Hello, welcome to the AXIS Capital Q3 2014 Earnings Conference Call and Webcast. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one on a touch-tone phone. To withdraw your question, please press star then two. Please note this event is being recorded. I would now like to turn the conference over to Rick Haran. Sir, please go ahead.
Thank you, operator. Good morning, ladies and gentlemen. I'm happy to welcome you to our conference call to discuss the financial results for AXIS Capital for the third quarter ended September 30th, 2014. Our earnings press release and financial supplement were issued yesterday evening after the market closed. If you'd like copies, please visit the investor information section of our website, www.axiscapital.com. We set aside an hour for today's call, which is also available as an audio webcast through the investor information section of our website. A replay of the telephone conference will be available by dialing 877-344-7529 in the U.S. The international number is 412-317-0088. The conference code for both replay dial-in numbers is 10053135. With me on today's call are Albert Benchimol, our President and CEO, and Joseph Henry, our CFO.
Before I turn the call over to Albert, I will remind everyone that statements made during this call, including the question and answer session, which are not historical facts, may be forward-looking statements within the meaning of the U.S. Federal Securities Laws. Forward-looking statements contained in this presentation include, but are not necessarily limited to, information regarding our estimate of losses related to catastrophes, policies and other loss events, general economic, capital, and credit market conditions, future growth prospects, financial results and capital management initiatives, the evaluation of losses and loss reserves, investment strategies, investment portfolio and market performance, impact to the marketplace with respect to changes in pricing models, and our expectations regarding pricing and other market conditions. These statements involve risks, uncertainties, and assumptions, which could cause actual results to differ materially from our expectations.
For a discussion of these matters, please refer to the Risk Factors section in our most recent Form 10-K on file with the Securities and Exchange Commission. We undertake no obligation to update or revise publicly any forward-looking statements, whether as a result of new information, future events, or otherwise. In addition, this presentation contains information regarding operating income, our consolidated underwriting income, and adjusted group and segment results, which are non-GAAP financial measures within the meaning of the U.S. Federal Securities Laws. For a reconciliation of these items to the most directly comparable GAAP financial measures, please refer to our press release and financial supplement, which can be found on our website. With that, I'd like to turn the call over to Albert.
Thanks, Rick, good morning, ladies and gentlemen. Thank you for joining us today. Last night, AXIS reported third quarter operating income of $133 million, or $1.27 per diluted share, an annualized operating ROE of 10.1%. We ended the quarter with diluted book value per share of $49.88, an increase of 12% over the last year. Adjusted for dividends, diluted book value grew 14% over the past 12 months. We achieved a strong result notwithstanding weak equity markets, which held back our investment income in the quarter. In addition, we returned $179 million in capital to our shareholders through share purchases and common share dividends in the quarter, and $556 million year-to-date, thus returning to shareholders 126% of year-to-date operating income in the form of dividends and share repurchases.
AXIS delivered solid underwriting results reflecting low cat activity, ongoing favorable reserve development, a broadly diversified portfolio of risks, and a more holistic approach to risk management. We're also starting to observe favorable outcomes from some of our targeted portfolio enhancement activities. Overall, we report a consolidated combined ratio of 92.2%, including 2.2 points of cats and 6.7 points of favorable prior year reserve development. Like most other participants in the crop business, we did accrue additional reserves in response to the dramatic drop in agricultural commodity prices over the summer, this is reflected in our combined ratio. However, we also purchased some hedges and ceded some of the risk to third-party capital providers such that our ultimate net loss was meaningfully reduced from the gross result. While the benefit of these transactions is included in our consolidated earnings, they are not reflected in our reported combined ratio.
Adjusting our results to reflect the positive impact of these actions on our net retained underwriting results, the adjusted combined ratio for our company for the retained risk would improve to 90.5%, the adjusted combined ratio for our reinsurance business improves to an attractive 78.3%. We continued to make progress on a number of initiatives during the quarter, including our Lloyd's Syndicate, our new medical malpractice unit, the re-entry into U.S. Primary Casualty, our weather and commodities business, AXIS Re Ventures. The contribution of our A&H business remains around breakeven for the second quarter in a row. Our accident and health team is working diligently to optimize the balance between insurance and reinsurance, between U.S. and international, to expand product and distribution across geographies.
We also continue to make progress on analytics and expense control initiatives that will drive underlying improvements in our results independent of the vagaries of the P&C cycle. With that, I'd like to turn the call over to Joe to discuss our financial results for the quarter. Joe?
Thank you, Albert, and good morning, everyone. During the third quarter, we generated good results with an annualized operating ROE of 10.1%. Our quarterly diluted book value per common share, a key metric in measuring the value we generate for our shareholders, increased by 0.4% to $49.88 per share. The growth in our diluted book value per share over the past 12 months was 12%. When our dividends declared of $0.27 per quarter are added to the growth in book value, the total value created for our shareholders over the last 12 months was almost 14%. Third quarter results benefited from a reduction in the level of natural catastrophe and weather-related losses compared to the same period of last year, and the continued favorable prior year development in our loss reserves.
These positive factors were offset by an increase in our current accident year loss ratio, for reasons I will explain shortly, and a decrease in net investment income, which was impacted by a decrease in returns from our alternative investment portfolio. Other notable items in our quarterly results include a large increase in foreign exchange gains, driven by the impact of the significant appreciation of the US dollar on our foreign-denominated liabilities, and a sizable increase in realized gains on our investments, which reflect sales of common stocks which have seen significant appreciation during 2013 and 2014. Moving into the details of the income statement, our third quarter gross premiums written decreased modestly by 1% to $897 million, with decreases in our insurance segment being largely offset by growth from our reinsurance segment.
In our insurance segment, our top line was down $19 million or 3% and reflected decreases in accident and health due primarily to timing differences, and professional lines where the decreases reflect the continued reshaping of our US D&O portfolio. These decreases were partially offset by our aviation lines, which were positively impacted by the timing of renewals of certain policies and new business. In our reinsurance segment, our top line was up $12 million or 3%. The increase was driven by our liability lines of business and was primarily due to a multi-year quota share treaty with an existing client, which generated $35 million of premium related to future years. This increase was partially offset by decreases in the agriculture, professional, and property lines, which reflected non-renewals, treaty decreases, and changes to premium estimates.
For the first nine months of the year, our gross premiums written were $3.9 billion, a growth rate of 2% compared to the first nine months of 2013. This increase was driven by growth in the reinsurance segment of 6% and was significantly impacted by the level of contracts written on a multi-year basis in the liability, property, catastrophe, and motor lines, with premiums written of $131 million relating to future underwriting years. Growth in the reinsurance segment premiums was partially offset by a decrease of 2% in the premiums written in the insurance segment. Our consolidated net premiums written were down. This reduction was driven by an overall decrease in written premium as well as increased ceded premiums due to the increased reinsurance protection purchased primarily in our insurance professional lines of business and the impact of changes in the business mix.
Our net premiums earned increased by 2% to $966 million in the third quarter of 2014. Increases were noted in both segments, with insurance increasing by 3%, reflecting the continued growth over our A&H book, business written in recent periods in the liability and professional lines, and the positive impact of the reductions in our ceded reinsurance programs implemented during 2013. Reinsurance increased by 1% with the growth in liability, motor, and professional lines being the most noteworthy. Our year-to-date growth in net earned premiums of 5% to $2.9 billion was primarily impacted by the same lines of business as the quarterly increase, with the continued expansion of our agriculture business also adding to the year-to-date growth in the reinsurance segment. Our third quarter consolidated current accident year loss ratio increased 2.3 points to 63.8% compared to the same period of last year.
Our year-to-date loss ratio was comparable at 63.7%. In our insurance segment, the third quarter 2014 current accident year loss ratio increased 8.8 points to 64.7%. Q3 2013 was a very quiet quarter with regard to losses incurred. The current quarter was impacted by natural catastrophe and weather-related losses of $19 million attributable primarily to weather losses in North America. In addition, the loss ratio was impacted by higher underwriting loss ratios for the property classes of business, reflecting recent loss experience and the change in the business mix with a shift towards less volatile lines of business that carry a higher loss ratio. It should also be highlighted the actions we have taken in reshaping of our U.S. D&O portfolio during the current year have resulted in a positive quarterly loss ratio variance on this line of business compared to the prior quarter and Q3 2013.
For the year-to-date, the current accident year loss ratio for insurance is 66.7%, up from 63.8% for the comparable period of 2013, generally driven by the same factors I just discussed. For our reinsurance business, the third quarter 2014 current accident year loss ratio was down 3.6 points to 63%. Current quarter's results included an insignificant amount of losses related to natural catastrophe and weather, compared to $51 million net of reinstatements incurred in Q3 2013. Net of cat and weather related losses, the current accident year loss ratio increased primarily due to an increase in the agricultural loss provisions following a significant drop in commodity prices, in particular corn, during the quarter. As you are aware, we hedge some of our exposures to agricultural price variations.
During the quarter, the variations in the prices of agricultural commodities produced positive mark-to-market returns on our derivative hedge positions of $8 million. The increase in the value of our agricultural hedges is reported as part of other insurance related income in line with the applicable U.S. GAAP rules. In addition, we ceded a portion of our agriculture book to our third party vehicle, AXIS Ventures Reinsurance Limited. AXIS Ventures is a variable interest entity and is consolidated on our financial statements. As such, the impact of the cession, which is positive to AXIS during the quarter, is included in amounts attributable to non-controlling interests. After the benefits incurred from the hedge and cessions to AXIS Ventures, the net pre-tax impact of these agricultural losses on the quarterly net income attributable to AXIS Capital was $22 million.
We realize that the accounting rules may make the full understanding of the movements in our reinsurance segment difficult. As such, in order to aid you in evaluating the performance of this segment, we have added an additional page in our financial supplement, which provides more information on the impact of the sessions to AXIS Ventures and the agricultural hedges on our reinsurance segment and group results. As Albert indicated earlier, adjusting for these offsets, the adjusted reinsurance loss ratio would be 47.5% and the adjusted reinsurance combined ratio would be 78.3%, a 3.8 reduction from the reported combined ratio of 82.1%. Other notable items that contributed to the variance in the reinsurance current accident year loss ratio included changes in the business mix, which was primarily offset by a reduction in attritional losses, most notably in the credit and surety lines of business.
For the first nine months of the year, the current accident year loss ratio for reinsurance decreased by 2.5 points to 61% on a reported basis, primarily driven by the reduced level of natural catastrophe and weather related losses. Turning to loss reserves established in prior years, our results continue to benefit from net favorable loss reserve development, which aggregated to $65 million during the third quarter. Short tail classes in both segments contributed $61 million of this balance, primarily reflecting better than expected loss emergence. In addition, we continue to give weight to actuarial methods that reflect our favorable experience for our reinsurance professional lines, which contributed $10 million reflecting lower ultimate loss estimates primarily for accident years 2010 and prior. Our year-to-date favorable loss reserve development was $193 million compared to $177 million recognized during the first nine months of 2013.
During the third quarter and the first nine months of 2014, our acquisition cost ratio increased by 0.8 points and 1.2 points respectively, compared to the same periods in 2013. Increases were noted in both segments. However, they were more pronounced in insurance due to the changes in the mix of business and reduced commissions received given the changes in our ceded reinsurance programs. The increases in reinsurance were primarily driven by higher acquisition costs paid on certain lines of business as well as variances in accruals for loss sensitive features in underlying contracts. Our total general and administrative expenses increased driven by personnel costs, professional fees, and other related expenses associated with the continued buildout of the company's global platforms. As we mentioned last year, we are incurring incremental costs now which will benefit our expense structure in future years.
Overall, the company reported an underwriting income of $113 million and a combined ratio of 92.2% for the third quarter. On a year-to-date basis, our underwriting income is $349 million with a combined ratio of 91.6%. Adjusted underwriting income for the quarter would be $6 million higher and the combined ratio is lower after adjusting for crop price hedges and the sessions to AXIS Ventures. Net investment income was $67 million for the quarter, down from $115 million in the previous quarter and down from $103 million in the third quarter of last year. The most significant driver of the decrease was the contribution to net investment income from our other investments portfolio.
Other investments produced a $3 million loss during the quarter versus a gain of $32 million last quarter and a gain of $32 million in the third quarter of the prior year. Primarily due to a decrease in income from hedge funds, which was impacted by the weaker performance of equity markets during the quarter. In aggregate, the total return on our cash and investment portfolio for the quarter was a negative 0.7%. The negative total return for the quarter was due mainly to a decline in prices on our fixed maturity portfolio as a result of strengthening of the U.S. dollar and the widening of credit spreads on both investment grade and high yield corporate debt.
We continue to hold a high quality, well-diversified portfolio with cash and invested assets totaling $15.5 billion at September 30th, down approximately $1.1 billion from June 30th and up $0.7 billion from a year ago. The year-over-year increase was primarily due to proceeds from our senior notes issuance, which was completed during the first quarter of 2014. The duration of our fixed maturity portfolio was 2.9 years at September 30th, no change from June 30th, and down moderately from 3.2 years at the end of September 2013. Our fixed maturities weighted average credit rating remains unchanged at double A minus. Our total capital at September 30th, 2014, was $7.3 billion, including $1.5 billion of senior notes and $628 million of preferred equity, a decrease of $0.1 billion from $7.4 billion at June 30th, 2014.
During the quarter, we repurchased 3.2 million common shares at an average price of $47.48 per share for a total cost of $150 million. As of today, we have $300 million of remaining authorization under our board authorized share repurchase program for common share repurchases through December 31st, 2015. As discussed with you previously, provided that market and financial conditions remain the same, we aim to return around 100% of our annual operating earnings to our shareholders through regular dividends and share repurchases. Our strategic expansion opportunities continue to progress well. We continue to be on target with our growth plans for our accident health unit. Our Lloyd's vehicle is making good progress in the London markets, and we also expanded the capabilities of AXIS Ventures, our third-party capital initiative during the quarter. With that, I'll turn the call back over to Albert.
Thank you, Joseph. Let's cover market conditions. In insurance, we continue to see a leveling off in pricing overall, with more pressure on some of the international property and specialty lines. However, despite a slowdown in pricing, there is rationality in most price action. In as much as it is generally the lines that have performed reasonably well that are seeing the most pressure. There remain good fundamentals and opportunities for profitable growth in many insurance lines of business. Within our insurance segment, the overall AXIS Insurance rate change for the third quarter of 2014 was down 3%, a change from -2% last quarter, and down from the +2% experienced in the same quarter last year. Pricing declines in property-related lines drove this result. Casualty pricing remains strong, although rate increases are moderated.
Across property, casualty, and professional lines, the U.S. is the strongest of the geographies in which we operate with respect to pricing environment. This favorable U.S. market works in our favor as close to 60% of our global insurance business is generated locally out of our 12 offices spread across the country. In our U.S. division, overall rate change was minus 1% from flat last quarter after 12 consecutive quarters of positive rate change, and we also maintained strong renewal retention across all lines. Price weakened in most of the property lines, while casualty lines continued in a positive direction. Casualty rate increases have begun to slow after steady increases since 2010.
Our own underwriting activity has reflected these trends with new business in our U.S. P&C operations, primarily comprised of casualty lines with the greatest contributions from U.S. excess casualty, where prices benefited from more than three years of rate improvement. In our professional lines division, overall rate was flat, in line with the second quarter, and broadly stable since 2012. 84% of the portfolio experienced flats to higher rates. As in previous quarters, rate changes are generally positive on primary accounts, while excess layers, which have seen good performance in the past few years, remain under pressure. Classes which require additional rate, such as primary public D&O and film in the U.S. or surveyors in the U.K. PI book, are showing the strongest positive rate changes.
As to international specialty markets, after strong pricing conditions and generally good industry results for close to three years, prices began to come down at the end of last year. They were down 8% on average for us this quarter. As usual, there were wide variations in rates depending on the line of business or geography. Energy lines drove most of the change. While aviation and terrorism have historically shown weak price action, we now expect recent aviation losses to provide some impetus for better aviation pricing. Our international division has delivered very strong underwriting profitability over the years. Even with recent price cuts, we believe that many lines remain reasonably priced. We continue to look for profitable growth and are expanding our opportunity set through our Lloyd's presence and other distribution initiatives. Overall, the insurance business still has plenty of opportunities to write attractive business.
Access to business and risk selection are increasingly an important differentiator in the market. From our perspective, AXIS is very well positioned in that regard. Moving on to reinsurance. Momentum in the last 18 months has resulted in a shift to what we believe is a buyer's market in most classes of business and regions. Abundant capacity, strong balance sheets, consolidation of reinsurance buying continue to pressure reinsurance pricing across most territories and lines of business. This has been coupled with some movement in terms and conditions. Multi-year commitments are in great demand, broadly impacting all lines of business. Non-concurrency of terms is more prevalent in the marketplace. As you heard from Joe, we participated selectively in a number of multi-year facilities where it made sense for us to do so.
The declining number of attractive opportunities in property catastrophe has encouraged traditional reinsurers to move aggressively into casualty lines, leading to softer terms, most visibly evidenced by increases in ceding commissions. However, in many cases, some of these higher ceding commissions are offset by improvements in primary pricing, such that margins are not down as much as would be indicated by the changes in cedes. While reinsurance terms are not ideal, underlying businesses are performing well across most of our major product lines, as indicated by our current year results. Many areas under pressure are still generating adequate margins, although in some cases, there isn't much room left. As a growing number of cedents look to reduce the number of reinsurers on their panels, we are benefiting as a highly rated global multi-line insurer with excellent service and strong relationships.
This, coupled with our innovation and technical strength, is allowing us to better defend our positions and mitigate the worst effects of a highly competitive market. Looking back on the most recent renewals, we reduced or non-renewed a number of treaties. We weren't the only ones. We are beginning to see evidence of pushback on pricing, terms, and conditions that reach too far. While we continue to anticipate further pressure, we interpret these developments as indications that we are approaching a slower rate of decline in pricing. In conclusion, there is no favorable tide to lift all boats in a transitioning market. Quality of relationships, brand reputation, service and claims management, financial strength, and ratings all influence access to business opportunities. Risk selection, risk management, and portfolio construction are paramount in extracting the best performance out of a declining market.
In these attributes, AXIS has a strong track record. We are convinced that our investments in data, analytics, and employee training will all serve to make us even better. I'm confident of our ability to navigate in these markets and continue to deliver superior value creation for our shareholders. We are not dependent on any one line or market and can afford to remain disciplined and pursue only that business which we consider to be profitable and additive to our portfolio. While we do see some pressure on reinsurance business, we also get the benefit of better terms on the reinsurance and retro that we purchase. We have good balance. Against the backdrop of more challenging market conditions, we believe our market reputation for superior service, strong capital, and superior ratings will allow AXIS to enhance its relative position and access profitable business.
We will continue to balance prudent growth and active capital management to deliver the best outcomes for our shareholders. At this point, I'd like to open the line for questions. Operator?
Yes. Thank you. We will now begin the question and answer session. To ask a question, you may press star then one on your touch-tone phone. If you're using a speakerphone, please pick up your handset before pressing the keys. If at any time your question has been addressed and you would like to withdraw it, please press star then two. At this time, we will pause momentarily assemble the roster. The first question comes from Kai Pan with Morgan Stanley.
Thank you. Good morning.
Good morning.
My first question regarding to you've been through sort of the business mix shift changes towards low volatility or potential high return business. In regard to that transition, you have seen partly contributed to the significant rise in the core underwriting margin for the four quarters in a row. I just wonder, are we sort of pretty much done in that process that we would not see such a significant increase in core margin going forward?
I think it's a very good point, your observation is correct. The best example that I would give you, is that we have seen the bulk of it. As we're moving into our current unearned premium and moving forward, you'll see less of an impact coming in from the mix. Let me give you a statistic to help you look at that. On a year-to-date basis, we estimate that the change in mix added 1.9 loss ratio points to our results. However, in the third quarter of this year, the change in mix was only contributing 1.3 points to the change. As you can see, we're leveling off, if you would, the growth rate that comes from mix, and that should stabilize as we get into 2015.
Okay. That's great. The second question is really shifting to your professional line. There in the U.S., there are some reserve issues last year, you took action on that. So far, if I heard you right, they actually have some reserve releases in that line. Why now you decided to purchase more reinsurance?
Well, the purchase of the reinsurance was done earlier this year. Two things I would like to say. The issues with the U.S. primary D&O book was less about reserve issues. It was more about the fact that we'd recognized that the profitability of that book of business was not as good as we expected. We did make an adjustment in the fourth quarter of last year, that was mostly for within the period. Then, of course, were carried it forward into 2014 with a higher loss ratio. I think that what we're trying to do, of course, is find the right balance with the improved terms that we could get on the reinsurance that we purchased. We felt it was a good transaction to modestly increase our cessions in the professional lines book.
As you know, over the last three years, four years, we've actually increased and decreased our retentions annually based on what we believed the reinsurance terms were. There's nothing unusual, if you would, at trying to optimize the net position. It was down the prior year. It was up the current year. Again, when we sit down for our renewals next year, we'll determine what is the best way to purchase reinsurance to optimize the book.
That's great. If I can ask last sort like a quick question. Do you have any exposure on the recent, the rocket launch failure?
No, we do not.
Thank you very much.
Thank you. The next question comes from Jay Cohen of Bank of America Merrill Lynch.
Yeah, thank you. Obviously, this year you had made some investments in the business. You've been talking about that, and it put some upward pressure on your overhead. As we head into, I guess, arguably a less robust market, I hate to use the word softer, but certainly more competitive. Could you see yourselves pulling back from those investments? Should we expect the investments to continue, or should they slow in 2015?
I presume you're referring to investments in new businesses? Or are you referring to
Exactly.
Yes.
New businesses, the money you are spending that's driving up your overhead ratio at this point.
Right. Well, the investment in new businesses can be found in a couple of areas, but you're absolutely right with regards to the fact that in a number of our businesses, the G&A ratio is still too high, given the low level of volume in some of those businesses. I'm pleased to say that the businesses that we chose to invest in, we believe are actually make very good sense for a company going forward. Obviously with regard to A&H, which has been a big initiative going forward, we now feel pretty good because as we've mentioned now, the results year to date are essentially approaching very close to breakeven. They've done very good performance for the last two quarters, and we think our decision to enter A&H is not a cyclical decision. Frankly, it's more of a secular decision about the balance of our book of business.
Our growth efforts in casualty make a lot of sense. It's still a very strong market. There are some opportunities, I think it makes sense to grow that casualty business. We entered Lloyd's earlier this year, as I mentioned in my prepared remarks, as you know from the analysis of the business, our international specialty book has been an extremely profitable book over the years. Although there are some pricing pressure there, it continues to be a very attractive book. The growth rate in certain lines of business might obviously move up and down based on the opportunities, but the access that Lloyd's gives us to more international markets and more opportunities to write in multiple jurisdictions, I think is a clear winner. All of these things make sense.
Ag, weather, and commodities, that's going to be an area where there's going to be more risk in the world going forward. Clearly there's going to be more demand for those products. All of these initiatives, I think, make sense to me. If you look at MedMal, which was our most recent one, clearly we believe MedMal has seen some pressure. I don't expect that we'll see huge growth in the next couple of years. Again, longer term, we think it's a very good addition to our overall portfolio, diversified portfolio of professional lines. Whereas the pace of growth will, of course, respond to the opportunities as we see them, we feel very good about the strategic rationale behind those expansion opportunities, and we will continue to invest in them.
That said, if it means that we have to slow down the growth because it's the right thing to do, we will not hesitate to do so. Jay, it's Joe. I'll just add a couple of comments to what Albert said here. First, on the new initiatives, if you compare the premium volume written in new initiatives in 2014 through nine months to where we were nine months a year ago, it's up about $80 million. We're getting quite a bit of growth actually coming from those new initiatives. Secondly, with respect to the expense ratio itself, it's at 15.9. I've basically said that there's about half a point in that expense ratio that relates to expense initiatives that we talked about after the second quarter call for things that we will be able to save significant amounts of money in the future.
We expect to continue with that in fourth quarter and 2015, That'll begin to show benefits in 2016 and 2017. Specifically, it's around IT sourcing. We have a major initiative underway in that area to basically allow us to save significant amounts of money going forward. Are we going to have an elevated expense ratio in the short term? Yes. Is that going to benefit us in the future? Yes. We're confident that we can get this expense ratio, all other things being equal, down into the 14% range or below by 2017.
Great. That's really helpful, Joe and Albert. Thank you.
Okay. No problem. Thanks.
Thank you. The next question comes from Vinay Misquith with Evercore.
Hi. Good morning. First is in the primary insurance operations, your accident year loss ratio ex-CATs really improved from the first half. Was curious what's driving that. Was it lower D&O, or also was it lower large losses?
Could you repeat that, please, Vinay? I'm not sure I got that.
Yeah. Sure. The accident year loss ratio ex-CATs for the third quarter in the primary insurance segment was about 60.6. First half of the year, it was roughly about 64, 65. I know the first half of the year had higher level of large losses and higher D&O. Just curious as to what the delta was between the first half of this year and the third quarter as to why it improved so significantly.
Let me give you just some insight into the accident year ex-CAT and weather loss ratio for the quarter itself. You're trying to get at what's changed in the quarter versus what it was year to date?
Yep.
Yes.
Earlier on in the year, we had property initial expected loss ratio increases. As you recall, we had some property losses. The actual level of those losses leveled off in the third quarter. We've decided to keep our initial expected loss ratios conservative, but that's one of the reasons. I think the second thing is mix of business, as Albert was referring to before. I think the third item it really is initial expected loss ratios on property and professional lines.
Yeah. In fact, one of the things that we indicated to you was that there would be a heavy influence of the corrective actions in the runoff of the US D&O book in the first half. Just to give you a sense of it, the professional lines added one and a half points to the first half loss ratio for insurance.
They didn't in the third quarter. We had told you that it was our expectation that the runoff of professional lines would start to have a visible impact on the loss ratio going forward, and that's happening as we speak. As you know, we still have a little bit of UPR to earn into the fourth, and then de minimis amounts will carry on into early 2015. More importantly than the runoff of the UPR is our team is doing incredibly good work at repositioning the portfolio, and in making sure that we've got the right balance and the right attachment points. That really is going well on plan. I can't help but speak a little bit about the fact that there is a lot of talk in the market today about healthcare D&O and some of those issues creating problems for a number of companies.
I feel compelled to remind you that that's exactly what we were discussing with you when we discussed the fourth quarter results in anticipating some of these trends and taking early action to try and reposition our portfolio as we were seeing these trends happening. I think that where we are in US D&O is where we want to be, given where we started.
Vinay, I'll just add to that on the professional line side, just to give you a sense as to improvement in the loss ratio. In the first quarter of the year, we were at 77.9%. In the second quarter, we were at 76.2% on a year-to-date basis, and in the third quarter, we were at 75.6% on a year-to-date basis. That'll give you an idea of the run rate improvement that we're seeing in overall professional lines. The overall improvement in CMS is actually even more dramatic than that. I'd rather not get into individual loss ratios by line of business, but that'll give you a sense that CMS is having a pretty good impact on the loss ratio improvement in insurance.
Great. That's helpful. The second question, just wanted to follow up on the 100 to 200 basis point margin improvement. I think last quarter you said that it could improve the accident year combined ex-CATs by about 100 to 200 basis points. Just wanted a clarification. Number one is that in 2015? And second is we've seen the expenses actually go up slightly third quarter, just wondering if you're still on track to deliver that by 2015 or is that more for 2016 target?
I think the one to two makes sense, and in fact, you're already starting to see the implications of that in the discussions that we've just given you on the loss ratio. Again, I think that there are some things on the expense side that we will absolutely see next year. There will also be continuing investments. I believe Joe was very disciplined in always saying that we actually expected an increase in our expense ratio in 2015 as we were investing through these items. As we're consolidating facilities, for example, you're seeing charges in our financials this year, but these are facilities expenses that we will not have next year. There will be a number of initiatives that we will see immediate impact in 2015.
Others, and certainly most visibly, the investments that we're making in IT, are likely going to be costing us more money in 2015. We will start to see those benefits in 2016 and 2017 and future years. In the aggregate, I expect the expense ratio will actually go up in 2015. That within individual initiatives, we do expect that some of the initiatives that were executed in 2014 will actually show us clear savings in 2015.
Okay. That's helpful. Thank you.
Thank you. The next question comes from Brian Meredith with UBS.
Hey, good morning. A couple of questions here for you. First off, I wonder if you could talk a little bit about some of the multi-year deals that you've done a couple of this year. I guess the question is why are we seeing the big increase in multi-year deals? Is that a function of the need to do that in order to secure renewals? Is it a function of you think that pricing is going to continue to get more competitive here going forward? I wonder if you could elaborate that a little bit.
Yeah. Well, let's first start with the basis that there has always been some amount of multi-year deals in the industry. A number of clients, for example, who take their cat program and they renew a third each year for three years. The intent for the client, of course, is to have more stability, both in supply and price going forward. We've always had those. We have a number of policies that have been two-year policies. It's not something which is absolutely new, but it's certainly something where we see significantly more demand. In our case, I would say that the vast bulk of what we call multi-year deals are actually two-year deals. I don't have the number at the tip of my tongue, but I would say that the number of three-year deals is de minimis.
What we're talking about here is accommodating a client's desire to lock in what they believe are good terms. Obviously, everybody knows that prices do respond to events. To the extent that they have an opportunity here to lock in good terms, they're happy to do so. In our case, it really depends on the kind of client and the line of business and the profitability that we're looking at. We tend to differentiate clients as opportunistic transactional clients and relationship clients. Certainly for relationship clients where it's our expectation that absent anything really unusual, we would expect to renew those clients in any case.
To the extent that we have appropriate protections in our contracts with regard to change in mix of business or change in the teams or things that would cause us to revisit our appetite for that book of business, if it's appropriately structured, reasonably priced with good relationship accounts, we will do so. On the other hand, for a book of business which we think is "marginal" or for terms that we've considered to be too aggressive or where we do not have adequate protections around the shift in the book of business, we will not do so. It's really being responsive. In many cases, in the reinsurance business, you do expect that you're going to renew it. If we have adequate protections, we will do so.
Thanks. That was helpful. I guess the second question. Last quarter, you gave us kind of a baseline to think of with respect to a combined ratio or actually your combined ratio ex cats and kind of the improvement there. I'm wondering if you could give us something similar from an ROE perspective. Is the baseline ROE here that you think you can improve upon the kind of 11% that we're seeing right now this year? Is it something lower than that since it's been a pretty light cat year this year?
I would be loath to provide projections, but fundamentally, if you're looking at anywhere between two, three, four points of combined ratio improvements to where we are, you're essentially looking at, with prudent capital management and a little bit better leverage, at somewhere in the 2 to 300 basis point improvement in the ROEs. Again, I hasten to say that we talk about these things independent of pricing. There are a number of other factors that will significantly impact our reported profitability. One being, of course, events. The second is whatever pricing environment we are at the time, and third being the availability of interest rates in the portfolio. Those are the factors.
What we believe is that the actions that we are taking to optimize the portfolio to increase operating leverage, and to control expenses should deliver somewhere between three and four points of improvements in combined ratio by the end of 2017. At current capital levels, that should be somewhere in the 2 to 300 basis points improvements in ROE, ceteris paribus.
Of that, just curious since it's going to be lower volatility business, how much of that 300-400 basis points, if any, is actually lower cat load, lower cat losses?
That's a very good point. On the one hand, we expect that this mix of business, as we've said, it's a higher combined ratio book of business, it's another extra point. We would hope to offset that extra point with lower overall cat losses. For the moment, we're assuming that's neutral. The increase in the mix is offset by lower average cat losses.
Great. Thank you.
Thank you. The next question comes from Josh Shanker with Deutsche Bank.
Yeah, thank you very much. Good morning. I had a few questions about AXIS Ventures. When you guys founded it back in November 2013, it was described as a collateralized vehicle, which generally to me means it's CAT. You said that you expanded the operation this year. Is it no longer a CAT vehicle or was it always more than CAT?
It was always intended to be more than CAT. It was more than CAT, it remains more than CAT.
If I look at it was capitalized with $50 million. From the way that the P&L reads that it received a $6 million loss from AXIS this quarter. If I say it that way, am I saying it correctly?
I believe the amount of capital we have in that is a little higher than $50 million.
Yeah.
The $6 million is the right number on the financials.
Yeah, Josh, there's multiple cells involved in AXIS Ventures. There's capital that comes in, and there's capital that's removed. There was initial capitalization from the first transaction, there are other transactions involved.
The transactions that led to the loss, though, I assume is one large transaction?
The loss by definition is tied to the agricultural business, which is what we refer to. The AXIS Ventures has, again, that piece of business has multiple transactions, most of which were in fact profitable. The crop one obviously was not this year.
Could AXIS have written the crop business that it wrote without ceding that risk to AXIS Ventures? Was the transaction that AXIS did to expand the crop part and parcel to having the reinsurance protection from AXIS Ventures?
Josh, I'm not sure that I would address it in that way. What I would say to you is that the crop business is business that we were writing in any case, then we shared it. This was not a transaction that we did to satisfy a specific demand from a capital provider. Somebody did not come to us and said, "Here's $X. Go find me that business." The crop business that we wrote was part of a diversified crop portfolio that we intended to write at the beginning of the year. One of the things that we absolutely believe is that over time, companies like AXIS will have a steady supply and a diversified supply of third-party capital.
As we think about it's really critical for us to have a very strong, very powerful front end with great people, great service, great brand, recruiting a great number of opportunities. That would be the gross book that we're talking about. At that point, it's really up to us as a company to determine how much of that gross risk that we've taken on board do we want to reinsure with traditional underwriters? Do we want to hedge in the capital markets? How much do we want to share with third-party capital or other forms of capital, and how much do we want to keep for our own account? All of those decisions are critical decisions in terms of optimizing the risk-adjusted returns for our shareholders.
In terms of the performance year-to-date for AXIS Ventures, do you think this in any way hurts your ability to find third-party investors who want to invest with you in the future?
It's an interesting question. One of the reasons that we've been reasonably slow in growing AXIS Ventures and third-party capital is specifically because we want to make sure that we choose partners who have a very good understanding of the risk that they are taking and a long-term commitment to taking those risks and to partnering with us going forward. Nobody should be in the insurance business if they don't expect occasional losses. Certainly the conversations that we have with our third-party capital providers demonstrate a very good understanding of the risks and an appetite to accept occasional losses.
Okay. It's perfectly satisfying. Thank you.
Thank you.
Thank you. The next question comes from Dan Farrell with Sterne Agee.
Hi, good morning.
Good morning, Dan.
Just a capital management question. Your buyback is outpacing income currently. I think in your prepared remarks, correct me if I'm wrong, you said you still think about capital returns sort of around earnings power. I'm wondering what that means for the near term, also when we think about your capital position, you're buying more reinsurance, you've lowered CAT aggregates pretty meaningfully, and you've diversified the book. Wouldn't that be having a benefit to your overall capital requirements, allowing you to do capital return in excess of earnings? Thanks.
Absolutely. You know, Dan, at the end of the day, you have to use as many levers as you can to optimize your risk-adjusted returns. We will absolutely change the amount of risk we take in, whether it's increasing or decreasing it. You've seen the changes both in the mix of business and in the geographic changes in the PMLs. We will increase or decrease the amount of reinsurance and now retro that we buy. In some cases, we will share some of that with third-party capital, all of which are tools that we need to use to make the best of the business in a transitioning market. You are absolutely correct that to the extent that we can cede business elsewhere or change the input of the risk that we take, we may need less capital.
All of those actions are things that we are doing today, which is what has made us comfortable to increase our stock repurchases in excess of our operating income. To do so even in the wind season, because we felt so comfortable that our risk management was such that we could afford to reduce our capital and still be in very strong shape. Again, difficult to make any directional predictions, but very much expect us to be active in using all of those levers to optimize our risk-adjusted returns.
Great. Thanks. Just a quick question on acquisition ratio. With the increased reinsurance purchase, would you think in the insurance segment you'd see some downward trend in that? How long does that take to flow through?
Yeah. Dan, it's a difficult one to answer. In general, I would say on our base commission rates, there is pressure both on the insurance side and on the reinsurance side. We've had some changes in ceded reinsurance strategy within the insurance segment. As you remember, two years ago, we were actually keeping more of the business we wrote. Now in certain circumstances, because frankly, of market conditions, we're ceding more and getting higher ceding commissions on that. In general, I would say the ceding commissions that we're receiving are helping keeping our acquisition costs relatively flat. I wouldn't see a big increase from where we are now.
Okay. Thank you very much.
Thank you. The next question comes from Meyer Shields with KBW.
Thanks. Good morning. I don't know if it's fair to talk about a run rate for reserve releases, we did see a slowdown in the insurance segment on a year-over-year basis, I was hoping you could talk to that.
Meyer, you're absolutely correct. It's totally inappropriate to talk about a run rate for reserve releases. We stand by our position that the reserves that we have today are the reserves that we consider prudent and adequate. To the extent that our reserves next quarter would identify specific areas where we believe we have more than we need, we would release it at that point in time. That said, our philosophy has always been, will continue to be, to reserve the current year prudently, to take the bad news early, to wait until further development of favorable news to release it. That philosophy generally does tend to promote consistent reserve releases. If you look at our reserve releases, certainly to date, a large amount of it really still relates to 2006, 2007, and prior.
Obviously, there is some for more recent years, but that would relate specifically to short-tail property lines, where within two years you know what there is. We continue to apply the policy of waiting for more maturity before reserve releases, and that gives us comfort with regards to our total reserve position.
Meyer, it's Joe. I'll just add on the insurance side, it looks a little low because it's a net of a couple of different lines of business. We actually had some substantial releases on the property side, approximately $20 million, and we did have a reason to increase some of our liability reserves from older accident years. Nothing major, just two claims we decided to strengthen a bit. It gave the impression in the third quarter that our insurance releases were a little bit lower than normal. Like Albert, I'm not going to get into predicting what our future reserve releases would look like. That's just more analysis of what's going on behind the scenes.
Okay. No, that's actually very helpful. Sort of bigger picture, I think, Albert, you mentioned in response to Brian's question that the higher core combined ratios of the less volatile business will offset some of the CAT provisions. Does that imply that you have to grow more dramatically than we've seen in 2014 to produce the ROE improvement?
I think that it's a common, certainly in some parts of our business, there is a growth requirement. We mentioned when we talked about our plan over the summer, there were four key points. One was improving the quality of the loss ratio, the second was profitable growth, and the third was expense ratio reduction, and the fourth was capital efficiency. I think with regard to our new initiatives, there is no doubt that our new initiatives currently have not all achieved their target volume. As Joe pointed out, we've got an excess of a half a billion dollars of new initiatives, and they've grown somewhere 17%-plus year to date. They're continuing to grow, and we continue to be confident in their ability to grow into the required scale to achieve their target numbers.
Again, I hasten to add that for those, we're generally quite satisfied with the technical ratios. It's really the ability of those businesses to grow into their fixed expenses. With regards to the rest of the portfolio, I'm not sure that we need to grow because we can always balance it through further management of the CAT book. I do expect that we should grow some more because I think it'll be the right thing to do, but the pace of growth, of course, will depend on the market.
Okay, great. Thank you very much.
Thank you. The next question comes from Charles Sebaski with BMO Capital Markets.
Good morning. Thank you.
Morning, Charles.
Morning. First question, I guess, Joe, on your commentary on the professional lines loss ratio improvement throughout this year. I think it's roughly about 230 basis points from the first quarter you mentioned to the third quarter. I'm wondering, what were the levers that help achieve that? It seems like a big move in a long-tail liability line in a short period.
Well, there's been some pretty dramatic changes in the portfolio itself in CMS. I can quote a lot of statistics here, but we're changing. Public D&O represents 39% of our book as compared to 53% a year ago. That's a pretty dramatic shift from where we were. There's some significant rate increases that are being achieved in that business on a year-to-date basis, it's 20%. Frankly, our retention ratios have shrunk pretty dramatically, resulting in the makeup of the book that I just mentioned. Claims development has been noticeably less in the current year than it was last year, just in terms of incurred losses. Through nine months in 2014, we've incurred $75 million worth of losses compared to $116 million a year ago.
There are three or four different points that are driving the improvement in CMS, and CMS is a decent-sized piece of our overall professional lines book. This is actually progressing exactly the way that we anticipated in terms of the profit improvement plan in CMS.
Okay.
Charles, one more thing on this one. Remember that when we identified the issues in the fourth quarter of last year, we immediately made some changes. What you're dealing with is the fact that the new business that we're writing this year, we feel very confident is being written at a lower loss ratio. The issue was running off the UPR. The amount of UPR that is running off at a higher loss ratio has declined in each of the last three quarters. As that UPR, which has been a very heavy drag on the loss ratio disappears, you see more of the quality of the rest of the business and more of the quality of the business that we're putting on in the current year. It's not so much about a significant change in the view of the book.
It's the fact that we had an isolated pocket of business which we are running off, and you're seeing the impact of the runoff.
Can I ask about the reinsurance business? If I look at the new slide disclosure you have, pulling out the AXIS Ventures and look at the net premium in the reinsurance business, it's $290 million. I think, Joe, you said there's $35 million of multi-year net premium that hit this quarter.
Yes.
Am I thinking about it right that the outside of that multi-year, an apples-to-apples basis versus last year is a $255 million net premium number for reinsurance versus three Q last year?
There's no question that the multi-year premiums are causing an increase, absent the multi-year premiums, there would be some pressure on the reinsurance growth. That makes perfect sense given current market conditions, which you're all familiar with. We are writing less of certain lines of business, we are not renewing certain contracts, that's putting some pressure. I think growth in the reinsurance area this year and certainly I would expect into next year really needs to take second place to profitability and balance of the book of business. You have my commitment. We are not going to write bad business just to show a pretty headline. Reinsurance may have opportunities to decline next year if we don't find the kind of business that we want.
Moving on, what we do with that premium then becomes very interesting because we could choose to keep it net, or we could choose to share some of that with third-party capital partners. We believe that it makes sense to start to establish, as we have in a reasonable and modest way, long-term partnerships with high-quality capital providers. We will share some of that so that on a net basis, the impact of the market on our top-line revenue generation, top-line premium generation, the third-party capital may in fact further accentuate the decline as we share some of that with third-party capital providers.
Again, we believe it makes perfect sense to do so both as a risk mitigation opportunity, but more importantly, to grow what we believe will be an attractive business model of writing business and then managing that risk, as I said earlier, through both internal retentions, reinsurance, hedging, and third-party capital partners.
Can you just tell us by chance what the crop book is marked at for this year currently?
At the end of the day, what you had in the third quarter this year was some catch up over some of the very modest profits that we had booked in the first half of this year, in addition to recognizing what we believe will be the ultimate impact. Now, as I caution you, we are all using the data that we have to make projections. We have a pretty good idea now that it's October 30th as the price that will be utilized with MPCI, but we don't yet have the details on yield. So we're making some estimates. But at the end of the day, we believe that the 2014 harvest will probably come in for us somewhere at 105 to 110 technical ratio.
Excellent. Thank you very much for the information.
Thank you.
Thank you. If there are no more questions at the present time, I would like to turn the call back over to management for any closing comments.
Thank you very much, operator. Thank you all for participating in our conference call. We look forward to speaking with you during the quarter and into next year. Thank you.
Thank you. The conference is now concluded. Thank you for attending today's presentation. You may now disconnect. Have a nice day.