Arch Capital Group Ltd (ACGLO) 2007 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the fourth-quarter 2007 Arch Capital Group earnings call. My name is Tanya, and I will be your coordinator for today. At this time, all participants are in a listen-only mode. We will conduct a question-and-answer session towards the end of the conference. (OPERATOR INSTRUCTIONS). As a reminder, this conference is being recorded for replay purposes.

Before we get started today, the Company would like to 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 assessment and assumptions and are subject to a number of risks and uncertainties. Consequently, actual results may differ materially from those expressed or implied. For more information on the risks and other factors that may affect future performance, investors should review periodic reports that are filed by the Company with the SEC from time to time.

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

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

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

Thank you, Tanya, and good morning, ladies and gentlemen, and welcome to our fourth-quarter and year-end earnings call. We're very pleased with the results we have achieved and equally pleased with the underwriting discipline our operating units displayed during the year in a much more challenging market environment.

Our book value per share, including the effects of share repurchases, increased to $55.12, a 25% increase from December of 2006. Our after-tax operating income for the fourth quarter was $3.11 per share, which represents a 24.3% annualized return on average common equity.

John, as usual, will give you a more detailed commentary on our financials in a few minutes. But before I turn it over to him, let me share with you some comments on subprime exposures, our Gulf Re joint venture investment and on general market conditions.

Our subprime exposures are relatively small. On pages 10 and 11 of our earnings release, we provided a more detailed listing of our investments. As you can see, our subprime holdings are minimal and the quality of our other holdings is excellent. John will provide further color later on in his presentation.

On the liabilities side of the balance sheet, we also believe that in relative terms, our exposures are not significant. Before I give you some of the specific data, I would like to remind you that we've begun to dramatically reduce our D&O exposure starting in the year 2005. This reduction was more acute on our reinsurance business than in our insurance business.

Our reinsurance units write no retro clash cover. In addition, our exposure to the top six D&O writers is limited to one company and only for a portion of their book of business. We estimate the market share of our reinsurance operations in the affected D&O and E&O lines to be in the range of 0.4% to 0.8%, a very minimal exposure.

As for our insurance operations, our total financial institutions premium volume for 2006 was $89 million on a gross basis and $46 million on a net basis, with an average limit of $4.5 million net and an average attachment of $60 million. In 2007, our gross written premium was $77 million, and our net written premium was $36 million, with an average limit of $4 million net and the same $60 million average attachment point. We estimate the U.S. financial institutions market to be between $3 billion to $4 billion. Therefore, our market share on a net basis is approximately 1%.

We believe that industry losses emanating from the subprime crisis will be from the 2006 and 2007 underwriting years and will develop over the next several years. It is also our view that primary writers will incur a larger amount of the industry loss than access carriers. Based on these assumptions, and although it is still early in the development of these losses, we believe that our potential loss should be contained within our loss estimates and our IBNR provisions.

Turning to strategic developments, on January 22 we entered into a joint venture agreement with the Gulf Investment Corporation to form a reinsurance company in Dubai International Financial Center. The Gulf Investment Corporation is owned equally by the six Gulf states which are members of the Gulf Cooperative Council.

The joint venture, which is a 50-50 partnership, will operate in the Gulf territories and provide property and casualty reinsurance. Our underwriting expertise, combined with our partners' strong local relationships in a region that is growing very fast, should afford us the opportunity to gain a meaningful amount of profitable business over the long term.

Gail Norstrom, a seasoned veteran of the insurance business, will be the CEO of Gulf Re. This venture is another step in our long-term strategy of gaining further territorial diversification.

The insurance market in general continues to drift downwards and is following the recent trends we have experienced in the past year or two, with rate movement varying by line of business. Rate reductions range from the low to mid-single digits to up to the low mid-double digits for some sectors. Large premium accounts continue to be under more competitive pressures than smaller premium accounts. Overall, our gross written premium declined by 5%, and our net written premium declined by 4%.

By unit, our reinsurance group reduced its premium writings by 10% on a gross basis and 12% on a net basis, while our insurance group premium volume was down by 3.5% on a gross basis and relatively flat on a net basis. We're pleased with the returns generated by both of our operating units, and although our focus on maintaining margins resulted in a declining premium volume, we're confident that the underwriting discipline exhibited by our units will enhance our ability to grow our book value per share at a very attractive rate over time.

In reinsurance, primary companies are increasingly scrutinizing their reinsurance purchases by retaining more business net and by attempting to shift from proportional placements to excess of loss. With the exception of more pressure on ceding commissions, other reinsurance terms are generally holding. On insurance, we continue to shift our emphasis to smaller accounts and loss-sensitive business where pressure on rates is less. Large premium accounts, as I mentioned before, continues to attract the most competition.

We have grown in the following sectors -- professional liability, construction surety, national accounts and executive assurance. Our professional liability growth emanates from our travel/accident business, which is included in the professional liability line because management responsibility lies there. Our executive assurance is experiencing, actually, negative growth in the U.S., and Bermuda, while it is growing its non-U.S. exposures in small to medium-sized companies, predominantly in Europe. The growth in construction surety and national accounts is coming predominantly from our loss-sensitive business, national accounts business. All other segments have shown negative growth due to market conditions.

As indicated in our release, given market conditions, we did not renew the Flatiron facility. As a result of this action, our net property and property cat volume will increase, but we intended to remain within our risk management guidelines in our aggregate PML exposures. As we have reminded you in the past, in determining our 1-in-250 event PML, we include all exposures that we believe could accumulate in a given event, not just the property exposures. As of February 1, 2007, our 1-in-250 PML from a single event expressed as a percentage of common equity was approximately 20%, with Northeast windstorm in tri-county, Florida, being the largest loss.

With that, I'm going to turn it over to John to get you through our financial performance. John?

Thank you, Dinos. Good morning, everyone. From a financial standpoint, our fourth-quarter results capped another terrific year, with a return on equity of over 24% driving growth in book value per share in excess of 7% for the quarter and 25% for the year. As usual, I'm going to briefly walk through the key components of our financial results, starting with the top line and 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 of note. For the year, premiums written by the insurance segment represented 64% of our gross volume and 59% of our net, while property and other short-tail lines of business now represent approximately 36% of our consolidated net premium volume. On a consolidated basis, the ratio of net to gross written premium in 2007 remained at approximately 70%.

On a reported basis, we ceded $35 million of written premium to Flatiron in the fourth quarters of 2007 and 2006. On an earned basis, premiums ceded under this treaty amounted to $76 million for the fourth quarter of 2007 in comparison with $62 million ceded during the 2006 fourth quarter. 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 that segment by 410 basis points in 2007, while the impact on their expense ratio in the comparable '06 period was 250 basis points.

As Dinos indicated, we did not renew the treaty with Flatiron. The unearned premium on businesses ceded to Flatiron was approximately $145 million at December 31, 2007. We also expect that an additional $25 million of written premium on existing contracts will be ceded to Flatiron in 2008.

Most of the ceded premium yet to be earned and the related fees, including profit-sharing, if any, will be reflected in earnings in 2008 and 2009, but predominantly in the first and second quarters of 2008. In addition, since we own the rights to the business previously ceded, any new or renewal business written will afford us the opportunity for additional profit.

Underwriting income for the fourth quarter of 2007 was $1.59 per share in comparison with $1.71 per share recorded in the fourth quarter of last year. On a consolidated basis, the combined ratio was 84.4% in the 2007 quarterly period, which was slightly higher than the comparable 2006 level. These outstanding underwriting results were due in part to the continuation of excellent results in the property and marine business of the reinsurance segment, as well as to the favorable development of prior-year reserves. The difference in the combined ratio quarter over quarter resulted from an increase in the loss ratio attributable in part to a lower effect on the loss ratio from favorable development.

On a consolidated basis, favorable reserve development, net of related adjustment to acquisition expenses, totaled $32 million in the 2007 fourth quarter compared to $33 million recorded in the fourth quarter of 2006. The components, when you look at acquisition versus loss, however, were different, accounting for the difference in the loss ratio.

A significant portion of the net favorable development in the 2007 quarter was attributable to short- and medium-tail lines. In general, reported and paid claim activity across most lines of business remained at favorable level, and IBNR and ACRs remained at approximately three-fourths of our total loss reserves.

Pretax net investment income in the fourth quarter on a reported basis increased by approximately 11% to $120 million or $1.69 per share. Investment income in the 2007 fourth quarter was adversely impacted by $1.6 million or $0.02 per share for mark-to-market adjustments on certain fixed-income investments that are accounted for in this manner because of the legal form of the investments. There were no such investments in the comparable 2006 period.

The growth in investment income on a quarter-over-quarter basis was primarily due to a higher level of average investable assets. This growth was generated by cash flow from operations, which amounted to $333 million for the 2007 quarter and $1.44 billion for the full year. After reflecting share repurchases, which I will comment on in detail in a moment, investable assets rose by 11% to approximately $10.1 billion at year end, and the portfolio remains very healthy and well-positioned.

The total pretax return of the portfolio is approximately 8.3% for the fourth quarter of 2007 and 6.5% for the full year. The average pretax yield of the fixed-income portfolio, before the effects of the mark-to-market adjustments I just mentioned, was 4.95% in the 2007 quarter. This represented an increase of 6 basis points over the comparable 2006 yield, while sequentially, on an adjusted basis, the yield was flat.

The increase in investment yield on a quarter-over-quarter basis resulted primarily from higher interest rates embedded in the portfolio as the portfolio's average credit quality remained near the AAA level. During the quarter, the duration of the portfolio basically remained unchanged at approximately 3.3 years.

Realized and unrealized gains on the portfolio increased book value per share by $1.01 for the 2007 quarter and were primarily attributable to interest-rate and currency movements, partially offset by the effects of wider credit spreads. The portfolio continues to be comprised primarily of high-quality fixed-income securities, with essentially no investments in hedge or private equity funds.

As Dinos indicated in his remarks, we've included additional data on mortgage-backed securities in our portfolio on page 11 of the release, which I encourage you to review. As the data indicates, our exposure to subprime securities is minor, and the quality of the mortgage-backed securities is very high, as reflected by numerous metrics, including their vintage, loan to value, subordination, market value relative to cost, and current ratings.

In addition, the portfolio contains no CDOs or no CLOs. We remain very comfortable with the quality and the liquidity of the portfolio. As a result, we're positioned to look for attractive opportunities that may arise as a result of the turmoil currently affecting the financial markets.

Turning to tax expense, we recorded an income tax benefit applicable to operating income of $1.9 million in the 2007 quarter. As you may know, the Company's tax provision is adjusted each quarter to reflect changes in our estimated annual effective tax rate. Moreover, a significant part of the Company's catastrophe-exposed written business is written by a Bermuda subsidiary. As a result, the Company's effective tax rate is favorably affected in periods with a low level of cat losses and adversely impacted in periods with significant catastrophic claims activity.

Primarily due to the below-average level of cat losses incurred, fourth-quarter results include a credit of approximately $6.2 million or $0.09 a share, due to a downward adjustment to our annual effective tax rate. We currently expect that our annual effective rate on taxes on operating income for 2008 will fall within a range of 2% to 4%.

Our balance sheet is in terrific shape, and our financial flexibility remains strong, with total capital amounting to approximately $4.3 billion at year end and with debt and hybrids representing less than 15% of the total.

With respect to capital management, during the fourth quarter of '07, we repurchased approximately 2 million common shares for consideration of $136 million. That brought the total number of shares repurchased in 2007 to approximately 7.8 million shares at a cost of $537 million, which represents an average price per share of $69.13 or 1.25 times our year-end book value per share. At year end, we had approximately $463 million remaining available under the current share repurchase authorization.

On a weighted average basis, the share repurchases were accretive to earnings per share by approximately $0.19 for the 2007 quarter. The effect would have been $0.22 per share if full weight were given to the repurchases in the quarter. The repurchases also enhanced return on equity for the quarter by approximately 220 basis points and 150 basis points for the year. For the quarter, share repurchases, net of accretion, reduced book value per share by approximately $0.08, while, for the full year, share repurchases reduced book value per share by roughly $1.45 on a net basis.

In summary, our 2007 operating results and capital management initiatives produced a return on equity of more than 24%, and book value, despite the effect of the share repurchases, grew over 7% during the quarter and 25% for the full year.

That concludes our prepared remarks. We will take questions now, Tanya.

(OPERATOR INSTRUCTIONS). Vinay Misquith, Credit Suisse.

Thanks for the clarity on the D&O and the E&O exposures. Do you have a sense for what the total industry losses will be for such exposures?

We believe, as most believe, that the losses will be around $3 billion. But it's too early in the game. That number is very, very soft. I don't want you to pay a tremendous amount of attention to it. It could be -- there is scenarios that they can make it larger, and there is scenarios that can make it a bit smaller than that.

The thing I want you to focus on is that the D&O/E&O premium for the industry is in excess of $10 billion, and this will affect two years, the '06 and '07 year. So you've got $20 billion worth of revenue the industry is getting from writing these lines. So even if the loss is double what I mentioned, as a percent, as a loss ratio percent, it's not going to be dramatic because all other activity within the lines has been benign. So, yes, it is a loss. It will develop over time. But at the end of the day, I don't think it is changing the market significantly.

When you set your reserves for your losses for '06 and '07, was it based on industry loss estimate of about $3 billion, or was it more based on contract specifications?

Well, we do two things. One is, you set case reserves on specific cases. So we had a few reported in our insurance group. You make your evaluation, and you set up a case reserve for those. And if we had any reports in the reinsurance side, we do exactly the same. The rest of it, we put in our IBNR account, and it's a combination of looking at industry estimated aggregate loss and what our market share is. And in the reinsurance division, we look contract by contract at what we believe our maximum exposure will be on a particular contract. The fact that we have not participated on the reinsurance side in the top six writers, we don't have that many contracts for us that give us concern.

Okay, that' fair. The second question is the growth in your surety and contractors. If you could just help explain that, and also, in our declining economy, how do you see the losses on that business stacking up?

Well, on the D&O lines, and this is predominantly commentary on the insurance group, you know, we saw reductions because of price pressures in the U.S. and also what we do in Bermuda, which is predominantly U.S.-exposed type of business. In Bermuda, we write the very high excess; a lot of it is Side A and is attaching in excess of $100 million in most cases.

What we have grown in the D&O area is our initiatives in Europe. We write small to medium-sized enterprises that have no U.S. exposure, no ADRs and no listing in the U.S. exchanges. So that's the mix in our D&O/E&O book. That was your question, or you had something further to that?

It was on the surety and contractors, actually. Sorry.

Okay, I'll get into that in a bit. We classify construction surety and national accounts into one bucket because of the way we manage that group. On the construction side, we are kind of flattish, and most of what we write is the medium to larger contractors, not the jumbos. A lot of what we do is loss-sensitive. These are accounts that they will retain the first $100,000 to $250,000 of each and every loss for GL, auto and workers' comp. That's our portfolio.

On the surety side, we have seen a significant reduction in volume for our subdivision bonds, which were a big facility. We write a lot of subdivision bonds. It's not a lot of premium, but we've seen quite a bit of restraint by developers in developing new tracts of land for development. It's the obvious thing; if they have high inventory of unsold homes, they are not going to be developing new tracts.

That business is performing extremely well for us. The unfortunate thing is that the volume is not as great as we had been in prior years, and probably won't be for another year or two. The rest of the surety is predominantly on commercial contracts, and a lot of it is for either federal or state work, et cetera, and we haven't seen a slowdown either in activity or requests, or we haven't seen significant degradation of the financials of some of these contractors, with the exception of some that they are on both sides of -- they do residential and commercial construction, and they go back and forth.

So it's too early. But traditionally, surety has not suffered because we go through a softer cycle. Of course, subprime -- it's going to create some credit crunch, and it will affect that sector also. But we're monitoring that, and along with our credit committees, we make sure that we have enough collateral when we extend credit to these contractors.

The thing I would add is, when you look at that grouping, the growth is coming out of the national accounts business, the loss-sensitive business. We are not growing the surety book at the moment.

Matthew Heimermann, JPMorgan.

I just had a couple quick numbers questions. The first one was, John, could you just remind us how much premium you ceded to Flatiron in '07?

Yes. We ceded roughly -- on an earned basis?

On a written basis, actually.

On a written basis, roughly $280 million we ceded to them in '07.

And then going forward, when we think about the premium left to earn, we should be summing the unearned premium, which I think you said was 147, plus the 25 that's going to be written?

There's going to be a little bit of written, too.

Well, that's 145 written and -- 145 unearned plus about 25 is our current estimate, because it's on pro rata contracts.

Perfect. I just wanted to make sure I didn't screw that up. The other thing was, Dinos -- oh, actually, one more numbers question for John was just -- or Dinos -- can you give us a sense of, in the commercial contractors business, how much of your book is state/federal? How does that compare to the industry? Because a lot of people have been talking about a lot of this is federal or state business. But I don't really have any metric to put that into context.

I don't have that number right in front of me, but we can get it to you. But usually, a lot of what gets bonded is state/federal work, because it's mandated by law. And in essence, the bigger portion of what we do emanates from those sectors. But we'll get you a number. We don't have it right at our fingertips, and I don't want to speculate. Speculation usually is not a good thing.

No, that's fair enough. I appreciate that. And then the last thing, Dinos, is just I guess I would appreciate your views on how the D&O situation is going to play out. Is your sense that -- it's going to take awhile for people to figure out losses, but do you think we are going to see the industry establishing case reserves increasingly over the course of the next year, let's say, or do you think what we're going to see is purely companies are going to hold higher levels of IBNR than they have in the past, and maybe you actually see a slowdown in the release of IBNR from some of these D&O and E&O lines?

It's kind of early in the game. Each case goes on its own facts and its own merits. And here, you have situations that there are going to be D&O cases, but also there are going to be E&O cases. A lot of the E&O cases potentially will be for the large investment banks, which they were selling these kind of products, and it only takes a lawyer with a law degree to draft a complaint. They sue, and it's going to go basically on the merits.

For the insurance business, not a lot of investment banks' E&O has been purchased because it's a cover that was not really readily available for them. So, in essence, the big investment banks are going to be on their own when it comes to the E&O side.

On the D&O, of course, there are going to be investor allegations, too. The Side A is probably much more protected on the basis that we don't see any investment banks going bankrupt. So Side A will give you derivative actions and bankruptcy. The rest of it, I think, has got to go case by case.

Companies there are setting reserves when they have the facts. But seeing as this got so much notoriety, also companies are trying to add to their IBNR because, believe me, if I had a clearer picture, I would be able to elaborate further. So at least what we do is we try to get a global view, what our market share is, insurance and reinsurance, et cetera, look at our specific cases, reserve those, and then throw IBNR, which in our judgment should cover the rest of it. That's the approach that we take.

I believe, and it's not that I have inside information, that most companies have a similar process to that.

Brian Meredith, UBS.

A couple quick questions here for you. First, just quickly on the D&O situation, how much of your business is primary versus excess?

We have almost zero primary. We're predominantly an excess writer.

Then, on Flatiron, can you give me a sense of how much of that Flatiron business actually renews at 1/1 in the business that you ceded? Then, on top of that, how much business of the Flatiron do you think you can keep here going forward without going above what your target threshold PML is?

Well, it varies by the two years. So I'm going to give you a blended, because it depends when we make decisions. But the January 1, I would say somewhere between 35% and 40% -- not January 1, the first quarter of each year. Our determination as to how much we're going to retain is going to depend on where the pricing is and what aggregate PMLs we want to retain on a net basis.

As I said in my prepared remarks, we were not going to exceed our maximum risk management limit, which is 25% of common equity at the maximum. I would guess, and this is depending -- if the market stays where it is today, probably you're going to see our PML go to maybe 22% or 23% right before the season. But I can't tell you exactly which contracts we're going to renew and which contracts we're going to cut back on. It will depend on the available pricing in the marketplace, and that's the way we allocate PML aggregates. We go deal by deal, we see where we think the potential for maximizing our profit is, and that's where we allocate the PML capacity.

But we're going to have that overarching limit of PML capacity, and our intention is to use it. We still like the pricing. Even though the pricing was about down 15% year over year on the cat business, we still believe it gives us adequate returns for the risk that we're taking. So we continue to be in that sector.

John, could you give us some help here with how you expect the reinsurance expense ratio to play out throughout 2008? It looks like you've been getting a benefit of about 3 points a quarter on your expense ratio from the Flatiron commission income. Should that just gradually wind down every single quarter to the end of the year?

Yes, and I think it will be weighted more towards -- you'll get more benefit in the first and second quarters from the runoff of the Flatiron business, because as the earned premium comes in, they will still be getting benefit, and then the increase in the acquisition ratio purely itself.

Now, to the extent, obviously, we write additional business and retain it for ourselves, that's going to be a counterbalancing factor. And how that plays out is just going to be a function of how much business we do take on and then whether or not it's pro rata versus excess.

And cat business usually is excess, and even though pro rata contracts will give you a cat component, but if we increase our excess business, that comes at a much lower expense ratio. It's the nature of how these contracts operate. So very hard to predict expense ratio, because I've got to have the deals, deal by deal, and determine if the quota share, which they have a high ceding commission, also high expense, or excess of loss, which they give you a very low expense ratio.

And we're basically agnostic as to whether it's one or the other. It's just where we think we can get the best risk-adjusted return.

The economics will drive the determination as to where we play.

And then last question, remind us kind of dividend philosophy -- any thoughts of implementing a dividend here anytime soon?

Well, at the moment we still, obviously, have a lot left under our authorization, and of course, the Board can always increase that again, if they desire. Where we are currently is we still, especially based on where the stock is today and when you look at what we would think intrinsic value is of the Company, we think it's a better use of the money to buy stock back at these levels. At some point, and it's something we continue to think about all the time, and at some point in the future the scales may tilt in the other direction. But I'd say for now, we'd still rather use the capital to buy back stock.

Susan Spivak, Wachovia.

I was hoping you could go into just a little bit more detail on the insurance side about the level of competition. We've just been hearing so much about how intense it has gotten, especially in the excess and surplus lines market, from a lot of the new players coming in. So I'm just wondering if you could talk a little bit about what your strategy is going forward and what you're seeing in those markets.

Yes. We see two things on the E&S side. Yes, we see more competition. It comes from two sources. The class of '01, if you refer to us as that, has been in this business now for five, six years, along with the domestic players. The new entrants is the class of '05, which some of them -- they are starting to set up E&S operations and go after that business. But more importantly, also the standard markets now is trying to claw back some of the business that shouldn't have gone to the E&S market, but it did. And now they will write it on an admitted basis. So that's what's going -- so price is shrinking a bit, so we're writing less of it, et cetera.

From a pricing point of view, I can only give you our numbers. In the third quarter '07, this segment for us, which includes both umbrella excess and primary surplus lines, was down 6% in rate. In the fourth quarter, it was down 7.9% in rate. That's on the business that we have renewed and kept. The business that we have lost, of course, had a higher percentage reduction. That's what's happening in that particular segment of the business.

So the new business pricing is down more than double that, then, of the renewals?

No. What I said is the business we have renewed and kept on our books, we lost 7.9% average rate. On business that we didn't renew, we lost to competition, the rate reduction was greater than 7.9%.

Matthew Heimermann, JPMorgan.

Just two quick follow-ups on Flatiron. One was, John, I guess maybe I would like the ceded earned premium from Flatiron last year. Then the other thing was, would you be willing to give us the PML as of year end, if you excluded the benefit of Flatiron, the reinsurance protection you get from Flatiron, as if that was all -- if gross equaled net there?

Probably with -- it's a little tricky to do that, only because of the Florida business. If I gave it to you in the Northeast, it might be more appropriate. I don't think it would be that dramatically different from where we are right now.

Don't forget, Flatiron covers our business written out of Arch Re Limited in Bermuda, and we have other portions of businesses that they contribute to our PML, like our U.S. operations, which is, for the Northeast, they can be a factor. The reinsurance operation in the U.S., they don't write a lot of Southeast wind, but they do write Midwestern hail and tornado and some Northeast business.

Of course, we have the insurance group, and the insurance group contributes to that. But the business that we do in Bermuda, and we were a 55-45 split, the PML usually is split on that same basis for that portion of the exposure.

John is working on some numbers (multiple speakers)

I was going to say, your point on Florida basically reflects the fact that there's -- probabilistically, you don't put a lot of risk in your PML at year end for that business, even if there's a premium left to earn, correct? So in other words, if I asked you the PML differential at 7/1, there would be a bigger differential than you're talking about today?

Yes. Well, what I said is, given the market conditions where they are today, our PML now is at 20% of common equity. Probably at the beginning of the season -- and this is just a projection; it might or might not happen because you don't know what kind of contract you are going to get -- that will probably increase to 22% to 23%. That's our estimate right now.

That's helpful.

That number I gave you was the earned as opposed to the written.

Okay. Do you have the written, then?

Yes, let me get you that in a minute here. You're working on your model, I guess? (multiple speakers) The written was about 310.

Perfect. Thank you so much. Was it that obvious I was working on my model?

No, but your model is pretty good. We will compliment you on that.

(OPERATOR INSTRUCTIONS). Ron Bobman, Capital Returns.

Congrats on a fine job. I had a question about your insurance business and your approach to buying reinsurance, whether you are buying more or buying less, and if you could talk about it on sort of the subsegment lines of business inside of the insurance book?

We are net underwriters when we write exposures for what we call small accounts with small limits. So usually, a lot of it in our professional liability, when we issue $500,000, $1 million policies, et cetera, we like to underwrite on our net account. And we keep that 100% net.

When it comes to capacity products, D&O is one, or property is another one, or large professional liability exposures or medical malpractice for hospitals, our approach there is to buy reinsurance. Usually, we want to retain, out of a $25 million capacity, somewhere between $10 million to $12.5 million of net of that, so somewhere between 40% to 50% of the line, net. The exception of that will be property that, even when we put $100 million capacity, we only retain maximum of 15% -- $15 million net line or 50% of the $100 million.

Our philosophy with reinsurance is as follows -- you want to protect your book of business, both on a horizontal basis and on a vertical basis. We make those judgments, and then, depending on what the market will give us, we determine if we're going to buy more or less. Right now, our tendency is to buy more reinsurance rather than less in the sectors that require capacity because we believe the pricing is not detrimental to us. So in essence, you might have a positive arbitrage in the marketplace.

The other thing we do is we might switch some covers from a pro rata to an excess of loss. Especially, we like the excess of loss cost. This is not unusual for companies to do in a softening market. They might switch some of the play.

So the bottom line is, I think we're buying a little more. And also, I think, in some of our programs, we are switching to an excess of loss, if we can.

And no change on what you described as the small capacity business?

No. As a matter of fact, those are the lines that basically -- none of our small business is experiencing rate reductions that exceed 5%. A lot of them, we have segments that they are flat. We have segments that there are only 1% or 2%. It's not a good picture because you still have the trend going against you. Maybe the frequency is still good, but the severity trend is increasing. But in a market that everything is going down, when you're getting flat or 1% or 2% or 3% reductions, it's a much better business to keep. Also, it's not as volatile, because you don't have significant limits exposed.

That's obviously where we sit today. It's something we look about and think about all the time. We always try to be in a position so that we can adjust to what's going on in the market in a variety of ways, and reinsurance purchasing is one of them.

Understood. Thanks again, and best of luck.

(OPERATOR INSTRUCTIONS). There are no other questions at this time.

Well, thank you, ladies and gentlemen. We are looking forward to seeing you next quarter. Have a good day.

That concludes the presentation. You may now disconnect, and have a great day.