W R Berkley Corp (WRB) 2013 Q3 法說會逐字稿

Good day and welcome to the WR Berkley Corporation third-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 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 by us that the future plans, estimates, or expectations contemplated by us will be, in fact, achieved. Please refer to our annual report on Form 10-K for the year ended December 31, 2012, and our other filings made with the SEC for a description of the business environment in which we operate, any important factors that may materially affect our results. WR 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 would now like to turn the call over to Mr. William R. Berkley. Please go ahead, sir.

Hi. Good morning.

We're pleased with the quarter and the direction of things. We'll start our call with Rob talking about our operating results, then he will turn the call over to Gene and then I'll continue trying to give you a summary and take questions.

So, Rob, the floor is yours.

Good morning.

Market conditions in the third quarter, by and large, were a continuation of the trend that we've seen over the past several quarters. The casualty market and the workers' comp mark continue to benefit from rate increases. The professional markets, on the other hand, continues to be a bit of a mixed bag with EPL pricing, as well as private and not-for-profit D&O getting significant rate increases. Lawyers also getting rate increases. Having said that, Public D&O remains also very much bifurcated between the primary and the excess, with the primary getting meaningful rate increases while the excess remains somewhat flat.

On the other end of the spectrum, the medical space -- no pun intended -- is somewhat of a blood bath, quite frankly, with the rates continuing to fall off. And the other miscellaneous D&O is also exceptionally competitive. In our opinion, the professional space is probably some 12 to 24 months behind the casualty market when you think about it from the cycle.

The property market continues to fray around the edges. Clearly a result of the lack of cat activity along with the increase in supply reinsurance capacity. These two factors are clearly putting a fair amount of downward pressure on pricing.

Now if we can turn our attention, more specifically, to our operations. Rate adequacy continues to be a priority for us. We are pleased with the 6.4% of rate that we got during the quarter. More specifically, we got 7% of rate in our domestic insurance operation. Yes, it is very much the fact that the US market is ahead of many of the other markets outside of -- or around the world, I should say, as far as hardening. Rate increases, we believe, will continue to move at this pace for the foreseeable future. It is worth noting that this is the 11th quarter in a row where we were able to achieve rates and the compounding of this rate-on-rate, if you will, as we referenced in our press release, is quite meaningful.

Obviously rate in a vacuum is something that we'll need to be very careful of. When we think about rate, we need to make sure that we're not experiencing adverse selection as these higher rates are coming through. Our renewal retention ratio is the tool that we look to to make sure that our rate increases are not creating this adverse selection. And our renewal retention ratio for the quarter remained at approximately 80%, where it's been for the past several quarters.

The other tool that we look to on the topic of pricing is new business relativity -- what the rates are for our new business versus a similar exposure [activity within] our renewal book. And based on this tool, we're seeing that we continue to get a bit of a higher rate for new business versus renewal business and for the quarter it was approximately 2.3% higher.

Gross written premiums for the quarter was $1.667 billion. This is up 12% from the corresponding period. Approximately half of that, as you may have noticed, was associated with rate. The lion's share of the balance had to do with exposure increase. Auto premiums was not particularly consequential. All three segments contributed to the growth, and more specifically, 40 of our 47 underwriting operations contributed to the growth.

The loss ratio for the quarter was at 60.1, which is a 2 point improvement compared to last year. We achieved this improvement in spite of the fact that we had $4 million more in cat losses. On an accident ER basis, the improvement was of a similar level going from a 63.7 last year to a 61.5 this year.

Finally, it's worth mentioning that we are seeing a continued improving trend with our paid loss ratio and this certainly is an indicator, from our perspective, as to how the book is running. In addition to that, when we look forward at our policy year loss picks, certainly we are seeing the benefit of the earned premium coming through over the foreseeable future at these higher rates.

With regards to the expense ratio, it was basically flat, coming in at a 33.8. Gene is going to be touching on this shortly. But to make a long story short, we had a little bit of noise in there, which he'll be speaking to. If you back some of that out, the improvement was probably give or take 0.5 points, maybe a little bit more. When you put all the pieces together, we came in at a 93.9, which is an improvement of approximately 2 points. And if you look at it on an accident year basis, it's probably a similar level -- or it is a similar level of improvement.

While our Chairman is going to be spending some time talking about our balance sheet shortly, I did want to make a few comments as it relates to the topic of loss reserves. Loss reserves are something that we take very seriously. We have historically, and continued to have, an approach that we feel as though one needs to set initial reserves with a cautious approach. With the idea over time as more information becomes available, you will tighten up those picks, given the fact that you will have better information. The fact of the matter is that we are in a business where we do not know our cost of goods sold until after the sale has been made. As a result of that, we feel as though that it is important to take a very measured approach in setting those initial picks. This is demonstrated by 27 quarters of positive reserve development, which is quite consistent with our approach, once again, of initially being cautious with picks and tightening as things develop over time.

When we look out at the market, we're surprised by the number of people that seem to be talking down the hardening of the market. The fact of the matter is it's simple math and common sense that would suggest that rates need to go up further. While we are aware of the comments that others are making in the marketplace, we are focused on our actions and what we can do to build our business going forward.

Thank you, Rob. Gene, you want to talk about the numbers a bit?

Sure. Okay. Thanks.

As Rob said, we had another solid quarter, highlighted by further improvement in our underwriting margins, an increase in investment income compared with a year ago, and significant capital gains.

Starting with the underwriting, our net premiums were up 11.5% overall to $1.4 billion. Net premiums for the domestic and reinsurance segment were each up 11% and the international premiums were up 18%. Premium growth was led by our two largest lines of business, other liability and workers' compensation, which were up 18% and 13% respectively. Our overall combined ratio for the quarter was 93.9, 2 points better than the third quarter of 2012 due to improvement in the underlying loss ratio, that is the loss ratio before cat losses and reserve releases. The underwriting loss ratio was 60.1 in the quarter compared to 62.1 a year ago. The underlying loss ratio improved by 2.5 points each for the domestic and international segments and by 1 point for the reinsurance segment.

Just to repeat what we talked about in the call last quarter, a 2 point improvement in the loss ratio is what you get when you do sort of a simple reasonableness test of the underwriting trends. Prices are up 6.5%. And if you assume a loss cost trend of something around 3%, that gives you a net trend of 3.5 points. And if you take our accident year loss ratio from the third quarter of 2012, which was 64%, and take 3.5% of that, you get just right at a 2 point improvement. And that's what we're showing.

Back to the quarter then, catastrophe losses were $13 million, or 1 loss ratio points, compared to $9 million a year ago. And favorable reserve development was $33 million, or 2.3 loss ratio points, up slightly from $28 million a year ago. The favorable reserve development this quarter was concentrated in our domestic segment. The overall expense ratio increased 0.1 points to 33.8 and the domestic segment expense ratio increased slightly over 1 point.

The reason for the domestic segment increase is there are three main factors. First, we are earning less seeding commission as a result of shifting some of our reinsurance programs from our quota share structures to excess of loss programs. Second, we incurred some one-time costs relating to reorganizing parts of our regional business in the quarter. And third, we're continuing to invest in new ventures, including two start-up companies, as well as several expansions into new products and territories within existing companies. We expect the revenues from these new ventures to begin to increase in the fourth quarter of this year and offset that expense ratio trend.

Our paid loss ratio for the quarter and for the year to date period was 54%. And that's the lowest paid loss ratio we've had since 2008. That's the main reason for operating cash flow more than doubling in the quarter to over $300 million. Our investment income was up 8% to $126 million in the quarter, due primarily to higher returns for investment funds. That increase was partially offset by a decline in fixed income returns due to lower reinvestment rates for bonds that are either maturing or being prepaid. The overall annualized portfolio yield was 3.4% in the quarter, up from 3.2% a year ago.

In addition, realized investment gains were up 61% to $44 million in the quarter with a majority of those gains coming from the sale of equity securities. At September 30, 81% of our portfolio was invested in cash and fixed income securities, unchanged from June 30. The average duration was 3.2 years, down from 3.3 years at June 30, and the average credit rating was unchanged at a AA minus.

Our overall effective income tax rate increased to 30% in the quarter, up from 27% for all of -- for the full-year 2012. That increase was due to a decline in the portion of the portfolio invested in municipal bonds. Municipal bonds represent 27% of our overall portfolio at September 30, compared with an average of 34% in 2012.

So in total, that adds up to net income of $137 million, up 36% from a year ago, and an annualized yield of 12.7%.

Thank you, Gene.

So let me try and go through a few things that I think are highlights and important to be sure you understand about where we're going and what's going on and then take your questions.

First of all, we see price increases continuing. I had generally thought they would do a little better. I had talked about 6% to 8% with a little more pressure on the upside. There seems to be less pressure on the upside. I would still use 6% to 8% as a range. And, in fact, we're seeing some price increases significantly more than that. But I would narrow the range. I think it is going to be hard for us to have 8% going forward. I think it's going to be more in the 6% to 7% range. But there's more erratic behavior out there. So there are some lines of business that we're seeing better increases. So I'm not changing my view, but I am thinking that the 8% is less likely, although I think we will do better than 6%. So if I were to choose a number, it would still be sort of 6.5% to 7.5%, as opposed to 6% to 8%.

We still see across-the-board pressures, less so on large commercial risks, especially property risks. The securitization of non-tail risks is having an impact on cat business and on those large property risks. There's lots of people who have investment portfolios who are looking for non-related risk profiles and, therefore, you're seeing an increase in cat bonds and other kinds of behaviors. That's going to continue to impact that kind of business. We think that people are beginning to recognize that investment returns are going to stay at this lower level, certainly for another 18 months, if not longer. And, however, we reconsider the level they need of underwriting profitability to achieve adequate rates of return. Every 100 basis points, as we have said, in lost investment income means you need, give or take, depending on the line of business, 4%, 5%, 6%, 7% more in underwriting profit.

So where as historically people would say if you write it at 93, 94, 95, you'd get a good return. Today that number is 88, 90 kind of number to get a good return on your capital. So we think there will be continued pressure on that. And that is beside the fact that prices today, when adjusted for the inflationary pressures on lost costs, are still not even approaching where they were in 2004. So you still have need for pricing just to get back to those underwriting profits and that doesn't offset the need to make up for investment income.

We have been moving our investment portfolio around. We've been changing where we put our money. Our common stock portfolio is moving into a little bit different strategy. You saw we sold a bunch of stock, common stock. It's being reinvested with a slightly different hedge strategy using other kinds of securities. But basically it's back -- the common stock portion will be back up to where it was before maybe a little more in a slightly different strategy. While we took down our municipal position and cash increased, again, it was a function of managing our portfolio. You are likely to see our municipal bond portfolio increase, primarily in the 7 to 10 year duration as that's where the yield curve for the moment is most attractive from our perspective. And we're looking to expand that back up closer to the 30% part of our portfolio.

I think that overall, though, cash flow continues to be strong and we would not expect the duration of our portfolio to be anything short -- we would expect it would continue to be shorter than our liability duration. While it might go from 3.2 to 3.4 years, it is going to stay under the duration of our liabilities because, inevitably out there, that risk of inflation and increased interest rates is there. So we're investing with a different set of criteria. So we will have less money in fixed income securities and look for other ways to generate investment returns.

We continue to strive for and achieve gains of at least $25 million a quarter, excluding our bond portfolio. We think we'll be able to continue that for an extended period of time. We've been able to do that for quit awhile. Certainly helped by the secular bull market trend but made up partly of our private equity investments. And we're quite pleased.

We think one of the best signs of looking at how a company is doing is focusing on the paid loss ratio. And our paid loss ratio, which sort of peaked in 2010, has continued moving downward quarter-by-quarter, and we're pretty pleased with where we are now. And we think it's likely to continue down. It's a good sign and it's a good way to say, are your loss picks good? Do they relate? It's a good absolute test. The one thing you know in this business for sure is money. And that paid loss ratio is as good a test as you can get.

So we continue to be pretty optimistic. I think that we see continued opportunities. As Gene mentioned, we had a couple of new start-ups. We added operating units to some of our existing business. It's been an excellent time to find great people who are interested in companies that are looking ahead instead of looking back. Fortunately, we're in that position.

So with that, I'm very happy to take any questions. The operator will start now.

(Operator Instructions)

Amit Kumar, Macquarie Capital.

Thanks and good morning and thanks for taking my questions. Two quick questions. First is a broader question for Bill on the industry. In terms of your comments on aggressive competitors, now we know that these things sort of take time to play out. Do you get the sense that there might be some of these names facing problems on the immediate horizon? Or are we talking more longer term?

Well with some of them I've have already faced problems in the public domain -- Tower, Meadowbrook, Taurus. People are already facing their problems doing it. There certainly are others that may not be in the same very difficult position of these companies but who are trying to deal with their problems who have plenty of capital but are saying, gee, we stepped in the wrong direction, we made some wrong assumptions, and are going to withdraw from the business. And I think there's plenty of those. And there certainly are a few more who have gone in wrong directions. There are large global companies who always saw the grass being greener in other places, and they found out it was AstroTurf. And it didn't work out that well.

So I think that we've yet to see the dramatic changes these people are having to take. But I think they're all starting -- the worst part -- one of the things that's interesting, and I'll digress a moment, is it was hard to believe that the peak pricing was in 2004, maybe early 2005, because the earned premium peaked the end of 2005, early 2006. But the peak pricing was the end of 2004, early 2005. Prices went down just a little bit. And then in 2007, they started to go down faster. But there are people who lost a lot of money and the worst losses probably were incurred in 2009 and 2010 because of the accumulation of those low prices. And if you aggressively wrote business then, you still were writing at terribly low prices in 2011, certainly the beginning of 2011. So those people are just now having to face up to that low pricing environment. So I think there's quite a bit more of pain to go and a lot of people who are going to say, what are we going to do, and who are very, very short on their reserves for some of those things and are going to have to try to figure out a solution.

But everyone doesn't have to go out of business. Some of the people are plenty well capitalized and have plenty of smart people. They just have to face the reality we have to do something. There will be more; however, than the three I mentioned, that will go out of business.

That's helpful. The only other question I had, and this one is for Rob, you mentioned the new business relativity metric of 2.3%. In Q2 that number was 3.6%. And I'm sort of trying to figure out why would it decline that much? Thanks.

You mean why would the -- we're talking about -- I don't know -- what, 100 basis points?

You have to -- when he said [too] low, 2 or 3, it was 103% or 102%.

Oh, okay.

It's not very much. It's like charging $103 or $102.

Got it. Okay. That's helpful. That's all I have. Thanks.

Michael Nannizzi, Goldman Sachs.

Thanks. Rob, I guess there was one question -- or the one comment in the press release you talked about some standard carriers maybe stepping away from business that they were writing, or some specialty business they were writing during the soft part of the market. Maybe that's manifesting. Can you give a little bit more context for that? What sort of action in years -- calendar years are we talking about? And it doesn't seem -- at least I haven't heard of standard carriers seeing a lot of adverse development even in kind of sub segments. Just wanted to get a little bit more context if I could. Thanks.

Mike, I think the answer is, to your question, is that we're seeing it's a greater number of submissions coming into the specialty market from the standard market. Ultimately we saw people looking back, if you will, probably starting in 2007, 2008, and reflecting on the profitability from the prior years. And their natural reaction is they want more so they start to cut rate and loosen terms and conditions and broaden their overall appetite. If you look at, for example, the casualty market, and certainly some of the stuff that we participate in -- if you figure that the average duration of the reserves is three-plus years, it takes a little bit of time for that to come into focus. And what we have been seeing over the, I don't know, past several quarters is that is starting to come into focus more and more. And as that is coming into focus, it's forcing a change in behavior of some of the standard market. And again, it's manifesting itself by them beginning to revisit what their appetite is. And again, we're seeing more coming into the specialty market.

So it's interesting because you can see the bit of a tug -- of the internal tug-of-war at some of these -- particularly some of the larger carriers that typically operate in the standard market and their appetite has grown. They tend to get the underwriting discipline back and ask their underwriters to be pushing for more rate and narrowing the appetite. And then they see what does it to their top line and then they will send another message, sort of the next quarter, as to what they want them to do, because they don't like when the top line starts to fall off. So as my father had mentioned earlier, you're seeing a little bit of mixed behavior where people are struggling with what their appetite should be. But by and large, we continue to see an increasing level of discipline in the standard market. Hence, the specialty market is getting more of a crack at things.

Got it. And I guess in just kind of looking at your growth, can you talk about the areas where you are growing -- kind of the attributes of the business that you like that are causing to you pursue growth versus the areas where you're seeing the most rate? If we were to like -- which we can't see -- but if we were to kind of try and compare those areas that are showing the biggest -- the most growth versus the areas we're getting the most rate, is there a relationship there, a positive relationship there? Or are there other factors involved?

I think, clearly, there's a relationship between growth and margin, if you will. And oftentimes there's a relationship between rate that can be achieved and the margin that you believe you will obtain. Obviously for our purposes, we're very focused on making an underwriting profit. And we're pleased to see that there are certain lines and classes where we're getting to the point where there's very much a green light. And we will not just be growing because of rate, but we will become more aggressive if things continue down the path that they've been on in trying to add to exposure or policy count.

I think as far as getting very granular as to where we see the best opportunities, typically that's not something that we've looked to highlight because we don't think it's in our shareholders' best interest to advertise where we think our best margins are today or where they will be tomorrow. But what I would suggest to you, that oftentimes where the market has gotten the ugliest is oftentimes where you will see the greatest, or the most severe reaction, and the pendulum will swing farthest going in the other direction. And you just need to make sure that you don't jump back in prematurely.

Got it. And I guess with specifically with the international segment, that's been in a double-digit, mid-teens sort of growth trajectory for several quarters now.

As far as the international goes, there have really been a couple of things that have been driving that growth. One would be some of the markets that we're in where their economies are doing particularly well and they have been for several years. So whether that's in Australia or whether that's in some of the Scandinavian territory, a Norway for example. Certainly Germany has fared much better than a lot of Europe. And there's been particular opportunities in the auto space. But -- and then, of course, we've seen some opportunities in Latin America, even though that does come with its complexity as well.

So, again, the growth outside of the US has been primarily, as far insurance goes, related to the strength of some of the economies around the world. As for as reinsurance -- the growth that we've had there, that has more to do with, quite frankly, the reinsurance operation that we started in Europe and which has gotten some good initial traction. And again, our reinsurance business down in Australia that writes in Asia, they have gotten a pretty good bump as well because of the general economic conditions of that territory over there.

Great. Thanks. And then one real quick one, if I could. In the domestic segment, which it sounds like that was a lion's share of development, can you just talk about the lines of business or the [accident] years that drove that favorable development? Thank you for all your answers.

Yes. Sure. I think as far as that goes, and the details, what we would suggest is that would you follow up with Gene, if you wouldn't mind, or Karen as to some of the more detail or minutiae. And we'll share with you what we can on a more granular level, Michael.

Okay. Thanks.

Josh Shanker, Deutsche Bank.

Thank you. Good morning, everyone. I'm wondering if you can give us some more information about the non-insurance aviation businesses? They had a very good quarter from a profit standpoint and I really don't know a lot about this businesses so I could use the education.

It's just an investment. It's a business that we invest in as we've invested in other businesses. And we carry it at cost and, frankly, it's not a fabulous return. It's an okay return. It just suffered a lot in the economic decline and it's returning to doing sort of what we expected. It refurbishes parts. It sells parts globally. It has a couple of FBOs. It sells used and new airplanes. But there's nothing extraordinary about it. It's really returned back to the level it was at, but it's doing well. We have really outstanding people and most of many of their competitors didn't survive the economic downturn at all.

Do you think that the 3Q 2013 result is closer to the run rate than the last few quarters?

Yes, we would think it would be closer, yes.

Okay. That's my only question. Thank you.

Vinay Misquith, Evercore.

Hi. The first question is on the impact of some competitors taking large charges. So we have seen that recently. Are you surprised that you have not seen a corresponding sort of increase in pricing in the industry because you have some competitors taking charges?

The reality is, trying to figure out what your competitors do is a Rubik's Cube. We look at what we see and know is going on out in the field and we wonder how that corresponds with their day-to-day behaviors. So, yes, it is strange to us about things like that. But some of our most aggressive competitors are facing problems in the business they wrote and we don't see them dealing with those problems. But we know they will. They have to eventually.

It does take time for bad results to get reported in financial statements. But eventually they do get there. And so we have plenty of companies that are out there that have problems that they have not dealt with and will come home to roost. And in some cases, as the few companies I mentioned, they may not have the resources to deal with them fully, but in others they have the resources but it will be a painful process. The real question is, will people try and solve the process or will they behave like ostriches and stick their heads in the ground and pretend they don't exist until they are unavoidable, at which time you have crises.

All right. The second question is just a few numbers questions. First is on the net investment income. The yield on the core portfolio was lower than we expected. I think you mentioned that you're increasing the duration of the municipal portfolio.

We're going to. I was a pro -- it was a -- I was forecasting, not -- that is not where we are now.

Sure. So just looking to the future, should we expect a roughly flattish --

I would think our net yields will not go down. Part of that decline is we have a lot more cash than we've usually had. We had over $1 billion of cash yielding 0.25%. So that has a huge impact on our yield.

So the fact that you are putting more money into munis you think will sort of --

It will -- I would expect our returns will not go down next quarter.

Okay. And on the tax rate, that was higher this quarter, I believe. Was it because of higher -- or lower proportion of munis? Should we look at the 31% effective tax rate as a run rate or should that go down? Because your --

I would surely hope it goes down. But that's going to be a question of how quick we can get more invested in munis. There's a -- tax rate is a complicated series of issues. And you can also --

I was going to mention, it's also impacted by the size of the realized gains. The realized gains are all taxed at 35%. And that was a pretty big number this quarter.

Okay, that's helpful. So you think that a normalized tax rate would be high 20s, you think?

Gene is shaking his head because the microphone obviously has a camera.

(laughter) Yes. I was shaking it yes.

(laughter) Okay. Thank you very much.

Greg Locraft, Morgan Stanley.

Hi. Good morning. Just wanted to ask about capital deployment. You haven't done much in the way of buybacks in recent quarters. If that trend continues, it will be the lowest than -- 2013 will be the lowest year in many years. How are you thinking about buybacks these days?

As you know, Greg, we don't really tell people what we're going to do about buying back stock. Last year-end, you may recall, we paid a dividend. A special $1 a share dividend because we had extra capital. We're going to try -- we try and measure how much capital we have, what we do and what are the opportunities. And we make that assessment and try to weigh that, all the alternative of dividend, buying back stock, and opportunities to deploy the capital in the business, and we would expect to continue to do that.

When the stock traded down, we bought some stock back. When it traded up, we didn't. So we're continuing that same strategy. We think we have more capital than we need at the moment but we think progressively buying stock back at the moment may not be the right thing. We think that there likely are going to be some opportunities to do something. And we also need to weigh the opportunities of returning cash in the form of a special dividend or increasing the regular dividend if we find we can't buy back stock.

Okay. And then I guess since you brought it up, the special dividend, was that sort of -- was the timing on that designed around the increase in tax rates? Or is that opening up a new kind of avenue for you to do it at the current stock valuation? Is that something you would like to --

We have always told people that there's a trade-off that managing capital is a key element in the property casualty business. Opportunities to use the capital in the business, one. Two, buying back stock or dividends -- special or increased regular dividends. And I think that that continues to be the issues we face. At that moment in time the tax issues certainly impacted us to make that decision. It made it a more effective use of a special dividend. But it's still the issue on the table that we have to think about.

Okay. Thanks.

Ken Billingsley, Compass Point.

Good morning. I just wanted to follow up on some comments that were made twice just regarding pricing and your look back to 2004 profitability. When you talk about the continued need for pricing, obviously the rates are not moving as quickly up as they did before. Do you at least believe that that 2004 profitability levels for underwriting are achievable -- unachievable given just where capital is in the market?

No, we think you can achieve the profitability levels of 2004. But what we're trying to say is that even if you get the underwriting returns, then you are not going to get the return on capital that you had then because interest rates are so much lower. So, yes, I think the prices will continue up for another, at least, 18 months, if not longer, at which time I think you'll probably be approaching pricing -- underwriting profitability levels of 2004. However, even when you are at that level, you are not going to have the overall profitability levels you had in 2004 because investment income is going to be down substantially.

And regarding the new capital that's come in, obviously it's -- as you said, for lines that don't have a tail, but do you feel that that pressure is going to be put on those reinsurers and international companies to deploy that capital into lines that may again more compete directly with standard market business -- even in the specialty market as well?

How long a story do you want?

How long do you have?

Not long enough on this conference call. So I will briefly tell you that when this Company went public 40 years ago, the 15th -- the16th, the day of the Arab oil embargo, I can still sitting -- remember sitting at my desk and writing the forecast for EF Hutton about what we would do and how we would do it. And I changed one little number and it was an amazing change in the return on capital. And I changed it 0.5%. And who could argue with 0.5% change? And I suddenly realized how fallacious forecasts in this business were because you made these small assumptions and you built everything around them.

I think these capital suppliers who are entering the business entirely based on models and forecasts are going to find out that human judgments actually are of value and important. And a number of them will get badly burned as they step away from the highly forecastable pieces of the business to other parts. So, yes, they may step and put their toe in the water in other things. And I can assure you it will be extremely costly and short-lived.

Very good.

Jay Cohen, Bank of America Merrill Lynch.

Yes, thank you. Couple of questions I guess for Gene. Gene, in your prepared remarks you had talked about the accident year loss ratio by segment, or the change from the year ago. Could you go over those again? I missed those numbers.

What were you referring to exactly?

I believe you talked about the improvement in the accident year loss ratio, excluding catastrophes by segment.

He did.

Right. By segment, I did. I said that the underlying loss ratio improved by 2.5 points for the domestic and international segment and by 1 point for the reinsurance segment.

Perfect. Thank you. The other question was in the press release. As you talked about improving returns you mentioned the expense ratio. As you think about the expense ratio going forward and any improvement, is it largely simply a function of maybe less investments and simply growth in the business, or are you talking more specific action to reduce the expense ratio?

Let me talk about a few things. There were some expenses that were unique and won't likely to recur going forward. That will probably take maybe between $5 million and $6 million out that won't happen going forward. In addition, there was probably $3 million to $4 million of expenses for businesses that generated effectively no revenue that will have corresponding revenue to some degree in the fourth quarter. Although that will still not get up to speed, it will have a less impactful aspect on the fourth quarter and going forward. So those two things are more measurable.

The change in the reinsurance is going to continue to impact it as we move from quota share to excess for a number of lines of business, that will be offset over a 12 month period, somewhat, as we get more earned premium because the nature of taking the quota share to an excess is we'll get more earned premium. But it takes more time to get that through the financial statement. All that being said, we're also trying to focus, to be sure, that while expenses never were a cornerstone to any insurance company's success, and we don't think it's the guide post to being a successful company, we do want to be sure we haven't gotten sloppy and that we're paying attention. Do we have the right numbers of people and the right people and the right structures everyplace to ensure that we're doing the right job?

So I think that all that together with what we expect will be continued growth in premiums. So I think it's a bunch of different things, Jay, but we would think that you'd very quickly see substantial improvement in the dollars and a measurable improvement in the expense ratio.

That's great. Thanks, Bill.

Larry Greenberg, Janney Capital Markets.

Thank you and good morning. I guess, Bill, just a bit of an academic question. I'm looking at the paid loss ratio which I, too, have always thought is an important indicator. But I always thought that was best analyzed in kind of a stable book of business. And the reality is you guys have added so many new ventures that I'm wondering -- I mean, obviously you know the numbers behind the numbers a lot better than we do. But doesn't it make it more difficult to rely on that as an indicator from the outside when there is so many new activities going on?

Why don't I make -- let Rob make a comment, then I will add on. Go ahead, Rob.

I think the observation is a very fair one, that you need to take into account whether it's a stable environment or whether you have a bit of apples and oranges. Having said that, when we're able to look into our business, obviously in a different way than you're able to, and we look at it on an apples to apples basis, the trend is quite apparent. And the other comment that I would share with you is that when we look at our mature businesses, because again, when you're looking at the younger businesses that are going a bit more, but when we look at our mature businesses and we look at what's happening with claim count, we certainly are seeing things move in a positive direction. And in part, that's a result of the underwriting actions beyond just rate increases that we have been taking over the past several years.

I think the other thing is, I don't think you look at a paid loss ratio as an independent thing. I think that when we look at it, what we really do is -- and we go back all the way to 2006. And we look at the incurred loss ratio to the paid loss ratio and look at how they relate and what are those trends. So what we're trying to say is, hey, if your paid loss ratio seems to be getting out of line one way or the other with your incurred, that probably means you're not reserving enough. If your paid loss ratio is moving in the other direction, it probably means you are being more conservative. And one of the interesting things is, when the cycle gets worse, it absolutely says you're not being more conservative, and your paid loss ratio goes up. And when the cycle gets better, it's the reverse. And this -- you could have heard me give this speech in 1986. I gave the same speech but we were a lot smaller company so nobody paid attention to me. But same speech.

Great. Thanks.

So I think the answer is the paid loss ratio taken alone, independently, doesn't tell you anything. It's when you look at it with respect to the incurred loss ratio and the direction of things because so many things can impact any number. I mean, it's the problem with the insurance business. Any one number can mean lots of different things. You have to look at in the context of lots of other pieces of information. So for us, it's that paid loss ratio relative to the incurred because the incurred is what's in your financials. So what you're really trying to say is, does the incurred make sense? So if you saw that paid loss ratio going up, and the incurred was not, then you should worry. The incurred is going down and the paid is going down, it's a good directional sign.

Great. Thank you.

Howard Flinker, Flinker & Company.

Hello, everybody. Bill, you're right that forecasts are 179, 180 degrees wrong except at the Fed, where they are omniscient. They're always right. I've got a question for your memory, Bill. About three or four years ago when the rig in the Gulf of Mexico blew up, in about three days or so, you said you would pay all claims. And it seemed like a pretty foresightful idea to acquire more customers. From your memory, did that pay off?

Yes. The answer is our guy who ran that business named Frank Costa, he did a wonderful job. And he was a real expert in the business and he went out and, in fact, his vision was correct that people appreciated the fact that we stepped up and wrote a check and that business has grown and he's done a wonderful job.

Yes, I was just curious. Nice job then and nice job now.

Thanks very much.

You're welcome.

Ron Bobman, Capital Returns.

I think Larry Greenberg might be the only person on this call who might have heard you in 1986 make that statement, Bill. I had a question on reinsurance. And I'm wondering if you're seeing, in the context of Berkley buying reinsurance, any knock-on effect whereby traditional reinsurers are showing themselves to be more aggressive and more competitive in selling intermediate and longer tail reinsurance coverages by virtue of the more competitive and shortage of opportunities for them to sell the shorter tail new capital focused line. Thanks.

I think Rob will have comments in addition to mine on this, but I would say that the reinsurance marketplace is still reasonably disciplined but -- on the longer tail lines, but it is certainly more competitive than the direct side of the business. And everyone is feeling the pressure of new capital entrants and concerned about where and how that's coming. That's why Berkshire Hathaway went into the large E&S business, because they felt the pressure of capital -- a big capital account wasn't enough just to get the business any longer. There were lots of people competing for that. Rob, your view? Thoughts?

I think, generally speaking, clearly there is more competition that has come into the property cat space trying to draw a clear correlation between the behavior of many reinsurers as a result of some of this alternative capital coming into the property cat space and how that's driving a possibly a change behavior in the casualty market. I think it's probably a little bit early to reach a conclusion.

So, again --

Thank you for your thoughts.

As I said, I think that there's pressure, but it's not -- you're not showing anything dramatic other in than in the cat space.

Thanks, gentlemen. Best of luck.

Bob Farnam, KBW.

Hi there. Good morning. I just -- can you provide any color maybe on the two new start-ups that you're talking about?

One would be -- Gene, these were in your comments. I assume that the ones that you're referring to is Design Professional, which is in the architect and engineer space.

And the regional company in the southeast.

And then, of course, our new regional business which we -- I believe we announced perhaps last quarter. But it's still getting in the process of up and running this quarter, which will be focused on the southeast. And as we've discussed in the past when we've chatted about our regional model, we feel as though one of the differentiators between a regional model and a national carrier is a focus on a particular territory. And we have shuffled a couple of things so we will have an operation that's dedicated to the southeast. And also as a result of that, we will be able to focus another operation even more so on the mid-Atlantic and another regional company on its core territory. So those are the two start-ups. It's architects and engineers and it's a formation, which I believe, again, we announced last quarter in the southeast.

Thank you.

Michael Nannizzi, Goldman Sachs.

Yes, just one quick follow-up on the international segment again. Sorry to keep asking on this. But the underlying combined -- so you said was 250 basis points better. How much did non-cat weather contribute to that year-over-year improvement?

For the international segment?

Yes.

With a non-cat -- the cat activity was minimal in both last -- the third quarter of last year and the third quarter this year so that didn't --

No significant improvement because of weather.

Like the model -- whatever the underlying -- whatever large but not cat losses were that are inside the underlying -- that wasn't materially different?

No, sir.

Okay. So I guess the question is then, is rate in excess -- is it rate is running an excess of loss trend in that segment? So that's what helped contribute to the margin expansion? Or is it mix, or something else, that helped to drive that year-over-year improvement?

I'll take a crack and then I think Gene will probably correct me. But I believe it certainly has something to do with rate. It certainly has something to do with mix. And then, of course, the other component as far as the combined ratio goes, the expense ratio is getting better as that earned continues to build. As, Mike, you recall, and we referenced early in the call today, we've add reasonable amount of growth in that group of companies. And we have for some number of years so we are really starting to see the benefit of that higher earned coming through and we're able to leverage that expense base a bit.

Maybe I might have misheard. I thought Gene had said it was 250 on the underlying loss?

Right.

Okay. So it wasn't -- so it was mix and then --

In other words, it was 2 points for the overall Company. And it was 2.5 points for international as they benefited a little bit more. Their rates were not out of line with the rate increases for the rest of the business.

They also (inaudible) and had some benefits from expense. Rob was just adding additional information.

Got it. Okay and then just -- and maybe my math might be faulty here but just from Gene's comments it looked like there was some adverse development there in the fourth quarter. If that's right, and certainly my math could be wrong, but if that's right is the driver of that development different than what it was in the third quarter?

First of all, it was the third quarter was the adverse development. You said fourth.

Oh, yes, third. No that would be -- sorry about that. Third versus second. I'm ahead of myself by a quarter.

And what was your question then?

I guess was the driver of that development -- so there was adverse development in the second quarter, and then if my math is right there was some adverse development in the third quarter.

A month from now, yes.

Yes. Were those similar drivers of -- in terms of what caused that adverse development or is it just individual policies here and there?

No, it's similar. It was a modest amount. It wasn't any difference between where it was coming from. It was coming from the same source basically.

And that was -- as a book of business that was which area?

I don't think we mentioned it.

Oh, you didn't mention it. Okay. All right. Thank you.

Thank you. I'm showing no further questions at this time. I would like to turn the conference back over to management for closing remarks.

All right. Well thank you all very much. We appreciate it. We're quite enthusiastic about the balance of the year. Clearly, capital management is on the forefront as we go forward. We expect continued price increases. And as I said, I sort of am bringing my band a little closer from 6% to 8% down to sort of 6.5% to 7.5%. But we're quite optimistic and expect the balance of the year and next year to generate returns well within the range of our expectation and continue to have capital gains in line with the recent past. Thank you all very much. Have a great day.

Ladies and gentlemen, this concludes today's conference. Thank you for your participation. Have a wonderful day.