Good day, welcome to the W. R. Berkley Corporation's fourth quarter 2013 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, beliefs, expects, or estimates. We caution you that such forward-looking statements should not be regarded as representation by us that the future plans, estimates, or expectations contemplated by us will be, in fact, achieved. Please refer to our annual report on Form 10-K for the year ended December 31st, 2012, and with 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, Kate. Good morning. We're really pleased with where things are going. We're pleased with the environment and the opportunities that we see. We're pleased not only because we see opportunities for going forward, but we're pleased because we see the issues that are problems, and we feel we have solutions that will allow us to move forward. We're going to start with Rob talking about the business, then Gene talking about our numbers, and we'll follow up with me talking more of an overview, and then take questions. Rob, you're up.
Okay. Thank you. Good morning, everyone. During the fourth quarter, market conditions were notably split between the world of insurance and the world of reinsurance. The insurance market, particularly the domestic insurance market, was for the most part, consistent with what we've seen in the past quarter or two. Property pricing continues to erode gradually. Professional is a mixed bag, and it varies depending on the class, and it varies oftentimes in primary versus excess. For example, medical remains quite competitive. Lawyers professional is offering opportunity for rate increase. D&O within itself is very mixed. On the public side, primary is offering opportunity for rate. Excess seems to be somewhat flat. Not-for-profit and private D&O, there seems to be rate that continues to be available, as well as EPLI. Having said this, general casualty and workers' comp continue to be the bright points.
We expect these trends to continue barring any unforeseen events in the foreseeable future. The one exception may be professional, which in our opinion, is likely to improve over the next several quarters. On the other hand, the treaty reinsurance market experienced an increase in competition like we haven't seen in some time. It started with an oversupply, as many are aware, in the property cat market that created somewhat of a feeding frenzy, if you will, which surprisingly actually spilled over into the casualty treaty market to a certain extent and created a bit of a downward spiral from a pricing perspective. Additionally, the environment for treaty reinsurers was somewhat compounded as far as the challenges go, as a result of an ongoing shift or change in the buying habits and patterns of many leading companies. It's unclear how this is going to play out in the short run.
However, it would seem reasonably clear that it will be challenging for the reinsurance market to achieve their desired long-term returns given where the current rating environment is. With regards to the company, net written premium for the fourth quarter of 2013 was $1.36 billion. This is an increase of 11% compared with the fourth quarter of 2012. The domestic insurance operations led this growth, with more modest growth coming from our international insurance and reinsurance segment. Of the 11 points of growth, 5.7 were associated with rate increase and the balance coming from exposure. The slight decline in rate increase is primarily due to a bit of a shift that we're directing within the organization with some of our operations that are achieving or exceeding our targeted returns on a policy year basis.
Consequently, we are refining the balance between rate that we are seeking versus growth as from an exposure perspective. It's also worth mentioning our renewal retention ratio remains at approximately 80%, which continues to give us comfort that the quality of the book is in no way being undermined and quite frankly, remains well intact. The loss ratio improved appreciably to 61.4%. This includes 1.2 points of positive reserve development and cats were a little bit less than one point. The paid loss ratio was approximately 52%, which as we suggested in the past, provides us a degree of comfort or an early indicator as to where the ultimate losses may come out. The expense ratio remained essentially flat.
Having said this, given the actions that we have taken in 2013, combined with the further actions we will be taking in 2014, we expect you will see some degree of improvement with the expense ratio during the 2014 year. Additionally, the expense ratio will benefit from continued growth in the earned premium. This gives us a combined ratio of 95.1% or an improvement of three points when compared with the fourth quarter of 2012. Gene's going to be giving you a bit more color on the numbers as he has in the past, but I would make a couple other comments briefly. Much of the improvement was due to our domestic or U.S. insurance operations, in particular. Some of the loss activity that we had in the reinsurance segment stems from property losses coming out of the property portfolio we have in Asia.
That's in the reinsurance segment. On the insurance front, we had some property losses and surety losses. Again, this is in the international insurance segment, and this was specifically in Europe. We have our arms around these issues and have already taken the required action to address them. The balance sheet remains strong. The fourth quarter of 2013 marks the 28th quarter in a row of positive reserve development. As we've discussed in the past, our philosophy is to set our initial loss picks cautiously with the idea as more information becomes available and those reserves seasoned, we're able to tighten our picks.
Beyond that, as far as the balance sheet goes, our chairman certainly will be discussing the investment portfolio amongst other things, but I would tuck in the comment that we continue to strategically manage the investment portfolio, trying to strike an appropriate balance between yield, duration, and expected movement and interest rates. We remain quite optimistic about the opportunities before our organization. As I suggested earlier, we think one of the bright points in the marketplace is the U.S. casualty market. Given how weighted we are towards U.S. casualty as a group overall, we believe that this will hold us in very good stead both today and for the foreseeable future. Thank you.
Okay, Gene, you want to pick up and go through some of the numbers, please?
Okay. Thanks, Bill. As Rob said, we finished the year with another solid quarter with strong premium growth, continued improvement in our combined ratio on both an accident year and a calendar year basis, and a significant increase in our operating income compared with the fourth quarter of 2012. Overall, our net premiums written were up 11% to almost $1.4 billion, the combined ratio decreased 3 points, to 95.1 in the fourth quarter. Catastrophe losses were $13 million in the quarter. That's down significantly from last year's fourth quarter cat losses of $41 million, which were almost all related to Sandy. Favorable reserve development in the quarter was $12 million or 1.2 loss ratio points, and that compares with $20 million or 1.6 loss ratio points a year ago.
The accident year loss ratio before considering catastrophe losses was approximately 95% in the fourth quarter. For the full year, our accident year loss ratio improved 2.5 points from 98 in 2012 to 95.5 in 2013. In addition, as Rob mentioned, our paid loss ratio, excluding the impact of a specific reinsurance commutation, continued to be very strong at 52% in the fourth quarter and 54% for the full year. Looking at the individual segments, for our domestic segment, net premiums grew 14% to just under $1 billion. The growth was led by our workers' compensation and other liability lines, which grew 19% and 14% respectively. The domestic segment combined ratio fell three points to 92.8 in the quarter with strong underwriting results from Excess and Surplus lines, our regional business, and our monoline workers' compensation company.
Domestic cat losses were minimal in the quarter at just over $1 million. For the full year, the domestic segment's accident year loss ratio before cat declined two points to 95%. Our growth was more modest than the other two segments, reinsurance and international, where, as Rob mentioned, the market conditions are lagging the primary insurance market in the U.S. For the international segment, our net premiums were up 1% to $184 million as growth in our Lloyd's business was partially offset by decline in our direct European business and by the impact of foreign exchange rates. The reported combined ratio decreased one point to 102.4, due primarily to lower catastrophe losses. For the full year, the international segment's accident year combined ratio declined two points to 96%.
The fourth quarter accident year combined ratio was slightly higher at 100% due to an increase in losses from short tail lines as well as a higher expense ratio. For the reinsurance segment, net premiums increased 4% to $188 million, and the combined ratio decreased five points to 100.2 primarily due to lower cat activity. For the full year, the reinsurance segment's accident year combined ratio also declined by four points to 99%. Our overall expense ratio for the company was 33.7 in the quarter, up 0.2 from a year ago. The domestic segment expense ratio declined 0.2 to 32.3. Although the international and reinsurance expense ratios increased slightly in the fourth quarter due in part to the modest growth in our premium, the longer-term trends for those segments are still much better.
Since 2010, the International segment is down 4.5 points to 39 in full year 2013, and the reinsurance expense ratio is also down four points to 34.8 in full year 2013. We expect those trends to continue. Our investment income was $139 million in the quarter. That's 8% below last year's fourth quarter, but it's also an 11% increase over the preceding quarter of this year due to increased earnings from investment funds. For the full year of 2013, our overall investment yield was 3.7%, compared with 4.0% in 2012. We also reported realized gains of $25 million in the fourth quarter and $121 million for all of 2013. Our effective tax rate declined in the quarter to 25.5%. That's due to the impact of both tax-exempt investments as well as higher foreign tax credits in the quarter.
You'll notice we reported a reduction in income of $5 million for non-controlling interest. We control and consolidate an investment company that has minority shareholders. That company reported a realized investment gain in the quarter, and approximately $4 million of that gain was attributable to the minority shareholders. The way we show that is we show the gross gain in our realized gains, and we show the minority shareholders' portion of that gain as a non-controlling interest. In total, that gives us net income of $130 million for the quarter or $0.93 per share and an annualized return on equity of 12.1%. One other comment. If you take a look at page eight of the release, you'll see that the breakdown of our investment portfolio is presented there, and that's mostly unchanged from September 30.
I did want to point out that we made a change in the presentation of this information. In previous releases, we had separately reported foreign corporate bonds, and we recently decided that it made more sense not to separate the foreign corporate bonds from the U.S. corporates. The main reason we made this change is that many of these, what we were calling foreign corporate bonds, are actually backed by multinational companies, and we felt the designation of foreign and non-foreign was somewhat subjective and not meaningful. At year-end, the average portfolio duration was 3.3 years. The average credit rating was unchanged at double A minus, and the aggregate unrealized investment gains for the portfolio were $257 million. Our operating cash flow, excluding the impact of the commutation I mentioned, was up. It was $255 million in the quarter and $881 million for the full year.
Finally, we repurchased 3 million shares of our own common stock in the fourth quarter and almost 4 million shares or 3% of our beginning outstanding shares in full year 2013.
Thank you, Gene. We were pleased with the results. Briefly, our investment portfolio changed only slightly. We effectively changed part of our common stock investment strategy to a hedged portfolio where we hedged with options and had less exposure. It reduced our net exposure to the market. It's proved to be a good decision. At the same time, we've slightly increased our municipal exposure, and we've slightly increased, effectively, our cash. Our general view is the biggest question we face as an enterprise is the tension between the risks of inflation and the threat of deflation. It's costing us a lot of money to maintain the liquidity we have and to keep the duration of our portfolio at 3.3 years, which is sort of 10% below the duration of our liabilities. Our liability duration is 3.6 years roughly, and we're at 3.3.
It's sort of a leaning, not being too definitive towards the fear of inflation. Inflation is how we set our reserves, assuming a certain level of inflation. The redundancies come out because, in fact, that inflation that we feel is just around the corner has not materialized. As long as that continues, we'll continue to have significant redundancies coming out or being built up in our reserves. That cushion is really nice. It's happened for an extended period of time, and it protects us from the uncertainty of inflation. We're doing the same thing in our investment portfolio. We're keeping that shorter duration. In fact, that's a cornerstone issue of minimizing our exposure to that unforeseen loss. We look at the $4 trillion balance sheet of the Federal Reserve, and we're worried. There's no sign we're not being foolish. We're not selling all our long-term bonds.
We're still investing and maintaining that 3.3 year duration. We're still establishing reserves with an expected level of inflation that's reasonable and not crazy, but it is the guidepost that says you need to worry. It's out there. It could happen, and it'll happen when you can least afford it. Some of our competitors are taking a different stance. In the short run, it is costing us. We think in the long run, we'll be rewarded. I think generally speaking, we're pretty pleased with our results. We haven't gotten our expenses where they need to go. It's at the top of our priority list, along with what's always been our first item, which is underwriting profitability, price increases, which, especially on a domestic front, we had an excellent year. We expect that same discipline is going to be applied throughout the world and most places it is.
With that, Kate, I'm happy to turn this over for questions.
Thank you. Ladies and gentlemen, if you have a question at this time, please press star, then the number one key on your touchtone telephone. If your question has been answered or you wish to remove yourself from the queue, please press the pound key. One moment for our first question. Our first question comes from the line of Amit Kumar with Macquarie. Your line is open.
Thanks, and good morning.
Good morning.
Just going back to your opening remarks, can you just talk a bit more about that shift in the direction regarding balancing rates versus growth? If pricing is at 5%-6% and loss costs are running at 4% or so, how should we think about this shift and its impact on margins going forward?
For first, I don't think we said loss costs are running at 4%. Somebody else may have, but that isn't what we said. Rob, you can.
Yeah, I think you're referring to a comment I made. Really, the point that we were trying to articulate is that it's a balance that all of our operating units are constantly trying to strike between rate versus adding to exposure or, in many cases, policy count. For us, we have a growing number of our operations that, on a policy year basis, are meeting or exceeding our targeted returns.
Again, we find ourselves when we get into that position saying, "Do we want to push rate harder and possibly write less business, or do we want to temper how we are pushing for rate and get what we think the market will bear but also grow count to a certain extent?" I think one of the pieces to your earlier point that one needs to keep in mind as it relates to the 5.7%, which incidentally for our domestic insurance was north of 6%, is that we remain very comfortable that we are out pacing trends by a notable margin to the extent that, quite frankly, our margins continue to improve.
Are loss costs running at 3% or so?
It depends on the line of business, to be perfectly honest.
I think that our view has been that three-ish has been the pick that we've been using for some time now. I think, quite frankly, there are some out there that in the past have been more optimistic than us, or perhaps having to catch up a bit, or maybe choosing to pick a higher number, but we feel based on everything that we know about our book and what we see going on around us, that three will continue to be an adequate number. Quite frankly, again, as the reserve development has played out, referenced earlier in the discussion, it's proven to be more than adequate.
That's helpful. I guess.
Let me just add that.
Yeah
That three number, which we sort of have used in our reserving, in fact, is the number that has proved to be, in reality, a little more conservative than what reality has been. I think that at least that's where it's been to date.
Got it. I guess in conjunction to that, in terms of the buyback, was that a function of growth opportunities in Q4, or was it a function of the stock price? Maybe just talk about the relative attractiveness, because if I recall your comments, I don't think a lot of us on The Street had that level of buyback in our model.
Well, the goal is always to keep everyone uncertain. I think that part of it is you buy back stock when the stock is available, when people come to you and offer you pieces of stock, when you can do things, and you think the stock is attractive relative to where you think the intrinsic value of the enterprise is, what you think the growth opportunities are, and what the returns are. Just as in the third quarter, we had a substantial capital gain, which generated unforeseen excess capital, which gave us the capacity to buy back a lot of stock outside of our modeled capital needs.
We plan on our capital use, and anytime we generate substantial capital above our capital plan, we step back and say, "Okay, are we going to be able to grow fast enough to use it? Do we want to buy the stock back? What availability do we have for buying back stock and what price?" It's a constant measure of where do we go, what do we do? Honestly, we felt the stock's value was good from the point of view of our shareholders versus the alternatives of how do we create value and maximize the returns for our shareholders. Tomorrow, we might decide it'd be better to pay a special dividend or find a company to acquire. I can't tell you. We make decisions, we talk to the board as to what the right opportunity is at the time.
The issue is we were generating, and in this case, mainly because we had an especially large gain, based upon what's opportune at the moment.
That's helpful. Just finally on the expense ratio comment and you mentioning that it's one of your top priorities for 2014. We have talked about it for some quarters, and we have seen some improvement. When we look forward, are we talking about a few points of improvement, or is it going to be sort of a slow trend line improvement? What would be the biggest driver at this juncture?
This is Rob. I think the answer is that in all likelihood, you will see a gradual improvement over 2014 and certainly into 2015. As I suggested, part of the improvement will come from higher earned premium, and quite frankly, some of the smaller businesses in their infancy, their earned premium getting to a more substantial level or catching up with their written as they grow a bit. I think the other thing that we're constantly looking at is whether we as an organization are as lean and mean as we need to. Are the things that we are doing, are we fully embracing efficiency where we can? At the same time, that should not be misinterpreted. We are not going to depart from our decentralized structure.
I think a lot of the benefit will come from higher earned premium at the same time as we have in the past, and we will continue to be vigilant about how we spend dollars and pennies as well. I think the other comment that I would make is it's a slippery slope to line up all P&C insurance companies and start comparing their expense ratios. I think one needs to take into account the mix of business and the nature of a higher expense model that often goes along with some of the specialty lines. One needs to be able to compensate for that, and then some with the loss ratio ultimately delivering an attractive combine, which we are acutely aware of.
I think that one needs to understand that there are parts of our specialty business, quite frankly, that are running at combines in the 80s, and they have an expense ratio that starts with a four. Ultimately, our view is that that makes sense because we're delivering a good return. Again, as it was suggested earlier, we are acutely aware of the expense ratio, and we would like to see that improve by certainly a couple of points over some period of time. At the same time, I would caution people and not leap into any conclusions based on comparing our expense ratio to others that have a very different mix of business.
Got it. Very helpful. Thank you for all the answers.
Our next question comes from the line of Michael Nannizzi with Goldman Sachs. Your line is open.
Thanks. I think one question, Rob, I guess, somebody asked the expense question, but I think it was either you or Gene that mentioned the underlying or actually year combined annually in the segments, and we're trying to figure out what that implied about the international segment in the fourth quarter. Can we get a little color on that?
Gene's comment and let me see if, well, Gene, are you able to connect those dots?
What I said was that the fourth quarter combined ratio was around 100.
That's a point below where it was a year ago. It's been slightly elevated just because of the expense ratio.
Okay.
It's improving.
Got it.
9 for the full year.
Got it. The growth, how much of the growth coming off in the fourth quarter was just due to FX?
Actually, the FX for the international segment on a gross basis was down one percentage point and on a local currency basis, it would have been up three or four percentage points.
Got it.
On a consolidated basis, it was down. It was nothing of consequence.
I understand. I'm just trying to understand. You had some growth there during the last few quarters, and that seems to have pulled back in the fourth quarter. Was there something specific, or was it just you reached scale in the businesses you were trying to grow or just trying to understand kind of what might have changed in the fourth quarter?
Yeah, I think it's a combination of both, Michael. There are certainly some parts of our international insurance where they've reached a critical mass, and you're not going to see the same level of growth that you have seen in the past unless you see an improving market that they operate in. Quite frankly, as we suggested earlier, there are many markets outside of the United States that remain remarkably competitive and, I would suggest to a certain extent, in some situations, irrational. Again, it's a combination of reaching some degree of critical mass in some places. In other places where we've just concluded that we don't like the opportunity, and we are willing to shrink the business. No different than what we have done in the past domestically when we don't like the opportunity.
We're in it to make an underwriting profit, and if we don't think we can do that, we'll just not do it or certainly do less of it.
I think withdrawing in particular pieces of the business on an international basis appears to be more significant because it's a much smaller business. We withdraw from one particular thing or another, and in a quarter, it particularly may seem more consequential than it would elsewhere.
Got it. Was that pullback related, or was that in any of the lines or areas where you were growing? Did you grow in something and then decide maybe you didn't like it as much and then you cut it off, or was it something where you had a presence for some time and for whatever reason, it just no longer met your hurdles?
It's probably a combination of both to a certain extent, but it's more driven by places that we have been for an extended period of time, and we remain astonished by the level of competition. To our colleagues' credit, they know where the line needs to be in the sand, and they stay on the right side of that. I would use as an example for you, U.K. professional liability. Our book of U.K. professional liability is one-third the size it was at its peak or maybe even a little bit less. We just don't get it.
We have lots of theories why some of these folks continue to chase it down the drain, that would be an example, Michael, of something that is moving the needle from a top-line perspective, where we have the people, we have the expertise, we're focused on doing the right thing, and we're taking a long-term view. That market will come back, we are convinced, at some point, and we will be there when others will have had to permanently retreat.
Got it. That's really helpful. Thank you. Just last one, not an underwriting question, but the net income from your wholly owned subs was higher this quarter, and is actually higher in 2013. It was actually pretty positive in 2013 versus really effectively flat in 2012. How should we think about that? I don't have a lot of insight into the, I guess, hangar leasing business or I think that's what part of it is. But if you could give us some color on that'd be great. Thanks.
It's an aviation service maintenance business as well. We service parts and international military and airports around the world. It's a business where we made an acquisition last year that helped us expand the business. The business is growing. It's just more profitable. The fourth quarter was especially profitable. I think the fourth quarter run rate was probably better than we'll have for the balance of the year, but the rest of the year will be 2014 rather, will be a good year, but not as good as if you annualize the fourth quarter.
Great. Thank you.
Our next question comes from the line of Josh Shanker with Deutsche Bank. Your line is open.
Yeah, good morning, everyone. I don't want to talk about a specific case. Of course you'll know where I'm getting. When you guys have a large judgment that affects you, what is the policy about case reserving for significant losses?
The policy is we always examine cases and reserve as we think appropriate.
Is there a pooling of general reserves for such losses, or if you had one specific outsized loss, would that be a risk that you'd have to take a case reserve at a later time?
We always reserve as we think appropriate, Josh.
Okay. Thank you very much.
Our next question comes from the line of Gregory Locraft with Morgan Stanley. Your line is open.
Thanks. You guys have, I think it's been 28 quarters or so in a row of reserve releases.
This past quarter, if my math is right, it was the lowest of the entire track record, and just in terms of absolute dollars.
I don't think actually it was the lowest, but it was amongst the lowest.
Yeah. The fourth quarter last year was 20, the second quarter of this year was 18, this is 17. We've been bouncing around.
We're bouncing around. I wouldn't say it's the lowest, but the answer is.
Well, 16 is lower than Okay, go ahead.
I think we've had several that have been. You also have to understand that these are netted numbers, so there's a lot of stuff moving around. I would say there's been three quarters that have been all around the same thing. What's the question?
Right. Actually, it was the stuff you mentioned. Can you talk a bit about the accident year movements underneath, or any kind of segment detail? Can you help us think about the moving parts?
I don't think we can give you the moving parts except to say that as we said, with a paid loss ratio of 52, which is again, towards the very low end of the paid loss ratio, and paid loss ratio continues going down, it still has a greater spread over our reported loss ratio, would indicate that the likelihood of continued redundancies is good, assuming we don't have an acceleration of inflation. Which I think answers your question. At least in a general way. It doesn't give you the specifics you'd like.
Yeah. We'll see the Schedule P when it comes out.
Yeah, and actually.
You can't help us with any kind of like which years moved around or anything.
You'll see. One of the problems is you're going to see a new Schedule P. It's going to be a consolidated Schedule P because we've moved everything under Berkley Insurance. For the first time, we won't have to have 100 people explaining it. The Schedule P will be much more self-explanatory. I don't want to get ahead of myself, but everyone will be able to examine Schedule P with much more precision and a much clearer understanding. I don't want to get ahead of myself. I want to let everybody look at it, and if you have questions, then I think you'll see them, and I think it will verify what we have been saying for a while, that our reserves will prove to be more comfortable than some people have implied.
Okay. Yeah, I look forward to that. The one thing is, I understand the paid loss ratio. It's good that it's not dollars out the door. My concern is there a trend somewhere in the accident years that's causing you to put up more case? Obviously, just causing you to put up more, whether it's the large loss that Josh Shanker just mentioned or the large potential loss that Josh mentioned or others. Is there a tick up somewhere that's causing you to put up more non-paid loss estimates that is driving overall reserve releases to be at the lowest level in many years?
Yeah.
It's Rob.
Yeah, sorry. Greg, it's Rob. I think if you go back over some period of time, I think you will find that over many quarters, the paid loss ratio has continued to be very attractive. I think what you will see also is that we've consistently had positive development, and a lot of that stems from where we had our initial loss picks proven to be perhaps a bit cautious relative to where reality is. I think, in my opinion at least, it would be a mistake to read into the situation more than that. I think as far as the reserve development, we go through a reasonably extensive reserve analysis by operating unit, by product line, every 90 days. What you see is very much a byproduct, if you will, of that exercise, and we're constantly reviewing and re-reviewing that.
Ultimately, we feel as though that process allows us to make sure we end up in a good spot, and there will be fluctuations from time to time. Just like if you look at 2013, it moved back and forth, and a lot of that has to do with because we're looking at it every quarter.
Okay, great. Thanks a lot.
Our next question comes from the line of Vinay Misquith with Evercore. Your line is open.
Hi, good morning. The first question is on growth in the domestic insurance operation. Just looking at gross written premiums of 13% this quarter, a sequential uptick from the last quarter. Could you help us understand why that happened, and are you turning on the spigot in certain lines that you had closed earlier?
I think the answer is, we are opening the spigot selectively where we think the policy year returns will hit or exceed our target, and consequently, we are willing to be a little bit less aggressive in some cases with rate and more interested in growing policy count
How do you see that moving forward in 2014? I understand that you are more comfortable with the trends now. We have also seen some competitors also reduce the pace of rate increases. Do you think that you can actually gain market share despite the market being more competitive?
Again, I'm not intimately familiar with what some of the other companies say, and certainly I'm not intimately familiar with what they truly think. From our perspective, we are seeing policy year basis, a growing percentage of our operating units or the business that we write, being able to achieve our targeted returns or better. To the extent that that's the case, we will continue to pursue that business. There is certainly nothing that leads us to believe that 2014 is going to be a year where the environment will not provide an opportunity to grow the business in all likelihood. We remain somewhat optimistic. I think the other thing that one needs to keep in mind is that we've had several years at this stage of rate increase, which then, of course, you get the compounding effect.
At this stage, we have many parts of the organization that have been getting rate on rate for multiple quarters, and it shouldn't be a surprise that we're getting to the point where some of the operations have very much a green light to try and increase their exposure.
Some of us aren't somewhat optimistic. Some of us are very optimistic. Those who are very optimistic are always somewhat optimistic.
Okay. All right. Thanks. The second question is on the expense ratio. You mentioned that you're taking certain actions. Curious, whether that's just in back office staff or you're looking sort of more at the underwriting staff?
Yeah. I think that you're leaping to a conclusion that it's a staff issue, and I think that that would be a mistake from my perspective. We're just constantly looking at the organization to try and find ways that we can become more efficient. We're looking at places where we can work more efficiently with our partners, ways that we can work more efficiently with distribution and customers, and we're looking at systems and things of that nature as well.
Okay. That's helpful. This is a question for Gene. Gene, what do you think is the normalized tax rate? Is it around the 27% mark?
Obviously, it depends a lot. Gains can influence that. If we have more realized gains in a quarter, those are all taxed at 35%, so that could cause us some variability in the number. 27%, 28% right now is about the right place to be.
Okay. That's helpful. The last question on the net investment income. You guys are pulling back or sort of keeping your duration low. Should we see some sort of continued drag on the net investment income in the future?
I don't really think it's going to change much. I think duration is going to stay around 3.3 years. I don't think there'll be a drag because we are generating lots of cash, so the duration will stay roughly the same. No, I wouldn't think that will happen. I don't think we'll get the benefit from a steepening yield curve. Some people are out investing and pushing that duration to 5 years. You see a 5-year duration. That's a really substantial benefit they're getting from that steeper yield curve. On the other hand, it's a lot more risk they're taking if inflation comes back. I think that's the biggest change. No, I don't think it'll have an adverse impact. Look, at some point in time, you make a decision that you think, the risks of inflation are less. I don't think that's the case.
Ultimately, right now, we don't have inflation because other investors from outside the U.S. are funding our deficits and are funding the borrowing of the Federal Reserve. As long as that happens, we're not going to have inflation.
Thank you.
Our next question comes from the line of Heather Takahashi with Three Bridges Capital. Your line is open.
Hello. I have some questions specifically related to the workers' comp line. I was wondering if you could talk more specifically about what trends you've seen from recent accident years in workers' comp, how the development's going, also what you're seeing in terms of pricing versus loss cost trends for recent years and now. We all know that pricing's been up quite a bit in workers' comp, how are the loss costs trending more recently? If you could also talk a bit about California.
We really don't talk about particular lines of business. If you have questions about that, you can talk offline with Gene Ballard and Karen Horvath, we don't talk about specific lines of business. We certainly wouldn't talk about a particular state and lines of business. It's competitive information, it's not something we would generally share.
Okay. Maybe I could ask another question. Perhaps the answer will be similar. What do you think now in terms of your excess capital position? You talked earlier in the call about all the things you could do with excess capital, what are you now thinking in terms of how much you have in excess capital?
Well, it depends, obviously, on our capacity to grow, so that's an issue that changes every quarter based on our earnings and our ability to grow. I think we have modest levels of excess capital. We'll continue to evaluate, as we do each quarter, either special dividends, buying our own stock back, and the alternative of profitability of growth, and I think that's a continuously evaluated situation. I think, as we made it in the fourth quarter to buy back stock more aggressively, it's a decision we make on a continuous basis. We have guidelines from our board as to what we can do, and we basically make that as a continuous thing based on opportunities we see at any moment in time.
Okay, thank you.
Our next question comes from the line of Bob Barnum with ABW. Your line is open.
Hi there, and good morning.
Good morning, Bob.
A couple of questions. Just one going back to the reserves. You talk about the inflation impact on reserves. What kind of inflation assumptions are you making when you're setting the reserves at this point?
Between three to three plus, depending on the line of business. In fact, inflation has really proved to be between 1% and 2%.
Okay. In your press release, you mentioned kind of new competitors, more rational competitors, it seems like. Are those competitors basically companies that used to write large ticket E&S that are looking to move into smaller E&S because of the?
Thank you
moving into the market?
We're amongst friends. The answer is people like Berkshire and other people who are trying to expand their footprint, who are rational people and want to write business, and other people who are, in fact, leaving the business. There are also other people who are not so rational, whose names I won't mention. The point I was trying to make is everyone is making much to-do about Berkshire, and there probably are some others who are entering the business, but those are rational, long-term people who want to make money. Long-term rational people who want to get in the business aren't of great concern to us. Ajit is a good friend of mine, and he's as greedy as anybody, and he wants to make money. That's not a problem, and anybody who worries about that is making a mistake.
The people you need to worry about are the dummies who don't know about making money and who do dumb things, and those are the people you worry about, and a lot of those people are going out of business. Those people we're happy to see go. There are a few other dummies who are in the business, and we'd like to see them go, too. They're not all gone yet.
Just give them some more time, huh?
Absolutely.
All right. Thanks for that.
Our next question comes from the line of Ian Gutterman with Balyasny Asset Management. Your line is open.
Hi, thank you. First, Gene, can you clarify, I might have misheard. I thought at one point you said there was $12 million of reserve releases, and I thought you also said 1.2%, which would be more like $17 million. I just wanted to clarify what you said.
It was $17 million, he said.
17, thank you. On the paid loss ratio, I guess one thing I was looking at is obviously you've shown good growth. It looks like the last 3 years have been double digit top line, paid this year are going to be up, call it low single digit. Obviously, part of that is good work on your part, and part of that is just paid's lag growth, right?
Yes, sir.
Does that imply that we're sort of marking the bottom on paid loss ratio and just a natural, the way losses pay out over time should suggest that paid will start to grow faster to reflect the growth over the past few years?
Paid always, in fact, has a lag with written, okay? Yes, absolutely, your statement is a correct statement. In trend is correct. Paid, let's just say you have to balance that paid with what the earned premium was and the written. You have a format that does that. Even after taking that into consideration, paid losses are down significantly.
Right.
For example, last year, I think the paid loss ratio was like 57% or 58%.
Yeah.
Again, it's trending down. If it had trended as our growth was, it would've been 53 or 54, depending, because you got to look at it as that percentage of premium volume, of net premium. They're trending down slightly faster than premiums are trending up. It's getting better and continues to get slightly better. That's the long and the short of it. If you said 52, what 52 means is it's probably a point or two better than last year, and last year probably was a point or two better than the year before, and so on.
Okay. At some point, I assume we're getting close to that inflection where it starts to go the other way, even if you're doing a good job on managing.
I would envision that you will be at the inflation point about six to 12 months after prices stop going up.
That's very helpful, actually.
That would be a fair guess. Probably it'd take you about a year after price increases stop going up, because a year after is when earned premium stop having those price increases. I'm giving you what would be a rule of thumb in my mind, not a mathematical calculation. If I looked at it, I would say paid losses a year after price increases stop, should bottom out.
That makes sense. My last topic on reinsurance. First, can you remind me just a general mix of, say, casualty versus property, maybe professional in that business?
More than two-thirds of it is casualty and professional, with the balance being shorter tail lines.
Okay. That's kind of what I was guessing. As we go forward, given the comments, I think it was Rob made on pressure in CAT spreading into casualty, should we maybe expect some at least expense ratio pressure there from higher ceding commissions and possibly even loss ratio as well?
I think it's certainly possible, I think that perhaps the thing to look at a little bit more closely will be just the top line, which obviously we expect there's a possibility that that could shrink depending on market conditions. Yes, of course, over time, as that reality earns through, that will affect the expense ratio to an extent as well.
Got it. Great. Thank you. That's all I had.
ladies and gentlemen, if you do have a question at this time, please press star, then the number one key on your touchtone telephone. Our next question is a follow-up question from the line of Josh Shanker with Deutsche Bank. Your line is open.
Yeah. Just one more question. You guys were kind enough to give us new disclosure in the last couple of quarters on development by segment. Is that not going to happen going forward, or do you have it in front of you?
Yeah. We'll have that laid out in the 10-K. It's $17 million in total, and it's predominantly the domestic segment and also the international segment.
Okay. I guess, those were both favorable and negligible on reinsurance.
Yeah. Well, there's some in all three. It's not that big a number to begin with. We'll have it in the K.
That's perfect. Thank you.
Our next question comes from the line of Jay Cohen with Bank of America. Your line is open.
Yes, thanks. I got somehow kicked off the call before. If this has been asked, I apologize, but on the investment income and the fixed income side, that's bounced around the last couple of quarters. This fourth quarter was a little bit above where it was in the third quarter. Is that just cash flow and normal variability in earnings?
Yeah, there's been no fundamental change in the investment fixed income portfolio.
It's a pretty good run rate fourth quarter for that line item.
I would not think that. I think part of it may well be, Jay, that we have chosen opportunistically when to invest our cash, we may have invested a couple of hundred, $200 million, $300 million at the end of the third quarter that we invest, in fact, earned some money at in the fourth quarter. In principle, there's no real change.
The yield on the fixed income for the full year is about 3.6% and 3.5% in the fourth quarter. It's pretty close.
If you looked at, for the fixed income, what the new money yields are, if you were going to duplicate what you are doing today, what's the spread at this point?
I don't think that we believe our investment income would go down. Probably, it would go down about 12 basis points over the year. We think we more than make it up in the aggregate because of cash flow.
Got it. Thanks. Very helpful.
I'm not showing any further questions at this time. I'd like to turn the call back over to management for closing remarks.
Okay. Well, one of the frustrations are we spend a lot of time on these calls talking about a lot of details, what we really are trying to do is express the general view about how we feel about the business and where it is. That sometimes is hard to do because we get immersed in a lot of detailed questions that help people make models work and figure out the little issues. I think I'd like to try and spend just a couple of seconds on big-picture items. Number one, our domestic business is strong. We're very pleased with how it's going. We expect we'll continue to grow at comfortably between 12% and 15%.
We would expect our price increases will stay above the 5% area for the year, but it will be spotty, we're expecting no dramatic increase in inflation, certainly in the first six months of the year. It is hard to tell. Primarily, that's a result of non-domestic investors wanting to put their money in the U.S., which is allowing us to have deficits without creating deficit-funded inflation. We believe that will continue for a while, therefore, inflation is not likely to change. We think we'll be able to improve our expense ratio modestly with more efficiencies on our part. We believe that we understand a couple of issues that arose in our international business that we've taken care of and addressed. We're quite optimistic. Our greatest threat, we feel, is, in fact, our investment income area.
The threat of inflation, the fear of deflation are sitting there, we're searching for ways to protect ourselves. Overall, we would expect our returns will increase modestly through next year. We're expecting a really good year. Thank you all very much. Have a great day.
Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program, you may all disconnect. Everyone, have a good day.