Argo Group International Holdings, Ltd.
Q4 2008 Earnings Call Transcript

Published: 13 Feb 2009

[Operator:]

Ladies and gentlemen, welcome to the Fourth Quarter 2008 Argo Group International Conference Call. My name is Tanya, and I will be your coordinator for today. At this time, all participants are in a listen-only mode. We will be facilitating a question-and-answer session towards the end of this conference. (Operator instructions) I would now like to turn the presentation over to your host for today’s call, Mr. Michael Russell, Investor Relations. Mr. Russell, please proceed.

[Michael Russell:]

Thank you, Tanya, and good morning, everyone. Welcome to Argo Group's conference call for the 2008 fourth quarter and full year. With me today is Mark Watson, President and Chief Executive Officer, and Jay Bullock, Chief Financial Officer. We are pleased to have the opportunity to review the company's results and provide management's perspective on the business. No earnings guidance will be provided in this call. I would like to remind you that this conference call is being recorded, and all participants are in listen-only mode. Following management's opening remarks, the operator will provide instructions on how you may queue in to ask questions. Let me remind everyone that as a result of this conference call, Argo Group management may make comments that reflect their intentions, beliefs, and expectations for the future. Such forward-looking statements are qualified by the inherent risks and uncertainties surrounding future expectations and are generally and materially differ from actual future results, involving any one or more of such statements. Argo Group undertakes no obligation to publicly update forward-looking statements as a result of events or developments subsequent to this conference call. For a more detailed discussion of such risks and uncertainties, please see Argo Group's filings with the SEC. With that, I would like to introduce Mark Watson, Chief Executive Officer of Argo Group. Mark?

[Mark Watson:]

Thank you, Mike, and hello to everyone. We appreciate that you have taken the time to join us today. I will lead off the call with some general observations regarding 2008, comment on the environment from a capital and pricing perspective, reflect upon what we accomplished last year and provide some perspective on why we believe those actions will manifest positive results ahead for Argo Group. After my opening remarks, our CFO, Jay Bullock, will provide additional details on our financial results for the fourth quarter and year ended December 31. After Jay’s comments, we will open the call for your questions. So let me begin. For property and casualty insurers, it was hard to believe so soon after 2005 that we would face another an anomalous year. Recall that in the second quarter of 2008, more than a dozen serious weather events destroyed properties in the US. As we rolled into the second half of the year, two hurricanes, including Ike, hit the Gulf coast region damaging property from Texas to the Upper Midwest. Also Ike is one of the most costly hurricanes in US history. Finally as 2008 entered the fourth quarter, we witnessed another type of catastrophe, a collapse of the financial and credit markets. As with most companies in our industry, Argo Group was affected by each of these events. I am pleased to report however that we weathered the storms and market turmoil and our business remains strong as we entered 2009. Moreover, what we achieved in 2008 ideally positions Argo Group to capitalize on the future. I will comment more about the market environment in a moment. Let me just make a few comments about the 2008 consolidated results. Despite the market challenges I'm just mentioned, our 2008 financial results remains solid. In fact, we were able to grow pretax operating income from $113.9 million in 2007 to $121.5 million in 2008. And despite the soft market and increased competition in many of our lines of business, our companies diversified business platform, which we built both organically and through acquisitions, allowed us to grow our business. In 2008, gross written premiums increased by nearly 36%, revenue grew by about 26%, and operating income was up 7%. During 2008, our businesses maneuvered carefully through the softening market, maintaining our underwriting discipline. Intense marketplace competition continued to impact parts of our excess and surplus line segment, yet we were able to produce operating profits for the year of approximately $98 million with a combined ratio of just over 93%. With Trident’s strategic acquisition of New England's leading public entity insurer, Massamont, our commercial specialty segment increased gross written premiums by 21% and continues to be a strong contributor to our bottom line. Our reinsurance segment performed to plan generating operating income of nearly $25 million in 2008. We see additional upside at Argo Re as reinsurance rates firmed. And finally since June 1, our international specialty segment became part of Argo Group. Unfortunately their heavily weighted property book was impacted by hurricane Ike and other attritional losses, resulting in a $5 million operating loss in the last seven months of 2008. While we reported a decline of 2.5% in book value per share, which normally would be very frustrating, but given the current environment, I can't complain too much, and I should say that our balance sheet remains strong as we enter 2009 with invested assets increasing to approximately $4 billion. I’d like to talk about our business platform for a minute. During 2008, we moved into the early stages of a much stronger position for 2009 than we were in before. Last mainly acquired the final piece to our international specialty platform, adding a Lloyd's syndicate that gave us a strategic presence, or I should say more a more significant strategic presence in the London insurance marketplace. With our presence in the Bermuda and the US markets, our broader geographic breadth allows us to offer Argo Group’s product suite to the entire specialty insurance distribution network, which from a strategic perspective, we view as a single converging marketplace. And our optimism about the company's diversified infrastructure, I should mention that parts of our platform are still in the early stages of development. Needless to say, we believe our platform’s full potential is yet to be realized. In Bermuda, our reinsurance team led by our Argo Re President Andrew Carrier just completed their first year of full operations, writing about $100 million of business, and delivering nearly $25 million in operating profits, notwithstanding the significance of Hurricane Ike. Our newly acquired London operation in only seven months as an Argo Group company wrote approximately $280 million of business, but as with many of our fellow Lloyd's peers with property exposed books, 2008 resulted in a higher frequency and severity of large market losses related primarily to Ike and Gustav. It now appears 2008 was the second most costly year on record for the insurance industry, exceeded only by 2005, which included Katrina, Rita and Wilma. In a typical accident loss year, we believe our Lloyd’s operation going forward will deliver returns closer to what it produced in 2007 when Heritage generated margins in excess of 20%. Not surprisingly, our international platform is generating recruiting benefits as well. With Argo Group’s extended reach, we have been attracting very talented and experienced people who can bring additional capabilities to our underwriting portfolio. Candidates we interviewed have expressed an interest in joining the early stages of our expanded platform. They look forward to participating in strategy formulation, having a tangible impact on results, and sharing in the benefits of long-term success. There is no better example of how our new platform is attracting talent than at Argo Re where Andrew Carrier in his first year successfully led his very capable underwriting team as they build our profitable reinsurance book from scratch. Also just recently, we appointed Nigel Mortimer to head up Argo Re’s newly established casualty and professional risks business and named Neil Chapman as our new Joint Active Underwriter at Heritage. The addition of these gentlemen and others to follow reflects the market strength of our international platform and is a strong indicator of the leveraged we now enjoy in the specialty underwriting markets as well. Let me talk about the underwriting environment for a minute. Regarding the property and casualty marketplace, many are projecting a return of the hard market in 2009. Given last year's catastrophic events and the state of the capital markets, one would think a hardening of ranks would be a safe assumption. While there is signs that pricing in some areas have stabilized, improvements seem to be materializing slowly and thus far have been confined to the property and reinsurance markets. As 2008 came to a close, casualty pricing had not yet improved, and may remain flat until the scarcity of capital is realized, which we take time to work its way though the markets. As it does, we believe the permanent reduction of available capital resulting from last year's hurricane and investment portfolio losses will eventually constrain capacity resulting in higher rates. How soon that happens is tough to predict, but we do believe that its occurrence is inevitable. Should the hard market return, Argo Group is much better positioned to capture its potential benefits more so than we were a few years ago. We're confident that when presented a piece of business, we can now offer our agents and retail brokers the broadest possible product portfolio through the broadest possible distribution network, including the US, Bermuda and Lloyd’s. We believe this breadth and depth differentiates Argo Group from most of our competitors. Let me say a few words about capital. Given the financial and catastrophic losses sustained by our industry last year and the amount of excess capital was far less today than a year ago, in the current environment, we recognized that capital is scarce and costly if needed. Therefore any new capital that becomes available would likely gravitate to those companies with prudent results. Otherwise, available capital will continue to be rationed. Eventually, the impact of capital constraints will be the primary factor when the hard market returns as well as increasing lost cost. Looking ahead, we believe that Argo group has the capital resources necessary to execute its business plan for 2009. Those resources include the growth capital needed to support our newest business units as they pursue opportunities in their respective markets. So if I could just say in summary, given the turmoil last year in the insurance and financial markets, Argo performed well by remaining profitable, growing our operating earnings and strengthening our infrastructure. In 2008, we completed the build out of our International Specialty platform, which gives Argo Group a differentiating advantage among the competitors, and strengthens our ability to serve this specialty marketplace and grow our business. Our business platform ideally positions Argo Group to take advantage of the anticipated hard market and on a much broader scale than in the last market cycle. The potential of our platform is attracting talented and experienced personnel that will help us grow in new and existing lines of business. Finally, we believe that Argo group has the capital resources necessary to fulfill our 2009 business plan including the volume of business projected to be underwritten by our newly created business units. Now I will turn the call over to Jay, who will review our financial results in more detail and then open the call-up for questions.

[Jay Bullock:]

Thanks, Mark. Let me go over and add some more color on the fourth quarter and full-year financial results, and after that as Mark said, we will take your questions. As Mark mentioned, 2008 was a challenging year for the industry impacted by significant storm activity, global property losses, and the continuing turmoil in the capital markets. Despite this challenging environment, we reported for the fourth quarter and year pre-tax operating income of $38.7 million and $121.5 million, essentially flat for the quarter but up 6.7% for the year. As we finish the year, we are again pleased with the firm-wide risk management efforts, which allow us to report book value per share of $44.18, down only 2% from the end of 2007. We entered the New Year with a solid capital base and a platform that allows us to direct capital to the most attractive opportunities. Our top line continued to advance during the quarter with net written premiums up 27.5% over the same period last year, largely a result of the additional premium from our International Specialty segment. For the year, our net written premiums increased 34.7% compared to 2007, driven primarily by the acquisition of Massamont in our Commercial Specialty segment, the launch of Argo Re, and the acquisition of Heritage. As Mark noted, the marketplace remains challenging and our insurers are increasingly – are facing increasingly difficult economic conditions. Our approach has been and will continue to be selective expansion where conditions are most attractive and through acquisitions where businesses are additive to our platform. Turning to our underwriting results for the quarter, we continue to see solid performance from our US operation supported by continued positive results from prior accident years. For the quarter and including our Run-off Segment, we saw a positive development of approximately $38 million predominantly from accident years 2005 and prior. This was offset in the quarter by approximately $19 million of reserve additions in response to some severity claims and large claims we saw coming mainly from the current underwriting year. Most disappointing in the quarter was the underwriting result we experienced in our International Specialty segment, where we increased our position for Hurricane Ike by $12.1 million, and took a provision for current and recent year property losses of approximately $11.4 million. The latter was the result of the significant non-catastrophe property losses experienced across the international marketplace in 2008. For the year our loss ratio was 64.3%, which included 6.7 points of hurricane and storm losses of $75 million, net of reinstatement premiums. In 2008, we continue to focus on efficiency. We saw improvement in the expense ratio reporting 36.1 for the year versus 38.2 for the same period in the prior year. This continues to be a priority as we have begun the new year, and we believe there is continued room for improvement. Now let me turn to our balance sheet, and I will begin with our investment portfolio. Both equity and fixed-income markets experienced unprecedented volatility in the second half of 2008, and during the fourth quarter we recognized a net pre-tax realized loss of $16.8 million. The net realized loss included other than temporary impairment write-downs of 22 million [ph] for the quarter on investment securities, largely related to our equity holdings and financial and commodity related businesses. These write-downs were partially offset by sales of various fixed-income and equity securities. For the full year of 2008, we recorded net pre-tax realized investment losses and OTTI write-downs of approximately $35.1 million. At December 31, our investment portfolio was approximately $4 billion with a net unrealized loss position of $7 million in a similar position to where we ended the third quarter. While economic uncertainty continued to hurt pricing of almost all equities, certain sectors of the fixed-income portfolio benefited from the risk aversion and (inaudible) quality. Treasuries, agencies, municipals, and higher quality MBS also spread compression with an aggregate gain of roughly $58 million over the market value of the portfolio at September 30, 2008. Our conservative portfolio management philosophies are reflected in our results for this quarter and for the year. At the end of December 2008, the fixed-income portfolio duration was three years with an average credit quality of AA+ and a tax equivalent yield of 4.5% for the fourth quarter and for the year. As we move into the New Year, and with a significant amount of liquidity that has been injected into the financial system we expect the yield environment to remain challenging as we continue to focus on and maintain credit quality. Our investment in equities securities is approximately 7% of the entire portfolio and generally is comprised of large cap companies. At the end of 2008, the unrealized gain position on our equity portfolio was approximately $17 million on a pre-tax basis. The second largest line item on the asset side of our balance sheet is our reinsurance recoverables. While the balance sheet at year-end of $1.5 billion was up significantly, we had limited increase here from the organic growth in our business segments. Instead, this increase is largely the result of the consolidation of the accounts of our trade capital partners in the International Specialty segment. The top 10 reinsurers that make up this balance comprise approximately 49% of the entire balance and were all rated A- or higher by A.M. Best. With the acquisition of Heritage, we have also taken on some exposure to non-dollar currencies, largely sterling. The dramatic move in sterling against the dollar impacted both the balance sheet and income statement in the quarter. Referring back to the income statement for a moment, our tax rate in the quarter was impacted by the move as on a tax basis, the loss we reported for the quarter in the International Specialty segment was converted to a gain, hence we incurred a tax provision rather than a tax benefit against the operating loss. Conversely, our book value was negatively impacted by the decline and the value of sterling assets we hold in that operation. Despite this year’s difficult operating environment, capital markets, and currency fluctuations we managed conditions well. With book value impacted for the year by the net effective earnings, (inaudible) result in the fixed-income portfolio and declines related to our equity portfolio and non-dollar denominated assets. Again, we are very pleased with the result being only a decline in book value of 2% reporting $44.18 at the end of the year. Finally, I would like to command on the overall capital structure before we open it up for questions. Argo Group entered the quarter with $1.8 billion in total capital, between $1.35 billion of book equity, and $429 million of debt. That debt is broken down between $311 million of trust preferred securities and $117 million of senior debt. Our capital ratios remain strong and we feel we are appropriately positioned to meet our business plan for 2009. Overall, the business model we built and diversified over the last year is well positioned to perform financially. Operator that concludes our prepared remarks and we are ready to take questions now.

[Operator:]

Thank you. (Operator instructions) And your first question will come from the line of David Lewis with Raymond James and Associates. Please proceed.

[David Lewis:]

Thank you and good morning.

[Mark Watson:]

Good morning.

[Jay Bullock:]

Good morning.

[David Lewis:]

Congratulations on a solid quarter. Mark, given the dislocations in the market can you discuss the current competitive environment, more specifically can you talk about the pickup in RFPs in the industry and whether you actually are seeing any additional new business writings coming out of that?

[Mark Watson:]

David, are you talking about some of the larger account business or just in general?

[David Lewis:]

Just in general I mean, AIG obviously a larger account buyer, but I wouldn't say they are across-the-board. I know a lot of players out there in the market have said that that business is getting chopped. I guess I'm curious whether, even though it is being chopped, is it actually finding new homes or is AIG defending their market share by being aggressive on pricing.

[Mark Watson:]

I would say – sorry, our experience is that there is being more business being shopped and we see that in the form of higher submissions year-over-year. That is not necessarily leading to more bound policies for us. In fact, we were just discussing this yesterday. Our hit ratio has actually gone down for some of our businesses, E&S in particular. So there is a flurry of activity but the pricing isn’t necessary at a level that we think is appropriate, which is why you have seen a decline in the amount of gross written premiums in our E&S segment for the second year running now. It depends on each market, but yes there are some people who are still trying to defend their renewal businesses, and there are other companies who are aggressively trying to take that business away. And so if somebody is undercutting your policy, your renewal by 20% and you want to keep it, and the only way to differentiate yourself is on price. Then the only way to keep it is to offer a discount more than the 20% that the guy who wanted to take it from was offering. So, we do see that happening in the market place on small accounts and large accounts, but mainly I would say we are just seeing a flurry of activity for medium to larger size accounts. On the small account business, I would say not so much and I think that has more to do with – it is just so expensive for agents and brokers to chart that business cost effectively for themselves or for the ultimate policyholder.

[David Lewis:]

Secondly, can you talk a little bit about the some of the lost underwriters from Heritage since you closed that transaction, and very feel that you are having any impact as a result?

[Mark Watson:]

Well, yes, I think it is a hugely positive impact. The underwriters you are referring to left at the very beginning in July. And as I mentioned in my opening remarks today, we were able to bring in very well-respected underwriter in the Lloyd's market named Neil Chapman, who has now had a chance for the last four months to really get his hands on the book and reshape the book. And we are already in a better position today and he will – he and his team will have finished reshaping that portfolio by the time wind season begins on July 1. So, I'm actually very positive and very pleased with the team that we now have underwriting that portfolio.

[David Lewis:]

Right, Mark. I will come back with some additional questions. Thank you.

[Operator:]

And your next question will come from the line of Mark Lane with William Blair & Company. Please proceed.

[Mark Lane:]

Good morning. I have a few questions. First, on the expense ratio and operating expenses over all, you know, what is your goal this year in terms of bringing the expense ratio down?

[Mark Watson:]

Well, Mark, I think – that is a function of what happens in the marketplace this year. Our first goal is to not have or I should say our first goal is to have non-acquisition expenses remain as flat as possible. As I was mentioning in an answer to the last question that was put to me, we are seeing more submission activity in most of our businesses. And while we have automated more of our business process and are able to do more with technology in particular the internet, the truth is when processing goes up, people still have to touch it. And so it is very difficult to cut expenses when processing is going up. And so we are trying very hard to keep expenses flat. Now the good news is if the market does change, and it only has to change a bit, then we should see written premium begin to improve in which case the expense ratio will stay flat and then slowly begin to improve as we begin to write more premium. And I'm really thinking about the E&S and the Commercial Specialty business when I say that.

[Mark Lane:]

And what about the growth opportunities or expectations for the reinsurance business and also the International Specialty business. You bought in some new teams, the markets are changing. You've got new underwriters in the Heritage business. What sort of expectation should we have for growth in those two segments?

[Mark Watson:]

So, let us talk about International Specialty first, which is Heritage. While we are actually seeing price improvement in the property market, which makes up a significant portion of Heritage, I think that the majority of 2009 will be spent reunderwriting the property portfolio of 2008, and I think we will then have an opportunity to grow the portfolio later in the year, but I think that right now, we are more focused on making sure that we have a more balanced portfolio that we think is more in line with our group and that takes the first half of the year and the very beginning of the third quarter. We – there are a number of underwriting teams that we have been speaking with off and on, not only in Heritage but within the United States as well, and I think we may have an opportunity to bring on another team or to during the year, but like the US those teams tend to write small Nietzsche business and I would describe it in terms of 5 million to 15 million pounds worth of business for each team during the year. Not 50 to 100 like some things that you see happening in our company and others. So, I think for 2009 we are focused on continuing to bring in teams that are additive to what we are already doing but given the current market pricing, I think it makes sense for us to write some business but not a lot of business and focus on making sure that we have got it right at Heritage.

[Mark Lane:]

Sorry. What is the size of that business you know, pro forma for 2008? I know where did, we only see the business since the acquisition. What was the gross return, gross premium written for International Specialty for the year? What is the size of the business?

[Mark Watson:]

For 2008.

[Mark Lane:]

Yes.

[Mark Watson:]

For the entire year.

[Mark Lane:]

Yes.

[Mark Watson:]

They wrote about, I'm doing this a little bit from memory because I don't keep the full year in front of me, but they wrote about 315 million pounds of premiums. So, peculiar exchange rate but $1.5 that will be $475 million.

[Mark Lane:]

Okay.

[Mark Watson:]

That is Lloyds premium right, so that is that of commission. If you want to think about it in terms of the same dollar amount of business that we are right here, you gross it up for commission.

[Jay Bullock:]

Think about $700 million in dollars and my guess, sorry, I believe given what I have just said that we – with the market conditions where they are today, I believe that will remain flat. If the market does begin to improve then there is an opportunity to grow premium by 10% or 20%. Also in 2008, we kept 54% of the syndicate capacity. In 2009 we will take 62% of the syndicate capacity. So, our net written premiums, if you will, will increase in 2009 versus 2008.

[Mark Lane:]

Okay, (inaudible).

[Mark Watson:]

Yes, now let me finish the first question and talk about reinsurance. While the reinsurance market is improving from a year ago, we are of the opinion or I should say, Andrew Carrier, who is running that book is of the opinion that we ought to write a bit more this year, but the pricing isn't really robust enough to want to write a lot more this year relative to the additional volatility that we bring on the books. There are few – there is a little bit of very reunderwriting that he would like to do in the portfolio. So, we don't expect. We are not planning from a premium basis for the reinsurance book to grow that much in 2009 over 2008. So, I would say growth is 5% to 10%. And some of the new initiatives that we talked about on the casualty side of our Argo Re, which is, you know their insurance, they will go into this segment. That will lead into written premiums in the second quarter and the remainder of the year but again we are talking about $10 million to $20 million of premium that I would say on an annualized basis is $30 million to $40 million. And some of that is very market specific or I should say market condition specific. While conditions have begun to improve they have not begun to improve to the point where we want to write a significant amount of business.

[Mark Lane:]

Okay. And then just last question, regarding just the underwriting, you mentioned reunderwriting a couple of times, first of all on the reinsurance business, I mean it is not an old business and what are you reunderwriting. It just started in the beginning or the end of 2007. And, you know, this – the new underwriter was there at that time and then in Heritage, you also talk a lot about reunderwriting the property book, which is basically the main thrust of the business. I mean, what – I mean what is going on there. You had a disappointing quarter from a loss perspective. You have got new underwriting in there. Are you not happy with the business that you have got when you bought the company or has something changed or –

[Mark Watson:]

The answer is no. I'm not happy with the business that is on the books there, and so yes, we are underwriting it so that we are happy with it. To be honest, I am very disappointed with some of the losses, particularly what we refer to as attritional losses. So non-cat losses that have come out of the book during the year. Now we are not the only underwriter to have experienced some of this, but I think we have experienced more than our fair share given losses that have come into the London market this year. We are well on our way to changing that and as I mentioned earlier we will be through by July 1. Now, as respects to reinsurance book, whenever you write a new book of business and you are trying to get a balanced spread of risks, at the end of the year you look and figure out where you are. And sometimes you need to realign it. So, perhaps and should I should not have said reunderwriting the book of business, I should have said realign some of the aggregate risk that we have on a worldwide basis. So, there is very – there is little change that needs to be made to the reinsurance portfolio. There is a fair amount of change that is being made to the property book at Heritage.

[Mark Lane:]

Okay, thank you.

[Operator:]

And your next question will come from the line of Bijan Moazami with FBR. Please proceed.

[Bijan Moazami:]

Hi, good morning everyone. A lot of the questions that I have been already asked, but in particular I am interested to know whether or not you have to make any additional capital contribution to the Heritage operation, because obviously sterling has decreased in value. You write a lot of the premium in US dollar and I am wondering if, you know, you have to post additional letter of credit there.

[Mark Watson:]

Well, first off, we have part assets at Lloyd's. We don't use letters of credit for our capacity there. We have had conversations before and we have gone through a (inaudible) change in the business plan and a change in the capital required. We had some additional capital on deposit at Lloyd's at year-end, greater than what we have or been required to have the prior year. And so we are not going to have to put any additional capital up at the moment. As the year progresses and we see how the environment develops, you have sort of provisionally discussed with Lloyds the thought that we may increase the amount of the syndicate, again depending on market conditions. That would require us to put up additional capital, but for now everything we have on deposit will be sufficient to meet the requirements.

[Bijan Moazami:]

Thank you.

[Operator:]

And your next question will come from the line of Doug Mirado [ph] with RBC Markets. Please proceed.

[Doug Mirado:]

Hi, good morning. I just had two questions. First, Jay, would you – what I guess investments are you putting most of your new incoming cash flow into, is it in terms of asset classes or in the risk range?

[Jay Bullock:]

High credit quality, there's plenty of yield in high credit quality today to get the returns that we like. We are certainly not chasing product quality. We’ve had a decent amount investment into municipals. We bought some of the government supported financials and we have very selectively bought some CMBS and we are finding opportunities where some of that CMBS is effectively treasury to [ph] fees and yet still offering some good yield, but that is a very, very small allocation. So for the most part, new money is going into municipals and government-sponsored securities.

[Doug Mirado:]

Okay thanks. Next for Mark, please refresh my memory, is there any exposure to win some accounts [ph] from what Heritage writes or what your Bermuda operation might write, and if so, give any indication of what impact that might have?

[Mark Watson:]

Well, we have been – the answer is yes. We do have some exposure. We are trying to figure out what it is because we write mainly – most of the accounts we think we may be exposed to, we’ve written on an excess basis, and we're not sure if the loss is going to get up to us, particularly on the reinsurance program. So based on what we know now, there will be some, but not very much loss.

[Doug Mirado:]

Okay. Thanks. That is helpful.

[Mark Watson:]

I wasn't very analytically specific, but it is just too early to tell.

[Doug Mirado:]

That is fine. That is what most other companies have said the same thing, with a wide very wide range of estimates. Thanks, it’s all my questions.

[Operator:]

(Operator instructions) And your next question will come from the line of Amit Kumar with Fox-Pitt Kelton. Please proceed.

[Amit Kumar:]

Thanks and congrats on the quarter. Maybe just going back to the discussion on the market, you do have I guess a 150 million buyback authorization and just listening to the commentary, is it fair to say that there could be some action on this front as we head into 2009 or is buy back still on the backburner?

[Mark Watson:]

Amit, I think the answer is that is always an option. And we certainly are thinking about it a lot, particularly where our share price is. But until the capital markets and the credit markets settle down, I think we need to keep our powder dry and make sure that we're properly capitalized.

[Amit Kumar:]

Okay, that is helpful. And in terms of – I know you don't give guidance, but we have talked about the mid- teens return goal, how confident are you that in 2009 we might be able to hit that?

[Mark Watson:]

Well, I think that is a real challenge for any of us. I think the last time I looked, it was all over the board, but for most specialty P&C companies, I think the consensus ROE for that group of companies was somewhere in 12% to 13% range. I am hopeful that we will be back in the double-digit range for 2009 as compared to the single digit range that we were in 2008, which has been quite frustrating. And a lot of it, of course, will depend upon what events happened during the year. If market pricing remains soft, which were still in a soft market, and there are a number of significant storm losses again this year, I think that will be challenging, but it will be challenging for the whole industry, not just us. So if we get some improvement in market pricing, I think that will help us as well. So for 2009, I think that focusing on a 10 percentage ROE is probably more realistic than a 15% ROE. And I think given where we are in the market environment and what our competitors are looking like, I think that is a reasonable goal for us given where we have been in the last couple of years.

[Amit Kumar:]

Okay. I think that is helpful. And I guess maybe two quick numbers questions for Jay, in terms of the foreign exchange impact, could you sort of quantify that?

[Jay Bullock:]

The foreign exchange impact hits in three places, hits the balance sheet, hits the income statement through FX – an FX line item in the income statement, and then it affects our tax rate. So on the income statement, the net FX gain was about $3.5 million. The tax rate as I pointed out, the exact opposite of what you would expect. Again that’s a result of our London business being a UK taxpayer. You take the entire business which is largely dollar denominated, you rendered it to sterling, and you end up in a situation where you’ve got a dollar business in sterling, having a lot of FX gains, hence the tax provision. On the balance sheet, the movement in sterling affects our sterling denominated assets, just as it would – just as any movement in interest rates otherwise would affect our assets and goes through the income statement – goes through the balance sheet. So the balance sheet for the year was down 2%. That is the net effect of earnings offset by the equity – the decline in the value of the equity portfolio, and the decline in the value of our sterling denominated assets. So if you kind of do the math from that, net income 62 million, and sterling moved on the balance sheet down about 40, and the equity position down about 60. Those are approximate numbers.

[Amit Kumar:]

That's helpful. And I guess just one other quick numbers question, could you just refresh us as to what is the reserve number remaining on the PXRE book?

[Jay Bullock:]

I believe the PXRE reserves is approximately 80 million.

[Mark Watson:]

Remember we sold the US subsidiary at the beginning of 2008.

[Jay Bullock:]

So that represents just the property portion of the PXRE run-off.

[Mark Watson:]

In Bermuda.

[Jay Bullock:]

In Bermuda.

[Amit Kumar:]

That's helpful. And then maybe just you know – this is the final question, just going back to Mark’s opening on the market conditions, and if I sort of compare and contrast it with others, it does appear and rightly so, that you are taking a cautious tone. In terms of the competitors, obviously we have heard some extremely bullish commentary. What exactly is going on, is it that account specific that some companies are sort of reaping the benefits, or do you think that they are being too optimistic in their projections?

[Mark Watson:]

Well, I think it is a combination of things. The market movements that we are seeing are kind of sub market specific. I think that we are all optimistic that given what we know that prices should go up, there is less capital in the market – there is less – there is less capital supporting the industry today, the P&C industry today than a year ago. So that has to translate into less underwriting capacity, and capacity is going down. If loss costs are increasing, it's investing income is going down, then it is just – I hate to say it is just a simple math, but it is. I think the challenges is that it happened in a different way that different factors that are affecting our industry have kind of come at it differently this time in that we have seen a challenge to both the asset and the liability side of the balance sheet instead of just the liability side. And margin is being impacted by both underwriting results and investment income results, and so I'm not sure that we're institutionally getting things around and affecting the underwriting side. Because with investment income going down, we can say – we can cut cost all we want, but the reality is, if we want to get margin back up, the only way we're going to do it to raise price. So I think more people see that as an inevitable outcome and are anticipating it affecting the marketplace sooner than others, and I guess I'm just being a little cautious.

[Amit Kumar:]

That is good. Okay, thanks so much and congrats once again.

[Mark Watson:]

Thank you.

[Operator:]

And your next question is a follow question coming from the line of Mr. David Lewis with Raymond James. Please proceed.

[David Lewis:]

Thank you. Just a couple of quick questions. First, Mark, are you seeing any changes in limits by current policyholders, if they are trying to look for ways to cut back on expenses?

[Mark Watson:]

Well, that is certainly one way. Everyone has a different book of business. For a lot of our accounts – well, let’s see, so we might see that a little bit on the commercial specialty side, but most of our accounts in the US tend to be million dollar policy limits or less, so we are more likely to just see that account go away on the insured side, not to buy insurance, if they’ve got to choose between that and making payroll. So we will see somewhat of a – we are seeing lighter demand, but we are mainly just seeing policies going away.

[David Lewis:]

That's helpful. And Jay, given that you are invested assets are carrying new cash flow, going into munis, government agencies for the most part, I assume those yields in the market today are lower than your current overall yield on the portfolio, so it is probably fair to assume that we are going to see net investment income kind of flat to down on a sequential basis, is that fair?

[Jay Bullock:]

Yes. Well, we will see some incremental growth in the size of the portfolio. But as I mentioned in my comments, the reinvestment – the reinvesting environment is challenging, because we are not going to take a lot of progress in this environment, and the underlying base rates, whatever they might be, the government yields are very, very low. So yes, I think it is fair to say that we are not reinvesting it at the moment at the same yield as our overall portfolio.

[David Lewis:]

All right. And do you by chance know what the AOCI impact was on book value or the book value excluding AOCI at the end of the year? Pretty (inaudible) I guess you indicated that you are 7 million underwater, and I guess…

[Jay Bullock:]

That's the net position on the portfolio, so some gains, some losses. Net position book to market down $7 million on $4 billion, so essentially flat right. So, are you talking about just the impact on the investment portfolio?

[David Lewis:]

Yes, just looking at the AOCI impact at year-end? You may not have that.

[Jay Bullock:]

Yes, I don't have that handy…

[David Lewis:]

All right. I know some people questioned how to cut back the effect of the investment losses, et cetera, but our calculation, we came up with kind of an operating EPS number of $0.80, does that sounds about right given the tax effects in the different markets?

[Jay Bullock:]

Yes. I mean I think if you – if you simply add – if you are adding back the OTTI, and assuming that most of that is in the US, maybe there's some of that that is in the UK, that gets you into about the right zip code, I think.

[David Lewis:]

Right, thanks very much.

[Operator:]

(Operator instructions) And there are no more further questions at this time. I would now like to turn the call back over to Mr. Mark Watson for closing remarks.

[Mark Watson:]

I would like to thank everyone for taking the time today to join us on our call. I think we have made a lot of progress in moving our company ahead during 2008. I think we are very well positioned for 2009, particularly if the market changes. 2008 was very challenging financially, but I think that we're doing the right things to be in a better position for 2009, as respects net income and ROE. I would like to thank all of our employees for working very hard during the course of 2008 because it was a very tough year, particularly at the end of the year, and I look forward to 2009. So thank you again for your time today.

[Operator:]

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the presentation. You may now disconnect and have a great day.