AXIS Capital Holdings Ltd (AXS) 2007 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Axis Capital second-quarter 2007 earnings conference call. My name is Jackie and I will be your operator for today's conference. At this time all participants are in a listen-only mode. We will be facilitating a question-and-answer session towards the end of today's conference. (OPERATOR INSTRUCTIONS). I would now like to turn the presentation over to your host for today's conference, Ms. Linda Ventresca. You may proceed.

Thank you, Jackie. Good morning, ladies and gentlemen. I am happy to welcome you to our conference call to discuss the financial results for Axis Capital for the quarter ended June 30, 2007. Our second-quarter earnings press release and financial supplement were issued yesterday evening after the market closed. If you would like copies, please visit the investor information section of our website, www.AxisCapital.com.

We set aside an hour for today's call which is also available as an audio webcast through the investor information section of our website through August 31st. An audio replay will also be available through August 24th. The toll-free dial-in number for the replay is 888-286-8010 and the international number is 617-801-6888. The pass code for both replay dial-in numbers is to 866-914-83.

With me on today's call are John Charman, our CEO and President, and David Greenfield, our CFO. Before I turn the call over to John I will remind everyone that statements may during this call, including the question-and-answer session, which are not historical facts may be forward-looking statements within the meaning of the U.S. federal securities laws.

Forward-looking statements contained in this presentation include, but are not necessarily limited to -- information regarding our estimate of losses related to catastrophes and other loss events; future growth prospects and financial results; evaluation of losses and loss reserves; investment strategies; impact to the marketplace with respect to changes in pricing models; and our expectations regarding pricing and other market conditions. These statements involve risk, uncertainties and assumptions which could cause actual results to differ materially from our expectations.

For a discussion of these matters, please refer to the risk factors section in our most recent Form 10-K on file with the Securities and Exchange Commission. We undertake no obligation to update or revise publicly any forward-looking statement whether as a result of new information, future events or otherwise.

In addition, this presentation contains information regarding diluted book value per common share calculated using the if converted method and operating income which are non-GAAP financial measures within the meaning of the U.S. federal securities laws. For a reconciliation of these items to the most directly comparable GAAP financial measures, please refer to our press release and Form 8-K issued last night which can be found on our website. With that I'll now turn the call over to John.

Thank you, Linda, and good morning to you all. We are extremely pleased to report our results for the second quarter of 2007. In the quarter we achieved $252 million in net income yielding an annualized return on average common equity of 24.1%. Our diluted book value per share has increased 25% since June 30, 2006. Even taking into account the mark to market impact of recent rising interest rates, our diluted book value per share has increased 7% since year-end.

For the year-to-date gross premiums written increased 5% to $2.3 billion with increases in our reinsurance segment more than offsetting continuing disciplined reductions in more competitive lines within our insurance segment. Our underwriting results were strong and healthy with a market leading combined ratio for the quarter of 75.4% and a combined ratio for the year-to-date of 78.1%. Our investment results continue to contribute meaningfully to earnings with pretax net investment income up 24% from the same quarter last year and up 29% for the first half.

Our quality underwriting portfolio and investment earnings delivered record results for the quarter and for the year-to-date, even with the greater frequency of small to medium-size of cat events during these periods. The second quarter specifically included the storms and flooding in Australia and England. It is the substantial recalibration of our underwriting portfolio over the last two years that has allowed us to absorb these losses without significant adverse impact on our portfolio. With that I would like to turn the call over to David to discuss our financial results for the quarter in more detail.

Thank you, John, and good morning, everyone. As John mentioned, we're extremely pleased with our results for the quarter. Our second-quarter results marked the seventh quarter in a row of record earnings against the comparable prior year period. This once again demonstrates the powerful earnings potential of the Axis franchise.

For the quarter net income was $252 million or $1.51 per diluted share, a 13% increase from the $223 million or $1.37 per diluted share for the second quarter of 2006. After-tax operating income, which excludes the impact of realized gains and losses on investments, was $256 million or $1.54 per diluted share, a 10% increase from the $232 million or $1.42 per diluted share for the second quarter of 2006.

For the first half of 2007 net income was $479 million or $2.88 per diluted share, a 14% increase over the $419 million or $2.56 per diluted share for the first half of 2006. After-tax operating income was $483 million or $2.91 per diluted share, an 11% increase from the $437 million or $2.68 per diluted share for the first half of last year. These results translate to an annualized return on average common equity for the quarter of 24.1% and 23.6% for the first half of 2007. Our diluted book value per share has increased 25% on a rolling 12-month basis and 7% for the year-to-date despite the negative mark to market impact caused by the sharp movement of interest rates in June.

Turning to our top line, our consolidated gross premiums written was $959 million for the quarter and compares with $995 million in last year's second quarter. Quarter-to-quarter comparisons are impacted by adjustments to prior year premium estimates in our reinsurance segment. The second quarter of 2006 included significant upward premium adjustments which I will discuss in a few minutes. Absent these adjustments in our reinsurance segment, consolidated gross premiums written were little changed from last year. For the year-to-date consolidated gross premiums written of $2.3 billion were up 5%.

Increases in our reinsurance segment in the first half of this year more than offset reductions within our insurance segment. Gross premiums written in our insurance segment were $613 million and compared with $630 million in last year's second quarter. Substantially reduced writings of marine hull, aviation and terrorism lines due to competitive conditions were offset by continuing growth in professional lines in our U.S. catastrophe exposed property account.

Our political risk business was lower this quarter when compared to the prior period. The unpredictable timing and lengthy analytically lead time associated with political risk business impacts any comparative analysis amongst periods. Gross premiums written in our reinsurance segment decreased 5% for the quarter. Last year's quarter included significant upwards premium adjustments from prior years. These items principally emanated from our property pro rata reinsurance line.

Excluding the impact of these adjustments in either quarter, gross premiums written in our reinsurance segment were essentially flat for the quarter. New business in our property catastrophe reinsurance account were offset by both reductions in our property per risk account due to more competitive market conditions and reductions related to both the property and U.S. casualty areas where cedents continued to retain a greater portion of their risk.

For the first half of 2007 gross premiums written in our reinsurance segment increased 11%. As discussed last quarter, this was the result of our success at the 1st of January renewal date in further penetrating the U.S. and European reinsurance markets. As a reminder, the majority of our European reinsurance portfolio and a significant portion of our U.S. property and liability reinsurance business are written at the 1st of January renewal date.

Consolidated net premiums written decreased 8% in the quarter. This was due to the purchase of expanded reinsurance coverage for a number of business lines within our insurance segment. In line with our restructuring of Axis Insurance earlier this year which emphasized global product management, we applied similar discipline to our reinsurance purchasing activities. During the second quarter this approach allowed us to expand our reinsurance coverage while significantly reducing our overall net retention relative to last year. This may be contrary to actions some competitors are taking, but we are confident we've delivered value in the form of an overall improvement in our risk/reward position. In line with our period-to-period changes in net premiums written and business mix, consolidated net premiums earned were up 2% in the quarter and up 5% for the first half of 2007.

Moving on to our underwriting results, our underwriting income for the quarter of $186 million is up 17% relative to the same quarter last year and includes both strong current year underwriting results and continued favorable development from prior periods. For the quarter our consolidated combined ratio was 75.4%, an improvement of 2.9 points from the same period last year due to a higher level of favorable loss development from prior years. Our insurance segment combined ratio was 67.1% and compares with 68.5% in the same period last year. Our reinsurance segment combined ratio was 78%. This ratio improved 6 points relative to the same period last year due to a higher level of favorable loss development this quarter.

Overall our net favorable reserve development in the quarter was $97 million or 14 points. Of this amount $56 million was from our insurance segment representing a positive impact of 18.7 points on the segment's loss ratio. Our reinsurance segment posted $41 million in favorable loss development representing a positive impact of 10.4 points on the segment's loss ratio. All of the favorable reserve development with one exception continued to be related to short tail lines. The exception was in our insurance segment where we recognized the favorable resolution of a major professional liability claim for which we had previously established a case reserve.

As ever, we caution against comparing the level of reserve development amongst periods. However, I would like to remind you that we continue to maintain the same disciplined and conservative approach to quarterly reserving established at our inception.

Our overall accident year loss ratio for the quarter of 65.7% compared with 66.9% in the first quarter of this year and 64.3% in the same quarter last year. Our insurance segment accident year loss ratio for the quarter was relatively flat at 63.5% and our reinsurance segment accident year loss ratio was 67.3%, up 2.4 points. This movement in our current accident year loss ratio in the reinsurance segment was primarily due to increased attritional catastrophe events which impacted a variety of our property reinsurance lines.

The storms and flooding in New South Wales Australia in early June and the flooding in northern England that began in mid-June were not major loss events for us. Our estimated net losses from these events emanate from our reinsurance operations and total $47 million on a pretax basis in the second quarter. The majority of this $35 million relates to the UK floods. On the whole these losses were within our expectations of large loss activity in our reinsurance segment for the year.

As you know, there have been new outbreaks of flooding in other areas of the UK into late July. We currently expect flood losses in our reinsurance segment in the third quarter due to these July occurrences, but these should be below the level of those recorded in the second quarter. Generally we don't believe the UK flooding events in June and July move the dial in terms of our expected underwriting profitability for the year.

Turning now to our investment portfolio, our total cash and investments increased to $10.1 billion at June 30, 2007, up 2% for the quarter and 5% from year-end. Net cash generated from operations was exceptionally strong at $410 million for the quarter and $715 million for the first half. Our pretax net investment income for the first half of 2007 was $239 million, up the 29% relative to the same period last year.

Focusing on the activity this quarter, pretax net investment income increased 24% this quarter over the comparable 2006 period to $114 million. The increase was due to larger investment balances and higher yields on cash and fixed maturities. This increase was somewhat muted by the recent movement in interest rates.

Relative to the second quarter of last year, pretax net investment income from cash and fixed maturity investments increased 28% to $111 million. Pretax net investment income from our other investments portfolio in the quarter was $3 million and compared to $5 million in the same quarter last year. This decrease was related to the negative mark to market impact of rising interest rates on the fair value of our life settlements investment. Setting aside this one item, our pretax net investment income from our other investments was $20 million for the quarter.

We remain optimistic that significant positive cash flow, higher reinvestment rates and robust returns from our other investments will continue to drive good growth in investment income. The annualized yield earned on our cash and fixed income portfolio increased to 5.0% from 4.7% in the same period last year. For the first half this yield also increased to 5.0% from 4.6% in the same period last year. The duration of our cash and fixed maturities including operating cash remains very short at 2.5 years. Our other investments portfolio produced a year-to-date return of 5.5% before considering the impact of our life settlements investment previously discussed.

Net realized losses for the quarter were $5 million as compared with net realized losses of $10 million in the second quarter of 2006. Net realized losses for the first half were $4 million as compared with $21 million in the same period last year.

We understand that recent events such as those related to sub prime mortgage exposure and low quality assets continue to cause concerns in the financial markets. We are comfortable that we have successfully avoided any material negative impact from these events on our investment portfolio. Our fixed income portfolio is of very high-quality with a weighted average rating of AA plus and 90.3% of securities rated A- or better.

More specifically, on the topic of sub prime and Alt-A mortgage exposure, $69 million represents the amount for which collateral comprises sub prime mortgages or sub prime home equity loans and $134 million represents the amount for which collateral comprises Alt-A mortgages. These represent negligible portions of our overall investment portfolio and are in AAA rated tranches. Further, in our investment portfolio we do not own CDOs with any significant exposure to sub prime and Alt-A. If anything, our overall investment portfolio returns have benefited from our alternative investment managers' net short exposure to sub prime mortgages.

On the topic of CDOs, the only meaningful allocation we have to this asset class is in CLOs. We do own in our fixed maturity portfolios only $11 million of CDOs which have commercial real estate as collateral. With respect to our exposure to CLOs, our quarter-end allocation to this asset class is $226 million or approximately 2% of our investment portfolio. Each investment in this portfolio was made after a significant amount of internal and external due diligence. For these investments we've enjoyed strong performance with excellent cash-on-cash returns. Our collateral managers are both conservative and high-end and we are comfortable with our current position.

With respect to foreign exchange, changes in exchange rates, primarily between Sterling and Euro versus the U.S. dollar, continue to have a positive effect on our net asset positions. In this quarter we realized $7 million in foreign exchange gains and $9 million in the first half of 2007. These gains compared with gains of $19 million in the second quarter and gains of $28 million in the first half of last year.

Our interest expense for the quarter was $14 million compared to $8 million in the second quarter of 2006. This increase was due to interest costs incurred on the $400 million repurchase agreement we entered into in December 2006 to fund the life settlement investment.

Returning to the balance sheet, our total net loss reserves stand at $4.0 billion and 71% of these net reserves are IBNR reserves. Total shareholders' equity increased 6% to $4.7 billion since year-end despite an increase in net unrealized losses of $63 million.

With respect to capital management, during this quarter we repurchased 2.7 million common shares for a total cost of $101 million. We have a further $299 million available under our current share repurchase authorization. We will continue to actively manage our capital position and take action as opportunities arise. However, we do not anticipate utilizing meaningful amounts of this repurchase authorization until after the Atlantic wind storm season. Total capital to deploy in our globally diversified franchise now stands at $5.2 billion.

Finally, I'm pleased to report that both S&P and A.M. Best have responded positively to our underwriting expertise, first-rate business model, overall financial strength and strong performance since our inception. Since our last call S&P placed a positive outlook on our A financial strength rating and, more recently, A.M. Best reaffirmed our financial strength rating of A. Importantly, A.M. Best simultaneously increased our issuer credit rating by one notch to A+. With that I'd like to turn the call to John to discuss overall business activity and our view on current market conditions.

Thank you, David. As a general comment, the market is a much more competitive marketplace than that of even three months ago throughout all our underwriting businesses. Our core competencies have become even more important. Risk selection, pricing experience, negotiating savvy, market positioning -- all of these vital attributes which are embedded throughout our underwriting businesses are showing and will continue to show their true worth in our current and near future trading activity.

While overall discipline in the established reinsurance marketplace is being maintained, competitive behavior in the insurance marketplace is accelerating in a number of areas. It is behavior which we believe is irrational and seems unmanaged and unmonitored. Even I find it difficult to comprehend given the substantial increased retention of risk in the U.S. insurance marketplace which we are witnessing amongst clients of our reinsurance operation.

Again here is another great example of Axis taking a contrary position to most of the rest of the markets. We not only increased our reinsurance purchase coverage but, more importantly, have taken the opportunity to substantially reduce our retentions in our insurance portfolio. Let me begin by commenting on the reinsurance marketplace.

In both the property and casualty reinsurance areas pricing pressure continues against a backdrop of a relatively loss free environment, but business is generally still attractively rated and, importantly, terms and conditions in our portfolio are being upheld. More pressure continues to come from the overall reduction in premium volume available in the reinsurance market as insurers, particularly in the U.S., continue to retain more risk. This is having a more negative impact in the U.S. casualty reinsurance marketplace than it is in the property area.

In the property area the reality is that overall demand remains strong and our view is that supply is generally in line with demand. This increased demand is defined by the following. Cedents are purchasing additional higher layers of cover. State coastal windfalls and other residual market facilities are utilizing reinsurance to manage growing exposures. Overall demand for Florida property cat covers has increased and offset the impact of the expansion of the Florida hurricane cat fund. And finally, the northeast wind exposure zone has become a much more significant exposure zone approaching the Southeast in terms of cat limits purchased.

As 2007 progresses underlying exposure growth and experience continues to be dealt with both appropriately and technically by the reinsurance market with some normal competitive wear on price. We witnessed this at the July 1st renewal where cat reinsurance pricing for our portfolio held up well at attractive levels. Broadly we did not experience any material slide in terms and conditions. Furthermore, overriding commissions are certainly not back to the levels of the previous soft market. However, one storm cloud which has been on the horizon for the last six months is the increased capacity sought by major commercial carriers to compete more aggressively in the primary U.S. property marketplace. Much can change during the balance of this year, so there really isn't much more to say on that point.

As you know, second- and third-quarter renewals in our reinsurance operations are heavily weighted toward the U.S., so we don't have any relevant information regarding international reinsurance business at this time. While it is in many respects to early to comment on the impact of the recent UK floods on pricing, we do expect price increases in the next round of UK reinsurance renewals, but we do not expect any broad correction on non-U.S. business.

Turning to U.S. casualty reinsurance business, not much has changed since our comments following the January renewals. There was some marginal downward pressure on better performing accounts, but most tended to renew at or near expiring . Accounts with deteriorating loss experience renewed at higher prices.

Moving on to a discussion of our insurance business, in some lines of business like catastrophe exposed property and offshore energy business rate increases have moderated. But current rate levels continue to produce returns above historic levels. In areas where the competition has been much more aggressive but, in my view, mindless such as terrorism, aviation, non-U.S. property and non-cat property, we are maintaining our extremely cautious and defensive posture.

In lines such as primary casualty, umbrella and professional lines we are witnessing rate declines in the high single-digits and low double-digits. We believe our areas of focus here still contain good profit potential and our risk selection and overall execution strategy have become even more critical. Historically we have demonstrated our capability to hold our own in this type of competitive environment.

During our last earnings call I discussed the significant of our acquisition of MediaPro, particularly with respect to the buildout of our franchise in areas which are better insulated from the vagaries of the P&C marketplace. I am pleased to report that the integration of MediaPro is progressing as planned and that we are working diligently to quickly lay the technology driven foundation for the global expansion of MediaPro's small and medium enterprise business. Whilst you will not observe large increases in our top line this year attributable to MediaPro, you will see meaningful contributions from its business activity next year.

In conclusion, we expect the balance of this year to be much the same as our experience in the first six months, absent any significant loss activity. We have focused our overall efforts on areas of the market where we see the greatest opportunity. We expect similar year-on-year dynamics in the second half of this year with areas of strength offsetting areas where we have deliberately reduced our activity -- those areas where competitive dynamics are yielding potentially unacceptable underwriting returns.

If there are dramatic negative changes in the market we have more than demonstrated that we will walk away from unattractive business. To all of us of Axis, regardless of softening market conditions, it's business as usual. To end on a positive note, there is no reason to expect anything less than continued strong book value growth at the highest quality from our activities throughout the rest of this year. Now I would like to open the line for

(OPERATOR INSTRUCTIONS). Vinay Misquith, Credit Suisse.

Good morning. Pricing clearly seems to be coming down, yet the profitability of your business, at least on an accident year basis, ex cat seems to be holding up pretty well versus the last quarter and versus last year -- especially in the reinsurance segment. If you exclude the $47 million worth of cat this quarter it seemed to have improved dramatically? If you can give me a sense of how it's holding up and what you see for the future?

Well, it's a pretty mixed bag, Vinay. But one thing that I just want to emphasize to you is the fact that we have probably one of the most robust and realistic price monitoring systems embedded throughout our company, and that flows directly through to the loss picks that we have within the accident year. And so we really do and are able to see the reality of our trading conditions relative to the competitive nature of the marketplace at any given moment in time.

We are having to churn our business a lot more and we're very mindful of the new business we're accepting and the level of pricing and the history of that business. But we're having to work much, much harder to find better pieces of business in the global marketplace. But without a shadow of a doubt the market has been softening over the last three months in a way that we had not anticipated it would, do.

But the fundamentals of our business are still very, very strong. We have great diversity in our product lines as well as our geographic reach. And our underwriters are very, very experienced in positioning themselves within portfolios to maximize returns where less capable underwriting businesses are really there and being used by the marketplace and they're the businesses that subsidize the rest of us.

Vinay, I just would add, in the analysis of looking at our loss ratio it's probably not the best thing to do to exclude the cats outright as an analysis. As I said in my comments, the cats that we had this quarter were within our expectations, so they are to an extent included in our loss ratio estimates. I would add that we have better experience reflected in some of our initial loss estimates as well which are probably driving some of the loss ratios down. But I would not leave you with the view that you should look at our loss ratio excluding the cats in this quarter.

Sure, okay, that's fair. John, you seem to say that on the reinsurance side pricing is holding up better or rather discipline is holding up better than on the primary insurance side. You often learn that reinsurance is sort of a derivative of primary insurance. I'm just wondering how those two play out if the primary insurance pricing insurance pricing is declining at an accelerated pace how are we managing to keep the reinsurance pricing and profitability better than the primary insurance?

I think that our reinsurance businesses -- and they're very diversified businesses so let me just make that point, Vinay -- are fully aware of what's going on within the primary markets. They have regular contact with our primary underwriters. There is a Chinese wall that from our reinsurance business back to our primary business, as you would expect, but it is critically important that our reinsurance underwriters see the underwriting behavior of the underlying marketplace and they look at the companies whose underwriting differs substantially from the presentations they make in their reinsurance submissions. And we will avoid those companies or there will be such increased pricing within those portfolios that we'd price ourselves out of the business.

So the market intelligence that we are able to have, and because we're a coordinated and connected business, which I know you get tired of hearing me say it, but it's critical in feeding that information through to our reinsurance underwriters so they can have an overall view and a more realistic view at the cedents that they are trying to do business with. It's a very proactive stance that we take and I believe that the focus we're able to get out of that makes us much stronger.

And one last thing if I may. You've been increasing your marketing with the mutual companies and reinsurance, when should we start to see the fruits of that or have you already started to see the fruits of that?

I think it's been mass masked within the churning of the portfolio. The dynamics within the reinsurance portfolio are quite complicated because with increased retentions we're moving away from certain cedents because of their behavior on the primary business and yet we're adding new business. So it all gets mixed up I'm afraid, but we will continue to market strongly and appropriately with the mutuals for the foreseeable future.

Thank you.

Josh Shanker, Citigroup.

Good morning. In terms of the new reinsurance purchases in terms of risk management I'm curious to know where you've trimmed your risk. Was that in terms of catastrophe loss, non catastrophe property or casualty would be the first question? The second question involves you being the outlier among your peers about buying more reinsurance here. Or perhaps are you noticing that the reinsurance markets are beginning to change and there is an arbitrage to be made here and that you would expect your competitors will figure it out over the next couple of quarters?

It's a competitive marketplace and people talk all the time. But let me just deal with the second question. We don't arbitrage. The whole point of our business is that anything that comes in through the front door has to be of a quality -- and I remind you we run our reinsurance portfolio net and we buy our reinsurance coverage for our insurance portfolio. But everything that comes through and is underwritten by Axis, other primary or reinsurance, has to be capable of sustaining profitability in its own right. We then use reinsurance to either enhance profitability or significantly reduce the potential for loss.

And we have taken advantage this year and I think we have a very good and reasonable track record within the reinsurance marketplace of substantially increasing the amount of coverage to protect us from cat events and at the same time significantly reducing our retentions which other companies have chosen -- seem to have chosen to go in the other direction. We believe it's prudent, we believe it's very cost-effective, and we believe that we've increased the risk reward of the underlying business that we're protecting. The first question you asked, Josh, I wasn't sure about what you were trying to get at, so forgive me.

In terms of you've downsized the overall risk to the portfolio, where has your risk declined?

We've been, in terms of our risk portfolio -- are you talking about the insurance portfolio or the reinsurance portfolio?

The reinsurance that you bought for the insurance portfolio has downsized your overall aggregate risk in what ways?

Well, it's downsized it because we've bought more coverage and reduced the retentions.

On the property side or casualty side, non-cat property?

On the property side. On the casualty side we have a series of pro rata treaties, which is now we protect ourselves as well as doing a lot of factory insurance on the casualty side. And you know that we treat the casualty side with the greatest of -- the utmost of respect. So there is a lot of faculty and pro rata treaty on that. Does that answer your question?

Very well. Thank you, John.

Kevin O'Donoghue, Banc of America Securities.

Good morning, everyone. Just a question on your professional lines writings. You talked about the sort of relative weakness of the primary insurance markets versus reinsurance and yet the growth in your professional lines insurance business was sort of on par with the nice growth you've been having in previous quarters while there was a pretty significant decline on reinsurance. And I was just wondering if you could talk about the professional lines market, reinsurance versus insurance and how that's flowing into your overall book?

Firstly, Kevin, I'd like to remind you that we started to diversify our professional lines portfolio two years ago because we saw the competition coming in mainstream D&O some way down the line. And part of the -- if you remember we entered into an into an [MGA] agreement with MediaPro two years ago exactly to diversify away from a portfolio we could see was going to come under a lot of pressure. And so we've completely rebalanced our professional lines. It's a huge portfolio of business across many different productlines. And so we've substantially recalibrated that portfolio to move away from what I would consider the more rational competition on the major D&O side.

And just as I said earlier, our reinsurance writings will reflect the current market conditions and the current market behavior of the underlying carriers. And so they are taken into account in the way that we will price the reinsurance that is made available to them. And if it does not meet our expectations, we will not write the business.

Okay, thanks. Then just one other quick question. How does your net exposure to southeast wind this year compared to what it was last year? Thanks.

Well, I said it is significantly reduced, and I would prefer not to, for competitive reasons -- I'm not being evasive. But one of the great concerns I have with all these calls is giving away far too much information to our competitors. But I can assure you it is a much more advantageous position to us.

Than even in 2006?

Substantially better than 2006.

Okay, great. Thank you very much.

Kevin, I would just add that we're within our risk tolerances for the property cat business, which is -- and other businesses -- which is at 25% of the total capacity.

Okay, thanks.

I'm sorry, capital.

Matthew Heimermann, JPMorgan Securities.

This is actually Keith Alexander on Matt's behalf. Good morning. I have two questions, the first of which pertains to favorable development. Have there been any changes to the lines in which you are seeing contribution now, and particularly in the insurance segment?

Sorry, what was that last bit that you said? I got the first bit.

Oh, yes, particularly in the insurance segment versus the reinsurance.

The reserve development continues to come from short tail lines. And as I mentioned in my remarks, there was one claim in the quarter that we had a favorable development on because of the case going away, if you will, and that is in the insurance space. So that produced a bit of an additional development, prior-period positive development. But otherwise, I would say the consistent approach we have to reserving has produced essentially the same types of development in the more recent years on our book.

Let's be clear, we have been very consistent in our approach in saying that we really at this stage in our development are only looking at our short tail lines. And it was very unusual for us to make a release like that. But because of the size of the reserve and because it was an individual claim and it was a specific case reserve, it went away. So there was absolutely no justification in holding it.

Okay, that was helpful.

Did that answer your question?

Yes, it was very helpful. My second question pertains to terrorism. You've cited increased competition in the line, but I'm wondering if there are any changes in the market that are presenting new opportunities, particularly maybe related to TRIA.

No, I'm afraid. I think that we have been dramatically reducing our exposure to terrorism over the last 18 months because of what I consider to the a rational and unmonitored underwriting behavior. Underwriting businesses are using substantial amounts of capacity which they're largely running net and are pricing in ways which I don't believe properly reflect the risk.

So we will continue to probably reduce that portfolio of business into the future, especially if TRIA is renewed for a long period of time. And we'll have to think about something else that we can do. But I'm very concerned about nuclear, chemical and biological creeping into coverage for terrorism. I really do not believe, even on the retention basis, it's appropriate for the industry to provide that form of coverage. It's something the world has yet to really grapple with, let alone try and price.

Okay, thank you for taking my questions.

(OPERATOR INSTRUCTIONS). Josh Smith, TIAA-CREF.

Thanks for taking the question. On the sub prime Alt-A exposure, you mentioned that it was all AAA. On the CLOs, does that typically have a rating? And if so, what's it at, the CLO exposure?

No, there aren't particular ratings on the CLO exposure.

Okay. And my second question is on the IBNR. Have you ever provided that or would you consider providing that with and without KRW reserves? Because obviously the percentage is going to increase over time as the KRW stuff runs off?

We don't actually provide it on a breakout basis, but KRW is really becoming a smaller and smaller portion of our remaining reserves. So I (inaudible) really be too wrapped up in that.

Yes, it's been pretty flat for quite some time.

And then finally, when you said -- John, I believe you said the second half was going to look a lot like the first half absent large losses. Obviously you must have contemplated the UK Floods continuing into the third quarter. But what about favorable development given that that large case reserve is not repeating?

We don't comment on favorable -- whatever it's going to be it's going to be. We make the point quarter-after-quarter and I know you guys try and wriggle it out of us, but at the end of the day we'll sit down -- at the end of each quarter and we have a very disciplined process which is documented and detailed and whatever pops out will pop out.

The only difference this time was that large case reserve, okay. And then finally, on your alternative investments, it was a little bit sluggish in the earnings there from what people expected. How do you get comfortable that you don't have outsized mortgage or sub prime exposure through that channel?

Well, we do look at that portfolio very, very closely, as I said in my remarks. We do vet each of the investments with a great amount of diligence. The impact in the other investment portfolio was primarily driven by the life settlement security that we have which I commented on. We had a sizable adjustment there related to interest rate movements. It is a long-term security and so it is a little more impacted by rate movements than the other items in the portfolio, albeit they're impacted as well.

And I would just tell you, to remind you, that we account for that life security on a mark to market basis, so each quarter there will be a bit of volatility on it. But as of today, two quarters into the investment, economically we're very satisfied with the underlying security, as we were when we put it on the books two quarters ago.

Great, thanks for the answers.

Ian Gutterman, Adage Capital.

A couple questions. First, just a follow-up on the life settlement. Was there anything unusual as far as the size of the mark to market, meaning now that (inaudible) have come back to about where they were will we get about a $17 million positive in the third quarter? And similarly, if rates went up again later in the year it would be about a $17 million adverse for that kind of rate movement? Or is there something --?

I wish I had the crystal ball to tell you all that. But I would tell you that since quarter end, since the June 30th date we've seen recovery of some of that $17 million. I'm not going to comment on the actual amount. But I look at it or think about it a lot like the overall fixed maturity portfolio. As rates move we're going to have ups and downs in that particular investment and the impact of that is going to end up in our income statement because of the accounting that we apply to it.

Okay, that's fine. And it is mark -- there's no kind of like one quarter lag like some alternatives, so I could just look at whatever a given quarter is doing to figure it out?

Correct.

Okay. And then John, I just want to understand the decision to buy more of the reinsurance a little bit better. Like you said, it's very contrary to what else is going on in the market and I guess I'm trying to think it through as far as what the evolution of it means for the rest of your business. And I guess I'm wondering --?

I think, Ian, that, as I say -- forgive me for cutting you short, but I know where you're going. To me it seems illogical that if the market is going to enter into a more competitive phase, and we've all been there, seen there and done it before -- if you have an opportunity to further protect your capital base and allow you better scope to expand say some of your cat writings where you're getting pretty good risk reward, and then I really don't see that there's much of a debate about it.

I'm more concerned about my other competitors who seem to be going in a complete new direction, but perhaps they may be focused more on maintaining premium or still trying to grow their premiums by increasing their retentions. But if you go back historically through market cycles you'll find that it tended to work against them, not for them.

Totally agree. I guess what I was wondering is could it be that the market has a different view of loss trend, meaning loss trend has been so favorable the last few years, and if people believe that's going to continue to some extent then it is rational and maybe you guys are being too conservative. And on the other hand, if loss cost does start to return to norm then you're doing the right thing and they're being too aggressive? Could that be the big point of contention?

Well, I made the point last year that you as investors and analysts couldn't understand whether people were just lucky or whether they had been deliberate in recalibrating their portfolios. And regrettably until a major event occurs or a series of events occur, you do not understand whether I'm just pulling the wool over your eyes or my competitors are acting in a way that is very inappropriate. All I know is the fact that I'm charged with the responsibility of not only protecting our balance sheet but growing our book value consistently and in a quality based way.

And I will use all the tools that are available to me including reinsurance. And I remind you, we don't just look at our reinsurance purchasing on an annual basis, we're essentially day in/day out managers, portfolio managers of the underwriting portfolio and we're constantly looking at ways to fine-tune it. It's an essential part of managing the overall underwriting book. And I believe it is the most prudent part. We are a conservative company, I admit it, but I think that my 35 years in the industry has shown that perhaps it might be better to adopt my sort of approach than the rather more cavalier approach that some other companies use.

I 100% agree with that, John. And I guess the only thing -- and to be honest, I'm glad you guys are doing that versus others. I guess the only thing that I wonder about is if others are being cavalier do you really want to be reinsuring them in your reinsurance (multiple speakers)?

As I said to you today, Ian, and I made the point time and time again, our reinsurance underwriters are very clear in understanding the underwriting strengths or weaknesses within the underlying marketplace. And they will definitely use that information in the way they assess risk and either walk away from cedents or are happy to continue to trade with them.

So it sounds like we're sort of in this in between plane where it's not uniformly cavalier, to use your word, but it is in part, is that fair, and the goal right now is just to pick and choose?

What a difference in grammar between the U.S. and the UK. Thanks, Ian.

Okay, thank you.

Thank you, gentlemen, and at this time there are no further questions so I'd like to turn it back over to John Charman for closing remarks.

Thank you, ladies and gentlemen, for taking the time to listen to us. We appreciate that you have taken that time and we appreciate your questions and we look forward to talking to you again very shortly. These quarters come around pretty quickly. Thank you.

Thank you, ladies and gentlemen, for your participation in today's conference. This does conclude today's presentation, you may now disconnect and have a wonderful day.