AXIS Capital Holdings Ltd (AXS) 2008 Q3 法說會逐字稿

Good day, ladies and gentlemen. Welcome to the third quarter 2008 Axis Capital Holdings Limited earnings conference call. My name is Erica and I'll be your coordinator for today. At this time all par participants are in a listen only mode. We will be facilitating a question and answer towards the end of this conference. (OPERATOR INSTRUCTIONS).

I would now like to turn the presentation over to your host for today's call, Ms. Linda Ventresca, Director of Investor Relations. Please proceed.

Thank you, Erica. Good morning, ladies and gentlemen, I'm happy to welcome you to our conference call to discuss the financial results for Axis Capital for the quarter ended September 30, 2008. Our third 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 or website at 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 November 21. An audio replay will also be available through November 7. The toll free dial in number for the replay is 888-286-8010 and the international number is 617-801-6888. The passcode for both replay dial-in numbers is 21842480. 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 made during this call including the Q & A session which are not historical facts, may be forward-looking statements within the meaning of the US 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, general economic capital and credit market conditions, future growth prospects and financial results, evaluation of losses and loss reserves, investment strategies, investment portfolio and market performance, impact to the marketplace with respect to changes in pricing models, and our expectations regarding pricing and other market conditions. These statements involve risks, 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 operating income which is a non-GAAP financial measure within the meaning of the US Federal Securities Laws. For a reconciliation of this item to the most directly comparable GAAP financial measure, please refer to our press release and Form 8-K issued last night which could be found on our website. With that, I'd like to turn the call over to John.

Thank you, Linda and good morning, everyone. As you know, during this quarter, the world's financial markets, our industry and we at Axis have experienced an unprecedented confluence of events. All these unprecedented events were adverse with respect to financial results for the quarter, including our results. More importantly, our view is that these events have acted as a catalyst, heralding an across-the-board hardening throughout the PNC marketplace. The hurricane activity in the quarter served as a healthy reminder of the significant risk borne in US coastal regions as well as the significant claims paying ability at the property and casualty marketplace. We have the potential to be the third largest hurricane of record in terms of market loss.

Even in the face of this unprecedented confluence of events, our industry has demonstrated remarkable resilience. Meanwhile, financial markets have experienced significant and unprecedented volatility and illiquidity. This is a transformational time and serves as an eye opener to the reality of capital and liquidity. It represents the first time since the 1930s that there has been a total collapse of confidence in the major international banking system. This in turn fueled significant concern about a major world recession lead by the US and other industrial countries. Fortunately, unlike the 1930s, governments and central banks remain active in stabilizing the situation.

Finally, our major and most aggressive competitor has suffered significant weakness. This competitor who historically has had significant influence deployed substantial capacity and as part of its culture, demonstrated extreme pricing competition across all of our product lines and is now so severely distressed as to require massive government financial and management assistance. This situation in isolation is enough to cause a positive change throughout our markets and products. Against the back drop of these unprecedented events, our fundamentals remain strong. Even with share repurchase activity over the last 12 months, significant market loss activity in the year impacting our underwriting portfolio, and substantial realized and unrealized investment losses following this financial market catastrophe, our diluted book value per share has declined less than 3% over the last 12 months; however, when considering the impacts of share repurchase activity during the period, it is essentially flat. We believe a hard market in 2009 is a near certainty and we are amply prepared to maximize shareholder value throughout this important next cycle.

Since our inception, we have demonstrated transparency and leadership in all of our lines of business through our combination of capital strength, global presence, diversification, specialty underwriting skill sets, and technical competency. In a world where capital is scarce and the cost is necessarily rising every day, we have every intention of deploying our capital when and where we are adequately compensated to do so. As David will discuss in more detail, our capital resources and liquidity position are very strong and we are more than prepared to address the market opportunity. We continue to rigorously monitor the impact of subprime issues and the broader global credit crisis on our liquidity and capital resources. This obviously includes the impact of a worsening economic environment on both our underwriting and investment portfolios. We remain comfortable that our identified exposures are within our risk tolerances and are manageable.

We have scrutinized our professional lines, credit and political risk lines, in the light of these events. We believe that based upon current conditions, we have addressed the potential for increased frequency of loss in these lines. The decline in political risk premiums in excess of 60% by volume has clearly demonstrated yet again how quickly we can and do shut down business lines within axis when we believe markets or pricing conditions have moved against us. Now I would like to turn the call to David who will discuss the financial results for the quarter.

Following David's review of financial results, I will discuss market conditions in a bit more detail. David?

Thank you, John, and good morning, everyone. As John mentioned, the extraordinary events which have upfolded have had a significant impact on our financial results this quarter but our capital resources and liquidity position remain very strong. This positions us extremely well to benefit from the market turn we expect will commence across short tail lines at the January 1 renewal date. Our net loss for the quarter was $249 million or $1.79 per diluted share compared with net income of $270 million or $1.65 per diluted share for the third quarter of 2007. This quarters results included $407 million of estimated net losses from hurricanes Gustav and Ike. When considering the associated earned premium impact, the overall after-tax impact of these hurricanes on the quarter's results was $371 million. Net asset tax catastrophe losses in the third quarter of 2007 were $34 million. Absent cat events in both periods, operating income was $210 million in this year's third quarter compared to $307 million in last year's third quarter.

John has already shared with you the headline news with respect to the financial markets and we were not immune to the impact of these events on our investment portfolio. Net realized losses in the quarter were $89 million. Our after-tax operating loss which excludes the impact of realized gains and losses on investments was $161 million or $1.15 per diluted share compared with operating income of $ 271 million or $1.66 per diluted share for the third quarter of 2007. The net realized investment losses in the quarter included $50 million in other than temporary impairments on investment securities, largely relating to firmed income securities of Lehman Brothers, $60 million in losses from the sale of Fannie Mae and Freddie Mac preferred equity securities and $23 million in net realized gains on the sale of fixed maturities. We saw a marked increase of $346 million in our net unrealized loss position in the quarter as credit spreads widened significantly and the US dollar strengthened.

We also repurchased 1.8 million shares of Common Stock during the quarter at a cost of $58 million and we declared and paid dividends of $39 million to common and preferred shareholders. After all these items, our shareholders equity balance declined by $662 million in the quarter, to $4.6 billion from $5.3 billion at June 30. Our diluted book value per share has decreased 13% over the quarter, 9% over the year-to-date, and less than 3% over the last 12 months. For the first nine months of 2008, net income was $220 million or $1.40 per diluted share compared with $749 million or $4.53 per diluted share in 2007. After-tax operating income for the first nine months of 2008 was $273 million or $1.74 per diluted share, compared with $754 million or $4.55 per diluted share in the same period last year.

Let me turn to the underwriting results for the quarter beginning with our top line. Consolidated gross premiums written were $725 million for the quarter, down 4% from the third quarter of 2007. While our year-to-date gross premiums written were $2.9 billion, down 5% for the first nine months of 2007. These reductions primarily emanated from our insurance segment, where gross premiums written this quarter were down 16% to $403 million over the prior period. Disciplined and focused underwriting in the face of competitive market conditions drove exposure reduction in a number of our property and casualty lines. In addition, our political risk premiums were down due to our decision to reserve capacity for expected increases in pricing when liquidity returns to the financial markets and a reduction in available transactions as private capital flows have slowed amidst the ongoing global financial crisis. This was partially offset by growth in our professional lines of business, stemming from rate increases for financial institutions on both new and renewal business.

Gross premiums written in our insurance segment for the first nine months of 2008 were $1.4 billion, down 9% from the same period in 2007. Gross premiums written in our reinsurance segment were $323 million this quarter, up 18% from the third quarter of 2007. This increase was primarily due to reinstatement premiums of $29 million in connection with Hurricanes Ike and Gustav. Although we were able to identify opportunities within our property and professional lines of business we otherwise continued to observe modest deterioration in market conditions which generally limited the opportunity for growth. For the first nine months of 2008, gross premiums written in our reinsurance segment were $1.5 billion, comparable with the same period in 2007. Excluding the impact of foreign exchange rate movements, gross premiums written were otherwise down 4% for the first nine months of 2008. Consolidated net premiums written decreased 6% in the quarter and year-to-date, reflecting previously mentioned reductions in gross premiums written. Net premiums earned in the quarter increased slightly over the prior year quarter. This was largely due to additional earned premium in our reinsurance segment in connection with hurricane loss experienced this quarter. Net premiums earned were otherwise down 3%, reflecting period to period changes in net premiums written and business mix. Net premiums earned for the year-to-date were down 2%.

Total underwriting loss for the quarter of $186 million represented a decline in income of $386 million over the same period in 2007. This reduction was driven by net losses incurred from Hurricanes Ike and Gustav of $4 07 million. Absent Hurricanes Ike and Gustav, our total underwriting income for the quarter would have been $200 million. Our total underwriting income for year-to-date was $91 million and represented a decline of $440 million over the same period in 2007. Absent Hurricanes Ike and Gustav, our total underwriting income for the year-to-date would have been $477 million. The year-to-date total underwriting income was also impacted by a higher frequency and severity of property losses within our insurance segment in the first half of the year. The overall impact of net favorable reserve development in the three and nine months ended September 30, 2008, was largely comparable with the same periods in 2007. Absent the CAT losses, our business is still generating very strong underwriting profitability, even against the backdrop of increased risk loss activity.

Our consolidated combined ratio for the quarter was 128%, an increase of 53.9 points from the same period last year. Excluding catastrophe losses, our combined ratio would have been 69%, which was comparable with the third quarter of 2007. The quarter's combined ratio included 11 ratio points related to favorable reserve development which I will describe in more detail later. The prior quarter combined ratio included 12 ratio points related to favorable reserve development. Our year-to-date consolidated combined ratio was 97%, an increase of 20.3 points from the same period last year, almost entirely due to the impact of Hurricanes Ike and Gustav.

Our insurance segment's current accident year loss ratio for the quarter was 92.7% compared with 56.9% in the third quarter of 2007, an increase of 35.8 points. Net losses from Hurricanes Ike and Gustav adversely affected the quarter by $115 million or 39.2 ratio points. The third quarter of 2007 included net losses of $11 million or 3.5 points from Hurricane Dean. Our reinsurance segment's current accident year loss ratio for the quarter was 128.5% compared with 62.1% in the third quarter of 2007, an increase of 66.4 points. Net losses from Hurricanes Ike and Gustav adversely impacted the quarter by $292 million or 73.7 points. The third quarter of 2007 was adversely impacted by net losses from UK flood damages, Hurricane Dean and other mid size catastrophe losses of $25 million or 6.4 points. Our consolidated net loss and loss expense reserves increased 8% in the quarter and 18% over the year-to-date to $4.9 billion at September 30, 2008. During the quarter, our estimate of reserves from prior accident years continue to develop favorably with prior year reserves reduced by a net amount of $76 million. Of this amount, $41 million was from our insurance segment and $35 million was from our reinsurance segment.

Favorable reserve development this quarter was primarily generated from accident years 2005 through 2007 and from our short tail lines of business. We also recognized favorable reserve development from our professional lines insurance and reinsurance businesses, totaling $29 million in the quarter. This favorable reserve development from professional lines business is very much a first for us and stems from the 2003 and 2004 accident years. As we discussed in our earnings calls earlier this year, we have reached a point where we can begin to prudently incorporate our own loss experience into our reserving analyses for certain of our claims made professional lines of business. Our current gross IBNR reserves relating to medium and long tail lines of business totaled $3.5 billion or 80% of our total gross IBNR balance. Offsetting the aforementioned favorable reserve development, we strengthened accident year 2007 professional lines IBNR reserves by $33 million this quarter. This prudent reserve strengthening in both our insurance and reinsurance segments recognizes the continued and substantial market deterioration of the subprime crisis which was precipitated by events in 2007.

Turning now to our G & A expenses, our G & A ratio increased one point to 12.6% over the prior year quarter. G & A costs of $87 million this quarter were in line with the guidance I provided last quarter. Our acquisition cost ratio declined 1.5 points to 13.1% this quarter. The reduction was driven by adjustments to prior year seating commissions in connection with the prior year reserve releases within the professional lines book of our insurance segment. Total net investment income for the quarter decreased $68 million over the same period in 2007 to $51 million. Our fixed income asset class produced $108 million of net investment income this quarter, an increase of 14% over the prior year quarter; however, this was more than offset by a decline in investment income from our other investment portfolio of $68 million.

Our other investments were primarily impacted by mark-to-market unrealized losses on our credit and hedge funds stemming from the unprecedented market volatility, disruption of the financial system, and deleveraging throughout the financial markets. Total net investment income for the year-to-date declined $ 85 million over the same period in 2007 also due to the performance of credit and hedge funds. The total return of our cash and investments portfolio for the quarter was negative 3.6%. This comprised net investment income of $51 million offset by net realized losses of $89 million, which I discussed earlier, and an increase of net unrealized losses of $346 million. Approximately 96% of the increase in net unrealized losses emanated from our high quality fixed maturity portfolio. The main contributors to this were our US and Euro investment grade corporates and commercial and residential non-agency mortgage backed securities where credit spreads widened to historically high levels during the quarter.

Our foreign denominated fixed maturities and equity securities were also negatively impacted by strengthening of the US dollar. Our overall portfolio is well diversified, liquid, high quality and short duration. Our investment grade fixed income asset class has a duration of 2.9 years with a AA plus average quality. Exposure in our direct investment portfolio to subprime and Alt A collateral is negligible at $161 million or less than 2% of total cash and investments. Our fixed maturities portfolio at quarter end also included $2.1 billion of corporate debt with a weighted average rating of A. This includes $876 million of direct exposure to the unsecured debt of financial issuers of which no individual issuer represents more than $85 million. This quarter we've expanded disclosures of holdings in corporate bonds in our financial supplement. We encourage you to review this for a better understanding of our credit exposure to individual issuers.

In the quarter we have initiated efforts to wind down our securities lending program and expect our securities on loan to be under $300 million by the end of the year. With respect to foreign exchange, during the third quarter, changes in exchange rates and changes in net currency exposure resulted in foreign exchange gains of $8 million which was comparable with the gains of $7 million in the prior year quarter. Our interest expense for the quarter was $8 million, substantially below the $14 million occurred in the prior year quarter. The reduction reflects the termination of the $400 million repo agreement in place through most of the third quarter of 2007. We continue to generate strong operating cash flows of $489 million in the quarter and $1.2 billion for the year-to-date.

Market illiquidity persisting throughout the US and other financial Markets this year has had minimal impact on the liquidity of our own investment portfolio, which includes over $4.8 billion of cash and cash equivalents in US government and agency backed securities. Further, most of our securities have liquid markets so there's significant liquidity available to us in our investment portfolio. We actively manage and monitor liquidity and asset duration of our portfolio to meet the anticipated cash flows of our insurance liabilities.

Our debt-to-capital ratios compare favorably with those of our peer group and are significantly below thresholds indicated by all of our rating agencies. Our business is supported by a $1.5 billion credit facility, the terms of which provide for direct borrowing of up to $ 500 million on an unsecured basis. This facility expires in August 2010. Issuances of letter of credits currently total approximately $300 million. As of September 30, 2008, there was no debt outstanding under this facility and we were in compliance with all covenants.

Our operating companies could provide over $1 billion of additional dividends to our holding Company if needed. The bottom line as we said earlier is that our capital resources and liquidity are very strong and we believe we are well capitalized relative to rating agency requirements. Further, our stock has traded near or below book value at various points during 2008. We have taken advantage of attractive valuations this year to repurchase shares. As mentioned earlier, during the quarter we repurchased 1.8 million shares for a total cost of $58 million. Since the end of the quarter, we repurchased an additional 1.8 million shares for a total cost of $50 million. We believe repurchases this year will deliver meaningful returns to our shareholders over time. With the expectation of a hardening market in 2009, we have now suspended our share repurchase activity.

Now, I'll turn the call back to John.

Thank you, David. And I would like to begin with a brief review of current market conditions. And then move on to the infinitely more important future prospects on market conditions. As I mentioned when I started off the call, we expect a positive turn in the cycle across all lines of business with the timing of this turn varying by line. Over the last two to three years, nearly all insurance business lines have been under extreme pricing pressure with one notable exception. We continue to see improvement in the financial institutions classes within our professional lines business and for larger financial institutions, availability of capacity has now become an issue. The balance of our professional lines business meanwhile has remained under pressure with the high access commercial business under the most severe pressure. Pricing financial catastrophe exposure in the insurance marketplace have reached marginal levels by the third quarter, particularly for California and earthquake.

The primary and excess casualty market remain very soft, in a State of flux. Downward pricing pressures remain consistently strong through the quarter. We expect with our determined actions over the last two years to materially reduce net risk in our insurance segment at a time when cycle risk was increasing will serve us well. Needless to say there has been significant activity emerging from the AIG situation, but in our view, it will take a little time for all of the dynamics influencing a positive pricing turn to work their way through the insurance market. In my view, AIG is the haystack, not the straw that broke our industry camel's back.

Turning to the reinsurance market, as we have noted for some time, this market has remained relatively stable with moderate rating pressure experienced throughout most lines. Our reinsurance portfolio has been significantly impacted by seeds retaining more business for some time. Before I move on to a discussion about the anticipated market turn, I would like to briefly discuss our underwriting portfolio's performance resulting from the catastrophes of the third quarter. As you know, we incurred net losses of $407 million from Hurricanes Ike and Gustav with the majority emanating from our reinsurance segment. These losses in the reinsurance segment mostly arise from our allocation of Texas capacity to the Texas windfall. Hurricane Ike with its wide, near Cat 3 storm profile moving right over Galveston and in-land through the Midwest has resulted in an outcome consistent with what our models have projected for such an occurrence, including our estimated total loss from the Texas windfall.

While it's painful this was actually highly affirmative for us. Our underwriting approach coupled with our interpretation of model results were tested by real events and found valid. Importantly, our expected Texas market share in our reinsurance segment for event sizes over $20 billion is well below 1%. As industry losses for Hurricane Ike continue to increase, we expect our overall market share of the loss will also reduce. Just last Thursday, RMS nearly doubled its range of expected industry losses to a range of 13 to $21 billion. We are confident that we formulated the right strategy. First, we de-emphasized our reinsurance portfolio due to prevailing political issues in Florida , the Texas capacity if we allocate it to the windfall, particularly in light of our analysis of the impact and assessments when the windfall back to other programs. Finally following the hurricanes of 2005 we made the decision to restructure our insurance offshore energy portfolio.

We repositioned this portfolio to drilling contractors and move away from fixed platforms by the major oil companies. Thus our net losses from offshore exposures were comparatively small at $23 million. We believe that market offshore losses will exceed $3 billion. With this further validation of our underwriting risk analysis, we want to discuss the opportunity which lies ahead for a strong market participant like AXIS. 2008 has presented the property Markets globally with historically high levels of risk losses and a material number of modest sized CAT losses throughout the world. Just to remind you, the industry has faced snowstorm and earthquake losses in China, mining and energy losses mainly due to flooding in Australia and South Africa, steel Mills and sugar refinery explosions, record numbers of tornadoes in North America, River flooding in the Midwest and US, hail storms in Germany and finally, three landfalling hurricanes in the US. In our view this hurricane activity in the third quarter coming on the back of this extensive worldwide loss activity has caused the property reinsurance market to pause and begin reverse its downward price slide.

Further to this, the industry faces significant value reductions of many types of assets as well as potentially significant D&O claims arising from financial institutions in the wake of the subprime crisis. Capital markets turmoil has concerns by the State of Florida and recognition by the rating agencies that the Florida hurricane Cat Fund may not be able to raise sufficient funding in the capital markets to meet its obligations. This in turn has lead the rating agencies to review the re insurance programs of all carriers who depend on the Cat Fund for their CAT cover in Florida. We believe this will lead to strong and increased demand in the Spring of 2009 that will have a python-like effect on Cat program capacity, reminiscent of the early part of 2006.

Pricing for CAT business will react positively to the supply/ demand imbalance as expected, but the story does not end there. Several of the world's largest commercial insurers including some European financial conglomerates with material insurance interest are suffering from credit related exposures. We expect this will lead to substantial amounts of business flowing to other carriers who in this capital constrained market are now more than likely to be more reinsurance dependent. For the market as a whole, reinsurance will be an available and necessary source of capital, even as prices rise. In our opinion, the property catastrophe market will be the first to respond.

Public statements by the largest global reinsurer will indicate that Europe will not be immune from these price increases at the January 1 renewal although we expect some of the positive effect will be muted. Euro Wind and Euro Flood exposure are material global consumers of reinsurance capital, with pricing for these perils under study downward pressure over the last few years we expect to see increases. We anticipate that the Asian Markets should witness a halt in price reductions and capacity driven programs will see re insurers seeking and requiring better data, improved pricing , and tighter turns and conditions. China is likely to see its lead reinsurers tighten turns and increase pricing to react to winter storm losses of historically high levels.

Alternative capacity for Cat coming from side car investors and Cat funds is expected to be significantly less available than it has been over the past several years. Well reported down grades of four Cat funds due to collateral quality and counterparty credit issues also will have a material impact and should drive more business back to the conventional reinsurance market. Our underwriters at Axis are focused and ready to translate the increased cost of capital to price increase requirements. Heading into pre-renewal conventions, we are armed with estimates that the price increases required to generate higher returns for our investors on capital deployed in our underwriting business. Clients seem to have accepted the direction, if not the magnitude of the changes that will be necessary to generate the returns that allow reinsurers to maintain their ability to respond to material trends activity.

The anticipated hardening in the reinsurance market as I have described should force primary insurers to pass along price increases. Our global specialty insurance business should benefit strongly from this dynamic in the market coupled with the emergence of huge volumes of business we expect from the weakened operating platforms of our competitors. Our insurance business stands to gain enormously and we are already seeing submission activity increase in our insurance segment. In both our insurance and reinsurance segments, which are global and diversified, we are established in all of the lines of business we want to be in and all of these lines will likely be subject to significant hardening of the market to come. We believe we are the most diversified and focused underwriting business in our sector to be formed in the last decade. We have the experienced people. We have the knowledge skills. We have state-of-the-art technology. We have the needed products, and we operate on a global platform. Our strong and proven business model is well prepared to deliver extraordinary value to our shareholders and our clients whose needs for quality and strengthen their business partners are growing daily.

Finally we have been extraordinarily patient and product defensive over the last two to three years. The gloves, thank goodness, are now nearly off. All of us at Axis can hardly wait to step strongly back into the global arena and with that I'd now like to take

(OPERATOR INSTRUCTIONS). Our first question comes from the line of Matthew Heimermann with JPMorgan. Please proceed.

Hi, good morning everybody.

Good morning, Matt.

Hi. John, you said with near certainty you thought you'd get a pricing turn across, seems like virtually most of the industry. I guess what's the difference between certainty and near certainty? Does that have to do with the resolve of your competitors or is there something fundamental that could change that would explain that small delta?

I am pretty comfortable about the market situation that we're moving towards in a relatively short period of time. And as I've tried to say, some products will react much more quickly than others but the reality of the market change is there.

All right, so just to restate this to make sure I've got it is the near certainty just reflects the fact that there might be some lag so you'll get lots turning, some may lag that initial turn and that's the difference?

As you know, Matt, there are some businesses who have much less control over their underwriting Operations than we have and it can take a little bit of time for those businesses to exert management influence over their underwriters but undoubtedly, it's there and it's not far away.

Okay. That makes sense. The other, got two other quick ones. One is theres obviously the distress in the financial markets has impaired some companies. Have you changed your appetite for M & A activity given some of the distressed pricing you've seen out there or is with the prospect of a cycle turn, your mind set and efforts exclusively focused on organic?

I think it's fair to say that with a potentially unique opportunity presenting itself, now in the underwriting side, a market changing event, that we're much more focused on organic growth. We believe that we can achieve significant incremental value for the foreseeable future.

Okay, that makes sense, and then the last question I had was on the political risk book. It seems, I'm just trying to get a sense of how much of the pull back had to do with what's happening with the financial markets and kind of maybe the risk prospects changing versus withholding capacity for pending renewals as we go forward.

Well, primarily it was the former, because we demonstrated time and time again if you go back three years and withdrawal from the aviation market, we've largely withdrawn from most parts of the marine market, and this is no different from the way we run all of our underwriting activity. We have become increasingly conservative and concerned about what was taking place in the global financial markets and we were able to step back from that marketplace. It was very deliberate and you can see the evidence of it before you, over 60% reduction.

Does the change in the financial markets in any way change your comfort with the business you've written up to this point? You obviously didn't take it to zero so there's still business out there you're comfortable with.

We obviously very closely monitor our enforced business and we're very happy with that. I've said time and time again that this is business that our group of people including myself have been underwriting for many many years. It's a tightly knit team. Risk selection is critical. Due diligence is critical. And we're comfortable with our enforced portfolio but we do see substantial opportunity in that line of business, probably emerging after the First Quarter of next year.

Okay, excellent. Thank you very much.

Thank you.

Our next question comes from the line of Susan Spivak with Wachovia. Please proceed.

Good morning, everyone.

Susan, good morning.

Thanks for the very detailed commentary, John. That's great. And I just want to follow-up. I have the same questions as Matt about the certainty, but could you just give us an idea, you mentioned sending your teams out to the conferences, I'm assuming you mean the PCI and Baden Baden with an idea of what message to send across that rates are going higher but what's the magnitude of the message that you're sending out, given the increased cost of capital?

Well, I think you've summed it up yourself. It's not in the increased cost of capital. We have to retake a lot of the ground that the industry has given away over the last two or three years and it's pretty well across-the-board. Some businesses take longer to arrive at the table than others but without a shadow of a doubt, Susan, everybody has to move in a very different direction and I've been very encouraged over the last few days that the statements that are emerging from these recent conferences both from the insurance side and from the reinsurance side.

Have you ever done in such a consensus among market leaders in anticipation of a cycle turn like this?

I think that this is a much broader and I think sustainable opportunity than 9/11.

Really? And with that being said, how much more premium do you think you could currently, right on your current capital base?

We have significant capacity. We have as I said, we've been very patient and you know me, that's really tough. We've been very patient for two or three years. We have significant capacity and capital to do what's necessary when it's necessary and how it's necessary.

Okay, that's great, John. Again thanks for all of the comments.

My pleasure.

Thanks.

Our next question comes from the line of Vinay Misquith with Credit Suisse. Please proceed.

Hi, good morning.

Good morning, Vinay.

You seem certainly more positive on the industry. What could go wrong with your price increases here? Certainly, most companies seem to be very positive so my question is that what could go wrong with prices stay flat? Thanks.

It's just not possible, the Balance Sheets within the industry. We've been talking about market conditions, softening and irrational competition over the last couple of years. That now must be getting its way through into company's balance sheet with deteriorating financials and then if you look at the capital losses that the balance sheets are having to deal with and the reality of the capital constraint that the industry is beginning to very quickly find itself in going into next year and for the near term future and the near term is probably the next two to four years, so I just cannot see how the market cannot positively react both on the insurance side and on the reinsurance side , unless they're suicidal and they want to go out of

I recall about a year or two you were marketing heavily with the mutual companies. Could you refresh my memory as to how much business you actually wrote from them and do you see more opportunities from those mutual companies on the reinsurance?

I think that we have, I haven't got the share of our portfolio for mutuals but we have been marketing more heavily through the US for the mutuals. It will be very interesting the mutuals having a greater proportion of equity within their balance sheet investments and to see the impact that that has on those mutuals and to see whether I'm pretty sure that there's going to be a boost in their reinsurance demand over the next two or three years , and I think we're well placed because that's pretty sticky business and we've been working hard over the last two or three years to establish relationships with them, convince them of our capital, convince them of our service capability and sustainability, so I would expect us to benefit very strongly from that

How about your ratings for your single A ratings, you versus competitors with double A ratings?

Well I would love to have a higher rating but at the end of the day, if you have an, if you're an A rated Company in this day and age and you have a great reputation and you've got great capital, you've got great people, you've got great markets and you're diverse at both globally and by product line, there's damn all difference between a double A , and an

All right that's great. Thank you.

Our next question comes from the line of Alain Karaoglan with Banc of America. Please proceed.

Good morning, John.

Good morning, Alain, how are you?

Fine, thank you. A couple of questions. So from your point of view, are you changing your return on capital requirements for business on average going forward, so next year we're going to have a hard market but is this whole uncertainty leading you to we need more than a 15% now going forward or you're staying with your old goals?

Well, that's a number of different questions in that one question. The reality is that we will maintain the fact that regardless of market conditions, we expect to earn a minimum of 15% over any cycle that you like to call.

The reality is that we will be very demanding because we've had to be patient over the last two to three years. We will be very demanding in the returns that we require in the near term future and we expect to maximize whatever profitability that there is out there in the marketplace and still stay within acceptable risk tolerances for the business. Okay, and in terms of it seems that reinsurance is going to react first. The insurance business a little bit later as companies come to grips with more with the situation. Are you, and in terms of the situation of AIG, isn't the risk in the short-term that they become more competitive in order to retain business and are you seeing that today in the market? They've always been extremely competitive historically but are they being more competitive now in order to retain business and does that hurt the market because of their situation it gives you opportunities?

Well, let me just answer the point about the reinsurance market. I have not understood why the reinsurance market hasn't been better valued by the investment community. The outlook for the reinsurance market for the foreseeable future is more positive than I have seen for many many years. I think the reality of the capital markets substantially withdrawing from providing capacity will lead to a reenergization of the reinsurance marketplace and a better understanding of what the reinsurance market provides to the insurance marketplace. And I believe that that will be witnessed over the next two or three years. As far as AIG are concerned, I shed no tears for them. I have been in the business for 37 years and I believe that any normalization of AIG, and I'm not talking to personally to the individuals, any normalization of AIG will be very beneficial to the marketplace because it will release huge volumes of business throughout the insurance portfolios both by product and by geography. So I don't want to jump on their grave but I do believe it's a very very important and significant event, so I think it's very positive for the marketplace.

Okay, thank you very much.

And you mentioned about, sorry, you mentioned about near term disruption. Yes, of course, but the brokers are very careful in terms of making any market that is weakened, forcing that market to compete even more aggressively on price risk renewal business, so we got a shadow of a doubt, new business will be steered away and is being steered away. Thank you, John.

Our next question comes from the line of Jay Cohen with Merrill Lynch. Please proceed.

Yes, thank you. A couple questions.

Good morning, Jay.

First is on the political risk side, have you gotten any political risk claims notices yet and if you could remind us because I'm not an expert in political risk claims, I've got to tell you, if you could remind us, what kind of credit exposure do you have there? Because if you read the description in your supplement, you do provide corporate credit insurance, so could you just remind us the kind of risks you have there? That's the first question and then secondly have you been able to hire any teams or people out of AIG at this point or do you expect to?

As far as the critical risk is concerned, I don't discuss individual losses but we have had what I would consider to be minimal loss activity in our portfolio, and we do not expect material loss activity in our in force book either, and we monitor it on a daily basis. The portfolio itself is over 50% corporate credit. These are individual transactions. I've said to you before we partner with a limited number of international banks. We do full due diligence alongside the banking due diligence. They're strongly collateralized.

Our banking partners have significant skin in the game, and we are very diligent about monitoring our aggregate exposure by industry and company and we correlate those industries both nationally and globally and then the second largest part of that portfolio is the national it specialization deprivation product and and we have been very careful with the industries that we insure within different countries around the world. We have embedded knowledge of the global international countries and we're very mindful of steering clear of industries that are more likely to be nationalized than those that are not, and we have avoided the events within Venezuela and Bolivia, specifically because of our proactive approach to this portfolio, and it is absolutely critical and I just cannot stress enough that the risk selection is critical in this portfolio but we have had a settled team of individuals here for over 10 years.

John, do you think you will see the industry losses even though you may not suffer, will others suffer big losses here?

I just said if a large loss that might be around in London, a Brazilian loss, but we're not involved in it. We declined it and then secondly, were you talking about the AIG personnel with regard to political risk or on a broader basis? I was thinking more broadly, John. Well, you know, we're always on the look out for really good people. We always have been and we will continue to do so and we have had a reputation for finding good people, individuals or groups of people wherever they come from and if we feel that they fit our culture and our Resource, we'll bring them in.

no big hires yet I assume?

No, we don't have any people in the crossway between AIG and Arch.

Very good. Thank you.

Our next question comes from the line of Josh Shanker with Citigroup. Please proceed.

Yes.

Good morning, Josh.

Good morning. One of the concerns that with the hard market, one of the concerns is that there's been no real loss experience in the form of standard business. What are you prospecting will eventually come of the 2007- 2008 accident year for the industry and what do you expect exclusive of catastrophe what 2009 holds before we start seeing price increases really impact underwriting results?

Well, sorry, I'm a bit confused. A) I can't predict what catastrophe is going to occur in 2009 but the reality is the market has to have significantly enhanced premium volumes on both the insurance side of the business and the reinsurance side to be able to deal with increased catastrophe numbers and the risk losses to continue to be profitable and it has to reset to make sure that there's a reasonable margin and be acceptable to our investors.

Ignoring catastrophe losses for a second, stripping them out, what do you think the industry's commercial property and casualty combined ratio is running at right now if pricing were to hold flat?

Well, I've said to you many times, I've said to this audience many times that I've not understood why with the rating environment, substantial rating competition that has been throughout the insurance marketplace for the last two, two and a half years, why we haven't seen greater deterioration in the financials coming out of the underwriting side. I'm not going to predict what combined ratios are going to be but I suspect that they will be different from what companies currently expect. And obviously you can't control other companies financials but you would expect ultimately that the 2008 or 2007 accident year for the industry would likely have unfavorable developments on it? Well, that was going to work its way through. As we've said before that if you looked at the excessive competition, pricing competition, not at the end of the short tail lines but equally as importantly on the professional lines business as well as casualty business, which we have stepped substantially back from during that period, that has to work its way through the system sooner or later.

Okay, and very quickly, well I appreciate it's a difficult question I understand but good luck on this opportunity coming up.

Okay. Well, we certainly are mindful of it. Thank you, Josh.

Our last question comes from the line of Tom Shalnake with Goldman Sachs. Please proceed.

Good morning, John.

Good morning, Tom.

I guess it's interesting as I listen to these conference calls everybody is talking about the damage to the supply side of the equation, and nobody seems to or at least nobody has addressed the issue that if we're in a period of a global slowdown and a period of very low inflation, is it conceivable that you could have better pricing but not really much in the way of incremental premium volume growth because exposures are actually declining or not growing? I guess that's the first question. And--

Just hold on. Let me just answer that. I think it's an important question. I believe there will be a substantial increase in premium take across the globe and across product lines because the markets have in my view substantially underpriced so many of the primary products and regardless of whether clients wish to pay or did not wish to pay, historically that pricing is relatively low level.

These are products that are absolutely necessary and quite frankly, one of the benefits that I see very clearly coming down the line is actually going to come from the problems the banking community currently have. The banks on their lending facilities, their lending covenants, they have not been enforcing in my experience very much at all over the last three or four years. They've been turning a blind eye to the requirements that they have within those covenants for insurance purchasing, let alone to significant levels and I believe going forward, the change in the risk appetite within banks and the identification of risk and the enforcement of those covenants is going to produce a great deal of new business or old business back into the market and I think that's a very very positive step so I think both I have two comments. One is the fact that I believe that there will be a general increase in actual premium take and then secondly, I think there will be a boost of that by the way the banks have to enforce their lending covenants.

But that's more for property isn't it rather than casualty?

Yes, but it's a pretty important amount.

I understand that but I guess from a casualty perspective you've got declining payrolls and declining sales and most insurance premiums are driven off those types of exposures and I would think that --

Well I'll let the guys who are heavily involved in casualty business answer that because it brings us out in spots most of the times but we have a casualty business with an umbrella business which is a very group business so we will incrementally benefit from a hardening of the marketplace because there will be a flight to quality back to people like us, so we'll have better earnings from the casualty side, thus much better quality earnings but all of the other products we will significantly benefit from.

Okay. And I guess just the last question, to the extent that you think managements have been shaken up enough that even if a lot of the unrealized gains that the industries incurred to date if those start reverse themselves over the next six to nine months and capital gets rebuilt back up, how much damage do you think really will have been done to the industry?

I think the underwriting damage is clear for all to see, and nobody can tell whether the volatility in the financial markets is going reverse over the next six, 12, 36, five years, so whether regulators, rating agencies or managers of businesses have got to work on what they know, and that's going to lead to this market changing event.

Okay, great. Thank you very much.

My pleasure.

I would now like to turn the call over to John Charman for closing remarks.

Well, thank you, everybody for bearing with us during this difficult third quarter market and I much look forward to a very changed report as we enter the underwriting for next year. Thank you very much.

Thank you for your participation in today's conference. This concludes the presentation. Everyone have a great day.