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Arch Capital Group Ltd. (NASDAQ:ACGL)

Q3 2009 Earnings Call

October 27, 2009 11:00 AM ET

Executives

Constantine Iordanou - President and Chief Executive Officer

John C.R. Hele - Chief Financial Officer, Executive Vice President and Treasurer

Analysts

Jay Gelb - Barclays Capital

Matthew Heimermann - JP Morgan

Vinay Misquith - Credit Suisse

Dean Evans - KBW

Mark Dwelle - RBC Capital Markets

Ian Gutterman - Adage Capital

Brian Meredith - UBS

Operator

Good day ladies and gentlemen and welcome to the Third Quarter 2009 Arch Capital Group Earnings Conference Call. My name Kate and I will be your operator for today. At this time, all participants are in listen-only mode. Later, we will conduct a question-and-answer session. (Operator Instructions).

Before the company gets started with its update, management wants to first remind everyone that certain statements in today's press release and this conference call may constitute forward-looking statements under the Federal Securities Laws. These statements are based upon management's current assessments and assumptions and are subject to a number of risks and uncertainties.

Consequently, actual results may differ materially from those expressed or implied. For more information on the risks and other factors that may affect future performance, investors should review periodic reports that are filed by the company with the SEC from time to time.

Additionally, certain statements contained in the call that are not based on historical facts are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. The company intends the forward-looking statements in the call to be subject to the Safe Harbor created thereby.

Management will also make reference to some non-GAAP measures of financial performance. The reconciliation to GAAP in definition of operating income can be found in the company's current report on Form 8-K furnished to the SEC yesterday, which contains in the company's earnings press release and is available on the company's website.

I would now like to turn the conference over to your host for today, Mr. Dino Iordanou and Mr. John Hele. Please proceed.

Constantine Iordanou

Thank you Kate and good morning everyone and thank you for joining us today. On an operating basis, we had a very good quarter from both an underwriting and investment perspective.

Our reported underwriting results as reflected by the combined ratio of 90% was satisfactory in the current environment and we're aided by livecad activity and favorable reserve development.

From an investment point of view we had an excellent quarter achieving a total return of 4.75% for the quarter.

We continue to remain cautious in our investment strategy, maintaining a relatively sort duration and high credit quality for the portfolio.

With respect to capital management, we invested approximately a 100 million in the repurchase of our shares during the third quarter.

Consistent with our prior practice, we were cautious on the size of the share repurchase during the hurricane season.

John will give you more details on our investment portfolio and financial performance in a few minutes.

The most important measure for our performance is growth in book value per share and we were very pleased with this quarter's and the year-to-date results.

Our annualized return on common equity was 16.4% and our book value per share grew by $8.72 to $69.48, a 14.4% increase from June 30, 2009 and a 35% increase from the end of 2008. Our cash flow from operations remained strong at 316 million for the quarter.

Now, let me share some thoughts on our operating units. Our gross and net written premium for the quarter grew by 3.7% and 5% to 937 million and 727 million respectively. On a year-over-year basis, our Insurance Group was down approximately 1% on gross written premium and up 1.5% on net written premium.

The slight difference in the net to gross relationship was due to the restructuring of certain of our reinsurance purchases as we purchased more excess of loss protection and less color share.

Our Reinsurance Group's gross written for the quarter were up 16% while their net volume increased by 12%. The difference in gross and net is due to the additional purchases for portfolio management reasons.

Most of the Reinsurance Group growth is coming from the property, property cad and property fac operations as more clients increased their alliance with us during the quarter.

A small portion of the increase is attributed to premium adjustments from casual to business written in prior years as actual border rules came a bit higher that our original estimates.

We continue to see the insurance opportunities for buyers, diversifying their insurance panels and graviting to more financially secure reinsures.

With respect to the operating environment, the degree of rate improvement that we saw in the first and second quarter is moderated and the pricing environment is basically unchanged from the first two quarters of this year.

We continue to see the best opportunities provided with risk adjusted returns in the property and property cap lines and we continue to be very cautious in our underwriting approach to the casualty business.

As always, our strategy is to allocate our capital to opportunities that we believe will generate the best returns. As a result of the current operating environment, our 12 months trailing mix of business is 48% short tail lines and 52% medium and long tail lines.

Of course the shift is more dramatic in our reinsurance business where 70% of what we currently do is property related and only 30% is casualty and professional liability related.

In the Insurance Group we're still 70% medium and long tail lines of business and only 30% short tail. This is a result of our capital allocation process as we continue to allocate 80% of our available P&L to the Reinsurance Group, as we see the better opportunities in that sector of the business.

With regard to loss activity, we have observed relatively benign activity over the last few calendar quarters. This favorable loss emergence appears to be driven by modest frequency as well as severity trends.

Independent of these trends, we continue the price and reserve our business based on the long term loss trends we see which are higher than our most recent experience.

Overall, we achieved a 3.4% rate increase during the quarter on our entire book of business ranging from single digit reductions to a low double digit increases depending on line of business.

This overall rate increase is consistent with the current loss trends we have experienced but is lower than the long-term trend projections. Before I turn it over to John for more commentary in our financials, let me update you on the P&L aggregate.

As of September 30, 2009 our one in 250 P&L from a single event expressed as a percentage of common equity was 20% below the June 30th level of 22% and our 25% of common equity self imposed risk management limitation.

The reduction was directly attributable to the increase in shareholders' equity not a reduction in P&L or our willingness to entertain additional cap writings. With that, let me turn it over to the John for some more commentary on our financials. John?

John C.R. Hele

Thank you, Dinos. Let me give some more details regarding that was exceptional quarter for both sides of the balance sheet.

The combined ratio of 90% this quarter with like activity of only 5 million in the re-insurance area compares to 105% a year ago when we have significant activity of 143 million.

Favorable reserve result development improved the combined ratio by 7.7 points this quarter, compared to favorable 7.6 points a year ago.

The loss ratio of 60.6% in the third quarter we reflected 7.6 points or 56 million, a favorable development in prior year reserves, compared to 9.3 points or 68 million recorded a year ago.

Approximately 60% of the total favorable development came from short-tail lines. While approximately 70% of the total development was in the Reinsurance segment. The Insurance segment loss ratio of 58.4 reflects a favorable development of 3.8 points, two-thirds from property and other short-tail lines and the remainder from medium and long-tail lines.

The Reinsurance segment loss ratio of 48.7%reflects favorable development of 13.4 points, approximately half from property and property cap and other short-tail lines and the other half from medium and longer-tail lines.

The total acquisition expense ratio of 16.6 decreased by 1.5 points from the prior year. As there was less impact from profit commissions, from prior year's favorable reserve development in the third quarter of 2009 compared to 2008 as well the change in the overall mix of business.

The total other operating expense ratio of 12.8% reflects an increase of 0.5 points from the prior year, mainly due to property, facultative operation in the Reinsurance segments.

Last year there was a one-time catch-up deferral acquisition cost and this year the facultative operation which operates primarily on a direct basis as a larger percentage of earned premiums.

And looking at the year-over-year expenses in the insurance operations which are basically flat, there were non-recurring expense accruals in the third quarter of 2008 of 5.7 million, while in the third quarter of 2009, their additional expenses related to the expansion of the executive assurance and professional liability lines of business of 3 million and as well as 1.8 million from the additional of personnel in Canada and other areas.

On a per share basis, the net investment income was a $1.60 in the third quarter of 2009 compared to a $1.86 in 2008. The pre-tax net investment during the quarter of 3.76% reflects a book yield before expenses of 3.93% at September 30th, down from the 4.06% at June 30th and 4.74% one year ago.

While the duration of portfolio remained approximately constant at 3.09 from the last quarter, lower available yields and high quality assets have continued to impact the portfolio.

The total investment portfolio grew form 10.7 billion on June 30th to 11.5 billion at September 30th, driven by a general recovery in asset prices, a 20% return in our total bank loan fund portfolio of 458 million, new investments with a the TALF program and cash -- free cash flow from operations.

During the quarter, we added to our 2009 issuance, non-agency RMBS portfolio that now totals 127 million with newly restructured deals called re-remix that offered very high credit protection. We also participated in the U.S. Government's TALF program purchasing securities worth 251 million during the quarter.

TALF was developed to encourage investments in certain highly rated asset backed securities.

Arch invested $31 million into AAA structures and also received non-recourse notes from the U.S. Government for $220 million. This structure gives an expected return on the portfolio in excess of 10%, after taking into account the interest and principal on the loan over the next five years.

Due to the unique aspects of the program, we are breaking out the TALF investments and loans in the balance sheet this quarter and in the future. We're also separating out the non-recourse TALF loans from our capital structure as these loans for TALF investments only.

Credit related impairments were $4.6 million, primarily due to some reductions in expected recovery rates on certain residential and mortgage backed securities.

Arch's CMBS portfolio comprise mainly of all vintage CMBS's performed well in the quarter with a market-to-book value of 102% and we recorded no impairments.

Our total accumulated other comprehensive income turned to a positive $222 million, the first time positive since March 2008. Our shareholders' equity increased to 4.46 billion at the end of the September. The common shareholders' equity was 4.14 billion representing 69.40 per share.

We took the opportunity to buy back $1.5 million shares for $98 million at an average price per share of $64.04 in the quarter, under a share repurchase plan which added $0.14 to the book value in the quarter.

Total shares repurchased to-date have added $0.37 to the operating EPS in the quarter, increasing the operating ROE by 2.8% to 16.4%. We will continue to consider share buybacks under our existing remaining authorization of $350 million. And we expect to discuss our longer term plans at our next board meeting.

We currently estimate our current excess capital at approximately 700 to $800 million compared to what we target for the various rating agencies. Portfolio liquidity remains strong and we experienced solid positive cash flow from operations of 316 million in the third quarter.

In the 2009 third quarter, our cash flows were negatively impacted by a $46 million payment due to the commutation of a non-standard auto treaty announced in the second quarter.

That concludes my remarks and we're pleased to take questions.

Constantine Iordanou

We're ready for questions.

Question-and-Answer Session

Operator

(Operator Instructions). Your first question comes from Jay Gelb of Barclays Capital. Please proceed.

Jay Gelb - Barclays Capital

Thanks. Good morning. On the excess capital position, how much of that do you intend to deploy into buybacks and over what time frame?

Constantine Iordanou

Well, Jay this is a discussion we're going to have at our next board meeting. Right now, I only have 350 million authorization remaining from the existing authorization.

As I said in my prepared remarks, usually we're not aggressive in share buybacks during the third quarter because even to the last few weeks, you still accept storms that might or might not happen. We'll probably be a little more aggressive in the fourth quarter but that's the discussion as John said that we're going to have with the board and as -- once we make decisions, we'll will probably announce them for everybody to know what that decision is.

Jay Gelb - Barclays Capital

And when is the board meeting Dinos?

Constantine Iordanou

It's next week.

Jay Gelb - Barclays Capital

Okay, thanks. And then separately, can you talk about -- you mentioned the weighting -- weight increases across the portfolio. Given what's happen in terms of recovery of balance sheets and still some stock demand in the economy, what do you -- what your sense in the outlook and on the persistency of those price increases?

Constantine Iordanou

Well there is two school of thoughts when give you some -- I was more bullish in the first quarter and second quarter than I am today. In the third quarter because of the recovery of the asset side of the balance sheets for most of our competitors and the benign cap activity, it makes people to be more competitive in my view.

On the other hand they are recognizing that when you strip out reserve releases, favorable development and you factor in normalized cash instead of livecad activity, the current action is they're not anything to home about, they still produce the returns but they are closer to the 10% range and that's not what we try to achieve, our long-term strategy is to achieve 15% ROEs over a long period of time.

I having said that I believe, we're going to be in a competitive market place for probably another year or two until you see some pain in the balance sheets. We can not see as of yet for most companies in the next four to five quarters. So, but in a very low interest rate environment, people are getting cautious and that's why you're seeing the leveling of price reductions.

So, I think we're going to be in the next year or two in a kind of a leveling of market in my view. I might be wrong, I don't know I mean only the future will tell us what happens. So, if you're asking my opinion, I think that's where I think the market is going.

Jay Gelb - Barclays Capital

All right. Thanks again. It's a real constructive answer.

Operator

Your next question comes from Matthew Heimermann of JP Morgan. Please proceed.

Matthew Heimermann - JP Morgan

Hi, good morning everybody.

Constantine Iordanou

Hi, Matt.

Matthew Heimermann - JP Morgan

Hi, just a question, I was hoping you could just speak to the actually your loss ratios in the quarter, I guess particularly in the Reinsurance segment but also Insurance. They both seem to be running a little bit hotter than they were in the first half of the year and I don't know if that was claimed specific in the quarter or there were other factors?

Constantine Iordanou

No, I don't think there is anything that is claim specific, it's our view. We're very systematic in the way we reserve the company, we make sure we understand, the rate increases or decreases that we would be achieving over the years and we try to be realistic with our accident year picks by factoring in what we've seen over the last two or three years, which --even though rate decreases have level off and in some cases, as you saw from my prepared remarks, we achieve a 3.4% rate increase on average on a blended basis.

Not everything is equal in every line of business. Some lines of business, we're still giving up rates, some lines of business we're gaining rate.

What we do maybe a little bit different than most other the companies, the most trends frequency and severity if you have a short window and you only look at it for the last few quarters, you can get optimistic.

We don't use that as a guidance to how we price the business or how we reserve the business. We use longer term trend averages and maybe that's what's causing the -- to be a book a bit higher but that's our view what we believe the business is from an accident year point of view. And we book it at such and if we're wrong, at the end of the day, the money is going be there, nobody is going to rob the bank.

They're up there, if we don't need it, we can always take it down in later quarters.

Matthew Heimermann - JP Morgan

That makes a lot of sense with respect to Insurance segment, I guess with the Reinsurance now being 70% property, I guess and I was just shocked that you would see running from like a 55 suddenly to 60, there was something wrong with my math...

Constantine Iordanou

No, you got to look at the mix. Some of it is excess of loss but we do write a lot of quarter share and when we write quarter share, you have to reflect the underlying pricing that is happening in the marketplace. So that's basically why that is happening.

Matthew Heimermann - JP Morgan

Okay. I won't beat that horse anymore. I guess the other question I had was with respect to the growth and executive in assurance and the national casualty business or the national business and casualty, can you opine a little bit on I guess what the pricing trends are specific to those two businesses and what you're picking up and how that might be different or how that might contrast with what's in the book already?

Constantine Iordanou

Let me start with national accounts. National accounts is a law sensitive business. These are large accounts that they self insure a significant portion of their risks.

So in that sense you're more of excess provider and a service provider for those business, is it covers the agenda liability, order liability and worker's COG and usually the contracts you issue is statutory comp and usually million dollar limits for GL and auto and is done either on retrospectively rated plans or high deductible plans et cetera.

So our advantage there is that there's been a slight to core, we saw some rotation of those accounts out of -- the major writers of that business has been AIG, (inaudible) Zurich, Ace, Excel, et cetera.

So what happened in the last couple of years, it gave us the opportunity. Also a model, the model that we have which we jointly choose a third party administrator between us and our clients to handle the day-to-day claims from a service perspective in some cases is more attractive to clients.

So we like that business, we do it carefully because there is credit issues associated with that business, you want to be always able to make sure that you're securing all the liabilities that you are having, even though you are not taking a lot of underwriting risk, you might be taking credit risk and we watch both.

So I would attribute growth in the national accounts in the kind of people that we were able to attract and also the market turmoil with some of our competitors, so it gave us more opportunities in the market place now.

Matthew Heimermann - JP Morgan

I guess that was looking more towards what was happening specifically with price. In that way this is relative to the ...

Constantine Iordanou

The price for our national accounts business has been up in the quarter about 2.1%.

Matthew Heimermann - JP Morgan

Okay.

Constantine Iordanou

But I was describing what the business is, we make our money not only just on the where we take underwriting risk which is the excess over and above their retentions but also we do make money on the service fee that we write.

On the executive assurance area I think let me give you -- the rate increase for the quarter was positive, so it was a plus. Some of our growth is coming out of the UK and some of the growth is coming also from the new teams that we have.

No need of major change in strategy other than we are writing more now in the private company segment and then on for profit segment as the new team that we have has more market relationships in that and we still like the pricing environment in the executive assurance but be more cautious.

And in some products, we have reduced exposure especially in the financial situations segment where pricing is still positive but it dissolves with the rate increases we're getting in the first and second quarter.

Matthew Heimermann - JP Morgan

Okay. And then I -- and just -- hopefully quick numbers question, I was just hoping on the bank loan fund, am I correct to assume that there is no leverage left in our portfolio? In another words, EBIT carried at 79.8% when we think about recovery, it be the par not par time something?

Constantine Iordanou

No well the bank loan funds, still have leverage in them and leverage is about 1.7.

Matthew Heimermann - JP Morgan

Okay. So 1.7 times 25 is kind of the -- would be upside the par that are coming back.

Constantine Iordanou

Yeah.

Matthew Heimermann - JP Morgan

The other question was just on the TALF participation, can you just give us a sense of what the yield is on the 250 million and what the interest cost is on the 220?

John Hele

Yeah, it's on about four and two I think.

Constantine Iordanou

It's slowing. It depends upon how it's earned overtime so and then when you level that up then you got in excess of 10 and it changes by bond in each -- it's different between the different portfolios but on average, we expect on this portfolio, slightly over 10.

Matthew Heimermann - JP Morgan

Okay. And that's 10 on the equity, on your equity?

Constantine Iordanou

Yeah, 10 on the equity but nominal yield is around -- it is a highly rated AAA tranches and they're not very long, two to three years.

Matthew Heimermann - JP Morgan

Okay. And then will that all be reported net through NII?

Constantine Iordanou

Yes.

Matthew Heimermann - JP Morgan

Okay. Perfect. Thanks.

Constantine Iordanou

No not realized through -- its not record fair value through the P&L both the assets and the liabilities. So also through the realized.

Matthew Heimermann - JP Morgan

Got you. Got you. Okay. Thanks.

Operator

Your next question comes from the line of Vinay Misquith of Credit Suisse. Please proceed.

Vinay Misquith - Credit Suisse

Hi. Good morning.

Constantine Iordanou

Hi, Vinay.

Vinay Misquith - Credit Suisse

Sorry folks to ask same question again but on the reinsurance side it just seems that the accident year loss ratio picked up 5 points in the third quarter versus the first half of the year.

And you mentioned the little bit of business exchange. Was this some prior period unfavorable development for the year and should...

Constantine Iordanou

No there was no prior year unfavorable developments. It's our call on the accident year. Don't forget, we monitor pricing when your write quarter shares we think that, that's the right accident year, that's how we're going to book it.

Vinay Misquith - Credit Suisse

So, should we expect a similar sort of run rate for the next quarter and for the rest of next year, would that be fair?

Constantine Iordanou

Well, I can't predict the future Vinay because at the end of the day one the thing about property lines, they're short tailed quarter-after-quarter and you factor additional information on performance and we think that attritional losses that have been booked higher and actual performance is better, we got to reflect it.

So, I can't predict the future. I am just giving you the methodology that we use in setting out our accident years and some people think that may be little bit more conservative than others but I don't know, I think we are what we are, yeah.

Vinay Misquith - Credit Suisse

And on the property fac business there was a significant amount of growth this quarter. Was that from new business or is it higher line sizes from existing clients?

Constantine Iordanou

It's both. Line sizes haven't changed, but I think we are penetrating more clients. I think we are doing business today with about 140 different clients so as the team is becoming more known in the market place and our penetration with clients gets deeper, that's what's causing it.

And it has been steady kind of growth from this team over the two years that they've been with us.

Vinay Misquith - Credit Suisse

And with respect to new business, one thing we've heard from competitors is that new business is written at maybe 5% lower pricing or sometimes even more lower pricing than renewal business. If you could -- understand your new business and your new business and how that compares to your renewal business.

Constantine Iordanou

You're correct in that assessment. We monitor that as we're one of the few companies that not only measures on renewal business but also we have a system, a benchmark system that allows us to compare our new business in relationship to renewal business.

It's not as high as 5% but it's less than. If renewal piece of business gets a 100, our new piece of business depending on the product line probably going to be on high 90. So there is at least 3-4 points of price differentiation between new business to existing renewals.

Vinay Misquith - Credit Suisse

And why are these clients coming to your company versus staying with old carrier?

Constantine Iordanou

Well I mean for many different reasons, sometimes it's -- when you compete in the market place, sometimes it's services, sometimes it's capacity you're put on, sometimes it is relationship with the underwriters, some of our new underwriters that we hired, they had existing market relationships, so they see some of the accounts they had a relationship with in the past.

So it's not one single reason that you are getting piece of business but yes don't fool yourself, when you get a new piece of business I mean you compete it in the market place and that's why as we monitor new business pricing, we find it to be a little more challenging than renewal pricing.

Vinay Misquith - Credit Suisse

Fair enough. And one last point on the executive assure, you mentioned some of that growth came from the new teams you employed. But the new team that you thought about contribute to some of the growth quarter within executive insurer?

Constantine Iordanou

Well don't forget we don't -- when we get personnel, I mean they did now once a whole segment of our professional liability and executive assurance. So one we get new people joining our team when -- we integrate that into our existing operation. So -- and basically underwriters have responsibility of accounts we had or new accounts that they coming in.

So I don't try to maintain statistics about what it was new and what's it came from -- either a new employee or an old employee. The whole team is fully integrated already and is in operation nationwide under the executive management of Dave Makanois (ph).

Vinay Misquith - Credit Suisse

Okay great. Thank you.

Operator

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

Dean Evans - KBW

Yeah, thanks good morning guys. I was wondering if you could touch may be on the progress of some of the newer teams of underwriters that you've brought over and some of the new hires recently. How they're progressing?

Constantine Iordanou

We are very pleased with all our teams. I mean going back with the fact teams we've brought or executive assurance or the teams -- or the underwriters we hire either in the U.K. office or in Canada, we are very pleased.

At the end of the day that's -- it's our trademark. We try to get talent when we have the opportunity to hire talent in the market place. I think we give them a strong balance sheet to operate from and a good underwriting environment that we don't put pressure on volume, we do put pressure on them on returns and a lot of good underwriters don't mind that environment, especially, when you link that with our compensation system that we -- our underwriters, they know that they're going to get compensated on ROE performance and we seem to be attracting those type of people.

Dean Evans - KBW

And I guess a quick numbers question as a follow up. John, could you give sort of mechanics behind the lower tax rate in the quarter and what drove that?

John Hele

Well we had -- some of -- when the reserves were released in the quarter, Bermuda drove less taxes through the quarter.

Dean Evans - KBW

Okay, so that's simple. There's nothing...

(Multiple Speakers)

Constantine Iordanou

... quarter most of the cap business is recent in Bermuda. There was a lot of investment income this quarter, most of guys coming out of Bermuda so that's an unusually low tax quarter.

John Hele

And to just clarify on the TALF investment income was booked just to be clear on this. The investments are booked should net investment income and the income statement and the expenses for the loan is in interest expense.

Dean Evans - KBW

Great thanks.

Operator

Your next question comes from the line of Mark Dwelle of RBC Capital Markets. Please proceed.

Mark Dwelle - RBC Capital Markets

Yes good morning. Related to the TALF, is that particularly facility -- does that have some pre-specified duration or maturity or can you come and go from that as you please.

Constantine Iordanou

We participate through various dealers. It's running now till sometime next year, is the current authorization. And we're going to still continue this but it's been fairly successful, we'd like to see some more but it's hard -- there is not that much supply of these things, we pick only the best quality pieces we can. And we operate through a couple of dealers. But we think it's an attractive opportunity for -- at very low risk to get some good returns.

Mark Dwelle - RBC Capital Markets

Okay. And then I know people have kicked the skin around already but in terms of the pricing, I understand your comments earlier Dinos particularly related to the casualty lines of business.

But I would have thought that there would be signs of much greater price pressure on the property lines, particularly after coming through a year with very little activity really anywhere in the world and particularly in the United States. So you're saying that we're not seeing that in...

Constantine Iordanou

No, I can tell you what we're measuring, I think in our property lines, we achieve a 5% increase for that quarter and of course it's down from 7.2% over the second quarter.

But it's still a positive increase and don't forget and that specific book of business, that book of business is more heavily ENS driven, of course we like some national property accounts too.

And now I don't know what's going to happen with January 1 renewals in the cap market which is going to get negotiated in the next couple of months in November and December for the cap placements both income January 1 and then April and of course the exposures in June and July.

But don't forget that market is being pretty disciplined, is being -- there are models, there is exposure, pricing that needs to be consider, I don't anticipate significant moving pricing. There might be a bit more competition but you can't go on one year with no CAD and based your pricing on that basis alone. We look at the long term operators, we look at what the long term expectancy is and we have to price our business on that basis.

Mark Dwelle - RBC Capital Markets

Okay.

Constantine Iordanou

And I think the rest of the market does the same.

Mark Dwelle - RBC Capital Markets

Okay. Most of my other questions have been answered. Thank you.

Operator

Your next question comes from the line of Ian Gutterman or Adage Capital. Please proceed.

Ian Gutterman - Adage Capital

Hi, Dinos.

Constantine Iordanou

Hi, Ian.

Ian Gutterman - Adage Capital

My first question is on the excess capital, if I just do some quick math and assume you deployed that 7-800 million, your P&L would just from the denominator going down, so your P&L will go from 20% to right around your 25% limit. So, I guess I'm wondering is that 7-800 million really deployable excess capital or to be only maybe use half of that and half of it needs to sort of sit (ph) mark-to-market impact or...

Constantine Iordanou

(Multiple Speakers)... you're doing a static calculation, don't forget. I don't expect to be reporting quarter-after-quarter with no earnings. So I want to keep my job.

Ian Gutterman - Adage Capital

But they're quarters where because of whatever credit markets do or because we have a CAD in a given quarter that it could go down for a quarter ...

Constantine Iordanou

The way we measure excess capital you got to understand. We look at the rating agency's requirement. We put a cushion on top of it. Because, we don't want to run thin on capital ever and then we measure excess above it.

So and the reason you see as we get an authorization for share repurchases, you don't do it all in one day.

If we know the time and you do it depending where your share price is at in the market place. And also what opportunities you have to deploy capital. I don't think the 7 or 800 is a number that is not available. I think all of it is available and it's a question and like I said we will have discussions with our board as to how and when and under what circumstances.

But our long-term goal and we're being consistent for years is that we always want to be capital conservative for the balance sheet for our insurance but also capital strength to our shareholders.

If we have excess, we'll find a way to get it back to shareholders.

John Hele

And so the think that buffer is and how much we have just remember that we have a relatively low debt structure to our capital position which is another area of our conservatives and that we run the company at.

Ian Gutterman - Adage Capital

Okay. That all makes sense. I guess I was wondering that if that is all deployable and is this the time to maybe start to reconsider dividend given the magnitude of the excess capital and that maybe the company's mature enough to be able to support even a small dividend?

Constantine Iordanou

Clearly we can support a small dividend but don't confuse one with the other.

A small dividend is not going to give you capital management. If we pay $0.25 a quarter, that's a buck a year, we only have 60 million outstanding shares is not going to be a lot of money and in a capital intensive business, you don't want to get locked in on paying a high dividend, that's not the right way in my view to run the company.

So when we talk about capital management, we're talking about something that is significant, we measure the excess, I think it belongs to shareholders. If I have a clear vision that I can deploy that into the market place at attractive rates I'm going to hold it on to the balance sheet and try to that because that's what shareholders pay us to do.

But if I see the horizon as, no I can't deploy it, the best way is to return it and right now, where our share price is trading, buying back shares is the most effective way in my view.

Ian Gutterman - Adage Capital

Now that makes sense. I just want make sure nothing changes for ...

Constantine Iordanou

No, I have not seen earlier.

Ian Gutterman - Adage Capital

And then I also want to top the question on the -- I guess on the Insurance segment. Can you maybe just help us understand, I appreciate that you are trying to be conservative and all that and that's the right thing to do but, what about your business mix suggests that you should be over 100%, I mean I guess, that's where I am a little confused, it's ...

Constantine Iordanou

We look at IBNR family -- by IBNR family and as you can see, we have a much higher excess and loss ratio in the Insurance Group because we have more casualty lines, is long-tail lines and at the end of the day, I don't think some of our competitors at fac doing in yet.

New money invested at what rate and what kind of a kind of a return you're going to get on that business. So, I think the market is pricing that, a bit light in my view and for that reason that's where you're seeing the shift that we have reduced our writings.

If you look -- and we gave you the supplement or in -- where we are growing and where we are shrinking and as you can see it's been consistent, both on the Reinsurance side and on the Insurance Group, we're shrinking and outcome, we're shrinking casualty. In the Insurance Group we're shrinking in causality which includes professional liability. So, we tried to do the best we can in navigating through these waters, but on the other hand, I'm not going to be on the accident years.

Ian Gutterman - Adage Capital

That's right. I guess why I'm confused Dinos is when I look at your insurance book, casualty is about 10% and ...

Constantine Iordanou

But don't forget, that's not the only thing that is long-tail, right.

Ian Gutterman - Adage Capital

But what are you calling long-tail, to me professional liability, executive assurance, construction, those are all mid-tails...

Constantine Iordanou

It just -- since you asked the question, I'll give you a flavor what it is. Our professional liability, most of what we do is small accounts and is all claims they make so, is medium-tail, right.

We still consider exactly assurance even though it's all claims laid long-tail. And our construction business is a national account that pretty much similar product we right free line and we right large deductible plans and those basically have long-tail characteristics.

The auto is not a predominant component. It is mostly worker's comp and general liability, that's the book of the premium we consider that long-tail.

Our program business is medium-tail and of course our healthcare is long-tail.

Even though it's written on a claims made basis and we do write a lot of facilities and we write some excess hospital liability, it is easily a long-tail line of business and in the other which includes our excess workers' comp, that's a very long-tail too. So, we don't try to -- we measure a long-tail business and we set up reserves on that basis.

Ian Gutterman - Adage Capital

Okay, fair enough and I understand what you are saying, and I probably need to do some more math and try to work it out all, I guess its just intuitively would seem you would need -- just given where interest rates are what that probably weighted average duration is that would seem you would -- you're talking and maybe a mid single digit ROE if we really end up having that insurance book over 100 at today's yields.

Constantine Iordanou

Some product lines that's what they're earning. That's why I believe at some point of time, you will see the kind of pain that I believe some managements will recognize because you're getting on your business is to what you're doing today. What you've done a year ago, five years ago, three years ago and you're letting off the hay that you have in barn is not the right way to think about the business.

You got to think about the what your pricing the business today and what's the returns today. And that's the way we try to focus and that's what we do. And at the same time, we don't try force ourselves because some always might not like that we book a current accident year excluding adjustments to over 100.

We're going to do what we believe is the right thing.

Ian Gutterman - Adage Capital

Very good. Thank you, Dinos.

Operator

Your next question comes from the line of Brian Meredith of UBS. Please proceed.

Brian Meredith - UBS

Yeah. Thanks good morning. Just two quick questions here. First back in the Reinsurance space when you increased loss pick this quarter, did that have any impact on the first and second quarter loss picks that you had booked at. So was there a little bit of catch up all.

Constantine Iordanou

No, that's all over.

Unidentified Analyst

Okay. So it is purely business written in the third quarter.

John Hele

Business burnt in third quarter.

Brian Meredith - UBS

And then second question Dinos can you chat a little bit about your view on the M&A environment and may be that is the use of excess capital here looking forward?

Constantine Iordanou

I mean I get this question, maybe I'm not a good M&A guy. It's really-really hard to find the right opportunity for M&A. The culture has to be right, the book of business or what you're trying to gain has to be right and more importantly you got to have a clear view of the balance sheet that you're merging into or you buying and the price got to be right and is very rarely you can get all four right.

So, I'd prefer where you are going is by finding people in adding to our underwriting talent that culture -- a good fit us in our philosophy as to how we want to run the company and we've been successful doing that for the last seven, eight years and unless there is an extraordinary opportunity that very rarely come across, we're going to continue on that path. I rather return excess capital to shareholders try to force some transaction that I would live to regret.

Brian Meredith - UBS

Right. Thank you.

Constantine Iordanou

You're quite welcome.

Operator

There are no further questions at this time, I would now like to the turn the call over to Mr. Iordanou for closing remarks.

Constantine Iordanou

Thank you operator and thank you everybody for joining us. We're looking forward to talking to you next quarter. Have a good afternoon.

Operator

Ladies and gentleman, this concludes the presentation. And you may now disconnect. Have a great day.

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