Arch Capital Group Ltd (ACGLO) 2010 Q4 法說會逐字稿

Good day, ladies and gentlemen and welcome to the fourth quarter 2010 Arch Capital Group earnings conference call. My name is Alicia and I'll be your operator for today. At this time, all participants are in listen-only mode. Later we will conduct a question-and-answer session. (Operator Instructions) As a reminder this call is being recorded for replay purpose.

Before the Company gets started with this 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 these 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 may 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 conference over to your hosts for today, Dinos Iordanou and John Hele. Please proceed.

Thank you, Alicia. Good morning, everyone and thank you for joining us today. Our performance for the fourth quarter was reasonable as we continue to operate in a challenging underwriting environment. Our annualized return on average common equity was 12.1% on a reported basis which, in our view, is acceptable for current market conditions. These returns, which were aided by favorable prior-year reserve development were not significantly affected by CAT activity as the combination of major CATS plus attrition CAT losses approximated the expected CAT load for the quarter. The Australian floods impacted the fourth quarter by $22.5 million while our early estimates for the 2011 Australian floods and Cyclone Yasi are estimated to impact the first quarter of 2011 by $30 million to $60 million in the aggregate.

By our own estimation, in the current insurance and investment environment, on a normalized basis, we're achieving approximately a 9% ROE on business written in the 2010 underwriting year. This return, even though it does not meet our long-term target of 15%, is realistic given the operating and financial market conditions that exist. As you all know, a target over a complete cycle is to achieve a 15% ROE and all of our incentive compensation targets are based on that metric. We still believe that in the long run the target is achievable, and as a Company we have chosen not to make any changes to this current rate due to the current environment.

In terms of creating shareholder value, we believe that our ability to increase book value per share is the most important measure, and in this respect we had a good result in a very challenging investment environment. Viewed against a back drop of a significant increase in interest rates in the fourth quarter, our investment returns were excellent and combined with adequate operating returns on our underwriting activity, book value per share grew to $89.98 which is an increase of 23% from the year end 2009 and 1% from September 30, 2010. From an underwriting point of view, we achieved a 92.7% calendar year combined ratio which, by our estimation, is 5% to 7% better than our normalized accident year combined ratio of 98% to 100%.

Cash flow from operations remains good at $145 million which is down from $184 million from a year ago. The lower level of cash flow was affected by a reduction in exposure in premium writings as well as from the maturation of claims from early accident years that had bigger exposure base. Another factor influencing cash flow emanates from our movement to short-tail lines over the past several years which has an effect on claim payment patterns. In essence, it accelerates the payment pattern significantly. From a production point of view, our gross written premiums were down 8% and our net written premiums were down about 6%. Our Reinsurance operations were down 13% on a gross-written and 12% on a net-written basis. Our Insurance operations were down 6.3% on a gross-written and 5% on a net-written basis.

During the fourth quarter and in our January 1 renewals, we saw no significant change in market conditions in our insurance business. We continue to see pressure from ceding to increase ceding commissions and in general saw a reduction in primary rates of approximately 5%. We also noted that clients are continuing to look for opportunities to switch some Pro Rata contracts to excess of loss in order to maintain a larger amount of net premiums on their books. In our CAT opportunities, the anticipated introduction of RMS 11 had no noticeable effect on either demand or pricing as of yet. However, in anticipation of the model changes during the January renewal period we adjusted our pricing for certain non-coastal exposures in anticipation of the rollout of RMS 11.

Even in the most difficult markets we always look for opportunities to find acceptable books of business to underwrite without sacrificing underwriting discipline. On January 1 we were successful on medium tail opportunities as we found that the improved pricing levels will produce acceptable risk adjusted returns and we took advantage of those opportunities. Our Insurance group continues to emphasize and move their books to less volatile lines and to reduce their writings in US Casualty business. Despite these actions, due to the challenging market conditions that exist, margins generally continue to be under pressure and as a result we saw a reduction in writings in our insurance group. We are pleased with these actions, as underwriting discipline will always take priority over premium production.

In the primary casualty E&S sector in the US we're starting to see isolated areas in which price increases are demanded and achieved by the market. These increases are specific to certain classes or territories, but it is an indication to us that the bottom may have been reached for this segment and underwriters are not willing to go further down in pricing. Having said that, looking at price adequacy on an absolute basis, it does not appear that the pricing corrections are enough for us to be interested in significantly expanding our book of business.

As we indicated in the last quarter call, third quarter share repurchases were relatively light due to the hurricane season. As you know, we accelerated our Share repurchase activity in the fourth quarter of 2010 and repurchased 2.9 million shares for $258.2 million which represents an average price of $89.23 per share. Also during the first quarter through February 11, we have invested an additional $140 million for 1.6 million shares at an average price of $87.87 per share. With these repurchases, our remaining available authorization is $90 million. And in light of that, we expect to review our Share Repurchase program at our next board meeting. I would like to emphasize that our capital management philosophy has not changed. We will continue to return excess capital to our shareholders until such time that we can profitably deploy it in our business.

Before I turn it over to John for more comments on our financial results, let me share a few thoughts on our CAT writings and PML aggregates. As of January 1, 2011, our one in 250 PML from a single event was $733 million or approximately 17.5% of common equity, down from $809 million as of October 1, 2010. Our Northeast wind area PML is now the largest PML exposure at $733 million, down from $756 million as of October 1, 2010. The PML for the Florida Tri-county area now stands at $683 million down from $809 million at October 1, 2010. Both zones are significantly below our self-imposed limitation of 25% of equity. John?

Thank you, Dinos. Good morning. I will now cover some of the financial highlights of the quarter. For the 2010 fourth quarter, property and other short-tail lines represented approximately 48% of our net earned premium volume compared to 47% in the 2009 fourth quarter. On a consolidated basis, the ratio of net to gross was 72%, the same as a year ago. Our overall operating results for the quarter reflected a combined ratio of 92.7% compared to 88.8% for the same period in 2009. The 2010 fourth quarter loss ratio included $31 million or 4.9 points of current accident year CAT activity compared to $3 million or 0.4 points in the 2009 fourth quarter. Fourth quarter current year CAT activity was primarily related to the Queensland, Australia floods totaling $23 million, and attrition property CAT events in the US of $7 million.

In the 2010 fourth quarter development on CAT events from earlier in 2010 were negligible with $9 million increase in the 2010 third quarter New Zealand earthquake event substantially offset by reductions in estimates for the Chilean earthquake and Windstorm Xynthia of $8 million. The impact of the Australian flood events and Cyclone Yasi are still preliminary in developing, and as Dinos mentioned, beyond the $22.5 million already booked in 2010, the range we are estimated at this time for 2011 is from $30 million to $60 million based on a total industry estimated loss of $3 billion to $5 billion for the aggregate Australian floods and a total loss of $500 million to $1.5 billion for Cyclone Yasi.

The 2010 fourth quarter combined ratio reflected 6.1 points for $39 million of estimated favorable development, net of related adjustments, compared to 2.3 points or $16 million in the 2009 fourth quarter. The prior development in the fourth quarter 2010 reflect a net favored development primarily in property and other short and medium-tail lines, as well as in the Reinsurance segment casualty business from the 2002 to 2006 underwriting years. For the 2010 full year, our net favorable development impacted the combined ratio by 5.4 points or $138 million, compared to 6.4 points or $183 million for the 2009 full year.

The 2010 fourth quarter current accident year loss ratio, excluding large CAT events and net favorable development is about the same as a year ago, which reflects the overall change in the mix of business, away from US casualty writings where we have increased the current accident year loss picks to shorter and medium-tail business that have relatively lower current accident year loss picks. It also reflects the shift during the last several years in the insurance segment from larger account business, which had the higher current accident year loss pick, to smaller account business, which had the lower current accident year loss pick and less volatility but a higher expense ratio.

The 2010 fourth quarter expense ratio of 34.6% was 3.7 points higher than in the 2009 fourth quarter, mainly due to the 2010 fourth quarter other operating expense ratio, which was 4.1 points higher than in the 2009 fourth quarter. Contributors to the higher ratio included approximately $7 million or 1.1 point in our Insurance segment resulting from an accrual for certain employee benefits that are not expected to recur in 2011. And approximately $6 million or one point in our Reinsurance segment related a higher incentive compensation costs primarily related to better experience in business written in prior years which should be averaged out over the year to estimate a run rate. Approximately 1.7 points of the other operating expense ratio was attributed to the lower premium volume.

On a per share basis, pre-tax net investment income rose to $1.81 in the 2010 fourth quarter, compared to $1.56 for the same period a year ago and $1.77 in the third quarter 2010. The growth reflects the accretive impact of the Share Repurchase program more than offsetting lower reinvestment yields. Our embedded pre-tax book yield before expenses were 3.25% in the 2010 fourth quarter, about the same as the 2010 third quarter. Total return on the investment portfolio was minus seven basis points in the 2010 fourth quarter. Excluding Foreign Exchange, it was minus four basis points in the quarter. The net total return was affected by the increase in interest rates during the quarter which impacted our fixed income portfolio by minus 70 basis points which were almost all offset by good returns in equities and other alternative assets.

Throughout the past few quarters, Arch continued to allocate more assets to equities and internal investments. Our allocation to equities was approximately 3% of our investable assets at year end, while alternative investments and equity method investments were 7% of our investable assets. The investment grade fixed income portion portfolio including the TALF portfolio plus short-term investments and cash at end of 2010 was 85% of total investable assets of $11.8 billion, compared to the end of 2009 when it was 91% of $11.4 billion. We continue to maintain a very high quality fixed income investment portfolio with an average credit rating of AA plus.

Our Municipal Bond portfolio of $1.2 billion had a market value of 102% of the book value at the end of 2010. Pre refunded and revenue bonds account for 42% of this portfolio. The General Obligation bonds have an average rating of AA plus and an average duration of four. With the three largest concentrations in Texas, which is 9% of the total Muni portfolio; Maryland, 7%; and North Carolina, 7%. Our exposure to uninsured General Obligation bonds of states of interest today of California, Michigan, Illinois, New York, New Jersey, Nevada, and Arizona, altogether only total 0.2% of the total municipal portfolio.

The duration of the investment portfolio in total decreased to 2.83, down from 3.11 at the end of the third quarter of 2010. The shortening in duration during the 2010 fourth quarter reflects the potential movement I mentioned on our last call in response to rising interest rates. As a reminder, we matched the duration of the portfolio of the portion of our investments that back our insurance and debt liabilities in order to economically immunize this large portion of our balance sheet, but we currently maintain a low duration target to remain in investments to dampen the impact from rising interest rates.

For the 2010 full year, our annual effective tax rate on pre-tax operating income was 0.5%, down from the 2% annual effective rate used in the third quarter which resulted in a tax benefit in the 2010 fourth quarter of $5 million or $0.10 per share. Our effective tax rate fluctuates from period to period based on the relative mix of income reported by jurisdiction. The full year effective tax rate was below the range indicated last quarter of 1% to 3% due to changes in the relative mix which resulted from favorable reserve development, CAT activity, and expense items by jurisdiction. Reserve development by its nature is not predictable and as indicated earlier fourth quarter expenses reflected certain nonrecurring items. Our expected range for 2011 is a gain 1% to 3%, but certain factors as experienced in 2010 can cause the tax rate to fall outside this range.

Our balance sheet continues to be conservatively positioned with total capital at $4.9 billion at December 31, 2010, down from $5.1 billion at the end of September and reflecting the share repurchase activity during the quarter. In the quarter, as Dinos mentioned, we repurchased 2.9 million shares for $258 million with an average price per share of $89.23. The estimated accretive impact of the cumulative share repurchase activity since 2007 added $0.75 to the diluted operating earnings per share and 3% to our ROE. Our debt plus hybrids represent approximately 15% of our total capital, well below any rating agency limit for our target rating.

Our book value per share ended the year at $89.98 up 1% in the quarter and 23% for the year. As of December 31, 2010, we estimate that including AOCI, we hold approximately $600 million to $800 million above our targeted capital level based on current rating agency models with an appropriate buffer. Excluding AOCI, our excess capital position would be $400 million to $600 million. Our liquid cash, short-term investments, and US Treasuries represent about 18% of our investable assets.

With these comments, we are pleased to take your questions.

Alicia, we're ready for questions.

(Operator Instructions)

Josh Shanker, Deutsche Bank.

John kind of explained the tax situation, but I realize there's a lot of moving parts in that. I note that you guys are forecasting again a 1% to 3% tax rate for next year. And John mentioned that it's differences in mix that caused the tax benefit this year. Maybe I just need a little bit more clarification, try and understand why it got better but why we're resuming the old prediction for next year's taxes?

Well I'll give you a few comments and then turn it over to John to give you more detail. It depends on where our income is emanating from. And as you can see, what we book in the US on an accident-year basis is not producing any underwriting profit. So when we have light cat activity, we have significant income from our overseas operations. So depending where the income comes from, it will determine what our effective tax rate is. That's why it's not very predictable. Of course everything we keep -- almost everything, not quite everything we keep in the US, we invest in triple tax-free municipal bonds. So on the investment income side we don't have much tax. The FET we book as an expense item, that's why you don't see it on that line because anything we reinsure overseas than we have to pay an FET. It's that combination and those are the moving parts. So for this quarter, a lot of our income came from the business we wrote overseas and that's the reason that the true-up of the tax rate from the all four quarters into the fourth quarter reduced the rate to that point.

So, Josh, we had reinsurance favorable development from the casualty lines, it mainly came from Bermuda, and that was an impact in the quarter. We had some of the cat events, some came out of the UK which would lower the effective tax rate. And also the expenses, the higher nonrecurring expenses in the quarter also lowered what we thought we may be paying in taxes and we had to adjust for the whole year as we go through this. So we have to true it up as you move through the year. And thus, it is hard to predict where these are going to come sometimes in various different jurisdictions and that's why it can fluctuate around a bit.

Now I don't mean too sound too dark, but it's not a long shot to say that you may not make an underwriting profit on the insurance side of the business in 2011. Would that cause you to have lower than 1% to 3% taxes for the aggregate business?

No, I don't think it will go lower than that. But because the effective tax rate we pay on the US-generated business excluding the FET, it's approximately 9% to 10% when you do that calculation. And that excludes the FET we pay outside that calculation. So I don't think that will change. It's just a significant part of our income for 2010 came from what we do in other parts of the world, especially in our cat book. And also, most of the reserve releases, they were from business we wrote overseas.

All right. And then along those lines about the underwriting in the insurance business, obviously reinsurance becoming a smaller part of the business given the opportunities you have there, insurance is kind of stagnating here. Is there -- given a reasonable amount of catastrophes and not a lot of insurance underwriting profit, what's your outlook for the next 12 to 18 months on underwriting? I guess it's a loaded question but I'm -- obviously the sources of underwriting income are drying up to some extent.

You're pretty smart in asking me to give you guidance when we don't give guidance.

Well how about industry guidance?

Well let me -- there is a lot of what-if scenarios that you can go through. The only thing I can tell you is what has happened, and we don't have that view for the future because I can't predict the future. I don't know what cat events will happen. I don't know. We go and we underwrite business where we believe we're getting adequate returns. As I said in my prepared remarks, we think the business in the aggregate, between insurance and reinsurance, is producing about a 9% ROE on a normalized basis. This is not allocating our entire capital to the business because I don't hold my operating units responsible for the excess capital I have. So in essence, it's not a great environment.

Having said that, we're not unhappy with what we're achieving on the Insurance Group or the Reinsurance Group. And from a volume point of view, it's too early to predict. But on January 1, it was very decent, the best we had in the last couple of years with probably both insurance and reinsurance being flattish. But the quarter is not out yet. This is just the general business that we already know what we have. That's the best we can do. At the end of the day, we don't run the Company in trying to predict the future. We try to react as best as we can to the market conditions that are presented to us.

Thank you for all of the answers and good luck in the new year.

Thank you.

Thanks, Josh.

Vinay Misquith, Credit Suisse.

Your margins have stayed remarkably strong in 2010 versus 2009 because of business and mix changes. Should we expect some sort of favorable impact because of mix changes in '11 too? Plus, if you could also add on the fact that you mentioned pricing is flat. So since loss strains are up, should we see some sort of deterioration on the margins this year versus last year?

Yes, I would think that pricing is about flattish, in some sectors down. We've seen a few glimpses of hope in some isolated instances as I have mentioned. Our Reinsurance Group found certain opportunities in Europe to write some decent business, medium-tail type of business on a quota share basis. So we see exposure demand to be slightly increasing. You've heard that from other calls from a lot of our competitors. That means that the four years of negative premium growth for the industry might be over with 2010 maybe being at the same level as '09 and then '11 projected to have some slight increase in revenue for the industry. So all that is positive. But on the rating -- on the rates, I think you're absolutely correct. So depending how a mix -- if a mix stays steady state and it doesn't change, yes, our accident year is going to go up a bit. If we continue to be affecting changes, and we try all of the time to make sure that we're going where we believe is the best returns, that effect might be dampened a little bit.

Sure, fair enough. The second question is really on the pockets of hardening you mentioned. Do you think these are isolated incidents or do you think this is a process of the market bottoming out and do you expect positive price changes later on during the year?

No, I see it as very isolated. And it is on a specific book of business in some parts of the country and sometimes it is precipitated because a major writer says we're not going to do this business anymore and we had some examples of that. Some of it in the E&S primary casualty, which a major leading candidate carrier says we're shutting that operation down so that creates a bit of angst on those accounts. They got to find another home. And it happened in a few cases. These are tougher underwriting risks. They belong in the E&S market.

But I don't get too excited about it because it's isolated. The reason I mention it is because I'm trying to -- for us and also for you guys to find signals...is the market going to continue to drift or are we in certain cases hitting the bottom? And I think in some cases we have hit the bottom and it has got to go the other way. And when people say, no mas, I don't want any more of this, it tells you that it can't get any lower than that.

So that's the only message I want to send. No tremendous opportunities, I'm not predicting a market trend. I still believe that the market won't turn neither in '11 or '12, it will probably be '13 to be a broad-based turn because more pain has to come. But we're starting to see it in isolated cases.

Okay, that's great. On the tax rate, if I may, we saw yesterday the Obama administration once again put up reinsurance taxes. Do you have a sense for what the probability of that passage would be, and also since you're making less underwriting income in the US, do you think it's going to be a major impact or a minor impact to you?

Well listen, there is not a lot of detail on what the administration's new proposal might be. And keep in mind, this is only a proposal and there is no bill drafted that we can react to it. We don't believe there is broad support for that and for its enactment. But these kind of proposals, if enacted, will probably lead to increased costs for policy holders and also it will affect relationships that US has with other jurisdictions, European and otherwise.

With all of that said, I ask our tax people to give me an indication, let's say if something like that was enacted, would it cause US businesses from an additional tax, and for 2010 calendar year the proposal will have no adverse impact on us? As a matter of fact, our tax rate for the US group including the federal excise tax wouldn't have changed. Don't forget, I said before that our effective tax rate in the US, and we buy a lot of municipals in the US, is hovering around 9%, 10% for the US business, so it was never zero. You're looking at our aggregated tax for our global operations. And I keep reminding people, we're a foreign corporation with some US subsidiaries, we're not a domestic company doing business overseas. So I don't expect significant change and a big impact in our business. It will take years to build up even if they do pass and enact tax legislation that is protectionist and we don't anticipate that for the time being.

Okay, that's great. Thank you.

Greg Locraft, Morgan Stanley.

Wanted to just understand even a little more perhaps, Dinos, on this bottoming in the E&S. Is it all excess casualty? Is that where you see it, excess and primary casualty, or is it broader than that in terms of pockets?

No, it's not -- I wish it was excess casualty. It's not excess casualty. Excess casualty being a very long line of business, that's why people are still very optimistic. This is primary E&S and it is in risk like maybe New York City contractors which they have a lot of exposure to the third party over counter claims that experience is not good and more and more underwriters don't want to write it. It might be habitational risks that the claim activity for frequency and severity is starting to perk up in some companies. They say, we don't want to write certain types of habitational risks. So it's isolated in these kind of pockets.

On the energy sector we've seen some of that. But it's not broad-based yet, and is primary. Where you're going to feel the effect of the claims a lot quicker than you will feel it when you are writing excess liability that you might be happy for a few years and then very unhappy when the losses start getting into the excess layers. So I haven't seen it on excess casualty. The excess casualty area, we still believe as a Company is the most challenging. And when I say excess casualty, I'm talking US; Canada, Europe is a different story. And unfortunately we don't see any signs of improvement in that yet.

Okay. So, great, that's helpful. And again you sort of see the primary lines you mentioned as a response to one big carrier?

Well no, it's a combination of things. Don't forget sometimes a big carrier will move -- like big carriers a year ago will say, I'm not going to write this and then you had 15 other people that they would write it. That's what the market is all about. Now though, we're starting to see resistance by the broad market on certain classes and they say no, he doesn't want it but I don't want it either as a new piece of business for me I'm not going to write it unless there is a price improvement, and to me that's the beginning of the most distressed segments starting to get attention by underwriters. And we've seen that even in 1999, early 2000, even though the market didn't start moving until mid-2000 and it accelerated in '01 and got real good in '02, '03. There were early signs that people, they were saying no mas.

Okay. And building on that as context, you'd mentioned 2012, '13, is sort of more in line when you think the market on a more broad-based basis could be better and more pain has yet to come. How do you think that will manifest itself in the reported results? What would you be watching in our shoes?

It will manifest in two ways. The things that I watch the most is -- actually I watch three, three empirical data points. One is the cash flow relationships because cash flow you can't fool around, either you have the cash or you don't. And usually when cash flows get to around 5%, this is cash flows to net written premium for the industry, you have signal that one gets below that number, you have a market turn.

Second is when the relationship of IBNR to total reserves gets into the -- for the industry, around the 45% level, and that happens when people exhaust their reserve redundancies by releasing them as the older years mature and then the diagonals indicate they had too much and they have to release it. And the more recent years being more realistic accident years and there is nothing to release, so it will change their relationship between total reserves to what is case versus IBNR and that relationship is another indicator that we usually watch. So if I were you I would look at cash flows, I would look at relationships to total reserves, IBNR, the schedule piece, what that tells you. And I would look at the change in the tone of how the calendar year results get reported without -- if there is no aiding by reserve releases all of a sudden people, they're not going to like -- we don't feel proud producing 8%, 9% ROEs. Don't forget, 9% ROE that I mentioned is on -- it's on a pro forma basis eliminating my excess capital. In total capital there's going to be a little less than that. And that's not a report card that you want to write home about if you're only producing 7%, 8%. And even if there is no reserve leases and benign cat activity, those numbers are going to be not as attractive and I think that's what causes markets to turn.

Okay. Thank you very much.

You're welcome.

Matthew Heimermann, JP Morgan.

Couple of questions if I may. Just on the January 1 renewals, can remind us how much of your reinsurance book is 1-1?

It's -- I don't have that number with me. But it's significant. I think it's about 40% -- a little over 40%.

Okay.Not that different from --

And it's not just January. I would say the first quarter.

Okay, that's helpful. And then I guess just in terms -- the PML has been falling. As we think about, and you mentioned that some of the reason that your volume is potentially stable in Q1 versus a year ago is quota share business and medium-tail lines. So should we think about, if we're looking at property, cat -- property, ex-cat, that, that will be a pretty good barometer for how we should think about your PML changing over the course of 2011?

Well don't forget the Florida business doesn't come up until second quarter. So usually, if you go back and you look at how we report quarter by quarter, a least amount of PML is usually deployed if the first quarter of any one year, and then it grows up when the contracts come up and what we're going to do, depending if we like the rates, we might deploy a little more, having the capacity for the Florida business. But, it is too early to tell. We're going to look at what's available, what kind of pricing we can get, and do we like that. And we'll go from there.

Okay.

That's the reason we shy away from giving guidance on anything because that's not the way how we run the Company. I'm not trying to predict what we're going to do quarter after quarter after quarter because I don't know myself. What I try to emphasize to underwriters, maintain discipline and do what you believe is appropriate and write the business that will have margin on it.

No, that's fair. I wasn't looking for guidance so much as just as we see the numbers reported if that'll be a good barometer because I'm trying to get a sense of what adjustment, if any, when we're looking at your book we should be making for RMS 11 for example, because when you say PML683 in tri-county from 809, is that net of RMS or not. So that's just -- that's where I was coming from.

Don't forget, our PMLs are calculated beyond RMS. We do make adjustments to the models. And I think I mentioned that in my prepared remarks that in anticipation -- when we get datasets from ceding companies we don't just run it through RMS and take their answer and that's not the way we underwrite. Our cat team makes adjustments. As a matter of fact, we did make adjustments on anything we wrote in the first quarter in anticipation of the RMS model, even though it's not increasing coastal PML calculations, it is increasing, and in some cases significantly, 30%, 40%, 50%, 60% on more inland exposures. And we made adjustments to the way we underwrite.

As a matter of fact our cat team from our own analysis of the 2004 storms. You remember we had four storms in Florida. One of them, Charlie, went right through from the west coast of Florida and exited the other way, and based on our own analysis we never really believed that if you're three or five miles inland, you had a significantly less PML from a property than one that was two miles from the coast. So we had made those adjustments and it wasn't a huge adjustment. We look at our own way of underwriting the cat business based on a combination of outside models we use plus our own internal, I wouldn't say manipulations, but changes to those models because we have our own ideas and we continue to factor that in. So my comments were more about -- there was a market anticipation that RMS 11 would have increased demand and maybe toned down the pricing which went down 5% to 7%. And I saw none of that. Demand didn't go up, and it didn't affect in a positive fashion -- price -- the buyers, they had good deals this year.

That's fair. And then I'm sure I'm reading way too much into this, but your press release when you talked about the Australia floods and Yasi had a different line with respect to potential variability in your catastrophe loss estimates and the difference really centered on reinsurance performance. So I guess were you -- is there anything specific that you're --?

No, it's the state of language we put in to make sure that investors should know that even though we have reinsurance recoverables, if you don't get the recoverables, a recoverable becomes your net loss. So it's no difference to what we've done in the last nine years.

Okay. It was different than previous press releases. I thought I was reading too much into it.

I don't know if we changed the language a little bit --

The language has changed a little bit, but it's really the same meaning now. There's no --

That's fair. I would have been remiss to ask if there had been questions around the number of incidents, et cetera. Okay. I think I'll cede the floor then, and let somebody else ask. Thanks.

Thanks, Matt.

Mark Dwelle, RBC Capital Markets.

Two questions. First in the $30 million to $60 million of additional Australian-related losses, will those primarily be on the reinsurance book or will they be in the insurance book affected there?

It's both, but from a size perspective, I would say 25% might be insurance, and 75%, reinsurance, so maybe 30%, 70%, something like that. I haven't done the calculations. We go unit by unit and we build it up. So John, do you have any more color on that?

No, it's about that. It's like one-third, two-thirds -- one-third insurance, two-thirds reinsurance. But it depends on the range and of course these numbers will move within this range on how all this works out between Yasi and the floods and how things recover, mines and everything else. So there's going to be variability around these numbers until all this gets sorted out.

Right.

And on our Insurance Group, all comes from our London operations, Lloyds and non-Lloyds.

Okay, understood. Thanks. The second question I had related to just a little additional detail related to the reserve releases, particularly on the insurance line. What accident years were involved there and was that net of any particularly -- any offsets in terms of charges or was it primarily all releases?

John is going to look for the details. But basically, we do analysis on our reserves by IBNR family and then for accident year. So you always get positive and negative movements. Some years we'll put a little up and some years we take some down. It depends how the empirical data points to us. As you get another diagonal on the triangle, you make those determinations.

I understand. Just sometimes you have 4% of favorable and 1% or 2% of unfavorable and it's --

And listen, that's not unusual. Especially if you're writing -- the actuaries will react to a single large loss on a book of business that is small. Right? If you're writing high limits and one year will look at a 40 loss and loss adjustment expense and another might look at a 60, and there was not that much difference in the marketplace but one year had the big loss and the other year didn't have the big loss. So, you get those kind of variations and they react to it depending on how the case reserves as we adjudicate some of these cases. That's the process that we go, it's a very detailed process. But --

I can give you a little bit of color on it. We had a total net favorable for the Insurance Group in the quarter, as mainly short-tail and some medium-tail lines and of course there's always some rebalancing by years. Of course the short-tail, it's more recent years. The medium-tail was like '06 to '08 and then a lot of other little lines had net releases as well. We did see some releases but some net strengthening in both executive assurance, a little bit for the subprime timetable, '08, '09, '07 as well as some casualty -- some specific events that happened in -- some in '04, '05, but then we had releases in '06 and '07. So it just balances out as you go across year by year and line by line.

I understand. That's helpful. Thank you. That's all my questions.

John Hall, Wells Fargo.

I just wanted to address the share repurchase real quickly. First off, I was wondering when the next board meeting is? And then secondly, I was wondering if you could just talk a little bit about how book value plays into your repurchase decision or your decision to be in the market at any given point in time.

Well, the first one is easy. The board meeting is in the next ten days or so. We don't give specific dates, this way you don't know when we're traveling. But it will be next week sometime. And on -- of course price has an effect on how we decide to return capital to shareholders. As long as our share price is at book value or below, there is not a lot of thinking here.

That's a very easy calculation to make.

Yes, very easy calculations. Of course, if share price goes to a multiple to book, we have a grid and I think we have presented it to investors and the calculation that we do is we look at what is our ROE return expected and what the multiple to book we need to buy and what the recovery period should be. And if it's three years or less, we continue to buy shares back. And if it's more than three years, we'll look for other ways to return capital. And we build this grid that gives us guidance as to which way we're going to go.

And right about now, if you look that up with Dinos's 9% to 10% ROE number that he just mentioned, we can go by just under 1.2. 1.15 to 1.2 would be the ratio the ratio that we could buy up to. Of course we're looking forward to that trading level at some point. But historically, the last few quarters when it's been below book, it's been a pretty easy calculation to make.

Great, that's perfect. Thank you.

Ian Gutterman, Adage Capital.

First, just to clarify that last one is that book value at valuation ex -115 or full book?

That's at full book.

Okay, just making sure.

What happened? Hello, Ian?

One moment.

We only paid for an hour or? I think we can afford.

Ian your line is open. Please proceed with your question.

Okay. Can you hear me now?

Yes. We can hear. You're in the back of the room, it's like in college again, right? You're a rabble-rouser.

That's my job. The excess capital I was looking at focused on the ex-115 that went down $100 million from last quarter and I'm looking at your ex-115 equity was essentially flat, and your PML is down $75 million which would free up $300 million of capital. So why is your excess capital less than last quarter?

We allocated more investments to equities and alternative investments that it's a very high capital charge on the S&P capital formulas.

That makes sense.

We moved, as you saw, 3% now is in equities. So it takes a bigger charge.

That makes perfect sense. Follow-up on the tax question, I'm looking through the supplement. It looks like round numbers, your net premium is about $1.5 billion in the US and a about $1 billion in Bermuda. I guess first, with that $1.5 billion in the US, is that before you quota shared to Bermuda or is that true net premium that stays in the US?

That's pre-quota share.

That is pre-quota share, okay. So that makes a part of my question. But I was just trying to think through how you're not making -- essentially making very little money to have a very low tax rate on basically 60% of your premium?

Well because most of our income -- most of our underwriting income is coming from the overseas operations. We've been booking the insurance group at over 100. So in essence you're taking an underwriting loss. And we don't have, in the US, a significant portion of investable assets that is not triple tax-free. All of our muni bond portfolio, which is about $1.2 billion, we buy in our US operations. So in essence that comes with no underwriting income and tax-free, so a lot of our income is coming from the investable assets we have overseas plus the underwriting gain from the business that we write overseas. So that's the reason that tax rate is so low.

And the reason the combined is over 100 on that business, is that more long-tail business or is there some other reason?

Some of it is long-tail business. We write some comp, excess comp, et cetera. And some of it is because the market is so tough that we don't think there is a lot of margin in that business. And you're next question is going to be, why don't you cut it off totally, and anticipating your last question is -- the answer is because you can't shut down your operations. You minimize as much as you can in sectors you don't have profitability, and you wait for the rainy day to go and then the sunshine to come and then you can capitalize with that opportunity when it shows up.

That makes sense. I wasn't even going to argue that. I just had two little ones, but they're quick. Professional liability insurance that had been growing all year, this quarter was down about 25%. What happened there? And also can you remind me, on the reinsurance business that other specialty is about doubled year over year, what exactly is other specialty?

The first one, professional liability, we have reduced significantly in Europe. In Europe we were writing for small, medium size enterprises, a lot of D&O, but also we had PL business and we didn't like the profitability of that business so we had discontinued that and it went to another carrier. That's difference in that. And your second question was on?

Your reinsurance, the business that you classify as other specialty was about $130 million of net premium this year versus $65 million last year, I'm just wondering --

A lot of that movement is the trade credit business.

Okay. That makes sense. Thank you very much.

There are no further questions at this time. This does conclude the question-and-answer session portion of the call. I will now turn the call back over to Dinos Iordanou for closing remarks. Plead proceed, sir.

Thanks, Alicia and thanks for everybody that shared the one hour with us and we're looking forward of talking to you in the weeks ahead. Have a good day.

Ladies and gentlemen, that concludes today's conference. Thank you for your participation. You may now disconnect. Have a great day.