Arch Capital Group Ltd (ACGLO) 2006 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the quarter four 2006 Arch Capital Group earnings conference call. My name is Michelle and I will be your coordinator for today. At this time, all participants are in a listen-only mode. We will be facilitating a question-and-answer session towards the end of today's conference. (OPERATOR INSTRUCTIONS)

Before the Company get started with its updates, management wants to 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 meanings 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 of GAAP and definitions 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 hosts for today's conference, Mr. Dinos Iordanou and John Vollaro. Please proceed.

Thank you, Michelle. Good morning, everyone, and welcome to our fourth-quarter call. We are very pleased with the financial performance of the Group. As you can see from the numbers, we had an excellent quarter. As a matter of fact, it is the best quarter in the Company's history. Clearly, the light cat activity for the year was a positive factor, but non-cat business also contributed significantly to these outstanding results.

This quarter marks not only our fifth anniversary of our recapitalization, but it was also our best quarterly and annual periods from a performance point of view.

Our operating earnings increased to $220 million, and our annualized return on equity for the quarter was 29%, bringing our full-year return on equity to 26%. Our book value per share grew to $43.97. Cash flow from operations continues to be strong at $359 million for the quarter and over $1.6 billion for the year. Our investment income continues to grow, and now represents approximately half of our pretax operating earnings.

John will get into more details on our financials in a few minutes. So let me now turn and make a few comments about market conditions in general and how our two units, our insurance group and reinsurance group, are responding.

The most attractive area from a pricing point of view is still cat-related business, with wind exposed areas leading the way. Despite a year of light storm activity, we do not see a significant change in the fundamentals driving the excellent market conditions we are seeing, with the only exception of personal lines business in Florida, in view of the latest legislative changes. We continue to be active in the cat sector and expect to stay well within the risk tolerance we have established, based on our risk management principles.

The rest of the market is generally experiencing price reductions ranging from the low single digits to up to 10%, and the size of the rate changes varies by class. As I have mentioned before in prior calls, one constant holds true. For most classes of businesses, the larger the premium, the greater the competitive forces.

Our reinsurance group produced great returns, aided by the benign cat season and excellent performance in the rest of their business. From an underwriting perspective, we made two [shares] in how we approach the current market based on what we saw in the July 2006 renewals and the fourth-quarter renewals.

In the casualty area, the nature of the reinsurance business requires us to make a forward-looking approach to the market. As a result of increased competition for large accounts, we cut back our participation on reinsurance contracts in the fourth quarter where the underlying book of business is Fortune 1000 type of accounts, and shifted our emphasis to books of business comprised of small- to medium-sized accounts.

On property and property cat business, we shifted more of our aggregate cat capacity to an excess-of-loss basis, where in the current environment we believe the risk-adjusted returns are more attractive. This shift, even though it causes a reduction in written premium, actually enhances profitability and returns per aggregate unit of exposure.

With the recent Florida legislative action, we expect the market to adjust over time. For us, the adjustment will be minimal, as we are very underweight on Florida-specific contracts affected by the legislation. Most of our Florida exposure emanates from our participation on national and E&S programs. This approach serves us well during the January '07 renewals, as cedents allocated shares to existing participants on these programs. Those who did not participate in 2006 had difficulty in obtaining shares in 2007 programs.

Based on these actions, our reinsurance gross written premium for the quarter declined 17% on an adjusted basis, and our net written premium declined by 29%. For the year, our gross written premium grew by 4% on an adjusted basis, and our net written premium declined by 12%.

Unless the casualty reinsurance market deteriorates significantly, we believe that much of our proactive adjustment to reflect softer conditions in casualty reinsurance has already been accomplished.

Now let me turn to our insurance group. Our insurance group had a good quarter, with strong underwriting results and good returns. We still find attractive opportunities in many sectors. However, the market at this stage requires a more disciplined and selective approach.

In the fourth quarter, we were impacted by aggressive behavior by some competitors, where the pressure to achieve annual premium budgets overrode prudent underwriting judgment. We are pleased that our underwriting units remained disciplined in the face of these pressures. We are also satisfied to report that for the January 1, 2007 renewals, this practice was not prevalent.

During the fourth quarter, except for property and programs, specialty lines continued to experience rate decreases in the range of 0 to 8%. On an absolute basis, though, the achieved rates continue to meet our hurdle requirements.

In property and in our program business, we continue to get rate increases. As a matter offact, in the property area, rate increases were 28% for the quarter, with E&S and offshore energy leading the way. In programs, our average rates were up 1.5%, with some programs slightly down and others slightly up.

In our other specialty lines, we saw rate reductions ranging from -2% to [-8%]on average. Healthcare was down 2%; professional liability was down 3%; executive assurance, or directors' and officers' liability, was down 5%; and casualty and construction was down 8%.

Our strategy is to continue to look for opportunities to expand our reach through geographic expansion and through new specialty products. Along these lines, in January, we entered the Excess Workers' Compensation business through an agreement with Wexford Underwriters. Wexford is a long-established Excess Workers Compensation underwriting specialist that has operated for over 20 years in the self-insured market, with an emphasis on the not-for-profit sector.

Our expansion into this sector meets all of our strategic criteria. It is a market that requires specialty skills, is not crowded with many competitors, and allows us to access their book of business on a going-forward basis without any exposure to prior-year liabilities. But most importantly, the facility is managed by a great team of expert underwriters that share our operating philosophy. We are very pleased to welcome them into our insurance group.

A disciplined response to market conditions and the significant growth in our capital base requires that we increase our focus on capital management. For those of you that have followed us from the beginning, active capital management has always been a key part of our strategy. It has always been our intention to actively manage our increased capital base in market periods that do not allow us to deploy effectively all of our capital in the business.

We remain focused on maintaining a strong balance sheet while achieving margins that allow us to meet our return requirements. At our upcoming Board meeting, it is our intention to request the Board for authorization to return excess capital to our shareholders.

Before I turn it over to John for a more detailed discussion of our financials, let me update you on our cat exposure. As we mentioned in our prior calls, I would like to again remind you that in determining our 1-in-250 event [PML], we include all exposures we believe could accumulate in a given event, not just the property exposures. As of December 31, our 1-in-250 PML expressed as a percentage of common equity was 17%. This is well within a 25% maximum risk management limit that we have established.

Based on our modeling and in anticipation of the effects of the Florida legislation in our peak zone, we expect that the Northeast and tri-county Florida areas will be our peak zones going forward. With that, let me turn it over to John for further financial analysis and then we will take your questions. John?

Good. Thank you, Dinos. Good morning, everyone. As Dinos indicated, this was another outstanding quarter, as we recorded our highest annualized return on equity ever, driven by strong growth in investment income and excellent accident year underwriting results.

With that, I'm going to briefly walk you through the key components of our financial results, starting with the top line. Dinos has commented in detail on premium volume, but there are a few items that are worth noting. As we indicated a year ago, the reinsurance segment's premium volume in the fourth quarter included approximately $110 million of one-off, non-recurring transactions related to last year's storm activity, while the 2006 quarterly amounts do not include any such numbers.

For the full year 2006, premiums written by the insurance segment represented 61% of our gross volume and 55% of our net volume, while property business represented approximately 29% of consolidated net premiums written compared to 27% in 2005; 24% in 2005 adjusted for the effects of the one-off items.

On a consolidated basis, the ratio of net to gross written premium in the 2006 fourth quarter decreased to 69% from 79% in the 2005 quarter, primarily due to business ceded to Flatiron Re, a dedicated reinsurance vehicle that we began ceding business to in January 2006. On a reported basis, we ceded $35 million to Flatiron Re in the 2006 fourth quarter, $273 million for the full year of 2006. On an underwriting year basis, the estimated amount to be ceded to Flatiron for the 2006 year of account was approximately $335 million.

Earned premiums ceded under this treaty is continuing to build and amounted to $62 million for the fourth quarter of 2006, bringing the amount of earned premiums ceded for the full year to $157 million. The override and estimated profit commission recorded on the treaty with Flatiron are reflected as a reduction of the acquisition expenses of the reinsurance segment, and improved the expense ratio of the reinsurance units by 250 basis points in the quarter and 160 basis points for the full year.

The consolidated combined ratio was 83% in the 2006 quarter. This result was primarily due to excellent results in property and marine business in the reinsurance segment, driven by substantially higher rates and a low level of cat activity. The outstanding underwriting results were achieved despite the impact of several large individual risk losses incurred by the insurance group in their property and surety classes.

Underwriting results in the 2006 quarter also benefited from favorable reserve development, net of adjustments to acquisition expenses, which totaled $33 million in the 2006 fourth quarter, compared with $56 million in the comparable 2005 quarter. The 2006 net favorable development was primarily attributable to executive assurance and other professional lines of business for accident years 2002, 2003, and 2004. Development on prior-year catastrophe events was negligible in the 2006 fourth quarter.

In general, reported and paid claim activity across most lines of business remained at favorable levels, and IBNR and additional case reserves continued to represent about 75% of year-end loss reserves.

Pretax net investment income in 2006 quarter was approximately $108 million or $1.41 per share before interest expense and deferred dividends, and $1.25 per share after deducting these items. Net investment income for the quarter was approximately 54% higher than the comparable 2005 amount, and 6% higher on a sequential basis. The substantial increase in investment income on a quarter-over-quarter basis was due to the continuing significant growth in investable assets and higher yields.

The increase on a sequential basis was mainly due to growth in investable assets. This growth was primarily generated by strong cash flow from operations, which increased by 4% over the comparable 2005 level. This brought cash flow for the full year to over $1.6 billion, an 11% increase over the comparable 2005 amount. As a result, investable assets were approximately $9.1 billion at year-end 2006.

Please note that this amount is lower than the total cash and investments reflected in the balance sheet in the release of $9.35 billion. The difference is primarily due to the net effects of securities transactions entered into but not settled at the balance sheet date.

The average recorded pretax yield of the fixed-income portfolio in the 2006 quarter was 4.89%. This represented an increase of 90 basis points over the 2005 level, while on a sequential basis the yield was up by 11 bps. At year-end, the embedded book yield, after considering the effects of expenses, approximated the yield recorded during the 2006 fourth quarter.

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 was AAA. In addition, we have generally continued to minimize our exposure to other forms of credit risk based on our current view of the risk-reward relationship of these assets. During the quarter, the duration of the portfolio remained at approximately 3.2 years.

Finally, the portfolio continues to be comprised primarily of high-quality fixed-income securities, with essentially no investments in hedge or private equity funds.

Operating income for the 2006 fourth quarter includes a tax benefit of $1.9 million. As you may know, we re-estimate our tax rate each quarter based on our annual expected taxable income, and any adjustment to the annual rate flows through earnings each quarter. The effective tax rate and operating income for the year ending December 31, 2006, was reduced to 3.5% at December 31st from 5.3% at September 30, principally as a result of a reduction in ceding commissions on certain intercompany reinsurance transactions in the 2006 fourth quarter, based on our annual independent transfer of pricing study. As a result, 2006 fourth-quarter operating income includes a benefit of $0.13 per share due to the adjustments in tax rate recorded during the first nine months of this year.

We currently expect that our 2007 tax rate will flow in the range of between 4% and 6%.

Our balance sheet continues to strengthen, as total capital increased to approximately $3.9 billion, with debt and hybrids representing only 16%. This provides us with sufficient financial flexibility as we continue our intense focus on generating appropriate risk-adjusted returns.

In summary, the 2006 fourth-quarter and full-year results were outstanding as recorded, our best return on equity to date -- nearly 29% for the quarter and almost 26% for the full year. As a result, book value per share rose to approximately $44.00 at December 31, 2006, a 30% increase from year-end 2005.

Operator, we are ready to take questions.

Thank you. (OPERATOR INSTRUCTIONS) Josh Shanker of Citigroup.

Good morning. Great quarter, gentlemen. The first question involves the [specter] of capital management that you said. In the past, you guys have said that you don't believe in giving regular dividends because you don't get reward for it in your stock. But how do you feel about special dividends versus share repurchase?

Well, it will depend as to where we are trading. And we have -- we're going to have that discussion among us at the management level and also with our Board. But probably we are leaning towards share repurchasing that special dividend. But those discussions have not taken place. At the range that we are trading now, probably it will be share repurchase.

Josh, the only thing I would add is I think -- and we have said this consistently in the past -- certainly at a multiple of 150% of book value or less, that definitely tilts us towards share repurchases.

Okay, the second question is, involving a very detailed analysis on line by line what rates are doing. How does that stand with terms and conditions?

To our pleasant surprise, terms and conditions are holding. They are holding on the reinsurance contracts and they are holding, to a great extent, on our primary insurance. The early signs of the market is more pressure on rate, meaning premium reduction. So I am not as concerned; we are not as concerned as a Company about terms and conditions.

Okay. And the large losses in surety and property all converging on the fourth quarter here. Are they the normal kinds of large losses, or are these exceptional sort of things? What exactly has occurred and is there risk of recurrence of these types of losses?

No, these are random kind of losses, I would characterize them. There were two explosions on the property side, and a major contractor who had issues with the price of oil. That, you might say, could have been anticipated. But, you know, I will categorize them all as random, and not losses we expect to be coming quarter after quarter.

Right, especially in the types of business that are involved, Josh, on this type of business. You know, you can go many quarters without anything happening, and then get a number in one quarter and then the next quarter be back in the same place. So I wouldn't read anything into it other than the fact that there was a confluence of them in the one quarter.

Okay. Very good. I have a bunch of questions, but I will get back in the queue.

Matthew Heimermann of JPMorgan.

Good morning, everyone. A couple of questions. First was can you just give us a sense, John, of where reinvestment rates stand now vis-a-vis portfolio yields?

Actually, depending upon where you are, the portfolio, as you know, is short. And if you looked at spread duration, especially, it is very short. So where we are taking credit risk, we are keeping it very short. And with the curve where it is today, you are in the area of 5%, 5.25%. So on a booked basis, we are at 4.89%. So I would say reinvestment rates are at slightly higher levels than what we recorded in the third quarter.

Okay, that's fair. And then with regards to Florida, can you just give us a sense of whether you have -- your reinsurance writings in the state, whether you have any specifically Florida homeowners' only business. and then just kind of a flavor for what is first on commercial and then national versus Florida-specific?

Yes, as I said in my prepared remarks, is predominantly our exposure to Florida is in national contracts and E&S contracts. Just to give you a comparison, I think in 2005, we had 14 contracts that were specific to Florida. Not all of them in the homeowners', but specific to Florida; some of them that were small commercial. And in '06, we only have three.

So, you know, the difference between number of contracts. Also when you look at the aggregate number of dollars that we have in Florida on a net basis is less than $15 million in premium. So that is why my comments were as such -- it is not a significant exposure to us.

That is on Florida, specifically on homeowners' contracts.

That's very helpful, though. The last question was on capital management. I guess -- am I right -- well, let me step back. Do your views on capital management encompass kind of you feeling like your arms are around the S&P model changes, for example? And I guess that is part A. And part B is can you just give us a sense of what your rating goals are in the big picture, as well?

Let me start with the rating goals. As I said in my prepared remarks, we want always to have a very strong balance sheet. And we have stated we want to be in the A/A+ range. More in the A+ than A, but currently we are at A.

We run the S&P changes using our existing data, and the changes will increase about -- our capital requirement by about 8%. So we factor that in, and, you know, it is not a significant change for us. It might be -- the outcome for others might be different, but at least for us, based on the analysis we had -- our people do -- it is not a significant change.

Let me add one thing. Keep in mind that as a newer company, we have historically been held to a higher level, anyway. So when we actually looked at this, from our standpoint, this will have almost no impact, almost no bearing on how we look at capital management in terms of excess capital. And as we mature, that excess standard we have been held to keeps coming down.

So from our standpoint, we are in real good shape, and we have done a fair amount of work on the S&P model.

Okay, very helpful. Thanks.

Vinay Misquith, Credit Suisse.

Hi, good morning. Great quarter. On the margins, your margins this quarter were really strong, especially in the reinsurance, but also in the primary insurance, if you back out the one-time items. I'm just curious, was there any favorable reserve release from this year in the numbers? And what number should we look at for margins next year? Should we base it off the fourth quarter or should we look at it more on the annual basis?

A combination of both, actually, but let me -- there were three things you need think about when you're looking at the accident year numbers. One is cat load, and we have talked about this before. Bearing in mind that our book of business is shifted more towards the property side, it probably has a slightly bigger impact than it did before. One is property loss ratios in general will tend to be lower than casualty loss ratios, so keep that in mind.

Two, you need to add between five and six points to the total for the cat load in the quarter, when you are thinking on a more normalized basis. The third item, actually it is a combination of both. In the quarter, we obviously had, as we said, sort of a confluence of larger events, which can occur in any given quarter.

By the same token, as we have discussed in the past, we have often -- in the fourth quarter, we will look at our property book for the nine months, both on the reinsurance and the insurance side, and evaluate the expected loss ratios on the attritional and the cat basis, and we might adjust that slightly. That had a slight favorable impact in the fourth quarter, but not a dramatic one. So when you combine the excess losses with sort of that adjustment, it probably has that adjustment you made on excess losses. And if you do that, I think you will get to a more normalized level.

That's great. On the higher reinsurance costs in the primary insurance segment, should they flow into the next year, also?

Well, don't forget, I don't think there is higher reinsurance cost. It is mix changes, if you are comparing the gross to net. I don't know. But the only area that we have increased cost in reinsurance, it was in the cat area. Everything else we do, actually, we have improved terms in buying reinsurance. That is why when I sell reinsurance, I'm more cautious. When we are buying it, I think we are getting advantageous terms. When I mean terms, better ceding commissions, et cetera.

So we are pleased with where we are on our reinsurance purchasing. Even though I do have to say that cat -- it is expensive. The good thing about cat is we sell a lot more than what we buy. So there I'm a seller in a greater extent than I'm a buyer.

In addition, on the cat side, remember, on our primary insurance basically, just about all of our insurance is on a non-admitted basis. So in terms of being able to pass the cat costs on, generally speaking, we were able to do that in 2006. And clearly things are moderating for 2007, so we will see how that develops.

Right, the fourth quarter E&S rate increases, they were 44%. And that is what most of our cat exposure is. And I can tell you, our cat price increase was significantly less than 44%.

Right.

So we are passing it on. As a matter of fact, we are improving margins there, in that segment of our business.

Sure. Now, as we go into '07, you mentioned that you don't have a lot of Florida homeowner specific business, and that is great. But the fact is that you are writing a lot of business, especially some of the business which you are ceding to Flatiron, which is property and marine business, which is cat exposed.

What impact do you think that business will have because of the Florida legislation? Do you think pricing is going to go down significantly there?

I think pricing will adjust. It is a supply-and-demand curve. As there is going to be more supply because now the state of Florida is in the reinsurance business, and it provides additional capacity, some of those prices will adjust.

However, I can tell you that a lot of people, they price off the models. And there is -- at some point in the pricing, there is inelasticity. Because once you go below what people think is an adequate price, the capacity disappears. Where you have programs with the right price that they get [overlined], and people are trying to get on, and brokers cut back lines.

When you got the wrong price, you have a difficult time filling those programs. So I think there will be an adjustment. The adjustment will be downward, so some of the margin of that business will get eliminated. I don't know what other effect, though, it is going to have. It is too early to tell what the effect will be, if this excess capacity is going to try to find its way in other parts of the country, like the Northeast, or in the West Coast, or throughout the world.

All I can tell you, '06 for us was a good year, because we balanced our cat exposure and we were able to obtain business in the Northeast and other parts of the country that, in the past, our penetration was not significant. So we are going to watch it and we're going to adjust with it. But at this point in time, on national programs and in other parts other than Florida, homeowners', we don't anticipate a significant change.

That's great. And Dinos, I think you mentioned before at the beginning of the call that your movement out of the casualty reinsurance is largely done. If you could just explain that as to how we should look at '07 premiums in light of that.

You know, I can't predict where the market is going to be, so let me give you some general flavor. We look at -- most of our reinsurance is written on a quota-share basis, as you probably understand. So in that sense, our performance and our cedents' performance mirror. So we like to be in those partnerships. So they make a dollar, we make a dollar. They lose a dollar, we lose a dollar. We like that approach to the business.

When we -- in contrast that we saw significant erosion of the underlying pricing. That is the contracts we took proactive action. And we said, hey, I am not going to sit around if some of our cedents are willing to cut prices 15%, 20% and in some cases higher percentages. And that comes through our audit process when we go and visit. And we have open discussions with them and we have certain expectations. And when they meet those expectations, we continue to be strong and good partners for the long run. And when they don't, then we pull away.

So we have done that review in all of our contracts, and in the contracts that we felt that our prospects for meeting our hurdles were not there, especially when you projected where the market is going to be 12 months out, that is where we took action.

Now, the market is not in bad shape. The January 1 renewals, both for our insurance and reinsurance group, they came as expected for us, so that we had no surprises. We had some surprises, as I mentioned in my prepared remarks, in December, where some people that were chasing premium dollars to make budgets. But that dissipated for January 1, which is a good sign.

So not knowing where the market is going to be, I don't try to be a prophet and predict where it is going to be. You know, our philosophy is always to adjust with the market, but we feel confident that '07 will not be as dramatic the adjustment that we had in '06.

So that's good. Thank you.

Adam Klauber of CCW.

Good morning. Thanks. With pricing coming down in both casualty and likely in property in '07, do you think accident year loss ratios will begin to move up? And what type of magnitude could we look for?

Yes, it is the obvious that accident year loss ratios are going to move up. If you take an estimate -- let's say your current accident year is at 60, and you take a 5% across-the-board reduction, that means your accident year for the following year will go to 63. It is 5% of 60. So I would say it is going to be in that range.

What is unknown here, that is what you've got to be very careful with projections, is that it is very easy to adjust your accident year, year-over-year, if you're 100% certain that the prior year is static. But prior years are not static, because you have got to see how the emergence of those accident years comes through. And so far, at least for our book and from reading what other competitors are doing, it seems '02 and '03 and '04 and '05 is better than expected.

So you have this moving -- if your base year is '03, you're going to base rate changes upwards or downwards. If that is moving, it is very hard to say what the accident year of '07 is going to be. And every quarter, we will look at all that information and we make adjustments. But if you are going to compare '06 and '07, I think it will be, in our view, about a 3% difference. However, I can't tell you exactly where '06 and '07 is going to be because they are both moving.

And remember, Adam, your earned premium sort of lags, too. So all of the changes sort of get phased in over a period. It is various changes. So it doesn't necessarily translate exactly. It can change mix of business, it depends on when you write it and how you earn it.

Right, right. You bring up, obviously, a very good point that premiums are obviously one-half of the mix; and you mention experience has been good. Has frequency, in general, been better in a lot of areas than you would have expected over the last three, four years?

I think both frequency and severity have been better than we expected. When you look at the broad trend of what we are experiencing is less frequency and clearly, less severity. Especially in some the professional liability lines, the D&O lines, et cetera.

Okay, a different area. As property cat pricing gets more reasonable, upcoming for June and July, and potentially you get more or more reasonable coverage, would you look to expand your E&S lines on the property side -- on primary?

Well, I mean, we have been trying to grow our E&S in other parts of the world -- I mean of the country. We are not Florida-centric. There is the Carolinas, there is the Northeast, et cetera. But our underwriters are always focused on returns.

So basically, we are going to go where we believe we are getting the best margin for the business that we write. We don't participate in any sector that we don't feel we can make a buck for our shareholders. And that is always very hard to tell you. I couldn't tell you because I wouldn't know. The instructions we give to the underwriters is look account by account, territory by territory, and see if you are getting the proper returns.

Adam, one point I think is accurate, and that is, just as in '06 and '07, we have allocated aggregate, or capital if you will, more to the reinsurance side because that is where the best bang for the buck was. If we get into a position where that situation reverses and it is more attractive to be a buyer than a seller, then we can allocate more of our capital to the insurance and deploy the aggregates that way.

Okay, and --?

As a matter of that, to that point, I have a whole team examining the Florida opportunity. If you can't be a seller, you might be a buyer. And the way you do it is you might be supporting takeout companies on a quota-share basis and buying cheap reinsurance from the state. So I'm not saying that's what we're going to do. But we're looking at that opportunity now to see if we can be a seller, maybe we ought to be a buyer.

But even in our regular E&S business, if the situation presents itself where the net economic effect is more attractive there, we certainly have the capacity and ability to allocate the capital there if we're allocating less on the selling side.

Okay. And one final question. You had nice growth in the professional liability book this year. I guess where were you seeing opportunities and do you think they're going to continue in 2007?

You know -- your question is specific to professional liability or --?

Yes.

Well, our professional liability book is -- it is a bit unusual. It is mostly -- I would say 90% of what we do is small- to medium-sized accounts. In any sector, independent of -- we do it in Europe, or if we do it in the U.S., we are in the small law firm practices, we are in the small accounting practices. We write a lot of captive agents, et cetera. And that is where we see the opportunities.

We continue to play in that sector. It is not as a volatile through the cycles as the large-account business is, but it takes you more time to find these opportunities, create these relationships and put the business on the books.

We don't have much. We have very little in large law or the huge accounting firms. It is only a few of them, et cetera. We don't do any for investment banks, et cetera. So our book is kind of unique, and is more small- and medium-sized E&S type of book.

Thank you very much.

(OPERATOR INSTRUCTIONS) Ron Bobman of Capital Returns.

Hi. Congrats on the quarter and the year. And maybe even more importantly, your willingness to not write business that falls below the threshold is fabulous.

I had a question -- a couple of questions. One was if you could remind us sort of the life of Flatiron --.

Ron, it is a two-year -- two underwriting years. So a year of account, 2006 and 2007. Of course the actual premium could spill over into '08 on an earned basis. But it is just those two years of account.

Okay. And does it have a finite end in that sense, or is there an option, so to speak, that you can elect to --?

If they are on a deficit, they have an option to elect to continue for one more year. If they are not in a deficit, it would be a discussion between us. Two good partners, they sit down at year-end and decide does it make sense to continue or doesn't it. We're going to make those decisions along with our partners when the time comes.

Yes, we contemplated two years ago that we couldn't see that far into the future. So toward the end of the year, we will sit down and figure it out.

Okay. Then I had a question, on the few individual risk losses that were landed this quarter, just from a risk management perspective, individually, in any one of those -- what was the largest one in a dollar size? How big was the largest loss of that few --?

It was low double digits -- like, I don't know, $11 million or $12 million. And, you know, you put these kinds of limits, you get an explosion, it's a total loss, you're going to get it. It is nothing unusual if you are in the high risk business and you write onshore energy, offshore energy accounts, or you write big contractors, you might get that.

Okay. And my last question was relating to the sort of Florida legislation. And, a little broader than that, just sort of industry lobbying. As a bit of an outsider, it seemed pretty pathetic to me the impact that the reinsurance industry had on -- I recognize it is just -- in some respects, it's sort of round one of the legislation coming out.

But it obviously appeared that the industry had zero impact in shaping the legislation in any form or fashion. And obviously, there is a risk of other states looking at this. People are increasingly troubled about the so-called tax advantage of being Bermuda-based and writing U.S. E&S business. And a couple of primary companies here are complaining about that.

So are you part of a group or inclined to initiate a greater degree of action on the industry's behalf to do a better job of shaping legislation? Thanks a lot.

Listen -- we belong to the associations. We are part of RAA. We are part of the AIA, the American Insurance Association, who has done a lot of work in Florida. Also in Bermuda, we're a member of the Association of Bermuda Insurance and Reinsurance, ABIR. So we are in the associations, we try to do our best.

There is very little you can do in Florida. listen, when a dealer opens down the street from you and wants to sell the Cadillacs for $3000 when the going price is $30,000, you know where everybody is going to buy their Cadillac. So they were determined to provide relief to their population, and they chose to do it through cheap reinsurance, and there is nothing we can do about that.

At some point in time -- only time will who is right and who is wrong. Of course, if there is no storms, you always look good. When the storms come, it might be a different outcome.

And Ron, rate suppression, which is really what this is all about, is not anything new to the business; it's been around for a long time. I mean, California comp is a great example. Rate suppression worked for a while, but ultimately, the forces overwhelmed everybody and you had a massive correction.

So they have a big problem down there. They tried to solve it in a way that was -- that met their needs in the short run. We will have to see what the long run -- how the long run plays out. I am personally not sure that it is going to work the way they hope it is.

Yes, my question is not so much about the merits of what they have done on that -- this particular problem facing consumers in the industry. It is just is the reinsurance industry going to get a little bit more aggressive in trying to control its destiny legislatively or have an impact on legislation? Allstate for two years now has been -- initiated this process about a federal cat program. And --.

And we have opposed that and AIA has opposed that. We spend enough time and resources and we do use our associations to bring our point of view in front of the regulators and the legislators. And at the end, I think we do as good a job as the reception allows us. Don't forget, the insurance business is not always the most welcome of industries in Washington.

Understood. Thanks and continued best of luck.

Josh Shanker of Citigroup.

Hi there. This is more than an industry question. We've talked about where rates are going. Everyone and his brother seems to be opening up an E&S primary company out there. And from the headlines of it, it seems like there is rampant competition going on. Maybe rates are holding up. Are they holding up in the face of rampant competition or is this a misperception on the part of me and maybe some others?

Well, listen, I give our numbers, and you saw where rates decreases -- they're somewhere between -2% and -8%. That is not catastrophic. I don't truly like it when it is 8%. 2% from a very high base doesn't bother me a bit. And you know, markets do adjust them. If you go back in the '84, '87, cycle, we had five-year adjustments, and still the industry produced very good returns from '89 all the way to '94. So that doesn't bother me.

I can tell you, though, that some of the business that we lose is not -5% or -6% or '7%, because we do -- we are feisty people; we do put a fight if it is 2, 3, 4, 5 and it makes sense to keep the business. When we fold our tent and go home is when somebody wants to cut 15%, 20% or 30%. And we have seen it, and the instructions to our underwriters is when you see that and if people, you know, and they want to cut 20 or more percent just to get the business, let them have it.

And at the end of the day, it is very, very hard to grow when everybody is protecting their renewals. So you have to fight, and it's been very difficult for us to compete with a few people. It is sporadic; I am not going to say it is a broad market moving. It is very sporadic, which otherwise, everybody would be affected. But you know, like I said, we remain disciplined, we still see a lot of opportunities, and we instruct our underwriters to remain disciplined.

When you are losing money on price to someone, is it to a smaller, younger competitor, to a legacy competitor or is at all across the board?

It is both, and as a matter of fact, sometimes it is very sporadic. It might be -- you might get a large competitor that has offices throughout the country, and I don't know, 9 out of their 12 offices they behave fabulously well. And then you get an outlier, one or two. And usually in their systems it takes them some time to catch up to them, and when they do, they correct it. And sometimes, it is small competitors. I mean, we see -- but it is not systemic and systematic.

And I don't think we would lay it at all at the feet of the so-called new entrants.

No.

Okay, very good. Thank you.

Bob Peck of Fremont Group.

Hi, I just wanted to note it is pretty extraordinary that in only your fifth year of business, you have earned $692 million. No wonder you're having to deal with the issue of some excess capital.

It's a good problem to have. No, I don't call it a problem. It is a good opportunity to have.

No doubt, no doubt. I just wondered if you might speak a little bit more to the issue that both of you spoke to earlier in the call in that just looking at net premiums written is really not going all the way to understand the various changes in your business, particularly because property cat takes more equity per dollar premium, and the same with excess of loss versus pro rata.

Can you just give us a sense, at least in a qualitative way, if you were to look at your business from a unit of risk or aggregate unit of risk or perhaps aggregate need for equity for the premiums you are writing, how that would be changing sort of run rate now versus a year ago versus two years ago? Could you speak to that at all?

Well, let's talk about historically. Historically, we started in '02; we had the least amount of capital for every competitor. We started with $1 billion. And we always came back to you, our shareholders, when we needed additional capital, because our business was flourishing. And we had two follow-ons, and we did perpetual preferreds and we did $300 million of long-term bonds. And we were very diligent in building our capital base to respond to the exposure in maintaining a very strong balance sheet.

When we look at ourselves at year-end '06, we believe -- and you have seen upgrades from the rating agencies, so also the rating agencies believe -- that we have adequate capital. As a matter of fact, in pure terms, we probably have, today, excess capital.

Looking at the prospects of where the market is going and looking at flattish premium revenue, it doesn't take an IQ of 2000 to know that any earnings we have in '07 probably will be excess capital. Independent of the kind of mixes in our business, we adjust for that and we are going to adjust for the S&P capital requirement, and we have open communications with A.M. Best. We talk to them regularly and openly about our business and our capital requirements.

Once we satisfy all of those needs, whatever excess we have, if I can't deploy it -- not meaning me, but we as a Corporation cannot deploy it in our business, then we have to return it. And that were our comments around capital management. And we intend to have those discussions with our Board in a few weeks.

Right, that makes sense. Is it fair to say from that then that the aggregate risk which you are writing, whether it's look at as I suppose a need for equity or just aggregate units of risk, adjusting for the various differences in the written premium per risk, is going along in a reasonable steady state year-to-year?

Well, yes and no. Let me give you some of the changes in the cat area. One of the things we saw '06 to '07 is most cedents retain the lower levels of their programs. So the 20%, 25%, 30% rate on line blocks, they retain. So if a company -- I will make this as hypothetical; it is not a specific.

If a company was buying excess of $100 million, and the $100 million of their 100, the first layer of their cat program was, let's say, 25% rate on line, and it will cost them $25 million. They will retain that.

And then they will go all the way up on the top where the rate online might be 10%, and buy another $250 million of capacity, way up on the top, okay? On a risk-adjusted return basis, probably being all the way up on the top probably gives you better profitability over time. The risk charges are a little higher than when you are down the bottom with one reinstatement at 100%.

And we have seen that as a general theme of buying from a lot of these national programs. They took more risk at the bottom, and they bought more capacity at the top. A lot of these companies, they have good, strong balance sheets, they have a lot of surplus, so taking another $100 million or $200 million or $300 million is not going to change their economics significantly, and they buy more protection upper top.

So it is slightly a different book that we had, but we like the return characteristics as we have modeled it.

Right, okay. Makes sense. Thank you.

Adam Gileski of Goldman Sachs.

Thanks. On the asset management side of things at Goldman. Two questions on the capital management. The first is, what is the time frame potentially for getting to that A+ rating that you -- it sound like Dinos was thinking about getting to eventually?

Well, I mean, it has been a long-term process. We work closely with the rating agencies. I think we are running our business in a conservative fashion, not only from a prudent underwriting point of view, but also from maintaining a strong balance sheet. As we gain their confidence, and as they review, they will probably get us there. But it might be two or three years. I don't know what the time frame is.

The difference -- the issue is one more of aging and maturity in time than it is of capital adequacy. So if we just looked at the modeled numbers, we are already to a higher level, particularly with A.M. Best where we score much higher than our current rating which just got upgraded would indicate. So from a pure capital standpoint, we are in great shape.

The only question one has to continue to deal with is that rating agencies tend to want to see an operating history. And so there is a maturation process you simply have to go through that only time can take care of.

And time is on our side.

Okay. Second question is, would you consider issuing one of these hybrid securities in order to finance your stock buyback that you might be recommending?

Well, where we are presently is we expect to generate capital from earnings that we can't deploy in the business, so we don't really need to finance it. Now we did, earlier this year, introduce hybrids into the structure, so --.

Last year.

Last year -- I'm sorry. In '06, we did introduce hybrids into our structure, so we have already put them there. We clearly watch what is going on in the capital markets all the time. They are very, very attractive. So over time, the capital structure of the Company will shift, along with everything else, and we will look to have a more -- or the most optimum capital structure we have.

But right now, we would be able to finance any buyback out of earnings; we don't need to go outside to do it.

Okay. And the hybrids that you introduced last year, those are the preferreds that you referred to earlier in the call?

Exactly right.

Okay, thanks very much.

Sirs, you have no further questions at this time.

Thank you, everybody, and we are looking forward to talking to you next quarter. Have a good day.

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Have a good day.