丘博保險集團 (CB) 2008 Q4 法說會逐字稿

Please stand by. Good day, and welcome to ACE Limited fourth quarter year-end 2008 earnings conference call. Today's call is being recorded. During today's conference, there will be a question-and-answer session. (Operator Instructions).

For opening remarks and introductions I would like to turn the call over to Ms. Helen Wilson, Director of Investor Relations. Please go ahead ma'am.

Thank you, and welcome to the ACE December 31, 2008 fourth quarter earnings conference call.

Our report today will contain forward-looking statements. These include statements relating to general economic and insurance industry conditions, our financial outlook and guidance, our investments in our variable annuity reinsurance business, business strategies and practices as market conditions evolve, competition, our stock price in the capital markets, pricing, and exposures to losses and reserves, all of which are subject to risks and uncertainties.

Actual results may differ materially. Please refer to our most recent SEC filings, as well as our earnings press release and Financial Supplement, which are available on our website, for more information on factors that could affect these matters. 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 would 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 will take your questions. Also with us to assist with your questions are several members of our management team.

Now it is my pleasure turn the call over to Evan.

Good morning. The fourth quarter was a difficult finish to a difficult year for all financial services companies, ACE included. As economic conditions worsened and financial markets suffered the worst period we have experienced in many decades. Given this environment, on an operating basis, ACE had a good quarter. Our property casualty and accident and health operations performed well. Our life reinsurance business did not.

After tax operating income in the quarter was $624 million, or $1.87 a share. For the year operating income was $2.6 billion, down about 4% from prior year. Our combined ratio for the quarter was just below 87%, and in our judgment simply an excellent result. We had good contributions from both underwriting and investment income.

Net income in the period was $20 million, impacted by other than temporary impairment losses of about $440 million. Our portfolio is of high quality, and over 94% fixed income related. About two-thirds of the OTTI is related to interest rate spreads, not true credit impairments, and in our judgment, the vast majority will recover in time.

Our investment portfolio is conservatively constructed, and appropriate for a global company like ACE, that invests its US dollar holdings from a number of jurisdictions, both US and non. We have provided you with more disclosure around our portfolio composition in our supplement, and Phil will provide more detail.

You know ACE is unique in that we are one of the few truly global P&C companies and this has been, and is a tremendous source of strength and opportunity. As I have said many times, we are also an underwriting company, we take risks and accept its attendant volatility, as long as we understand the risk, and are paid an adequate price to take it. And this quarter we experienced the volatility that can accompany the business activity of a global risk-taking organization.

Our book value declined in the quarter by 6%, and 10% for the year. The decline in the quarter is attributed to investment portfolio-related losses, which again we believe are largely transient. Foreign exchange losses and a realized fair value related loss associated with the GMIBs and our life RE business.

To put this in perspective, even with this year's market and economic conditions, our book value has grown at a compounded annual growth rate of 12% the last five years. Our long-term shareholders benefit from the fact we are a global disciplined risk-taking organization.

Our variable annuity reinsurance business had a difficult second half of the year, the fourth quarter in particular.

As you know, this is a CAT-like portfolio, but with a different kind of CAT. There are two unique characteristics, duration and potential for reversal of loss. In our original models, when we priced the business, this kind of event is a 1 in 100 years. Even with this kind of second half, we earned $107 million of operating income in '08 on this portfolio, though we produced about $400 million of net loss, which is within our range of tolerance for an infrequent and large CAT.

Our current projected future annual operating income run rate is between about $120 million and $140 million, so the payback period can be reasonably quick. During '09 we can experience more volatility, given equity and interest rate markets. Again, Phil will provide some more detail around this point.

Operating income in the quarter benefited from positive prior period development of about $250 million pretax, which included a $70 million takedown of a reserve on a single large structured transaction that expired during the quarter. $160 million of the prior period was short tail related, and about $45 million of this is from '04 and '05 CATs, and other prior CATs. Our prior period number also includes the results of our annual, and the state of Pennsylvania's bi-annual reviews of our A&E reserves, and other runoff liabilities. As a result, we incurred a charge before $50 million pretax.

Our expense ratio in the quarter was up about 1.4% over the prior year. The ratio was flat in North America, down in global RE, but up in International, which was driven by our A&H business, including the consolidation of Combined. Excluding the impact of A&H, our expense ratio was up less than a point in International, and flat in total.

We are well capitalized. Our balance sheet is in good shape, and our operating cash flow was strong, almost a billion for the quarter, and over $4 billion for the year. During the quarter, as you know, a number of the rating agencies expressed a favorable view of ACE's capital position.

Turning to growth and underwriting during the quarter, I want to make a few comments. Total company net written premiums were up about 8%. Adjusting for foreign exchange, net written premiums were up about 13%. Our P&C net written premiums shrank 1%, but on a constant dollar basis, adjusting for foreign exchange, they grew about 3%. Our insurance business grew, while our reinsurance business shrank.

The underwriting environment is improving. Rates firmed through the quarter, and continued to do so into January. Globally for the business we renewed in the quarter, rates went from minus 6% in the third quarter, to flat in the fourth. The rate of change varies by territory. Greatest in North America, followed by the London company market, Australia, and Latin America.

Our rate to exposure improved, and so did the quality of our portfolio, particularly in North America and UK retail. We are beginning to benefit from a flight to quality, and where rate is adequate, we are writing more business, beginning to improve our position on accounts, and gaining share. While still choppy, the overall market is moving, and reacting to a need to raise rates, but not as fast as we are. Where rate is not adequate, we are walking away, and in some classes we are continuing to shed business. I might add while rate to exposure is improving, exposure is declining due to recession. This means better margins, but not necessarily more premium.

Let me add some more color around this. In the fourth quarter on a constant dollar basis, our global retail P&C business, that is ACE USA and ACE International grew 10%, while our London and US wholesale business shrank 15%. In North America we have substantially more opportunity to quote business, as a result of market turmoil. Submissions are up significantly, though our quote to close ratios have dropped modestly. In those lines were rate is adequate, we are benefiting from the weakness of others by improving our position on accounts, moving into primary lead or first excess position. For example, in excess casualty, D&O, environmental, and medical liability. We are also gaining new business in certain lines we already enjoy a strong lead position, such as our E&O business and Risk Management division, which was down in the fourth quarter, due to a single large transaction last year, but had its best fourth quarter and January 1 for new business in a number of years. On the other hand, there are classes where our retention rates and new business writings were impacted by continued inadequate pricing, such as both large account and CAT-exposed property, E&S casualty, and due to recession, construction-related business.

Overall, US retail rates went from minus 3.5 in October, to plus 2 in December, and in January plus 5%. Retention rates dropped a bit, impacted by our pricing actions and recession, but were reasonable at about 86.5% on a premium basis. Our US wholesale business shrank in the quarter, again primarily due to inadequate pricing in the E&S casualty and CAT-related property. For our wholesale book, rates went from minus 5 in October, to plus 8 in December, and about plus 5 in January. Our Bermuda-based insurance business had a very good quarter, with net premiums up 6%, driven by D&O in particular, and this is a clear example of flight to quality.

Turning to International, in the fourth quarter our P&C business in original currency experienced it's best quarter of the year, up 6%, while A&H was up 15%. Asia and Latin America both grew double-digit in P&C and A&H. In International, P&C rates went from minus 3 in the third quarter, to plus 1 in the fourth. Our reinsurance business shrank during the fourth quarter; however for January 1, Global RE had reasonable growth on a treaty year basis, not to be confused with book basis. That was because of improved pricing.

This is the first time this business has seen growth in a few years. Rates that were declining all year, moved to flat or modestly up in many classes at January 1. Though most US casualty pricing remained competitive. We gained revenue from improved signings, due to competitor weakness, and more clients looking for a reinsurance solution to solve a capital need. In reinsurance we are noticing more clients willing to pay more, though in most cases not dramatically more to have ACE on their program.

Overall, the bottom line, rate-to-exposure is improving. Rates are firming. And in my judgment will continue to firm as the year goes along. How fast, what lines, and where I cannot predict with certainty. But as they do, we will gain share and that equals growth. On the other side of the coin, recession is impacting exposures and clients' insurance budgets, and this along with foreign exchange, will negatively affect premium growth rates.

With that said, while the environment is complex and clear visibility is difficult, both the rate environment and our growth rates in January are in-line with what we contemplated, when we provided '09 guidance in December. We remain optimistic about the year. Again, our balance sheet is in very good shape. And we believe opportunity is growing, as a result of the flight to quality to a company like ACE, that has the balance sheet, the geographic presence, and the product breadth.

We are continuing to invest in and enhance our capabilities to take advantage of market opportunities. We are continuing to invest in people and infrastructure, to grow our presence in lines of business globally, where we see an opportunity for ACE to grow share at reasonable terms. We are also continuing to invest in our enterprise Risk Management capability, our systems and data environment, and our research and development capabilities. Finally, we are prepared that this difficult economic and financial environment will be with us for some time. This is a nimble organization, and we can adjust rapidly to both threats and opportunities.

With that, I will turn the call over to Phil, and then we will come back and take what I know will be your many questions.

Good morning. Let me pick up where Evan left off, and provide some more details on some of the items. Book value was reduced by realized and unrealized losses in our investment portfolio, foreign exchange, and a loss related to our GMIBs.

On an aftertax basis, realized and unrealized losses from our investment portfolio were about $1 billion, resulting from the mark-to-market impact of credit spreads and global equity markets during the quarter. Investment-grade spreads widened by 150 basis points in the quarter, and high-yield spreads widened by 500 basis points. Global equities declined over 20%.

Aftertax realized losses from our investment portfolio were about $400 million. We provided detailed information on the realized investment losses on page 24 of the supplement. We estimate that approximately $30 million of these realized losses relate to actual credit impairments. The remainder of the loss is price related. Realized and unrealized losses were determined as of 12/31/08.

We have no significant asset classes that were reported based on values at an earlier date. For example, we have no lags in our reporting, and everything was up right up to year end. For the unrealized losses in the portfolio, we believe our strong liquidity and continuing positive cash flow, support our view that will hold our highly-rated fixed income investments until they recover their value, as they approach maturity.

Our global equity holdings represent about 2% of the portfolio, are actively managed and they are highly diversified. Our global asset allocation is consistent with our liabilities, and our tax, capital management and regulatory considerations. US dollar investments represent about [80%] of the global portfolio, with about a third in our US-based entities, and two-thirds in our overseas operations, including Bermuda. Investments in our nonUS operations are currency matched with insurance liabilities, and are invested in taxable securities.

Our investment portfolio continues to be predominantly invested in publicly traded investment grade fixed income securities, and is well diversified across geographies, sectors, and issuers. The average credit rating is AA, with nearly two-thirds invested in AAA securities, the duration of the portfolio is 3.6 years. As we have said, we don't invest in CDOs or CLOs, or complex credit structures, and we don't use leverage in the portfolio. We also do not provide credit default protection.

Our exposure to hybrid fixed income securities of UK and European banks and financial institutions is about $350 million, and these are not preferred securities. Our global exposures to bank preferred securities is $45 million, as you know, we have experienced significant movement in foreign exchange rates. Major currencies in the quarter declined between 15 and 20% against the US dollar. These declines reduced our book value by about $300 million.

Our realized losses also include about $200 million relating to the increase in the net fair values of the GMIBs. The loss was primarily due to year-end long-term Treasury rates, which we believe are at historic lows, and not in our judgment representative of realistic long-term rates. In fact these rates have already risen 70 basis points since year end. It is important to say that while this business is considered a derivative for technical accounting purposes, we feel that our operating income, which includes the results of insurance accounting, is a more meaningful way to look at the business. Operating income for VA was also negatively affected by the drop in the S&P 500.

We completed our quarterly actuarial review, which resulted in several changes to our VA reserving model. The most significant changes were made to our mortality and annuitization rate assumptions. I mentioned that, as you know, we have substantially all of our actuarial reviews, reviewed by third party actuaries during the course of the year.

Financial flexibility at the holding company level remains strong, given our operating company's dividend capacity, and low levels of debt refinancing risk over the next five years. Our debt-to-total capital leverage ratio of about 18% at year end, continues to be conservative relative to our current rating levels.

We have a 21% investment in Assured Guaranty or AGO at year end, which we carry at a book value of $397 million. As you know, AGO is planning to close on the acquisition of FSA from Dexia in 2009. When the acquisition closes, our investment will be reduced between 9 and 11%, and that will require us to change our accounting from the equity method to mark-to-market. I also mentioned our tax rate of 22% is somewhat higher than it has been running, and it just a function of the tax jurisdiction where we earn our underwriting income. Net loss reserves declined in the quarter by about $890 million, due primarily to foreign exchange of about $700 million. Year-to-date net loss reserves increased about $500 million.

With that, I will turn the call back to Helen.

Thank you. At this point, we will be happy to take your questions.

Thank you. (Operator Instructions ). We will take our first question from Jay Gelb with Barclays Capital.

Thanks and good morning. I want to touch base on the 2009 earnings guidance, in terms of some of the components of how you get to your range. Can you give us a sense on expectations for premium volume, investment income, and could you maybe, Phil, go through that life business annual run rate on earnings? I didn't know if that was for the whole segment, or just some portion of it?

This is Evan, Jay. Good morning. We have given the extent we are going to provide of guidance. It is on an EPS basis, and we did put CATs with it. The rest of that we leave to you guys to put what you think, but we gave you the bottom line, and the run rate on, and Phil can speak more about it, but the run rate was on the VA only.

So not including the acquired Combined business, right?

Definitely not.

Okay. And then can you update us on your view on the Directors and Officers in the errors and omissions market, in terms of ACE's current penetration there, and whether you feel your reserves are adequate going forward?

Yes. We feel our reserves are adequate going forward, of course. And we think we are, I assume you are referring to the financial crisis and all of that, and our reserves do contemplate our exposures as we know them to be. We did strengthen our reserves through the year. And so all of our exposure as we know it, is reflected in our current accident year, and even the prior year, because we took reserves in '07 loss ratios.

Okay. And then separately, I don't know if you have an estimate for Klaus losses, the European storm?

Right now on the insurance side, it just doesn't appear consequential to us. On the reinsurance side, reports are coming in. We don't have a major share of, we don't write a major portfolio in Europe. We are not one of the major writers of CAT there. We do write CAT. We will have some losses, but I don't expect it to be anything huge.

Thanks for the answers.

You are welcome.

We will take our next question from Brian Meredith with UBS.

Yes, good morning. A couple of things here. First, Evan, looking at the Overseas General accounts and your combined ratio ex-CAT, it looks like it was running right around 98% in the quarter, and it has been trending up pretty nicely. I was wondering if there was anything unusual in the quarter, or is that a combined ratio to expect in the business now that the combined NH business is in there?

Will you repeat that about what your numbers calculate to?

I get an accident loss ratio ex-cat of 58.5, and then you add the expense ratio, and I get to 97.9 in your Overseas ex-cat.

I think what you are doing, I think you didn't do the expense ratio right, just for your information. But I am going to respond on the loss ratios. Because you used the average expense ratio for Overseas Gen, and tagged it to a loss ratio. Remember the A&H runs a lower loss ratio, higher expense ratio, P&C is the opposite, okay?

Okay.

It is not running a combined that high in the P&C internationally. The P&C loss ratio has ticked up a bit. It continues to because of what is the rate environment, and trending of losses at the same time. It is natural the business would. Other than that, not really. Just there has been some noise in short tail, but nothing of concern. The combined in the P&C is running quite well.

Okay. Great. And then next one, Evan, can you talk about your trade credit exposure internationally? I think you guys write that business. What do you think about that business, and kind of what loss experience could look like?

Yes. And I assume you want me to talk about political risk as well?

Yes. (laughter)

I thought so. Seems to be the flavor of the month. The trade credit book we write is a structured trade credit book. And it is, as you say, it is trade credit, it is not domestic credit. It is not a huge book of business. We write it on an excess of loss basis, and that is we write it for companies where they have very good credit analysis capabilities themselves, the insureds do, and we take excess of their own retentions. We are very selective on how we do it.

Our limits are fairly modest. It runs a certain frequency of loss. And right now it is exactly as we expected. The claims in this period would be a bit higher than they would traditionally, because of the economic conditions. The business is short term. We can get on and off of this business very, very quickly, and change and adjust, and we do.

Our loss ratios pegs, they contemplate losses and development in an environment like this, and there is nothing that we have seen to date, that is outside of our expectations of loss for the business, and it is not running any temperature, or anything like that. The political risk business, the character, the nature of it is different than the trade credit, and I will talk about that for a little bit.

We have modest exposure in many of the countries that are in the news, and that you might be concerned about. And we are not in a lot of the sectors in those countries that are receiving attention, that might be more sensitive. We have no claims of any size reported or pending at this moment. We always have a watch list. We are always reviewing our portfolio, and in fact what I am telling you is based on the most recent review we have just done in the last couple of weeks of this business.

We have been getting off risk in a number of countries of concern. Our exposures have been rapidly running off. We have IBNR for this business. We have reinsurance for the portfolio. We insure mostly CEN, that is the kinds of risks we take.

We also do contract frustration. We insure both debt and equity. It is all against sovereign action, not commercial disputes. We insure risks, typically that generate hard currency, and for any country, those are the last to have a problem.

The business has conditionality within it. Waiting periods, deductibles, we have a very good track record in recovery, and again we are just not seeing, our book is very clean, and we are not seeing claims at this point, or notices of loss. And I am confident about it. We do have IBNR for the business, and I just at this point from everything I can see, I don't see a problem on the horizon in political risk.

Thanks for that thorough answer. One point of clarification on guidance. I just want to make sure it does not include any anticipated reserve releases?

No, it does not.

Excellent. Thank you.

Next we will hear from Thomas Mitchell with Miller Tabak.

If we take the $250 million improvement in prior period reserves out of the picture, your operating EPS for the quarter looks like it would have been closer to let's say $1.30 or so. And I am assuming, but I didn't see anything in your report, so I think I should ask. Is there some factor related to the catastrophes that took place in the third quarter, that carried over into the paid claims of the fourth quarter, that would have without the reserve release would have made that a tougher quarter, and that you don't expect that in 2009?

Well, I would say two things. First of all, I don't think you mean paid claims. I think you mean incurred claims. And we had $66 million of CAT from the third quarter storms as a development in the fourth quarter. And if you took out CATs in prior period, we ran around a 93 combined ratio, and I don't find that, I think that is a pretty good result. Did you have anything further?

Well, no, I just wanted to make sure that, so you would say that the 725 to 825 would be consistent, with a continuing underwriting ratio similar to the fourth quarter?

No, I didn't say that, but the 725 to 825 is our guidance. And we are comfortable with our guidance.

Okay. Thank you.

You are welcome.

Next we will take a question from Matthew Heimermann with JPMorgan.

Hi, good morning, everybody. Good morning, Evan. A couple of questions. The first question I had was just to understand what is happening in the investment portfolio. Were you a net seller of any of the nonUS holdings, mortgage backs, or other investments? Or were those declines all mark-to-market?

They were both mark-to-market and FX. There was a big FX component especially in the nondollar US, that is primarily what caused the change. Actually free cash flow went into that category, but it was more offset by the FX.

With respect to the MBS, when the government made their announcement they were going to purchase agency MBS, the yields in the sector declined, and so we took advantage of that to move into Corporates and MUNIs. There were just tactical moves.

That is helpful. That answers the next question on that. The other thing, Evan, just with respect to kind of the underwriting behavior this quarter. You seem to be seeing much better pricing in your book than others. And you talked about having to walk away from some business. Did you have to walk away from more business than you did in the third quarter, to kind of ensure you got the pricing you wanted?

Yes. Yes. And maybe it would help if I give a little color around that. You want some data points on it?

That would be great.

In the USA, I am going to distinguish a little bit, because I think others have this same question. Between what business grew, the businesses where we grew, were the business versus some of the business that we shrank. And give you some in those categories, some examples on lines of business what happened.

Overall, first of all, we will take ACE USA, as the example for our retail business. ACE USA had a retention rate, and it is on premium basis, and I realize there is a bunch of discourse going on, about how do you account retention. This is on a premium basis. In the fourth quarter, we ran about an 86.5% retention, and in January about an 87.2. And that is a couple of points impacted, we would say by our action on pricing.

On the other side of the coin, for ACE USA in total, in October, our prices were down about 3.5%. In December they were up 2. In January they were up 2. Now I am going to give you some examples on lines that were up, and some lines that were down.

Umbrella aexcess. Our retention rate was 88% in fourth quarter and 92% in January, and rates there moved from a minus 2.3 in October, to about a 5.7 positive in January. And if you look at the trend month by month, it kind of went along with that.

Our Risk Management business had a retention rate of about 87% in the quarter, and about 86.5 in January, and their rates went from a minus 7.5 in October, to a plus 3 in December, and about a 1.5% in January.

Our professional liability business. It ran retention rates in the 90s in the quarter, and that is both E&O, D&O and FI, and rates went from a minus 2 in October, to a plus 13.5 in December, and in January about a plus 6. And our medical business ran retention rates in the 90s, and there we went from sort of a negative in October in terms of rate, to flat to up in December and January.

Now on the other side the coin, the business that shrank was really lines like Marine Cargo, large account property, small comp, and in those lines, if I took Marine Cargo, we did get even though the business shrank on what we retain, because we are driving rate, we got a 7% increase. And on large account property that shrank overall, our rates changed, from a minus 2 to a plus 5 between October and January. And the small comp business, which is a competitive business, was minus 5 in October, and the rates went to flat in January. So maybe that gives you a little color around that.

That is really helpful. Thank you. It is fair to say too that whatever you are losing in premium from walking away, is being made up on the margin side it seems.

I think so. And our new business in January, our Risk Management business, our environmental, our professional liability, our medical, those all had really record new business months in January.

Okay. The last question if I can sneak it in, Phil on the GMIB side, can you just give us some color into whether or not consumer behavior is tracking along with expectations, and I guess specifically with respect to either annuitization rates and surrenders?

As we did our study one of the things that we saw, is that the annuitization rates that we are seeing as experience is emerging, was better than we originally expected, and that was one of the adjustments that we made in our model.

But I am going to add there, that was on our business when we priced it. We were very conservative in the rates. We don't really see yet the industry's annuitization rates, whether they are better than they expected them to be. We can't tell you that. Remember, we don't start paying out until '13 on the business.

That is fair. Thank you very much.

You are welcome.

Next we will hear from Jay Cohen with Banc of America.

Yes, good morning. It is Banc of America-Merrill Lynch still. I was going to ask about the claims side. Relative to the economy, I have heard different dialogue about what that might mean from a claims standpoint. Have you noticed anything in the fourth quarter, whether the US or outside the US from a claims standpoint, that you can sort of suggest is due to the economy? And secondly, what would you expect to see going forward, given the global recession from a claims standpoint?

It is a little early. I am going to let Brian and John maybe give some comment on it. It is a little early. We don't see, obviously everybody does in the professional liability area. We have been watching it develop all year, and before that, which is financial crisis related.

As far as recession goes, we are not seeing a big, we are seeing more exposure-related reduction impact. The claim trend comes later, and we will expect to see that. We are in deflationary times, and that will be a benefit on one hand.

On the other side of the coin, frequency and severity in certain lines can pick up. And we anticipate that, but I don't believe we are seeing much of that yet. John or Brian, do you want to add to that?

I guess I would add in the US, there are often conversations about workers comp, and what the effects of the recession would be. We monitor both our internal data as well as industry data, and to date we haven't observed any increase in either claims frequency or claims severity.

NACI studies shows that at the beginning of recessions, you actually see a reduction in frequency, and the theory there is the newer, less-trained workers are the first laid off, and you are left with more experienced reliable workers. Towards the end of a recession as the expansion begins, you will see some severity go up, more of the workers who have higher wages and have longer durations of outages. So you start to see maybe some uptick in severity at the end of a recession. But to date, we actually haven't seen any meaningful changes from our expected ranges on worker's comps.

And I would just add on the International side, maybe to pick up on Evan's point about exposure, is really what we are seeing first. We haven't seen anything on the claims side, but we are watching it carefully.

Having been in Germany and France just last week talking to our client base over there, I mean, pretty consistent with the US economy as you talk to the clients, the fourth quarter, the manufacturers in Europe saw their orders drop off the cliff, and are now anticipating major cutbacks in terms of their production, major cutbacks in people, perhaps closing facilities in 2009 in response to what they saw at year end, and that we are seeing already come through, in terms of the impact on exposure. While we are getting rate improvement on our business it is not necessarily in all cases translating into premium increases.

Got it. If I can sneak in one more question just on the political risk. Evan, can you talk about the reinsurance program you have in place protecting that business?

Yes, it is done on a proportional basis. We have two books. We have a London book, we write it out of London and write it out of Bermuda. On the Bermuda book, it is a quota share ground up with a major reinsurer, unnamed. And in the UK, it is a combination of quota share, and a risk excess of loss program. But in both cases, and between the two units, there is close coordination.

So we never overalign ourselves. We have clear guidelines about ACE retentions. And on average, which I think is what you really want to know, our net retention is in the modest double-digit millions. It is in the teens on average. And in London it is lower, and in Bermuda a little higher.

That is really helpful. Thanks, Evan.

You are welcome.

(Operator Instructions). We will take our next question from Josh Shanker with Citi.

Good morning, Josh.

Good morning to you. I was curious about the OTTI charges on a spread widening. I assume that you think they are going to recover. Why did you choose to account for it with an OTTI mark?

(laughter). Boy --

You sound like --

It is binary.

You sound like my boss. (laughter). What we have done in the portfolio is looked at the duration, how long the account has been under water. The severity of the decline in price. And we view a dramatic and significant decline in price to be at least indicative of an issue. So we go further than that, we look at ratings and credit issues on the mortgage-backed securities, we are looking at underlying cash flow. And it is a judgment to make, but the more severe the decline of the value, the more likely we were to impair it.

Okay. Second question. I noticed some changes in the investment portfolio. I was wondering if you could give me some philosophies behind that? I assume you were selling , or you were selling Treasuries and buying single A bank debt. Wondering if could you talk about what you are doing and what you are

Tim, do you want to cover that?

Sure, this is Tim Boroughs. As Phil mentioned, the Fed announced in November a plan to buy mortgage-backed securities. Those yields fell dramatically, and when they did we took advantage of that, and did a tactical shift into Corporates and into Munis. I think generally speaking, I would make just a couple of points on strategy, and that I don't think we consider, we are not considering or contemplating any major change in strategy from our conservative approach, where we are really focused on a high value for liquidity.

Given the weakness in the economy, the severity of that weakness, we expect short-term rates to be low for an extended period, and this will certainly affect the way we think about our duration management of the fixed income portfolio. Also we believe that the government efforts to provide liquidity, and stabilize the banking system, will help to bring down private borrowing costs. And I think it is from this perspective we feel credit spreads, which have now begun to narrow, will continue that trend in the weeks and months ahead.

Okay. Thank you. And one other item, and feel free to extrapolate slightly more controversial, and I am happy for you to take it where you want. I am curious where the derivative liability mark is for the GMDB and GMIB books at this point right now? Cumulative.

Cumulative. Let's see. What the --

The cumulative fair value liability is about $820 million.

For both together?

Yes. I thought you were going to-- Any other question?

No, that was great. Thank you very much.

We will take our next question from Steven Labbe with Langen McAlenney.

Good morning. Can you give us the latest NARs for the annuity reinsurance business?

We have been going around about this, and one of the things that we have talked about is, it is not a real meaningful number. We are working on disclosure for the 10-K, that we think will help better dimension the risks that we have, and how we think about it. So I would prefer to have you look at that, and then we will address any questions when you are through it.

Okay. Within that same business, I was curious as to whether or not you were growing the traditional mortality-based life reinsurance business?

We are trying to. And I think probably like yourselves, we expect that there is an opportunity there. So far to me, it is growing a little more slowly than we expect or would anticipate. And so we will see how the year unfolds with that. But I do think there is an opportunity in the future, because life companies have a capital need.

They have all their XXX problems, and life mortality pricing ought to be better, and you ought to earn a reasonable ROE, but if we can't see a decent double-digit ROE, we are not going to write the business. And I think that says it all.

Okay. And one last one please. Just as it regards the professional liability business, it seems like you have a lot of opportunities there. I was just wondering if accident year loss picks in the fourth quarter, changed at all relative to the full year?

We increased in the US. We didn't increase internationally. We increased internationally in the third quarter. I think that says it.

Okay.

We increased in the US. We increased in the International in third quarter, brought both up on an accident year basis, to what we think reflects our ultimate liability.

Where does that accident year loss ratio reside these days for that business?

(laughter) I know what you want to know, the number, but I will give you the literal answer, it resides in International and it resides in North America in the P&C business. I am not giving out the loss ratio.

Okay. No problem. Thanks a lot.

You are welcome.

And next we will hear from Mark Lane with William Blair & Company.

Good morning, Mark.

Good morning, Evan. I have three follow-up questions from earlier questions. The first on claims inflation, so what has happened with your claims inflation assumption for 2009 versus three months ago? You said you haven't seen anything, but what is contemplated in your expectations for this year?

We really didn't change our assumption rates for '09. As you can imagine, casualty business in particular, that is longer tail. And I don't think that is driven, I don't think that inflation rate is that impacted by obviously commodity prices, or any of that. We didn't adjust our property or short tail development our rates for trending. You might argue, well, you will see commodity price goes down. I will argue on the other side.

You will see frequency and potentially severity, because of housekeeping and other matters, those will tick up on the other side. No one knows with certainty. So we did not change them.

Okay. The second question, Phil, so this earnings impact on the GMIB and GMDB, so is the right way to think about this, is that the '08 earnings contribution was $107 million, and then some sort of base case scenario for '09, the earnings contribution would be the 120 to 140 range?

Yes, that is right, that is from an operating standpoint. Obviously to the extent that markets change that will be impacted.

Okay. Last question is regarding the guidance. Now I understand that there is no explicit expectation of reserve releases in your guidance, but when you look at the run rate for the fourth quarter, and have taken out the favorable development and adding something back for the higher-than-expected losses in the life reinsurance business, I find it very difficult to get into your range. So is your strong reserve position, or your view on claims inflation, give you the confidence to continue to expect strong margins if you are not anticipating some reasonable level of development, or if things continue to go the same way that you would expect to see some development? Or how do you think about it?

We do not project reserve, any reserve, favorable reserve development in our numbers. Obviously our reserves are adequate. Just that, they are adequate. And so when we put together guidance, they don't consider an explicit reserve release. We gave you an EPS range ,and it is based on the calendar year number we expect, which is made up of all parts and pieces. I know you want more explicitly, and I am not going there.

Okay. Thank you.

You are welcome.

We will take our next question from Ian Gutterman with Adage Capital.

Hi, Evan. How are you?

All right.

Good. I just wanted to follow up I guess for Phil, the earlier question on the impairment. Can you just maybe a little more detail talk about the impairment policy? I guess just when I look at your impairments for the year relative to your unrealized, to be honest, it is higher than even a lot of the life companies percentage-wise. Seems like you are more aggressively impairing things, which is obviously conservative, but I want to understand why that is the case?

I can't tell you why it is the case that you believe we are more conservative than others. We think we have been very thoughtful. We have looked in detail, security by security, and as I say, if the security is underwater by more than 40% for some length of time, we would tend to impair something like that. Now there are different judgments that can be made, and it is very judgmental. If equity is underwater for more than 12 months, we consider it impaired.

And as we look at it, right, one of the things we do for example, on our mortgage-backed securities, we say that, well, if they are trading at 70, and we do a cash flow test, and it shows that we are going to maybe get to 92, well, the rule is that you don't market to 92. It is impaired because of the fact that it goes to, because the recovery is expected to be 92, and then you mark it to 70. And there is a fair amount of that in our marks. So I can tell you, as I said, we are looking at the duration of how long things have been underwater, and how severe the decline is, our judgment on recovery. You would have to look at it security by security, and that is how we have made our judgments.

Okay. Is there any more details you can give us within, I guess you gave us for Q4 the breakout by investment grade versus high yield, MBS, and so forth. Do you have those numbers for the year? I am just curious how much of the fixed income?

I think it is actually on page 24 in the supplement, and it is on the right hand side.

Right. I guess I was looking on page 25 you give within fixed income for Q4, and it is mostly high yield in Q4. I was wondering for the year, was it also the case it was mostly high yield, or was it the other asset classes?

I would say it is similar, but what we will do is we will include the prior year in the 10-K.

Okay. That would be great. And then just quickly, I know there are a lot of questions that come up on the political risk. Evan, if you can just maybe further talk a little bit about sort of, I think people maybe, there is a lot of uncertainty about actually what causes losses, because we haven't really seen many events in a long time. Can you just talk a little bit about, sort of if we hear of an event, and whatever there is, a $50 million claim out there. What exactly does that mean for you given not just your reinsurance, but subrogation, and things like that. What kind bottom line impact is that at the end of the day? If you want to think of it differently, what kind of environment does it take for this to be equivalent to a CAT-type event, where you are talking at more than a couple hundred million dollars?

Okay. A CAT-like event in my mind would really be a contagion, number one, going across many countries, or a number of countries. It would be either currency markets lock up, governments nationalize or ex-appropriate. We are not big in the energy sector. One of the reasons we are not is when commodity prices, when they were really rising, we know that governments were tearing up contracts, and renegotiating them. And we certainly weren't going to get in the middle of that.

But you would see nationalization within an industry, or ex-appropriation within an industry. Where governments potentially, in certain areas, we don't do general bond issues, but where there is debt guaranteed by a government, where they might repudiate that, and say they are going to renegotiate all of that. Those would lead to claims.

Recovery rates are generally quite high in this business. We support banks as one of our classes of insureds, where they take on a certain amount of exposure, and on some of those loans that they might make, generally it is an investment-specific, it is related to a specific property or business, where there is government exposure. We will take part of that loan exposure.

The banks generally never want us involved, want to declare a default, and have us involved in the claim. They care about the ongoing relationships. They care about many other factors, that frankly we don't care about, except getting our money back.

Right.

And it is very hard ultimately to gain access to multilateral agencies in the future for loans. Or to others, if you have outstanding claims of recovery against members of the burned union, and ACE is a member of the burned union.

Got it.

Our recovery rate has been, we haven't had that many claims, but where we have, our recovery rate has been a very important factor in the ultimate net loss on the business.

Okay. And just to clarify again while we are talking about a contagion, is one country having a major nationalization meltdown scenario a CAT event, or does it really have to be multiple and major countries?

For the most part it has to be multiple major countries. We can paint a crazy scenario that Brazil, where we have quite a bit of exposure, nationalizes everything, and I think that is possible, but that is also while it is not the same frequency, it is also, that is sort of like talking about the meteor striking the planet, or our total net amount at risk invariable goes down, because everybody in the United States dies.

So I think you can go far enough out on that tail, but we could from one country, you could generate some substantial losses. It is very few countries. And they are much more highly rated countries. But even in that case, I have a very hard time, we have a hard time seeing that. And we manage the limits pretty carefully.

Okay. Sounds like frankly we still should be worrying more about the weather or the earth shaking, than about political risk?

I think so. I am not going to tell that you that, it is a risk business, and we are in a riskier environment. And I am not pollyannish about it, none of us are. We do ultimately expect claims in this business, but I think we manage with that in mind, and while of course it can present some volatility in your earnings and that, I don't see any of that at the moment. And I am not parsing words about it. That is with our up-to-date knowledge, a thorough knowledge of our portfolio.

Great. Very helpful Evan, thank you.

I do want to go back on one, I think it was asked by Mark on guidance. And I want to give a little better answer to that. There are many things impacting guidance this year, that made it more difficult to do guidance, and that is why we also gave a broader range. We are in a much more difficult external environment. And we are a global company. And we had to make our own judgments around what do we think will happen in terms of rate increases, and how will that benefit our portfolio, what kind of competitive environment are we going to have.

We had to make our judgments around foreign exchange, and where the foreign exchange rates as we currently see them, will be the foreign exchange rates as the year goes along. When you are looking at guidance in November or December, and you are looking at foreign exchange movements like we haven't seen before, we have expense management. We have CATs. We were outside the expected in '08 versus '09.

So there are a lot of ingredients that went into it, that were more volatile and more uncertain in this period, than have been in other periods. And all of that went into our guidance, into our own projections for our budgets for the year, which in turn produces the guidance to you. And that is also why we have a broader range around that guidance. And I wish I could be more explicit than that, but I hope that gives you a little more color, Mark. I don't think I gave you a great answer.

All right. We will go to our final question from Vinay Misquith with Credit Suisse.

Hi, good morning. Within the life insurance and reinsurance business, the life and annuity benefit expense picked up. Could you help us understand how much of that was because of the VA business, and how much of that was a one-time expense, because the equity markets fell, and how much is an ongoing expense?

Expense, be careful because of the Combined --

Yes. I would say that as, I think the better way to look at it would be that we did have a one-time event, or maybe not one-time but a market-driven event, and I think the best thing to do would be to go back to Evan's point about the run rate, the 120 to 130.

You are talking expenses though, right?

The life and annuity benefit expense of $154 million, that was up significantly this quarter, versus the last few quarters running which were about $84 million.

That is principally VA that is causing that increase.

Okay. Fair enough. And would that be more like a one-time item? Or would that also continue into next year?

You tell us what the equity markets are going to be in particular in the benefit ratio. Interest rates more impact the fair valuing in the net income line. You tell us what that volatility is going to be, and we will tell you the number.

(laughter) So If things stay the way they are, would that number will be flat next year versus this year? That was more my concern.

We anticipate it will be flatter. I gave you what the natural run rate of the business is. We tell you there can be some volatility around that, depending on market behavior.

Fair enough. The second question, Evan, it seems to be trying to be more disciplined on the pricing front, and you have seen maybe some business move away from you in the near term. How do you foresee things happening in the future? Are clients paying out for quality security, or are they more willing to save money by going to another carrier?

Both flavors. There are some lines of business that it is just pure commodity, where you put up capacity and a price, there are 20 guys who do it, and it just doesn't matter, and they will take, and the client isn't so security driven, and they will just take the price. There are many lines of businesses, however, where your balance sheet, where your presence, where your capabilities in terms of service really are a necessary part of the insurance buy.

And in those lines of business, and by the way, those are more sensitive lines in many cases, and there, ACE does have a distinguishing feature, and our disappointment in pricing impacts us far, far less. And then there are two kinds of clients, those who right now, and I understand it because of particularly recessionary pressures, and this and that, they want to find, they view insurance as another expense, and they are going to pay as little as possible for it.

And in those cases, we are also trying to offer those clients, while we are being disciplined in pricing, cheaper alternatives, with deductibles or co-insurance, or coverage changes, where they can afford it within their budget. You have got to recognize the times you are in. So that as well. Does that help you?

Yes. That is it. Thank you.

You are welcome.

That concludes our question-and-answer section. I would like to turn the conference back over to Ms. Helen Wilson.

Thank you for your time and attention this morning. We look forward to speaking with you again at the end of next quarter. Thank you and good day.