XL Group plc (XL)

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XL Group plc (XL)

Q4 2011 Earnings Call

February 09, 2012 5:00 pm ET

Executives

David R. Radulski - Senior Vice President and Director of Investor Relations

Michael S. McGavick - Chief Executive Officer and Director

Peter R. Porrino - Chief Financial Officer and Executive Vice President

Gregory S. Hendrick - Chief Executive of Insurance Segment

James Veghte - Chief Executive of Reinsurance Operations and Executive Vice President

Unknown Executive -

Susan L. Cross - Global Chief Actuary and Executive Vice President

Sarah Elizabeth Street - Chief Investment Officer and Executive Vice President

Analysts

Unknown Analyst

Keith F. Walsh - Citigroup Inc, Research Division

Jay Gelb - Barclays Capital, Research Division

Matthew G. Heimermann - JP Morgan Chase & Co, Research Division

Michael Nannizzi - Goldman Sachs Group Inc., Research Division

Jay A. Cohen - BofA Merrill Lynch, Research Division

Brian Meredith - UBS Investment Bank, Research Division

Randy Binner - FBR Capital Markets & Co., Research Division

Vinay Misquith - Evercore Partners Inc., Research Division

Michael Zaremski - Crédit Suisse AG, Research Division

Meyer Shields - Stifel, Nicolaus & Co., Inc., Research Division

Josh Stirling - Sanford C. Bernstein & Co., LLC., Research Division

Presentation

Operator

Good afternoon. My name is Shirley, and I'll be your conference operator today. At this time, I would like to welcome everyone to XL Group plc Fourth Quarter and Full Year 2011 Earnings Call. [Operator Instructions] Please be advised, this conference is being recorded. I would now like to turn the call over to David Radulski, XL's Director of Investor Relations. Please go ahead.

David R. Radulski

Thank you, Shirley, and welcome to XL group's fourth quarter 2011 earnings conference call. This call is being simultaneously webcast on XL's website at www.xlgroup.com. We posted to our website several documents, including our quarterly financial supplement. On our call today, Mike McGavick, XL Group's CEO, will offer opening remarks. Peter Porrino, XL's Chief Financial Officer, will review our financial results; followed by Greg Hendrick, our Chief Executive of Insurance Operations; and Jamie Veghte, our Chief Executive of Reinsurance Operations, who will review their segment results and market conditions. Then we'll open it up for questions.

Also in attendance and available for questions are Susan Cross, our Global Chief Actuary; Sarah Street, our Chief Investment Officer; and Stephen Robb, our Controller.

Before they begin, I’d like to remind you that certain of the matters we'll discuss today are forward-looking statements. These statements are based on current plans, estimates and expectations. Forward-looking statements involve inherent risks and uncertainties, and a number of factors could cause actual results to differ materially from those contained in the forward-looking statements, and therefore, you should not place undue reliance on them.

Forward-looking statements are sensitive to many factors, including those identified in our annual report on Form 10-K, our quarterly reports on Form 10-Q and other documents on file with the SEC, that could cause actual results to differ materially from those contained in the forward-looking statements. Forward-looking statements speak only as of the date of which they are made, and we undertake no obligation publicly to revise any forward-looking statement in response to new information, future developments or otherwise. With that, I'd turn it over to Mike McGavick.

Michael S. McGavick

Thanks, David. As you have seen by reading our release, the fourth quarter of 2011 was highly unusual, and that understanding it requires some explanation, which we will attempt to do thoroughly tonight. At the same time, once we clarify the unusual items, I think you will come to the same 3 conclusions that we do. First, that XL has become an excellent manager of catastrophe risk across the firm. Second, that while there are large blocks of excellent underwriting at XL, we remain plagued by lost activity in a handful of insurance lines that undermine our results. And third and most important, that we have the proper focus on improving or eliminating these sources of poorer results.

Now for clarity's sake, this is how the call will go tonight. First, I will walk through the unusual items for the quarter at a high level. Second, I will similarly walk through our underwriting results highlighting the evidence of the 3 points I just made. Then I'm going to turn the call over to our CFO, Pete Porrino, who will walk through these unusual items in deeper detail, as well as updating you on other critical aspects such as investments. After Pete, our newly appointed CEO of Insurance, Greg Hendrick, will provide even more detail on the breadth of correction underwriting actions underway, and give some examples of the early results that would not yet appear in the financials, but will give you a sense of why we have such confidence. Finally, we will conclude with a very positive report by Jamie Veghte on our Reinsurance operations. Both Jamie and Greg will also give their perspectives on the improving rate environment. Then we will take your questions.

So let me begin with some of the unusual items that drove the quarter's results. First, I want to give you the thinking behind the largest item for the financial note, the goodwill charge. Next I want to give you some perspective on expense levels, as you will notice, that expenses ran higher in the fourth quarter. Finally, I need to provide you with some perspective on tax in the quarter and for the year, as without understanding this nuance, one could wrongly conclude that our underwriting was worse that it in fact is.

First, about the goodwill charge. As you well know, the P&C insurance sector is continuing to trade at low valuations, and XL is traded at an even greater discount. When these conditions persist long enough, we must closely examine the goodwill we carry, in relation to the purchase of these operations. In our third quarter 10-Q, we described that this examination was intensified. When the fourth quarter showed higher levels of non-cat loss activity, as had the third quarter. We felt that our assessment of how the market would value these operations had to reflect these recent poor results, even if we remain bullish about our potential over time.

Pete will give you the greater detail, but this is the basic thinking behind our goodwill write-down of $429 million. Note that this has no impact on our calculations related to excess capital. Second as to operating expenses.

Back in June, we said that we thought the fourth quarter of 2010, would have been a good proxy for the 2011 run rate. And so it proved to be. Our 2011 full-year expenses were, in fact, roughly 4x the expense load in the fourth quarter of 2010. But what does this say about 2012? While we generally stay out of the business of giving guidance, for 2012, we expect to come in at the right around about 100 more -- $100 million more in expenditure, than our actual full year 2011 level. But we need to emphasize that going forward, there will likely continue to be meaningful volatility from quarter-to-quarter. Technology spending, for example, can be quite lumpy. And new hires can be very hard to predict in terms of quarterly timing. And it is in those less predictable areas, we are exactly where we are making investments. Investing teams who can grow the business in lines where we find current and future returns appealing, upgrading talent where we have found it to be deficient, and building pricing and product modeling and the technology to deliver it while lowering costs.

And so on to the third item. Tax. Now this item would not be obvious just from reading the materials you have in front of you. At XL, we typically have an effective global operating tax rate in the mid-teens. And this was true through the first few quarters of 2011. But in the fourth quarter, an unfortunate phenomena took place. Pete will get more granular about this, but it has a simple idea behind it. The heavy losses we experienced, such as the Thailand floods, ultimately were written in low tax jurisdictions. While our positive earnings, such as the reserve releases in our London markets operation, came in a high tax jurisdiction. As a result, the effective tax rates for the year, instead of being in the mid-teens, was in the mid-30s. And in the fourth quarter, this tax item added fully $59 million to our operating loss. This rare phenomenon of tax adding insult to injury has happened at XL before, in cases of high volatility, low earnings quarters like we just experienced. In general, however, and over time, our tax strategies have proven to be very effective. And while we will always work to make sure our global structure is tax efficient, there are no obvious changes suggested by our studies of this fluke pattern. I should add that the move of the holding company last year to Ireland, has nothing to do with this result.

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