Good day, and welcome to ACE Limited Fourth Quarter Year End 2013 Earnings Conference Call. Today's call is being recorded. At this time, all participants are in a listen-only mode. Following the presentation, there will be a question and answer session. If you would like to ask a question at that time, you may do so by pressing star one on your telephone keypad. Now for opening remarks and introductions, I would like to turn the call over to Helen Wilson, Investor Relations. Please go ahead.
Thank you, welcome to the ACE Limited December 31st, 2013 fourth quarter and year-end earnings conference call. Our report today will contain forward-looking statements. These include statements relating to company and investment performance, pricing and insurance market conditions, and potential acquisitions, including our recently announced expected acquisition in Thailand, all of which are subject to risks and uncertainties. Actual results may differ materially. Please refer to our most recent SEC filings as well as our earnings press release and financial supplement, which are available on our website for more information on factors that could affect these matters. This call is being webcast live, the webcast replay will be available for one month. All remarks made during the call are current at the time of the call and will not be updated to reflect subsequent material developments. Now I'd like to introduce our speakers.
First, we have Evan Greenberg, Chairman and Chief Executive Officer, followed by Philip Bancroft, our Chief Financial Officer. We'll take your questions. Also with us to assist with your questions are several members of our management team. Now it's my pleasure to turn the call over to Evan.
Good morning. ACE had an excellent fourth quarter that contributed to a record year. All divisions of the company made a positive contribution to our results that were highlighted by both strong premium revenue and underwriting income growth globally. The outstanding underwriting performance benefited from both good current accident year margins and margin improvement, as well as low catastrophe losses and strong positive reserve development. After-tax operating income for the quarter was $824 million, or $2.39 per share, up 67%. The P&C combined ratio in the quarter was 89.3. For the year, net operating income was $9.35 per share, or over $3.2 billion of operating earnings, up 23% from 2012, records for our company. Our P&C combined ratio for the year was 88%, resulting in $1.8 billion of underwriting income, which was up over 110%, simply outstanding.
ACE's strong current accident year underwriting has been at the heart of our great calendar year underwriting results. The current accident year combined ratio, excluding CATs, was 90% for the year, almost three points better than prior. The current accident year results reflect our premium revenue growth globally, a more favorable pricing environment in North America, continued margin improvement globally in many of our businesses as a result of portfolio mix efforts and product mix. Finally, our current accident year combined ratio benefits from excellent expense control, another hallmark of our company. To break it down a step further, our current accident year results, excluding CATs for global P&C, which excludes agriculture, was 89.4 for the year, and our combined ratio for ag was 95.
Ag ran 105 in the fourth quarter, which was worse than we projected due to significantly lower corn yields in Iowa, Missouri, and Southern Minnesota. Net investment income was quite strong in the quarter and a bit better than we anticipated. For the year, given our strong cash flow, net investment income of $2.1 billion was down less than 2%, a good result given the continued pressure from ultra-low interest rates. Phil will have more to say about the quarter and the year. Our earnings led to an excellent operating ROE of over 12% for both the quarter and the year. Per share book value grew five for the year, or 11 if you exclude the unrealized losses from our investment portfolio as interest rates rose. I look at adjusted book value growth because we are fundamentally a long-term buy and hold investor, so the mark is a timing question.
At nearly $29 billion at December 31, our book value has doubled in the last five years and tripled in the last 10. Turning to growth. P&C net premiums written in the quarter grew nearly 20% on a constant dollar basis, with growth coming from a majority percentage of product lines and all regions. As this earns its way in, it will be a source of future earnings. For the year, P&C net premiums increased about 8% in constant dollars or 11% excluding agriculture. Let me add a bit more insight and break down the P&C growth by area. For the year, our commercial and specialty businesses generated growth of 10% globally, with contributions from every region. U.S. retail and wholesale grew 11% and 13% respectively. Internationally, retail commercial P&C was up 10%.
Latin America led the way with commercial P&C net premium growth of over 20% in constant dollars, followed by solid single-digit growth in Asia, Europe, and Japan. Growth in our London-based D&O business, which saw more competition during the year, was modest at 2%. Net premiums for our agriculture business were down 12.5 for the year and were in line with our expectations. The decline was due primarily to an increase in the amount of crop reinsurance we purchased. For the year, our A&H business grew 5% globally in constant dollars, with international up 10%. Premiums for our combined insurance business were down 2%. For our core combined business, as I reported last quarter, agent manpower counts in North America are way up, and so are new sales. Those factors will translate into net premium growth at the combined.
Net premiums written for personal lines were up 40% in constant dollars in 2013 or 11.5% excluding the contribution from our acquisitions, particularly in Mexico. We have done a good job to date of integrating these companies, and they have been accretive to our earnings in their first year. We are making them more valuable by combining their impressive talent and local product and market expertise with our global underwriting and analytics capability and our distribution management capabilities and our broad product portfolio. Our personal lines business is poised to continue its substantial growth globally. Our international life insurance business, which is focused primarily on Asia and secondarily on Latin America, had a reasonably good year. Premium production grew 18.5% in constant dollars.
Our global reinsurance business had an excellent year with a combined ratio below 66% and underwriting income up over 45% due primarily to low catastrophe losses and good results from the core P&C book. Net premiums declined 3% as we maintained underwriting discipline in the face of flat to declining rates and increasing competition as the year progressed. Given the soft conditions in the reinsurance market, which is awash in capital, Global Re is not going to be the place where ACE expects to achieve near-term growth, as we are fully prepared to shed further volume as necessary in order to maintain an underwriting profit. We take great pride in the underwriting discipline of our reinsurance colleagues. We applaud them, and we reward them for it.
On the other side of the coin, ACE is a substantial buyer of reinsurance, one of the largest in the world, and our risk appetite has not changed. It remains steady. We pride ourselves on the long-term relationships and the money we have made for reinsurers over the years. We are a sought-after cedent. The softening reinsurance market benefits ACE in terms of pricing and improved terms, and that will positively impact our future financial results. Looking forward, we are off to a great start in January, where pricing was similar to the fourth quarter. Remembering, of course, that we are in a risk business, I expect we will have a good year in 2014 from a revenue growth perspective as we continue to take advantage of the many growth opportunities we see around the globe, including right here in the U.S.
I want to say a few words about the current pricing environment. Our commercial P&C business in the U.S. continued to benefit from a positive price environment with another quarter of rate on rate increases. Overall, North American pricing, both wholesale and retail, was up 3% in the quarter. General and specialty casualty related pricing strengthened in the quarter, up nearly 4.5% compared to an average 3.5% year to date. Large account risk management related casualty pricing was up 4.3% versus 4.8% for the year. Management and professional lines pricing was up about 3.5% in the quarter, the same as it has been for the year. The rate of increase for property related pricing continued to flatten in the quarter, up about 0.5% versus an average of 3.5% increase for the year.
In our U.S. retail business, new business writings grew 6.5% year-on-year, and our renewal retention rate, as measured by premium, was 100% in the quarter. On the North American wholesale side of our business, new business was up 22%. Internationally, the retail commercial P&C environment is competitive but remains stable. In total, rates were down 2% in the quarter versus 1% for the year. Rate decreases varied between 1% and 3%, depending on line of business and territory. The U.K., Latin America, and Asia are competitive, while the continent is reasonably stable. In fact, we secured rate increases on the continent for certain classes such as property and professional lines. Let me add a comment here. Strategy for ACE is not simply about achieving more rate and improving margin. It's about using underwriting and marketing to achieve growth where risk-adjusted underwriting margins are favorable.
On the other side of the coin, achieving better terms or shrinking where they are not. John Keogh and John Lupica can provide further color on market conditions and pricing trends. Earlier this month, shareholders approved a 24% increase in the common stock dividend. Raising the dividend this amount is consistent with our long-term commitment to a strong dividend, with a target payout ratio of approximately 30% of operating earnings. Our dividend has increased 80% since the beginning of 2012. As all of you know, we also announced in the quarter a plan to target the repurchase of up to $1.5 billion of our shares in 2014. The buybacks are not a change in strategy or our view of opportunity.
We have simply reached a point, all things being equal, where we have built up sufficient capital flexibility for both opportunity and risk that we can return additional capital surplus we generate in 2014 via share repurchase without impacting our growth capability. We will continue to capture organic growth where the returns are attractive, while pursuing acquisitions opportunistically to complement our growth strategies. To that point, as you all saw, we announced earlier this month plans for a small but strategically meaningful acquisition in Thailand. We plan to acquire a 60.9% stake of The Siam Commercial Samaggi Insurance PCL, a writer of auto, small commercial, and personal accident insurance. Samaggi is well established with excellent distribution, including its 12 branches and 1,000 independent agents, and a close commercial relationship with Siam Commercial Bank, one of the country's most venerable financial institutions.
The addition will complement our existing commercial P&C, A&H, and life businesses in that country. After we close on this transaction, we hope sometime in the second quarter, we plan a tender offer for the remaining 39.1%, for a total transaction cost of approximately $185 million. In summary, ACE's financial results for the quarter, and much more importantly, the full year, distinguished our company. We performed well, as measured by operating and net income, combined ratio, book value, and premium revenue growth, and of course, ROE. We finished the year more diversified in terms of product and geography, increasing our presence in areas such as the U.S., Asia, and Latin America, that present opportunity for future growth. Of course, our balance sheet is in excellent shape. We are, in fact, well-positioned for an excellent 2014 and beyond.
With that, I'll turn the call over to Phil, then we'll come back and take your questions.
Thank you, Evan. We had an excellent quarter and record year. Full-year net income was $3.8 billion, or $10.92 per share. Tangible book value per share grew 3% for the quarter and 4% for the year. If we exclude the impact of our acquisitions, tangible book value per share grew 6.7% for the year, whereas if we just exclude the unrealized losses from the investment portfolio, it grew 11.8%. Our cash and invested assets grew to $61.5 billion, and cash flow was $1.3 billion for the quarter and $4 billion for the year. Our balance sheet risk profile remains extremely strong.
Net realized and unrealized losses pre-tax were $21 million for the quarter, and principally comprised losses in our investment portfolio of $151 million, foreign exchange losses of $16 million, and gains in our VA reinsurance portfolio of $149 million, which included a $92 million realized gain from an out-of-period adjustment for an error in a third-party market valuation model. Investment income for the quarter was $557 million. This was better than anticipated, principally due to higher private equity and other distributions, and slower prepayments in our agency mortgage portfolio, which have a higher yield than current new money rates. Current new money rates are 3% if we invested in a similar distribution, and our current book yield is 3.8%. We estimate that the current quarterly investment income run rate is approximately $540 million, which is subject to variability in portfolio rates, private equity distributions, and foreign exchange.
Our net loss reserves were up $508 million or 2% for the year, adjusted for foreign exchange. The paid to incurred ratio was 96% for the year, or 85% on a normalized basis, which takes into account cat loss activity, prior period development, and crop loss activity. During the quarter, we strengthened reserves in our Brandywine runoff operation by $91 million pre-tax. The reserve increase, principally relating to asbestos, is driven primarily by settlements of a few accounts and incurred development in our assumed reinsurance book. Our portfolio of accounts remains reasonably stable, both with respect to frequency and severity. We have seen no real changes in the asbestos claims environment. The Brandywine strengthening was more than offset by $213 million of positive prior period development, principally from short tail lines, primarily from 2009 and subsequent accident years.
Cat losses were $31 million after tax in the quarter from worldwide weather events. A&H net premiums written were up 4.7% in constant dollars compared to last year's quarter. Operating income was down 7%.
Excluding non-recurring tax items, A&H operating income is up 3.8%. Our tax rate for the quarter of 9.2% was favorably impacted by the split of PPD and CATs between taxable and low tax jurisdictions and a one-time tax benefit in the quarter. We believe a reasonable current accident year run rate for tax is in a range of 13%-15%. We have repurchased approximately $160 million of our shares since the November announcement of our plan to repurchase up to $1.5 billion. I'll turn the call back to Helen.
Thank you. At this point, we'll be happy to take your questions.
If you would like to ask a question, you may signal by pressing star one on your telephone keypad. If you're using a speakerphone, please make sure your mute function is turned off to allow your signal to reach our equipment. Once again, that is star one to be placed into the queue. We'll take our first question from Amit Kumar with Macquarie Capital.
Thanks. Good morning, and congrats on another strong quarter. The first question is a follow-up on the discussion on risk-adjusted margins in your opening remarks. In terms of loss cost trends in North America Commercial Lines, are there any lines which might be witnessing meaningful more pressure, I guess, compared to maybe six months ago, in terms of loss cost trends?
I'm just thinking for a moment before answering that, but no. One word answer, no, not really.
I guess related to that would be any change in the competitive pressure?
Well, competitive pressure. It really varies by line of business. You can't generalize about that. Where margins improve and become more adequate, heads up underwriters compete more for that business. That's just natural. You see that. On the other side of the coin, when people are suffering, under competitors are suffering because rates are inadequate or loss costs are rising more than pricing and there's a deterioration, then usually you'll see more of a pullback in that class and more adjustment to pricing. It varies.
Got it. The only other question I have is, I guess a follow-up on your comment.
The one thing I tell you, it's hardly that the market is not competitive. The market is a competitive marketplace.
Yes.
That's all there is to it.
Yeah. I guess what I was trying to ask is, are you seeing some competitors being much more aggressive based on their capital position than what we might have seen in 2013?
No.
Okay. No, that's helpful. The other question was on the reinsurance purchase comment. Would it be fair to say that you might look to consolidate your U.S. and international CAT treaties when they renew at July 1?
Stay tuned.
Okay. I'll stop there and re-queue. Thanks.
Are you in the reinsurance broking business now?
No.
Okay.
Maybe I should be.
I don't know, buddy.
We'll take our next question from Mike Zaremski with Credit Suisse.
Hey, good morning. Thanks. I guess the first question on operating leverage, top line growth's been outpacing expense growth for a little while now. Should we expect that dynamic to continue into 2014?
That's going to vary by area, by mix of business, overall, that's thematically correct.
Okay. I guess next, if I look at, I guess this is related to Amit's a little bit. Top line growth seems to have accelerated a little bit. I think some of that's due to, on a net basis, due to lower ceding levels. I guess, how should we think about the top line growth rate, in 2014, maybe overlay that with potentially, should we expect the ceding levels to continue falling as well, maybe back to their historical average ceding levels? Thank you.
First of all, whatever is to be judged by about 2014, that'll be your business. We're not giving guidance, I'm not trying to work on your worksheet here. We have not changed our risk appetite, as I said, therefore, our net to gross remains pretty steady. It varies depending on mix of business. If certain lines of business that have a higher net retention to them grow faster, then the overall net to gross will be a higher net as a percentage. Within each cohort, each line of business, our risk appetite is steady.
Okay. Just a final follow-up to that question then is some of the recent acquisitions impacting 4Q potentially?
Impacting the fourth quarter.
Growth rate.
results?
Correct.
In terms of retention or overall?
Premiums written. Maybe I'm missing that dynamic in terms of the upward growth trajectory.
Of course they do. Mexico impacts our growth. As I said, our personal lines business grew 40%, but if you take out the impact of acquisition, it grew 11%. For our total international, Phil?
Total AOG in total, as reported, grew 15.1%. Excluding acquisitions, it grew 8.8%.
Acquisitions impacted the growth, of course, and they do impact the net in that case as well, the net to growth, because there's more personal lines, which is a higher retention line. That's one of the dynamics.
Thank you.
You're welcome.
We'll take our next question from Michael Nannizzi with Goldman Sachs.
Thanks. Just a couple questions. On the crop book, so I know you retained less this year versus last year, purchased a bit more reinsurance. Do you expect to repeat either this year's version of how much you retained or last year's? I think you had said at one point that you expect to kind of revert back to 2012 type levels. I'm just trying to understand, is this a business that you're going to either grow more and cede more or go back to your prior levels of sessions? Thanks.
Michael, I think our reinsurance purchases most likely in 2014 will be very similar to what they were in 2013. As far as third party private reinsurance is concerned, we purchased both quota share and XOL. I'd expect that to repeat. Our sessions with the government can vary on the margin, though that also depends on loss-making or not loss-making state crop per year.
Great, thanks. Then on the development, Phil, could you specify a little bit in terms of what lines broadly drove the favorable development this quarter?
Well, I did say it was principally short tail lines.
Short tail, yeah.
If you put the Brandywine aside, it was principally short tail lines for 2009 and subsequent. We'll give you the detail of the lines in the 10-K.
Got it. I'm just thinking, short tail, I would think, and I'm sure I'm not thinking about this right, but I would think that really recent accident short tail line, year short tail lines would be the ones that would be developing just because they probably would have already developed. The 2009 years probably would have already developed by now.
Michael, I think the thing you have to keep in mind is, first of all, the development comes from where we do our reserve studies in a quarter, and our reserve studies occur all year long. We don't study all reserves every quarter in actually a deep dive way. These are the results of the deep dive. More short tail is reviewed in the quarter than long tail, and that's why it's more short tail versus long tail related.
Got it.
Development, when you're thinking, well, you think most of it is more recent than 2009, et cetera. Depends where it's coming from. Wholesale business, for instance, where you're writing on a policy or basis, a year of account basis, that accounting and the development of that can take longer than, say, a primary retail book. If you're a prudent underwriter, there could be a different development pattern even for short tail, then it's not all created equal.
Got it. Then just one last one, maybe. You talked about the reinsurance markets. Obviously, there are a lot of players that write reinsurance and also insurance primarily through broker intermediate markets. Is there any possibility of the conditions that you're seeing manifest on the reinsurance side rolling into the insurance markets, or do you feel like for a host of reasons that that's not something that will manifest soon? Thank you.
Who knows? I can't speculate about that, of when or what. Thematically, look, of course, reinsurance becomes competitive, and it's almost like arms dealers. That feeds the primary side of the business. As reinsurers are hungry, that generally leads to a more competitive marketplace on the insurance side. If that occurs, we are fully prepared for that. I have absolute confidence in our ability to outperform in an environment like that. We're global, the whole world won't behave the same way. We got a lot of lines of business that are not subject to cycle. We're in growth areas of the world where, in fact, exposures are growing. We're in areas of commercial P&C that require distribution to reach customer bases and are in areas that are not subject to the same kind of cycle movement.
For a host of reasons, then when I look at our commercial business, our insights and portfolio management of how to distinguish among cohorts of risk, in both pricing and terms, ACE will outperform.
Great. Thank you.
When it happens, bring it on.
Got it. Thank you.
We'll take our next question from Jay Gelb with Barclays.
Thank you, good morning. With regard to the accident year combined ratio ex-CAT, Evan, you sound pretty constructive on the outlook for 2014, including the top line growth. I'm just thinking directionally, should we expect that important metric to improve again in 2014?
Jay, I'm not guiding that way. I'm not going to give direction that way. The only thing I can say, I'll just repeat one thing I did say. A lot of the discussion I listen to is so obsessed simply about margins, and I get that when it's speaking to companies that aren't growing. The only source of earnings stability is through margin improvement. I got that. ACE is a growth company, growing in many areas and with a lot of opportunity. Margins are good. Look at the underwriting margins. They are decent. Now, it's not all classes, and so where underwriting margins, we judge them to be a good risk-adjusted return, we view that as an opportunity, and it is our job to ferret out that opportunity for growth.
Where we see underwriting margins are not decent, it's to do what we always do, either achieve terms, including price, that will secure a reasonable risk-adjusted return or shrink that business. That's how we're planning.
Okay, switching gears on the share buyback authorization. Is that just for 2014, or should we consider this something we should anticipate in future years as well? When Phil mentioned the 30% target payout ratio for the dividend, it basically backs into around a 50% use of operating income for the buyback. I just want to see if I'm thinking about that the right way.
I won't comment on the 50%, but the share buyback is a 2014 only. When we get to the end of 2014, we will speak about capital management for 2015, and that is going to depend on our capital flexibility at the time, and combined with how we see the environment going forward. Right now, we have plenty of firepower and flexibility, and we didn't need to continue to increase that. It was plenty to do exactly to execute strategy exactly the way we have been. Anything surplus that we generate, we can afford in 2014 to return that. All things being equal. If we find a great growth opportunity that uses capital, that would be our preferred way to use it. The secondary option is when we can't put it to work, we will return to shareholders.
Just to clarify on that point, Evan. What you're saying is that the $1.5 billion authorization for this year, that's the decision based on the expected capital generation. You're also leaving the door open for that to continue. You're not saying that this is a one-time deal.
That's exactly correct.
All right. Just wanted to clarify. Thanks.
You're welcome.
We'll take our next question from Greg Locraft with Morgan Stanley.
Hi, good morning. Thanks, great quarter and great year.
Thank you.
I wanted to just pursue the last, what Jay was just talking about on the capital deployment side. I think that the way all of us are modeling ACE or many of us are modeling ACE, we're unable to model for M&A. Therefore, there's this future growth optionality in your company where we're not modeling it appropriately in the out years. What I feel like we should be doing is we actually should continue the buyback in perpetuity. What you've effectively done in the fourth quarter is you've said, "We have enough excess capital to do what we want to do." Again, all else being equal, in other words, static world, which we know won't be, the only way to model a company appropriately is to continue to take the excess and put it through buyback. Is my philosophy meshing with yours?
That still leaves you the ability to do M&A. If you do M&A, we pull in the buyback in whatever year.
Greg, we have to each live in our own hell. You have to do what you think, as you're going to model the company, and we have to do what we think. I can't answer that question for you of how you should imagine the future beyond that. The only thing I can tell you is buybacks are not our first choice. Our first choice is to grow book value through growing the company and deploying. If, in fact, we find the surplus, we use the surplus capital or a portion of the surplus capital, we will likely generate that back, retain that, an amount to come back to where we are.
If we find opportunities, which we're always on the hunt for, organically or through acquisition to deploy that capital at a rate of return favorable to shareholders, we will do that as opposed to a buyback. Yes, you can't see it. We can't project the unknowable. You're right, the world is not static, and it's dynamic, and it's just a matter of timing, generally.
Okay.
Got to be patient if you're not going to make a mistake.
Yeah. Great. It's just the change in philosophy was the news in the quarter. Again, you've now said, I feel like you've said to the world, "We have plenty, and we're going to give back the excess from here.
Right. To the extent we use the plenty, there you go.
Okay. Great. Last on capital deployment as well, how did you get the 30% as the right payout ratio for the dividend? Why not 20? Why not 40? How'd you set that level?
Well, we study it. We over-obsess around here. We studied what are payout ratios of companies, they vary between 30% and 70% on average, depending on whether you're a growth company or you're a value company, based on whether you're a balance sheet company or you're more of a cash flow company. Based on the study of that, what we arrived at that 30% was a good balance between a good payout ratio and dividend to shareholders, while at the same time we're in a risk business, flexibility so that we feel that that dividend rate is protected even in down years, if you have bad loss-making years because you want your dividend to be steady and not hurting our optionality for growth.
Okay, great. Congrats again on the year and the quarter.
Thank you very much.
We'll take our next question from Vinay Misquith with Evercore.
Hi, good morning, Evan. Congrats on good quarter. The first question is on the future margins, and I know you answered Jay a little while back. You guys did a good job last year, that's in 2013, of increasing margins quite significantly by lowering the expense ratio and through business mix. Should we expect some of those elements to also play out in 2014?
We continue to strive to improve the efficiency of the company. I'm not going to give you a point estimate, but what I'm going to tell you is that thematically, on one hand, we strive to improve and grow expenses at a rate slower than we grow revenue. On the other side, we continue to invest in the company. Finally, it depends on mix of business. We write businesses that will have a higher expense ratio and a lower loss ratio that have very favorable underwriting margins. We have a mix of those. Some have good margins, and they're a higher loss ratio, lower expense. As I said, the other way around. It's going to depend on how that comes out. I'm not going to thematically, though, give you the expense ratio is going to continue to drop in 2014 answer.
Sure, fair enough.
You're welcome.
A follow-up to growth. Your growth was very strong this last year. Now that the market's getting just a tad more competitive, especially in the U.S., should we expect the top-line growth to slow in 2014 versus 2013?
Vinay, we're not guiding revenue growth numbers for next year. It's not happening. The only thing I will say that I did say.
Right
ACE has outpaced the industry in growth rate both on a global basis and in the U.S. by itself. I expect that ACE in 2014 will continue to outpace the industry's growth rate.
Okay. Thank you very much.
You're welcome.
We'll take our next question from Josh Shanker with Deutsche Bank.
Yes, good morning. You've had two years in a row of unfortunate experience compared to history in the crop business. Can you help me think about normalized premium volumes for the second half of 2014? Not really looking for guidance, but of course, there's so many adjustments
In the last two years, I could use a little help there.
Well, no, not really. What I'll tell you is this. Premium for the year really is dependent an awful lot on what commodity prices are. Our exposures are pretty steady. They've grown a little bit. I don't expect dramatic growth, meaningful growth in exposure. What will affect premium growth is primarily or premium levels, primarily commodity prices. Right now, commodity prices, for when you would price insurance contracts at the moment, are lower than they were in 2013 when we priced. All things being equal, that would bring premiums down. I would not confuse that with underwriting income abilities. That'd be number 1.
Number two, what you look at in the second half of the year in particular, in the fourth quarter, is premium adjustments that have to do a lot with the loss or gain sharing with the government based on how each individual state and crop's loss experience comes out. That is very state specific, very crop specific. It's experience driven. There is no way I can speculate on how you should imagine that for the future, except to tell you the way I imagine it, is I would think about commodity prices for premium on one hand, and when I think about underwriting, I think about a long-term historic average because we don't use one or two years, though the most recent years go into the average, as we compute what we think would be next year's combined ratio.
On that basis, it's roughly in the same range as we imagined when we entered 2013. I think that's more than you asked me.
Yeah. The extent to which we saw a high CED in Q3 and a low CED in Q4 this past year, and the year before we saw a low CED in Q3 and a high CED in Q4.
You just got it backwards, that's okay.
You understand my point. Just trying to understand how that works.
You're just down to worksheet that we'll take offline. You can call Phil and he'll talk to you about that.
Okay. Thank you.
You're welcome.
We'll take our next question from Brian Meredith with UBS.
Yes, thanks. A couple questions here for you. The first one, I'm just curious, could you give us your thoughts on kind of the economic environment in Latin America, and what could that potentially impact do you think that could potentially have on your A&H business and personal accident insurance business down there?
Yeah. The theme of Latin America right now that I see is about the same as we had in 2013. Maybe a little better. It's very country dependent, country specific. What I mean by that is I expect Mexico's economic growth to actually improve in 2014 versus 2013. It'll be in that 3.4-3.5 range is what's projected. Whereas 2013 was much more tepid. Colombia's growth rate will continue reasonably well. I don't see a lot of change there. Chile and Peru will do reasonably well. The Andean and Mexico, I think reasonably stable. I don't see economic activity impacting our business versus 2013 better or worse, except maybe in Mexico where I expect it to be better. On the other side of the coin, Brazil is underperforming.
Yes, it's got a current account deficit as do a number of large emerging market countries. It has failed to implement reforms that would stimulate growth in the country. It is more protectionist. We experienced this throughout 2013. I expect that to continue in 2014. I don't see a lot of change at this moment, maybe on the margin to our growth rates in Brazil in 2014 versus 2013.
Great. Thanks. Then just one other just quick question on the agriculture business. Any thoughts on the impact of the Farm Bill?
Well, the Farm Bill, actually, remember something about agriculture insurance that I just want you to keep in mind. It doesn't rely on the Farm Bill for authorization. It's a separate permanent law. It didn't need to be reauthorized. However, what the Farm Bill did do is it eliminated direct subsidies to farmers. Roughly, I think it's about $5 billion. It actually puts more reliance on crop insurance as the centerpiece of government support for the agriculture industry.
Great.
They actually strengthened crop insurance offerings in areas in the bill.
That could be somewhat of an offset to the lower commodity prices?
No, I don't expect to see that. No.
Okay.
Listen, for all of you, the reason that we break out crop when we show you revenue growth from the balance of our business is, the balance of our business, you're using revenue growth as a proxy for exposure growth of the company and market share in areas around the world and its presence. Crop is different than all that. We have a steady market share. We have a steady exposure to the business, and it's commodity prices that fundamentally are the biggest driver of increase or decrease to revenue. By the way, is a head fake if you're using that to try to determine what the underwriting profit will be on the business. It's not. In many ways, not in all ways, but in many ways, premium revenue growth in crop is just a head fake. Growth or decrease.
Great. Thanks for the answer, Evan.
You're welcome.
We'll take our next question from Thomas Mitchell with Miller Tabak.
Thank you. A couple of things. The first is the area of manmade catastrophes, whether it's something like credit cards being hacked or, let's say Amazon starts using drones to make deliveries and they crash into gas terminals or something. In the sense of technology-driven, manmade catastrophes, is this an area that becomes a specialty for an underwriter and that the customer pool actually is either now paying for or seems likely to be paying for in another two years or so?
First of all, Tom, the way you couched it, you sound like a Luddite. Number one. Look, to answer your question directly, yes. The answer is yes. I don't know about your two-year timeframe, and in fact, people are buying today. Cyber risk insurance is growing. Society continues to evolve. Science, law, regulation, all drives and other factors, all drive exposure changes to society. Exposure growth in new areas exposes clients to potential loss. For insurance to remain relevant, you have to be able to offer protection in areas where exposure is growing. Good underwriters are constantly innovating. You can't do it in a mindless way, though. We have limitations to begin with our balance sheet. You can only take exposure to the extent of your balance sheet.
You can only take exposure to the extent you actually understand the risk that is creating the exposure. You can structure it and you can price it, and then you can transfer it. That's a process. For thoughtful underwriters, that's a process, and it evolves over time, just as these exposures do. Sure, we're looking at all of those, maybe with the exception of we're not looking at drone delivery at the moment. Standby, I think it's terrific. We'll be delivering our homeowners policies to high net worth customers that way in the future. Your drone will be there.
Thank you. The other question I have is that it seems like, it may be just the tone that the Asian life insurance business is adequate, it would seem that being a higher growth area of the world in terms of GDP, the possibilities that we should be seeing increasing populations of people who have more reason to be covered by life insurance. Is 15%-20% really as much as we should be looking for, or should it be closer to something like 25%?
Well, first of all, I'm not going to guide the future. What I'm going to tell you is it grew overall our international life business, which included Asia, grew at 18.5%. I characterize that as reasonably good growth. My colleagues know that to take off the qualifier reasonable, I obviously expected something a little different. The Asia business in that 18.5% grew at a faster rate.
Great. Thank you very much.
You're welcome.
We'll take our next question from Ian Gutterman with Bank of America.
Hi, thanks. I'll try to bang these out quick. First, Phil, on the investment income run rate of 540, that was up, I think, from about 525 last quarter. Just curious what drove the change. I guess I would've thought the buyback, if anything, would have brought it down a little bit.
It is new money, and we're seeing, as I said, our mortgages are persisting. The prepayments on the mortgages are extending the duration, and they have a higher yield than new money rates. In general, we've had a slight uptick in interest rates. Those three things together are making us believe 540 is the right run rate.
Got it. Then, I had some different questions on crop. Evan, I was a little surprised you said the reinsurance purchase would be similar to last year, just given your comments last quarter that the lower prices for corn means there's essentially less risk this year versus last year because they're starting at a lower point. I would've thought that would've opened up the opportunity to opportunistically cut back your quota share and keep more of that for yourself if you think there's less price risk in this year's crop.
First of all, we don't speculate. We don't use reinsurance to speculate. We make rational risk appetite decisions versus the terms we're offered for reinsurance. That's as far as I'm really going to go on that one. It's rational, and I wouldn't be surprised on a risk/reward basis with my answer.
Got it. Then, is winter wheat a meaningful portion of your crop book, and any concerns about the harsh weather?
No, it's not a meaningful portion. About the harsh weather, I think Brian Dowd will give you the most eloquent answer on that.
I know he will.
There's the word eloquent. I think it's too early to really make any view on how winter wheat will turn out. What we know is most of the crop got planted timely. It emerged and is now dormant. There's certainly areas where we'd like it to be a little moister than it is right now. You're at the stage where winter wheat is essentially dormant, and the next few months will determine what the ultimate yields look like. Most of the crop got planted in a timely fashion.
Got it. Great. I think my last one, since we're getting late, is, Evan, any thoughts on Turkey and just, or maybe just a quick refresher. I know when these things happen, people worry about political risk. Maybe a refresher on what exactly you do in political risk in places like Turkey, and I can't remember if Argentina is meaningful or not, why we shouldn't hopefully have to worry too much about that.
Look, I'm not worried in Turkey about confiscation or expropriation or nationalization of foreign businesses. That is hardly the history of Turkey. Turkey is a country of laws, of a market-based economy, of relative political stability. They have reasonably strong institutions. When it comes to currency exposure, which would be the other, that would be about where you can't exchange the currency, where in fact it is not available to be exchanged. If we have any exposure to currency inconvertibility, which is what they call the coverage, it always has long deductible waiting periods on it, six months, three months, a year. No, I do not have concerns when it comes to political risk. I'm always vigilant, I don't have concerns. Remember, we don't write general bond issues or any of that. That's not what we're insuring.
Perfect. Just wanted a reminder. Thank you.
You're welcome.
We'll take our next question from Meyer Shields with KBW.
Thanks. Two quick ones if I can. One, can you walk us through the negative expense ratio in North American agriculture?
It's due to profit and loss sharing with the government is in essence how it works. Phil could flesh out a talk for a moment about it. We can take you offline on a worksheet and give you a little more tutorial of how it works.
All I have is, to your point, it's just a true-up of the full year admin and profit commission cost for the results of the year.
It comes through the expense line when the government makes us whole. We don't make money on the operating expense. They don't even make us whole, but they pay a large portion of the OpEx, that comes through in a reimbursement to us. Other than that, we collect a pure rate just for losses. Then you got the true-up of profit and loss.
Okay. That's helpful. I'll follow up for, I guess, the worksheet issue. Second question. I don't want to overread into what you're saying, but if loss cost inflation remained basically stable.
Is the only reason that the favorable development was focused on short tail lines is simply because the reserve reviews for longer tail lines wasn't done in fourth Q?
Correct.
I'm sorry, I missed that.
I said correct.
Oh, okay. What is the timing for that? Is that something that you've disclosed?
We do them all during the year. We don't give a schedule of any of that. It depends on the division. North America does some of it throughout the year. More predominantly in the second and third quarter. They do some in the first, and then AOG has different timing depending on line of business, and Global Re has different timing depending on line of business.
I think an important thing to note is that we are consistent every year in what we do, in what quarter.
Yeah. Our studies, it's bandwidth of our actuaries and timing of data and all of that, and we have the same schedule every year.
Okay, fantastic. Thanks so much.
Welcome.
We'll go next to Jay Cohen with Bank of America Merrill Lynch.
Yeah, a couple questions, I guess, for Phil. The first is, Phil, you suggested there was some discrete tax benefit
I think he said that.
At the operating level.
Yes. We had about $15 million of one-time benefits. $10 of it was in the life division and the rest was in P&C.
Great. That's helpful. Secondly, if you could just describe the out-of-period adjustment on the life reinsurance business, what exactly that related to.
Yeah. In the fourth quarter, we found a mistake in the way a third-party market valuation model that we use to set up our liability, if you will, for the VA mark. It was just misusing the interest rate inputs that we put into the model. It caused a higher fair value liability than was necessary, and we took the adjustment in the fourth quarter.
Did that cause you to reflect on other valuation models that you use, or is this kind of a one-time thing?
Well, it is a one-time thing, although we have a program in place to evaluate both third party and internally developed models throughout the company.
Okay, thanks.
Jay, what's clear is any time we find something like that, then we also reflect on what are our controls in place to assess and look at mistakes that could have been made and see if we learn from that. Is there something we should know that would cause us to tighten our procedures, to adjust them, et cetera? We reflect that way on it.
Great. Thank you.
You're welcome.
We have time for just one more person to ask questions, please.
We'll take our final question from Charles Sebaski with BMO Capital Markets.
Thanks for getting me in. I just had a thought or question, Evan, about conceptually growth in emerging markets and probably more so in Mexico and Latin America. What do you think is more important for your growth potential? Would it be exposure growth with GDP or insurance penetration in these markets?
I would tell you that it is, in fact, both. That's how I actually think about exposure growth. GDP growth increases exposure because let's talk about what creates GDP growth. If it's business activity, that is more businesses growing, and it's more businesses as a cohort, and it is more business growth of the existing businesses. That increases exposure and that increases availability of insurance exposure, number one. Number two, economic activity increases wealth generally among a broad segment of the population. More poor emerge to the middle class, more middle class move up the ladder, contrary to some of the speaking that I listen to among politicians. That creates exposure growth. Automobiles in Mexico. They manufacture more autos, and they sell more autos. That's economic growth. Guess what? Who's buying those autos?
That's because the emerging middle class is growing, and they're buying a car. That increases more opportunity for insurance, more growth of business, more trade in goods and services, more marine, more casualty, more companies raising capital, more public markets, therefore more D&O. More people visiting doctors, more lawyers active because of more rule of law, because the more the economy that grows, the more people want certainty of property rights, and E&O grows. There you go. By the way, they've all got to house themselves, either for commercial activity or for residential means. Construction.
So would you think-
If you're a heads-up government, you're creating more infrastructure, less regulation to support all that, and you get real economic growth. Somebody tell that to Washington.
Outside where we might think about growth potential in a mature market as GDP being a metric, this couple, this GDP and then exposure. I mean, is it a two times GDP when you incorporate penetration?
Yeah. I don't know how you mathematically do that. It really varies by country. What is true is as economies grow and they emerge and move up the scale, insurance penetration increases. You get both.
Excellent. I appreciate the answers.
You're welcome.
Thank you for your time and attention this morning. We look forward to speaking with you again at the end of next quarter. Thank you and good day.
That does conclude today's conference. We appreciate your participation. You may now disconnect.