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Executives

Helen M. Wilson – Director, Investor Relations

Evan G. Greenberg – Chairman, Chief Executive Officer

Philip Bancroft – Chief Financial Officer

John Keogh – Chief Executive Officer, Overseas General

Brian Dowd – Chairman, ACE USA

Analysts

Jay Gelb – Barclays Capital

Josh Shanker – Citigroup

Tom Cholnoky – Goldman Sachs

Ron Bobman – Capital Returns

Matthew Heimermann – J.P. Morgan

Susan Spivak – Wachovia Capital Markets, LLC

[Scott Frost – HSPC]

Ian Gutterman – Adage Capital

Brian Meredith – UBS

Paul Newsome – Sandler O’Neill & Partners, LP

[David Small] – J.P. Morgan

Vinay Misquith – Credit Suisse

Steven Labbe – Langen McAlenney

ACE Limited (ACE) Q3 2008 Earnings Call October 29, 2008 8:30 AM ET

Operator

Good day everyone and welcome to ACE Limited’s third quarter 2008 earnings conference call. (Operator Instructions) For opening remarks and introductions, I would like to turn the call over to Miss Helen Wilson, Director of Investor Relations. Please go ahead, ma’am.

Helen M. Wilson

Thank you and welcome to the ACE Limited September 30, 2008 third quarter earnings conference call. Our report today will contain forward-looking statements. These include statements relating to general economic and insurance industry conditions; our financial outlook and guidance; business strategy and practices; competition; growth prospects; investments and use of capital; integration and performance of recent acquisitions; our re-domestication to Switzerland and its effects; our stock price in the capital market; pricing; and exposures, losses and reserves all of which are subject to risks and uncertainties.

Actual results may differ materially. Please refer to our most recent SEC filings as well as our inked press release and financial supplement which are available on our website for more information on factors that could affect these matters. This call is being webcast live and will be available for replay for one month. All remarks made during the call are current at the time of the call and will not be updated to reflect subsequent material developments.

Now I’d like to introduce our speakers. First we’ll hear from Evan Greenberg, Chairman and Chief Executive Officer, followed by Phil Bancroft our Chief Financial Officer. Then we’ll take your questions. Also with us to assist with your questions are several members of our management team. And now it’s my pleasure to turn the call over to Evan.

Evan G. Greenberg

Good morning. I want to make a few comments about the financial markets and our industry and then follow with ACE’s results. To say this was a difficult quarter for the global financial markets is an obvious understatement. What we witnessed since the beginning of September is simply seismic; destruction of companies and wealth, all in a blink. In roughly a six week period the role of government and regulation in the market has changed.

The structure and order of the financial services industry, banking, investment banking, brokerage and insurance are changing before all our eyes. Across the financial services landscape, true credit related losses, unreasonably exaggerated by fair value accounting have contributed to a cycle of fear and tight liquidity that has fed on itself, resulting in severe and indiscriminate price declines for all classes of financial assets and near zero liquidity in the lending markets.

The ultimate impact of all this is still in front of us and not 100% clear. Economic, political, geopolitical, regulatory, all consequences yet to unfold but undoubtedly will over years. I am encouraged by the extraordinary actions taken by central banks and governments around the world to provide capital and inject liquidity and confidence into the banking system. There are early signs of stability in the debt markets. However, credit and equity markets remain under severe stress. A continued impact of de-leveraging and the specter of severe recession are the principal factors impacting pricing.

In the insurance industry so far this year we have witnessed a significant and rapid destruction of capital. We began the year with an over capitalized industry feeding the soft market. Since then, natural catastrophes and financial market losses have destroyed a great deal of this excess capital. Additionally, downgrades and government ownership are impairing the ability of a number of companies to operate in the same manner as they have in the past. And this adds to industry capital pressures.

Moreover, the cost of debt and equity capital has soared for all industries globally, including insurance and this will be true for some time to come. While all this is going on, insurance company margins are under greater pressure as underwriting experience deteriorates due to increased cuts, soft market pricing and declining returns on investment portfolios. In sum, the end of the soft market in insurance has arrived.

During the quarter, the balance sheets and income statements of all financial services companies, including insurance, have been stressed; some far more than others. Through those, these extreme conditions ACE in my judgment has performed quite well. I believe our results demonstrate relative balance sheet stability and earning strength. In fact, if there ever was a test of our operating policies or how we endeavor to run our company conservatively and manage it for permanence, it has been this period.

This environment has and will create quite a number of casualties in the corporate world. Witness Lehman, Bear, Merrill, WaMu, Wachovia, AIG as well as others in our industry. This period will also create significant opportunities, many of huge proportions for those with the wherewithal and franchise to take advantage. We’ve already witnessed some of that in the banking world and we will in insurance as well.

ACE will be one of the companies that strives to take advantage of these opportunities. The exact size, shape and timing are unclear as events are unfolding rapidly. I expect we will emerge from this period bigger and stronger. Again, our results for the quarter and nine months were excellent all considered. ACE recorded after tax operating income in the quarter of $504 million or $1.51 per share, bringing year-to-date operating income essentially flat with prior year. It was down about 3%.

Our PMC combined ratio for the quarter was 97.9. Underwriting results were impacted by 12.5 points of cat losses, almost exclusively from Hurricanes Gustav and Ike. These were within our expectations of loss when we priced and wrote the business. Results in the period also benefited from positive prior period development in the amount of $277 million pretax. About 55% of the release was related to casualty related lines and the balance was short-tail.

For casualty we completed a number of actuarial studies in the quarter and the majority of the release was for accident years ’04 and prior. The balance of the release was for short-tail lines. Loss reserves year-to-date increased by $1.5 billion and this is another point of our balance sheet strength. Our balance sheet and capital position are in good shape and our operating cash flow quite strong at $1 billion for the quarter and $3 billion year-to-date.

Net income and book value were impacted significantly in the quarter by realized and unrealized of $1.3 billion. The vast majority of this was due to pricing and not true impairments. As a consequence, book value declined by 6% in the quarter. Our book value in the last 12 months is essentially flat and our annualized return on equity year-to-date is 16.5%, pretty good use of capital in our judgment.

Concerning our variable annuity reinsurance business, as we have explained before accounting convention requires us to account for these liabilities like a derivative, using fair value accounting even though they are in fact long term in nature, consistent with a buy and hold business. This is a cat business and we are in cat-like financial market conditions. Our portfolio had a net loss of $78 million in the quarter which includes a realized mark of 161. Phil will provide more details about this.

During the quarter our net premiums increased 17% with strong contributions from crop insurance, our international A&H and the impact of the consolidation of Combined Insurance which by the way is on track with its savings and growth initiatives. Turning to market conditions, as I said earlier I believe the soft market is now over and this fact will work its way to the trading level of our business over the next few months.

Rates are now in the early stages of firming. In many parts of the world rate decreases have slowed or stopped and in some classes rates are beginning to rise, particularly in lines that have performed poorly such as energy. Again, its early days. As I said before, given the amount of capital that has been destroyed, as well as the capital on balance sheets that cannot be effectively deployed due to downgrades and government ownership, I believe rates will rise in the future.

How far and how fast I cannot predict. There is simply not enough visibility.

At ACE however we have mandated as a rule flat pricing, no reductions. Under more normal circumstances you would expect us to provide ’09 and earnings guidance by mid-December. However, we are in a period of great uncertainty due to the global economic slowdown, and continued financial market stress, and dynamics within our industry, our business mix may very well change. Until we get more visibility we will likely delay issuing guidance. That means end of the year or very early ’09.

It’s worth repeating. I believe that based on what we know today we will see a reordering of players in the insurance industry. Some will be in a position to take advantage of these challenging times while others will shrink or disappear. I have confidence that ACE will be one of the winners.

Before I turn the call over to Phil, I’d like to comment on a statement I made yesterday on behalf of the American Insurance Association addressing news at the Treasury Department is considering whether insurers should be included under the Capital Purchase Program which is part of the $700 billion Emergency Economic Stabilization Package approved by Congress. My statement said that the majority of insurers represented by the AIA do not support the inclusion of PMC insurers in the CPP program. That’s the equity program. And if made available, they would not elect to participate. And that statement includes ACE.

In fact, we are adamantly opposed to taxpayer capital being used for the insurance industry and that goes for both general and life insurance. There is simply no need or cause. We believe the CPP funds should be used as Treasury intended them; to prevent systemic risk to the financial system as a result of a counter party failure or as a means to inject liquidity into the credit system, two criteria the insurance fails. To protect policyholder interests there is the well established system in place.

If CPP funds were used for insurers, the capital would represent a cheap and distorting subsidy from the government, rather than a means of crisis correction. In short, taxpayers should be a last resort rather than a cheap source of capital. With that, I’ll turn the call over to Phil and then we’ll come back and take your questions.

Philip Bancroft

Thanks Evan. Good morning. For the quarter we had positive operating cash flow of approximately $1 billion and our balance sheet and capital position remain strong. In fact, Standard and Poor’s recently reaffirmed all of ACE’s counterparty credit and financial strength ratings including our A+ ratings for our core operating companies. The S&P, A.M. Best, Moody’s and Fitch outlooks on all ACE companies remain stable.

Net investment income grew 6% in the quarter and 9% for the first nine months. On an after tax basis, realized and unrealized losses from our investment portfolio were $1.1 billion with approximately $850 million in unrealized losses resulting from the mark to market pricing impact caused by the dramatic widening of credit spreads and drop in equity prices in the quarter. After tax realized losses from our investment portfolio were approximately

$280 million, comprising losses on sales of securities and losses on securities deemed impaired.

Approximately $120 million of the impaired amount relates to our holdings in Lehman Brothers debt. Overall, our invested assets decreased $2.1 billion in the period. Approximately $1.5 billion of this decrease was due to pretax, realized and unrealized losses. An additional $1.2 billion was used to settle repurchase agreements used to finance the acquisition of combined and to pay for purchased securities which remained unsettled at the end of last quarter.

These reductions were partially offset by our $1 billion of operating cash flow. Our portfolio continues to be predominantly invested in investment grade, fixed income securities and is broadly diversified across geographies, sectors and issuers. The average credit rating is double A and its duration is approximately four years. Our holdings at financial institutions that have recently experienced distress, related to the credit market difficulties, are not significant to our capital position.

We do not invest in CDO’s or CLO’s or complex credit structures and we do not use leverage in the portfolio. We also do not provide credit default protection.

With respect to the unrealized losses in our fixed income investment portfolio, we believe our strong liquidity and our continuing positive cash flow support our view that we will hold our highly rated fixed income investments until they recover their value as they approach maturity. We have longstanding global credit limits for our portfolio. Exposures are aggregated, monitored and actively managed by our global credit committee. We also have well established, strict contractual investment rules requiring managers to maintain highly diversified exposures to individual issuers.

We use state of the art technology to monitor manager compliance with portfolio guidelines on a daily basis. You will find additional information in the supplement about our investment portfolio, including a breakdown by sector, credit quality and geography. This disclosure includes our top 25 holdings.

Our realized losses include $161 million relating to the increase in the fair value liability of the GMIB’s in our variable annuity reinsurance business. The loss was reduced from our pre-release estimate by approximately $60 million, following the subsequent completion of our regular quarterly reserve study. Our operating income also improved by approximately $18 million or $0.05 per share.

The level of operating income and the mark to market losses are contemplated in our models and within our range of expectations when we originally priced the business. In fact, our models show that as of 9/30 this is approximately a 1 in 50 year event. While this business is considered a derivative for technical accounting purposes, we feel our operating income which includes the results of insurance accounting treatment, is a more meaningful way to look at this business.

It’s worth contrasting our variable annuity reinsurance to the life companies that originate this business. First, we have no deferred acquisition costs. Second, our contracts are issued to life insurers covering the portfolios of business they wrote and our contracts contain annual limits and deductibles that limit our exposure. Third, the premiums we charge companies generally do not fall when equity markets decline. And finally we reinsure only guaranteed minimum death benefits and guaranteed minimum income benefits. No other guarantees.

We’ve been asked to reinsure other benefits but didn’t consider it prudent to do so. We have controlled our aggregate exposures and our portfolio has been declining. We stopped writing new or renewal business in 2007. There are no liquidity problems and the business produces positive cash flow. We have included the cash flow for this business for the last several quarters in the supplement.

On substantially all of our GMIB exposures our clients, policyholders, are not eligible to trigger claim payments until 2013 or later. As you may recall, our debt to total capital leverage was inflated at June 30 due to $700 million of repurchase agreements used for the combined acquisition in the second quarter. These repurchase agreements were repaid in the third quarter and our debt to total capital leverage at September 30 was 17.6%. We have also provided additional disclosure in our supplement on our debt maturity profile and bank credit facilities.

You will see that we have minimal debt refinancing needs over the next five years. Our LOC and revolving credit facilities were executed in 2007 for a five year period. The LOC facilities are principally used for collateral requirements related to our reinsurance business in Bermuda.

As of September 30 we have entered into securities lending agreements totaling approximately

$2 billion. The proceeds from these agreements are invested in prime, short term money market funds. We do not issue commercial paper or any other short term securities to finance our operations.

Our cat losses of $311 million, net of tax, were in line with our previously reported estimates. We have included our estimates by storm and segment in the supplement. The combined acquisition is performing as expected. We are on track with our expense reduction plan and with our operating income estimates. We estimate that the acquisition of combined will be $0.24 per share accretive for 2008.

We are updating our 2008 earnings guidance. We now expect that our earnings per common share will be in the range of $7.55 to $7.75. Cat losses included in our estimated earnings are $100 million pretax for the fourth quarter. I’ll turn the call back over to Helen.

Helen M. Wilson

Thank you Phil. At this point we’d be happy to take your questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) Your first question comes from Jay Gelb – Barclays Capital.

Jay Gelb – Barclays Capital

First on the earnings guidance, I know you mentioned the catastrophe expectation. Are there any expectations in there for reserve releases?

Evan G. Greenberg

No. Absolutely not.

Jay Gelb – Barclays Capital

And then second and I guess more broadly, with regard to AIG can you give us a sense of how much you or how much ACE can benefit from the dislocation there in terms of attracting business or buying operations or bringing over teams of people? And then on the pricing side, Evan, you said no reductions on pricing in P&C. Does that apply to new and renewal business?

Evan G. Greenberg

First, the no pricing reductions applies to new and renewal business. The new business has to meet our pricing standard, so if it was priced below our standard then we’re going to raise the rate on it. On renewal business yes, it applies to renewal business and that’s the rule. Any exceptions to that rule require quite high level sign-offs within every division, for instance in North America it requires each division president sign-off to be able to “other than flat or up”.

On AIG look there is opportunity from AIG. I’ll give you a couple of data points in terms of business that is coming to market and it is seeking an alternative and in fact securing an alternative. As far as acquisitions go I’m really not going to speak about that. AIG has announced that they’re going to sell assets and you know we have a strategy, a very clear strategy and we will make acquisitions where they further are strategy. And where they enhance and make our company stronger. And if that includes businesses in AIG then that will happen.

As long as it’s accretive and so therefore it’s at the right price to shareholders. We’re not going to break discipline and we are quite mindful of the high cost of capital today. On the side of business, if I give you just a sense of business that is coming in and a lot of it is due to the trouble or the weakness that is occurring within other insurers in terms of either the rating downgrades of some others or those owned by the government today.

You know, our submission activity and this will just give you a window into it, our submission activity in August, September, was up about 12% over prior year. In early October our submission count from late September, early October was up over 31% over prior year. And for all of October as of now it’s up over 50% over prior year. So it’s increasing just rapidly. And 80% - our submission count for large account business is up 80%. For middle market it’s up about 60% and for the small commercial it’s up about 36%.

We have seen so far in October as many submissions as we saw all of fourth quarter last year. So I hope that gives you some window.

Jay Gelb – Barclays Capital

And then in terms of the conversion on that, the quotes are written?

Evan G. Greenberg

The conversion ratio, you know, I don’t mind saying when it comes to the one large player who is under stress they are an outlier right now in the pricing environment today. They are aggressively cutting pricing in an irresponsible way to maintain business and it’s worrisome. The balance of the market we’re seeing really rates kind of going flat, in some classes up. We’ve seen where rates are going down in a dramatic slowdown in the rate of decrease in pricing. The last four weeks have been almost a [sea change], beginning of a sea change in the market. But there is that one outlier and we’re just not going to break discipline to write to business.

Operator

Your next question comes from Josh Shanker – Citigroup.

Josh Shanker – Citigroup

You mentioned the word, Evan, energy – that energy rates might be on the rise and we haven’t heard that from anyone else yet. I’m wondering if you can go into a little detail about whether that’s just reacting to the storm losses or is there something greater afoot here?

Evan G. Greenberg

I’m going to ask John Keogh to comment for a moment and on offshore energy and then Brian Dowd to talk for a moment on onshore energy. Go ahead John.

John Keogh

Sure. On offshore, Josh, as you know Ike has given that part of the industry a significant loss in the Gulf of Mexico. That loss will be multiples of the premium for the industry on the heels of a big loss a couple of years ago. So we are already seeing - it’s early days we’re already seeing rates in the Gulf of Mexico offshore go up significantly over expiring.

Evan G. Greenberg

And other than the Gulf we’re also seeing offshore energy rates rising right now. I mean, this is early days, rising double digits though significantly less than the Gulf. Brian do you want to talk a little on onshore energy?

Brian E. Dowd

On onshore energy property, frankly, the number of losses in ’08 have been historic frankly. And we started trying to push pricing in early April on onshore energy. And practically with limited success and starting in the third quarter we have started to get some traction and starting to see prices move up. In the single day [genera] is a start. And we’re also starting to see differential pricing. We’re seeing some carriers get pricing increases and one large carrier, frankly, getting prices that aren’t the same as the rest of the market.

Josh Shanker – Citigroup

And the other question and I don’t mean to force the conference call to continue to be a little about AIG, but I can promise you you’re not the only conference call. In terms of markets where there’s not a lot of competitors where you’re there and AIG is there, some of the emerging markets and whatnot, I’m wondering if you can go into a little detail about how the products sold and whether or not the counterparty risk is prevalent in the buyers insurance in these more emerging marketplaces?

Evan G. Greenberg

Let me answer it this way. The United States and the UK are, and to a lesser extent Australia, are where there is the greatest concern about counterparty for the most part. Right now less so on the continent. It is to some degree in Latin America, less so in the balance of Asia. Large accounts, though, around the world have a greater concern and you see more CFO involvement around the world than you do in middle market or smaller accounts. Though again like the U.S. and the UK it’s kind of – it’s front of mind for most.

The business is sold mostly through brokers, though when you get to some of the smaller markets it is agency driven. And so, you know, the recognition and the understanding of what is occurring is – it’s kind of like throwing a stone in the water and the ripples move out. The ripples are continuing to move out. And the comments – how I would have commented on it two weeks ago or four weeks ago is different than the comment I’d give you today. It’s dynamic.

Josh Shanker – Citigroup

And in terms of business that’s sold through brokerages is it the customer asking for more quotes or are you seeing the brokers being proactive in terms of doing a deeper dive they’ve typically done for more sources of protection for their customers?

Evan G. Greenberg

You know, it’s thick and thin. It depends on how diligent the broker is in doing their job. In many – you know where a broker is diligent, they’re presenting their clients with the information, they’re giving them their own professional advice, but of course it’s always the clients’ choice. And I think in most cases, whether it is the broker or the client, they’re prudently exploring all opportunities.

Operator

Your next question comes from Tom Cholnoky – Goldman Sachs.

Tom Cholnoky – Goldman Sachs

I wanted to just pursue this comment that Phil made regarding your invested assets. You know, clearly we can all see the impact that the weak financial markets have had on companies’ balance sheets. But I was intrigued by the comment that you and other companies have been making that, you know, frankly, you know, this is all credit spread related, we have the full intent to hold, which kind of implies that what we’re really facing here is a temporary impact to capital.

And if you and other managements really feel that way, that this is all going to come back, where is this financial pressure that everybody’s talking about? How will this actually impact behavior in the market over the long term if you and others believe this is all money good investments?

Evan G. Greenberg

Well, two comments I’d make about that. Number one, Phil was not referring to equity markets. He was referring to debt markets, number one. Number two, he was referring to the amortized, the ultimate amortized cost of these securities. They will amortize themselves back to the original price that we paid for them. That doesn’t mean that if you traded them in the meantime because of spreads that you wouldn’t take a realized loss. You would.

And so what he didn’t comment on is that whether he thinks credit spreads are going to come back to where they were, and frankly let’s assume equity markets recover and let’s assume that debt markets recover to some degree, we don’t think the cost of capital is going to return to where it was. And that recovery is going to take some time so there is just that practical reality.

Tom Cholnoky – Goldman Sachs

But in the end, though, you would argue that some of the – what you’re really saying is that a lot of these unrealized losses will ultimately reverse themselves.

Philip Bancroft

Over the next three to four years, right? Depending on the duration of the ec –

Evan G. Greenberg

On the fixed income, as it amortizes itself back.

Tom Cholnoky – Goldman Sachs

Or as spreads might narrow, right?

Evan G. Greenberg

As it accretes back or as spreads narrow. Correct.

Tom Cholnoky – Goldman Sachs

Secondly I’m just wondering, Evan, if you could just talk a little bit about the demand side of the equation. Obviously you’re going into a global slowdown in terms of growth. How much of an impact will that have do you think on actual premium writings? In other words even though your rates might be going up, if exposure growth is declining, will that somewhat slow the impact on the top line?

Evan G. Greenberg

Yes, I think that’s a – that’s fair. And that’s why I’m saying I don’t have – it’s chaotic right now, it’s dynamic. So if you want to put it all in a neat box I think that’s at your peril. I don’t think any of us have that kind of a neat picture of it right now. Tom, I want to be careful of one thing you said. What I said is the market is firming and that to me means rate decreases have slowed, the market is going – I see in the first instance the market going flat. How much rates will rise past that, how long it’ll take, which classes exactly I don’t know.

On the other side of the coin we see all the market dislocation, we just talked about one player [no one’s] obsessed with and that will benefit ACE in I think broadly there will be other market dislocation that will benefit ACE. On the other side of the coin, recession is slowdown, severe recession which is what we’ve – you know, that’s the picture we have, I’m sure it’s the picture you have will impact exposure and business activity. And so therefore that will on the other side of the coin impact the growth of our business.

Tom Cholnoky – Goldman Sachs

Could I assume – would it be fair to assume that you’ve kind of pushed back your concerns about the impact being placed on lost costs?

Evan G. Greenberg

Yes, at the moment we have, yes. But I will tell you this; I hope everyone’s very mindful that all the government stimulus, all liquidity is putting a tremendous amount of capital cash into the market. And when we come out of this, we’re going to come out of this likely in a higher inflation period hump with an increased cost to capital.

Operator

Your next question comes from Ron Bobman – Capital Returns.

Ron Bobman – Capital Returns

I had a question about re-insurers and choosing or sort of not choosing to support AIG as the AIG reinsurance programs come up for renewal. Will what happens there have a meaningful impact on sort of AIG’s continuing ability to act in the manner and way you’ve described?

Evan G. Greenberg

You know, I don’t want to speculate on how re-insurers are going to respond to AIG. Re-insurers are there to provide capacity when it is to their advantage, when it’s good for their balance sheet and shareholders. And they’ll make those judgments. The only thing I’ll say is that re-insurers do, its part of their job, they look at every cedent, you know, who are they reinsuring? And they look at the quality of their underwriting and they do that for all of us. They do that for the entire marketplace and I’m sure AIG or ACE none of us are any exception to that rule.

Operator

Your next question comes from Matthew Heimermann – J.P. Morgan.

Matthew Heimermann – J.P. Morgan

In terms of the stabilization you expect in the market, when you think about the risks to that stabilization and potentially increases, are those more fundamental risks, i.e., investor markets increase more quickly than you expect? Or is it more resolve on behalf of some of the competitors?

Evan G. Greenberg

I don’t think it’s necessarily just resolve. I think it’s, you know, your business behavior is really impacted by your view of the realities that you face, the environment that you face. So the realities right now which I think none of us can guess with any certainty but I think it’s fairly reasonable to assume are not going to reverse themselves in the near term. And that is the cost of capital has gone up dramatically. That’s not going away in the immediate future. If it did then we’d have to reassess.

The amount of capital that has been destroyed within the industry or that is dislocated that is a reality that we assume is going to be with us for the foreseeable future. And if that changed, then you would be, you know, you’d cause to reassess. Severe recession obviously, if all of a sudden we were in a growth environment instantly, that would be a change. But you know we make our plans and you know I make some of these pronouncements this way to kind of give you some clarity and what we expect based on the realities as we see them and as we expect them to be.

Now obviously if some of these become more transient then we’ll readjust. But I don’t – you know, I think there are smaller odds of that and so I’m not playing the small odds, I’m playing the big odds.

Matthew Heimermann – J.P. Morgan

ACE is a company that at least I’ve viewed as pretty well capitalized, especially in relative terms. I’m curious if you could kind of comment about how much capacity for growth you feel like you have and in particular whether or not you’re going to change your reinsurance use if the market really doesn’t improve from here?

Evan G. Greenberg

I don’t anticipate much of a change, you know, within our reinsurance use, fundamentally the same. We measure our appetite – we measure our reinsurance really based on our appetite for risk. And that’s been based on the strength of our balance sheet to the exposure and how much leverage we want to take relative to any one risk or concentration of risk. And so I don’t foresee any change of any magnitude that way. And as far as capital for growth or opportunity, from what I can see right now we are reasonably capitalized.

And you know obviously if opportunity comes along and it requires more capital, the only way we would do that is if we thought it was good for shareholders, and then we would make a capital management decision. What we’re not going to do is allow constraint of capital to constrain our growth, if it is accretive and makes sense for shareholders.

Matthew Heimermann – J.P. Morgan

I would be curious whether or not to the extent you think demand for reinsurance goes up; do you believe there’s enough supply of reinsurance in the market to meet that demand?

Evan G. Greenberg

It’s going to vary by line of business. And you know I think the first one everyone has their mind on and I think it was, I’m giving them free advertising, I think it was Dowling who said you know, cat, well it’s a smaller part of the reinsurance market; it does dominate a lot of mind share in North America among investors. And it does. You know, there is an example of line where companies because of more balance sheet fragility may try to buy more cat protection. I agree with that statement.

There is the notion that private equity, hedge funds, etc. because of other issues are going to pull capital back. You’ll see less private capital participating in this. I agree with that. So there you could see supply, demand become a little more strained which generally drives pricing and that’s possible. Now whether you’re seeing it in other lines or not, so far I don’t see that. I don’t anticipate that.

Operator

Your next question comes from Susan Spivak – Wachovia Capital Markets, LLC.

Susan Spivak – Wachovia Capital Markets, LLC

Most of my questions have been answered but just following up on your last comment, Evan, could you talk about how do you plan on participating in the upturn in the reinsurance market? By selling protection come January or increasing organic growth on your reinsurance company?

Evan G. Greenberg

Will we expand Tempest? Write more business? Is that the question in reinsurance?

Susan Spivak – Wachovia Capital Markets, LLC

Yes, that’s my question.

Evan G. Greenberg

Okay. Thanks Susan. Yes, sure, look Tempest is there to write business. And if we like the pricing, we like the terms, Tempest will write the business. And it will grow. And you know it’s a multi-line insurer operating out of the U.S., out of London and out of Bermuda principally. And if we see opportunity and it looks good, we will write it. We’ve been shrinking the business because we didn’t like the risk reward. We’re perfectly happy to turn around and expand the business if we do.

Susan Spivak – Wachovia Capital Markets, LLC

Well, will you be making that capital decision for January renewals or will you keep powder dry for the remainder of the year, anticipating a slower upturn?

Evan G. Greenberg

You know what; we will shoot the birds when they go by, so if we like the trade at that time then we will make that trade.

Operator

Your next question comes from [Scott Frost – HSPC].

Scott Frost – HSPC

I just wanted to go over a little bit on your securities lending portfolio. You may have touched on this but I might have missed it. I know it’s small but for the payables could you just go over maybe how often this stuff comes up for renewal, how much is unopened? And on the collateral that you hold against it, how much - what’s sort of the breakdown between I guess treasuries and MBS, high rate corporates and other?

Evan G. Greenberg

Well, the collateral is placed in money market funds and its all short term, you know, very safe investments so we take no risk on the asset side. And the contracts are of varying length but all short term.

Scott Frost – HSPC

So is it fair to say that most of the stuff rolls overnight?

Evan G. Greenberg

No, 30 to 60 days –

Operator

Your next question comes from Ian Gutterman – Adage Capital.

Ian Gutterman – Adage Capital

Some more question on pricing obviously. First your directive that to your underwriters that pricing needs to be flat or up, I guess I’m just thinking human nature is such that is an underwriter going to think that hey if I held rate flat or I got it up 2% I made Evan happy when I really should have been pushing for 10 or 20? What exactly are your instructions so that case doesn’t happen?

Evan G. Greenberg

I don’t think it’s a matter of making Evan happy. I’m looking to Brian Dowd, John Keogh and boy if you don’t make them happy – forget about me. You know, I’m going to let them comment on that. Brian do you want to talk about that?

Brian E. Dowd

Yes, I’ll go first again. First in North America you know we started the mandate on no more price cuts in early September and our view was, frankly, that pricing was starting to get [calloused] in virtually all classes of business and so we started to mandate flat pricing. In fact we get great statistics on every submission that every underwriter gets and we get to monitor by individual, by class how they’re doing against those statistics. And any time you’re in a downward market and the first thing you’ve got to do is you get it flat, right?

And so you know pricing is a good start to go from single digit – higher single digit decreases in September to single lower digit decreases in the beginning of October to flat at the end of October so we’re definitely seeing that trend start. And you know it’s interesting, underwriters they do like to trade, but they do like to trade up whenever they can. They’re actually – the creature is designed to sell product at a better price. And we monitor it in every line of business by every underwriter. And they’re rewarded for such behavior.

John Keogh

I would also add that, you know, that’s a general statement we’re making about flat – flat rates. And there are certain product lines and territories around the world where frankly that’s not good enough. And whether that’s in - we talked about energy or aviation or certain areas of the D&O business right now, I think our teams around the world know what we need which is more than flat. So we’re managing it very carefully by product, by territory and frankly, management they’re getting out there and being part of it on a regular basis.

Ian Gutterman – Adage Capital

And then I guess my broader question is, you know, we talked about a lot of the issues of why pricing needs to go up and obviously capital being very costly these days around the globe, whether it be insurance or elsewhere. I mean, how are you thinking about what the right hurdle rate is for new business? I mean, is the old 15% good enough when if given the growth opportunities might be so good that you come down the road and want to raise some equity to go further that maybe the cost of that equity is more than 15?

Do you have to set the bars say at 20% or maybe even higher to not so much talking about your renewal book but to actually grow the book, that that hurdle rate needs to be really high, given how costly capital might be to fund the growth?

Evan G. Greenberg

Yes, without putting data points on it I agree with that thinking and that’s how we think. You know, look, you can’t go out to shareholders to raise capital if you don’t believe it’s going to be accretive, and produce a reasonable return. As we said cost to capital went up so hurdle rates on returns go up.

Ian Gutterman – Adage Capital

Where will rates go up first or should they go up, casualty or property? Well, basically what needs rate the most?

Evan G. Greenberg

You know, frankly we see property needs rate and so does casualty needs rate. You know, I now there’s the view that property – the general wisdom is property is going to go up before casualty and property cat will go up first. But I have to say for ACE early days, we’re seeing in some markets, like in the UK we’re seeing property harden before casualty. In the U.S. we’re seeing actually casualty tightening in the primary casualty areas.

So whether it’s a primary D&O or it’s primary or it’s primary environmental or it’s primary risk management casualty, those sorts of lines and I go on – we’re seeing actually rate movement in those before we’re seeing really property movement. So you know is that a trend? I don’t know that that’s a trend but that’s what we’re seeing in the first few weeks of this. But where is rate needed? Rate is needed, boy, I think in the property and in the casualty areas. It’s both.

Operator

Your next question comes from Brian Meredith – UBS.

Brian Meredith – UBS

It looked like lost picks went up by almost 400 basis points in North America and even overseas, if you factor in combined it looks like lost picks went up. Anything unusual happen in the quarter that may have caused that to happen?

Evan G. Greenberg

You know, there’s two things and no, it’s not unusual. First of all, I’d look at the year on year of Quarter 3 to Quarter 3 and I think when you look at that comparison you see the loss ratio, ex cat in prior period development so accident year end cat up about a point. And that’s really trend in pricing. In North America you have a few things that have done sort of the year on year and the quarter on quarter, and what you’ll see in the quarter on quarter crop insurance has an impact on our loss ratio.

There were more energy and property losses in the quarter that were outside the loss ratio peg and so you know we eat those and that made the loss – that put the loss ratio up a little. And then the year on year increases really just the strengthening of loss ratio because of rate and trend. In the international, it’s really the same story. It’s trend and pricing primarily driving and that’s what you see in the year on year. And then on the quarter on quarter there was some aviation losses and some large property losses.

Brian Meredith – UBS

And then, Evan, in the past you’ve talked about 15% being kind of a good return on equity, kind of the target. But if your cost to capital has gone up here shouldn’t that number be higher now?

Evan G. Greenberg

Maybe. And I want to give you a thoughtful answer and I don’t have a thoughtful number in my head for you right now. Let’s just both agree on this, that the return on capital is a risk adjusted return on capital and you’ve got to – you know, you’ve got to start with that. And you’ve got to obviously consider that it’s got to be accretive to capital and so that means that you’ve got your cost to capital.

Brian Meredith – UBS

Evan, can you talk a little bit about opportunities possibly to get business or move business in the international A&H area? I mean I know a lot of that business is tied in with either banks or affinity groups. Is that business tough to move or is there opportunity do you think in this environment to potentially move some of that?

Evan G. Greenberg

The A&H business internationally comes in two flavors. On the one hand, there’s the direct response and that’s where you’re thinking of banks and sponsors. On the other side, we have a substantial business in the corporate world and that is writing accident business programs that are part of employee benefits that corporations purchase. That business is written through brokerage distribution and that business moves rather readily like P&C does, so there’s opportunity there.

And on the financial institution side where you’re doing it for direct response, yes, there is opportunity and we are seeing opportunity in that area. How easy it is to move or not, it’s moving for new programs generally and that is all their new campaigns will be written by another carrier and it depends on the contract they have with their incumbent carrier. Sometimes you can’t move for a year, sometimes you can move right away. So it varies. But there is opportunity there.

On the other side of the coin I don’t mind telling you that recession impacts direct response business in my mind. It slows it down, it can increases lapses, it can make it more difficult because in a recession many people in the same financial institution side you’re marketing to credit cards or mortgage holders and that sort of thing, or those who lease automobiles. So your business on the other side of the coin can slow down or suffer as a result of recession also. So opportunity and risk.

Operator

Your next question comes from Paul Newsome – Sandler O’Neill & Partners, LP.

Paul Newsome – Sandler O’Neill & Partners, LP

I was hoping you could maybe give us a few comments on how Combined is working out so far this quarter?

Evan G. Greenberg

Yes, it’s working fine. The – as I said just in the quick statement, the efficiency strategy we have between ourselves and that expresses itself in cost reduction is right on target. Growth initiatives be they new operations, expansion is on target. We just launched Mexico and it’s – so please don’t ask me every quarter how Mexico is doing because it’s small and it takes time to build and you know I will periodically update about that. But remember policies are written $100 at a time.

And then really the growth initiative in the developed territories, which is the remodeling, revamping, modernizing of the agency distribution is moving along well. And it’s moving along – the early day tests of that are doing so well that we’ve accelerated the rollout schedule of the new agency model in the United States and overseas. We’re going to implement it in New Zealand and Australia rather quickly and we’re now looking at the UK and an accelerated timeframe for implementing it in the UK.

In the U.S. we were going to really rollout the model through ’09 where is and maybe even into early ‘010 whereas now we’re accelerating that. And by mid-’09 it will have been implemented in almost all regions of the United States. So it’s doing very well in the regions that we’ve tested. Productivity is up significantly. Now whether that’ll hold, those productivity increase numbers will hold at the level they’re at as we roll it out across the country remains to be seen. But even if it comes down a little bit, boy, it’s exceeding what we initially anticipated.

Paul Newsome – Sandler O’Neill & Partners, LP

How much was accretive this quarter?

Philip Bancroft

It’s about $0.09 and what we say is, you know, what we originally estimated is about the same as we’re saying now for the full year it’ll be $0.24.

Operator

Your next question comes from [David Small] – J.P. Morgan.

David Small – J.P. Morgan

And what would be your willingness to expand the line sizes that you offer to your customers now? And secondly, how do you think about the D&O business now when you’ve described your book to us in the past, you’ve talked about it a lot being excess and a lot being [ACE side]. Would this be an opportunity for you to try to write more primary business there?

Evan G. Greenberg

ACE is now writing more primary business there and I would not be surprised to see us become one of the two or three largest D&O writers over the next few years. And we are presenting an alternative to the marketplace now and it is well received. As far as expanding our line size, expanding our net line size at the moment I don’t really see much. If we did at all, it would be modest. And it would be very targeted.

Expanding the line that we offer because of reinsurance partners – reinsurance partnering on programs, well, we’ve done that recently in some of the casualty lines in the United States in particular, and we will continue to do that as we see an opportunity and it doesn’t create a negative arbitrage for our company.

Operator

Your next question comes from Vinay Misquith – Credit Suisse.

Vinay Misquith – Credit Suisse

In terms of the market opportunity from AIG could you help us understand how it is in the U.S. operations versus worldwide? That is, do you see more opportunities in the U.S. versus worldwide business?

Evan G. Greenberg

You know, I don’t know. We’ll let the markets speak about that. I can only tell you what I see now and you know which I’ve spoken to already and I’d really rather not dwell on it. So I think what I’ve already said, let’s let that stand and then I’d rather not speculate on the future.

Vinay Misquith – Credit Suisse

And on the combined specialty business how do you see the persistency of the business right now since the economy has gotten even worse in the last quarter?

Evan G. Greenberg

We haven’t seen an impact on persistency. And remember something, on one hand there is the notion that people will – that this is – if this is a discretionary buy, they’re canceling discretionary buys because their budgets are tighter. We sell to the pretty much the middle, middle income and lower middle income are our buyers. In many cases, this is the most important insurance they have or among the most important insurance they have. People also cyclically seek protection when there are times of unknown and stress. They want security.

And so that is the underpinning of, to me, of why the numbers are also showing the same thing that there is not an increase – we don’t see an increase in lapse.

Operator

Your next question comes from Steven Labbe – Langen McAlenney.

Steven Labbe – Langen McAlenney

Evan, as it related to your comments on the CPT, I guess just a quick clarification please. Were you referring specifically to the property casualty industry or were your comments meant to be inclusive of the life insurance industry as well?

Evan G. Greenberg

They were meant to be inclusive of the life insurance industry as well; the insurance industry. The only exception to my comment that I could note would be the financial guarantee insurers where there that could be systemic risk, counter – that could I could imagine present systemic counterparty credit risk. And that would sit within the standards of CPP.

Steven Labbe – Langen McAlenney

And a quick follow up if you will, please. A hypothetical, if a key competitor of yours were to somehow ultimately have access to the attractive funding via the CPT, would you reconsider your position of refusal?

Evan G. Greenberg

I’ll tell you something, the amount of pause you just heard me take is probably the extent of the pause I would take before I said no. You know, I think like most of you I believe in the private market. I believe in the free enterprise system. It is extraordinary to see government ownership of companies and today and what has taken place in such a rapidly short period of time. I understand as all of us and we struggle with that, the need to preserve the fundamental stabililty. But if you get past that and this is about capital that’s simply doing it to get cheap capital and not about stability of the – and avoid systemic risk, I reject that. We’ll row our own boat.

Operator

Your final question comes from Matthew Heimermann – J.P. Morgan.

Matthew Heimermann – J.P. Morgan

Just a follow up question on your professional book in general, can you give us a sense of how much premiums your total professional book is?

Evan G. Greenberg

I don’t have a number in my head. And you know the guys are going to reach around to try and add a number up and I’d rather not speculate on that. We’ll get back to you. But we haven’t disclosed that.

Operator

And as that was our final question this does conclude today’s question-and-answer session. Miss Wilson, I’d like to turn the conference back to you for any additional or closing remarks.

Helen M. Wilson

Thank you for your time and attention this morning and we look forward to speaking with you again at the end of next quarter. Thank you and good day.

Operator

This does conclude today’s conference. We thank you for joining us today and hope that you have a great day.

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Source: ACE Limited Q3 2008 Earnings Call Transcript
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