PartnerRe Ltd. Q3 2008 Earnings Conference Call Transcript

PartnerRe Ltd. (PRE)

Q3 FY08 Earnings Call

October 23, 2008, 10:00 AM ET

Executives

Robin Sidders - Director of IR

Patrick Thiele - President and CEO and Director

Albert A. Benchimol - EVP and CFO

Analysts

Joshua Shanker - Citigroup

Susan Spivak - Wachovia Capital Markets

Matthew Heimermann - J.P. Morgan

Ian Gutterman - Adage Capital

Jay Cohen - Merrill Lynch

Vinay Misquith - Credit Suisse

Jay Gelb - Barclay Capital

Presentation

Operator

Before we begin the call, I would like to remind all participants that they are in a listen-only mode. [Operator Instructions] If you haven't received a copy of the press release, it is posted on the company's website www.partnerre.com or you can call 212-687-8080 and one will be faxed to you right away. I'll hand the call over Ms. Robin Sidders, Director of Investor Relations at PartnerRe, who will begin the call.

Robin Sidders - Director of Investor Relations

Good morning. And welcome to PartnerRe's Third Quarter and nine months 2008 Earnings Conference Call webcast. As a reminder our third quarter financial supplement can be found on our website at www.partnerre.com, in the Investor Relation's section by clicking on supplementary financial data on the Financial Reports page.

As usual on today's call are Patrick Thiele, President and CEO of PartnerRe and Albert Benchimol, Executive Vice President and CFO of PartnerRe. Patrick will start with an overview of the third quarter and year-to-date and then hand over to Albert, who'll provide more details on the results. Patrick will conclude with some additional commentary and then we'll open up the call up as normal for question and answer session.

I'll begin with the Safe Harbor Statements. Forward-looking statements contained in this call are based on the Company's assumptions and expectations concerning future events and financial performance, and are made pursuant to the Safe Harbor Provisions of the Private Securities Litigation and Reform Act of 1995. Such statements are subject to significant business, economic, and competitive risks and uncertainties that could cause actual results to differ materially from those reflected in the forward-looking statements. PartnerRe's forward-looking statements could be affected by numerous foreseeable and unforeseeable events and developments such as exposure to catastrophe or other large property and casualty losses, adequacy of reserves, risks associated with implementing business strategies, levels and pricing of new and renewal business achieved, credit, interest, currency, and other risks associated with the company's investment portfolio, changes in accounting policies and other factors identified in the company's filings with the Securities and Exchange Commission.

In light of the significant uncertainties inherent in the forward-looking information contained herein, listeners are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the dates on which they are made. The company disclaims any obligation to publicly update or revise any forward-looking information or statement. In addition, during the call, management will refer to some non-GAAP measures when talking about the company's performance. You could find a reconciliation of those measures to GAAP measures in the company's financial supplement.

With that, I'll hand the call over to Patrick.

Patrick Thiele - President and Chief Executive Officer and Director

Thanks Robin and thanks everyone for dialing in to hear our story during this rather interesting time. I will keep my introductory remarks brief as Albert will spend more time on the details of the results. But there are three points I'd like to make, two relating to the metrics that we believe define fundamental performance and one relating to the velocity by which we manage our company.

First return on equity, 2008 certainly has been an extraordinary year for losses both in terms of severity losses such as hurricane Ike in the third quarter and a frequency of loses such as we saw the first quarter of 2008. Despite this we posted an operating return on our beginning equity of 15% for the first 9 months of the year. And we expect to finish the full year 2008 with an operating return on equity in excess of our long term target of 13%, provided of course there are no unusually large losses during the remainder of the fourth quarter. Second, book value, we like every other reinsurance [ph] in the industry are not immune to the severe financial turmoil that we've seen in the past several quarters.

Despite the magnitude of these crisis our book value per share was down just 4% year-to-date and is flat with our book value per share at September 30th 2007. This shows the balance and diversification we've achieved across our portfolio and the cautious view that we've taken in our divestment portfolio this year.

Finally and most importantly I believe the results we've delivered over the past several years and most notably in the current turbulent quarter clearly demonstrate the value and effectiveness of our integrated risk management framework which I considered to be a hallmark of our company. Our risk management approach on both the asset and liability side of the balance sheet fits within the context of a clearly defined risk tolerance we have established for each one of our major risk crisis. We are not over leveraged to the investment markets nor to the large catastrophic events nor to casualty loss trend.

It's this risk management philosophy that has led to the balance is clearly demonstrated in our results year-to-date. The stability combined with the strength of our balance sheet positions PartnerRe very well in these difficult times to continue to provide our clients with exceptionally secure capacity, and to provide continued value generation for our shareholders. Now I'll hand the call over to Albert to walk through the results of the third quarter, and our operating performance year-to-date.

Albert A. Benchimol - Executive Vice President and Chief Financial Officer

Thank you Patrick and good morning everyone. In this most turbulent quarter we witnessed continued softening of insurance and reinsurance markets, several hurricanes including Ike which will likely emerge as one of the top five catastrophe losses in history, and the most dislocated financial market with the great depression. In this environment we still delivered in underwriting profits meaningful growth of investment income and a respectable operating profit.

As you are all aware we adopted FAS 159 at the beginning of the year, and so we reflect on the face of our income statement both realized and unrealized losses on substantially all of our invested assets. Given the reduction in the market value of our portfolio in the quarter this accounting standard caused us to report a net lose substantially larger then we otherwise would, under different accounting standard and so I would caution you to consider that when you analyze the results or compare them to those of other companies. In any case FAS 159 has no impact on underwriting result, operating income, comprehensive income, nor book value. And our performance on these metrics remain superior on both an absolute and relative measure, given the environment in which we're operative.

We delivered a strong non-life performance in this quarter; reported net premiums written were down 1%, while premiums earned increased 1%. Without the impact of FX, net premiums written would be down 5% and net premiums earned down 3%. Reinstatement premiums related to the CAD also contributed $19 million for a couple of percentage points to both premiums written and earned. As per these factors, the reduction in premiums is consistent with a management our book of business in a softening market.

Not withstanding an active hurricane season and a number of large losses, we reported a combined ratio of 95.5% including 20.5 points relating to hurricanes Gustav and Ike. This speaks to the profitability and balance of our book of business. Non life reserves continue to develop favorably with estimates for prior years reduced by a $103 million, a number that is consistent with prior quarters. In addition, estimates for loses from prior quarters of 2008 will reduce by $28 million for a total benefit this quarter of $131 million. By contrast, in the third quarter of 2007, total reserve releases from prior period were $116 million of which $89 million related to the prior years.

Our approach to reserving has not changed. We continue to book the immature years prudently and release reserves when we have sufficient confidence that they are no longer necessary. On the reserves released year-to-date, over a half relate to short tail lines, with the balance more or less evenly split between mid tail lines and longer tail casualty lines. With these strong quarterly results, our nine months non-life results includes 6% growth in net premiums written aided by apex, the growth of U.S. agricultural book and renewal of rights transaction we booked last year. The technical result was $388 million and the combined ratio 91.4. The increase in the combined ratio over the prior period is due to higher catastrophic losses in 2008 as well as deteriorating loss trends.

In our Life segments, premiums written were flat in the quarter and up 5% in the year-to-date period. But those premiums would have been down 4% for the year were it not for the weaker U.S. dollar. Although we continue to grow our mortality business, longevity business is declining. Profitability metrics for these segments are essentially on plan with an allocated under writing result which includes allocated investment income and operating expenses of $9 million for the quarter and $21 million year-to-date compared $11 million for the first nine months of 2007.

Capital markets activities performed respectively in the quarter, but of course we could not avoid the dramatic reductions in financial markets. Investment income continues to shine, with 8% growth to $146 million in the quarter and 11% growth to $429 million for the nine month period.

As I noted in prior calls, the continued growth of investment income, derived some strong positive cash flow on the one hand and a straight forward portfolio of fixed income in equity securities churns [ph] partnerships and hedge funds investments. As long as we continue to generate cash from operations, we can look forward to a dependable investment income stream. Operating cash flow was $891 million for the year-to-date period. However, we did incur $324 million in realized an unrealized losses in the quarter.

As credit markets seized up financial institutions failed spreads gap and stock markets sank. The detail is included in our financial supplement. Realized losses of $169 million include the impairment of the Lehman Brothers Securities we announced in our press release of September 16th as well as the sale of various stocks, bonds and to mark another financial instruments. The remaining $155 million reflect the reduction in the value of assets we continue to hold. And, as I noted earlier, we report both realized and unrealized losses on our income statements due to the adoption of FAS 159, a practice that is not shared by all companies.

Other income statement items exhibit normal growth and fluctuations based on business activity and FX rates. We booked a tax benefit of $39 million in the quarter comprised of a charge of $3 million against operating income and a benefit of $42 million on net realized and unrealized investment losses. The low effective tax rate on the operating income is due to expiration of certain FIN 48 reserves as well as the benefit of lower tax rates in Canada. We expect average operating tax rates in the 8% to 12% range going forward after the European reorganizations we completed in the first quarter this year and assuming that geographic distribution of earnings consistent with historical trends. The tax benefit on the non operating loss was 13% reflecting the geographic distribution of realized and unrealized investment losses. For the nine month period, the tax benefit was $50 million comprised of a $56 million tax charge on operating income and a $106 million tax benefit on non-operating losses.

Putting it all together, operating income was $120 million or $2.27 per share as compared to $274 million or $4.78 per share reported in the third quarter of 2007. The major drivers for the decline in operating profits being the large cat losses and lower underwriting profitability partially offset by higher life contribution and growth of investment income.

The same trends drove the reduction in the year-to-date operating income. As you will recall, in the addition to the third quarter hurricane, 2008 also experienced a higher frequency of mid size and large losses. The net income numbers include both realized and unrealized losses in 2008, but not in the prior year and thus are not directly comparable. I do want to bring to your attention the comprehensive loss of $243 million this quarter, $91 million larger then the net loss of 152. Given our adoption of FAS 159, the only major difference between the net income and comprehensive income is a change in the currency translation account, which reflects changes in the carrying value of our subsidy areas, caused by changes in currencies. We do not hedge the capital supporting our European and Canadian operations, because we think it is appropriate that both the international business risk and the capital supporting it should respond equally to fluctuations in currencies. In any case, CGA movements tend to even out over the longer term, although they may exhibit large movements when the U.S. dollar moves dramatically as it is doing currently.

The U.S. dollar strength in the 11% against the Euro and 4% against the Canadian dollar in the quarter; and that led to a reduction of $92 million in the carrying value of our foreign subs. The effect is more muted in the year-to-date period, where the CTA account decline by a more modest $35 million. I want to emphasize the changes to the CTA account have nothing to do with business profitability nor asset quality. It is purely a reflection of the relative currency movements.

Let's move on to the balance sheet. Most changes year-over-year or quarter-to-quarter are consistent with business volume or seasonality. But I will address investments, reserves and capital. Total investments in cash stand at $11.5 billion about flat for the beginning of the year. During the quarter the investment portfolio decreased by $489 million. Of that amount, $344 million is due to currency but that does not affect our book value or economic value to any material extent because our reinsurance liabilities tend to move in equal and opposite direction. The remaining reduction of a $145 million is due to the realized and unrealized losses partially offset by investment income and new cash into the portfolio.

For the first nine months of 2008, the investment portfolio decreased by $66 million. Investment income and new cash into the portfolio were not quite sufficient to offset the impact of FX, the decrease in market value of the fix income or the equity securities. It goes without saying that we remain very comfortable with our invested assets. We haven't reduced the risk in our portfolio ahead of the current crises and continue to manage it prudently.

Common stocks comprise about 6% of the portfolio and our fix income portfolio is 96% investment grade with fully 59% securities rated triple A. Only a third of our fixed income securities are in corporate credit, the rest is substantially all governments or government backed entities and high quality mortgage backed and asset backed securities. We have not been investors in sub-prime or Alt-A [ph] nor CDOs.

Finally, we are not an active insurer in the CDS market. Other than a limited number of principal finance transactions, where we are heavily involved in the analysis and structuring of the securities we enhance. We are otherwise a buyer of protection on a limited number of risks purchased from high quality counter parties.

Given the current economic and financial market turmoil, we won't be able to avoid the occasional impairment. But our high asset quality, diversification and prudent risk limits are such that the losses can be absorbed with an acceptable overall portfolio result. Another important feature of our portfolio is that we manage it ourselves. We know exactly what's in it and we control the investment strategies and the risk budget to achieve the returns we expect for the risk we are prepared to assume.

Through September 30th, we are ahead of the index returns we use to monitor the risk and returns of our various strategies. In the interest of time, I would refer you to the substantial amount of detail on our investment portfolio contained in our financial supplement.

Gross Non-Life reserves are $7.5 billion at September 30th, net Non-Life reserves were $7.4 billion, showing healthy year-over-year growth in balances but lower than last quarter due to the impact of FX. You will find all relevant metrics on our reserves in our financial supplement. We also released on our website, during the quarter, our annual detailed Non-Life reserve triangles.

I want to remark on the impact of interest rates on the time value of money on our reserves. As you know, we carry reserves at their nominal value even if they will be paid out over a number of years. Discounting them at the risk free rate for the relevant payment schedules and currencies generates the time value of money in our reserves which is not reflected under GAAP. Given the lower risk free rates in the third quarter, the time value of money in our Non-Life reserves declined by a $137 million to $1.47 billion.

The interplay between the impact of interest rates on our fixed income portfolio and our Non-Life reserves generally dampens the volatility of the economic value of our company. Gross reserves for policy benefits for Life and annuity contracts were down $115 million for the quarter and essential flat to only down 1% for the year and totaled $1.5 billion at September 30th. The decrease was almost entirely due to the impact of foreign exchange. Total capital was down 6.1% for the quarter and 4% for the year-to-date reflecting the operating profits more than offset by the realized and unrealized losses and the reduction of the CTA account, preferred and common dividends and net stock repurchases.

Book value per share declined by 6.9% for the quarter and 3.8% for the year but was up modestly on a per share basis compared to September 30th, 2007. Before I pass the call onto Patrick, I would like to review some of the capital management activities we announced during the quarter. In 2005, as you may recall, in the aftermath of Katrina, Rita and Wilma, we raised $400 million of new capital through our transactions that included bank debt and a forward sale of 6.7 million shares.

This transaction allowed us to obtain capital benefit immediately but defer the potential dilution of the stock sales until a later date. The forward sales portion of the transaction was to mature in October of this year and the debt, next April. We have discussed with you in prior calls. In July of this year we announced that we split this original transaction in two and extended half a bit by 18 months involving $200 million of debt and the forward sale of 3.4 million shares. The remaining half for an equal amount of debt in shares would mature according to what's written in old terms in'08.

On September 25th,we announced that we initiated the delivery of the 3.4 million shares that were subject to the October 2008 maturity. Given the terms of the contract, we would receive no less than $59.37 per share and no more than $79.58 per share depending on the then applicable market price. We will receive no less than $202 million in the aggregate and potentially more if our stock trades above the floor price. Our UN financials will fully reflect the increased shareholders equity. We will continue to retain the full benefit of the range forward equity sale relating to the extended half of the original transaction, which will mature in 2010.

To facilitate the extension of the range forward transaction, we also purchased 1 million shares in July at a total cost of $70 million bringing our total share purchase activity in 2008 to 1.5 million shares with total consideration of a $110 million. Given current market conditions, as well as our new found optimism regarding opportunities in reinsurance markets, it is unlikely that we will be repurchasing any meaningful quantities of our stock in the near term. And with that I'll return the call to Patrick.

Patrick Thiele - President and Chief Executive Officer and Director

Thanks Albert, and now to the forward-looking part of the call. As I said before, 2008 has been a difficult year for the industry both the insurance industry as well as re-insurance industry. We had $8 billion of large losses in the first quarter, $20 billion of cash in the third quarter with that an investment disaster with the stock market dropping over 25% in first nine months and still declining. Credit spreads have widened leading to mark-to-market losses on corporate bonds and including even our own portfolio even with its high credit quality. On top of that, we continue to be in a slow motion casualty loss up trend led by the DNO and ENO lines

Early this year, I gave an industry loss estimate of approximately $6 to $10 billion for the sub prime mortgage related DNO losses in the U.S. for the industry as a whole. Obviously, the credit and equity issues are much larger and more widespread today and consequently I would expect total DNO losses and ENO losses to be higher than our initial estimate. All these losses will be reflected in loss fix across several under writhing years I believe will put some degree of strain on the U.S. insurance and reinsurance industry over the next year.

So not surprisingly the insurance industry is under significant financial pressure, operating earnings, invested assets, loss reserves, all pointing to capital strain for our clients and as a result we are seeing demand for reinsurance increase. For mutual's in many stock companies both in the U.S. and in Europe, reinsures are the only readily available sources of capital in these difficult times.

We would expect that this increase in demand will be sustained for sometime, just as it was in the early 2000 after a number of precipitous events like the European Storms, Lothar and Martin, the stock market crash at 2000 through 2002 and casualty reserve increases in 2003 and 2004. The issues this time around have impacted reinsures just as they did post 2000.

In fact the reinsurance industry is much more leveraged both in investment and reserve leverage than the insurance sector. I would expect that overall the industry would report a decline in shareholders equity of over 10% through nine months. And this time I do not expect the capital markets will provide new capital to offset that strain. That decline coupled with a continued deterioration in the capital markets we've list... witnessed since September with increasing losses and with increasing demand mean that prices should rise over time and price profitability should improve. That isn't to say that in the short term however there won't be continued volatility in the insurance financial and the currency market. There very likely will be and already we've seen that in the fourth quarter.

PartnerRe will not be immune to that. However our performance in this past quarter which is the result of our clear end practice risk management protocols should give comfort to continued ability to succeed through difficult times. I believe that PartnerRe has maintained its premier position with clients through this difficult period.

I also believe that our operating return on equity should be among the highest in the industry for the nine months of 2008 and our capital position has weathered this turbulent period well. Our invested asset portfolio was made significantly less risky over the past year in anticipation of the downward trend, and is now positioned to take advantage of an upswing in the capital markets whenever that happens and our reserve position is as prudent as it ever was, of course.

Looking ahead to January 1st, we expect to have some attractively price business and given our positioning we should be the beneficiary of that not just in the shorter term but in the longer term as well as these improving trends continue through 2009. With that, we'll open the call up to questions. Operator, we are ready for the first question.

Robin Sidders - Director of Investor Relations

Operator.

Question And Answer

Operator

Thank you, sir. [Operator Instructions] Our first question comes from Josh Shanker of Citi. Please go ahead.

Joshua Shanker - Citigroup

Good morning to you. First question going back to the 2000 cycle turn, I guess, the [Indiscernible] that was really a casualty led the market up. Given the situations you are seeing right now and given the all those issues with the Gustav and Ike, going into 2009 do you see better opportunities in casualty than property or are saying, just taking a wait and see sort of attitude at this point?

Patrick Thiele - President and Chief Executive Officer and Director

I don't quite agree with your characterization that the 2000 turn was in fact led by casualty. It was led by Lothar and Martin actually kicked it off and then the stock market continued and then the casualty kicked in at the last part. I do think that the current turn here is not an individual line turn or potential turn here; it's unlikely to be an individual line turn like the 2005, 2006 marking environment which was only caused by the catastrophes and was only significantly felt in the catastrophe and the property lines.

My expectation is that this current industry environment... transitional environment, it will be similar to the '99, 2000 in the sense that it'll likely be a rolling movement from line-to-line. I really don't have a prediction as to which line moves first or to which degree; I just believe that in fact generally demand is up, supply is flat to down, I think loss trends are deteriorating, not improving and I think the expected return on our capital has had go up.

Joshua Shanker - Citigroup

Okay. And the second question, looking at PartnerRe's, the total return type company where you're managing both sides of the balance sheet for profits; does the current market conditions lead I to say, look there's great opportunities coming on the reinsurance side so we should, we should focus there or the term will give you a desire to take a little more risk on the asset side of the balance sheet here?

Patrick Thiele - President and Chief Executive Officer and Director

I think...it's a good question. We have a bias towards the reinsurance market place. We think one is more inefficient than the capital markets, frankly. And two is, we think we can demonstrate a franchise in our risk management, our risk valuation and evaluation there. So we have a bias toward insurance risk classes. But certainly we look at the capital markets and the expected returns on the capital market and we would expect that we would achieve rates to return ... priced rates to return on the reinsurance side that would be in excess of what we could reasonably expect on the capital market side. Albert, do you have anything to add to that?

Albert A. Benchimol - Executive Vice President and Chief Financial Officer

I guess the only comment is that our capital is first and foremost supporting our clients, which confirms what Patrick says. I think also it's likely that returns may well be more predictable and within an hour or a band on the reinsurance side than the capital market side. So I think that will color the way we position our capital in the near term.

Joshua Shanker - Citigroup

Okay and finally the moving pieces of the equity sale, the losses and the tougher sort of potential use for the rating [ph] you use, how much more capital do you think you have now than potentially you had three months ago?

Albert A. Benchimol - Executive Vice President and Chief Financial Officer

I'm not sure we'd look at it that way. The first thing that I would do is I would exclude the rating agencies because we don't know what they will or will not do. I think basically the new capital that we are raising today is new shareholders equity capital, it was always capital on the form of the bank debt, if you would. I think that the capital that we have, that we are raising in the third quarter goes a long way. So ... in the fourth quarter I mean goes a long way to towards offsetting certainly anything we've experienced to date in the fourth quarter. So, I would say that net-net, we're probably equal, third quarter to third quarter, but its still very early on the fourth quarter and we'll see how that all materializes,

Joshua Shanker - Citigroup

Very well, thanks very much.

Operator

Our next question comes form Susan Spivak of Wachovia. Please go ahead.

Susan Spivak - Wachovia Capital Markets

Good morning, Patrick and Albert. I was hoping ... just two questions, Patrick you talked about a lot of factors with the financial crisis impacting the demand for re-insurance. I just wanted ... we know they are two large global re-insurers out there that have a big influence on pricing and I was just wanting to know, are you sensing that they're on board with the need to drive rates higher as well? That's my first question. And the second is, do you think this financial crisis makes M&A more or less likely near term and how will it be financed?

Patrick Thiele - President and Chief Executive Officer and Director

I usually don't like to talk about competitors and their underwriting strategy and I'm not sure that's valid. All I think I can say is that certainly the turmoil that exists within the financial markets typically has a leveraged impact upon the European re-insurers more than it does to Bermudian and the ... re-insurers because they are much more leveraged to the investment markets typically in Europe, they would have five to six times their equity in invested assets, so small percentage declines would have a leveraged impact upon their equity. I don't know what they will do in response to that fact but that is the fact.

Secondly, your question was about potential merger and acquisition within the I guess the insurance and re-insurance industry. Again, I don't have a view on the insurance industry, they'll have to decide how they want to respond to this. But I think on the reinsurance side, its clearly finely balanced. I think for those re-insurers who are comfortable with their capital position and comfortable with their position in the market place vis-à-vis the clients, in fact in some ways the attractiveness of acquisitions is declining as we begin to see more organic opportunities to expand their reinsurance book. I can't again talk very intelligently about the less well positioned re-insurers.

Susan Spivak - Wachovia Capital Markets

Okay, and thanks for your interest. That was helpful.

Operator

Thank you and our next question comes from Matthew Heimermann of J.P. Morgan. Please go ahead with your question.

Matthew Heimermann - J.P. Morgan

Hi good morning everybody. Couple of questions, first when you think about how I don't the right way to ask this question in terms of products or geography but could you prioritize in your mind what opportunities you think your going to see first?

Patrick Thiele - President and Chief Executive Officer and Director

On the reinsurance side or the capital market side?

Matthew Heimermann - J.P. Morgan

Reinsurance.

Patrick Thiele - President and Chief Executive Officer and Director

I think the...this will sound ... while as I mentioned in the notes, I mean there is a large swath of the global insurance industry both US and European which is, mutual's ... which are mutual's, which have a very difficult time even in the best of times, raising capital, they tend to have to do it through retained earnings and I had done a small run of mutual insurance companies primarily in the Midwest, United States and they are currently running at in excess of 110 combined ratio so they're not making money on the operating side and 40% of their statutory surplus was in common stock. So they're not having a very good year on their investments as well. My expectation is that that segment mutual's both in the U.S. and the Europe midsize to large mutual's will in fact need to come to the market place ... the reinsurance market place to allow them to presumably take advantage of what hopefully will be an improving insurance market place as well.

The specialty lines aspect of our business which has historically been kind of a lords [ph] dominated increasingly also Bermuda having a participation in there tends to react much faster as well to improving market conditions they tend to be the marginal lines and so there are swings in terms of pricing tend to be quicker and more dramatic. I think the large stock companies, both in the U.S. and in Europe will probably be the last to respond.

Matthew Heimermann - J.P. Morgan

And then just in terms of lines of business, I mean when you think about the specialty lines, the mutual comp, well actually maybe more get towards the mutual companies, is the most effective way from your perspective for them to improve their capital situation is to buy on the property side and reduce that capital train or do they need a more balanced approach?

Patrick Thiele - President and Chief Executive Officer and Director

I would expect they would need a more balanced approach but each one of them is going to come to their own conclusion as to that based upon their own book of business and I think from a reinsurance perspective, as we've said over many- many times is the most important thing ... or one of the most important things for us is balance in our book.

We want to make sure that we get a proper slug of property, casualty, motors, specialty lines, Life and so we would be encouraging of a broader view of the capital support through the purchase of reinsurance rather than being in one particular area trying to solve one particular problem with an excess of loss treaty.

Matthew Heimermann - J.P. Morgan

Fair enough. And then just in terms of risk I mean what do think of potentially undermine a more optimistic view of the market?

Patrick Thiele - President and Chief Executive Officer and Director

Risk to the current supply and demand situation?

Matthew Heimermann - J.P. Morgan

Yeah, I guess, I mean, how if credit markets return to normal maybe next year, I mean, you could have a situation where it spreads actually tightened you actually recreate some of the capital I know some companies are more equity levered versus fixed levered. But how would you think about that and then to the extent that on the mutual side in the U.S. ... well just that in particular and then anything else you could think of?

Patrick Thiele - President and Chief Executive Officer and Director

I don't think demand is likely to ... the increase in demand is likely to change in the near to intermediate term. I don't think that will go away even if in fact some of the capital markets rebound. Because I do think that losses are coming into the system and that's probably going to stay with us for more than a six month or nine month period even if the stock market does rebound.

Two is, I think the supply situation is pretty well know and if no other nothing else comes to this one in seven to five year occurrence in the credit markets will probably lead to a significantly increased sense of risk on the part of reinsures around their investment portfolio and I would not expect them to automatically adjust the risk appetite just because we go back into a little less turbulent time.

I guess the real concerns would have to be what the broader impacts of this are on, particularly in the reinsurance industry and here I'm thinking around what is potential for increase regulation, the ... we, in some ways we've benefited from the fact that while re-insurer's obviously solvency insolvency regulation is very important to us. We haven't had significant straits on our profitability or our pricing capabilities. I worry at some point of time that in fact we get caught up with the increasing regulatory environment that absolutely is going to occur on the banking side. And that could be troublesome.

And as Albert said we don't know how to predict the rating agencies in the rating agency's response to this kind of event as they deal with their own issues must become harder and harder to predict exactly how they're going to view the reinsurance industry and even with the fact that probably people don't pay quite as much attention as they used to it could have some negative impact.

Matthew Heimermann - J.P. Morgan

And then one last quick one if I can sneak it in which is just you mentioned your view that DNO exposure ENO exposure is up relative to your last comments does that, does the increase in magnitude change your view of your own share of loss?

Patrick Thiele - President and Chief Executive Officer and Director

No, our share would stay the same and it doesn't change my view as well as that we stated at the end of the first quarter that the financial impact of ... is already contained within our balance sheet both on the under premium reserve and the loss reserve. I will not expect that it might expanded view with a potential liability that exists in the DNO and ENO market, United States would have a significant impact upon our going forward financial result.

Matthew Heimermann - J.P. Morgan

Okay, appreciate it thank you.

Operator

Thank you, and our next question comes from Ian Gutterman of Adage Capital. Please go ahead.

Ian Gutterman - Adage Capital

Hi, first a quick numbers question for Albert. Due the dollar of CAT by segment when I tried to back into them from the combined ratio of math on this segment disclosure I got to something like 180 not the 200?.

Albert A. Benchimol - Executive Vice President and Chief Financial Officer

Don't forget that part of the CATs were the ILS unit.

Ian Gutterman - Adage Capital

Okay, how much is in there?

Albert A. Benchimol - Executive Vice President and Chief Financial Officer

There is $20 million of CAT from the ILS unit, 15 of which is through the other income, the technical result and $5 million is in the realized loss.

Ian Gutterman - Adage Capital

Okay that's nice.

Albert A. Benchimol - Executive Vice President and Chief Financial Officer

That's why you got it. You actually got it right.

Ian Gutterman - Adage Capital

Okay, then I guess for Pat on pricing. You've talked obviously, historically always about targeting a 13 plus percent return on capital and I guess what I am wondering is given the environment we're in, is that adequate given that if we had a quake tomorrow, and you had to raise capital or just that this growth opportunity is so good that you want to opportunistically raise capital. The cost of that could be a lot more than 13%. So do you need to start raising your targets to something a lot higher than what you thought of historically, may be it needs to something closer to a 20% given the environment we're in?

Patrick Thiele - President and Chief Executive Officer and Director

We're smiling a little here, I mean the 13% is a long-term target and we suddenly expect that we would have a different view in any given year. Some years in fact we would target or allow the underwriters to price to something below 13 and some years we'd expect them to make something in excess of 13 and so the 13 is a long term target, it does not really specify what we would expect to making in a given year.

The indisputable fact at the moment is that I can make a 10% return buying singly bonds where they promised to give me a 100% of my money back. And in that kind of environment its unlikely that we would be willing to risk our capital at the kind of mid to high single digit returns on equity that we were looking at having to write at least some of our business at six months ago nine months ago. So yeah then in the broader financial markets do have an impact both on the pricing that we think we can achieve and then also on what our target ought to be for the year.

Ian Gutterman - Adage Capital

And I guess related...

Patrick Thiele - President and Chief Executive Officer and Director

But we're not in the business gouging our clients.

Ian Gutterman - Adage Capital

Sure.

Patrick Thiele - President and Chief Executive Officer and Director

We would ... will they expect to have continuity and consistency of offer and there should be at least some relationship with the price that we charge today with the price that we charged six months ago, a year ago, two years ago. The industry, the reinsurance industry has done a lot of damage thanks to itself over the last few years in terms of jacking the prices up significantly, one year and then competing them down in the next. I think the clients would prefer a more consistent approach to pricing.

Ian Gutterman - Adage Capital

I agree with that; I guess I was think though from the customer's standpoint to some extent do they want to ... gouging maybe isn't the right word but may be its sort of the new reinsurance arbitrage right, if I'm a primary and my capital is impaired and I'm looking at very expensive debt or equity options, why not buy as much reinsurance's as I can if it's only 15 or 16 returns cost of capital such as 13. I would think I would buy as much I can, so may be they're not going to feel gouged if just to charge them 18 or 20 given other alternatives?

Patrick Thiele - President and Chief Executive Officer and Director

Thank you for that. I think obviously it is very difficult to generalize on all that. Each one of our clients has unique sort of situation and each will take kind of a different view, what I was trying to say is that I think something has changed in the marketplace, I think there is for the first time really in 4 or 5 years there is an opportunity that the cost of capital, the price of capital has probably gone up somewhat. And then now we're down into the negotiation and the transactions that we're always dealing with. We don't as a company typically put in across the board arbitrary pricing, top down pricing decisions we try to allow our business unit leaders and our senior underwriters to make transactional decisions within an overall profitability framework, Albert.

Albert A. Benchimol - Executive Vice President and Chief Financial Officer

Yeah just to put in the framework I think what really matters in terms of the franchise is that our clients, we want our clients to see value in the product, and value in the relationship and I ... Matt you make a good point definition of value is at a different ... Ian sorry, different price at different points. But they need to see value and we'll work hard to make sure that they see very good value in their relationship while we still achieve our economic goals.

Ian Gutterman - Adage Capital

Okay. And then just a final follow up and that is, historically we always hear especially when times get tough that we're going to see a fight to quality and higher rate of companies will benefit and I guess I am wondering is from a theoretical standpoint, given everything that's gone under the market that concerns about credit quality, it would seem not just that there should be a flight [ph] to quality but this actually might be time where AA companies can actually charge a premium versus an A company. Specially I am an insurer and I am worried about whose going to be around if the credit markets keep getting worse. Is there any possibility you think that we see a change in the way progress is indicated or where there's differentiated pricing to the higher credit quality companies?

Patrick Thiele - President and Chief Executive Officer and Director

Albert and I are both chomping at the bit to answer that one. I think we charged the right price and an A company should probably charge a discount. So that's charge of premium, go ahead, Albert.

Albert A. Benchimol - Executive Vice President and Chief Financial Officer

The short answer Ian is you should be asking those questions to the primary company telephone calls.

Ian Gutterman - Adage Capital

I will. Alright, thank you guys.

Operator

Thank you. Our next question comes from Jay Cohen of Merrill Lynch. Please go ahead with your question.

Jay Cohen - Merrill Lynch

Yeah, thanks. Yeah Patrick, during your comment I believe you said you are already seeing some signs of increased demand. I'm wondering if you could flush that out a little bit.

Patrick Thiele - President and Chief Executive Officer and Director

Yeah, I mean it's primarily in the area that I talked about, we are certainly getting some significant enquiries from what I call kind of bread and butter mutual's in the U.S. and beginning to see in Europe as well those results have been somewhat impacted by the financial world and they're beginning to look for alternatives in terms of capital relief. There have been some approaches as well as people try to understand what the AIG situation is likely to mean from a competitive standpoint and we do get inquiries around that.

And again because of the Ike and the Gustav impact we have seen in the ... since the renewal season at least portion of renewal seasonal is already starting for the cap business January 1st cap business we have had people begin to enquire about increased levels of cap protection

Jay Cohen - Merrill Lynch

Great. And then second question that your stock where it is, is; I would say, comfortably below economic value.

Albert A. Benchimol - Executive Vice President and Chief Financial Officer

Well, uncomfortably below economic value as the case maybe; it's all matter of perspective.

Jay Cohen - Merrill Lynch

Well, I mean if I just take ... if I discount the reserves and throw it a good will forgetting the embedded value of the Life business you come up with 76 bucks. And you are 20 points below that which is usually a pretty good time to buy back stock. I understand there's opportunities but do you balance off. I mean do you ever say to yourself, well let's actually write a little less business, we can buy back the stock at this price, create value in a risk free way, that we can measure right now.

Albert A. Benchimol - Executive Vice President and Chief Financial Officer

I take a slightly different view of that and at the end of the day, the value of any company is the net present value of all future cash flows. And we're building ... and we're building a franchise for the ages here and I think that I spoke earlier about creating value in the products and creating value in the franchise. We've seen what has happened in the past when companies or the industry make short-term decisions.

We are in the business of supporting our clients and we are in the business of making a very adequate return while we do that. I think that I certainly understand the math of buying the stock today. I believe the creation of a franchise and relationships that will generate superior returns over a longer period of time represent for us the better mid-term investment.

Patrick Thiele - President and Chief Executive Officer and Director

I might add argue a little bit with your characterization as debt being risk free, I don't know of any transaction that's risk free.

Jay Cohen - Merrill Lynch

That is fair.

Patrick Thiele - President and Chief Executive Officer and Director

And we look at the risk that would come and potentially come from having a strained capital structure not only just the fact that we'd be giving up future, our earnings strains but if we did it to an extent where we weren't able to withstand the one in the thousand. I am sure the one in a thousand would happen. So I mean there is a no risk for us frankly and we try to make sure that we hold the right amount of capital in this organization; we still have more than adequate capital to meet the needs of our clients but it is not unlimited.

Jay Cohen - Merrill Lynch

Personally what do you think the market is getting wrong, when you are that much ... when you were that much more dead than alive? What do you think the market's telling you?

Patrick Thiele - President and Chief Executive Officer and Director

I think there is no... I think ... this is our view here but I think everything that we see right now is that the valuations in this market have nothing to do with reality. I think it's a rush to liquidity, I think people need to generate cash any way they can. We find it difficult to believe that any rational individual would consider this to be a fair price in any point in time. But this is not irrational market. I think it's difficult to answer question about how the market is getting it wrong when we ... I mean that's not our job.

Our job is to try to create value in this organization and we do look a little bit of quizzically look at the stock market and it's ability over the last three months to adequately price anything. We take a fair amount pride in being able to evaluate and value risk that's what we do for living on the reinsurance side and the capital market side and we can't figure out how the stock market is doing the equivalent thing, we just ... we don't see it. We don't see underlying sense of risk in the capital charge as we go to it, we don't see it in terms of people's expectations. As Albert says it's a chaotic environment and the only difficult thing for that, for us in that case is it does cause some issues for us internally because ... and with our clients because I think still the clients and sometimes our own employees view the stock price as some kind of barometer of the underlying health to the organization and I think that's not true anymore.

Jay Cohen - Merrill Lynch

Okay, I am scratching my head as well so. Thanks a lot.

Patrick Thiele - President and Chief Executive Officer and Director

I appreciate you are saying that. Thank you.

Albert A. Benchimol - Executive Vice President and Chief Financial Officer

Thank you.

Operator

Thank you and our next question comes from Vinay Misquith of Credit Suisse. Please go ahead.

Vinay Misquith - Credit Suisse

Hi, good morning. Pat, I was wondering whether your view on higher pricing is both for the primary insurance and reinsurance or would that only be limited to dually insured?

Patrick Thiele - President and Chief Executive Officer and Director

I can let also ... I am not sure authoritatively, most of my logic or my logical construct here applies to the reinsurance industries. The insurance industry has some other difficulties because, in fact there are in many cases regulated or semi regulated as to profitability and they are also much more sensitive to some of the underlying economic trends which are unlikely to be constructive over the next year to two years.

An so while as a relatively code unregulated industry we have I think more flexibility in changing our pricing in the insurance industry which has less and there is some potential for a squeeze of some extent on the insurance industry as they struggle with trying to get their prices up to what would be an adequate level given the increase in lost trends. While the re-insurers are more free to raise the reinsurance rates and that is an issue I think that we have to be aware and we have to be sensitive too. The clients cannot change terms and conditions nor change pricing with quite the rapidity that the reinsurance industry can?

Vinay Misquith - Credit Suisse

Have you seen a hard market in the past or reinsurance without the primary insurance pricing moving at out over...?

Patrick Thiele - President and Chief Executive Officer and Director

Not over a longer term we are in the sense of derivative industry of the insurance industry, which means at the end of day we both have to be healthy. But that is over a longer term over cycle. But yes there have been times it's worked the other way, where insurance pricing has been strong and reinsurance pricing has been weak and the re-insurers have let it down the market. Over a time, over a three to five year period we have to be concert and we have to have similar economics we just tend to be more leveraged. And more volatile, and obviously more risky than the insurance industry but that doesn't mean we have be in lot stack [ph] every year.

Vinay Misquith - Credit Suisse

Sure, so you are still positive that the reinsurance would be able to increase pricing even though primary insures may or may not move or may move slowly in the near term, correct?

Patrick Thiele - President and Chief Executive Officer and Director

Yes, its I guess two points for that one is we're starting, at least PartnerRe is starting not from a negative return on equity we are as we shown we're still making a pretty decent rate return so in fact a pricing turn if it is purely pricing and not just we could also do a few things in terms and conditions by reducing the risk in the treaty. We're not so far off that I think its going to be hugely dramatic, this doesn't need to be 40 to 50 to 60 points of rate increase to get to an adequate level of profitability in this industry. And two is the reinsurance spend of insurance companies is relatively small in most cases except for again some mutuals, it is less then simply 10% most of the time it's around 5% or 6% of their gross rated premium. And that could probably go to 7% or 8% without a dramatic impact upon the insurance companies financial stability, financial results. And it would certainly improve their financial stability.

Albert A. Benchimol - Executive Vice President and Chief Financial Officer

And in any case Vinay, I mean you've got to go back in many ways to Jay's comment and Ian's comment. The industry is going to have alternatives with the uses of it's capital. And at the end of the day, the industry will end up at a place where it places it's capital in the place where it gets it's best risk adjusted returns, that is the economic and logical thing for it to do. And given the various opportunities we have including as Jay pointed out stock repurchases, I think that has to be a floor below which it just does not make sense to utilize that capital in the reinsurance business.

Vinay Misquith - Credit Suisse

Fair enough. One last question, if I may. How harder for market do you think this is going to be versus '01. '01 was really hard. Do you think prices need to grow up as much or much, much less than it was before?

Patrick Thiele - President and Chief Executive Officer and Director

As I said the industry as a whole from the reinsurance side, from the liability side isn't in distress at the moment; it's certainly below what I would consider to be an at good rate to return, but is not anywhere close to where it was in '99 and 2000. And so I don't have a crystal ball as to how hard a market gets, we'll find that out as we kind of go through the January first renewal system process. But I don't think the damage that's been done to the reinsurance industry and this cycle has been quite as bad as it was in the last one. So, my expectation is that the wrenching changes won't be quite as much.

I also want to make sure that, I tired to say it in my prepared remarks that we're not forecasting a dramatic turn in the near term. I think there's still going to be great deal of volatility in both financial markets, the currency markets and in the reinsurance market places, really for two things; one is, anytime you go into a transition it is difficult to find the price finding mechanism. The trend needs to begin to be established and until the trend is established and the brokers especially can begin to understand where are the prices, you are going to have a fair amount of volatility and that will probably occur in January 1st as well.

The ...then so it'll be difficult for ourselves and later on you to try to figure exactly what is going on in terms of pricing trends over the next three to six months. And again I think there will be volatility on the losses, the losses will emerge not in this straight line and not in a consistent fashion and not dramatically stating, okay the loss trend now went from three to ten, you will have a period of uncertainty around there as well.

Most of my comments ... all my comments are saying in the intermediate term I think something has changed I think the price profitability environment is likely to improve for the reinsurance industry. But it's not ... we turned the lights on today and all of a sudden everything is fine.

Vinay Misquith - Credit Suisse

That's good, thank you.

Operator

Thank you. And our last question comes from Jay Gelb of Barclay Capital. Please go ahead with your question.

Jay Gelb - Barclay Capital

Thanks just knocking here at the end. Patrick with regard to your comment that you expect attractive price bids for January 1st. One of the things that I was thinking about is it appears that the re-insurers could have some capital constrain on them as well, between the catastrophe losses. I'm talking about the industry as a whole. The catastrophe losses as well as the impact of financial dislocation and we're seeing that in terms of book value erosion. Should we anticipate that although there may be better price business as of January 1 we are not necessarily going see that in the terms higher premium volume similar to what we after Katrina?

Patrick Thiele - President and Chief Executive Officer and Director

I don't know, I don't think about it in terms of premium volume. I think about in terms of and when I say increased opportunities I think there are opportunities. I'm not ... again I am not sure exactly how the trend is going to look and whether I will let the brokers tell me what the pricing trend is after the fact. Only thing I can do is react to individual opportunities as they come to us do I expect premium for PartnerRe would higher after January 1st and before. I don't know.

Albert A. Benchimol - Executive Vice President and Chief Financial Officer

I think perhaps we can take a broader view here, I think the different between 2006 and 2009 is that its unlikely that you are going to have the influx of new capital in the industry in 2008 and 2009. And so whatever is the impact on the reinsurance capital at some point pricing will have to find a clearing level. Because they will not be a substantial amount of new supply, so there is going to be in many ways some inelasticity of supply and we'll figure out just how much is the required ROE to deliver to the primary market the capacity that it needs. Excuse me Jay.

Jay Gelb - Barclay Capital

No question.

Patrick Thiele - President and Chief Executive Officer and Director

So the I guess in conclusion I understand that we're looking for certainty around our trend we're all kind of certainty about how 2009 is going to play out. I can't and we can't obviously give you a clear picture of that because in fact it is evolving and I don't think anyone actually knows how it's going to actually evolve, and certainly we can't predict the near term surprises that we are likely to see.

What I think is different at this time, is in fact that I do believe that the economics for the reinsurance industry have changed because of readily demonstrable changes in demand, changes in supply. And I think the final keys which is the uptick potentially in casualty loss of trends are setting the stage for some time over the next year, two years.

A better profitability environment for the reinsurance industry and I think that another day you have to have a certain amount of face in the organization that you investing that we know how to traverse, we all know how to get how to operate the good environment. These are difficult times because of the volatile unit uncertainties that currently exit the marketplace and we work very hard at this organization to handle that volatility and that risk for you and I don't think that's gone change over next six to nine months.

So thank you very much listening. Thank you for the good questions that was quit a good series of question and we will talk to in three months.

Operator

Thank you.

Operator

This...

Patrick Thiele - President and Chief Executive Officer and Director

Okay.

Operator

Go ahead sir.

Patrick Thiele - President and Chief Executive Officer and Director

That's it.

Operator

Thank you everyone for joining today's PartnerRe conference call. This call has concluded and you may now disconnect. .

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