W R Berkley Corp (WRB) 2011 Q1 法說會逐字稿

Good day, and welcome to W.R. Berkley Corporation's first-quarter 2011 earnings conference call. Today's conference is being recorded.

The speakers' remarks may contain forward-looking statements. Some of the forward-looking statements can be identified by the 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, but as the future plans, estimates, or expectations contemplated by us will in fact be achieved. Please refer to our annual report on Form 10-K for the year ended December 31, 2010, and other filings made with the SEC for a description of the business environment in which we can operate, the important factors that may materially effect our results. W.R. Berkley Corporation is not under any obligation, and expressly disclaims any such obligation to update or alter its forward-looking statements, whether as a result of new information, future events, or otherwise.

I'll now be turning the call over to Mr. William R. Berkley. Please go ahead, sir.

Thank you, Jerome. Well, it was a good quarter. We were pleased with the results. We continue to see the beginnings of a market turn. Because of how everyone perceives a market turn, this doesn't look like a market turn for lots of people, and that's because when we think in terms of a market turn, we think of October of 2000 when Reliance and Frontier went out of business and there were some dramatic changes, or 9/11, or other particular periods of events when something dramatic happens.

But in fact, market turns happen gradually. Things slowly change, and we think we're seeing it now. But before I sort of go on and talk about the market and some other things, we're going to let Rob Berkley talk about our operations a bit, and then Gene talk about our financials, and then I'll join.

Rob?

Thank you, good morning. The first quarter could be described as a mixed bag. Market conditions continue to offer significant challenges. There's an ever-increasing number of data points that would indicate change is near. The industry continues to grapple with the realities that stem from a lack of underwriting discipline over the past several years. This is being compounded by deteriorating loss trends, as well as ongoing modest investment returns. Additionally, the recent shock losses in the global property market have applied further pressure to the situation.

While this may sound like a grim picture, it, in fact, is just what is needed. It is this current circumstance which is serving as a catalyst in changing behavior. The Company's net written premium for the quarter was just shy of $1.1 billion. This is an increase of approximately 10% over the same period in 2010. The growth came primarily from our International and Specialty segments. International writing continues to benefit from both further development of our younger operations, as well as the general lift from doing business in select international economies that are enjoying significant growth.

Our Specialty business growth was equally noteworthy. The growth in this segment was primarily driven from our businesses serving the energy industry, as well as the environmental insurance market. Additionally, there are select parts of the professional liability market that remain attractive. Furthermore on the topic of growth, it is worth noting the Group overall continues to benefit from an improving US economy, which is reflected on many fronts including our improved audit premium activity.

Having said this, we are clearly not yet in the throes of a hard market. Many lines remain quite competitive including but not limited to public B&O, large workers' comp, and excess transportation, to name a few. Additionally, the construction classes remain challenged as this part of the economy continues to struggle.

Our price monitoring for the quarter suggested an improvement in rate approaching 1%. On the surface, this may not seem like a meaningful number; however, this is the first time in 17 quarters rate in the aggregate has increased for the Group. Obviously, rates across various product lines do not move in perfect lock step; however, the overall momentum is becoming more visible. Additionally, renewal retention ratios continues to hover around 80%. While it may be premature to declare this a trend, it certainly can be interpreted as early evidence that [tights and] leverage is increasing.

The loss ratio for the quarter was at 61.8. This includes 2.5 points for storms. Of the 2.5 points, 1.5 is associated with losses from exposure to New Zealand, Australia, and Japan. Gene will be giving further detail on this a little bit later. The expense ratio was at 34.5 for the quarter, which reflects a 0.5 point improvement from the corresponding period in 2010. This represents continued progress as our growth in written premium begins to materialize in our earned premium.

When one puts all the pieces together, we reported a 96.3 combined ratio. However, when one adjusts for reserve changes and cat, the accident year combined remains just shy of 100. With each passing day, there is growing evidence that the industry is going through a time of transition. While the pace of this change will become more evident with time, it is unlikely the industry's course, headed towards a hard market, will be derailed.

Okay, Gene. Do you want to pick up now?

Okay, thanks, Bill. Well, Rob covered the growth in premiums for the quarter. I'll just start my comments with the underwriting results. Our overall combined ratio was 96.3, that's up 2.2 percentage points from the first quarter of 2011. As Rob said, the combined ratio includes 2.5 points or $24 million for catastrophe losses, Regional storm losses were $9 million, and our estimate for potential losses from major catastrophes was $15 million. That's $12 million for the earthquake in Japan, $2 million for the earthquake in New Zealand, and $1 million for the floods in Australia.

The loss estimates for these major catastrophes is all IBNR. We have actually had no known losses at this time. Catastrophe losses by segment were $9 million for Regional, $10 million for International, and $5 million for the Reinsurance segment. Prior-year reserve releases were $51 million or 5.2 loss ratio points in 2011, down from $62 million or 6.7 points in 2010.

The development in 2011 was mostly related to the Specialty segment where we continued to see growing reserve margins, especially for the ENS business. We also experienced favorable reserve development for the Regional, Reinsurance, and International segments in the quarter.

The underlying accident-year loss ratio was up 1.3 points to 64.6 in 2011 from 63.3 in 2010. And I'll just go through the changes by segment. The Specialty accident-year loss ratio was essentially flat compared with a year ago, as the impact of significant favorable reserve development in the prior years has flowed through to the current-year loss pick. We raised the Regional and Alternative Markets accident-year loss ratios approximately 3 points each to reflect the impact of pricing and potential loss cost trends.

The Reinsurance accident-year loss ratio is up almost 7 points due in part to differences in contract structures. There's an offsetting decrease of about 4.5 points in the Reinsurance commission ratio, so the overall accident-year combined ratio for that segment is up just 2.5 points. And finally, the International accident-year loss ratio is down 7 points due to growth in the earned premiums and improving profitability for our new Lloyd's Syndicate, as well as our business in Australia.

So that gives us an overall combined ratio accident-year based combined ratio of 99, excluding cats, and 101.5 if you include the catastrophe losses. The paid-loss ratio was 59.1, down from 60.4 a year ago, and that loss reserves increased by $42 million from the beginning of the quarter.

One last comment on underwriting is with respect to seeded Reinsurance. You'll see on the segment results that the ratio of our seeded to growth premiums actually increased to 15% in 2011 from around 13% in the first quarter of last year. That's because we experienced significant growth in the International segment, which has a relatively higher percentage of seeded premiums, and also because our sign-rich premiums, which are 100% seeded, were up $11 million, which is an increase of 40% over the prior year.

With respect to investments, our investment income was $132 million in 2011, down 5% from $139 million in 2010. Merger arbitrage earned $7 million in 2011, with an annualized return of 7.2%. That compares with $11 million, and an annualized return of 10.2% in 2010. The annualized return on the rest of the portfolio was 4.0% in 2011, and 4.1% a year ago.

At March 31, unrealized gains were $479 million, and the average duration of the fixed-income securities was 3.6 years. We also reported realized gains on investment sales of $29 million, and income from investment funds of $15 million. You'll notice that we modified our definition of operating income to include income from investment funds. We had started excluding income from investment funds from operating income during the financial crisis in early 2009, in part because the fair-value marks for those funds became more uncertain and hard to determine under the volatile market conditions at that time. Those conditions stabilized, and our investment funds have reported profits in 5 of the last 6 quarters.

Also, including these results in operating income is consistent with the way that income from funds is reported by most other public companies. So for the first quarter, income from funds was $15 million or $0.06 per share, and that compares with $5 million or $0.02 per share in the first quarter of 2010. So that gives us net income for the quarter of $116 million, and income per share up 7% to $0.79, and operating return on equity of 12.6%, and an increase in book value per share of 2% to $20.78 (sic - see press release).

Thank you.

It's $26.78, big difference. It's always a problem reading numbers.

So, let's try and look at what's going on from 40,000 feet. Fundamentally, for large risks, business is still competitive. For certain lines of business, you still have more competition than you should probably. Excess comp is a good example, where people are making assumptions. A number of our competitors are making assumptions of higher interest rates. So they're willing to pay or check much lower premiums because the leverage on a excess comp policy goes out a duration of let's just say 17 years.

The difference in assumption of a current interest rate of let's just say 3.5% versus 5.5% is enormous in the assumption of pricing. We make the assumption of 5.5%, which many of our competitors are doing, you can price the business as much more competitive rate. That kind of line, and also in very large risks, you have a number of competitors that are still quite aggressive.

Across the board, however, you're seeing changes. Workers' comp, definitely prices are up. We see it really virtually every place. The prices aren't up enormously, but I would say on average probably close to 5%, and more importantly, you're seeing a change in attitude where people are recognizing this is an area where you have to respond; you have to do things.

You're starting to see some improvement, not in large-scale construction, but in the home improvement industry and other things. Again, improving economy. Overall, as Rob mentioned, audit premiums have gone from negative to positive. Lots of those things are starting to impact business overall, and those signs are letting us get prices back to adequate levels or, in fact, improving margins.

There are signs that this is happening every place. When you look at the assigned risk number, our assigned risk premiums are up substantially. That's a sign that for the worst quality business, the standard markets are no longer fighting to write that business. It's an early sign.

It doesn't necessarily mean the market has turned, but it's an early sign that there's a bit more underwriting discipline. And it can be sporadic, so a quarter doesn't mean that's changed, but again, it's a weigh point. It's a directional indication. Obviously, when you say prices have increased something less than 1% for the quarter, we have not planned a party. However, above, prices being up for the quarter, where we haven't seen this for 17 quarters in a row, is a real change directionally. And in some of our markets, it's been a lot more than 17 quarters.

We believe that the aggregation of losses to the reinsurance marketplace in Australia, New Zealand, Japan, we can't ignore Chile, are so significant that many markets haven't fully reflected all of these issues. And we think that's going to have a major impact on the Reinsurance marketplace. That, combined with RMF 11, which is a new modeling basis, we're not great believers in modeling as a way of life, but certainly the world seems to have a different view.

RMF 11 has gotten a very conservative stance, especially on the range inland of cat-exposed business based on several recent hurricanes in the US. And that's going to increase people's exposures. It will be especially difficult for regional companies who suddenly will find their needs for cat coverage are much greater, and the capacity for companies to buy or just obtain catastrophe protection may be quite different. We think that's going to lead the people's reconsidering the world.

Markets don't change because of capital. I've been pounding the table about this for a long time, but the only thing I have that's in my favor are the facts. No one seems to want to believe the facts, but you can go back to 1974, and the facts have always said that there's always been plenty of capital. What's changed is people's state of mind, and that is the fear that the capital will erode. The losses are unexplainable, unfathomable, and when that starts to happen, people start to behave in a different way.

We believe that while the direct financial impact of the catastrophe exposures will be the first thing to hit people, we think it's going to start to impact people's state of mind. So that, along with the very poor results, underwriting [wise], the low investment income, because unlike 1985, '86 when investment returns were a lot higher, or in fact, 2000, investment returns are low. So you'll have poor underwriting results combined with low investment returns, gives you no operating profit. So the lack of operating profit, combined with the current level of risk, we think will get people to reconsider.

Behavioral economics has been able to generate Nobel prizes, but it still hasn't gotten most businessmen and investors to understand that it is in fact the driving force for how people act. And we think we're building the basis for that change. It is going to be slow. It's not going to happen at 10% and 20% price increases tomorrow.

What's going to drive that is something that brings about fear. Fear will replace greed, and when that happens, you'll see the dramatic price increases. For now, again, 5%, 7%, 8%, that's what we would expect this year. We had expected that to start by the fourth quarter of last year. We were wrong. I should say I was wrong, but, in fact, those changes are beginning to happen now, slower than I would have liked, but they are definitively happening.

So with that, Jerome, we'll take questions.

Thank you. (Operator Instructions) Our first question comes from Mike Grasher from Piper Jaffray.

Good morning, everyone. Rob or Bill, I just wanted to ask about the Regional markets. Can you remind us really of those markets the lines of business that are included in that, and in that segment? And then the competitive behavior right now?

Rob is going to take that question.

It's really a combination. It's a package business, both the property, the liability, the comp as well. There's going to be some auto in there in addition to that, and really the focus is providing a whole list of solution to small and middle market commercial lines where you'll write the whole account. Competition-wise, the competition is certainly still significant at this time. I don't think that the competition is increasing further or going deeper. It would appear as though pricing, so to speak, for the marketplace has bottomed out, and one is on occasion opportunistically able to squeak out some additional rates. But certainly things have not turned altogether.

Our statistics say that elect section has had again, the same modest price increases that we've seen around, but again, not dramatic.

Okay, appreciate that color. And then the Alternative Markets business, the growth that you showed in the quarter, is that driven by rate or the number of -- or the amount of exposures?

Really the significant growth that we have there was coming from our Alternative Markets segment. I'm sorry, you're talking about our gross written premiums? Yes? I want to make sure I understood the question.

Yes.

On the gross written premium, it really had to do with the assigned risk plan, and other areas of the growth that we have in the segment have to do with our accident and health business in particular.

On a net basis, it's actually down $10 million. So, even though the gross is up, the net premiums are down from 210 to 200.

You know when I pointed out the assigned risk plan?

Yes.

That was where the gross was up mainly because the assigned risk plan was up I think what, $11 million or $12 million?

In total for the Company was $11 million, but we also have more of the assigned risk premium going into the Alternative Market and less going to the Regional segment. So, it's even up more for that particular segment.

Right. So, and also in addition to that, our accident and health business is in there. So, that was up and there's more Reinsurance with that.

Okay. Final question, just around the excess comp piece of it, where are attachment points currently?

Typically it tops about $1 million. That will vary depending on individual accounts, but that's not a bad rule of thumb, if you will.

Okay. And has that moved much over the past year?

Not for us. It has for others.

All right. Thanks very much.

Our next question comes from the line of Josh Shanker from Deutsche Bank.

My first question, I wonder if you could elaborate on what you're seeing with Workers' Comp both for the price for various kinds of business and not by name, but who are the key competitor types who are writing this business right now?

I think first of all, I would say prices are in general up, say, 5%. We think in some places, it is more or less competitive, but in general, we think most people are recognizing the line of business [needs] rate. And I think most people are responding to that. I think that in the excess comp area, as I said, I think there are a few people who are entering the business pretty aggressively or in the business and being quite aggressive because of the interest rate they're using has a discount because excess comp and comp Reinsurance, you generally discount the reserves and those people are using quite high rates. Today, when we price those things, we price at the marginal treasury rate, and I'm not sure if you're looking for something specific, Josh.

I'm just trying to get better information. You said that Workers' Comp is up about 5%, and Rob said on the conference call it's certainly not as if all rates are moving in lock step. I'm just trying to reconcile that with the statement that everything more or less seems up, but with an average of less than 1%. That feels to me that some things are up, some things are down, with an average of 1% high.

But my response on comp is a snapshot as of the moment.

Yes.

Not where we were as of the average for the quarter. We have apples and oranges. Do you understand what I mean?

Okay. Yes.

I'm talking about where pricing is at this moment, and in fact, pricing has changed over the quarter. So, especially in comp, pricing has been improving for the quarter. And, yes, I think Rob talked about a number of places that prices were softer and less soft. But I think comp is one of the places that prices are better today than they were in January.

Okay, and can you bifurcate at all the ROE, or at least expected ROE, on new business lines as opposed to legacy business lines?

We have targeted returns that we find are acceptable based on different product and the characteristics of those products. We don't necessarily look or target a lower return for new business versus renewal business or vice versa.

I think I would add that we're probably patient. Every time we have a new venture, we have a 3-year time horizon, 4-year time horizon to get to our target of return. We don't want anyone to ever feel they have to write business, so our target is return. We don't go into a business without target with return of better than 15% after tax.

Okay. Thank you very much.

Our next question comes from the line of Mike Nannizzi with Goldman Sachs.

Thanks. Just a quick question on the Specialty segment. What accident years drove favorable development there? Gene, can you talk about that?

Yes, it is the hard market years, 2005 right through to 2009 and 2010 even had some modest development.

Okay. So, if reserve development is favorable in those lines, and more recent lines, just trying to understand what is the catalyst then for price changes in those lines? And maybe the answer is not right now or maybe it is. I'm just curious.

I think, first of all, even with those price changes, we're not at the kinds of returns that we'd like to have gotten from them. We didn't have lots of improvement and the positive developments early on in all those years and all those companies. We had much more modest positive development than many of our competitors because we were more cautious. I think that fundamentally, you're going to get price increases because the returns for those years are going to have to get better because interest rates are down and your aggregate returns on capital are going to be lower even if your combined ratios are in the 90s.

It used to be when you have a treasury return of, let's just say, 5% on a 10-year treasury, at a 93, you'd have a great return on capital. You don't get a 5% return. You're not nearly there. And that is your benchmark as such that you need a better return. So, I think there's lots of moving pieces in the puzzle, Mike, and I think that overall, we don't price by company, we price by individual underwritten risk, by line, by exposure, by anticipated inflation and all those things with it and we don't need 30% rate increases. We just need some rate increases. We wouldn't be happy with 1%, but if we can see 10% or 12% rate increases, we wouldn't be terribly unhappy.

And just on that, the price increases average 1%. How does that compare to loss trend for those on an apples/apples basis.

Loss trend is relatively flat. I would say that when you take in a frequency and severity at this point, it's a push. There's no adverse stuff in loss trends at this point in time. So, it's a real benefit for having price increases at the moment. There's a lot of talk about inflation, but we're not seeing a lot. And in fact, there seems currently to be a bit more pressure on medical costs at the moment.

Great. Thank you very much.

Our next question comes from the line of Greg Locraft with Morgan Stanley.

Just wanted to get your sense as to how we should be thinking of buy backs going forward. Obviously, gross returning, and you didn't buy back any stock in the quarter. What's your appetite at these levels for buy backs, and how should we think about it?

Good morning, Greg. We're constantly evaluating opportunities. We're looking at where things are going, and what we can do with our capital. And we continue to look at buying back stock as one of the options to use our capital, dividends are another option, and growth rate and expansion and acquisitions are other. And we're constantly trying to make those alternative decisions, and we certainly have not put aside buy backs, and the stock is selling within the range that's certainly on our list.

Okay. So, all right. So, I mean the stock's done very well. Is there a level at which it gets more -- obviously, there's a level where it gets more attractive, but do you pay attention to the valuation in the market or is it more just a capital management tool that you're using?

The answer is both.

Okay.

At some price, you think it's better to pay a dividend to your shareholders than buy back stock at a too high premium.

Okay.

But I think, how do you return value to your shareholders? We are focused on using our money to grow our earnings, using our money to return it to our shareholders, and return it to our shareholders in two ways, buying back stock or paying dividends.

Okay. Great. And then the other question, Bill, growth is really coming back strongly for you and yet rates are only up 100 basis points. So, in a way, how high could premiums go for you? How do you think about the level -- ?

We're not pushing growth at all. We -- I shouldn't say we, Rob, more than I, but we ask each of our companies exactly that question in much harsher terms, and that is, we don't want to grow just to grow, we want to grow in places where prices are getting better, where opportunities are better, and we think there are such places. And we're trying to emphasize that's the places we want to grow. Do you want to add to that, Rob?

I would just add, as we tried to articulate earlier, the growth is not across the board and it would be a mistake for anyone to operate under the assumption that it is. The growth is coming from specific or select pockets of the organization and quite frankly, when we see the significant growth, as you would expect, we dig a little bit deeper along with the management team to make sure that we are able to reconcile in our own minds the growth and the rate that we are charging. This is not a top line place.

And I will tell you that even if we see just one month increase in a consequential way, the first discussion we have is with actuaries about the pricing. What's going on with pricing? We clearly don't want growth without pricing increases. If we see one of our operating units growing and pricing is not getting stronger, they'll hear from us about our unhappiness about such.

Okay, and then last is just if we play out -- you've seen the first meaningful change in price in 17 quarters. When do you think in your experience we would see a turn in the accident year margins from a year-over-year perspective? When should we begin thinking about uptick?

It's going to have to be at least 3 quarters. So, the first time you'll see the accident year numbers is going to be in the third or fourth quarter.

3Q, 4Q of this year. Okay, great.

But recognize it will be a very modest change unless we start to see an acceleration of pricing.

Okay. Great. Thanks for taking my questions.

And our next question comes from the line of Jay Cohen with Bank of America Merrill Lynch.

Thank you, good morning. Two questions. The first is Gene, you had mentioned when you were talking about the loss reserves, I think you had used the expression a growing reserve margin, and I'm wondering what exactly you mean by that.

With ENS, I was referring to the redundancies that have been growing in the ENS segment within Specialty.

So, it's not necessarily a comment on the reserve adequacy as it stands today? In other words, you don't feel as if your reserves are more adequate or more redundant?

No, I was just referring to over the last few years, we've seen the reserve redundancy and reserve releases in that segment become larger and a bigger part of the total reserve releases.

Got it. Got it. And then the other question was you mentioned the renewal retention was around 80%. I guess it's been hovering around there. Where did it go down to several years ago? I'm wondering what the progression is of that number.

Jay, it went down in the mid to low 70s. And in the, what I would call the good years of 2004, '05, '06, we were in the high 80s. So, it probably went down by 10 or 12 points. So, it went from 87%, 88%, in 2005, down to probably let's say 73%, 74%, and now it's crossed 80% and it's continuing to move upward.

Got it. And then last question, do you see an opportunity in the Reinsurance business given some of the strain as you rightly point out among the Reinsurance companies? What's your plans for that business?

The answer is yes, we do, and as we explained from the beginning where we constantly are talking to people. We have lots of people who we're visiting with all the time and, yes, we think there are some good opportunities in the Reinsurance business that will give us really excellent rewards.

I assume the cat business is still not a huge interest for you?

The fundamental problem with the property catastrophe business is it gives you the same kinds of returns as much less volatile business, and you have to deal with the volatility. So, because you're required to have so much capital, the returns look great in many years but then are negative, terrible in other years. We don't think people like those extremely volatile years, and we think somebody like Berkshire Hathaway who it doesn't interfere with their business because they have so much capital, can be in this business just like an ordinary course event because it doesn't change their business plan. But other people who don't have so large a capital pool have to constantly manage their capital base for a chicken today, feathers tomorrow business and it's a problem. So, we think unless the returns on catastrophe business changed, it's just not an attractive business for someone like us.

Got it. Thanks a lot.

And our next question comes from the line of Vincent DeAugustino with Stifel Nicolaus.

We've heard with the exposure estimates with insureds, they're probably sandbagging those estimates a little bit with better to be expected exposures likely be picked up in the audit. Are you getting that sense?

I'm sorry, could you -- what is this?

This is just asking if you're getting the sense that insureds are sandbagging their estimates on exposures, and whether or not there would be better than expected exposures to be picked up in the audit later.

You talking about audit premiums?

Yes.

I'm sorry, the answer is I think there's a combination of people who are -- first of all, I don't know that I would suggest people are sandbagging. I would suggest that people were pessimistic, and the end result may be the exactly the same as you're suggesting. But I think that if you think about people's state of mind 18 months ago, a year ago, people were a lot more pessimistic about the world. So, they gave you lowball estimates because they were afraid of the world, and they were pessimistic and I think your conclusion is correct. I think we're likely to pick up a lot more positive audit premiums in the next 12 months, by a good margin. Both because of that, and because business has really gotten better. So, I think your conclusion is completely correct, but I really don't think many people has tried to sandbag you, but certainly there were some of those. I think the world was a lot more pessimistic.

Just to change gears in a question for Gene, looking back at 4Q '09 and 1Q '10, 4Q '10 and now 1Q '11, it looks like there's some seasonality with a higher tax rate for fourth quarter and first quarter? Is that accurate or is there something that I'm missing there?

The variability in the tax rate has lot more to do with the size of the pre-tax income because our tax exempt income has been fairly stable. So, it really has more to do with how much we make on a pre-tax basis that affects the relative portion of tax exempt to taxable income than anything else. It's been pretty stable when you adjust for that.

Thanks. That's all I have.

Thank you.

Our next question comes from Doug Mewhirter with RBC Capital.

Just had two quick questions. First, Gene, if you could just refresh my memory, the investment fund income, what asset base is that off of? Is that just that one, the $548 million of investment funds, or is there any of the arbitrage funds that gets thrown into there as well as?

The arbitrage funds are separate from that. So, it's exactly what you have said, it's the $548 million, what we call investment funds, those are externally managed investment funds.

And one of the problems is because interest rates are so low, we're putting more money into those investment funds and into other kinds of investment fund vehicles, and that also is going to compound the problem. As we put more and more money into those funds, we'll be excluded from our investment income, so that was going to become a worse and worse problem.

Okay. Thanks for that. And the second question is Bill, you mentioned just throwing around speculation about possible price increases this year, and you're saying things like 5%, 7%, 8%. Given that you're at 1% off the board -- across the board, notwithstanding your bullish Workers' Comp commentary, it seems like a little bit of a stretch to get there by the third or fourth quarter considering how slow and gradual the market seems to be turning.

First of all, I think that it's the rate of the prices, not prices will have gone up by. It's by the end of the year, I think prices will be increasing by that rate. So, I'm not suggesting that for the year prices will be up 5% or 8%. I'm suggesting that if you look at prices in the fourth quarter, they will be 5% to 8% higher than they were the fourth quarter of 2010.

Okay. So, it's a snapshot at the end of the year.

But not that our earned premium prices for the year will be 5% to 8% higher than the earned premium prices for the prior year. Mathematically, would be very hard to get there. So, what I'm suggesting is that price levels by the end of the year will be 5% to 8% higher than they were in the fourth quarter of the prior year. And I think that's going to happen, because you're going to see things like Workers' Compensation that is going to be, in fact, up next quarter at a higher level and a number of other lines are going to be up. So, I would expect that our price increase levels for the second quarter won't be 1%, but will be 2.5% or 3%.

Thanks. That's all my questions.

Our next question comes from the line of Amit Kumar from Macquarie.

Thanks and good morning. Going back to the discussion on premiums and talking about Reinsurance and International segment. I'm just wondering looking at the growth from 2006 to 2011 in these units, based on your comments, is it fair to say that the international premiums will exhibit meaningful growth going forward? Or do you think we're at that level, where it plateaus from this point on?

No, I think it's likely to have meaningful from this point going forward.

That's helpful. The only other question I have is on the cat modeling when you have talked about RMS 11. Some of the companies have in fact remarked that's not the only model they use. They have internal models and they use all three models. And my sense is that if I'm a company and if I come for the range of numbers, why would I be, in fact, picking the highest number based on my current returns? Could there be a scenario where the impact could end up being much more muted than what we thought initially?

Well, first of all, Amit, I don't think I said that everybody's going to use RMS 11. If I did, that was not what he meant. What I meant to suggest is that with all the catastrophe losses that have taken place and we haven't really got into what historically the big cat loss season, which is approaching. It's likely to be quite a disastrous cat year. The exact losses taken in the aggregate for Australia, New Zealand, Chile, Japan, are likely for the reinsurance marketplace to be certainly well in excess of $50 billion.

So, when you take all those losses, the catastrophe reinsurance business is going to be under a lot of pressure. I, then was trying to express to you that, that pressure will be exacerbated by the fact that RMS 11 is going to cause the rating agencies having just seen these cats, which are much worse than anyone anticipated, to look at a conservative model. And I think RMS 11 is overly conservative and is not the only model we use either, but when rating agencies see losses far in excess of what they imagined, which is what they saw clearly in New Zealand and Japan, they're going to look at conservative models, not aggressive models.

And it's not what a company says, they want to use. Undeniably, it's the rating agencies that are going to set that tune. And I think the rating agencies are going to certainly, at least, want to look at RMS 11 as one of the keystones. So, I'm not suggesting it's going to be the be all and end all. And heaven forbid, I think we would be a terrible state if we relied on one rating model, and I don't believe in one rating model. I actually don't believe in any of them, but the fact is that I think it's going to be taken together, that there will be a lot of pressure on catastrophe coverage's availability and exposure. That's all.

Got it. Thanks for the color.

Our next question comes from Ajay Meli with Eagle Capital.

Hey guys, good morning. A quick question to follow up on your talk about inflation. I know you guys have been thoughtful in the past about baking in some conservative inflation expectations in the different lines, and I realize it depends where inflation shows up. But I'm curious if any of the current Fed's actions in QE2, and potential further actions are worrying you at all. And if you're doing anything differently now, or if it's the same old play book?

I think that our general view would be reflective of the following. Number one, we think that just as we got benefits for a long time from the low production costs and low costs of goods being provided by China and the much of the rest of the world; we're going to suffer as they have an increasing middle class and demand for food, energy and raw material. So, we think food, energy and raw materials are going to create inflation here, and that's going to cause inflation all across the board. What's maybe even worse is, it's unlikely that the Fed tightening is going to have any impact on that because it's not within their control. So, that inflation is likely to be much more dependent on how the Chinese and some of the other powers that we trade with are going to act.

So, we're continuing to be more a bit cautious about inflation than a number of people. We think inflation is down around the corner. We don't think it's going to be terrible runaway inflation. So, we continue to bake in inflationary expectations. And what's more concerning, honestly to us, is we don't think it's within the Fed's capacity to manage that inflation. So, unless the Chinese and some of the other foreign countries that are going to drive this inflation -- this one world is really true when it comes to food, energy and raw materials. So, it continues to be baked into our numbers.

Okay, great. Thanks, guys.

Our next question comes from Vinay Misquith with Credit Suisse.

On the cycle turn, Bill, you mentioned that fear was the big factor that drives cycles, and you also mentioned that there's not much inflation near term, and we can see most companies having strong reserves. So, curious -- ?

I don't think I said most companies have strong reserves.

Okay, yes, yes. You didn't say that, but most companies that have reported so far, have shown pretty strong, favorable reserve releases. And at least from looking at the industry triangles, it doesn't seem like they're under-reserved like they were back in '99. What do you see that will really drive fear? Is it the cash flows within the industry?

First of all, I think that we're going to start to see investment income start to decline as cash flows haven't been significant, and yields are going down. I think number two, you're likely to see some adverse development from some of the aggressive competitors starting to have to pay the price of that aggressive behavior. There are lots of companies that are doing a fine job and are going to do just fine, and they may have a hiccup or a bump, but they're all the guys who are talking about raising prices. When you hear people talking about they don't need to raise prices, those are the people who are in denial.

All you have to do is -- you can look at the most conservative people who do pricing measure, and the fact is prices are down significantly; and there is some inflation, especially medical inflation. And that tells you the industry is running as a whole at 110 or 115, and given where investment income is, that means a certain, certain proportion of the industry is having a major operating loss. The sum of the parts has to equal the whole. You can't have everyone doing okay when we know what pricing has done, and we know what investment income has done. And then when you add up the industry, it's quite at odds with those numbers. I just think eventually you run out of redundancies from past. Eventually, you have to say wait a minute. It isn't everybody, but there certainly are places.

Fair enough. And in terms of this cycle versus the last cycle, I would say '99, how is this cycle different from the last cycle? Do you think that rate increases will be slower than it was back in 1999, 2000?

I think, first of all, the one place where you're quite right is reserves were much, much shorter in 1999, 2000 than they are now. I mean, reserves were just a disaster at that period of time for everybody. I don't think there was anybody adequately reserved then. A lot of people thought they were, but they were wrong. Now, keep in mind what I said just then. A lot of people thought they were and they were wrong. A lot of people think they're redundant and my guess is they're wrong now, too.

So, we have better numbers, better statistics, the business is going to be modestly less cyclical, but it's still cyclical. The numbers are the numbers. People who say it's a less cyclical business. They want to say that price declines aren't the case. Well, I think there are people who exaggerate price declines because they get hearsay evidence from brokers, from whatever, that aren't statistically driven. But the fact is prices are down, and they're down substantially.

Terms and conditions are less good. If you look at our existing businesses, businesses that we've been in since 2000; our auto volume is down more than 25% for most of them, and some as much as 40%. It's down because prices are down and the number of units we insure are down, and we don't do that because we like getting smaller.

Thank you for your answers.

It's reality. So, I just think that in '99, everybody thought in '98 -- if you talked to everybody in '98, they'd tell you their reserves were fine, too.

All right. Thank you so much.

Our next question comes from Mike Nannizzi with Goldman Sachs.

I just have a quick follow up. If we're to back out the new business, the new platforms in Specialty and maybe in International, what is the trend on top line of that legacy book exposure from the exposure perspective?

Well, I'm guessing -- for the quarter, it was probably flat. For the past couple years, it's down probably what would you say, down 15% or 20%?

For the quarter?

For the quarter.

For the mature? Non-start up lines?

Yes.

I think 10.

Down?

Down. Down 10% to 15%, but obviously, Mike, that's going to be skewed depending on the part of the business. For example, the Regional business that's historically been a lot more sticky when you go to the EMS, or you go to the facultative world -- the reinsurance world, the retention ratios are very different.

Got it. In terms of new business, if you were to isolate that, if we were to look at new business. Again, excluding the new platforms, new business on the old legacy book relative to what you wrote new business-wise quarter, 10%?

You mean new business versus renewal?

Yes. So, new business versus renewal, but on that legacy book. So, again, excluding the startups.

I don't have the number that I can give you off the top of my head.

Okay.

It's not in my head, and it's not in the pieces of paper in front of me. And I don't want to give you a number that I don't -- it's a good question, but I don't know the answer to it. But we'll try and get back to you with that.

No problem. I guess maybe from the other side, Gene, I know the last few quarters, I think it was last quarter, you had talked about the new business trends in the startups, or the premium percentage startups versus the legacy book. Do you have that?

Yes, we could get that for you. One of the reasons we aren't discussing this as much as because some of the startups were started in 2006.

Now, they're old. They're effectively legacy book at this point.

At some point, we got to stop calling them startups.

That's all right. Thanks again. Sorry for the follow-up.

Not a problem.

Our next question comes from Ron Bobman with Capital Returns.

I have a question that reminds me of Charlie Gates type of questions. And it's simply, how do rates go up? And I'm curious about the interplay at the underwriter's desk at the agent and at the insured, or the prospective insured. The back and forth that begins the increase in rates. Is it simply underwriters getting less push back as they propose a higher rate and they sense it from the agent and the insured that it's less of a competitive environment. And the retention rate, they can just see ticking up; and that fuels the confidence to do more of that?

Ultimately, rates go up -- they start to go up because you've spent enough time with the broker, and the broker is particularly concerned that they have good markets. We heard from one of our ENS competitors that their prices are down substantially; and we looked in the mirror because our ENS people said for the first time, they're seeing the ability to raise prices. So, what's interesting is that what's going on at this point is there's a differentiation. People saw Japan. They saw the catastrophe. They're beginning to recognize that there's a value to insurance and it matters who you do business with.

So, you reiterate that to your brokers, you make the point. And you don't go in a and ask for a 10% or 20% rate increase. You ask for 1%, 3%, 5%. As long as you keep it under 5%, brokers understand there's inflation. Everybody's talking about inflation and in most cases, you're able to get a modest rate increase. Not every place, and in some cases the customer wants to fight and compete and you got to sell the idea that the uniqueness of this product that people fail to understand, if you're really lucky, you bought a product that you get nothing for. There aren't many products that are like that. But when you buy property casualty insurance, you hope you wasted your premium, that you've bought something that you'll never use. But you really don't want to buy something that you need to use, and it's not there. And that's the message we spend a lot of time talking to our customers about.

Will the more passive companies, with respect to rate increases, increase their confidence and ability to propose, and I guess ultimately get rate increases as they hear the likes of Berkley and as they hear the likes of Travelers talk about their in effect successes in getting rates? And that will reinforce and fuel further, and maybe even greater rate increases for the market as a whole?

Without a doubt. But they're also going to be the same companies -- the smaller companies are the ones that are going to have the most pressure for catastrophe reinsurance. So, they're going to also all find out they've got a lot of reinsurance cost pressure going against them at the same time. So, they're going to have to raise prices. They're going to have that pressure. See other companies raising prices, and they're going to have even more impetus to do it. So, yes, I think that's going to happen.

Thanks a lot and best of luck.

Our next question comes from Ken Billingsley with BGB Securities.

It's kinds of a follow-up to some of the comments you just made around Ron's question. Can you talk more about the competition, about your for new business versus renewal business? You're saying that the brokers understand when you're trying to ask for 3% and 5% rate increases. Obviously, just a few quarters ago, competition may have come in and been able to come in and steal that with I'm assuming with 10% or 15% rate declines. Can you talk about the shifts in what's going on, whether it's terms and conditions, and your ability to price your renewal business versus the ability to price the new business that you're looking at?

I think that it's a gradual process. We talk to every agent, every broker, we talk to them because brokers are afraid, agents are afraid they're going to lose the business. On the other hand, many of them also know that it's important to them to have solvent insurers who pay claims. There are companies that are in business, and they need them to stay in business. They need competitive marketplaces. They need viable companies. The worst thing for a broker or agent is a company that doesn't pay its claims. So, they need viable companies, and I think you talk candidly about them and you talk to them about the reality.

I'm going out the end of the week to talk to a group of our agents, and it's reality. They will have seen companies go out of business and they know it. And what brings that issue to their attention are things like Japan where they say, what the heck is going to happen? What companies are going to survive? And there will be articles everywhere soon about New Zealand, that there is not enough premium in New Zealand to pay for the earthquake exposure in New Zealand. And the government is going to have to subsidize the premiums, or people won't be able to afford the risks.

And as those kinds of things start to become pervasive, people are going to start to understand. So, I think that brokers are afraid they're going to lose the customer to the broker next door. But more importantly, they're afraid that they're going to have a customer who's going to have a claim that's not going to get paid. And I think that's the evolution of change from greed to fear. And I think when that fear starts to take over -- they're not going to be afraid enough to raise prices 20% because they don't have that much fear. The World Trade Center gave them that much fear, but today, they're going to get a little bit of fear.

And I believe, really to the comments you made earlier about, obviously the reserves in the industry today are not as weak as they were going into the last cycle at the end of the '90s?

They were not as weak, but they're much weaker than people perceive at the moment. If you don't establish your case reserves, your cases where they need to be, and if you don't understand that your pricing is inadequate, until that loss level gets to where it's supposed to be, you don't realize your reserves are inadequate. So, there are a lot of people who don't understand that their reserves are inadequate at this moment in time. But they'll be finding out soon because when you cut prices enough, even a long tail line becomes short tail.

Thank you.

Our next question comes from the line of Bob Farnam with KBW.

Thanks, good morning. So, it looks like you're selectively increasing your non-casualty business mix? I think that means property, but it also sounds like you're not looking for property catastrophe business. I'm just curious, one, is that an opportunity you see because of improving rates? And two, what types of risks are we looking for and in what segments are they going in?

Okay, you want to talk, Rob?

Sure. The answer is that it's not that we move as you suggested solely into property. We certainly have increased our property exposure a bit, but pure property as we define it remains, give or take, around 10% of the portfolio. It's really been the expansion into some other specialty lines, such as energy, agriculture, other things like of that nature that we have discussed in past calls. It's expansion that is not necessarily taken us deeper into some of the traditional casualty lines that we have had a significant presence in. Yet, not pure property but shorter tail lines.

All right. So, this is mostly coming in the ENS segments?

It's mostly coming in the Specialty lines, and once again, it's not a true shift to property, but it's more of a shift to Specialty lines that are shorter tail in nature. And, as I had mentioned earlier in the call, also our presence in the ANH space is growing as well, which is obviously shorter tail than much of our historic portfolio.

Some in land marine, and just various things.

Okay, very good. Thanks.

Our next question comes from Josh Shanker with Deutsche Bank.

I just want to clarify, when you say $14.5 million of investment gains from funds, that only includes the investment funds, not the arbitrage portfolio?

That's correct.

Correct.

Income from arbitrage funds is in and has always been in investment income.

Okay, and that's never been broken out separately?

Right.

Okay.

We talk about it separately.

We describe it separately.

But it's in operating income.

Fantastic. Thank you.

I'm showing no further questions in the queue.

All right. Thank you all very much. Have a great day.

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program and you may all disconnect. Everyone have a great day.