Aspen Insurance Holdings Ltd (AHL) 2017 Q3 法說會逐字稿

Good day, and welcome to the Aspen Third Quarter 2017 Earnings Conference Call and Webcast. (Operator Instructions) Please note, this event is being recorded.

I would now like to turn the conference over to Mr. Mark Jones, Senior Vice President, Investor Relations. Please go ahead, Mr. Jones.

Thank you, Anita, and good morning, everyone. On today's call, we have Chris O'Kane, Chief Executive Officer; and Scott Kirk, Chief Financial Officer. Last night, we issued our press release announcing Aspen's financial results for the third quarter of 2017. This press release as well as corresponding supplementary financial information can be found on our website at www.aspen.co.

Today's presentation contains, and Aspen may make, from time to time, written or oral forward-looking statements within the meaning under and pursuant to the safe harbor provision of U.S. federal securities laws. All forward-looking statements have a number of assumptions concerning future events that are subject to a number of uncertainties and other factors. For more detailed descriptions of these uncertainties and other factors, please see the Risk Factors section in Aspen's annual report on Form 10-K and quarterly reports on Forms 10-Q filed with the SEC and posted on our website.

Today's presentation also contains non-GAAP financial measures, which we believe are meaningful in evaluating Aspen's performance. For a detailed disclosure on non-GAAP financials, please refer to the supplementary financial data and our earnings release posted on the Aspen website.

With that, I'll now turn the call over to Chris.

Thank you, Mark. Good morning, everyone. In what was a remarkably active quarter of events, we experienced 3 major Atlantic hurricanes and 2 Mexican earthquakes. These events were the main reason for Aspen's third quarter operating loss. While significant, our estimated losses from the hurricanes are within our expectations for events of this nature. Approximately 75% of the estimated cat impact in the quarter was recorded in our Reinsurance segment, largely in Property Reinsurance. Our Insurance segment accounted for the remaining 25%, mainly, in the Property, Marine and Energy lines.

Now I'd like to comment specifically on the performance of our Insurance business and year-to-date. I like to summarize this in 3 words. Not good enough. The main issue lies within property insurance and centers on a relatively small book of business written on a primary basis. This group of risks is quite exposed to weather-related events and was identified earlier in the year as potentially creating some unwelcome volatility. This happened in both the second and third quarters of the year. Remedial action account was taken a long time ago, but it is taking longer than I had hoped for these additional -- for these actions to have the impact that we are looking for. In this quarter, we will take further steps to drive out the volatility and mitigate these exposures. The book consent is an one-off, and we do not expect any more exposure from this source by some time in the middle of next year.

Outside of the property-related issues, the insurance ex cat accident year loss ratio is running at approximately 60% year-to-date and is more indicative of the current performance of our underlying book. We've also taken other actions on the expense side that are already starting to benefit the business and will grow over time. First, as we mentioned during previous calls, we increased use of proportional reinsurance treaties in our Marine and Energy lines starting in July 2016 and in our Casualty and Financial lines starting in 2016, November. These treaties have already begun to benefit our acquisition expenses and the impact of the treaties will be fully present in our ratios by the end of the fourth quarter this year. Second, in the effectiveness and efficiency program that we announced yesterday, 70% savings will benefit our Insurance segment. Once completed, this will leave the segment with a more competitive G&A ratio and a strong operating platform. Third, as a result of the repositioning that we carried out in 2016, combined with significant underwriting expertise we had at that time, the phase of remediating our book is complete, and we are beginning to see growth again. Thus going forward, we will be leveraging our expense base from a higher premium level. So taking these 3 factors into account, we expect to have a competitive total expense ratio in combination with a better underlying loss ratio, this will lead to a better performing Insurance business.

This, however, is not the end of the story. Post-hurricanes, the insurance market as well as the reinsurance market are undergoing a period of repricing. In my view, the underlying cause of this is a 5-year period of rate reductions, which affected all lines on a global basis, but was most keenly felt in Energy, Marine and Property lines. I'm not going to provide a yardstick to the level of rate increases by line that can be expected, but I would like to make a few comments. The vast majority P&C lines in both insurance and reinsurance will see rate increases. For Casualty lines, in general, we expect increases with the greatest coming in troubled lines, such as commercial auto. Short-tail lines, which saw the biggest rate declines over recent years, can expect the biggest corrections. We see a much better market coming in Energy. And we expect that while cat exposed property insurance will reprice, property reinsurance will price -- reprice at a greater rate. Cat reinsurance will see more significant increases still from the rest of property and retro is already seeing the highest increases of all.

One of the areas where Aspen has always been very strong is reacting to market opportunities and nimbly deploying capital. As we think about reallocating capital, this process is not just limited to underwriting capital. We are also examining whether the scale of the underwriting opportunities that may be emerging would justify withdrawing capital from reserving risk and deploying it into underwriting. Hence, the offensive use of an adverse development cover is something that we might contemplate. Capital will be redeployed very quickly to those areas where the best return expectations are going to be found. However, we're doing this without increasing our catastrophe exposures as a percentage of shareholders equity. At this stage, our planning assumption is that, the cat risk up to the 100-year level will be maintained where it was in the first half of this year. But the tail, at the 1/250 or beyond, for example, could be reduced. We remain confident in the future of Aspen with highly satisfactory Reinsurance business and a well-placed Insurance business repositioned under the leadership of Steve Postlewhite and David Cohen. In addition, with a much more efficient operation, as our effective and efficiency program rolled out and an agile reallocation capital, we anticipate a period of significantly improving results.

I will now turn the call over to Scott, who will take you through our financial performance in more detail. And then, I'll talk to you about the operational effectiveness program we just announced.

Thank you, Chris, and good morning, everybody. In the third quarter of 2017, we recorded a combined ratio of 151.4%, an operating loss of $277 million and diluted book value per share at September 30 of $44. Our results for the quarter have clearly been impacted by the significant level of cat losses that Chris has already mentioned. But as a reminder, we reported total net cat losses of $360 million. This included $110 million from Hurricane Harvey, $135 million from Irma and $65 million from Maria. We also reported $50 million of other cat events, including the Mexican earthquakes. Included in the net cat losses were $13 million of net reinstatement premiums. Gross written premiums for the quarter were $853 million, an increase of 12% compared with the third quarter of last year, with growth coming from both segments. Net written premiums decreased 5% from the third quarter 2016 to $607 million, due primarily to the quota share reinsurance placements we mentioned previously. As a result, the ratio of net to gross written premiums for the group declined to 71% from 84% in the third quarter of 2016. We continue to expect to see this ratio to be in the low-70s for the full year 2017.

The loss ratio for the group was 119% compared to 57.2% in the third quarter of 2016, with the increase largely due to the cat losses. Prior year net favorable reserve movements were $18 million or 3 percentage points in the third quarter of 2017 and came largely from Reinsurance. This compares to $35 million in the prior-year quarter. As in any quarter, reserve movements tend to vary, so the year-to-date figure is a better proxy for comparison. For the first 9 months of the year, we recorded $93 million of releases with $71 million from Reinsurance and $22 million from Insurance. This compares to total releases in the first 9 months of 2016 of $78 million.

Our accident year ex cat loss ratio was 65.9%, which compared with 58.6% in the third quarter of 2016. We had approximately $30 million of non-cat losses in our short-tail Insurance lines, primarily from U.S. property insurance, which accounts for around 5 percentage points of the increase. There was also an impact from Reinsurance segment where change in business mix, driven largely by AgriLogic, which added an additional percentage point to the exiting year ex cat loss ratio this quarter.

Turning now to our expense ratios. You'll recall that we said previously that our acquisition ratio would improve, which it has done, coming down from 20.1% for the full year 2016 to 16.2% this quarter. This was driven by a combination of AgriLogic. These earnings are largely weighted to the second half of the year and the quota share seating arrangements. The operating expense ratio was also down to 16.2% this quarter compared with 18.2% for the full year 2016, due largely to reductions in accruals for performance-based compensation. In looking at the total expense ratio for the full year 2017, we still expect this to improve over the prior year.

Turning now to our segments. Firstly, Reinsurance. Gross written premiums increased by 18% compared with the third quarter 2016. The third quarter is the largest for the AgriLogic business, which generated $135 million of gross written premiums in the quarter and the growth here was the main reason behind the premium increase in our Specialty subsegment. We also recorded $20 million of reinstatement premiums following the third quarter cats. This drove much of the growth in our Property Cat and Other Property subsegments. Aspen rerecorded an underwriting loss of $250 million and a combined ratio of 154.6%. We had net cat losses of $276 million or 75 points on the loss ratio. The accident year ex cat loss ratio was 61.7% compared with 58.2% in the third quarter last year. AgriLogic accounts for little more than 3 percentage points of the increase on the accident year ex cat loss ratio.

I'll turn now to Insurance. Gross written premiums were $421 million, an increase of 6% compared with the third quarter 2016. Growth came primarily from targeted areas such as Excess Casualty, our U.K. regional business, along with a number of Aspen pro lines, including crisis management, surety and credit political risk. We continue to see a further impact this quarter from the reinsurance changes that we implemented last year. Net written premiums were $244 million and decreased by 25% from $324 million in the third quarter of 2016. This resulted in a net to gross written premium ratio of 58% in the quarter compared with 76% for the full year 2016. The net loss ratio in the Insurance segment increased to 101.3% compared with 57.7% in the third quarter last year. The current quarter included $84 million or 31 percentage points of net cat losses, primarily from Hurricanes Harvey, Irma and Maria. The accident year ex cat loss ratio was 71.3% compared with 59.1% in the third quarter of 2016. The current quarter included increased losses in short-tail insurance lines, primarily property as I previously mentioned. These impacted the accident year ex cat loss ratio by 12 percentage points.

I'll now move on to investments, where we continue to deliver strong performance. This quarter, we recorded net investment income of $46 million, together with realized and unrealized investment gains of $18 million. The total return on the aggregate investment portfolio was 80 basis points in the quarter, reflecting net gains across our equity and fixed income investment portfolios. In the first 9 months of 2017, Aspen's aggregate investment portfolio had a total return of 310 basis points. The fixed income book yield was 2.54%, up from 2.49% at the end of 2016. The duration of the fixed income portfolio was 3.9 years at the end of the third quarter 2017.

With equity markets continuing to make new all-time highs, we decided to take more equity risk off the table during the quarter. We sold approximately $200 million in equities, reducing the equity position from 8% to around 5% of total investments.

I'll now turn to capital. We repurchased $20 million of ordinary shares during the third quarter, bringing the year-to-date buybacks to $30 million. In addition, we redeemed our 7.25% Series B preference shares at the start of the quarter, and together with the redemption we did earlier this year, we reduced our total preference shares on issue by $43 million in 2017.

So Chris is going to talk more about our effectiveness and efficiency program in a moment. But before he does, I just wanted to briefly discuss how this will impact our expenses. As you think about our G&A expenses going forward, I want to point out that 2017 expenses reflect a significant decline, largely from the impact of lower variable compensation. To that end, it's best to use the 2016 G&A expenses of $480 million as a more normalized expense base. We expect the total program savings, as we announced, will be $30 million in 2018, $55 million in 2019 and $75 million in 2020. And then the full run rate will be $80 million savings in 2021 and beyond. As a consequence, we expect to see the overall expense ratio to decline into the mid- to low-30s over the next 3 years.

So with that, I'll now turn the call back to Chris.

So thanks, Scott. Over the past 15 years, Aspen has pursued a strategy of building a successful Reinsurance business and a successful Insurance business. We focused on identifying market segments, where underwriting expertise is valued and rewarded, attracting outstanding underwriting talent, achieving scale enrollments in select major products and regions, allocating capital to the best opportunities and consistently delivering excellent solutions to our clients. We're proud of what we build. We're a recognized leader in many of the lines we serve and a valued partner for our brokers and clients. However, any company that has grown as much as we have, must periodically take a step back and evaluate its organization, its business processes, its effectiveness and its overall efficiency. This is particularly important in an industry environment, where for some time, we have been confronting the various headwinds of the systems, rate softness, low investment yield and the rapid pace of technological advancement.

In March of this year, we initiated a comprehensive operational review of our organization with a goal of creating a more dynamic and scalable platform to execute on opportunities and enhance long-term shareholder value. With the help of McKinsey, we looked across our businesses and procurement and premises and most importantly, we did a deep analysis of how we work, how our time is allocated, how much time our client-facing staff spends and engage with clients versus handling administrative matters and so on. First, we will reduce our spending on procurement and we will reduce our spending on premises. Among other things we have identified opportunities to more efficiently use office space, particularly, in the higher cost locations, such as New York and London. We're also looking to optimize our operating processes and activities. We have identified many opportunities to reduce inefficiencies such as rekeying of data. We've also identified processes that could be made more efficient through the use of advanced analytics. We also have opportunities to integrate various components of our IT systems, providing access to better and more timely data to support decisions. I want to emphasize that we are not replacing our core system. We are making what we have interact more effectively.

Lastly, we will enhance our current operating model by bringing greater cost efficiency to selected support functions through the use of outsourcing. As a result of these changes, we anticipate significant headcount reallocations and reductions, particularly from our higher cost locations. These changes obviously affect people, they are difficult to make, they need to be made sensitively, and they need to be made in accordance with local requirements. But they are absolutely necessary to strengthen the competitive position of our company. In total, we expect that the program will deliver around $160 million of cumulative of savings over the next 3 years. We expect to achieve $30 million of savings in 2018, $55 million in 2019 and $75 million in 2020, after which, the run rate savings are expected to be approximately $80 million a year. We will take a charge of approximately $95 million to implement the program and achieve the expected savings. Around $50 million of this charge is for employee severance, benefits and related expenses, $30 million for business transformation and program costs and $50 million for outsourcing and premises. The majority of the charges are expected to be incurred in 2018 and 2019. We also spend approximately $55 million in incremental capital expenditure, primarily on information technology over the same period. This expenditure is expected to be amortized over a period of 3 to 5 years from the start of 2020.

While this is a company-wide initiative, the largest beneficiary in terms of operation improvement and expense savings will be in Insurance. We expect approximately 70% of the total savings to benefit the Insurance business. There are multiple opportunities to increase operational efficiency across the platform. For example, our administrative functions that are currently performed by multiple underwriting teams that can be done more effectively on a centralized basis. These operational changes build on the review of our Insurance business lines that we conducted in 2016 and will drive better results in Insurance. We expect the impact of this program will help us create a lower cost, more durable, dynamic and scalable platform to execute on opportunities before us and enhance shareholder value over the longer term.

And with that, I'm happy to take your questions.

(Operator Instructions) The first question comes from Amit Kumar with Buckingham Research.

It's Amit Kumar from Buckingham. Just a few questions, I guess, on -- I guess, let's talk about capital liquidation. If you look at your gross versus sort of net loss and the role retro played, how do you think about your capital position if the retro costs go up, which they will? And do you need, I guess, more reserve development covers on your legacy book to leverage the improvement in market condition?

So I think there's 2 parts to that question, Amit. And the first one is, what's the implication of retro cost? We are quite a small buyer of retro historically. We buy a lot of reinsurance where I think, there's been value and to be honest, retro has been comparably scarce and comparably expensive and sometimes has carried lot of basis risk. So it's actually quite a small proportion of how we protect our Reinsurance operations. That said, I think, it is the fastest repricing area. And that's why we've already purchased a substantial part of our retro covers for 2018, it's already done. The way I see retro currently is, it might be a place to start writing the business, accepting the business, maybe more than it is to be buying the business. That's what I think the repricing needs. I think the other part of the question is, do we need to do something with our reserve? No, we don't. We have had a very, very strict and fairly independent reserve committee comprising actuarial, legal, claims, finance, underwriting, reporting to me and through me to me and through Scott to the Audit Committee of the board. That process has led to -- as a reserving set of standards that's more stable that might exist elsewhere in the industry. So we -- a key measure is, what is the margin, and what holding that would mean best estimate. And it's substantial and gives a lot of comfort. A point, however, I made in there, I think, this is really about any business at this point, potentially, a dramatically changing market, is where are you going to get the best return for your capital and where is the capital sitting, doing something useful, but not that interesting for shareholder return? So one thing, I think, that's worth examining and it's not to say we decided to do it and all, but absolutely worth examining is whether some of the capital that impacts our reserving risk would be more efficiently transferred to underwriting, if the underwriting opportunities are coming and I kind of think they may well be. And then if there's someone else who wants to hold those reserves for us, maybe somebody with a more favorable investment approach, both sides win. Maybe better than a portion of reserves is better off in someone else's balance sheet. So I think, this is just let into our thinking that it varies time to market. This isn't coming from a sense of need, though. This is coming from the sense of, if there is a serious opportunity, how would we capitalize to the maximum safely possible from internal resources. I hope that clarifies it for you, Amit.

Yes, it does. The second question I have -- and I have one more and I'm sure there are a lots of questions on the queue. The second question I have is, how does McKinsey get compensated for this? Do they have to sort of stick around for these savings to come through? Or maybe just help us understand the whole thing, so that you understand if there are [some fortunes] are tied to you being able to achieve these over time?

So obviously, I can't go into the details of severance between the 2 firms. But as a company we used to say, in the preparation stage and in the conceptual stage, as we thought about what we need to do, frankly, McKinsey have been valuable. They do this for a living, we do not, and they're probably amongst the best, most expert people in the world, if you want to look at the type of restructuring. We're now moving sort of today really into the implementation stage, and a different part of McKinsey is actually quite expert at monitoring implementation. Now what you got to say to yourself, over 2 years or so, where do I expect to be a month from now, 3 months from now, 6 months from now? But you don't want to wait 6 months to check. You won't be checking almost daily. I think McKinsey are very good at helping a management team monitor progress. And more importantly, if progress is behind where all would be stepping in, thinking about why, escalating it to me or escalating it to the board, whoever it might need to go and making sure we get back on track. So I would want them run through the implementation stage. The way they're compensated depends on their success and our success. And the way we measure success will be an independently audit process. It will be essentially we start to make these savings, did they and if we did, a proportion of that benefit will accrue to them. There are some other features that arise and which I think would not be appropriate to go into. But fundamentally, we got lot of skin in this game, they've also got a lot of skin in this game, which is I think, which you really want to hear.

Got it. The final question, and I will stop here is, Chris, obviously, you've been trying to right size this franchise for quite some time, and I do you commend you on your effort. In retrospect, would you agree that many of the issues stems from Aspen's smaller size? And it's time to sort of think about, if it makes sense to be part of a bigger organization to really capitalize on the market opportunities?

Well, again, I mean, I think, there is 2 parts to question. And the first one is size any kind of inhibited success. And regrettably, I have to be -- we've made some mistakes, but those mistakes, assume those mistakes were made by much bigger organizations. They are, you see a block of business, it's not performing right, you believe it can be fixed, you write it to fix it. And the fixes don't happen even after 3 years, you're disappointed, you give up and every underwriter has that. It's not really a function of scale at all. What I think we've done to address that is, got better and better risk evaluation, upgraded the leadership, upgraded the talent, so that the gap between what we hope, what we planned for and the actual out turn will minimize. The other part of the question is a question about, is this company going to be strategically and financially better off as part of the bigger organization? And the answer to that really is, possibly and possibly not. It depends which the organization is, what the benefit will bring, what the price would be. So I think, the board will always keep an open mind, they have continue to keep an open mind about that question. But we do believe the business we have, particularly, with the effectiveness and efficiency programming coming in and particularly as the repositioning of insurance is done and particularly as the market is looking a lot better, there's an awful lot of value that is created on our own. And that's what we hope to do in the next so many months and year or so. And if there is more value to create by this en route and keep an open mind on that one, I think would be my view and the view of the board.

Our next question comes from Josh Shanker with Deutsche Bank.

Looking at the past, I don't know, well, you can call it 15 years, 10 years, you've announced a restructuring plan, you've had restructuring plans in the past. I can see where you can save on some costs here. But can you talk about the goals of this restructuring compared to past ones? And were the past ones successful? What have you learned from past times restructuring of the business?

So Josh, Winston Churchill said, the British and Americans are one people divided by common language. And we may be, but without getting on this morning, in my mind, restructuring is a term relating to organizational restructuring, repositioning and changing cost structure, taking a financial charge for that. I don't believe we've done that before. This is the first time ever. What I would describe the past has been various attempts, you're right, to position Insurance as effectively in its chosen lines, as Reinsurance for us has operated in its chosen lines. So it's been about the underwriting portfolio mix, it's about distribution, it's about having the right talent, it's about having the right pricing actual back up and it's about building that perfect portfolio. It's also recognizing by the way, there's no perfect portfolio that is eternal. Market changes, you've got to change it too, and we may well want to do some of that in the next few months. So in my mind, that's about running the business of underwriting. What we've -- which we've worked very hard, you're quite right there. What we're talking about now is about IT, it's about premises, it's about the way we do procurement, it's about how automation can help us, it's about avoiding rekeying of data, it's about avoiding having Balkanized mini operational teams with each lines of underwriters and rather centralizing that and making it more efficiently by streamlining the organization. These are the things, which frankly, Josh, we have not done before. We've been working on this for, I suppose, 9 months now with McKinsey. There has never been such a thorough evaluation. We have had to, obviously, upgrade the talent in the operations and change management area to be absolutely confident we can do that, and we continue to work with McKinsey. This is -- it would be quite wrong to think, this is something we tried before, and we didn't succeed. And this -- I think in 15 years of doing earnings calls, the first time the word restructuring came out of my lips was this morning, because we haven't it done before. So 2 very, very different things. Does that make sense to you?

It does. It does.

Yes, thank you.

And so when you think -- when you get to the end of this, will the employee count at Aspen be radically different? And do you think that most of the changes that you'll make, the employees can move out of Manhattan and into the suburbs and that can be done without changing the team dramatically?

The headcount of the organization....

Yes.

At the end of this will be lower. I'm not going to be saying anything more about that to you on the call this morning, but it will be. In terms of what are the functions? Some functions, you do them in Bermuda, because Bermuda is the best place in the world to do it, and we're very committed to that market and that is not going to change. I'm thinking from our point of view, certain lines of business, property catastrophe reinsurance is the most obvious one. We do a lot of casualty, particularly, Excess Casualty. Bermuda is a great to do these, and I see no change in the underwriting appetite we'll be exposed to, for example, that office. Equally, we have a very effective treasury and investment function based in Bermuda, done a great job, and I also see no change there. When I come to the bigger and more expensive centers in the United States and in the U.K., we have about 630 people in London EC3. London EC3 is the most expensive postcode or one of the expensive postcodes in England in the world. And clearly, we need a lot of people there because that's where Lloyd's of London is, that's an insurance center, our underwriters need to be there, proximity brokers. And those people need to back up the underwriting need to be there too. But there are an awful lot of other functions where we have to ask ourself, do you need to do them in the most expensive place in the world or could you do them somewhere else? You also have to ask the second question, which is, are those functions that you really want to have your own in-house factory you're doing or do you want to go to some of these specialist firms who assist with outsourcing and have those functions performed as well or maybe better in a low-cost location, in a lower-cost labor market? And answer we have included in many cases is, some of these functions do need to be done inside the organization, but not in an expensive location or outside the organization altogether. But in terms of the customer, we are in business because our clients trust us to pay their claim and our brokers trust us in terms of the service we do. We will do nothing to interrupt or make more inconvenience to those relationships. In fact, what we're actually doing here is, currently, an underwriter's life at Aspen is quite a lot of underwriting and a fair amount of administration. We don't want the underwriters having to do administration. We want them to do talk to a client, understand it. Equally, we have very, very high quality accounts in our finance function. They spend a lot of time checking and rekeying data. They're very good at that. But frankly, you don't have to have their level of skill sets and abilities to do that. So by using technology to take the drudge part of the job away, you get more value out of people, and people get to do the jobs they want to do. So I think over this, we will be a smaller organization in headcount terms, but we'll be a much more efficient and much more enthusiastic and much more job fulfilling place to work. That's the exciting part of what is here.

The next question comes from Brian Meredith with UBS.

So couple questions here for you. First, just on the efficiencies program, to just like kind of going through the numbers, and Scott, what you mentioned about the kind of target expense ratios, it does appear that you're thinking about potential reinvestment of those expense, I mean, those expense savings in the business. Tell me about how you're kind of thinking about that if opportunities are going to come up, would you kind of reinvest some of these savings back into the business or are you kind of dead set on just kind of we've got to get more efficient here?

Brian, I'll -- I guess, the best way to try to answer that is, we're in a changing marketplace at the moment, and I think Chris talked about several opportunities across the market, where there might be some repricing. If those opportunities come up, we're going to take those opportunities. And if we have to support those through some additional expense, clearly, we're going to do that. So would we reinvest under those circumstances to generate incremental ROA and incremental return to the business? Yes. But I think, largely speaking, it will be good to see the incremental savings come through.

Great. And then, Chris, just curious. So a lot of companies have come out and talked about stronger pricing kind of across the board, particularly in the property lines. Just curious if we can dive little bit more. Number one, much of the talk about pricing is based upon the massive amount of loss, obviously, the industry has seen from these hurricanes -- or earthquakes and cat losses. But when you add up your losses, you're probably less than half of what I think some of the modeling firms are going to say, and they're going to come are to be. So the first question is, where are the losses in your view? And then also, what's kind of different this time around because in prior firming markets, there's generally been a change in perception of what's cost or risks. And I'm not sure if that's happening in this event or maybe it is. I'm curious what's your thoughts are there?

Very interesting questions, Brian. And you know what? I don't know the answer to either, which isn't going to stop me talking to you about them. The big 3 cat losses, okay, I see estimates across the 3, 75 to 95 or 100 billion. We struggle to get to the upper end of that range. Why do we struggle? We have a modest size Insurance business. And we see a lot of loss there, but we don't see enough to project after those kind of market losses. And there we have a more substantial reinsurance business, where we write small shares of a lot of major carriers. A lot of these -- a lot of these majors are the biggest, the best and more sophisticated companies in United States. They, generally speaking, don't get it wrong. Generally speaking, are pretty good at estimating. And based on what they tell us, do we assess, do we agree or do we want to put a little of IBNR on top of what tell they us. And generally speaking, we will put some IBNR of top of what they tell us based on our view of market loss or external data. But we don't think they are radically wrong, and if you add them all up and you extrapolate from there to the market loss, you just don't get to these bigger numbers, and nowhere is that more true than in Puerto Rico and Maria. The modeling agencies, I think, are useful in the early days, no one knows what happened and some of these guys said, expect this or expect that. Now let me remind you, the first estimate we saw of Harvey was a loss of something like $1.5 billion to $2 billion. That was the 1 of the modeling firms as it came on-shore. How many multiples was that wrong by, but nobody takes those things too seriously. I think as time goes by, that kind of pre-loss supposition needs to be replaced with empirical evidence and data. And in Puerto Rico and now, a lot of people [be] into Puerto Rico. For a few days nobody knew but it's clear that, in human terms, this is awful. It's very sad for the people of Puerto Rico. In overall financial terms for that economy, which is already as you know highly stressed equally are [falling in] catastrophic. But we're just in the business of insurance, insurance of property and other risk, and San Juan is not badly affected. There are badly affected areas in the interior, very little insurance penetration there. There's not a massive tourist island but there are some hotels and there is some tourism, and I think that's either it's severely damaged or it's just very ugly. The tourist revenue is going to be gone. And I think the international carriers rather than Puerto Rico carriers are going to be picking up losses from that. And then there is a much talked about industrial part of the pharmaceuticals, I think, sort of about 14-or-so risks. Some of those are highly engineered, that's where we have the exposure. And some of them are not, we cannot be exposed there. And the guys who do that engineering are best-in-class in the world. And yes, they may have some bad news lurking, coming inside of the pharmaceutical. We haven't seen it yet. In our reserving, we have assumed that there is a degree of exposure there. But as day and day goes by, you begin to expect to hear about it. We know that there's fuel, we know generators are working, we know there was interruption to the potential for exports and some of these organizations, therefore, had to pick-up supply from other locations which they did. But now I think, supplies are beginning to work again. So I think, maybe in Maria, there was a little bit of panic and little bit of exaggeration. So maybe this is too organized to run on the losses. But I think, they're severe rather than absolutely catastrophic. Probably near the 75 and 100, would be my guess. There are some other stuff this year, of course, there's some other -- we've got the Mexican quakes. We've got some other weather in the U.S., et cetera, et cetera. But no, I don't think the world is going to change because it's up to $100 billion event. Why would the world change? Change perception. Yes, I've heard that said a lot recently. I have the drawbacks and some of the benefits of having been around a long time. And I will tell you, I remember the change in '86 and the change in 2001, very, very good. It is as if they were yesterday. In both cases, what we've seen was a long period of inadequate pricing. We'd seen attritional losses at a level that was on unsustainable. We've seen people robbing reserves, we've seen reserve adequacy coming down. And so maybe it was '97, 2001, and it's probably '82 to '86, the industry was beginning to be less than fully transparent about its assets, its exposures and future liabilities. And in a strong sense, we've got to change that. And then the -- and this is an environmental crisis, which was pretty serious by itself, gave people the courage, gave them the reason, gave them the view, we got to do it. 9/11, which was in human terms, absolutely appalling. In financial terms, was not nearly as bad as we thought about at that time, but it changed the mindset. And I think the industry is experiencing one of those moments, where we're saying, 4 or 5 years of price cutting, no excess return anywhere an inadequate return or even below one of our involvements, all parts of P&C just needs to come to an end. I think most of the market appreciates that. Usually there is a divide between brokers and underwriters. And clearly, individual deals where it will be negotiated with the broker acting as the advocate for their clients. But if you step back and you look overall, I think the brokers would recognize that what they need is a sustainable industry that can pay the claims and meet the needs of the clients, and current pricing is not going to lead to that. So I think that there is a kind of acceptance of a need for increase, that is different than a year ago or a couple years ago. I don't think there's anything people could talk about, a Houston flood, who'd have thought it? Several cat [size] in the same year and maybe a bit more, those people who are concerned about climate change could be more concerned after this year. I don't see that myself. I think these events, we always knew were there. There are always possible terrorists, and I don't there's a learning myself from any events. I have to admit some were very big and very scary, could have been worse. So sorry, a bit of a long answer, Brian, but it's fascinating question to really dive into.

Absolutely. And then just one other quick follow-up question here, and I'll be done with, like go back to the queue here. You talked about potential opportunities, particularly, kind of in the property cat area where we kind of see may be the best pricing going on here. But without increasing your PMLs, I'm just curious, how do you plan on doing that? Is -- or your kind of thoughts on maybe getting more capital in Silverton? How did Silverton perform through these kind of these events? Is it through other types of reinsurance? Kind of what are your thoughts about taking advantage of opportunities without increasing your PML?

So you have to look at how you're assuming cat risk. Let's say, U.S. wind, in particular, is the one we were talking about. We get it through property insurance. We get it through the risk assessment for obvious reasons. We get it by writing property cat excessive loss. We also pick up some in Energy, both on the Insurance and Reinsurance side. We also pick up some in Marine, not so much there. And there may even be some liability components of an extreme cat. You've got to say to yourself, what's the return carry through 6 of each of those? Because they're always different. Sometimes, you want to be a buyer of retro, sometimes you want to be a seller of retro, et cetera. The way I think the market is going is, all this is going to improve in pricing, but some of it is from a lower base and some of it's going to improve more rapidly. So our view would be, withdraw capital from the place with the lesser return and allocate it to the place with the better return. And one of the points I made there is, it's not just the capital you already have in property, it's capital that's underlines the business that might not move as much that you want to get where the fun is. In terms of Silverton, it performed, I would say, in line with expectations. I think it's satisfactory. We've -- we got good relations with the guys in Silverton and the other people whose capital we represent. Most of them, I think, would be willing to take increased shares next year, and we may very well do that. That's just a matter of commercial negotiation. I think we probably will want to grow the gross exposures. If our assumptions about pricing are correct, then let me clearer, we definitely want to grow the gross exposures. But you also have to think about capital and you have to think about risk and you have to think about volatility. And I would say, we for 12 years or so had a maximum of 17.5% of shareholders equity exposure to 100-year return period. We've operated comfortably within that and I'm comfortable continuing to operating companies in that. The opportunity may come in the form of improved commissions, improved property commissions and other ways, but it's a combination of those things. It's not the wish, however, to make this a more risky organization. The other thing I'd say to you and our guys are looking at this in detail, but -- and it goes back to your previous question, maybe there are more unknowns than we knew about. You know how people like to say. That flood in Texas, that was really -- that was outside of the parameters of what most expected. Now as an insurance loss because of the way [homes are constructed], it may not be that serious, but there may be some legal issues still to be looked at there. The number of cat 5s this year, it says to me, that, in the more near-term frequency end of the curve, we kind of know where we are. And as we go out into the unknown, we know even less than we thought we knew. I don't think that the industry is necessarily getting rewarded for taking that kind of unknown risk. And simplest way I'm going to put it, beyond the 1/100 even beyond the 1/250. So sitting on those kind of exposures seems to me, where you can be less sure of how to quantify the risk and less sure that you're right price and a capital intensive, I think that makes sense. So I think clipping the tail of the loss distribution curve up in that 250 area, probably makes a lot of sense. And I say this based on what I think the market is. If the market changes and says, we're going to pay 10x more for this kind of less well known risk, then I might have a different view. I'm a commercial person.

The next question comes from Ian Gutterman with Balyasny.

I have a lot to try to get through here with limited time, so I'll try to be quick here, Chris. First, looking through the balance sheet and based on how much your recoverables went up, it look like you're gross loss was over $1 billion. Is that correct?

Ian, it's Scott here. The gross loss was not over $1 billion. The gross loss was a little bit over $630 million for the 3...

So why did your recoverables go up so much in the quarter then?

Combination of a couple of the things, Ian. Actually, it's not only in the quarter. Let me talk about the year-to-date. A couple of things in there. Some adverse development covers that we'd -- that we talked about in addition to the quota share arrangements that we've put in place. So I would say that the main one is the quota shares that we have in place.

Okay. I'm trying to look at this real quick. I mean, in June, your recoverable was $779 million, now it's $1.369 million. It went up $600 million in the quarter, Scott?

So $300 million and a bit of that, Ian, will be the cats. Another chunk of that will be the quota share arrangements.

I guess I'm not familiar what quota share arrangements you are talking about. You didn't mention that. I didn't hear that...

Sorry, okay. Within our Reinsurance segment, Ian, we've put in place the...

Oh, I'm sorry. (inaudible) okay, I understand. I understand. So why did those kick in more this quarter than prior quarters? It looks like...

Yes, the earnings are up a little bit. Ian, let me tell you, there's a third piece in there. We've put a little bit more protection in place on some casualty reserves that we had -- that's sitting out there. So a bit of that has come from some adverse development cover.

Okay. Got it. And then so that leads into the next thing is, Chris was little a unclear earlier. I think I caught it but just to be sure, you said something about going an offense through -- I think, you said adverse development covers, is that what you said? Or was it something else?

Yes, yes, what I'm really saying, sorry, to be unclear, is, if the market is turning as much as we think it may be, it makes sense to, I think, view capital as a scarce commodity, and therefore, deploy that capital in the place where it's going to get the best return. Capital sitting on the balance sheet backing up reserves, doesn't produce a lot of return. So buying an ADC -- a substantial ADC, freeing up capital and allowing that capital to get a better return is something that I think is worth thinking about. It's not something we decided to do. And whether you do it or not would be depending on, is it a good deal? If it's not a good deal, then it won't happen. But it's something we wouldn't have necessarily thought about doing 6 months, a year ago, because they weren't that many underwriting opportunities, I think in the...

Understood. So I guess, my concern there is and this is sort of my broader concern given that the quarter's hit to equity, is your debt-to-cap is on the high side now. I would think ADCs usually require an upfront reserve hit which takes you equity down further. So how do you manage the debt load here and still be able to have flexibility?

Ian, it's Scott here. Actually, there is no real meaningful hit to equity, they're all as a result of the adverse development cover. There is -- there's, obviously, a transfer of those reserves to a third party, but the actual risk premiums that are applying to this business is not that significant. So that the capital position is relatively unchanged in terms of the absolute levels. But our available capital through rating agency models or our own internal capital model is in fact increased because we've taken volatility or uncertainty out of our balance sheet.

Okay. But you don't have -- you don't feel you have an issue managing just with the rating agencies the headline debt to cap right now?

No, I don't. Actually, we've been -- we've obviously been chatting to rating agencies throughout the quarter. We have a very open and transparent relationship with those guys and they're all supportive.

Okay. Perfect, perfect. So Chris, I wanted to push back on a couple things. First, I think, it was -- I think, it was Brian, I'm losing track. But question about the rate level of volatility, for your balance sheet. And I guess, to me, one of the lessons from the past couple of months is, if someone's starting out with a higher debt-to-cap than peers, shouldn't their PMO be lower than peers? Because the reason your stock got hit more than most while Irma was offshore was the fear about your balance sheet being able to withstand a 1/100 event versus some others. So it doesn't sound like there's been much reconsideration of that. I guess, I'm wondering, why not? Until the debt-to-cap comes down and until ROEs go up substantially, if we're looking at maybe 10% ROE at best for the overall company, why does a high PMO makes sense these days?

So Ian, you've asked the most interesting questions and sometimes I think about your questions and see that you're right and I'm wrong and do things differently in time, and let's not rule that out. But my current perception is that, if you look at 3 hurricanes, that's what we're talking about, we lost about 8% of shareholders equity in those 3 hurricanes. And I think that puts us, not even in the middle, but at the lower end of peers in terms of the damage. There are a lot of people well into double digits and further up. So I would say, we already were in a relatively risk adverse place, but I do accept that there was some talk, particularly, as Irma was coming in, which I think, was misplaced and was frankly wrong about the degree of cat exposures that we had. And I think that exposure we have at both the gross level and the net level is at a reasonable sort of point. So what I was saying to Brian is, notwithstanding a much better pricing environment for property lines, we won't want to take anymore, let's say, from 0 to 100-year exposure on the balance sheet than we currently have. But I think, what we have is a pretty good place to be. I was also saying to Brian, beyond 100, I don't think -- I think the number of unknowns becomes clear in a year like this, and that's not in the models, it's not priced for, it's kind of just it's kind of a nasty thing lurking in the tail. I don't think the industry gets paid for it adequately. And therefore, I thought would take our exposures to that down somewhat, let's not quantify it today. But that's the way we're thinking. And I think that's a pretty sensible responsible risk where we're waiting. But if you think that's wrong, I, absolutely, would be interested in hearing what you say in more detail.

Yes. No, we could take it offline when there is not 6 earnings calls. I'm happy to do that. But just a couple of other quick things, because I would like to have that conversation, but probably have to save it for when there is more time. Just real quick, if we do see that -- the history obviously of big storms is a quarter later, 2 quarters later, people take up their estimates. I'm not saying that will be the case this time. But if it is, can you just give us a sense of how much protection you have left, if you have another $100 million gross? Should I expect $100 million net or is very little net because you still have a lot of cover left?

Hi, Ian, it's Scott here. Now it does depend on where the loss comes from, which storm it might come from, if it was to -- if any of those were to deteriorate, we have additional retro and ceded reinsurance in place to account for some of the gross deterioration. I mean, it would have to be pretty severe for it to be in anyway meaningful to our bottom line.

Got it. Perfect. Okay. And then very last one, Chris. I think originally when you talked about the program with McKinsey and such, you talked about underwriting like just being part of it and you did mention insurance property in the script. Are there any other places where you're exit -- maybe you haven't announced it yet and you can't tell us, but are there further lines of business we should be expecting you to basically planning to run up? Or is property the big one?

So maybe a bit of a misunderstanding here, Ian. The effectiveness and efficiency program is really about building a better operating model for the company. So it's premises, it's procurement, it's outsourcing, it's use of technology, it's better ways of working and streamlining the organization. In terms of the other side, the underwriting side of the business, well, this review didn't actually look at that in detail. But I think, what we have today is a place where you can get paid better, put your money in certain places and there are other areas where it doesn't look like you're going to get paid a lot better. So our job is to just figure out how are we doing that, where we should be allocating the most capital. So I couldn't say we'd take a decision to exit any line. There was a small pocket of property, not the whole of U.S. Property Insurance, there one property of that, which I wish, we've never done it and we've paid the price. But thank god, the cost of that, we've basic -- we've kind of done paid back all the installments almost by now, so it should be coming to an end, that issue.

I was making sure there aren't others like that, that, that was the main one.

Yes.

(Operator Instructions) The next question is a follow-up from Amit Kumar with Buckingham Research.

Just two clean-up questions. First, I want to go back to Ian's discussion on, I guess, the debt-to-cap. I thought that the prefs got equity-like treatment in their rating frequency model. Is that not correct? Is that -- how is the treatment of the prefs in the model?

Amit, it's Scott here. I think it depends on which rating agency model you're looking at. I think if you're -- I guess, the 2 primary ones that you look at in terms of the debt-to-cap ratio as you're talking about it are S&P and Moody's. On an S&P basis, there is a 15% threshold, which we're under in terms of that prefs, so there's 100% equity treatment on those. And then on a Moody's basis, they are what they refer to is as Basket Ds, which give a 50% equity credit.

That's actually very helpful. But the only other question I had was, just probably going back to the point on outsourcing, it wasn't clear to me if you are talking about outsourcing your back-end IT function? Or is it catastrophe modeling? Or is it some level of, I guess, initial underwriting? What exactly is getting outsourced? And are these going to be Aspen employees? Or is this with a third-party?

Amit, it's a variety of different support functions that we will be considering outsourcing. In fact, we already have some outsourcing arrangements in pockets of our business. So it's really just an extension of some of those things, but on a bigger scale. We haven't decided yet entirely on how that outsourcing arrangement will be executed in all parts. But it's likely that it would be more third-party than it would be an internal type arrangement.

And let me just add to that, Amit, I may have heard you say, are we going to outsource underwriting? If you did, the answer is no. You can't outsource underwriting. That's -- that is a core skill of the organization and you keep it as close as possible under your nose at all times. So I'm not sure you said that, but I just want to stamp on that.

Yes because it is reminding me of a company whose name started with a [S], but let's not go there. Okay. That's helpful. That's all I have but I guess just one final question. The incentive compensation discussion, you give the numbers, I mean, how does it change from here? And will it now be based on, I guess, growth in book value ex charges? Or how should we think about that?

Well, we can't really talk about that today because the compensation committee is going to meet later this year, and again, in February and decide that. But yes, I think, we do need to make some changes to the arrangements for the next few years. And I think that's something that we would see external consultants and the guys on our board compensation committee will be working through. But what you want to do is, compensate and incentivize people intelligently to get the results that you wanted to get, and probably, we will need to make a few changes. We'll maybe talk to those I would think February would be a better time for that conversation.

This concludes our question-and-answer session. I would like to turn the conference back over to Chris O'Kane for any closing remarks.

This conference is now concluded. Thank you for attending today's presentation. You may now disconnect.