Endurance Specialty Holdings Ltd. (ENH-NYSE)
October 16, 2009 Issue
The Most Powerful Name In Corporate News and Information
As A Global Specialty Provider Of Property And Casualty Insurance And Reinsurance, Endurance Specialty Holdings Is Finding That Smaller Is Better From A Control Point Of View With Management Involved In Real Time Decision Making
Endurance Specialty Holdings Ltd. is a global
specialty provider of property and casualty insurance and reinsurance,
publicly traded on the NYSE (symbol ENH). Headquartered in Bermuda, the
company has offices across the U.S. as well as in the United Kingdom,
Switzerland and Singapore. Through its operating subsidiaries, Endurance
writes property, casualty, healthcare liability, agriculture, and
professional lines of insurance and property, catastrophe, casualty,
agriculture, aerospace and marine, and surety and other specialty lines of
reinsurance. Endurance maintains excellent financial strength as evidenced
by ratings of A (Excellent) from A.M. Best (XV size category) and A (Strong)
from Standard and Poor's on its principal operating subsidiaries. As of June
30, 2009, total capital was $3.1 billion, including shareholders' equity of
and Chief Executive Officer
Mr. LeStrange has been Endurance's Chairman, President and Chief Executive Officer since the Company's formation. Mr. LeStrange has over thirty-one years of experience in property and casualty underwriting. He has significant experience as a treaty and facultative underwriter and manager of treaty underwriting operations at Swiss Reinsurance Company and American Re Corporation. He began his underwriting career with Hartford Insurance Group and held several underwriting management positions at Swiss Re. During his tenure at American Re from 1986 to December 1997, he served as Executive Vice President of American Re and as President of its alternative market subsidiary, Am Re Managers, Inc., from 1989 to December 1997. In December 1997, he joined Aon Corporation as Chairman and CEO of its alternative market operations and was later named Chairman and CEO of Aon's retail brokerage operations for the Americas. Mr. LeStrange remained with Aon until he joined Endurance in 2001. Mr. LeStrange received a BA in both Economics and English from Colgate University. He has pursued graduate studies in Finance at New York University and Fordham University.
Interview conducted by: Lynn Fosse, Senior Editor, CEOCFOinterviews.com, Published: October 16, 2009
CEOCFO: Mr. LeStrange, what was your vision at the beginning of Endurance, and where are you today?
Mr. LeStrange: The context of our formation is rather important. In 2001, the property and casualty insurance and reinsurance industry that we serve, had gone through a very difficult phase, coming out of a very competitive cycle where prices and terms and conditions were getting more generous over time. Insurers had begun to see a new rather expensive influx of asbestos claims and new classes of claimants, although many in the industry thought that had abated in the 1990’s. The industry had also experienced the burst of the dot.com bubble, first on the equity side and later with the corporate scandals that led to the collapse of companies such as Worldcom and Enron. Not only was a great deal of loss borne by our industry in the bonding area, but also in investment accounts in terms of corporate bond exposure.
On top of that, we had 9/11, which was a terrible human tragedy first and foremost, but for our industry it was the largest insured loss ever. The loss was comprised of components that were very surprising to many organizations and confounded their risk management approaches up to that time. We saw one rather incredible event create massive property losses, business interruption losses, aviation losses, workers compensation losses, life insurance losses and accident insurance losses.
The World Trade Center event was a catalyst for
profound change. It brought to the fore the magnitude of all of these issues
in combination with one another and very suddenly our industry found that it
was dramatically undercapitalized. We have developed a pattern in our
industry that when large loss events occur, and they will happen every
decade or so, new capital is formed. The business model that has emerged is
that companies formed predominantly in Bermuda to address basic supply and
demand, i.e. supply of capital versus demand for risk transfer.
Our core strategy is specialization and that means that we have underwriters and other talent focused upon particular market niches, each of which have their own particular challenges, issues and opportunities. The risk from one niche to the other can be quite different. We have organized our company around this core strategy of specialization and we have about 32 specialized underwriting units in the company that pursue particular aspects of the property/ casualty insurance or reinsurance market.
Overarching that, our industry at large has not been very friendly to shareholders over time. It is a very cyclical business that can exhibit boom and bust type of results. When you aggregate them over time, you can see that some of the biggest companies in the business generally achieve low to mid-single digit returns on equity over time, which in most times in the economy is about equivalent to a risk-free rate of return. Yet, the risks of our industry are quite high. In order to deploy capital to us, investors deserve to generate a risk premium in terms of the returns over time. Our strategy incorporates thinking and acting like shareholders at all times, and that underpins the decisions we make, such as how to deploy our capital, how we invest our money, and how we select and manage risk.
CEOCFO: Would you give us an example of something you did based on the shareholder focus that you might have done differently from others?
Mr. LeStrange: The strategy that many pursue in our industry is one of scale on the premise that there are economies of scale that come with being large. We have a contrary approach. We think the bigger you are, the more likely you are to regress to the mean in terms of industry results. It then becomes very hard to navigate and adjust your portfolio to reflect market conditions. There are times in our business when pricing gets so competitive that literally the transaction is not worth doing. Very few organizations come to that conclusion. They continue to trade and hope for the best. In some cases, they believe that they need to continue to maintain their positions in order to take advantage of or to experience the better part of the cycle. We don’t believe that. Competition is very fierce in our business and opportunities are spotted relatively quickly and focused upon by the marketplace. Other competitors are often willing to price the product below what we think it is worth and in some cases at a loss. Today, a good part of business in the industry is priced at a real economic loss. When market niches or segments lose their profit potential, we choose to strategically reduce our writings or withdraw. We are careful not to abandon our customers in the process.
We have found that our ability to move in and out of market niches is quite good and as a result our company has grown and evolved and our mix of businesses can change significantly from one year to the next. To answer your question, choosing to allocate capital or not in terms of our shareholder equity and our risk that we take on it is a choice that we make everyday.
CEOCFO: Do you need to constantly find new personnel as you move in and out of specialized areas?
Mr. LeStrange: It is a combination of finding new talent and redeploying our people to new opportunities. Overarching our specialized business units is a very robust culture of controls, IT infrastructure, data warehouses, proprietary databases, etc. It supports our corporate governance and the functions we need to perform as a public company. In addition, we have a very robust infrastructure of risk management, capital allocation and financial planning. That discipline carries through quite nicely in all of our activities as a company and can be applied at a specialized level.
However, when one moves into a new niche, it is
important to have the right talent to pursue it. When we abandon a niche,
for a period of time, some of our underwriting resources that are focused on
that specialty may be underutilized until we can redeploy them. But that is
a cost that we are very much willing to bear because the company has been
successful in renewing itself. As one opportunity is waning, we have one or
more coming on stream that have the right profit potential for the future.
CEOCFO: You have a mix of insurance types; is the mix where you want it to be?
Mr. LeStrange: At its core, risk is risk, and the reason we have pursued both sides of the business is that the cycle that dominates the competitive behavior of our industry manifests itself differently and at different times in insurance and reinsurance. Sometimes it is better to be a reinsurer and sometimes it is better to be an insurer. We told our investors when we started the company that they should expect about 50% insurance and 50% reinsurance and 7 ˝ years into it, that is just about where we are now.
CEOCFO: What has happened today given the economic scenario?
Mr. LeStrange: The credit crisis has certainly made us more aware and sensitive to macroeconomic risks in the system. We have a very large investment portfolio of about $5.5 billion. When the credit crisis started, our average quality was triple A and our duration for the portfolio was three years, which is rather short and therefore conservative for a company like ours. Disruption and dislocations in the market caused an incredible level of volatility in terms of how the securities in our portfolio were valued. Although we do attribute a degree of volatility to risk from our investment portfolio, this would have been a multiple of what we would have expected, and unprecedented. The credit crisis has caused us to focus more attention on our investment portfolio, which we predominantly outsourced to outside managers. We started to involve ourselves at literally an individual security level in terms of checking and validating our managers’ perspective on the risk/reward of those securities and that has served us very well. The unrealized loss in our investment portfolio has reversed as valuations have become more rational. As the market recovered, our portfolio has also recovered and validated that we did in fact have a very high quality portfolio.
CEOCFO: Are you looking for more opportunities internationally?
Mr. LeStrange: We are pursuing international opportunities and strategies against the backdrop of a very competitive marketplace. In the US, our industry has been shaped since 2001, by any number of crises and, of course, by 9/11 itself. In 2004, we had four significant hurricanes that made landfall in Florida and, as a result, many companies delivered very poor results that year. In 2005, we had three major hurricanes - Katrina, Rita and Wilma. Katrina was a particularly devastating and unusual event, resulting in very significant industry losses. Last year we had Hurricanes Ike and Gustav in the Texas/Louisiana area, with Ike being one of the ten most expensive hurricanes of all time. Then we had the credit crisis. The competitive forces in the US have been tempered by these losses and the reaction of our competitors to that has been to keep pricing in many areas at reasonable levels.
On the international side, there have been few catastrophic events in developed insurance markets. Although we have experienced recent typhoons and earthquakes in China, they have not been significant enough to change the industry competitive dynamics. Therefore, prices in international reinsurance have steadily declined since 2002. Some of our larger international competitors pursue scale strategies and they have delivered only single digit return on equity over the past thirty years. They are so large and they offer such significant capacity to clients that they can actually affect competitive forces in the market. Last year, we established offices in Zurich and Singapore to be closer to our clients and get to better understand them. We began to pursue a strategy consistent with the returns that we seek by fulfilling customer needs that are underserved by the more established players in those markets. We feel very good about the talent of our team and the capabilities that we have as an organization. We are starting from a very small base in Zurich and Singapore, and I expect our business to grow slowly until such time as there is a dislocating event that affects the international reinsurance market. When that happens, our organization internationally can grow quite large in a short period, much like Endurance has done in the United States.
CEOCFO: Your vision is to become the best specialty insurance company in the world; address potential investors how are you getting to that vision and why should investors take notice?
Mr. LeStrange: We have the aspiration of being the best specialty insurance and reinsurance company in the world, and with all due humility, we acknowledge that it will be difficult to achieve. We have established a target date of 2012, which is quickly approaching and, from the time that we established our goal three years ago, we have made a great deal of progress. This obviously is a subjective evaluation so to more objectively assess where we are towards our goal; we identified a number of dimensions to measure. I mentioned our desire to deliver to shareholders an appropriate rate of return to the risk they take. When we started the company, the risk-free rate of return was about 4 ˝ or 5 %, and we aspired to achieve a 15% return on equity or better throughout an underwriting cycle. Since 2002, the interest rate environment has been below that historical level and today the risk-free rate of return is measured in basis points, less than 1%, yet we still aspire to and are achieving better than a 15% return on equity. From our inception in 2001 through the 2nd quarter of this year, we delivered a 14.2% return on equity, which given the credit crisis and the hurricanes I mentioned and many other factors, is an exceptional result for our industry. This year, we achieved better than a 19% return on equity through the second quarter. Catastrophic events such as earthquakes, hurricanes and the like can significantly influence our future results, but fortunately, the Atlantic hurricane season has been quite benign so far, much different than forecasters’ predictions, and we haven’t had any significant earthquakes around the world that have affected insured values. Our goal is generating not only superior returns versus the industry, but also intrinsically attractive returns to investors and if we can continue to achieve approximately 15% return on equity, then I think we stand out as an attractive company.
Our industry is one where there is a great deal of subjectivity in terms of reported results. There are many estimates in the balance sheets and income statements of insurance companies, so one of our core values is that we deliver transparency to our shareholders. We give our investors a great deal of detailed information about our performance and we are very active apart from our filed financial results in communicating with investors both one-on-one and in groups. They own the company; they have the right to know what we are doing with the capital. We feel that we need to be very transparent. Over time if we can continue to achieve our goal of 15% return, we believe that our share price will reflect our performance in terms of the valuation that the company achieves in the public market. Today our whole sector is at a suppressed valuation level, with our competitors trading today at a modest discount to book. In more normal economic times, the sector traded at a price to book ratio of about 1.25 to 1. Over time, if we continue to perform well and we compound our book value over time, we believe that our valuation level will rise, yet another source of value for shareholders.
CEOCFO: Final thoughts, what should people reading about Endurance Specialty Holdings remember most?
Mr. LeStrange: It is interesting to me that, what we and a few others in our industry who formed in Bermuda in the last decade have achieved, is almost taken for granted. I have been in this business for 31 years now and there had not been a time until 2001, nor has there been an opportunity since then, to create such a large and successful company on every dimension. The fact is that we, and a couple of our peers like Arch and Axis, have created companies that have grown large and have become successful financially in a short period. Back a few years, we were looking at how much money we were earning versus internet companies for instance and we couldn’t understand why they are valued the way they are, and we are valued the way we are. Things have gotten more normal recently in the stock market in terms of valuations. We have accomplished something special at Endurance and we have achieved this while remaining true to our core values. We have been conservative and cautious in our reserving. We have been conservative and thoughtful in applying our capital to risk. We have been very conservative and thoughtful in investing our assets.
Our company is built upon an important premise;
it is all about teamwork and bringing people with diverse skills and
experience to opportunities and challenges. That, frankly, is what I am most
proud of. Our company focuses around challenges and opportunities and deals
with them as well or better than any company. That is because we have such
talented people that are committed to our mission and what we are trying to
accomplish. They bring a wealth of experience and knowledge, some
specialized and some general, to bear on us. By harnessing those abilities
and focusing them, we have achieved spectacular results.
The risks of our industry are quite high. In order to deploy capital to us, investors deserve to generate a risk premium in terms of the returns over time… From our inception in 2001 through the 2nd quarter of this year, we delivered a 14.2% return on equity, which given the credit crisis and the hurricanes I mentioned and many other factors, is an exceptional result for our industry… Our strategy incorporates thinking and acting like shareholders at all times, and that underpins the decisions we make, such as how to deploy our capital, how we invest our money, and how we select and manage risk. - Kenneth John LeStrange
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