. And that's what caused us to said -- myself and Trevor Carvey, we got together and said, right, there's COVID, there's the opportunity to launch a new company. And those companies that we show on the right-hand side were companies that have previously done start-ups in similar conditions. Arch raised $1 billion in 2001 and its market capitalization today is $27 billion. So if you'd only really ever own one stock, that will certainly be a stock to own. Although Conduit in itself only 3 years old, I've known Trevor since 1983. We've both been in the industry for about 40 years. We've both done these types of missions before. There's my CV on the left. I started life as a reinsurance broker working at Benfield, which is now part of Aon. We then started Brit in 1995, which you may have -- if you're a cricket fan, you will remember that Brit sponsored the England cricket side and the Oval. I've always been interested in the weather. So in 2005 -- I've done 10 years at Brit, and I was invited to be a founder/CEO of a company called Climate Exchange, which went on to dominate the early days of carbon trading. It was sold to ICE. I then went into the energy market because I was noncompeted from financial, Aggregated Micro -- all of these, by the way, were listed companies. I've done 7 IPOs in my life. Trevor, as I said, I've known since 1983. He was one of the founder-underwriters at Arch. And you'll recall from the last slide, I mentioned how successful Arch was. If you come -- in our industry, if you come across people who've got long careers and they've avoided stepping on banana skins, it generally means they are very good at what they do. And when I was a broker, I knew Trevor as an underwriter, and I knew that he -- I mean he basically fundamentally always pick the right risks that I was trying to broke and avoided the bad ones. So that was the genesis of the relationship. We have a very experienced CFO, Elaine Whelan, previously at Lancashire, and very accomplished at what she does. I mean I have extreme confidence in both Elaine and Trevor. Greg Roberts, our CUO, he earned his trade at Amlin, where he worked for Tony Holt, who is one of the best reinsurance underwriters that I came across. Once again, he is -- I mean Trevor has had so much underwriting experience that when you combine Trevor, Greg and the rest of the team, it's a powerful unit. So we are a small team. We have about 60 staff. We listed December 2020. The first 3 years of the company's life, you will never work so hard and not see results. It takes 2 to 3 years for the premiums and the profits to start flowing through. We did quite a brave thing. We went straight to the market as a start-up and IPO-ed and we did raise sort of just short of $1 billion net of expenses. And the plan was to have a single location, single balance sheet, where all the decision-makers sit within 10 yards with each other. We do not have offices in London, Munich, Singapore. We don't have distribution centers. We underwrite through brokers. Guy Carpenter, Aon, Gallagher, Tiger Howden (sic) [ Howden Tiger ]. There's a few reinsurance brokers that have a pretty substantial market share. So we can see all of the business we want. We underwrite property reinsurance. We underwrite casualty, which to the general public, that's liability coverage. And we write specialty, which is effectively the specialist classes that aren't property and casualties, such as marine, aviation, satellite, the whole cargo specie, it's the specialist classes. So that's the book of business. You will see the effects here of what I mentioned about only being 3 years old. One of the benefits of being 3 years old is we do not have exposure to the liability account written from 2012 through to 2019, which, in my view, was fundamentally unprofitable. And we call it legacy exposure. It exposes you to lawsuits going back into old years. We have a new, clean, strong balance sheet. You can see how the premium developed across the years. We wrote about $472 million in the first year, $600 million and something in second year. And this year, analysts are forecasting we'll write about $850 million, $870 million. The combined ratio is, in effect, the margin. And you can see that in the early years, we were having to pay all of the expenses of being in business, but without being able to recognize the earnings. That's because it takes time for earnings to flow because of we have to post reserves against the account. Even though we may not be advised of claims, you have to hold prudent reserves. And it's only once the years have developed and the loss patterns are emerging, you can start to release the profits. So the timing of this presentation for retail investors is fortunate. In the first half, we declared our first profit, $78 million, which on an annualized basis, would be about an 18% return on equity. In our press release, we said we made a 9% return in H1 because we could not have forecast whether there would be an active hurricane season this year. We are now about 6 weeks away from the -- 7 weeks away from the year-end. And to date, there's been no major hurricanes making landfall in the U.S. So it's a different year from last year where we encountered -- 2 things happened last year, a, interest rates rose dramatically affecting people's bond portfolio and their investments. And also, there was the second largest hurricane in history, Hurricane Ian. This year, so far, is looking good. What we have said -- and if you look at the Hiscox Q3 release today, we're all saying the same thing. It is the best market conditions we have seen in decades. This is good. One of the tricks that you -- we launched -- we raised the money in 2020. It's important that you start the company 2 or 3 years ahead of peak market so that you are traveling at full velocity when business is at its most profitable. We believe that this market environment will persist. Inflation, in a strange way, is our friend because it increases demand for the product, values go up, the cost of repairs go up, which means people have to buy more coverage. And that means there is a constraint, a lack or a shortage of capital to support the reinsurance sector. That drives up rates, but it also means that brokers need new markets. If you start a company at the right part of the insurance cycle, the brokers -- you will be preferred market because you're even more important than renewal because they all need new capacity. We have been surprised at the lack of new money turning up in the space. But that, to an extent, is history repeating itself. In the early 2000s, there was a shortage of capital. And it wasn't really until the end of the decade that the industry balance sheet repaired itself. And that's why that period was so persistently profitable. So we're seeing strong demand for the product. We're also seeing a structural shift in the way that the U.S. industry is operating. And a lot of our business is North America. There are 2 types of insurers in America. There's admitted carriers who have to file their rates with the U.S. regulators. These will be household names like State Farm, Allstate, Liberty Mutual, Farmers. And then there's non-admitted, which are smaller companies that don't have to file their insurance rates. The admitted carriers are pulling back from certain target regions. They are wary of coastal regions such as Florida, the Gulf and they're wary of places which are exposed to wildfire, earthquakes such as California. They have very big balance sheets. State Farm by itself is $200 billion. And when they start to pull back, the business flows through into the smaller excess and surplus lines market, and they need to buy reinsurance. The last point on this slide is legacy. Some of the very biggest companies are still experiencing adverse development on their old liability accounts. And as a new player, we do not have exposure to that, but it benefits us because it creates a drag on those businesses and it means they have to keep prices up. So my takeaway from that slide is we really are in a good position to capitalize on the conditions. We have this morning reported our Q3 trading update. Premiums were up 56% compared to 9 months previous, and that's a good guide to market conditions, the fact we're experiencing that level of growth. And it means we're maturing into our -- the size of our balance sheet. Gross premiums for the 9 months was 76 -- $760 million, also up 50%. We continue to be shown new business, and we can diversify in terms of type of risk and geography. But above all, margins are very attractive. We saw a 15% rate adjusted increase net of claims inflation. So we adjust those figures to take into account claims inflation and the 15% was the rises after inflation. Property & Specialty are leading the charge. Casualty is now flat. It went up enormously in price between 2018 and 2022. But it's flat at a level that we find to be totally rate adequate. Whilst this year has not seen a major Atlantic hurricane make landfall, there have been what we call secondary perils, things like tornadoes, severe convective forms, wildfires. Every time that you switch on the news at the moment, if it's not floods in Libya or Greece or Germany, it's a wildfire in Hawaii, fires in Canada. There's a lot going on in the world, which continues to mean that the industry has to be disciplined in the way it prices events. We have not experienced any individual event that is material enough for us to need to report on that event. If we have a large loss, such as Hurricane Ian or the Ukraine, we would publish a number, but there's been nothing that is material so far. This shows the chart, and our growth this year was more than the entire book of business that we wrote in the first year. There's an enormous amount of work when you start up, even just physically finding offices, implementing systems, opening accounts with brokers, getting customers to accept you as a counterparty. And as I say, you'll never work so hard for no return in the early years. This year, as I say, the first profitable year in H1. That shows the 3 classes. Property, the pricing dynamic continues. And we believe, as I said in earlier slides, the market has legs. Casualty, underlying inflation, still the key driver. The market is holding firm. At least at these pricing levels, we continue to have appetite for the risk. And Specialty is actually the class of business that's growing for us as fast as any segment and continues to show really good rate. This shows the rating environment. And as I said, Casualty, flat; Specialty up 9%; Property, 30%, giving us a weighted average of 15%. And that's on top of what we already regard as a very profitable environment. So if one is worried about a potential recession, this is one of the sectors that is very different in terms of its profile. The business will not be affected by recession. The demand will still be there. Insurances in the main, not a discretionary purchase. Inflation is very important. It's driving industry discipline. We have a high-quality capital base, no legacy exposure, and we have enough capital to support our planned growth and beyond. We have an organic growth model that will enable us to continue to drive higher earnings. We have a diversified portfolio, and 70% of our business is non-cat, i.e., is business that is not exposed to hurricanes, wildfires and those natural perils. The model is scalable. We write over $13 million per employee, which is one of the highest in the industry. And the reason we can do that is because we only do reinsurance. Most other groups do insurance and reinsurance. And the act of insurance, you've got to have a relationship with end customers, either an industry or the general public, and it's a much more complex model. So we now have a portfolio that comes in and renews. Writing a risk for the first time, you have to do a lot more work than when you actually renew it. Even the policies we declined, we record all the data so that if prices keep rising, we will know where that risk is and it may come into our rating wheelhouse. So the investment proposition, it's a pure-play reinsurance company. It's the perfect part of the insurance cycle. We think the cycle has duration. It's a management team who've done it before. It's a simple model, single location. But one of the other benefits is we have modern systems. We use pricing analytics. We have a strong balance sheet. Importantly, I think from a retail investor perspective, we trade at a discount to book value, we trade at 0.9x net tangibles and we pay a dividend of 6.8%, which is now twice covered. So with that -- there are some appendices. We give details on our investment portfolio. We give details on various parts of the company, but I'll now hand over -- okay, back to Paul.

Fantastic. Thank you very much, indeed, for the presentation, sir. [Operator Instructions] Neil, as you can see, we've received a number of questions, both pre-submitted and throughout today's presentation. Perhaps I could start with the first one here. What are the benefits of being a single location specialist reinsurer? I think you've touched on some of these throughout the presentation, but if there's anything further you can add, that would be great.

It's the simplicity of the model, I have worked in much more complex organizations. If you are dealing in multiple locations, the management -- we're in the risk business, and you want your decision takers to be close to each other, peer review. So Trevor and Greg are literally within 10 yards of anyone who is binding risks for our business. It's much simpler from a regulatory perspective, you're dealing with one regulator. Global businesses are dealing with multiple regulators in multiple territories. Their accounting, their taxation. There's just layer on layer on layer of complexity. So we've gone for the simplest thing we can go for in what we think are the best market conditions that we could wish for.

Fantastic. Next one we've got here. Why do you think the current hard market, which I understand means very positive, will be extended? And again, I think you've put on some of these trends as we've gone through the presentation, which is probably worth reiterating, I guess.

Yes. I'm a believer that history repeats itself. And it almost feels like we're having an action replay of the early 2000s. World Trade Center was an unmodeled loss. COVID was an unmodeled claim and was serious for the insurance industry. We started -- a few companies started up. And then in 2005, we had the worst hurricane year in history. Hurricane Katrina, people may remember, New Orleans; Rita and Wilma. We got -- Wilma was W in the alphabet, and we actually got to G in the second alphabet. It was the first time in history that we got all the way through our hurricane alphabet. That prompted conditions that are similar to the ones that we see today. And that market, it took really 7 or 8 years for the balance sheet to repair themselves and for new capital to turn up. So I believe that the history can sometimes serve as a guide, and this does feel very similar. But that market really lasted, well very profitable for 8, 9 years.

Fantastic. I've got a question here from David. Are we now in that realization process, so those premiums you've previously written? Will you reinvest all the capital returns?

No, we paid dividend. So our dividend yield is 6.8%. And that was a commitment we gave to the income funds at the time we did the IPO, and we've maintained that dividend flat. But after that dividend, we can reinvest all of our retained earnings. Analysts are forecasting earnings of around GBP 125 million this year, which means that we will have retained earnings, so we can grow our balance sheet year-on-year. But in these current conditions, we will deploy every penny that we retain.

Fantastic. Another one from David here, how much business can you write from your current capital base?

It's very hard to -- you have to have a crystal ball and be able to predict the economic performance in the future of the business. We can sustain continued growth and we can go way past current levels of premium. It is not possible for me, and we don't give guidance on a finite number because that number, as I say, is dependent on future performance. But what we do say repeatedly in our Q3 update is we will not be issuing any shares or needing to raise capital within our current planning horizon.

Fantastic. I think you've pretty much covered this off, but just, John, thank you for the question. With regard to capital allocation, is Conduit now in a position that an increased dividend may be considered? Was it more a case that funds be allocated to the growth of the business?

I mean we think the profitability is so good that we can't -- we would rather deploy -- I mean we will be able to fully deploy. And therefore, we won't be increasing the dividend whilst these conditions are as profitable as they are. If we ever get to the stage where we have got more capital than we think we need, at that stage, we will consider special dividends or share buybacks. But right now, it's about as good as it gets.

Perfect. Mark, thank you for your question. Climate change appears to be radically affecting the level of trust placed in modeling future loss trends. Is this the prime reason for Conduit's low valuation due to the skepticism around hard rate -- I'm sorry, skepticism around the hard rates market, converting to profit and shareholder returns?

Yes. I don't think so. I think what we suffered was most people that start insurance businesses do it in the private equity market and they come to the stock market once they are making substantial profits. The first 3 years of our life, we were in the public arena. The stock market doesn't like jam tomorrow. It doesn't like promises. It just wants to see people printing results. So our share price did go down. We had a couple of major sellers who called us about the IPO. But fundamentally, we were putting a business together that will deliver and is delivering now results. And the share price went as low as GBP 3 post-IPO, and it's now at GBP 4.50. And it is showing the volumes are increasing, the interest in the market is increasing. So I don't think it's climate change. We are now -- Lloyds is a good proxy for a basket of many, many businesses. And in 2022, which experienced one of the worst years ever in terms of climate-related losses, Hurricane Ian was $50 billion by itself, there were $130 billion of climate-related losses. The Lloyds market turned a combined ratio of 93%, e.g., a 7% profit margin. And if the marketplace can do that, that says that there is pricing resilience in spite of elevated claims activity. And this year will be a better year than 2022 and there's been subsequent rate rises. So I think Conduit share price reflects the stage of its development, but I firmly believe we are now at an inflection point.

Fantastic. Mark, thank you for your question. What do you need to do to double the size of the business written in terms of teams and capital?

So the model is scalable. And I think -- we currently have about 60 staff, and I think that we get to maturity at around the 70 mark. But the platform is scalable, and we can just write slightly bigger lines. We're being shown more business all the time. The really hard work was not to 7 -- not to $400 million, not going from $850 million to one-point-something million dollars next year. I think analyst forecasts are for about GBP 1.7 billion next year. So we've got the bits in place, we've done the heavy lifting, we have the balance sheet to grow and we've got the teams, really. It's now just a question of polishing the model a bit. So as I say, we're 60 staff now. At 70 we can scale and increase the premium in this model.

Thank you, Neil. And the next question I got here is what would be the estimated 82% combined ratio of no Atlantic hurricane hits land?

Yes. I can't give that number, and I'll tell you why, because it's not just hurricanes that affect the market. It's wildfires, it's earthquakes, it could be a war. There's any number of things that could happen between now and Christmas. So just to say, exclude one loss and tell me a combined ratio. What I can tell you is that our combined ratio in the first half was 84%. And so you can see the trend is emerging. 84% implies a 16% margin. But I can't answer the question the way it's asked. I'm trying to be helpful by just pointing people to what we did achieve in H1.

That's great. Thanks, Neil. A question from Peter. How important is the interest rate cycle for the business? It must help your investment portfolio brackets if they fall, but are there other effects?

So at the moment, the reinvestment yield -- we have a bond portfolio that's in the appendices. It's AA rated. Its average duration is 2.3 years. I mean, basically, we are ultra conservative on investments. We make our money underwriting. But the current portfolio yield is 3.2%. The reinvestment yield is 5% and a bit, even in AA and U.S. treasuries. So that all helps should interest rates fall from here. Obviously, we will have investment gains. We certainly took the pain when interest rates were rising. So yes, it's -- current investment conditions are good for us, and any fall in interest rates is advantageous.

A couple of questions here, but I just have from Peter just around, I guess, valuation. First one reads, based on the fact that you're coming into the sweet spot of earnings and fully using your balance sheet, what should be your price-to-book ratio?

All I would say is that there are plenty of companies, including some London Stock Exchange companies such as Hiscox. Hiscox, I think, trades close to twice book. Arch trades at twice book. Ren Re at twice book. Beazley trades north of 1.6, I believe. So if we continue to print similar metrics and profitability as those sorts of peer groups, then I would honestly hope that we would close that discount. What long-term price that we arrive at, I can't forecast, but all I can do is point to our peers.

That's fantastic. That concludes the questions, Neil. We did have one final question, which you just wrapped into that. That's great. Look, thank you very much indeed. Any further questions that do come through, the team will be able to review those and we will publish those responses back on the Investor Meet company platform. Neil, perhaps before just redirecting investors to provide you with their feedback, which is particularly important to you in your team, can I just ask you for a few closing comments, sir?

Well, firstly, thank you to everyone that took the time and had the interest to see the presentation. I would hope that you've learned something about our business. I think my summary is market conditions are just it's exactly the right time. We're reaching a stage of maturity, which I think gives people an investment opportunity. We are well positioned for growth. We have the capital. And we -- if analyst forecasts are right, we'll have retained earnings. We pay a good dividend. If you're worried about a recession, this is probably one of the places that you'd want to invest. So thank you all for your time and your interest. And of no doubt, we will do future presentations like this. The next corporate event, we -- the 1st of January is a very big time in the insurance market. A lot of people buy annual coverage starting from the 1st of January. We will be wiser about market conditions for next year by mid-January, and we will do a trading update in the third week in January. We'll announce when it is on the RNS. And then our final -- our results come out mid-February. Once again, the dates will be on our website. So please stay in touch, and hopefully some of you will end up being shareholders. So thank you very much for your time.

Fantastic, Neil. Thank you indeed for updating investors today. Can I please ask investors not to close the session. You should be automatically redirected to provide your feedback in order for the team can better understand your views and expectations. This will only take a few moments to complete and is greatly valued by the team. On behalf of the management team of Conduit Holdings Limited, we'd like to thank you for attending today's presentation. That concludes today's session, and good afternoon to you all.