Good day, and welcome to the ACE Limited second quarter 2012 earnings conference call. Today's call is being recorded. If you'd like to ask a question today, please signal by pressing the star key followed by the digit 1 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, to ask questions, please press star one. For opening remarks and introductions, I would like to turn the call over to Ms. Helen Wilson, Investor Relations. Please go ahead, ma'am.
Thank you, and welcome to the ACE Limited June 30th, 2012 second quarter earnings conference call. Our report today will contain forward-looking statements. These include statements relating to company performance, guidance, premium growth, ACE's business mix and acquisitions, impact of catastrophes and droughts, and pricing and insurance market conditions, 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. A 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. I'd like to introduce our speakers.
First, we have Evan Greenberg, Chairman and Chief Executive Officer, followed by Phil 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. It's my pleasure to turn the call over to Evan.
Good morning. ACE had a very good second quarter, marked by excellent operating earnings, strong broad-based premium revenue growth, and an improving P&C pricing environment in a number of areas of the world. Book value growth was up modestly in the quarter as we were impacted by the Euro debt crisis and the consequent flight to safety, which affected foreign exchange, interest rates, and equity markets. After-tax operating income for the quarter was $743 million, or $2.17 per share. Our operating ROE was over 12.5%. For the first months, we have produced almost a billion and a half in operating income and an ROE, again, of 12.5%. All divisions of the company made a positive contribution to the quarter's results. Our underwriting results this quarter were again outstanding, as illustrated by a P&C combined ratio of 88.7%.
The strong calendar year results benefited from both favorable current accident year experience and positive prior period reserve development. The current accident year results were excellent, both with and without the impact of cat losses, which were relatively light this quarter at $55 million pre-tax. ACE's underwriting performance has been consistently strong all year, with over $890 million in underwriting income and a combined ratio of about 89% for the first six months. Investment income held up pretty well in the quarter and was down only modestly despite the historic low interest rate environment. The strong operating fundamentals contributed to book value growth of 1.3% in the quarter that was impacted by mark-to-market losses and for financial market and foreign exchange movements. Book value was up almost 6% year to date.
Phil will have more to say about the market's impact on our investment portfolio, the VA mark, and foreign exchange. We announced a small but important acquisition last month. Asuransi Jaya Proteksi, one of Indonesia's top general insurers and a leader in personal lines. The company, which has an extensive branch network and distribution system, will complement our existing business and diversify our presence in Indonesia with a well-established personal lines franchise. The transaction is expected to close later this year. ACE's total company net premiums in the quarter grew 4.5%, or 6.5% adjusting for the impact of foreign exchange. Our growth in the quarter came primarily from three regions of the world, North America, Asia, and Latin America. North America grew over 7% in the quarter, or approximately 10% excluding crop insurance. We had excellent growth in commercial P&C, both retail and wholesale, as well as personal lines.
In Asia and Latin America, we were up 16% and 23% respectively, with strong contributions from P&C, A&H, and personal lines, which all grew at double-digit rates in original currency. Growth in Europe and the U.K., on the other hand, was flat due to both market and economic conditions. In North America, some of the product lines where we saw our best growth were in primary risk management business, which was up 9%, retail, general and specialty casualty lines of business and aggregate, which were up 11%, and property, which was up 27%. Our U.S. E&S wholesale business was up 24%, led by property, which was up 37%. Our high net worth personal lines business in the U.S. was up 15 points. In our international business, property was up double digit in Latin America and Asia, as was marine, while energy-related classes in aggregate were up double digit globally.
A&H growth globally picked up in the quarter as expected, and this trend should continue for the balance of the year. A&H premiums, excluding Combined, were up about 9% globally in constant dollars, led by Asia, with growth of 17%, and Latin America, with growth of 15%. Combined Insurance's premiums were down about 4.5%, which was better than what we planned. Growth at Combined is beginning to trend upward and should be neutral by year-end or first quarter next year with growth from there. The underlying fundamentals, Europe aside, are definitely improving. Our global Re business was up over 9% in the quarter, led by Bermuda, which was up 18%. We benefited from continued cat price increases on Japanese renewals at 4/1, and also from price increases on U.S. wind business. Crop insurance revenue was down 1% in the quarter, in line with our expectations.
Crop premiums, as I explained on our last call, are impacted by commodity prices. There is much discussion about the drought conditions in the U.S. In some states, quite severe and with a serious impact on crops. Based on conditions as they stand now, and given our portfolio mix by state and crop, we will adjust our crop loss ratio for the year up in the range of five points during the third quarter, bringing our crop-related business combined ratio to between 93% and 94%. This year-to-date loss ratio change is equal to about $68 million after tax. This is our best estimate at this time. We continue to closely monitor crop conditions for changes that would lead us to alter our view.
If the current drought conditions worsen and continue till harvest, our modeled worst-case loss, based on what we know, would be an additional circa $200 million after tax. We are not predicting this outcome. We are simply letting you know the outer bounds of reasonable worst case. To put the five-point loss ratio adjustment we are now taking in perspective, the $68 million is less than the difference between our actual nat cat losses and our cat load for the first six months of this year, a difference that has benefited our earnings by $75 million. At this moment, we remain within our year-to-date current accident year projection. While crop is not part of our cat load, these drought conditions are another form of cat. When one area base is potentially worse, another can be better, showing the benefit of our diversification, balance of business, and risk management.
Returning to the quarter, I want to make a few comments about pricing and the market environment to put our revenue growth numbers in perspective. The positive U.S. pricing trend we have been discussing the last two or three quarters continued to improve again in the second quarter, with rates further increasing, albeit gradually. Prices in the second quarter were better than in the first. The rate increases were again more broad-based than in the first quarter, which was better than last year's fourth. This included many casualty lines, with the professional lines, for example, turning positive, while property rates held up quite well and equal to the level of pricing we saw in the first quarter. For the first time, pricing in our international operations in aggregate turned positive, up 3%, led by cat-exposed property, U.K. casualty, and across-the-board slowing of rate decreases in other classes.
Even professional lines internationally in aggregate turned positive and showed a 1% rate increase. Let me break this down a bit further, beginning with North America. Overall for the quarter, pricing in North America was up 4.7%, and we achieved better pricing on our new business when compared to our renewal book. The average rate increase for our retail business went from 2.6% in the first quarter to 4.1% in the second quarter. Similarly, in our wholesale business, the average rate increase went from 6.6% in the first quarter to 8.4% in the second. Remember, in reporting rate increases in ACE, we separate out exposure growth, which was up 3.1% in the quarter. The U.S. retail and wholesale property book led our rate increases with rates up 14% and 10% respectively. Our U.S. retail casualty book achieved positive 5% rates, and this excludes risk transfer workers' comp.
Risk management business pricing was up 3%, and management liability, E&O pricing, was up 4%. Finally, our E&S portfolio pricing was up 8.5% overall. We had positive rates in all E&S classes. We are achieving this pricing in a marginally more disciplined marketplace. Our new business writings in North America grew 30% year-over-year, while the renewal retention ratio was measured by premium in U.S. retail was 97%, and on a policy count basis, it was 84%. John Keogh and John Lupica are with me and can provide further color on market conditions and pricing trends globally. In summary, we had a very good second quarter and posted strong first half results. We are optimistic about our growth prospects for the balance of the year. P&C pricing globally has turned more favorable, and we are well-positioned to take advantage in many places around the world.
Although we face the uncertainty from deteriorating economic and geopolitical conditions impacted by the Euro debt crisis and U.S. fiscal cliff, our earnings prospects for the balance of the year look good, with the notable exception of crop insurance. With that, I'll turn the call over to Phil, then we'll be back to take your questions.
Thank you, Evan. We ended the first half with a very strong balance sheet and capital position. For the quarter, cash and invested assets grew by almost 1.4% to $58.3 billion. Operating cash flow was strong at $811 million. Tangible book value per share grew 1.7% in the quarter and is up about 6.5% for the year. Net realized on unrealized losses were $138 million pre-tax, including a $266 million gain from the investment portfolio and a $397 million loss from our variable annuity reinsurance portfolio. The gain from the investment portfolio resulted primarily from declining yields on investment-grade bonds, while the VA loss resulted primarily from decreases in worldwide equity values and a decrease in long-term interest rates. Year-to-date, the net loss from our VA reinsurance book was about $120 million. Our investment portfolio is in very good shape.
We have no direct exposure to sovereign debt of distressed European countries. Our exposure to Eurozone financial institutions totals $1.1 billion, or less than 2% of the portfolio, and is concentrated in Northern Europe. The overall credit quality of our Eurozone financial institution securities is AA, with over $550 million rated AAA. Investment income was $537 million for the quarter and was in line with our expectation. Our current book yield is 3.9%. Current new money rates are 2.8% if we invest it in a similar distribution to our existing portfolio. We estimate the current quarterly investment income run rate will be approximately $530 million on average, with some marginal variability up or down. Foreign exchange had a negative impact in the quarter, reducing net income by $24 million and book value by about $100 million.
Our net loss reserves were up $66 million in the quarter after adjusting for foreign exchange. During the quarter, we had positive prior period development of about $100 million after tax, primarily from short tail lines. Cat losses after tax were $40 million for the quarter. The current accident year P&C combined ratio, excluding cat losses, is 2.7 percentage points lower than last year's quarter. This is due primarily to our successful efforts to shift our book of business through portfolio management to our higher margin products, our ability to achieve rate and growth in our short tail classes, and fewer large losses in the quarter in property and energy this year versus last year. Our press release issued last night included our updated guidance for 2012. Our range is now $7.20 to $7.60 in after-tax operating income per share for the year.
First, the update reflects the positive prior period reserve development and lower than planned cat losses in the first half of $0.74. Second, the update includes a reduction of $0.19 to reflect a projected third quarter increase in our year-to-date crop insurance loss ratio. Finally, the guidance includes estimated cat losses of $270 million after tax for the second half of the year. As usual, our guidance for the balance of the year is for the current accident year only. With that, I'll turn the call back over to Helen.
Thank you, Phil. At this point, we'll be happy to take your questions.
It's off.
We'll take our first question from Amit Kumar from Macquarie.
Macquarie Capital. Thanks, good morning. Thanks for the color on the range of, I guess, losses for the crop book. My first question relates, what would be helpful is if we could get the distribution of crop hail versus MPCI in your crop book, maybe also talk about group 1 versus group 2 and 3 states.
Yeah, we're not doing that. We have given you what you need to know as an investor, our projection, where we do the projections, and if there is any material change to the estimate as we put out there, we will notify the Street and all investors in a timely manner.
Okay. How about this? Can you talk about the impact of the stop loss program in your crop book? I presume when you mentioned the 93%, 94% numbers, those do not factor in the stop loss, but probably the $200 million which you gave us factors in stop loss. Is that a fair assumption?
It factors in any of our estimates, factor in our reinsurance protections, both the risk-sharing we do with the federal government and any private sector reinsurance that we place.
Okay. How about this final question? There is this debate that this could be similar to 1988. Maybe just comment on what we're seeing in 2012 versus what we saw in 1988. I guess the program was a lot different at that time, but maybe just give us some color as to where you think this might be versus what we've seen in the past.
You are correct. These are the worst drought conditions that we have seen and that has been experienced in the farming community since 1988. It is broad-based, though it is very much concentrated in the Midwest states. In 1988, crop insurance was much less of a factor in the overall financial plumbing of the agriculture industry. It's far more widespread and taken up as a valuable protection and as a centerpiece for the support of the agriculture industry today than it was in 1988. These are the worst drought conditions we have seen since 1988. That is true.
I guess just related to that, there is this debate that I guess smaller companies might be up for sale down the road, just based on what's happening. Would ACE be interested in sort of that, or you feel that the current position is good enough, you don't need to acquire any more companies going forward, especially as it relates to the crop program?
Thank you for your questions. I think we can't dominate the call. There are many others in the queue who want to ask a question. We'll move on now. Thank you.
We'll take our next question from Matthew Heimermann from JPMorgan.
Hi. Good morning. Couple questions. First was just with respect to the A&H business and Combined in particular, I guess, can you just remind us what kind of gives you conviction that we're going to bottom out and then spring to neutral next year? I think the international side is a lot easier to get your arms around from an external perspective.
You're talking about Combined specifically, Matt?
Yes.
Yeah. It's what we see in the real fundamentals. Remember, that's an agency distribution channel. What we see in both growth in number of agents, productivity per agent, retention of business, of renewal retention of business, and the trends in that have turned positive or neutral in a number of territories. Canada, Australia, New Zealand, U.S., where the core of the business is. It's those fundamentals that really is what I and the management team measure on a monthly basis and a quarterly basis. We see sustained what we can now have confidence is trend in that. I think management is doing a really good job. While there's no guarantees around it's what gives us the confidence that it's on the upswing that way.
Okay.
Remember, you have to see it that way first because it's $150-$300 a policy.
Yeah. Okay. That's helpful. I guess another question would be just with respect to the rate you're pushing. In the past, you've kind of talked about a need for a lot more rate and kind of small gains would have to sustain themselves to kind of make this real material over time. I guess, how comfortable are you with your ability to kind of keep pushing rate and kind of finding these incremental opportunities as we kind of seem to be hitting a point where rates, at least at some companies, are starting to plateau out?
Yeah. You'll be able to ask my colleagues who would be prepared to give you more color around this. Here's what I'd say about what we see at the moment about pricing. Property pricing is reasonably robust, particularly if it has any cat exposure around it. While the rate of increase has obviously flattened out, and is decelerating, it's still positive rate on what is reasonably robust on pricing. As I say, particularly if it has cat around it. When you get to casualty lines. The price increases are more broad-based, and while they're far more muted, we are seeing that they're sustained. The rate of increase is not declining. If anything, it's accelerated a bit, and it is more broad-based now. That's obviously ameliorating, and it varies by line of business. If it exceeds trend in any class, then you're actually gaining on an accident year.
If the rate of increase is equal to trend, you're not deteriorating any further. If it's below trend, it's ameliorating the decline. In any event, any rate is good rate, and it is more broad-based than it was. Our risk selection capabilities have only improved, and we're getting better risk-reflected pricing because we're more insightful on our portfolio than we were even one year ago or two years ago.
Okay. That last point, is that fair to assume that for separating the good versus the bad, maybe this time around, that'll be the differentiator, is just how intelligent the underwriting is in terms of risk selection rather than your ability to just kind of pump rate through an entire portfolio?
I think that is so axiomatic about the insurance business, is that your ability to select better is what differentiates you in the marketplace, period. That's it. That's the guts of the business. That's underwriting.
All right. Thanks much, Evan.
You're welcome.
Let's take our next question from Michael Nannizzi, Goldman Sachs.
Thanks. Just one quick follow-up on crop. I'm just trying to put my head around this. If this is a worst case here or effectively a cat year, it sounded like from your math, it would be about a 10 point, like 110 or maybe 115 point combined ratio. Just trying to understand the risk management part of that and how big of a role reinsurance has to play in that sort of risk return. Just one follow-up. Thanks.
Yeah, sure. Look, risk management is at every level of the business when you think about it. First it's in how good's your data and how insightful are you in selecting one farm versus another farm, and understanding that. How much concentration you take by county, one versus another. How much concentration you take within a state, and how you balance your portfolio. Then understanding and having the data as we have both the computer power, the software programs, and years and years of data to be able to do scenario analysis. While none of it's perfect because the past is hardly the reflection of the future, it makes you more insightful. Then your ability to do portfolio management because this is a government-private sector risk-sharing. Then from there, what do you do? How insightful are you to understand your concentrations?
Further, if you choose to protect your own retentions with stop loss, or any other forms of reinsurance protection, which we do.
Do you expect the reinsurance will get more expensive then? It sounds like the reinsurers will be absorbing some of this loss. Do you expect that the cost for protection next year will be more expensive given this year's loss experience?
I can't speculate on that. Remember, crop is like a cat business too, and it's long term. The pricing reflects long-term experience, not just a moment-to-moment change. I really can't speculate on that. I don't know.
Great. Thanks. If I could, one quick one for Phil. Alternative investment income, so I think Huatai Life is a big part of the other investment income, but that piece is now about a third of investment income. Just trying to get an understanding of what drives that, it seems like about a 20+% return. Is it mostly the private investment there, and how should we think about that as it becomes a bigger part of the overall pie? Thanks.
Huatai is actually a part of other income.
Not other investment income, right? Other investment income is predominantly private equity and hedge funds.
Okay.
They contributed about $10 million of income to the quarter.
Oh, Huatai Life did?
No. Huatai Life is not a part of investment income. It's a part of other income, which is down below the line. It's a partially owned subsidiary, so we don't include that in our investment income.
Okay. Can you help me understand then the contributions of fixed income was about 2.8% yield from the supplement. That seemed like it was about $350 million. The total investment income was low five. Just trying to understand what is the rest of that piece and is that a yield? How should we think about that as it becomes a bigger part of the pie?
Okay. I'll tell you what. Mike, can we take this offline?
Sure.
I'll take you off through it.
I appreciate it. Thanks, Phil.
Hey, Mike. I want to give you one piece of information on crop that I think rather than just the general that I didn't give you specifically. Our stop loss protection attaches at about 104% combined ratio, and it runs up to about 154% combined ratio.
Got it. That's very helpful. Thank you, Evan.
You're welcome.
We'll take our next question from Greg Locraft from Morgan Stanley.
Hi, good morning. Just wanted to actually pursue a question I've been getting from investors. With investment yields where they're at, with your excess capital being where it's at, a drag of, say, 150+ on the ROE, then now we're living through the worst crop loss probably in the history of the industry. These results are amazing. Double-digit ROE. The guidance is strong. I guess what is allowing ACE to outperform the peers, given the headwinds, especially usually when a company takes a loss like this, the numbers do fall versus peers. You're laying out top quintile results even with this loss.
Greg, I'm going to try to answer. I am going to answer that for you, I'm going to say this. I think it is right in front of you, and it's right in front of everyone. It shows itself right in the numbers in a reasonably transparent way. That is, you see our geographic spread and where we are growing. We're growing where we know we can make an underwriting profit. There are areas of the world that are doing better economically than other areas of the world, and the needs for insurance are growing. Secondly, you look at our product breadth. Commercial P&C is now about 60%. The U.S. has become a growth engine for us in the last two quarters, along with Asia and Latin America.
You see an improving pricing environment, ACE is taking advantage of that because we did trade market share for underwriting in the past, we engaged in better portfolio management and shed business where we couldn't make a reasonable return, i.e., E&S casualty, i.e., risk transfer workers' comp, where we said, "We can't make the money. We'll get out of those things, we will focus on other areas." We're a specialty underwriter, where an underwriter makes a difference. Our broad spread of casualty products in the U.S. and globally, our growth in commercial P&C in Latin America and in Asia, our ability to write a profitable book in the U.K. because we focus on casualty and energy and construction and property where we can make an underwriting profit.
You complement that with our A&H book, which has been built brick by brick in those economies of the world where we see that rising middle class and that ballast and balance it brings to our overall business. Crop insurance is a great business. Over any period of time, it has been very good, and it's because we've got a great, insightful franchise in that business, but it's a cat business. Right now, at this point, while the earnings are under more pressure, they're still projected to be reasonable. The risk/reward balance within that, we think between public sector sharing and private sector protection, we've got the risk/reward balance of what we could lose in a bad year versus what we could earn. Our management of risk concentration, we focus a lot on it because this is fundamentally an underwriting company.
That's what we do. From there, we've been saying it, we're planting the seeds today. What you see as results are the things we've been working on the last seven years. The things we've been planting the seeds for in the last two or three years, they'll begin to show in years to come. We're long-term builders. That's what you can tell your investors. Thank you.
Okay. That's great. Thank you very much, Evan. Nice quarter.
You're welcome.
We'll take our next question from Michael Zaremski from Credit Suisse.
Thanks. Evan, in regards to the updated guidance. I know you can't see my model, but if I strip out reserve releases-
I don't want to see your model.
Okay.
I've seen too many models.
If I strip out reserve releases, the below-plan cat losses and the crop guidance, the guidance, I guess, appears to imply no margin improvement or maybe even some deterioration, whereas there was clearly considerable margin improvement this quarter and pricing momentum has continued. Does that imply there were some one-time items positively impacted this quarter?
I don't think so. What I would say is that our guidance is almost the same as where we started the year. When we started the year, we had an anticipation that we would be earning these results. These really reflect what we have in our base plan. The other thing we did, obviously, is reduce the guidance for the crop, the $0.19 of crop. Remember something, if we have pricing better than we assumed in our plans, it's got to earn its way through.
Okay.
That takes time. These are pretty good current accident year projections for the balance of the year.
I agree. Phil, you said reserve releases primarily stem from short tail lines.
Yes.
I think that differs from previous quarter trends. Should we read anything into that? Can you provide color on the reserve releases this quarter?
No, not at all. It's a seasonal thing because we have reserve studies all throughout the year. In this period, the reserve studies were basically on the shorter tail lines.
Okay. Lastly, this does relate to crop. Did crop impact this quarter's results?
I'm sorry?
Did crop impact this quarter's results in terms of?
No, it did not. We don't believe it's a second quarter event. The issues with crop really emerged in July with the weather that we had in July. It would be something that's going to affect the third and fourth quarters.
Got it. Thank you very much.
We'll take our next question from Vinay Misquith from Evercore Partners.
Hi, good morning. The first question is on growth, and I think you talked about it a little bit earlier in the call and last quarter, too. Looking at new business up 30%, and I think retentions remain pretty reasonable. Just wondering how ACE is managing to outperform peers who are having weak retentions and weak new business.
I really can't opine on peers. That's not my job. Whatever their results are, their results, they have different mixes of business. They have different distribution. They have different geographic concentrations or kinds of customer concentration. I or my colleagues can answer questions specifically about ACE that we think, obviously to us, the results we see are logical and make all the sense in the world to us. One thing I told you last quarter that I would keep in mind, our new business writings had dropped off substantially year by year by year, as they should. It's rational in a soft market. The kind of increase, it's 30%, but it's on a relatively small base of new business. I said that last quarter when we had robust growth, and I tell you that again this quarter.
Sure, that's fair enough. As you look at growth in the future, do you think that the slowdown in the economy worldwide will have a negative impact on growth and also your ability to raise pricing?
ACE doesn't exist in a bubble, and I think the global uncertainties that really emanate from Europe and from the United States, and that are political, that are impacting the economic fundamentals, create both headwind and a great deal of uncertainty and inability to predict. I talk to a lot of CEOs in a lot of different industries, and what is very clear, their level of confidence in the future is, and their ability to predict with any confidence, is at a relative low point right now, and for the obvious reasons. If we don't get our leadership and political act together, both in the U.S. and in Europe, this has an impact on economic growth, and it will. Insurance, we're a reflection of activities of society at large, beginning with economic activity.
Oh, sure. Fair enough. One last question, if I may, just on margins. You've had strong price increases in the U.S., maybe flattish outside the U.S., but you've grown more on property lines. Do you expect margins maybe to slightly improve next year versus this year?
Oh, I'm not predicting at this moment.
All right.
I get the mixed question. I don't want to give you an off-the-cuff answer and don't have a thoughtful answer for you right off the top of my head.
Okay, thank you.
You're welcome.
We'll take our next question from Larry Greenberg from Langen McAlenney.
Good morning. Evan, I'm just wondering if you'd be willing to elaborate on really what has to happen in crop for conditions to worsen. I guess I'm just wondering, as we sit here today, does your current assumption incorporate the highest probability outcome from any visibility that we might have?
It does. Yes. It does incorporate the highest probability outcome. Both our current projection as we have it and what I told you as what we can model as a worst case is the highest probability outcome to us. Yes. Look, what I gave you is the, and I said it clearly, but I'm going to say it again, the $0.19 that we just took, that we're going to take in the third quarter as a charge, is based on the conditions today as we see them. We don't expect that it's worse than that. If we thought it was worse than that, then it wouldn't be $0.19. It would be a different number. What we do know is there's still that question out there. Could it be worse? No one can predict the weather.
What we said was, if these drought conditions continued, and you got this heat, and it continues right up to harvest time, what is that likely worst case outcome? That's why we put that number out there. It can be anywhere in between. Right now, we're at $0.19, and that's the honest representation of it.
Great. Great. That's helpful. The volumes in agriculture about flat year-to-date. You had said that you expected it to be down $250 for the year. Is that still the case that you would expect crop agriculture premiums to be down that much?
Expect it to be down closer to Brian Dowd?
175.
$175 million. We'll see. It'll be less than the $250, and you'll see that. That'll show itself.
Great. Thank you very much.
You're welcome.
We'll take our next question from Jay Cohen from Bank of America Merrill Lynch.
Yes, thanks. Topic of the day, crop insurance. Just a couple questions.
[You wear your own rules].
Phil, you had mentioned that the effect of the drought would be in the second half of third. You said third and fourth quarter. I'm assuming the $0.19 kind of incorporates sort of an annual impact. Would you expect an additional loss in the third quarter and, excuse me, in the fourth quarter?
We were saying that we're going to increase our loss ratio for crop in the second half.
In the third quarter.
We'll increase it. Right.
Got it. Okay. The second one, it's a small number, the earnings from the ag line were up pretty substantially from a year ago, and I'm wondering what drove that.
Hey, Jay. Brian's going to answer that question. Let's be specific. The crop adjustment year to date in the third quarter, the loss ratio is raised five points year to date in the third quarter. The fourth quarter will carry that same loss ratio. That raised loss ratio, that's in your $0.19.
It affects both the third and fourth quarters.
Got it.
Okay, your second question, Brian?
Second question, yes, I think was the year-over-year second quarter ag results, and this year's were better than last year. Remember last year in the farm component of the book, we had cat activity, both flood and tornado losses, and that's the real difference this year. Second quarter, pretty benign for us on cat loss on the farm book versus a crop specific question. Crop, no real change year-over-year.
Got it. That makes sense. Thanks a lot.
You're welcome.
We'll take our next question from Josh Sterling from Sanford Bernstein.
Hey, good morning. Listen, I was hoping to just get a little bit more color on pricing. Commentary is obviously that it's broadened some of the casualty lines. The professional lines seem to be ticking up internationally is great. Would love to get your color, though, on if this is leading you to reset your sort of general underwriting posture, which has been sort of very property focused versus casualty over the past couple of years. Obviously, in the numbers you report, it looks like you did increase your casualty writings this year, and with pricing going up, it'd be nice to know if you think that's something that we should broadly see as just sort of a better place for opportunities these days.
No, I don't agree with how you're viewing it at all. We have many more casualty underwriters in this company than we have property underwriters. In fact, we have many more casualty units in the company than we have property units. The fact is we play ball the same way in a soft market as we do in a better pricing market. It's just what's the return we get for the effort. Guys and gals are just getting better returns for their effort right now. We may have quoted 100 risks a year ago in a certain casualty line of business, and our pricing and terms and conditions would have called for X, and that could have placed us right outside the market, and others would do it cheaper.
They win, we lose, or in our way of thinking about it, they lose, we win. Now those same risks, we're underwriting them the same way. However, the market has raised its standards, we are more successful in securing those accounts now. We have not switched our focus. The people who do those lines for a living, that's all they do for a living. They are focused on them. It's just the yield for the effort.
Marginal change of environment.
We don't take property underwriters and put them in the casualty department.
If I could ask one other headline question, although it's not the headline question we're all talking about. It's obvious you guys have been defensively underwriting for a couple of years, broadly. Europe stress is sort of not an open area, is not new news. I would love to get a sense of some of the policies and sort of just generally industry areas on the liability side that you have been sort of defensively positioned around. I'm thinking of things like industry exposures to surety, trade credit, political risk, other financial lines. Areas where perhaps, you've been monitoring the environment and perhaps so should we. Pardon me.
You're thinking in context, Josh, of Europe?
Yes. I'm sorry. In Europe.
Got it. Fine. Both in Europe outside Europe related to Europe.
Yes.
Yeah. Okay. I'm going to ask John Keogh to maybe give you some more color around that.
Yeah. Why not, Josh? I'll use the color around our trade credit political risk book of business, which is one of the questions you asked, and I'm sure a question others have as to the impact of Europe potentially on that book of business. One, I can tell you right now from what we're seeing in terms of claim notices or potential for claimed activity in Europe or anything that's coming in other parts of the world as a result of the economic slowdown in Europe. Right now, there's nothing we see that is outside of what we planned for in our loss pace for both political risk and trade credit. Having said that, we do run models and do run realistic disaster scenarios on those books of business.
When we run an RDS that shows what we think would be an extreme event, but nonetheless one that we model, which is a breakup of Europe where the PIIGS leave and the core, France, Germany, stay in the euro, and what that would mean in terms of loss to our political risk and trade credit business. That models out to about $150 million worst-case scenario for loss for us.
Okay. Would you?
As respects surety, we have not been a market for surety in Europe.
If just thinking about those sorts of numbers in the political risk business, is that a function of you guys sort of modest exposure there, or do you think that's something we could extrapolate to sort of broader industry into industry exposures?
Don't extrapolate. That was an RDS scenario specifically around a euro breakup defined as the PIIGS countries leaving the Eurozone. That's a stone in the global pond. What would be your global losses in trade credit political risk as a result of that? It wasn't just the losses in the Eurozone region. It was caused by a Eurozone breakup. What would be your losses globally in trade credit political risk?
Great. Well, thanks for the color. Hope we won't talk about it anymore.
Of course you'll talk about it. It's okay.
Our next question comes from Brian Meredith with UBS.
Yes, thanks. Just a couple of quick ones here. Just a point of clarification, the five points that you said, is that for crop or the total ag book?
Crop.
Just crop. That's what I thought. Okay. Just quickly, the North America growth, how much of that is coming from recent acquisitions like Penn Millers?
Very modest.
Okay.
Penn Millers was roughly $70 million of annual premium.
Got you. It's organic.
Yes.
Great. Last question. I'm just curious. The growth that you're seeing in your property business, what impact is that having on your PMLs? Do you kind of think about it that potentially you're willing to accept some more volatility here going forward just because of the attractiveness of property versus the casualty business?
Brian, to date, we have really not increased our PMLs. They're steady. The growth we have seen in exposure is within the PMLs as we establish them. Would we be willing? Let's see how pricing looks and opportunity as it presents itself, but we have not increased our PML exposure.
Great. Thanks. Just one other quick one, just curious. Evan, are you seeing any benefit from or any flight to quality kind of going on right now, particularly with what's going on in Europe? I know there have been some ratings activity on some of the European insurers. Has that been a benefit to you, or do you anticipate it to be going forward?
Not really. John, you want to add any color on that?
No, not yet, Brian. I mean, it's obviously a question that we're looking at on the ground in Europe. Right now, I think it's relatively stable still. Kind of the culture of Europe is such that people don't move as quickly in reaction to those kinds of situations as they might here in the U.S. I think if there is an opportunity, it's going to be in front of us as opposed to immediately.
Great. Thank you.
Our next question comes from Thomas Mitchell from Miller Tabak.
Uh-
Morning, Tom.
This is sort of a broad conceptual thing, but if the central banks around the world continue to attempt to keep interest rates as low as possible, both short-term and long-term, for an extended period of time, let's say another two years or so, it strikes me that puts tremendous pressure on underwriters who are less skilled at making underwriting profits than perhaps you are. I'm wondering if you are observing that you having an advantage relative to other insurers is actually helping you gain market share in the market you want to be in.
Well, Tom, I think what you're saying to me, if I didn't speculate and looked forward and just took the current environment. The current pricing environment is not driven by balance sheet pressure, as you know. It's really more driven by ROE pressure because of low interest rates. They're already low. Investment income is therefore declining for the industry. The yield is declining. Loss ratios have climbed to a point where ROEs are just under so much pressure. That has driven pricing, and that is a rational response as opposed to where it's real balance sheet pressures.
You're already seeing that, as the marketplace becomes more disciplined in underwriting, it creates varying degrees of opportunity for us, which really varies by line, by territory, and based on our view of what is the experience in that line of business today relative to its price need, relative to what the marketplace will allow in terms of price. I think what you're speculating out loud, you're actually already seeing it, and the question is to what degree does that continue, accelerate, broaden geographically? That's a question mark. No one knows. The good news here is we don't need to speculate a lot about it because we're ready when it occurs. When pricing improves and it presents opportunity, we're all day long working on our capability to just be there, ready to take advantage of it.
That makes a great deal of sense. My second question is, I think I know the answer. I don't think it's a positive answer, but I was looking for the potential for a silver lining in this drought. Is it possible that the silver lining could be that crop prices are higher in the next crop year and that you end up writing a lot more business?
Commodity prices?
Yes.
That's possible. If you were good commodity price pickers, we'd be the world's great commodity traders. That's not what either of us do, but of course, it's going to depend on global crop conditions as well as projected U.S. weather conditions.
Thank you very much.
We all know how easy it is to predict the weather.
Thanks a lot.
You got it.
Our next question comes from Paul Newsome from Sandler O'Neill.
Good morning. I wanted to also ask sort of a broad question. My supposition is that as prices increase, broadly, we should see retentions decline and as well as an acceleration of E&S versus primary. I'm not sure we have seen that. I was curious as to, particularly given your large E&S business, if you thought there was a reason for that this time around.
Well, I don't think you're looking at a raw, hard market. I don't view this as a hard market. I view it as that we're in a pricing correction period, but hardly in a hard market. I define that broadly where prices are broadly adequate or beyond what you require to beat your hurdle rates in terms of combined ratio on current accident year business. Let's start with that. Secondly, what I'd tell you about E&S is it's true about a lot of classes. That while pricing is improving, E&S casualty lines pricing is not improving enough to broadly make most E&S casualty lines attractive from an underwriting perspective. To me, it's sort of like the akin would be workers' comp, where you look at if the industry's running a 117 or a 120, great, you're getting eight or 10 points.
It's hardly enough when you add trend to put it in the black from an underwriting perspective. Well, that's true about most E&S casualty lines. You're not seeing that classic pattern that you would imagine, though you're seeing incrementally greater opportunity than there was in E&S lines.
Excellent. For what it's worth, it's raining on our farm.
Cool. You won't be making a claim to us.
I think it's way too early to tell.
Yeah. Speaking like a true insured.
Our next question comes from Josh Shanker from Deutsche Bank.
Thank you for taking my question. I know there's been too many questions on crop, but it's really what everyone wants to know. Can you talk a little about the reinsurance markets and business that you're ceding, and given your scenarios, how big a loss you're anticipating for the industry, both in your modeled $0.19 versus your worst-case scenario?
No. Sorry, Josh. On the reinsurance side, I gave a little bit about how our stop loss works. That's as far as I'm going to go on that. How the industry is going to run overall in crop insurance is way too early to know. We have no idea.
And-
I could talk about us, and I can only tell you what I already said about us, that I think is pretty fulsome.
Well, I'll try one more way, but I'm sure I'll be denied. Can you talk about the.
You want to ask it.
You never know. Maybe I'll get lucky.
Okay.
For your reinsurance, in terms of the loss, is the loss that you're ceding sizable or right now your retention is high, given your forecast?
Josh. If you look back on what I said, I said that we were increasing our loss ratio by $0.19, that was five points of loss ratio and a combined ratio. That would put us in a combined ratio below 100%.
On the retention.
I told you where stop loss attaches. Actually, you did get lucky. I am talking about retention.
Okay. Very good. Thank you. I appreciate it.
Thanks.
Where are loss costs on excess casualty right now? Are they benign at this point?
Loss costs? Well, they're never benign. No, they're never benign. Excess casualty is never benign, but loss costs I'm sorry. Sean Ringsted, our Chief Actuary, will finish that.
Well, Josh, I think we've commented in prior quarters, we monitor frequency and severity. In the second quarter, we do the same, broadly, frequency and severity overall are in line with our expectations. As I said, our expectations are not benign.
No real change from previous quarters?
No real change from previous quarters.
Thank you very much.
You're welcome.
We'll take our next question from Meyer Shields from Stifel Nicolaus.
Thanks. Pardon me. Evan, in your commentary, you noted that your pricing is better on the E&S side than on the retail side. Is there a similar differential in loss cost trend between E&S and retail?
That it's better on one side than the other side?
Are loss cost trends higher on the E&S side, or is it just the market adjusting more rapidly?
Not particularly, no. Not when you measure them on a like-for-like basis. The portfolios are different. I'm not evading your question, but what I'm telling you is on level, if I could put portfolios like for like, they behave the same. The portfolios, by its nature, what comes into E&S is tougher, more difficult risk.
Okay, that's helpful. Thanks so much.
You're welcome.
Our next question comes from Ian Gutterman from Adage Capital.
Hi, Evan. I think all my question of the quarter were picked over, so maybe I'll ask you a bigger picture question. If this cycle is going to play out differently, like you said, it's not a hard market yet. If we're going to sort of be in, I guess what we'll call Goldilocks, which is slow increases in pricing greater than trend, but we don't get a true turn, if you will. How does that affect the way you approach a market? The reason I'm asking is I think of ACE as being a company who sort of takes advantage of when there's chaos, right? When there's disruption and there's big opportunities for you to out-underwrite people.
If we have sort of a more steady market that never gets that big, hard turn, do you have to change the way you approach how you seek to grow the company over time?
No. Ian, let me ask you a question. If we looked at what do you think of this quarter's growth results?
To be determined. It depends on.
No, ACE's. Do you think they were pretty good?
Again, I want to see where those action years end up first, and then I'll tell you.
It's not clear to me we're getting enough profitability in the last quarter to be growing fast.
I'm trying to answer your question. You just now are asking a different question. It's a different question. I think what I'm really trying to say to you is, in this environment, I think we have taken pretty good advantage of market opportunity as we see it. We're not simply built for a hard market. We're built as an underwriting company to take advantage where we see an opportunity to make an underwriting profit. That's different than saying you're a company that is just built to take advantage when you can make excessive underwriting profits, to fill the holes of the industry's bad behavior from the past, which is typically what happens in an overcorrection in a very hard market. In this case, we're seeing more opportunity to earn an underwriting profit because of market pricing than we had seen.
We have a very broad geography and product portfolio, as you know. I think our revenue growth in the quarter reflects our capability to do that. I think therefore, that answers how we'll look going forward and why I say to you, "No, there's not something to rebuild for a different playbook here.
Got it. Interesting. Thank you.
You're welcome.
We'll take our final question from [Jay Gelman] of Park Avenue Capital.
Thank you. I wanted to touch base on two things. First, with the Libor scandal for the European banks, what's the potential response or coverage implications for D&O and professional liability writers? I have a follow-up for Phil.
Yeah, I'm going to ask John Keogh to answer that question, and I don't know, if he's not fulsome enough, then John Lupica will fill it in. Go ahead.
Sure. I'll answer for ACE. I can't answer for the industry, but first, generally, we are an underwriter for large financial institutions. I don't think it's a surprise to anybody, both here in the U.S. and internationally. I would say that most of our coverage in this space is in the D&O area. We've pulled away from E&O over the last few years and have very little E&O exposure currently. Further, I suspect the E&O business we do, a vast majority of our exposure to financial institutions in D&O is Side A only. Now, to your question about the whole Libor investigation, which is underway, I would just be speculating right now. The investigations are underway. The facts are yet to emerge. As those facts emerge, they're going to be very specific to certain allegations and certain financial institutions.
What that means for that financial institution in terms of liability or what it means in terms of the actual coverage they may have with insurance carriers, that's all yet to play out.
John Lupica, is that fulsome enough?
Very fulsome.
Okay.
Something like Side A typically, well, it seems like that may not be designed to respond to civil litigation amounts related to something like that, correct?
Yeah. Side A is just for situations where the insured is unable to or unallowed to indemnify the individual directors, officers that are covered by the policy. The scenario you worry about there, which is the remote one with these big financial institutions, is that they're bankrupt and therefore can't indemnify because they're financially unable to. The more likely scenario in terms of coverage would be derivative action against the financial institution, which because of the specifics of derivative, which is actually suing on behalf of the company against the D&Os. Those sorts of cases are not allowed to be indemnified. That would be the scenario that would more likely be covered by D&O. It's going to be a question of, again, the facts as to does cover apply? Are there exclusions? Where do you sit? Are you primary?
Therefore, you got to worry about defense costs. Are you sitting excess and remote from that? It's something I would be very careful to generalize about in terms of what this may mean to any company or the industry.
Right. Then typically, regulatory fines and penalties aren't covered under D&O, right?
Typically not. Again, these are bespoke policies, so again, going to be very fact-specific to the actual policy form itself for a particular financial institution.
You can see that John's been spending a lot of time in the U.K.
My suits are.
Okay. Then for Phil, the effective tax rate continues to run sort of below that 18% level that has been kind of modeled for a while. What do you think about for the back half? Where could that effective tax rate come in?
We're not giving guidance on that, I can tell you that it's going to be driven by where our PPD falls and what jurisdiction it falls in, and caps as well.
Right. With the crop losses in the second half, would that have the effect of driving the effective tax rate lower?
No, I would think it would tend to drive it up a bit.
Okay. I'll follow up with you on that. Thank you.
Okay.
That concludes today's question and answer session. Ms. Wilson, at this time, I will turn the conference back over to you for any additional or closing remarks.
Thank you, everyone, for joining us this morning. We look forward to speaking with you again at the end of next quarter. Thank you and good day.
Ladies and gentlemen, that does conclude our conference for today. We do appreciate your participation.