Arch Capital Group Ltd (ACGLO) 2006 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Arch Capital Group first quarter 2006 earnings conference call. (Operator Instructions).

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 laws. These statements are based on 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 fact are forward-looking statements within 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. This (indiscernible) to the non-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 available on the Company's website.

I will now turn the call over to your host for today, Mr. Dinos Iordanou, Chief Executive Officer and John Vollaro, Chief Financial Officer. Mr. Iordanou, please proceed.

Thanks Tony. Good morning, everyone, and welcome to our first quarter call. We're very pleased with the performance of the quarter and it's a really good way to start the year. Operating earnings increased by 28% compared to a year ago. Our annualized return on equity was 22.8%, and our book value per share increased to $34.53. Cash flow from operations continues to be strong at 423 million and premium growth was 19% on a gross basis and 9% on a net basis.

John will provide you with a lot more color on our financial performance in a few minutes.

Now let me give you a bit more flavor of what we saw in the market and how our two operating units - our Insurance Group and our Reinsurance Group - responded.

Our insurance group had a good first quarter as they continue to produce strong underwriting results and returns. Gross written premium grew by 22% while net written rose by 23%. The largest contributor to this growth came from our property marine and aviation division with 65% gross and 63% net growth year-over-year driven by our excess and surplus lines operations where we saw the best market opportunities.

The effective rate increases achieved on the entire worldwide group was 39% for the quarter. Our expansion in Europe and Canada continues at a good pace, aided by favorable market conditions in the short tail lines. 60% of our book of business in Europe and Canada is in the property marine and energy segments and the balance is in the professional liability and D&O sector.

Our construction and surety business grew by 29% and we are now according to the latest Surety Association statistics, the 8th largest surety underwriter in the U.S. Surety capacity is still very tight and rates are firm. Our construction book is retrospectively rated and our ability to offer unbundled services is a distinct competitive advantage.

Our professional liability business expanded by a healthy 33% with most of the growth coming from our European operations. As most of you may know, our domestic and foreign professional liability business primarily provides low limit policies to small- to medium-sized professional firms. Rates in this segment were flat for the quarter.

Our casualty operations saw a reduction in their premium of 20% as our underwriters responded to competition for middle market business in the (indiscernible) umbrella area and more competition in the primary surplus lines sector. Although rates went down 5% and still adequate, we were concerned with the broadening of terms and conditions in these two areas.

We also achieved good growth in our executive insurance area which group 27% on a gross basis and on an adjusted basis by 40% on net. This growth came predominantly through the expansion of our not-for-profit and private Company initiatives. Our further penetration in the [Side A] segment where we also chose to retain a higher percentage of what we write and the expansion of our non ADR-exposed European business. The rate movement for this sector was -2.3% for our worldwide book.

Overall, we continue to see competition increasing in some segments of the liability business. But, we are still positive on general market conditions as in most segments we're still able to meet our hurdle rates. The flexibility of the specialty insurance platform that we carefully built over the last four years also affords us the opportunity to adjust our book of business in response to changes in market conditions.

Now, let me turn to our reinsurance operations. Our reinsurance group also had an excellent first quarter, with good operating results. Their underwriting discipline enabled them to take advantage of market opportunities. The insurance group's gross written premium was up by 16% while their net written was flat with last year's first quarter. We continue to see erosion of primary pricing and reinsurance terms in European casualty and professional liability lines and as a result, we have kept back our participation in many programs.

Accordingly, our premium volume in these lines was down by 22.6%, both on a gross and net basis. As we expected, though, on the property and marine side, we saw significant market improvements both in price and terms. With the formation of Flatiron Re, we have the ability to grow our participation in these sectors without increasing our risk tolerance. For the first quarter, on a gross basis, our reinsurance property book grew 40%, our reinsurance property cat book increased by 178%, and our marine and aviation business grew by 56.2%.

We remain committed to our strategic principle of being disciplined underwriters as reflected by the reduction in our casualty and professional liability business, of being opportunistic as indicated by the growth of cat exposed short tail lines and of maintaining our commitment to risk management as demonstrated by our sessions to flood iron.

We believe that this strategy will continue to serve our shareholders well. Let me conclude before I turn it over to John by discussing the impact of our underwriting actions vis-a-vis our risk tolerance.

Let me start with Insurance Group where we have increased our retention from 60 million to 100 million for their one in a 250 year event. This change was based on our economic analysis of the cost of maintaining the prior level of retention.

In addition, we purchased an additional 125 million of coverage for the insurance group. Combining the increase in retention with the exposure of reinsurance operations we have in the cat area, on a consolidated basis the one in 250 year P&L was 11.5% of equity capital at March 31, 2005 - a year ago. If you assume no change in the model results from a year ago, our exposure to the one in 250 year event at quarter end was 15% of our equity capital.

Factoring in the recent model changes, our exposure to the one in 250 year event is 18% of equity - still well within our self-imposed limitations of 25% of equity. Because rates increase at a faster pace than exposure, adjusted for the current changes in the models, if the 2005 events were to occur again in 2006, the net impact to our earnings would be no worse than and would possibly be less than the actual 2005 impact.

With that, let me turn it over to John to run you through our financial performance, and after that, we will take your questions. John?

Thank you, Dinos. Good morning, everyone. As Dinos indicated, this was certainly another excellent quarter from a financial standpoint as we reported an annualized ROE of approximately 23% which was driven by strong growth in investment income and good underwriting results.

With that, I will just briefly walk you through our financial results, starting with the top line. On a consolidated basis, the ratio of net to gross premium written decreased to 75% from 82% in the 2005 quarter, primarily due to the business ceded to Flatiron RE. During the 2006 first quarter, we ceded $82 million to Flatiron RE - a dedicated reinsurance vehicle, for those of you who are not familiar with it as this is the first period that the treaty was in effect.

The cession, however, did not have a significant impact on earnings for the quarter as the earned premiums ceded to Flatiron RE was only $18 million. Combined ratio for the quarter was 88.3% in the 2006 quarter and was basically unchanged on a year-over-year basis.

Cat activity was higher in the 2006 quarter than in 2005, as losses from the US tornadoes and Cyclone Larry totaled approximately $16 million. Underwriting results in the 2006 quarter were also impacted by adverse reserve development, net of related adjustments, of $7.6 million as development on the 2005 storms - primarily from Hurricane Wilma - more than offset favorable development in other lines.

Our 2005 estimate for Wilma was based on an estimated industry loss in the $8-12 billion range. As additional claims information was received and analyzed, both our insurance and reinsurance units increased their projected losses and it became clear to us that the industry loss will be well above original estimates.

In our Insurance Group, which accounts for roughly 50% of the total Wilma loss, we now have booked at just below the attachment point of our catastrophe reinsurance program in 2005. So, future development if any for the Insurance Group should not be significant on a net basis.

Approximately 40% of the 2006 net favorable development in other lines was attributable to short tail lines of business. The balance was attributable to medium and long tail lines. Although we continue to place substantial reliance on industry data, as we discussed in our last call, starting with the fourth quarter of last year, we have begun to give some weight to our own experience, mainly in the Insurance Group.

As a result, based on this data in the 2006 first quarter, we reduced our prior loss fixed for certain medium and long tail lines. In particular, those lines written on a claims made basis.

Turning to investment income, pre-tax net investment income in the 2006 quarter was 80.3 million or $1.06 per share, and represented more than 50% of pre-tax earnings - the first time this has occurred in a quarter for Arch in a quarter without significant cat activity. Adjusted for the effects of the preferred stock issued in February, net investment income for the 2006 quarter was 58% higher than the comparable 2005 amount and 13% higher on a sequential basis. The substantial increase in investment income on both a quarter-over-quarter and a sequential basis was due to both the continuing significant growth in investable assets as well as higher yields.

Cash flow from operations increased to 423 million for the 2006 quarter, an increase of 29% over the comparable 2005 period, and 22% higher than the fourth quarter of last year. That was achieved despite the effects of the 2005 storm activity.

As a result, investable assets increased to approximately 7.7 billion at March 31, 2006, of which 1.3 billion or approximately 20% of the portfolio was invested in cash and short-term investments. At quarter end, the ratio of investable assets to common shareholders equity grew to approximately a ratio of 3 to 1.

The average pre-tax yields in the portfolio recorded in the 2006 fourth quarter was 4.3%. This represented an increase of 30 basis points on a year-over-year basis and was also up on a sequential basis. The embedded book yield of the portfolio before expenses rose by 40 basis points on a sequential basis to 4.60 at quarter end. The increase in investment yields on a quarter-over-quarter basis resulted from higher interest rate levels as the portfolio's average credit quality remained very high at double A+ and we generally continue to avoid other forms of spread risk based on our current view of the risk reward relationship of these investments. The increase in yields was also achieved despite a reduction in interest rate risk as we lowered the duration of the portfolio to three years at quarter end from 3.3 years at December 31.

The tax provision applicable to operating income was 7.5% for the quarter. We presently estimate that our annual effective rate on operating income for all of 2006 will fall within a range of 6.5 to 9.5%.

In summary, book value per share grew to 34.53 per share during the first quarter. Total capital employed in the business at March 31st increased by 10% to 3.05 billion with debt and hybrids representing 16% of total capital. That concludes our prepared remarks and we will turn it over for questions now.

(Operator Instructions). Tom Cholnoky. Goldman Sachs.

A couple of questions. Number one, John can you walk through the mechanics of how you're going to be booking Flatiron? What income statement lines is that going to impact? And to the extent that you (MULTIPLE SPEAKERS) any profit kickers in there, how is that going to be reflected?

Sure. Basically, obviously gross and net premiums written get impacted as well as -- in terms of premium earned, you won't see it because what we show in premium earned is always reflected net. The significant impact will show up in the acquisition cost line because it is a quota share. It is recorded as a ceding commission. So, both the fee we get for producing the business - which is embedded in the ceding commission - and any profit commissions will flow through the acquisition cost line. As I indicated, with 18 million of earned premiums there clearly wasn't much impact this quarter.

Can you give us some idea of what kind of impact this might have on the acquisition expense line?

No. At this time, not giving guidance. I can't. It's going to depend on a lot of factors. We have a confidentiality agreement with the people at Flatiron. Remember, we don't own any of it. It's totally owned by outsiders and so I'm not at liberty to tell you what the upfront fees are nor what the profit sharing arrangements.

And sorry, so the profit sharing will also work through the expense line?

It will also work through the expense line and everything of course, both the fees upfront and the proper sharing commission on a GAAP basis, will be reflected in earnings based on earned premium not on written premium.

Right, okay. And then, Dinos, can you just talk a little bit about -- sorry -- about -- I think you mentioned the casualty business and it was also I guess in Europe. Well, Europe, your business was down in reinsurance. Talk a little bit more about what's going on in Europe and is that -- just expand a little bit more on your comments if you could.

Well, first let me start about our view between insurance and reinsurance. On reinsurance, it seems you are making a forward bet, most of what we write is [coda share] and in essence, you've got to project terms and conditions and prices 12 months in advance. We have a more cautious view of the world and through our underwriting orders, we have seen price erosion. And in Europe and then, some in the US in some sectors.

You know, having said that, the absolute erosion is not worrisome today but, if you project it out going in that same trajectory, would be worrisome maybe a year or two from today and our attitude is, you know, to be more cautious on the reinsurance side and cut back when we see those kind of trends. On our insurance book, we have pretty much the same view in Europe as you'll see our London office writes no liability business at all. Meaning, general liability business. And, they don't participate in the large account arena.

Most of what we wrote in D&O and professional liability in Europe is mostly small-, medium-sized accounts. And the entire D&O book in Europe has no US exposure -- is non US exposed, non ADR exposed, is Spanish and Italian and German companies, indigenous to that part of the world. And we still like the rate environment we see in that sector.

So, it's more specific to what our book of business is than I don't think you can translate this into a market view in general. Because our book is a little more specific to what we do in Europe. I hope this gives you an idea or on a little bit of the flavor.

Now, turning to the US, our [excess] in umbrella book is mostly middle market and a lot of it is coming from the wholesale sector. And, we've seen as I said, about 5% -- at least in our book - 5% rate erosion which you can measure and factor in and that is not problematic. But, also, we're starting to see broadening of terms and that is more problematic for us. The same thing happened on our primary surplus lines operations and again, because most of it or all of it by definition is surplus lines, we've seen admitted markets that have the willingness to take some of the business back now. The rate erosion is not significant but, we lose those opportunities because if an admitted carrier wants to write the business than nonadmitted market will not get into the batter's box and we reacted to those market conditions.

John, just one quick follow-up. What's the capacity of Flatiron? How much can you cede to them?

Well, the amount we cede to them is basically tied to PML essentially because they have to collateralize based on probable maximum loss not based on actual losses. So, what you would have to do is look -- they have to have by July 1, they need to have 900 million of capital in that -- in the collateral account so, if you -- given the fact that a lot of what they are writing is fairly volatile, you are probably looking at a premium to surplus ratio there of something between .3 and .4 to one and you can do the math from there.

I think even I can do that. Thank you.

Matthew Heimermann. J.P. Morgan.

John, based on the comment you just made on having 900 million of capital by July 1, does that imply based on what you've seen in terms of activity that you would fully utilize the capacity Flatiron will provide?

Does that mean we will do that? You know, we don't know. It depends on what happens. We're coming into the Florida season now. But, based on what's going on in the marketplace, you know, its capacity is growing tighter and tighter as some people say by the day. And we will really get excited when it is by the hour. But, it would be surprising if we weren't able to use that capacity.

I agree. I think we're coming to a capacity crunch around June.

Okay. And then, can you -- the comments -- the commentary you had, Dinos, on the PML, and how some of those change was helpful. Could you also give us what the PML is on a gross basis?

We don't disclose the PML number on a gross basis. All I can tell you is that on the insurance group, a PML year-over-year on a gross basis has gone down by about 15%. Of course, on the reinsurance side, it's going up just by the fact that we have 45% sessions to Flatiron and every time we use that, you are almost doubling your PML. You know, everything else staying steady.

But, you've got three different forces moving here. Three parts that they are moving. And, one is a current view of PMLs, which is influenced by what happened in the last two years and also by the changes in the rating models. And, depending on structures because on the reinsurance structure sometimes you have terms that limit PML, you know currency caps, etc.

But if you eliminate all that and you allow new model PML to be monitored on an apples-to-apples basis, probably for the same exposures you'll get somewhere between 50 and 60% more running the same exposures out of the new revised models. And, we factor that in, in the way we view that business.

So, I would say that as you've seen, and I gave you the apples-to-apples comparison, we went from approximately a little less than 12% of capital to 15. On an apples-to-apples basis, for both operations together and that includes the additional retention we have on the insurance group. The insurance group a year ago was purchasing 200 million in excess of 50 on the cat. And we had a corridor -- a 5% corridor up, in essence, we had 60 million of net retention if you went all the way up to the top of your cap program.

This year, our cap program by choice you know, we increased to 325/75 and a gain, we will maintain a corridor. So that's why net retention utilizing their entire 400 million capacity is 100 million. Factoring that in and the exposure we're taking on a net basis on the reinsurance group, now we are at 15% of equity capital. On an apples-to-apples basis.

But, because of the models now, they are going to give you a much different PML. We also calculate that and try to see what that does to us and it brings us to 18%. So, I think that will give you a better flavor as to what the environment is and what our risk management tolerance is. Yes, we're taking a little more but it's not because we were underweight in this sector. Now, we're coming a little bit to not neutral but closer to our maximum, that we self-impose on us. Which is 25% of equity capital for a one in a 250 year events.

Okay and then the -- just as a follow-up, the insurance -- the reinsurance you buy for your insurance operation in a one in 250, does that blow through your limit or not?

No. We buy on the basis that you will -- the approach on the insurance group is that we set how much net we want to take on any one event. And then we will buy enough reinsurance to make sure that we're covering a bit excess of one in 250.

Okay that's fair. And then, just one quick follow-up. The growth in the health-care segment -- is that just a continuation of opportunities in kind of the low hazard medical professionals and facilities?

You're talking about the growth from like 16.5 million to 18? We wanted to make sure we were in the right sector there because it's rather modest in health-care.

(MULTIPLE SPEAKERS) we haven't grown very much. It's a little bit -- we went from, I think it's for the quarter, it was 16 to 18 million and but, you are correct. Most -- we had 16 for a year ago and we are at 18 1. So, it was about a 10% growth or about a 1.5 million. But, most of it is coming from the sector that is the small account. The facilities business as we call them which is lower hazard, surety centers and outpatient kind of facilities.

I just wanted to make sure you were not changing the focus. Okay.

We're not changing the focus. As a matter of fact, we are seeing stiffer competition on the hospital sector. You know -- the overall price erosion on the health-care business for the first quarter was 5%. And it's the first time in our rate monitoring that we have seen two consecutive quarters with a negative rate movement. Health-care was going up, all the way up to the past second quarter last year. With positive increases.

Vinay Misquith, Credit Suisse.

The accident with your loss ratio and ex-cats appears to have increased about eight points in the insurance segment in the first quarter versus the fourth quarter so I'm just wondering if there was anything happening there?

Let me take that, Vinay. Basically, it's in the property business and it comes from, essentially, it's due to two factors but it's related to the attritional loss ratio. So, whenever we start out a year on the property side we try and estimate how much is on the insurance side, in particular, how much is the cat -- we do it on both and how much is attritional. Over the course of the year, we continue to look at that. In the fourth quarter of last year - and we alluded to this in our earnings release last quarter - it was obvious to us that the attritional loss ratio we would be booking for the first nine months was higher than what experience would indicate. So, we actually adjusted it downward in the fourth quarter of last year, and had a very low loss ratio.

In the first quarter of this year, we're booking - again, based on the expected losses from a long-term perspective and that number could get adjusted downward as we go forward. But it will depend on actual experience.

Right. In fact, I see that it is down a point maybe from the first quarter of last year. So, you appear to be booking your business now for the insurance book at a slightly more profitable [accident] year than last year?

Yes and that's based on, as Dinos indicated, on our property book we had 39% rate increases across the book. Now, that obviously should influence the level of expected attritional loss on the book of business. But, as we usually do, we're taking a very cautious approach in how we reflect that.

That's wonderful. Do you have a number for IBNR as a percentage of total reserves?

Yes. I don't have it handy at the moment but I can get it in a second, if you will bear with me.

So that's fine. Yes, while you look for that, I think I will just have another the question then. If you could provide me with some more clarity on the strong premium growth in the US insurance, you had strong growth in contractor's liability. And you know [IBNR] business and we understand that in California at least, contractor's liability's pretty competitive and also the PML landscape is pretty competitive in the US and the liability landscape is competitive in Europe.

So, with that, I'm just curious as to what you are seeing and how you're managing to grow so much?

Okay, let me -- let me clarify quite a few things for you. Let me start with the construction business. The construction business in our book and -- comes in two sectors. It comes in the primary surplus lines which is in our casualty line, which was down 20%. And, we agree with you. We've seen more competition. It's not just California. It's in other parts of the country. People have discovered the sector and we have been cutting back on that. The area we're growing is surety and large construction that is done on a retrospectively rated basis and also, when we say surety and construction, because the management team, managing our national account is in the same sector, it includes also our national accounts business. Which is also you know what we call a three line retro.

Our advantage there is that we are -- our model is an unbundled model, meaning that we allow customers - because they pay for most of the losses themselves their retentions there in the 250 you know .5 million each and every loss - to choose along with us and agree on a third-party administrator that they are comfortable with. And, that's the model we've been using from day one; and you know, we've seen penetration both in our national accounts and large account construction business.

But, that's different than the guarantee cost we write which is in the casualty area and is done on a surplus lines basis. Now, if we -- let's turn on the D&O. The D&O we've done and we announced this maybe about a year ago -- I don't know exactly which call that we brought it in the book in areas that they have been traditionally very profitable the private and not-for-profit segment segments.

Also we're growing our book in Europe in the non-US exposed business. That's the non ADR, non US exposed business. And, the other changes you see here, one quarter makes a difference. We chose to take more net on the side A participation. So, even though the gross didn't go up as significantly, the net went up further because of our choice to -- we like the probability of that sector and we are retaining more. That's what happened in our D&O and professional liability book. You know, which basically that's where most of our growth came from.

Vinay, basically the percentage IBNR total reserves changed very little from the fourth quarter, which when it was 75%. So, it's still in the 74, 75% range. And side A covers - you'll recognize those - only apply, only basically come into play when for the most part either there's an insolvency or in certain cases you can get derivative losses. But, they are not directly exposed which is one of the reasons we like the area of the business.

Josh Shanker, Citigroup.

A couple of questions for you. You mentioned some [initiating] mental exercise about what would happen if 2005 were to repeat itself under current market conditions and the constructural changes you made in your business and suggested that your loss would be equal if not less than it was last year. I guess I realize it's a mental exercise but was that on a percentage of equity basis or is that on an absolute dollar basis?

No. What I said is the net income to our earnings -- that means because you -- our exporter is going up a bit. But our premiums are going up. So, the combination of netting out as to how much more premium you're getting for the exposure, you won't have a different PML impact that we had a year ago.

Clearly Josh, the ratio of if you think of premium for risk is much stronger in the property book which gives us a lot of confidence when we make that statement.

And in terms of thinking about Hurricane Katrina, a $45 billion storm potentially, in terms of talking about a one in 100 year event, a 1 one in 250 year event, is there some sort of scaling in terms of what you guys think of Katrina is in terms of a one in how many year event?

We thought of Katrina less than one in 100. We were in the one in maybe 40 or 60. You've got to look at the historical patterns and how often -- Katrina is such an unusual event because of the breaking of the levees but, that kind of a storm with that kind of force, it can happen more frequent than in one in 100. It might not have the same effect because you kind of had a very unusual path that it went. And we had the problem with the levees that made it so unusual.

Josh, the way we sort of think about that is that the actual event itself is maybe a one in a 15 in or a one in 20 or 25. Because you know, a force three hurricane hitting the Gulf Coast is not that infrequent. If you measure it by the size of the loss, then it gets to be more like a one in 150 to a 1 in 200 year event.

Okay, very good. And the final question is that you guys are increasing your exposure obviously in property and property cat. And a lot of the very well entrenched players claim that one of their advantages is that the cedents know that they're going to be there for the next year even if they take a big loss. You guys are much more opportunistic than some of your peers.

How easy or difficult do you think it is to move in and out of the sector? And if you move out after the pricing cools off perhaps next year, does that mean that you're going to have a hard time being opportunistic in the future?

No. Listen. The cat business is supply and demand. Why's the price of oil at $70 and not at $30? You know, you can grow the exact same conclusions on the supply and demand. It's not very difficult to enter the business. And it is not very difficult to exit the business. It is a business that has no tail to it. It's reasonable that all claims get negotiated within a year or two so this is not liability business that's going to be forever.

It requires a significant amount of capital but, if you find the capital, it doesn't require a significant number of people to engage the capital. You saw that with the startups so, I don't view that from a marketing point of view to be a problem. Usually, what happens is, when the clients need you the most is when the prices are the best. And we give them that capacity and when they can find capacity a little cheaper, it's not us walking away from them. It's them walking away from us because they found a cheaper alternative and we don't get mad about that. You know, but we maintain our capacity for the next time that they need it.

If pricing, Josh, stays strong, even in the event of the face of -- in the face of a loss, presumably pricing adjusts again and as long as we like the pricing, we probably will make a market in the product. We don't like the pricing, then we're not going to write the business. We already did that in 2004 and 2005. So, we've been through sort of a little bit of a mini-cycle in the cat area.

Adam Klauber, CCW.

Going into June when the season seems like there's a lot of opportunity out there. Can you give us I guess some clue as to which way you are leaning -- do you see better opportunities on the primary commercial side, better opportunities on the reinsurance side and if it's on the reinsurance side, it seems like there is almost no capacity in some of the lower layers. Does that interest you at all?

We have a view and this is our own view - I'm not trying to profess it is right or wrong but it is our view. And our view is that the opportunities are much better on the reinsurance side than on the insurance. The reason being is on the reinsurance side, through contractual terms, you have a better understanding of what your aggregate accumulations are going to be. You impose current caps, you have specific limits etc.

So, having said that, also that's where we put more emphasis in trying to participate in the sector. We're going to try to do it through our reinsurance operations, okay? On the insurance side, if you are in the E&S world. Which you have more of the ability to have freedom of rate and form, you probably can make the adjustment you know very -- more quickly than when you are playing on the admitted side of the business that you require prior approval of rates by the state insurance department.

So, you know, I think this market is going to continue to improve because the economics right now in some cases, that the (indiscernible) for the primary side because the cost of cat protection is kind of arbitraged against that. And since they have the exposure and they need to protect the book, they have to buy the coverage. Or they have to change their risk profile and take significantly more risk on their balance sheet. And, that's why we believe the advantage now is to be on the reinsurance side.

I didn't like the terms and conditions I was getting as a buyer on the insurance group and that's why you saw I increased my retention and I have done other things. But, I still had to buy and I had to buy more than a year ago because the PMLs with the new models are going up. We think there's a change in the frequency patterns a bit and there's a change in -- because of demand surge and other that need to -- you know -- to adjust. It's frequency, severity, and demand surge changes.

Having said that, I would rather be a seller as a reinsurer than a buyer on the insurance side. And, that's our view.

Thank you. And one other question. John, as we had expect the paid losses excluding the hurricane pays are moving up. Is that just normal function of the book maturing? And should that trend continue to move up throughout 2006 and into '07?

The answer to -- yes, yes, it is moving up as a function of the book maturing. And over the last 1.5 year or so, our growth rates on the longer tail business have moderated fairly substantially. So, it's basically in line with our expectations and overall, the paid loss ratios generally still tend to be looking better than what we were anticipating.

Now, what happens prospectively will depend on what goes on with the book. If we continue, currently, we are reducing in casualty but we are still able to produce some growth in professional liability though the longer tail lines are stable to down a little bit. But, it wouldn't be surprising as we mature as a company that ratio will move up. But, it's still -- the pay to incur when you look at it that way is still a very healthy ratio.

Yes, it is very good. Thank you very much.

Stephen Peterson. Citadel.

Three quick questions. Just to follow up real quickly on Vinay's question. The construction book that you described -- the large account retrospectively rated book. Is that mostly claims made?

No. It's GL, [corridor] and workers compensation for midsize and large contractors. And you know, it's a [currents] book and usually has either significant deductibles or self-insured retentions in the range of anywhere as low as 100,000 per claim to as high as .5 million or more per claim.

And the data favorable development that you described -- that came in that large account business or that came in (multiple speakers)

No. The bid favorable development came from our surplus lines book of business which is -- where we're starting to see more competition and that's why are we're starting to cut back.

Okay, the bit of adverse development, specifically for Wilma. Curious about your industry view there in terms of what the industry might be looking at and what may have occurred other than the typical seasoning that you would've gotten in the last three months that may have increased that number by, I believe it was 18 or so.

Well, we have seen demand surge beyond our expectations. You can't get anybody to fix anything in Florida at a reasonable cost and it's starting to work itself into the numbers. Because, our book is an ENS book and is usually layered. We change our view on certain accounts if a particular layer would get hit or not.

So, we made adjustments to it. And as John said, now with those adjustments we have moved the net loss to the attachment point of our cat cover. So on the insurance group, we don't expect any further net development. And depending on what happens you got 200 million protection above the 50 and we are right around that level on Wilma.

Our reinsurance group -- it was more their changing of the view that the laws might be more in the 12 to 15 billion category instead of our original view that it might have been 8 to 12. So, that change, running it through our models and what we have in the contracts we have, gave us a different outcome in that and we chose the book at all in the first quarter.

Clearly, Stephen, Wilma from a four standpoint wasn't that big a storm, in terms of the strength of the storm. And clearly, the losses are coming in at a higher level than was originally anticipated. So, it definitely looks like it's a bigger storm than people were thinking three or four months ago.

And John, just a quick numbers question. In terms of, as we see your stock price appreciate, what should we think about in terms of the effect to the denominator on a dilutive basis? What's kind of a current (multiple speakers)?

What's going on with equity, you mean?

No. In terms of the share count and in terms of like trying to think about the diluted share count as we go forward. Is there a quick number, like, per dollar of increase in your stock price?

You know, I don't have that. It's not huge. You got to realize that when you are going -- especially quarter-over-quarter -- from March of last year until March of this year, the stocks appreciated pretty dramatically. So, as you go from the first quarter of this year into the second quarter, you know, the kind of movements you get quarter-to-quarter don't move it that drastically.

No. Sometimes I like to think about what might happen next year. But, I will follow up with you -- I will follow up with you later. Thanks.

Yes, we will try to model it for you and then we (multiple speakers)

We can guess. It's not that hard to guesstimate. The data is all public. So, we can get that for you.

Ian Guterman, with Addis Capital.

I actually have the opposite of Vinay's earlier question. On the reinsurance segment, when I look at the accident year, ex cats, it dropped like eight or nine points from where it was running last year. I'm just wondering -- I know there is obviously a mixed shift [first] property but I wouldn't think it would cause that dramatic a shift.

Do you mean on the accident here (multiple speakers)

Are you sure? Because on our analysis, the reinsurance didn't move very much year-over-year.

Your reported combined ratio was 85, right? And you had about four points of cats and basically no development. That's like an 81?

On the reinsurance?

Yes.

Well, but you've got to factor in the mix because you have more property than liability. Property lines on an accident year basis, they get booked at a lower ratio than the liability lines.

Well, sequentially it's a couple of points better than it was last quarter.

I'm really looking '06 versus the total year '05.

Versus the total year '05. I was focusing on sequential.

Right, but sequentially, you had the attritional stuff last quarter, right?

Well, we clearly definitely have a more property as a percentage of the total book on the reinsurance side.

But, how much of that would have been earned in the first quarter? I would've thought very little.

Well, remember, we also wrote -- remember, we wrote a fair amount of business in the fourth quarter (multiple speakers)

Fourth quarter -- it was over -- (multiple speakers)

We did $100 million of business in the fourth quarter alone, which you only got a piece of the earned premium. This quarter, you got a full impact of that.

Good point. Okay. I guess what I was really getting at is, the X in your X-cat -- where you booked for Q1, it's fairly sustainable. There was nothing unusual as far as attritional losses or anything else?

No. There was nothing -- in fact as I said, if you look at the way we approached things in the fourth quarter, on a reported basis the attritional loss ratio would've been way better than it was in the first quarter on a reported basis.

Right. Is it also fair to assume as the year progresses, given the mix shift and just more -- and just improved pricing that accident year X cats will probably improve as you go forward sequentially?

Certainly the property component where we're getting dramatic rate increases. And you know, in the first quarter, it was about 70/30 casualty and professional liability and other lines being about 70%, property being about 30. That -- a year ago that was about 78/22. So, as that earned premium builds, you normally would expect -- and a lot of it is coming in the more cat exposed property, expected losses are at or better, you would expect a lower loss ratio on that component as it's a bigger component. It probably had some impact on the overall loss ratio.

And that didn't happen a year ago and two years ago. Because cats can change -- can rain on that parade. You know that.

And just one other quick question. Why did you take the duration down now since I would've thought this would have been a time when you maybe started to think about extending a little bit.

We've been putting a lot of our cash flow into cash, because the yield curve was pretty flat and it didn't pay for us to extend. But, we will look at it.

And in our view - we have a CIO, we have a finance committee - but our view still was that the Fed has room to go. Obviously, you could still -- the curve is so flat, Ian, that if you want to adjust on a moment's notice, you can pretty much adjust if you think that there's sort of more upside -- it's more likely that rates are going down or rates are going up. At the moment, our view is still that there is more risk of rates going up than they are coming down.

And there wasn't a penalty as far as keeping the money [short]. We were maybe 20 bps less than if you committed to five or ten years.

Well, for most of the quarter it was flat. Now it is maybe it's the first time in a while I guess to the 10s you've got about 30 bps or so. But, you know, that's something we got a full-time person who is on top of that. And, if our view changes, we are an a position to lock up the longer-term deals, if that's what makes sense.

I mean, it makes a lot of sense. I was just really thinking about how much of either a change in the shape of the yield curve is just an absolute rise in the tenure before you start thinking about lengthening that for the (MULTIPLE SPEAKERS).

Well, you can't -- it's not -- you are focusing on the return part of it. We've got to look at the risk part of it too. So, if part of it is a view, where do you think -- not that we think we can predict carefully interest rates. You know, no one does that well. But, we certainly have a view as to where the risks line up on one side or the other and right now, our view still hasn't changed.

We still think that there's a greater chance you get higher rates than shorter. And remember, it doesn't -- since it's still relatively flat, you can make your adjustment pretty quick.

And I guess, just the other part I was wondering on that is what would you say your average duration for your liabilities is today and especially as it's moving more for its property?

The average duration of the liability is with the -- it's still between three and four. It's trending a little towards the lower end of that range than it was at the higher and.

That makes sense, too.

Operator, we will take one more question.

(Operator Instructions). There are currently no questions in the queue. I would now like to turn the presentation back over to Mr. Iordanou. Please proceed.

Well, thank you, operator, and thank you, everybody. We will see you next quarter. Have a good day.

Thank you for your attendance in today's conference. This concludes the presentation. You may now disconnect. Good day.