Good day, ladies and gentlemen, welcome to the fourth quarter 2010 Arch Capital Group earnings conference call. My name is Alicia, and I'll be your operator for today. At this time, all participants are in listen-only mode. Later, we will conduct a question-and-answer session. If at any time during the call you require operator assistance, please press star followed by zero, and an operator will be happy to assist you. As a reminder, this call is being recorded for replay purpose. Before the company gets started with its update, management wants to first remind everyone that certain statements in today's press release and discussed on this call may constitute forward-looking statements under the Federal Securities laws. These statements are based upon management's current assessments and assumptions and are subject to a number of risks and uncertainties. Consequently, actual results may differ materially from those expressed or implied.
For more information on these risks and other factors that may affect future performance, investors should review periodic reports that are filed by the company with the SEC from time to time. Additionally, certain statements contained in the call that are not based on historical facts are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. The company intends the forward-looking statements in the call to be subject to the safe harbor created thereby. Management also will make reference to some non-GAAP measures of financial performance. The reconciliation to GAAP and definition of operating income can be found in the company's current report on Form 8-K furnished to the SEC yesterday, which contains the company's earnings press release and is available on the company's website. I would now like to turn the conference over to your host for today's call, Dinos Iordanou and John Hele.
Please proceed.
Thank you, Alicia. Good morning, everyone, thank you for joining us today. Our performance for the fourth quarter was reasonable as we continue to operate in a challenging underwriting environment. Our annualized return on average common equity was 12.1% on a reported basis, which in our view is acceptable for current market conditions. These returns, which were aided by favorable prior year reserve development, were not significantly affected by cat activity as the combination of major cats plus attritional cat losses approximated the expected cat load for the quarter. The Australian floods impacted the fourth quarter by twenty-two and a half million, while our early estimates for the 2011 Australian floods and Cyclone Yasi are estimated to impact the first quarter of 2011 by $30 million-$60 million in the aggregate.
By our own estimation, in the current insurance and investment environment, on a normalized basis, we're achieving approximately a 9% ROE on business written in the 2010 underwriting year. This return, even though it does not meet our long-term target of 15%, is realistic given the operating and financial market conditions that exist. As you all know, a target over a complete cycle is to achieve a 15% ROE, and all of our incentive compensation targets are based on that metric. We still believe that in the long run, the target is achievable, and as a company, we have chosen not to make any changes to this hurdle rate due to the current environment.
In terms of creating shareholder value, we believe that our ability to increase book value per share is the most important measure, and in this respect, we had a good result in a very challenging investment environment. Viewed against a backdrop of a significant increase in interest in the fourth quarter, our investment returns were excellent, and combined with adequate reported operating returns on our underwriting activity, book value per share grew to $89.98, which is an increase of 23% from year-end 2009 and 1% from September 30th, 2010. From an underwriting point of view, we achieved a 92.7% calendar year combined ratio, which by our estimation is five to seven points better than our normalized accident year combined ratio of 98 to 100.
Cash flow from operations remained good at $145 million, which is down from $184 million from a year ago. The lower level of cash flow was affected by a reduction in exposure and premium writings, as well as from the maturation of claims from earlier accident years that had bigger exposure base. Another factor influencing cash flow emanates from a movement towards short tail lines over the past several years, which has an effect on claim payment patterns. In essence, it accelerates the payment patterns significantly. From a production point of view, our gross written premium were down 8% and our net written premiums were down about 6%. Our reinsurance operations were down 13 on a gross written and 12 on a net written basis. Our insurance operations were down 6.3 on a gross written and 5% on a net written basis.
During the fourth quarter, in our January 1 renewals, we saw no significant change in market conditions in our reinsurance business. We continue to see pressure from cedents to increase ceding commissions, and in general, saw a reduction in primary rates of approximately 5%. We also noted that clients are continuing to look for opportunities to switch some pro-rata contracts to excess of loss in order to maintain a larger amount of net premiums on their books. In our cat opportunities, the anticipated introduction of RMS 11 had no noticeable effect on either demand or pricing as of yet. However, in anticipation of the model changes during the January renewal period, we adjusted our pricing for certain non-coastal exposures in anticipation of the rollout of RMS 11.
Even in the most difficult markets, we always look for opportunities to find acceptable books of business to underwrite without sacrificing underwriting discipline. On January 1, we were successful on medium tail opportunities as we found that the improved pricing levels will produce acceptable risk-adjusted returns, and we took advantage of those opportunities. Our insurance group continues to emphasize and move their book to less volatile lines and to reduce their writings in U.S. casualty business. Despite these actions, due to the challenging market conditions that exist, margins generally continue to be under pressure. As a result, we saw a reduction in writings in our insurance group. We are pleased with these actions, as underwriting discipline will always take priority over premium production. In the primary casualty E&S sector in the U.S., we are starting to see isolated areas in which price increases are demanded and achieved by the market.
These increases are specific to certain classes and territories. It is an indication to us that the bottom may have been reached for this segment. Underwriters are not willing to go further down in pricing. Having said that, looking at price adequacy on an absolute basis, it does not appear that the pricing corrections are enough for us to be interested in significantly expanding our book of business. As we indicated in the last quarter call, third quarter share repurchases were relatively light due to the hurricane season. As you know, we accelerated our share repurchase activity in the fourth quarter of 2010. We purchased 2.9 million shares for $258.2 million, which represents an average price of $89.23 per share. Also, during the first quarter through February 11, we have invested an additional $140 million for 1.6 million shares at an average price of $87.87 per share.
With these repurchases, our remaining available authorization is $90 million. In light of that, we expect to review our share repurchase program at our next board meeting. I would like to emphasize that our capital management philosophy has not changed. We will continue to return excess capital to our shareholders until such time that we can profitably deploy it in our business. Before I turn it over to John for more comments on our financial results, let me share a few thoughts on our cat writings and PML aggregates. As of January 1, 2011, our 1 in 250 PML from a single event was $733 million, or approximately 17.5% of common equity, down from $809 million as of October 1, 2010. Our Northeast wind area PML is now the largest PML exposure at $733 million, down from $756 million as of October 1, 2010.
The PML for the Florida Tri-County area now stands at $683 million, down from $809 million at October 1, 2010. Both zones are significantly below our self-imposed limitation of 25% of equity. John?
Thank you, Dinos. Good morning. I will now cover some of the financial highlights of the quarter. For the 2010 fourth quarter, property and other short tail lines represented approximately 48% of our net earned premium volume, compared to 47% in the 2009 fourth quarter. On a consolidated basis, the ratio of net to gross was 72%, the same as a year ago. Our overall operating results for the quarter reflected a combined ratio of 92.7%, compared to 88.8% for the same period in 2009. The 2010 fourth quarter loss ratio included $31 million, or 4.9 points of current accident year cat activity, compared to $3 million or 0.4 points in the 2009 fourth quarter. Fourth quarter current year cat activity was primarily related to the Queensland, Australia floods totaling $23 million and attritional property cat events in the U.S. of $7 million.
In the 2010 fourth quarter, development on cat events from earlier in 2010 were negligible, with $9 million increase in the 2010 third quarter New Zealand earthquake event substantially offset by reductions in estimates for the Chilean earthquake and Windstorm Xynthia of $8 million. The impact of the Australian flood events and Cyclone Yasi are still preliminary in developing, and as Dinos mentioned, beyond the $22.5 million already booked in 2010, the range we are estimating at this time for 2011 is from $30 million-$60 million, based on a total industry estimated loss of $3 billion-$5 billion for the aggregate Australian floods and a total industry estimated loss of $500 million-$1.5 billion for Cyclone Yasi.
The 2010 fourth quarter combined ratio reflected 6.1 points or $39 million of estimated favorable development, net of related adjustments, compared to 2.3 points or $16 million in the 2009 fourth quarter. The prior development in the fourth quarter 2010 reflected net favor development primarily in property and other short and medium tail lines, as well as in the reinsurance segment casualty business from the 2002-2006 underwriting years. For the 2010 full year, our net favorable development impacted the combined ratio by 5.4 points, or $138 million, compared to 6.4 points or $183 million for the 2009 full year.
The 2010 fourth quarter current accident year loss ratio, excluding large cat events and net favorable development, is about the same as a year ago, which reflects the overall change in the mix of business away from U.S. casualty writings, where we have increased the current accident year loss picks to shorter and medium tail business that have relatively lower current accident year loss picks. It also reflects the shift during the last several years in the insurance segment from larger account business, which has a higher current accident year loss pick, to smaller account business, which has a lower current accident year loss pick and less volatility, but a higher expense ratio.
The 2010 fourth quarter expense ratio of 34.6% was 3.7 points higher than in the 2009 fourth quarter, mainly due to the 2010 fourth quarter other operating expense ratio, which was 4.1 points higher than in the 2009 fourth quarter. Contributors to the higher ratio included approximately $7 million, or 1.1 point, in our insurance segment, resulting from an accrual for certain employee benefits that are not expected to recur in 2011. Approximately $6 million, or one point, in our reinsurance segment related to higher incentive compensation costs, primarily related to better experience in business written in prior years, which should be averaged out over the year to estimate a run rate. Approximately 1.7 points of the other operating expense ratio was attributed to the lower premium volume.
On a per share basis, pre-tax net investment income rose to $1.81 in the 2010 fourth quarter compared to $1.56 for the same period a year ago and $1.77 in the third quarter 2010. The growth reflects the accretive impact of the share repurchase program more than offsetting lower reinvestment yields. Our embedded pre-tax book yield before expenses was 3.52% in the 2010 fourth quarter, about the same as the 2010 third quarter. Total return on the investment portfolio was minus seven basis points in the 2010 fourth quarter. Excluding foreign exchange, it was minus four basis points in the quarter. The net total return was affected by the increase in interest rates during the quarter, which impacted our fixed income portfolio by minus 70 basis points, which were almost all offset by good returns in equities and other alternative assets.
Throughout the past few quarters, Arch continued to allocate more assets to equities and alternative investments. Our allocation to equities was approximately 3% of our investable assets at year-end, while alternative investments and equity method investments were 7% of our investable assets. The investment grade fixed income portion portfolio, including the TALF portfolio, plus short-term investments and cash at the end of 2010 was 85% of total investable assets of $11.8 billion compared to the end of 2009, when it was 91% of $11.4 billion. We continue to maintain a very high quality fixed income investment portfolio with an average credit rating of double A plus. Our municipal bond portfolio of $1.2 billion had a market value of 102% of the book value at the end of 2010. Pre-refunded and revenue bonds account for 42% of this portfolio.
The general obligation bonds have an average rating of double A plus and an average duration of four, with the three largest concentrations in Texas, which is 9% of the total muni portfolio, Maryland 7%, and North Carolina 7%. Our exposure to uninsured general obligation bonds of states of interest today of California, Michigan, Illinois, New York, New Jersey, Nevada, and Arizona altogether only total 0.2% of the total municipal portfolio. The duration of the investment portfolio in total decreased to 2.83, down from 3.11 at the end of the third quarter of 2010. The shortening in duration during the 2010 fourth quarter reflects the potential movement I mentioned on our last call, in response to rising interest rates.
As a reminder, we match the duration of the portion of our investments that back our insurance and debt liabilities in order to economically immunize this large portion of our balance sheet. We currently maintain a low duration target through our remaining investments to dampen the impact from rising interest rates. For the 2010 full-year, our annual effective tax rate on pre-tax operating income was 0.5%, down from the 2% annual effective rate used in the third quarter, which resulted in a tax benefit in the 2010 fourth quarter of $5 million or $0.10 per share. Our effective tax rate fluctuates from period to period based on the relative mix of income reported by jurisdiction.
The full-year effective tax rate was below the range indicated last quarter of 1%-3% due to changes in the relative mix, which resulted from favorable reserve development, cat activity, and expense items by jurisdiction. Reserve development, by its nature, is not predictable. As indicated earlier, fourth quarter expenses reflected certain non-recurring items. Our expected range for 2011 is again 1%-3%, but certain factors, as experienced in 2010, can cause the tax rate to fall outside this range. Our balance sheet continues to be conservatively positioned, with total capital at $4.9 billion at December 31st, 2010, down from $5.1 billion at the end of September and reflecting the share repurchase activity during the quarter. In the quarter, as Dinos mentioned, we repurchased 2.9 million shares for $258 million at an average price per share of $89.23.
The estimated accretive impact of the cumulative share repurchase activity since 2007 added $0.75 to the diluted operating earnings per share and three points to our ROE. Our debt plus hybrids represent approximately 15% of our total capital, well below any rating agency limit for our targeted rating. Our book value per share ended the year at $89.98, up 1% in the quarter and 23% for the year. As of December 31st, 2010, we estimate that including AOCI, we hold approximately $600 million-$800 million above our targeted capital level based on current rating agency models with an appropriate buffer. Excluding AOCI, our excess capital position would be $400 million-$600 million. Our liquid cash short-term investments in U.S. Treasuries represent about 18% of our investable assets. With these comments, we are pleased to take your questions.
Alicia, we're ready for questions.
Ladies and gentlemen, if you have a question, please press star followed by one on your touch-tone phone. If your question has been answered or you wish to withdraw yourself from the queue, please press star followed by two. Questions will be taken in the order received. Please press star one to begin. Your first question comes to the line of Joshua Shanker from Deutsche Bank. Please proceed.
Good morning, everyone.
Hi, Josh. How are you?
Good. How are you doing today?
I'm doing well. Thank you.
John kind of explained the tax situation, I realize there's a lot of moving parts in that. I note that you guys are forecasting, again, a 1%-3% tax rate for next year. John mentioned that it's differences in mix that caused the tax benefit this year. Maybe I just need a little bit more clarification to try and understand why it got better, why we're resuming the old prediction for next year's taxes.
Well, I'll give you a few comments then I'll turn it over to John to give you more detail. It depends where our income is emanating from. As you can see, what we book in the U.S. on an accident year basis is not producing any underwriting profit. When we have light cat activity, we have significant income from our overseas operations. Depending where the income comes from, it will determine what our effective tax rate is. That's why it's not very predictable. Of course, everything we keep, almost everything, not quite everything we keep in the U.S., we invest in triple tax-free municipal bonds. On the investment income side, we don't have much tax. The FET we book as an expense item. That's why you don't see it on that line because anything we insure overseas, then we have to pay an FET tax.
It's that combination, those are the moving parts. For this quarter, a lot of our income came from the business we wrote overseas, that's the reason that the true-up of the tax rate from all four quarters into the fourth quarter reduced the rate to that point.
Josh, we had reinsurance favorable development from these casualty lines that mainly came from Bermuda. That was an impact in the quarter. We had some of the cat events. Some came out of the U.K., which would lower the effective tax rate and also the expenses, the higher non-recurring expenses in the quarter also lowered what we thought we may be paying in taxes. We have to adjust for the whole year as we go through this, so we have to true it up as we move through the year. It is hard to predict where it is going to come sometimes in various different jurisdictions, and that's why it can fluctuate around a bit.
I don't mean to sound too dark, it's not a long shot to say that you may not make an underwriting profit on the insurance side of the business in 2011. Would that cause you to have lower than 1%-3% taxes for the aggregate business?
I don't think it will go lower than that. The effective tax rate we pay on the U.S.-generated business, excluding the FET, it's approximately 9%-10% when you do that calculation. That excludes the FET we pay outside that calculation. I don't think that will change. It's just a significant part of our income for 2010 came from what we do in other parts of the world, especially in our cat book. Also, most of the reserve releases, they were from business we wrote overseas.
All right. Along those lines about the underwriting in the insurance business. Obviously, reinsurance becoming a smaller part of the business, given the opportunities you have there. Insurance is kind of stagnating here. Given a reasonable amount of catastrophes and not a lot of insurance underwriting profit, sort of what's your outlook, I guess, for the next 12 to 18 months on underwriting? I guess it's a loaded question, obviously the sources of underwriting income are drying up to some extent.
You're pretty smart in asking me to give you guidance when we don't give guidance.
Well, how about industry guidance?
There is a lot of what if scenarios that you can go through. The only thing I can tell you is what has happened. We don't have that view for the future because I can't predict the future. I don't know what cat events will happen. I don't know. We go and we underwrite business where we believe we're getting adequate returns. As I said in my prepared remarks, we think the business in the aggregate between insurance and reinsurance is producing about a 9% ROE on a normalized basis. This is not allocating our entire capital to the business because I don't hold my operating units responsible for the excess capital I have. In essence, it's not a great environment. Having said that, we're not unhappy with what we're achieving on the insurance group and/or the reinsurance group.
From a volume point of view, it's too early to predict, our January 1, it was very decent. The best we had in the last couple of years with probably both insurance and reinsurance being flattish. The quarter is not out yet. This is just the general business that we already know what we have. That's the best we can do. At the end of the day, we don't run the company in trying to predict the future. We try to react as best as we can to the market conditions that they presented to us.
Well, thank you for all the answers, and good luck in the new year.
Thank you. Thanks, Josh.
Your next question comes from the line of Vinay Misquith from Credit Suisse. Please proceed.
Hi, good morning.
Hi, Vinay.
If you could also add in the fact that you mentioned pricing is flat. Since loss trends are up, should we see some sort of deterioration on the margins this year versus last year?
Yeah. I would think that pricing is about flattish in some sectors down. We've seen a few glimpses of hope in some isolated instances, as I have mentioned. Our reinsurance group found certain opportunities in Europe to write some decent business, medium tail type of business on a quota share basis. We see exposure demand to be slightly increasing. You've heard that from other calls from a lot of our competitors. That means the 4 years of negative premium growth for the industry might be over with 2010 maybe being at the same level as 2009, and then 2011 projected to have some slight increase in revenue for the industry. All that is positive. On the rates, I think you're absolutely correct. Depending how our mix, if our mix
Stays steady state and it doesn't change, yes, our accident year is going to go up a bit. If we continue to be effecting changes, and we try all the time to make sure that we're going where we believe is the best returns, that effect might be dampened a little bit.
Sure. Fair enough. The second question is really on the pockets of hardening you mentioned. Do you think these are just isolated incidents, or do you think this is a process of the market bottoming out, and do you expect positive price changes later on during the year?
No, I see it as very isolated. It is on a specific book of business in certain parts of the country. Sometimes it's precipitated because a major writer says, "We're not going to do this business anymore." We had certain examples of that. Some of it in the E&S casualty, primary casualty, which a major leading carrier says, "We're shutting that operation down." That creates a bit of angst on those accounts. They got to find another home. It happened in a few cases. These are tougher underwriting risks. They belong in the E&S market. I don't get too excited about it because it's isolated. The reason I mention it is I'm trying to, for us and also for you guys, to find signals as to, is the market going to continue to drift, or are we, in certain cases, hitting the bottom?
I think in those cases, we have hit the bottom, and it's got to go the other way. When people say, "No mas, I don't want any more of this," it tells you that it can't get any lower than that. That's the only message I want to say. No tremendous opportunities. I'm not predicting a market trend. I still believe the market won't turn neither in 2011 or 2012, will probably be 2013, to be a broad-based market trend because more pain has to come. We're starting to see it in isolated cases.
Okay. That's great. On the tax rate, if I may. We saw yesterday the Obama administration once again put up reinsurance taxes. Do you have a sense for what the probability of that passage would be? Also, since you're making less underwriting income in the U.S., do you think it's going to be a major impact or a minor impact to you?
Well, listen, there is not a lot of detail on what the administration's new proposal might be. Keep in mind, this is only a proposal, and there is no bill drafted that we can react to it. We don't believe there is broad support for that and for its enactment. These kind of proposals, if enacted, will probably lead to increased cost for policyholders, and also it will affect the relationships the U.S. has with other jurisdictions, European and otherwise. With all that said, I ask our tax people to give me an indication. Let's say, if something like that was enacted, what it would cause our U.S. businesses from an additional tax. For 2010 calendar year, the proposal will have no adverse impact on us. As a matter of fact, our tax rate for the U.S. group, including the federal excise tax, wouldn't have changed.
Don't forget, I said before that our effective tax rate in the U.S., and we buy a lot of municipals in the U.S., is hovering around 9%-10% for the U.S. business, so it was never zero. You're looking at our aggregated tax for our global operations. I keep reminding people we're a foreign corporation with some U.S. subsidiaries. We're not a domestic company doing business overseas. I don't expect a significant change and a big impact on our business. It will take years to build up, even if they do pass and enact tax legislation that is protectionist, and we don't anticipate that for the time being.
Okay. That's great. Thank you.
Your next question comes from the line of Gregory Locraft from Morgan Stanley. Please proceed.
Hi. Good morning.
Morning.
Wanted to just understand even a little more, perhaps, Dinos, on this bottoming in the E&S. Is it all kind of excess casualty? Is that sort of where you see it, excess and primary casualty, or is it broader than that in terms of pockets?
No, it's not. I wish it was excess casualty. It's not excess casualty. Excess casualty, being a very long line of business, that's why people, they're still very optimistic. This is primary E&S, and it is in risks like maybe New York City contractors, which they have a lot of exposure to the third party over kind of claims that experience is not good and more and more underwriters don't want to write it. It might be habitational risks that the claim activity for frequency and severity started to perk up in some companies. They say, "We don't want to write certain type of habitational risk." It's isolated in these kind of pockets.
On the energy sector, we've seen some of that. It's not broad-based yet, and it is primary, where you're going to feel the effect of the claims a lot quicker than you will feel when you're writing excess liability, that you might be happy for a few years and then very unhappy when the losses start getting into the excess layers. I haven't seen it on excess casualty. The excess casualty area, we still believe as a company, is the most challenging. When I say excess casualty, I'm talking the U.S. Canada, Europe is a different story. Unfortunately, we don't see any signs of improvement in that yet.
Okay. Great. That's helpful. Again, you sort of see the primary lines you mentioned as a response to one big carrier?
No, it's a combination of things. Don't forget, sometimes a big carrier will move. Big carriers, a year ago, will say, "I'm not going to write this," and then you have 15 other people that they will write it. That's what the market is all about. Now, though, we're starting to see resistance by the broad market on certain classes, and they say, "No. He doesn't want it, but I don't want it either as a new piece of business for me. I'm not going to write it unless there is a price improvement." To me, that's the beginning of the most distressed segments starting to get attention by underwriters. We've seen that even in 1999, early 2000. Even though the market didn't start moving until mid-2000, and it accelerated in 2001 and then got real good in 2002, 2003.
There were early signs that people that were saying, "No mas.
Okay. I guess, building on that as context, you'd mentioned 2000, kind of 2012, 2013 is sort of more in line with when you think the market on a more broad-based basis could be better and more pain has yet to come. How do you think that will manifest itself in the reported results? What would you be watching in our shoes?
It will manifest in two ways. The things that I watch the most is, actually, I watch three empirical data points. One is the cash flow relationships, because cash flow, you can't fool around. Either you have the cash or you don't. Usually when cash flows get to around 5%, this is cash flows to net written premium for the industry. It had signaled that when it gets below that number, you have a market turn. Second is when the relationship of IBNR to total reserves gets into the, for the industry, around the 45% level. That happens when people exhaust their reserve redundancies by releasing them as the older years mature, and then the diagonals indicate that they have too much, and they have to release it. The more recent years being more realistic accident years, and there is nothing to release.
It will change the relationship between total reserves to what is case versus IBNR, and that relationship is another indicator that we usually watch. If I were you, I would look at cash flows, I would look at relationships to total reserves, IBNR, the Schedule P, what that tells you, and I would look at the change in the tone of how the calendar year results get reported without. If there is no aiding by reserve releases, all of a sudden, people, they're not going to lie. We don't feel proud producing 8%, 9% ROEs. Don't forget, 9% ROE that I mentioned is on a pro forma basis, eliminating my excess capital. In total capital, it's going to be a little less than that. That's not a report card that you want to write home about, if you're only producing 7%, 8%.
If there is no reserve releases and benign cat activity, those numbers are going to be not as attractive, and I think that's what causes markets to turn.
Okay. Thank you very much.
You're welcome.
Your next question comes from the line of Matthew Heimerman from JPMorgan. Please proceed.
Hi, good morning, everybody.
Hi, Matt.
Hi. Couple questions, if I may. Just on the January 1 renewals, can you remind us how much of your reinsurance book is 1/1?
I don't have that number with me, but it's significant. I think it's a little over 40%.
Okay.
Yeah.
Not that differently.
It's not just January. I would say the first quarter.
First quarter.
Yeah.
Okay. All right. That's helpful. I guess, just in terms of the PMLs been falling, I guess, as we think about, you mentioned that some of the reason that your volume is potentially stable in 1Q versus a year ago is quota share business and medium-tail line. Should we think about if we're looking at property cat, property ex cat, that that will be a pretty good barometer for how we should think about your PML changing over the course of 2011?
Don't forget, the Florida business doesn't come up until second quarter. Usually, if you go back and you look at how we report quarter by quarter, our least amount of PML is usually deployed in the first quarter of any one year, then it grows up when the contracts come up and what we're going to do, depending if we like the rates, we might deploy a little more, having the capacity for the Florida business. Too early to tell. We're going to look at what's available, what kind of pricing can we get it, and do we like that? We'll go from there.
Okay.
That's the reason we shy away from giving guidance on anything, because that's not the way how we run the company. I'm not trying to predict what are we going to do quarter after quarter after quarter, because I don't know myself.
Sure.
What I try to emphasize to underwriters, maintain discipline and do what you believe is appropriate and write the business that it will have a margin on it.
No, that's fair. I guess I wasn't looking for guidance so much as just as we see the numbers reported, if that'll be a good barometer, because I'm trying to get a sense of what adjustment, if any, when we're looking at your book, we should be making for RMS 11, for example, because when you say PML is 683 in Tri-County from 809, is that net of RMS or not? That's where I was coming from.
Don't forget, our PMLs are calculated beyond RMS. We do make adjustments to the models.
Yeah.
I think I mentioned that in my prepared remarks that in anticipation, when we get data sets from cedants, we don't just run it through RMS, and then we take their answer, and that's the way we underwrite. Our cat team makes adjustments. As a matter of fact, we did make adjustments on anything we wrote in the first quarter, in anticipation that the RMS model, even though is not increasing coastal PML calculations, it is increasing, and in some cases, significantly, 30%, 40%, 50%, 60% on more inland exposures, and we made adjustments to the way we underwrite. As a matter of fact, our cat team, from our own analysis of the 2004 storms, you remember we had four storms in Florida.
Yeah.
One of them, Charley, went right through from and exited the other way. Based on our own analysis, we never really believed that if you're three or five miles inland, you had a significant less PML from a property that it was two miles from the coast.
We had made those adjustments. For us, it wasn't huge adjustments. We look our own way of underwriting the cat business based on a combination of outside models we use, plus our own internal, I wouldn't say manipulations, but changes to those models because we have our own ideas, and we continue to factor that in. My comments were more about there was a market anticipation that RMS 11 would have increased demand and maybe toned down the pricing, which went down 5%-7%. I saw none of that. Demand didn't go up, and it didn't affect in a positive fashion pricing. The buyers had good deals this year.
That's fair. I'm sure I'm reading way too much into this, but your press release when you talked about the Australia floods and Yasi had a different line with respect to potential variability in your catastrophe loss estimates, the difference really centered on kind of reinsurance performance. I guess, is there anything specific that you're dealing with behind the scenes?
No, it's just the language we put in to make sure that investors should know that even though we have reinsurance recoverables, if you don't get the recoverables, a recoverable becomes your net loss. It's no difference to what we've done in the last nine years.
Okay. It was different than previous press releases. I thought I was reading too much into it.
We changed the language a little bit.
Yeah.
The language was changed a little bit, but it's really the same meaning. There's no new data.
No, that's fair. I would have been remiss to ask given.
No.
If there have been questions around number of incidents, et cetera. Okay. I think I'll cede the floor then and let somebody else ask. Thanks.
Thanks, Matt.
Your next question comes from the line of Mark Dwelle from RBC Capital Markets. Please proceed.
Good morning. Two questions. First, in the $30 million-$60 million of additional Australian-related losses, will those primarily be on the reinsurance book or will there be any insurance book affected there?
It's both. From a size perspective, I would say 25% might be insurance and 75 reinsurance, or maybe 30/70, something like that. I haven't done the calculations. We go unit by unit, and we build it up. John, you have any more color on that?
No, it's about that. Like one-third, two-thirds. One-third insurance, two-thirds reinsurance. It depends upon the range, and of course, these numbers will move within this range on how all this works out between Yasi and the floods and how things recover, mines and everything else. There's going to be variability around these numbers until all this gets sorted out at some point.
All on our insurance group all comes from our London operations. Lloyd's and non-Lloyd's, both.
Okay, understood. Thanks. The second question I had related to just a little additional detail related to the reserve releases, particularly on the insurance line. What accident years were involved there, and was that net of any offsets in terms of charges, or was it primarily all releases?
John is going to look for the details. Basically, we do analysis on our reserves by IBNR family and then for accident year. You always get positive and negative movements. Some years we'll put a little up, and some years we take some down. It depends how the empirical data points to us. As you get another diagonal on the triangle, you'll make those determinations.
I understand. Sometimes you have four points of favorable and one or two points of unfavorable, it's discernible.
Listen, that's not unusual, especially if you're writing. The actuaries will react to a single large loss on a book of business that is small, right? If you're writing high limits one year we'll look at 40 loss and loss adjustment expense, another might look at 60. There was not that much difference in the marketplace. One year had the big loss and the other year didn't have the big loss. You get those kind of variations, and they react to it depending of how the case reserves, as we adjudicate some of these cases. That's the process that we go. It's a very detailed process.
I can give you a little bit of color on it. We had a total net favorable for the insurance group in the quarter as mainly short tail and some medium tail lines. Of course, there's always some rebalancing by years. Of course, the short tail is more recent years. The medium tail was like 2006 to 2008. A lot of other little lines had net releases as well. We did see some releases, some net strengthening in both executive assurance, a little bit for the subprime timetable, 2008, 2009, 2007, as well as some casualty for some specific events that happened in some in 2004, 2005. We had releases in 2006 and 2007. It just balances out as you go across year by year and line by line.
I understand. That's helpful. Thank you. That's all my questions.
Your next question comes from the line of John Hall from Wells Fargo. Please proceed.
Good morning, Dinos. Good morning, John.
Hi, John. How are you?
Morning, John.
I'm doing well, thank you. I just wanted to address the share repurchase real quickly. First off, I was wondering when the next board meeting is. Secondly, I was wondering if you could just talk a little bit about how book value plays into your repurchase decision or your decision to be in the market at any given point in time.
Yeah. Well, the first one is easy. The board meeting is in the next 10 days or so. We don't give specific dates. This way you don't know when we're traveling.
Yeah.
It will be next week sometime. Of course, price has an effect on how we decide to return capital to shareholders. As long as our share price is at book value or below, there is not a lot of thinking here.
That's a very easy calculation to make.
It's a very easy calculation. Of course, if share price goes to a multiple to book, we have a grid, and I think we have presented it to investors. The calculation that we do is we look at what is our ROE return expected, and what the multiple to book that we need to buy, and what the recovery period should be. If it's three years or less, we continue to buy shares back. If it's more than three years, we'll look for other ways to return capital. We build this grid give us guidance as to which way we're going to go.
Right about now, if you look that up, with Dinos' 9% to 10% ROE number that he just mentioned, we can go buy up just under 1.2. 1.15 to 1.2 would be sort of the ratio that we could buy up to. Of course, we're looking forward to that trading level at some point. Historically, the last few quarters when it's been below book, it's been a pretty easy calculation to make.
Great. That's perfect. Thank you.
Your next question comes from the line of Ian Gutterman, Macquarie Capital. Please proceed.
First, just to clarify that last one, is that book value valuation ex 115 or full book?
That's at the full book.
Okay, just making sure. Okay.
What happened? Hello, Ian?
One moment.
We only pay for an hour? I think we can afford.
Ian, your line is open. Please proceed with your question.
Okay. Can you hear me now?
Yes.
Yeah, we can hear. You're in the back of the room. It's like in college again, right? You're a reinsurer.
That's my job. The excess capital I was looking at, I'm focused on the ex 115 that went down $100 million from last quarter. I'm looking at your ex 115 equity was essentially flat and your PML is down $75 million, which would free up $300 million in capital. Why is your excess capital less than last quarter?
We allocated more investments to equities and alternative investments that it's a very high capital charge on the SAP capital formulas.
That makes sense.
We moved, as you saw, 3% now is in equities, so it takes a bigger charge.
That makes perfect sense. Follow-up on the tax question. I'm looking through the supplement. It looks like round numbers, your net premium is about a billion and a half in the U.S. and about $1 billion in Bermuda. I guess first, is that billion and a half in the U.S., is that before you quota share to Bermuda, or is that true net premium that stays in the U.S.?
That's pre-quota share.
That is pre-quota share. Okay. That answers part of my question, but I was just trying to think through how you're essentially making very little money to have a very low tax rate on $1 billion, on basically 60% of your premium.
Well, because most of our underwriting income is coming from the overseas operations. We've been booking the insurance group, but over 100%. In essence, you're taking an underwriting loss. We don't have in the U.S. a significant portion of investable assets that is not triple tax-free. All of our muni bond portfolio, which is about $1.2 billion, we buy U.S. operations.
Yeah.
In essence, that comes with no underwriting income and tax-free. A lot of our income is coming from the investable assets we have overseas, plus the underwriting gain we have from the businesses that we write overseas. That's the reason that tax rate is so low.
The reason the combined is over 100% on that business, is that more long-tail business, or just some of the reasons-
Some of it is long-tail business. We write some comp, excess comp, et cetera, and some of it is because the market is so tough that we don't think there is a lot of margin in that business. Your next question is going to be, why don't you cut it off totally? Anticipating your last question is, the answer is because you can't shut down your operations. You minimize as much as you can in sectors you don't have profitability, and you wait for the rainy day to go and then the sunshine to come, and then you can capitalize with that opportunity when it shows up.
That makes sense. I wasn't even going to argue that. I just had two little ones if they're quick. Professional liability insurance that had been growing all year this quarter was down about 25%. What happened there? Also, can you remind me, in the reinsurance business, that other specialty is about double year-over-year. What exactly is other specialty?
The first one, professional liability, we have reduced significantly in Europe. In Europe, we were writing for small, medium-sized enterprises, a lot of D&O, but also we had PL business, we didn't like the profitability of that business, so we have discontinued that, it went to another carrier. That's the difference in that. Your second question was on?
Your reinsurance, that business that you classify as other specialty, was about $130 million of net premium this year versus $65 last year. I'm just wondering what combines-
A lot of that movement is trade credit business.
Oh, okay. That makes sense. That's getting the sense of that group. Okay. Thank you very much.
There are no further questions at this time. This does conclude the question and answer portion of the call. I will now turn the call back over to Dinos Iordanou for closing remarks. Please proceed, sir.
Oh, thanks, Alicia, and thank for everybody that share the one hour with us, and we're looking forward of talking to you in the weeks ahead. Have a good day.