Arch Capital Group Ltd (ACGLO) 2007 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Arch Capital Group 2007 second quarter earnings conference call. My name is Samuel, 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 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's with the SEC from time to time.

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

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

Now I would like to turn the call over to today's host, Mr. Dinos Iordanou, and Mr. John Vollaro. Please proceed, sir.

Good morning everyone and welcome to our call. We had a very good quarter against the backdrop of a market that in our view continues to drift at a somewhat accelerating rate. Our operating earnings were $209 million, or $2.78 per share. And our annualized return on common equity for the quarter was a very strong 24.5%. Our book value per share grew to $47.41 despite $1.10 of dilution due to our share repurchases.

Cash flow from operations continues to be strong at $274 million for the quarter. The contribution of our earnings -- to our earnings from investment income was $117 million. And it represents over half of our pretax operating earnings. Our investable asset base is growing nicely and now stands at $9.5 billion. As a result the stability of our earnings is quite high.

On capital management during the quarter we made significant progress in executing on our share buyback program. John will get into more details on our financials in a few minutes. But now let me share some comments about common market conditions in general and how more specifically our two units, Insurance and Reinsurance, responded.

The market is drifting down with rates in most classes declining anywhere from 5 to 15%, which is a bit worse than the first quarter of this year. This trend was most prevalent in the July 1 renewals. And as we have mentioned in prior calls, the competition for business is more aggressive on larger premium accounts.

We continue to see market opportunities on smaller accounts in the professional lines and in the property and other cat-related lines. As a result, the composition of our book of business continues to shift with an increase in short-tail lines and decrease in our long-tail business.

At the group level for the quarter property, marine and aviation represented 36% of our book versus 27% in the year ago quarter, and 24% two years ago. This is a significant shift. Terms and conditions in general are holding; however, we continue to see more requests to broaden terms. And in some cases we have seen certain markets responding by granting these coverage enhancements. This is a slippery road.

Our Reinsurance Group produced great returns again. All of their lines of business performed well, and light cat activity also aided their results. From an underwriting perspective we continue to adjust our book of business, putting less emphasis on large accounts casualty business, while we continue to take advantage of opportunities in other areas. As a result of these changes in underwriting approach, our Reinsurance Group's mix of business for the second quarter was two-thirds short-tail and one-third all other.

We were very pleased with the 4/1 and 6/1 renewals in the property and property cat areas where we were able to expand our participation and achieve rate increases which range from 1% to 10%. However, for our 7/1 renewals we saw rates drop on average about 15%, both for northeast wind and also for Florida and southeast wind-exposed programs.

Our Insurance Group, also another good quarter with strong underwriting results and good returns, even though the competition in many of our sectors intensified a bit.

On an absolute basis current prices still allow us to achieve our return hurdle; however, at this stage of the cycle a more disciplined and selective underwriting approach is required. As a result of this approach, we are focused on retaining our renewal business, which has progressively become a larger percentage of our premium volume. This progression actually started in '05 and has continued throughout '06 and '07.

During the second quarter we achieved rate increases on average in our professional liability and program segments. All other sectors experienced average rate declines in the range of 5 to 14%.

In our program business average rate increases were 1%, the same as -- approximately the same as last quarter, while professional liability rates were up 2.3% for the quarter. In all our other specialty lines we saw rate reductions. In the property area rate decreases were 14% for E&S property and 11% for global property, while offshore energy was down 9% and onshore energy was 5%.

Healthcare experienced an average decrease of 10%. D&O was down 11.5%. Casualty declined by 5%. And construction saw average reductions of 6.3%. In general we are in a more challenging market where underwriting discipline would be paramount for future success.

Before I turn it over to John for a detailed discussion of our financials, let me update you on the level of our cat exposures. As we mentioned in prior calls, we would like to remind you that in determining our 1-in-250 event PML we include all exposures that we believe could accumulate in a given event, not just property exposures.

As of July 1, '07 our 1-in-250 PML from a single event expressed as a percentage of common equity was approximately 18%. Because the effects of the Florida legislation were less than we anticipated, the tri-county area in Florida continues to be our peak zone, with northeast wind and San Francisco quake as our next to significant zones.

With that I will turn it over to John to go through our financials, and then we will come back to take your questions.

Good morning everyone. From a financial standpoint our second quarter results continued our excellent start to the year with an annualized return on equity of over 25% on a year-to-date basis. I'm going to briefly walk through the key components of our financial results starting with the top line, focusing primarily on the quarterly results included in the release.

Dinos has commented in some detail on premium volume, but there are a few additional items that I think are worth noting. On a trailing twelve-month basis, premiums written by the Insurance Segment represented 63% of our gross volume and 58% of our net volume, while property, marine and aviation represented approximately 40% of consolidated gross and 30% of net. Dinos gave you the numbers for the quarter. The trailing 12 will take whatever seasonality is out of those numbers.

On a consolidated basis, the ratio of net-to-gross written premium in the 2007 second quarter decreased slightly to 69% from 70% in the comparable 2006 period, primarily due to business ceded to Flatiron Re, a dedicated reinsurance vehicle. On a reported basis, we ceded $116 million of written premium to Flatiron Re in the second quarter of 2007, compared to $78 million in the comparable 2006 period.

Earned premiums ceded under this treaty is continuing to build and amounted to $73 million for the second quarter of 2007 in comparison with $25 million ceded during the 2006 second quarter.

The override, an 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 Segment by 310 basis points in the 2007 quarter, while the impact on their expense ratio in the comparable 2006 period was 90 basis points.

Our consolidated combined ratio was approximately 84% in the 2007 quarterly period, an improvement of about 2 points over the comparable 2006 quarter. This improvement was primarily due to the continuation of excellent underwriting results in the property and marine business of the Reinsurance Segment, which represents a larger part of their 2007 earned premium, as well as to favorable development of prior year reserves. These outstanding underwriting results were aided by a low level of cat activity.

Favorable reserve development on a consolidated basis, net of related adjustments to acquisition expenses, totaled $32 million in the 2007 second quarter compared to favorable development of $18 million recorded in the second quarter of last year. Development on prior year catastrophic events was negligible in the 2007 second quarter.

The 2007 net favorable development was primarily attributable to medium and long-tail lines, with professional lines including executive insurance accounting for the most significant part of the development. In general, reported and paid claim activity across most lines of business remained at favorable levels. And incurred but not reported and additional case reserves combined represented approximately 75% of quarter end loss reserves.

On a consolidated basis specific cat losses amounted to $12 million during the second quarter of 2007 compared to $11 million in the corresponding 2006 period. Losses resulting from the June flooding in the UK should be substantially contained within our IBNR reserves.

Pretax net investment income in the 2002 quarter, as Dinos mentioned, was approximately $117 million. After giving full effect to share repurchases through June 30, $1.60 per share before consideration of interest expense and preferred dividends, and $1.43 per share after deducting these items.

Net investment income in the 2007 quarter was approximately 30% higher than the comparable 2006 amount. And it was 4% higher on a sequential basis. The substantial increase in investment income on a quarter-over-quarter basis was due to significant growth in investable assets over the last 12 months and higher yields.

In addition, investment income in the 2007 period benefited by $3.4 million, or $0.04 per share, from the mark-to-market of certain fixed income investments that are accounted for in this manner because of the legal form of the investment vehicle.

The growth in investment income on a sequential basis was partially due to a higher level of average investable assets on a quarter-over-quarter basis. This growth was primarily generated by cash flow from operations, which amounted to approximately $1.5 billion on a trailing twelve-month basis. After reflecting share repurchases, which I will comment on in detail in a moment, investable assets amounted to approximately $9.5 billion at quarter end.

The average pretax yield of the portfolio in the 2007 quarter was 4.99%. This represented an increase of 46 basis points over the comparable 2006 yield, while on a sequential basis the yield increased by 8 basis points. The increase on investment yields on a quarter-over-quarter basis primarily resulted from higher interest rate levels as the portfolio's average credit quality remain near the AAA level.

During the quarter the duration of the portfolio remained basically unchanged at approximately 3.3 years. The unrealized loss in the portfolio for the quarter was primarily attributable to interest rate movements and reduced book value per share by $1.24.

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

In view of the current interest in the CMO/CDO sectors, I thought it would be beneficial to take some time and give you information on the position of our portfolio. At quarter end approximately $2.3 billion, or 24%, of our investable assets were invested in various types of mortgage-backed securities. Slightly more than half or approximately $1.2 billion of this allocation was invested in single-family mortgage-backs, with about $1 billion of this amount in pass-through securities of Ginnie Mae, Fannie Mae and Freddie Mac. And most of the balance in prime AAA rated non-agency paper, with only a minor amount in highly rated subprime securities.

The rest of the mortgage-backed portfolio consists of $1.1 billion of securities backed by commercial mortgages, of which approximately 40% was in Ginnie Mae project loans. The balance was invested in short duration, AAA securities largely underwritten and issued between 2000 -- between the years 2000 and 2002.

In addition, the portfolio of our collateral backing our securities lending program contains approximately $166 million of AAA rated very short duration subprime securities. And finally, and most importantly, our portfolio contains no CDOs of any sort.

Turning back to the income statement, the income tax provision applicable to operating income was 3% for the 2007 quarter. As you may know, the Company's quarterly tax provision is adjusted to reflect changes in its estimated annual effective tax rate. As a result, the second quarter of 2007 included a benefit of approximately $2.2 million, or $0.03 per share, to reflect the downward adjustment of the first quarter rate. We presently expect that our annual effective tax rate on operating income for the balance of 2007 will fall within a range of 3% to 5%.

Our balance sheet remains strong with total capital amounting to $4 billion, and debt and hybrids representing only 16% of the total. During the second quarter of 2007 we repurchased 2,956,000 common shares at an average price of $71.21. That brings the total number of shares repurchased through the end of the second quarter to approximately 3,640,000 shares at an average price of $70.07, or 1.48 times our June 30 book value per share. At quarter end we had approximately $745 million remaining available under our current repurchase authorization.

On a weighted average basis the share repurchases contributed $0.05 per share to EPS for the 2007 second quarter. The effect would have been $0.11 per share if full weight were given to them in the quarter. The repurchases aided our return on equity for the quarter by approximately 90 basis points, and would have aided it by approximately 140 basis on a pro forma fully weighted basis. Share repurchases through June 30 reduced book value per share by roughly $1.10.

In summary, our 2007 operating results so far have represented a return on equity of 25.1% on average capital. And our book value per share, including the effects of the share repurchases, rose to approximately $47.41 per share at quarter end.

With that we will take your questions.

(OPERATOR INSTRUCTIONS). Vinay Misquith, Credit Suisse.

On the pricing role, pricing is clearly coming down and competition is getting more heated. How do you look at your premium volume as you go into next year? Do you have any new programs or new opportunities that you're looking at?

We don't -- as we have said many times before, we don't run the Company on top line volume. We focus more on bottom line. So it is very hard to predict as to what our units are going to do over the next two, three, four quarters. What we instruct our underwriters to do is to make sure that they remain disciplined in underwriting their business, and look for opportunities in sectors that we believe there is more of an ability for us to achieve our target returns.

Having said that, we always look for opportunities. The only major shift I will say we made in the future in all of our operations is that we have -- are starting to focus a lot of our units to be writing even smaller accounts. Which in the past, because of how busy we were with midsize and larger accounts, we didn't have the opportunity to penetrate. so we are seeing some penetration in smaller sized accounts in the same specialty lines that we have expertise.

But very hard to predict what premium volume is going to come in the future, because I don't know where the market is going to end up being.

Sure. What is the mix of your small accounts, what is the large accounts right now?

We're still weighted heavily on smaller accounts in a lot of our units. But in some of our units we had artificial barriers in the past. Like 50,000 -- I'm talking about the Insurance Group. We had a 50,000 minimum premium requirement. And in some of those units we have removed that, and we have gone down to $25,000 as a minimum premium. We are still not in the very early small tiny accounts. Some of those we're doing it through our Program Division.

On your new prop fac team what has been the impact of the litigation? And when do you expect them to start producing some business?

First, they are producing business now. As you have probably been aware, the temporary restraining order was lifted. It was replaced by an agreement between us and Gen Re that requires us to not use any proprietary information. We never intended to use any proprietary information. We had none, and we don't intend to acquire any. So basically we are in the market. They are open for business. And they are writing business.

Having said that, when you are in litigation it is time consuming and it is a bit of a distraction to us and them. And at the end of the day that had some effect. But as I said in the last call, we like the team very much. We are in the game for the long run. We believe this is going to be an important part of what we do in our insurance groups over the years, and we're very patient.

One last question on the UK flood losses. John, I think I missed what you said. Did you say that it would be in the IBNR? I don't think you mentioned the number.

Yes, I said it would be contained within the IBNR. What I mean by that, given the size of the loss based at least on the current estimates that are out there, and based on what has been reported to us so far, first of all we are fairly underweight in the UK, and have been for some time, particularly on the flood side. We are more underweight on the flood than we are on the wind. It is a relatively small fraction of what our peak zone PML would be. That is number one.

On the insurance side, number two, we don't write homeowners. We don't write small commercial there. We write very large accounts. We're not anticipating anything dramatic.

Number three, we do every quarter, as we have discussed on other calls, in reserving for catastrophes there are two levels of catastrophe. One what we would label attritional. And that has a certain level. And we put IBNR up on that. In addition, when we reserve our pro rata property business, we also have attritional reserves for cat activity. And at the moment, based on what we know to date on the June storms, we believe that whatever losses come out will be contained within the IBNR that has been provided.

Could that also be true for the July storms?

Yes, the July -- remember, we have a cat load normally in all of our pricing. And that cat load anticipates a level of attritional losses and a level of more substantial losses, you know, bigger events. This would I believe still fall within the smaller end of the spectrum. And if it is similar to what it was in June then it probably will get absorbed in the IBNR(multiple speakers).

Matthew Heimermann, JP Morgan.

Just a couple of clarification questions. First, John, so the total subprime exposure across the whole portfolio, is it fair to say it is like $0.1 billion plus the $166 million?

No. Subprime exposure?

Yes.

It is less than $0.1 billion. (multiple speakers) It is $166 million. And the $166 million, when I said very short duration, is a duration of three to four months. We don't see that as issue at all.

Less than $100 million plus $166 million with a half-life of two months?

Correct.

In the Insurance Segment there was some negative development there. I just was wondering what was underlying that -- what lines?

It primarily came on the shorter-tail lines. Our tendency is on the shorter-tail lines is to just look at what happens in a quarter. You can get certain losses above and beyond what you expected. We just didn't adjust the IBNR. We let the losses flow through.

Were those like medium-sized individual risk losses, those types of things?

They were a variety of different type losses. We write a lot of different short-tail lines. We write property where we're fairly high excess. Some of that can develop over time. It is a variety of things.

Then I was wondering if -- you gave a lot of detail on what was happening, primarily in the U.S. European operations, I guess, could you just give a couple of quick comments on how you think the competitive environment is there?

Our European operations, and let me define it for you. Mostly what we do in Europe is a lot of energy-related business, so offshore/onshore energy. And that is the biggest sector of our business out of the UK office. The numbers I gave, the more global kind of numbers is what is happening with offshore and onshore energy.

The other part of what we do in Europe is we write small to medium-sized enterprises. And we write their professional liability and also their D&O. And that business has been under pressure, with about 10 to 15% rate reductions. We put those numbers into our D&O presentation. So in Europe, at least for our book of business for the sectors we participate, we see rate reductions around 10% on average.

(OPERATOR INSTRUCTIONS). Joshua Shanker, Citigroup.

Congratulations. My question really revolves around something you did about this time last year, where after you had a very successful renewal you went through what your new aggregate exposure would be in the case of a loss. I'm wondering you stepped up to the plate a little bit given the pricing of reinsurance for cat lines. And what do you think compared to one and two years ago your aggregate loss would be for Katrina kind of events? And where do you think your maximum exposures are?

As I said, we did step up to the plate, and now it represents slightly over 18% of our common equity -- that is the 1-in-250 event -- still is tricounty area, that is Dade, Broward and Miami counties in South Florida. But it is still well within our risk tolerance that we said if we like the pricing we might go as high as 25% over equity capital.

Now we -- see Katrina was such a unique event because of the flooding, etc., what we do is we run different tracks of different types of events, a cat three, cat four, a cat five, going through different entry points. And that is how we model where our exposures are. And basically, we feel comfortable.

If a Katrina-like event, which now viewed models more like 1-in-40, 1-in-50 years, but 1-in-250, our losses are going to be significantly less than the 18% of equity capital. Unless we get into a specific track, you know --.

The losses would be less on a dollar basis. And they would probably, when you look at the P&L impact, they would be substantially lower because of the much higher premiums we're getting for the same level of exposure.

Very good. In the Flatiron ceding commissions I was estimating premiums this quarter they would probably be flattening out here, but they were up a little bit. Are they going to begin to decline going forward?

It is obvious some of it depends on the profitability of the business. But as you noticed, they are going to track on a P&L basis, not on an economic basis. On a P&L basis they are going to track with earned premium. And since we began the program January 1 of last year the earned premium built very slowly throughout the year. So the year-over-year comparisons will -- it will slow a little bit, but it will still continue to build. We still haven't probably reached peak earned premium yet in the quarter for that.

Yes, I think third, fourth quarter will probably be your peak earnings quarters for the business we have written. And then depending on what we do at year end with the arrangement, then we will start deescalating as the unearned premium reserve goes through earnings over '08 and a little bit beyond that.

Nice work. Thank you.

Tom Cholnoky, Goldman Sachs.

A couple of quick questions. Dinos, I'm interested in your comments obviously on pricing. And I know you guys don't like to talk about projections, which is fine. At some point I assume pricing -- if pricing continues to decline at the same rate that it is declining, presumably you have got to start walking away from business a lot faster than you are doing now. I guess what I'm trying to get some sense is if the current trends, or you start to continue to compound at the current trends would it be a normal progression to think that your premium volume, there's no way, no matter how many opportunities that come up, that you're going to be growing premium volume in 2008?

If I take all your hypotheses, and all your hypothesis comes true, I think your statement is correct. I think we will be reducing premiums. Don't forget, markets adjust. We're clearly going into a more competitive environment. This is a business that responds to fear and greed, and there is no fear yet in what people think the business.

And rightfully so. As I said in my prepared remarks, everything that our units are writing today in our view, based on the underwriting principles we use and the pricing principles we use, still produce our 15% ROE target. So in essence, yes, the business is not as attractive as it was a year or two ago, but it is still reasonably priced.

Now when you get into people thinking that they can underwrite business and set targets at 10% ROE, and they get there, that environment will get very difficult for everybody, including us. And then you've got to be disciplined on top line, and probably we will be reducing volume further.

I guess a couple of companies, I didn't listen to the conference calls, I heard this just in looking at some transcripts that there is some complaints about what is going on in the E&S markets right now regarding competition. I was wondering if you can give us a little bit of an insight as to what you're seeing in various parts of the E&S markets?

I try to listen to the calls too or read them at night, and the transcripts. And I think generally I agree with some of your comments. Two things are happening on E&S. First, in the whole market too many things get thrown into the E&S market. Some of them belong and some don't. And usually the standard markets it takes them a few years, and then they recognize they threw -- excuse my phrase -- the baby with the bath water. And sometimes they go to retrieve their baby.

So there is some business that goes -- and it is a natural flow -- it goes back to the admitted market. You have to understand for us that is not a big issue because we are both in the admitted and E&S markets. So we do have the ability, if we like the terms, the price, and the account, to write it on an admitted basis. As a matter of fact, in the last year some of our business shifted from surplus lines paper to admitted paper just to maintain the account.

Having said that, I think the E&S part is shrinking. And unfortunately some of the time the standard markets, they take the business and they underprice it. They use a different approach to the business. The E&S market is tough on terms. They put big SIRs, etc. They usually don't like -- don't write the business on a deductible basis, where the admitted markets they write it with smaller deductibles, etc. That is where your big difference(inaudible).

You take a business, a piece of business that you might have a $25,000 SIR, it changes the frequency and severity of losses you are going to see. It goes into the admitted market. The SIR goes to $1,000 or $1,500 to $2,500 deductible. And all of a sudden the price is about the same, so you gave them a big discount from a rate point of view. And we see some of that happening in the marketplace.

That makes sense. Then just back to the property fac operation, did you -- I don't recall whether you initially gave us any sort of idea of how big this business could be. Because obviously these 30 some odd people at General Re were responsible for quite a big bit of business. And I'm not asking you when they could get there, but I mean there has got to be some sort of premium level that you would be happy with at some point that these folks should be able to generate for you.

We basically gave this answer in the last quarter. That business behaves no different than our insurance business. And we said that at steady-state it might take them a couple of years, maybe three years, to get there. We will be getting probably somewhere between $2.5 million to $3 million of revenue per employee. And that is no different than what the rest of our underwriting units, that they are underwriting individual account one by one do in our existing structure.

If you look at our Insurance Group today they write approximately $2.6 billion of gross written premium. And we have all-in approximately 900 employees or so in the Insurance Group. It is in $3 million per employee range that we get. And I think this business will behave similarly when it is firing on all cylinders.

Sorry, just too wrap that up, how many employees do they have currently?

We have approximately 35 employees.

Brian Meredith, UBS.

A couple of questions here. First, Dinos, can you talk a little bit about terms and conditions and what is happening out there? And relate it somewhat to maybe the loss cost environment we have right now, where frequency in the commercial lines business is pretty favorable. And if terms and conditions indeed are loosening up some here, would you expect frequency to start trending upwards here?

Yes, I think -- well, frequency gets affected by socioeconomic events, what happens in the kind of products we produce and the kind of cars we drive, etc. And there has been in pure accident. But also frequency gets affected significantly by terms and conditions. Because when you're moving deductibles up, you're moving SIRs up, some losses that otherwise will be reported to insurance companies they get absorbed by the insurers themselves. And that has an effect.

As terms and conditions start to loosen up, especially in the amount of risk that a client will absorb, your frequency trends will change. Having said that, even though I did mention in my prepared remarks that there is attempts by the client and the brokerage community to broaden terms, that is more anecdotal, they're not persistent throughout the market in everything that we see. So terms and conditions, and I'm talking about insurance now, they're holding but there is broadening that is happening anecdotally here and there. It is not yet pervasive in everything that we do.

Any lines in particular?

It is in everything. Even in property they tried to broaden their occurrence definition. In umbrellas they want to throw French coverages in, etc. It is the typical request they're going to come when a broker is trying to do a better job for their client and try to broaden coverage.

On the reinsurance side, and at least for us because we're predominately a quota share reinsurer, we don't write a lot of excess of loss. We write all of our excess of loss on the property and property cat lines. Everything else that we do is pro rata because we like to be side-by-side with our clients. Then there the only pressure we get it is on ceding commission. They want a little more for them to share their business with us. And that has been going on now for four, five, six quarters. But terms and conditions for us when you write pro rata reinsurance is what is happening in the underlying business. And we spend a lot of time monitoring to see where that is.

I'm not as much concerned yet that terms and conditions change is that is significant. But we are seeing that train leaving the station. And it is part of the whole mix of a softening market. And when I report rate movements, at least the way we measure them at Arch, we factor in not only premium dollars, the change in the dollars, but also the changes in deductibles and SIRs, and what that effect has on the rates. When I am quoting rate changes I'm talking about effective rate change, and it includes what we can measure in changes in terms and conditions.

Then the second question. You mentioned the Flatiron facility comes up for renewal here at year end. I'm wondering if you can walk us through a little bit your decision process as to whether to renew it or drop it down? Because candidly looking at your profitability right now in your reinsurance business, it would appear that you are probably a better return on capital to retain that business rather than using the excess capital to buy back stock.

It is the million dollar question of risk/reward. Yes, of course, if you take a lot more risk, and it is a business that rightfully should have good return characteristics, it will improve your returns. But don't forget, we start with what is our risk appetite? How much we want to risk the balance sheet, and at what level we want to keep that. And we have been doing -- I think a reasonable job is not overexposing the balance sheet, independent of how good the opportunity.

In our deliberations when year-end comes, or with our partners, which had been very good partners and we have great relationships with them, we together are going to assess the market. And we will say, what is the opportunity for satisfying first the Arch appetite for that business? What we believe the market is going to give us, and how much of that goes beyond our appetite. And if it is beyond our appetite, and our partners want to continue with us, I think there would be an opportunity for us to continue at some form the Flatiron.

But those discussions are premature. I think we've got to go through the hurricane season, which we are in the midst of right now, and have those discussions at the end of October, early November.

Meyer Shields, Stifel Nicolaus.

I guess my question is right now we're moving to an increasingly soft market. What are the implications for the Bermuda Group, since you're going to be competing largely with a group of carriers that really weren't around and therefore don't have data dating back to previous soft markets?

It depends which class you're talking about. I think for our group we have -- we work -- we have five years of data, and now we're working on our sixth year. For our Reinsurance Group, data is not an issue because they are sharing data with their clients. So they have --. Third, all of our profit center managers -- and we had no turnover in profit center managers since our inception in insurance or reinsurance. It has been minimal. They are all very experienced, seasoned executives with 20 to 30 years experience.

And fourth, there is a lot of available pricing data from the Insurance Service Office, NCCI, etc., for workers comp. In essence, there is enough tools in the marketplace for people who want to do prudent underwriting and prudent pricing of their business to have the ability to get the data and the tools to do it.

We don't view that, at least for the class of '01, which is one of them, we don't feel we're handicapped from that perspective. As a matter of fact, for Arch -- and I will be specific to Arch -- our systems that they will build or new technology that allows us to do very, very detailed rate monitoring. And it allows us to dice the data -- slice it and dice it as many ways we want. Somehow it gives us a certain advantage for what we have in trying to reach underwriting decisions.

Jay Cohen, Merrill Lynch.

Most of my questions were answered. But I guess just for modeling purposes, as you go out over the next several years with the insurance business, and the U.S.-based insurance business hopefully growing faster, should we expect the tax rate to tick up?

And I guess related to that we haven't heard much recently about some of the challenges to the tax status of companies like yours that are based in Bermuda and have operations in the U.S. Can you give us an update? Is there any concern on what is happening there?

On the tax rate, that is more driven again by where the business is written and what the profitability of that business is, more than anything else. Right now clearly property is a bigger part of the business. We write more of the property cat out of Bermuda that almost anywhere else. It is almost exclusive.

In terms of the tax rate picking up, it will depend again on the mix of profitability, so I wouldn't forecast that going to happen, it could happen, but I'm not sure that that is an absolute in this case.

On the tax question, we are a foreign company that does business in the United States with U.S. subsidiaries. There is existing laws dealing with transfer pricing. We abide by that. We pay excise tax. We paid transfer tax on some of the business. Without seeing a specific legislation, I don't know what that effect is. But we're not seeing a lot of traction yet in Washington to do anything that is specific to Bermuda.

Don't forget, this is a complicated issue. It has a lot of trade implications, and is not -- it can't be just Bermuda only. It is an issue that affects a lot of other jurisdictions. We continue to monitor it. Very hard to predict where legislators will go. But at the end of the day I think we have very good alternatives.

To the host, we have no further questions at this time. So I will turn the call back over to you both for any closing remarks you care to make.

It has been a great quarter for us. We're prepared -- I think we have an experienced underwriting staff. We are prepared to enter a softening (inaudible) cycle with a lot of experience. And we're looking forward in speaking with you in the next quarter. Have a good day.

Thank you, ladies and gentlemen, for your participation in today's conference. This concludes the presentation. You may all now disconnect. Have a great day.