Arch Capital Group Ltd (ACGLN) 2010 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Quarter 2 2010 Arch Capital Group earnings conference call. My name is Jennifer, and I will be your operator for today.

At this time, all participants are in listen-only mode. Later, we will conduct a question-and-answer session. (Operator Instructions). As a reminder, this conference is being recorded for replay purposes.

Before the Company gets started with its update, management that 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 laws. These statements are based upon management's current assessments and assumptions and are subject to a number of risks and uncertainties. Consequently, actual results may differ materially from those expressed or implied. For more information on the risks and other factors that may affect future performance, investors should review periodic reports that are filed by the Company with the SEC from time to time.

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

Management also will make reference to some non-GAAP measures of 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 website.

I would now like turn the call over to your host for today, Mr. Dinos Iordanou, and Mr. John Hele. Please proceed.

Thank you Jennifer. Good morning everyone, and thank you for joining us today.

Our performance for the second quarter was reasonable in light of the challenging environment in which we are operating. Our annualized return on average common equity was 13%, which, in our view, is an acceptable result. These returns benefited from light cat activity for the quarter and favorable prior-year reserve development, while they were negatively impacted by the Deepwater horizon loss in the Gulf of Mexico.

We continue to estimate that, under the current market conditions, we are achieving a 9% to 10% return on equity on business return in the current underwriting year. This return is realistic for the current environment, but it does not meet our long-term goals.

In the most important measure for creating shareholder value, which is our ability to increase book value per share, we fare very well. At $82.07, our book value per share increased 12.4% from year-end '09 and 6.7% from March 31, 2010.

From an underwriting point of view, we reported a 90% calendar year combined ratio, which, in our view, is 5 to 7 points better than the normalized accident year combined ratio of 95 to 97.

Cash flow from operations remain healthy at $206 million, even though our current book of business is declining and our prior year's book is maturing. In addition to that, our mix of business has moved to more short tail than in the past, which also affects claim payment patterns. It accelerates the paid claims.

From a production point of view, our gross and net written premium were both down about 10%. All of the reduction was attributable to our reinsurance operations. Our reinsurance group continues to pursue a strategy of reducing writings in long tail lines while moving to more [XOL] contracts on short tail business.

In addition, it should be noted that the 2009 second quarter included a large property cat contract which is written on a two-year basis. That negatively affected the quarter-over-quarter comparisons.

On July 1, property cat rates were down 5% to 15% with a few late deals being written at better rates than January 1 and last year's pricing. On quota share contracts, terms and conditions remain basically stable with most of the rate erosion occurring in the primary business level. The actions we have taken in our reinsurance business, which I just referred to, have an exaggerated affect on written premiums, but a more modest impact on overall profitability and a beneficial affect on returns.

Our Insurance group continues to emphasize and move their books of business to less volatile lines and to reduce their writings in the casualty lines. Despite these actions, due to the challenging market conditions that exist, margins continue to be under pressure. Rates in the US market range from a plus 2% to minus 9%, depending on the line of business and size of account. Across all lines, rates were down 3% for our book of business, as compared to a decrease of 2% recorded in the first quarter of 2010.

Our capital management philosophy has not changed. We intend to continue to return excess capital to our shareholders as long as we do not see attractive opportunities to deploy it in our business. With our share price trading below book value in the second quarter, we repurchased 3.6 million shares at an average price of $73.83 for a total of $269 million. At June 30, 2010, we have $541 million authorized for future share repurchases, and our excess capital is estimated to be in the range of $600 to $900 million.

Before I turn it over to John for more color on our financial results, let me share a few thoughts on our cat writings and PML aggregates. We continue to find the East Coast wind opportunities still attractive even though pricing has come down from a year ago. We chose to deploy about 80% of our available PML capacity due to the change in rates. As of July 1, 2010, our 1-in 250 PML from a single event was $797 million, or 19.6% of common equity, up from $674 million at April 1, 2010. These PML is for the Florida tri-county area, which is our largest PML zone, as we have expected. Our northeast [wind] area PML stands at $733 million, up slightly from $719 million we had as of April 1, 2010. Both zones are significantly below our self-imposed 25% of equity limitation based on our risk management guidelines.

With that, let me turn it over to John for his comments, and then we will come back to handle your questions.

Thank you Dinos.

For the 2010 second quarter, property and other short tail lines represented approximately 46% of our net premium volume. However, adjusted for the two-year property cat contract written in the 2009 second quarter, the comparable percentages are 48% for the second quarter of 2010 versus 46% in the 2009 second quarter. On a consolidated basis, the ratio of net to gross was 76%, the same as a year ago.

Our overall operating results for the quarter reflected a combined ratio of 90% compared to 87.2% for the same period in 2009. The second-quarter loss ratios for both 2010 and 2009 included little to no cat activity. As of the end of the 2010 second quarter, the provision for the first quarter cat events, which included the Chilean earthquake, did not change materially.

The 2010 second-quarter loss ratio also reflected physical damage net losses of $15 million, or 2.4 points, from the Deepwater Horizon rig that was not booked as a cat loss. The 2010 second-quarter combined ratio reflected 5.2 points, or $33 million, of estimated favorable development, net of related adjustments, compared to 8.8 points or $62 million in the 2009 second quarter. The prior-year development in the second quarter of 2010 reflected favorable development, primarily in property and other short-tail lines, partially offset by adverse development in casualty after the midyear reserve review in the Insurance segment.

The 2010 second-quarter expense ratio of 31.7% was 1.5 points higher than a year ago, reflecting lower premium volumes year-over-year as well as changes in the mix of business and changes to the reinsurance ceded structures in the Insurance segment. The second-quarter expense ratio was about the same as the first quarter of 2010.

On a per-share basis, pretax net investment income was $1.70 in the 2010 second quarter, compared to $1.60 for the same period a year ago and $1.67 in the first quarter of 2010. The growth reflects the accretive impact of the share repurchase program offsetting lower reinvestment yields.

Total return of the investment portfolio was 1.74% in the 2010 second quarter. Excluding foreign exchange, it was 2.22% in the quarter. Also, the total net return benefited from a deliberate $135 million natural short position that we took against the euro.

The duration of the portfolio increased slightly to 2.9, up from 2.77 at the end of the first quarter of 2010, principally in the treasury space. However, the overall duration of the asset portfolio at 2.9 is still less than the estimated overall duration for the liabilities, which we feel is appropriate given the "unusually uncertain economic outlook". We continue to be conservative with regard to the investment outlook and maintain an AA+ average credit quality on the portfolio.

Our balance sheet is conservatively positioned, with total capital of $4.8 billion at June 30, the same as at March 31, which reflects the share repurchase activity during the quarter totaling $269 million. The cumulative share repurchases added $0.63 to the diluted operating earnings per share, or 3 points to the ROE. Our debt plus hybrids represent approximately 16% of our total capital, well below any rating agency limit for our targeted rating.

As Dinos mentioned, as of June 30, we estimate that we hold approximately $600 million to $900 million above our targeted capital level based on current rating agency models with an appropriate buffer. Our liquid cash, short-term investments and US treasuries represent about 22% of our investable assets.

With these comments, we are pleased to take your questions.

Jennifer, ready for questions.

(Operator Instructions). Keith Walsh, Citigroup.

Good morning everybody. A few questions here -- first on the -- within the commentary and the press release that you had some adverse development in the '03 to '05 accident years in the Insurance segment. Maybe just give us a little more color on that. I've got a couple of follow-ups.

We do probability reviews in all of our profit centers pretty much every year, some of them on a six-month basis. At the same time we do profitability reviews, we also always look at the reserve position we have on a profit center by profit center.

As you probably recall that, in our excess and umbrella segment in the Insurance group, we had a couple of large losses that we took, total limit losses. Of course, once you do that, the case, incurred and paid for that year changes, and then the actuaries, in reviewing that, they will establish a new projected loss ratio pick. That's what happened with that segment. We allow our actuaries to always review all of our reserves. Where they believe that we have a different outcome than we thought, we make the adjustments. That's what happened in that particular case.

John, do you have anything further on that or --?

Well, being an actuary, we tend to blend these in over time. We looked at the lost development patterns in excess casualty and strengthened in the '03 '05 accident years. In specialty casualty, the frequency resulted in some general strengthening across the board, so just really truing up to be on track for where we think that these will end up.

Then the second question, you mentioned 10% ROE on 2010 written business. Were there any specific lines where you can achieve more robust returns? Then I've got a final one.

Yes. That's a blended -- you know, there is lines of business that are in the low single digits, nothing to write home about. But your question is why don't you get out of there? It's not that easy to get out of all business, especially in the Insurance group. You've got to maintain the infrastructure; you've got to maintain market relations, and you've got to continue to service customers.

We still believe the best returns there are still in the property cat area, and some of the A&H lines, some of our low limit professional liability business that we write on a claims made basis. So those, they are in the probably double digits, mid double-digit ranges. Of course, in order to average down to 9% or 10%, that means there's other lines that are not carrying their weight.

So we try to be realistic, and that's how we navigate as to what we want to write and what we want to reduce in writings over the year. These are open discussions we have with our pricing actuaries and the profit center managers in each one of our units, and it's part of our capital allocation process and also resource allocation as to where to allocate more resources, underwriting personnel versus where we, through attrition, we might be shrinking personnel.

Then my last question around contingent commissions, I think you've probably seen the two largest distribution partners out there saying they will take them. At what point are you in your discussions with them to reinstating those types of payments? Thanks.

We are always in discussions on contingent commissions. There are some cases when there is benefit in the overall approach, it was that we will do some, and there are cases that we are going to refuse it. At the end of the day, it's got to be some value to both parties in order to do it. If it makes us more efficient on contingents because they're providing us either better information to underwrite or a more efficient way to transact the business, then those efforts will be rewarded. On the other hand, we are not interested in paying just contingent commissions just for the asking.

Let me share a couple of statistics, a little more flavor, even though it wasn't in your question. We monitor total commission and our gross commission in the insurance group year-over-year was flat. It was 14.8% in '09 and 14.7% in '10.

Of course, you know, you have got to get into the granularity and you've got to see the mix of business and different books of different commissions, etc. But in the aggregate for the Corporation in totality, those were the numbers.

When you look on our submission activity, we were flat. We got 27,000 submissions in '09, and we have 27,000 submissions in the second quarter this year.

So from an activity point of view, we are seeing the same business from a total commission payout, at least on a gross basis. Commissions would have been steady in either case. On a net basis, our commission of course went up by 1.7%, but that's structural changes to our reinsurance structure and how much ceding commission you're getting, and are you moving from quota share reinsurance to XOL. So there's a lot of moving parts in those calculations, but we monitor all that, and we make the appropriate decisions.

John, anything to add to it -- or?

No, I think that's well covered. We continue to remain disciplined across the board as we write these.

Thank you very much.

Josh Shanker, Deutsche Bank.

Thank you. I want to talk just a little bit about more on the expense associated with the prepayment of the GNMA interest only CMBS funds. I'm trying to understand how much interest you are earning off those bonds to sort of put in relationship to the scale between the charge and the interest that you are receiving on those bonds.

We -- what we have approximately was about 100 --

We had $100 million of the IOs.

$100 million of these IOs, interest only bonds.

Is that par or your purchase price?

That is our amortized value today.

Right. The effective yield is a little north of 10% on those bonds. So of course, at the end of the day, as we receive these cash payments on a monthly basis, part of it is for the yield and part of it is to pay down the principle, so between principle and payments. We have -- the 3.7 is associated with our change in the prepayment pattern, that I think we have a more conservative (multiple speakers).

[It's gone on]. We bought these in very late '08 and '09, and so we've had to -- how the accounting works is you check how the prepayments are happening on these, and you true up in a quarter to fix the amortization as you go more or less than you think. So $3.7 million over $100 million over the last few quarters isn't a great deal of change.

It is a great deal of change, yes?

It is not.

Oh, it is not? So essentially you received probably about $2.5 million of interest on this quarter? Is that reasonable?

Yes.

So I'm just trying to understand, because I don't know this industry at all, the extent to which there is a risk that that would repeat itself.

Well, unless patterns change significantly, you know, no risk. Basically in -- we took a different approach to it than in the first couple of quarters that one of our outside investment managers that we'd take in recording these. We believe that, unless there is a change in the patterns, a significant change in the pattern, there will be no further adjustments. We don't anticipate a change in the pattern.

We like these kind of bonds. The prepayment schedules and default, it affects the pattern. But we haven't seen anything troubling, and when we stress test these things, they still produce very high yields, even at 3X change in the flow rate. So, we're very comfortable with the investments on their own, and I think we are getting the accounting to where we are very comfortable with.

Appreciate it. Can you discuss some claims emergence patterns you're seeing on the '08 and '09 executive insurance book?

That was related to the financial crisis out of our London book.

Some in the US book from credit, this credit crisis.

Right. So the combination of those, we put some additional reserves for the D&O lines for those. Again, part of this is in our quarterly reviews. When we look at the reserves and we go in a granular basis and see what got reported, what potential for some of these cases to materialize in losses, we make those judgments and we adjust our reserves.

At this point, this is IBNR and not case?

Yes.

Are the increases severity related or frequency related?

It's probably both. In a couple of cases, a couple of Madoff cases, we put some, you know, I will consider that, more severity. There is no significant appreciable change in number of claims reported on the frequency side. But in the aggregate, we put some money up.

Thank you for your candor.

Dean Evans, KBW.

I was wondering first I guess if you could give some more details sort of on the decline in the Reinsurance segment. First off, I guess could you give a little more clarity sort of as to how large the two-year property cat contract was from last year? But second, also really was the decline just sort of more related to pricing or was it true-ing the book or sort of what was the blend there?

Well, there's a few things. I'll give you some general color and have follow-ups if that doesn't answer your question.

First, the contract, the contract is for a large client; it's about $43 million, $44 million, thereabouts. It's a two-year contract. So we look at it every two years. We bound this two years ago, so it was written premium last year, not this year. The following year, we will renew it. It will show up again next year.

Now, what is happening in the Reinsurance segment, with the exception of a lot of the short tails that -- especially property cat that we do on a XOL, we are a company who prefers quota share contracts. So we try to align our interests with the interests of cedents. For that reason, a lot of our decisions if we're going to continue on the contract or not is our view as to what's happening with the underlying primary business and where rates go in that sector.

In the casualty area, we've been reducing consistently now for the last four or five years, and we continue to do it to almost nothing. I think our reinsurance operation in Bermuda has very little, probably less than $30 million, and we write a little more out of our US reinsurance operations, etc.

But it's our view about the pressure that casualty business is feeling on the primary sector. Of course, we are not a big XOL writer on the casualty side.

Similarly, on the property side, some of the quota share opportunities for this year we felt that rates were coming down significantly, especially on international, national kind of accounts. For that reason, we chose to reduce some writings in that area. That's what's going on, on the Reinsurance side. We'll continue to remain disciplined, you know. We'll react to the market conditions. If we have to give up some volume to maintain margins, we are prepared to do so.

Very helpful, good color. My second question kind of a bit of a numbers question, but looking at the other expenses, it seems that they are always a bit higher in the second quarter. What is sort of the driver behind that, and (multiple speakers)?

Well, you've got a little bit of incentive calculations, so usually we've got to pay our underwriters. So that usually has an effect. But when you look at our expenses, the expense ratio went up and they -- most of it is coming from the change in the reinsurance structures who, even though our gross commission, which is the commission we pay on individual deals out, hasn't really gone up, on a net basis, it has gone up because we are not getting as much ceding commission. Also in the second quarter, if you read our proxy statement, that's when we do all the equity grants and share appreciation rights to the true-up. So that hits in the second quarter.

Yes, and there is an accounting provision that for some portion of those we have to book all in the -- when it's given, not spread out over time. That's why there is a bump in Q2; you see it again last year, or the year before. So this is a bump up of other operating expenses (multiple speakers).

Yes, it's for us old guys. I think the provision is, if you are eligible for retirement, I don't -- don't get any wrong ideas. I am still a very young 60s, so don't get any ideas. But accountants think we are eligible for retirement so (multiple speakers).

(multiple speakers) all right away.

That makes perfect sense. I guess my last one, sort of a quick numbers question, you did mention, in your discussion, that the rig losses were booked as non-cash and I think that was $15 million. So then the cats that were in there, what was that, that $7 million I believe, related to?

Yes, about 1.1%.

You know, some of the Tennessee storms and some of the smaller windstorms that affected players. But for us, it was not that big an event.

There was no movement on the Chilean earthquake. It was like less than $1 million movement negative coming down. And so it was not a cat event for us this quarter.

Perfect. That's all I had. Thank you.

Vinay Misquith, Credit Suisse.

Good morning. On the adverse development, I'm just curious as to whether the higher casualty claims you're seeing from the 2003 to the 2005 years, how do you think your reserves are holding up versus peers'? Was it just that you decided to raise your loss picks rather than take down IBNR when you saw the numbers?

I don't know what our peers are booking for those years. All I can tell you is we have raised our reserves. Now, raising the reserves doesn't mean that those years are unprofitable for us. They are still profitable years for us, but not to the extent that we originally thought. So in that sense, it's our own view that the '03 and '05, at least for us in that segment, in that profit center, the results are not going to be as robust as we originally thought. As for our peers, I don't know. I don't have inside information. Everybody else says accident year by line of business to give you a comparison.

Sure. Could you give us a sense for the IBNR for the Company as a whole? How has it changed this quarter versus last quarter?

We are still at 68%, which I believe is about the same as a quarter ago, so it hasn't changed at all. Even though somebody will argue as our earned premium is coming down and we are writing less, maybe that should be changing a bit. We haven't changed.

Fair enough. The second question was on the Deepwater loss. How much of that would you say is a normalized loss? Because I believe it was $15 million or 2.4 points.

What do you mean normalized?

Do you think this was a higher loss than you would normally expect in the quarter?

No, listen. When you get an event like that, which is significant, you know, this is not an unusual loss for us to take. At the end of the day, it's lumpy. In offshore energy accounts, you put out big limits, you get it on the reinsurance, you get it on the insurance. So it could have been $30 million and it wouldn't be a surprise to us. It depends what you write, and did you get hit on that particular account.

Of course, you know our philosophy in the Insurance group, we have a maximum net position that we take, especially on first party coverage that you have to write big limits, which can be no more than $15 million any one risk. Then on the Reinsurance side, we take much smaller lines because you might get hit from multiple clients. When you have a big loss that all the layers go, you might get it from two, three or four cedents and you get a small portion of each one's loss. So it was not an unusual loss for us, but it is lumpy. Some quarters, you're going to have it and some quarters you're not going to have it.

Sure. Which segment did that come from?

It's offshore energy sector.

Both Reinsurance and Insurance.

Oh, so it's both reinsurance and insurance. How much came from reinsurance versus insurance? Do you have a --?

It's about $10 million from Reinsurance and $5 million net for Insurance.

Great. When is the last falloff with respect to the adverse (inaudible) development. I'm just curious. So does that mean that there is a lower probability that your reserves develop favorably from the past all those years? Or do you still think that you've been more conservative putting reserves up, and there is still a possibility that, as time goes by, those reserves may be redundant?

Well, you're asking a question that only the data can answer in future quarters. We will react to the information that comes through. When we get another diagonal on the triangles, we make those determinations. Like I said, we spend a lot of time making sure that we try to get the reserving right, because that affects what action we are going to take in the marketplace. If you don't get reserves right, you're not going to price your business right, or at least you won't know if there is profitability or not in the business that you are underwriting. So it's part of our fabric when we do profitability valuations in all of our units to make sure that there is an in-depth analysis and discussion as to what our reserve position is, and what we believe each one of these years' profitability is. So it's through that process.

So we do react, I think, faster on negative news and slower on positive news, because that's a better way to see it. You guys get very excited on minor adjustments if they are negative; if they're positive, you forgot about them. So for that reason, we try to be as cautious as we can.

In all of our lines but in particular I think the longer tail lines, we try to be very disciplined from when the developments come in, to book them in, and be cautious on taking them down because it's a very long tail line. It's a bit lumpy from time to time, so you'd rather have the reserve there than not.

Yes. Vinay, listen. I think we are a reasonably good company, but we are not perfect. We're not going to get everything perfect, so we don't profess to be perfectionists.

That's great. I appreciate your candor. Thank you.

Jay Gelb, Barclays Capital.

Thanks and good morning. First, on the year-over-year comparisons for gross written premium growth, the reported number was a decline of 10% overall for the Company in 2Q. Am I right in saying, if you back out that two-year reinsurance contract written in the second quarter of last year, it would have been down 6% on a reported basis?

Yes and no. It depends how you do it. The proper way to do it is you've got to split that contract into two, and says you know, on -- if it was annual contracts, it would have been like $21.5 million and $21.5 million. If you do that calculation, I think you'd be right.

Because you can't say I have it in one year and I won't have it in the next year because, in essence, -- the accounting rules doesn't allow you to say, yes, I've got two payments but I've got all the cash upfront, and it's $21.5 million each time.

I see. But on the reported results, it was -- the full impact was -- the benefit was in the second quarter of last year, and nothing in (multiple speakers)

(multiple speakers)

That is correct, but when you go on the earnings pattern, it doesn't change that because a two-year contract, you're going to earn over two years where a one-year contract you're going to earn in one year.

I understand. then second, on the Deepwater Horizon, is there any exposure up at all for liability?

(multiple speakers)

Yes, there is exposure for liability. Basically, there still, there are a lot of contractual issues that need to be resolved, etc. But at the end of the day, there are four or five parties that they might be involved. Depending on what we get from our Insurance and Reinsurance participants, there might be some exposure there. Having said that, it is way too early. Clearly, most of the liability goes to BP when you look at all the contractual agreements. On the other hand, there are some other companies who probably have liability either because they made equipment that failed and/or they provided services that they were not -- and there is a dispute as to some of the facts.

But there is a very long way to go I think before we get clarity as to what the exposures are there.

I see. Then finally, on the access capital position, at the midpoint, that's about 20% of common equity, which seems pretty substantial. To what extent can the share buybacks help to draw that down in light of the Company probably still earning well over $400 million this year?

Well, listen. I think we have been friendly to shareholders so far; at least that's the feedback I get. Usually, we like to be a little quieter in the third quarter because that's when we have exposure to the cat season. So, we like to be more conservative and keep a lot of excess capital on the balance sheet to see exactly what happens. Even though we are very comfortable with our underwriting and long-term patterns, when you're writing cat business, any one year can be a year of surprises.

So -- but having said that, fourth quarter, depending where we trade, we will probably get back to our policy of returning excess capital to shareholders. You know, that discussion always happens in every board meeting we have on a quarterly basis in our investment committee and finance committee at the board level. It's a critical question as to what do you do with your capital structure and how do you deploy your excess capital? Clearly, I don't want to give it to our underwriters and try to spend it in the wrong place if there's not an opportunity for them to write profitable business. That's not the place we want to put it.

Would it be aggressive to expect Arch to complete the share buyback authorization this year?

Hard to tell, but based on a lot of the rules, it's difficult to do that much in one quarter. There's limitations as to how much you can buy, etc. For that reason, absent of, for whatever reason, a reduction, a significant reduction in price and availability of a blocked trade or some sort, it is very hard to find that much.

Right, it makes sense. Thanks very much.

Matthew Heimermann, JPMorgan.

Good morning. I have a couple of questions, but hopefully they are pretty quick. Gross versus net on Horizon?

The gross was --

$22 million, I think.

No, it was more than that. It was --

(multiple speakers)

We'll look at that number. The gross on that, it was -- it might have been -- the gross on that on Reinsurance, it was the same. I believe $22 million was the gross on Insurance that netted out to $5 million. So it might be $32 million to $15 million.

Perfect. Then with respect to the management liability research change, was any of that related to increased defense cost assumptions?

No, you know, it is not a specific reserve attributed to that. It was an evaluation of us of putting more on the '08/'09 year based on the financial crisis, so it's kind of a bulk number.

Just to clarify, is that management liability stuff, just where are you attaching (multiple speakers)?

These are excess placements, predominantly. We are not a primary writer in -- we believe that, in order to get to us, it will go through a lot of layers. But people can be optimistic; people can be pessimistic on these things. We see it with our set of eyes, and we have very good people who understand that business. Based on our pricing actuaries, the evaluation of our claims department and our underwriting and what we have seen, we put up the bid in '08 and '09.

That's fair. That's fine. I just wanted to -- I just was curious about that topic specifically.

I've got the right number. It's $29 million was the gross VAR.

Oh, on the Horizon?

Yes, on Horizon.

Right. The insurance, it was $17 million to $5 million, and then the reinsurance was $12 million to $10 million.

Perfect. Then just two other ones -- quick, just a quick comment on the travel accident line (technical difficulty) an area of growth that slowed down. Then the other question was on the reserve development, just reserve development generally. Does any of the assumption changes on the insurance side affect how you think about the reinsurance side?

You know, yes and no. Listen, the reinsurance side depends -- we look at every single contract that we have. Some of these contracts, especially old quota share contracts, they have a lot of underlying data coming from our cedents that they might have their own patterns. Then we will reserve based on those patterns, because there is significant credibility due to that information.

Having said that, we will always have also the kind of sixth sense to evaluate a product line, how the marketplace is doing on that product line for the accident years. Are we significantly different and why? If we can't explain it, then we've got to make adjustments. That's why we hire outside actuaries also to review our reserves, from a holding company point of view, to make sure that we don't stray in the wilderness without having all information feeding into our reserve decisions. But as we mature and we promise the Street we are going to really use release our triangles, which are going to come in August, I think I deserve a little vacation, so I am leaving next week and the week after. When I come back, hopefully they will let me look at them before we put them up. But in August, you're going to see our triangles. I will tell you that it's still a blend. We don't depend 100% on our own data, but more and more of our own data affects our reserve positions.

That's fair. Then just on the travel accident?

The travel accident, you know, it has been a good business for us. It has been a good business for the industry. It's difficult to grow it organically, and we are doing the best we can to try to grow that business.

Thanks much.

Beth Malone, Wunderlich Securities.

Thank you. Good morning. A question on the investment portfolio -- you mentioned that you were starting to write up more of the short-tail business in your total book. I was wondering. Are you making any changes to your investments portfolio as a consequence?

Not at the time being, but let's talk about a little bit because we have a philosophy on how we deal with our investable assets. We bucket those into three categories. First, we've got the reserves; second, we have the Company capital; and third, we have borrowed money. On the borrowed money, $300 million of bonds we have, we try -- when we got those funds, we only wanted to be subject to the spreads, so in essence we invested them in the same duration.

Where we make judgments is we are -- should we be with the funds that are there for reserves? Those we match duration of liability. So if duration of liabilities in our reserve changes, we will change that component. Where we adjust the -- the view that we have on the economy that should we be longer or shorter from our liability durations, we do with the equity capital of the Company.

We've been shorter in duration than what our liabilities are. Right now, we are probably, I would say, three quarters of a year, call it six months to three quarters of a year shorter than the duration, because we don't like the economic environment, and we believe that being more conservative and not taking duration risk is -- even though it comes at a small cost to shareholders, it's a better position to be than being long at this point in time.

We also make sure, in addition to matching the duration, that the key rate durations that were matched with cash flows from buckets one, two, three, four, five, six, so it's not just matched on an average number, it's matched across the board. We also keep a good portion liquid in case of a large cat that comes through from property/property cat that we can have the ability to pay in a pretty rapid timeframe.

Thank you. Then one other question -- on the Transocean event, you said it was not a catastrophic -- it's not defined as catastrophic. I was just curious as to why it might not be.

Well, no, we consider cat activity to be natural cats, not man-made cats. It's a catastrophic event, but it's man-made, an explosion in a refinery or a blowout in a well, etc., it's not what we consider a natural catastrophe. this is not a hurricane or a tornado or a hailstorm or wind or an earthquake. So that's where we make the distinction. So you might prefer the expression, some companies call it man-made cats, or attritional cats. So you know, they use different phraseology. For us, always a cat numbers is what comes from natural catastrophes.

Okay. As regards to the Transocean, I assume you've seen improved pricing in the energy market as a consequence in the second quarter.

Slightly on the first party, but it is still disappointing not much on the liability side. So that tells you that the market is pretty soft, an event like this. Even though the liability questions are still unanswered, we have not seen any movement on the liability side, which is disappointing.

Thank you very much.

Brian Meredith, UBS.

Good morning everybody. Dinos, a quick question -- the Neal bill has been getting a lot more talk recently, some speculation that it may pass here. I guess my question is what do you think about that? Do you think it could pass? Number two, are you doing anything at Arch to potentially prepare yourself, in the event that it does happen, to minimize any financial impact?

For your first question, I don't know. Washington does a lot of strange stuff. Clearly, the Neal bill is a protectionist bill. If you can see from who's behind it, it's predominantly a few domestic insurance trying to serve their own interests at the expense of policyholders and the consumer. What you see behind the coalition for affordable rates and insurance is a much broader coalition of people.

Having said that, every company looks to make sure that it has the proper structure and tries to maximize its ability to service customers at their lowest possible cost. We are one of those companies. At the end of the day, our interest is to provide a lot of cat capacity to the US at the best possible prices. I don't know what the future will bring, but we are prepared.

But I guess my question would be then, what do you think the financial impact would be today if something went through?

It is going to be minimal because unbeknownst to what -- not knowing what they will pass, we still pay a lot of tax when you consider the excise tax and the risk transfer tax that we paid on the business we write in the US. Don't forget, all of our income is coming from investing our capital, which is offshore, and investing some of our reserves that are offshore. So, that is not going to change.

The second question is can you talk about the interest rate environment right now? It looks like it's going to be low here for a little while. As a result, have you changed kind of your return thresholds that you think about that you can achieve? Then particularly when you look at underwriters and allocating capital down and what kind of return on capital they need to see, have you lowered the return assumptions?

Well, what we do in the investment department and how we price business are two different things. Our underwriters, they are required to produce a return based on the risk-free rate of return of new money invested. So, in essence, in a lot of cases today -- maybe that's why we are pessimistic on casualty business or long-duration business, is because when you look at the risk-free rate of return, three-year, five year T-bills, you're not getting much in return. That's what our pricing actuaries are instructed to factor in when we develop our rates. So, it's probably affecting us by being less optimistic as to how much return we can have come on a other risk-free basis in writing business. But that's reality. You can't escape reality. The reality is that the returns are going to be very skimpy moving forward.

So a 15% return on capital, when you're talking to underwriters, you're not telling them we need to make (inaudible) 15% return on capital. It's something a lot lower than that now. Where maybe a couple of years ago it was higher?

Listen. We have not officially, through our discussions with either our underwriters or our board or our shareholders, have changed our long-term goal of achieving 15% return over a long period of time. Having said that, we always said that there are going to be years we are going to give you high teens, even 20% or more, and there are going to be years we are going to be in the single digits. But if this environment stays for a long period of time, which we don't believe it will, at some point in time, I think insurance rates, they're going to move up. I don't know exactly when, but then the 15% might be unrealistic if we have a prolonged period of time --

Like a Japan scenario (multiple speakers) years that rates stay at 2%.

2% or 3% interest rate. But I am not that smart to predict interest rate movements into the future. I think -- and that discussion we always have with us, senior people. At the end of the day, I can tell you earning 9% or 10% in today's environment is pretty difficult. It's not an easy thing to do, and we believe we are earning it.

Great, thank you.

Jay Cohen, Bank of America Merrill Lynch.

Yes, thank you. Good morning. Two questions -- the first is if you could comment maybe more broadly on claims trends in general, the frequency of claims being reported, because obviously, even though we've kind of zeroed in on some of this adverse development, overall you are still having favorable development, which suggests still just favorable trends.

Then secondly, I'm going to zero actually in on the adverse development for another second. What you have seen, whether it's from '03 '05 year in the casualty business, or the more recent years in executive assurance, has any of that made you rethink where your pricing is today on those lines of business?

Let me take the last part and then I'll go to the first part. That, no. As a matter of fact, we were reducing casualty writings way back in '05, '06 actually, not because we had any reported claims but because we just didn't like the pricing environment. The rate reductions, they were significant, and at the end of the day, we were just factoring industry loss ratios and how much rate we were giving. We didn't find that business to be the most attractive, so we started cutting back a long time ago. So from that perspective, no surprise.

The same comment for our D&O business. It's not a surprise. It is just a further detailed evaluation of the financial crisis and making adjustments to it.

So now your first question, I will -- John, do you want to comment on it and then I'll come back to it?

Yes. Generally, in this quarter, if you took the expected claim activity that we would have, we were favorable across the board in sort of an aggregate -- in a total aggregate sense. We had many lines that had some positive development, because in total we were positive. But we thought it was appropriate to flag the areas that also had some adverse development to give you a clearer picture into what's going on within our business. We think that's important to do, but this adverse development, I wouldn't put it in the totality of -- it has to be balanced with the fact that, overall, we still had a total positive development in the entire quarter. It's just part of the ongoing process. Every quarter, or every six months, we review the trend and what's going on and we adjust. There's positives and there's negatives on an ongoing basis as we move forward.

On the frequency and severity, frequency has been steady and has been better than expected for quite a bit of time. We don't see significant change in frequency trends. Severity is ticking up a little bit, but not anything to write home about. From a pricing point of view, when we calculate trend, our offshore is actually, they are looking at the long-term patterns. We still have -- I would tell you we have more than 3% trend in most of our lines when we factor in as to what pricing we need in order for us to get adequate returns.

Great, thanks for the answers.

Ian Gutterman, Adage Capital.

I guess --

You're always towards the end. You're the rabble-rouser who sits in the back of the room.

I try to be patient and let others get their questions in, so if I take up too much time, it won't offend anyone. So on the -- just a little bit more on adverse development just maybe from a different angle. The executive assurance, I guess the only thing that surprised me a little bit about that was not so much that you've shown it, but that many of your peers have protested rather fiercely that the credit crisis claims are kind of not that big a deal and everything is coming in favorable and we are all too worried about it. So you actually have become the outlier showing some adverse development there. Do you have any thoughts on --?

No. The only thought is we like independent thinking.

Did you see anything that refutes the claims that many others are making that this is (multiple speakers)?

We are starting to -- no. Listen. There is -- you can sit around the table and smart people can come to two different conclusions. Do you put some Madoff related -- when you look at contracts that were issued out of the London market etc., especially for some of the feeder funds that they might not have done, the proper due diligence, etc., we think there might be a potential for exposure there. So there's people that they say, no, that's not going to happen. So they choose not to put any money. We have a different opinion. It's independent thinking. Different people will see the same set of facts and come up to different conclusions. We are comfortable where we are.

Because you say historically European courts haven't been that big on these things, but on the other hand, there's a trend now of some countries starting to be a bit more consumer oriented in their findings. We would rather err on the more conservative end of that, and we will see how things develop over a period of time. It's going to take some time to shore itself up.

That makes sense. I appreciate that approach versus the hoping for a approach. The other that I don't think we discussed as much, I think there was a lot of discussion on the casualty insurance. I was wondering if you could talk a little more about the casualty reinsurance from recent years, what would've happened in recent years' casualty that would've been developing adversely already?

Well, it's not anything that is coming and developing. It's our view that the '08 '09, maybe the '10 year is not going to be as good as the industry thinks it is. In essence, we try to be ahead of the trend and make sure we have enough reserves up, so I don't have to spend my life explaining why I have adverse development.

Fair enough. Any specific lines in casualty that showed up on reinsurance?

No, it's a general -- listen. The audio and the video has to match. We are telling you we are not writing a lot of casualty; that means we don't like it today. So we can't say, well, we are going to do wonderful well in '08 '09, but we don't want to write a lot of that business. So, we've got to match our story. What we believe is that these are not the most attractive years. For that reason, you'd rather be more cautious as to what reserves you're putting up.

That makes sense. Then my last one, I have to ask the accident year question again, I guess. The reinsurance -- when, again, I look at the accident ex-cat, and your first half is high 70s%, around an 80%. It's the best first half you've ever had in the history of the Company in reinsurance accident year ex-cat. Why would that be, given the environment we are talking about? I know you (multiple speakers)

Because their book of business is probably 70%-plus short tail, and (multiple speakers) there's no cats, and there is no (multiple speakers) traditional is being low. My hands are tied as to you can't put that much in reserves on short tail lines. It is what it is. It is lumpy business. Some quarters will surprise you one way and some quarters will surprise you the other way.

I guess, in those numbers I gave you, that 79% to 80% had 4 points of Deepwater in there, and I didn't even strip that out.

No, I understand. But it's short tail. This is not an actuarial exercise. It is what it is.

A building burns down or it doesn't.

No, I understand. I guess where I get confused on it is when I look at your year -- your first-half 2010 versus first-half 2009 earned premium, which is where I think we should see it, your overall earned is down 21%, your casualty is down 24%, and your property and short tail are down 20%. There's not that much of a difference; that doesn't look like a big mix shift to me.

(inaudible)

Don't forget, you've got to look -- you can't look at the sequential change. You've got to look at the overall book of business and how much is short tail versus -- the short tail runs on its own. There's no actuary that says I'm going to book this at 50%, 60% or 70% loss ratio. The short tail book, it is what it is. Either you have attritional losses or you don't have them, etc., and you've got to let it run through the book. You can't imagine things that might happen and put up reserves on short tail business. That's why you're going to get some lumpiness. When you book is probably 70% short tail, you're going to have that.

Short tail builds up over time, as has been happening the last year or so. So the overall mix is -- the mix of the risk of the book is becoming shorter tail. So, it's flowing out on an ongoing basis now if we don't have the claims.

If you look at our first quarter of '09, the property and other short tails for reinsurance was 73.5% of the book and 26.5% was casualty. This second quarter of '10, 77.9% is property short tail and only 22% is casualty.

So if you go back -- let me take you back to let's say '07. If I look at '07, it was 63% short tail, 36% casualty. If I go a year back, in '06, it was 54% to 46%. So there's been shifting over time. But at the end, the key number is 78% of what you are writing in reinsurance is short tail, it's going to run itself, and it's going to be lumpy. Some quarters are going to be very good; some quarters might not be as good. Hopefully, our underwriting is good enough that, overall, for the whole year, we are going to have pretty good numbers.

Fair enough, I'll follow up with you off-line. It's just when I do the numbers on earned premium, I get first half of last year was 29% casualty and first half of this year was 28% casualty. That's why I'm having trouble. Maybe I'll follow up off-line on that.

Well, it could be on the earning pattern depending if I have some property that -- these are the written premium that I mentioned. Net written premium, it's the numbers that I mentioned to you for '10, '09, '07, and '06.

Got it, thanks.

Justin Nyweide, HMI Capital.

My question has been answered. Thank you.

Vinay Misquith.

Just the 9% to 10% ROE you said that you have on your current business, is that based on the current interest rates?

It's based on the current returns we get on the investment portfolio.

Great. And so if rates are flat because they were down now versus the fourth quarter, should we expect the ROE to go down next year versus this year?

Well, if pricing environment doesn't change, yes, that would be a good conclusion to get to. Of course, if the pricing environment changes and maybe we can make a little more money on the underwriting side, then that would be different.

I don't expect the pricing environment to improve. I am not as optimistic as some others are on changing. I think '11 is going to be a tough year and probably '12 will be a tough year, because I haven't seen enough blood on the street yet for people to change the market, change on fear, and there is no fear yet out in the marketplace.

Thank you.

There are no further questions. I'll now turn the call back over to Mr. Dinos Iordanou for closing remarks.

Thank you for your patience, and we went a bit over time, so next time I'll speak faster so we can do it in an hour. Have a good day everybody. Thanks.

Ladies and gentlemen, that concludes today's conference. Thank you for your participation. You may now disconnect. Have a great day.