丘博保險集團 (CB) 2007 Q3 法說會逐字稿

Good day and welcome to ACE Limited's third quarter 2007 earnings conference call. Today's call is being recorded. All lines are in a listen-only mode for the duration of the presentation. We will be conducting a question-and-answer session at the end of today's presentation. (OPERATOR INSTRUCTIONS). These instructions will be given again just prior to the question-and-answer session. Now for opening remarks and introductions, I will turn the call over to Ms. Helen Wilson, Director of Investor Relations. Helen, please go ahead.

Thank you, and welcome to the ACE Limited September 30, 2007, third quarter earnings conference call. Our report today will contain forward-looking statements, such as statements relating to our financial outlook and guidance, business strategy and practices, growth prospects, legislation, competition, pricing, and market conditions, renewals, exposures, losses and reserves, and reinsurance recoverable. Actual results may differ materially. Please refer to our most SEC filing as well as our earnings press release and financial supplement which are available on our Web site for more information on factors that could affect the forward-looking statements.

This call is being Webcast live and will be available for replay for one month. All remarks made during the call are current at the time of the call and will not be updated to reflect subsequent material developments. Now I'd like to introduce our speakers. First we have Evan Greenberg, Chairman and Chief Executive Officer followed by Phil Bancroft, our Chief Financial Officer, then we'll take our questions. Also with us to assist with your questions are several members of our management team. Now it's my pleasure to turn the call over to Evan.

Good morning. As you can see from the numbers, we had an excellent third quarter. Earnings were strong with all divisions of the company performing well. After-tax operating income and net income were up 6% and 13% respectively, over prior year's third quarter, which as you'll recall was an outstanding quarter. Our combined ratio for the third quarter was 88.5 and book value increased by $851 million. Modest catastrophe losses in the period contributed to the favorable results, and we also had $70 million of pretax benefit from prior-period development. Phil will comment further about this in a moment.

Adjusting for the favorable impact of the light cats in prior period, we produced a combined ratio of about 90%, a very good result. Looking back on the year so far, I believe our nine-month numbers tell an excellent story about ACE's performance across the board. To date, book value has increased by nearly $2 billion or 12%. Our return on equity for the year so far is over 18%. Nine-months operating income is up 18% over the prior year, with strong contributions from both underwriting income and investment income, and year-to-date operating cash flow is almost $4 billion, adding to our invested asset, which now stands at $42 billion.

Expense discipline has been excellent across the organization, resulting in a nine-month expense ratio that is below prior year. Our loss ratio year-to-date is up about one point. This year we have taken approximately $128 million in positive pretax prior period development, over three-fourths of which is from short tail lines. On the other hand, our cat losses have been approximately $125 million greater than in the same nine-month period last year. So that one point, or about one point, year-to-date increase is truly an accident year increase and reflective of market conditions.

Speaking of the market, the market is soft and softening conditions are a reality around the world. Reflecting these conditions, revenue growth in the quarter was essentially flat to down, with some areas growing while others shrinking, in line with our underwriting discipline. Our insurance business grew roughly 2% in the period, while reinsurance shrank by 24%. Specifically on the insurance side, our wholesale or excess and surplus lines businesses around the world, namely ACE Global Markets, ACE Westchester, and ACE Bermuda in aggregate shrank 7%, while our retail businesses overall, but both U.S. and international, grew 7%.

Our retail insurance business in the U.S, was up modestly in the quarter, driven in part by higher customer retention rates and our large account business which is somewhat less price sensitive and more service oriented and by growth in our middle market specialty lines, driven by higher customer retention rates and the expansion of our business with second and third tier producers as we take advantage of our full-service local presence nationally. Overseas, our retail P&C insurance business was up modestly in Asia-Pacific, Latin America, and continental Europe. Our international A&H or personal accident business had another good quarter, growing nearly 18% while our life insurance and life reinsurance businesses had a fine quarter. Operating income for life insurance and reinsurance as you can see now stands at $133 million for nine months and we had a good quarter in spite of the mark-to-market volatility and the impact that has on our variable annuity reinsurance line.

Notwithstanding the soft market, we are very confident in our ability to continue growing book value in all market conditions. Our organization is built for that. We have the underwriting insight and discipline to know how and where to grow, and our geographic footprint and broad product breadth gives us the ability to execute our vision. We are confident in our execution and we will continue to take advantage of opportunities without sacrificing underwriting profit. We are also confident in our ability to maintain a reasonable ROE over the medium and long-term by deploying our capital wisely, efficiently, and patiently.

Turning to one other matter, I would like to make a comment on the TRIA extension bills that were recently introduced in both houses of Congress. We are encouraged by the bills and applaud the leadership in both the House and Senate. We think both bills continue the public/private partnership that has successfully increased the availability and affordability of terrorism coverage in the United States. Importantly, the bills provide some measure of financial certainty for American business and they diminish the financial impact from a catastrophic terrorist event. We are optimistic that a single piece of legislation will ultimately be passed before TRIA expires at the end of this year.

With that, I'll turn the call over to Phil, and then we'll come back and take your questions.

Thank you, Evan, and good morning. Our third quarter results were very strong, which contributed to continued improvement in our balance sheet strength, both financial and operating leverage continued to improve. Our tangible book value grew by $851 million or 7% for the quarter. Our operating cash flow was almost $1.5 billion, resulting in a very strong and sustainable liquidity position. Our cash in invested assets grew by $2 billion, or 5% for the quarter to $42 billion. This included realized and unrealized gains, which increased the value of our portfolio by $274 million.

The value of our portfolio increased despite the difficult credit markets during the period. This quarter, we realized a $50 million loss relating to our 28% share of the negative mark on derivatives reported in our unconsolidated investment in Assured Guaranty. We also realized a $50 million loss related to derivatives embedded in the variable annuity reinsurance liabilities included in our Life segment. This charge related principally to rising equity volatility, and declining interest rates during the quarter. The credit quality of our overall portfolio remains at AA, and our duration decreased modestly to 3.6 years. Our net loss reserves increased approximately $600 million for the quarter and now stand at $22.6 billion with IBNR representing 61% of total reserves.

During the quarter, we had cat losses of $21 million and favorable prior-period development of $70 million. This development related primarily to short tail lines, but also included approximately $30 million principally relating to long tail claims made financial lines business from accident years 2003 and prior. Our tax rate for the quarter was 17.1%, which resulted from higher income emerging in low-tax jurisdictions, driven mainly by favorable prior-period development and the low level of cat losses. As Evan mentioned, our loss ratios increased in the quarter for the current accident year before cat losses in prior-period development. This increase resulted both from declining prices in 2007 and from unusually strong results in our short tail lines in 2006.

I'll also note that we plan to provide 2008 guidance in December. Now I'll turn the call back to Helen.

Thank you, Phil. At this point we'd be happy to take your questions.

(OPERATOR INSTRUCTIONS) We'll go first to Josh Smith with CREF.

Can you hear me?

Yes, we can hear you. How are you, Josh?

Just a quick question on the capital, your favorite topic, Evan. If you can continue doing a high teen to 18% ROE, you can have all the capital you want in my book, but for comparison purposes I was looking at Travelers and Chubs, two of your comps, and since the fourth quarter of '05, they've -- you've grown book value 38% versus high teens for them. They've bought back about $3 billion in stock each, negligible increase in rolling net written premium for all three of you. So by comparison, I think people are looking for you to do more on the capital initiative given what some of your peers are doing. My vote would be to do more with acquisitions that are accretive than buybacks, but if you could just comment on how you are faring relative to your peers in that regard?

I'm going to make two comments. First of all, each company has its own strategy, so I'm really not looking right and left in deciding what's best for ACE. So I'm not really looking at the playbook of others to determine that.

We have a strategy and I think you have to view your capital in terms of your strategy. Our strategy is clearly endorsed by both our board, the management, and our shareholders, and we speak regularly with our major long-term shareholders. It's correct, we have capital flexibility to execute our strategy, and our strategy does call for diversification. Either it's going to be done organically or through acquisition, or a combination of both. Over a medium and longer-term period. We don't simply view the short-term. That's our plan, to continue to enhance our franchise and we'll do both that kind of diversification is both geographic and line of business oriented.

As I say, we have the capital to do that. We're earning a reasonable return on capital at this time, and we have no plans at this time for share buybacks. And I might add, we've done our own studies of what share buybacks ultimately do. And we think it's quite transient and really doesn't do much. It's more of a question of are we good stewards of capital, and so are we the fiduciaries that shareholders want to entrust with capital.

I agree with that. As long as you keep delivering that ROE, I think you're fine.

Thank you.

Thanks.

Our next question comes from Matt Heimermann with JPMorgan.

Hi. Good morning, everyone. Two questions. One was, was there anything unusual in the current period that drove the sequential increase in the Overseas General segment?

You're talking about in the combined ratios?

The loss ratio, specifically.

There's two things to recognize. One is that in 2006 we had a very strong year, particularly in the short tail lines. And 2007 hasn't run as well. The other point I'd make is that in 2006, there was a current accident year reserve adjustment that took place in the third quarter and there was a positive. In this quarter we had a negative adjustment for the current accident year. If you look at it net of those two adjustments, you actually see a slight uptick in the loss ratio for the quarter for AOG. When you look at the overall organization and all the current accident year adjustments that we've made, in 2006, those adjustments reduced our overall accident year results by about a point. In this year the current accident year adjustments actually increased the loss ratios by about 2 points. And if you look at it adjusted for all those things, our overall accident year loss ratio is up about 1.5 points.

That's helpful. I was focused more on just the sequential increase this year. So are you telling us based on your comment you increased, you had an adjustment in the third quarter to increase your full-year pick?

That's exactly right.

There were two things -- three things. We're telling you number one, last year had a positive adjustment in the quarter downward and that benefited. Number two, we did have an increase for year-to-date loss ratio, so for the peg, and that was a portion of it. And then 1.5 points is simply the loss ratio increase for the current quarter.

Okay. That's fair. And what drove the decision to make the increase in the peg for this year?

Well, the overall peg for the year is that market conditions. Rates are going down and I think an overall increase of one point in the loss ratio for the nine-month period, which is how I think you ought to view this, is -- you could view as relatively modest. But then remember we have lines of business within there, like crop or A&H or cat business that would not be getting rate increases -- that would not be getting loss ratio increases.

That's fair. Anything specifically related to some of the credit D&O /E&O issues out there?

No.

On the in-depth portfolio, there was a significant decrease 2Q versus 3Q and AVS agency treasury, and that corresponded to increases in corporate municipals and non-U.S. government. Anything?I guess, what drove the dramatic change?

There was nothing strategic. It was just a tactical move and we are a U.S. taxpayer and look to move into municipals to the extent that they're priced right, so again there was no strategic intent.

Okay. Thank you.

Our next question comes from Brian Meredith with UBS.

Yes, good morning. A quick question. Looking at the net to gross in the quarter premium, it looks like there was more reinsurance buying, particularly in the North American operations this quarter versus last year's third quarter. Anything to read into that?

If you look at North America, the retention is down about 3 points and the change is almost entirely caused by the increase in written premiums in our crop business, which has a very low retention. The retention there is about 26%. So it makes it appear that the retention is down. Strong crop year.

Great. One last question. Evan can you comment a little bit more on market conditions, particularly terms and conditions and what you're seeing out there?

Yes, let's see. I'll give you some sense of rates. Particularly, this is on our book of business and on our renewals, and I'll give you a sense of what we see on the new business we're writing. The market, as I said earlier, is soft and has softened. The third quarter was more competitive than the second, which was more competitive than the first. So that trend continues and that's global.

Casualty lines in the U.S. were down. All casualty lines together were down about 5 to 10% on renewals with pricing. Property, when the physical lines were down in the 10 to 15% range, and also remember that's cat and non-cat, because last year, the July pricing hit a zenith in cat. General casualty renewals pricing is off about 5 to 9 and new business is off another 10 points from renewal pricing. Small workers' comp, which we write small not medium-sized risk transfer workers' comp, overall across the country it was off about 12%, more in California, less in other territories. Risk management large account business was off about 11% on renewals and new was off about an additional 8 points. Professional lines, D&O and FI was off about 11 on renewals and new business was off from that an additional, roughly, 10 points. E&O was off 10 points on renewal, property was off about 13, energy-related business was off about 13, and commercial marine was actually relatively flat, off about 3 points.

I give you all that so maybe you get a more granular sense of pricing. And Overseas, pretty much the same story. The physical lines were off a little less, more 3 to 7% in the short tail lines on renewals, though new business was off an additional 10 points on pricing and general casualty was off about 7 points on renewals and new business was off another 5 to 10 points on pricing and D&O was off roughly 11 on renewal and another 10 for new. So there it is, around the globe.

That's good. What about deductible, coverage terms, that kind of stuff? Are they continuing to loosen up?

They are on the margin. In my own gut, it's a death by a thousand cuts. It's small -- there's not a wholesale change in conditions and conditions are holding -- terms and conditions are holding pretty well, but we are seeing slides in deductibles, we're seeing broadening of wordings to include coverages that may have been chucked out before, wordings that will broaden what is the risk exposure. So we're seeing it on the margin, but we're seeing it.

Thanks, Evan.

You're welcome.

Next question from Jay Cohen with Merrill Lynch.

Just a question on the cash flow, I guess for Phil, it was particularly strong in the quarter. I'm wondering what was behind that?

One thing we did see in the quarter was pretty strong collections of both premiums and reinsurance, particularly in the U.K. and the U.S. So it was just a strong quarter.

And paid losses continue. You can see the paid to incurreds, paid losses continue well.

Great. Thanks.

Our next question from Steve Labbe with Langen McAlenney.

I was wondering, Evan, if you could share with us what you believe are the odds that as the Senate and House negotiate and come to an agreement on a total flood insurance reform bill that wind could potentially be added, being that it's in one version and not the other.

Boy, I have no real crystal ball for this. I can't tell you. I can tell you what you all already know, and that is particularly in the Senate,the House is always much more of the hot handle and the Senate is a cooler, longer-term view, and when the House put up its version, the Senate, and you've been hearing calls in the Senate that have been pushing back on this and not to be so quick to extend and put wind in there and particularly the comments I've noticed focused on maybe almost a disbelief in the GAO report that said adding wind would have a negligible cost, which we all know is fallacious. I don't know what kind of actuary they used, but I doubt he had all his exams. My own sense is that they're going to,especially, they're looking for income, they already have a lot of pressure on the expense side, on the spending side. I would give it less rather than greater odds that it passes.

Okay.

Extended to include wind.

And a second question -- thank you. I know it's been a few quarters now where the decline in reinsurance writings has been meaningful. I'm curious, is it possible that you are so opportunistic in reinsurance that you could see that actually get to zero? In other words, are you tied to having a business? Do you get to a point where you say, we just have to be in the market because we always want to be there, or if the conditions lend itself to these type of declines almost indefinitely, is it okay with you?

I had a talk with the reinsurance management team yesterday, and I told them a few points which I will make right to you now. I am committed to our reinsurance business, I am committed to our team. I think we have got just a great team. We run it quite lean. At the end of the day, it's an underwriting trading business. Relationship aside, we're going make money on the trade and we're going to make an underwriting profit and a reasonable return, and where we can't, they will walk away and we will shrink this business as long as we have to in order to make that underwriting profit.

I think going to zero is a theoretical number. I don't believe it will go to zero. But it could go down significantly from where it is and I am very comfortable with that. There is no such thing as you have to stay in and the price of staying in is you have to suffer a loss. We'll not do that. And people will always want to buy reinsurance from ACE given the choice, because of our balance sheet and our expertise in the business.

Okay. Great. Thanks for the answers.

And our next question today from Ian Gutterman with Adage Capital.

Good morning, Ian.

Hi, Evan. I hate to do this, but I need to ask about the capital.

I thought I just answered this.

I want to go through some math. I'm at the same perspective as Josh, I don't want you to do a repurchase just to do one, that's not what I'm trying to understand. What I struggle with is, just mathematically, if you do a 17 ROE minus 2% for dividends, you're growing book value 15%. To maintain the ROE, basically, how do you maintain the ROE? The invested asset to surplus ratio is steady, it's not going up, and the premium and surplus shrinks -- mathematically the ROE has to go down.

I didn't say maintain the ROE and we are perfectly willing to weather some ROE dilution for a period of time. We don't just measure it in the short-term.

Okay. That's what I wanted to make sure I'm understanding. So then the bet is that you take the ROE down short-term so you can have a higher ROE over the cycle because you have the capacity to act when others don't down the road?

You got it.

Just want to make sure I'm on the same page.

And to take advantage of opportunity that will occur during the cycle.

Okay. Just want to make sure we're on the same page.

You got it. It's a big world out there, Ian.

Our next question from Bill Wilt with Morgan Stanley.

Evan, two questions for you. The first is professional liability. You probably addressed this on the second quarter call. Frankly, I've forgotten. Could you speak to professional liability exposure, D&O, E&O, to the various actors in the subprime space, the companies, the lenders, other financial institutions, mortgage brokers, a general sense for your positioning there?

Yes. First of all, we're not a major writer of FI business. We write some. We're a more modest player in that area. And in the business we do write, we deploy relatively modest limits. I could tell you they're in the single digit millions on a net basis per account. They're not, for the most part, double digit. I would start with that as an overall picture.

We've assessed our exposure and we continue to, and you know this is a continue,this is a story that is evolving. At this time, we have all of our insureds put into potential for a claim versus on a watch list versus those that have given us notices. We are comfortable with our exposures, they fit within our pegs, as we know it all to be today and I don't see this as a major event for ACE.

That's helpful, thanks.

And that can change and we could have to reassess, but we're constantly looking at it and that's how I see it now.

Okay. Fair enough. Thanks for that. Part two, the A&H line, 17%, 18% growth, I think that was for both the quarter and year-to-date. Main contributors to the growth, more producers, different countries? Both comments on the sources of growth and then expectations or reasonable expectations over the next year or two for that business?

Yes. The growth is driven -- the fastest growth is coming out of Latin America followed by Asia followed by the continent of Europe. They're all doing double digit growth. The business, as you know, is fundamentally driven by direct response marketing. We have call centers all over the world. We engage in direct mail activities as well, and we have built, we believe, a franchise in that.

We have a growing -- we constantly are adding new sponsors because we need somebody with a brand and a customer base and a billing vehicle and we're constantly working on that and expanding that. Always some countries up, some countries down a little bit. Television response rates in Korea get better or get worse while something happens on the credit portfolio that we're marketing to in Thailand, short-term, but overall it's pretty stable growth rates, which are in the, as you know, mid- to upper teens and I envision that to continue as it is, maybe accelerate slightly in terms of growth over the next year or two.

Thanks for that. And in terms of when you add new sponsors, new relationships, are there typically meaningful fixed or incremental costs to ACE, or is most of that borne by the sponsor or dependent on the strength of their brand or their normal marketing?

It varies by sponsor, are we taking the marketing risk or are they taking it? In most cases,in the vast majority of cases, we take the marketing risk. So therefore, we have to have the apparatus to execute against it, but most of that is an incremental build out for us now where we just continue to add on to our plant and then we put up more marketing dollars as you grow this business and want to keep growing this business, you've got to put up more marketing dollars every year and increase the amount of marketing dollar you're spending versus the year before. That becomes a GAAP asset that you're constantly testing. We're comfortable with that. So we continue to invest to grow that business.

Thanks very much.

You're welcome.

Our next question is from David Small with Bear Stearns.

Hey, good morning. Could you maybe help us understand how the changes in the proposed farm bill would impact your crop insurance,your crop book?

Yes. I'm going to actually ask my crop expert, Brian Dowd, to give you a few words on that.

Hi.

Can you hear him?

Yes.

You probably read, there are actually two versions of the bill out this. There's a House bill and a Senate bill and they haven't gone to compromise yet. Both bills as they come to compromise won't affect the '08 year. It really doesn't take affect until '09 or '10, depending on the version of the bill. Depending on what happens, the House bill more or less affects the subsidies back on expense reimbursement, the Senate bill affects more of the premium side of the equation. I expect a compromise, frankly, in the next quarter or so and that will probably have a little bit of an affect on both. So I think those carriers that have large portfolios, frankly, will probably weather it pretty well. Those companies with small portfolios may have a difficult time if there's actually a decrease in the farm bill.

I guess, just in terms of what that would do, though, if the subsidies go down, presumably that book becomes less profitable for you?

Marginally so, yes.

Okay. And then just in terms of a second question, as the cycle softens and the brokers try to get carriers to compete with each other more and more, obviously, how do you prevent the Westchester unit, the U.S. business and the London business from all competing with each other?

Well, because we do. That is just a rock bottom part of the rules of the road in ACE and our ethos, our culture and the way we operate. Each franchise is distinct and they're not in competition with each other. So for instance, the Westchester only deals through wholesale brokers, whereas USA is retail and deals through retail brokers. ACE Global Markets in London wouldn't be competing really with the Westchester. There are some classes where they and U.S.A. actually complement each other, because they play on different layers, they write lines that would be complementary, and they actually coordinate all accounts. And we even have accounts where ACE Bermuda, because they play in a different place, maybe on a given line on an account, they and Global Markets and the U.S. coordinate. It's rare and almost I can't remember the last time I have heard about competition between any ACE units. It's just not what we do.

Okay, great. Thanks.

You got it.

Our next question from Josh Shanker with Citi.

Good morning. Listening to your discussion about favorable development and releasing some long term reserves from 2003 prior, I'm trying to do some reconciliation of schedule P data with the global loss triangles that you provided for us and I would like to know, a) the perils and the shortcomings of using the U.S. business that's comprised on the schedule P to understand it, and two, to understand, looking at the other liability claims made line of business, there was according to schedule P substantial favorable development from '04, '05, and '06 in the OLCM line. Wondering how that jives with what you've seen over the course,over the entire business and why those two things are different.

If you don't mind, because you're asking some very granular and technical, which is fine and we're happy to get into that with you. I'm going to ask we take that offline and have Sean Ringstead, our Chief Actuary talk with you about that and help you guide through that.

Okay, that's fine. The other question, can anyone talk about capital management philosophy, what's ACE's thought on dividends in general, regular dividends, raising that, special, what not?

We like regular dividends and we like raising them. And we've had a very clear, steady, policy of increasing our dividend in a steady rate year by year and I anticipate continuing that policy.

Okay, thank you. I'll take it offline.

Thank you.

We'll go next to Tom Cholnoky with Goldman Sachs.

Good morning, Evan. I have two unrelated questions, if I can. As we think about your capital management in terms of potential acquisitions or potential investing for organic growth, should we think that in the next three to five years that ACE will just simply continue to grow out its current portfolio of products, or would there be potentially new areas of the market that might be of interest to you?

There are some areas of the market that are of interest. You could see if it -- we see it right, you'll see more expansion. It depends what you call new areas. We're already in personal lines, but in a modest way. So you will -- and we've talked about this before. You will see an expansion in that area in a targeted fashion, not just willy nilly around the world. We know what geographies and areas of personal lines we have our eye on. You'll see our A&H business continue to expand. You'll see our life business continue to expand and that could be with acquisition. You'll see the small commercial business expand, particularly in Asia and potentially in Latin America. So there'll be a geographic bent to this as well.

Okay.

You will not see us go beyond core insurance business and you won't see us get into areas that we don't understand as management.

Okay. That's fair enough. Just if you can make a comment on these California fires or how we ought to think about them with respect to ACE?

Yes. It's just a tragedy, obviously, to all of us that's just unfolding before our eyes. I expect very little in the way of activity for ACE on the insurance side and I expect very little in the way of activity on the reinsurance side.

Okay. Terrific. Thank you.

You're welcome.

Our next question is from Thomas Miller -- I'm sorry, Thomas Mitchell at Miller Tabak.

Hey. I probably should remember how this works, but I have forgotten.

I'm Evan.

If rates decline this year and lower rates are embedded in this year's premiums written, then next year or with some lag, the premiums earned will reflect the lower rates and presumably that would drive higher underwriting loss ratios and would also prompt some greater reserving relative to the amount of premiums that are written this year. If I haven't confused you at this point, then my question is...

Go ahead.

Is why shouldn't we be looking, not only for the industry, but even for ACE, to also reflect this,not this year, but with a lag of 6 to 12 months, the pricing would become embedded in your book of business and theoretically then both your reserving as a percentage of premiums would go up and your loss ratios would go up. Doesn't that make sense? And what do I have wrong?

Let me see if I say it simply to you, okay? Number one, when you want to get to the earned premium and figure that, which is separate from loss ratio, right? So one's the denominator, one's the numerator. Look at the written premiums, and they will become earned premiums and that will give you a sense for that pattern. On the loss ratio side, which is a function of,which increased loss ratio is a function of rates going down. It's true, if your exposure stays the same, and rates go down, then the business you're writing, as it earns its way in, will have a higher loss ratio. That was the conversation at the beginning of this call about what's happening to ACE's accident year loss ratio. And that's what you're referring to. So an increase, you would expect, all things being equal as exposures stay the same and rates decline, the accident year loss ratio will increase. So as the written premium earns its way in, there is loss ratio inflation.

Okay. And the alternative is that you might find ways to reduce your exposures relative to the amount of premiums you're writing?

Different class, different mix of businesses, different geographies, that's right.

Okay. Well, thank you very much.

You're welcome.

(OPERATOR INSTRUCTIONS) We'll go now to Jay Gelb with Lehman Brothers.

Thanks, good morning. First one just on the effective tax rate, given you explained why it was a little lower in the third quarter. Can you give us a sense of where that tax rate may be going forward?

As you know, it bounces around, right? In the past when we gave guidance on tax, we said we'd expect it to be in the 20 to 22% range, but that's moved around quite a bit over the years. We've had times where we've been able to repatriate funds, tax-free. We have periods now where we have losses in taxable jurisdictions or low losses in taxable jurisdictions, so it's really going to be in reaction to what happens in the period. But on balance, maybe it probably averages 20% over time.

Okay. Then separately, can you give us an update about where you stand on some of the legacy liability issues, like asbestos and lead paint and whether you have a reserve review coming up?

As we do every year, we do an internal review of our asbestos and legacy reserves on an annual basis. We're in the middle of doing that. We did that last year and all the years before and you know that every other year, so last year we concluded an external review as well, because that happens every other year and we concluded at the end of that study last year that our reserves were in good shape and there was less of a difference between us and the external actuaries who had their loss pick came down.

We are now in the middle of updating our study. It will be done at the end of the fourth quarter, but can I tell you that from the macro environment, the macro environment, particularly in asbestos has been stable, I would say. And as you can tell by the Manville reporteds and we can see it on our own book, the number of new claims arising is at a relatively modest level and the number of mesos relative to all of the injured, all of the impaired hasn't increased as a percentage and that's where the higher paids are. We do see tort reform at the state level continue to have an ameliorating affect and so when you do your study, your study is not based on the macro, it's based on your own individual cases within your book of business, and we know that on a very granular level. We're studying that. But at this moment I don't see anything on the horizon that is giving me any concern.

Great. Then separately on --

If we do, you guys will know.

Separately on lead paint, with the Rhode Island decision, does that change the calculus of how you think about that exposure, or is it just...

No. No, it does not.

All right. Separately, I don't know if you would like to comment on some of the movement that's been going on with the Bermuda tax issue?

Yes. I would like to comment on that. I might give you, actually once I start, I'm going to give you a rather lengthy comment, but I'm going to give you a comment. The effort in my view is a protectionist reaction rather than a competitive and free market proposal. And I'm afraid if it was enacted it will raise cost to consumers. In fact, the proposal to increase taxation on reinsurance to offshore affiliates strikes a chord with some in Congress because of its revenue-raising potential. Though I think it flies in the face of calls being made in Congress, the State of New York, and Treasury for greater competitiveness in financial services in the U.S.

In my judgment, this proposal, which is still taking shape and not yet in draft bill form could set a very dangerous precedent for taxing insurance companies, not where the ultimate risk is taken, and where the profit and loss is earned, but rather in the country where the risk resides. While this proposal might not affect those mostly U.S. insurers who are its primary backers, it could impact those insurance companies that do business globally if other countries adopted a similar tax policy. My company and I are opposed to this misguided proposal and fundamentally it's on the basis of principle. Given that frankly, it will have little financial impact on ACE. We reinsure less than 15% of our gross insurance business to offshore affiliates.

Thanks very much for the answer.

You're welcome.

We'll go next to Charles Gates with Credit Suisse.

Hi good morning. I just have one industry question. Seemingly, if you went back to the mid-80s, the property casualty industry, if you marked bonds to market didn't have any capital. Today, seemingly, it's awash in capital. How do you see that getting resolved?

Charles, you're exactly right. It's everything in all industries is about supply/demand and the supply is very high and that's what drives the cycle. And until you remove that supply, you're going to have a continued softening or soft market conditions. So it will resolve itself by removal of capital.

And that's going to happen in one of two or three ways. Many who can't do anything with the capital return it to shareholders. That has been modest. People -- some others deploy the capital wisely, or you waste the capital, and you return it to policy holders through lousy underwriting, which has been the history of this industry. I don't know any other way. I think that is the bitter truth of it.

Thank you.

We'll go next to Ken Zuckerberg with Fontana Capital.

Good morning, Evan and Phil. Just wanted to ask you about progress being made with the rating agencies on your current financial strength ratings? And I guess my premise here is, for a few years we've seen the agencies reiterate AA ratings on a certain few companies that have seemingly gone in the wrong direction, and one of which is actually stepping up to the plate now to address a legacy liability. Tangible book value has grown tremendously; we talked about capital in response to Evan with Ian and Josh's questions. Your record is stellar. Just wondered where we are?

We're going to give you their phone number.

Our relationships with the rating agencies are very strong. We meet with them throughout the year, keep them up to speed with our progress and they understand where we are. As you say, I think we're stronger today than we've ever been. It's not part of our strategy to approach for an upgrade, certainly. We're comfortable with the rating that we have and from a business standpoint we're satisfied with that. So I guess if we were elected, we would, if we were asked, we would run, but it's not really that important to us.

So when it comes to the reinsurance business, fair to say there'd be no change in strategy with a higher rating? I.e., would you get paid anymore incrementally in that business by being rated higher?

No. We don't think that's true in any of our businesses.

Great. Thanks very much.

And our final question today will come from Todd Bault with Bernstein.

Hi, guys. Evan, in light of some of the topics you've had about capital and discipline, I've got a hypothetical for you that I think is potentially relevant in the coming years. You've said that you're being disciplined with your capital and disciplined with your writings and you're still generating good returns. Let's layer on top of that the assumption that you and most of your peers right now have good levels of loss reserve adequacy. And my claim that the chief analytical problem in the last few years has been loss trends. Loss trends have been very favorable and people don't quite know what the cause of that is and in general they've been distrusting of them, so right now discipline's been okay and there's been signs that pricing's been weakening now in line with the lower loss trends.

Here's the question. If someone like you stays discipline with your pricing and your writings and you don't return as much capital as peers and some peers become more aggressive and start to grow, that may put pressure on your stock relative to their stocks and leaves you vulnerable to being acquired. There could be other stocks that that could apply to too, but in your context, the strategy you've laid out, it's a potential risk. How do you regard that?

Todd, have you ever noticed, you may not know this, but where ACE is a Cayman company, have you ever seen maybe our articles of incorporation, but anybody who buys -- you can buy more than 10% of our stock, but you can't vote more than 10% of it.

Okay.

Thanks for the question.

Okay.

You know what, we live in a world of risk. That's all there is to it. Choose your poison. We're not insecure. If someone wants to come and buy ACE, bring a big bankbook. Thanks a lot.

Thank you, everyone, for your time and attention.

Where'd she go? Ladies and gentlemen, thank you for your participation. This does conclude the conference and you may now disconnect your line.