Good day, welcome to the W. R. Berkley Corporation's first quarter 2012 earnings conference call. Today's conference is being recorded. The speakers' 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 representation by us that 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, 2011, 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. Good morning, everyone. We were pleased with our quarter. We were pleased with how business is going. We're glad all of you are here, so you'll get the opportunity to hear about our loss reserves and so forth. We don't put it in our press release about our development things in order to get a better audience on the call. With that, we'll start with Rob talking about operations, and then we'll follow with Gene talking about the financials, and then I'll talk a little bit about what's going on, and then we'll take questions. With that, Rob, why don't you go ahead?
Okay. Thank you. Good morning. Market conditions continued to improve during the first quarter. While a cycle turn may not appear visible during any 90-day period, when one reflects back on where we were a year ago, it is clear there has been significant improvement. Evidence of this change can be seen in many ways, including the increasing number of carriers publicly announcing significant rate increases. Additionally, we are seeing many market participants adjusting their risk appetite, resulting in a gradually increasing flow of submissions into the specialty market. This increasing flow predominantly tends to be risks with poor loss experience or other complications. Furthermore, the distribution system seems to have recognized and accepted that we are generally exiting the soft market. Consequently, they are becoming ever more successful in selling the rate increases that many carriers are requiring.
Lastly, the continued accelerating growth of the state-assigned risk plan populations clearly supports the notion that market discipline is returning. Having said this, life is not perfect, and that includes the insurance industry. There are a few carriers in both the standard and specialty insurance market, as well as the reinsurance market, that don't seem to fully appreciate that things are changing. As a result of this circumstance, there is somewhat of a lopsided barbell in the marketplace between those that are seeking rate adequacy and those that don't get it. Having said this, the market is turning in spite of this limited number of irresponsible companies that are serving as a hindrance, not a barrier. Primary workers' compensation and CAT-exposed property continues to lead other lines with regard to rate increases.
The reality of increasing loss costs, combined with CAT activity over the past several years, has clearly caught people's attention. Additionally, the impact of recent revisions to CAT models, as well as the growing consequence of lower new money rates, continues to apply added pressure. While change in behavior may vary by territory and product line, clearly the general trend is definitively upward. Having said this, for the moment, there are certain lines such as excess workers' compensation and parts of the professional liability market that have remained more resistant to increased pricing. Fortunately, however, it would seem as though pricing has bottomed out in even these lines and is generally no longer deteriorating. As we have suggested in the past, there is a correlation between the duration of the tail and the time it takes market participants to recognize a change in behavior is required.
Additionally, the lack of frequency can also experience a similar delay in recognition of underwriting issues. However, even longer-tail lines of business that have become exceptionally competitive can overshadow these rules of thumb. As our Chairman says, even long-tail lines of business can become short tail if they are sufficiently underpriced. The company's net written premium for the quarter was $1.2 billion. This represents an increase of 11% over the corresponding period in 2011. More than half of this growth came about as a result of improved rates. While all five of our business segments grew during the quarter, the lion's share of the increase came from our international and specialty segments. The performance in these two segments continued to be driven by their exposure to strongly performing industries as well as strongly performing economies.
Additionally, some of the operations in these two segments are amongst the most leveraged in the group and greatly benefit from a hardening market. Finally, a significant number of our younger operations are in these two segments. The group's rate monitoring for the quarter indicated an increase of approximately 6.5% over the same period in 2011. It is worth noting this is a significant increase from the 4% that was achieved in Q4 of 2011. Furthermore, it is also worth mentioning that this is the first time in several years the group has achieved rate increase on top of rate increase for corresponding periods. This is significant, given it suggests we have reached a new level of momentum where it is truly beginning to build upon itself.
Additionally, with our renewal retention ratio remaining at approximately 80%, it provides comforting evidence that we are not sacrificing the quality of the book while achieving improving rates. Margin on new business also appears to be headed in the right direction. The company's new business rate relativity metric would suggest we are charging 104.2% for new versus renewal business. Put another way, with like exposures, we are charging 4.2% more for new versus renewal business. The company's general philosophy continues to be that one should be charging more for new business, given the additional knowledge we have about our existing book. Our loss ratio for the quarter was a 61.8%. While this is a similar performance to the first quarter of 2011, the result was achieved in a different manner due to varying contributions from the different operating units in the group.
This result also includes $4 million of natural CAT losses, in addition to $2.5 million associated with the Costa Concordia loss. The expense ratio for the quarter was a 34.7%. While this performance was in line with our expectations, we anticipate it will improve as the year progresses. Gene will be providing more detail on this topic, along with others shortly. In the aggregate, the company delivered a combined ratio of 96.5%. This result was achieved through the contribution of all five business segments generating an underwriting profit. When you adjust for the performance to an accident year basis, we believe the business is running in the high 90s. We continue to have great confidence in the soundness of our balance sheet and, in particular, the strength of our aggregate loss reserves.
As we have explained in the past, the company reviews each of our operations reserves in a detailed manner every 90 days. This allows us timely insight into how the book is performing. We would caution observers not to leap to the conclusion that the lower level of reserve redundancies recognized in the first quarter will be the new norm going forward. While it would be premature to declare we are in a hard market, there is undoubtedly sufficient evidence, both in our results as well as those of others in the industry, to support our view that we are clearly in a hardening market. The underwriting discipline that our organization has exercised throughout the soft market, combined with the investments we have made in new and existing platforms, will undoubtedly offer increasing returns as the trajectory of the market turn continues to steepen and accelerate.
Thank you, Rob. Gene, you want to go through the numbers now, please?
Okay, Bill. I'm going to start first with a brief summary of the impact of the change in accounting for deferred acquisition costs. I'm sure you've all heard enough of this by now, but the FASB issued new guidance that limits the deferral of acquisition costs to those costs that are directly related to the successful acquisition of new and renewal insurance contracts. We adopted this guidance on January 1, 2012, and we retrospectively restated our previously issued financial statements to reflect the change in accounting. The impact of that change to our balance sheet at December 31st was a reduction in the DAC asset of $84 million and a reduction in our common stockholders' equity of $55 million or $0.40 per share.
The impact on our income statement for the first quarter of 2011 was to increase underwriting expenses by $1.3 million and to increase our overall expense ratio by 0.2 of a point. There's a schedule on the investor relations section of our website that shows the details of the impact of this change in accounting on our financial statements for each of the past four years. We expect this accounting change to cause some delay in the recognition of improving expense ratios, especially when business is growing, and to have the opposite effect when business is shrinking. I'll cover this further when we get to the details of our expense ratio for the quarter. Turning to our results, it was a solid quarter with respect to both underwriting and investment income. Our net premiums written overall up 11% to $1.2 billion.
As Rob mentioned, that growth was led by the international segment, which was up 50% with strong growth in the Asia-Pacific, European, and Lloyd's businesses. That was followed by 9% growth for specialty, 6% for reinsurance, 4% for regional, and 1% for the alternative market segment. The overall loss ratio was unchanged from a year ago at 61.8%. Losses from natural catastrophes were $4 million, it doesn't include the Costa Concordia loss, compared with $24 million a year ago, which is an improvement of 2.1 loss ratio points. Prior year reserve releases were $25 million, down from $51 million a year ago, which is a difference of 2.9 loss ratio points. Most of the favorable reserve development in the quarter was related to the specialty and reinsurance segments and was related to accident years 2009 and prior.
The 2012 accident year loss ratio, excluding CATs and reserve releases, was 63.7% in the first quarter, down 0.9 of a point from a year ago, as price increases exceeded our reserving assumptions regarding loss cost trends. In addition, our paid loss ratio was down slightly from 59.1% to 58.5%, but it's a good sign that that's beginning to move in the right direction. The expense ratio was 34.7% in the quarter, unchanged from the restated expense ratio for the first quarter 2011. As I mentioned, under the new DAC policy, expenses are recognized earlier than before, which will slow the recognition of improving expense ratio somewhat. Another way that we look at expenses internally, and I know some companies actually report this in their earnings releases, is on a written basis, which compares expenses incurred during the period without any DAC deferral with business written in that period.
This takes out the process of trying to reallocate expenses from one quarter to another in an attempt to match them with earned premiums. The written ratio varies a little bit more from one quarter to the next due to the seasonality of premium writings, but it provides a very objective measure of the year-over-year expense trends. On a written basis, our expense ratio was 32.7% in the first quarter of 2012, down nine-tenths of a point from 33.6% in the first quarter of 2011. Net investment income was $158 million, up 8% from a year ago. Income from fixed income securities, including cash, was $119 million. That represents an annualized yield of 3.9%, compared with 4.1% in the first quarter of 2011. Income from investment funds was $28 million, up $16 million from a year ago, with strong earnings from energy and real estate funds.
The merger arbitrage trading account earned $6.5 million, which is an annualized yield of 8.5%. Realized gains, primarily the sale of equity securities, were $47 million in the quarter, compared with $29 million a year ago. Unrealized investment gains after tax were $452 million at March 31st, up from $430 million at the beginning of the year. We have a summary of our investment portfolio on pages nine and 10 of the earnings release. You'll see that total invested assets were just over $15 billion at March 31st, were up $555 million from the beginning of the year. That increase includes $350 million of proceeds from a senior debt offering that we completed in March. Of that amount, $200 million will be used to repay senior notes that are maturing in February of 2013.
All that adds up to a very solid quarter with net income of $135 million, an annualized return on equity of 13.7%, and an increase in our book value per share of 3.8%. Thank you.
Thank you, Gene. Overall, we're pretty happy with the quarter. Our results are reflective of what I think are the discipline we've shown over the prior years and substantial improvement in our performance as we gain market position. We're pleased with what we see. We measure our reserves carefully, as both Rob and Gene mentioned. We're comfortable. In fact, our reserves, as we measure them, which is we look back at the prior three years' earned premium and then look at our total reserves outstanding. We choose three years' earned premium because that's sort of the duration of our loss reserves, and our reserves are at an all-time high compared to where they've been at any measuring point we've used in the prior periods. We're pretty happy about where we stand reserve-wise. Inevitably, our ongoing accident year loss ratio is going to improve.
It's going to improve only because of price increases exceeding loss cost. As that 4% from the fourth quarter starts to come into earned premium and the 6.5% from the first quarter, as it becomes earned, we're going to see improving results. By the end of the year, we would expect 3% or 4% improvement in that underlying accident year loss ratio. That's setting aside all the unusual variables you can see quarter to quarter in the property casualty business. In fact, with price increases where they are, that improving loss ratio is certain to come into play. We think that while in individual lines of business, you still are seeing people compete aggressively here and there, it doesn't take long before people figure out that what they're doing is stupid. Stupidity is not limited to any one company or any one underwriter.
It pops up in all markets. We just notice it more when most companies are beginning to be disciplined and understand what's going on. The unusual behavior becomes more visible. I think that the cyclical change is always the same. Exactly how it's implemented may well be different, but it isn't going to be a hockey stick, and it never has been a hockey stick until some particular event happens, which drives a dramatic change. It can be a hockey stick, dramatic rate increases in a particular line of business or a particular segment of the market. Overall, we're seeing good, strong pricing increasing, and the business is moving towards profitability. We don't think interest rates are going to dramatically move up. We think it is still one world, and the difficulties in Europe are going to impact the investment opportunities.
We think lots of the marketplace has capital embedded in Europe, so it's going to keep pressure on the overall market. We're excited. We think we'll have an excellent year. We would expect that we'll be able to deliver on our book value increasing by 13%-15% for the year. We expect that we will be able to have additional capital gains as some of the things at Berkley Capital and some of our other investments will deliver realized gains for the balance of the year. With that, Kevin, we'll be happy to take questions.
Well, ladies and gentlemen, if you have a question or a comment at this time, please press the star then the one key on your touch-tone telephone. If your question has been answered or you wish to remove yourself from the queue, please press the pound key. Our first question comes from Amit Kumar with Macquarie.
Thanks, and good morning. Just going back to your comment regarding pricing versus loss cost. Did I hear that correctly? Did you mention a 3%-4% delta? Maybe just expand on that, in terms of your thoughts on the earned premium rates versus loss cost and how you got that.
No, I don't think it was the delta. I think what I said is, we would expect that by the end of the year, we would start to see an improvement in actual year loss ratio, possibly as much as three to four points. For example, by the end of the year, if my expectations are correct, let's just say by the end of the year, you have 8% or 9% increases in your premium rates. If you have 8% or 9% and you have, let's just say, a 3% loss cost increase, part of that would come through, and then you weight it for each quarter prior to that. I'm just saying that that's likely to give you, by the fourth quarter, a 3%-4% increase or decline in your actual year loss ratio.
Okay, thanks. Thanks for the clarification. Maybe, I guess, touch upon California comp. Where do you think those trends are now as it relates to workers' compensation? Do you think rates are finally increasing loss costs?
I'm going to let Rob talk about that.
I think the answer is trying to get your head around California comp loss costs is a pretty slippery slope, given that they're willing to change benefits at a drop of a hat and make it retroactive. Having said that, I think the market realizes that they have significant catching up to do. I think the rate increases that we are getting at this stage in that book are certainly keeping up with our belief as to where loss costs are going or will be over a period of time, and we're reasonably comfortable. Having said that, I think that the average pricing in the marketplace overall, they find themselves in a hole, and even the rate increases that they are trying to get today, I don't think is getting them to an underwriting profit in general.
Got it. That's helpful. I guess one other question, just going back to your opening comments regarding increasing flow in specialty. Can you talk about what the pricing differential between E&S versus non-E&S entities for W. R. Berkley companies on average?
Yeah. I think the tricky part here is it's not just about if it's an individual risk, what a regional company would price it versus a specialty company, because it's terms, it's conditions, it's a lot of moving pieces. It's not just purely price. What I would suggest to you is this, I'm not just speaking about our businesses, but I'm speaking about the marketplace, if you will, is that, as I suggested earlier, it's the risks that have a bit of hair on them, whether they be property or casualty, for whatever the reason may be, or other issues or complications with them, that they are flipping back over the wall into the specialty market. To the extent that they actually drift all the way over into the E&S market, the rate increase that exposure would be experiencing is quite material.
I think, Amit, you have to understand how we got here.
Yes.
That is, what really gets us to a softer market is standard market rates. First, they get cut a bit. What happens is they loosen their underwriting standards. They say, "We're writing all this business and not cutting rates anymore." What they're doing is they've loosened their underwriting standards, so business that historically was in the E&S marketplace or otherwise, starts to move to the standard market. To add insult to injury, they cut prices even more because they compete for that crap. The sequence of things that happen is, first people start to raise their rates, then they figure out they can't raise their rates enough to pay for this business that never belonged in the standard market at all. They tighten their standards, and it goes back.
That's how it got there, and that's how it reverses itself. That's how the cycle moves. The cycle moves as far as terms and conditions all of a sudden, because when you realize you can't charge enough, you just stop writing the business. It represents the worst business in the standard market, and it's the business that they don't want to renew.
Got it. Okay, thanks so much for all your answers.
Our next question comes from Keith Walsh with Citi.
Good morning, everybody. First question for Gene. You alluded to this in your commentary around the expense ratio. Maybe if you could talk about when do we start to see more leverage in that number? Maybe if you could even talk about that number currently excluding the startups. Are we seeing leverage there currently? I've got a couple of follow-ups for Rob.
Yeah. Well, we're already seeing, in our written expense ratio, the leverage come through. I think, like I said before, that this DAC calculation and DAC policy kind of slows that down a bit. We're seeing it today and expect it to continue, not so much as a result of the startups anymore, but I think more so as a result of the fact that the top line is growing as much as it is.
Keith, in some ways, growth now with this new DAC calculation is a penalty again. That is, you're not even recovering all your costs on a financial basis. Growth is now once again, especially real growth, significant growth, is not only not beneficial or breakeven, it's a penalty. The faster you grow, especially once you pass some single-digit number, it starts to have an adverse impact because you're not deferring even your real costs. The faster we grow, the more adverse that's going to be, at least for the short run.
Okay. Rob, I'm just curious, why is the net earned premium growing faster than the gross and the net written if rate continues to improve sequentially? I would have thought the opposite.
Could you repeat the question?
I want to make sure I understand that, Keith.
Yeah, why is the earned-
Why is the net written different than the gross written as far as growth rate?
No, the net earned is growing faster than the net written, and I would have thought the opposite if rate is improving sequentially quarter-over-quarter.
Gene?
Gene, go ahead.
Yeah. The earned is a reflection of the growth, not just in the quarter, but over the last 12 months of the growth rate.
This is the insurance treaties over the last.
We have some policies that are even longer than 12 months. You can't really tie them directly to the change in the written in the quarter.
There's nothing that's changed, if that's what you're asking, Keith. It may be because of a reinsurance treaty.
I would think reinsurance is probably the big differentiator because how we will, as Gene suggested, obviously the timing of the earned coming through versus the written and how we'll change our reinsurance purchasing over a period of time.
We bought some different kinds of reinsurance coverage this year, which may have had an impact on it.
Yeah. That, of course, will affect the difference between the gross written and net written.
Right.
We have had some of that. In terms of the earned, that's more just a different time period that we're measuring there.
Okay. Just last one for Rob. In your commentary, still a few carriers don't get it. Does that imply a highly competitive market for new business? Would you expect your retention as a result of that to dip below the 80% level it's been running at? Thanks.
When I say a few carriers, I guess what I'm trying to suggest is that they are the minority and the greater marketplace, if you will, not only hasn't realized or recognized action needs to be taken, but it's actually translating into their behavior. From our perspective, you are seeing a change and some of these folks are serving as an obstacle. I think the reason why you're seeing renewal retentions hanging in there for ourselves and presumably for some others is because the distribution system recognizes the market is changing, and they are less inclined to try and shop business solely on price. I think all things being equal, it's becoming a less competitive or aggressive market compared to where it was. Having said that, it can vary by line of business.
Okay, thanks a lot.
Our next question comes from Joshua Shanker with Deutsche Bank.
Good morning, everyone. I wanted to talk a little bit, Bill, for a couple of years you've been concerned about the industry's reserves. When we look at competitors and peers in the industry, they still seem to be releasing a lot of reserves. Do you stand by your concerns about the industry reserve positions, and when do you think that starts to become an issue?
The answer is, I think that some people in the industry have been more aggressive than they probably ought to have been. I don't know that I can tell you when that's going to happen. I think you've already seen several companies have deficiencies and by and large, smaller companies have already had to address those. AIG had to address it and has, My guess is there'll be more to come. I can't tell you how soon that'll happen.
Do you have an opinion on the pace of loss cost trends, where we've been one year ago, where we are today, and where we'll be in a year? You can talk to your book or you can talk to the industry broadly, depending on how you think it's appropriate.
I think loss cost trends are no longer totally benign. They're certainly increasing modestly. The global economic picture always has an impact on how these things happen and come down, and clearly, I think that the issues that are being faced in Europe, overall, will impact the economic picture every place. That being said, I think we've passed through the period in the United States, at least, with the benign loss cost picture. I don't see anything running wild. If you saw loss costs grow at 2%-3%, I think that would be my expectation. Look, and at some point the United States, just like the rest of the world, is going to have to face up to the ultimate issues of how do you deal with deficits that have accumulated over a long time and inflation and all that goes with that.
At least sitting here today, that's certainly more than 18 months away.
Thank you very much.
Our next question comes from Vinay Misquith with Evercore Partners.
Hi, good morning. The first question is on the top line. While strong this quarter, that seemed to sequentially decline. Were there some sort of one-time items this quarter, and how do you foresee your top line over the next two quarters?
I think, first of all, last quarter, there was a particularly beneficial item that caused some of the increase. I think that the turn in the cycle is not a nice, predictable straight line. Candidly, we were more optimistic about that growth at the beginning of the quarter than we are today. We didn't know why. We were surprised that it wasn't a point or two higher. Only when you sit and write numbers on a piece of paper can they be very predictable, Vinay. I'm not trying to be cute. I don't really know precisely why and where. We had some companies that grew much faster in the first quarter than in the fourth quarter. Then we had some that just sort of seemed to stop their growth.
We had a couple of companies where because they were disciplined in their pricing and we were really pleased they were disciplined in their pricing, they actually contracted in the first quarter, and we were okay with that. It only takes a couple of companies in a narrow marketplace on one line of business or another to make the business competitive for the short run. That's happened in a couple of lines of business. I don't think it's a trend, and if we were in a position where we saw growth at this level, we'd probably be more aggressive in buying back our stock, for instance. We're going to have to wait and see ourselves. You're at this turn in the cycle and at that moment in time, predicting how much you're going to grow and how much price increase are going to happen, hard to tell.
We're still very positive, and we would still expect certainly growth at least the level we're at now, maybe a little more.
Sure, fair enough. The follow-up is on the loss cost trends. You mentioned that Berkley is looking at a 3% loss cost trend. Some competitors out there are saying it's about 4%. That still seems to be not very high. How would you look at pricing in the industry going forward? I believe you mentioned about 8%-9% in the next two quarters. Sort of in the absence of significant spike in loss cost trends, do you still see pressures building within the system for rate increases?
First of all, I think a couple things. I said I thought loss cost trends were 2%-3%, and I thought that by the fourth quarter, I thought price increases would be in the 8%-9%. I don't think they're there now. I think that they'll continue to get a little better. I might point out that every 1% decline in interest rates, for the reinsurance business, you need 7% on price. For the standard property casualty company business, you need about 3.5%. You've had 150 basis point decline in interest rates over the past two years, maybe more. It depends on who you want to use and how you want to measure and what you want to say.
Just to offset interest rates, you need substantial rate increases without giving consideration to the fact that in specialty lines, prices have to come down 25%, and in standard lines, probably 15% or 17%. Yeah, I think that right now, if people were to print their actual year results honestly, a lot of people would have, for company results, operating losses on a marginal basis. Yeah, I do think you're going to have to have pretty significant price increases for a while before the companies get to where they're, on a marginal basis, making money. You can't look backwards at your portfolio. You have to reinvest the money each day, and you have to look forward.
Some of the people who are going to be in the most trouble are the people who priced their underwriting margins and built them based upon their average portfolio yield as opposed to their marginal portfolio yield, and they're going to find out that companies are losing money. No, I think price increases are essential for the industry just to get to break even.
Okay, that's good. Thank you.
Our next question comes from with Larry Greenberg with Janney Montgomery Scott.
Thank you and good morning. I'm just curious, with the new business pricing at 104.2 versus renewal, does that allow you to basically make loss picks consistent new and renewal business?
I'll let Rob answer that. I think that precision is something that we'd like to have, but I'll let Rob answer.
The answer is that what you're suggesting is what we target. When we think about our design loss picks, and we revisit them every 90 days, we certainly contemplate what the mix and the contribution is in new to renewal business. Having said that, our approach to erring on the side of caution a bit with new business versus renewal business is not just in how we price the business, but also in how we book the business. From our perspective, as I suggested earlier, you know a whole lot more about your in-force book than you do about new business. We look for a higher rate for new business, and we probably err a bit on the side of caution as to how we book it from a design ratio pick.
Having said that, when we look at the book that has been written, we are cognizant of what percentage is new versus what is renewal as we revisit those loss picks, once again, every 90 days.
Okay, great. That's helpful. Then, with regard to your comment on the favorable reserve development for the quarter, that we shouldn't assume that the drop this quarter is indicative of anything in the future, was there anything unusual in that, or is it just to suggest that one quarter doesn't make a trend?
I think we're trying to get across a message, and the message is, which I followed up on when I made the comment, that our reserves relative to the average three years' earned premium is at as high a level or higher actually than they've ever been. They've gotten higher in each successive year for the past five, in spite of reserve releases. No one should think that the amount of reserve releases was indicative in some way or another of our concern about reserve positions. We do a review, we conclude where we think we are, but we didn't want people to get the wrong impression. Frequently, people think that the amount of reserves you release is a reflection on your reserve position. I now think I can speak for our company as well as a number of others. I don't think it necessarily is.
Some companies who are deficient still release reserves. They even may release record amounts of reserves. It doesn't change the fact that they're deficient, it's just they're more anxious to show better earnings. Some companies that are redundant are cautious in what they release, and they may be getting more and more redundant. I think investors tend to read too much in about reserve releases reflecting upon a company's overall reserve position.
Great. Thanks. Finally, just reading between the lines, Bill, I know you're talking about kind of a gradual uptick in pricing this year. It's still relatively moderate loss cost growth. I sense that you still believe at some point in time, this is going to turn into a more traditional hard market. Is that an accurate perception?
Hard markets always start this way, then something happens. Something happens because someone cheated more than they thought they were and gets into dire financial difficulties. It happened to AIG, but AIG got bailed out by the government. Look at all the billions of dollars of deficiencies they had to make up for, and we don't know if that's done or not. They do have very honest guys running the business now, and I'm sure they will get there. The fact is, none of us know where and what is sitting out there, and all I can tell you is that every time we go into the beginnings of an upward cycle, it takes people a long time to get through paying for their past sins. Usually, someone doesn't have the ability to make it through.
I don't know who that's going to be, I can't tell you for sure, but there certainly are lots of issues and risks to that situation. I think that you can have other kinds of problems out there. We certainly don't know who might be impacted by the European issues and the financial issues of the European banks. Lots of the capital that supports the overall industry is based in Europe. I think there are a lot of uncertainties. I think that the fact is profitability increases very dramatically with 8% or 9% price increases in this year, and with the same next year, you see dramatic increases in return on capital. Return on capital in the high double digits, certainly for us. Excuse me, high teens. Certainly, in the second year of 8% or 9% price increases, our returns would be in the 20s.
I can't tell you about any more than that. Yeah, I do think prices will continue to go up, and I think that those price increases will get to be more substantial because just like today, a few companies can restrain price increases by their aggressive behavior. Those few companies end up going broke. It's what happened with Reliance and Frontier. They cost a lot of people a lot of money because they restrained prices in a couple of areas, and then they went broke, and then literally in one month, prices in commercial transportation in October of 2000 went up 28% on average. That will happen. There will be a couple of, what I would call, small, large, and mid-size companies that go out of business.
Great. Appreciate your thoughts.
Our next question comes from Michael Nannizzi with Goldman Sachs.
Thank you. If we back out the international segment, trying to understand what happened to exposure trends relative to the pricing change. I'm assuming, and this may not be right, but I'm assuming that price change outside of international in your segments was better than the pricing change in international. Just one follow-up.
Mike, we typically don't get into the detail of the pricing, so to speak, by segment. I would tell you, though, that the international segment, while rate played a component, it had more to do with additional units, if you will, of exposure driving the growth there, as opposed to some of the other segments where rates played a more significant component in the growth.
Right. Got it. If we back out the international entirely and we just focus on everything excluding that, I think net written premiums were up just under 5%. If the 6.5% price change that you saw year-over-year, then I'm just trying to figure out how to think about what happened to exposures, whether it's regional or specialty, given those are the bigger of the remaining segments.
I want to make sure I was following you. Gene was sending me a piece of paper, which was of not much help.
Sure. If we take the consolidated results and we take out international written premiums. If my math is right, net written premiums were up 4.7%, excluding international. You said that in international, more of the growth was exposures, not rates. I'm assuming that 6.5% is probably just fair as a starting point for the business outside of international. It looks like if you were $100 of business last year, and then you lost some, and then you wrote some new business, you're getting 6.5% rate on the business you kept. I'm just trying to understand why the exposure line actually increased less than the rate change. 4.7 versus 6.5, I guess is my question.
Well, first of all, I think you have to break out it a little more, and it's a longer question than we can answer here. A big part of that is impacted by alternative markets, which grew at a very low rate, barely grew at all. That was because of one particular area that, in fact, declined because how a competitor priced their business, and we had substantial decline in premium in that one area. When you take that out, I think that's probably a little misleading. For example, specialty grew at roughly 9%.
Right.
It's a lot more complicated than we can answer on this call.
I understand.
I think your underlying assumption is like adding up how many dogs do you have if you have 17 animals. It's hard to give you an answer that will make sense. I think that in the specialty business-- and by the way, you also have to weight it by amount of premium, and it's not just adding up the pieces. I think that the answer would be that the units of exposure in the alternative markets declined and slightly increased in the specialty business, price increases still drove most of it. As I said, I'm sure if you want to go through the details of it, we can try and do that, and Gene will go through it with you, Michael, later on. It's not something you can sort of aggregate and just sort of add up. It's a fairly detailed thing.
I think it's one of those cases where the mathematical conclusion is correct, I think it doesn't give you the correct aggregate conclusion. As I say, the biggest section is specialty. Prices were up 8.8%, volume was up 8.8%, units of exposure were up slightly.
Got it. I'll follow up later. Thank you very much. Just one question about some of the new businesses, whether in specialty or international. Did you add any new teams or new platforms during the quarter? In terms of the capacity of folks that you've brought online, I guess particularly in international, where we've seen the most growth, what sort of % of the business that they were writing before they came online here are they writing now? Just to kind of get an idea of pipeline of potential business there. Thank you for your answers.
Mike, we added one new team, they are going to be focusing on the public entity space. At this stage, they have not even begun to write business, or there's nothing that's been bound. We expect that to be happening later this quarter. There has been no impact from what we did as far as starting new businesses in the first quarter on the income statement. We do think that over time, it will be a meaningful contributor to the group. Certainly, at this stage, there's been no impact.
Great. Thank you very much.
Our next question comes from Doug Mewhirter with RBC Capital Markets.
Hi. Most of my questions have been answered. Just two quick questions. First, I noticed, if my calculations are right, your wholly owned investees reported a pre-tax loss. Is that, I guess, a seasonal swing, or is there any particular issue?
No, it's just a seasonal swing. They expect to meet their budget for the year.
Okay. My second and last question. You talked about how primary workers' comp rate's been going up industry-wide, although loss costs have been kind of unpredictable as well. You said that excess workers' comp isn't following, and you talked about how there's still some competition in your alternative markets. Why do you think there's a disconnect? Do you think that that logjam would eventually break loose this year, or do you think it'll take a while? Going up to the excess market, I mean.
Yeah. I think what you're really seeing is just the, as we had suggested earlier, the difference in tail or duration of tail, as we had suggested earlier. Excess comp has a much longer tail than primary comp. As a result of that, it takes a bit more time for insurance carriers or market participants, if you like, to recognize that they have an issue. I do expect that you will see a shift in excess comp. As we also suggested earlier, that's probably give or take bottoming out. There is a bit of a lag or a delay before the reality comes into focus and you'll see the same type of momentum building in the excess comp line that you are seeing in primary comp.
Okay, thanks. That's all my questions.
Our next question comes from Meyer Shields with Stifel Nicolaus.
Thanks. Good morning. Two quick questions, if I can. First, for Rob, when you, I guess, cautioned us not to extrapolate too much from the first quarter's reserve releases, were you-
Were you saying that $25 million is lower or higher than the expected run rate?
I think I was trying to suggest to you that I wouldn't hang my hat that is the number or the level going forward. I think it would be very problematic if I answered your question more specifically.
Not for me. Second question, I'm sorry-
I think if you put that together with what I said, you should have the answer.
Yeah. No, I think I do.
Which is our aggregate reserves have never been stronger.
Right. No, that's why I was I think I misinterpreted Rob the first time. That's why I was asking.
Okay.
In general, Bill, when you think about the mix between property and casualty, it looks like you're a little bit more heavily focused on the property side than historically. Is that a reflection of rates or a change in approach because as a larger company, you can afford a little bit more volatility?
I think there's several things that are happening. First of all, with interest rates down, the difference in expected return for short tail lines, and I don't mean property lines, but short tail lines, is changed because you're now no longer getting the benefit of that higher investment return on longer tail reserves. On marginal business that we write new business now, the improved return from casualty business is less than on shorter tail lines of business. Yes, we have shifted, whereas longer tail lines of business used to represent, let's just say between 85%-87% of our business today, it probably represents 82% of our business. Still very predominantly casualty focused, very predominantly long tail, but yes, consciously a decision that says we're willing to shift. Number 2, pricing on some of those lines of business have gotten much more attractive.
Number 3, some of those specialty lines, in fact, do have some volatility that when we were a lot smaller company, we couldn't take, and now we can afford to take it. Things like marine business, where we can afford to have an adequate net to make money on the line of business. All of the above that you mentioned.
Okay. Thank you very much.
Our next question comes from Jay Cohen with Bank of America.
Good morning. Just one question to something you guys had talked about, that was in the quarter, the underlying loss ratio was better than a year ago. I guess as I thought about it, I suspected that the earned premium for the first quarter still reflected, obviously, business written last year when price increases did not keep pace with claims inflation. While I think you're right, you certainly should see improvement later in the year. I was surprised to see it in the first quarter. Anything else going on there?
Jay, there are a couple of things going on there, probably the most noteworthy would have to do with a pretty benign first quarter as it relates to property losses. Obviously, that drops right through. Relative to what our expectations would be for property loss activity in Q1 versus what it turned out to be, things were a little bit better. While there were a couple of different moving pieces, I would suggest to you the lack of property loss activity was the leading contributor.
That was my second question. That's fine.
Overall, I think that the trend of loss costs, again, were less than 4%, probably slightly less than the 3% of the third quarter. There's a slight benefit from those price increases in the third and fourth quarter of last year.
Got it. On the fixed income portfolio, can you talk about the difference between the new money yields and the expiring yields or your book yield, I should say?
First of all, we have been pretty cautious about reinvesting. In the past 45 days, you could on a 10-year get anywhere from 240 to 197, we've been cautious in what we've done. We have more cash than we've ever had. I shouldn't say ever had. We have more cash than usual. We have, I think, $1.4 billion of cash, give or take. I would say a couple things we're doing, Jay. Number 1, we're looking to try to buy highly protected mezzanine mortgages where we can get 5% or 6% that have sort of a 3- to 4-year duration, 5-year at most. That'll help us offset by lower yields on our fixed income marketable securities. I'd say overall, we're sort of investing at between 3.75% and 4.25%. We think it's going to have slightly adverse impact.
We hope that's going to be offset by common stock dividend yields, which we've invested probably $400 million in common stocks based on dividend yields and attractiveness for what we think will be gains. Not what I call a dynamic stock portfolio, but a conservative one. In addition, finding these particularly small niche things that we've bought some housing bonds that give us tax credits that'll give us effectively a 7% or 8% yield, but it doesn't appear in the investment income. It's going to appear in a lower tax rate. For now, we think we're okay still sort of maintaining this give or take 4% bogey on our yield. As I say, I'm very comfortable at the market changing. There's no doubt in my mind about price increases and where they're going.
My biggest concern is the harder the market turns and the greater our cash flow, will we be able to keep finding niches to invest in and opportunities to invest in at the current portfolio level? I think that certainly, the situation we're seeing in Europe, which is the populist movement, not to face facts of economic discipline, fiscal discipline, is an issue we're going to face here, too. If we don't, we're going to have inflation, and with inflation, you don't want to lock in higher rates for longer terms, which we've actually not done.
Got it. Then one last quick question, I guess for Gene. Can we assume that the catastrophe losses were all in the regional segment?
That's right.
Great. Thanks a lot.
Our next question comes from Bob Farnam with KBW.
With AIG pulling back in that space, have you seen any changes thus far, and do you see that as a good opportunity to have that market change more quickly?
AIG had reduced their relative competitive position before. They had gotten more sensible. Their pulling back was certainly helpful. There is one company that we think was a very aggressive pricer of the business. They didn't price their discount on their investment yields, and the excess comp is the average duration of the portfolio is probably 17 or 18 years. It's an enormous impact with rate assumption, interest rate assumption, and they base their discount on their average portfolio yield, not based on current marginal interest rates. Because of that, their prices were from 20%-40% less than ours, and that's the one place in our industry where we lost business, substantial business. That company's in the process of being sold, so hopefully their new owners will get sensible.
Okay, thanks.
Our next question comes from Samir Khare with Capital Returns Management.
Morning, guys. How are you?
Good morning.
I just wanted to ask about the 4.2% higher price increase you're achieving higher than your renewal business. How has that comparison of pricing for these two buckets trended over, say, like the past four quarters? Could you also comment on what the bound versus quoted trend has been doing in the same time period for the new business?
Let me answer the first one, and then if you could ask the second piece. I didn't catch the whole thing.
Sure.
Relatively speaking, within a certain number of basis points, that delta between new versus renewal has been pretty consistent over the past several quarters. That is not a new phenomenon. We just decided to start to bring that to people's attention because, A, we think it's relevant, and B, it surprised us how the industry in general doesn't really seem to talk about new pricing. They tend to focus only on renewal pricing, which we didn't feel is appropriate. The short answer is that it's been pretty consistent.
Okay. The second question was actually just how your bound versus quoted metric has been trending in your new business in, say, the same time period, let's say four quarters.
As far as those ratios by the group or by segment or by operating unit, that's just not stuff that we typically get into. I would tell you that new business is a bit more competitive today than it was in prior quarters. At the same time, we are finding opportunities. Once again, it's become perhaps a bit more competitive for new business. That's more, I think, a reflection on a change in the attitude of the distribution system as much as anything.
Great. Thank you.
Our next question comes from Dan Johnson with Citadel.
Surprising. Almost all of them answered. Maybe just one question. As you move more into mortgages on the asset side, you gave some good statistics there, but what sort of loss assumptions do you use in those sorts of assets relative to what you might be using when you think about corporate investments? Thank you very much.
The mortgages we're buying are all less than 50% debt to value. We're not really using anything with significant leverage, and the mortgages we're buying have relatively short durations. The things we're using is, very frankly, we don't think there's any consequential risk of loss. We're not in the open market. We're not buying just stuff in the marketplace.
Do you have a team underwriting these, or are you buying a product from others?
I'm not going to talk about the specifics. We've had relationships with people who have done this for a while.
I'm not showing any further questions at this time. I'd like to turn the conference back over to the host for closing comments.
Well, thank you all very much. While clearly we thought we would grow more this quarter than we did, I think one of the things that happens in a cycle is turning the distribution part of our business is sort of sitting and adjusting to price increase environment, they're not out shopping their business. That also means until some of the companies start to set higher standards for terms and conditions, there's not as much business out loose. I think that's going to start to change more dramatically. I think right now, we would expect that price increases continue and to accelerate somewhat. As I said, by the end of the year, we'd expect eight or nine %, maybe even a little better. We'd expect our growth to get somewhat better than it was in the first quarter.
Thank you all very much. Have a great day.
Ladies and gentlemen, this does conclude today's presentation. You may now disconnect and have a wonderful day.