AXIS Capital Holdings Ltd (AXS) 2009 Q2 法說會逐字稿

Hello and welcome to the AXIS Capital Holdings Limited second quarter 2009 earnings conference call. All participants will be in listen-only mode. There will be an opportunity for you to ask questions at the end of today's presentation. (Operator Instructions). Please note this conference is being recorded.

Now I'd like to turn the conference over to Linda Ventresca. Ventresca?

Thank you Ryan. 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 30th 2009. Our earnings press release, financial supplement and quarterly investment supplement were issued yesterday evening after the market closed. If you would like copies please visit the investor information section of our Web site, www.axiscapital.com. We set aside an hour for today's call which is also available as an audio Web cast through the investor information section of our Web site. A replay of the teleconference will be available through Friday August 14th, 2009 by dialing 877-344-7529 in the U.S. The international number is 412-317-0088. The conference code for both replay dial in numbers is 432235.

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 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, 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 factor 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 statements whether as a result of new information, future events or otherwise.

In addition, this presentation contains information regarding operating income, which is a nonGAAP financial measure within the meaning of the U.S. Federal Securities Laws. For a reconciliation of this item to the most directly comparable GAAP financial measure please refer to our press release which can be found on our Web site. With that I'll now turn the call over to John.

Thank you, Linda and by the way, happy birthday. Good morning, everyone and thank you for joining our call. I'm pleased to report that we have delivered strong diluted book value growth of $2.37 or 9% during the second quarter of 2009. And an annualized operating return on average common equity for the quarter of 17.4%. Book value accretion was primarily driven by the significant improvement in asset valuations across much of our investment portfolio during the quarter. The total return for our investment portfolio was 3% for the quarter and 3.1% for the year-to-date. Net investment income was up in the quarter over the first quarter of this year. Our combined ratio is 80.4% and included $97 million of favorable reserve development from prior accident years. I believe this underwriting result is very respectable given our belief that in 2009 we are at the bottom of the earnings cycle across all lines.

Net investment income was up 13% relative to the first quarter of this year and down 18% over the prior year quarter. Both our Insurance segment and our Reinsurance segment performed well and retained discipline against the backdrop of a very spotty market. The result was an overall increase in gross premiums written and net premiums written of 5% and 2% respectively during the second quarter. With the exception of a few areas where we have continued to pull back rates are stable to increasing in all lines, and this has now been the case for the last two quarters. Now I'd like to turn the call over to David who will discuss the financial results for the quarter. Following David's review of our financial results, I will discuss some underwriting portfolio items and market conditions in a bit more detail. And just as another aside, happy birthday, David.

Thank you, John and good morning, everyone. As John mentioned we're pleased with our results for the quarter. Strong underwriting results enabled us to achieve an annualized operating return on average common equity for the quarter of 17.4%. This combined with the significant improvement in asset valuations across our portfolio contributed to the 9% increase in our diluted book value per share to $28.72 in the quarter. Diluted book value per share increased 11% for the year-to-date. Net income for the quarter was $159 million or $1.06 per diluted share compared with $231 million or $1.47 per diluted share for the second quarter of 2008.

After tax operating income, which excludes the impact of realized gains and losses on investments, was $183 million or $1.22 per diluted share compared with $229 million or $1.45 per diluted share for the second quarter of 2008. For the first half of 2009 net income was $275 million or $1.84 per diluted share. Compared with $469 million or $2.95 per diluted share in the first six months of 2008. After tax operating income was $338 million or $2.26 per diluted share compared to $434 million or $2.73 per diluted share for the first half of last year.

Turning to our top line, our consolidated gross premiums written were $915 million for the quarter, an increase of 5% from the second quarter of 2008. Consolidated gross premiums written for the first six months of 2009 increased 5% over the same period in 2008. Growth in gross premiums written for the quarter and the year-to-date were driven by our Reinsurance segment which increased 22% for the quarter and 17% for the year-to-date. Gross premiums written for the quarter in our Reinsurance segment totaled $388 million. We were able to grow our catastrophe reinsurance line which benefited significantly from pricing improvement. Also, our property reinsurance line increased this quarter relative to the same quarter last year due to the renewal of a significant prorata treaty which was previously renewed in the first quarter of 2008.

Finally, we grew our professional lines reinsurance in the quarter due to the new business and increased participations on attractive treaties. As a general comment, we've seen substantial increases in submissions to our Reinsurance segment which continued into the major July 1st renewal date. John will discuss this renewal date in more detail later in the call.

For the quarter gross premiums written in our Insurance segment were $527 million, down 5% from the prior year quarter. The decrease was driven by a continued reduction in our credit and political risk business. The impact of these reductions were partially offset by growth of our professional lines business driven by new business opportunity together with rate improvement primarily in D&O and in financial institutions. As John will discuss later we're also beginning to benefit from rate improvement in other parts of our insurance portfolio, notably our energy and property lines.

Consolidated net premiums written increased 2% in the quarter and 5% for the year-to-date, reflecting the previously mentioned growth in gross premiums written. In line with these changes, net premiums earned increased 4% in the quarter and 2% for the six month period.

Moving on to our underwriting results. Total underwriting income for the quarter was $141 million compared with $138 million in the second quarter of 2008. Our combined ratio was 80.4% this quarter versus 81.2% in the prior year quarter. Our current accident year loss ratio was 67.2% which was essentially flat with the prior year quarter. There are a few items to note here. Relative to the prior year quarter, our Reinsurance segments accident year loss ratio decreased seven points to 59% reflecting a lower level of catastrophe and other large loss activity. Our Insurance segments accident year loss ratio increased 9.1 points to 78.3% for the quarter. Higher claims activity this year from our credit and political risk line resulted in an upward movement in the accident year loss ratio of approximately 13 points relative to the same quarter last year. This was partially offset by a lower frequency of large property losses this quarter relative to the prior year quarter.

Our consolidated current year loss ratio for the year-to-date was 69% compared to 67.8% for the first six months of 2008. During the quarter our estimate of net reserves from prior accident years continued to develop favorably with reserves reduced by $97 million this quarter. Of this amount $47 million was from our Insurance segment representing a positive impact of 15.7 points on the segment's loss ratio. In our Reinsurance segment we recorded $50 million in net favorable prior period reserve development representing a positive impact of 12.2 points on the segment's loss ratio.

Approximately three quarters of the net favorable reserve development this quarter was generated from our short tail lines. The balance of the net favorable development this quarter came from accident years 2004 and 2005 for our medium and long tail lines as our own experience continues to become more actuarially significant in the analysis of historical accident year ultimate loss assumptions in certain lines. I do want to emphasize that we have not released reserves for longer tail casualty lines in any meaningful way.

As we have in the last few quarters, I'll update you on the status of loss activity and reserving for our lines of business impacted by the financial crisis. Those lines are trade credit and bond reinsurance, professional lines insurance and reinsurance, and credit and political risks insurance. Starting with the trade credit and bond reinsurance. As a general comment, loss experienced in this line remains purely frequency driven at this point. Large insolvencies have not had any significant impact. Our estimated accident year combined ratio for the trade credit and bond reinsurance line now stands at 99% for 2007, 138% for 2008, and 124% for 2009. As this is a line with primarily short tail characteristics, we are comfortable that the 2007 and 2008 combined ratios are reasonably developed.

For professional lines insurance our estimated accident year combined ratio stands at 115% for 2007, 116% for 2008, and 102% for 2009. For professional lines reinsurance our estimated combined ratios stand at 108% for 2007, 110% for 2008, and 110% for 2009. All of these years contain a substantial amount of IB&R. To put this in perspective IB&R for these lines in the 2007 through 2009 accident years is approaching $900 million. Our net average line size was in the low-single-digits in the millions during the period.

Finally in our credit and political risk lines our estimated accident year combined ratio is 50% for 2007, 74% for 2008, and 118% for 2009. Loss activity has been in line with our expectations for 2009. Because the average length of policies is longer in this line of business, approximately five years on average, it's important to consider not only IB&R but also unearned premium reserves. Together these reserves are in excess of $0.5 billion at June 30th, 2009.

Moving on to expenses, our acquisition cost ratio and general and administrative expense ratio for the quarter were 14.6% and 12.3% respectively. These ratios were in line with the second quarter of 2008. I want to comment on one additional item in our underwriting results. You may recall that we have longevity risk exposure in the form of a life settlement agreement in our Insurance segment. Based on a review of the valuation this quarter we made a negative fair value adjustment of $15 million which is recorded in the other insurance related income or loss line in our income statement.

In our quarterly financial supplement we've updated information about PML's as of July 1st for the access group at various return periods for peak industry Cat zones. We have also provided estimates of industry losses at these return periods. The only change of note in the quarter relates to a modest increase in our PML's reported for California earthquake. The increase was driven by attractive opportunities in our Reinsurance segment.

Moving on to investment results, in aggregate the total return on our cash and investment portfolio for the quarter was 3%. This comprised net investment income of $112 million, a decrease in net unrealized losses of $239 million, and net realized losses of $24 million. The reduction in net unrealized losses this quarter was primarily due to tightening of credit spreads related to corporate debt and structured securities. Net investment income for the quarter of $112 million represented an increase of $13 million or 13% relative to the first quarter of this year and a decrease of $25 million or 18% relative to the second quarter of 2008.

Investment income from fixed maturities and cash and cash equivalents was $103 million this quarter. This compared with $95 million in the first quarter of this year and $116 million in the second quarter of 2008. The decrease, relative to the prior year quarter, primarily reflects the impact of lower short-term and intermediate interest rates. The increase relative to the first quarter of 2009 reflects the impact of higher average invested balances as well as redeployment of cash and cash equivalents into higher yielding grade-- higher yielding high-grade fixed income investment.

As a reminder, our alternative investments or other investments are accounted for at fair value with a change in fair value reported in net investment income. Net investment income from other investments was $12 million in the quarter. This represented an increase of $5 million relative to the first quarter of this year and a decrease of $8 million relative to the same period last year. Strong performance in the quarter from our credit funds, which are largely focused on bank loan investments, and our hedge funds was partially offset by a $26 million reduction in the fair value of our CLO equity holdings.

We also adopted the new FASB guidance for the recognition of other than temporary impairments of fixed maturities-- securities in this quarter. The adoption of this guidance had no impact on our book value per share.

During the quarter we incurred net realized investments losses of $24 million compared to net realized investment gains of $2 million in the prior year quarter. Net realized investment losses for the quarter included $15 million of impairment charges on certain mortgage-backed and corporate debt securities and impairment charges of $6 million on certain equity securities. At June 30th, 2009, net unrealized losses within our available for sale portfolio were $529 million, a reduction of $239 million in the quarter. The improvement in asset evaluation experienced during the quarter was primarily due to tightening of credit spreads on corporate debt and the structured securities.

During the quarter we reduced U.S. agency residential mortgage-backed securities and invested primarily in U.S. agency debt securities and high grade corporate debt. This shift has resulted in reduced extension risk while maintaining our investment portfolio yield levels.

Looking ahead, we expect to continue redeploying cash into short duration, high-grade liquid investments with higher yield. At June 30th, 2009, we held cash and cash equivalent balances of $1.4 billion or 13% of total cash and investment. Our fixed maturity investment portfolio, which represents 81% of total cash and investments, is well diversified, has a weighted average credit quality of AA plus, and has an average duration of approximately 3.13 years. Our investments represent 5% of our cash and investment portfolio at June 30th, 2009.

With respect to foreign exchange during the quarter, changes in exchange rates and exchanges in net currency exposure resulted in foreign exchange losses of $24 million compared to $7 million in the prior year quarter. However, from a book value perspective these losses were offset by foreign exchange related appreciation of our available for sale investments. This is recorded in other comprehensive income.

During the quarter we generated $207 million of positive operating cash flows. Total capitalization at June 30th, 2009 was $5.4 million including $500 million of long-term debt and $500 million of preferred equity. Common shareholders equity increased $416 million to $4.4 billion during the quarter. Our financial flexibility is very strong with debt to total capital at 9%. Debt and preferreds to total capital at 18.5%. And total capital well in excess of rating agency requirements. We remain strongly capitalized for the risks we hold and the risks we are targeting and continue to deploy, prioritize deployment of capital in underwriting opportunities. With that I'd like to turn the call back to John.

Thank you David. I have referred to sometime to our belief that we are not experiencing a classic soft market where by the reinsurance market leads the insurance market in softening. Our approach to the P&C marketplace over the last couple of years not only reflects the strength of the reinsurance market relative to the insurance market, but as importantly it reflects our strong competitive positioning in the reinsurance marketplace. For the Insurance segment the story for the most part is also more positive this quarter than last, but remains unsatisfactory on the whole. Overall rates in the Reinsurance lines we target is at a minimum stable and in the best cases increasing meaningfully. As David noted earlier, business flow to our Reinsurance segment has been increasing steadily and we are binding good opportunities for quality [cedance].

We continue to benefit due to concerns over the financial strength of distressed reinsurers or dislocation in the wake of our weaker competitors derisking activities. The first of July renewal was very successful for our Reinsurance segment. At this renewal, we estimate our AXIS re underwriting year premiums were up approximately 19% over the expiring amounts. We normally need approximately 13% of expiring premium and 25% of the business found at this renewal was new business. We expect some other activity in the quarter that will impact top line for the segment for the first of July generally gives a good indication of our competitive positioning. The most significant drivers of growth for us at this renewal were our property catastrophe reinsurance line and our U.S. casualty reinsurance line. We continue to evaluate other opportunities driven by capital needs of smaller regional specialty companies that may also represent new business for the Reinsurance segment in the third quarter.

Overall, AXIS property Cat reinsurance premium was up at the first of July. Broadly we continue to attach higher in a number of programs. This renewal is dominated by large national U.S. property Cat placements. In general these renewals were orderly and pricing was attractive. We estimate that overall year-over-year percentage increase in pricing, on a risk adjusted basis, was in the mid-teens for the majority of the portfolio.

Despite our disappointment with respect to the nonrenewal at the Texas windstorm insurance association Cat program, we were able to quickly reallocate a material portion of that capacity to other well paid transactions. While raised modestly for property pervious Reinsurance renewals, in our opinion these rate increases were not enough, particularly in lower layers with less experience. Therefore we maintain our cautious posture in this line.

At the first of July renewal we took a strategic position in bond reinsurance business in Latin America. A significant gap has been introduced with a pull back of the former dominant market in this business. We had very little of this business going into the renewal and in advance of this major renewal date we recruited a market leader known to us for many years which placed us in a particularly good position to address this dislocation.

In our U.S. casualty reinsurance business, quality capacity is limited and demand has been strong. Against this backdrop our track record of consistency, service and performance coupled with our strong balance sheet and ratings have positioned us well. We are benefiting from the flight to quality and the continued trend towards counter party diversification. Where we have written new business or achieved increase signings, we have done so on attractive terms. The general trend across the casualty reinsurance lines has been small, but steady rate increases with no slippage in terms and conditions. There are of course exceptions. Such as reinsurance of financial institutions D&O where rate is up dramatically.

For the most part we believe U.S. casualty reinsurance lines have bottomed. This bottoming is consistent with what we see it in our [cedance] experience and confirmed by our own casualty insurance lines. Simultaneously we were successful in pushing reinsurance terms. We expect this trend will continue.

Moving on to Insurance. Based on recent experience, it is fair to say that we continue to see mixed conditions in commercial insurance lines. For the most part where we have grown rate was the primary driver. In a number of our U.S. wholesale lines admitted markets continue to compete aggressively for the business. Distressed competitors remain an easy target for price sensitive clients and brokers who wish to turn up [line dye] to counterparty security strength and expertise. In this environment we believe our competitive advantage tends to come from our strong underwriting reputation and our global consistency of behavior and service.

Moving on to commentary by line. As expected, property insurance market pricing globally has responded positively. The most significant increases are seen in our London wholesale portfolio where rate increases have been approaching up to 25%. This act is heavily influenced by North American catastrophe exposure, so this is to be expected. Our U.S. based D&S property account, which is also influenced by it's Cat exposure, has seen positive rate movement up to 10%. Our retail property account began to see positive rate increases but regrettably this trend has recently moderated.

In offshore energy, clean international accounts renewed with rates up 10%. Gulf of Mexico accounts excluding wind renewed with rates up to 15%. Exposures are down overall and construction activity in the Gulf has substantially slowed. Fueled by four to five years of profitability, there was an increasing trend by clients towards higher retention of wind exposure. Despite this we achieved a good balance in our portfolio while maintaining overall premium volume and reducing our offshore energy-related wind exposure by approximately 25%.

The trend in our Insurance segments professional lines is a continuation of that in the first half of the year. Financial institutions business is up at least 20% and nonfinancial institutions commercial D&O and E&O is flat to down single-digits reflecting low loss activity. We continue to see many new and attractive opportunities in these lines.

Casualty lines have for the most part stabilized although reductions in the market are still common place. However, we continue to maintain a defensive posture in these lines.

Looking ahead in the aviation line, the fourth quarter accounts for most renewal activity. And we are pleased that the market has at long last acknowledged the lack of profitability in this sector following severe underwriting losses this year. This latest year follows a string of unprofitable years for this line of business. We believe that there will be a major upward correction at this year end. And if this correction exceeds our return requirements, we expect to selectively re-enter the market. As we have discussed on a number of occasions in the past, we materially reduced our participation in this line when in our view rates reached inadequate levels at the end of 2005. As a general comment, in the property and casualty insurance and reinsurance markets, top line continues to be under pressure as some insureds elect to choose lower coverage or altogether forgo insurance purchases. This may be acting temporarily as a drag on the speed of hardening in insurance lines in particular.

To keep some of our negative comments in perspective here, we are in fact experiencing rate increases across most lines at AXIS, whilst there's a long way to go. These increases are in line with our expectations for this year and are decidedly positive.

Also it is worth noting that for the most part we do not believe the current underwriting environment is worse than the environment which proceeded the last cycle turn when casualty was the last part of the market to harden in 2003. There were several factors contributing to poor results at that time besides rate erosion. Specifically there was a significant broadening of terms and conditions which was not considered in either pricing or reserving. Also loss trend was accelerating prior to that point in time and many companies were behind the curve in recognizing and reporting that trend. We do not believe that this is true today although inflationary pressures appear to be lurking on the horizon.

Throughout AXIS we believe that we have been consistently conservative in our estimates of loss cost trend and our pricing and reserving activities. We are optimistic that the positive experience of the last two quarters will bode well for continued steady hardening across all lines. However, absent a major event, we remain more tentative about predicting the scale of that hardening. Regardless, we are well equipped to manage our diverse portfolio to produce good returns on capital, whatever the market conditions may offer. Our portfolio continues to perform well and within expectations. Our business model, which is predicated on diversification by product and geography, continues to allow us to comfortably absorb losses in some lines while continuing to generate good profitability in others.

Looking beyond this year we are confident we have successfully positioned ourselves to be the benefactor of any market disruption that may arise. We remain focused and disciplined. We continue to redeploy capital away from softer lines of business and into more profitable ones. Whilst we have been very defensive over the last couple of years, we have also been very diligent about building out our specialty presence geographically and in new lines of business. We have a strong balance sheet with plenty of capital available. And we will take advantage of opportunities as they present themselves. And with that, thank you, operator and we are ready to open the line for questions.

(Operator Instructions). Our first question comes from Dan Johnson of Citadel Investment Group.

Great, thank you and good morning.

Good morning, Dan.

Thanks. You went through on the Insurance segment and talked about how the political credit book had added I think about 13 points year-over-year. But sequentially the accident year x Cat loss ratio came up a fair bit likewise on the combined ratio. Was there a sequential increase driven by that line or did we have large losses or anything else you could add some color, and then I've got a follow up?

Well, as far as my take on it, Dan, is the fact that the underlying activity within the primary lines has been very good for claims activity. We-- I talked about the political risk increase in reserves and I no doubt will be answering more questions on that as we go through this Q&A, which I'm happy to do. But actually the portfolio, the primary portfolio, when you consider that we're at the bottom end of a very soft cycle, I think has performed extremely well. And I'm not in any way uncomfortable about either the totality of it or the individual components within it. David, I don't know if you --

Yes, no I-- just to elaborate in the components. I mean much of the increase in the ratio sequentially is driven by the credit and political risk business. There is some other attritional losses that have come through, but it's primarily from that credit book business.

And is that driven because there's a different earned premium pattern or is it because the loss picks were higher in 2Q versus 1Q?

The loss picks are somewhat different, but by in large similar. So it's not largely different loss ratio in the second quarter to the first quarter. I think you hit on a point that's very important in this book of business, which is this is a long tail book of business in the sense that the policies as I said in my remarks are on average five years and that premium is spread out over multiple years as opposed to single years as in much of the other parts of our business. So that drives the loss ratios and the ratios off a little bit when you're comparing them to other lines of business.

And then --

If you think-- and if you think about the fact that there are three lines that have been affected by the global credit crisis, of which two of those lines sit within the primary side, that's political and credit risk as well as professional lines business. The professional lines numbers have been remarkably consistent and static.

Okay. And then on the follow up, in terms of any larger losses in the quarter, can you talk a little bit about anything in particular, Air France comes to mind, and if there's anything else worth highlighting? And whether or not frankly that'd be on the Insurance or Reinsurance side?

Yes you know that-- well, the Air France thing I think is a terrible tragedy. And it will be interesting to find out whether they will eventually be able to discover what actually happened to the airplane. But you know and I've said time and time again that we withdrew from the vast majority of our airline business in the-- in November-- October,/November of 2005 because we saw huge price reductions being passed on to airlines, which we felt at that time would make the account unprofitable because all the published numbers that you see are at leaders terms and they don't necessarily-- premium terms tend to be averaged out. As well as that, if you were to, if you were to actually put on the expense costs associated with that portfolio of business, whether it's reinsurance cost, G&A and acquisition costs, you'll find actually that in 2006 it was pretty well maybe a break even. 2007, 2008 and 2009 are definitely loss years. So I think that the Air France loss was the straw that broke the camel's back and the market has no option but significantly move in a different direction. And we've been sitting patiently for nearly four years now waiting for it.

And so you're-- maybe add on to that, were there actual losses of any size to note from that event and you've cut back I think almost two thirds or maybe 75%?

We were involved, but it's not material.

Okay.

Because we have very longstanding relationships with a number of the world's airlines which go back 25 years. And so whilst we disagree with their pricing from time-to-time during market cycles, if we don't withdraw from those coverages we substantially reduce our exposures. So it's really not material to us. And that allows us to quickly ramp up when the market hardens. And we will be able to move back in reasonably freely.

All right. Well that was the add on I had, so that was it for me, thank you.

Thank you.

Our next question comes from Jay Cohen of Bank of America/Merrill Lynch.

Good morning.

Good morning, Jay.

I got several questions. I guess first is you made a comment early on in your prepared remarks John, about 2009 being the bottom of the earnings cycle. And although we're seeing pricing stabilize you also suggested at another time in the call that we still had a long way to go. And so you've given how your premiums are earned, I'm wondering how you're confident that 2009 is the bottom of the earnings cycle versus say 2010?

I think, Jay I think there's a very important point to your phrase. I think you really have to look at the diversity that we have within our portfolio. And that helps us enormously. We're one of the most diversified specialty businesses out there, not only by product, but by geography. And as well as that we can play between insurance and reinsurance. I often think that people don't give us as much credit as they should do for our ability to move capital between those businesses quickly and speedily and in a very focused way to find real earnings value even at the lowest point in a cycle. And I think we continue to demonstrate that. So yes, we're not predicting a substantial one off resetting of the industry. We think it's going to be much more steady and much more deliberate. But I think our portfolio allows us to continue to get through that transitional stage if you want to call it that. But I'm pretty comfortable about being able to do that.

So I guess you kind of wouldn't necessarily apply to the industry being at the bottom of an earnings cycle?

Absolutely.

Got it. And then two other quick follow ups. First is bond reinsurance in Latin America, I'm just not familiar with that business. Can you give us a 30 second summary of that what business is and who's pulled back there?

Yes. Well, I think that it was one of the largest reinsurance companies of the world whose pulled back and not pulled back because of any adverse experience in that part of the world, but because of greater problems they might have had within their balance sheet. As I said in my prepared remarks, this is a line of business that is highly specialized. That company has been doing business in that part of the world forever. The individual concerned is extremely well respected in the industry, is a very capable person, we have a lot of respect for him and we were delighted when he agreed to join us at AXIS. And so it's a combination of the opportunity, which is reasonably unique, it's very steady business, it has very, very good profit characteristics, very stable as I said. And we actually have the reputation and this gentleman's reputation to be able to, be able to build a portfolio down there.

What's the underlying risk like that you're taking, what kind of credits are you, are you incurring?

Could be construction, construction, commercial construction. This has been, this is a portfolio that's been in existence for decades.

Got it.

And if you look at countries like Brazil and there is a long history of buying this type of insurance, so this is not something that actually has been largely unaffected by the credit crisis as well.

Great. And one last quick one. David I think you had mentioned the losses in the CLO equity portfolio and I guess that was somewhat surprising, what drove those losses?

Well, I think the-- that's an investment category we have where there isn't a clear market trading information. So we use various assumptions and models to price that portfolio and you can see all that in our 10-K and 10-Qs. What really drove the movement in the-- or the pricing there was recovery rates, adjustments to recovery rates and default rates in the quarter. There was a number of things that caused us to want to change those assumptions be it rating agency reports on default rate movements and also underlying performance within those investments. We were seeing a higher trend of defaults in some of the investments in the class. So we made adjustments to those assumptions and that triggered the price movement in the portfolio.

Isn't that sort of like a bit of a catchup maybe?

No, well, I mean I think not so much a catchup because we look at it very, very closely and we've had very good performance in those in the past. But there was some downturn in the past quarter that triggered us to change those assumptions.

Great. Thanks a lot.

Thanks, Jay.

Our next question comes from the Josh Shanker of Citi.

Hey, Josh, good morning.

Good morning to you. I was reading over your press release and although I often am interested in your comments, the press release also had some pretty strong words in it, the words blindingly obvious that the market needs to change. And following up on that, looking at your results and your peers, accident year results for almost everyone still look good. While I might agree with you that the market needs to change, when are we going to see those accident year combined ratios come up for the industry that's going to shock it out of it's own ambulants?

Well, I think that financial results are one thing. When you're actually underwriting a portfolio you really have to look at what's happening to the underlying exposures and really see whether you're getting paid for the underlying exposures, especially when you overlay climate change and the changes that have occurred there over the last five to ten years. So whilst you could argue that the accident year numbers look pretty reasonable, as an old fashioned underwriter I believe that the market is giving away its capital far too cheaply relative to the exposures that it's assuming. And I'm not only talking about the short tail stuff I'm talking about the long tail stuff, because I still believe that tail risk is not being properly priced by the market. So-- and we've been in a relatively benign loss position so far this year if you strip out what's been happening from the global credit crisis. But it's been pretty benign. So don't get fooled by accident year loss ratios. I look at the quality of the earnings and the quality of the premium that the market is harvesting for the risk it is accepting. In my old fashioned sort of way I think it's still very inappropriate and I think it's naive.

Do you think without any notable change in the marketplace AXIS would be shrinking in the coming year 2010?

The market has moved Josh on the primary side. So it's stabilizing and moving upwards across the board. The reinsurance market, I've been banging on now for three years, is a much better place to be than the primary market. And I think that that's-- our view has been justified by our results. I'm not too fast, the movement is in the right direction, it's just the speed of it. Just I don't understand why companies are not looking more closely at the risk reward characteristics of the business they're writing.

Okay. Well, thank you and I'm very interested, and we'll see what happens.

Thanks, Josh.

Our next question comes from Terry Shu of Pioneer Investments.

Extending on to Josh's question.

Good morning, Terry.

Good morning. Is it not true, John in the past though that the players in the market have to be really shocked into action, that very few of the underwriters, the good underwriters do as you say which is to think about returns and risk reward. So therefore the firming so far has been slow frustrating as you said and it may not continue. Is that one way to look at it, because I don't remember any time in the past where the industry turns just because it's the right thing to do, to price properly?

No. Absolutely I'm afraid our industry has never been terribly good at understanding price to exposure. It's a bit like dangling a carrot in front of a donkey. Unless you dangle it there the donkey is not going to move.

Therefore is it not then fair to say that one may have to wait and maybe if there's some directional move, but it doesn't have the impetuous to go ahead or not, right?

Well I think that as I've said before that I've been concerned really for the last couple of years because the primary market has not been able to give margin away because it's come from the reinsurance market. And so the net erosion of a primary balance sheet should have been showing through more than it appears to have done. But I know my own balance sheet very well. What I don't know is what other industry players balance sheets, how they work their loss picks. But I would have expected to have seen a greater deterioration on that net margin than has been shown so far.

So there--

It may be a combination of things.

So the driver therefore probably has succumb more from like a push from the primary side with that deteriorating providing impetuous for the overall market to turn more, right?

Yes, I think the-- well, it depends on what happens on the asset side of the balance sheet for the rest of this year as well. But if you're looking at a low interest rate environment going forward you'd have thought that would have been even greater input pressure on primary companies to expand their underwriting margins.

And then a separate question, you gave us quite a bit of data on the trade credit and bond insurance multiple years 2007 to 2008, the combined ratio. And when we look at those results clearly when we look back the-- those lines have not been yielding sufficient profits. So is it more because pricing was not right or just this credit crisis was much worse than we thought?

No, no I think we're in the business of providing insurance or reinsurance policies to people, we expect losses.

Right.

And let me-- and as I said earlier, that these three lines, the political and credit risk insurance portfolio, the reinsurance credit and bond risk portfolio, and the professional lines D&O financial institution business in insurance and reinsurance, those are lines that you would naturally expect to have increased loss activity during a serious global financial meltdown. And so otherwise nobody would buy these policies.

Correct, right.

And so we-- the-- when you consider the severity of the financial crisis we have had to deal with, I think that those three portfolios have performed very well considering. And actually have stabilized significantly. And the characteristics is exactly as what we expected and the loss trends are exactly where we thought they would be. And I've talked myself blue in the face trying to explain these different accounts. But I-- they're part of a fully diversified portfolio where we're producing significant profitability in other parts of the portfolio. Not everything moves in the same profitable periods and that's why we have a diversified portfolio. But if you take political and credit insurance risk, AXIS is nearly nine years old, eight years old, and for the first five years we didn't have a claim.

Right.

We started to, we started to see a few claims emerge in 2007, it's still profitable. And the nature of this sort of business is the fact you have one year going into it, which is 2008, and we have one year coming out of it. I've said that I expect the 2009 accident year ultimately to be there or thereabouts, it'll be break even or thereabouts. And I'm still as comfortable today as I was at the beginning of the year when I expressed my opinions. So don't get hung up on the fact that those three lines are loss making, of course we don't like to have anything that's in negative territory.

Right.

But nobody would buy the policies unless they actually had value from them in such extraordinary times such as we live in.

Right. When you say you believe 2009 will in the end be break even, so when we look back --

Well, there or thereabouts, there or thereabouts, Terry.

Right okay, so--

I don't have a crystal ball, but I have my 38 years of experience in this business.

Right, right, so--

That tells me that I would be-- there or thereabouts.

And therefore, 2009 is probably going to be, or 2008 the worse year and things are, claims are receding, so that's the way we should look at it, more on a multiple year basis?

I think that you have to look at these lines individually.

Okay.

2009 in my view will be the worse year for the political and credit risk business.

Okay, okay.

I think the credit and bond and professional lines have stabilized. And I'm very comfortable about the performance now of those product lines.

Thank you.

All right. Great pleasure.

Our next question comes from Vinay Misquith of Credit Suisse.

Hi, good morning.

Good morning, Vinay.

Just a follow up to Dan's question on the credit and political risk insurance business, just looking at it quarter-over-quarter, first quarter versus second quarter the accident year loss ratio x Cat was up about ten points. So help me understand was it that an earnings pattern for the political risk business, where you earned more premiums this quarter versus last quarter, that's why the loss ratio went up or why a loss picks for the second quarter higher than the first quarter? And if you could give me a sense of the claims you received, are they picking up the second quarter versus the first quarter?

Yes. Hi, Vinay, good morning. The-- as I said a little earlier and maybe to give a little more color to it, you've hit on an important point and I don't think you've seen this information yet, but it'll be released when our financial statements are finalized where we have earned premium information by line. But the earned premium for this line of business was higher in the second quarter of 2009, and as you-- substantially higher than it was in the first quarter. And that's a function of the comment I made a bit earlier about the length of the policy, the earning patterns and the like. And in situations where losses do come in, we are going to match up the premium for the policy at the same time we record the losses. So that has to do with some of the movements you'll see in the earned premium within the quarter, because as you know for the last several quarters we've not written much business in this line. So you will see an increase in the earned premium. The loss ratio this quarter relative to the first quarter is around the same vicinity, it's not substantially different and-- but overall when you look at the quarter-over-quarter and the earnings within the lines of business you'll see that increase in this line of business driving that loss ratio up or combined ratio up.

Fair enough. Do you expect to earn more of these premiums in the next few quarters just because it's a now larger portion of your earned premiums?

No, I wouldn't answer the question that way, and I don't want to necessarily comment on future quarters. But we have a static portfolio at the moment in the sense we're not writing very much new business. So the earning pattern will continue in connection with the length of the contract. But in the case where we receive claims on a contract, we are going to match up the premium recognition with the claim recognition.

Sure. And are you seeing more claims in the second quarter versus the first quarter?

The issue, Vinay is, we-- if you-- these claims activity tends to sort of lag about three months what's happening in the global economy. And so we, as I've said to you before and I think I certainly said it publicly, for the last 18 months as the world went into this global recession, we have had a list of-- we've reviewed our portfolio thoroughly, we do that very, very regularly. And so we've had a hit list of potential issues that may arise. So whether we have two claims in a quarter or four claims in a quarter it's in that sort of region. And the average claims when they come through on a net basis tend to be the very low double-digits in millions. As well as that, our recovery assumptions we're still very comfortable with.

And then a very important point,which I'm sure you haven't missed, is the fact that over the last two or three months commodity prices have recovered quite substantially. That helps enormously in terms of liquidity and underlying collateral values. So again I can only the say to you that bearing in mind the scale of the global recession we're having to deal with, I'm very comfortable with where we are with this portfolio at this time.

So fair enough. And just a follow up question, if I may, on the investment portfolio. I believe David mentioned that you'd be putting more money to work in higher yielding securities, so would that be fresh cash flows or would you move money out of some other securities you have and move them into higher yielding securities? And should we expect a high yield on your investment portfolio going forward?

Well, a couple of things I guess. The answer to the first two parts of your question is yes, we are going to deploy and have been deploying more cash into the investments I mentioned. We're also reallocating in the portfolio from one class of assets to another. So we're doing both of those things in concert with the market conditions and what seems appropriate for our balance sheet and for our expectations. On the last point about yield, we're fighting against reductions in rates. So wherever we're moving money we're looking for good opportunities that meet our risk return characteristics, but we're also being challenged by a low rate environment.

Okay, that's great, thank you.

Thanks, Vinay.

Our next question comes from Ian Gutterman of Adage Capital.

Good morning, John.

Good morning, Ian.

Hi. It's interesting with talk about all the birthdays today, I guess it's our President's birthday, too.

Yes I know, I can't believe that these two can have within a day of each other.

One big party here.

Well what's ironic to me about that is all the talk-- your talk about the need for change and lack of follow through, it seems ironic. But anyway. I guess I want to follow up on what Josh and Terry had to say. I guess what's, and I share all your thoughts in it and I'm probably as disappointed as you are, but given we are starring into the teeth of another great depression and not knowing where companies balance sheets were and whether they can raise capital if you need them and so forth, and you had companies told were cutting prices and the government seems to have no regard for what its entity does. Now that the storm has mostly passed, what's going to put the feet to the fire. I mean it just seems there's no--accident returns are going to deteriorate slowly, right, it's not like we're going to have some shock that's going to wake people up. And it kind of feels a little bit like boiling the frog, right, you do it a little bit a time and they don't know that they're dead. And isn't that just what's going to happen, that people are willing to disregard what we were seeing last six months ago, what's going to make them wake up now?

Well I think, Ian, absent a major event I really believe that a number of companies have been very optimistic in the way that they've not only put their premium numbers, but also the way that they've established their loss picks. And some companies, and I don't know which ones they are, will pick a loss pick at the beginning of the year and they probably won't look at it for 12 months to 15 months.

Right.

And my view is that because the margins on the primary side are just not there in the way that they're being reported, that has to come up-- that has to catch up sooner or later. And so being the eternal optimist I am, because as I said I've been in this business for 38 years, I'm hoping that those financial numbers will come under greater strain over the next six to nine months. And I think that when CEO's, and you hear me criticize some of my colleagues in the industry, but being far too detached from the actual reality of what is taking place in their business, and some of the pretense about risk monitoring and the reality of what is taking place from what is being reported, I hope some of that actually washes through. Without a shadow of a doubt the risk reward tractors for the primary industry for this year have been under a great deal of strain. And that's why I said at the beginning of this year, this is a year to get through. We are getting through our balance sheet on the asset side, rebuilding that, and I want to make sure that on the underwriting side we're strong and as well prepared as we possibly can be. We've got great reserves, we've got great underwriters, we've got great product lines and just give us a business we can trade in.

Right. And I share that same criticism as some of your colleagues and how you differentiated yourself. But I guess my concern is isn't that sort of how 1997, 1998, out of the 1997 to 2001 period started right, is we were a little bit behind on accident year results and we all-- enough companies sort of did a wink and nod and by the time they got serious about it we were into 2000 where things were really bad and it was --

The reinsurance market was soft.

True.

Yes, Ian the difference, the reinsurance market was soft then, it's not. The reinsurance market has been pretty professional, pretty focused and maintained its margins, and it's been trying to grow them.

Okay, I mean that's--

That's very differentiated.

Okay so you-- I guess my-- I agrees that's definitely the positive, I guess my concern would be that some of these sort of government-sponsored entities, if you will, on the insurance side maybe start to weaken in terms of conditions and we see the T&C side go down the way it did last time.

Well, I really don't see that on the cards.

Okay.

I think it's a recognition from some of these CEO's that the returns that they're looking at in the near term are maybe not going to be there for them.

Okay, very good job, and I thank you for the time. I agree with you 100%, hopefully others will start to listen.

Thank you.

Our next question comes from David Small of JPMorgan.

Just a few quick questions, good morning.

Good morning, David.

On the political risk you had mentioned, I just want to clarify, so are there new claims that are coming in this quarter that because they've-- the waiting period is up and the-- and essentially the banks haven't been able to come to a resolution? Or are these new notices where they're still in the waiting period but you are putting up reserves for them?

No, David, these are claims that have come in in the door this quarter. Well these-- we haven't really talked about the specifics of the claims this morning, but we did have new claims in the quarter as we had in the last several quarters. As John commented on, none of them individually were that significant. But as I mentioned again, we have-- it's a long duration in some of these policies between the time the contracts written and the time all of the premium associated with that contract is earned. And so as we look at the book and we're looking at the reserving for the book and we're looking at the claim values, we're going to adjust the premium that is sitting on our books unrecognized in cases where we're recognizing claims amounts. We don't record-- I mean I would-- let me be pretty clear on this or very clear on this point, which is we don't record claims unless the waiting period has passed. I mean we need to have a default and a waiting period has to expire before it becomes a claim on our books, an actual claim. But we do reserve for the book as well on an overall basis.

Okay. And then, and then just in terms of you extended duration of portfolio in the quarter, is that all reflected to Vinay's question in this-- in the run rate net investment income we saw this quarter?

Well, the duration extension comes just from the rate environment. I mean we have seen a tick up in rates on the mortgage-backed portfolios or on the mortgage rates out there. So the amount of refinancings and prepayments, if you will, have slowed and that's really the result which is an extended duration on the portfolio. As I mentioned in my remarks, we did reduce some of the mortgage-backed portfolios which also helps reduce the duration, but nevertheless it's a big portion of our overall asset. So the tick up really is related to what's going on in the prepayment market.

And then just could you remind us what drives the negative fair value adjustment on the light settlement?

Well the-- one most important factor is the underlying experience of the portfolio and just as a reminder there's-- it's a limited portfolio of, or a small portfolio of lives in that overall contract, something about 180 or so lives. And we have assumptions about the number of expirations that will occur in that portfolio over time and certainly it's not going to be every quarter where our assumptions are going to bear out exactly, but as we see experience that's different than our underlying assumptions, we make adjustments. So we had less experience this quarter than was anticipated and that triggered that adjustment.

Okay, great, thank you.

Thank you.

Our next question comes from Brian Meredith of UBS.

Good morning, Brian.

A couple quick questions here for you. First one, was there any meaningful adverse development in the quarter on any lines just kind of like we had in trade credit reinsurance in the first quarter? Sorry, I didn't catch that Brian, sorry could you-- I'm sorry. Was there any meaningful adverse development on any lines of business in the first quarter kind of like we had in the trade and credit reinsurance in the first quarter of 2009?

Yes. I mean there wasn't really any meaningful in that sense Brian, and that's why I didn't comment on it in the prepared remarks. There was some adverse development in the professional lines 2008 year, but it was small enough that it wasn't worth mentioning frankly.

Great. And then a question once again on the duration investment portfolio, where do you stand right now relative to the duration on your liabilities and do you have more room to extend duration on the asset side?

Yes, we definitely can extend duration. We're purposely staying short because the issue here I think is going to be that rates begin to rise and we don't want to be caught out in that issue. So we definitely have a much shorter duration than we otherwise could have.

Okay. And then just quickly lastly here, John, I wonder if you could remind us on the political risk business, what are the kind of average limits exposed on that business and what protection do you have in place to kind of net down your potential losses on these exposures?

Well the average, the average limits that we put out around $30 million, $35 million.

Okay.

And we actually do not buy reinsurance on that portfolio. The way I look at it is it's got an in-built reinsurance which is actually the recovery rate of the underlying assets, which has been proven to be very strong over a long period of time.

Okay. And just on the average limits, just the average limits, there is one particular political risk out there that I guess is publicly disclosed, and it looks like your limits are fairly large on that one. Is that kind of a one off type of item?

Yes, it is.

Okay.

Yes.

Thank you.

Our next question comes from John Hall of Wells Fargo.

Good morning.

Good morning, John.

Yes, John, in your comments you were talking about smaller and-- smaller regional and specialty carriers. I was just wondering if you could categorize or give a little bit more detail on the demand that you're seeing there, what they're looking for exactly?

Well, I think that there's some signs emerging of some capital relief issues that need to be addressed. Which may present us with some opportunities over the next couple of quarters, which we will look forward to.

So that hasn't fully played out as of yet.

No, it's just emerging.

Great. And David I was--

I think it'll be good.

And David, in your response to David Small's question about life settlements, I'm just wondering if you could offer what the size of that life settlement portfolio is?

In terms of lives I mentioned it's $188 million in terms of, in terms of the size of portfolio and I have to go back and look on whether we've disclosed that, I just don't remember. If it is it would be in our 10-K, I just-- I'm sorry, I don't have it in front of me.

Okay, thank you.

That does conclude our time allotted for the question-and-answer session. I would now like to turn the call back over to Management for any closing remarks.

Well, thank you again, ladies and gentlemen, for listening to us this morning. I was interested to hear the Stairway of Heaven music just before we started our commentary. I hope that you can think of us as sort of moving strongly up that stairway and we'll get there as quickly as we possibly can. Thank you again, bye.

The conference has now concluded. Thank you for attending today's presentation, you may now disconnect.