Everest Group Ltd (EG) 2002 Q3 法說會逐字稿

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  • Good day, everyone.

  • And welcome to this 2002 third quarter earnings release call for Everest Reinsurance.

  • Today's call is being recorded.

  • At this time, for opening remarks and introductions, I would like to turn the call over to Mr. James Foster, Senior Vice President of Investor Relations.

  • Please go ahead, sir.

  • - Senior Vice President

  • Thank you.

  • Good morning, everyone, welcome to the call.

  • With me this morning, as usual, are Joe Taranto, our CEO, and Steve Limauro, our CFO.

  • Before I turn the call over to Steve for a review of the numbers, I'll preface our comments by noting that our SEC filings include extensive disclosure in respect to forward-looking statements.

  • In that regard, I note that statements made during today's call, which are forward-looking in nature, such as statements about projections, estimates, expectations and the like, are subject to various risks.

  • As you know, actual results could differ materially from current projections or expectations.

  • Our various SEC filings have a full listing of the risks that investors should consider in connection with such statements.

  • Now let me turn the call over to Steve Limauro.

  • - Executive Vice President and Chief Financial Officer

  • Thanks, Jim, and good morning.

  • I'll briefly highlight our results in general and then take questions you may have.

  • We are pleased to report another quarter of solid results with operating earnings of $66.5 million, or $1.29 per diluted share, up from a loss of $37.8 million or 82 cents per share for the third quarter of 2001, which included the impact of September 11th losses.

  • Net income, which includes realized capital gains and losses, was 61.3 million, or $1.19 per diluted share.

  • This contrasts with a loss of $43.8 million in the third quarter of 2001.

  • Operating earnings year to date were $202.2 million or $3.97 per diluted share, up 187% from the $70.5 million or $1.50 per diluted share in the comparable period of 2001.

  • Net income at $175.7 million is up from $63.7 million in 2001.

  • These are strong results from what is the continued execution of the business plan in the market which continues to strengthen.

  • The quarter was affected by a $12.5 million, or 24 cents per diluted share noncash derivative valuation expense.

  • This relates to the stock index derivitave transactions described in our 10K.

  • The expense is a function of the dramatic fall in the S&P 500 index as well as interest rates.

  • Excluding this expense, operating earnings were $1.53 per diluted share.

  • I'll note that, as of the close of business yesterday, the valuations for these derivatives have recovered by 8.8 million over 70% and there is no tax on this and this occurs in the fourth quarter.

  • Capitalizing on the improving marketplace, we grew our worldwide gross written premiums, on a year to date basis, up 37.6% to 1.934 billion.

  • Net written premiums are up 54.2% to 1.826 billion.

  • Worldwide gross written premiums for our reinsurance operations are up 29.8% to 1.317 billion, while our insurance operations are up 58% to 617 million.

  • Our U.S. reinsurance operations are up 34.5% with the increase reflecting strong pricing across the property and casualty spectrum, on both facultative and treaty basis.

  • We're particularly encouraged by the recent improvements in casualty lines.

  • Our U.S. specialty operations are up 11.8%, reflecting improving markets from marine aviation insurity, as well as slowing growth in our medical stop loss business.

  • International reinsurance operations are up 41.5% reflecting improving conditions in virtually all of our markets, particularly for our Latin American, London, and Canadian operations.

  • Our Bermuda operations are up 60.6% or $31million of premium.

  • The 58% growth in our insurance operation reflects continued but moderating growth in California workers compensation arrivings, with a growing contribution from excess and surplus [INAUDIBLE] business.

  • As we've indicated before, our view avoids placing too much emphasis on individual quarters.

  • Rather, we focus on the full year, where we expect gross written premiums to be up about 35% with net rating premiums up over 50%.

  • Our combined ratio for the quarter was 96.7% compared to 141.1% for the third quarter of 2001, which was impacted by losses from the September 11th events.

  • Excluding catastrophe losses, which were $10.2 million in 2002, mainly relating to the European floods, the third quarter combined ratio improved nine points from 104.8 in 2001 to 95.8 in 2002.

  • Our year-to-date combined ratio for 2002 is 97.8% compared to 115.3% in 2001.

  • Excluding catastrophe losses, the combined ratio improved 3.5 points from 100.9 in 2001 to 97.4 in 2002, mainly reflecting improving rates, terms and conditions we're seeing in the 2002 underwriting year.

  • It also reflects our continued focus on prudent reserving.

  • For information, I want to point out that this quarter, we've included year-to-date underwriting ratio results for our segments in the supplemental financial material we make available.

  • We believe this is useful information to make available in the earnings framework work, but we do note that this information does and will show variability.

  • Pretax investment income of $86.4 million for the quarter is up 2.9% from 2001's 84 million, generally reflecting the impact of lower interest rate environment, partially offset by strengthening cash flow from operations and investment earnings on the additional capital we raised in the first quarter.

  • The embedded pretax and after-tax yield in the quarter end portfolio are 5.6% and 4.7% respectively, down from 6% and 5% at December 2001, again reflecting lower interest rate environments together with our portfolio actions.

  • The quarter includes realized capital losses of 7.7 million dollars pretax and $5.2 million after tax.

  • Unrealized appreciation was 118.5 million on an after-tax basis driven by the fixed income element of our investment portfolio.

  • Cash from operations for the quarter was 179.9 million, compared to 71.7 million for the third quarter of 2001.

  • Cash from operations through September was 455 million, more than double the 215.5 million for the comparable period of 2001.

  • And this would be an important driver of future profitability.

  • Cash and invested assets stand at $6.7 billion and are up $956 million, or16.5% from December 2001.

  • With the change mainly reflecting our $346 million secondary offering and the $455 million of cash flow from operations, together with $87 million of year-to-date after-tax unrealized appreciation.

  • Total assets stand at $9.0 billion, with $2.1 billion [INAUDIBLE] in the investment portfolio in our Bermuda entities, Everest RE Group, Bermuda and Everest RE Group, Limited.

  • Shareholders equity of $2.2982 billion, or 45,000.18 cents per outstanding share is up from 1.72 billion and $37.19 per share in December 2001.

  • Our annualized year to date rate stands up 14.7%, up from 7.5% in 2001.

  • During the quarter, we repurchased 450,000 shares at an average price of $50.86 for a total cost of $22.9 million, leaving 1.7 million shares under our existing authorization.

  • At these price levels, we believe our shares represented compelling value.

  • As we go forward, we will continue to balance purchase opportunities against the capital needs of our business.

  • As respects capital, we did replace the common equity only shelf registration filed last November and used in February with a $475 million universal shelf registration, which gives us more flexibility as we consider capital and financing issues.

  • I'll also note that. while there is no common appetite for common equity at this point, we are actively considering a potential fourth quarter financing.

  • With respect to more general accounting matters, those of you who make use of our supplemental financial material will note that we have added information beyond the segment ratios which I mentioned earlier.

  • We remain committed to sound disclosure and accounting governance practices.

  • This committment has also led us to implement the expensing of stock options this quarter within the framework of financial accounting standard 123.

  • Our modest use of stock options for aligning the interest of management and shareholders will impact earnings per diluted share by about 1 cent in 2002 and 3 cents in 2003; amounts considered in our guidance.

  • Overall, we had a very strong nine months.

  • We are solidly reinforcing the expectations we had as respects our business, markets, and opportunities.

  • We believe that the strong markets we now see should persist through 2003 and likely beyond.

  • As a result, we are reiterating our guidance for 2003 operating earnings in the range of $6.60 to $7.20 per diluted share, absent unusual loss activity.

  • Overall, we are very pleased with the way 2002 is shaping up from a business perspective, and, in particular the opportunity it gives us to fully use our capabilities and infrastructure.

  • Joe and I will now take any questions you may have.

  • Thank you.

  • Today's question-and-answer session will be conducted electronically.

  • If you'd like to ask a question, you can simply press star followed by the digit 1 on your touch-tone phone.

  • There will be a brief pause.

  • And our first question will come from Tom Shlonke from Goldman Sachs.

  • This is Charles Nolke, but we'll try again.

  • I have a couple of questions, but maybe I'll just do them one by one.

  • On the equity derivative, Steve, can you kind of explain what you're doing here?

  • Where does the S&P have to go until you basically recapture this?

  • I'm assuming if you held everything constant and the fourth quarter was over today, would we see a $8.8 million gain in the fourth quarter?

  • - Executive Vice President and Chief Financial Officer

  • Excuse me.

  • That is absolutely correct, Tom.

  • I mean, basically, we do a black shols pricing model approach to these transactions which at this point in the life cycle of the transactions, which do go out 18 and 30 years is very sensitive to changes in interest rates and changes in the index.

  • And given that interest rates have hit, you know, 30- or 40-year lows and the index has had its worst quarter in 15 years and worst first half in 28 years, these have driven the calculation to the point that we had a $12.5 million charge at September 30th, redoing all of those calculations at the close of business yesterday.

  • You know, we've recovered 8.8 million of that 12.5, or better than 70% of it.

  • The practical matter is, these are transactions which were forced by FAS133 to adopt a very technical pricing model approach that is driven by an assumption that they are market transactions.

  • We wouldn't look at these as market transactions, there's a relative handful of folks who would have the appetite and capacity for these.

  • And frankly, the accounting model produces a very different result from the economic model.

  • On an economic model basis, we wrote these expecting to make a profit.

  • It was consideration of about 17 million dollars.

  • Our expectation was that there would be no loss.

  • Our expectation continues to be that there will be no loss, although certainly the move in the index raises the probabilities a little bit.

  • And which industry are you talking about?

  • - Executive Vice President and Chief Financial Officer

  • The S&P 500.

  • Okay.

  • And I guess second question, in terms of the fixed-income portfolio, looks like your duration came down pretty significantly in the quarter relative to where it was after six months.

  • And it kind of -- there seems to be a disconnect between the capital losses you report.

  • If you could just talk about the relationship there.

  • I would have thought that in this kind of bottom market, you would have been reporting capital gains opposed to capital losses.

  • - Executive Vice President and Chief Financial Officer

  • Sure, the duration is actually down a little bit reflecting point number one, the very heavy cash flow, which was biased toward the latter part of the quarter.

  • Point number two, during the quarter, we have been moving pretty significantly to try and rebuild investments that are tax preferenced in the U.S. municipal bonds investments.

  • So a lot of the trading that we were doing behind the scenes was really oriented to flipping back into municipal bonds.

  • In addition, you know, we ended up with a good amount of liquidity at the of the quarter, which has since been directed back into the longer duration instruments.

  • So I'm not too concerned that the duration has drifted in a little bit.

  • I expect it will drift out a little bit as we get to the fourth quarter.

  • Looking on the expectation that, you know, in this kind of environment, we would be taking gains.

  • We did, in fact, take gains, as we saw trading going on in the taxable portfolio, those gains generally speaking, were offset with capital losses where we did take about $15 million of impairments during the quarter that offset -- otherwise would have been capital gains.

  • We continue to actively monitor our portfolio for credit events and weaker names.

  • We think we have been very proactive over the course of the year, staying on top of this.

  • We did make some adjustments in the third quarter.

  • They were principally smaller kinds of adjustments in the $3 and $4 million range.

  • Okay.

  • Sorry, one last question.

  • I promise I'll make this the last one.

  • On specialty, Joe, if you could give us an indication why you're running that, why the combined ratio is running so high relative to your other businesses in specialty insurance?

  • - Senior Vice President

  • Really, that's driven by the surety component of the specialty reinsurance.

  • The other items within specialty are actually doing quite well.

  • But 2002, for the surety operations, and frankly, I think just about everybody's surety has run to poorer numbers.

  • Clearly, we are doing a lot to change the contract, the market is changing and we expect better numbers going forward.

  • But as far as the combined ratio being above the others, Tom, that's really the surety component.

  • Okay.

  • Thank you.

  • And we will now move to Don Armitage with Beaverton Capital Limited.

  • Hi.

  • Congratulations on a great quarter.

  • Could you just tell me a little bit about whether or not there was any changes to your outlook and your reserve experience, et cetera?

  • How you see any trends with these big settlements and other companies filing for bankruptcy today and every year.

  • - Senior Vice President

  • Yeah, we -- as you'll note from the A&E numbers that we included in the supplemental material, we basically did not incur any A&E losses this quarter.

  • That is the reserves that we've established in previous quarters, we considered to be adequate.

  • We continue to look at our A&E exposures and claims on an ongoing basis.

  • And frankly have not seen anything that is telling us that there's an appreciable change that's going on.

  • We do look at this every quarter, and we really just don't see anything on the horizon.

  • Having said that, you know, A&E is going to be around for a long time.

  • The numbers are large.

  • We continue to try and improve the way we look at it each quarter.

  • And, you know, there's a lot of time and energy spent looking at it.

  • And perhaps Jim Foster could add a bit more there.

  • John, hi.

  • It's much the same today as it was a month ago, two month ago, in that vein, and that's why Steve says we haven't seen material changes.

  • Having said that, the steady state in the asbestos environment is that there is always a lot going on.

  • And there is a lot that we are both active in and in monitoring, all of which feeds into our viewpoint about where our reserves are and where they should be.

  • Within that context, the fact that we've had a couple more companies, one in the U.S., and I think you said one in the UK file for bankruptcy in the last few weeks doesn't change things fundamentally.

  • It's just something that we're dealing with.

  • Yeah, there's a lot going on.

  • But fundamentally, nothing that's gone on very recently has changed our viewpoint.

  • Anything further, Mr. Armitage?

  • No, that's great.

  • Thank you.

  • That's great.

  • Thank you.

  • And we will now move to Bill Whit with Morgan Stanley.

  • Good morning.

  • Could you give an update on some of the new business opportunities you're pursuing?

  • I think I recall last time you talked about getting back into medical malpractice, trucking, if you could comment on growth in [INAUDIBLE], that would be helpful.

  • - Senior Vice President

  • Let me take that question and give a bit of a commentary on the overall marketplace.

  • And what we see is that the marketplace continues to improve at the insurance level, reinsurance level.

  • Much of the improvement after September 11th was initially in the property area.

  • But now we see that improvement really extending to a number of areas within the p&c world.

  • Most importantly, the casualty market is starting to pick up, and we see more and more lines within casualty correcting, both the general liability and some of the specialty lines, like d&o in recent months have really started to show significant changes in terms, rates, and conditions.

  • Of course, in many cases, these changes were needed, but we're pleased to see them continue, and really, if nothing else escalates.

  • These changes are something that we're being able to capitalize on, both at the reinsurance level and at the insurance level.

  • As you noted on the insurance side, our two biggest lines have been workers' comp and medical malpractice.

  • And we see continued improvement in those areas.

  • But now we're starting to see improvements in general liability to the degree that we believe we can do more business on the insurance side, much of it ENS in the coming -- in the rest of the year, in 2003.

  • As far as some other areas, the energy market within the marine market is looking better.

  • The aviation market continues to improve.

  • On the international scene, we're going great guns in Latin America and Canada.

  • We had pulled back in the last few years rather dramatically in Europe and in Asia, as those markets were quite difficult.

  • And we're hopeful that 2003, those markets improve significantly.

  • Clearly it has been a lot of red ink in those areas in the last few years.

  • And now on top of that, especially in Europe, we have the European floods.

  • So there are early signs that 2003, the market could change meaningfully in Europe and in Asia.

  • And we're well positioned to capitalize on that, if that is, indeed, the case.

  • Adding to that, our Bermuda operation is really starting to get in gear.

  • The Bermuda marketplace continues to grow.

  • And we have about 60% growth this year so far in Bermuda, but I expect that to increase well beyond 60 into 2003.

  • So just taking a look at the marketplace overall, there's no shortage of opportunities, both insurance and reinsurance, domestic and international.

  • And on the reinsurance side, both treaty and FAC.

  • Our FAC operations are really doing extremely well.

  • And in this kind of challenging marketplace, a lot more opportunities get thrown into the FAC market.

  • If I could, just two quick follow-ups.

  • The distribution system that you use on the insurance side for some of the new areas, med-mal, I don't know if trucking is considered more of the insurance or reinsurance, but in any event, just generally, the distribution system that you're using?

  • And the other is, I think Steve in the opening comments commented that California worker's comp was moderating some.

  • And if you could offer some thoughts on that, that would be great.

  • - Senior Vice President

  • Well, the distribution system is both open brokerage business.

  • Most of our med-mal is that way.

  • And on the comp side, many have retail agents beneath them.

  • As far as trucking, I'll just touch on that.

  • We only do that on a reinsurance basis.

  • We don't really have any intentions of entering the trucking market on an insurance basis.

  • California workers comp, we continue to like the marketplace, and our position within that marketplace, we took another rate increase in September.

  • The marketplace looks poised for taking another rate increase this coming January, although a chunk of that rate increase will be benefit-related.

  • But what we have seen is that the market in terms of rates have just continued to move up throughout 2002.

  • And frankly, we've taken three or four rate increases in 2002, all of which will work into our January renewals and then adding to that will be the additional change that we'll be taking.

  • It looks to be very good at this point in time.

  • Our results are holding up, turning out to be just what we expected.

  • The marketplace seems to be supporting the rate increases that we are taking.

  • That is, that other companies are taking those rate increases as well.

  • So we look forward to a pretty good 2003 in the California worker's comp market.

  • Thanks.

  • - Senior Vice President

  • You're welcome.

  • And we will now move to Mike Smith.

  • Excuse me one moment.

  • Mike Smith with Bear Stearns.

  • Yeah, my question has been answered.

  • Thank you.

  • And we will now move to Hugh Warner with JP Morgan.

  • Good morning.

  • Everyone this is Dave Schuze with JP Morgan.

  • - Senior Vice President

  • Good morning.

  • Could you just talk a little bit about maybe the end user, the demand for this type of business, and your appetite going forward?

  • And then the second piece of it is on your ability to, I guess, hedge the downside risk or perhaps the volatility across this line.

  • - Senior Vice President

  • I'll tackle that.

  • These are deals that we did simply because we like the economics at the time.

  • We still like the economics and as Steve indicated, we just expected to make a profit on it.

  • We -- really at the end of doing these deals, pretty much said that, you know, that's a good amount that we've parked in this area.

  • We weren't really looking to it then or particularly now, expand on this particular bed.

  • As far as the sensitivity, you didn't see much change in the prior quarter.

  • This is an unusual quarter we had with the S&P index changing dramatically and interest rates changing as well.

  • Of course as Steve noted, we pretty much had the flip side of that.

  • But the reality is we don't really anticipate doing many more, if any of these, simply because these were spot deals that we did at the time that we liked.

  • And just to kind of give us a flavor in terms of the declines or the deals that you put together, is this something that, say, a pension fund would get involved in?

  • Who uses these products?

  • - Executive Vice President and Chief Financial Officer

  • These are generally exposures that fall out when somebody is trying to structure a complicated CDO or CBO application obligation and to get the rating agency they want, they need to get the rating exposure.

  • And generally speaking, there are very few of these, they relate to large deals.

  • They generally go into a market that probably only has five to seven players willing to take on this kind of risk.

  • And frankly, our view has always been opportunistic in the sense that these are not, you know, transactions or derivative transactions you go into with the intent of trading.

  • They are transactions where you look at the risk, you evaluate the risk.

  • And then you evaluate the amount of money you need to get to take that risk.

  • And then you put on top of that, an amount of money that really reflects the shortage of capacity for doing these kinds of transactions.

  • And so, when you do these, you're really only going to do them when they're originally priced at the get-go.

  • And you know, when we see a transaction like that, whether auto derivative or reinsurance, you know, that sparks -- whether it's derivative or reinsurance, that sparks our line.

  • And we don't have all of the exposure associated with them.

  • There are other people in the deal.

  • And so, you know, from a practical perspective, we liked what we saw.

  • We were able to get it at a price that we thought produced a strong economic return.

  • And you know, since the exposure does go out 18 to 30 years, there really isn't a hedging mechanism associated with this.

  • And frankly, as we look at it again, we continue to believe that there will not be any losses.

  • I mean, for us to have losses, what you've got to have is the S&P, essentially, in the case of the 30-year transaction, the S&P actually has to be down 30 days out in the future from the day we incepted the transaction.

  • The expectation is that that is -- I won't say physically impossible, very unrealistic.

  • And we like that kind of risk when you attach a good premium to it.

  • - Senior Vice President

  • But getting back to what Steve has to say, there are very few of these out there.

  • They're usually done because somebody needs to close a deal.

  • Okay.

  • Thanks.

  • That's helpful.

  • And switching gears on the marketing environment.

  • - Senior Vice President

  • Sure.

  • Joe, you sound meaningfully optimistic on the European piece and probably more bullish on calls.

  • Number one, is this operating environment outside the U.S. contemplated in the earnings guidance that you have provided?

  • Was that kind of the forward view?

  • And then maybe just provide some additional color on just, I guess different segments of the market, I guess, just outside the U.S., reinsurance versus primary.

  • - Senior Vice President

  • Well, you know, I am quite optimistic overall.

  • I mean, throughout 2002, the market is just continued to improved and I see it, you know, every day, as I talk to our people about the next month's worth of renewals.

  • More and more classes have kind of moved into the acceptable category.

  • More and more classes have moved into the better-than-acceptable category.

  • I see the continued flight to security, where our security is attracting better business and frankly, I haven't seen a move to this in all of my years in the insurance business.

  • On top of that, our management team has been together, you know we have a very focused culture.

  • We have the financial wherewithal to write a lot of quality business.

  • So I am, indeed, quite optimistic.

  • Doubling back to the European market, you heard what I said, which is that we have been waiting for it to improve for a long time.

  • We now think that the floods should accelerate that process.

  • And we've kind of, in our own thinking and own guidance, built in that we would do more in Europe and in 2003.

  • It's still difficult for us to kind of peg just how dramatically that market will change.

  • We really can't be sure.

  • Frankly, we won't know real well until we're in late December, early January.

  • So I wouldn't say we've built into our own thinking and models dramatic changes in the European market in 2003 that give rise to a significant boost in earnings in 2003.

  • So we're kind of guardedly optimistic, if you will, about the European market at this time, same for the Asian market.

  • But having said that, the U.S. market, the Latin America market, the Canadian market, the London/UK market are moving at a very nice clip.

  • And you can see our numbers for 2002.

  • So a lot of it is already in the bank.

  • But we see the trends that you see in 2002 continuing very nicely into 2003.

  • Great.

  • Thanks for your comments.

  • And we will now move to Mike Lewis, with UBS Warburg.

  • Good morning, everyone.

  • My question has to do with the obvious trend for demand that you're seeing.

  • And some comments you made on your capital or financial positioning.

  • You did raise money at $71 a share a while ago.

  • You are now talking about doing some other financing without equity.

  • Two questions, the rating agencies are a lot tougher, right now a lot more proactive in how they're looking at insurance risk and what capital they want.

  • How are you trying to position Everest to be best positioned to fund the growth that you see in all the different arenas and keep the rating agencies happy?

  • Maybe what I'm trying to ask here is how are you trying to position yourself on a capital basis so you can leverage yourself out enough without getting too far?

  • Maybe you can address that first.

  • - Senior Vice President

  • That's a great question.

  • And I'll let Steve get to the details, but I want to say first that we are in great position with all of the rating agencies.

  • And if anything, you know, we're looking for upgrades here and there.

  • But we want to stay in that great position.

  • We want to keep it a very positive outlook.

  • And we do have a lot of growth.

  • And we do have to support that growth.

  • Without diluting shareholders' interest.

  • With that, I'll give Steve the lead-in.

  • - Executive Vice President and Chief Financial Officer

  • As Joe mentioned, we're -- we are in great shape with the rating agencies.

  • In fact, Standard & Poors has us on a positive outlook.

  • We're very sensitive that in this marketplace, with the flight to quality, our capital base is really very important.

  • So we continue to look very hard at the capital alternatives available to us.

  • You know, we, from the perspective of capital, have not previously used hybrid equity.

  • That is, forms of debt that get capital treatment from the rating agencies to the extent we did anything in the fourth quarter, we'd probably be going in that territory.

  • Seeking to essentially build out the capital structure and take advantage a form of debt, if you will, that gets equity treatment.

  • We are very sensitive to that, ratings are a part of what we sell.

  • We want to stay ahead of the curve.

  • We have seen a dramatic amount of growth this year and expect good growth next year.

  • The capital we raised earlier this year positions us very well, but we continue to want to stay ahead of it.

  • It is important to us to focus on, you know, moving that S&P positive outlook to an actual notch improvement in our rating.

  • We certainly want to make sure that we do nothing to diminish the pluses we're seeing in the market place from offering very high security capacity.

  • Thanks.

  • And just a quick follow-up.

  • Could we read into what you've said today and with what's going on in the derivatives?

  • Any change in your appetite for financial solutions type business?

  • Is it really worth, you know, pushing that kind of business with the fluctuations or the volatility that may be there?

  • And secondly, was it maybe Joe being a little more conservative in the past?

  • What I'm trying to understand is what has really changed in the last three months that makes you feel so much more optimistic the way the market is going and extending the cycle out at least a year.

  • Wasn't this all there after the July renewals?

  • And I'm just trying to figure out what's changed in the world so much in the last three months?

  • Was it just a cautious attitude by management?

  • Or are there major, major changes?

  • And what brought it on in the marketplace?

  • - Senior Vice President

  • I think, Mike, what's happened is the marketplace has just continued to improve.

  • And we see some classes of business, particularly in the casualty areas that I would have told you, in last June, still weren't anywhere where they needed to be and weren't showing signs of getting there.

  • Having some of those classes move in a meaningful way in the last three months.

  • Also in the last three months I guess we've had European storms, which have given us a little more hope for the European marketplace.

  • But generally speaking, I'd like to think that we were positive, you know, even a quarter ago.

  • We certainly published very good numbers through the course of six months.

  • And now you're seeing continued very good numbers through the last nine months.

  • But I am seeing this where our security is just selling better.

  • You are now seeing a net premium that's up rather dramatically for nine months.

  • And we're seeing parts of the market continuing to come around, as well as the other parts of the property, et cetera, maintaining themselves at a pretty good level.

  • So our insurance operations are firing on all cylinders.

  • I think the key with us, Mike, is that we have a real diversity of product line.

  • And we have a lovely distribution system around the world.

  • And, you know, in the marketplace improvements, mainly in the property side, we were certainly pleased to do more in that area.

  • But now that we see it extending to other areas, I think we're just very well positioned to take advantage of that.

  • Okay.

  • And just a follow-up.

  • Do you need derivatives kind of business or financial solutions as much now?

  • Are you going to pull back on that a little and concentrate on what a-

  • - Senior Vice President

  • No.

  • Let me explain that.

  • I think you have the wrong understanding of that.

  • There have been some companies that have clearly made a business out of what they call financial solutions and derivatives and hired scores of people to open up in those areas.

  • We have not done that.

  • We don't plan to do that.

  • This particular deal that we did here was just something that came our way that we liked.

  • And that will always be the case, that if something comes our way that we like and we think makes good economic sense, then we'll enter into it.

  • But we, unlike some others, have not really opened up shop to in a very, very big way to financial -- derivatives.

  • Thank you very much.

  • I appreciate it.

  • - Senior Vice President

  • You're welcome.

  • And we will now move to Susan Stevac, with Wachovia Securities.

  • Can you hear me?

  • - Executive Vice President and Chief Financial Officer

  • Yes.

  • Good morning, Joe and Steve.

  • Great numbers.

  • You really did surprise me.

  • I wanted to explore a couple of issues.

  • The first one, I asked this down in Bermuda last week and I couldn't get an answer, so I'm hoping to get one from you, Joe.

  • - Senior Vice President

  • Okay.

  • Casualty rates, and we all know how bad the U.S. casualty market has been from a reinsurance standpoint since I guess the mid-90's.

  • - Senior Vice President

  • Right.

  • How much have they had to improve the rates and how much rate can you get for it to be attractive for you to write?

  • - Senior Vice President

  • Yeah, you know, well, that's -- I always like to break it down into kind of the categories.

  • You are right that the casualty rates in general in 2000, even 2001, and almost all classes were beneath what they needed to be.

  • And then we started seeing in 2001, some pockets of that business starting to change, at least early in the year.

  • Med-mal was starting to change dramatically.

  • And there were some -- pockets within the med-mal world that we were suddenly attracted to.

  • Although I would tell you probably 90% we probably weren't attracted to.

  • The trucking world, which we had stayed away from for years, suddenly in 2001, we saw some meaningful changes there.

  • And more of that market looked interesting to us because they were getting rate increases like 40 and 50% in 2001, over 2000.

  • The workers comp area, we've talked about California, where we've increased rates rather dramatically.

  • That's been perhaps the most dramatic rates in terms of state increases.

  • But a few other states have looked pretty good to us.

  • Probably -- and then specialty lines like , frankly, corporate D&O, I think that needed some very dramatic changes.

  • And I did not see those changes start taking place until this past July.

  • But I have seen pretty meaningful changes since July.

  • In fact, we had our own D&O renewal in the last couple of weeks, and I can assure you the rates are on their way up.

  • The general liability section of the market, which is very big; umbrella liability, product liability, those are areas that I thought have needed the most in terms of rate increases.

  • Trying to explain more, guess at what the market is collectively getting today.

  • It might be oh, 30%, 35% over what it was getting last year.

  • But many, many of those classes still require another round of at least that kind of rate increase to get where they need to be.

  • Doesn't mean that there aren't pieces of that marketplace that we now think are worth doing, whereas a year ago, there was nothing in that marketplace that was worth doing.

  • So the -- kind of summarizing it for you, it's a mixed bag, but it's all starting to improve.

  • And some pockets of it now look quite good, where if you have quality underwriting, you can pick out those good parts.

  • Some parts of it are still to be avoided, in my opinion.

  • But I do believe most of these casualty rate changes will continue throughout 2002 and 2003.

  • Just to follow up, Joe, are you seeing it on -- are you seeing a switch to excess business from proportional?

  • Or are the underlying primary rates going up?

  • - Senior Vice President

  • Well, you know, it's a combination.

  • Certainly the underlying primary rates are going up.

  • That's without a doubt.

  • And that, of course, make its more attractive to begin with.

  • I would say that more of what we are doing is excess.

  • But that's not just because we might prefer it on that basis.

  • I think what we're seeing is a lot of the buyers are more keen to keep more of the risk as they like the underlying rates going up a bit more.

  • So it's kind of both of those going on.

  • But clearly underlying rates are going up.

  • And then reinsurance casualty rates are ticking up on top of that.

  • And I'm just assuming that a great portion of your growth is coming from these other players just dropping out of the market, a lot of the European reinsurers?

  • - Senior Vice President

  • Well, a lot of European reinsurers have had serious trouble.

  • And yes, that's kind of benefited us.

  • A lot of other players, even if they have sizable surplus, have had management changes and are really trying to kind of figure out just what to do in this marketplace.

  • And that has benefited us.

  • Our ratings -- our, you know, solid base, the fact that we've had the same management team at the company is really serving us very, very well at this point.

  • Okay.

  • And Steve, I don't want to leave you out.

  • In terms of talking about capital raising, did you say that you're not going to do equity?

  • Or you just left that open?

  • That's number one.

  • And then number two, where is the premium for surplus now?

  • And you know, where do you want it to be to get that upgrade?

  • Like what's your capacity for raising the capital from a debt standpoint?

  • - Executive Vice President and Chief Financial Officer

  • Yeah.

  • On the issue of equity, we don't have a near-term appetite for common equity, particularly where the stock is trading.

  • But even generally speaking, what we did earlier in the year positions us so that we can build out other elements in the capital structure.

  • You know, having said that, we're looking at a premium to surplus level this year of roundly one to one.

  • It's a little disproportionately allocated between our U.S. operations and our Bermuda operations.

  • But we are seeing, you know, an ability to deal with that through internal reinsurance.

  • We are looking for substantial growth next year.

  • We have been very fortunate to build a good bit of capital this year through the equity offering, through significant gains in unrealized appreciation.

  • We think as we get into the fourth quarter and we look at one of these hybrid mechanisms, nothing too fancy, but something that would give us some equity credit.

  • That builds the story.

  • We continue to want our capital adequacy scores as done by each of the rating agencies to improve.

  • We think that we'll be able to engineer that.

  • As I look to the future and anticipate considerable growth next year.

  • You know, we'll be growing a lot of our capital through earnings, but there's always the need to make sure that we keep the ratings momentum up.

  • So that's really what the focus is.

  • Okay.

  • Thank you.

  • And we will now move to Marco Pinzon with Salomon Smith Barney.

  • Hi.

  • Good morning.

  • A couple of questions.

  • Number one is, clearly insurance has been increasing as a share of your overall book of business, and I think, Joe, in your comments, you mentioned that the workers comp environment still remains attractive.

  • Med-mal is an area that you've been growing in.

  • You're looking to make, I guess, a greater move into GL .

  • As of the first nine months of 2000, insurance, if I have the numbers right here, comprise some one third of your overall book on a premiums growth business.

  • Where should we expect or where do you kind of see the mix falling in 2003, given your current view of both reinsurance and insurance markets?

  • - Senior Vice President

  • Yeah, I think that one third might be a little high.

  • And certainly on a net basis it's lower than that.

  • But I think I see very good opportunities at this stage both in reinsurance and in insurance.

  • Now, you know, if the European markets really open up, that obviously would mean reinsurance is going to grow a bit more than we would have thought otherwise.

  • But there's also some excellent new frontiers on the insurance side.

  • Probably reinsurance will grow a bit more than the insurance operations in 2003.

  • But that's not actually the way we run the company where we kind of decide how much one is going to grow.

  • We're going to look for quality opportunities and frankly try to capitalize on as many of those as we can.

  • And if that means that insurance grows more than reinsurance, then that's absolutely just fine.

  • I think the bottom line is I see some very good opportunities, both reinsurance and insurance in 2003.

  • Okay.

  • Fair enough.

  • Not to beat a dead horse, but if I can get back to the derivatives real quick.

  • At the end of the second quarter, I think there was 2 million in net exposure remaining on a credit default swap.

  • Now we have the issue with the equity options.

  • Can you give us a sense as to what your aggregate net exposure is today on all the derivatives business that you have?

  • - Executive Vice President and Chief Financial Officer

  • Well, you know where it is on the credit.

  • It's roundly that same 2 million.

  • On these equity index, it is hard to put a number on it.

  • If you look at where we were at the end of the quarter, with, you know, the S&P in the seller and interest rates as low as they have been in 30 years, the practical matter is I'd kind of look at that as being the outside movement in the valueuation.

  • And now, Marco, if you'd like to talk about kind of the mechanics, we can certainly do that, perhaps off line.

  • But it's very hard to quantify what the exposure is when you've got an 18- or 30-year transaction that requires that in 18 or 30 years, the S&P index, you know, stay at about the level it's at today.

  • And while the theoretical calculations says, you know, that limit could be big, the practical reality is we think there's really very little exposure unless the free world as we know it comes to an end.

  • Well, I hope that doesn't happen.

  • - Executive Vice President and Chief Financial Officer

  • Yeah, me, too.

  • Just one last question.

  • I notice the increased borrowings on some of your credit facilities during the last three quarters.

  • What's going on there?

  • - Executive Vice President and Chief Financial Officer

  • That was simply to fund the repurchases that we did in the quarter.

  • And you know, we'll be brought down a bit as we get through the end of the year.

  • Okay.

  • Great.

  • Thank you.

  • And we will now move to Paul Newsome with Lehman Brothers.

  • Thanks.

  • I just want to beat this dead horse with the derivatives just one more time.

  • The -- I was surprised that the equity thing even existed.

  • Could you just walk through what you have there in the derivative exposure?

  • You have the credit, the S&P 500?

  • Is there anything else that we should be aware of that could affect the earnings?

  • - Executive Vice President and Chief Financial Officer

  • There is not.

  • The credit default exposures done on a derivative basis are essentially done.

  • There's about a $2 million after-tax possibility left in those.

  • But the bulk of those is gone.

  • These S&P 500 derivatives are, you know, they are what they are.

  • They were five transactions done in 2001.

  • And the practical matter is, you know, they -- that's all there is.

  • There isn't anything else.

  • Next question.

  • - Senior Vice President

  • That's an easy answer.

  • Thank you.

  • Yeah.

  • Anything further, Mr. Newsome?

  • No.

  • I'm all set.

  • Thanks.

  • And we have time for one more question and that question will come from Adam Star with CRM Investments .

  • My dead horse has already been beaten.

  • - Senior Vice President

  • Thanks, Adam.

  • Okay.

  • With that, I will now turn the call back to Mr. James Foster for closing remarks.

  • - Senior Vice President

  • Thank you.

  • Once again, we appreciate you all joining us this morning.

  • If anyone has follow-ups, Steve and I will certainly be here to take your calls.

  • And have a good day, everyone.

  • And that will conclude today's program.

  • We thank you for your participation.

  • You may disconnect at this time.