Good day, welcome to W. R. Berkley Corporation's third quarter 2014 earnings conference call. Today's conference is being recorded. The speaker's remarks may contain forward-looking statements. Some of the forward-looking statements can be identified by the use of forward-looking words, including, without limitation, believes, expects or estimates. We caution you that such forward-looking statements should not be regarded as a representation by us that the future plans, estimates or expectations contemplated by us will in fact be achieved. Please refer to our annual report on Form 10-K for the year ended December 31st, 2013, and our other filings made with the SEC for a description of the business environment in which we operate and the important factors that may materially affect our results. W. R.
Berkley Corporation is not under any obligation and expressly disclaims any such obligation to update or alter its forward-looking statements, whether as a result of new information, future events, or otherwise. I would now like to turn the call over to Mr. William R. Berkley. Please go ahead, sir.
Thank you very much. Well, we're very pleased with our quarter. We think it demonstrates our earnings capacity, we think that in looking ahead, while there are bumps in the road, we're quite optimistic that we'll continue to be able to deliver outstanding returns. I'm going to let Gene start out by talking about our financial results. Excuse me. I'll let Rob Berkley start by talking about our operating results, followed by Gene. Go ahead, Rob.
Thank you. What a relief. I thought Gene was going to take all my material. Well, good morning, everybody. Market conditions during the third quarter, by and large, followed the trends that we've seen over the past few quarters. The domestic insurance market continues to offer the greatest promise from our perspective. Casualty and workers' comp continue to stand out as particularly attractive. The non-CAT exposed property also offers some opportunity, we are seeing the ability to get additional rate there. Having said that, CAT exposed property is a bit of a different story. As it relates to professional liability, it is very much a mixed bag or continues to be, as we've suggested in the past. By example, a D&O is very split between what we would define as the Fortune 1000, where that excess market is particularly competitive.
Having said that, the smaller cap part of that marketplace, there is opportunity for meaningful rate increase in both the primary as well as the excess. Commercial auto continues to be a bit of a challenge. Rate increases are being achieved in the marketplace. We expect that this is going to need to continue for an extended period of time. Adequate returns for this product line at times feel as though it's a carrot tied to the far end of a long stick, I think we're getting there gradually. On the international front, it depends on the corner of the globe that you're talking about, I would make the comment that both the U.K. and select parts of continental Europe remain exceptionally challenging. The big question mark or concern from our perspective continues to be the global reinsurance market.
We've talked about this over the past several quarters. It continues to be front and center on our radar screen. The fact of the matter is the cold that the property CAT market caught some time ago seems to be continuing to spread to other parts of the reinsurance marketplace, it would seem as though no bottom has been found yet. While a benign CAT season can mask some of these issues, there should be no misunderstanding, the underlying challenges persist. Turning to our organization and how we did over the third quarter. Net written premium came in at approximately $1.525 billion. This is an increase of 7% when compared with the corresponding period last year. The growth was primarily driven by our domestic insurance business, which grew at approximately 12% and was partially offset by our reinsurance segment, which was off by approximately 16%.
This very much fits with our expectations given the market conditions in the reinsurance space that I mentioned earlier, as well as in prior calls. Let there be no misunderstanding, we applaud our reinsurance colleagues for their underwriting discipline. Rate increase for our insurance operations was approximately 3%. The domestic insurance was a bit above that, our renewal retention ratio remains at about 80%. Loss ratio for the quarter was at 60.7, which includes approximately one point associated with CATs. It's worth noting, Gene's going to get into this in a bit more detail, that in our CAT number, there are two aviation hull war losses that are coming out of our international segment. Expense ratio showed improvement. We thought it was encouraging, particularly what came out of the domestic insurance segment.
This is another area that we're very focused on. We expect that we'll be able to continue to improve on what's going on with our expense ratio over the quarters to come. I would caution you that on occasion, we'll need to take one step back in order to take two steps forward. As it relates to the combined, it was a 93.5 on a calendar year basis. When you adjust for reserve development as well as CATs, we came in at a 93.4 on an accident year basis, I would remind you that this is approximately a two-point improvement from the third quarter last year. On the topic of loss reserves, we had net $13 million of positive reserve development. I would remind you also that this is the 31st quarter in a row of net positive reserve development.
As we look forward to 2015, we remain encouraged as we continue to see our rate increases in excess of loss cost trends continue to earn through. Thank you.
Thanks, Rob. Gene, you want to pick it up?
Okay. Thank you, Bill. Well, as you can see, we did have an outstanding quarter with a 46% increase in net income and an annualized return on equity of 17.4%. I'll start with just a few more details on the underwriting results that Rob covered. As he said, overall premiums were up 7%. The domestic growth of 12% was led by workers' compensation, professional liability, and selected short tail lines. In the reinsurance segment, the decline of 16% was a result of less treaty business written in both Asia and the United States. With respect to the underwriting results, underwriting profits were up 17% to $95 million, with a combined ratio of 93.5%. Just recapping again the major components of underwriting.
Accident year loss ratio before CAT down one point to 60.6%, as rate changes more than offset our loss cost assumptions. CAT loss is $15 million, one loss ratio point, and that included $9 million from storms in the U.S. and another $6 million that Rob referred to from the aviation events in the Ukraine and Tripoli. Favorable reserve development was $13 million, primarily in the domestic segment. Overall expense ratio down a percentage point to 32.8%, with the domestic expense ratio down a full two points, as many of the expense initiatives underway are beginning to have a stronger impact across more of our companies. If you look at those combined ratios by segment, domestic improved by 1.6 points due to improvement in both the accident year loss ratio and expense ratio, partially offset by slightly lower reserve releases.
The international segment combined ratio increased six points due to the aviation-related CAT losses that I mentioned before, as well as modest unfavorable reserve development, and the reinsurance segment combined increased by one point to 98.7 due to lower earned premiums and slightly lower, but still positive reserve development in the quarter. Turning to investments, our overall investment income increased 43% to $179 million. Most of the increase was related to investment funds, which earned $59 million, up from $12 million a year ago. The increase in the investment fund earnings in the quarter was primarily related to strong returns for funds in the aircraft leasing, real estate, and energy sectors. The overall yield on the portfolio, excluding gains, was 4.6% in the quarter, up from 3.4% a year ago. In addition, we reported realized gains of $72 million, up 65%.
The largest gain in the quarter was a $39 million gain that resulted from an IPO by one of our private equity investments. We report that investment under the equity method of accounting. Under that method, our share of the increase in the company's stockholder's equity as a result of the IPO, which was $39 million, is reported in realized gains. However, the full market value of the stock at its current price is not recognized if and until the stock is sold. At the current price, the market value of our stock exceeds the carrying value by $260 million, and that's not in the earnings or on the balance sheet. For our overall portfolio, aggregate pre-tax unrealized gains were $561 million, and the average duration and credit rating were unchanged at 3.1 years and double A minus.
In August, we issued $350 million of 4.75% senior notes that mature in 2044. A portion of the proceeds from that offering will be used to repay $200 million of 5.6% senior notes that are due in May of 2015. Our effective income tax rate increased to 31% in the quarter from 29% a year ago. As I talked about on our last call, as we earn more from underwriting and from investments other than investment income, our effective tax rate has moved closer to 35%. We repurchased 738,000 shares in the quarter and 5.6 million shares so far this year. With that, we finished the quarter with a book value per share of $37.10.
Up 13.1% from the beginning of the year.
Thank you, Gene. I'd like to talk about a couple things about our investment results, complain about the accountants, and try to give you a little bit better picture of where we expect to go. As hopefully most of you remember, I've told you certainly for the past few quarters that we would anticipate on average $25 million or more per quarter of investment returns. That's going to be a little lumpy. It may be more one quarter. We may miss a quarter. The fact is, achieving the kinds of investments goals that we've set forward and the returns we want for our company preclude us from having high-quality fixed income securities for all of our portfolio. We still have the vast majority of our portfolio in those high-quality fixed income securities, more than enough to meet all our liabilities.
We're talking about relatively modest amounts, $2 billion or $3 billion of our roughly $16.5 billion or $17 billion investment portfolio where we invest in these non-traditional kinds of things. We've been very successful in doing it. Part of the issue that we face is the accounting rules, which tell us where we book things, how we book things, which are not relevant from the point of view of building book value, but it seems to impact analysts more substantially than reality. That is, if it's in operating income, people think that's good. If it's in capital gains, it doesn't count. Oftentimes, these things are the same. We continue to build our investments portfolio in alternative kinds of things, our private equity portfolio, which is where we own large percentages of companies.
A good example would be HealthEquity, which is the company Gene was speaking about, where we booked a substantial income gain, and we have an unrealized gain in the portfolio, which is not reflected anyplace of $260 million or as of probably yesterday, $285 million. In fact, those are the accounting rules. We carry it at our equity. If it was in our regular ordinary portfolio, our book value would increase. There are other things that are similar to that. In our real estate portfolio, we have substantial gains that aren't recognized, again, carry it at cost. It's not that these realized gains are new and they went from yesterday's value to today's value. They are reflected because of accounting rules at cost, at equity or whatever. When, in fact, something happens to allow us to move the unrealized, unrecognized gains, it suddenly becomes visible.
We think that's a very significant number. Hard to get a definitive number on it, but certainly you'd measure it in $5 a share or more. We're pleased with our real investment results, have to recognize we've elected to take a course that gives returns that are less subject to building a model around them. We continue to be optimistic that there'll be opportunities to find such returns. We, at this point, have been able to continue to do that, we're very pleased at where we are this quarter and are optimistic about the balance of the year and continue to see opportunities that we can invest in. With that, Ben, I'm happy to take questions.
Ladies and gentlemen on the phone lines, if you'd like to ask a question, please press star and then one now. If your question has been answered or you would like to remove yourself from the queue for any reason, you may press the pound key. Again, for a question, please press star and then one now. Our first question comes from the line of Amit Kumar of Macquarie. Your line is open. Please go ahead.
Thanks. Good morning, and congrats on the quarter.
Thank you. Good morning, Amit.
Just very quickly. That color was very helpful. Some of the questions we were getting last night related to the discussion on the energy-related exposure in your investment funds, and especially as it relates to the drop in, I guess, crude and energy pricing of 22% in Q3. How should we think about that piece and its impact in Q4 numbers?
Well, current gave us a $5 million-$6 million positive in the third quarter, and my guess is it'll be break even to a loss in the fourth quarter. It's a bumpy process, the energy markets. They're not highly leveraged from that point of view. Our exposure to Current has been constantly diminishing as they liquidate their assets. It's a smaller number at the moment. I would think that would be a negative swing in next quarter.
Got it. The other question I had was, I think when Rob was talking about the expense ratio on domestic, obviously you pointed out the improvement, yet there was some cautionary language around that. Should we think about, I guess, the 31% as sort of the number we should think about for the next few quarters? Or is there more room for improvement in that?
Well, I'll let Rob answer the question.
I think as far as the domestic goes, I would encourage you not to get fixated on the 31.1. It can move up and down some number of basis points. Having said that, I think over a longer period, the trend is going to be downwards. A lot of it is, quite frankly, going to be driven by a mix of business and market conditions. I think what you really have seen in the domestic business is that our earned premium continues to grow, and we have gotten to the point where we're able to further leverage our platform. Again, I would suggest that you recognize that it could go up or down a little bit, but I think overall there's probably more likely over time room for a bit more improvement than not.
Got it. That's helpful. Just a quick numbers question for Gene. Do you have the paid losses number?
The paid losses or the paid loss ratio?
Paid loss number. I'll take anything.
The paid loss. Okay.
He doesn't give much, I'll tell you, not even to me.
The paid loss ratio in the quarter was 53.4%.
Got it. Okay, that's all I have. Thanks for the answers and good luck for the future.
Thank you.
Thank you. Our next question comes from the line of Michael Zaremski of Goldman Sachs. Your line is open. Please go ahead.
Thank you very much. Just a couple of questions in the domestic business. It looks like the short tail lines grew a bit, and comp also grew a bit. We saw some other players look like they're pulling back a little bit there. In comp, is that excess or primary, and can you give a little bit of color on the short tail lines, please? Thanks.
Sure. The growth is primarily driven by the primary comp as opposed to the excess comp. I think we had a little bit of growth in the excess comp, but again, it was mainly primary. That's just because, again, as we've suggested in the past, Mike, we don't think that everything is rosy for comp nationwide, but we think that there are certain markets, certain classes within the comp space that are particularly attractive, and we like the returns. We recognize that it's a cyclical business. The name of the game is to build up the iceberg as big as you can, because over time, market conditions will become less attractive. That's what we're doing in the comp space, adding to exposure, adding to count, again, because we like the returns.
Got it. Thanks. Just on international, how should we be thinking about that? Looks like the combined is kind of sticking up in the kind of 98-ish range recently. You've had some growth. The growth kind of pulled back a little bit this quarter. How should we be thinking about the trajectory for that business? Is that an area where you expect to continue to grow? Do you want to see that, or do you expect to see maybe the expense ratio follow the same sort of pattern that we've seen on the domestic side recently?
I think in the short run, you're going to see the growth rate slow a bit from what you have seen in past quarters. I think on the expense ratio side, clearly we have some work to do, and we are focused on that. As far as the loss ratio, there's just some work to be done there. Some of the businesses that make up that segment are performing particularly well. The syndicate is doing reasonably well, putting aside the two aviation hull war losses. Our European/U.K. insurance business, aside from our Lloyd's operation, we have some work to do there, as I think I mentioned a quarter or two ago, and we have already taken some action to get that to a better place, and we think the results of those actions will be coming through in 2015.
Got it. Just, Gene, can I ask a numbers question on other expenses? Looks like that number ticked up in the quarter. Obviously, that doesn't run through the combined ratio, but just trying to think about just overall operating income. Looks like it ticked up from about $33 million to about $42 million in the third quarter. Is that just some seasonality trend, or is that just something that flipped up this quarter and last quarter, or is that a level that we should be thinking about?
Yeah. That's the parent company expenses and then any expenses that we don't allocate back to the subsidiaries. One of those is a big portion of our incentive comp program is kept here at the parent level. As we make more money, we accrue a little bit more for that, and that comes through in the quarter when our returns are higher. It's unallocated expenses that we choose to retain here at the parent level.
Got it. That's in that Sorry.
Mike, let me just be a little more explicit.
Okay.
Our return for the year is going to move over 15%, we start to have to accrue on a different level for an incentive plan, which is all paid for at the parent company expense level and not allocated. As it's become much more likely that we'll exceed that 15% return for the year, one of our long-term incentive plans required a greater accrual.
I understand. Okay, as time goes on and you're accruing past that threshold on a net basis, you start accruing more incentive comp.
Yeah, except this was a catch-up for the first three quarters. Not quite, but we weren't there. When I say a catch-up, you make it for the year. For example, God forbid, we would have a terrible fourth quarter, we would find that would be an over-accrual.
Got it. If I were to take that accrual piece out and look at whatever the corpus of the expenses were, other than that, is it fair to say whatever that was, that didn't change much year-over-year?
There'd be some modest growth, but nothing significant.
Great. Okay. Thank you very much.
Thank you. Our next question comes from the line of Joshua Shanker of Deutsche Bank. Your line is open. Please go ahead.
Yeah, good morning, everyone. I want to talk to you guys about the traditional investment portfolio as opposed to the alt investment portfolio. I noticed that your investment yield seems to have gone up by about 20 basis points compared to a year ago or the second quarter. Have you changed strategy at all in investing, or what might be causing that?
No. The answer is no. Our duration is unchanged. Our quality of the portfolio is unchanged. For a period of time, we were able to invest our short-term cash and bring it down because cash flow was up. Our mix of short-term cash changed a little bit. It was quirky. Honestly, we did better than we had expected to do, and we were very pleased. We don't think there's anything that's particularly different.
If we look past the previous quarters, the run rate trend on shrinking NII in this industry environment is more normal instead of the big pop that you had in the quarter.
I don't know if I'd say shrinking, I would think that it would be more like flat to slightly up. I think this quarter probably ended up being disproportionately more cash invested in. The cash has increased again, the return probably will move back sort of in between where we were and where we are. I don't think you should think we'll get a much higher yield than we've averaged. It might be slightly higher. I think because of how we invested our cash, I think it was slightly better.
Do you have a breakdown for prior development by operating segment?
As you know, we do not give it on this call, but it'll be available afterwards.
Thank you very much.
Thank you. Our next question comes from the line of Kai Pan of Morgan Stanley. Your line is open. Please go ahead.
Thank you so much for taking the call, and good morning. The first question is on the investment side. Thank you for the disclosure about the substantial gain that's not on the book. I just wonder if you can quantify, if you were to mark-to-market all your holdings which are currently not on the book, do you have estimates of how much would that be as a percentage of the current shareholders' equity?
I said it would certainly be more than $5 a share.
$5 a share. Thank you so much. Also, just try to understand a little bit about that investment process, basically for the non-traditional investments. Could you give a little bit more sort of color on what's the approach there, and how do you come up with these deals? The question is really to say, what's the consistency of the return going forward?
Consistency in the short run, there is none. Consistency in the long run, we continue to be opportunistic, searching for what we believe are good risk-adjusted returns where we aren't required to have liquidity. We bought an office building in West Palm Beach, Florida, because someone needed to close, and it needed to be a cash closing in a very short period of time. It was the very best office building, and to get approval to do that again at this point in time would take years. That would be an example.
These deals just come to you, or you have a regular sort of process, like a basic investment process, and you evaluate as opportunity arises?
Both. We have a regular process as far as private equity things where we have our own private equity team where things come in. We have our own real estate team that looks at these. Some things, such as the real estate transaction in West Palm Beach, they come to us because someone here knows someone. We're sort of just out there looking.
Great. Second question is on the reinsurance side. Given all the alternative capital as well as of now that there are some carriers, primary companies talking about creating internal reinsurers that potentially pulling the demand from the open market. I just wonder your thoughts on both as a buyer and seller of reinsurance in this changing marketplace.
I think, stating the obvious, it's a better moment to be a buyer than a seller. I think as far as long term goes, it's still a bit unclear as to the permanence of this alternative capital. It hasn't fundamentally been tested from a loss perspective, where a lot of the decisions and judgments which are based on models prove to be wrong as a result of some type of unforeseen or unfortunate event. I think in addition to that, while parts of the casualty reinsurance market have become a bit more competitive, much of the alternative capital has not necessarily found a way to effectively penetrate that market. To make a long story short, our expectation is that the reinsurance market, particularly the traditional one, is not going to go away overnight.
This is a challenging moment, and there remain opportunities to participate in the reinsurance market that are reasonably attractive, but there is no doubt it is a competitive time.
I think that this is an ever so alluring business, appearing so predictable, but proving to be particularly unpredictable when the unforeseen event arises. Many companies after Katrina and several other events would have proved to be insolvent if, in fact, anyone had said, "Okay, you have to pay your claims now." They went out and rushed and raised capital very quickly on financial statements that, at best, were questionable. I think when Rob said they've been untested, it's a very quick period of time when these companies could be tested, their capital accounts could be gone, and not only will they be tested, but the people who purchased reinsurance from some of them will be tested.
The moral commitment of participants in this business is a really important factor, and many of the people who are now playing in that industrial game don't have substantial moral commitment to our industry.
Okay. Thank you so much for the thought. Lastly, on capital management, and it seems like you have a very strong earnings year-to-date and buyback slowing down a little bit. Just wonder your thoughts on buybacks going forward or any thoughts on a special dividend.
One of the things we face is the opportunity to buy back stock when we're blacked out because our lawyers say we're taking a risk when there's opportunities. We're trying to constantly measure our capital, our alternatives of regular dividends, special dividends, and buying back stock. As you and everyone knows, when we talk about myself and other senior management of the company, everyone is concerned about capital usage, and we'll be very conscious of all those things, and we're examining all those options.
Thank you so much for the answers.
Thank you. Our next question comes from the line of Vinay Misquith of Evercore. Your line is open. Please go ahead.
Hi, good morning. Several small questions. First, thanks for the $5 number of unrealized gains. Is that an after-tax number, Bill?
It was an estimated number to give people a magnitude picture of what it could be. I'm really trying to give people an idea. I would tell you that it probably is, but it's an estimate.
Sure. Fair enough.
As I said, it shouldn't be modeled in, it can't be modeled in.
Oh, no.
It's a number to give people a sense-
Yes
of what's out there.
Yeah. No, that's fair enough, but I think that's really helpful. Second question was pricing versus loss trend, and I believe Rob said that you have some ways to go on the international side where you can actually reduce the combined ratio. Given that pricing and loss trends are now roughly flattish and maybe going the other way, but that may be offset by some margin improvement in the international, do you still think that you can keep margins flat, or do you think that the combined ratio is going to tick up next year?
Did you want to? Would you like to?
You can go. I'd rather let you talk, and then I can comment on what you say.
Thank you. I think, obviously, we're in the throes of our planning process, but when we look out the front windshield, our expectation is that for 2015, we should be able to certainly keep up with trend if not exceed it in general. In addition to that, we think that there will be some further benefit coming through in the expense ratio, particularly on the international front. All things being equal, I think the reported numbers, barring unforeseen events, should probably hang in there or improve next year. On a policy year basis, I think there's certainly room for us to do as well, if not better.
Yeah. I am more optimistic. I think that, in fact, as premiums get earned, we will see continued improvement from the past 12 months' rate increases.
Okay. That's helpful. Just wanted to have a clarification on the yield on the fixed income. I thought that the dollars of fixed income earnings this quarter was about $120 million. That was about $107 million, $108 million in prior quarters. There seems to be a jump this quarter. Was this a one-time item in there?
There are various things, but you got to remember our cash flow was almost $400 million also.
Okay.
There was a big amount of cash flow also that accounted for part of it. The fact is that, every quarter there are various changes, things that happen. We have 52 operating units. We have lots of bundles of securities. The general view I would have is our core portfolio will have a slightly better trend than it had in the prior quarters, but you shouldn't think we'll do a lot better than we did before.
If I could just give another reference to that. Our yield on the fixed income portfolio for all of last year was 3.6, and it's 3.6 in the third quarter of this year. It was slightly lower in the first two quarters, but it's back around where it's been for the last four quarters.
Okay. I just want to be sure that there was nothing sort of untoward this quarter, and this quarter is maybe the base for the run rate for the future. Okay.
I think that this quarter had a couple of quirks in it to make it slightly better, but not an overwhelming number.
Okay. The last thing, if I may. The pace of reserve releases has slowed a little bit this quarter. Just curious as to what's happening there. Thanks.
The answer is, over time, as pricing in reserve releases get more modest, they should get more modest. The fact is, as you saw, we've already had three or four companies have adverse reserve releases. We're pretty pleased. Our reserve position is very comfortable, and I think that everyone has been spoiled by a few of our very large competitors with huge reserve releases. It's never been an issue with us.
Thank you.
Thank you. Our next question comes from the line of Brett Horn of Morningstar. Your line is open. Please go ahead.
Yes, I wanted to ask a follow-up question on the previous question on the expense ratio on the domestic lines. I appreciate your comment that it could potentially tick up here in the very near term, but it sounds like you're positive about the longer-term direction. Obviously, you've got more active in those lines and presumably are scaling your costs there. I guess my question is to see a positive longer-term trend, do you need to see the pricing picture get even better, or would just a status quo situation allow you to continue to leverage that cost?
I'm pausing because I'm trying to figure out how to answer the question without getting myself in a corner or splitting hairs. I think the answer to the question is for the domestic insurance business, we think give or take a certain number of basis points, we can do a little bit better over time as our earned premium continues to grow, reflecting the written growth that we talked about earlier. I think that that is not necessarily perfectly smooth or perfectly predictable, and it can ebb and flow by quarter. What I can tell you is that all of my colleagues, both domestically as well as outside of the United States, are focused on our expense ratio overall as a group and are determined to make sure that we are spending what we need to spend and not spending more than we need to spend.
Will the 31.1 come down X number of basis points? Yeah, I think it's possible that it could get a little bit better from here over time. A lot of that's going to be driven, quite frankly, by mix of business as well and to a certain extent, the type of reinsurance we're buying. I think the areas of lower hanging fruit are probably in the international segment over the next six to 12 months.
Okay, great. Thank you.
Thank you. Our next question comes from the line of Jay Cohen of Bank of America. Your line is open. Please go ahead.
Thank you. A couple of questions. I guess, first, on the reinsurance side, one thing we do notice is that you retain the bulk of your reinsurance premiums. Your net to gross really hasn't changed. In fact, it's gone up a little bit. Given the softness in the reinsurance industry, have you explored, and could there be an opportunity to buy some retro from people that want to sell it too cheaply, potentially?
Jay, I think probably the best way for us to answer that is we are cognizant of the market. We are cognizant of the various types of pools of capital that are out there that seem to have an unquenchable thirst to participate in this marketplace. We have in the past and continue to explore and consider whether there are alternatives to using our shareholders' capital that would make more sense.
Got it.
How was that for a non-answer answer?
Yeah. It's a reasonable non-answer, though, so that's okay.
Thank you.
The other question was on HealthEquity. You obviously gave us the numbers for its market value in excess of cost. When we think about the contribution-
By the way, that's in excess of our book cost. We have a real cost of zero at this point.
Got it. Carrying value, let's say.
Correct.
When we think about the economic value, forgetting accounting, is that something we should tax adjust anyway, or is that an after-tax number?
No, that's a pre-tax number. We elected not to sell any of the stock because we think it's an outstanding company. I think that we have not tax adjusted it.
Eventually, when you do sell it, obviously, there'd be a tax bill.
Yes. The answer is yes.
Okay. That's all I got. My other questions were asked and answered. Thanks.
Okay. Thank you.
Thank you. Our next question comes from the line of Larry Greenberg of Janney Capital. Your line is open. Please go ahead.
Hi. Thank you and good morning. Just one quick one related to HealthEquity. They declared a dividend, I think, the day before the IPO, and you guys got $17.5 million. Is that included in the gain that you reported, or is that something that you might report on a lag basis?
No, that's taken into account.
That reduced our cost basis, and then the increase in book value took it up. It's my frustration with the accounting treatment. Sorry. I've finally gotten old enough that I could tell the accountants they're wrong, I wouldn't convince them they're wrong.
Okay. That's all I had. Thanks.
It all appears as in the gain.
Okay. Thank you.
Thank you. Our next question is a follow-up to the line of Amit Kumar of Macquarie. Your line is open. Please go ahead.
Thanks. Just one quick follow-up on the investment funds. I guess the other question we were getting was the discussion on the merger arb piece of your investment portfolio. There has been a lot of chatter in the news regarding the unwinding of some deals. Apart from the tax discussion, do you get the sense that you will see some impact from all that is going on in the merger arb space in your Q4 numbers, or is that somewhat unaffected?
You're asking me to tell you what already has happened, right?
Yes.
The answer is no, we did not get particularly adversely impacted.
Okay. That's.
That goes under the forecasting what already happened exception under our.
Under Harper.
Go ahead.
Thank you. Our next question comes from the line of Ian Gutterman of Balyasny. Your line is open. Please go ahead.
Hi. Thank you. Bill, I was hoping, or Rob, I was hoping one of you could expand a little bit more just about market competition and how it might affect your future growth plans. I guess I'm thinking specifically, well, you mentioned internationals, maybe you could expand upon what you're seeing there in London, so forth. Also, are we seeing competitors that maybe six months or a year ago would've been focused more on improving their own books, starting to be more aggressive for new business, or are we seeing more E&S business return to standard markets, things like that?
I think it would be fair to characterize, maybe to bifurcate between domestic, and then we can talk about any markets outside of the United States that we participate in if you wish to. On the domestic front, I think it is fair to say that the market is a bit more competitive now than it was 12, 18, 24 months ago. Having said that, we do believe that we're still able to achieve rate that's a bit above what we believe loss cost trend to be. Having said that, it's an interesting moment because the level of competition seems to ebb and flow by the month. For example, we found July to be particularly competitive August was a bit competitive. September was a little bit less competitive, and actually October was very encouraging for many of our companies in the group, and again, this is domestically.
It's up and down. Clearly, some of it is driven by competitors, perhaps trying to make their budgets at certain times of the year. I think we're pretty comfortable that by and large, the market conditions that we have seen in the third quarter will certainly continue into the first half of 2015, if not beyond. As it relates to the U.K. market, I think you had referenced also, look, it's an exceptionally competitive place. You got a lot of very skilled people managing a lot of capital within a couple of blocks of one another, and as a result of that, you get a very competitive marketplace.
In addition to that, much of the business they write is CAT-prone and short tail, so when things don't go the wrong way, people end up feeling pretty good about themselves, and sometimes that euphoria from the shorter tail lines of business can appropriately or inappropriately spill over into the longer tail lines of business. As a result of that, you get a very competitive market. That's been the case for some period of time, and it is our expectation at some point you're going to have to see that change, particularly for some of the casualty lines.
Got you. International, obviously more difficult. In the U.S., those comments then, again, I assume it always does on some accounts, but as an overall theme, it's not impacting your ability to grow in the areas you want to grow in then?
We are comfortable with the U.S. insurance market. We think, again, a bit more challenged than it was 12, 24 months ago, but we still think it is a good opportunity as opposed to the reinsurance market, which is facing more of a headwind on a global basis, and the international insurance market. Obviously, it varies by territory, but as we suggested, U.K./parts of Europe are also facing a bit of a headwind.
Great. Thanks for the answers.
Thank you.
Thank you. Again, ladies and gentlemen, to ask a question, please press star and then one. Our next question is a follow-up from the line of Joshua Shanker of Deutsche Bank. Your line is open. Please go ahead.
Yeah, Bill, sorry to belabor things on this cash in the quarter. Just trying to understand a little better. If you receive a lot of cash in the quarter and reinvestment at the current market, doesn't that depress the overall yield of portfolio? I guess I need just a little education on how that works.
I'm sure you can talk to Gene after the call.
Okay. Next question. I try to answer it for myself. I noticed over time that there's been a concerted effort to decline the percentage of the portfolio invested in municipal bonds, which municipal bonds, of course, have a lower yield than traditional fixed income corporates. Is that going on? Why, if maybe we think that tax rates are at risk to rise or maybe they're not at risk to rise, why is the strategy of the company trying to own less munis over time?
In the areas that we invest, the relative yields on municipals are not as attractive. The reason our tax rate is going up is because we're having substantial realized gains, which are fully taxable. The investment income is a smaller percentage of our overall income. If you look at the relative yields on an after-tax basis, municipals are particularly rich in the five years or under.
Okay, thank you.
Thank you. Our next question is a follow-up from the line of Jay Cohen of Bank of America. Your line is open. Please go ahead.
Thank you. If I build in a little bit of adverse development, low single-digit numbers, millions of dollars, it looks like the accident year loss ratio in that segment, ex CATs, jumped up quite a bit from a year ago and even quite a bit from the first half. I'm wondering, are there any other non-CAT large losses in that segment and/or what drove the presumed increase?
No, there's nothing else in there. We did raise our loss pick as we saw some of that unfavorable development come through. We raised our loss pick, and there was a bit of a catch-up because it came through in the quarter. The expense ratio is slightly higher as well.
I was just focused on the loss ratio.
Yeah.
On that loss ratio then, Gene, for a reasonable run rate number, should I look at maybe the first nine months of the year as kind of what you suspect that business is producing?
I think that would be pretty accurate.
Great. Thank you.
Thank you. I'm showing no further questions. I'd like to turn the conference back over to management for any closing remarks.
Okay. Well, thank you all very much. We're really quite pleased with the quarter and quite optimistic with the balance of the year. I wish you all a very happy Halloween.
Ladies and gentlemen, thank you for your attendance today's conference. This does conclude the program, and you may all disconnect. Have a great rest of your day.