Everyone, welcome to the third quarter 2017 earnings call of Everest Re Group, Ltd. Today's conference is being recorded. At this time, for opening remarks and introductions, I'd like to turn the conference over to Ms. Beth Farrell, Vice President of Investor Relations. Please go ahead.
Thank you, Jennifer. Good morning and welcome to Everest Re Group's third quarter 2017 earnings conference call. On the call with me today are Dom Addesso, the company's President and Chief Executive Officer, Craig Howie, our Chief Financial Officer, John Doucette, President and CEO of Reinsurance Operations, and Jonathan Zaffino, President of North America Insurance Operations. Before we begin, I will preface our comments by noting that our SEC filings include extensive disclosures with respect to forward-looking statements. In that regard, I note that statements made during today's call, which are forward-looking in nature, such as statements about projections, estimates, expectations, and the like, are subject to various risks. As you know, actual results could differ materially from current projections or expectations. Our SEC filings have a full listing of the risks that investors should consider in connection with such statements. Let me turn the call over to Dom.
Thank you, Beth, and good morning. Let me begin by first extending our sympathies to all of those affected by the recent events. The community at large has responded to the relief efforts, but still there is more that can be done. I'm especially proud of the way our organization has responded on both the business and personal front. We have advanced monies to our reinsurance clients, so they, in turn, can quickly settle with their insurers, allowing them to start the process of rebuilding their lives and businesses sooner. On the insurance front, our claims staff is working diligently to do the same. These events tear at us with many personal stories, but also remind us of the value that our industry and company can bring during times like this. We protect against volatility, and therefore expect the periodic loss that we will discuss this morning.
This means, of course, that during times of limited catastrophe loss activity, we should be able to produce strong results, as we have. It also means that after a series of events that claimed $100 billion from the system, there needs to be a reset in the market as we reevaluate pricing, terms and conditions, and the impact the recent year's softening has had on the industry's risk-adjusted returns. For this reason, we believe that these recent events will lead to a general market firming across all lines and territories. In non-loss affected areas, the push will be to achieve adequate return levels over a reasonable timeframe. Events like these create a greater awareness in the market around the cost of capital and the price of risk. For those regions affected by loss, the price reaction will be more pronounced.
This will start with the retro market since it is heavily supported by the collateralized market, whose capital is in large part locked up. This may very well create some unique opportunities for us, especially given our capital position coming out of these events. The firming of the retro market will also have a beneficial downstream impact on the rest of the property catastrophe market and may very well push into other lines. We anticipate that well-rated capacity will be in demand, and this will drive better rates, terms, and conditions across the spectrum. Given our strong risk management practices and laddered protection mechanisms, the losses from these events remained well within our expectations. One important factor that is often overlooked is the tax benefit that is used to offset the loss.
We manage our PMLs on a net basis, meaning net of tax and reinsurance hedges, despite many publications that only highlight our gross PMLs. Considering the reinsurance and tax recoveries against the third quarter events, our net operating loss for the nine months stands at $180 million. This suggests that with a normal operating result in the fourth quarter, inclusive of our cat load, we could achieve a profit for the full year. This would be an excellent outcome in a year with an unprecedented level of catastrophe losses. We manage to these types of scenarios and measure our success over the long term as we recognize there will be periods of volatility. Over the last five years, including results so far in 2017, our average return on equity is 12%, which we consider exceptional relative to the industry. This is a testament to the long-term value of our strategy.
We emerge from these events with a strong capital base and ample reinsurance capacity with our growing Mount Logan facility, multi-year cat bonds, and other third-party reinsurance, are therefore ready to respond to the new market demand. While I recognize that the cat events are deservedly getting the focus, let me now turn your attention to the underlying business trends that support our long-term success. On the reinsurance front, our effective use of third-party capital has allowed us to grow the book and profits during periods of low cat activity. Yet, during one of the highest cat years in recent times, contained the loss within full-year earnings. Using alternative capital for U.S. cat exposure has allowed for expansion and diversification into other regions as well as other lines of business Another expansion opportunity we have leveraged with this essentially expanded capital base is our insurance business.
For the past two years, we have experienced growth of over 20% in a balanced and well-diversified fashion. With that growth and repositioning has come an improvement in the underlying attritional ratios. At $2 billion of annual premium and growing, we are now a known market that brings capacity and ratings to meet the needs of the commercial and specialty marketplace. The underpinnings of our collective organization have never been stronger. While this year is challenged from an income perspective, over the long term, we are delivering what we promised, higher ROEs than the industry with our disciplined expense model and cat losses that on average are within our expected outcomes. I continually remind people there are never any losses, then we don't have a business.
The goal is to produce an above-average ROE through the cycle, and we believe we have thus far delivered and will continue to do so. Thank you, and now to Craig for the financial report.
Thank you, Dom, and good morning, everyone. Everest had a net loss of $639 million, or $15.73 per common share for the third quarter of 2017. This compares to net income of $295 million for the third quarter last year, or $7.06 per diluted common share. The operating loss for the quarter was $16.43 per share, reflecting the catastrophe losses in the quarter and the foreign exchange losses of over $1 per share, which is the primary difference from consensus. The operating loss excludes realized capital gains and losses. You will note the 2017 earnings per share calculations utilized basic common shares instead of diluted shares due to the loss in the quarter and on a year-to-date basis. The group had a net loss on a year-to-date basis of $102 million compared to $623 million of net income in 2016.
These results were impacted by a series of major catastrophe events that are driving both the quarter and the year-to-date figures. In the third quarter of 2017, the group saw $1.2 billion of net pre-tax catastrophe losses with a net economic impact of $900 million after taxes. The breakdown of the pre-tax loss by event is as follows. Hurricane Harvey was $270 million. Hurricane Irma was $475 million. Hurricane Maria was $400 million, and the earthquakes in Mexico were $85 million. There is considerable uncertainty in these estimates, and we expect it will take several months before relative clarity emerges from the multiple events. However, the company has significant unused retrocessional capacity, including aggregate protections, which would provide coverage above these estimated levels. On a year-to-date basis, the results reflected net pre-tax catastrophe losses of $1.3 billion in 2017 compared to $143 million in 2016.
Excluding the catastrophe events, the underlying book continues to perform well with an overall current year attritional combined ratio of 85.6% through the first nine months, compared to 85.2% for the same period in 2016. Our year-to-date expense ratio remains low at 5.3% due to higher earned premium, including reinstatement premiums after the catastrophe event this quarter. For investments, pre-tax investment income was $137 million for the quarter and $394 million year-to-date on our $18 billion investment portfolio. Year-to-date investment income was up 10% from one year ago. The result was primarily driven by the increase in limited partnership income, which was up over $20 million for the first nine months of 2016. We've been able to maintain investment yield without a shift in our overall investment portfolio.
However, we have gradually shifted allocations within our alternative investment bucket by reducing exposure to high yield debt and public equity while committing more towards limited partnership investments, all while maintaining a conservative, well-diversified, high credit quality bond portfolio. The pre-tax yield on the overall portfolio was 3%, and the duration remained at just over three years. Foreign exchange is reported in other income. Foreign exchange losses were $43 million in the third quarter, or over $1 of earnings per share. Year-to-date foreign exchange losses were $48 million compared to $29 million of foreign exchange losses in the first nine months of 2016. The foreign exchange impact is effectively an accounting mismatch since it's offset in shareholders' equity through translation adjustments. Overall, we maintain an economic neutral position with respect to foreign exchange, matching assets with liabilities in most major world currencies.
Other income also included a $6 million loss from Mount Logan Re in the first nine months of 2017 compared to $10 million of income in the same period last year. The decline essentially represents the higher level of catastrophe losses during 2017. On income taxes, the tax benefit is based on the actual year-to-date loss, not the annualized effective tax rate. We would expect any fourth quarter income to be taxed at an effective rate of about 10%. Stable cash flow continues with operating cash flows of over $1 billion for the first nine months of 2017, compared to $961 million in 2016. We expect this will decline as we pay claims for the recent catastrophe events, but still remain positive for the year. Shareholders' equity for the group was $8 billion at the end of the third quarter, leaving us well-positioned to take advantage of business opportunities.
Thank you. Now John Doucette will provide a review of the reinsurance operations.
Thank you, Craig. Good morning. As a leading global reinsurer, we have consistently achieved industry-leading results in periods with low catastrophe loss activity. The true test of our franchise and business strategies is our ability to demonstrate resilience in a quarter and in a year with several major catastrophe losses or other large unusual shock losses. While some characteristics of the recent property loss activity were unusual, the magnitude of insured losses was well within our expectations, owing to our proactive and comprehensive risk management efforts. Learning from other large catastrophe and shock loss years, such as 2001, World Trade Center. 2005, Hurricane Katrina, Hurricane Rita, and Hurricane Wilma. 2008, global financial crisis. 2011, a string of losses including earthquakes in Japan and New Zealand, floods in Thailand and Australia, and severe convective storms in the U.S. We have continually enhanced and refined our group-wide enterprise risk management framework.
This includes our large risk and catastrophe strategy across all underwriting areas within the company. Now both our reinsurance and insurance portfolios each are expected to benefit from the post-loss market conditions. This applies across our underwriting risk spectrum, from property insurance to facultative, to proportional treaty, to property catastrophe, excess of loss treaty, and ultimately to retro. We believe it is essential that a global industry-leading specialty reinsurer and insurer such as Everest truly understand its risks and develops a comprehensive, resilient business strategy that allows us to stand with our clients while protecting our investors' capital. A proactive, farsighted approach is critical to the continuity of an enduring franchise. Expect the unexpected as every loss is different and unique. This includes relentless preparation for black swans and other tail events, or an accumulation of varying losses across multiple lines of business.
Everest continues to be well-positioned to bring tailored solutions and value to our reinsurance clients. We pride ourselves not just on paying our clients' losses quickly and efficiently, but also maintaining our financial strength in a quarter with unprecedented catastrophe loss activity. More importantly, we provide continuity to our clients, going on the offense and providing additional support and capacity when it is needed most. With our global geographic and line of business diversification across our underwriting portfolio, strong earnings power, and substantial capital resources, we have once again demonstrated the success of our business strategies, which insulate the balance sheet from large events such as those just experienced. As we head into the one-one renewals and onward into 2018, we will continue to harness capital, whether in the form of traditional equity and debt, Kilimanjaro catastrophe bonds, Mount Logan, or other forms of traditional and non-traditional reinsurance capital.
Across the spectrum, our accordion-like capital structures provide ample dry powder to deploy commensurate with market opportunities. We remain very well-positioned today, and our existing hedges remain substantially intact with the vast majority of our $2.8 billion of cat bonds still in force and unexhausted, coupled with a growing Logan capital structure, both of which help Everest efficiently manage its overall net risk appetite. Uniquely, we manage alternative capital in a fashion that relieves our clients around the globe from the complexities and structural weaknesses of collateral, lockup, and release mechanisms from unrated reinsurers, while delivering to our clients our evergreen promise to pay from our highly rated balance sheet as we have proven over the last 45 years.
Additionally, we have significant portfolios of business across the entire P&C opportunity set, including meaningful books of business in mortgage, casualty, professional liability- Structured reinsurance, international property, specialty, and other short tail lines throughout the world that have been unaffected by recent cat loss activity. Thus, our global geographic and business line diversification decreases volatility from any one line of business. Profits from these diversifying lines and territories offset losses, such as those recently experienced in the U.S. and Caribbean. Going forward, we are ready and eager to capture market opportunities that convert the value we provide to our clients into returns for our shareholders.
We are especially pleased that we were one of the few reinsurers immediately deploying capital post-event as we actively quoted backup covers in all loss-affected areas to meet the needs of our clients, whether they were U.S. regional clients, large U.S. national clients, retro clients, Lloyd's syndicates, or Caribbean reinsurance clients. With financial strength and resilience, we are headed into the January renewals with the clear message that Everest is open for business. That does not mean we will write reinsurance business at any price. As we have supported our core clients through hard and soft market cycles, the recent losses are a reminder of the value that we deliver. As in the past, we will deploy our capital where that value is most recognized while reducing our positions on business with less attractive pricing terms and conditions.
Our clients can rely on us to offer our reinsurance capacity, whether the same or a higher amount of capacity needed as long as it meets an appropriate return on capital, and the cost of that capital has gone up for the industry. Turning to specifics on our results. Excluding reinstatement premiums, gross written premiums for our reinsurance operations increased 13% for the quarter and 15% year-to-date with broad-based growth in our U.S. and Bermuda operations from crop reinsurance, mortgage, strategic quota shares, reinsurance business, international surety and property, and structured reinsurance. Growth was offset slightly by lower international premium volume in the third quarter due to the renewal of certain structured deals that ran their course. This underscores our ability to not only seize opportunity in property cat business but to continue to write and expand our franchise in diversifying and value-added lines for our clients.
While this quarter's reinsurance underwriting results were heavily impacted by the catastrophe losses in the quarter, the underlying trends in these businesses remain solid. The reinsurance operations overall attritional loss ratio was up 2.6 points on a year-to-date basis against the comparable period of 2016. This was due to growth in pro rata and crop business, both with naturally higher loss ratios offset by some favorable loss trends in our international operations. Our year-to-date attritional expense ratio dropped over 2 points, benefiting from a business mix with naturally lower commissions. Despite this year's loss activity, in the long term, the reinsurance market will continue to trend toward more efficient capital management and scale with better operational and expense management. We believe we are very well-positioned both now and into the future.
Our ability to execute on these key drivers provides value to our clients and our shareholders in both hard and soft markets. Our strategy remains nimble and dynamic and enables us to thrive in this ever-changing market. Thank you. Now I will turn it over to John Zaffino to review our insurance operations.
Thank you, John, and good morning. As catastrophic events unfolded in the third quarter, particularly of the magnitude and scale that occurred across North America, the resultant impact to the primary insurance market has been predictably quite significant. While the Everest global insurance operations were not immune to the impact of this widespread devastation, the performance of our various books of business, notably our U.S. property portfolio, were in line with our expectations. We are pleased with the continued growth and development of our global insurance platform. We are increasingly confident that our vision to organically build a world-class diversified insurance organization that is relevant within the global specialty P&C industry is being realized.
Our leading growth in written premiums, our enhanced operating platform, the many new product launches, our successful talent acquisition strategies, and our growing relationship with a diverse group of trading partners is a testament to this approach. Progress on our journey is also fairly measured by an increasingly resilient underlying combined ratio, which again was solidly profitable for the quarter. Notably in the quarter, we were pleased to receive conditional approval from the Central Bank of Ireland for our newest European operating platform, Everest Insurance Ireland. This is another example of the thoughtful organic build of our franchise and the expansion of our global underwriting operation. Our Irish operating company will be an important component of our overall international insurance strategy, and is an excellent complement to both our North American and Lloyd's operations. I will turn now to the financial highlights in the quarter.
Following this, I will provide some comments on the cat activity experienced within the insurance operations, along with our views of the operating environment forward. As in prior quarters, due to the divestiture of Heartland in late third quarter of 2016, I will discuss our comparative results excluding this business. For the third quarter of 2017, the global insurance operations produced $480 million in gross written premium, an increase of $109 million or 30% over third quarter 2016. Another tremendous result and a recognition of our growing relevance in the specialty P&C market. On a year-to-date basis, we achieved $1.5 billion in gross written premium. Again, another solid performance. This represents growth of $349 million or 31% over the comparable period in 2016. As in prior quarters, contributions remain balanced across the diverse group of underwriting divisions within the Everest Insurance global platform.
This also represents the 11th consecutive quarter of growth for our global insurance operations. Turning to net premiums. As we have shared in the past, net premiums slightly lag gross written premium growth due to the marginally more conservative reinsurance position we have taken to support the growth across our underwriting divisions. Net earned premium in the quarter was $376 million, an increase of $63 million or 20%. For the year-to-date period, net earned premium of $1.1 billion increased by $181 million or 20% over the prior year period. Our GAAP combined ratio for the quarter was 141.4%, clearly impacted by the catastrophe activity in the quarter, which contributed 43 and a half points to this result. The attritional combined ratio, however, was 98% in the quarter, which compares favorably to the third quarter '16 attritional of 99.5%.
The underlying loss ratio for the third quarter of this year was 68.4%, a 1.4 point improvement over last year's 69.8%. On a year-to-date basis, the GAAP combined ratio was 113.9, with again nearly 17 points of cat included in this result. The year-to-date attritional combined ratio for the global insurance operations produced a 96.5%, which also compares favorably to the 97.1 for the comparable period in 2016. Again, the underlying loss ratio shows 1.2 points of improvement on a year-to-date basis, coming in at 67% from the prior year of 68.2%. Year-over-year, we are seeing a downward drift in the attritional loss ratio. This is a result of improved mix of business that benefits from the many new businesses launched and the strategic underwriting actions of the past two years.
Our expense ratio in the third quarter was 29.5%, essentially flat from the 29.7% from the same period last year. For the year-to-date period, the expense ratio remains 29.5%, up slightly from the 28.9 in the comparable period of 2016. As we have stated in prior calls, an expense ratio of roughly 30% remains very competitive in the specialty insurance segment. Turning now to the cat picture for the quarter. As you heard from Dom and John, Everest as an organization deploys a proactive and multifaceted approach to risk management. The insurance organization is deeply ingrained in these same processes and hence adopts many of the same views and strategies. The third quarter of 2017 certainly tested the efficacy of these strategies, and the insurance operations results were consistent with our expectations and well within our tolerances.
In addition to measuring our performance against modeled assumptions, we also gauge our performance against industry loss and market share analysis, and of course, from a fundamental bottom-up view of our underwriting decisions with a keen focus on any outliers that may emerge from these underwriting strategies and assumptions. Again, against all of these measures, the various books of business performed well and as anticipated and consistent with our global view of risk. To put this in further perspective, we estimate roughly $160 million in net pre-tax losses from the three large cat events of Harvey, Irma, and Maria, with the concentration of loss emanating from Harvey and Irma. The majority of this exposure was originated from our U.S. property underwriting division, covering the wholesale, retail, and inland marine markets, with some minor contributions from our Lloyd's platform.
This loss is against roughly $450 million in annualized worldwide property insurance premium and roughly $2 billion of similarly annualized premium within the overall insurance operation. Together, these data points suggest these events are in proportion to our portfolio, and again, within our various modeled expectations. One final comment on the cat side. It is important to remember that we are in the middle innings of a significant transformation of our insurance platform. As we have stated previously, this has caused a temporary lag in earned premium, and several of our new underwriting divisions have yet to achieve critical mass. As these new units continue to grow, as we are demonstrating quarter after quarter, we expect that our short-tail property exposure will be even more balanced against a larger non-property base.
This will further allow us to drive the consistent profitable result we have been experiencing more recently in our attritional combined ratios. As for the question on market conditions, it is a very fluid situation and will take some months to find a balanced view. In fact, the current market is evidencing a fair amount of pricing volatility across lines as we work through this adjustment process. Overall, as we stated, we do believe there is a need for rate firming, certainly within the property markets, cat and non-cat alike, and also in other markets. It is our sense that general firming will continue to occur across property lines to different degrees, and other major lines of business are likely to experience positive rate movement.
Remember, certain casualty lines of business, namely commercial auto, have been experiencing rate increase for many quarters, and based on underlying loss cost trends, that needs to continue. Other lines of business likewise need to adjust to proper technical pricing, and I believe the industry at all levels understands that we can't perpetuate in an environment where pricing persists below these technical levels. Again, each market, each geography, and each line of business are different. However, the need to achieve adequate technical pricing remains universal. That is our focus. In conclusion, despite the impact of the cat event in the quarter, we remain pleased with the continued progress we are making in the establishment of a world-class specialty insurer. The underlying performance of our diverse books of business are encouraging, and we feel we are well-positioned to create value for all of our constituents in the evolving market ahead.
We look forward to continuing our momentum and reporting back to you on our progress next quarter. Now back to Beth for Q&A.
Thanks, John. Jennifer, we are open for questions at this time.
To ask a question on today's call, that is star one on your telephone keypad. We'll go first to Elyse Greenspan with Wells Fargo.
Hi. Good morning. My first question, just Dom, going back to your introductory comments when you pointed to a market firming across all lines and territories. If we can get more color on, is this dependent on alternative capital reloading or not reloading following the events? I guess, how do you see the dynamics underlying the market firming as we get closer to the January one renewals?
Well, there's a number of factors, Elyse, that lead us to believe that there will be a market firming. First of all, starting with the various industry events that clearly we have been attending throughout the past month, starting with Monte Carlo and moving on to PCI and Baden-Baden and the CIAB. The strength of the market in terms of its resolve continued to increase based on our assessment in various talking with customers, brokers, and other markets. That's number 1. Underpinning all that has been what I've been saying for some time, is that the returns on capital, return on equity of the industry in general, as you well know, has been in the mid-single digit for a period of time. Therefore, these types of events are unsustainable with mid-single digit ROEs in times of low to no cat activity.
Clearly, the market has been below technical pricing adequacy. That's number 1. With respect to alternative capital coming back in, start off with a good portion, a significant portion of alternative capital is locked up. It's our belief that certainly some new capital will come back in, but it's not clear yet that 100% of that, at least in the short term, is ready to move back in. Frankly, alternative capital is not going to come back in unless it sees some price improvement. That's my fundamental belief as to why I think there will be a market firming. I don't think it's dependent on alternative capital. There's technical pricing needs across many of our lines of business, not just property. There's been a reassessment of cost of capital and price of risk.
What level of rate do you think we could see on both loss and potentially non-loss impacted accounts?
I knew it would eventually get to that question. I'm not necessarily going to say that we're expecting X% by this timeframe. I think you will see in the retro market very strong double-digit rate increases early on. Perhaps that would last into a second renewal season. Of course, as you know, with firm retro pricing, that has a waterfall impact on the rest of the property cat. We're already, as Jonathan somewhat alluded to on the primary side, it's mixed early days. We are beginning to see some price movement upward. That will take a longer period of time to get to what we believe will be rate adequacy.
At the primary level, ultimately, in the early days, it's high single digit. That might take several months to really play out. On the reinsurance front, straight up property cat, I think it'll start in the teens, again in loss affected areas. Perhaps that will take multiple years to play out. We don't know for sure. Clearly, we are approaching the January 1 renewals with the anticipation that rates are going up.
Okay, great. I appreciate the color. Also if you could talk about the potential implications on the tax side if the Neal bill is included within tax reform.
Potential implications to the industry, to us?
For Everest, sorry, for you guys specifically.
There's many derivations of that. We have various companies that are in place obviously in the U.S., in Bermuda, in Ireland, in other jurisdictions. We have capital in most of those locations. Depending on what the final shape of that bill is will dictate where we position our capital and what companies we will be running business on.
Okay. Thank you very much. I appreciate the color.
Thank you.
We'll go next to Kai Pan with Morgan Stanley.
Thank you. Good morning. First question, just follow up on Elyse's question on alternative capital. How much was the total losses for Mount Logan and what your investors risk appetite after those events?
If I asked Craig the total loss for Mount Logan.
The total loss for Mount Logan was almost $200 million. Then, of course, they have quarterly income as well. You'll see that their AUM is down about $160 million for the quarter.
Then, I'm sorry, the second follow-on to that, Kai, was?
What are the investors in Mount Logan, what's their risk appetite following these events?
We have and have had actually before the events, but even after the events, we have investors that are ready to put capital in. Some reload, some new investors that are interested in going forward with the Logan platform, all with an expectation that rates are going up. It kind of relates back to my early response to Elyse.
Okay. My second question is that you stated about 10% of your reinsurance premiums, about 20% of your insurance premiums. I just wonder if the retro or reinsurance rates going up from double digits, how would that impact your underwriting strategy in terms of net gross?
John?
Good morning, Kai. It's John. I think there's a lot of dials that we look at, both in terms of absolute and relative rate adequacy. We'll look at it both on the gross side in terms of how we're going to deploy the capital, to which area, which product lines, which territories, and then how much we want to deploy. How much we want to deploy and how much we want to retain, that will be a function of what we think the overall rate adequacy is. Yes, we'll look to the different hedges, whether it's traditional hedges of reinsurance and retro. Remember, we have a lot of dials to turn on how we get the business from, as I mentioned, from insurance, reinsurance, all the way to retro.
We have a lot of different dials to turn in terms of how we manage our net risk appetite and net risk exposure. Those include Mount Logan, that takes shares of different pools of risk and stand with Everest on whatever the rates are that we get, and as well as the catastrophe bonds that we have, where we have $2.8 billion of multi-year aggregate catastrophe bonds, most of which those, the vast majority of that is still intact going forward into January 1 and later.
To add to that, to pick up on something that John's alluded to there, keep in mind that what we have been doing through the market cycle here is the market had been softening over the past couple of years. We've been moving attachment points and deploying our capital to what we felt was the best risk-adjusted returns. Where we will be going forward, perhaps we'll be changing that again, so that where the market is getting the appropriate rate increase and where the best risk-adjusted returns are is where we will be deploying our capital. That could change over the next 12 months.
Okay. If I may, one last question, a quick one on the tax rates. What's the expected tax rate for the fourth quarter? Will it be normalized like 11%, 12%?
I mentioned in my script, Kai, that I believe the tax rate for the fourth quarter, any income earned in the fourth quarter should be at an effective rate of about 10%.
Great. Well, thank you so much.
Thank you, Kai.
We'll go next to Jay Gelb with Barclays.
Thanks very much. I know you mentioned the view that the third quarter catastrophe losses were within your risk parameters. Was there anything coming out of your after-action reports in the third quarter that Everest possibly could have done different or better, looking back on these catastrophe losses?
There's always things around the edges that you can improve upon. There's nothing material that stands out. I guess in the very extreme and the absurd could have been, we would've written no property cat. That's obviously not a realistic scenario. I have to be honest with you, I think what we have done and the way we've managed our portfolio, I think has been pretty much spot on. As again, over the last couple of years, as you know, we've been earning very good returns on our capital. We've been leveraging the retro market, the capital markets, and it allowed us to maintain our writings while not diminishing our returns on capital. The loss, frankly, has come out well within our parameters.
There's not really. I suppose the only other thing that we could have done is, again, Monday morning quarterback, buy more reinsurance for our insurance portfolio. Looking at it from this vantage point, I certainly would've made the same decisions.
Thanks, Dom. Using that as kind of a starting point for the next question. The calendar year combined ratio in the third quarter in the insurance business, over 140%, what can be done differently there to bring this to a, obviously not in 2017, but in 2018 and beyond, bring this to a calendar year underwriting profit for the business?
Well, that combined ratio that you cite includes the catastrophe losses. Are you talking attritional or are you talking all in?
All in. Looking out into next year, it's been a number of years, I think, since the insurance business has generated an underwriting profit.
Well, on an attritional basis, it is generating an underwriting profit, you see the improvement in the attritional combined ratio year-over-year. We are moving in the proper direction. Our cat book, we view on a corporate or global basis. When we are allocating capacity, when we're looking at the marketplace, we're looking at our cat exposure globally and, I should say, corporately. That was well within our risk appetite. To the extent that it is, we could certainly entertain some intercompany reinsurance opportunities that would, in effect, manage that combined ratio perhaps to the point that you're describing. Overall, we are very confident and very pleased with the attritional performance of our book.
That's helpful. Two final quick ones. One, any perspectives on exposure in the fourth quarter from the California wildfires? Separately, since the company's more focused on deploying capital in the business, should we kind of zero out the potential for share buybacks going into next year?
Let me answer the wildfire question first. At this point, it's clearly still early, but the losses, we've modeled it, and what we're hearing from customers and underwriters is that it is well within our normal quarterly cat load. We're not concerned about that event, at least at this point. Relative to share buybacks, as you know, we don't give an indication of what our appetite is. We are in the process of just reformulating, if you will, our plans for next year. We'll have perhaps more to say on that in the weeks and months ahead.
Appreciate it. Thank you.
Thank you, Jay.
We'll go next to Joshua Shanker with Deutsche Bank.
Yeah, good morning, everybody.
Morning, Josh.
I wanted to square talks about improving pricing with also your appetite for growth. Compared to many of your peers, you have found opportunities in this marketplace where others haven't. You grew very nicely in this third quarter as well. As someone who says, look, if there's attractive opportunities, prices maybe doesn't need to go up, or how do I square those two things?
Well, is your question on the reinsurance front or the insurance front?
Well, you can talk about, clearly the insurance book is obviously growing faster, but you're also finding, I guess, in financial lines, you found opportunities in reinsurance, which is obviously not property. Not just you, there's a lot of people saying pricing has to go up. Here's Everest in respect to your work and whatnot, and you guys are finding opportunities very healthily, I think, or maybe I'm not reading it correctly.
No. In part, the reinsurance growth is, remember, we took on a crop reinsurance portfolio, so the growth was coming from that. Mortgage has been growing as well, and then a few pro rata deals have added to that as well. Some of our structured products there, our structured solutions group has been adding some premium as well. Our straight-up property cat business has not really grown all that much year-over-year, and that's frankly because of softening market, moving attachment points, all of those things in the mix have kind of capped out our appetite on property risk, cat risk.
Yep.
I don't know if that's clear.
As you're adding on business in the primary insurance book, is that business dependent on the industry having cheap reinsurance on the property side to allow you to grow there?
Absolutely not. As Jonathan pointed out in his opening comments, we expect the non-property lines actually to grow a little faster in the coming quarters. You'll see even a better balance between property and non-property.
Okay. We'll try and dig a little deeper on that. The other question, obviously you guys bought more protection throughout the year, lowering your PMLs, but we never really got any numbers to that. Is there any color you can give us on where your PMLs stand now versus where they stood at the beginning of this year?
Josh, it's John. Yeah, I think they were basically materially similar. There was a decrease due to the cat bonds that we issued in the March and April time period. Part of that, and we continue to use third-party capital as a way to think about managing our portfolio, managing the overall risk appetite, shaping it. To the extent that we had some additional capacity through the aggregate catastrophe bonds that we purchased, that covered Texas, Florida, and Puerto Rico, among other areas, that helped us in terms of then as we went into June one and July one, in terms of the renewal period, to maintain a net PML position that we were comfortable with.
Okay. Well, thank you for all the color and good luck with this renewal season.
Thank you, Josh. Thank you.
We will go next to Amit Kumar with Buckingham Research Group.
Thanks, good morning, thanks for the questions. Two questions. The first question is the discussion on the catastrophe bonds, I think what I heard was they didn't kick in. Can you remind us, I know they all have different attachment points, what do the industry losses need to get to for your cat bonds to trigger?
Good morning. The catastrophe bonds, some of them we purchased. Across the $2.8 billion, there's several layers, different perils covered. They all cover North America in some fashion, and Puerto Rico, several of them. Some of them are on an occurrence basis, and some of them are, including the most recent $1.25 billion, as well as some of the previous ones, are on an aggregate basis. These bonds that we purchase are typically done tied to industry losses, there's different market shares that are applied as per the bond. There are different market shares based on territories that are exposed. There's not really a simple answer to that question. The market shares in each of the bonds and each of the territories will vary as we try to shape the bond to then best hedge our overall portfolio.
The most latest catastrophe bonds of the $1.25 billion that we issued, they are done on an industry basis, people such as yourself can do your own research on whether you think they're expected to be penetrated or not. There has been some markdowns in the bonds that reflected that there may be some potential penetration to the lowest layer. That really is going to end up being ultimately up to what the final industry losses are going to be.
Got it. That's a fair point. It's a bit tough to figure out with the weighted index attachment. The second question I had was, I guess a discussion on the missing industry losses, and we've sort of raised this topic on other calls as to how do we get to the industry loss of $100 billion-plus versus the current addition of the disclosed losses. If the industry loss were to move downwards, does your net loss move up? Can you just help us understand that metric a bit better?
No. If the industry loss moves down, you're expecting our loss to go up. Is that what you said, Amit?
No, I was thinking about the recoveries, how they trigger in and what level they trigger in. That's what I was asking, sorry.
Our net loss contemplates recoveries from the various instruments that John was just kind of outlining.
Which does mean that if the industry loss goes down, our net loss position really doesn't change a whole heck of a lot. There is some movement that could occur, but it all depends on industry loss, where the loss is coming from, what the weightings are. It's a little difficult to give a precise answer to that. My point is that there shouldn't be.
Our net loss position doesn't change a whole heck of a lot.
Got it. Dom.
The same on the other side, which is the losses go up because of the various protections, including the aggregate catastrophe bonds I was just talking about, which are very close to the aggregate retention being exhausted or slightly into the first layer. It also means that if the industry losses go up, that our net loss position won't change materially.
Fair point. Dom, any view on this, I guess, the missing billions of industry losses? Obviously, we're talking about rate firming. You're quite positive on the market scenario. I'm just curious if you had an opinion.
All you smart folks have been exploring this and asking managements on all the calls and been looking at it for weeks, and you can't find it. I don't know how you expect a simple man like me to figure that out for you. If there was a place to look, I would look in the capital markets piece. That's my expectation of where kind of the missing numbers are.
Yeah, that's a fair point. That's all I have. Thanks for the answers, and good luck for the future.
Thank you, Amit.
We'll go next to Meyer Shields with KBW.
Thanks. I had two big picture questions and then one more number specific. Dom, I was wondering, one, if you could give us a sense of third-party investor elasticity. In other words, how various levels of rate changes might affect the supply of third-party capital. Secondly, whether based on your experience, it makes sense to hold back some capital from 1/1 renewals in anticipation of better rate changes later in 2018.
Two great questions. Third-party capital is looking to come back into the space or what I would call reload, if it can get meaningful rate increases. The definition of meaningful can vary by company, it can vary by investor. Do I see a material increase in third-party capital if we have some level of market firming? I do not. I think first the capital has to be reloaded, I think what your question was implying was, is the third-party capital going to increase materially if there is some material increase in pricing? We don't see that just yet. I also think the other side of the equation is that what we've heard from some clients is that they're more interested in potentially increasing their purchases from rated paper as opposed to third-party capital. The whole issue of reinstates are always a problem there.
There does seem to be an increased interest in rated paper. Now, that doesn't mean, by the way, that reinsurers like ourselves, which utilize third-party capital and see it as an opportunity to expand our capital base, wouldn't increase. To the extent that it does allow reinsurers to perhaps increase the participations with clients directly as opposed to have those clients buy from third-party capital, we think that might represent an opportunity, certainly in the medium term. In terms of holding back capital, we're in a marketplace. We have customers, and we have sufficient capital and/or access to capital that we can trade forward or trade in a bigger way if rates are even firming more into the year. I think that the fundamental question is we won't be deploying capital unless it meets our risk-adjusted return hurdles. That's the first test.
If it meets our hurdles, and we would anticipate it would probably even, in some circumstances, exceed our hurdles, then we will deploy the capital. There isn't a need to hold back capital in that environment. Does that answer your two questions?
It does phenomenally well. Thank you. Follow-up, well, not follow-up, but within the insurance segment, I guess both last year and this year, the attritional loss ratio was higher in the third quarter than it was in the preceding two. I was wondering, is this an element of seasonality or is that just luck of the draw?
In any one particular quarter, there's adjustments we're making to pick loss ratios. Our A&H book of business, for example, has been growing, which by definition carries a little bit higher attritional loss ratio. We think it's more appropriate to look at the year-to-date performance and takes out some of those quarterly anomalies, which its mix of business, it's where we're pegging loss ratios in any one particular quarter. We make adjustments in a quarter. It's the year-to-date number that really is what we think and what we look at predominantly. That's improving year-over-year. That's trending in the right manner.
Yeah, absolutely. Thank you very much.
Thank you.
We'll go to our final question from Brian Meredith of UBS.
Yeah, thanks. A couple quick questions here for you, Dom. The first, I'm just curious, at Mount Logan, how much collateral do you expect to be tied up at the 1/1 renewals, and do you plan on kind of replenishing that with new money here on that?
John might have the answer.
Yeah, John. The amount that would be tied up would be consistent with the expected losses that are there, plus a buffer that would be on top of that against ceded losses. In terms of how much we would look to raise or redeploy, we're in the process of talking to Logan investors, both existing and new ones. We would expect, we don't know what the final number will be, but we would expect it to be up.
Those investors, to make it clear, are looking also for rates to be up. I mean, they're not looking to deploy capital in a flat to down market.
Right. It allows, as Dom said earlier, there clearly is a trend in the buyers, both in the reinsurance and retro market, looking for rated paper because there's some fundamental structural problems, which we're going to see. It's going to play out in real time with the collateralized product in terms of collateral release mechanisms, forced collateral release. People may realize they thought they had cover and then they don't have as much cover as they thought, or they don't have continuity of cover from one year to the next as collateral gets trapped. There's a clear demand for rated paper. We, with our balance sheet, our ratings, and kind of our 45-year trading relationship with clients around the world expect to be in a good position to capitalize on that.
Part of that would be to make sure that we get to the right net risk position to be able to use our different capital structures, such as Mount Logan, to help. Basically, if Everest gets rate, the Mount Logan investors benefit from that. We stay in pari passu with them.
Right. Exactly. That's great. I'm just curious, given history has kind of shown that on the property cat line, rate increases tend to be fairly short-lived. Not sure if you expect that this time around, but given that, would you expect to potentially disproportionately put more into a Mount Logan or some type of a soft capital facility to kind of help manage that risk?
I think we have demonstrated over the last couple of years that we deploy our capital in the best risk adjusted areas. We have used third party capital. We will write the business on the basis that we think is best for the organization and use the capital that's out there in the most highly efficient manner possible. It's difficult to answer that question precisely, but I think what we've demonstrated is that we're flexible and we tend to be within ranges, opportunistic, and we move our capacity around, and we will continue to do that as we trade forward if what you're suggesting is that the firming would be short-lived.
Great. That's great. One last one. I'm just curious. John, Dom, I appreciate your point about the industry kind of cost of capital going up here. Do you think that the kind of cost of goods sold for property cat reinsurance based upon models and stuff is also going to rise here and it going to drive some of this rate activity, or do you not see that happening?
I'll ask John to address that.
I think a lot of times, every time a loss happens, there's always something that the different vendors learn from something different than before, and they adjust it. That typically takes a few years to ripple through the system as they update their models to kind of fit the historical event set or the different events that happen. Certainly, I think take what happened in Houston. I think there's going to be a heightened awareness to flooding risks in different ways than people, certainly some of the vendor models had thought about it before. This is true with the different earthquakes, whether it was the New Zealand earthquake or the four zones on the Japanese earthquake. It has been a long time since a catastrophe of that size hit Maria. I think the modeling agencies will think that through.
For a little while there, we were looking at a Cat 5 hitting Miami. I think that will both change some customers' views of their risk management as well as potentially change some of the vendor models with that as they think about the possibilities of the different storm tracks. A lot of that takes a while. The customer views may be more happen in real time as people think about what their overall, what board of directors for some of our clients think about what their risk position is and how much they want to keep net, and that may put some upward demand on reinsurance. In terms of the modeling agencies, it usually takes a little bit to go through the system.
Great.
The bottom line, Brian, I think the models are great and everyone in the industry uses them. Events like this, I think, cause all managements to take them with a little bit of grain of salt and recognize that there is risk that is not evidenced through the models. And that, in fact, will have some impact on pricing, will have some impact on buying behavior as well.
Next, I just one quick numbers question for Craig. Let him do some talking here. In the operating expense line, was there any kind of reversal of maybe variable incentive comp that happened?
Yes. We did that this quarter as well, Brian, just because of a matching with the events. But that'll be determined again in the fourth quarter, depending on where we stand with respect to income in the fourth quarter.
Great. Thank you.
I'm glad Craig was able to respond. That's it. Okay. We've had all our questions and thanks for those. Now, in summary, I think what you heard this morning is that our risk management practices have contained the losses within our expectations. That kind of permits us to trade forward and participate fully in what we believe, and I think the market believes, there will be firming. We think this is true not only because of what markets in general are saying, but also because there will be some dislocation of capital. Which, as I said before, will benefit highly rated paper such as ours. This is the business we're in, but this does create some opportunities for us going forward. Thank you for your participation on the call, and I look forward to our continued dialogue. Happy holidays.
This does conclude today's conference. We thank you for your participation.