丘博保險集團 (CB) 2012 Q2 法說會逐字稿

Good day, and welcome to the ACE Limited second-quarter 2012 earnings conference call. Today's call is being recorded.

(Operator Instructions).

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

Thank you, and welcome to the ACE Limited June 30, 2012, second-quarter earnings conference call. Our report today will contain forward-looking statements. These include statements relating to Company performance, guidance, premium growth, ACE's business mix and acquisitions, the impact of catastrophes and droughts, and pricing and insurance market conditions, 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. A webcast replay will be available 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's my pleasure to turn the call over to Evan.

Good morning. ACE had a very good second quarter, marked by excellent operating earnings, strong broad-based premium revenue growth, and an improving P&C pricing environment in a number of areas of the world. Book value growth was up modestly in the quarter, as we were impacted by the euro debt crisis and the consequent flight to safety, which affected foreign exchange, interest rates, and equity markets. After-tax operating income for the quarter was $743 million or $2.17 per share. Our operating ROE was over 12.5%. For the first six months, we have produced almost $1.5 billion in operating income and an ROE, again, of 12.5%. All divisions of the Company made a positive contribution to the quarter's results.

Our underwriting results this quarter were again outstanding, as illustrated by a P&C combined ratio of 88.7. The strong calendar year results benefited from both favorable current accident year experience and positive prior period reserve development. The current accident year results were excellent, both with and without the impact of Cat losses, which were relatively light this quarter at $55 million pre-tax. ACE's underwriting performance has been consistently strong all year, with over $890 million in underwriting income and a combined ratio of about 89% for the first six months.

Investment income held up pretty well in the quarter and was down only modestly, despite the historic low interest rate environment. The strong operating fundamentals contributed to book value growth of 1.3% in the quarter that was impacted by mark-to-market losses and from financial market and foreign exchange movements. Book value is up almost 6% year-to-date. Phil will have more to say about the market's impact on our investment portfolio, the VA mark, and foreign exchange.

We announced a small but important acquisition last month, Asuransi Jaya Proteksi, one of Indonesia's top general insurers and a leader in personal lines. The company, which has an extensive branch network and distribution system, will complement our existing business and diversify our presence in Indonesia, with a well-established personal lines franchise. The transaction is expected to close later this year. ACE's total company net premiums in the quarter grew 4.5%, or 6.5%, adjusting for the impact of foreign exchange.

Our growth in the quarter came primarily from three regions of the world, North America, Asia, and Latin America. North America grew over 7% in the quarter or approximately 10%, excluding crop insurance. We had excellent growth in commercial P&C, both retail and wholesale, as well as personal lines. In Asia and Latin America, we were up 16% and 23%, respectively, with strong contributions from P&C, A&H, and personal lines, which all grew at double-digit rates in original currency. Growth in Europe and the UK, on the other hand, was flat due to both market and economic conditions.

In North America, some of the product lines where we saw our best growth were in primary risk management business, which was up 9%, retail general and specialty casualty lines of business in aggregate, which were up 11%, and property, which was up 27%. Our US E&S wholesale business was up 24%, led by property, which was up 37%. Our high net worth personal lines business in the US was up 15 points. In our international business, property was up double digit in Latin America and Asia, as was marine, while energy-related classes in aggregate were up double digit globally. A&H growth globally picked up in the quarter, as expected, and this trend should continue for the balance of the year. A&H premiums, excluding combined, were up about 9% globally in constant dollars, led by Asia with growth of 17% and Latin America with growth of 15%.

Combined insurances premiums were down about 4.5%, which was better than what we planned. Growth at combined is beginning to trend upward and should be neutral by year end or first quarter next year, with growth from there. The underlying fundamentals, Europe aside, are definitely improving. Our Global Re business was up over 9% in the quarter, led by Bermuda, which was up 18%. We benefited from continued Cat price increases on Japanese renewals at 4/1, and also from price increases on US wind business.

Crop insurance revenue was down 1% in the quarter, in line with our expectations. Crop premiums, as I explained on our last call, are impacted by commodity prices. There is much discussion about the drought conditions in the US, in some states quite severe and with a serious impact on crops. Based on conditions as they stand now, and given our portfolio mix by state and crop, we will adjust our crop loss ratio for the year up in the range of five points during the third quarter, bringing our crop-related business combined ratio to between 93% and 94%. This year-to-date loss ratio change is equal to about $68 million after-tax. This is our best estimate at this time. We continue to closely monitor crop conditions for changes that would lead us to alter our view.

If the current drought conditions worsen and continue until harvest, our modeled worst-case loss, based on what we know, would be an additional circa $200 million after-tax. We are not predicting this outcome. We are simply letting you know the outer bounds of reasonable worst case. To put the five-point loss ratio adjustment we are now taking in perspective, the $68 million is less than the difference between our actual net Cat losses and our Cat load for the first six months of this year, a difference that has benefited our earnings by $75 million. So at this moment, we remain within our year-to-date current accident year projection. While crop is not part of our Cat load, these drought conditions are another form of Cat. When one area base is potentially worse, another can be better, showing the benefit of our diversification, balance of business, and risk management.

Returning to the quarter, I want to make a few comments about pricing and the market environment, to put our revenue growth numbers in perspective. The positive US pricing trend we have been discussing the last two or three quarters continued to improve again in the second quarter with rates further increasing, albeit gradually. Prices in the second quarter were better than in the first. The rate increases were again more broad-based than in the first quarter, which was better than last year's fourth. This included many casualty lines, with professional lines, for example, turning positive, while property rates held up quite well and equal to the level of pricing we saw in the first quarter. For the first time, pricing in our international operations, in aggregate, turned positive, up 3%, led by Cat exposed property, UK casualty, and across-the-board slowing of rate decreases in other classes. Even professional lines internationally in aggregate turned positive and showed a 1% rate increase.

Let me break this down a bit further, beginning with North America. Overall for the quarter, pricing in North America was up 4.7%, and we achieved better pricing on our new business when compared to our renewal book. The average rate increase for our retail business went from 2.6% in the first quarter to 4.1% in the second quarter. Similarly, in our wholesale business, the average rate increase went from 6.6% in the first quarter to 8.4% in the second. And remember, in reporting rate increases in ACE, we separate out exposure growth, which was up 3.1% in the quarter. The US retail and wholesale property book led our rate increases with rates up 14% and 10%, respectively. Our US retail casualty book achieved positive 5% rate, and this excludes risk transfer workers comp.

Risk management business pricing was up 3%, and management liability D&O pricing was up 4%. Finally, our E&S portfolio pricing was up 8.5% overall. We had positive rates in all E&S classes. We are achieving this pricing in a marginally more disciplined marketplace. Our new business writings in North America grew 30% year-on-year, while the renewal retention ratio as measured by premium in US retail was 97%, and on a policy count basis, it was 84%. John Keogh and John Lupica are with me and can provide further color on market conditions and pricing trends globally.

In summary, we had a very good second quarter and posted strong first-half results. And we are optimistic about our growth prospects for the balance of the year. P&C pricing globally has turned more favorable, and we are well-positioned to take advantage in many places around the world, although we face the uncertainty from deteriorating economic and geopolitical conditions impacted by the euro area debt crisis and US fiscal cliff. Our earnings prospects for the balance of the year look good, with the notable exception of crop insurance.

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

Thank you, Evan. We ended the first half with a very strong balance sheet and capital position. For the quarter, cash and invested assets grew by almost 1.4% to $58.3 billion. Operating cash flow was strong at $811 million. Tangible book value per share grew to 1.7% in the quarter and is up about 6.5% for the year. Net realized and unrealized losses were $138 million pre-tax, including a $266 million gain from the investment portfolio and a $397 million loss from our variable annuity reinsurance portfolio. The gain from the investment portfolio resulted primarily from declining yields on investment grade bonds, while the VA loss resulted primarily from decreases in worldwide equity values and a decrease in long-term interest rates. Year-to-date, the net loss from our VA reinsurance book was about $120 million.

Our investment portfolio is in very good shape. We have no direct exposure to sovereign debt of distressed European countries, and our exposure to Eurozone financial institutions totals $1.1 billion or less than 2% of the portfolio and is concentrated in northern Europe. The overall credit quality of our Eurozone financial institution securities is AA, with over $550 million rated AAA. Investment income was $537 million for the quarter and was in line with our expectation. Our current book yield is 3.9%. Current new money rates are 2.8%, if we invest it in a similar distribution to our existing portfolio. We estimate the current quarterly investment income run rate will be approximately $530 million on average, with some marginal variability up or down.

Foreign exchange had a negative impact in the quarter, reducing net income by $24 million and book value by about $100 million. Our net loss reserves were up $66 million in the quarter, after adjusting for foreign exchange. During the quarter, we had positive prior period development of about $100 million after-tax, primarily from short-tail lines. Cat losses after tax were $40 million for the quarter. The current accident year P&C combined ratio, excluding Cat losses, is 2.7 percentage points lower than last year's quarter. This is due primarily to our successful efforts to shift our book of business through portfolio management to our higher-margin products, our ability to achieve rate and growth in our short-tail classes, and fewer large losses in the quarter in property and energy this year versus last year.

Our press release issued last night included our updated guidance for 2012. Our range is now $7.20 to $7.60 in after-tax operating income per share for the year. First, the update reflects the positive prior period reserve development and lower than planned Cat losses in the first half of $0.74. Second, the update includes a reduction of $0.19 to reflect a projected third quarter increase in our year-to-date crop insurance loss ratio. Finally, the guidance includes estimated Cat losses of $270 million after tax for the second half of the year. As usual, our guidance for the balance of the year is for the current accident year only.

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

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

And we'll take our first question from Amit Kumar from Macquarie Capital.

Macquarie Capital. Thanks and good morning. Thanks for the color on the range of, I guess, losses for the crop book. My first question relates -- what would be helpful is if we could get the distribution of crop, hail versus MPCI in your crop book. And maybe also talk about group one versus group two and three states.

Yes. We're not doing that. We have given you what you need to know as an investor, our projection. We do the projections, and if there is any material change to the estimate as we put out there, we will notify the Street in a -- all investors in a timely manner.

Okay. How about this? Can you talk about the impact of the stop loss program in your crop book? I presume, when you mentioned the 93% and 94% numbers, those do not factor in the stop loss. But probably the $200 million, which you gave us, factors in stop loss. Is that a fair assumption?

It factors in any of our estimates. We factor in our reinsurance protections, both the risk sharing we do with the federal government and any private sector reinsurance that we place.

Okay. How about this? Final question. There is this debate that this could be similar to 1988, and maybe just comment on this -- what we are seeing in 2012 versus what we saw in 1988. I guess the program was a lot different at that time. But maybe just give us some color as to where you think this might be versus what you've seen in the past.

You are correct. This is -- these are the worst drought conditions that we have seen in -- that has been experienced in the farming community since 1988. It is broad-based, though it is very much concentrated in the Midwest states. And in 1988, crop insurance was much less a factor in the overall financial plumbing of the agriculture industry. It's far more widespread and taken up as a valuable protection and as a centerpiece for the support of the agriculture industry today than it was in 1988. But these are the worst drought conditions we have seen -- have been experienced since '88, that is true.

I guess just related to that, there is this debate that I guess smaller companies might be up for sale down the road, just based on what's happening. Would ACE be interested in sort of that, or you feel that your -- that the current position is good enough, you don't need to acquire any more companies going forward, especially as it relates to the crop program?

Thank you for your questions. I think we can't dominate the call. There are many others in the queue who want to ask a question, and we will move on now. So, thank you.

We will take our next question from Matthew Heimermann from JPMorgan.

Hi. Good morning. A couple of questions. First was, just with respect to the A&H business and combined in particular, can you just remind us what kind of gives you conviction that we are going to bottom out and then spring to neutral next year? I think the international side is a lot easier to get your arms around from an external perspective.

You are talking about combined, specifically, Matt?

Yes.

Yes. It's what we see and -- in the real fundamentals of -- remember, that's an agency distribution channel. So what we see in both growth in number of agents, productivity per agent, retention of business -- of renewal retention of business, and the trends in that have turned positive or neutral in a number of territories, Canada, Australia, New Zealand, the United States, where the core of the business is. And it's those fundamentals that really is what I and the management team measure on a monthly basis and a quarterly basis. We see sustained what we can now have confidence as trend in that. I think management is doing a really good job. And while there's no guarantees around it, it's what we -- it's what gives us the confidence that it's on the upswing that way. Remember, it takes -- you have to see it that way first, because it's $150 to $300 a policy.

Yes. Okay. That's helpful. I guess another question would be just with respect to the rate you are pushing. In the past, you've kind of talked about a need for a lot more rate, and kind of small gains would have to sustain themselves to make this real material over time. I guess, how comfortable are you with your ability to kind of keep pushing rate and kind of finding these incremental opportunities, as we seem to be hitting a point where rates, at least at some companies, are starting to plateau out?

Yes, but -- and you will be able to ask my colleagues, who would be prepared to give you more color around this. But here's what I would say about what we see at the moment about pricing. Property pricing is reasonably robust, particularly if it has any Cat exposure around it. And while the rate of increase has obviously flattened out and is decelerating, it's still positive rate on what is reasonably robust, on pricing. As I say, particularly if it has Cat around it.

When you get to casualty lines, the price increases are more broad-based, and while they are far more muted, we are seeing that they are sustained. The rate of increase is not declining. If anything, it's accelerated a bit, and it is more broad-based. Now how long -- that's obviously ameliorating, and it varies by line of business. If it exceeds trend in any class, then you are actually gaining on an accident year. If the rate of increase is equal to trend, then you are not deteriorating any further. And if it's below trend, it's ameliorating the decline. So in any event, any rate is good rate. And it is more broad-based than it was. And our risk selection capabilities have only improved, and we are getting better risk-reflected pricing because we are more insightful on our portfolio than we were even a year ago or two years ago.

And that last point, is that fair to assume that, like, for separating the good versus the bad, maybe this time around that will be the differentiator? It's just how intelligent the underwriting is in terms of risk selection, rather than your ability to just kind of pump rate through an entire portfolio?

I think that is so axiomatic about the insurance business is that your ability to select better is what differentiates you in the marketplace, period, and your results. That's it. That's the guts of the business. That's underwriting.

All right. Thanks much, Evan.

You're welcome.

We'll take our next question from Michael Nannizzi from Goldman Sachs.

Thanks. Just one quick follow-up on crop. I'm just trying to put my head around this. So, if this is a worst-case year and effectively a Cat year, and it sounded like from your math it would be about a 10 point -- like 110 or maybe 115-point combined ratio, just trying to understand the risk management part of that and how big of a role reinsurance has to play in that sort of risk return. And just one follow-up, thanks.

Yes. Sure. You know, look. Risk management is at every level of the business, when you think about it, because first, it's in how good is your data and how insightful are you in selecting one farm versus another farm and understanding that. How much concentration you take by county, one versus another. How much concentration you take within a state and how you balance your portfolio. And then understanding and having the data -- as we have -- we have both the computer power, the software programs, and years and years of data to be able to do scenario analysis. Now, while none of it's perfect, because the past is hardly the reflection of the future, it makes you more insightful. And then your ability to do portfolio management, because this is a government/private-sector risk sharing. And then from there, what do you do? Do you -- how insightful are you to understand your concentrations? And then further, if you choose to protect your own retentions with stop loss or any other forms of reinsurance protection, which we do do.

Do you expect that reinsurance will get more expensive, then? It sounds like the reinsurers will be absorbing some of this loss. Do you expect that the cost for protection next year will be more expensive, given this year's loss experience?

I can't speculate on that. Remember, Cat is a -- crop is like a Cat business too, and it's long-term. And the pricing reflects long-term experience, not just a moment-to-moment change. So, I really can't speculate on that. I don't know.

Thanks. And then, if I could, one quick one for Phil. Alternative investment income, sorry, I think Huatai Life is a big part of the other investment income, but that piece is now about a third of investment income. Just trying to get an understanding of what drives that -- it seems like about a 20%-plus return. And is it mostly the private investment there, or -- and how should we think about that as it becomes a bigger part of the overall pie? Thanks.

Huatai is actually a part of other income, not other investment income, right? So, other investment income is predominantly private equity and hedge funds.

Okay.

They contributed about $10 million of income to the quarter.

Huatai Life did?

No. Huatai Life is not a part of investment income. It's a part of other income, which is down below the line. It's a partially owned subsidiary, so we don't include that in our investment income.

Okay. So, can you help me understand then? The contributions of fixed income was about 2.8% yield from the supplements, so that seemed like it was about $350 million. The total investment income was low 5%s. So just trying to understand what is the rest of that piece and is that a -- how should we think about that as it becomes a bigger part of the pie?

Okay. I'll tell you what, Mike. Could we take this offline?

Sure.

I'll take you all through it.

I appreciate it. Thanks, Phil.

Hey, Mike, I want to give you one piece of information on crop that I think, rather than just the general, that I can give you specifically. Our stop loss protection attaches at about 104% combined ratio, and it runs up to about 154% combined ratio.

Got it. That's very helpful. Thank you, Evan.

You're welcome.

We'll take our next question from Greg Locraft from Morgan Stanley.

Hi. Good morning. Just wanted to actually pursue sort of a question I have been getting from investors. With investment yields where they are at, with your excess capital being where it's at, a drag of, say, 150-plus on the ROE, and then now we are living through the worst crop loss, probably in the history of the industry. It's actually -- these results are amazing. Double-digit ROE, the guidance is strong. And I guess, what is allowing ACE to outperform the peers, given the headwinds, especially what is -- usually when a company takes a loss like this, the numbers do fall versus peers. But you are laying out top quintile results, even with this loss.

Greg, I am going to try to answer. I am going to answer that for you. But I'm going to say this. I think it is right in front of you, and it's right in front of everyone. It shows itself right in the numbers in a reasonably transparent way. And that is, you see our geographic spread and where we are growing. And we are growing where we know we can make an underwriting profit. And there are areas of the world that are doing better economically than other areas of the world, and the needs for insurance are growing.

Secondly, you look at our product spread. Commercial P&C is now about 60%. The US has become a growth engine for us in the last two quarters, along with Asia and Latin America. And you see an improving pricing environment, and ACE is taking advantage of that because we did trade under -- we did trade market share for underwriting in the past. And we engaged in better portfolio management and shed business where we couldn't make a reasonable return, i.e., E&S casualty, i.e., risk transfer workers comp, where we said we can't make the money. We'll get out of those things, and we will focus on other areas.

We are a specialty underwriter, where an underwriter makes a difference. So our broad spread of casualty products in the US and globally, our growth in commercial P&C in Latin America and in Asia, and then our ability to write a profitable book in the UK, because we focus on casualty and energy and construction and property where we can make an underwriting profit. And then you complement that with our A&H book, which has been built brick by brick in those economies of the world where we see that rising middle-class and that ballast and balance it brings to our overall business.

And crop insurance is a great business. Over any period of time, it has been very good. And it's because we have got a great, insightful franchise in that business. But it's a Cat business. And right now, at this point, while the earnings are under more pressure, they are still projected to be reasonable. And the risk reward balance within that, we think between public sector sharing and private sector protection, we have got the risk/reward balance of what we could lose in a bad year versus what we could earn. So, our management of risk concentration, we focus a lot on it, because this is fundamentally an underwriting company. That's what we do.

And I think -- and from there, we have been saying it. We're planting the seeds today. What you see is results of the things we've been working on the last seven years. And the things we have been planting the seeds for in the last two or three years, they will begin to show in years to come. We're long-term builders. That's what you can tell your investors. Thank you.

Okay. That's great. Thank you very much, Evan. Nice quarter.

We'll take our next question from Mike Zaremski from Credit Suisse.

Thanks. Evan, in regards to the updated guidance, and I know you can't see my model, but if I strip out reserve releases --

I don't want to see your model.

Okay.

I see too many models.

If I strip out reserve releases below planned Cat losses and the crop guidance, the guidance I guess appears to imply no margin improvement or maybe even some deterioration, whereas there was clearly considerable margin improvement this quarter, and pricing momentum has continued. So, does that imply there were some one-time items positively impacted this quarter?

I don't think so. What I would say is that our guidance is almost the same as where we started the year. And when we started the year, we had an anticipation that we would be earning these results. So these really reflect what we have -- what we have in our base plan. The other thing we did, obviously, is reduce the guidance for the crop, the $0.19 of crop.

Remember something. If we have pricing better than we assumed in our plans, it's got to earn its way through.

Okay.

And that takes time. These are pretty good current accident year projections for the balance of the year.

I agree. Phil, you said reserve releases primarily stem from short-tail lines. I guess that differs from previous quarter trends. Should we read anything into that? And can you provide color on the reserve releases this quarter?

No. Not at all. It's a seasonal thing, because we have reserve studies all throughout the year. And in this period, the reserve studies were basically on the shorter-tail lines.

Okay. And lastly then, and this does relate to crop, but -- so did crop impact this quarter's results?

I'm sorry?

Did crop impact this quarter's results, in terms of --.

No, it did not. We don't believe it's a second quarter event. The issues with crop really emerged in July with the weather that we had in July. So, it would be something that's going to affect the third and fourth quarters.

Got it. Thank you very much.

We'll take our next question from Vinay Misquith from Evercore Partners.

Hi. Good morning. The first question is on growth. And I think you talked about it a little bit earlier in the call and last quarter too. But looking at new business up 30%, and I think retentions remained pretty reasonable, just wondering how ACE is managing to outperform peers who are having weak retentions and weak new business.

You know, I can't -- I really can't opine on peers. That's not -- that's not my job. And so, whatever their results are their results. They have different mixes of business. They have different distribution. They have different geographic concentrations or kinds of customer concentrations.

So, I can -- I or my colleagues can answer questions specifically about ACE that we think -- obviously to us, the results we see are logical and make all the sense in the world to us. One thing I told you last quarter that I would keep in mind, our new business writings had dropped off substantially year-by-year-by-year, as they should. It's rational in a soft market. So, the kind of increase -- it's 30%, but it's on a relatively small base of new business. And I said that last quarter when we had robust growth, and I tell you that again this quarter.

Sure. That's fair enough. Then as you look at growth in the future, do think that the slowdown in the economy worldwide will have a negative impact on growth and also your ability to raise pricing?

You know, ACE doesn't exist in a bubble. I think the global uncertainties that really emanate from Europe and from the United States and that are impacting -- that are political and are impacting the economic fundamentals create both headwind and a great deal of uncertainty and inability to predict.

I talk to a lot of CEOs in a lot of different industries. And what is very clear, their level of confidence in the future is -- and their ability to predict with any confidence is at a relative low point, right now, and for the obvious reasons. And if we don't get our leadership and political act together, both in the US and in Europe, this has an impact on economic growth, and it will. And insurance, we are a reflection of activities and society at large, beginning with economic activity.

Fair enough. One last question, if I may, just on margins. You have had strong price increases in the US, maybe flattish outside the US. But you have grown more in property lines. Do expect margins maybe to slightly improve next year versus this year?

Oh, I'm not predicting at this moment. I get the mix question, but I don't want to give you an off-the-cuff answer and don't have a thoughtful answer for you right off the top of my head.

Okay. Thank you.

You are welcome.

We'll take our next question from Larry Greenberg from Langen McAlenney.

Good morning. Evan, I am just wondering if you would be willing to elaborate on really what has to happen in crop for conditions to worsen. And I guess I'm just wondering, as we sit here today, does your current assumption incorporate the highest probability outcome from any visibility that we might have?

It does, yes. It does incorporate the highest probability outcome. Both our current projection as we have it and what I told you as what we can model as a worst case is the highest probability outcome to us, yes. And look, what I gave you, and I said it clearly, but I'm going to say it again. The $0.19 that we just took -- that we are going to take in the third quarter as a charge is based on the conditions today as we see them. We don't expect that it's worse than that. If we thought it was worse than that, then it wouldn't be $0.19. It would be a different number.

But what we do know is there is still that question out there. Could it be worse? And no one can predict the weather. But what we have said -- what we have said was, if these drought conditions continue and you've got this heat and it continues right up to harvest time, what is that likely worst-case outcome? And that is why we put that number out there. It can be anywhere in between. Right now, we are at $0.19, and that's the honest representation of it.

Great. That's helpful. And the volumes in agriculture are about flat year-to-date. You had said that you expected it to be down 250 for the year. Is that still the case, that you would expect crop agriculture premiums to be down that much?

Expect it to be down closer to -- Brian Dowd? $175 million. So, we'll see -- it will be less than the 250, and you will see that -- that will show itself.

Great. Thank you very much.

You're welcome.

And we'll take our next question from Jay Cohen from Bank of America Merrill Lynch.

Yes, thanks. Topic of the day, crop insurance. Just a couple of questions. So you had mentioned that the effect of the drought would be in the second half, sorry, you said third and fourth quarter. I am assuming the $0.19 kind of incorporates sort of an annual impact. Or would you expect an additional loss in the third quarter -- excuse me, in the fourth quarter?

We were saying that we are going to increase our loss ratio for crop in the second half. In the third quarter, we will increase it.

Got it. Okay. Then the second one, it's a small number, but the earnings from the ag line were up pretty substantially from a year ago, and I am wondering what drove that.

Jay? Brian is going to answer that question. But let's be specific. The crop adjustment, year-to-date in the third quarter, the loss ratio is raised 5 points year-to-date in the third quarter. The fourth quarter will carry that same loss ratio, that raised loss ratio that's in your $0.19. So it affects both the third and fourth quarters.

Got it.

Okay. Your second question. Brian?

Second question I think was the year over year second-quarter ag results. And this year's were better than last year. Remember last year in the farm component of the book, we had Cat activity, both flood and tornado losses, and that's the real difference this year. Second quarter pretty benign for us on Cat loss on the farm book versus a crop specific question. Crop, no real change year over year.

Got it. That makes sense. Thanks a lot.

You're welcome.

And we'll take our next question from Josh Stirling from Sanford Bernstein.

Good morning. I was hoping to just get a little bit more color on pricing. The commentary is obviously that it's broadened some of the casualty lines. The professional lines seem to be ticking up internationally, is great. I would love to get your color, though, on if this is leading you to reset your sort of general underwriting posture, which has been sort of very property focused versus casualty over the past couple years. Obviously, in the numbers you report, it looks like you did increase your casualty writings this year. And with pricing going up, it would be nice to know if you think that's something that we should broadly see as just sort of a better place for opportunities these days.

No. I don't agree with how you are viewing it at all. We have many more casualty underwriters in this Company than we have property underwriters. And in fact, we have many more casualty units in the Company than we have property units. The fact is, is we play ball the same way in a soft market as we do in a better pricing market. It's just what's the return we get for the effort. So, guys are just getting -- guys and gals are just getting better returns for their effort right now.

So, we may have quoted 100 risks a year ago in a certain casualty line of business, and our pricing and terms and conditions would have called for X, and that could've placed us right outside the market. And others would do it cheaper. And so they win, we lose. Or in our way of thinking about it, they lose, we win. And now, those same risks -- we are underwriting them the same way. However, the market has raised its standards, and so we are more successful in securing those accounts now. We have not switched our focus. The people who do those lines for a living, that's all they do for a living. They are focused on them. It's just the yields for the effort.

So, marginal change of environment.

We don't take property underwriters and put them in the casualty department.

If I could ask one other headline question, although it's not the headline question we're all talking about, it's obvious you guys have been defensively underwriting for a couple of years broadly. And Europe stress is sort of not an open area, is not new news. I would love to get a sense of some of the policies and sort of just generally industry areas on the liability side that you have been sort of defensively positioned around. And I'm thinking of things like industry exposures to surety, trade credit, political risk, other financial lines, areas where perhaps you have been monitoring the environment and perhaps so would she -- so should we, pardon me.

You are thinking about -- you are thinking in context, Josh, of Europe?

Yes, yes, I'm sorry. In Europe.

I've got it. Fine. Both in Europe and outside Europe related to Europe?

Yes.

Okay. I'm going to ask John Keogh to maybe give you some more color around that.

Josh, I'll give you some color around our trade credit political risk book of business, which is one of the questions you asked. And I'm sure it's a question others have as to the impact of Europe potential on the book of business. One, I can tell you right now from what we are seeing in terms of claim notices or potential for claim activity in Europe or anything that's coming in other parts of the world as a result of the economic slowdown in Europe.

Right now, there's nothing we see that is outside of what we planned for in our loss risk for both political risk and trade credit. Having said that, we do run models and do run realistic disaster scenarios on those books of business. And when we run an RDS that shows what we think would be an extreme event but nonetheless one that we model, which is the breakup of Europe, where the PIIGS leave and the core -- France, Germany -- stay, in the euro and what that would mean in terms of loss to our political risk and trade credit business, that model is out to about $150 million worst-case scenario for loss risk.

Okay.

As respects surety, we have not been a market for surety in Europe.

Great. Great. And just thinking about those sorts of numbers in the political risk business, is that a function of your guys' sort of modest exposure there? Or do you that is something we could extrapolate to sort of broader industry exposures?

Don't extrapolate. That was an RDS scenario specifically around a euro breakup, defined as the PIIGS countries leaving the euro zone. And what would be -- that's a stone in the global pond. And so, what would be your global losses in trade credit political risk as a result of that? It wasn't just the losses in the euro zone region, it was caused by a euro zone breakup. What would be your losses globally, in trade credit political risk?

Great. Well, thanks for the color. Hope we won't talk about it anymore.

Of course, we will talk about it. It's okay.

Our next question comes from Brian Meredith with UBS.

Thanks. Just a couple of quick ones here. So, just a point of clarification. The 5 points that you said, is that for crop or the total ag book?

Crop.

Just crop. That's what I thought. Okay. And then just quickly, the North America growth, how much of that is coming from recent acquisitions like Penn Miller?

Very, very modest. Penn Miller was roughly $70 million of annual premium.

Got you. So it's organic.

Yes.

Great. And then, last question. I'm just curious. The growth you are seeing in your property business, what impact is that having on your PMLs? And do you kind of think of that as potentially you're willing to accept some more volatility here going forward, just because of the attractiveness of property versus the casualty business?

Brian, to date, we have really not increased our PMLs. We have kept them -- they are steady. And the growth we have seen in exposure is within the PMLs as we establish them. Would we be willing? Let's see how pricing looks and opportunity as it presents itself, but we have not had -- we have not increased our PML exposure.

Great. Thanks. Just one other quick one. I'm just curious. Evan, are you seeing any benefit from or any flight to quality going on right now, particularly with what's going on in Europe? And there have been some ratings activity on some of the European insurers. Has that been a benefit to you, and do you see it going forward?

Not really. John, you want to add any color on that?

No, not yet Brian. It's obviously a question that we are looking at on the ground in Europe. But right now, I think it's relatively stable still. The culture of Europe is such that people don't move as quickly in reaction to those kinds of situations as they might here in the US. So I think if there is an opportunity, it's going to be in front of us, as opposed to immediately.

Great. Thank you.

Our next question comes from Thomas Mitchell from Miller Tabak.

Good morning, Tom.

This is sort of a broad conceptual thing, but if the central banks around the world continue to attempt to keep interest rates as low as possible, both short-term and long-term, for an extended period of time, let's say another two years or so, it strikes me that that puts tremendous pressure on underwriters who are less skilled at making underwriting profits than perhaps you are. And I am wondering if you are observing that you having a relatively -- an advantage relative to other insurers is actually helping you gain market share in the markets you want to be in?

Well, Tom, I think what you are saying to me, if I didn't speculate and looked forward and just took the current environment, the current pricing environment is not driven by balance sheet pressure, as you know. It's really more driven by ROE pressure because, of low interest rates, they're already low, investment income is therefore -- is therefore declining for the industry. The yield is declining. And so -- and loss ratios have climbed to a point where ROEs are just so -- under so much pressure, that has driven pricing.

And that is a rational response, as opposed to where it's real balance sheet pressures. And I think that's the -- and so you are already seeing that. And as the marketplace becomes more disciplined in underwriting, it creates varying degrees of opportunity for us, which really varies by line, by territory, and based on our view of what is the experience in that line of business today relative to its price need, relative to what the marketplace will allow in terms of price.

So, I think what you are speculating out loud, you are actually already seeing it. The question is, is to what degree does that continue, accelerate, broaden geographically, and that's a question mark. No one knows. The good news here is, we don't need to speculate a lot about it, because we are ready when it occurs. When pricing improves and it presents opportunity, we are all day long working on our capability to just be there ready to take advantage of it.

That makes a great deal of sense. And then, my second question is -- I think I know the answer. I don't think it's a positive answer, but I was looking for the potential for a silver lining in this drought. Is it possible that the silver lining could be that crop prices are higher in the next crop year and that you end up writing a lot more business?

Commodity prices?

Yes.

That's possible. If I was a good -- or you were good commodity price pickers, we would be the world's great commodity traders. And that's not what either of us do. But of course, it's going to depend on global crop conditions, as well as projected US weather conditions. We all know how -- we all know how easy it is to predict the weather.

Thanks a lot.

And our next question comes from Paul Newsome from Sandler O'Neill.

Good morning. I wanted to also ask a sort of broad question. My supposition is that as prices increase broadly, we should see retentions decline, as well as an acceleration of E&S versus primary. I'm not sure we have seen that. I was curious as to, particularly given your large E&S business, if you thought there was a reason for that, this time around.

Well, I don't think you are looking at a broad, hard market. I don't view this as a hard market. I view it as a -- that we are in a pricing correction period, but hardly in a hard market. And I define that broadly, where prices are broadly adequate or beyond what you require to beat your hurdle rates in terms of combined ratio on current accident year business. So let's start with that.

Secondly, what I'd tell you about E&S is while -- and it's true about a lot of classes, that while pricing is improving, E&S casualty lines pricing is not improving enough to broadly make most E&S casualty lines attractive from an underwriting perspective. To me, it's sort of like the akin would be workers comp, where you look at a -- if the industry is running a 117 or a 120, great. You are getting either 8 or 10 points. It's hardly enough, when you add trend, to put it in the black from an underwriting perspective. Well, that's true about most E&S casualty lines. You are not seeing that classic pattern that you would imagine, though you are seeing incrementally greater opportunity than there was in E&S lines.

For what it's worth, it's raining on our farm.

Cool. You won't be making a claim to us.

I think it's way too early to tell.

Spoken like a true insured.

Our next question comes from Josh Shanker from Deutsche Bank.

Thank you for taking my question. I know there's been too many questions on crop, but it's really what everyone wants to know. Can you talk a little bit about the reinsurance markets and business that you're seeding, and given your scenarios how big a loss you are anticipating for the industry, both in your modeled $0.19 versus your worst-case scenario?

No. Sorry, Josh. On the reinsurance side, I just gave a little bit about how our stop loss works. That's as far as I'm going to go on that. And how the industry is going to run overall in crop insurance is way too early to know. We have no idea. I can talk about us, and I can only tell you what I already said about us, that I think is pretty fulsome.

Well, then I'll try one more way, but I'm sure I'll be denied. Can you talk about --

Then why ask it?

You never know. Maybe I'll get lucky. For your reinsureds, in terms of the loss -- is the loss that you are seeding sizable or right now your retention is high, given your forecast?

Josh, Josh, read -- if you look back on what we -- what I said. I said that we were increasing our loss, our loss. We are increasing our loss ratio by $0.19. And that was 5 points of loss ratio and a combined ratio -- that would put us in a combined ratio below 100%. And I told you where stop loss attaches. So, actually, you did get lucky. I answered.

Very good. Thank you. I appreciate it. And where are loss costs and excess casualty right now? Are they benign at this point?

Loss costs? Well, they are never benign. Excess casualty is never benign. But loss costs are. I'm sorry? Sean Ringsted, our Chief Actuary, will finish that.

Well, Josh, it's benign. I think we have commented in prior quarters we monitor the frequency and severity, and in the second quarter, we do the same. And broadly frequencing severity and broadly bearing it in mind with our expectations. Our expectations are not -- they are not benign.

Then no real change from previous quarters?

No real change from previous quarters.

Correct.

Thank you very much.

You are welcome.

We'll take our next question from Meyer Shields from Stifel Nicolaus.

Thanks. Pardon me. Evan, in your commentary you noted that pricing -- your pricing is better on the E&S side than on the retail side. Is there a similar differential in loss cost trend between E&S and retail?

That it's better on one side than the other side?

Are loss cost trends higher on the E&S side, or is the market just adjusting more rapidly?

Not particularly, no. Not when you measure them on a like-for-like basis, but the portfolios are different. But, if I -- I'm not evading your question, but what I'm telling you is on level, if I could put portfolios like-for-like, they behave the same. But the portfolios, by its nature, what comes into E&S is tougher, more difficult risk.

Okay. That's helpful. Thanks so much.

You're welcome.

And our next question comes from Ian Gutterman from Adage Cap.

Hi, Evan. I think all my questions for the quarter have been picked over, so maybe I'll ask you a bigger picture question. If this cycle is going to play out differently, like you said, it is not a hard market yet. If we're going to sort of be in I guess what we'll call it Goldilocks, which is slow increases in pricing greater than trend, but we don't get a true turn, if you will. How does that affect the way you approach the market? The reason I'm asking is, I think ACE as being a Company who sort of takes advantage of when there's chaos, right? And when there is disruption and there's big opportunities for you to out underwrite people. If we have a sort of more steady market that never gets that big, hard turn, do you have to change the way you approach -- how you seek to grow the Company over time?

No. Ian, let me ask you a question. If we looked at -- what do think of this quarter's growth results?

To be determined. It depends on --

No, ACE's. Do think they were pretty good?

Again, I want to see where there's action years end up first, and then I will tell you. It's not fair to me --

I am trying to answer your question. You just now were asking a different question. So, I think what I'm really trying to say to you is, in this environment, I think we have taken pretty good advantage of market opportunity as we see it. We are not simply built for a hard market. We are built as an underwriting company, to take advantage where we see an opportunity to make an underwriting profit. And that's different than saying you are a company that is just built to take advantage when you can make excessive underwriting profit to fill the holes of the industry's bad behavior from the past, which is typically what happens in an overcorrection in a very hard market.

In this case, we are seeing more opportunity to earn an underwriting profit because of market pricing than we had seen. We have a very broad geography and product portfolio, as you know. And I think our revenue growth in the quarter reflects our capability to do that. I think, therefore, that answers how we will look going forward and why I say to you, no, there is not something to rebuild for a different play-book here.

Got it. Interesting. Thank you.

You are welcome.

We'll take our final question from Jay Gelb from Barclays Capital.

Thank you. I want to touch base on two things. First, would be the Libor scandal for the European banks, what is potential response or coverage implications for D&O and professional liability writers? And then I have a follow-up for Phil.

Yes. I'm going to ask John Keogh to answer that question. And if he's not fulsome enough, then John Lupica will fill it in. Go ahead.

Sure. I will answer for ACE. I can't answer for the industry. First, generally, we are an underwriter for large plan institutions. We don't think it's a surprise to anybody, both here in the US and internationally. I would say that most of our coverage in this space is in the D&O area. We have pulled away from E&O over the last few years and have very little E&O exposure currently. And then further, I suspect it the D&O business that we do, a vast majority of our exposure to financial institutions in D&O is Side A only.

Now to your question about that whole Libor investigation which is underway, I would just be speculating. Right now, the investigations are underway. The facts are yet to emerge. As those facts emerge, they are going to be very specific certain allegations and certain plans and institutions. What that means for that financial institution in terms of liability, what it means in terms of the actual coverage they may have with insurance carriers, that's all yet to play out.

Something like Side A typically, that -- it seems like it -- that may not be designed to respond to civil litigation amounts related to something like that, correct?

Yes. So, Side A is -- it's just for situations where the insured is unable or unallowed to indemnify the individual losses that are covered by the policy. So, the scenario you worry about there, which is the remote one with these big financial institutions, is that they are bankrupt and therefore can't indemnify because they are financially unable to. The more likely scenario attributable to coverage would be derivative action against the financial institution, which because of the specifics of derivative, which is actually pursuing on behalf of the company, those sorts of cases are not allowed to be indemnified. And that would be the scenario that would be covered -- more likely covered by D&O. And then, it's going to be a question of again, the facts. Does cover apply? Are there exclusions? Where do you sit? Are your primary, and therefore are you going to worry about defense costs? Are you using an excess and remote from that? It's something I would be very careful to generalize about in terms what this may mean to any company or the industry.

Right. Typically, regulatory fines and penalties aren't covered under D&O, right?

Typically not. But again, these are bespoke policies, so again, they'll be very fact specific to the actual policy result for a particular financial institution.

You can see that John's been spending a lot of time in the UK.

My suits are.

And then for Phil, the effective tax rate continues to run sort of below that 18% level that has been kind of modeled for a while. What do you think about for the back half? Where could that effective tax rate come in?

We aren't giving guidance on that, but I can tell you that it's going to be driven by where our PTD falls and what jurisdiction it falls in and Cats as well.

Right. So, with the crop losses in the second half, would that have the effect of driving the effective tax rate lower?

I would think -- no -- I would think it would tend to drive it up a bit.

Okay. I will follow-up with you on that. Thank you.

That concludes today's question-and-answer session. Ms. Wilson, at this time, I will turn the conference back over to you for any additional or closing remarks.

Thank you everyone for joining us this morning. We look forward to speaking with you again at the end of next quarter. Thank you and good day.

Ladies and gentlemen, that does conclude our conference for today. We do appreciate your participation.