Tower Group, Inc. Q3 2008 Earnings Call Transcript

Nov.25.08 | About: Tower Group, (TWGP)

Tower Group, Inc. (NASDAQ:TWGP)

Q3 2008 Earnings Call

November 6, 2008 10:00 am ET

Executives

Michael Lee - President and Chief Executive Officer

Frank Colalucci - Senior Vice President and Chief Financial Officer

Thomas Song - Managing Vice President

Analysts

Mike Grasher - Piper Jaffray Companies

Elizabeth Malone - KeyBanc Capital Markets

Operator

Good morning, ladies and gentlemen. My name is Shirlan and I will be your conference facilitator today. At this time, I would like to welcome everyone to the Tower Group third quarter 2008 earnings conference call. All lines have been place on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer period.

It is now my pleasure to turn the floor over to your host Managing Vice President, Mr. Thomas Song. Sir, please begin your meeting.

Thomas Song

Thank you, operator. Good morning. Before I turn the call over to Tower Group President and CEO, Michael Lee, and the Company's Senior Vice President and CFO, Frank Colalucci, I want to remind you that some of the statements that will be made during the call will be forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Actual results could differ materially from those projected in these forward-looking statements. For more information on the risks and other factors that may affect future performance, investors should review periodic reports that are filed by the Company with SEC from time to time.

Also, I want to remind everyone that a replay of this call will be available in the Investor Relations section of Tower's website.

Now, I would like to turn the call over to Michael.

Michael Lee

Thank you, Tom, and good morning, everyone. I would like to thank all of you for joining us on this conference call to discuss our third quarter operating results.

During the third quarter, our industry faced unprecedented financial turmoil, losses from Hurricane Gustav and Ike and continuing soft market condition. Despite these challenges, we are able to achieve another strong quarter of operating results that exceeded our guidance for the quarter. In addition, our investment portfolio performed reasonably well during the quarter with a manageable level of realized investment losses. Finally, the acquisition of CastlePoint Holdings and Hermitage Insurance Group that we announced during the quarter are proceeding on track as expected.

During this morning's call, Frank and I will provide further details on these positive developments that occurred during the third quarter.

Excluding net realized investment losses and gains, net income increased by 28% to $18.5 million for the third quarter as compared to $14.4 million for the same period last year and this translates into diluted earnings per share of $0.79 during this quarter as compared to $0.62 diluted earnings per share during the same period last year.

Our return on equity was 23.1% for the third quarter compared to 19.6% for the same period last year after excluding net realized investment gains and losses. We continue to experience volatility in certain investment sectors and as a result, we impaired some of our corporate and mortgage-backed securities holdings. However, due to the actions that we have recently taken to further strengthen our investment portfolio, we do not anticipate that these investment losses will have an impact on our operations. In fact, despite the volatile credit markets and economic downturn, our net realized investment losses for the quarter was limited to $1.7 million after tax. Including the loss of $1.7 million, our reported net income and diluted earnings per share for the quarter was $16.7 million and $0.72 as compared to $14.4 million and $0.62 for the same period last year.

Frank will review our investments in further detail later during today's presentation. For organic top line growth continues to be superb, as reflected in our 34.4% growth this past quarter and total premiums written and managed as compared to the same period last year.

Our strong top line growth during the quarter was driven by continued success in growing our business in the Northeast and successful expansion into California, Texas, and Florida. We believe we will continue to successfully expand into these states throughout the year and well into 2009. We were able to achieve favorable underwriting results as reflected by our 81% net combine ratio comprise of a 50% net loss ratio and a 31% net expense ratio.

We are extremely pleased with these results given that most companies in our industry reported a combine ratio either slightly below or well in excess of 100% during this quarter.

Overall, our policies in force increased by approximately 20% this past quarter compared to the same period last year. This very positive trend demonstrates our success in using our broad product line platform to achieve a desired business mix and our ability to identify profitable market segments in response to changing market conditions. In addition, our retention for the quarter was approximately 79% across all lines of business that we underwrite and we managed to see relatively flat changes in our renewed business.

More than a few companies reporting third quarter results have adjusted a possible shift in the market cycle due to the significant unprecedented investment losses suffered by our industry and to a lesser extent, losses from Hurricane Gustav and Ike. While we have not yet experienced this shift in the market cycle during the third quarter, we do agree that these significant events during the third quarter may pave the way for an improved pricing environment.

Irrespective of general market conditions, we are confident in our ability to continue to grow our business profitability by successfully executing our growth strategy. This is a proven approach that focuses on territorial expansion as well as prudent and disciplined underwriting. Furthermore, we are emphasizing a careful allocation of capital and resources to profitable market segment by using our broad product line platform and diversify distribution system.

During the third quarter, we successfully navigated through the competitive market conditions by expanding our geographical footprint outside the Northeast to offset a lower growth rate in the Northeast. The large account and operating middle market segments are the most competitive premium segments. We are exercising underwriting disciplining by gradually reducing our exposure to these market segments in the Northeast and instead by emphasizing and growing our profitable small commercial and personalized business outside the Northeast.

Territorial expansion continues positively as market inroads are achieved in Florida, Texas and California. Growth from Florida, Texas and California counted for approximately 25% of the new business production during the third quarter and we believe we have established very strong distribution relationships in these territories. We continue to maintain our conservative underwriting and catastrophe management philosophy as we expand into these territories. Minimal net losses from hurricanes Gustav and Ike which we project to be approximately $1 million reflect this commitment to maintain conservative underwriting and mismanagement controls that we have put into place throughout our history.

Given our success in maintaining our 81% combined ratio during extremely challenging market conditions, we certainly should be in an even better position to continue to profitably grow our business if the market conditions improve as the result of the industry events that took place during the third quarter.

I would now like to spend sometime to update you on the status of the CastlePoint and Hermitage transactions. Both are well on track to close at the yearend of this year or possibly, in early January. With respect to the CastlePoint acquisition, we have already cleared the regulatory hurdle now that we have received written confirmation from the New York State insurance department that we do not need to obtain their approval for this transaction given Tower's existing affiliation with CastlePoint.

At this point, we are focused on obtaining approval to this transaction from Tower and CastlePoint shareholders and in order to do that, we will need to obtain the SEC's approval for the registration statement that was filed on September 30. We received comments from the SEC last week and plan to file our response shortly. We hope to work through the filing process expeditiously in order to produce a final proxy for the shareholders as well as to set the date in which shareholders of both Tower and CastlePoint will vote on the transaction.

The Hermitage transaction is also expected to close at nearly the same timeframe. It too is on track and it was structured in a manner that allows for a closing date before, at the same time or after the CastlePoint transaction. I would like to remind everyone that external financing is not required for either transaction.

I would also like to recap why the transactions make sense particularly in light of the volatile conditions in the capital markets today. The CastlePoint transaction increases our own level of our capitalization, further strengthens our balance sheet and provides us with the opportunity to generate additional underwriting capacity from other reinsurers by utilizing Tower's hybrid business model. By shifting Tower's quota share reinsurance business from CastlePoint Re to other reinsures, we are able to create additional underwriting capacity that we can use to grow Tower's business organically or externally through acquisitions.

Tower and CastlePoint's acquisition of Hermitage Insurance Group, reinforces this strategic benefit that can be derived by freeing up CastlePoint Re's capital and redeploying that capital to make strategic acquisition. With the Hermitage acquisition, Tower is well positioned to continue to profitably grow its business in 2009. With CastlePoint shareholders, we believe their participation in a combined business provides them with an opportunity for greater potential for stock appreciation than CastlePoint would have on a standalone basis. In addition, this transaction significantly reduces the risk factors associated with dependence on powerful premium production and allows capital to be redeployed from reinsurance to primary insurance to achieve a higher growth and return on equity.

With that overview, I will now turn the call over to Frank to review our financial results in more detail. Frank?

Frank Colalucci

Thank you, Michael, and good morning everyone. I will cover some additional financial highlights and then provide an update on our outlook for the fourth quarter of 2008 and 2009.

As Michael mention, third quarter growth of premiums written and managed was very strong. The national wholesale initiative generated $20.6 million in business written for the quarter and $53 million year-to-date. In addition, in contrast to recent periods which our personalized products led our growth, we are seeing our commercialized contribute significantly to our premium volume. Additionally, we saw a continuing growth in the traditional and specialty programs managed by CastlePoint, which increased to $35.8 million for the third quarter this year as compared to $5.7 million for the same period last year.

On a year-to-date basis, gross premiums written for programs were $77.6 million for the nine months end compared to $14 million in the same period last year. A portion of this business as currently we see with the CastlePoint is important to mention this as a significant contributor of growth since the total premium amounts of the consolidated after the acquisition of CastlePoint is completed.

Total consolidated revenue was increased by 16.7% to $130.7 million this quarter over the third quarter last year. Net premiums earned increased by 20.7% to $88.2 million for the quarter over the same period last year. Although gross premiums earned increased 8.5%, ceded premiums earnings decreased 5.1% as we reduced the quota share of ceding percentage as of July 1 I have talked under the premium reserve and to new and renew business written in the third quarter.

For the third quarter, we see the 25% of our growth in this business to CastlePoint and 5% to other reinsurers under these agreements. These changes were directed toward achieving our targeted net retention.

Net premiums earned represented 68% of total revenues. Commissions and fee income represented 28% of total revenues this quarter while our ceding commission decreased slightly as a result of the change in the ceding percentage from 40% to 30% from the last year's third quarter. This was more than offset by the increase in insurance service revenue which doubled from TRM which produces premiums on behalf of CastlePoint United States insurance company, CastlePoint Insurance Company.

Net investment income, excluding realized capital gains, represented 6% of total revenues in the third quarter of 2008 as compared to 8.6% in the same period last year. Our portfolio activity was directed around maintaining overall credit quality and included reducing our allocation to residential mortgages and other asset-backed securities, prohibiting new investments and financial service credits as rotating more of our assets to high quality tax-exempt positions which increased to about one-third of our investment assets excluding cash and cash equivalents.

Cash and cash equivalents were as over $150 million at the end of the quarter as we awaited optimistic trades including additional purchases of highly rated tax-exempt securities which we had secured in October.

As we do under GAAP rules every quarter, in particular EITF 99-20, the cash flows of certain non agency residential mortgage-backed holdings are tested and if those securities exhibit projected cash flows that are less than in the previous test period, they are recognized as an OTTI loss. We point it out here that the fair value of these types of securities is $11.4 million as of September 30 which is less than 2% of our total investments including cash.

As a result of this required testing, we recorded $2.3 million as an OTTI loss on nine of these non-agency residential mortgage-backed securities. In addition as we already announced, we have had three Lehman Brothers' bonds with $3.3 million for a total of $5.6 million in OTTI on 12 securities. We also have some realized gains on other securities including the previously announced gain on a technology company investment. So now realized capital loss was $1.7 million after tax.

Simply stated, these investments do not have a meaningful impact on our operations because most of these losses are already reflected in book value. However, as we write down these investments primarily due to cash flow and impairment testing, we shift these losses out of the comprehensive net income bucket into the net income bucket.

It also bears mentioning, our investment portfolio is projected to increase from about $700 million at the end of 2007 to approximately $1.3 billion at the end of 2008 on a pro forma basis including CastlePoint. In connection with this acquisition, we also have the opportunity to mark CastlePoint's investments to market our fair value and use that lower amount as our cost basis. Recovery in the value of the CastlePoint investments will allow us to further strengthen our investment portfolio and reduce the effect of unrealized losses in our investment portfolio.

The targeted duration of our fixed income portfolio is about 4 years and we were slightly higher at 4.3 years at June 30th. On a tax equivalent basis, the investment yield was 5.5% during the quarter compared to 5.9% in the third quarter of 2007. Again, this was due to a larger than usual position in cash. However, a new money rate is about 6% to 6.5%.

For the quarter, net investment income decreased by 15% to $8.2 million as compared to $9.6 million last year. The investment yield was lower this quarter than in 2007 from having sold off investments that were providing higher yields but declining in value and from the application of another accounting statement, FAS 91 that requires certain adjustments to the amortization of bond discount on mortgage-backed securities. This amount was about $200,000.

The gross loss ratio for the insurance segment for the three months ending September 30 was 46.5% and the net loss ratio was 49.8%, which compares to a net loss ratio of 54.7% in the third quarter of 2007. This was due to lower accident year loss ratio resulting from favorable claims frequency in our homeowners and the effect of the earned pricing increases in the commercial multi-peril and auto liability lines and favorable development from prior year’s net loss reserves of about $3.2 million primarily in homeowners and commercial multi-peril.

For the quarter, the gross expense ratio was 30.6% and the net expense ratio was 31.2%. We expect this ratio to remain in this range during the remainder of the year. Our gross and net combined ratios were 77.1% and 81% respectively. We have successfully reduced Preserver's expense ratio to be in line with the rest of our operations as we have discussed previously.

I would also point out that this quarter's net income was affected by a loss from our 6.7% equity share of CastlePoint's net loss that included realized capital losses from OTTI and transaction in other expenses incurred in connection with the upcoming merger with us. In both the first and second quarter of this year and in the third quarter of 2007, our equity share of CastlePoint's net income was approximately $750,000 whereas our equity share of CastlePoint's result this quarter saw to a loss of $820,000. This is a negative string from pre-tax income to a pre-tax loss of $1.6 million and about $1 million debt of tax having the effect of reducing diluted earnings per share by about $0.04.

At September 30, our book value was $318.2 million and book value per share was $13.65 as compared to $12.86 at the end of the third quarter last year. Looking towards the fourth quarter, Tower expects fourth quarter of 2008 diluted earnings per share and net income excluding realized investment gains and losses to be in the range of $0.80 to $0.85 and $18.5 million to $19.7 million respectively.

For the full year, we anticipated diluted earnings per share to be between $2.85 and $2.90 per share including adjustments from equity and CP's net income which we estimated to have a $0.07 effect. So, I like to emphasize here that our earnings per share guidance would have been $2.97 and was within the range of our prior guidance but for the effect of this full year estimate of CastlePoint's adjustment.

We have previously provided estimated yearend 2000 and book value of $865 million and book value per share of between $18.45 and $18.65 including the effects of the CastlePoint acquisition when we announced this transaction on August 5 which presumed the closing in 2008. We have not updated this estimate since the calculation is dependent upon a number of variables that may change from the initial estimates including especially our average stock price during a certain period prior to the closing and our cap book value at the end of 2008.

Although we are targeting a closing in 2008, should the closing occur in 2009 and new accounting rule FAS 141R will be effective that will be acquire among other things expensing approximately $12 million in transaction and merger related expenses that will affect book value as these would have been capitalized under the accounting rules and effect in 2008. In 2009, including the effects of the CastlePoint transaction, Tower projects diluted earnings per share excluding realized investment gains and losses to be in the range between $3.20 and $3.40 per diluted share. Combined gross premium written is projected to be in the range between $1.1 billion and $1.2 billion for 2009.

We will now turn the floor over to the operator for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Mike Grasher - Piper Jaffray Companies.

Mike Grasher - Piper Jaffray Companies

I got a few questions. First of all, you spoke of the 34% top line growth, you mentioned in Northeast. I am wondering, how much of the growth was actually attributable to the new states, the California, Texas and Florida and I believe those are all, with regard to wholesalers as the distribution point, can you talk about where you stand? I think you had mentioned earlier in the year that you hope to get around $50 million, if I am not mistaken, out of the wholesalers. Can you just give us an update on all that?

Michael Lee

Yes, this is Michael Lee. The 25% as I mentioned, 25% of the new business production came from those three states; California, Texas and Florida and I think Frank, you also gave some statistics on the total amount of business year to date which I think was approximately $50 million or so from those states, the three states. As far as Northeast, we have maintained underwriting discipline and we have reduced our exposure to middle market accounts. Therefore, we are seeing slower growth rate. I believe it is probably 5% to about 6% organic growth so that slowdown somewhat but we are making it up through the growth from these states that we have expanded into.

So, consistent with our strategy of allocating cap specific from market segments depending on the competitive market conditions. We have been able to manage, to grow profitably so I think we are doing a very good job despite the challenging market conditions of rotating our capital and resources to profitable market segments. For that reason, we are able to report these very positive results.

Mike Grasher - Piper Jaffray Companies

And then to follow up on that, had you, do you feel like you have rolled out your product line up to these wholesalers at this point? And I guess second question would be what are you doing in terms of new product development at this point?

Michael Lee

I am glad that you asked that. I think we are in our early stage especially in California. We are not getting, we have not really seen the full benefit of expending into California. California is a big state for us. We think that many of the characteristics that we have experienced in New York metropolitan area; we are seeing those same types of trends in California. So, I think that state is very good fit for us and therefore, we see that state to be a territory that will give us very good opportunity not only in 2008 but into 2009 and beyond.

As far as product development, we have an initiative to expand into different industry groups and we have been working on it for quite some time. After the closing of the CastlePoint transaction, our strategy is to set up regional hubs throughout United States. Obviously we have done very good job of expanding in the Northeast. We are setting up our presence in the Southeast through Hermitage acquisition. We are picking up a book of business in Mobile, Alabama area with another office in Atlanta, Georgia and we are doing very well in Florida. So, we see another hub, a regional hub building in the Southeast and of course we have already opened up an office on the West Coast.

So, we see us building these regional hubs that will contribute to our top line growth and we are also diversifying our product line by working with managing general agents. What we have done is to identify classes of business that we want to get into and we have partnered with managing general agents that have that type of book of business that we cannot capture through our retail and wholesale distribution system. So, our partnership with these managing general agents would allow us to broaden our underwriting appetite in a prudent way and that we are looking to partner with managing general agents that have established books of business that can be verified, that the loss ratio can be verified so that we are not just expanding into these classes of business without having a partner that have the experience in underwriting these types of classes of business well.

So, with this initiative, we think that we will be able to further broaden our underwriting appetite and get into specialty areas that we have not currently penetrated into and that allows us to offer those products to all retail and wholesale agents. So, we are very excited by this initiative. We see a lot of opportunity for growth through our partnerships with managing general agents and also, we will continue to look for acquisitions. So, given the fact that we already have the Hermitage acquisition at hand and that is going to start generating premium volume in 2009 and we have all these expansion plans that we worked on in 2009, we think we are very well positioned in 2009 and if the market does harden, we think we are one of the players that would benefit significantly from that shift in the market cycle.

Mike Grasher - Piper Jaffray Companies

I would agree with that. And then I think in the press release, you mentioned some unfavorable development within workers' comp. Can you comment on that a little bit more? How much was there and are there just trends developing that are any cause for concern at this point?

Michael Lee

We actually had a favorable development and we were seeing the benefits of firm pricing over the last couple of years and we have been conservative but we actually released in excess of $3.2 million of reserves from prior year. So, we are actually seeing positive development and we have not had any adverse development and I believe and Frank keeps on mentioning this but as you know, as believed in about 24, 25 quarters, we have not had any adverse development. So, we are producing these excellent results with very good pricing and that is reflected in our ability at this point in the market cycle to be able to release these reserves from prior years.

Mike Grasher - Piper Jaffray Companies

So, there is nothing with regard to workers' comp area?

Michael Lee

No. I do not know where you got that. We have a favorable…

Frank Colalucci

It is just a normal, let me add, nothing at that concern.

Operator

Your next question comes from the line of Beth Malone - KeyBanc Capital Markets.

Elizabeth Malone - KeyBanc Capital Markets

Just a follow up on the last question, it does state in the press release that your favorable reserve development was partially offset by unfavorable loss development in workers' compensation and auto liability line.

Frank Colalucci

Yes, that is just a normal development of reserves as we look at the total picture; we have significantly more favorable development. This was a partial offset coming from these auto lines and there is nothing significant that we will be concerned about.

Michael Lee

Yes, I think in aggregate we had a favorable development of $3.2 million. We are trying to add more color to that but I think the main point is that we had in aggregate favorable development.

Elizabeth Malone - KeyBanc Capital Markets

Okay that is fine. As we look at the results from both Tower Group and CastlePoint for the quarter, was there a shifting? I know that you were reinsuring last business through CastlePoint in preparation for this transaction to be completed. Did that actually boost the results in Tower more and is that what caused that Tower results to be above what your range was and caused CastlePoint to show a decline year-over-year? I mean that is fine compared to…

Michael Lee

Yes, I am glad you brought that up. No, that is not the reason why we had favorable results in Tower and less favorable in CastlePoint. Let me explain what happened. What we have been trying to do at CastlePoint is to be able to rotate the capital out of reinsurance into primary business given the more favorable opportunities that are arising the primary area and that with a strategic shift that we have previously announced at CastlePoint. Consistent with that, what Tower has been doing is shifting more of the primary business through the pulling or the primary re-sharing mechanism that it has with CastlePoint. So, CastlePoint received significant amount of premium volume during the quarter from Tower through the primary risk sharing solution in lieu of the reinsurance solution.

So, in aggregate, Tower has not provided less premium volume to CastlePoint. However, there is another factor that influence CastlePoint's decision with respect to wanting to conserve their capacity in CastlePoint Re. That is related to the Hermitage acquisition. CastlePoint is allocating $130 million or so to acquire Hermitage possibly in the fourth quarter and in order to that, we had to reduce the amount of writings in CastlePoint Re so those moves were already discussed early on and once we announce the transaction, we were able to, Tower and CastlePoint were able to jointly execute on that plan but CastlePoint's results are really due to the fact that they are primarily shifting the Castle from a reinsurance sector to primary sector in anticipation of its merger with Tower as well as in order to prepare itself for the acquisition of Hermitage.

And of course, there were other factors involved with CastlePoint mainly related to the expenses that they have incurred in preparation of the closing. For example, I think there was a charge of about $9 million in merger related cost as well as they had lost some investment income due to the fact that they had to liquidate their investment holdings in preparation of its merger with CastlePoint and with the Hermitage.

Elizabeth Malone - KeyBanc Capital Markets

Okay, alright. That is helpful, thanks. And then also on the closing, it sounds like there is a meaningful incentive to get the transaction completed by the end of this year given that the accounting rules may change. So, is there nothing you can do to accelerate that or to ensure that it closes this year as oppose to next?

Michael Lee

We are trying but we do not really, we are not looking at it that way. I think first of all, merger-related costs are approximately a little over $20 million. CastlePoint was required to expense that and they have already expensed that. So, Tower's expenses, we can obviously capitalize that but if we expense that, it has a minimal impact on the overall book value so given the transformation that would result from the significant event, I think $12 million of expenses whether you capitalize it or expense that is really a minor issue in our opinion given that overall transformative event that this transaction would brings for both Tower and CastlePoint.

Elizabeth Malone - KeyBanc Capital Markets

Okay and then another question on the pricing environment, we are hearing a lot of discussion among insures that there is a cycle turn coming and pricing may harden. Are you seeing any evidence in your book that pricing is starting to moderate or increase?

Michael Lee

As I mentioned during the earnings call, we have not seen that evidence right now but you do the math and you look at what is going on in the industry and you look at the weakness and some of the weakness that we have seen with some of the large insurance companies that obviously have a significant impact on our industry. It is reasonable to conclude that the impact of all this would result in lower surplus levels and as a result, you will see reduced level of competition. We have not seen that in the third quarter but we do agree that what has happened in the third quarter will have a meaningful impact on the market in 2009. But I just want to point out a couple of things. Our performance during the soft market has been terrific and that is demonstrated by our result, 81% combined ratio. So, we are not in market segment where there is an intense level of competition. So, we are not going to see that in our market segments because we intentionally allocate our capital into market segments where there is a reduce level of competition and where end markets were below the radar.

Now, we do compete in market segments where there is intense level of competition and as I mentioned, we have withdrawn our capacity, underwriting capacity from those markets and ours strategy is to wait it out and let others really compete fiercely and drive the rates down but we are not in those markets, so we are not affected. Now, if the pricing levels do increase, what that does for us is that we are able to utilize our financial strength, the substantial amount of increasing capital that we will derive from the CastlePoint transaction and deploy their capital into those market segments. So, what we can anticipate if the markets harden is that we will have more market segments. We will have the opportunity to get into many more market segments where there are opportunities to allow us to price our products in a way that meets our profitability standard.

Elizabeth Malone - KeyBanc Capital Markets

Okay that is helpful and then one last question on the book value forecast or pro forma, Frank you mentioned that, you have given some guidance early on. When you provided that guidance on the book value, you could have assumed the realized losses and the write downs that have had to take place in the industry and in your book. So, should you assume that that book value assumption is actually going to prove to be a little lower due to the right off you said to take in the portfolios?

Frank Colalucci

Yes, I think it is reasonable too to estimate not only the third quarter but results of the unknown about the fourth quarter but on the other hand, we also do not know where the Tower stock price would be at the time of the closing which is an offsetting event which is why we did not attempt to refine or update that book value of estimate. So, again as I said before, there is a lot of variable that go into that estimate.

Operator

(Operator Instructions) You have a follow up question from the line of Mike Grasher - Piper Jaffray Companies.

Mike Grasher - Piper Jaffray Companies

Yes, just a couple of follow ups here. I guess following up on that question about the outlook in 2009. Frank, what are you thinking in terms of risk to capital ratio as you look out by the end of 2009? Where do you see that sitting?

Frank Colalucci

I am sorry…what was the risk you are asking about?

Mike Grasher - Piper Jaffray Companies

The risk to capital.

Frank Colalucci

The risk to capital, well, I mean…

Mike Grasher - Piper Jaffray Companies

Well, related to stock for example.

Frank Colalucci

Average. Well, we typically target a net leverage, we look at it from a surplus point of view but also from a GAAP point of view because that drives our return on equity and as you know, as you have seen in our recalculations, we tend to focus on a GAAP equity to be in the range of 1.1, 1.2 in that range. So, in statutory basis that would be close to that or maybe 1.3.

Michael Lee

Just a follow up on what Frank said, this is Michael, we do have additional underwriting capacity from using reinsures so not only do we have the additional capacity from increasing our own level of capitalization resulting from the CastlePoint transaction. We also have many reinsures that are willing to partner with us to provide under additional underwriting capacity. So, what we see opportunity in 2009 beyond what we are expecting, we are positioned very well to have the underwriting capacity, sufficient level of underwriting capacity to meet the additional demand that may arise from the market hardening.

Mike Grasher - Piper Jaffray Companies

So, the combination of the CastlePoint coming in and the reinsurance aspect of it would, you are pretty comfortable with that your expectations are at this point.

Michael Lee

Absolutely. We are only, we de-levered in excess of two in terms of total premium writings to our surplus or Castle in 2008. That is what we are projecting and then we will down to 1.1 with the CastlePoint merger. So, we can rebuild that leverage and that is the beauty of our model and as a result, we are very well positioned to be able to look to substantial increase or writing shoot the opportunities arise in 2009.

Mike Grasher - Piper Jaffray Companies

Okay and then final question here for Frank. Just in terms of putting new money to work and as you forecast investment income in 2009, what type of yield are you modeling or forecasting or expecting on the investment portfolio?

Frank Colalucci

Well, we are trying to stay a little bit on the conservative side while the new money rates as I mentioned before are very high this quarter. It is hard to predict what will happen so I think we are probably trying to stay in the 5.5% range.

Operator

And that concludes our question-and-answer session. I will the conference back over to Mr. Mike Lee for additional or closing remarks.

Michael Lee

Thank you, operator. Given the significant financial turmoil and the hurricane losses experienced by our industry during the third quarter, we are extremely pleased that we were able to achieve another strong quarter of operating results. Due to our strong operating performance and the benefits from the strategic acquisitions that are projected to substantially increase our revenues, financial strength and size; we believe we are well positioned to respond to the market challenges and opportunities. We thank everyone for participating in this earning's call and look forward to speaking with you again.

Operator

That concludes today's conference. You may now disconnect at this time. We do appreciate your participation.

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