丘博保險集團 (CB) 2003 Q1 法說會逐字稿

Good morning, ladies and gentlemen. Welcome to the ACE Limited first quarter earnings conference call. At this time, all participant have been placed on a listen only mode and the floor will be open for questions and comments following the presentation. If after the presentation you would like to ask a question, you may do so I by pressing the numbers 1 then 4 on your touch tone phone at this time. To remove yourself from the queue, please dial the pound sign. It is now my pleasure to turn the floor over to you host, Ms. Helen Wilson. Ma'am, you may begin.

Thank you and welcome to the ACE Limited March 31, 2003 quarter earnings conference call. I'm Helen Wilson, Director of Investor Relations, and I will be your host for today's call.

Our report today will contain forward-looking statements such as statements relating to our financial outlook, business prospects and business mix, market conditions, pricing, policy terms, profitability, growth, premiums, cash flow, tangible equity, capital and surplus, income, financing plans and cost of capital, interest expense, casualty classes and capacity, rating agency actions, tax rate, exposures and reserves, reinsurance recoverables and [INAUDIBLE]. Actual results may differ materially.

Please refer to our most recent annual report on form 10-K and other documents on file with the SEC particular on our Safe Harbor language as well as our earnings press release and financial supplements which are available on our website for more information.

I'd also like to remind you that this conference call and its content and any taped broadcast or publication by ACE Limited is the sole copyrighted property of ACE Limited and may not be copied, taped, rebroadcast or published in whole or in part without the express written consent of ACE Limited.

This call is being webcast live and will be available for replay for two weeks. All remarks made during the call are current at the time of the call and will not be updated to reflect subsequent material developments. You may also listen to a replay of the call at 877-519-4471 or 973-341-3080. Access code number 3862534.

Now I would like to introduce our speakers. Brian Duperreault, Chairman and Chief Executive Officer will gave an overview of the quarter, followed Dominic Frederico who will provide highlights of North American and Financial Services Segments and Evan Greenberg who will give highlights Global Reinsurance and Overseas General.

Philip Bancroft, Chief Financial Officer will review the highlights of our overall financial position and results then we'll take your questions. Now I'll the call over to Brian.

Thanks, Helen.

Clearly this was a very good quarter for ACE. All of the positive elements in the business that we cited in previous conference calls came together to produce record quarterly earnings per share.

Operating income per share rose 32% to $1.02 compared with 77 cents a year ago. That, in turn, was up 18% over 2001. Quite a progression.

The growth and earnings came from a combination of increased earned premiums of 52% and improved underwriting margins better by 2.1% and as a result, net underwriting income increased by $96 million or 108%. Growth in net investment income continues to lag the growth and underwriting income rising by only 3%.

Our annualized net operating return on average equity was 16.7% and our book value per share increased to $25.14, a gain of 4% over year end. Most of our growth in the quarter came from our primary property and casualty insurance operations. With North American net premiums written of 82% and overseas general up 60%.

Global reinsurance was up 25%, financial services up 11%, and global light free insurance which is comparatively small, up 68%. Dominic, Evan and Phil will give you more details on their respective areas of responsibility. I just want to provide an overview.

In my view, our rapid growth was a reflection of the strong position we have achieved in the global insurance and reinsurance marketplace. ACE Limited's consolidated net premiums written were up 48% in the quarter.

Rates in both property and casualty lines continue to move up in the quarter. Some classes more than others.

Looking forward I would have to say that property rate increases in the U.S. have probably run their course and we don't expect further significant increases for the remainder of the year. Growth will have come from units rather than pricing even faithful to our high underwriting standards which means that we won't write business that compromises underwriting profitability.

Property in the rest of the world particularly Europe continues to experience good rate increases which should continue through the year.

On the casualty side, it is an even better story with both rates and demand continuing to rise particularly in those areas where the legal system is not functioning properly. Hopefully the tide of public opinion is beginning to turn against the a grievously excessive fees and awards captured by the plaintiff's bar.

However we do expect premium growth in subsequent years to slow somewhat from the very rapid levels of the first quarter with our mix of business changing toward longer tail lines. We also expect cash flow to continue to increase due to increased premium and a greater waiting in long tail casualty lines.

For example, in this year's first quarter cash flow was positive by $600 million and total cash and invested assets exceeded $19 billion. All this growth and earning power has been masked in recent years by sharply declining yields.

I pointed out on our 2002 annual report that an 80 basis point decline on our average portfolio yield cost us $140 million in lost annual investment income. In short, we're building ACE's earning power for the future.

Let me turn back to more immediate issues. During the quarter, three principal rating agencies completed their review of our operations and reaffirmed our strong financial strength ratings although they downgraded our debt ratings by one grade. This should not have a significant impact on our cost of capital since we have been deleveraging slightly over the last few quarters.

On the financial side, our balance sheet continues to improve. Our capital and surplus increased to $6.7 billion dollars and should exceed $7.5 billion at the end of the second quarter after our preferred stock financing and the conversion of $311 million of mezzanine equity on May 16th together with retained earnings anticipated in the second quarter.

In short, it all seems to be coming together for us in 2003. We're quite pleased with our positioning. The team executing ACE's business strategies has been doing exceptionally well.

Before I turn it over to a key member of that team, Dominic Frederico, I'd like to offer a word of caution about annualizing the first quarter results. The first quarter is seasonably very strong for us.

Certainly this has been true over the last three years. While the progression and earnings from year to year has been outstanding, please look at subsequent quarters in the context of seasonal patterns when making your full year forecasts.

Thank you and now let me turn it over to Dominic for additional background on our North American and Financial Services Operations.

Thanks, Brian.

In short, the North America segment had strong operating results for the first quarter. We experienced solid growth and continue to achieve price increases as demand continued for our traditional property and casualty risk transferred business written in the United States, Bermuda and Canada.

Insurance North America produced operating income of $120 million versus $94 million in the same period last year. An increase of 28%.

This business posted a combined ratio of 90.6% in the quarter versus 93.1% in the same period one year ago. This improvement in the combined ratio was split evenly between our loss ratio and our expense ratio.

Our net to gross ratio improved from 40.6% to 56.1%. This was largely driven by increased net retentions and changes to our mix of business. Also, last year's net was negatively impacted by a large [ERROR BASED] session which affected the change.

The North American insurance market continued to improve during the first quarter and saw additional contraction in competition and capacity in selected segments. Overall, our North American rate increases continue their upward trend.

The casualty marketplace continues to be strong with rate increases north of 40%. DNO rate increases continue to be more significant especially in Bermuda where the book of businesses is predominantly with Fortune 500 businesses.

The property marketplace has become more competitive during the quarter. With rates increasing slightly and then leveling off at the end of the quarter.

All business lines have continued to drive bearable changes in terms, conditions, attachment points and exposure limitations. Additionally, we saw significant new businesses especially in our risk management division which benefited greatly as competitors continue to redefine their position in the market.

The Westchester Specialty Group saw its gross written premium grow by 58% over the same period last year. This growth was attributable to new business in the crop hail segment and better than expected growth in the casualty lines.

As I mentioned last quarter, we expected the Terrorism Risk Insurance Act of 2002, TRIA to have some impact on our first quarter results. To date, takeup rates for TRIA coverage under the property programs is about 15%.

The average additional premium for TRIA property coverage ranges from a low of 5% to north of 50% depending on the location of the individual property. Name brand companies, real estate management firms and accounts influenced by their lending institutions make up the majority of the purchasers of TRIA coverage.

On the casualty lines, TRIA coverage has been more universally accepted with takeup rates nearing 100%.

Moving on to ACE Financial Services segment made up of ACE Guaranteed Corp., ACE Capital Re and ACE Financial Solutions, we continue to achieve reasonable results in spite of a very volatile credit market. As previously discussed, we evaluate these businesses on their bottom line contribution. As production results vary based on our mix of business.

Our net operating income increased to $59 million in the first quarter. An increase of 26% over the same period last year.

In the first quarter of 2003, ACE financial products gross written premium showed a strong increase over the same period last year. This increase was driven by strong facultative municipal premium at ACE Guarantee Corp. and strong activity and structured credit at ACE Capital Re.

In addition, ACE Guarantee Corp. had a robust quarter in the trade credit product line. The increase in municipal volume resulted from continued low interest rates and a reduction in competition as two formerly AAA rated financial guarantee reinsurers lost their ratings and reduced their activity.

The increase in structure credit is based strictly on market opportunities in the first quarter. Trade credit volume was also driven by a reduction in competition as traditional players withdrew capacity due to capital constraints.

ACE Guarantee Corp.'s superior ratings and strong capital base permitted the company to drive better [INAUDIBLE] terms and conditions while being highly selective in its participations. Net earned premiums followed the written premium with a strong increase quarter-to-quarter.

The first quarter increase in municipal and structured credit gross written premiums will affect earned premiums in future periods due to the extended earnings periods of those businesses. Municipal premiums are generally earned over an average of ten years and trade credit premiums are earned over a two to three year period.

Looking ahead, the market for credit-based products continues to be strong and pricing for municipal bond insurance is experiencing double digit increases. Due to the combination of volatility caused by FAS 133 and weak pricing, ACE Guarantee reduced its participation in the insurance of single name, credit default swaps during the quarter.

We expect this trend will continue as the year unfolds. The average life of this book of business is under two years, providing for a significant runoff of our exposure during the balance of 2003.

To compensate for this shift, ACE Guarantee is accelerating its strategic movement into the direct financial guarantee business.

The Financial Solutions business also had a steady first quarter. While gross written premium was slightly down to $411 million compared to $423 million during the same period last year, we're pleased with our volume.

As we explained in the past, quarter-to-quarter production results for Financial Solutions are often volatile because this business unit writes a limited number of large complex custom tailored transactions which are generally not renewable on an annual basis.

As stated previously, we manage this business on a contribution to bottom line basis and believe we can continue to grow net income in accordance with our business plans. Financial Solution continues to experience strong demand from the corporate insurance market which generated several new finite risk programs bound this quarter.

These programs provide efficient solutions to customers facing increased retentions and changing insurance programs. We also found several new property [INAUDIBLE] programs which are structured with mortgage transfer that such programs generally incorporated in the past. This adjustment enabled us to take advantage of higher margin levels available from the market.

Finally in March, we created a Financial Solutions unit in Europe to provide customized, non-traditional finite insurance and reinsurance products for our European-based customers. The strong first quarter financial performance by both the insurance North America and Financial Services segments have set the stage for continued growth throughout the balance of the year.

However, we expect our net written premium growth to slow somewhat through the remainder of the year driven by a flattening in the property markets as well as a reduction in new business, stemming from market dislocations which began significantly in second quarter of '02 and will have a smaller impact through the remainder of 2003. Now let me turn the call over to Evan for a detailed review of our international and reinsurance segments.

Good morning. ACE Overseas General had an excellent first quarter and start to the year. Net written premiums were up 60% to $981 million. After tax net operating income increased almost 100% to $65 million. While the combined ratio came in at $93.4, down over 3 points from last year first quarter.

Overall, we continue to retain more of the business we write. An important strategy for us and in this regard, our net to gross retention ratio increased to 70% from 64%.

AGM ACE Global Markets was the single most important contributor to our ratio change. ACE Global Markets net to gross increased to 74% up from 49%.

Let me briefly highlight each of the international operations, ACE International and ACE Global Markets.

First ACE International. Net premiums written were up 56% to $725 million. Excluding the effects of foreign exchange, growth was 42%. And the combined ratio improved to 91.3.

As with prior quarters, we experienced strong growth across a wide geography and over a broad portfolio of PNC lines. Net written premium growth in Asia Pacific was 71%. Europe was up 66%, Latin America 22%, and Japan 14%.

Our PNC lines of business were up over 60% and we continued strong growth in our accident and health areas which were up 49% for the quarter. Broadly speaking, market conditions internationally remain firm and improving. Rates for PNC lines were up overall by approximately 25%.

The rate of increase in the property related lines are slowing down but rates do continue to move up. However, with that said, it varies by territory. For instance, in some countries, such as Germany, property rate increases are actually accelerating.

In the casualty lines overall, rates are continuing to move up at a strong pace. As rates move up and terms tighten, we're finding more opportunity to write business that meets our underwriting standards.

Given our global position with a strong on the ground local presence in over 50 major insurance markets, we're taking advantage of the worldwide market opportunities to grow profitably and our results demonstrate that. Touching for a moment on SARS, since it is on everyone's mind, we do not anticipate any material effect on our future growth as a result of SARS.

Now, let me turn to ACE global markets. Our London-based ENS business. It had a very good start to the year.

The headline is, we returned to underwriting profitability with a 97.9 combined ratio, down from 107% last year. Net written premiums in the quarter were up 72% to $256 million.

Growth was positively impacted by the reduction from last year in reinsurance spend to protect the legacy portfolio. We experienced strong growth from our property, energy, professional liability and marine lines of business.

Pricing continues to harden in most lines. Overall, in London. And rates increase by about 21% in the quarter. We have a strong disciplined underwriting team and I expect results to continue to show improvement as the year goes on.

Now, let me touch on ACE Global Re. ACE Global Re property and casualty had an excellent quarter. In fact, our best ever.

After tax operating income was $87 million up from $76 million last year. Net written premiums for the quarter were $443 million, up 25% over the first quarter of last year. The combined ratio for the quarter was 71%, compared to 54% for the corresponding period.

This increase is in line with our expectations and is a result of our change in mix as we continue to diversify our business. ACE Global Re is now a true multiline reinsurer.

Premiums written for Bermuda property [CAT] business represented 44% of overall production for the quarter compared to 58% last year. The balance is well spread between casualty, risk property, marine and aviation lines.

All three of our operations, Bermuda, U.S. and London, have performed well during the quarter. During the last call, I commented upon greater competition in the property [CAT] market with rates down when viewed on an exposure adjusted basis. Which is the only correct measure in our judgment.

ACE Tempest Re Bermuda has maintained underwriting discipline in the face of increased competition and has not compromised either our risk selection or pricing standards. Consequently, we've seen a 5% reduction in premiums written for [CAT] business.

ACE Tempest Re operations in the U.S. and Europe have once again achieved tremendous growth in the quarter. Net premiums written increased by 209% in the U.S. and 44% in Europe. With each operation contributing to operating income.

Overall, underwriting conditions are favorable. Casualty classes are continuing to tighten as they well should. Capacity in the casualty classes has tightened as well.

And for risk property related classes, there's plenty of capacity when terms are acceptable and overall, our rates have peaked in these classes. We're seeing a flight to quality in the face of rating agency action across the reinsurance sector.

Consequently, ACE Global Re is well-positioned given our rating. In summary, a very satisfactory quarter.

Now, let me turn it over to Phil Bancroft.

Thanks, Evan. Good morning.

Today, I'll talk about our first quarter financial performance, the investment portfolio, reinsurance recoverables, lost reserves and our capital structure. I'll also update our guidance for 2003.

I'll make some references to our first quarter financial supplement. It is available on our web site.

Our operating income for the first quarter of $279 million or $1.02 per share represents a return on average equity of 16.7% and a return on average tangible equity of 28.5%. Our net income was $247 million or 90 cents per share which represents returns of 14.7 and 25.2 on average equity and average tangible equity.

Operating income and net income were up 29% and 25% over the first quarter of 2002.

While the underwriting environment and loss activity were favorable in the first quarter of 2003, the investment environment continued to be difficult. The equity market showed no recovery but a lot of volatility and interest rates were at historic lows.

We continue to maintain a conservative approach in our investment portfolio where predominantly invested in high grade fixed income securities with an average credit quality of double A and our duration remains at about three years. Our exposure to equities is 3.5% and the current average portfolio yield is 4.2% down from 4.4% last quarter.

The significant changes in our portfolio values for the quarter were at as follows. We recorded $64 million of realized losses by recognizing impairments of equity and fixed income securities.

We realized $24 million of gains on the sales of securities and the change in the value of our S&P indexed derivities. We also had unrealized gains from equities to fixed maturities and other investments of $88 million.

Overall, our net realized and unrealized gains and losses after tax added $47 million to our book value. Based on our latest review, our net portfolio position hasn't changed substantially since March 31st.

Turning to another key area of interest, reinsurance recoverables relating to our ongoing business increased by $227 million while our runoff book decreased by $88 million. During the quarter, $984 million was billed to reinsurers. We collected approximately the same amount and we've seen no evidence that our reinsurers are unwilling to pay.

We significantly expanded our disclosure for this item in our 2002 fiscal year financial supplement which is again included on pages 24 through 26 in this quarters' supplement. Gross loss reserves relating to our ongoing business increased by $534 million reflecting our growth in business.

Our runoff reserves decreased by $213 million principally due to lost payments. With respect to lost reserves, we provided a roll forward of both reserves and reinsurance recoverables in the supplement so you can see the impact of the items that affect these balances.

Page 28 of the supplement also shows the current status of our A&E reserves. There be have been no new incurred losses this quarter.

Our combined ratio for PNC operations was 90.6%, an improvement of 2 percentage points over the first quarter of 2002. During the quarter, we had $25 million of prior period development which represents about 1.5 percentage points on our combined ratio.

The modest increase in our loss ratio compared to the prior year is due to the increase in casualty and other risk lines particularly on our global reinsurance segment and the increase on our retentions.

Our capital structures on page 29 of the supplement. Although there were no changes to our debt from last quarter, two changes are expected in the second quarter of 2003.

First, we expect to issue $500 million of perpetual preferred securities in the near future including a retail offering we expect to launch next week.

Second, our mezzanine equity will convert to ordinary shares on May 16th which will increase our shareholder's equity by $311 million. Our outstanding shares will increase by 11.8 million but will no longer incur the quarterly dividend for these securities.

The balance sheet item I would like to discuss last is shareholders equity. During the quarter, our shareholders equity increased by $313 million and our diluted book value per share is now $25.14 up from $24.16 as of December 31st, an annualized growth rate of 16.2%.

Our annualized growth in tangible equity was 34.8%, and we project continued significant growth in our tangible equity through earnings as well as the conversion of the fee line prides and the planned issuance of $500 million of perpetual preferred securities. These increases should allow us to reduce our debt to total capital ratio below 20% and our debt plus trust preferred to tangible equity to below 50%.

We're very comfortable with the ratios and they're consistent with the averages of our peer group.

Now, I would like to turn to an update of our guidance for 2003. We expect a growth rate in earned premiums on our PNC business of between 35% to 38% for the year which is an increase from the previous guidance of 30 to 33%.

The remainder of our guidance hasn't changed from previous estimates. We continue to expect our combined ratio will be in the 90% to 92% range for 2003. We have assumed $100 million of cash for the year from our catastrophe reinsurance business.

In the Financial Services segment, we said that premium is not a good indicator of earnings because in each transaction, we generate a stream of income over time. We expect that growth in operating income for the year will be 15% to 20%.

We expect net investment income to be in the range of $845 to $865 million for 2003, based on an operating cash flow estimate of $2.5 billion an estimated income on the proceeds from our planned offering.

Considering the conversion of the fee line prides and the issuance of perpetual preferred, we expect total interest expense and dividends of approximately $220 million. Also, we expect that our tax rate will be in the 18% to 20% range. It is dependent on the mix of earnings from different jurisdictions with various tax rates.

So far, in 2003, we're continuing to experience favorable conditions in the insurance and reinsurance markets. We believe we're positioned to significantly strengthen our financial position during 2003 and that our tangible equity could increase by as much as 50% for the full year. And now I'll turn the call back over to Helen.

Thank you. At this time we'll be happy to take your questions.

Thank you. The floor is now open for questions. If you do have a question or a comment, please press the numbers 1 followed by 4 on your touch tone phone. To remove yourself from the queue, please dial the pound sign. We do ask while you pose your question, that you please pick up the handset to provide optimum sound quality. Once again, that is 1 followed by 4. Our first question is from Tom Cholnoky of Goldman Sachs.

Good morning, Evan, I was just wondering if you could just go into the global reinsurance a little bit? Given the mixed change that's going on to what I assume is more casualty business, is it fair to assume that the combined ratio in that business will -- is still perhaps abnormally low relative to the mix target that you're going after? And then secondly, it looked as though investment income on a sequential basis from the fourth quarter declined by about $5 million. I was just wondering what was going on there.

Fine. Tom, in Global Re, it is a mix of business change. It is casualty related, risk property, marine and aviation. So, it is a broad portfolio, not simply casualty that is representing that other 56% of the business.

That business will continue to grow at a faster pace than the [CAT] business which is flat to slightly down. That business will run at a higher combined but very acceptable combined ratio. And so that's why we're targeting to continue growing that and that's really out of the U.S. and out of the London operations

Would it be fair that say that segment might be running -- if you were to disabrogate it, although you don't would be running more in the 80 to 85 combined ratio range? Just to get a sense of feel for sensitivity.

I don't want to give a number specifically and tend to a number but it varies by line. The physical lines, would run more in those ranges. The casualty lines might be running a little bit different.

Ok. Then the investment income?

The investment income -- there was a -- Phil, you want to answer that? We paid some dividends. There's two things. Global Re paid dividends out in the fourth quarter to ACE Limited and that reduced the investment portfolio overall and number two, our average rate, it is a little shorter term portfolio in Global Re is part of the overall ACE Limited mix and so it runs at a rate that's a little more sensitive to interest rate changes and that affected it.

Ok, great. Thank you.

You're welcome.

Our next question is coming from Mark Lane of William Blair and Company.

Good morning.

Good morning, Mark.

Couple of questions. First question regarding the comment about not annualizing the first quarter. Just to clarify, $1.02 in the first quarter consensus is 405. And you're saying don't annualize the first quarter. So, are you trying to at least implicitly lower guidance at all for the year?

No. In fact, we went the other way, Mark. We increased the earned premium we thought we would have this year, in the property casualty area. Original guidance was 30 to 33. We raised that another five points to -- up closer to 38 maybe. And of course that -- clearly falls to the bottom line because we didn't change anything else.

What I was trying to get across is that particularly our [CATS] they don't come in across the board, they're not annualized. They show up when don't you expect them. Our first quarter though is usually [CAT] free and it was [CAT] free again.

But we've said in the guidance, expect about $100 million of [CATS] as a reasonable expectation. So, if you just take the accident combined ratio is about 89%. Our guidance was 90 to 92. And all I'm saying is don't forget that there are [CATS] out there so don't think we're going to revert to 89 just because the first quarter was that way.

So it's more the combined ratio than the bottom line number?

Correct. The combined ratios we think will be in that range for the year.

Ok.

That's normal. It could be a little higher in one quarter and a little lower in another.

Okay. Just to clarify, with the increase in the stock price, you're not considering at all raising any straight equity as part of your capital rate?

Read my lips, huh? We said before we weren't going to do it. We've been pretty consistent about how we want to do this. We're doing very well economically as a company. But we felt the need to raise the perpetual preferred as Phil pointed out and that's what we're going to do. So there's no equity-like capital raising anticipated.

All right. Just wanted to bring that out. Last question is regarding the loss ratio in this business mix issue. If you strip out the annualized adverse loss reserve, the quarterly adverse loss reserve development in '02 and the $25 million that you mentioned in this quarter, the loss ratio still is up about 350 basis points first quarter '02 to first quarter '03. Given all the rate increases you're getting and the tightening terms and conditions and lower attachment points, all the things you've been talking about over the past three years, I don't understand even how a business mix issue could explain a 350 basis point increase and accident your loss ratio year-over-year particularly given a really benign first quarter.

[INAUDIBLE] It does work out. You have to take it in its component parts. Evan got a question on his book of business. If you look at it, the [CAT] business is down now below 50%, 44%. The rest of that business runs a much higher combined ratio so it just naturally is going to rise. So, the contribution of the reinsurance business is to increase not only loss ratio but basically the combined ratio, too. So, you have that thing going on.

You take Lloyd's. Lloyd's, we are happy to report we're under 100 again but if you look at the component parts of the Lloyd's combined ratio, the loss ratio has changed. The expense ratio is down and the loss ratio is up. That's a phenomenon of higher net retentions. That's going on in a few other lines of business. A few other areas where, as we raise our net retentions, loss ratios tend to rise.

Then we have the straight mix of business going on in the U.S. And in part internationally where the casualty business was growing much more rapidly than the property business and casualty businesses run a higher combined ratio. They have a different ROE dynamic because there is a longer tail to it. You get more investment income. It naturally has a higher combined ratio. This is simply a natural consequence of the way the mixes are going. I mean that's --

Ok.

That's the way it is. You step through the arithmetic and it works out. So, you know, we have an 89 combined ratio for the quarter, the expense ratio is down, but the mix of business is the loss ratio. But I think it is a good trade because I think the casualty business long-term builds very strong earnings powers. I think it is a wonderful trade.

Ok, thank you.

Thank you. Our next question is coming from Susan Spivak of Wachovia.

Good morning. Brian, part of my question was on the CATS] and you answered that. You talked a lot, Evan, Brian and Dominic about rate increases. I was hoping you could go deeper into what's happening in terms of the fundamentals in the global market and just in terms of competition and what do you see with the flight to quality and has that changed since the last time we had this conference call or has it accelerated?

I think if anything, it's probably accelerated on the direct side. As opposed to reinsurance where there are a few players, direct side, you know, we seem to be losing players. Dominic referred to a very strong first quarter which was for primarily the result of further drops in competitors so we just have fewer guys out there that we see bidding on a particular program. So, in the U.S., I think it continues to accelerate. And that is born out with what's happening in casualty. Casualty rates continue to rise and they're rising rapidly.

Now, in Europe, you know, there is a major sea change taking place in the way the European market is sorting itself out. We are getting offers to write business and hire people in certain countries particularly Germany as a result of a decline in our competitors' capabilities. And you know, I've never seen this before. To me, this is a real change in the environment. You know, usually the French and German markets were very, very difficult to break into. That's changing. And that's more on the slow boil.

The U.S. was more advanced let's say in the change in the competitive situation whereas Europe is a little slower to move but when it moves, it moves for a longer time. So, we see the whole European situation changing in our favor for certainly for the foreseeable future. Those are the two principal markets. Competition in the rest of the world is relatively thin and we've had -- our Asian business -- Asia-Pac business grew very well.

Brian, could you also update us on the latest asbestos proposal? What's your view on that?

Well, the legislative process, you know, it doesn't go in a straight line. Very hard to predict. There are an awful lot of players. You read the papers. In the Times article, et cetera. There is an awful lot of players, manufacturers, insurance, labor, everybody weighing in on this thing. I would say that the senators that we talked to in particular feel something has to get done so I think there is a positive feeling in Congress. There's certainly a need for some reform in this area.

But I don't really want to -- I don't want to go out on a limb and predict where this thing goes because predicting legislative process is very difficult. All I can tell you is there is an awful lot of goodwill in Washington to get something done. A lot of minds being applied to it. And let's hope that occurs because the country needs it.

Can you just -- how will it affect the actions that you took last year on the asbestos front?

Well, I guess the logic in it, we put it up -- we put our reserves up not expecting anything. So, something happens, it shouldn't hurt.

Ok. Thanks, Brian.

Ok.

Thank you. Our next question is coming from Michael Lewis of UBS Warburg.

Good morning. I have a question on the retention side. A year ago, you were kind of saying you liked to share your profitability with your reinsurers because they'll be there in the bad times to help you out and blah blah blah. But now it seems when your capital position is getting better and your mix shift is taking place, you're going more for increased retentions. Brian, can you give me an idea of where you stand in the curve of retentions now versus where you were and where you want to get to and a little bit more of the rationale. Is this because you have an improved financial or capital position and how does that go with your overall risk profile and your move towards casualty away from property?

Michael. I did say we've been raising our retentions. We said it last year. I guess the first quarter wasn't quite as obvious. I got a question about I thought you were raising your retentions but the progress is in that way. You know, it stems from a couple of things. Evan pointed out what was happening at Lloyd's. We changed our reinsurance profile there to take more net. We consciously -- we put our money where our mouth is with respect to the reforms we thought were required at Lloyd's, and we've raised our net. So, that's a consequence of that. When you write casualty, when you write casualty, you tend to take more net.

It is less reinsurance driven than property business so there is a natural kind of movement up on a net retention basis as you shift your business. We're writing more reinsurance. We write reinsurance as a line of business. It is a rapidly growing piece of our portfolio. And that is in that retention business so again, that raises it.

We were doing some program business in the past which we have de-emphasized quite significantly and that has a very low retention level. And yeah, frankly, I likes the prices better and you know, if you get paid to take the risk, you take the risk. So, there is certainly that part of our thinking going on at the same time.

And one quick follow-up. [INAUDIBLE] on the AIG dropping ACE as a reinsurer company.

I didn't mention we were ever on. Not a big deal for us. That's not a new phenomenon.

That was very helpful. Thank you.

Thank you. Our next question is coming from Jay Cohen of Merrill Lynch.

I guess this is a question for Phil. What's the typical seasonality, if there is one, of your cash flow? It just seemed that the cash flow is weaker than the fourth quarter. I don't know if there was some seasonality there?

Phil, you want to talk about that?

Really just turned out to be the difference between the claim payments that we've made during the quarter and the premium. And that it is seasonal and that we're going to expect a little lower first quarter. A lower first quarter cash flow.

We have our reinsurance payments. They're pretty significant in the first quarter. First quarter premiums are pretty high. They take a lot of collect so it tends to spill into the second quarter. If you look at our pattern, that's the way it's been for a long time. And even with, that I think our cash flow is about three times plus what it was in the first quarter last year so it certainly is showing an improvement.

That makes sense. Thanks.

Ok.

Thank you. Our next question is coming from Brian Meredith of Banc of America Securities.

Good morning. Couple quick questions. First, on the capital situation again. What kind of growth do you anticipate you can have going forward in the premium growth for the year? Without having to raise additional capital later on down the year. What kind of flexibility do you have with the rating agencies?

We've given you new guidance on our earned premium. We think that earned premium is sustained, our capital can sustain that kind of earned premium.

Would you be -- let's say things continue to develop extremely favorably and you can get better than that growth. Would you restrict growth for capital reasons or would you instead go to the capital markets?

Should I get into speculation here? You know, we did anticipate and I said it to you -- said it before in the earlier remarks that we thought this would not be sustainable, this level of growth. It will come down a bit. So, we're frankly not expecting that to occur.

You have to understand that. We gave you the earned premium we thought we could generate. It is an interesting question if it arises. I mean, it is hard to, you know, our marketplace again doesn't move in a straight line so if there's something more dramatic that occurs later in the year where we have a further tightening and accentuation of the tightening and the market conditions are significant, then I guess we look at it at that point and decide what would be the best course for the company. We're not anticipating anything like that occurring.

Ok. And then another quick one. I know that you were actively reducing your gross limits after September 11th. Any change in that philosophy or increasing your limits now?

Are we in increasing our gross limits? I don't think we've increased our gross limits anywhere materially, no.

Any anticipation of doing that given that rates are much more adequate today?

Well, I would say that you may find a line of business where we increase our gross but that would probably be the exception.

Ok.

And again, remember, because where's the movement taking place? It is really in the casualty. The casualty tends to be lower gross limits anyway. Gross tends to be closer to net and so I just think that's happening here and that's probably more the headline.

Ok. Last question. I guess this is more for Dominic. On the credit default swaps, I noticed that [INAUDIBLE] swaps actually increased sequentially. Any concerns there and then also what kind of reserve do you have up for that business?

As we said, we've looked at the market as we always do very specifically and have targeted a different mix of business going forward. The movement was anticipated and is obviously accounted for in our reserves. And we don't expect any material change throughout the year. As we did talk, our exposure to the single names will continue to drop rather precipitously over the year as we've kind of changed our focus on that business and moved more into our direct strategy that we've introduced at the end of last year.

Great. Thanks.

Ok. Next question, please.

Thank you. Our next question is coming from Ira Zuckerman of Nutmeg Securities.

One technical question and one general. The technical one, you had what looks like 40 plus million dollar impairment on an equity side. Could you give us little more detail on that?

Yeah, sure. You want us to do that first and then the next question?

Sure. We have a policy where we look at our securities that are underwater by more than 20% and we make judgments about whether we think they're going to recover in the short term and I say we have take an conservative view of that and as securities approached the nine month time frame, we're -- I mean they've been underwater for nine months. We've been very aggressive in writing them down.

Well, but wouldn't you be carrying them at market anyway?

Yes, but this is a flip between unrealized loss and realized loss.

Ah-ha.

It only gets into the income statement, it's always been in our book value.

Ok. The other question is, given the state of the investment yields you're getting, how much have you increased rates to either generally or specifically take account of that?

Are you talking about insurance rates?

Yeah, yeah. Obviously pricing special and long tail lines includes an investment component.

Well, you know, it really --

Are you doing it --

The line of business, obviously so that in a short tail line, it is probably much less significant. And so there is certainly an implied rate increase across the board for this. I wish I could tell you it is as precise as that.

The question is are you doing it implicitly or explicitly?

Well, it is probably explicit in certain lines of business where you have a more model oriented approach to it. So, you know, anything like the property [CAT] business, you know, it has some kind of an implicit rate but it's not a big deal for them so it is a very small component part.

In DNO going to the absolute other way, you were in a marketable bear and the interest rate is a very small component of why the rates are going up. So, you know, there, it is much more an implicit number. What we do is, we look at the rate movements being obtained and we determine whether those will produce a reasonable ROE given yields, et cetera, so it is incorporated in our thinking but we are -- I would say it is more of a market bear in a lot of these lines right now.

Ok. Thank you.

Thank you. Our next question is coming from Ron Frank of Salomon Smith Barney. Good morning, Brian.

Good morning, Ron.

Ron Frank, CFA: A few things, if I may. One is for Phil. Phil, I noticed that while cash flow declined on a consecutive quarter basis for the second quarter, likewise, LPTs also declined to zero in this quarter versus the last two quarters. Does that also have an impact on the cash flow? Is that all counted as sort of up-front cash flow?

That is part of our operating cash flow. That would have an impact.

Ron Frank, CFA: Ok. Second question is, one of your peers recently took a hit on an auto residual value program. As I recall, you are or were a player that may be on the financial side and I was wondering if you could elaborate on any exposure there? And finally, I wondered if Evan could comment on what he considered to be a sustainable growth rate for ACE International assuming that it's not in the 40s.

[ LAUGHTER ] Dominic will do the residual value then Evan will pick it up. Evan, why don't you start? We'll do Evan first.

On sustainable growth rate internationally. You know, Ron, it is as much as we can get. And maintain underwriting discipline and profitability. You know, I don't think the -- without saying, going prognosticating too far into the future about this, the growth rate right now is in the 40s ex the affect of foreign exchange. I think you'll bang around. You could bang around in that area in the near term. Continue to. That's about what I would say about it. Do I think in the long-term we're going to maintain that growth rate? No.

Ron Frank, CFA: Do you expect that continue at least for the time being to reflect a continued strong contribution from both sides, the ANH and the PNC?

I do. I would say I expect to see a growth rate in the 30s to 40s.

Ron Frank, CFA: Overall.

In global -- in the international business.

Ron Frank, CFA: Ok.

So then Dominic on the residual value.

With that point, Ron, just so you know, the PMC is growing faster than the ANH.

Ron Frank, CFA: The ANH is growing pretty well though.

Very well.

Ron Frank, CFA: Ok. But anyway, Dominic on the residual.

Sorry. Ron, getting back to the RVI, obviously that line of business is getting a lot of attention these days. We are not and were not a significant player in it. We've got a few programs. Obviously we think we maintained adequate reserves as we book these things and there has been no development that has changed our forecast of where we're at today. Quite honestly, our position is very good in the deals that we have written. So we anticipate no issues whatsoever and as I said, it is not a featured line of business for us anyway.

Ron Frank, CFA: All right. Thanks so much.

You're welcome, Ron. Next question, please.

Our next question is coming from Hugh Warns of J.P. Morgan.

Hugh Warns, CFA: Good morning, everybody.

Good morning, Hugh.

Hugh Warns, CFA: One quick question for Dominic. Dominic, question we've asked for a couple of quarters here and I think Brian answered some of it at the beginning. Loss ratio again about 68% inside of North America. Haven't seen a substantive improvement. Can you actually give us the breakout of the changes between property mix and the casualty mix so we can try to more accurately model that?

Well, I would say a good percentage of our growth, the majority is nonproperty. So, therefore, it comes in with a higher loss ratio. Number two, the new lines of business, the environmental, accident, health, medical malpractice all have significantly higher loss ratios than the traditional business we had in previous quarters.

Hugh Warns, CFA: But if you're trying to range it out and just think in your mind where are you today in the book of business, property versus casualty, do you have a guess?

In terms of what, percentage of the book?

Hugh Warns, CFA: Yes.

Wow.

Hugh Warns, CFA: You can get back to us on it.

Yeah. Because I would say off the top of my head, it is predominantly casualty.

Hugh Warns, CFA: Yes.

Remember, we cap on our national accounts business, we now keep the bottom layer which obviously has a very, very, very high loss ratio relative to what you did in the past. So that -- that's one of our fastest he growing areas so that has a significant impact on the loss ratio and the combined ratio.

Hugh Warns, CFA: Is the driver of this shift on the rate side as we've seen that slow down in the large commercial U.S. or is it unit? Obviously it is a little bit of both. But what is your feel there?

I couldn't hear the last part of your question. I couldn't hear the last part of your question.

Hugh Warns, CFA: The last question is try to understand the mix shift. Obviously new products which you've talked about but rates are puttering out in the U.S. commercial large account property side. Casualty is still accelerating. Is it a unit change, rate change? What's the driver primarily?

For the higher retention?

Ron Frank, CFA: For the mixed shift.

The mix shift is really availability in the market. Where we see opportunities. We shift capital and resources. Obviously in the casualty side or the nonproperty side, there is definitely a redefinition of who's playing and where they're playing, and on what type of accounts it has created significant opportunity where the property side obviously, it is a little bit easier business to stay in and it's got a little bit -- a lot shorter gratification to the holders of that business.

So, you need to be more hale and hearty to stay on the long tail side and that's where we've seen a lot of our opportunity and where clients, getting back to a question earlier, in terms of flight to quality where we've seen a tremendous inflow of opportunities because of those type of issues that risk managers are now really focusing on.

Ron Frank, CFA: Ok.

I'd just add one thing on this rate issue. The DNO ENO business is something that we entered I guess relatively recently in the U.S. It wasn't a line of business that was featured prior to our acquiring the SINA. That's growing rapidly. Certainly rate is driving it. We would have been interested in that business in any case.

Umbrellas is a little different story. We've always written umbrella business but we've been very defensive for a very long time in that business because the rate levels just were not sufficient. Now, they've started to get to a point where they are. So, you're going to see a surge in our umbrella activity. And our net retention of that business.

Because it is now at a rate level which we would like to see on a long-term basis and workers comp very similar where most of our workers comp is written on a loss sensitive basis. We didn't do guarantee cost comp because we didn't like the features of it. A little bit better climate now for workers comp so you see us starting to take a little bit more comp. Again, that's rate related so this casualty movement by and large is because the rates are finally getting to the point where we would like to write the business.

Did the other -- the other thing I would expand on in terms of the umbrella, remember in the old days, prior to the acquisition of ISNA, we basically had a stand alone profit center. Today we have an integrated book of business where in -- Sue, correct me if I'm wrong but I think approximately 60% of our umbrella business today is written over our primary business.

So, there we have a greater linkage to the account of greater understanding which allows us then to take a more aggressive stance in the marketplace or more opportunistic stance in the marketplace because of the fact we've now got a very integrated business platform that allows us that opportunity.

Hugh Warns, CFA: The policy acquisition cost inside of North America is actually kicking up and is kind of I guess running counter to what I thought would have happened in this environment. Can you talk to that?

Remember, it is net. As you retain more, you change your reinsurance profile. A natural consequence of that is your acquisition -- net acquisition cost goes up.

Hugh Warns, CFA: And then Evan, one last question. Are you seeing -- can you talk to your response from the reinsurance side about the commission on the brokerage piece of the business. We've heard from some other players they've been very aggressive in attacking the brokerage commissions.

We've attacked all features of the business. Rates, terms, seasons as well as all expense areas including commissions. We think most of the -- we go by the policy that most of the increase we're getting belongs to the underwriter.

Hugh Warns, CFA: Ok. Great. Thank you.

Ok. Another question, please?

Thank you. Our next question is coming from Paul Newsome of A.G. Edwards.

Thank you and good morning. Just a quick question to beat the dead horse a little bit more. If we have continued casualty price increases and flattening in property, and the mix change continues to trend toward casualty, should we be thinking if we dare think beyond 2003, that more of your profit will be coming from net investment income and less from underwriting profit?

Yes. You know, it is now, Paul. If you look at our -- if you look at our income about 2/3 roughly comes from investment income and a third from underwriting which is a relatively high underwriting mix. Historically, we've done better than the industry in terms of combined ratio. But yes, it is definitely going to shift up to investment income and the interesting thing there is because the yields are so low, this phenomenon isn't showing up yet. But as rates change, it will.

So, in 2004, we should be increasingly watching for that investment income to rise?

Yeah, you should. I mean, I can't control rates. We can control the business and the cash flow and build up our net invested assets so just because of the cash flow, you're going to see our investment income rise and then we'll see what happens if rates change as well.

And then just maybe also a little bit of a review. At what point does the reinsurance recoverable given that you're raising retentions and begin to actually fall? If ever?

Well, it is flattening out right now. I don't know. It's a good question. You know, we have -- we've got legacy reinsurance collections. We don't add to that. When we collect it, it goes down. And then we have the post '99 business activity where we added a lot of reinsurance. But you know, as that starts to fall off, I think you're going to see certainly should start to flatten out. And we bill and collect. We haven't seen much of an issue there. So, yeah, if we don't add a new dollar reinsurance, it should start to come down.

Good. Thanks.

You're welcome.

Thank you. Our next question is from Mike Paisan of Legg Mason.

My question was answered. Thank you.

Mike, thank you.

Thank you. Our next question will be coming from Gail Golightly of Wachovia Securities.

Mine was answered, too, and I couldn't get out of the queue.

Once again, to ask a question, please dial the numbers 1 then 4 on your touch tone phone at this time. Our next question is coming from Jeff Trebek of Miller Trebek. Jeff, your line is live. We'll move on to the next question. A follow-up from Mark Lane of William Blair and Company.

Yes, regarding the bad debt expense on the reinsurance recoverables, reinsurance recoverables were up sequentially and you increased the reserve by just $18 million. How do you manage that on a quarterly basis? Is there some sort of formulaic number that gets put into bad debt expenses that grows? Did that change because of any specific issues? And you know, are we going to get into a case of next year where this is going to be coming down bad debt expense? You're going to be adding $15, $20 million a quarter or something like that?

What we do every quarter is look at the portfolio of reinsurance balances, the actual -- determined are gross reserves. We allocate them to reinsurers. We make judgments about the reinsurers based on their credit quality and we establish a reserve based on that credit quality. And that's going to change period to period. We have write-offs, we have additions to reserves, but it is very closely monitored relative to the reinsurers that we have in our portfolio. We don't expect any major change in that. As I said in the commentary, we billed over $900 million of amounts to reinsurers and we collected almost that same amount.

But is there any general provision for that given that it increases in the first quarter or is that all reinsure by reinsurer specific?

Well, it is reinsurer by reinsurer specific. We also make allowances for amounts that we project may go into dispute based on historical dispute rates. So, there is in addition to the amount that we do just based on pure credit. But it is based on a look at what's actually in the portfolio.

Ok. Thank you.

Next question.

Our next question is coming from Charles Gates of Credit Suisse First Boston.

Charles Gates, CFA: Hey, congratulations on your disclosure. That's real good.

Thanks, Charles.

Thank you.

Charles Gates, CFA: I'm just being honest.

Thank you. Appreciate it.

Charles Gates, CFA: I have only one question. I guess post the tragedy, some 15 new property casualty reinsurer and insurance companies have been created. Stepping back, how would you assess their import in the market to the extent of impacts, the markets that you operate and serve?

Well, Charles, you know, the most if not all of those new companies are reinsurance companies. Of course we're blessed to have them all with us in Bermuda. From a reinsurance point of view, we have a few more players. They are and have had an impact I think on the reinsurance market.

Evan pointed out that property [CAT] rates have shown the effect and I think they're part of the reason for that. Part of it is just that rate levels, it is a pretty precise business and returns on equity get to a point where the market self-corrects. But so in our reinsurance areas, certainly we've seen them as players. And nothing bad to say about any of them. But you know, if you look at the market that we play in, we're about 90% direct and 10% reinsurance. So, the other 90% of the business we do, they haven't had much of an impact.

In fact, if anything, as we've talked about earlier in the phone call, competition has declined and continues to decline. Post-tragedy, post-the beginning of 2003, we still see that. So, they have had an impact in a particular area with much less of an impact for us. So, we just see that there are maybe a handful -- there are very few global players left and that's really what's driving our market position right now.

Charles Gates, CFA: Thank you.

You're welcome.

Once again, to ask a question, please dial the numbers 1 then 4 on your teach touch tone phone at this time. Our next question is a follow-up from Ira Zuckerman of Nutmeg Securities.

Yeah, we've been through most of this year and stuff in general, how much growth going forward into next year can you finance and do you expect say in 2004?

Ira, yeah, we -- as I said earlier, we've given guidance with respect to volume changes. Premium volume changes.

For 2004?

And we believe that those volume changes are sustainable with our capital base.

For 2004?

Well, yeah, through 2004.

Ok.

Ok.

Once again, to ask a question, please dial the numbers 1 then 4 on your touch phone at this time. I would like to turn the floor back over to Helen for any closing comments.

Thank you, if there are no more questions, we'll conclude the call. We thank you for your interest in ACE and we look forward to speaking with you again at the end of next quarter. Thank you and good day.

Thank you. This does conclude today's teleconference. You may disconnect your lines at this time and have a great day.