Arch Capital Group Ltd (ACGLO) 2006 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the second-quarter 2006 Arch Capital Group earnings conference call. My name is Shanik, and I will be your coordinator for today. (Operator Instructions). As a reminder, this conference is being recorded for replay purposes.

Before the Company gets started with its update, management wants to first remind everyone that certain statements in today's press release and discussed on this call may constitute forward-looking statements under the federal securities laws. These statements are based upon management's current assessments and assumptions and are subject to a number of risk 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 the financial performance. The reconciliation to GAAP and definition of operating income can be found in the Company's current report on Form 8-K, furnished to the SEC yesterday, which contains the Company's earnings press release and is available on the Company's website.

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

Good morning everyone, and welcome to our second-quarter call. For the quarter, we saw stable market conditions, which I characterize as very favorable in the cat-exposed short tail lines, stable in professional liability lines and under some pressure in casualty lines. Our diversified operations provided us with good growth opportunities in the first half of this year. And we're very pleased with the performance of both of our operating units. In particular, we're very pleased with their ability to shift emphasis to the lines of business that afford us the greatest opportunity for profitable growth.

Operating earnings for the second quarter increased by 51% compared to a year ago. Our annualized return on equity was 26%, and our book value per share increased to $36.39. This is very, very good performance by any measure. Cash flow from operations continues to be strong at 400 million for the quarter and 823 million for the six months and has been driven by solid premium growth and excellent underwriting results. Gross written premium grew 21% and net written grew by 10% over the same period last year.

John, later on in this call, will provide you with more color on our financials. Now, let me give you a bit more flavor on what we saw in the market and how our two operating units, our insurance group and our reinsurance group, responded. Our reinsurance group had an outstanding quarter as reflected by their combined ratio of 80.8%, which was helped in part by low cat activity. Their gross written premium was up by 32%, while net written was up by 10% compared with last year's second quarter. In terms of market conditions, we continue to see erosion of primary pricing in the range of 5 to 7.5% for large professional liability accounts. In the casualty lines and other professional liability sectors, rate reductions were in the 5% range, where reinsurance terms and conditions were stable.

On the property, property cat and marine side, we saw further positive movement to the significant market improvements on price and terms that we experienced in the first quarter. This is a continuation of an improving marketplace for those lines. In line with our strategy of moving capital and resources to the areas affording us the best opportunities for high returns, the mix of business of our reinsurance group has changed to 42% of our property cat and marine, up from 33% as of a year ago. Of course, this change in mix of business has been achieved without changing the risk tolerance we set for ourselves based on our risk management principles.

Now, let me turn to our insurance group. Our insurance group also had a strong second quarter as they continued to produce strong underwriting results and good returns. Gross written premium for the group grew by 12%, while net rose by 9.5%. The largest contribution to this growth came from our construction, surety and national accounts units with 26% growth on a gross basis and 38% on a net basis. This growth was primarily driven by further penetration in the surety market and the continued expansion of our large accounts retrospectively rated and large deductible business. Although rates were flat for surety in the quarter, this market remains very attractive. Rates for the construction sector were flat with the exception of California workers' comp, where we experienced rate reductions in the 15 to 25% range. Overall for the entire division, the rate reduction was a blended 3%.

Property, marine and aviation business grew by 48% on a gross basis and 10% on a net basis. Most of our growth came from our E&S unit, which represents roughly half of the insurance group's property business as rates were up by 100% for the quarter.

In our global accounts business, rate increases achieved average 88%. While for offshore energy, we achieved 104% increases. For Gulf of Mexico accounts, rate increases exceeded 200%. And for onshore energy rates, we achieved an average rate increase of 27%. This is a very good market in this sector. Our expansion in Europe and Canada continues at a good pace, aided by favorable market conditions in short tail lines. Our book of business in Europe and in Canada on a gross basis continues to be approximately 60% in the property, energy and marine sectors.

Our professional liability units expanded by 12% on a net basis with most of the growth coming from our European operations. As you may know, our professional liability business primarily provides low limits to small and medium-sized professional firms. In general, rates were flat to up slightly, depending upon class. On average, this division achieved rate increases of 3%.

Our casualty operations saw a reduction in net written premium of 8%. In the excess and umbrella segment, our underwriters were responding to a softening in terms and conditions. In this line of business, we believe terms and conditions are critical and just as important as rate in determining profitability. In addition, in the primary surplus lines casualty sector, we saw more competition from standard markets who are recapturing some of this business. On average, rates were down by 1% in excess and umbrella and 4% in our primary casualty business during the quarter.

We also achieved good growth in our executive assurance business, which increased by 21% on a net basis. Two-thirds of this growth came from our facilities outside the US and one-third from our US operations. Rates for this segment were flat for the quarter.

On a net basis, our healthcare unit grew 12%. For this quarter, we saw sporadic competition in this line of business, predominantly from new entrants, which led to a rate pressure in some segments. The traditional competitors in this sector continue to act responsibly in our view. Overall, rates declined 10% on average in this sector for the quarter.

In general, we continue to see competition increasing in some segments of the casualty and professional liability business, but we are still very positive on general market conditions. This quarter demonstrated once again that the flexibility of our specialty platforms, which we carefully build over the past four years, afford us the opportunity to adjust our book of business on a timely basis in response to changes in market opportunities.

Before I turn it over to John for a more detailed discussion of our financials, let me update you on our cat exposures. First, before I discuss our cat exposures, I would like to remind everyone that in determining our 1 in a 250-year PML, we include all exposures that we believe can accumulate as a result of any given event, not just the property lines. Second, I'm pleased to report that we have implemented RMS 6.0 in all of our operations.

Now with respect to our exposure, on an apples-to-apples basis assuming no change in model results, meaning that the '05 model used again in '06, our exposure to a single 1 in 250-year event based on our projected portfolio in force at August 1, 2006 and using the same version of RMS of a year ago would have been 14% of our common equity capital. Now, using RMS 6.0, our exposure to the same events for the first book of business as of August 1, 2006 is 22% of common equity capital. Again, 22% remains well within our self-imposed limitation of 25%.

With that, let me turn it over to John to run you through our financial performance. John?

Good morning everyone. This was another outstanding quarter from a financial perspective as we reported, as Dinos indicated -- an annualized ROE of over 26% driven by both strong growth and investment income and excellent underwriting results. I'm going to walk you briefly through the key components of our financial results starting with the top line.

Net premiums written rose approximately 10% with both segments contributing just about evenly to the increase. It should be noted that the reinsurance segment's net premiums written includes approximately 22 million of additional premiums from adjustments to premium estimates on contracts written in 2003 and 2004. Most of these adjustments were in the casualty line of business. On an adjusted basis, therefore, the increase in consolidated net premiums written was driven primarily by strong growth in the property and marine lines.

On a consolidated basis, the ratio of net to gross written premiums decreased to 70% in 2006 from 77% in the 2005 quarter, primarily due to the business ceded to Flatiron Re, a dedicated reinsurance vehicle. We ceded $78 million to Flatiron Re in the 2006 second quarter and $160 million for the first six months of this year. Earned premiums ceded under this treaty was $25 million for the second quarter of 2006 and 44 million on a year-to-date basis. The override and estimated profit commission recorded during the quarter are reflected as a reduction of the acquisition expenses of the reinsurance segment and improved the expense ratio of the reinsurance segment by approximately 90 basis points in the quarter. The impact on the consolidated expense ratio was 50 basis points.

The combined ratio in the quarter, as Dinos indicated, was 86.3%, an improvement of 3 points over the comparable 2005 period with two-thirds of the improvement coming from the loss ratio. Better accident year results in property and marine business, primarily in the reinsurance segment driven by higher rates and light catastrophic activity, was primarily responsible for the improvement in the loss ratio. These results were achieved despite two significant individual risks losses, which impacted the insurance group's incurred losses by $18 million.

Underwriting results in the 2006 quarter also benefited from an increase in favorable reserve development net of related adjustments, which totaled 18 million in the 2006 period, an increase of 13 million over the comparable 2005 amount. The 2006 net favorable development was primarily attributable to medium and long tail lines of business, which more than offset adverse development in short tail lines, including development on the 2004 and 2005 catastrophic events of $10 million. The favorable development in medium and long tail lines resulted mainly from claims made policies written in 2002 and 2003 as the reported paid claim activity for these periods continues to be better than anticipated.

Pretax net investment income in the 2006 quarter was 90.5 million or $1.19 per share before deducting interest expense and preferred dividends and $1.05 per share after deducting these items. Net investment income for the 2006 quarter was approximately 70% higher than the comparable 2005 amount and 13% higher on a sequential basis. The substantial increase in investment income on both the quarter-over-quarter and sequential basis was due to both the continuing significant growth in investable assets and higher yields. The growth in investable assets was primarily generated by strong cash flow from operations, which increased 12% over the comparable 2005 level. As a result, investable assets increased to approximately $8.2 billion at June 30, 2006, of which more than 1.3 billion or roughly 15% of the portfolio was invested in cash and short-term investments. At quarter end, the ratio of investable assets to common shareholders' equity was 3 to 1.

The average recorded pretax yield of the fixed-income portfolio in the quarter was 4.5%. This represented an increase of 110 basis points over the comparable 2005 level. While on a sequential basis, the yield was up by 20 basis points.

The embedded book yield of the portfolio before expenses also rose by 20 basis points on a sequential basis and stood at 4.8% at quarter end. The increase in investment yield on a quarter-over-quarter basis primarily resulted from higher interest rate levels as the portfolio's average credit quality remained very high at AA+. We have generally continued to avoid most forms of spread risks based on our current view of the risk reward relationship of these investments. As a result, we are well positioned to take advantage of opportunities when spreads return to attractive levels. In addition, the increase in yield was achieved despite a reduction in interest rate risk as we lowered the duration slightly during the quarter -- of the portfolio slightly during the quarter to 2.9 years from 3.0 years at March 31.

In summary, book value per share increased by 5% during the quarter to $36.39. Total capital employed in the business increased to over 3.3 billion with debt representing 9% of total capital and the combination of debt and hybrids representing 19% of total capital. With that, we'll open it up for questions.

Operator, we are ready for questions.

(Operator Instructions). Joshua Shanker, Citigroup.

Congratulations on a great quarter. The first question I have -- just a numbers question -- how are we doing on IBNR as a percentage of the overall portfolio? And is it possible to strip that out with the 2005 storm losses with and without?

I can give you -- clearly, reserves at June 30 were 4.537 billion, up from 4.3, so a healthy increase in the overall reserve levels. IBNR was basically the same percentage that it was at the end of March 31. It's still right around 75% of the total reserve picture, so there was no movement in that. In terms of the IBNR from the storms, that is not a significant amount of the more than $3.3 billion of IBNR. Most of the IBNR relates to casualty; although, we are carrying of course IBNR for the storms.

Now in terms of more of a process question, you talked about standard carriers coming into the E&S market. What's the process by which you see admitted bids coming in for E&S-type opportunities? And you have I know the admitted licenses. Do you compete for those opportunities on an admitted basis?

Yes, we do. But you have to understand the process. First, let me give you the clear picture. This is not -- they are not coming back. This is a business that they threw out during '02, '03, '04. And now in '05/'06, they are starting to recapture. Part of the reason is maybe they didn't have the proper file rates to accept that business. As they have adjusted their file rates into the various states, now they like that business with the proper rates.

Having said that, if a piece of business goes to an admitted carrier of course doesn't have the opportunity to go to an E&S market. As we participate in the market, we do see more and more opportunities to write business on an admitted basis because we do have the license. But that mostly is new business to us. Because if you do have a renewal and it's written on an E&S basis, you have an obligation to support the E&S broker that you have that business with. So if that opportunity is not there, you'd probably lose the renewal.

Would you want to be competing for these lines with your admitted licenses that you have?

We use E&S and admitted licenses tactically. Basically, the underwriting units, they are looking at price, terms and conditions and which of the two licenses will give them the greatest opportunity to write the business. If we have file rates that allow us to get the proper price and that piece of business is going to be placed into the admitted market, we will compete for it through our admitted market paper. If it's in the E&S market, we will compete through that channel. So the dual channel actually is helping us to see a complete view of the marketplace.

Is there any lines in particular worth mentioning that you are seeing this more than others?

You're starting to see some of the contracting business going back admitted. You are trying to see some of the habitational business to -- you know this is hotels, motels, apartment, houses that they are going back into admitted markets. So I don't see it on an underwriting desk day to day. But these two sectors, we've seen quite a bit of it going back into the admitted markets.

Matthew Heimermann, JPMorgan.

A couple of quick questions. One, in the 8-K you filed in June, you talked about the collateral in Flatiron moving down to 800 from 900 million. I just wondered with the changes in RMS 6, how many multiples are we looking at -- the 1 in 250 PML being?

It still provides -- the reason that we moved it down was -- remember we established -- you've got to go back to basically the fourth quarter of last year when we were sort of trying to anticipate market conditions. Market conditions have been better than what we would have expected -- what we were expecting at that time in 2006. And we actually were able to build a better portfolio -- more diversified. That actually gave them more capacity. So from that standpoint, that was a positive. In terms of coverage, we still have -- it's still more than adequate to cover more than two 1 in 250 events.

That criteria in our agreement has not changed. Usually, we drive the size of the funding (multiple speakers) --

The collateral is all driven off of PMLs.

Off of PMLs.

It's a formula. It's intended to take into account single event PMLs and multiple event PMLs. So we are still -- from the -- because the portfolio has better diversification, we are still in a position where we still have the same coverage we had before.

Then I appreciated the comment you made on the apples-for-apples change in PML under 6.0. Where do you hit the brakes on -- can you just remind us where you hit the brakes on an apples PML basis?

We hit the brakes at 25% of common equity. So that's where we hit the brakes. On the 6.0, we're getting close to that. But the season is pretty much over. The maximum exposure you're going to get on this business is usually around August 1. There might be a couple of deals that might come our way, but pretty much that season is over.

Yes. Because the reason we used August 1 is that has all of the 7/1 business in it.

Your reinsurance business, you tend to support a lot of companies that tend to be niche players -- you know regional need your capacity to kind of support their business plan. Given that you participate on a primary and reinsurance market, how are you feeling about the relative opportunities outside of property to write it yourself versus to support some of your competitors -- not competitors -- some of those other niche players?

I think the opportunities if I had to -- excluding the short tail lines, which they are extremely attractive on the reinsurance side -- I think the rest of the market would prefer it. Probably the advantage now is with the insurance side. But both are coming under some pressure, especially on some of the large accounts' casualty lines, large accounts' professional liability lines. And we took significant action on the reinsurance side, where we participate on treaties that have that kind of portfolio. Of course on the insurance group, it's a little easier game -- not that it's easy -- it's a little easier because you see account by account, so you've got to make your underwriting decision on -- you have the opportunity to make your underwriting decisions on a daily basis. So you can shift your strategy based on what the market is showing you.

So, going forward, it is hard to predict because if I knew what the market conditions would be six months from today, I would be a lot wealthier than I am. But you know we will react in that fashion. But my guess will be that we will get more opportunities on the insurance side than on the reinsurance side. The flipside is true on the short tail lines. We like the advantage of the reinsurance game in selling property and property cat in that area, and we don't like it as much on the insurance side.

Just -- actually, I will just get back in queue. I don't want to monopolize this. I will follow up.

[Stefan Peterson], Sentinel Investment Group.

I was wondering -- it seems that you guys are way ahead of the curve based on other conversations we've had with folks in terms of getting RMS 6 implemented. Are you marginally at risk at least in the short term for being at a competitive disadvantage? I mean because it seems that you guys are sort of on top of this versus some of your competitors, who may be prone to making maybe naive pricing decisions based on working with the old model.

Listen, I always have this belief of -- as a matter-of-fact, one of our founders, [Paul Ingrey] believes that knowledge is king. We are in a knowledge business. So I'd rather know where I am and make underwriting decisions than naively fool myself that I have some sort of an advantage that doesn't exist. So we always try and strive in everything we do to be collaborative in our decision-making and do it with as much information as possible. When 6.0 came, both our insurance and reinsurance guys and us up in the holding company were forcing them to implement as quickly as possible. Because I don't want to be entering rooms without the lights on. Entering a dark room is not a good thing in the underwriting business. So from my perspective, it might -- has caused us some loss of some business but for the right reasons. Sometimes, not writing a bad piece of business is as good as writing a good piece of business.

But the thing you've got to remember is we certainly did it and other people did it also. People were estimating what 6.0 was going to do. It wasn't precise. But when you get into a hard market like this, the model number isn't necessarily the final number. It's a starting point. And when there's capacity shortage, the margin is above the model number I think anyway. So pricing out in the marketplace, we don't think -- was not heard because 6.0 wasn't implemented in time to write a lot of business.

Good quarter.

Ron Bobman, Capital Returns.

Congrats on another fabulous quarter. I had a couple of questions. Dinos, the PML figures that you gave us on the RMS 5 and RMS 6.0 and the amount of equity exposed, I'm trying to understand -- to what extent does that analysis include the prospect for one severe storm sort of bouncing against the US more than one time and making landfall in two locations, going through Florida and hitting the Gulf or hitting Florida and hitting the Atlantic?

The numbers we gave you -- the model number is on different tracks. And in essence, as we said in many calls before, our highest area of PML is Tri-County area. And in essence, there is a significant amount of PML calculated in that, emanating from the Caribbean. Because the different paths of different storms that we model have the potential to hit the Caribbean first and then go through the lower end of Florida, which will have the higher PML.

So some paths, we might run up north Florida, let's say the Tampa and St. Petersburg area coming east to west and then hitting up the Mississippi coasts. So we do different paths and we measure that. So the short answer is we take that into consideration when we model these numbers.

This is the highest number we get running all the paths. When they run them on the probability of not exceeding a 1 in 250 basis, this is the highest number we get.

There was an announcement I don't know in the last week about a newly-formed private entity. I had a couple of questions. I think some alumnus from Arch are involved in that. I'm curious to know because I've been surprised -- I think it's split depending upon the company -- what sort of non competes do you have. I know you are I think planning on participating in the investment of it. But what sort of non competes do you have with your underwriters at the line level in the event they ever leave? And then also, could you help us out; how do you pronounce the name of the new entity?

It's a Greek name and I'm Greek, so --

Wait, wait. There is some controversy over this. But I'm going to let Dinos, who is definitely our expert on the Greek language --

The god of wind is called Aeolos. Of course, you're going to have an American pronunciation to it. You know my many years as a Greek allows me to say it with a Greek accent. But having said, first, your first question -- the non competes. We have non competes for our senior people. It doesn't go all the way down to the underwriting desk. Depending on the level, the very, very senior is 18 months and the next level is 1 year. Having said that, the individuals that participate in this venture had no non competes with us as they had left the Company long before they decided to do that.

(multiple speakers) What's the logic behind not having a line underwriter, who I assume get stock options awarded to him annually -- for example -- and obviously a comp package? What is the logic for not having some non compete?

Very hard to enforce non competes. At a senior level, they are always easier to enforce than on a lower level. Their views especially most of our personnel is in the US that people should have the ability to earn a living. So leaving us and going elsewhere and underwriting a different set of accounts, it's very, very hard to even enforce it. So we don't bother with something that is very difficult to enforce. While at the senior level, we have a lot more success and that's where we use it.

Thanks again. Continued best of luck.

Vinay Misquith, Credit Suisse.

High quarter. Each quarter, I wonder whether it can get better but it does. I've not seen a casualty company generate 26% ROE. So good job, guys.

On the property risk -- thanks for your disclosure for the 1 in 250 event. I think you said that it would be 14% of equity using the old model. Last quarter, I believe you said it would be 15% of equity capital. So am I reading this right that you've now reduced your exposure to cat or you reduced your risk appetite because it may be RMS 6 versus the last quarter?

Yes, the answer is yes. On an apples-to-apples basis, we have reduced our exposure very slightly. Having said that, it doesn't mean we have less premium. Don't forget, we had a lot of opportunities to diversify and really optimize what we do in a lot of different zones. Your PML is driven by the zone that you have the most exposure. And for us, as we disclosed before, the three areas that we have the highest exposure is Tri-County and then is the Tampa/St. Petersburg area and then of course the West Coast for the earthquake exposure.

So having said that, your conclusion is correct. We slightly at 8/1 have a little bit less apples-to-apples exposure that we had in April 1. We didn't do it because we're trying to reduce the exposure. We're doing it because we're trying to manage our entire portfolio and optimize it. We had opportunities to write more business in areas that we didn't have exposure before but that didn't raise our largest PML area.

So would it be fair to assume that you've increased your spread of business because of better pricing in say the Northeast and the other areas, which are not your peak zones (multiple speakers)?

Yes.

Yes, it's good news and bad news with that. Good news, you get a lot more premium. Bad news, you can't miss a storm now because you have exposure all over the place, right?

On the reinsurance margins, I mean each quarter, it just keeps on improving. I'm just wondering with 65% of your business in casualty lines, I'm curious how your accident margins are improving even now even though I believe pricing is starting to taper off. And I just want to add something on. In the fourth quarter, I believe you wrote $100 million worth of premiums. I'm just curious whether that had an impact on this quarter and whether it will have an impact on the quarters moving forward.

The answers -- we'll take them in reverse. The answer to that is yes. We wrote a lot of property business on an opportunistic basis in the fourth quarter of last year, which as you remember we pointed out would be earned over a 12-month period. So we're not quite finished, but we've earned a fair amount of it.

Secondly, as Dinos pointed out, the book on the reinsurance side has been shifting. And so on a year-over-year basis, we have now 42% of the business in property. So the results on the quarter on the reinsurance side are reflective mostly of the good results in the property business. There's not a dramatic change on the recorded results on the casualty business.

That 42% is in the reinsurance book you're talking about?

That is correct.

Yes, the mix in the reinsurance book is -- it moved from being 33% property to being 42% property year-over-year for the first six months, which is a significant shift.

For the year, I'm sure it's going to be slightly lower than that because property renews mostly.

It could but not that dramatically. It will -- obviously, you're right. You tend to write because the 1/1 and 7/1 is renewals. But remember, we don't have the third quarter in that yet. So you only have the first quarter. You don't have the third quarter, which is a heavy property renewal quarter.

You haven't earned much of the new premiums into your second-quarter earnings, correct?

What we wrote in the first quarter, you would have a full quarter's contribution. What we wrote in the second quarter, you would have basically half of a quarter's just approximated.

Everything we wrote in the fourth quarter last year is earning (multiple speakers) --

Roughly one-fourth of it is probably earned in the second quarter this year.

Back to that Florida business that you wrote, when does it expire? Is it at the end of the second quarter or will we see some benefit of that in the (multiple speakers)?

It varies. Some of that business is written 6/1 and will expire May 31st of next year. Generally speaking, most of them are one-year contracts. And then there's a lot of Florida business that is written as of 7/1. Of course, that's not in the numbers yet.

(multiple speakers) You were referring to the 100 million of opportunistic business?

Yes.

As you recall, we did -- Quanta announced the deal. So we did that. Most of that is pretty much over by now.

Yes because we picked up an unearned premium portfolio. So by June 30, most of that premium will have been earned.

Then there were a couple of other contracts that most of it is pretty much over.

Sorry, one last question if I may. Did your decision to increase your property business on Jan. 1 have an impact or more of an opportunity cost that you're seeing strong operating in June and July?

Even when we increase our writings, we also reserve quite a bit of capacity throughout the year as we said in the firs-quarter call. First, we had an obligation to people that we were participating on their treaties to reserve capacity for them and we did that. And also, we're looking for opportunities.

Having said that, also when we price the business on January 1, we -- even though 6.0 wasn't out, we were using the old model and we modified it, based on the indications we were getting first from our own experiences of what we saw with the storms in Florida but also what RMS was giving their customers. And that modification, taking 5.0-modified version to compare to 6.0, we weren't that far off. We were about 10% off as we compare it today. 6.0, it is higher by about 10% to a modified calculations we're doing using the old model and putting adjustments to it. That's pretty close from our perspective, looking at all the kind of changes that 6.0 brought.

So, yes, maybe we lost a little bit. But at the end of the day, the margins they were pretty thick for us and we liked the business we wrote.

Adam Klauber, Cochran Caronia.

Could you give us some idea of when profit commissions from Flatiron may flow through your earnings stream if it's a good weather season and what the magnitude of those profit commissions could look like?

There's no way for me to know the magnitude of the profit commissions because I don't know the magnitude of the losses. But they get recognized as we earn the premium, right? So we've only had a relatively small amount of earned premium. All things being equal, that number should build as you go through the year, assuming the experience stays the same. Also, what we're doing is obviously at this stage, we're booking on the experience to date plus the expectation of whatever that it's going to hold up at that level. So, we can't -- we don't give guidance. So we can't give you a specific reference there. But it will come in as the premium is earned.

Right. Will you break that out going forward so we can get an idea (multiple speakers)?

Yes, as we did this quarter, we told you what impact it had on the acquisition expense ratio. We've told you what the earned premium is, so you can get a sense of what the total means. We're not breaking out the difference between the override and the profit commission.

Also, what type of conditions do you feel attractiveness to lengthen the duration of your portfolio? What are you looking for?

We are actually at a point now. We obviously have a full-time chief investment officer and a very active finance committee. We spend a lot of time working on this. We all agree that we can't prognosticate interest rates one way or the other, but we're constantly looking at the upside/downside risks from a certain point in time. And we are clearly closer now probably to a point in which we might extend.

Let me tell you how we get to that three year duration. We look at the various components of the portfolio. Part of it is represented by debt and hybrids, which has a duration component to it. Part of it is represented by -- the majority of it is represented by the loss reserves, which have a rough duration. So we are matching on those first two items. The third part is obviously the shareholders' equity, and that's where we have chosen to be the most conservative from a duration standpoint. And clearly now, we are reaching a point where the risk/reward dynamic and the upside/downside analysis is different than it was a quarter ago and certainly a lot different than it was a year ago. So that's something we're looking at all the time. We're probably closer to that point now, but it depends on a lot of factors and a lot of variables that have to be analyzed.

I'm not sure if you mentioned this. But how much capacity do you have left to cede to Flatiron? Do you have more -- do you have enough capacity on your E&S property reinsurance to write more E&S property?

We have quite a bit capacity on both. Don't forget when we do projections of our PMLs, we take the entire in force business. So meaning, you are assuming that what is going to come off, either that account or something similar will replace it over the period of time. You saw on the E&S side, we're getting 100% rate increases. So in essence, you can maintain the same exposure and increase premiums significantly. So I think there is plenty of capacity on both sides.

As Dinos before and as we've said from day 1 now, we still see the reinsurance sector as more attractive. So we have allocated most of our capacity to the reinsurance side, which allows us to continue to cede the Flatiron.

[Ian Gutterman], Adage Capital.

I just had a few -- I guess a few quick numbers questions first. Maybe you gave it and I missed it, but did you give the paid losses for the quarter?

The paid -- I can tell you that the paid losses in the quarter were $260 million. That includes -- let me search for that. That includes about 63 -- 64 million related to the 2005/2004 events.

You mentioned in the release a couple of large losses. Can you just talk about what they were?

Yes, one was a major explosion at a chemical facility.

Yes, a vapor cloud.

(multiple speakers) Most people got hit by that in Texas. And the other was a surety loss on which we put up a reserve.

Again, in the press release, you talked about a little bit earlier the long tail releases -- reserve leases that you said were '02/'03 acts in your claims made. Can you just give a little color on what lines they came from?

Policy year. It came from basically professional liability and executive assurance -- would be the one (multiple speakers).

I think it said there was some adverse property in the insurance segment ex cats. What would that have been from?

Mostly out of the marine section in the insurance side, not offshore energy, but on the rest of the marine business and a little bit on some of the global business where you write on an in excess basis and you make an assessment of the size of a major loss. And occasionally, you will come up above the attachment level you thought it was going to be at.

The other thing I wanted to understand a little bit better -- you mentioned that a lot of the growth in the insurance business came on the construction book. I guess it was a large deductible construction business from the release?

This is a -- think of it as three line retro business. These are accounts that they take the first -- most of them 250 or even $0.5 million of each and every loss themselves. And then, we provide the difference between that and $1 million for all three lines -- auto, GL and workers' comp. It's either done on a retro plan -- retrospectively-rated plan or a high-deductible fire plan, etc. That's where -- it's a business we're trying to build. It was originally done just for the construction segment. But now, we have expanded it to other different manufacturing segments, and we call it our national accounts initiative. And that business is getting more traction for us.

It's a business that at least historically has had the low volatility than casualty business in general for us.

That's what I was trying to understand. It sounds like it's -- I guess the contracts, there was a lot more skin in the game than what we typically think of as construction business.

Right. But these are bigger, more sophisticated type of companies that they have the ability to manage risk and also pay what we call the frequency area of their losses. So they are only buying severity from us.

Tom Cholnoky, Goldman Sachs.

Just two quick questions. John, when you guys set up IBNR reserves for your attritional property reinsurance business, typically, how do you adjust that IBNR as the year progresses? Do you kind of wait until the end of the year or do you kind of adjust it on a go-forward basis as each quarter burns this out?

No, actually, we tend to wait towards the end of the year to make adjustments there. Now obviously, we started out using strictly industry -- let me bifurcate it. There's the insurance group versus the reinsurance group. So the reinsurance group, you're writing mostly excess. And the insurance group, you're writing all the policies. On the insurance group, we start out with an expected attritional ratio. And usually in the fourth quarter, we have a better handle on what that looks like and we tend to make our adjustments then. Obviously, the cat stuff falls through.

On the reinsurance side, we do the same thing. Although, on the reinsurance side, it takes a longer time actually because if you looked at historical experience on attritional cats, they tend to actually to come in over a period of anywhere from 18 months to 3 years. So we have a pattern established -- a curve. And we take it down according to that curve. And once we got enough data on a given policy here, we take a harder look there and we might adjust it. But we certainly -- we rarely would do it. We haven't done it and I can't imagine circumstances on which we would do it early in the year.

Then, second question -- I know this might be a little bit on the order of projections. But obviously, your net to gross came down significantly in terms of the reinsurance. But how should we think about that for the balance of the year and also within the insurance area?

Again, the primary driver of that change is the Flatiron session.

But will that be seasonal? I mean could the--?

It's somewhat but not completely because we're not just ceding pure cat business to them. So it's our whole book. However, I think most of the cat business -- cat-exposed business gets written -- most of it not all -- during the first nine months. We've already seen the first six months/seven months of pretty heavy renewal. So in the third quarter, you know --

Conceivably, your net to gross could even decline further.

It could decline further or be comparable. And then in the fourth quarter, which is a low-volume quarter anyway, you might get a magnified effect. But it won't have that much impact on the net to gross in the whole year.

So is it better to maybe just think about where it stands for the six months and kind of think of it in that--?

That's as reasonable a method as any.

What about on the insurance side because that also dropped? I assume that's --

That dropped a little bit but that was driven more by the changes in the cat market. So we paid more -- as we've told you before, we paid more for our property cat cover. And to a certain extent on some of the underlying coverages, we've shifted some from excess to pro rata, which has a slight effect also on that. That probably doesn't move as much as the reinsurance might because of Flatiron.

Matthew Heimermann, JPMorgan.

Just a quick question on as you move into '07. Do you have -- given that rates certainly improved over the first six months, is there incrementally potentially in first quarter maybe a step-up in terms of the property volumes related to Flatiron year on year? I am just trying to understand if there is -- if that will have any effect whatsoever in terms of the appetite there.

You guys probably listen to other calls from the other companies. I don't know how many companies have implemented 6.0. Once that implementation is complete, it's in our view, we believe that it will continue to have an imbalance between supply and demand for those kind of covers. So we believe that January 1 renewal seasonal will probably be better in '07 than '06. And a lot of it is driven by the recognition that a lot of companies, especially primary companies, they have more aggregate exposed because of the model changes that they need to deal with. So either they're going to deal with it by shedding exposures, which raises primary pricing, or by purchasing cat reinsurance, which improves that market. So we are pretty optimistic that January 1, '07, it will still be a very, very good market for these short tail lines.

There are no additional questions at this time. I would now like to turn the presentation back over to Mr. Dinos Iordanou.

Thank you everybody for attending and listening to us, and have a good day.

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