W R Berkley Corp (WRB) 2008 Q3 法說會逐字稿

Good day everyone, and welcome to the W. R. Berkley Corporation third quarter 2008 earnings conference call. Today's conference is being recorded. Before we begin, we would like to note that the speakers' remarks may contain forward looking statements. Some of the forward looking statements can be identified by use of forward looking words including without limitation, believes, expects, or estimates. We caution you that such forward looking statements should not be regarded as a representation by us that the future plans, estimates, or estimations contemplated by us will in fact be achieved. Please refer to our report on Form 10-K for the year ended December 31, 2007, and our other filings made with the SEC for description of business environment in which we operate and the important factors that may materially affect our results. W. R. Berkley Corporation is not under any obligations or expressly disclaims any such obligations to update or alter its forward looking statements, whether as a result of new information, future events, or otherwise. I would now like to turn the call over to your host, Mr. William R. Berkley. Please go ahead, sir.

Welcome. We had quite a satisfactory quarter if you didn't look at the bad things. Like most quarters, if you overlook the things you didn't expect or that were bad, it was a fine quarter. While Gene will go through the numbers and I will go through some more details in a few minutes, I think that the overall view we have of the business has changed markedly in the past quarter. We're much more optimistic about the upcoming period of time.

Our forecast, which we've been on track with, which is the market will turn in the end of '09 and the first quarter of 2010 is still our position, but if anything were much more confident in that position and believe that it's possible that change will take place sooner, we now see the catalysts for that change. We understand what's going on.

Our own business is performing quite well. Our combined ratio is running -- when you take out reserve releases and all of the external things, the ongoing rates are between 95% and 96%, and we are pretty pleased with that. That keeps our return right around the 15% level, which is where we would hope it would be in spite of a lower than anticipated investment income.

We think that business continues to be okay. There is a turn to the point that prices are going down at a much slower rate. In fact, on a few places prices are going up. But in general on our price monitoring reports, we saw in September the price declines at immeasurable levels of improvement compared to the prior quarter's declines. Our regional business generally is not under as much pressure, although here and there is aggressive behavior on the part of some participants. Our specialty business, while still competitive -- the pressure is easing a bit here and there.

The reinsurance business has continued to be price sensitive, but there is a general sense out there that a lack of capacity with the changing financial markets and there is just not as much capacity there. And a lot of people are rethinking their retentions as those adverse pricing decisions they made in the prior two years are coming home to impact their loss ratios. So overall we are pretty optimistic. I will talk a bit more about that when Gene finishes and then we will go into questions. So, Gene, go ahead.

In spite of a difficult quarter we managed to report after tax operating income of $123 million or $0.73 per share and operating ROE of 13.8% on an annualized basis. I will begin first with a summary of the two more significant items in the quarter, which are the storm losses and investment writedowns.

With respect to storms, our net losses before tax were $62 million, and that compares with just $8 million in the third quarter of 2007. Losses from Hurricane Ike alone were $33 million. That includes our participation in a Lloyd's syndicate, our estimate of ultimate losses from the Texas wind storm association, as well as reinstatement premiums. In addition to Ike, we incurred another $29 million of losses from a combination of Hurricanes Gustav and Dolly and an unusually large number of wind and hailstorms in the Midwest. The breakdown of the net losses by segment was $39 million for the regional segment, $14 million for the reinsurance segment -- and that's primarily the Lloyd's participation -- and $9 million for the specialty segment.

With respect to investments, we reported a net realized investment loss of $220 million in the third quarter. That loss includes $211 million of losses from Fannie and Freddie preferred stock which we wrote down after they were placed into conservatorship by the Federal Housing Finance Agency on September 7.

Turning now back to the insurance results for the quarter, our net premiums written were $996 million -- that's down 12% from the prior year quarter. Again this quarter the decrease is mostly attributable to declines in the reinsurance business, which was down 40% as well as declines in ENS business which was down 24%. On the other hand, regional and alternative markets were down just 4% and 6% respectively, and our international segment was actually up 37% due to our new reinsurance company in Australia as well as strong growth in South America.

The reported combined ratio was 96.2% and if you look at the combined ratio excluding storms it would be 90.4%. Prior year reserve releases were $49 million in this year's third quarter compared to $18 million in the third quarter of 2007. Paid loss ratio including storms was 58.1% in the quarter and net loss reserves increased by $81 million to $8.2 billion at September 30.

Operating cash flow still strong at $375 million in the quarter and $730 million year to date. Our overall investment income was $153 million compared with $166 million a year ago. And the investment income from the alternative investment -- that's the arbitrage account and the investments in partnerships and affiliates -- was $28 million in both periods, both this year's quarter and the quarter a year ago, but the composition was quite different. For one, deal spreads widened significantly in September, and as a result the arbitrage trading account reported a net loss of $2 million in the quarter compared with a profit of $21 million in the prior year quarter. Offsetting that, however, was significant improvement in investment income from affiliates, which rose to $31 million from $7 million a year ago. The improvement in earnings from affiliates was mostly due to mark to market gains reported by one of our external investment funds.

The core portfolio, other than the arbitrage account and partnerships and affiliates, investment income declined by $13 million, and that's primary a lower short-term interest rate as well as the impact of cash used for our share repurchases. The average annualized yield on the portfolio was 4.8% for the quarter compared to 5.2% in the quarter of '07.

There is a summary of the carrying value of the portfolio by investment category on page 9 of the release. Just a few things that I like to point out there. One, the municipals have an average credit rating of AA and that's without considering any credit enhancements. The mortgage securities are mostly agencies. The corporate securities are short duration, high quality names. The loans receivable are all commercial mortgages and the foreign government bonds are primarily UK guilds. Also want to point out that as we mentioned in our prerelease we do not invest in CDOs or CLOs, never been a party to a credit default swap, and don't engage in securities lending.

At September 30, the net after tax unrealized losses were $155 million or 1.2% of the total portfolio. We repurchased 1.9 million shares of our stock in the quarter at a cost of $44 million. And that brings our year to date share repurchases to 19.4 million shares. The financial effect of those repurchases which were made at prices above stated book value was to reduce book value per share by $0.90. Our ending book value per share at September 30 was $18.81, down $0.99 from the beginning of the year.

Thank you, Gene. Basically, let me just quickly go through this. The real story for our business is our regional business is generally flat. Prices are down slightly less than 5% this year. Little less competition currently than there was again sporadically in a few places, and a few companies more aggressive, especially those companies who are particularly concerned about cash flow are out there trying to aggressively write business.

Our specialty business continues to see standard markets entering into the business as well as some aggressive competition from less well rated, less established competitors where they are searching for opportunities to get into the business. We've actually seen business lost to people where the prices they quoted would be 100% loss ratio or more. We just aren't sure that people understand what they are doing. But that is the nature of the bottom of the cycle. We continue to see that.

And the reinsurance business, it's not only been price decline, but terms and conditions for the largest buyers of reinsurance where they try to drum in terms and conditions, take away the rights to audit claims. They basically force reinsurers to say we want you to pay, you pay. You have no questions, you have no rights, and you have no ability to verify. And our own experience has shown that without those capacities, in many cases it doesn't do particularly well. And some of the same very large companies tend to give us the worst results.

So that volume is down substantially. We have a lot of capacity to do more business. We think that capital will be very well rewarded for sitting on the side lines because the capacity and the reinsurance business has been hurt substantially by the debacle of the securities market. The side cars in a lot of these vehicles have been eliminated and we think we will stay on the side, no pun intended, for this next cycle, at least for a while. And a lot of the participants have had their capital cut back. We think we will be able to take advantage of that more quickly.

Overall, the alternative market business will continue to do all right. We still see opportunities. A lot of that business is built on relationships, although we do see a number of people who have captives are facing the strains of the current economic climate, and their investment portfolios are under stress and are going to be looking for more reinsurance and more solutions, which will give us a real advantage. So we are pretty optimistic about change.

Our overseas business, the UK is more competitive than we expected it to be. Australia has been a great advantage. We have a domestic insurance business in Australia and it's led by an excellent management team. It got off to a great start at what we think is the right time which is the middle of this year. And while it has in the short run increased our expense ratio because we have very little earned premium. They have done a great job of getting it going. And our Latin American business is doing quite well, and we have been pretty well protected in all these cases currency-wise, although not totally protected.

The reason we are optimistic is because we had a lot of experience and a management team that's been around a long time and last market cycle started to change really at the end of '99 where you started to see prices start to move up slightly. Then the end of 2000, you had Reliance and Frontier effectively go out of business. And then you began to see dramatic price increases followed by the unfortunate events of 9/11 which just accelerated that trend. Reliance and Frontier were small companies. Today you have a number of large companies that are under great stress. Clearly AIG is under stress. Other companies have other problems because the capital markets.

The pricing cycle has effectively brought people to where it's likely the underwriting results for 2009 are going to result in the industry -- combined in the area of [110%] could even be worse. And very poor investment results, which in our view means the industry will have a net operating loss -- investment income underwriting losses. When the industry has a net operating loss with at least several of the very largest players suffering capital problems and stress with a lack of excess capital, side cars and excess companies on the side not available, capital markets reasonably closed to the industry because of where we are, we think this is going to be an excellent opportunity. We think those catalysts for change are here. We would expect again -- our formal position is still the very end of 2009, the first quarter of 2010, but there are a lot of things out there that tell us it could easily happen sooner. We are sitting here looking at opportunities. We see a number. We hired a couple of teams of people and we continue to talk to people and look at opportunities. The pricing of things that are for sale is much more attractive, although most of the things are still not of an interest, but we continue to see what we think are exciting opportunities, and we expect by the end of 2009 we will have fully utilized our capital, although at that point, we expect to be generating enough capital to allow us plenty of growth. We have great reinsurance partners that have supported us and made money doing business with us and we expect to use them to participate with us in this anticipated growth. With that now, we will take questions, please.

Thank you. (OPERATOR INSTRUCTIONS) And we will take our first question with Josh Shanker with Citi. Please go ahead, sir.

Thank you. Good morning. My first question involves the access and surplus lines market. Obviously a Lexington is a big player there. In terms of how wholesalers look at the marketplace, what's the prospect for some programs that are associated with Lexington to look for sponsorship among other ENS players?

First I should understand and be sure you understand my General Counsel is looking at me right now and reminding me, he handed me a note that said -- remember, your first amendment rights are curtailed by the relatively important aspects of insurance regulators who say you have to be careful what you say about other companies.

Absolutely. I'm actually -- talk to me about process. I'm more interested in process.

I want everybody to understand I'm trying to be careful. I think that in general people always are concerned with uncertainty. Uncertainty is out there, and AIG is the biggest excess in surplus lines writer in the business. It houses some of the most talented people in the business. Brokers, agents and their employees are all facing uncertainty. Nothing new for anyone. And what's happening is everyone is trying to assess how that plays out, what happens and how do we hedge our bets. So everybody is looking around and trying to figure out what to do. And I think the process is AIG has some unique capacities that no one else has. And everybody is out there trying to assess how can I hedge my bet? What can I do? And that is the process that's going on. As the leverage of AIG's advance increases and the uncertainty increases, people get more anxious and they look around and try to figure out what to do. And I think that clearly at the pressure point that's not going to go away, and if anything is likely the increase.

Taking AIG out of the equation so we don't stumble on things, if I may -- I'm a wholesaler and work for myself, but use another company for capital support -- am I early in the process of looking for a new partner? Or am I -- is that the stickier kind of business or the least sticky kind of businesses?

I think that there are issues of capacity there are issues of capacity. There are issues of when the business renews. I think that most people are sitting there saying let me wait for renewal. Let me examine what are my options. Where can I get the capacity? If you are a broker, you will look where you are going to get paid, what commissions. I think that most people are looking to diversify their exposure and ensure they don't have everything back as they did at AIG. AIG was the unassailable star of our business for so many years. And I think it takes a long time before people recognize, what happened? And I mean that in the kindest way. I think people are still adjusting to this and trying to figure out what does it mean and where does it take you? I think you are seeing people search for ways to diversify their risk right now and trying to find ways to offset that risk. And in some places they can find alternatives and in others they can't. And then they make a decision, do they do things in a different way than they have for the past ten years using AIG's capacity, et cetera.

Okay. Well, sort of an answer. I'll take it, though. The other question going back to 2003, you were writing about twice the premiums to surplus you're writing today. Is it possible for Berkley given all of the rating agency changes over the past few years, given changes in the marketplace in general -- even if things got favorable, where can Berkley get to a premium surplus basis? I realize it's a mistaken metric to use, but all we have.

I think first of all the rating agencies have gotten smarter. I think they're a little more -- I make fun of the rating agencies all the time because I think they use models too much. But they have gotten smarter. First of all the rating agencies always look relative to the industry and if the industry starts to move up a little bit, the rating agencies are going to move up a little bit, not a lot, but a little bit. So I think that we have a little better chance at capacity. Second of all, I think the rating agencies look at quality of reserves, quality of business, diversification. We all have much more positive things going than we did five or six years ago. We're much more diversified. We have much stronger reserves. We are in much better shape.

That having been said, I think when we wrote at a higher payment surplus, it was always with a commitment to the rating agencies that we were coming down. We understood where we needed to get to and it was a blip and it was -- and we showed them it was because of price increase, not because of exposure increase. So let me give you an example. If we doubled our prices and our exposure unit stayed the same, I don't think the rating agency -- they would start to yell and be unhappy, but I don't think it will be a disaster with the rating agencies if we could give them statistical backup because they aren't naive. If we told them policy count was the same and exposure was the same and it was merely premium that changed because we charged more, that would not be a disaster. So I think they are smarter about price changes and these things than we think.

That having been said, if we zoomed to 3 to 1 and couldn't demonstrate it was primarily price increase, we would have a hell of a problem. On the other hand, if it was 70% price increase and 30% volume increase and were writing 2 to 1 and they could see us earning a lot of money and not coming down to 1.5 to 1 and so on, I think that they would be more flexible and understanding if that's mainly driven by price increase and modestly by that. I think the other thing is we think we have good relationship with reinsurers. We have a lot of other avenues for capital. So we think we can certainly manage that issue for a while. We think that if there is a significant jump in that premium of surplus, it would be for a year or 18 months. It wouldn't be for a long period of time. It would jump up and trend down mainly because our earning power is so high. I think that if you put back the development from prior years, our returns on capital are pretty awesome and I think that if anything they are likely to improve much more rapidly this cycle than the last.

And one final question, I apologize -- with regard to the rating agencies, do you have a relatively clean balance sheet compared some of the more imperilled peers? Do they view in your estimation the unrealized losses in a similar way you view unrealized losses?

As far as we know. We've got very recent reviews. Nobody has any problem. And one of the things that -- the variability on some of these things is so enormous, on the 20th of October, the world went to hell with municipals. Now the world is fine with municipals. I think there was 110 basis point move in the municipal bond market. If we were to mark that to market on the 20th of October and mark it back to market now, it would be pretty dramatic. On the other hand we only have a 3.5 year duration of our investment portfolio, which is costing us money, but minimizes that stuff. I think that we also still have some unrecognized and unrecorded gains on our balance sheet that we are working on trying to find a way to recognize.

Very good. And I'm just going to talk about the real estate in the past -- like [one of those things]. All right, very good. Thank you, Bill.

Thank you.

And we will take our next question with Mike Grasher with Piper Jaffray. Please go ahead.

Good morning, Bill. Just a quick question here. Follow-up to your discussion of premium surplus. I guess how do you balance the I guess the -- you have catalyst out there on the horizon. You had it here in the short run. Could you -- and you see these opportunities. Could you still involve yourself with share repurchase or get back engaged in a share repurchase?

I think if the stock traded down to the book value range, we would have to seriously think about it. But I think that at this point we see some pretty exciting opportunities. We hired two teams of people. One we announced yesterday for offshore business. And we hired a team from -- we hired a team to do B&O business. We also started up a group in Canada where we hired a fellow who had built a specialty book of business in Canada, and we are looking at a couple of other things where transactions are a global value, so we will talk about getting very attractive returns and build the business. I've had the consistent position that if we can build the business and effectively get better returns than buying our own stock back, we would do that. If our own stocks start to sell at book value or less we will go back to seriously considering that. And the one piece that is there now that wasn't there is that the capital markets are much more uncertain. Although we have been informed that we have access to capital markets, that access is less certain and the price is less certain. If you are desperate you always have access at least in our position. The price may be dear.

Understood. And moving on to a different topic. I guess if you could speak to any concerns you may have on the outcome of the election, one way or the other. And just as a secondary question to that, more specifically around regulation of the insurance industry from a federal or state level.

There are three pieces there I comment on. Number one, we are of the belief that the government and industry need to work together for a rational outcome. We are in intermediary trying to balance out and spread risk, and our goal is to have a reward for acting as that buffer, and we think that to the government and the consumers buy in terms of best interest, predictability is what insurance does best in. We think that either person that's elected is fine. We are particularly pleased that Mr. Obama has come out with a certainty of supporting our tax on non US insurers. That's a positive. Mr. McCain has been less certain. That would be a plus. I think that given our new direction in the government, it's more likely that there will be some national insurance regulator of some type. I think one of the problems they had in dealing with AIG was having to deal with AIG when you had state regulators and federal government and federal reserve and FDIC -- I think those conflicts dealing with AIG a more complicated thing. I think the government suddenly realized that. I think that Berkley as well as a number of other well capitalized insurers are opposed to property casualty companies participating in the TARP program. We don't think we need it and we don't think that for the most part the insurance industry needs the participation of the TARP plan and those companies that are seeking participation are seeking it primarily because of liquidity issues that could be dealt with the borrowing [interest] securities as opposes to capital infusions. We are not in favor of TARP at all, for the insurance industry at least.

And then a final question for Gene. A numbers question. In terms of the new businesses or new startups that were on the books at January 1, how much have they contributed to the total premium production for the year?

That were started prior to January 1.

We have been starting up business for several years.

Within the past year.

Something less than $40 million.

Thanks very much.

For the quarter.

And that's just really new startups.

Right, that is the recent startups, not the older startups. Startups are a continuing process for us.

Understood.

Okay.

And we will take our next question from Meyer Shields with Stifel Nicolaus.

Good morning, everybody. If I could play off that question, is there any relationship between how long you had a unit up and running and the amount of business that they lose in a soft market?

It's interesting. When companies start up, they generally are more selective. They get business from people who they know, from business they wrote. They know the pricing. They don't lose much business because by and large the business they get is not as price sensitive and is relationship driven for the most part. Some of the new businesses get almost nothing for the first year, and some jump off to a extraordinary start in the first six months. So the answer is most of the new businesses don't lose business at the start because the business they get is either built on relationships or built on some particular area of expertise they develop. We didn't have that many new ones that were started prior to the 2006 peak. Most of them started after that and most didn't get to a particularly big size that it's a consequential amount.

Very helpful. Is it safe to infer from your remarks you are expecting a market turn in reinsurance come earlier than [other] insurance?

Yes. I think this year end you are going to start to see a change in the reinsurance marketplace. I don't think -- I think in the property capacity business you will see it at this year end. I think it's been announced that for instance that [Sisiole] is getting out of the property cat business. I think sidecars and a lot of the securities that everyone said was the future of reinsurance business were impacted by the current market. So I think that a lot of that stuff is already being impacted at the moment. Yes, I think that the reinsurance market is going to start to do better sooner. I think that the property side will have a better year end 2008. And the entire industry will start to do better as we go into 2009. I think that's the other piece that will be a little different than the last cycle. The last cycle was led by the primary business turning before the reinsurance cycle. The cycle before that was led by the reinsurance business. I think you will have the reinsurance business leading this but compounded by the lack of capital in the primary business. I mean, there is a real possibility this is going to be a very dramatic change. That is not a prediction. That is merely the hypothesis of a possibility.

One question on that if I can and then I will pass the torch. What are the issues that [defer] that's hampered rate increases in the past in the fact that some insurance companies have intentionally or otherwise played shenanigans with the losses. Do you expect that to be a factor in '08 or '09?

I think there are two issues that you have to look at. First of all, a lot of companies have brought down redundancies from prior years more quickly than they have in other cyclical changes. So I think you saw people trying to bring down redundancies because they showed redundancies up in their balance sheet. They made assumptions that were a little optimistic about inflation. So they brought reserves down. They came through their income statements. So I think there is not as much left as redundancies for most companies.

And the second thing is I think in the financial climate we are in today, most people are going to be a little more cognizant of the concerns of wanting to get their numbers right. The fear of screwing up in this climate is pretty severe. We spent a lot of time thinking should we preannounce this and what should we do. And we never like to to preannounce anything. You are guessing. You don't really have every number tied together. Yet we are sort of backed in the position to preannounce with not as exact a number as you like. And that is again a function that the insurance world is cognizant of investors more than they have ever been. So I think most companies are going to do their best to do their best to get it right. There is always an outlier. Most companies will try to get it reasonably right. There are a couple that may not do that.

Thank you very much.

And we will take our next question with Doug Mewhirter with RBC Capital Markets. Please go ahead.

Listen, my substantial questions have been answered, but I have two number related ones. First, Gene, I looked at your $122 million of operating income and you said you had 162.7 million of diluted shares and that gets to about $0.75 of operating income per share. Is that -- am I missing something?

Well, we are using -- for the operating income we were using our diluted shares of 168 million. I think for the income statement we are using basic shares because we had a net loss, so that would be anti-dilutive to use the diluted shares. On the operating income and you will see that on page eight of the news release, I think, in a footnote there we mentioned that we used the diluted shares of 168 million, [761].

There is some crazy accounting rules that we had to use for taxes and for the diluted shares and stuff because of the tax rules and the loss for the quarter that sort of mess up some of those calculations. I'm happy for you to give them a hard time. I did already.

I see in the footnote now, thanks for pointing that out. And the second question, little more general is you gave your overall federal reserve development. Was that concentrated in any particular business about line or reasonably spread out?

It's more in the specialty line than anything else. But it was reasonable. It was spread out mainly in the specialty.

Okay, thanks a lot. That's all my questions.

And we will take our next question with Larry Greenberg with Langen. Please go ahead.

Thank you very much and good morning. You touched on my questions, too. I was wondering if you could just discuss loss trends and whether you are seeing anything more recently that's out of line with what you had in seeing and perhaps just touch on how you think the macro-economic environment might impact some of those trends going forward?

No. I think that -- I think there are three things I'd say. Number one, in this economic climate it's easier to settle things and even if you are moving toward slightly more inflation, you usually have an easier time to settle losses. I think that the macro environment does give you some concern. You have to be careful with agents and ensure that you get paid. And other than that, it doesn't have a big effect at the moment.

What if I said that the outlook was for deflation?

If you said the outlook would be for deflation, then we probably have very, very redundant reserves and then I would guess that it would in fact have a huge amount of positive leverage on our balance sheet.

Thank you.

And we will take our next question with Keith Billingsley with Signal Hill. Please go ahead.

It's Kenneth Billingsley. I have a question on -- you were talking about essentially the capital in the industry and I thought you did a good walkthrough of why you think rates could stabilize in '09 beginning in 2010. But the capital impact of writedowns have done little to change underwriting leverage at many insurers this quarter. Are you expecting to see further writedowns since October 1? Also maybe for the industry as well as for yourself?

First of all I think that it's important to understand that I started by saying a couple of things, that in addition to the public issues of AIG, a number of other particular insurers have their financial statements quite strained. But again as I warned you, my first amendment rights are somewhat restricted I've been told.

I understand.

Let me finish. There are a couple of very specific. But remember, those couple of specifics who are large companies have an enormous impact. When this cycle starts to turn in 1999 and 2000, it was two [expletive] little companies -- Reliance and Frontier. Here you've got AIG alone is 10% of the commercial lines market, and 20% of the specialty market, the ENS market. Plus there is some others that have real strengths. You have that piece and in addition to that piece, you have all the sidecars and other vehicles that were funded by investment people who have different issues. Not industry people. And you then have to put that together with the industry that is not earning money and have had some mark down of capital. It's not that they are in trouble, but the marginal people who are these several big companies that have capital issues and the peripheral people who solve those capital problems all coming together and then the pressure of the reinsurers I think will drive the cycle much harder than people think.

With the economy in the face of the pressure it's under, would you not expect to see either a cutback in coverage by customers as prices go up because they can't afford it similar to what we saw post 9/11 as well as primary companies just increase their retentions?

Yes. But that may happen to some extent. And you also notice post 9/11 the industry had amongst its best periods of time ever. I think that, yes, that's true. But people still more than ever need to buy insurance because they can't accept or risk the volatility of uncertainty.

And seems everyone on their calls this quarter have been cheerleading higher rates, but that no one has seen it in their own numbers as a whole nor are they proposing that they are going to be the leaders to raise rates. I suspect that you guys are not going to be the first ones to raise your rates. Will that be correct?

Well, I wouldn't say that, no. Not only wouldn't I say that, I would say that in some areas we already raised rates. And I think that I said last quarter and the quarter before I thought the turn of the cycle would come at the end of '09 and the first quarter '10. You can look up our conference call and we said exactly the same thing. All that's happening now is the specific facts that will make that a catalyst. But ultimately rates change when you have a zero return or a negative return and that's what's going to happen in my view in 09. But prices aren't going to change particularly much right now. It's going to be -- we are at least six months away from that price changing happening. And we are probably three quarters away before we see any real dramatic price changes. It's going to start to happen. I think what I'm saying and I have said for some period of time and now there are others that are saying it also is that the catalysts are all here, prices are going to begin to change. Yes, in fact, we started to change our pricing.

Very good. Thank you.

(OPERATOR INSTRUCTIONS) We will take our next question with Meyer Shields with Stifel Nicolaus.

I have a couple of quick follow-ups. Can you outline which accident years contributed to the reserve release this quarter?

I think you to chat with Gene about that. You start to get into where and what. If you wouldn't mind chatting with Gene after the call?

No problem at all. A couple quarters ago you talked about your expectations for the different investment segments. I was wondering if you could update us in terms what you are thinking for the arbitrage et cetera in the back quarter of 2008 and 2009.

Our arbitrage account has been mainly cash for a fairly extended period of time. That's why it didn't lose hardly any money. We lost a little bit of money, and part of that was because of the restrictions on short selling and other things, but our big arbitrage account which was Milton Partners continued to run a conservative book to business and it was -- they did an outstanding job. They didn't make money and nobody likes to not make money. But basically they had about 60% cash. And I think that we had -- excuse me.

I apologize. I was just corrected. The quarter actually it was in September we lost money, but the quarter Milton made money. The outside managed, we had lost money. And our in-house arbitrage mainly was and is mainly cash. We continue to have a lot of faith in what they do. I think that clearly that's the vast majority of our external money. I think that we have relatively modest amounts in other things -- I think that yields have clearly come down. The yield curve is steepening with a 3.5 year average duration, which is well under what our duration of our loss reserves are. We have capacity to extend that. Right now we were investing money basically in AAA securities, basically at three to five year duration, primarily three years which is giving us adjusted pre-tax returns of 5.5%. We can get up to about 6.5% over five years. And we still have pretty good positive cash flow which is being invested only in that fixed income areas for now.

Okay. That's helpful. And I guess one last question. When we look at some of the new units that have been formed recently, we are starting to see building assets. Are you starting to get comfort with a property risk for larger account DNO compared to these smaller casualty focus that you had to start with?

I think that we always tried to find great people. We built our business on great people. We think that we continue to believe that small to middle sized casualty business is our sweet spot and the place we like to continue to build our business. It's what we like. When a couple of great teams came available, we felt that great teams don't come around very often.

The reason we haven't been in property business very often is because I learned about the insurance business and reinsurance business 35 years ago. And I learned a different language than everybody runs their business today. And I am only comfortable with my old fashioned language. And my old fashioned language is called underwrite to an AML. AML is absolute maximum loss. So the only kinds of property exposures we will ever get in is where we can underwrite to an AML or absolute maximum loss. So the kinds of things that we will be doing when you see us getting in the property business is getting in businesses where the underwriting teams have a philosophy that matches with mine, and my son's, which is you always need to know how much you can lose in the worst possible scenario because the worst possible scenario always occurs when you can least afford it. That allows you buy quota share reinsurance and excess reinsurance with the defined limits. It allows reinsurers to do business with you with much more comfort because they understand what their exposures are and how it is and what they are getting paid for taking those exposures.

We haven't changed our view. It's just the kinds of people that are attractive to us haven't been around. And when they get around, we haven't been able to hire them for any reason particularly. And now suddenly we found a couple. So that was really exciting to us. It goes along with our view of always know the risk you are taking. And if you want to know a cornerstone, it's that three letters, AML -- most everybody else in the property insurance business and reinsurance business underwrites what they call PML. Probable maximum loss. I was a statistical major. I actually understand that PML means probable. Not absolute. Therefore you might be wrong and you can go broke. Therefore that is why we are looking and doing these things because we love the idea of underwriters who know what risk management is about.

Thank you very much.

That does conclude our question and answer session. I will turn it back to management for additional or closing remarks.

Well, we thank you all. As I said, we really see now more clearly than ever that the cycle is beginning to turn. We are quite optimistic. It's not here now. It's beginning. It takes five quarters before any change comes in to be fully reflected. So even if it's the third quarter when things change, it's five quarters from then. It's really the end of 2010 when it's 100% reflected. That really means 2010 can easily be quite a good year and we think that it will be very visible in the second half of 2009. Thank you all very much. Have a great day.

Once again, ladies and gentlemen, this will conclude today's conference. We thank you for your participation. You may now disconnect.