Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

XL Group (NYSE:XL)

Q4 2012 Earnings Call

February 07, 2013 5:00 pm ET

Executives

David R. Radulski - Senior Vice President and Director of Investor Relations

Michael S. Mcgavick - Chief Executive Officer and Director

Peter R. Porrino - Chief Financial Officer and Executive Vice President

Gregory S. Hendrick - Executive Vice President and Chief Executive of Insurance Segment

James H. Veghte - Chief Executive of Reinsurance Operations and Executive Vice President

Susan L. Cross - Global Chief Actuary and Executive Vice President

Analysts

Jay Gelb - Barclays Capital, Research Division

Michael Zaremski - Crédit Suisse AG, Research Division

Michael Nannizzi - Goldman Sachs Group Inc., Research Division

Gregory Locraft - Morgan Stanley, Research Division

Vinay Misquith - Evercore Partners Inc., Research Division

Joshua D. Shanker - Deutsche Bank AG, Research Division

Jay Adam Cohen - BofA Merrill Lynch, Research Division

Brian Meredith - UBS Investment Bank, Research Division

Meyer Shields - Stifel, Nicolaus & Co., Inc., Research Division

J. Paul Newsome - Sandler O'Neill + Partners, L.P., Research Division

Ian Gutterman - Adage Capital Management, L.P.

Josh Stirling - Sanford C. Bernstein & Co., LLC., Research Division

Randy Binner - FBR Capital Markets & Co., Research Division

Ryan J. Byrnes - Langen McAlenney

Operator

Good afternoon. My name is Shirley, and I'll be your conference operator today. At this time, I would like to welcome everyone to the XL Group plc Fourth Quarter 2012 Earnings Call. [Operator Instructions] Please be advised that this conference is being recorded. I would now like to turn the call over to Dave Radulski, XL's Director of Investor Relations. Please go ahead.

David R. Radulski

Thank you, Shirley, and welcome to XL Group's Fourth Quarter and Full Year 2012 Earnings Conference Call. This call is being simultaneously webcast in XL's website at www.xlgroup.com. And we posted to our website several documents, including our quarterly financial supplement. On our call this evening, you'll hear from Mike Mcgavick, XL Group's CEO, will offer our opening remarks. Pete Porrino, XL's Chief Financial Officer, will review our financial results; followed by Greg Hendrick, our Chief Executive Insurance Operations; and Jamie Veghte, our Chief Executive of Reinsurance Operations who will review their segment results and market conditions, and we'll open it up to questions. Among those also available for questions are Susan Cross, our Global Chief Actuary; Sarah Street, our Chief Investment Officer; and Stephen Robb, our Controller.

Before they begin, I’d like to remind you that certain of the matters we'll discuss today are forward-looking statements. These statements are based on current plans, estimates and expectations. Forward-looking statements involve inherent risks and uncertainties, and a number of factors could cause actual results to differ materially from those contained in the forward-looking statements. And therefore, you should not place undue reliance on them. Forward-looking statements are sensitive to many factors, including those identified in our annual report on Form 10-K, our quarterly reports on Form 10-Q and other documents on file with the SEC that could cause actual results to differ materially from those contained in the forward-looking statements. Forward-looking statements speak only as of the date in which they are made, and we undertake no obligation publicly to revise any forward-looking statement in response to new information, future developments or otherwise.

With that, I turn it over to Mike Mcgavick.

Michael S. Mcgavick

Good evening. We're pleased to report that 2012 was a year of progress across XL and our fourth quarter continued that momentum. A year ago, we committed to expand margins and we were able to do so due to a combination of price increases, greater underwriting vigor and being more disciplined about our spending, while also benefiting from a benign year as with respect to non-CAT large losses.

We also said we would buy back shares. We estimated that we would buy back about $400 million worth and maybe more if the year progressed better than we expected. In the end, we bought back about $500 million in shares that we associate with our 2012 performance, $402 million during the year itself and another $98 million in January, a delay made necessary by the uncertainty around the losses caused by Superstorm Sandy.

And in connection with buying back our shares, I would observe that this level could go higher in 2013 if the year plays out as we expect. It is not our goal to expand our capital buffer but rather to keep it level. As we enter 2013, we intend to keep grinding away at what we must do to keep our progress going. As mentioned, we know from what we've heard so far in the earnings season, it is clear that 2012 was, in many ways, a light large loss year for the industry. These kinds of years come and go. What we feel best about is that with the tighter management processes we had been driving home these past several years, if 2013 were to be to an above-average year for large losses for the industry, we will perform much better than we have in the past.

So let me share some other results from the fourth quarter. Of course, the most notable event was Sandy, one of the top 3 insured storm losses in history and devastating to many on the East Coast. XL's current loss estimate of $355 million is in line with what we provided in our December release and we think is a continuing example of solid risk management and underwriting.

Greg and Jamie will provide more detail in a moment. But looking beyond Sandy, it is pleasing to us that our underwriting operations on an ex-CAT, ex-PYD basis continued to trend in the right direction.

Our Insurance segment delivered a 96.5 ex-CAT, ex-PYD combined ratio for the quarter. This segment was about breakeven for the year on the same basis, even after the very challenging quarter one results. But as we told you before, we won't be satisfied with our underwriting in this segment until we are regularly delivering a combined ratio of around 90%. The trend is in the right direction and we are pleased with the momentum.

Reinsurance, even after taking the brunt of our Sandy losses, had a combined ratio of 104.4% for the quarter and 96.9% for the full year on an all-in basis. We are very pleased by these underwriting results.

Turning to reserves. As you know, every second and fourth quarter, we make a deep examination -- someone just said I got the number wrong, 86.9% was the full year combined on Reinsurance. Thank you. We are very pleased, as I said, by those results. Turning to reserves, as you know, every second and fourth quarter, we make a deep examination of all of our reserves. And for the fourth quarter of 2012, this resulted in $98 million in releases.

As for our booked value, our fully diluted tangible booked value per share was $33.35 at year end. This was up 1.6% in the quarter and 18% higher than where we began 2012. The 2 largest contributors to this growth were gains in our investment portfolio, mark-to-market and net income.

A couple of last areas of comment. First, with respect to ROEs, and second with respect to pricing. As for ROEs, I would say our all-in 6.2% operating ROE for 2012 was not where we want it to be. But it is certainly an indicator of improvement, built upon an increasingly solid foundation. To be clear, driving a better ROE is best achieved by expanding our core operating margins. No other action makes a comparable difference. This grinding work will not stop. And as we get our operating earnings moving in the right direction, the goalpost we will focus on more and more is the ROE we produce. We really need to get back to double digits. And we are very driven to do so, even in this low interest rate environment, should it persist. In this connection, there is one thing you should know, and that is we are focused on getting to double-digit ROEs on an x AOCI basis, given that mark-to-market fluctuations, currently positive about $1.3 billion in our fixed income portfolio, could obviously turn the other way. As a result, we won't focus on these fluctuations and we'll focus on x AOCI ROEs in our drive toward double-digit performance.

Second, on the pricing environment. This is the first quarter in which I feel that those of us who operate insurance businesses on the whole are finally getting it. You can see that rate is starting to grow year-on-year. We have been expecting this, because in these interest rate environments, the rate levels that are being priced into these risks have not made sense. So it is really good to be hearing the kinds of commentary I've heard across the market about rate and about underwriting discipline overall, particularly on the primary side. This makes sense to us, as we have been in a long time willing to walk away from business that was not adequately priced and have been pushing rate across our lines of business. But let's be clear, rate levels are not yet where they should be and we will not change our approach. But I do feel strongly there's now a bit more tailwind to our efforts than there has been in the past.

2012 was a solid year of continued progress. We certainly are not done making this a better company. It is not yet the XL we dream of, but I can confidently say we are prouder of the company every day.

With that, I'll turn it over to Pete.

Peter R. Porrino

Thanks, Mike, and good evening. As Mike mentioned, our fourth quarter results were significantly impacted by Sandy. Catastrophe losses net of reinsurance and reinstatement premiums in the fourth quarter were $352 million, which is composed of Sandy and some modest positive reserve developments from other 2012 catastrophes.

Our CAT losses in the fourth quarter of 2011 were $195 million. For the full year, our CAT losses were $464 million compared to $761 million in 2011.

Despite Sandy's impact, we generated fourth quarter operating income of $39 million or $0.13 per share compared to an operating loss of $80 million or $0.25 per share last year. For the full year, we reported operating profit of $614 million or $1.98 per share compared to $89 million or $0.28 per share in 2011.

Net income attributable to ordinary shareholders was $81 million for the fourth quarter and $651 million for the full year.

Our accident year, ex-CAT, Property & Casualty combined ratio improved by 9.8 percentage points in the quarter and 4.8 points for the full year, a nice illustration of Mike's earlier comments regarding XL's margin improvement.

Prior year reserve development in the quarter was a favorable $98 million or 6.4 loss ratio points and is up from $68 million in the prior year quarter. This reflects favorable development of $43 million and $55 million in the Insurance and Reinsurance segments, respectively, resulting from our fourth quarter detailed ground-up reserve review.

For Insurance, positive movements came from Professional, Specialty businesses, partially offset by reserve strengthening in our Excess & Surplus lines business.

In the Reinsurance segment, the favorable movements were predominant from our short-tail lines with contributions from our U.S. Casualty book.

Our operating expenses for the fourth quarter were down 7.2% versus the prior year quarter and down 6.2% compared to the third quarter of 2012. The decrease from last year was largely due to the timing of costs associated with our strategic initiatives. The decrease from Q3 2012 was due to changes in variable compensation due to Sandy.

Our Investment Portfolio delivered total returns of 1% in the quarter and 6.7% for the year. A positive mark-to-market of $72 million for the quarter was driven by tightening credit spreads, partially offset by a marginal increase in interest rates. We had a positive mark-to-market of $987 million for the year.

Our P&C fixed income duration increased by 0.3 years to 3.1 years since the end of the third quarter due to lower cash holdings and an extension in our agency mortgage-backed portfolio due to a slowing in prepayment projections. However, we continue to manage the P&C portfolio approximately a year short of the corresponding liabilities it supports.

The life fixed income portfolio duration marginally increased by 0.1 years to 8.8 years. At $169 million net investment income on the P&C portfolio in the quarter was 12% below last year due primarily to lower reinvestment rates.

The $3 million increase in our P&C net investment income from Q3 2012 was primarily due to a small positive adjustment on our inflation protected portfolios this quarter versus a negative adjustment last quarter.

We expect net investment income will remain under pressure, given the low interest rates. The P&C gross book yield at the end of December was 2.9%. We estimate that approximately $3.5 billion of P&C assets with an average gross book yield of 3.1% will mature and pay down over the next 12 months compared to average new money rate in Q4 on our P&C portfolio of 1.9%.

Our net income from Investment affiliates was $32 million compared to a loss of $24 million last year. We experienced more constructive markets this quarter compared to challenging markets in 2011.

Net realized gains on investments in the quarter were $11 million. And net realized gains for the full year were $14 million compared to net realized losses of $188 million in 2011.

Last quarter, I discussed nonrecurring beneficial tax items that had impacted operating income. This quarter, there was a $24.5 million tax benefit arising from the release of valuation allowances held against capital loss carryforwards that we utilized in the quarter. This had no impact on operating income. Our full year tax rate on operating income, excluding nonrecurring items, was approximately 11.5%.

We continue to act on the compelling economics of buying back our ordinary shares. As Mike discussed, during the fourth quarter, we bought back 2.1 million ordinary shares at an average price of $24.78. For all of 2012, we bought back 18.3 million ordinary shares at an average price of $21.99. And in January 2013, following our Sandy loss estimate release, we bought back an additional 3.8 million shares at an average cost of $25.94. This leaves $250 million available -- remaining available for buybacks under the current program.

And finally, for those of you who might have missed it back in December, S&P revised their outlook from stable to positive.

I'll now turn it over to Greg to discuss our Insurance segment results.

Gregory S. Hendrick

Thanks, Pete, and good evening. So I'll cover the results for this segment, discuss Superstorm Sandy and finish remarks on recent market conditions.

Beginning with the results, Insurance segment combined ratio for the quarter was 106.6%, reflecting the adverse impact of Sandy, which contributed 14 points to the loss ratio, $138.7 million in losses, $11.8 million in reinstatement premiums.

Our underwriting loss is always disappointing. This is a 9.6 point improvement over the fourth quarter of 2011, which was also impacted by CAT losses, namely the Thailand floods and development from prior quarter CATs.

On an accident year basis, excluding CATs, the combined ratio for the quarter was 96.5% or 8.6 points better than the prior year quarter. Once again, our current accident quarter loss ratio is contributing to most of this improvement. For the fourth quarter, the accident loss ratio, ex-CAT, was 66.8% or 5.1 points better than prior year quarter, driven by favorable loss experienced in our international and North American property books as well as a lower current accident year loss ratios in the aerospace and international primary Casualty.

The expense ratio in the quarter improved by 3.3 points, 2.4 points driven by flat operating expenses relative to growing net earned premiums and 0.9 points of improvement in the acquisition ratio.

Given the variability of quarterly results, the best indicator of our improvement in 2012 is the reduction in our accident year ex-CAT loss ratio. For the full year of 2012, we experienced a 66.6% loss ratio, which is a 6.4% improvement over last year and this is our best full year performance since 2007.

Insurance gross premiums written grew by $161 million or 13.9% in the quarter and $468 million or 9.7% for the full year when normalized for foreign exchange and long-term agreements. Both the quarter and full year growth is attributable to the numerous additive and corrective plans we had put in place over the last 12 to 18 months. We are realizing planned growth in many of our new businesses, in particular, North American construction, E&S and Political Risk.

In addition, new leadership has helped reinvigorate a number of our existing businesses. For example, our North American U.S. risk management team continues to build momentum in the marketplace and underwrote a unique nonrecurring policy of $17 million of gross written premium, contributing to the high growth rate in the quarter.

Also contributing was material rate increases in most of our North American Property & Casualty lines as well as our U.S. professional book.

In the U.S. professional portfolio, we experienced growth from both increased rates as well as an increase in number of accounts that reached our pricing hurdles.

Turning to Sandy. The adjustment process continues to progress smoothly, and I am pleased with our claims and underwriting performance to date. As of the beginning of the week, we have received 641 loss notices and new claims have all but stopped. We have closed 84 claims with the resulting paid loss of just under $20 million. To date, we have only a few notices that are in dispute and just one has resulted in litigation.

Our gross loss estimate is $207 million and is split 80% property and 20% marine and fine art. The largest individual risk loss net of faculty of Reinsurance is $10 million, and this is indicative of an event with a relatively large number of small losses.

We have attached to our Property Catastrophe and Marine Reinsurance covers, so any adverse development would largely be absorbed in these Reinsurance protections. Our policy holdings are holding up well, and in particular, a strong underwriting of flood and contingent business interruption has served to keep our losses contained.

Finally, turning to recent market conditions. The fourth quarter was very much a continuation of what we saw in the second and third quarters, with positive rate indications in nearly all our businesses and an overall segment rate increase of just over 3%. Roughly half of the fourth quarter premium experienced rate increases this quarter and in the fourth quarter of 2011.

North America Property & Casualty continues to show the most strength, where rates increased by 5%. Our global Professional portfolio had another solid quarter with increases of over 3%, led by our U.S. Professional portfolio with a nearly 6% increase and a strong December of just under 9%.

International Professionals, 1 of only 2 businesses to experience downward rate pressure. As a result, our solicitor's gross premiums written were reduced by $28 million in response to aggressive competition, some of it from unrated carriers. Our Specialty business were virtually flat, driven by a competitive aviation renewal.

And our International Property & Casualty book had the strongest quarter in years, albeit on low volume with rate increases exceeding 4%. Additionally, an early analysis of our international January 1 renewals, which represent nearly 1/3 of the portfolio, shows rate and property up 3% compared to up 1% in 2012, and casualty up by 2% compared to down 2% last year.

While we are in a much better position for a pricing perspective heading into 2013 than we were a year ago, we remain convinced that further rate is needed broadly and in particular on long tail lines of business, given persistently low investment returns.

We have sacrificed top line in a number of areas where returns are not in an acceptable level and showed no signs of improving. We will maintain this discipline in 2013.

In summary, I think 2012 was a decent year for the Insurance segment, reflecting a great deal of hard work. But more importantly, I think it sets the stage for further improvement in 2013. And so far, from what we've seen in the last quarter and the early weeks of this year, we believe we can make further progress towards our ultimate goal of combined ratio of 90% or better, as underwriting diligence and expansion of margin continues to be our utmost priority.

And now to Jamie to discuss our Insurance results.

James H. Veghte

Thanks, Greg, and good evening. I'd like to cover 2 principal issues tonight, a review of our fourth quarter and full year results, and also some comments on our recent renewal season and market conditions.

The Reinsurance segment underwriting result was obviously heavily impacted by Sandy and produced a combined ratio of 104.4% and an underwriting loss of $22 million in the quarter.

CAT losses in the quarter, net of reinstatement premium, were $204 million with Sandy representing the vast majority of this amount. In addition, we had the benefit of $55 million of prior year releases in the quarter. Excluding both CAT losses and prior year releases, the segment had a very solid combined of 72.9%. This compares favorably to the 85.6% for the fourth quarter of 2011. Six points of this improvement relates to the property CAT book, which includes the benefits of a lower level of development on smaller current-year CAT events compared to 2011. We also had a 4.7% improvement in operating expenses, driven by reduced year end compensation accruals and an improvement of 2.5 points resulting from changes in business mix.

We remain very prudent around reserve releases on long tail lines, particularly for recent underwriting years. For the full year, this segment had a combined ratio of 86.9%, which compares to the 97.8% combined in 2011. This was impacted by catastrophe losses of $241 million and prior year reserve releases of $176 million compared to 2011, where CAT losses were $406 million and reserve releases $208 million. Excluding the impact of both CAT losses and prior year releases, we had a combined ratio of 83.1% compared to 85.7% in 2011.

Overall, we had a very solid year of underwriting results. We remain convinced that Sandy will be materially north of $20 billion to the industry and our own loss was within expectations, given the size of the industry loss.

Turning to top line. Gross written premiums in the quarter were $158 million, which compares to the $105 million written in the fourth quarter of 2011. This increase was driven principally by reinstatement premiums as a result of Sandy and new business opportunities at XL Re America.

We reentered the crop business on a primary basis. On a year-to-date basis, our gross written premiums were $2 billion, down 3% from 2011. You will recall that our gross written premiums were down significantly in earlier quarters this year as a result of the conversion of the Heartland Crop program from a primary program to Reinsurance assumed program in 2012. A more appropriate year-on-year comparison therefore would be on a net written basis, where we grew 9% to $1.88 billion for the year.

Turning to market conditions. Our year end renewal went largely as expected, although we did see some unexpected pockets of competitions in areas of the market and we reduced our position or retired from several large placements.

For U.S. CAT business, loss impacted programs saw rate increases in the 10% to 15% range, while loss-free programs were either flat or in some cases down, particularly for non-win driven programs.

Demand for capacity was broadly flat. There was more momentum for aggregate-type structures, and 2 large U.S. programs moved that format.

In the U.K., prices were down 5% on a risk-adjusted basis. And in Continental Europe, the reductions were 3% to 5%, with the exception of Italy, where we saw a double-digit increase as a result of the earthquakes last May. Again, for very large programs, there was plenty of capacity available once the pricing cleared the main lead markets.

On Specialty lines, the Marine market saw a very robust renewal as Sandy was the latest of the series of significant losses into that market. All indications suggests the Marine component of Sandy was as much as $2.5 billion to $3 billion, and the market reacted accordingly with significant price increases and coverage changes.

On the aviation side, the general airline book showed price reductions of 5% based on continued good experience, while the general aviation account was reasonably stable.

Turning to Casualty. Both the U.S. and international markets remain competitive. Reinsurers were again quite determined to retain their renewal accounts and most tried to increase their lines with limited success. There was some increase in seeding company retention levels, a pattern we have seen repeatedly for a number of years. We do take comfort from the continuing improvement in the pricing environment on the primary side and we do find opportunities to write selected business. But broadly, our posture in these markets remains highly defensive.

Finally, I'd like to highlight one operational note. During the quarter, we added Craig Wenzel, most recently from a leading investment bank, as Senior Vice President of Capital Markets. The convergent space and utilization of third-party capital in our underwriting activities is not new to XL. However, we see this trend becoming an ever increasing part of the capital landscape of the industry, and we are delighted to add Craig to lead our efforts in sourcing and structuring alternative capital to support our underwriting teams.

With that, I'll turn it back to David for Q&A.

David R. Radulski

Shirley, can you please open the lines for questions?

Question-and-Answer Session

Operator

[Operator Instructions] And our first question comes from Jay Gelb with Barclays.

Jay Gelb - Barclays Capital, Research Division

Mike, on the share buyback potential, I believe you mentioned more than $400 million is likely in 2013. Given your return on equity goals, where do you feel the capital base needs to be sized to? And how can the buyback get you there?

Michael S. Mcgavick

Yes, let me make, Jay, the first one. The first thing I would emphasize is that the capital leverage by virtue of buybacks is not the most powerful lever we have on producing acceptable ROEs. By far, the most powerful lever we have is on expanding our operating margins and we are moving nicely towards that objective. That's going to be our core focus. That said, as I emphasized, it is not our goal to expand our capital buffer at this time. We'd like to keep it level. And if we are successful through the year in expanding our margins, to keep it level obviously, that would imply that we would need to buy back at a higher level than the $400 million we committed to early last year. I'm not ready to put a number around that. I think it's premature as we have a number of our capital management policies still to consider with the board. But just the logic of keeping it level would suggest that we would be looking to do more over the course of this year if it plays out as we expect. But our focus in driving the better ROE comes from expanded operating margins. That's what we're working toward, and we believe we can continue to deliver that in 2013.

Peter R. Porrino

Jay, this is Pete. Just one point of clarification on the way you asked the question. We view our buybacks in '12 as $500 million, right, because of timing difference from Sandy. And I think Mike's comment that he made in his prepared remarks was that was where we were starting from.

Jay Gelb - Barclays Capital, Research Division

That's an important clarification. Okay. And then on the Insurance segment, if we look at the ex-CAT, ex-prior development baseline, it went from 94.7% in 3Q, this is with the Insurance segment, to 96.3% in 4Q. Previously, it had been improving every quarter on a linked-quarter basis and this ticked up a bit. It'll be helpful to understand, does this reflect some onetime items or some noise, or should we expect that to continue to head back down in subsequent quarters?

Gregory S. Hendrick

Jay, it's Greg. I'd say one note at the high level is that given the nature of the business we're in, upper middle market and large corporate space, the quarter is always going to have some variability to it. So what I'd like you to do is focus on the accident year ex-CAT loss ratio, which is the real -- I think the real interesting piece. If you look at that, for the full year, our accident loss ratio ex-CAT was 66.6% and 6.5 points better than prior year. And I'd put that improvement into 4 categories. First, our traditional short-tail property lines performed better than prior year and account for about 2% of the full year improvement. So this is the result of a lot of hard work in re-underwriting the portfolio, particularly around driving rate, where we've had the highest rate increase in our North American property book, in terms of conditions as well. The second piece is around large property losses which account for roughly 3% of the improvement. And there, we used $10 million of the threshold for large losses. And in accident year 2011 we got $157 million of those large losses versus just $11 million in 2012.

Now this is a scenario where it's hard to attribute precisely between fortuity and scale. We are de-risking the international property portfolio, but it's really impossible to tell you precisely how much we have done that on scale and fortuity. The last 2 drivers are rate exceeding trend on the entire portfolio, and that's about 0.5 point, and change in business mix drive the other point. So year -- our full year over a full year, I had to attribute at least half better improvement to our underwriting actions. I know this is a subjective exercise. You can't put a pinpoint on it. So I just say any quarter-to-quarter there's going to be noise in it, but let's really focus on that full year to full year result because that's a little more of time particularly because we can't have lumpy books of business and activity in a particular quarter.

Jay Gelb - Barclays Capital, Research Division

That's helpful. And just to clarify, that 90% combined ratio target in the Insurance segment, that's on a calendar year including CATs and any prior-year development?

Gregory S. Hendrick

It wouldn't include prior-year development.

Operator

Our next question comes from Mike Zaremski with Credit Suisse.

Michael Zaremski - Crédit Suisse AG, Research Division

My first question, the expense ratio appears to have benefited from operating leverage. Is that a trend you believe will continue in 2013? I guess that's kind of a backdoor way of asking about the growth outlook as well.

Michael S. Mcgavick

Yes. So I would tell you that toward the end of the year and particularly in the fourth quarter, we did begin to see some lift from the relationship between expenses and top line for the first time. And that is because some of the investments that we've been making so heavily over the last couple of years are beginning to pay off. We expect that to be a more pronounced feature of how 2013 plays off. So I think you are seeing the initial signs of that. But as we think about expenses relative to growth next year, we think that should be a trend that does continue.

Michael Zaremski - Crédit Suisse AG, Research Division

I guess, in regards to the growth this quarter, I think higher retentions were cited in the press release. What type of a component was -- did that play in the growth?

Gregory S. Hendrick

For the year -- sorry, this is Greg. In Insurance segment, for the year, I'd break it roughly down new business both within existing businesses and in what I would call new operations, like construction and E&S, was about half the driver. Rate increases were about 1/4 of the driver. And that increased retentions, a larger base of renewal -- retention are actually mix, depending upon which segments you're in, but over the whole book we are up a little bit. It was about 12% of that rest of that change. And the rest is a lot of other noise that -- lots of them are small items.

Michael Zaremski - Crédit Suisse AG, Research Division

Okay. And just lastly, in regards -- there's lot of different names for this type of business, that convergence, I guess, initiative or -- do you expect to have that up and running by midyear? And any other kind of details around what the plans are for that segment with the new hire, Craig Wenzel?

James H. Veghte

I'm not sure how you define up and running by midyear. Craig has already joined us...

Michael Nannizzi - Goldman Sachs Group Inc., Research Division

I guess the announcement of side cars or whatever you guys are looking to do.

James H. Veghte

Well, we're not certain. And frankly, when we hire new underwriting teams, we don't push them to put business on the books because they've joined us. We've hired Craig because he's an expert in this area. And one of the things we want him to spend a lot of time on in the first 3 to 6 months of his tenure is to figure out where we fit into this environment and what the best products would be for us to go out in the market around it. So even if we don't have a structure in place by the end of the year, we won't consider this a failure. This is something that we are planning for in the long term. We think it's part of the capital landscape of this industry for a long time. And we will put structures in place when they are appropriately sized. And Craig, he got to spend a lot of time trying to figure out what the best way forward for us would be. So we don't have any current target date to put any structures in place.

Michael S. Mcgavick

The only thing I'd add into Jamie's exactly correct answer is that they can be -- they can come in to market pretty quickly. And it's not like we haven't been looking at these kinds of deals over the last several years, it's just that we've finally decided that we really did need to get into the space and wanted someone who is a market leader and thinking about it on our team as we did. So it could be that we don't do any next year. It could also be -- it could happen relatively quickly. It depends on how we feel about the specific opportunities that are advanced. And I really love the emphasis, we feel no -- under no pressure. We will do the right thing as they come along.

James H. Veghte

I do -- I'd add one thing, too. I do think we're ideal candidates to attract interested members of the investment community into the space. We've been in the property CAT business for 20 years now based on our origins with Mid Ocean Re. Our loss ratio is in the mid-40s. And I think there would be very, very few companies that could match that sort of track record.

Operator

Your next question comes from Greg Locraft with Morgan Stanley.

Gregory Locraft - Morgan Stanley, Research Division

Just wanted to understand how are you thinking about CATs within your guidance of -- or within your target of the 90% accident year?

Michael S. Mcgavick

While we don't discuss it in precision publicly, we of course have an average CAT load that we developed based on the models and our recent experience. And that CAT load is built into the budget, and it's part of how we would expect -- when we say getting to a 90% combined, we think of that with the average CAT load as the core plug for what will happen in the year.

Gregory Locraft - Morgan Stanley, Research Division

Okay, good. That's how we actually model it. So 3-year, 5-year, 10-year average CAT load is between 7.5 to 10 points. So I mean, I guess I'll just -- my math would then mean that you're aiming accident year ex-CAT for the low 80s? Have to be, right?

Michael S. Mcgavick

Well, look, we write large accounts, large limit complex business. So you would expect that we would have the lumpiness that Greg expressed and that we would have meaningful CAT loads as a part of it. That's one of the reasons when we're talking about reinsurance, for example, we don't focus on ex-CAT numbers because we're in the business. And for large parts of our industrial business, that same is true. So yes, we would have meaningful CAT load in there, but we haven't chosen historically to get into the details of the CAT loads we view as competitive.

Gregory Locraft - Morgan Stanley, Research Division

Got it. Okay, great. And the somewhat along the same lines, if you take today's -- or if you take the 2012 accident year, you're over 1,000 basis points away from the target. It seems that 100 basis points improvement is about $0.19 a share. So you just did $2 in earnings, $2 plus on the year. If you do another 1,000 basis points, that's another $2. That's $4 in earnings. Are you aiming better? Are you aiming for better than a 10 ROE? Or how do we think about it?

Michael S. Mcgavick

Well, I guess I look at it as steps along the journey. The reality is with the interest rates being where they are, those double-digit hurdle rates that used to look sort of like the least you would expect are getting very difficult to produce. So as I look at it in the near term, our fundamental objective is to get back to double digits. And once we're there, we'll see how far we can push it. But when you get to the kind of 90% combined, if you can run the 90% combined as we believe we can in our insurance operations, if Jamie and his team keep the kind of performance levels we've seen over the last several years on a blended basis, you get to the right kinds of returns. And remember that some of the capital that is now used surplus starts to get -- put to work through our growth over that same period. So you have to be able to kind of triangulate the growth, the declining combined ratios, stability in our expenses. When you get all those pieces in line is when it will produce the right kinds of ROEs.

Gregory Locraft - Morgan Stanley, Research Division

Okay, great. And then last one just on the same thing. It's just this trajectory, and we can see it coming through the numbers, I mean, it's happening. What is sort of the gating mechanism on speed at which you can achieve these targeted returns? I mean, I know you've broken out granularity in the business and stuff. So what's keeping it from happening, say, in 1 year's time versus 3 years' time aside from the weather being a bit of a wildcard?

Michael S. Mcgavick

I'll give you -- well, as long as we feel confident in our modeling around CAT loads over time, I feel very comfortable with ignoring the weather, if you will. Obviously, any insurer has to be thinking very seriously about the frequency of large events right now, and we are too. The good news is that most of the modeling organizations and certainly the additional work we do beyond what the modelers give us includes a real respect for recency. And I think that's the appropriate way to take into account what we're seeing. But as I think about the speed of improvement, we've seen over -- on a year-on-year basis, when you strip away all the noise, and I really like Greg's answer with regard to 1 quarter versus another. I don't look at it 1 quarter versus another. We love it when it keeps coming down. We don't expect it to come down every quarter. But if you put a ruler on over any 4-year period -- or any 4-quarter period, we expect to see real improvement. I personally have a view that it should accelerate. Why? Because we've been getting rate on rate. And that's the first time we've been able to say that in a long time. When you start seeing rate on rate year-over-year, you're going to get some improvement, especially as in many lines, we are certainly exceeding loss cost trends at this stage. That's very positive. The second thing is if you go back through the period in which we've had this more rigorous mentality around our underwriting operations, our fresh leadership in place, many of them are getting their second crack at their books of business on this renewal stretch. So you're going to get there first wave of impact because day by day last year we were improving the books through underwriting actions. That starts to compound itself. So these things should accelerate. I haven't established publicly, nor will I, any particular "on this date, we will hit 90%". But clearly, the trend is very positive and we believe momentum should accelerate if we remain focused, disciplined and grind it out.

Gregory S. Hendrick

Yes, let me just add that this is really a question for me around rate adequacy. And Greg, you started kind of with that high-level look down. We do a top-down look at rate adequacy. When we run it through economic capital models and translate that back into a combined ratio, targets we get into that same 10% to 12% range -- 10% to 12% improvement range that you started with. We also measure it, although it's a building skill for us, we measure it from the bottom up as well in a number of our businesses. And a lot of that technology spend that we've talked about over the last 2 years is going towards making us better at building it from the bottom up, so account by account. But even that way coming up, it gets us into that same range of kind of 10% to 12%. How do we get there? How do we get to adequacy? It is a grind. It's not a fun word, but it is a grind. I believe that where the market pricing is going, we will get there in a couple of years in of itself, but we're not going to sit by here and contingently watch that happen. We're going to grind it and mix within businesses. So within a particular business where they're doing an exceptional return overall, winnowing out some of the parts of it that aren't performing well. And then we're mixing our business in total towards more profitable segments of the portfolio. So it's not just rate, it's rate and it's mix in both directions.

Operator

Our next question comes from Vinay Misquith with Evercore Partners.

Vinay Misquith - Evercore Partners Inc., Research Division

The first question is on growth. That was pretty significant in the primary insurance operations this quarter. Did your new operations have some traction? And should we expect some sort of similar level of growth in the near future? Or were these some onetime items this quarter?

Michael S. Mcgavick

This is Mike. I'm going to turn it over to Greg. But to be clear, as he described in his introductory remarks, there were some pretty remarkable onetime experiences in this particular quarter like the one in risk management, the kind of one-off short-term contract that affected these numbers. But in general, should we expect to be growing and should those new operations be contributing? Yes. I don't think that will be the big defining moment. I think the rate beginning to accumulate, combined with some of our existing operations that have also been able to source some more attractively priced risk, I think that will be the main driver.

Gregory S. Hendrick

Vinay, at the risk of being redundant, always pointing you towards the full year rather than the individual quarter. Particularly though, to give you a little bit of color in the quarter, the normalized growth was just over 12%. About 1/3 -- almost 40% of that was in new businesses coming online. We talked about, I talked about construction, E&S, political risk. About 1/4 of it was in rate increases. And then there are just -- it's just the nature of the business we are in. They are quite often large transactions that can be lumpy, and so there are a whole number of moving parts that would take way too long to go into what makes up the rest of that particular movement in the quarter.

Vinay Misquith - Evercore Partners Inc., Research Division

Sure, that's very helpful. The second is a numbers question. Within the Reinsurance segment, the operating expense ratio was really low. Should we be using the prior quarter's number as more as a baseline versus the current quarter?

Gregory S. Hendrick

There was a significant reduction this quarter principally around compensation, accruals, both in the annual cash plan and reductions versus 2011, in particular because some long-term incentives paid last year and didn't pay this year. As to whether we would use it as a normal run rate would really depend on where the bonus pools come out each year.

Vinay Misquith - Evercore Partners Inc., Research Division

Right. So normally you would expect it to be higher than 10?

Gregory S. Hendrick

Slightly, yes.

Operator

Your next question comes from Josh Shanker with Deutsche Bank.

Joshua D. Shanker - Deutsche Bank AG, Research Division

In terms of the last years of re-underwriting your commercial property book, do you have the right exposures you wanted to be in New York City commercial property now that Sandy happened? What are sort of the postmortems on this loss and your exposures?

Gregory S. Hendrick

So Josh, I mean, one high-level comment is always to be very careful both from a positive or negative standpoint to overreact to one event, right? It's -- you're looking at 1 point on a -- when you look at the CAT model in particular, you've got 1 point on a curve of 100,000 events. So you don't want to overreact one way or another. We are able to track our flood aggregates quite tightly. We have made a big push on that. So from the dimension of Sandy and flood in our exposure in New York City, I'm quite comfortable with those. In terms of the overall book, I don't -- we monitor across, not just nat cat but also across terrorism, earthquake -- I'm sorry, not just winds and flood but earthquake, terrorism. And all those things are well within our risk tolerances. So I think the mix of business we have there is strong, and I think the exposure levels we have are appropriate.

Joshua D. Shanker - Deutsche Bank AG, Research Division

Let me try and ask this another way, which sounds completely different but really about the same thing. To what extent do you think that Hurricane Sandy will post rate increases to New York City commercial property and other lines of business as this storm is a storm with a payback?

Michael S. Mcgavick

So that's a different question. And there, I do think that Sandy was a very meaningful wake up call to exposures that are concentrated in these intensely urbanized areas. I thought our book performed -- first of all, it performed as we expected under such an event and performed well. And I think our underwriting teams had done a good job of thinking about our exposures, particularly in the flood and business continuation spaces, as Greg mentioned earlier. But I do think that there's going to be a number of rethought approaches to underwriting in the area. And I think we and our competitors are going to sort that out. Whether that will lead to wholesale price changes, I'm not so sure. I certainly think that it will lead to some reaction in the marketplace, and we're seeing that. I also think, to be clear, there are few lines of business that really made Sandy stand out, and I think you'll see very strong reactions to those. And I wouldn't be surprised, as the mayor and the governor have indicated, to see structural responses in the region that will also affect how one will approach rate over time. So to break that down a little bit, lines like fine art space [ph], those are going to get significant changes. And I bet there's differences in business practices that emerge as a result of the losses we saw. When you see the marine space, I imagine there will be differences in business practices and in structures than when those things are rebuilt than we saw before. So whether it leads to wholesale price changes, I don't think is exactly the right question. It will be what will be the changes in risk and how will we price those going forward. And I think that will require a lot of thought because it's going to -- it's not going to be a static game. It's going to be a moving game.

Joshua D. Shanker - Deutsche Bank AG, Research Division

Well, it's been 3 months now I realized, probably right off Sandy there were no increases in terms of -- have these started to flow through? I mean, I don't know much about the artwork insurance market, but have you been able to reprice? Is this business going elsewhere if it's not meeting the price? What's been happening in the past 2 months?

Gregory S. Hendrick

So Josh, yes, in the property insurance market, this has definitely put a -- and particularly in the Northeast, put a floor under the pricing environment. It varies greatly by risk to risk and whether you're loss effective or not. In general, watching the market on property drive lower sublimits for flood, higher deductibles for flooding and some movement of coastal wind deductible. But this is in the large property space, right? These are large upper middle market or large corporate customers. Particularly, your question to fine art, a little early and not enough data points to make a strong standard point, but certainly anecdotally, from my conversation with the team, yes, we're getting rate. I think our team performed exceptionally well in Sandy, but we are getting rate there. I wouldn't want to put a lot of figures around it, but right now we're seeing more rate.

Operator

Your next question comes from Jay Cohen with Bank of America Merrill Lynch.

Jay Adam Cohen - BofA Merrill Lynch, Research Division

A couple questions. The first is I guess a year ago, you talked about an expense load that would impact your 2012 year. I'm wondering if you could talk about the -- are we talking about the investments really you are making. I'm wondering if you could talk about the level of those investments in '13 versus '12, if it would make it even more challenging or will it lighten up a little bit?

Michael S. Mcgavick

In fact, I almost did a run-on sentence in the prior question because this is the other piece you need to look to when you get to the ROEs we're talking about. It's not just what we can do on the underwriting side, but how the expenses now give us some operating leverage instead of being kind of a hill to climb every year. So I'll let Pete get into specifics but the short answer to your question, Jay, is the burden comes down because a bulk of this expansion has been made.

Peter R. Porrino

Yes, so Jay, what I'd say is we're not -- we're clearly not done in that space, but we do see a leveling off. And as I think about expenses for the next year, I see, I would call it normal expense growth that you would see, plus a little bit for some of the new business initiatives that Greg and Jamie have in mind. If I sort of look at in the big picture, I would see it in the low to mid-single-digit range, which certainly was less than what we told you we would do last year and what we actually did last year.

Jay Adam Cohen - BofA Merrill Lynch, Research Division

That's really helpful. The other question is on the Life Re business. You've seen a number of transactions or certain companies have been able to greatly reduce or eliminate their exposure to run off businesses, Sun Life, Cigna. And the environment just seems to be getting better for those types of transactions. Is that something you could possibly do for your Life Re business?

Michael S. Mcgavick

Should I give you my phone number now? I mean, we have been actively open to proposals that could yield such an outcome for us. However, nothing has come forward that makes any sense. The book is performing as expected. And if it's a run off, it's a run off. So we'll just have to see what comes. But make no mistake, all on the call and any beyond, if you have a brilliant idea for that block of business and can do something more attractive than we can run it off, we're all ears.

Peter R. Porrino

Jay, this is Pete. Just a little amplification. I agree completely obviously with Mike. The other thing I would add is we do have conversations here from time to time. I would make 2 comments with a comparison. One, life reinsurance has got different set of obstacles to it than primary life business does. And the second one is our book, as you know, is based in Europe and that also has a complication to it.

Michael S. Mcgavick

So you can see how this works. I encourage all callers and then Pete says don't bother.

Operator

Our next question comes from Brian Meredith with UBS.

Brian Meredith - UBS Investment Bank, Research Division

Greg and Mike, I'm just curious here. Greg, you mentioned that casualty pricing is up about 2%. And if I think about what the decline in interest rates have been over the last couple of years, I'm kind of struggling to understand why is casualty all of a sudden attractive? And why all the growth all of a sudden?

Gregory S. Hendrick

Well, Brian, so let me -- so the 2% was around international book, which I know it's sad somewhat to cheer plus 2%, but we've arrested a number of years of declining rates. I think if you're looking at the financial supplement, I'll let Pete and Steve add in here, part of the growth there is coming from lines of business in the casualty other for the year. I think it's about $200 million. The 3 biggest movers in there are the U.S. risk management business, which -- okay, it's casualty, but given the structured nature of that, I don't view it in the same way as being as hugely investment sensitive -- interest-rate sensitive as some of the excess casualty or the large limit casualty. International upper middle market, which has a component of casualty and property to it, and our construction business, which has some workers' comp, some g/l, but also some professional and property. And this is just a consistent thing. We've mapped those businesses by casualty class for a number of years based on the fact that when we started out with those, they were predominantly casualty. But that -- those 3 alone explain about 80% of that growth year-over-year. And, Steven, you want to add to that?

Brian Meredith - UBS Investment Bank, Research Division

And then I wonder if you could kind of talk a little bit about you're seeing with respect to loss trend? Anything unusual going on?

Gregory S. Hendrick

Nothing unusual. For the full year of 2012, our 3% rate change maps to a blended overall loss trend of 1.8%. So not a large victory but a victory nonetheless. Generally speaking, short tail lines are ahead of trend, and long tail lines are trailing. And on a geographic basis, the U.S. book is getting rate ahead of trends, and the international book is lagging. You can -- always happy, and you'll take it when you're beating trend, but clearly that differential needs to keep growing.

Operator

The next question comes from Meyer Shields with Stifel, Nicolaus.

Meyer Shields - Stifel, Nicolaus & Co., Inc., Research Division

We haven't talked at all about the lines of business that were considered challenging at the beginning of this year or described that way. Is it safe to infer that they're basically in line with the balance of the book now?

Michael S. Mcgavick

Yes, entirely. We don't think about them anymore. What we think about is that every part of our book has to perform well. And anywhere we're not getting the performance we need, we're going to put a lot of love and care and attention on it. And so we don't break it out internally anymore. It doesn't have any meaning. It's just kind of a thing of the past. But we do -- we can give you some numbers if you'd like, but I don't think it adds any insight to how we're performing.

Gregory S. Hendrick

Yes, at the risk of open-door, but the business formerly in the challenged category, performed at an -- in the quarter ex-CAT loss ratio 96.6 -- combined, I'm sorry. Combined, 96.6 compared to 112.4 Q4 '11, and 96.5 for the remainder of the portfolio. For the full year, which I have always said is the more important one, the ex-CAT -- the accident ex-CAT combined ratio was 99.3 compared to 113 last year and 98.3 for the performing portfolios. So 5 of the 6 businesses experienced the fourth quarter accident ex-CAT improvements. And that's it, we're done breaking them out.

Meyer Shields - Stifel, Nicolaus & Co., Inc., Research Division

I don't remember if it was Peter or Greg that talked about adverse development on excess and surplus lines. I was hoping to get a little more detail on that.

Peter R. Porrino

Sure. Greg, do you want me to...

Michael S. Mcgavick

We have our Chief Reserving Actuary here, too, Susan Cross. She is the best to answer that question. Sue?

Susan L. Cross

Right. So the development that we experienced from the quarter on the excess and surplus line portfolio was $50 million. And that is concentrated in 2 specific portfolios, an apartment book and New York contractors. And that we've experienced more notices and a longer period of reporting than what we had previously assumed.

Gregory S. Hendrick

Let me add, you also heard me talk about growth in E&S, which I know it sounds somewhat contradictory, if you look at the $50 million. It is a completely different book. I think we've talked about this before that it's a brand-new management team. We have added expertise in railroad. We've added expertise in properties, something we didn't have before. We've completely re-underwritten to almost the point of extinction the 2 books that Susan mentioned. We've added auto capability and excess -- and umbrella capabilities as well. So that's a whole different book of business going forward, just to be clear why I note the growth in it.

Operator

Our next question comes from Michael Nannizzi with Goldman Sachs.

Michael Nannizzi - Goldman Sachs Group Inc., Research Division

Jamie, would it be possible just to understand how much of the low frequency of large losses impact the loss ratio in the Reinsurance segment in 4Q? And just one follow-up.

James H. Veghte

The delta from Q4 '12 to '11, roughly 13.5 point improvement, 6 if it was from the CAT. And the reason is that we assess our IBNR requirements for the benefit of the information on actual CAT activity through the year. During 2012, the level of smaller CAT events has been significantly lower than past years and lower than 2011, in particular. So we reduced the loss ratio for this business during the fourth quarter, even though it really was attributable to activity during the course of the year. In effect, it's a true-up based on the sort of that target pick relative to the actual.

Michael Nannizzi - Goldman Sachs Group Inc., Research Division

So better to think about the full year kind of number as ...

James H. Veghte

Exactly. The New York CAT-loss ratio this year was 35%, last year was 71.6%.

Michael Nannizzi - Goldman Sachs Group Inc., Research Division

Great. And then, Pete, one question I was wondering. From what we've seen so far this quarter, we've seen AOCI marks have been mostly negative. So I was a bit surprised that you're bookmarked up in the quarter, and I realized it's hard to kind of speculate why yours zigged when everybody else zagged. Is there any granularity you can give us on why that -- what might have contributed to somewhat of an unexpected outcome?

James H. Veghte

Sure. I think our portfolio probably is a little bit different because of the European Life book that we have. I would say that probably contributed the vast majority of that surprise to you.

Michael Nannizzi - Goldman Sachs Group Inc., Research Division

I see. And then you said or could you give us an idea of how much capital is supporting that Life Re business?

James H. Veghte

It's in the Fin Supp. We disclosed both the GAAP capital. And since last quarter, we also disclosed in essence to get into the statute -- the regulatory capital as well.

Michael Nannizzi - Goldman Sachs Group Inc., Research Division

Last one, real quick. Satellite loss in the quarter, is there any -- do you know if we have exposure there or if you have exposure there?

Gregory S. Hendrick

Mike, we don't talk about individual losses. We do -- we are an active participant in the satellite market on the insurance side. We have roughly on average of 3% to 5% market share of a given launch. But we then buy reinsurance, protected it for about 50%. So that gives you hopefully enough color to put a box around it.

James H. Veghte

Mike, so you don't have to look it up. It's in the Fin Supp Page 22. It's about $2.2 billion of GAAP, net assets, and the regulatory would be about $1 billion.

Operator

And our next question comes from Paul Newsome with Sandler O'Neill.

J. Paul Newsome - Sandler O'Neill + Partners, L.P., Research Division

Why do you think that the rate outside the U.S. has been so different than in the U.S.?

Michael S. Mcgavick

I think -- this is Mike. I think there are couple of factors that affect us internationally, and particularly in Europe. Number one is culturally, the insurance buying process there has a larger expectation of continuity than we would see in the U.S. market, where there is much more responsiveness to fundamental economics. So there's just a cultural difference that I think makes achieving rate a more difficult task in the European market. I think the second thing you have to look to, and this is an area where there's opportunity for us, is that Europe is under tremendous pressure. So if you're a risk manager in Europe, you are working like the devil to try and lower your cost of your operations to your company because the economy there is providing such a bleak and difficult outlook to you. And this means that's what's really important for us is to work with those risk managers. And we're often the lead on these programs. So we're in the position best able to work with them. Not so much to gain rate but gain rate per risk. So try to restructure programs so that they can actually lower their cost, which may yield the result for us that looks like decline in premium, but may actually be better structured in our own eyes in terms of the rates per risk that we're taking on.

But the 2 characteristics that I would cite are the pressures they're under economically over there, combined with the kind of the continuity culture that drives the renewal process.

With that, I'm going to turn over to Greg for a more specific answer.

Gregory S. Hendrick

I'd only add one thing to Mike's answers, which is quite often again, we're in the large corporate, upper middle market space. Most of the business is quite often what is referred to as trophy accounts. So in the market, they are big-name clients that everyone's -- that carry large premiums relative to whatever else is bought and sold in the marketplace and the competing insurers want to have on their roster of insureds. So that's another dynamic where you have a fewer number of insurers to draw from. And the large ones where we are particularly specialists in get quite competitive with the local carriers.

Michael S. Mcgavick

That's one of the reasons we called out the progress we're making in terms of early indicators on rate this year. It's a small sample size relative to the book because we're really pressing our folks. And we feel they've done a -- given those difficulties that we've described, we feel they're doing a really nice job, and we're standing behind them 100%.

J. Paul Newsome - Sandler O'Neill + Partners, L.P., Research Division

Unrelated question. There's been a lot of talk that the securities market is sort of absolutely here to stay in the property CAT business, [indiscernible] financial issues the CAT bought. Do you think that this is -- I guess what's your opinion on whether or not this is a sign that profitability is somewhat capped in that business now?

James H. Veghte

I don't know whether it would be capped. I certainly think like any business, the law of supply and demand are going to have an impact on things. And there is a tremendous amount of capacity available on that market, both traditional and nontraditional. So I think by definition, there's liable to be some impact on rate levels. But I do believe that third-party capital is going to be a component of this business for quite a long time. The level at which it participates in the market will depend probably on interest rate levels and other opportunities that these sources of capital have invested.

J. Paul Newsome - Sandler O'Neill + Partners, L.P., Research Division

Do you see this as kind of a fundamental change in the market or not?

James H. Veghte

I beg your pardon?

J. Paul Newsome - Sandler O'Neill + Partners, L.P., Research Division

Do you see this as sort of competition just from another source as opposed to a real change in how the market dynamic is working?

James H. Veghte

Yes, I mean, we think it represents about 15% of the market now. That's probably going to ebb and flow over time. I think the days of automatic startup pure equity-related entities after major losses may be different. Next time you might see ramping up of third-party capital that can participate directly into the market rather than that. But it is liable to go up and down over time, depending on the broader investment environment.

Michael S. Mcgavick

This is Mike. I'd add a couple of other thoughts. I certainly think that where you suddenly, to get into a harder market, it would take the top off of that move because you'd have people -- in current conditions, you'd have people flooding in. But you have to remember, part of this is the tremendous pressure these managers are under to find new sources of opportunity. The rest of the investment world just looks so bleak. So that's one piece that we don't know how long that piece lasts.

And another piece that we think about around here is, it's one thing to have it happen in times like these. But if you ever got into a big set of losses, I'd be curious to see how many folks are really in for it 100% of the time when big losses are over and over. So as long as it kind of bounces along like it is, I think what Jamie said holds true. But there's a lot of volatility that could come into that market, and we'll see how it performs after that. That's why I think the fundamental traditional reinsurance market is going to continue to have its place. It's just going to have this additional activity that will be a part of the market episodically, and that's fine, and we intend to participate.

Operator

Our next question comes from Ian Gutterman with Adage Capital.

Ian Gutterman - Adage Capital Management, L.P.

Just hoping to clarify some of the -- a couple of earlier things I'm still a little confused on. So on the expenses, Pete, I just was looking at the overall full year P&C expense ratio. And in 2010, it was 31. In 2011 it was 31. In 2012 it was supposed to go up and it was still 31. So I guess my question is, is 31 just the right rate? Or was this year's 31 under what you would've planned, and this is going to be higher than that going forward?

Peter R. Porrino

So I would say, 31 is what we planned for this year. I'd say the expectation is, as Mike and Greg talked about, is that it is going to go down. It's going to go down because of the operating leverage that we are putting in place at the company. Our rate of -- obviously our rate of expenses are going to grow I think pretty significantly, less than our business is going to grow down the road. You will see that accelerate with time.

Ian Gutterman - Adage Capital Management, L.P.

Got it, great. And then on the capital buffer question, maybe I'm oversimplifying it, but the simplest way to look at capital buffer being steady is to say you'll buy back earnings minus dividend?

Michael S. Mcgavick

We'd never put it in exactly those terms, but that is -- that would be the simplest idea. However, you have to remember growth. As we grow, some of the capital is consumed by that growth.

Peter R. Porrino

I think we've said -- Ian, this is Pete. I think in the past we've said that it depends on your mix of business. But certainly you can easily get to where 40% of your growth in business as a capital charge.

Ian Gutterman - Adage Capital Management, L.P.

Got it. And then just my last one, Peter, the affiliate income this quarter is about $31 million. I'm just curious, do you consider that a normal quarter, a really strong quarter? I'm just trying to get some sort of sense of where run rate is for those businesses?

Peter R. Porrino

We would put that slightly above our expected run rate.

Operator

Our next question comes from Josh Stirling from Sanford Bernstein.

Josh Stirling - Sanford C. Bernstein & Co., LLC., Research Division

So we talked about -- I think, Greg, you mentioned growth in U.S. casualty is from the risk management, upper middle market in construction. I was curious, is this for you guys more of a cyclical story, so competitors raising pricing and pulling back and creating these opportunities, or are these some of the strategic growth initiatives from a couple of years ago? And if that's the case, are these businesses for you guys structurally attractive? Sort of remind us sort of how do you think about them?

Gregory S. Hendrick

These are certainly strategically important businesses to us. And the one you picked, U.S., the U.S. risk management for the primary casualty business. I mean, this is a great product to cross sell from our existing customer base and also to attract new customers, and then we can then cross sell remaining products to them. Construction, E&S, primary casualty, political risk, inland marine, those are all businesses we've talked about in the last 2 years. They're all very well-planned out and really very strategic for us. I do think like any other underwriter, I'm always fond of a market dislocation. I wouldn't call the U.S. risk management space that you particularly observed completely dislocated, but there certainly is some movement around in that area. We're looking at it closely. We won't do anything rash. Where we have an opportunity, we'll take advantage of it. It does put a little bit of lumpiness into the premium figures because they can be large gross and premium transactions. So I'm optimistic, but I wouldn't want to convey it to you as a raging dislocation.

Josh Stirling - Sanford C. Bernstein & Co., LLC., Research Division

Okay, that's an interesting color. Jamie, I was waiting for the follow-up. One final question -- maybe there'll be others, but on convergence, you mentioned the point that there were 2 large programs places aggregates[indiscernible]. From a distance, that feels like a big move by the seeding carriers to try to put traditional reinsurers at a bit more level playing field with collateralized players. Is that one of the primary drivers of this, or am I just imagining sort of too much[indiscernible]?

Peter R. Porrino

No, I don't really think so. I think there has been such a frequency of CAT events over the last couple of years that they're trying to protect themselves against that, rather than play one part of the market against another.

Gregory S. Hendrick

And, Josh, I'd just add, this is Greg. I'd just -- from XL insurance perspective, we're going to be looking at that same trade-off of currents and aggregate for ourselves to -- for our own protection. I think it's just a good risk management principle to follow, to consider the kind of coverage.

Josh Stirling - Sanford C. Bernstein & Co., LLC., Research Division

Right, and obviously you are not just a reinsurer.

Operator

Our next question comes from Randy Binner with FBR.

Randy Binner - FBR Capital Markets & Co., Research Division

Most of it, asked and answered, but one thing is the question on D&O. I feel like a year ago, there was maybe more chatter about kind of more claim activity as a follow-through from the financial crisis. And I suppose there has been this LIBOR issue, but I'm not hearing that from this conversation or in the financials. And it sounds like you're growing on the other side of the equation. So is there still claim activity that come from the financial crisis? Or are you not seeing it, it is hitting others? Or how is that body of risk developing?

Gregory S. Hendrick

So there's a number of pieces in there, and I'll give you a high level, and then let Susan, who oversees the reserving if she wants to add anything in particular. Let me start with LIBOR, which I heard you mention in there. LIBOR continues to be an emerging topic. I know it for myself and probably for you as you asked the question, it's unsatisfying to say 9 months after we start talking about it that the original news coverage arose that it's an emerging topic, but that is the reality of it. We don't know how many institutions didn't follow the guidelines. We don't know the exact culpability of the particular insurers. And we don't have a full feel yet for how it's going to break between what's exposed to U.S. versus international legal standards. As a reminder, the standard D&O coverage for public companies excludes regulatory fines and penalties, Side A responds only if a company cannot indemnify any individual director or officer. And we have a good strong spread of business between Side A, D&O and E&O for financial institutions. We believe that any LIBOR exposure would be covered within our current reserving levels. If you're wanting me to step back now and say some of the other older events, let me turn it over to Susan because she spent more time in that area thinking about those reserves.

Susan L. Cross

Sure. Randy, I would just say that the reserves that we have established for the subprime and credit crisis events really are holding up very well. And some of the older claims are reaching that level of maturity that actually in Q4, for the first time, we actually released a portion of reserves from the 2007 year related to the subprime event. So we're very comfortable with the reserves that we have established. Those claims are developing kind of much to be expected, if not more favorably. And we did take some action in Q4 in that regard.

Gregory S. Hendrick

And I think I've heard in there as well around where we see the market. And certainly we're observing, on the whole, that there is a reduction in class action activity. But there is an increase in some of the M&A-related, what I would call, legal expense, which really is really hitting primarily layers. So when we talk about rate increases, we're seeing that 9% we had in December in the U.S. professional, it's a very different number for -- much higher for the primary book of business and a lot lower for the excess book of business. So you're seeing the reality of the shift at least in the last few years from less big cases -- less big numbers to kind of smaller claims or eating away at the lower primary layers.

Randy Binner - FBR Capital Markets & Co., Research Division

If I was going to kind of bottom line it, at least for XL, because I know you can't speak to how other firms are managing claims and setting reserves, it sounds like you are slowly kind of chewing through the exposure from the financial crisis, just working its way into the numbers. It seems like we're going to hear a lot more about it if I thought back 1 year or 2, and it's kind of disappearing in. And so is that a fair statement for XL?

Michael S. Mcgavick

Yes. I think it's the right way to think about it. But remember, this is just a very slow developing set of claims and activities. And so it'll, as you said, bleed in over a long period of time. But our view of it is that the environment for professional is actually getting better, both in terms of what's going on in the claims side and in terms of what's going on in rate. And that gives us a lot of good feeling about the future for this line of business.

Operator

Our final question comes from Ryan Byrnes from Langen McAlenney.

Ryan J. Byrnes - Langen McAlenney

I just have one last one left over. In the property-casualty net investment income, I think last quarter it was a little lower than expected. I think there were some onetime items due to some tips in RMBS. But it was -- in the fourth quarter, it was I guess equally as maybe a little bit lower than expected. I just wanted to see if there were any onetime items in there.

Peter R. Porrino

I'm sorry, the fourth quarter -- so this fourth quarter of 2012?

Ryan J. Byrnes - Langen McAlenney

Yes, versus third quarter of '12 in a net investment income.

Peter R. Porrino

Yes, so that one I would say the fourth quarter '12 we would say is more indicative of a go-forward run rate than the third quarter was. There were some -- we talked about it on the call, some reasonably large adjustments negative for some -- for our tip securities. This quarter, they were a very small positive. This quarter, they were a very small positive, right? And so if you're thinking about going forward, I think Q4 is a better starting point, of course, taking into account what we've disclosed as the $3.5 billion leaving the portfolio and being reinvested in that a much lower yield.

Operator

At this time, I'll turn the call back over to the speakers.

Peter R. Porrino

This is Pete. Just one clarification for an earlier question that came up on our insurance combined ratio targets. One thing, I -- just one clarification that might have been obvious to everybody but me. But when we talked about that 90%, we're talking about that as fully developed. So it doesn't include PYD for past accident years, okay? But if we do what we believe we do, which is be very prudent in the way that we set our reserves, okay, you need to let that develop out to open it.

Michael S. Mcgavick

So with that -- this is Mike. I just want to thank everybody again for taking the time on this call. I know it's getting late in the evening here in the New York area. But I just want to observe that this was a very positive year for XL. It's a real turning of the corner for us, operating this book of business. We feel very good about the insight we've gained, momentum we've gained, but we're very humbled. We know this is a very hard business. There's a lot of small things done every day by 4,000 people around the world that produced this improvement, and that can produce the future improvements that we expect. And while we're not yet the XL we dreamed of, we can see where it is, and we feel very excited to get there. And we'll work with the kind of urgency you have a right to expect in the coming year.

Thank you very much for your time.

Operator

Thank you. And this does conclude today's conference. We thank you for your participation. At this time, you may disconnect your lines.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: XL Group Management Discusses Q4 2012 Results - Earnings Call Transcript
This Transcript
All Transcripts