W R Berkley Corp (WRB) 2013 Q1 法說會逐字稿

Good day, and welcome to the W. R. Berkley Corporation's first-quarter 2013 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 use of forward-looking words, including, without limitations, believes, expects, or estimates. We caution you that such forward-looking statements should not be regarded as a representation by us as future plans, estimates, or expectations contemplated by us will be, in fact, achieved. Please refer to our annual report on form 10K for the year ended December 31st, 2012 and our other filings made with the SEC for the description of our business environment in which we operate and the important factors that may materially affect our results. W.R. Berkley Corporation is not under any obligation and expressly disclaims any such obligation to update, alter its forward-looking statement, whether as a result of new information about future events, or otherwise.

I would now like to turn the call over to Mr. William R. Berkley. Please go ahead sir.

Thank you very much.

We were really pleased with our quarter. I think that a number of things I would like to just comment on, and I will turn it over to Rob.

First of all, you will see our change in format as we try to address what we think is a better presentation as an ongoing basis of how to look at our Company. That is an evolutionary process. We think this gives people a better picture, in part because our various segments seem to move around and overlap and no longer gave a good picture of our ongoing business.

Second of all, I think that the growth that we are showing in the increase in prices is coming into our financial statements, as we've tried to explain, on a slower basis than one might have expected. But we are really enthusiastic about it continuing to build over the balance of the year. We're very optimistic as to how things are going.

With that, I will let Rob talk about our operations. After that we will turn it over to Gene and I will come back and make a few more comments and answer questions. Rob?

Good morning.

Through the first quarter the commercialized market continue to experience further gradual tightening. This ongoing trend seems to be primarily fueled by concerns stemming from prior-year reserve development. However, the low interest-rate environment is also beginning to have a real impact on investment income; and consequently, overall profitability for the industry. And people are beginning to recognize the issue and react. There has been a lot of talk about this over the past couple of years, but we are now beginning to see it translate into action in the form of greater discipline on the underwriting side. We believe these factors will sustain the market improvement.

While on the surface, market conditions during the first quarter appeared consistent with the second half of 2012, there were a number of signs that a sense of urgency is on the rise. The combination of continued strong growth in the assigned risk plans, and less competition for certain large accounts, with a noticeable spike in submissions coming into the standard market is evidence that we are likely to see further tightening as the year progresses. The overall casualty market continues to firm as companies are looking to raise rates as well as reduce capacity or line side. While the professional market lagged the broader market, it is also now showing signs of improvement; although in general, the excess lines continue to be more resistant to such changes.

The workers' compensation market was also somewhat of an anomaly, with discipline returning to the primary market while the excess space remains surprisingly competitive. One can only assume the explanation is the difference in the duration of [tail], and that companies are not yet recognizing that there excess business was underpriced. The commercial auto market, aviation, and rain market, all continue to remain quite competitive. However, given the industry results, we are anticipating a noticeable shift over the balance of the year. Finally, the property market -- while improving rates are available, they are less robust than one might expect given the global Cat activity over the past two years.

We continue to emphasize the importance of rate adequacy and underwriting margins throughout our organization. The Company's rate monitoring of renewal business for the first quarter indicated an improvement of 7.3% over the corresponding period in 2012. Our new business relativity metric indicated that we charge roughly 2% more for our new versus renewal business. All three business segments contributed to this improvement in rate for both new and renewal business, though not equally. More specifically, about four of our operations did not contribute to balance contributing.

This is the ninth quarter in a row the group achieved additional rates, and consequently the fifth quarter that rate on rate was achieved. Cumulatively, our written rates are up 15% since 2010, and our prices are on level with where they were at the beginning of 2005. Of course, loss costs have risen since then, and interest rates are lower, so there is still more work to be done. As in the past, we continue to believe we are obtaining this improved rate without jeopardizing the quality of our book, which is demonstrated in part by our renewal retention ratio continuing to remain at approximately 80%. We continue to believe these two meaningful data points demonstrate that the Group's underwriting margin is improving.

Gross written premium for the quarter was $1.63 billion. This is an increase of 16.4% when compared to the first quarter of 2012. When you take a closer look at the breakdown of this growth, 7.3 points came from rates, 8.5 came from exposure growth and audit premiums added 0.6 points. Our International Insurance and Global Reinsurance segments grew by 25% and 23% respectively. While our new businesses are contributing to the growth, they're not the sole driver. 37 of our 47 underwriting operations reported increases in premiums during this period.

For the quarter, the Company's calendar year loss ratio was at 60.4, an improvement of almost 2 points compared with the first quarter last year. The improvement in the ex-Cat accident year loss ratio was about the same, as Cat losses and reserve per leases were comparable to the same quarter a year ago. Perhaps more importantly, the Company's paid loss ratio was 53.8, which is the lowest it has been in several years.

Our expense ratio for the quarter was at 34.3, a reduction of approximately 0.5 point. This is gradually improving as our earned premium continues to build momentum. We expect this trend will continue; however, it is impacted from time to time by costs associated with developing new operations. When you put it all together, the Company produced a combined ratio of 94.7, which represents an improvement of approximately 2 points.

As the year progresses we expect this trend to continue, primarily due to the benefit that both the expense ratio and the loss ratio will gain from higher earned premium as well as improved rates. We continue to be comfortable with our balance sheet due to the strength of our investment portfolio as well as the health of our loss reserves, as evidenced by 25 consecutive quarters of positive reserve development.

The Company continues to subscribe to a general philosophy that in the aggregate, it is better to err on the side of caution when selecting initial loss ratios and adjust accordingly as more information becomes available. The market continues to tighten, evidenced not just by higher rates and the power of comp timing of these higher rates, but is additionally supported by the narrowing appetite of the standard market, once again demonstrated by growth in assigned risk plans as well as increased submissions into the specialty market. Our Company remains well poised to take advantage of this improving market.

Thank you, Rob.

Gene, you want to take us through the financials, please.

Okay. Thank you.

Before I go through the numbers, let me just take another minute to describe the change that Bill referred to in the way we define our business segment. First, the new Domestic insurance segment is really just an aggregation of former Specialty Regional and Alternative Market segments. Over the time, the distinction between these segments has become a little less relevant from a financial reporting perspective. As Bill said, that is because many of our profit centers, especially the newer ones, do not just write one type of business. It falls within one type of category or another. Therefore, they do not specifically fit in a sub-segment. We thought it was better to combine them.

The other two segments -- International Insurance and Global Reinsurance -- are the same as we previously reported, except that we moved two companies, Berkeley Re Australia and Berkeley Re UK, from the International segment to the Reinsurance segment. You can find an exhibit on our website that presents our historical financial results under the new segment alignment.

By the way, we also recently completed a significant change in our statutory financial structure, effective January 1, 2013. All of our US insurance business is being reinsured to our lead Company, Berkley Insurance Company, under a 100% inter-company pooling agreement. This will significantly reduce our administrative and regulatory costs. We also think that having all of the business in one annual report will provide more useful statutory financial information.

Now, with regard to the financial results, it was another strong quarter, underwriting quarter, with an overall increase in underwriting income of 70% from a year ago. The improvement was driven by a 12% increase in earned premium and by lower loss and expense ratios for each of our three business segments. As Rob said, gross premiums were up 16% to $1.6 billion.

Ceded premiums were up more than that, at 30%, due to two things -- higher reinsurance limits as well as strong growth in some of our newer companies. We tend to buy more reinsurance for companies in their early years while they are developing a sufficient spread of risk. You should also know that approximately 1/3 of our ceded premium is business ceded to state assigned risk plans and related self-insured [entities] that we administer.

Net premiums were up 14% to $1.4 billion, with increases of 12% for the Domestic insurance segment and 22% each for International and Reinsurance. For the Domestic insurance, the growth was led by our E&S companies and our Monoline workers comp business. The International growth was mostly from our businesses in the UK and Europe. And the increase in Reinsurance was driven by growth in Asia-Pacific region and the UK. Changes in foreign exchange rates had minimal impact on the International growth rate.

In terms of our combined ratio -- just to add a few comments to what Rob had to say -- the combined ratio declined by 1.8% to 94.7. The underlying loss ratio before Cats and reserves declined by 2.62. Prior year reserves developed favorably by $24 million, almost unchanged from $25 million a year ago. All three business segments reported favorable reserve development this quarter, with the majority of that coming from the Reinsurance segment.

Cat losses were light again at 0.4 loss ratio; points unchanged from a year ago. And the expense ratio improved by 0.4 of a points to 34.3. Because we're growing so significantly -- we talked about this before -- we also look at our direct written expense ratio. That's before ceded premiums and DAT, because we think it is a more current measurement of our expense trend. And on that basis, the expense ratio declined a full point to 30.6%

Investment income from our core portfolio was down $2 million to $121 million, with an annualized yield of 3.6%. Income from investment funds was $11 million with an annualized return of 5.7%. Although the investment fund income was in line with our expectations, it is well below the 18% return that was earned in the first quarter of 2012. The difference is mainly due to energy funds that had especially strong earnings in the first half of 2012.

Realized gain from investment sales was $20 million during the quarter and pretax unrealized gains were $804 million at March 31. At the end of the quarter, 81% of our portfolio was invested in cash and fixed income securities with a duration of 3.3 years and an average credit rating of AA-minus. Unrealized gains were up slightly in the quarter, but a 6% decline in the British pound exchange rate resulted in an unrealized currency translation loss of $46 million. About a third of that decline has reversed so far in the month of April. So, that gives us net income of $117 million; an annualized return on equity of 10.8%; and book value per share of $32.19. And if you adjust for the special dividend that we paid in December, our book value per share is up over 11% for the last 12 months.

Thank you, Gene.

We're pretty pleased with how we're going and where things are going. There were some things that were unusual, as the volatility. We're well-hedged in the euro. We are invested in sterling, still. That decline in sterling at the end of the quarter did cost us in book value. Although, as Gene said, between a third and a half of that is back already. We think that sterling is a better alternative for us than the euro at the moment.

We do have a number of investment alternatives that we think will protect us over the long run from inflation. But in the short run, we are less concerned with inflation because we think that the dollar is still the place to go. And we think that foreign flows into the US will really keep inflation under control, certainly the next 12 to 18 months. We are feeling a little less pressure for inflation being around the corner, which is causing us not to be in such a rush to shorten the duration of our portfolio.

As far as our own opportunities, we are seeing growth in almost all of our operating units. There is a lot of volatility as people leave segments of the business that they entered without properly positioning themselves. We are finding good opportunities with people and relationships where we are able to step in and gain market position. It is clearly becoming a marketplace of the haves and have-nots. For the haves, it is going to be an excellent next few years.

With that, Kevin, we are happy to take questions.

(Operator instructions)

Amit Kumar with Macquarie Research Equities.

Just two questions. First of all, just going back to your pricing comment and the shift from standard to specialty markets. Do you get the sense that perhaps we will be able to hit double digit rates by the end of 2013, or do we stay in the 7% to 8% range for the remainder of the year?

Amit, this is Rob. I think that it would just be speculation. Certainly there are lots of data points that would suggest that pricing leverage in favor of the carrier is potentially built from here. At the same time, I am not sure if it is such a perfect science that we can call it with any -- within any 90 or 180 day period. Are the fundamentals there? Does the pressure continue to build that would drive further change in behavior and what people are looking to achieve as far as rate? Absolutely. That is the case. But our ability to answer your question with a level of precision that you are looking for, I think it is a stretch. Having said that, is certainly is a distinct possibility.

The one external factor that is here today that was not here in the last cycle is we have an economy that is not as robust. That is going to keep a little more pressure on the marketplace. I think that it is not as much of an insurance question as an economic question. There is plenty of pressure for improving rates as the needs for returns. On the other hand, you do have that economy that is improving, getting better, but not at a robust rate.

Got it. Secondly, I guess related to that, is the discussion on loss cost trends. I know we spent a lot of time talking about, I guess, using a 3% number on the past calls. Why? Maybe that is what you view as the trends might be even better than that. Has anything changed on the loss cost trend front, or is it pretty much the same, what we discussed about on the last call?

I think that we would generally -- based on what our actuaries see with medical costs and everything else, we would say that it is generally steady. We think because of less pressure on inflation overall, we would have expected a little more pressure. There is definitely less pressure. I think to be more optimistic at this moment would probably be foolhardy. We would still sort of stick at that 3% level and be happy if it came out to be 2%, that would be great. But I think we're going to still stick at the 3% level.

Got it. Final question. You have been given us the chicken today feathers tomorrow analogy in the past. There is a lot of discussion on third-party capital entering the reinsurance marketplace and providing additional capacity to the market, which already has a lot of capital. Do you have any thoughts on third-party capital? Even perhaps, utilizing third-party capital backed reinsurance to write some lines which you might not have written in the past? Thanks.

Third-party capital or if you will, capital provided by various pieces of the capital markets ranging from private equity funds and hedge funds to banks have been available for a while. I think it is an interesting avenue. We have used it on occasion to provide us with reinsurance. However, our own view at this point is we are not really interested in the uncertainty or the volatility that those kinds of returns offer. We have looked and considered providing services to some of those people. For the moment, do not think it is where we want to go. We believe that when we do that for someone, we are still putting our name on that risk variant. These business and it is not something that we're going to do tomorrow. If we think that we can do it in a way that provides a return for them, and fees for us, and they are willing to accept the volatility, we may well go there as these markets develop. But we are not willing to do it tomorrow.

Thank you for all of the answers.

Mike Nannizzi from Goldman Sachs.

One question I had, I guess, in growing now. Are you able to find areas where margins on business you pick up is consistent with or are consistent with the margins that you are seeing on your retained book?

The pricing on our new business is in general 2% higher than our renewed. So, in fact,, the answer is yes.

Okay.

In fact, it is a little bit better. But you'd think you need it to be a little bit better because you do not have the same experience, you don't have the same knowledge. So, the certainty of your underwriting skills is not as good.

This may be a really basic question, but who is giving -- who is not writing that business? If the business is in good margins, may be better margins, what is causing that business to be available?

I think, in general, what is happening is you have lots of people who are more concerned with the quality of their insurers and are saying, we need to be sure that people are here so that you have people going for stability. Going to people who they know will be there. I think that you have got several larger companies that are trying to sell themselves, trying to get out of business, that is freeing up business. People are saying, we do not want this. We will pay a little more to have stability. Like everything, there is turmoil in the marketplace in some segments or another always. So, I think that is going on. People are underwriting their books of business. There as it is not like there is one company. There is probably two or three medium size companies that are currently going out of business.

Got it. Okay.

And I think that all we need to do is look at the list of companies that people like Goldman Sachs are selling. Those customers are the ones who are creating opportunities.

Got it. Okay. Thanks. Can you give a little bit more color -- you mentioned primary versus excess. I thought that was really interesting. Just kind of the competitive dynamics between those two different distribution placed businesses.

Rob?

Good morning, Mike.

Good morning.

Obviously, we can't specifically pinpoint what is driving other behavior. But we are noticing a great difference as to the tone and the attitude when it comes to pricing of primary versus excess in a couple of parts of the overall marketplace. Our hypothesis or theory is that the excess tends to take a little more time for the results to come through and for people to recognize the issues that they may be facing, as opposed to the primary where the consequences come through in a more timely manner. Which is why you are seeing people respond to the primary more quickly.

Do you think part of it might be -- I'm just curious -- may have to do with the fact -- to write traditional business, you need more infrastructure, you need fully built out claim system and maybe if you are writing higher, mid layer access, you need less of that. Is that a possibility? Or is that not likely?

I guess it is a possibility, but based on what we see, it has less to do with expense ratio and more to do with perhaps a lack of underwriting discipline and how long it takes when you're in the excess layers for that to become apparent. The excess comp would be a great example of that.

Got it. Great. And one last thing, if I could. What are the attributes that you look at when -- you mentioned your start-ups. I would imagine a lot of that is still taking place outside of the US. What are the attributes that you look at in terms of deciding where you want to grow? I'm guessing -- we have heard from other folks that pricing is still better in the US. And outside of the US, I'm guessing, you just have a longer lens in terms of what you want your profile to look like. But any color there would be helpful. And thank you for all of the answers.

I think that we will let Rob give you the answers and the specifics. But I think that our strategy, as opposed to the specifics to your question, is always an opportunistic one. It is not -- here is what we are going to do. It is finding the opportunity that presents itself.

From a general approach, when looking at opportunities, on a macro level, the same domestically as well as outside of the United States. We are looking for market opportunities, which we think is a sustainable opportunity. We want to differentiate between intellectual capital and expertise as opposed to purely capacity because that makes you ripe for becoming even more of a commodity.

As far as your comment about the US versus the non-US, I think to paint with such a broad brush to say that price increases in the US are better than outside of the US, I think that is a bit of a broad brush. Certainly there are markets outside of the US that remain more competitive than our domestic markets here. Perhaps Europe being an example of that or parts of Asia. Ultimately, when we look at opportunities, whether it be in the US or outside of the US, we are looking at it from a risk-adjusted return perspective.

Obviously, when you are doing business outside of the US and some jurisdictions, you need to take into account the environment or the country risk, which we factor into the analysis. We do not have the luxury of investing in operations that hopefully a decade from now will start to generate a return. That is not our approach or philosophy. At the same time, we are prepared to build domestically. And outside of the US, invest in opportunities that we think over the foreseeable future will help grow value for the organization and the shareholders.

To try and be a little bit more specific as to what our general process would be, somehow or another, through referral or someone we know, we would find a group of people who we think are talented. We'd examined their expertise, the market that they do business in, the country, specialty, whatever. We evaluate what we would think is the risk-adjusted return, the volatility, the exposures, decide its fit within the group. What does it take to do it, and then try and move forward. It would be possible but not usual that we would say that we want to be in this business. It has happened. Some of our units got started because we said--we want to be in this business.

Did you evaluate those opportunities based on local interest rates, local country and equity risk premiums? Or do you centralize that?

It is all based on hard risk adjuster return. Understand the risk is related to wherever it is, whatever lines of business it is. Obviously, the risk of doing business in some places is much different than the risk of doing business in others. Either because of the lineup, the nature of the country, it's legal system, whatever.

Okay. Thank you, so much.

Ron Bobman with Capital Returns.

Last year in the excess workers comp market, your main competitor was bought by one of the giant Japanese companies. And then at the year-end, it seemed the main competitor took a massive reserve addition. I'm wondering if it is a big seasonal renewal in that line of business in January and I think the summer time. So, I'm curious at 1-1 or of late whether you see sort of behavioral change from that competitor? Thanks. That is it for me.

I am not going to speak specifically about the one competitor, but we will speak about the market in general or competitors as a group. Certainly we are observing a somewhat change in appetite and attitude. Quite frankly, I do not think that we are seeing the same level of competition that we saw 12 months ago. Not to suggest at all that rates are dramatically going up and that there has been a seed change in behavior. Certainly the blind leading the blind does not seem to be the case any longer.

I think that you should say the blind leading Berkeley. I thought they were the blind ones according to Bill's comments.

Yes. (multiple voices) I think they are the blind ones, but I can assure you that we are not following them. Long story short, as far as excess comp goes, it is not the free fall that it was in maybe last year and prior. At the same time, certainly we are not seeing the excess comp market react the way that we're seeing the primary comp market over the past quarter or two.

Thanks.

Understand the excess comp market is the epitome of risk in this environment. That is because it is such a long [tail line] inflation is inevitable to impact their cost of claims. You have the average duration of about 17 years or 18 years, and you know that you will have inflation long before we get to that point in time, by a substantial degree. You have to discount based on current interest rates, if you are cautious. And if you are not cautious, you choose an optimistic interest rate. That optimistic interest rate could cause you to have a huge difference in your pricing. So a combination of optimism as to low inflation forever and higher interest rates than we currently have can create differentials in price of the 50%. You can justify it. You just have to worry about retiring before you have to pay the piper.

Just a follow-up. I would think that the rational man-- you would pull back your writings dramatically in a line like that.

(multiple speakers) It just means that you have to adequately price and make rational decisions. In fact, our writings are down substantially. How much are they down now roughly?

They are down probably about 40% from where they were at the peak.

Thanks, gentleman. Best of luck.

Thank you.

Vinay Misquith of Evercore Partners.

The first question is on the base of growth. It seemed pretty healthy the past few quarters. I'm just curious on what the outlook is going forward? Are you seeing higher pricing? I guess more businesses now becoming attractive. Do you see the pace continuing or do you see the pace slowing down from these levels?

As far as -- I would like to make sure that I understand the question. It is it whether we see rates to continue to progress at this level?

No. It is really about the top line growth.

The top line growth? Certainly, it depends in part as to how we see the market harden from here. We would expect that many of our businesses have quite a bit of runway in front of them and opportunity to grow as we have suggested to you and others in the past. We feel like we have the fundamental platform in place for our business to be able to grow dramatically beyond what it is. It is hard to know with certainty what market conditions will be tomorrow, which will play a big role in defining how big we can get and how quickly we can get there. There is nothing that is in front of us right now that leads us to believe that we are not going to be able to continue to grow at a healthy pace. Once again, as we mentioned earlier, there are signs that the market may continue to tighten from here, which will give us more opportunity to grow the business.

Okay. That is helpful. Second question was on the accident and loss ratio improvement. There was about, roughly 200-basis points. Your rate increases are about 600-basis points to 700-basis points and loss cost trends of 300-basis points. So, I would have expected maybe slightly more marginal improvement. Is that just a normal lag?

I'm going to let Gene explain it. Do not expect it to make sense but Gene will explain it. (laughter)

I will try. Really what happens is for every 1% change in net trend -- and by net trend I mean price increases less loss cost trend -- equals a 1% change in our loss ratio. A 1% change in our loss ratio is 0.06 of a point. Not a full point. So we would expect for every point change in that net trend, a 0.06 of a point change in our loss ratio. We are estimating a 3-point improvement in the net trend, 3.5 maybe, that equates to about 2 points in the loss ratio.

Okay. I will follow up on the math later.

Vinay, he will go through it with you.

I would be happy to.

Okay. Great. The last question, if I may, on the arbitrage account, I notice that you put a significant amount in terms of the arbitrage account this quarter. Two questions on that. Do you expect that to remain at these levels for the future and what is your normalized returning expectation for that?

The arbitrage goes up and down almost daily. That was what it was at the end of the quarter. But it can go up or down pretty dramatically based on opportunities that are available at that point in time. It's just a user of cash. From our point of view, we can convert 90% of that to cash within a day or two. For us, we actually got into the arbitrage business 25 years ago because it was just a short-term way to use cash at a lot better return than cash. Historically it has given us a return of probably 300-basis points or 400-basis points, net of all expenses and so forth above cash returns. We would expect to continue to do that. In fact, it is probably, in the long run more like 500-basis points better than cash. At the moment, it went up because there were opportunities to do things at the end of the quarter. That is all. It would not be surprising for that to be down by a few hundred million dollars at the end of the second quarter.

Fair enough. Thank you.

Ken Billingsley with Compass Point.

Good morning, Ken.

The question I have is on the rate increases. I'm sorry, the growth that has occurred in the quarter. After backing out rate increases, where is the growth coming from? Is it from recent start ups or is it grabbing market share with existing lines of business? Where is that mix of growth coming from?

It really is a combination, as we had suggested. Much of the growth was in our reinsurance segments and our non-US business percentage wise at least. As far as the reinsurance goes, the lion share of that was coming from non-US reinsurance activity. As far as the international insurance business, that is where they are coming from--at this stage all over, ranging from South America to our Lloyds operations to some of our activities that were in our European business as well as our insurance activities in Australia.

I would imagine the comments that you made are not necessarily domestically related. For somebody in the international business, is the competition less there, or is it just organic growth?

I am sorry. Can you repeat that? You didn't come through.

I'll just repeat the question then. I would imagine your comments about competition backing away and creating opportunities is not just domestically related. So, in the international business is that organic growth or are you seeing the same trends both domestically and internationally?

The answer is the change in appetite is perhaps a little bit more -- or behavior is a little bit more visible domestically, but we certainly are seeing that some places outside of the United States as well. I think also some of the growth that we have is where we participate in markets or economies where they have been going through a great boom. As a result of that, we have been benefiting as well. Whether that be a place like Brazil or Australia, as far as our European business goes. Certainly Germany has fared reasonably well. And Norway has done quite well also. I would suggest that while it does apply across the board, the market dislocation, if you will, is more the case domestically. Outside of the United States, while there is a bit of market dislocation, the growth has more been as a result of the economies that we operate in and benefiting from the momentum they're enjoying.

There have been comments recently that the regional competitors and especially the renewal business -- I'm sorry, new business, is being more aggressively priced than renewal business. You guys commented that you were getting 2% more. I'm not asking you to comment on obviously other people's events, but why are you able to -- maybe your trend seems to be counter to at least what comments are coming out this quarter.

While not using names, we're happy to comment on what other people are doing and explain to you how that is different from our philosophy. There seems to be others that are interested in what we would define as buying market share or buying accounts with the approach or philosophy that when it becomes a renewal, they will make up for that, raise the rates, and they look at it from a perspective of the total value of account. We struggle with that a little bit because to the extent that you can finally get your rates where they need to be and it is a hard market historically. When it is a hard market, you do not have to [balk visit] you can write as much business as you want at good prices. The idea of buying it up front does not really resonate with us.

We have a philosophy that you should charge more for risk. That applies to the organization on multiple levels. Presumably, you know more about an account that you are renewing than business that is new to you. As a result, there is more risk with a new account than a renewal account. So, you would think that you should have some type of surcharge for that additional risk. Again, I guess on two fronts, it really -- the differences, philosophy as it relates to buying market share with the attitude that you will make up for it in the future with your rate increases, and also how you fundamentally view the risk that comes along with new business versus renewal business.

Last question I have is on the excess workers comp business, you talk a little bit about that. Can you explain what is the typical reporting time lag between losses in the primary side as it actually impacts the excess carrier in the case of workers comp?

It is certainly more for three years and probably north of five years. It really depends on the attachment point and how the deal is structured, if you will. Certainly, it takes longer to figure out your issues in the excess comp world than it does in the primary, there is no doubt about that. The difference would be, at least, two years.

In part, you have to remember that excess comp is, in fact, very similar to comp reinsurance. Again, you have to see how the claim develops, see how the underlying risk develops. A small percentage of the claims, you know right away. But the vast majority of the claims, even disability claims, takes times to know whether people will get back to work, whether they are going to be permanently disabled, whatever. That the place where it really runs into big amounts of money. It takes time. And then the question is when you find out about it, do you set up the adequate reserve to start with, or are you a newbie in the business and you think that this is more like primary comp and you do not recognize the nature of how large of a reserve to set up.

On these issues, it is not necessarily the fact that historically looking at the loss ratio for the last few years has been kind of poor in that space, and though it's still pretty bad. It is more of a case of the medical and inflation trend that they are not capturing?

It is not just a medical inflation trends. Lots of it is just rehab costs, what is going on with drugs. It is a very complex business in general. It is the discount rate that you are going to use on claims payments. You want to be optimistic or pessimistic on the discount rate. The discount rate can double the amount of reserve or cut it in half. There is a lot of variables that have to do with judgment.

Thank you for taking my question.

Bob Farnam from KBW.

Hi there, good morning. I do not mean to keep hammering at the excess workers comp piece, but you said that competitors could have issues if they are not looking at the discount rate correctly. Have you changed your assumptions --basically inflation assumptions, in the long-term reserves there? And what are you looking at?

We always use the current discount rate of current treasury market. Each year is a piece of the market. The reserves that were set up in 2006 will have -- let's just make up the number 5%. And the reserve that we set up in 2012 might have 2%. It is an average of the historical discount rate. We buy long-term bonds to try and match that for that piece of our portfolio.

So basically the business -- the reserves you're setting up now are set with the expectations with the current rates?

Yes. And what you really have is a composite rate of all of those years that gives you, hopefully, the average.

Right. Okay. That's it for me. Thanks.

Larry Greenberg with Langen McAlleney.

Good morning. Hey, Bill. I think that we probably all agree that this is a fairly unique period in the pricing environment in the industry.

I assume that you mean that the prices aren't going up as fast as they should?

Yes, yes. That would be one explanation, I guess. But, you know, you have some saying that it is not a hard market. Some saying it is not a classic hard market. Some wondering that we are now going into round three of price increases and could it continue. I am just curious. You have your antenna up, obviously. If anything is out there that might truncate the momentum that we have in pricing right now, what do you think it is? Where might it come from? What would be the characteristics of that segment of the market that could get in the way of this momentum?

There is really nothing that I see -- but we are in a strange world. You never know what can come out there. I think that we have more sophisticated managers for what I call the haves in the insurance business. They understand that they cannot continue running a business, pretending that there is underwriting results and there's investment income and they are separate. The reality is with investment income down so dramatically, and older portfolios coming off, you need more underwriting profitability. If anything, there is more and more pressure to gain underwriting profits because we have had a longer and longer time where those old bond yields are going off. We have a longer duration on average than most of our competitors.

There are lots of people who have 2.5 years, and their duration is down to 1.8 years. That is a lot of pressure. You have to make it up. Some people are making it up because they are going to do more speculative things. Some people are extending the duration on what they are buying now. There are a lot of strategies people are following. The reality is with investment returns down a lot, you have got to get underwriting profits. There is nothing I see that is going to change that trend for certainly through next year. I think there will be continued price increase pressures through this year and through at least next year with increasing pressure, honestly, as we get towards the end of this year into next year.

Okay. Thanks. I appreciate that. I am pretty sure that I misheard this from Gene --

You know, he does weird things. (laughter)

Listening to the conversation, I am certain that I misheard this. I thought he said that a lot of the growth in the domestic insurance piece was from monoline -- I thought he said your monoline excess workers comp company.

No. Monoline workers comp -- we have monoline workers comp that has been able to grow. We actually have several that have been able to take advantage of the market. Not our excess comp. This business is unfortunately still not growing.

Thanks. I appreciate it.

He has a lisp. (laughter)

He should slow down. (laughter)

It might be my hearing. (laughter)

Jay Cohen with Bank of America.

Thank goodness, Jay. I've missed you. You used to be the first to ask.

I know. Well, Larry's hearing, and my fingers, I guess. I have three questions. They are relatively short. The expense ratio, while down from a year ago, did tick up from the past several quarters. I'm not sure if there is any seasonality in the number?

Not really. We talked about this before. The more growth we get the more of a drag that this DAC has on our numbers. And also I mentioned in my comments the reinsurance. So, if we are buying a little bit more reinsurance we have a lower net premium base, so that also impacts the ratio.

I think that the change in the DAC accounting probably cost us a 0.5 point, or something close to it on expense ratio. The buying of more reinsurance as we have a disproportionate number of new startups where we do not have a real spread of risks, probably cost us something like a similar amount. I think as we go through this year and into next, I would expect -- unless our growth accelerates, which of course is possible. If it does not accelerate, I would think that spread should start to diminish.

Great. Second one. Also a numbers question. The paid loss ratio, you had mentioned it Bill, it looks like it is the lowest number in almost five years. Is there anything to read into that, or if that just normal variability in paid claims quarter to quarter.

I am going to answer before the lawyer can wave to me. The answer is yes. You should read into that. You should read into it the fact that we think we are continuing to be cautious because we are using a higher trend than some of our competitors. And we're being cautious in establishing our reserves. But as you and I have talked over many years, Jay, paid loss ratio's are the one thing you can never hide behind. You cannot avoid that. I think it is a very good sign as to directionally where things are going. And while one quarter does not make the difference, I think it is a number that people should probably pay more attention to.

Got it. The last question on the debt. I guess you have retired $200 million of debt that was maturing. Where is the debt-to-capital ratio now post that retirement?

31%

31. Okay. Very good. Thank you.

Gregory Locraft for Morgan Stanley.

Most of mine had been answers. Just one I am wrestling with is your RE versus your peers. Those that have already reported, all of them are at much higher levels. And yet, you guys run with higher balance sheet leverage on the underwriting and investment side. So, can you help us think about why the business engine is running with a lower return than peers in the current environment? I do not know what part of the P&L is lagging the others?

Good morning, Greg. This is Rob. I think that one of the things that is difficult to do, but I think it is relevant is the mix of business or portfolio -- the fact is that many of those that have reported had benefited in a very large way from what their property results were. We, as an organization, have a bit more of a casual event to us, so when the wind blows and the earth shakes, we do not have the same issues that others face. Having said that, when it is a benign quarter, they certainly benefit from that. We do not have the same level of volatility. Again, if you look at the results of those that have reported, certainly they benefited greatly from the significant amount of property exposure that they write, whether that be on the commercial line side or certainly in many cases on the personal line side as well.

One of the things that we have always tried to do is try to have a certain level of consistency and not have the volatility that property tax exposure has been. It seems today that lots of people in the marketplace, when the wind blows, if it weren't for the CATs, and they do not count it. (laughter) And when the CATs don't blow, they say what great returns. I think if you looked at those differences over an extended period of time, it would probably equalize the differences. Rest assured, we ask that question everyday. And every quarter.

Fourth-quarter certainly showed that with Sandy and the results for everyone. I appreciate it. Thank you very much.

I am not showing any further questions at this time. I would like to turn the conference back to our host for closing remarks.

Well, thank you all very much. We're quite pleased, as I said, with the quarter, and we are expecting a continuation of that. No one asked the question, but I did not want it to be a special comment to any analyst. We do expect our funds to be back on track between $17.5 million and $22.5 million for the second quarter, and we do have most of those backend. That is not a guess. That is an estimate based on most of the reporting in. Thank you all very much. Have a great day.

Ladies and gentlemen, this does conclude today's presentation. You may disconnect. Have a wonderful day.