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Executives

Todd Mills - Treasurer and Vice President of Investor Relations

Mike Miller - President and Chief Executive Officer

Paul McDonough - Chief Financial Officer

Analysts

Robert Glasspiegel - Langen McAlenney

Jim Bradshaw - Bayers Capital Management

Dean Evans - Keefe, Bruyette & Woods

Jay Gelb - Barclays Capital

OneBeacon Insurance Group (OB) Q1 2009 Earnings Call May 1, 2009 10:00 PM ET

Operator

Good morning and welcome to OneBeacon Insurance Group's First Quarter 2009 Financial Results webcast. This call is being recorded at 10:00 AM Eastern Time, Friday, May 1st, 2009. All participants are in listen-only mode.

At the conclusion of the prepared remarks, we will host a question-and-answer session.

Now let me turn the call over to Todd Mills, OneBeacon's Treasurer and Vice President of Investor Relations.

Todd Mills

Thank you and good morning.

On behalf of OneBeacon's management team, welcome and thank you for joining us as we review our first quarter 2009 financial results.

Today's call is being hosted by Mike Miller, our Chief Executive Officer; and Paul McDonough, our Chief Financial Officer. They will be joined during the Q&A by other members of senior management.

We released our first quarter results earlier this morning. Our press release, today's slide presentation and our financial supplement are available on the Investor Relations section of our website, www.onebeacon.com. An audio replay of today's webcast will also be available on our site following this call.

Turning to slide two; let me remind you that any statements we make during today's call that are not historical facts constitute forward-looking statements. These statements are based on certain assumptions and analysis made by OneBeacon, in light of their experience and perception of historical trends, current conditions, and expected future developments as well as other factors. However, actual results may differ materially from expectations.

Please refer to the summary of risk factors at the end of our earnings release, as well as the detailed list of risk factors contained in our annual report filed on Form 10-K for the fiscal year ending December 31, 2008, filed on February 27, 2009.

In addition, any forward-looking statements represent our views only as of today, and should not be relied upon as representing our views of any subsequent dates.

Slide 3; during this call, we will refer to non-GAAP financial measures. These non-GAAP financial measures are not prepared in accordance with generally accepted accounting principles. A reconciliation of the non-GAAP financial measures and the most directly comparable GAAP measures accompanies the press release financial segment, and is provided in the financial supplement posted on our website.

Now let me turn the call over to Mike.

Mike Miller

Thank you, Todd, and good morning everyone.

We're very pleased with our strong start of the year resulting in a 3% increase in our book value for the quarter. Our investments results stabilized in the quarter from 2008 results. We have substantially reduced our equity holdings, which Paul will discuss with you in a few moments.

Our 93.6% GAAP combined ratio is a strong start, particularly considering our Northeast footprint and a tough whether experienced this winter. This also reflects our shifting business mix, where specialty lines represent a growing percentage of the company.

Turning to slide 5, our premium growth is driven by specialty lines. Our first quarter results were quite good on both the calendar year and the accident year basis. We continue to see a favorable development in our commercial lines and professional liability businesses. This was partially offset by adverse development in personal alliance most related to personal injury protection litigation in our New York LAD business.

While non-cap weather growth higher reported claim comps this year, we continue to see no significant changes to our underlying frequency and severity fronts. Our expense ratio continues at roughly 35% consistent with our expectations. As we mentioned last quarter, our OUE expenses have been reduced over the past two years with our emerging business mix most notably the collector car business has increased our acquisition costs.

Turning to slide 6, specialty lines had another great quarter reporting a 71% GAAP combined ratio. As of April 1st, we have now completed our first full year writing the collector car and boat business, which has been a key growth driver for both factory and the company.

Non-cap loss levels remain low, and we're positively impacted relative to 2008 by the inclusion of the collector car business and its seasonally low loss ratio in the 2009 results. Besides continued favorable development for our professional liability business that continues to perform much better than anticipated. The expense ratio continues to reflect investments in new businesses as well as higher acquisition costs associated with our MGA relationship, producing the collector car and boat businesses.

Turning to slide 7, OBPP pricing was down slightly, compared to recent quarters, largely driven by one segment, our provider excess business that has most of its accounts renewing on January 1. Excluding the PTI rates, overall rates in OBBP were down minus 4, a sign of modest continuing gradual improvements.

Our IMU rates were up slightly. Retentions are holding study in the mid 80s for OBPP and the mid-70s for IMU. The business growth was strong across specialty lines with contributions from OneBeacon professional partners, EBI, which is our new entertainment, sports and leisure business, Accident and Health and OneBeacon Government Risks.

Turning to slide 8, commercial lines had a solid quarter. Earnings were down, reflecting a continued competitive pricing environment and our selective approach to new business opportunities. Accident year results were improved from last year in line with our expectations. Calendar year results were positively impacted by continued favorable development.

Turning to slide 9, commercial lines pricing showed continued, very gradual improvements in the quarter. On a pure rate basis, our middle market pricing was down 3.5%, while our small business pure rate was down 1%. These levels are slightly improved from the fourth quarter of 2008.

Our renewal retention levels continue to be strong. We are retaining 82% of our premiums, which includes both rate and exposure, but 86% of our customers.

New business levels were down roughly 20% as the marketplace remained overheated to rate new business, and we chose to wait to grow aggressively until rates firmed more.

Turning to slide 10; in personal lines, the premium decline reflects the new traditional personal lines homeowners quarter share agreement we put in place at the first of this year. Absent debt reduction in premium, the total personal lines premiums would be flat.

Current accident year non-cap losses were higher primarily due to results in our New York flat operation and more severe Northeastern weather compared to 2008. A higher level of weather related losses was not outside of our expectations, but it was higher than last year.

As I mentioned earlier, personal lines adverse development was driven by New York litigation cost. We underestimated the litigation cost associated with set on these claims and have now updated our view.

Moving to slide 11; new pricing trends remain consistent with prior quarters. During this quarter, we implemented two rate increases and continue to benefit from cumulative effect of rate increases following through the book. Our premium retentions also held steady with prior periods as is the PIP counts or policies in force. New business is in line with previous quarters.

And now I m going ask Paul to walk through our investment results and capital management activities, and then I'll come back to wrap things up before we take your questions.

Paul McDonough

Thanks, Mike. Turning to slide 12. As Mike mentioned, our investment portfolio generated a total return of 0.5% in the first quarter, which Reflects A return of 1.4% on the fixed income components of portfolio and the return of negative 4.3% on the equity component.

We believe this is a decent outcome in the period when the Barclays U.S. Intermediate Aggregate Index was up 0.9% and the S&P was down 11%. The yield on the portfolio in the quarter was 0.6%, a decrease of 50 basis points year-over-year driven primarily by a general decline in yield, also contributing to the decrease in the yield was the adjustments of our inflation index treasury was genitive 7 million in Q1 '09, and positive 3 million in Q1 '08. In dollar term, excluding 4 million of income from the preferred stock using trust (ph) in the prior year period.

The total net returns in the portfolio in the quarter improved to 16 million from a loss of 9 million last year. That investment income declined to 22 million from 46 million last year, decline in NII reflects the lower yield including the $10 million adverse impact to the inflation adjustment year-over-year, and have lowered the average invested asset base, which declined to roughly 3.9 billion in Q1 '09 from 4.4 billion in Q1 '08, again after the season trusts (ph).

Turning to slide 13, in the first quarter, we continued to reduce our equity holdings primarily through the sales of common stock. As of march 31, we had roughly 100 million of common stock down from about 275 million at the end of 2008 and down from about 800 million at December 30th of last year.

Together with convertible bonds and other investments, our total equity investments as March 31, just under 500 million, down from about 715 million at December 3, and down from nearly 1.4 billion at December 30. As reflected on slide 14, the strength of the equity component of our investment portfolio down to 13% from 19% at December 31, and 32% at September 30th.

We reduced our common stock holdings by another 50 million or so in April, resulting in equity investment as defined that consists primarily convertible bonds for trading not far from their bond values, permitting the downside risk and hedge funds, which haven't aggregated exposure to the equity markets less than 50%.

Our fixed maturity investments continue to be very liquid in high quality with relatively short duration. The cash raised from selling common stock in the quarter was redeployed primarily into corporate bond. We also moved some of our short-term investments into corporate bonds in the quarter, resulting in total corporate bond investments of about 1.3 billion or 35% total investments as of March 31, up from about 870 million at December 31.

Leaving us with this sale sizeable allocation of short-term investments, roughly 800 million or 21% of total investments at the end of the quarter.

Turning now to capital management on slide 15, our capital position remain strong with the slight improvement from year-end 2008, but with less margin for errors in six to nine months ago. That circumstance together with the ongoing uncertainties in the current economic environment and the reason for our shift to way from equities in our investment portfolio and for the steps we have taken to reduce risks in our underwriting business, most notably the 30% quarter share we entered into on our homeowners business that Mike referenced in his remarks.

We achieved some modest deleveraging in the quarter from 38.8% down to 38.1%, and we'll continue to look for opportunities to delever further over time. In the mean time, we have plenty of liquidity and our fixed charge coverage remains healthy and in line with our rating.

And with that, I'll turn it back to Mike.

Mike Miller

Thank you, Paul.

In summary, this was a very good quarter for us and a good start for the year. The underwriting results were very solid, and while we are pleased that pricing continues to modestly improve, the marketplace remains highly competitive. Underwriting discipline and restrain remain important. Overall, I am very pleased with our execution in our first quarter results.

Thank you for being with us today. And that operator, we're happy to take questions.

Question-and-Answer Session

Operator

(Operator Instructions). Your first question comes from the line of Bob Glasspiegel with Langen McAlenney. Please proceed.

Robert Glasspiegel - Langen McAlenney

Good morning everyone. First question is on your security lending change in the Q that you discussed. I didn't quite follow what was going on.

Paul McDonough

Hi Bob, it's Paul. Basically, what we're doing is orchestrating an exit strategy for seg funding, and what we've done is entered into an agreement that gives us much more control over the collateral assets. They've moved out of the overall collateral trust into a separate account that we essentially control.

As a consequence, we've moved the assets out of the separate line item on the balance sheet up into the invested assets. While you still see the payable as a separate line item in the liability, you can see on a balance sheet, if the payables gone down from about 108 million at the end of last year to about 49 million at March 31.

Our expectation is that by the end of next quarter that number will be zero. And the other change that you'll notice is on the cash flow statement because of the control that we now have of the assets. We now treat the entire process, if you will, as a cash transaction or else before that under normal seg funding accounting, it's a non-cash transaction. So you'll see in the cash flow statement a cash outflow in the investing section and a cash inflow of the financing section.

Robert Glasspiegel - Langen McAlenney

Oiling it down, the motivation is to get your offer receivable from banks or is there something more simple that explains?

Paul McDonough

I am not sure I'd necessarily put it that way, Bob. The motivation is to unwind the debt funding program, because you didn't continue to see the benefits in it that we saw before.

Robert Glasspiegel - Langen McAlenney

Okay. I'll hit you offline. The second question is on the investment income sort of... you said 10 million swing on tips year-over-year, but it wasn't clear whether last year's was strong than this year. Just sort of appeal for the core run rate is, assuming you keep 21% of your portfolio short?

Paul McDonough

Moving pieces are last year we had an adjustment of a positive three; this year, we had an adjustment of a negative seven. And it's difficult to say what the run rate will be unless you can predict what's going to happen with CPI.

Robert Glasspiegel - Langen McAlenney

Okay. Well, if there is no change in inflation...

Paul McDonough

There should be no adjustment.

Robert Glasspiegel - Langen McAlenney

Then we should add 7 million back?

Paul McDonough

Yes.

Mike Miller

Yes.

Robert Glasspiegel - Langen McAlenney

The core. And is the 21%... what motivates the 21% short? Is it you think interest rates are going higher? You need liquidity, it helps you with rating agencies. I mean is it sort of pure investment decision, Paul, that you have such a short portfolio or are there other factors in play?

Paul McDonough

I wouldn't describe it 21% a long-term target. It's mostly a consequence of selling down our equities and most fourth that in the fourth quarter went into cash. We're now redeploying that cash and cash equivalent into primarily corporate bonds. And we'll continue to work that down. What exactly is the optimal short-term we may have that discussion on a later call, it's sort of move right now. We clearly have more than we think we need. But certainly maintaining an appropriate amount of liquidity will continue to be a priority for us.

Robert Glasspiegel - Langen McAlenney

Thank you, Paul.

Operator

(Operator Instructions). Your next questions comes from the line Jim Bradshaw with Bayers Capital Management. Please proceed.

Jim Bradshaw - Bayers Capital Management

Good morning. I was wondering if you could discuss a little bit more your thoughts on the investment portfolio and specifically the equity side of it. You continue reduce and your exposure there. And I was just wondering if that's... is it driven at all by discussions with rating agencies or any of that kind of thing or what are your thoughts there?

Paul McDonough

It's really driven, Jim, by... our view of capital and our view that the economic climate and the financial market environment continues to be very uncertain. So we thought under those circumstances, it was appropriate to reduce risks and we've done that both on the investing side and on the underwriting side.

Jim Bradshaw - Bayers Capital Management

Okay. And then so going forward, do you anticipate getting back to where... excuse me, equities are a large portion of your investment philosophy, I guess or?

Paul McDonough

Yeah, we currently have shifted from a focus in our investments from a total return focus to a capital preservation focus, we still believe in the long-term and a total assets return velocity in our investments. So I think over time what appropriate you may see us increase the allocation to equities, but I don't see that happening in the near term.

Jim Bradshaw - Bayers Capital Management

Okay. And obviously that's, I guess this past month of April that probably was not as for two it is some move is that may have been previously. Is that I guess that... does that factor into your thoughts at all or...

Paul McDonough

I really don't think you can look at four weeks into market.

Jim Bradshaw - Bayers Capital Management

Sure.

Paul McDonough

Declare victory on where we are with economy with the financial markets broadly.

Jim Bradshaw - Bayers Capital Management

Sure, sure. Okay. Thank you.

Mike Miller

Jim, and I would just add, it's Mike that obviously look just like we have, we'll continue to look at this and we still believe in the overall philosophy, but our operating results really are performing quite well. And we want to continue to be in a position to support those. And the continued volatility on the investment side is something that we have... we feel that that was important to managing content.

Jim Bradshaw - Bayers Capital Management

And you think at point that's well contained.

Mike Miller

Well, we certainly have a much different mix than we did.

Jim Bradshaw - Bayers Capital Management

Yeah.

Mike Miller

And you can certainly make an argument as time goes forward that we would early begin to bring equities back into the mix, and I think that would be true.

Jim Bradshaw - Bayers Capital Management

Okay. Thank you both.

Operator

Your next question comes from the line of Dean Evans with KBW. Please proceed.

Dean Evans - Keefe, Bruyette & Woods

Hi, just have a quick question about other revenues. I noticed spike up a little in the first quarter, just want to know what the main driver for this was?

Paul McDonough

Dean, it's Paul. If you look at the revenue net of G&A year-over-year, it increased by about 3 million and the main driver of that is the gain that we recorded on the modest debt repurchase. We repurchased 10.6 million of out senior notes in the quarter and recorded a free tax gain of 2.5 million.

The other thing that you may be observing, although it doesn't translate to a year-over-year that changes that the revenues, the other revenues in the G&A or both growth stuff or the EDI agency we acquired last year, was about 3.7 million of revenue and about 3.8 of G&A in the '09 period.

Dean Evans - Keefe, Bruyette & Woods

Okay, great. Thanks.

Paul McDonough

Okay.

Operator

Your next question comes from the line of Jay Gelb with Barclays Capital. Please proceed.

Jay Gelb - Barclays Capital

Thanks. Hi, this is Jay Gelb from Barclays. Could you discuss what the effect on premiums and margins should be as a result of the 30% quarter share home owners business?

Mike Miller

Yeah, Jay. What I would share with you is that; as we indicated it's 30% quarter order share on the home owners on an annualized basis. You will see roughly about 60 to 65 million of premium impact and you saw 13 million, I think in the first quarter. And I would say that would clearly be the most significant impact. Obviously your point there is impact on the loss ratio, which is tough to forecast without an event, right? So...

Jay Gelb - Barclays Capital

I see. Okay. Can you talk about what type of return on equity profile you think you can deliver now in the time PNC environment with buying more reinsurance and also taking into account the investment environment?

Paul McDonough

Jay, it's Paul. I think mid teens weighted to still a meaningful target in the current environment.

Jay Gelb - Barclays Capital

Okay. And can you just also give us a sense where you're with the rating agencies?

Paul McDonough

Yeah, I'd say that our dialog with rating agencies has been fairly stable over the course of this quarter and obviously with a strong quarter behind us that should remain the case.

Jay Gelb - Barclays Capital

So, no need for just no capital here or to do anything on the share of the dividend?

Paul McDonough

Well, as indicated on our last slide, our capital remains above the threshold rating agencies established. So there's no issue there.

Jay Gelb - Barclays Capital

And how often is the dividend discussed at the Board level?

Paul McDonough

We discuss it at every quarterly Board meeting.

Jay Gelb - Barclays Capital

Okay, thank you.

Mike Miller

Sure.

Operator

At this time, there are no additional questions. I would now like to turn the call back over to Mike Miller for closing remarks.

Mike Miller

All right. Thank you, operator. Thank you everyone for joining us. And we look forward to talking with you after the next quarter. Thank you.

Operator

Ladies and gentlemen, this concludes the presentation. You may now disconnect. Thank you and have a good day.

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