Earnings Call Transcript - GLRE Q3 2021

Operator, Operator

Thank you for joining the Greenlight Re Conference Call for the Third Quarter of 2021 Earnings. The Company reminds you that forward-looking statements that may be made in this call are intended to be covered by the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are not statements of historical fact but rather reflect the company’s current expectations, estimates and predictions about future results and events and are subject to risks, uncertainties and assumptions, including those enumerated in the company’s Form 10-K for the year ended December 31, 2020, and other documents filed by the company with the SEC. If one or more risks or uncertainties materialize or if the company’s underlying assumptions prove to be incorrect, actual results may vary materially from what the company projects. The company undertakes no obligation to update publicly or revise any forward-looking statements whether as a result of new information, future events or otherwise, except as required by law. Please note today’s event is being recorded. I would now like to turn the conference over to Greenlight Re’s CEO, Mr. Simon Burton. Please go ahead, sir.

Simon Burton, CEO

Good morning, everyone, and thanks for joining today’s call. In the third quarter, the reinsurance industry was challenged by an unusually high incidence of large losses related to catastrophic events. Our exposure to Hurricane Ida, flooding and hailstorms in Europe, and riots in South Africa drove us to an underwriting loss for the quarter with a combined ratio of 109.3%. Excluding the impact of catastrophes and minor reserve adjustments, the adjusted combined ratio for the quarter was 90.3%. We have seen a steady reduction in our adjusted combined ratio over the past few quarters, which reflects improvements in both the quality of our underwriting business and the overall rating environment. I’d like to summarize some of the major movements in written premium by class during the quarter. We are now seeing a reduction in motor liability premium that I discussed in the past two investor calls. We believe the reasoning behind our decision to reduce exposure has been validated as we are seeing an uptick in accident frequency along with increases in claims severity driven by elevated repair costs as U.S. drivers have reverted to normal driving habits over the past few months. Our auto exposure will likely take another step down in 2022 as we have decided not to renew a further portion of this book at January 1. In the financial class, written premium increased during the quarter driven mainly by a rebound in demand for representations and warranty insurance from M&A activity that had decreased in earlier stages of the pandemic. Accident and health is a fairly small class for us, but a couple of things are going on there. First, our traditional A&H business has reduced as we replace it with support for our innovations partners who are doing a great job on offering new products and disrupting an otherwise inefficient class. Second, we have restructured some of our exposure from quota share to excessive loss with equal or greater dollar margin potential but much lower written premium. Looking forward to 2022, it’s not clear how the market will respond to yet another loss-making year in the property catastrophe class. Rate increases last January were disappointing as new capital arrived to replenish supply, which leaves us skeptical that sufficient capacity will be removed to support the needed catastrophe price improvements at this year-end. On the other hand, we expect the cat losses this year will help support and extend the generally favorable market conditions in most other classes. The continued low investment interest rate environment provides further support for pricing conditions overall. Our innovations unit continues to perform well with an investment gain of $9.6 million during the quarter, which is an increase of 31% from the prior quarter's carried value. While the investment success is the welcome result of great execution by the innovations team, our central objective continues to be to enhance our underwriting products and the quality of return by establishing a range of proprietary strategic partnerships. Year-to-date, innovations business represents approximately 6% of our total written premium. We see the potential for significant growth from innovations-derived underwriting opportunities going forward. Finally, we completed our annual review with A.M. Best last quarter, which resulted in the reaffirmation of our A- rating and an uplift in outlook to stable. We’re pleased that A.M. Best concurs with our own view of the balance sheet strength, underwriting prospects and the compelling strategic potential of our innovations business. Now I’d like to turn the call over to David.

David Einhorn, Chairman

Thanks, Simon, and good morning, everyone. The Solasglas fund returned negative 2.7% in the third quarter, longs detracted 3.5%, shorts contributed positive 1.1%, and macro was flat. During the quarter, the S&P 500 Index returned 0.6%. Our long positions in Green Brick Partners and Chemours were our largest detractors. Positive contributors included our long position in Atlas Air Worldwide and our short exposure to several so-called story stocks. Our largest position, Green Brick Partners, held an Analyst Day in August. At the meeting, the company highlighted that its revenues have compounded at 28% annually since its 2014 IPO. In 2020, the company earned $2.24 per share, which is a 93% increase from 2019. The analyst community has taken its estimates for the year and next higher, and they now expect the company to earn $4.06 per share in 2022. This would represent a remarkable 250% cumulative growth in its bottom line in 3 years. These days, it’s not uncommon for the market to reward a company experiencing this amount of growth with a double-digit valuation multiple on its revenues or an above-market multiple on its earnings. Green Brick ended the quarter down 10% to $20.52 and was valued at just 5.6x 2021 expected earnings. Our long position in Atlas Air was the largest positive contributor as the stock advanced 20% during the third quarter. The company had a nice beat on reported second quarter earnings and gave strong third quarter earnings guidance, signed a number of new multiyear customer contracts. Atlas continues to benefit from what now appears to be a structural support shortage of air cargo capacity. The airfreight market is benefiting from e-commerce growth and global supply chain disruptions. Meanwhile, airfreight supply has shrunk as international passenger belly capacity remains significantly below pre-pandemic levels, and there are long lead times to deliver new freighters. Atlas trades at a P/E multiple of around 5x. Lately, it feels like many of our longs have been exceeding both consensus and our own often more optimistic expectations for their operating performance. But the share price reactions to these positive developments have been minimal. We believe this dynamic ultimately cannot persist. If the stocks don’t rerate higher, it will eventually be resolved through share repurchases. There are several companies in our portfolio that appear poised to return their current market caps to shareholders over the next few years. As we continue to hold the quaint view that shares represent a fractional ownership of a business, as the denominator of shares goes down, the fraction of the business that each share represents goes up. Year-to-date through October, Solasglas has returned 0.7%. Net exposure was approximately 35% long in the investment portfolio at the end of the third quarter and roughly 46% at the end of October. While our underwriting suffered in the third quarter from several cat events that Simon discussed, the underlying reinsurance trends are favorable. We continue to make progress with the overall repositioning of our portfolio, in addition to the reaffirmation of our A.M. Best A rating with a stable outlook. We just returned from a Board meeting with our new Board members, and I want to welcome Urs, Victoria and John to the team. It was terrific to have fresh viewpoints from industry practitioners that should help enhance our business and strategy over time. Now I’d like to turn the call over to Neil to discuss the financial results.

Neil Greenspan, CFO

Thank you, David, and good morning. At the end of the third quarter, our fully diluted book value per share was $13.25, representing a 2.6% reduction from June 30. Our net loss for the quarter was $13.9 million or $0.42 per share. We reported an underwriting loss of $12.6 million during the quarter and a combined ratio of 109.3%. The quarter’s underwriting results included $26 million of catastrophe losses, which contributed 19.1 percentage points to our combined ratio. Most of this loss was due to Hurricane Ida. We did not recognize any material adjustments to prior year loss estimates, including those related to COVID-19. Gross premiums written were $128.7 million for the quarter, down 5% from the third quarter of 2020. The bulk of this decrease related to motor contracts on which we elected to reduce or withdraw our participation. Premiums ceded were insignificant in the third quarters of 2021 and 2020. Total general and administrative expenses incurred during the quarter were $6.1 million, representing an 18% increase over the third quarter of 2020. This increase was driven by the growth of our innovations unit, higher professional fees and increased technology expenses. We reported total net investment income of $4 million during the quarter, which includes $9.6 million of unrealized gains on our innovations investments. We incurred a $6.1 million loss from our investment in the Solasglas fund during the third quarter. I’ll conclude with an update on our share repurchases. During the third quarter, we repurchased 354,000 shares at an average price of $9.18 per share, equating to a discount of 31% off our September 30, 2021, fully diluted book value per share. Now I’ll turn the call back to the operator and open it up to questions.

Operator, Operator

Please note our first question will come from David Bell of Bell Brands.

Unidentified Analyst, Analyst

Yes, David Bell. Simon, I had a question on the $9.6 million innovation gain. Did you all sell one of the companies to realize the gain? Or did you mark it up? Can you elaborate on this part of the business?

Neil Greenspan, CFO

Sure. David, thanks for the question. No, we have not realized, none of those gains represent realized gains. The way we address valuations is we actually don’t carry these investments technically at fair value; we carry them at cost less impairment. And what the markups represent is if there is basically the identical security in a subsequent capital raise, we will mark up our carry value on the basis of that new valuation. So that’s what you see there. It was a capital raise and a new valuation, and so we marked up our carrying value accordingly. That’s the bulk of it.

Unidentified Analyst, Analyst

Right. And can you share, I mean I’ve been following them from the news, from the press releases. Can you share which ones are doing better? Or any clarity on that or detail?

Simon Burton, CEO

David, it’s Simon here. We don’t do that. In fact, we don’t share information on any of our partners or customers. And these are private companies still, so I’m reluctant to do that.

Unidentified Analyst, Analyst

That's understandable. You mentioned that innovations currently account for 6% of the premiums and that this segment is expanding. Could you provide your expectations for its future growth? Additionally, I would like to gain a clearer understanding of how you plan to increase the written premiums in this area, as innovations appear to play a significant role in your vision moving forward.

Simon Burton, CEO

Sure. As I said in my prepared remarks, innovations has long been an important strategic component of the company, and we’ve been growing it steadily. We launched the unit in early 2018. Frankly, I started thinking about this day one on the job, mid-2017. We’ve been steadily growing our portfolio. As I mentioned, the characteristic of these partnerships are both an early-stage investment typically and often rights into the subsequent placement of reinsurance business. So that’s generally a right to access that business but not necessarily an obligation to provide the capacity. These early-stage start-ups are on a runway, and we’re backing companies who are very methodical in the way they execute. They’re not purely looking for growth. So this takes time. And we’re really just starting to see, on the reinsurance side, the fruits of that sort of four-year path. I’m reluctant to give you any guidance on what future premium volumes could be, but it stands at around 6% of written premium to date this year. And I do expect that to increase perhaps materially. Certainly, the opportunity is increasing materially, and we have a large and increasingly sizable portfolio from which to choose reinsurance opportunities from. So watch this space, but I’m going to hold off on giving you specific guidance there.

Unidentified Analyst, Analyst

Okay. Fair enough. It’s great to see the progress it’s making so far. So congratulations on that. And this is another question, I guess, on the broader portfolio. David Einhorn mentioned the progress on repositioning of the portfolio. Can you elaborate more on that? I understand you’re moving away from cat. But this past quarter, there’s a 19 percentage points on cat. Is it going forward? Or are you now moving away from cat? Or will there always be a certain amount of cat? Can you help me understand that?

Simon Burton, CEO

Sure. Yes. So our view on cat is, let’s call it, middle of the road. The exposure that we take on, we’re well paid for, notwithstanding that there’s been some volatility over the past few years and a loss this quarter. We don’t consider cat sufficiently well priced to be outsized in terms of our portfolio. That may change in the future. But I’m skeptical, as I said in my prepared comments, that cat tends to be one of those classes where losses appear to drive sentiments, and the industry may demand price increases. Ultimately, price is a function of supply. And the supply that’s to be available to address the market at January 1 is unknown at this point. So we’re skeptical. I’m not currently expecting a situation where we’ll take an outsized position in the cat business. It’s quite unlikely. We think our current exposure is reasonable given the cat prospects. So something around where we are today.

David Einhorn, Chairman

And David, just so there’s not any confusion, when I talked about repositioning the portfolio, I actually meant away from auto as opposed to away from cat.

Unidentified Analyst, Analyst

Just one more question, if I still have time. Did Arch or Ren Re, or Partner Re also face a tough quarter in the cat business?

Simon Burton, CEO

No. This is an industry event, so I won’t discuss individual peers. However, the third quarter experienced significant natural catastrophe losses. The industry overall, particularly companies with a substantial focus on reinsurance, was likely heavily affected.

Unidentified Analyst, Analyst

If I have time, I have one more question. This is regarding the portfolio side for David Einhorn. I’ve read in the K in the past about a gold position, and I’m trying to understand how that relates to the $220 million total investment. Is that included, or is it a separate part? I see that it's 80% long and about 40% short. Could you provide some clarity on how that total number is calculated? I think DME holds 20% as well.

David Einhorn, Chairman

When we think about the capital in the account, the gold is counted against whatever the limits are for the investment policy. When we give the long/short ratio, that does not include gold.

Unidentified Analyst, Analyst

Okay. So the $220 million, does that include roughly $20 million of gold?

David Einhorn, Chairman

That sounds right to me, yes. I don’t have it in front of me, but that sounds about right.

Unidentified Analyst, Analyst

Okay. So 10%. Okay. I’m trying to come up with a cash book value, which I don’t know if that exists in this business. But I understand the GAAP book value, but I’m trying to kind of get the simple pieces of the liquid books, the simplest piece, and then I can back out the bond debt and then add back the cash on the balance sheet. And anyway, I’m trying to look at it very simply to try to understand cash book value, if that makes sense. So that helps.

David Einhorn, Chairman

I’m not really sure. I’ve got the balance sheet here. I’m not really sure what you’re getting at exactly. Unless you’re just talking about like the deferred acquisition costs or something.

Unidentified Analyst, Analyst

No, I’m trying to understand, I guess, the difference between the restricted cash and the unrestricted and how that adds into the book value. Maybe I’ll be able to form this question better next quarter.

David Einhorn, Chairman

I think a lot of the restricted cash is pledged as collateral as part of the reinsurance business. It is in cash but held in some kind of a trust account. We cannot make direct claims on it until the policies are resolved.

Neil Greenspan, CFO

That’s correct.

Unidentified Analyst, Analyst

That helps. And the total amount, you can invest is half the equity, half the shareholder equity.

David Einhorn, Chairman

That’s the current situation, yes.

Unidentified Analyst, Analyst

Okay. Great. Lastly, can you provide insight on the share repurchase? Was there a restricted period during the quarter when you continued to buy as the stock price decreased? Are you permitted to share any information so we can better understand? Although there's an authorization in place, is there currently available cash to purchase shares without impacting equity or A.M. Best?

David Einhorn, Chairman

Yes. Look, there’s a continued balance between the business needs, the need to post collateral, the rating agencies and our ability to compete in the market. And so we balance the capital in the business with the different opportunities, including share repurchase, which we’ve been pretty active with. I think we’ve bought back about 15% of the company since the beginning of 2020.

Unidentified Analyst, Analyst

Yes. It’s impressive. Okay. Well, I really appreciate it.

Operator, Operator

The next question comes from Kyle Labarre of Dowling & Partners.

Kyle Labarre, Analyst

A few questions for me. Just one more on the innovations units. Simon, I certainly appreciate that you don’t want to give too much color on all the moving pieces in there. Just curious how you look at the profitability profile on the reinsurance you’re writing within the innovations partnerships versus sort of the overall book or the non-innovations piece, if there’s any gap there.

Simon Burton, CEO

This is a key element of our strategy. As I mentioned earlier, the investment results from the innovations portfolio have been promising, and this year has been a rewarding experience. However, our main objective remains reinsurance, focused on strengthening our business and enhancing the quality of our operations. We're seeing an increase in this flow. The key is that we have the flexibility to partner with companies we are very familiar with. Due to our ongoing relationships, early-stage sponsorship, and insight into their operations and governance, we have a comprehensive understanding of these businesses, which is highly valuable from a reinsurance underwriting perspective. Unlike dealing with an unfamiliar third-party client, we have a profound understanding of these entities. Additionally, the costs associated with writing this reinsurance are typically lower than those in the open market. While there may be a broker involved, the fees are usually less than the full market rate. Importantly, we hold a one-way option; we have the right but not the obligation to engage. These factors have led me to believe that the margin potential in this sector is generally better than what we observe in the open market, which is currently strong. This is why we are enthusiastic about innovations, as it fosters strategic relationships and provides opportunities for well-priced reinsurance business.

Kyle Labarre, Analyst

Got it. And then, Simon, last quarter, I thought you gave some helpful comments on sort of how you’re viewing the social inflation environment. Now that’s clearly still an issue for the overall insurance industry, but there’s been sort of a shift in focus to the economic inflation side and cost of goods sold and supply chain issues. Just wondering, based on the sort of shorter to medium tail of your book, how you’re thinking about economic inflation, and are you seeing any effects on that in the portfolio?

Simon Burton, CEO

Yes, we are. I mentioned auto, and that’s probably the part of the book that I’d point to as potentially being impacted. As you know, as I said earlier today and for the last couple of investor calls, we’ve been dialing down our auto exposure steadily. We took a big step down at July 1. There will be another step down at January 1. And that’s a class where we are seeing not only the return to normalcy and the increase in miles driven but some of the supply chain effects and increased cost of sourcing replacement parts after accidents. So yes, we have seen it. We’ve taken action quite proactively. I think on reflection, it’s been a good decision to take that book down. Across the rest of the portfolio, there’s a thread of this theme, but I’d say the auto piece was perhaps most impacted.

Kyle Labarre, Analyst

Got it. And then maybe one for Neil. Any chance we can get the split on the cats between what were idle losses, what were flood losses and what was the South African riots. May not be possible to run through or not, but just curious.

Neil Greenspan, CFO

No, not any retro there. As I said in the call, Kyle, the biggest loss was Ida. Net of our total amount, that was about $18 million. The European floods and hail together came a little bit higher than $4 million. And then the South African riots, included in the total catastrophe loss, was about $3.5 million. And we also included, even though it was a prior quarter, but it was current year, there was a few hundred thousand of development on Uri. So that was the breakdown.

Kyle Labarre, Analyst

Got it. And one more for me, and I realize there’s probably no answer yet, but a lot of talk on global minimum tax and what may happen there. Curious how Greenlight Re is thinking about that and how you might manage what’s still an unknown situation.

Simon Burton, CEO

Yes, it remains uncertain. However, I would highlight a few important points regarding Greenlight and the industry. Firstly, we lack significant overseas affiliates generating local business, as that has shifted to the Cayman Islands. While we do have an office in Dublin, our operational structure is not as extensive as some of our competitors in the industry. This makes the potential implications of any global minimum tax easier for us to navigate. Secondly, I acknowledge that much is still uncertain, but there has been mention of a revenue threshold above $700 million or $800 million. This is not definitive, and we are currently below that mark, though we may approach it in the future. Additionally, there is potential for an industry exemption for reinsurance in the Cayman Islands, which we are looking into. At this moment, I would say that we are very attentive to the situation, monitoring it closely, and while some work is being done behind the scenes, it isn’t currently a major concern for us.

Operator, Operator

The next question comes from Mikel Abasolo of Solo Capital Management.

Mikel Abasolo, Analyst

This goes back, just very top down. But from my point of view, the market seems not to trust that your insurance operation is viable long term. And I think that it’s unlikely that adjusting your combined ratio by the cat losses will change that. So my question would be, what needs to happen for you to wind down the insurance operation and just manage the proceeds like the hedge fund with a permanent capital? I see your investees, and you’re happy to see Brighthouse or Atlas Air shrink and rightly so, in my view, despite the fact that they are operating very profitably as opposed to Greenlight Re. So that’s a puzzle to me. I acknowledge that you’re buying back stock. But why not apply the recipe to Greenlight Re more aggressively and just follow the insurance operation? And the last question would be, is this issue discussed at all by the Board?

Simon Burton, CEO

Mikel, this is Simon. David may want to add his thoughts. Please go ahead, David. I want to clarify that we are primarily a reinsurance company, which is our main operational focus. Our investment platform is also important to us and is a key aspect of our value to shareholders. We believe it will remain significant. To manage expectations from the markets, regulatory bodies, and rating agencies, we need to balance the overall risk associated with various return factors. Regarding your point on reinsurance returns, I acknowledge that profitability has been weak over the past two years, particularly in 2020 and 2021. However, we have performed relatively well compared to the industry overall. In 2020, our combined ratio was about top quartile for the reinsurance sector, depending on the peers chosen. This quarter, despite facing significant catastrophe impacts from events like Ida, our results still compare favorably with many competitors. I stand by our risk management practices. It’s unfortunate that, amid substantial improvements in the underlying business, you haven't yet seen the benefits of this work as a shareholder. However, I assure you that progress is being made.

David Einhorn, Chairman

I would just add that while the Board did do a sizable strategic review of all kinds of alternatives, including winding down the business in early 2020, we conducted the review. And the conclusion of the review was just the best outcome for shareholders to pursue what we have been pursuing. I don’t think there should be any expectation that we will wind down the business and invest the money alongside what we do in the hedge fund. Were we to wind down the business, I believe we would return the capital to the shareholders and let them decide how they want to invest it. Let me say that, though, having been a considered alternative, we don’t think that it is a better alternative than what we are doing. Finally, to compare to other companies and like the Greenlight portfolio, which are buying back stock and we advocate them buying back stock, fortunately for them, unfortunately for us, they’re in a better position to do so because of the strength of their balance sheet and the excess capital they have in their businesses relative to their business opportunities, which doesn’t mean we don’t buy back any stock; we have been buying back stock. And I don’t want to set expectations higher or lower; it will depend on how we’re able to generate capital so that we can have capital to return. And lately, we’ve had a hard time achieving that. Nonetheless, at least personally, I’m optimistic that, that should improve.

Mikel Abasolo, Analyst

Okay, Simon, I want to clarify that I'm not questioning your professional abilities. I'm just skeptical about whether an operation of your size or position can be profitable in the markets you're trying to enter. While I'm not an expert in reinsurance, we do have some insurance and reinsurance companies in our portfolio that appear to be performing better, possibly due to their broader scope. I can't argue with those results. You mentioned that 2020 or 2021 was a good year, and I agree. However, I believe there isn't enough evidence to suggest that your combined ratio is consistently or sustainably below 100%, and the market does not seem to recognize your ability to manage the business profitably in the future. I acknowledge that you're buying back stock, but I'm curious if the Board has been discussing this topic regularly. I remember the strategic review and the hiring of Credit Suisse, but time has passed, and the business and stock don’t seem to have improved. It might be a flaw in the market, but I think it's relevant to reintroduce that strategic discussion. That's all I wanted to express.

Simon Burton, CEO

I understand, Mikel. And thank you for your question. I certainly don’t take it personally, and I welcome the scrutiny. I would say that your top position that we’re relatively small in the reinsurance industry, and it can be challenging to make a pure reinsurance business of this scale work is a good observation. But I need to go back to point out that that’s why we have a different strategy. We do have bucketing of capital allocation to our investment strategy. We have the growing innovations initiative, which we think is really a home run for a company of our size with relatively lower market power in open market reinsurance business. So we are excited about where we’re positioned, notwithstanding that the open market business can be challenging at our scale, but our strategy is designed to mitigate that.

Operator, Operator

This concludes our question-and-answer session. Should you have any follow-up questions, please direct them to Adam Prior of The Equity Group Inc. at 212-836-9606, and he will be happy to assist you. We also remind you that a replay of this call and other pertinent information about Greenlight Re is available on our website at www.greenlightre.com. The conference has now concluded. Thank you for attending today’s presentation. And you may now disconnect.