丘博保險集團 (CB) 2011 Q3 法說會逐字稿

Good day, everyone, and welcome to the ACE Limited third-quarter 2011 earnings conference call. Today's call is being recorded. At the end of today's presentation, you will have the opportunity to ask questions. (Operator Instructions)

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

Thank you. Welcome to the ACE Limited, September 30, 2011, third-quarter earnings conference call. Our report today will contain forward-looking statements. These include statements relating to Company performance and guidance, recent corporate developments and acquisitions, (inaudible), our variable annuity reinsurance business and mark-to-market securities, economic outlook, and insurance market conditions, all of which are subject to risks and uncertainty. 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 1 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 your 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. ACE produced outstanding operating results despite challenging financial market and economic conditions. We produced record after-tax operating income of $759 million or $2.22 per share. All divisions of the Company made a positive contribution to the quarter's operating results. The quality of our earnings was excellent, with strong balanced contributions from both underwriting and investments. Net operating income was up 10% over prior year, with underwriting and investment income growing in the quarter by 11% and 9%, respectively. Underwriting income of $391 million benefited from both favorable current accident year results, and positive prior-period development, which was flat with last year. Our operating ROE was over 13.5%, bringing the year-to-date to over 10%.

Net income and book value in the quarter were impacted by realized and unrealized losses of $838 million, resulting from extreme financial market volatility, and interest rates which fell to their lowest level in a century, as well as equity and in foreign exchange markets. Approximately $706 million was attributed to a realized fair value related mark associated with our variable annuity reinsurance business. We also had pricing-related realized and unrealized losses of $87 million in our investment portfolio. Both of these marks, we believe, will be largely if not wholly transient, and will be recovered over time.

Concerning the VA mark, we are required to mark-to-market these long-term liabilities using derivative accounting, though we believe the mark is not a good representation of our Company's liabilities. For operating income purposes, we use traditional life insurance GAAP accounting. And in our judgment, this is more representative of our ultimate liabilities, since this is a traditional buy-and-hold, long-term insurance portfolio, and not a trading business.

As I said, we also believe, while markets are unusually volatile and unpredictable at this time, the majority of the mark will reverse over time and accrete back, benefiting book value and net income in the future. In fact, as a point of reference, as of Monday's market close, the market improved by approximately $200 million, illustrating the transient and volatile nature. Phil will go into more detail, and we have included additional disclosure in our supplement, which we hope you will find helpful.

Returning to the quarter's operating performance, the P&C combined ratio was 90.3%, which included pretax net Cat losses of just over $120 million, the vast majority of which came from Hurricane Irene in the US. Our overall Cat impact was quite modest, and again, reflects good risk management, as well as our spread of business globally, and lack of over-concentration in any one business.

Our earnings growth and balance of business, both product and geography, have been enhanced by the acquisitions we have made in the last year, all of which are on track and should achieve or exceed the current-year targets we established at the time of each acquisition. In particular, given its size and importance, I want to say a few words about our crop insurance business. For Crop insurance, loss ratios are a function of yield at the time of harvest, and commodity prices. Our 2011 plan and calendar year-to-date booked loss ratios contemplate an average to modestly worse than historical average loss ratio year. At the same time, we wrote substantially more premium volume this year than we originally projected because of higher crop commodity prices.

Consequently, from what we know now, our 2011 earnings from Crop will be better than we originally projected when we acquired Rain and Hail. Financially, Rain and Hail will produce an excellent return on investment to ACE. And because of our deep national presence and expertise in this business, we expect we will have superior results relative to most peer companies engaged in this business.

As you know, we made a small, specialty-focused acquisition in the quarter that is complementary to our agricultural industry business strategy. Penn Millers is a good, solid company that has served the agri-business market since 1887, and currently operates in 34 states. We expect the transaction to close in the first quarter of 2012.

We have a very strong balance sheet, great liquidity, and plenty of capital flexibility. As a result of these stressed times, we are seeing a greater pipeline of opportunity than in the recent past, and we are open to additional acquisitions where they further our strategy and are accretive financially.

I want to make a few comments about revenue growth, pricing, and the general insurance market environment. Total company P&C net premiums were up 33% in the quarter, with premiums up 53% in North America and up 19% in overseas general. Growth in the quarter was driven by double-digit gains from Asia and Latin America, excellent performance from our international A&H business and our personal lines business globally, and improved pricing in US commercial P&C where prices are firming more broadly, particularly in a number of property and casualty classes. Our growth, of course, benefited substantially from strong contributions from our recent acquisitions, particularly our crop insurance business. As I mentioned on our previous call, our long-term and patient strategy to pursue product and geographic diversification, and invest for growth, both organically and through acquisition, is clearly paying dividends in terms of revenue growth and earnings.

Focusing on North America specifically, growth primarily came from crop, high net worth personal lines, and our US-based wholesale business where we experienced modest growth for the first time in many quarters due to improved business and net retentions, and broad-based price increases of about 3%. Our US retail commercial P&C premiums were flat after adjusting for a one-time transaction we wrote last year. Our US retail again achieved positive rates, with standard lines property and casualty rates up 3.2%. Property and energy rates were up mid-single digits while general and specialty casualty were up about 2.5%, ranging from up 6 to down just 1. For our risk management business, rates were flat for the quarter, the first time in a long time that we haven't experienced a rate decrease in that class. On the other side of the coin, professional lines rates were down 5.5%.

The floor under pricing overall continues to firm, and more classes achieve positive rate while rate decreases were smaller. In fact, September pricing was the best month of the quarter and the year. Now, whether this is a trend and continues or not remains to be seen.

Our premium renewal retention rates in US retail were very good, and benefited from about 3 points of exposure increase as well as rate increase. Renewal retention rates in terms of policy count were stable, but lower by 3 to 4 points than historical averages, and our new business ratings remained relatively low. For me, all that adds up to the difference in underwriting discipline between ACE and the market in general, as we continue to further refine and focus our data-driven portfolio management in each class of business we write.

In our international commercial P&C business, retail net written premiums were up 24%, or 12% in constant dollar, while our international wholesale was up 2%. Like our US wholesale business, this is the first time we have seen growth in our wholesale business in some time. International retail P&C premiums were flat to up in all territories, but growth was especially strong in Asia and Pacific and Latin America, which registered gains of 25% and 18%, again, in constant dollar.

For our international commercial P&C renewal book, rate increases ranged from 2% in our London wholesale business to 1% in our ACE international business, with a wide range of deviation around these numbers depending on the class and the territory. Except for Cat-exposed property lines, pricing trends internationally lag the US, and they remain soft. Renewal retention rates held steady. John Keogh, John Lupica, and Brian Dowd can provide further color on market conditions and pricing trends.

Our international A&H business, led by Asia Pacific and Latin America continued to produce strong double-digit premium growth, up 25% in the quarter with a 12% benefit from foreign exchange. Operating income for A&H globally was up about 10%, with good contributions from both ACE International and combined. Combined's growth, meanwhile, continues to suffer from the economic climate in the US and Western Europe. Global Re had another excellent quarter, with a combined ratio of 65%, which reflects excellent underwriting discipline, though premium writings were down, a price we are willing to pay to maintain a reasonable underwriting risk reward.

In closing, our operating performance was simply excellent, though our book value suffered from the volatility of financial markets. The operating results are what endures. They highlight the strength and vitality of this organization, and I am very confident about our prospects for the fourth quarter and beyond.

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

Thank you, Evan. We had an excellent quarter in terms of underwriting and investment income, and our balance sheet and capital position are very strong. Our financial and reinsurance recoverable leverage remains low, and cash flow was a strong $935 million. Investment income was $564 million for the quarter, up 9% over last year's quarter. This increase was driven by an increase in the portfolio's cash flow, a positive impact from foreign exchange, and a slower turnover rate in our portfolio. We expect our current quarterly run rate for investment income to be in the range of $555 million to $565 million, which is subject to variability in portfolio turnover rates, private equity distributions, and FX.

Current new money rates are 3.2%, if we invest in a similar distribution to our existing portfolio. Our current book yield is 4.3%. On a pretax basis, unrealized and realized losses from our investment portfolio were about $87 million, resulting from the mark-to-market impact of credit spread widening in the quarter. Investment grade corporate credit spreads widened 100 basis points in the quarter, while high yield spreads widened by 250 basis points. The mark included a gain of about $360 million in our investment grade fixed income portfolio, offset by a loss of about $450 million in our B/BB high yield bond and private equity portfolios. This is a high quality portfolio, and the decline in value was related entirely to market volatility.

We realized minimal credit losses. These portfolio movements are summarized on page 19 of our financial supplement. Our fixed income portfolio overall remains in an unrealized gain position of $1.3 billion; as of Monday night, approximately $80 million of this quarter's portfolio mark had reversed.

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 duration of the portfolio is 3.7 years. We have no exposure to sovereign debt of distressed European countries, and our exposure to Euro zone banks totals less than $1 billion, or 2% of the portfolio. The overall credit quality of this bank portfolio is AA, with over $700 million rated AAA.

In the third quarter, financial market volatility impacted our variable annuity reinsurance business, resulting in a net loss of about $660 million, which comprised a realized loss of $706 million related to the change in fair value liabilities, offset by $45 million in operating income. The results in the quarter were in line with our expectations, given market conditions, and were consistent with published guidance in our 10-Q regarding how these liabilities behave under distressed market conditions. Approximately 50% of the realized loss was attributable to an extreme drop in interest rates, with about 30% of the loss attributable to the decline in equity markets.

As we've explained on previous calls and in our disclosure, a technical provision in the accounting rules requires us to mark-to-market our variable annuity reinsurance liabilities like a derivative using fair value accounting, even though this is a traditional insurance business that we intend to hold for the long term. Therefore, we believe traditional insurance reserve accounting provides a better reflection of the liabilities and long-term performance of this insurance business.

For clarity and a window into our thinking, I'd like to elaborate on these two methodologies, while referring you to page 10 in the supplement. Accounting for derivative uses prescriptive assumptions that require us to value the policyholder accounts as if they were invested in risk-free US treasury securities, when in reality they're invested primarily in equities for a long term. Under derivative accounting, equity indices are assumed to have zero appreciation over the next 20-plus years, and interest rates remained depressed at the September 30 yield curve, when the 10-year US treasury rates were at 1.9%, and the S&P was at 1131. As of Monday, the S&P was at 1254, a 10-year note was at 2.2%, and, as Evan said earlier, the fair value of our VA liabilities had improved by approximately $200 million.

By substituting a risk-free rate for long-term equity performance, and using the current interest rate curve for the long term, we think fair value accounting does not provide a good representation of our VA reinsurance liabilities. In comparison, we believe traditional insurance accounting is a better approach, and provides a more representative view of the business. We've provided data in what we believe is a very practical way on our insurance accounting assumptions for equities and interest rates for the next few years. As you can see on page 10 of the supplement, the insurance model assumes the S&P grows at a moderate pace, and while we're in a very low interest rate environment, we expect the yield curve to begin to normalize over time.

You can see from the two scenarios we gave you, if the insurance model interest rate assumptions prove correct, the fair value mark will accrete back into book value in a reasonably short period of time. If the risk-free interest rates under accounting for derivatives are a better representation of the future rate at a given point in time, there would be a very modest impact to ACE's operating income in these future years. Under both scenarios, book value would increase in each year, as some or all of the mark unwinds and accretes back to book value. Finally, the mark is not relevant to rating agency or regulatory capital requirements; neither use fair value for establishing required capital.

Turning to all the other insurance business, our net loss reserves were up 1.1% for the quarter, adjusted for foreign exchange, and are now up approximately $1 billion for the year. Our paid-to-incurred ratio was 86%. We had favorable prior-period development of $194 million pretax; almost all of the development was long tail, predominantly from years 2006 and prior. Cat losses were $86 million after tax, most of which related to Hurricane Irene.

The expense ratio was 25.6%, down from 30.2% last year, due primarily to a changing mix of business, especially crop, while our accident year loss ratio was up, all due to the impact of crop. Our growth in net written premiums was 33%. Excluding crop, and adjusting for a large risk management contract in last year's quarter, the growth was 5.6%.

In our 2011 guidance discussed in our second-quarter call, we said we expected operating income to range between $6 and $6.20 per share. Catastrophe losses included in that estimate were $744 million after tax. Our operating income projections included in guidance, remember, were for current accident year results only, and by definition did not include any estimate for prior period reserve development in future quarters.

In light of the level of year-to-date catastrophe losses, prior-period development, and higher investment income, we're increasing our guidance for the full year. Operating income is now expected to range between $6.55 and $6.75 per share for the full year. This includes $630 million after tax in catastrophe losses for the first 3 quarters, plus $75 million after tax in catastrophe losses for the fourth quarter. The guidance also includes $335 million of after tax positive prior-period development reflected in the first 3 quarters. There is no prior-period development included in our guidance for the fourth quarter. We also repurchased $100 million of shares in the quarter.

With that, I'll turn the call back to Helen.

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

Thank you.

(Operator Instructions)

Keith Walsh, Citi.

Hey, good morning, everybody. First question forEvan, it seems in your commentary, pricing gains seem slightly broader, but are we tracking loss costs? And then if you can just comment on how new business pricing is trending versus renewal. What's the gap there, and how is that trending? Thanks.

New business -- thanks for asking that question. New business pricing and renewal pricing are actually tracking very closely, right on each other. In fact, I'd tell you that new business pricing, in many cases, has been a bit better than renewal pricing. And that is an improvement to trend from what we've been seeing in the past.

Regarding loss cost, look, it varies by product. Over -- and depending on what -- how you view loss cost. When I took at short tail business, any rate increases we're receiving are greater than loss cost trend.

On long tail business, if you believe the past is an indicator of the future and inflation has been relatively benign, except in healthcare costs, then, some of the rate we're seeing in some of the classes is tracking loss cost. On the other side of the coin, that's not how I view things. I don't believe that the past is an indicator of the future and I think that loss costs continue -- we continue to use loss cost trends that frankly are greater than the rate increases we're receiving today.

Okay. And then just second question. You know, I understand the need to give pricing with investment returns where they are, but what's the reality of actually achieving enough rate to offset the down draft from investment returns with a sluggish economy and, I guess, relatively healthy balance sheets for underwriters? Thanks.

Well, at a moment in time -- I mean, you get it, at a moment in time what it just says is -- and I tell you how we -- what we continue to say. You're not going to achieve your cycle over a cycle ROE target, in a product line. Sometimes in the cycle you achieve greater ROE than is your target and sometimes you achieve below that.

But our guide is combined ratio and so we walk away when we can't earn an underwriting profit. And I think that's the more clear-eyed way to think about this.

Thanks a lot.

You're welcome.

Mike Zaremski, Credit Suisse.

I'm curious. International growth clearly very healthy. You've cited Latin America, Asia Pacific. I'm curious if you believe that ACE is taking market share in those regions and if you think --what your outlook for this growth being, whether it's sustainable?

Well, it has been sustainable and sustainability is going to be -- I'm bullish about the future. A lot of the growth is coming, because the pie is growing. When you take the economic, much more robust and rigorous economic development that is taking place in parts of Asia and in parts of Latin America, greater economic activity means greater exposure and there's more consciousness about insurance and more insurance being purchased.

There are more people, not just businesses, but more who are entering the middle class in those territories. So, I think the trend for business and consumer has been, and will continue to be favorable. So, like anything else in life, it will have its -- it will have its volatility.

Okay. And also curious, Evan, you've talked a lot in the past about the 15% ROE goal over the cycle. Does that change at all, if you did believe, and I believe you guys don't believe, current risk-free rates stayed near current levels for a prolonged period of time?

We are -- well, I'm not going to speculate on that part of it. We're not changing and we -- with all the thought we give to it, our target for ROE over a cycle has not changed.

Okay. And then lastly, it sounds like you were more constructive M&A. Are there certain areas or geographies, potentially international, where you are growing at a very healthy clip where you'd prefer to look at opportunities?

Stay tuned.

Thank you.

You're welcome.

Vinay Misquith of Evercore Partners.

Hi, good morning. First question is on asbestos review. You do an annual review in the fourth quarter. Do you see any changes in the expected paid claims or the settlement costs that we should be aware of, that you may need to take up reserves in the fourth quarter for?

Vinay, for both asbestos and environmental, in fact, for all the, quote unquote, Brandywine run-off liabilities, we're in the middle of our annual review right now and I don't have any results yet. As you know, and as all of you know, any reserve movements are individual claim or client dependent and I just don't have any visibility into that now. We're doing the reserve study.

Okay. Fair enough. The second question is for Phil. Phil, the earned premiums in North America increased about $850 million year over year and more than $700 million (inaudible) quarter over quarter. Were there some one-time premiums in that or is this mostly because of crop?

Year on year, there are 2 things. There was a large risk management contract in last year's quarter and in this year's quarter, it's obviously the impact of crop.

Okay. And most of the premiums for crop are earned in the second and third quarters?

Yes.

Okay. That's great. Thank you.

You're welcome.

Michael Nannizzi, Goldman Sachs.

Thank you. One question. I'm trying to reconcile, your comment about rates and exposures being up in North America, but it looked like that you said that excluding crop, premiums were down about 5% in North America, is that -- am I not connecting those things right?

No, you are connecting them right. You want me to expand on it for you?

Please. That would be great. Thank you.

Sure. It's down 5%. You have to -- there's 2 things, and then I'm going to make an overall statement about that.

Okay.

Number one, have you to adjust for a one-time -- have to adjust. You normalize for a one-time transaction that we wrote last year, a loss portfolio transfer. And, also, as we have spoken in many quarters in the past, we reduced substantially, almost to zero, our writings in traditional risk transfer workers comp. We're just not going to write business that's running 115% to 120%. And I might add that many of the rate increases I hear out in the marketplace right now overall are related to workers' comp, where maybe you're getting 7% or 8%, but you're starting from 115% or 120% combined.

We deemphasized that class, and that plus the one-time transaction together, when you adjust for that, North America is flat. We're receiving rate and, as I said, we're maintaining underwriting discipline and we're very portfolio focused.

And so while we're achievingrate, at the same time we're not writing -- new business writings are up in the quarter over last year, but they're still relatively modest and on a policy count basis, we're still trading market share a bit for achieving better rate.

Great. Thanks, Evan. And Phil, if I can just ask one question on the life reinsurance mark. So if you were to use -- assume rates are flat and then revert to a traditional insurance approach, I mean, what would the -- on an apples-to-apples basis to that 706, what would the accretion look like over the next few years? Thanks.

I think that's what we depicted on page 10 of the supplement, right? We said -- in the top part of that schedule, we showed the assumptions that are implicit in our insurance accounting, and then in the bottom table, we showed the rates that are current and the current yield curve.

And so as you look at it from -- the first column it says operating income. You can see there's a relatively modest change when you change those interest rates to our operating income and then the column to the right shows the realized gains that result from the various -- from those 2 scenarios. So in each case, the book value grows. It will grow faster, obviously, if interest rates rise faster.

Right. But the base income in that segment is probably -- I would imagine includes some of that operating income, or are you saying that on an apples-to-apples basis that the dollars coming back to that 706 are the realized gain numbers or the total net income slash book value.

It's both. So, all the way over to the right on that page shows the total of the operating income and the realized gains and loss and that would be the total increase to book value.

Got it. Okay. Great. Thank you very much. You add them up.

Yes, that's right.

Right. Thank you.

Jay Gelb, Barclays Capital.

Good morning. Thank you. I didn't see the share buyback in the press release. Did I miss it?

Well, we -- Phil will answer whether it was in the press release, but he did just tell you -- you got what he said on the -- in his comments, right?

Yes, $100 million.

It's in the supplement, Jay.

Okay. What should we expect for 4Q and is this all related to offsetting dilution from stock issuance related to compensation?

Is it related to dilution. We said we will buy back -- we will have a program to buy back our dilution. We don't match it, necessarily, quarter for quarter, just over a period -- over a reasonable period of time when we think it's right, we execute buy back.

Okay. And then, Evan, you seem to be increasingly constructive on the rating environment in terms of US P&C rates finding a bottom. Is this similar to what we saw in 2000 when we had a slow and steady pace of increases that seems to be more easily absorbed by customers and brokers?

Well, I'm kind of a cautious guy about this. I'm not willing to declare that this is a future trend, but we have been seeing it now for a couple of quarters and it is -- the floor is continuing to firm and where we were getting rate increase, we're getting more rate increase now than we were a quarter ago.

And we're even seeing that, as I said, for September the rate was even better and more classes are achieving that. What you're finding is, the marketplace in general is unwilling -- less and less willing, there are always cowboys and outliers there -- but less and less willing to go along with any rate decrease and, in fact, brokers are less and less requesting rate decreases or bludgeoning the weak to give them. And that is --

Right.

That is a favorable trend and, I'd hardly declare it a hard market, but I'd say it's firming. The market is not softening, and it is beginning to firm.

That's what I thought. Thanks. And then on the last one. Reinsurance purchase trends, the net to gross premium ratio on P&C continues to increase. Is that a trend we should expect to continue over time?

Well, look, substantially crop had a huge impact on that. Remember, our seeded ratio on crop was substantial. First of all, rain and hail had an insurance company and that's one of the things we bought, and so they had a retention. And then there was more third-party reinsurance even from them, because of their limited capital. Well, we captured both and that changes the net to gross. Our policies were out front on all that business. That's the major change here.

Makes sense. Thank you.

You're welcome.

Matthew Heimermann, JPMorgan.

Hi, good morning.

Hi, Matt.

Hi. Couple of questions, I guess. Just big picture internationally -- I mean, do any of the free trade agreements that have gone through, how -- I guess how material are those to you over the short and medium term? And then are there -- do you see any big picture risks, I guess, to the US market or European market, just developed markets generally from some of the austerity we're going through or should we just think about that as a continued growth challenge?

Say the last part again, the first --

Oh, just with respect to developed economies, when we think about all the austerity and deficit reduction actions we're seeing, should we just think about the risks associated with that being tied to growth, or are there some other things that maybe we're not -- we should be conscious of?

First on the free trade agreement, look, it's -- there's no -- I don't see any big event as a result of that, but, it's all incremental. Everything helps and when -- particularly in Korea, there is commitments to treat foreign participants the same as you treat domestic participants and there's greater transparency.

That isn't a sea change, but it's an incremental benefit and it also increases trade, which increases activity and that increases opportunity for insurance. In Colombia, which is -- frankly, I think we were almost fighting a defensive action as a country, because Colombia, which has been a long-term ally of the United States and very pro-American was turning their gaze towards -- more towards other countries, China, Canada and was becoming more disillusioned with America, which makes it more difficult for American businesses when we go down there to generate opportunity.

This is a reaffirmation, though we certainly tried their patience, in waiting all the years we did to do this and we certainly didn't handle it, I think, in the best of ways and lost some political capital along the way with them. This definitely improves, it shows America's commitment towards Latin America and that is a benefit for American business. When it comes to -- but I don't expect a sea change in ACE's business. It's all steady, step by step, another brick in the wall.

Austerity and the United States and Europe. First, it creates a drag on economic growth and that will eventually show up in exposure growth for the industry, which is the biggest impact and then we know how much is being driven by the political environment right now. Whether it is Europe, whether it is the US and our deficit and our inability to create confidence in business -- those really weigh on growth and they will weigh -- and the insurance industry is a reflection of that.

All right. That's helpful. And then just -- just with respect to the competitive environment, I would just be curious how consistent you feel like -- how much consistency between companies you're seeing in terms of underwriting appetite? And I guess maybe another way to think about that is how much of the market do you see leading the charge for better rate versus just still following at this point?

I think a couple of -- I think the best peer companies are endeavoring to do what we do and show discipline, and they are trying to press the market to recognize a price that reflects the risk. And then I think there are those who will just follow along with that, and then there is still quite a number who will -- who, given the chance, will take advantage to just write business for market share, they don't even -- they don't know any better.

I am convinced many of them don't even know the difference between what's an adequate or an inadequate price. But I see a number of companies that are trying to -- a few that are brand names and I think are well-run companies that are trying to do what we're doing.

All right. Thanks much.

And the way you lead is simply -- it's very simple. It's not that you say I'm going to lead the market. It's that you say I am going to get a price that is commensurate with the risk or I'm willing to trade market share, period.

That's helpful. Thank you.

You're welcome.

Paul Newsome, Sandler O'Neill.

Good morning. You know, I'm not a big fan of mark-to-market accounting, as you know, and I do think the market will look through this variable annuity thing, but I have a couple of questions on it. The first question is, why do you think the charge was bigger in this quarter than it was in the '08 period?

And my second related question is, why is the losses on a cumulative basis over -- my model just goes back 8 years, negative? It doesn't look like we at least on a realized gain perspective, actually got the benefit of a rebound.

You know, on your -- you want to take the first question? Go ahead.

Could you say the first question again? I'm sorry.

Well, why was the charge for the VA bigger this time around --

Oh, I'm sorry. There were 2 things. I think there are 2 periods where, if you look at the disclosure we do around the sensitivities, the result for the quarter was a lower loss than you would have expected.

The fourth quarter of '08 and the second quarter of '10, and as we disclosed in our 10-Qs and all during those quarters, we made other assumption changes. We changed assumptions relative to annuitization and the impact on annuitization of people being deeper in the money, those types of things.

So, we made some changes to the models that reflected our updated view of policyholder behavior. In this quarter, we had no model changes, so there were no -- so as it turns out the reported results were, in my view, right in line with the sensitivities that we disclosed.

And the --

On your second question, we've recovered a reasonable portion. We have not recovered all of it. Interest rates continued to fall. Equity markets, from where they were in '07, '08, came down substantially. So, when you add those together, it has not fully recovered as of this time.

So simply --

It took another leg down.

So, I guess the risk here is just interest rates stay low and the market stays relatively flat, you essentially just accept the loss that you booked this --

Well, you say that, but we -- Paul, what we did was -- and let me go a little further with this. We gave you 3 or 4 years of transparency on that. That's why we did that, so that you could see the sensitivity around that and do interest rates move in line with what we have in the buy and hold accounting, do they behave or do they behave just like they did in fair value or is it something in between and you can see how it accretes back? One, it will take longer to accrete back and the other one, it's shorter and something in between is just that.

And so, you could see those assumptions in that transparency. And I might add, if you look beyond that, what we assume for interest rates for years past that in the life accounting is simply around 4% to 4.3% or 4.4% over many years to come in the future, the next 20 years. So, nothing crazy. And so that, again, I think will help to ameliorate and we will accrete back.

Great. Thank you very much.

You're welcome.

Greg Locraft, Morgan Stanley.

Hi and good morning. Wanted to just ask a question around accounting for DAC. You know, things are changing, does it impact ACE at all?

Yes. Based on what we know now, we don't think there's going to be any material impact on either our book value or our income going forward. Now, we're still in a process of reviewing it and having it audited, but that's where we are.

And then back to the VA book, just wanted to confirm that -- my sense was you guys stopped writing new business for this book back in '07.

That's right.

So, is this a business that you like? Are we seeing -- should we be seeing more of it going forward or is this effectively in runoff and we're sort of stuck with the accounting ramifications until it runs off?

Well, it's effectively in runoff, been in runoff. We have not written any new business. We don't have any intention, at least in -- at this point in writing any new business and while you say stuck on one hand, that's true, and it's also producing about $40 million, $45 million a quarter of operating income. It does continue to produce around -- you know, between $160 million and $180 million a year of income.

Okay. Great. And then one last one is just the expense ratio, the improvement was excellent. Any comments as to -- I mean, again, it was a step function improvement, so can you talk about maybe some of the initiatives or how that occurred?

Yes. You know, look, most of the expense ratio improvement was due to the crop, the consolidation of all of the crop business into ACE. That was the substantial event that did that. It increases the loss ratio and decreases the expense ratio substantially.

So it's more of a mix of business-related. We've been practicing what we believe to be very tight expense control for many years. We don't let expenses get out of hand and when we're in a fast growth period and, therefore, it's more steady as she goes in a slower growth period. There is no period where we are not trying to become more efficient and wring out every dollar we can find.

Okay. Great. Thank you very much.

Shareholder -- it's shareholder money and we're not going to waste it.

Got it. Thanks.

You're welcome.

Cliff Gallant, KBW.

Good morning. Actually just following up on that last question of expense ratio then. So, we should expect to see a little bit more seasonal volatility in expense ratio as crop premiums have a certain seasonality. Is that a fair statement?

I think that's fair, absolutely.

My other question was on --

You see seasonality anyway in our business, in our expense ratio as it is, and this just adds another factor of seasonality to it.

Okay. Okay, good. I also noticed that paid losses in the quarter looked a little high, running higher than normal. Above $2 billion. Was there anything going on there?

Cats.

We had Cat payments.

Just the Cats, that came up. All right. And then I just wanted to clarify. You did say that there were no actuarial assumption changes in the VA book. Is that correct?

That's correct. And, no types of modeling changes or anything else.

Okay. So when I look at the -- that disclosure, then, from the second -- the 10-Q, you see equity markets down probably in the -- sorry, I guess the best column is the minus 20 and interest rates down. That's the area, the minus 798 number, that's what you're indicating when you say that you think that table performed well?

Yes. I think we-- actually, we would have said the equity markets were down 14% for the quarter and interest rates were off 40%. So, we've done it ourselves, you can back right in, we tested the disclosure and it works very well.

Okay. Very good. Thank you very much.

You're welcome.

Alan Zimmerman, Macquarie.

Thank you. I just want to stay on the variable annuity for a second, because, conceptually, it's easy to see how lower interest rates and a lower equity market drive up the fair value of a liability, but it's harder to see -- and it's easy to see how they can reverse -- but it's harder to see what the policyholder behavior is doing both to the liability and I don't think we have enough experience to know if that will reverse or how that will perform. I was just wondering if you could comment a little bit on how that affects the model?

Yes. Phil may talk about how it affects the model. But I can tell you this. The policyholder behavior, the annuitizations in our portfolio don't begin -- you get a little bit of -- people, policies that mature and could annuitize in '12, very little. You get a bit more in '13, you get much more in '14 that are eligible for annuitization and that's where you're going to see substantial policyholder behavior.

And what we know right now from the studies -- from the clients we have where they have written this business long enough that there's enough data on annuitization, from what we've seen, they're behaving -- the annuitization rates are in line with what we would expect -- what we expect and what are in our models.

Okay. Which is why there's no change in the models?

No. We continue to study. Each period we see the experience of the merges in the period and we decide whether that indicates a change to what we've used for the annuitization rates, for example.

But you're right, that's why there's no change, because we're not seeing anything that would tell you to change up or down.

Right.

Okay. Thank you.

Welcome.

Brian Meredith, UBS Financial.

Yes, thanks. Two questions for you. The first one, I wondered if you could talk about your thoughts on and the potential implications of the administration's proposal on cutting some of the crop insurance subsidy?

Yes. The RMA has done, in our judgment, an excellent job in administering crop insurance over the years. And, as you know, number one, there has been a number of changes to crop insurance, not favorable to insurers, over the last few years. There have been 2 changes. They've changed it twice, number one.

Number 2, there is very strong recognition and support from both the agricultural industry and both sides of Congress, Democrat and Republican, for the value of crop insurance, the recognition of the value of crop insurance in the agricultural economy.

And I can tell you when the industry and when both sides of Congress who are involved in this are discussing this subject, they are more focused on achieving any deficit reduction in other areas of agricultural support than in crop insurance. Those are their priorities out in front because they recognize there's been change, and they all recognize the value of this and it's quite overwhelming.

So when I'm -- while there are many things I'd be concerned about, this is not the one that I'm really focused on as a concern.

Okay. So you just don't think it's going to go through and you don't think there will be much of an impact, then, going forward.

Look, no one can make -- in this environment, no one can make any statements of -- definitive statements of certainty, but I feel fairly confident about that, yes.

Great. Thanks. And then just a second question, Evan. I wonder if you can just quickly comment on impact to the industry and maybe ACE of some of the Thai floods that's going on right now?

Well, it's like one of these disaster movies -- they keep saying it's coming, it's coming, it's coming, and it's like -- they're expecting significant flooding in Bangkok. They've been saying it for the last week that major flooding is coming and when we talk to the people on the ground, they say I keep looking out the window and seeing a sunny day and it's still dry.

The water is moving down there. It's a question of whether the levees will hold and if they do, and they can pump water through the canals, then, while the city will have water -- it remains to be seen how inundated it becomes.

Right now most of the industrial parks that are up in the north, most of the early reports we have, and it's very early. In talking to our folks last night, they say that while there's water all around them and they can't open, because people can't get to work right now, the facilities themselves have not experienced any significant flooding as of this time.

Now, that's very early. Don't go to the bank on that and we'll see. This is just unfolding.

Would that mean there could be some CBI losses?

I don't know.

Okay.

We don't write a lot of CBI ourselves. And I really can't tell you, because that's a very insured specific. We'll have to see. You know, just keep your eye on it, give it some time and we'll see.

Great. Thanks, Evan.

You're welcome.

Jay Cohen, Bank of America, Merrill Lynch.

Thank you. Good morning, Evan. A couple of questions. First is, given that the crop business is having a -- I guess a distorting effect on the loss ratio, expense ratio mix and also the net to gross, is that something you can break out, and tell us actually what the premium level is for the crop business?

Well, we -- I think we in essence did, but we'll work on that, Jay. Whether we -- you know, because we don't really break out by line of business and so -- and we don't want to really start heading down that rabbit hole so much, but this is a big book, so we'll take that under consideration.

But the thing that we did do, is we told you that in constant dollar, that on a published basis, our growth is 5.5% roughly, excluding crop and the one-time transaction we wrote last year. So, it gives you sense of order of magnitude there.

Right. Second question, in re insurance, you had some, I guess, negative catastrophes, obviously some favorable development from prior periods. What drove that?

Well, it's a combination. We had negative and positive, by the way. And they netted out to fundamentally neutral, okay? I think it was a $4 million change. So, there were ups and downs and it's what you find.

You never -- you know this about reserves, they're never right. They're either a little better or a little worse and it was each Cat related back to each quarter, each quarter's Cat, a little change in this one and a little up and a little positive in this one. So when you net them out, between them, it nets to fundamentally zero. (multiple speakers)

So no big moves from any particular Cat, it sounds like.

I'm sorry?

No big moves from any particular catastrophe?

No, no big moves from any particular catastrophe.

Okay.

Except I should say that -- one of my colleagues wants to say something. Japan is where -- because by the nature of it, is where the largest change took place.

Right.

The gross came down.

Got it. Then the last question, you mentioned the pipeline for deals has improved, you're seeing more opportunities. My question is, has the type of deal you're seeing, potential deals you're seeing, has that changed at all?

Well, it's -- has the type of deal? I don't want to give you a glib answer, so I'm thinking about it for a moment. A little bit. It's more on a theme that I've been saying for a while that is showing itself and that is, we're seeing a little more around opportunities with financial institutions that own insurance companies where insurance is a secondary business to them, not their primary business.

Got it. That makes sense. Thanks, Evan.

You're welcome.

James Keating, McLean Budden.

Hi, team. Hi, Evan. I was intrigued by your comment about how loss cost trends, estimates, therefore, I think, were above what -- expected price increases were tracking at, and I guess I wanted to ask you to expand on that, if I could.

Well, we have been insistent and clear that loss cost trends in casualty overall -- we still price in, depends on the line of business, 5% to 6% in primary, going up to, like the 9s to 11s, in excess because of the leverage. And that continues, that doesn't change. And you're not getting rate increases that track that.

Though the difference between -- but then there's 2 things that are ameliorating. You're getting price, so the gap is not growing, it's shrinking and, secondly, what you benefit from is, as business you wrote in the past begins to run off as it matures, that business, because of inflation being less than you priced in in the past, that business is running off more favorably and those 2 things are ameliorating to what you see as trend. So I hope that expansion helps you.

It sure does. Thanks a lot.

You're welcome.

Ian Gutterman, Adage Capital.

Ian, good morning.

Hi, Evan. I was wondering if there's been a difference in the ability to get rate between agency-sourced business and broker-sourced business?

Not really. And, you know, ACE is more of a brokerage company and so, no, we don't notice that. And I might add, in fact, probably we're getting better -- doing a little better on the larger trade, more sophisticated client, than we are on the smaller just slow business commodity.

Okay. Interesting. That was going to be one of my follow-ups. And are any of those claims -- (multiple speakers)

That's the opposite of what some others might say, but that's how we're seeing it.

Interesting. And are any of those large clients buying less coverage to offset rate yet or is there no real change in demand for cover?

No, no real change in demand for cover.

Okay. Great. And then the other comment you made about Westchester seeing some growth, I guess I had seen some other talk about submissions in the E&S marketplace increasing. Is that kind of what you're seeing behind that and, if so, what's driving that?

We're seeing increased submission, but we're seeing better retention of business, which first is the -- that's the more stabilizing, to me. And we're seeing pricing, not just in property, which, by itself would move you to positive rate even if other classes were negative, but we're seeing positive pricing not just in property, but we're seeing it in casualty in E&S as well.

Are you seeing the standard market that was sort of playing in that space the last couple of years starting to back off? Is that driving as well?

No, not yet. Don't go overboard.

Okay. Got it. Then just my last one, real quick, on the Penn Miller acquisition, I think I understand the strategy there, I just want to make sure.

From what I understand, they've historically struggled a bit at trying to leverage the equipment business with the crop and I assume just given -- you obviously have much more scale and better distribution, that it's sort of a natural fit to go to your customers and try to cross sell, if you will?

Yes. You got it. You know, look, Penn Miller was a mutual company and when it was a mutual, it could focus very, very well on what it does particularly well. It takes the keys, which is in that agribusiness-related property. The company went public and as such, you feel some of the company, public company pressures and they were expanding out into other things that weren't really within their wheelhouse.

We'll focus them on their wheelhouse. And then we've got very large distribution and a great brand with rain and hail and this is just -- this is adding an expertise that we will take advantage of.

Is this one of the examples -- I think -- I can't remember if it was earlier this year or last year, you talked about that this agency planned to have the opportunity to do more things with it. Is this kind of what you had in mind or one of the things you had in mind?

This is one of them.

Okay. I assume there might be more to come?

There -- yes. But a number of those will come from current day's product capability, not from acquisition, whether it's in the high net worth area, whether it's growing in the farm area, whether it's environmental opportunities, whether it's overseas exposure for those in the agribusiness, whether it's what we're doing in small commercial that this gives us reach into more rural communities.

So, over time, remember, it's not going to be quick. You have to do this in a thoughtful and methodical way -- method -- methodical way. Over time we'll add product, and we're beginning to do that

Thomas Mitchell, Miller Tabak.

Just briefly, in trying to follow the investment income trends, you came in again quite a bit higher, I think, than your guidance had been for the second quarter. And I'm just wondering if we should be thinking of closer to 530 to 540 or if we should be thinking of closer to 560 as a kind of regular quarterly run rate?

I gave the run rate, you know, in our opening remarks at 555 to 565. That's our view.

Okay.

It's going to be subject to some variability. One of the things that we're seeing is, in some of the mortgage portfolios, the durations are extending so we're not moving as quickly into the lower new money rates, and we've estimated those things. But it's going to be subject to volatility of that and FX and private equity distribution, so that's our best guess at this point.

Okay. Good. Thank you. And the second question really has -- when I look at the page 10 of the supplement, I guess -- as I recall, the sensitivities in the 10-Q refer to the fair value model. I'm wondering what would the traditional life insurance model sensitivities look like if -- just for the purpose of argument we did something like say the 10-year treasury was 1.5% and the S&P 500 was at 850 for an extended period?

Yes, well, from a mark standpoint, what we said -- I'll just give you a couple of numbers as examples. But the -- if the mark -- if the S&P fell to 1000, for example, we'd have an additional mark of 250. If the interest rates fell another 50 basis points, just as an example, and that's falling from the 1.9, as we said is a 100-year low rate. If that fell, it would be another 250.

Okay. And I guess, my question is, would that affect the traditional insurance accounting model at all?

Not necessarily.

Yes, not necessarily.

And you can see in our disclosure, we talk about our protocols and it depends -- remember something. It depends on where we think interest rates are going to be at the time someone annuitizes. That's when interest rates come into play.

They're a function of what somebody will receive when they annuitize and so it's in their -- it's in their contract with their insurance company and then the insurance company has a protocol with us. So, if we think interest rates would be at that level when someone is annuitizing in '13, then we would reflect that in our life insurance accounting reserve.

And that's the same point on the equity index, right, to the extent that we believe that there's a fundamental change, and we no longer believe the assumptions in our insurance accounting model, then we would change it.

Right. Okay. Thank you very much.

You're welcome.

Larry Greenberg of Langen McAlenney.

Good morning. Not much more to ask, but just one house cleaning. Just on the -- I'm assuming that the piece in your operating statement that you broke out, losses from separate account assets, presumably, that would reverse in a better interest rate and stock market environment along with the fair value mark?

Now, let me be clear. Those 2 things are completely unrelated. In Hong Kong, we have separate account products. So, the results of the assets belong to the policyholders. So, we have two things going on, the value of the assets go down, that goes into other income. The value of the liabilities go down, correspondingly, completely offsetting, and that goes into benefits.

So, there's no net impact or no book value or no impact to that. It just has to be separated because, it's a technical thing that, since it hasn't been proven in the courts that those accounts are bankruptcy remote, they just have to be shown that way. But, there is no net effect. It doesn't reverse to ACE, it reverses to the policyholder.

Okay. Thank you. That's helpful.

And at this time we have time for one final question. Mike Grasher, Piper Jaffray.

Thank you. Just to follow up on your comments earlier, the question would be how much more pain can we anticipate seeing in the industry before maybe you get interested, or more focused, I should say, on that specific line of business?

On the VA line of business?

Workers' comp.

Oh, on workers' comp line of business. I have to tell you something. When we think we can earn an underwriting profit, that's when we would consider expanding in any significant way in that line of business, and I do not see that on the horizon.

You run a 115 and you're earning 1%, 2%, 3%, at that point in our judgment you're destroying capital, you're destroying shareholder value and we just don't have an interest in it and I don't see on the horizon a change in that that is substantial enough.

So, fair to say there's more pain to come and we should continue to see rate improvement within that line of business?

I think so. You know, I don't know. That's rational, and so the first thing I say is, I think so, because that's my rational mind speaking and we'll see.

Thank you.

You're welcome.

Thank you, everyone 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.

And again, that does conclude today's conference call. We'd like to thank you for your participation.