Everest Group Ltd (EG) 2004 Q2 法說會逐字稿

Good day, everyone.

Welcome to the second-quarter 2004 earnings release call of Everest Reinsurance.

Today's conference is being recorded.

At this time for opening remarks and introductions, I would like to turn the call over to Ms. Beth Farrell, Senior Vice President of Investor Relations.

Thank you.

Good morning and welcome to the call.

With me this morning I have Joe Taranto, our CEO, and Steve Limauro, our CFO.

Before I turn it over to Steve for a review of the numbers, I will preface our comments by noting that our SEC filings include extensive disclosures with 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 SEC filings have a full listing of the risks that investors should consider in connection with such statements.

Now let me turn it over to Steve Limauro.

Thanks, Beth, and good morning.

I'm pleased to report that Everest had its best ever earnings quarter with after-tax operating income of 174.4 million or $3.07 per diluted share, a 63 percent increase from 2003's $107.1 million or $1.94 per diluted share.

Net income, which includes realized capital gains and losses, was $264 million or $4.64 per diluted share, a 141 percent increase from 2003's $109.6 million or $1.99 per diluted share.

On a year-to-date basis, operating income is $325.9 million or $5.73 per diluted share, a 54 percent increase over 2003's $211.2 million or $3.96 per diluted share.

Net income year-to-date is $390.1 million or $6.86 per diluted share, reflecting a 91 percent increase over 2003's $203.9 million or $3.82 per diluted share.

We believe these are excellent results, and with continuing strong company fundamentals coupled with a changing but still solid market, we continue to expect 2004 to produce great financial results.

On a year-to-date basis, we have written $2.3 billion of gross premiums, and increase of 12 percent over 2003.

This includes an 11 percent increase in our reinsurance operations and a 13 percent increase in our insurance operation.

Worldwide total net written premiums at $2.2 billion and total earned premiums at $2.1 billion rose by 15 percent and 28 percent respectively.

Focusing on year-to-date gross written premium, which we believe minimizes quarter-to-quarter variability inherent in our writings;

I will highlight the segment writings as follows.

Our U.S. reinsurance operations are down 5 percent to $687 million, reflecting modest softening with respect to property lines and facultative business in general, partially offset by continuing strength in casualty treaty business.

Our U.S. specialty operations are down 17 percent to $225 million, reflecting flat markets for marine, aviation, and surety, and a reduction in our accident and health business.

International reinsurance operations, which with the first quarter sale of the UK branch from Everest Re to Everest Bermuda have been restated to shift the results of the UK operations to the Bermuda segment, are up 64 percent to $306 million, reflecting continued favorable, conditions in Latin America, Canadian, and Asian markets.

Our Bermuda operation, again including the UK operations for both years, is up 42 percent to $428 million from $302 million in 2003.

Basically, Bermuda now offers a full suite of treaty and individual risk coverages, as well as treaty coverages in the UK and Europe through its UK branch.

For those of you who had asked for a quarter-by-quarter pro forma with respect to international and Bermuda, I ask you to note that we have included this information in the financial supplement on our website.

Our insurance operation is up 13 percent to $665 million, reflecting continued moderation in the growth of workers' compensation business and growing diversification into E&S lines and selective direct brokerage writings.

Although our workers' compensation production relationship with AARIS in California will end in mid-October, our diversification efforts have been deemphasizing this source, and we expect that our insurance business will continue to grow.

Importantly, across all of our segments, changing and variable market conditions but generally characterized by pricing which remains at or above adequacy, have on balance caused us to become more wary and, therefore, more vigilant as respects underwriting discipline.

Turning to underwriting results, the quarter reflected a combined ratio of 91.5 percent, bringing our year-to-date combined ratio to 91.1 percent.

These are down 4 points and 3.4 points from the 95.5 percent and 94.5 percent reported in the respective periods for 2003.

Catastrophe losses negligible in the second quarter versus 28 million in the second quarter of 2003 contributed, as did overall improvement in rates, terms, and conditions.

Probably offsetting these improvements was $49 million of net adverse loss reserve development with respect to asbestos exposures.

This development relating mainly to our Mt. McKinley exposures reflects increasing clarity on ultimate settlements, as we have had significant progress in the last few months bringing cases closer to conclusion.

Reserve runoff apart from asbestos was fairly nominal.

Reserve strength remains an ongoing focus with net loss reserves increasing $258 million for the quarter and $625 million year-to-date.

Pretax investment income at $136.8 million for the quarter is up 34 percent from 2003's $102.2 million, with $24.3 million of the increase relating to income from other invested assets, primarily one limited partnership which had an extraordinary quarter.

You may wish to review the supplemental information we have added in our Web supplement, which has been expanded to segregate such assets and the return thereon.

Excluding the other invested asset income, pretax investment income was $108.1 million, up 11 percent from 2003's $97.7 million, principally reflecting our growing asset portfolio.

After-tax investment income was $110.8 million, including the LP income, and $91.4 million excluding it, up 26 percent and 7 percent actively.

The embedded pretax and after-tax yields of the quarter and portfolio are 4.6 percent and 3.9 percent respectively, down from 4.8 percent and 4.1 percent respectively at December 31, 2003, generally reflecting the interest rate environment and an increased proportion of cash and short-term holdings.

The quarter reflected realized capital gains of $116.7 million pretax and $89.6 million after-tax as we closed out our position in interest-only strip securities, generating virtually all of these gains.

With the unwinding of these positions, which had contributed negative duration, our duration ended the quarter at 5.4 years, up from 4.2 years at December 31, 2003.

Unrealized depreciation on the company's investment portfolio declined by $344 million pretax and $265 million after-tax, principally as a result of interest rates changes.

Cash from operations was $393 million for the quarter, including a onetime $44 million annuity portfolio outflow.

That is up 11 percent compared to $353 million in the second quarter of 2003.

On a year-to-date basis, cash from operations was $793 million, up 16 percent from 2003's $681 million.

Cash and invested assets stand at 10.2 billion and are up $924 million or 10 percent from December, 2003, with the increase mainly reflecting our $793 million of cash flow from operations and the $320 million proceeds of our April trust preferred offering, partly offset by a $196 million decline in unrealized depreciation on our investment portfolio.

Shareholders equity at $3.365 billion or $60.02 per outstanding share is up 6.3 percent from the $3.165 billion and $56.84 per share at December, 2003.

Our annualized ROE stands at 22 percent, up from 18.1 percent for the year ended December.

In summary, we had a great quarter and our continuing strong fundamentals position us for a great year in 2004.

Accordingly, we are raising our guidance for 2004 for an operating earnings range of $10.50 to $11.50 per diluted share, absent unusual loss activity.

Overall, we remain focused on a very disciplined approach to our markets and using our expertise, capital, and infrastructure to maximum advantage on still strong business opportunities.

Joe and I will now take questions you may have.

Actually, I think Joe wants to make a statement, so I will turn it over to Joe.

Thanks, Steve.

I would like to just make a few brief comments with regard to what we have seen most recently in the marketplace, particularly commenting on the July renewals.

If I had to use one word to categorize what we have seen, it is disappointing.

We have seen a continued decline certainly on the short-tail business with regard to insurance rates.

In fact, property rates if anything in July we thought were down a bit more than we had seen in months just before July.

Casualty insurance rates where we had seen a flattening in recent months in terms of rate changes, we are now at least for certain pockets seeing rate reductions.

Some of those pockets include the excess D&O business, umbrella business, California workers' comp business.

Reinsurers, we did see more competition amongst reinsurers.

Frankly, we're seeing a lot of reinsurers (ph) and reinsurers looking back at the absolutely terrific results that have been achieved in the last couple of years, aggressively pursuing market share and not adjusting, in our opinion, to the changing market conditions as much as perhaps they should be.

This is something that Everest will not do.

We will change as market conditions change.

Clearly, we will do less business in our property fac operation.

That is something that the market still is okay and offering reasonable opportunities, but by no means as robust as it was a year ago.

We will do less business in our individual risk property operation, which is out of Bermuda; again, a market that I would characterize as good, but not what it was a year ago.

We will do less business in the medical stop loss area.

Again, there is opportunity, but rates are off of the peak of last couple of years.

And in pockets of the casualty business, especially the areas that I previously mentioned, we will be more cautious going forward.

Going into the year, we had kind of guessed that our top-line growth for '04 versus '03 would be in the 10 to 15 percent area, and through 6 months we are pretty much tracking with regard to that estimate.

Having said that, I do not see the second half of the year coming up to that.

In fact, I think we may write less in the second half of '04 than we did in '03.

Once again, there are opportunities.

There is certainly a very, very meaningful amount of business that is reasonably priced that we're very happy to do, but when I compare it to 1 year ago and the opportunities we were seeing then, it is again just not quite as good.

So, as Steve indicated, we're happy with the results.

We expect to have continued good results, top line, bottom line, but the market has dipped, and second half of the coming year, my sense is we will probably do a bit less than we did a year ago second half.

We would be happy to take any questions that you have.

Thank you. (OPERATOR INSTRUCTIONS) Thomas Cholnoky with Goldman Sachs.

Two questions, one clearly on asbestos.

This is the second quarter in a row that you've strengthened reserves in asbestos, and I guess I'm just a little confused as to what has changed in a 90-day period that would cause you to strengthen reserves by as much as you did.

And are we getting to a point where you are filling up the bucket?

I mean, are we 50 percent full, are we 100 percent full, or is the environment changing so dramatically that this is going to be a line item that we are just going to have to consider factoring into our estimates going forward?

I just want some more color on what is really driving this and where are we in this continuum?

Tom, most of what we've done this quarter is on Mt. McKinley and, of course, on Mt. McKinley where we have a direct relationship with the policyholder, we have over the past year or so significantly topped (ph) our focus on actively engaging with those policyholders, particularly where they have potentially significant asbestos exposures, looking to achieve settlements; where basically we are able to strike a deal which gives us what we view is a very good economic result and which hopefully settled the entire exposure at some modest percentage of the potential that we have.

Certainly you have seen through the disclosures that we've had for the first and the second quarter that we settled 2 cases.

We've settled 2 additional cases in the last few weeks and, as a practical matter, we have very active discussions going on with several additional policyholders.

Basically, what we are trying to do is strike settlements which we think make sense.

As we have entered into these very intense negotiations, it has become apparent to us that we needed to adjust our reserves for these cases and make an appropriate provision for IB&R.

We have done that and we will continue to do that as these negotiations and our normal, underlying settlement activities continue going forward.

As to where we are on a continuum, I would have to say that asbestos is a very difficult exposure.

The environment is very difficult.

Particularly on the Mt. McKinley side, our discussions and exposures with individual policyholders are very unique and very case specific, and the practical matter is it's not clear what the right answer is.

And so what we do is go through a process that we have been going through for some time now of trying to review all of the particularly significant cases on Mt. McKinley, as well as review the cases that we don't put into our high-profile group on Mt. McKinley and review all the exposures we're aware of on the reinsurance side, trying to get what we believe is an appropriate reserve established.

Having said that, asbestos is a very difficult exposure to deal with.

There is a changing environment.

There is lots going on at the individual policyholder level and at the treaty level on the reinsurance side, and we certainly have made clear that it is not possible for us to put a range around this.

By the same token, we have tried to do the best job we could on a quarter-to-quarter basis, getting to what we believe is the right answer.

Tom, let me add to that that in the last 6 months, there's been tremendous amount of settlement activity, I'd probably say more in the last 6 months than in the prior 6 years.

So I think there's been a lot of progress in the last 6 months, certainly for our book of business, in bringing a lot of these cases to finality or pretty close to finality.

Can you give us at least some insight as to the cases that you've closed, what percentage of that exposure are we along the way?

Have we kind of only closed 10 percent of your potential exposures?

Are we taking some good swipes out of your exposures so that the need to strengthen reserves on a go-forward basis will slowly start to diminish?

No, I think we've kind of made progress on a really meaningful chunk of really top exposures.

I think it's important to note, Tom, that we really have been very focused on the larger exposures, and most of that really relates to those 26 or 27 that we identify as high-profile.

We have knocked off 2 that's through the disclosure, 2 subsequent, and we've got several more in progress.

Certainly, it's a significant element of the exposure on those individual names which are our biggest names.

I shouldn't hog the whole call here.

Please, next.

Stephan Petersen with Cochran, Caronia Securities.

Steve, a couple quick trivial questions here.

The limited partnership gain in the quarter, can you provide any more color on that?

I assume it's going to be a non-recurring benefit.

Was the partnership liquidated?

There is one partnership that is driving it.

Basically, that partnership is in a liquidation mode.

We got into it in 1993.

We have under 10 percent of the holdings.

It is a private equity partnership that had not done very well for us up until this point, but the practical matter is they struck it pretty well on an individual investment they had made, and we have now seen the reporting to us of the results of that revaluation to market, which we actually bring through using our equity method as an investment income item.

I would comment that generally speaking, our other invested assets do produce a reasonable return, and so there is an expectation that we are going to generate a reasonable yield on $130'ish million of other invested assets that we have.

But the practical matter is you are not going to see too many repeats of the $24'ish million that that group of assets generated for us this quarter.

And the current duration at 5.4, fairly comfortable with that, or should we expect any change there going forward?

I think we're fairly comfortable with that.

The practical matter is when you look at our interest rate risk, you certainly see on the accounting side the revaluation of our assets, basically to a net present value, i.e. market value.

What you don't see coming through, our income statement is the same kind of an adjustment with respect to our liabilities.

I think you are aware there is a mismatch that we basically book through our income statement the ultimate undiscounted losses, and we have on our balance sheet a significant amount of losses and unearned premium reserves which turn into losses.

As we look at what happens to the net present value of those liabilities, getting at the concept of the equity that we have embedded in those loss reserves, we basically look at roundly 6.7 billion of total loss reserves and adjusted unearned premium reserves as being discounted at about a 25 or a 27 percent rate.

We think that has got about an 8.3 or 8.4 average maturity, a duration in the mid 5's.

And if you look at how that is influenced by interest rates, we are guessing that where we saw about $340 million of pre-tax change on our asset base, our fixed income asset base during the quarter, that is a reduction of unrealized depreciation, we probably saw almost $300 million of increase in the equity we hold in our loss reserves when you adjust for comparable interest rate moves.

So we are reasonably comfortable with the duration where it is.

We think we have got a reasonable match against our liabilities.

I would comment as well that as we look at the portfolio, greater than 50 percent of our assets turn over in the next 5 years.

We are adding significant amounts of cash flow.

There is an accounting concept where some folks might categorize their assets as held to maturity and, therefore, keep them at cost as opposed to marking them to market.

We don't do that in the sense that we look at the entire portfolio as available for sale, but the practical matter is we generally speaking do hold many of our investments to maturity.

So you put all of that together, and I don't mean to be long-winded, but I think we're very comfortable.

Now, we did sell off the I/O portfolio this quarter at a gain of about $117 million.

That really -- the I/O portfolio was actually reducing our duration by about 1.6 years of the end of the year.

That reduction is no longer there, so what you see is the underlying duration that is the traditional duration calculation.

We have shortened it a bit through a buildup in cash and short-term assets.

We will continue to monitor it as we go forward, but I think net-net we feel pretty comfortable that we've got the right balance of investment income and duration.

Terrific.

Thank you.

Michael Lewis of UBS.

I have 2 questions.

Number 1, if you look at your guidance, what you're telling us is there is further reserve strengthening.

Because if you factor in somewhat more normal weather, you're running combined ratios over 90 percent the rest of the year, even in your most favorable scenario.

So maybe you can address that.

Number 2, with the sharp fall-off in production and what Joe said about the reinsurance renewal period and the further reduction likely into 2005, it appears to me you are generating excess capital.

When do you start addressing the capital management issue and when are you going to start returning capital to shareholders, and how are you going to do it?

Let me start that and Joe can chime in.

Mike, we're certainly not projecting continuing adverse development.

We basically, as you know, try and get our reserves right at the end of every quarter.

That is the requirement for us.

That is the practice that we have had in place.

As we look over the remainder of the year, there are a couple of things that are causing us to consider and issue the guidance we have issued.

Point number 1, there is the potential for caps and we certainly do want to make sure that we have a normalized provision for caps.

Point number 2, it has been an extraordinarily benign period with respect to property losses over the last couple of years.

We would expect that there is at least the potential of some reversion to the mean, and that is certainly something that we have considered.

Point number 3, we certainly have seen some good things happening in terms of investment income.

The benefit this quarter from limited partnership holdings, generally speaking considered a non-recurring kind of a thing.

We are very comfortable with our cash flows, but as we look at investment yields, it is not clear how those yields will play out in the future, and we have built up a considerable base of cash and short-term assets over the last quarter.

We also have continued our investment program in equities.

That does have an effect on investment income.

Beyond that, we haven't felt the need to try and be aggressive with respect to reserves.

We think that our ratings and the strength of our balance sheet is paramount.

We certainly want to make sure that we reverse the trend we have seen in the last couple of years.

We have seen some unfavorable development in the last couple of years that we prefer not to see going forward, and that is certainly an element of our discussion.

As well, we certainly want to be positioned with respect to the rating agencies in terms of being able to defend strength of that balance sheet as we go forward.

That brings me forward to your question on capital adequacy.

You may recall late last year, earlier this year, there was a view that if our premium went higher than anticipation, we could be looking at the need to add capital.

We clearly are not in that mode.

We monitor our capital position very carefully.

It is important we know for our shareholders.

It is also important to our clients and our rating agency constituencies.

We certainly are aware of all the possibilities out there in terms of share repurchase, and I will note that we have 1.673 million share of authorization still remaining.

So that certainly is something that we keep in mind.

We also are aware of where we are from a dividend perspective, but it is early to be talking about some kind of capital adjustment.

We don't have good clarity yet on 2004's second half.

We don't have good clarity on 2005.

All told, our very strong capital position has played extraordinarily well for us with our clients, with our rating agencies.

We understand and are committed to the needs of our shareholders in terms of creating shareholder value for them, and we need to balance that.

And I can assure you we do that and look at capital management issues on a day-to-day basis.

Just as a quick follow-up, based on what conversations we have had in the last quarter, based on what I have seen in this quarter and based on what Joe has said, one would be pretty hard pressed to look for production next year more than flattish, as was a comment I think the Company used.

That seems like a pretty safe assumption unless you feel that the more competitive environment we just saw is a fluke more than a trend.

I don't think it's a fluke.

Obviously, things can happen to change it like catastrophes and other items, but no, I kind of agree with you, Michael, that that is the road as far as we see it for 2005.

And so as Steve indicated, that means that we will look at capital differently than we would look at it if we were growing top line robustly, so that will be taken into consideration more so as we go forward, along with all the other items, rating agencies, clients needs, etc., etc.

So it kind of gets up in the scale of things that we look at, and that is about all that we can tell you at this point in time.

Three months ago, we were thinking about raising more capital.

That is not something we're going to do at this point in time.

Thanks very much, Joe.

Dave Sheusi with JP Morgan.

Good morning, everybody.

Just a couple things.

First I wanted to get your reaction, Joe, to the most recent news with Converium and implications on Everest Re.

You recall from the press release here this morning that came out on their company news -- I don't want you to specifically comment on their perspective, but essentially, they have given the potential for about a $400 million reserve addition.

This triggered impairments of about $289 million and a write-down of goodwill, netting out north of 780 million to hit the equity position.

So this drives the need for a massive equity infusion for Converium.

What is the buzz in the market?

How is the market reacting to this news and what are the implications for Everest Re?

Well, I don't know about the market, but I'll give you my own opinion and certainly thoughts on Everest.

Obviously, a number of companies had posted additional reserves for '97 through 2001 in 5 quarters, some putting up reserves in 2002 and many putting up reserves in 2003.

We were among that group that had a strength in reserves for that period.

I think probably all insurers and reinsurers that were writing any casualty business in that period had to strengthen reserves beyond what initial estimates were.

Having said that, I think at least in the case of Everest, we feel very comfortable with where the reserves stand for that timeframe at this point in time.

We have had essentially no development or, if anything, modestly favorable development in the last quarter on that timeframe.

We, through that time frame, were very cautious on the casualty side.

Some of the classes that Converium mentions, I have seen at least some of what was put in print on this; our classes of business like umbrella business that we were excluding through that period of time.

We just wouldn't write it, and so that served us very well.

My own sense of things is many companies recognize this issue, and I think most probably took care of it last year or the year before, but I thought there would be a few perhaps that still had to recognize more.

This is one of them, but my sense is the industry has largely recognized this, and my sense is Everest most definitely has recognized it, although there was less for us to recognize given the fact that we had a low-profile during that time frame in many of these casualty classes.

If I could just amplify, Dave, just speaking a little bit about the diagnostics that we run on our reserves, Joe mentioned some view that there could be redundancies there.

We basically do track how our reserves are performing on a month-to-month, quarter-to-quarter basis, and our reserves from that period are performing very well.

We haven't recognized favorable development that might be there on the premise that it is important for our balance sheet to remain strong, and we will let these reserves play out as they season, and that for a company like us is an important element of keeping our balance sheet strong and our reserves prudent.

Thanks so much.

(OPERATOR INSTRUCTIONS) William Wilt of Morgan Stanley.

Good morning.

First, thanks for the candor on the state of the market.

That read is helpful.

Could you offer maybe some detail on the plans in California workers' comp for dealing with the loss of the AARIS relationship?

Sure, be happy to, Will.

First let me, before I say that, give you a little bit of a report on what we're seeing in the marketplace out there.

We have been reporting, as you know, for the last almost year that our premiums were off relative to the prior year as our rates were probably the higher end of the rates and not selling as much as they had the year prior.

In May and in June, as an example, our premiums were roughly 30 percent off relative to the May/June book of '03.

When we entered July, literally all companies were putting through a rate adjustment in July, recognizing the legislative changes.

We lowered our rates 7 percent in July.

The market in total lowered their rates by more than 7 percent.

There were a few carriers that lowered them 7 percent, but everyone lowered them at least 7 percent and some lowered them as much as 15 percent.

What we've seen in July is that we are going to write roughly half the premium volume that we wrote in the prior July.

So what we've seen happening out there is results for the last couple of years have just been excellent and the market is recognizing that, and between those excellent results and the legislative reform that has been put through, we're just seeing increased competition.

We have been seeing it for some time, but it really is heating up more and more recently.

Berkshire Hathaway coming into that space and looking to write big volumes is really just one more clear example of the increased competition in the California workers' comp marketplace.

Now, it is our plan to stay in the market, but it is also our plan to continue our current rate structure and current commission structure.

Essentially, what we will do is we will write business out of our existing facility, our Orange County office.

This is an office that we started building about a year ago, and we have had that group of people writing large accounts up until recently, 250,000 premium and above.

A few weeks ago, we changed that where for new business, they are writing accounts off 100,000 and above, and as we move forward we're kind of staffing up more so.

We will be even lowering the 100,000 down to a much lower number, and essentially the business that we write in California will be written directly by our own employees out of our California office.

We continue to look at the market as a market that is a reasonable market that we want to stay in, although like a lot of other pockets, we're looking at it as a market that is not as rich and robust as it was a year ago.

And if we start projecting out to 2005 and we continue to see more competition, clearly we will write less in '05 than we did in '04.

But we are happy with the structure in terms of the marketing and the underwriting going forward.

We do have and have had for some time another agency out there that is writing some business for us.

That will stay in place, but in the main new business that we have picked up will be written directly by our California office.

That's helpful, thanks.

Does going down, writing smaller on a direct basis, writing smaller accounts, create the need for systems and infrastructure and people that you don't currently have?

And does that make it -- once those people are in place, does that make it more difficult to get in and out of the smaller end of the market quickly?

Well, we are staffing up as we are really asking the group out there to write, to see more submissions than they had from frankly more retail agents and wholesale agents than they had been seeing in the past.

So we are already in the process of staffing up quite significantly.

I think on the systems side, we are really in pretty good shape.

You are right, if you start getting down to the small account, the $10,000 account, that's not something that I think will have employees underwriting out of the office.

That might mean that we structure some individual deals with retail agents and wholesale agents, although we don't at this point plan on another MGA agreement like we had.

The market going forward, I mean it is changing.

As you can hear, we still think it's very good but although a lot of that is speculation in terms of just how much this legislative reform will change losses at the end of the day.

But we want to be in it.

We want to be in it at our rates and our commissions.

We are prepared to do less if that's what makes sense, but not doing less because we have less resource out there.

We will put the resource in play that the market dictates we should put in play.

So I'm not particularly concerned about the marketing and the underwriting.

If you can hear me, I'm more concerned about where the competition is taking things, because we have seen people really looking for market share and lowering their rates.

We have seen more people coming into this space.

That's helpful.

Thank you.

Adam Starr with CRM.

Michael Lewis already addressed my question but how long do you think it would take to come to some kind of conclusion about capital reallocation if the business continues to slow?

Does this involves really getting an okay from the rating agencies still in this environment?

Certainly part of it is discussions with the rating agencies.

That is a very meaningful part and the other part is just our sense of what we can achieve in 2005.

So timing wise, Adam, this is a week by week, month by month thing that we analyze and discuss amongst ourselves in conjunction with the appropriate outside parties.

Okay, thanks a lot.

J.F.

Tremblay of CSFB.

Good morning.

Joe, I wanted to get back to your overall market overview.

First of all, can you summarize what you see as the areas of market strength, where you feel that commission rates were holding up well and you feel that its going to be an interesting source of premium for you?

I'm sorry, could you just give me that one again?

I'm not sure I heard the whole question.

Getting back to your market overview.

Can you summarize what you see as the areas of market strength, where you feel that terms, conditions, rates are holding up well and will be representing good opportunities for you?

I wish I could tell you that I see meaningful pockets of the market that are getting stronger, but that is not particularly what I see.

You have seen it in recent; we've been happy with the international markets, Europe, Canada, Latin America, and we continue to be pleased with those markets.

But even there we're starting to see some downward rate correction.

In the main for most classes, terms and conditions have held up, but again I see some of that starting to change as well.

At the end of the day, this market is going perhaps the way you'd expect it to go, not the way you would necessarily like it to go, but you look back at the results for many classes for the last two to three years and the results are absolutely terrific.

And on top of that, we have companies that have been charging for the last few years and frankly we were happy to grow quite nicely in 2002 and 2003 as well.

But as I said, some of these companies are not adjusting for some of the changes.

So we still see parts of our market as quite good.

And frankly there are few parts that we still think are excellent.

But in the main, the general property and casualty is correcting as we have in our industry for many, many years.

We are still a cyclical industry and we really just wanted to convey to you that that adjustment is continuing and if anything, in July we witnessed that and maybe witnessed a little more of it than we would have liked to.

So we look at today as if it's a normal market; maybe a little bit better than a normal market if you take a snapshot of rates and exposures, but it's not the market we saw a year ago.

Okay and I know it's very hard to do but can you characterize the main source of aggressiveness in the marketplace?

We won't mention any individual companies, but I think you could look at some of the growth and I think you can ask a few questions because whereas a couple of years ago tremendous growth made a world of sense, some of it was just taking place on the back of a rate increase.

Today's growth is not taking place on the back a rate increase, so it's just a few more questions I think for you to ask other companies.

That's very helpful.

Finally, I have just a number question.

In the supplemental thing, you had a positive number and a net pretax catastrophe losses, 1.2 million.

Can you explain that?

Is that some kind of reserve takedown?

Yes, J.F., minor adjustments on a couple of old-year losses.

Every one of our exposures gets updated every quarter when there is noise on 3 or 4 individual catastrophes from prior years.

Once you reach a point where you believe all the loss is in, we just flush any noise through the quarter.

This quarter it happened to be $1.2, $1.3 million.

Okay, so were there any catastrophe losses, and what was the magnitude of this positive look on the catastrophe side?

I'm sorry, J.F.?

So what was the magnitude of the positive development; were there any catastrophe losses that were entirely offset by this?

There were no catastrophe losses in the current quarter from current-quarter events.

What you are seeing is that positive development that is under $1.5 million is noise on 3 or 4 events dating back to '03 and '02, but not the World Trade Center, and it's mainly the storm losses we would have had over that period.

Thank you very much.

Ken Zuckerberg with Stadia Capital.

Two questions if I could.

Joe, just to clarify your guidance with respect to second half '04 premium production, is the potential decline mainly a function of AARIS, or is it a combination of AARIS and more competition in some of the business lines you mentioned that were softening?

No, it is not mainly because of AARIS.

By the way, AARIS has been trailing down for the last year anyhow, and as I said is off 50 percent in the last month, and our arrangement with them lasts through October.

No, no, it is mainly me talking about changing market conditions, property reinsurance, casualty reinsurance, our main product at the end of the day.

And just insurance rates going down as well in property and casualty business, so it's just an overall general trend.

So more of a same-store sales issue because of market conditions that you've (indiscernible)?

Yes.

Okay, great.

Then just a question for Steve.

Steve, as I look at paid to incurred this quarter and notice an uptick in paid but lower net addition for loss reserves, I guess I just wanted to -- it seems counterintuitive to me just with respect to claims (indiscernible) inflation and obviously wanting to put away more money for future losses.

Can you just speak to that and how we should think about the paid to incurred ratio going forward?

The paid to incurred ratio is still pretty darn low.

It's going to move around several points over the course of a quarter in the sense that there is not an inherent smoothness, if you will.

Our cash flow for this quarter continued to look very strong, particularly after one adjusts for a couple of events that we saw.

One of the things that does get into the paids is the asbestos paids.

They had ticked up this quarter as a result of a couple of those settlements I mentioned, but we don't see anything in that measure which is suggesting substantive change or breaking of trends, if you will.

Having said that, that certainly is an area that we will continue to monitor closely as we go through the rest of the year.

Thanks very much.

A follow-up from Stephan Petersen.

Real quickly, the 106 combined ratio in Bermuda, anything unusual going into that number in the quarter?

Basically the issue there is to the extent that we have asbestos losses that are recognized now that we are beyond the stop loss cover provided by the Prudential on Mt. McKinley.

Basically, those losses get ceded to Bermuda.

So not only does it affect Bermuda's combined ratio, it also affects our effective tax rate in the sense that to the extent the balance shifts between Bermuda and the U.S., more income in the U.S., less in Bermuda, you get a shift in the tax dynamics as well.

Terrific.

And you've kind of commented on California compensation.

Where's the growth coming from then in U.S. insurance?

We have really, I'd say, 2 or 3 other programs that are performing quite nicely.

We have a credit program that we started about 6 months, 9 months ago out of Denver, which is a very unique program which is performing quite good, and volume is, if anything, a little bit ahead of schedule.

We have a national restaurant program that we also put together maybe 9 months ago that is doing quite well.

We have a security guard program which has blossomed this year, a national security guard program which is also doing well.

And we have a Midwest comp program that is new to the mix, which is also giving us premium in '04 that did not in '03.

So we actually have 3 or 4 programs that are becoming meaningful for us and performing quite nicely, and frankly giving us very nice diversification on the insurance side.

We at one point had one program, basically the California Comp program, that was more than half our premium.

And again, looking back at 2003 and 2004, we were happy to ramp that up quite quickly because we look at those years as if they will produce terrific results.

But at this stage of the game, we are happy that we are diversifying into some other programs that look as if they will also do quite well.

Terrific, thank you.

At this time, I would like to turn the conference back to our presenters for any additional or closing remarks.

I would just thank you all, and I'd just like to make one comment in closing, which is we were pleased that we had a 22 percent ROE for the quarter, and we will look to work hard and expect to continue to deliver high-quality ROEs like this into the future.

We had this ROE despite the fact that we put up some meaningful reserves in asbestos, which again gets you into the underlying power of the current operation.

Market is changing and we will adjust, but again we do expect going into the future to continue to deliver quality ROEs.

Thank you.

That does conclude today's conference.

Thank you and have a great day.

You may now disconnect.