Arch Capital Group Ltd (ACGL) 2008 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the second quarter 2008 Arch Capital Group earnings conference call. My name is [Lacey] and I will be your coordinator for today.

At this time, all participants are in a listen-only mode. We will be facilitating a question-and-answer session towards the end of this conference. (Operator Instructions).

As a reminder, this conference is being recorded for replay purposes.

Before the Company gets started with its update, management wants to first remind everyone that certain statements in today's press release and discussed on this call may constitute forward-looking statements under the federal securities law. These statements are based upon management's current assessment and assumptions and are not subject to risks -- and are subject to risks and uncertainties.

Consequently, actual results may differ materially from those expressed or implied. For information on the risk factors and other -- for other risk factors that may affect future performance, investors should periodically -- periodic reports that are filed by the Company with the SEC from time to time.

Additionally certain statements contained in the call are not based on historical fact are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. The Company intends the forward-looking statements in this call to be subject to Safe Harbor created thereby.

Management also would like to reference non-GAAP measures of the financial performance. The reconciliation to GAAP and definition of operating income can be found in the Company's current report on Form 8-K furnished to the SEC yesterday, which contains the Company's earnings press release and is available on the Company's Web site.

I would now like to turn the conference -- your presentation over to your host for today's call, Mr. Dinos Iordanou and John Vollaro. Please proceed.

Thank you, Operator, and good morning, ladies and gentlemen, and welcome to our second quarter earnings call.

Against the backdrop of very competitive underwriting environment and an extremely volatile investment climate, we are very pleased with the performance of our operating units and the results that we have achieved. Our book value per share, including the effects of our share repurchases, increased to $57.49, a 21.3% increase from the end of the second quarter of 2007. Our after-tax operating income for the 2008 second quarter was $2.82 per share which represents a 20.5 annualized return on average common equity.

Even though our premium production is down and our book of business is maturing, our cash flow from operations continues to be strong at $256 million for the quarter. John will give you more detailed analysis of our financials in a few minutes, but before I turn it over to him let me comment on the market environment as we see in our two businesses, Insurance and Reinsurance.

On the underwriting side, the market continues to be competitive without any meaningful change from what we saw in the first quarter of this year. As underwriters of specialty lines, where technical knowledge expertise and experience are key to underwriting performance, we believe we have a strong team of underwriters that gives us a competitive advantage.

We are pleased with the discipline that all of our units are demonstrating in this difficult market environment. From an investment perspective, the extreme volatility that affected the credit markets has had minimal effect on our portfolio. Our sub-prime exposures are relatively small on both the asset side of the balance sheet and also the liability side of our balance sheet.

Our Reinsurance Groups' net premiums declined by 13.5% predominantly due to market conditions. Average rates continue to decline at a low double-digit level with terms and conditions generally holding, except for persistent requests by cedants for increased seating commissions.

We have reduced to participate on treaty accounts where the negative arbitrage to us was significant. This has caused us some business, but it is the right thing to do.

Our Casualty lines which include professional liability and D&O were down 21% and our Marine and Aviation lines were down 9%. On the other hand, our Property and Property Cat book was down only 6%. And this is due mainly to a large two year cat contract written in the second quarter of 2007 that makes the year-over-year comparison difficult.

With the termination of our Flatiron facility, we have the opportunity to choose to increase our participation on existing business. Where we believe the returns are most attractive, we have increased our participation, but we have always remained within our risk management limitations. Our Property Fac operations, which we started approximately a year and a half ago, are gaining good acceptance in the marketplace.

In June of 2008, we received 1477 submissions from 96 different client companies. This is an all-time high for us. For the second quarter, we bound approximately 1100 certificates and $12 million in premium.

Our Gulf Re joint venture has received the appropriate licenses and an A- rating from A.M Best and is off the ground as of June 2008.

Now let me turn to our Insurance Group. Our Insurance operations sought a reduction in net written premium of 6.7%. Rates were down 5% to 10% in most lines. Two exceptions were our Program business in which rates were basically flat and our Professional Liability book, which saw a 1% reduction for the quarter.

Our program and Professional Liability's books of business are predominantly comprised of small accounts. We find this sector more attractive than the large account sector. The other exception was in our Executive Assurance unit, where financial institutions D&O moved to a plus 11% rate increase and commercial D&O rates decreased moderately to a minus 6% for the quarter.

Overcapacity and lack of major catastrophes continue to put great pressure on rates in the Property lines, with rates going down 24% on average for the quarter.

From a volume point of view, we recorded growth in our Construction and National Accounts business which is, to a great extent, comprised of large deductible and retrospectively rated policies, as well as our Program business. All the other lines declined at high single- to low double-digit except for Casualty which declined more than 40%. In this division, Casualty division, we predominantly write all of our excess and umbrella business in our Excess & Surplus lines business, which is under pressure not only from other competitors but also from the standard markets that they are moving to write E&S business on an admitted basis.

Before I turn it over to John, let me upgrade you on our P&L aggregates. As of July 1st, our one in a 250-year event from a single event expresses a percentage of common equity was approximately 23% with Tri-county Florida and Northeast windstorm continued to be our largest exposed zones. This is a slight increase over the 22% we reported in the last quarter.

With that, let me turn it over to John to go through a detailed discussion of our financials. John?

Thanks, Dinos. Good morning, everyone. As usual, I will briefly walk through the key components of our financial results starting with the top line.

Dinos has already commented on some detail on premium volume, but there are a few additional items that are noteworthy.

On a trailing 12-month's basis, premiums written by the Insurance segment represented approximately 68% of our gross volume and 60% of our net volume, while Property and other short tail lines now represent approximately 44% of our net premium volume.

On a consolidated basis, the ratio of net to Gross Written Premium in 2008 increased to approximately 77% from 69% in the 2007 quarter, primarily as a result of the nonrenewal of the Flatiron Treaty. On a reported basis we ceded $7 million of written premium to Flatiron in the second quarter of 2008 and $116 million in the prior quarter.

On an earned basis, premiums ceded under this treaty amounted to $46 million in the second quarter of '08 in comparison with $73 million ceded during the 2007 second quarter. The override in estimated profit commission recorded on the treaty with Flatiron are reflected as a reduction of the acquisition expenses, the Reinsurance segment which improved the expense ratio of that segment by 230 basis points in the 2008 quarter, while the impact on their expense ratio in the comparable 2007 period was 310 basis points.

The change in ceding commission was due to a lower level of earned premium in 2008. The earned premium on business ceded to Flatiron was approximately $66 million at quarter and. We expect an additional $5 million to $10 million of written premium on existing contracts will be ceded to Flatiron. Most of the ceded premium yet to be earned and the related fees, including profit-sharing if any, will be reflected in earnings, primarily during the balance of 2008.

It should also be noted as Dinos pointed out that on a quarter-over-quarter comparison for the Reinsurance segment was affected by a large cat contract which was written for a two-year term in 2007, while 2008 did not include any comparable contracts.

Turning to the operating results, underwriting income per share for the second quarter of 2008 was $1.39 in comparison with $1.60 per share recorded in the second quarter of last year. Our consolidated combined ratio was 87.1% in the 2008 quarterly period which was 300 basis points higher than the comparable 2007 quarter.

2008 underwriting results were driven by the continuation of excellent underwriting results in Property and Marine business, the Reinsurance segment as well as favorable development of prior year reserves. The difference in combined ratio in a quarter-over-quarter basis resulted from increases in both the loss and expense ratios. The increase in the loss ratio of 70 basis points was attributable to an increase in catastrophe and large individual risk losses in short tail lines, as well as to an increase in our loss picks for intermediate and long tail business.

These effects were partially offset by an increase in the amounts of favorable loss development as well as to the continuing shift in the overall mix of business towards short tail lines which, relative to longer tail lines, generally have lower loss ratios.

On a consolidated basis, favorable reserve development, net of related adjustment acquisition expenses, totaled $55 million in the 2008 quarter compared to $32 million recorded in the second quarter of 2007. Approximately two-thirds of the net favorable development -- of the development in the 2008 quarter was from short and medium tail lines.

In general, reported and paid claim activity across most lines of business remained at favorable levels and IBNR and ACRs were approximately 73% of total loss reserves at quarter end.

The consolidated expense ratio was 230 basis points higher on a quarter-over-quarter basis. Approximately 60 basis points of the increase was due to additional acquisition costs related to the favorable loss development. In addition, the 2008 expense ratio includes charges of roughly $2 million for costs incurred in connection with actions that are underway to significantly reduce the operating expenses in the insurance -- in the Company's insurance operations. We expect further charges will be incurred during the next several quarters as these measures are implemented, but that over time they will have a beneficial impact on the expense ratio.

The balance of the increase in the expense ratio results primarily from the effects of lower premium volume.

Turning to investment results, in the 2008 quarter pretax net investment income per share rose by approximately 18% on a quarter-over-quarter basis to $1.78. On a sequential basis, net investment income per share declined slightly, primarily due to the fact as we reported previously, first quarter net investment income included interest income earned on a favorable arbitration decision.

The growth in investment income per share on a quarter-over-quarter basis was primarily due to a higher level of average investable assets. This increase primarily resulted from the continuation of strong cash flow from operations.

This quarter's cash flow brings the total float produced by the recapitalization of the Company to approximately $9.2 billion. After reflecting share repurchases, which I will comment on in detail in a moment, investable assets rose slightly to approximately $10.3 billion at June 30th and the portfolio remains healthy and well-positioned.

Taking into account yields, realized and unrealized gains, and income from certain investments accounted for under the equity method, the total pretax return of the portfolio was slightly negative for the second quarter of 2008 -- an acceptable result considering the substantial increase in interest rates during the quarter. The average credit quality of the portfolio remains high at AA+ and the reported duration increased slightly in the second quarter to approximately 3.4 years.

The portfolio continues to be comprised primarily of high quality fixed income securities, but essentially no investments in hedge funds or private equity funds.

Our balance sheet remains in excellent shape and our financial flexibility remains strong with total capital amounting to approximately $4.3 billion at quarter end and with debt and hybrids representing approximately 17% of the total.

The increase from the third quarter is due to the fact that in May we funded $100 million of our investment commitment to Gulf Re utilizing our revolving credit facility. The cost of these borrowings is LIBOR one, two, three or six months plus 28 basis points. And these borrowings mature in August 2011.

With respect to capital management during the second quarter of 2008, we repurchased 2.9 million common shares for consideration of approximately $200 million, which represents an average price per share of roughly $69.61 or 1.21 times book value per share at quarter end. Through the first 22 days of July, we repurchased an additional 1.7 million shares at an average cost of $65.94 per share. As of July 22nd, 2008, we had approximately $461 million remaining under our current share repurchase authorization.

On a weighted average basis, share repurchase are accretive to EPS by approximately $0.30 per share for the 2008 quarter. Moreover, the repurchases enhanced ROE for the 2008 quarter by approximately 290 basis points. For the quarter, share repurchases, net of accretion reduced book value per share by approximately $0.54.

In summary, the combination of the operating results and capital management initiatives produced an ROE of about 21% of the quarter and book value per share despite the short-term effects of the share repurchases. And the significant increase in interest rates grew by approximately 1% during the quarter.

That concludes our prepared remarks and we will take questions now, Lacey.

(Operator Instructions) Josh Shanker with Citi.

Good morning. First the numbers question. Can we find out the IBNR percentage of the reserves and they would be maybe the additional case reserve amount?

Yes. IBNR is a little over 70% and (additional) case reserves are a little under 3%. Together they total about 73%.

Thank you. I'm wondering the first thing, growth seems actually much more stable or at least premiums seem more stable at Arch than the competitors. Can we strip out -- do we have the gross premium or the -- and the net premium numbers for Flatiron in 2007 so we can normalize our numbers for '08?

Yes, we will get you those numbers, but it was approximately, I think Flatiron was about $300 million on annually sessions. So I think if my memory -- John is looking up the specific number -- if my memory is good, I'm usually good with numbers about $311 million for '07, but we will give you the specific number in a minute.

And given where you are playing, you know we listened to one of your competitors' conference calls last night. They felt that combined ratio for the industry was headed over 100% this year. One of your other competitors out in Connecticut thought that by next year we would be at 110% combined.

Given the business that you are writing in your parts of the market, do you agree with this sort of market summary?

Let's refine combined ratio, you know, for us. Is it on the calendar year, accident year or policy year?

I think they are talking about policy year probably.

Policy year. No, even on a policy year basis which truly reflects the current market environment, for our book of business, we believe that based on our mix and where we're operating, we are in the low 90s and there will be some deterioration over '09.

Assuming there is no -- the market conditions continue to drift as we have seen them, but that deterioration will probably be in the range of 3, 4 points on the combined ratio. So that will get us for '09 to probably in the high 90s and I am talking about us in the industry. So I will disagree. I don't know who you are referring to, but I will disagree that the industry is going to experience 110 on a policy year next year.

Yes, just quickly, so far in '08 the ceded written to Flatiron is just about $25 million. In '07 we ceded just about $300 million. Is that --?

I will (inaudible) it through. I'm trying to get some run rates numbers on your premium volume. I will figure it out and I'll get back to you. Appreciate it.

And finally given the pace at which you are buying back shares, does it cross your minds to get a partner? Does it makes sense for Arch to be a public company during the soft market here?

Well, yes. I think it's a capital-intensive business, the insurance business. So we believe you need to have the ability to have access to the capital markets, plus the rating agencies is so much they will allow you to put debt on the company and maintain your ratings. So it makes sense from that.

On the other hand though, I think when our share price as viewed by the public markets is significantly below what we believe is the intrinsic value of the Company, it's prudent for us as a management team to invest in ourselves and buy back shares aggressively. And we have done so.

Congratulations on another great quarter.

[Susan Spivak] with Wachovia.

Good morning. I have a few questions. One, I'm not exactly sure how to phrase so I'm just going to say it how I think it. We all know there's been a recent downgrade of a major competitor on the island who is in similar lines of business to you, been taken off the security list. I've seen brokers issue warnings and so I just want to know what you are doing to capitalize on that opportunity? That's my first question.

Second, I want to know can you give us some idea what the premium volume from the Middle East joint venture will be?

Okay. Let me take (multiple speakers)

And then I'm sorry. One more, [third]. Just remind me if you have released any casualty reserves or what you mean by medium tail lines on the reserve releases?

Let me start with the first one. Listen the insurance business is a highly competitive business. So usually you try to find opportunities in the marketplace. Independent if it's because a competitor stumbles or you have the opportunity to pick up a team or you have the opportunity to pick up a program that somebody else had.

So we've seen some opportunities, but in a very, very competitive environment, I wouldn't say those opportunities, they are going to change the volume direction that we see. Yes, we look to find opportunities that are better rating and [they're] confident their distribution channel has in our people and the stability and the response that we give to the brokers makes a difference.

So from that perspective and, of course, if we find opportunities to hire good people, we take those opportunities.

Have you hired any in the recent months?

Yes. We have -- don't forget net, net we have -- are down in personnel because we are managing predominantly through attrition and also with some job eliminations to try to match our revenue with the expense structure. In a soft market you have got to be cognizant of your expenses.

But in certain situations where we could upgrade personnel, we took that opportunity to do it even though net, net probably we're down 55 people for the quarter, you know, as a company.

Now your second question is way too early for the joint venture. They just opened the doors. They are writing some business. They are seeing opportunities. I would be guessing as to what they are going to be able to do.

This is -- they have only been in operations for a few weeks, so --. But early indications is that they are seeing stuff and they are seeing the kind of business that we expected for them to see and they're starting to [buy in] some business. We will know more about that as the year progresses.

(multiple speakers) 2009 benefits, then.

Right. Then I want to turn it over to John to give you a little bit on, more flavor on the (reserve) releases of short, medium tail and some long tail.

Your question specifically what we would consider to be medium tail lines would be relatively low limits, professional liability, i.e., claims made types of business. So for miscellaneous types of professional liability, for instance, we would not consider executive assurance to be medium tail. We consider that to be long tail even though its claims made because of the nature of the limits and the fact that a lot of it is written excess and it takes a long time to develop.

So we have released periodically, depending upon where the data takes us, both some of the medium and some of the longer-term. So in this quarter we said two-thirds of it came from short and medium tail and I would say it was predominantly short tail with some medium tail releases. The balance was from longer tail lines.

Again on the longer tail side which would include executive assurance as well as certain types of professional liability in the health area, excess over hospitals and miscellaneous facilities we did include, some longer tail lines were released. But most of that came, again, most of that came on claims made business.

Thank you and again I commend you on your discipline share repurchase and how you are navigating through this soft cycle.

Thank you.

Dan Johnson with Citadel.

John, could you remind us or say again, what was the average book or average repurchase price in the second quarter?

In the quarter.

In the first or second quarter?

Second quarter please. (multiple speakers)

Second quarter was $69.61 and then in the first 22 days of this month it's $65.94.

$69.61.

Yes.

Okay. Then the question on the outlook for investment yields. Can you talk a little bit about, relative to the average yield that we are earning on the portfolio now, where are you putting new money to work and in terms of yields? And then where are you putting new money to work in terms of types of assets?

We pretty much haven't changed what we've been doing. We did as we mentioned put -- we did in the quarter put a little bit more money into the bank loan funds. They performed very, very well for the quarter. Remember they are predominantly floating rate instruments. So those are a nice hedge against some of the interest rate volatility we've seen.

We have put a very minor amount of money in addition into certain high yield opportunities on a case-by-case basis. We haven't committed any more money per se to that area through a manager. And the rest of it is we are in -- we continue to look for areas where on the credit side where you're getting paid today, it's a lot more attractive on high-quality stuff.

So we are continuing to invest primarily in the higher end of the credit spectrum. We are still somewhat cautious about the overall outlook for the economy and for credit. We are not sure we have seen the end of what is going on in the credit cycle. So we remain cautious.

But given where spreads are and given where treasury yields are, given the backup in the second quarter which obviously impacted everybody, we are still investing new money around the yield that we reported this quarter. Obviously, that can change either way, depending upon what goes on in the marketplace.

But we're not seeing any and we do track certain -- we manage a portfolio actively. So we are, we do, will continue to sell or buy things based on relative value. But for the most part the stuff we track, new investments are yielding comparable amounts to things we are selling. So I don't think you'll see anything dramatic -- any dramatic fall-off there.

Dan, and we're not -- you know we are not going to be aggressive on the investment side. People buy our stock because we are good underwriters so --.

Obviously if we thought there were other areas that were attractive we might, given the fact that we have -- despite the fact that we returned a lot of capital, we still have excess capital. And that will give us the room if we say opportunities that are attractive enough.

But again it is always on a risk-adjusted basis. And it is always going to be within our tolerance for risk.

The after-tax yields came down. It looks like something like 8-ish basis points.

Yes, about 8 basis points. Yes.

Sequentially and call it roughly 10 year-over-year. I'm just trying to figure out the marginal trend going forward is not for lower yield?

Not dramatically lower. I think if you look at -- because, remember, even though interest rates which were extraordinarily low in the first Treasury's -- we talk about treasuries which were very low in the first quarter, bounced back quite a bit in the second and then spreads have widened quite a bit.

So we are currently still able to find relatively high-quality instruments in that neighborhood.

Last question to this piece is when you look at the maturity schedule of your investment, how does the maturity, how do the maturity yields compared to the reinvestment yield today?

That is what I was just mentioning. We track more so than the maturities although we -- because we do -- again we actively manage. So we are buying and selling all the time and we do track sort of what's leaving the portfolio against what is coming in.

And it's fairly consistent. It can move around on you a little bit, but it's reasonably consistent. And it's not down dramatically at least in the last few weeks that we been watching it here.

Where it goes, I can't predict. We don't know where all the (multiple speakers) spreads and rates are going. Our feeling is spreads have a way to go to get to where they are more attractive. But it depends on which sector you're looking at and we don't -- we try not to forecast interest rates. We'll leave that to other people.

Fair enough. Thanks very much for the questions.

Vinay Misquith with Credit Suisse.

Nice quarter. On your Program business, I saw that that is one of the only lines where you actually had some growth. Could you let us know what's happening there? Did you have a new program in that business? .

Yes. Actually, we have three new programs that some of them we introduced in the first quarter, some in the second and they are starting to get some traction. So that's --.

You know, our Program business is behaving well from a rate point of view, flattish overall, and then by adding new opportunities you see a little bit of growth.

Yes and about half the growth you see -- we talked about this last year but about a year or so ago we reduced the amount of the quota share reinsurance we purchase. So about half the growth you see in programs.

On a net basis -- .

On a net basis which is [why he's] looking at it comes simply from the reduction in quota share ceded the balance's growth net.

Fair enough. In this environment, are you really seeing opportunities for new programs given that everyone is having pressure on the topline? How hard is it for you to find new programs?

It is very hard for us. Don't forget. We see 100 a year and we do a couple, you know, maybe three and they have got to be specialized. I'll give you an example.

I mean the new stuff that we are doing is highly specialized. It's heating, ventilation, air-condition (inaudible) contractors. We are doing some water and sewer contractors. They're specialized to the point that you need that expertise to be able to do it.

So it eliminates some of the competition if they don't understand the sector. Or for more difficult classes you need better underwriters. You need knowledge to do it.

So it is from that perspective, because we are not interested in writing on differentiated programs that they just write package policies for run of the mail competing with the standard markets. That is not what we are all about.

Sure. On the surety side, I know you guys are a small player, but sort of Top 10 player. Are you seeing any trends of higher claims in that business?

No, I mean the surety is a credit line business and it's kind of lumpy either you (have a loss or don't)--. But we haven't seen a trend of additional claims.

What we see is that, yes, from a production point of view we have less volume because some contractors are not getting as many jobs as they used to. Also the companies including us are looking to have -- we are looking for more collateral, better credit analysis, more of a view that the credit crunch is not behind us.

So for that reason it eliminates some of the volume that you're doing. But we haven't seen uptick in the [falls].

We are however cognizant of the environment we're in. So from an underwriting posture standpoint we are definitely taking a cautious approach there.

Right.

And the contractors you are exposed to are they on the residential side or are they on the public work side?

It's mostly on the public work side with the exception of our national accounts business and we talked about this in past calls. We write a lot of subdivision bonds, but that business is down significantly, because nobody is subdividing new tracks now for development. And the experience on our subdivision bond business has been extremely good. Because it's the first part even a residential contractor does. And usually they complete that because they can't start building unless all the utilities and roads and services are in.

And will this business have been written on a claims made basis so if you've not seen the claims you're done?

Well, it's not -- it's contract by contract. It's not claims. Completion work. So in essence, some of it they take a year or two. Some of them they take two to three. Once you complete the project you are off the bond.

So it's more like in an occurrence policy?

Finally on the share buyback, you bought back about 10% of your stock last year, 8% first half. How much do you see yourself buying back (inaudible)? Do you see yourself buying about 10% of the Company each year? Is that the run rate (multiple speakers) --?

We have an authorization that has $461 million remaining. And basically there are different events that determine what we will do with share repurchase.

First, foremost is our earnings. If we continued to generate excess capital and we cannot deploy that capital in the business because of market conditions, we are not going to hoard capital within the Company. We are going to return it to its rightful owners, the shareholders and we chose share repurchase -- repurchases as the proper vehicle, based with our share prices which we believe -- a biased opinion by us, you know it does not reflect increasing value of the Company as to where their stock is trading.

Now if situations change, either because there is significant cat activity and earnings get impacted or for whatever reason, and we are not anticipating this that there is event that changes the market and we can deploy capital on the underwriting side. Of course, we are going to change our posture.

But the way we see things today we believe we are going to continue with share repurchases periodically on that basis, trying to distribute the excess capital back to shareholders. If our share price continues to be attractive to buy, we will do the share repurchases. If the market rewards our efforts with a different share price, there might be other vehicles to return excess capital to shareholders, such as special dividends, you know.

Thank you.

Matthew Heimermann with JPMorgan.

Couple of questions. Just securities lending, your commitments there, is there anything happening, anything in the credit environment that makes you more or less excited about that?

No, well, actually there's two things that are going to drive that. One, it's a function of what you have, what type of securities you own because predominantly it is treasuries that get loaned.

Then the second thing that you have got to be very careful about there is what kind of risk you take when you invest the collateral and we've always taken the very conservative approach there as we do with everything, i.e., we are not going to effectively borrow short and lend long which can get you in trouble. And it's gotten some people in trouble and we are not looking to take a lot of credit risk when we do that. And they are interrelated because, obviously, if you take, you go out longer you take interest rate risks and you take more credit risks.

So our volume of what we've lent has declined. That's a function of the makeup of the portfolio. The actual earnings declined somewhat in the second quarter versus the first, but that's because in the first quarter the premium you were being paid for lenders' securities was extraordinarily high. 10X, what you might otherwise ordinarily expect.

So, again we think it is an area that is like everything. Everything you do is risk and you have to be aware of the risks. And then it comes down to your risk appetite. Our view there is we are not looking to take a lot of risk at all. If we can add some marginal earnings and with minimal risk we will do it, but we are not going to take a lot of risks on the lending side.

That's fair. Then I can't recall whether or not you have any preferred stocks.

No, we do not own any preferred stocks.

I wanted to make sure I wasn't missing any nonredeemable. Then I guess did you quantify the risk losses in the quarter at all? Is that something you can do?

No. We did not quantify that. You are always going to get some -- I think we quantified them at one of the units. I don't have that offhand, but they were -- you're probably looking at $20 million to $30 million of what we -- unusual. Right? There's always some level of average risk losses you expect in the quarter.

Nothing else. Have a great weakened.

Brian Meredith with UBS.

Couple quick questions here. First on that Other insurance line, can you just tell us what areas are actually growing there? I know there's a couple of things that makes up that Other insurance area. It's the excess comp business right? In the accident health?

(multiple speakers) is not growing. This quarter is not growing. It is some miscellaneous stuff. So there's not -- it's just such a small line (multiple speakers)

There's nothing big in there.

There's nothing big in there. We do some -- .

But with respect to comp with -- that book is not growing. The excess workers comp.

Okay, good. Next question your [PMLs] went up modestly. Is that because of business that you are taking in from Flatiron or keeping on your own books or did you just have some pretty good success at [7 1] renewals in the reinsurance area?

No, actually most of it -- the PM -- the dollar, the expected loss didn't move very much. The PML didn't move. You know equity capital actually went down a little. And that's as much responsible for that slight change in that ratio.

So how were 7/1 renewals?

They were as expected. Pretty good, the rates went down a bit, single digits. But we pick and choose our spots. With the Flatiron we had a bigger portfolio to look and we pick and choose the opportunities that we felt gave us the better returns. And that is what we [bound].

Yes. Actually it was an interesting phenomenon because 7/1s were better on -- we are talking Property Cat now. (multiple speakers) US property cat and we know it's mostly Florida at that point. The 7/1s were actually better than the 6/1s. And from what we could determine, what we saw was some people (multiple speakers) ran out of capacity.

So we were able to do some things at 7/1 that were much, were more attractive than some of what we saw at 6/1.

Last question. Can you comment about lost cost inflation? I mean you put your lost picks up in the Casualty and long tail lines. Is that largely due to lost cost inflation in pricing or what's going on?

It's mostly because of pricing. I mean you know you -- it's pricing and you do have some lost cost inflation, but nothing is moving dramatically still. To a great extent I think frequency is leveling off. It was coming down. Severity is upticking a bit and you have got to go by the byline, but we are giving up rates.

So that's the effect on the loss and loss adjustment expense and we think the industry, year-over-year, if you take '07 to '08 it will be probably on average up 3 to for loss ratio points as an industry. We are not going to be immune from that. As much as we try to focus people to good underwriting and not walk away from accounts that -- really there are stupid deals out there, you still are part of the industry and your loss ratio is going to get affected.

Thank you.

Jay Cohen with Merrill Lynch.

One of my questions was answered and they've been good answers. Thank you. Just a couple of things, just as more of a clarification. Where you are releasing some of the longer tail reserves, my assumption is those are the older accident years '03, '04 maybe?

Yes. It would be predominantly '05 and prior with most of it coming out of '04 and prior.

And it's claims made and some of it is high access to write.

Which is consistent with what you have been saying for the last five years, so --. And maybe just a follow-up to the last question on claims inflation. You know you pick up the paper, you read a lot about inflation throughout the economy and you know some of that is going to seep into insurance claims.

It sounds as if you haven't seen it yet, but when you guys are doing the underwriting and your actuaries are looking at pricing assumptions, are you building in an escalation in claims inflation?

Yes. Yes we do. And we try to take also a forward look and, for example, we are very much concerned about the high-end of the Property business. Because we are not immune to -- when steel prices, they're growing up 40, 50% and other commodities. Yes, labor might be coming down a bit, etc., but we try to factor that in.

It is not that easy to have that forward look, but our actuaries when they decide to get with the underwriters on how they're going to project future pricing and create a benchmark pricing that we measure everything, renew our business or new business, they take that into consideration. Sometimes we are right and sometimes we are wrong in our projections.

Jay, I mean some lines, like Executive Assurance, we are using more longer-term averages because if you look backwards, claim inflation is very benign. And you have to be careful that looking backwards you don't lose sight of what can happen going forward.

So they periodically are reviewing every line of business and updating the expected claims inflation for each line. And that's not only factored into our pricing but it is factored into our reserving as well.

As you talk with other executives in the business, Dinos and John, I'm sure you have a consistent dialogue with folks. Do you get a sense that everyone is getting a little concerned about this or are people a little bit too comfortable with the recent past, which has been more than (multiple speakers) --?

No, no. I think they are concerned. Don't forget, I don't -- and there are lines of business that the uptick has nothing to do with inflation. The uptick has to do with economic conditions.

For example the Workers Comp line, it's going to get affected with soft tissue injuries on people that they get laid off. All of a sudden their back hurts and their arm hurts, etc. And they are going to put claims in and a lot of those claims -- I wouldn't call them fraudulent claims, but I am going to call them claims that you wouldn't have in the past because if somebody is working, he takes an Advil and he goes to work and it's okay, and when he's not working he goes to the doctor and he puts in a claim.

So, and companies and senior executives, they are aware of that and they are starting to look at it. Same thing with auto liability, especially on the trucking flees and all that. Is maintenance going down? That has an effect on frequency and in essence the severity of losses.

So we try to factor that in, especially for those of us who have a lot of gray hair and been around cycles. In a down -- independent of the insurance cycle, in a downturn economic cycle you will get an uptick on claims and you are going to -- an uptick on cost.

That's great.

Dan Johnson with Citadel.

From a market point of view if a belief is -- call it 4 points of -- 3 to 4 points of loss ratio deterioration in '08 and if there is not a whole lot of sign of the change in the pricing trend and we are concerned about the potential implications of inflation -- which haven't shown themselves in current loss ratios, why isn't the first starting point for '09 something north of 4 points from an industry point of view?

I'm not saying in my -- with certainty that is going to be 3 points, 4 points or 5 points. In this business and that's the reason you see usually more conservative on the Reinsurance side and I wouldn't say less conservative, but more comfortable on the insurance because we have the ability to price on a quarter to quarter basis, on a month to month basis.

And you navigate the ship so to speak, based on what you see in the marketplace and what is coming through and we will continue to do that. It I was that good a predictor of what is going to happen, we will have more precision.

You might be right by putting in your models at 5% or even at 6%. You know? I don't know. We haven't seen it.

One thing I will tell you when we look at our numbers between the first quarter rate reductions and the second quarter, the second quarter rate reductions is slightly less than the first quarter. You know, the data shows it and it is not because DNO financial institutions went up or commercial D&O eased. It's kind of across the board. If it was 10 now it's 8. If it was 11 it is now 9 or something of that sort.

But I can't tell you what the third quarter is going to do and I can't tell you what the fourth quarter is going to do because I've seen competition heat up for the wrong reasons. Somebody is trying to make their budgets in the fourth quarter for the year and all of a sudden you get an anticipated competition. You've got to factor that into what you do.

And that is why basically I spend most of my time, and John, talking to our units and trying to have our fingers on the pulse as to what is happening quarter to quarter. So if you want to project 5 or SIX, I am not going to beat the guy who is going to dispute that. You might be right.

I always appreciate your thoughts. Thank you.

Quite welcome.

And at this time we have no questions in queue.

Thank you, everybody, for giving us time and listening to us and we are looking forward to the next quarter. Have a good afternoon.

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