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XL Group plc (NYSE:XL)

Q4 2013 Earnings Conference Call

February 05, 2013, 17:00 PM ET

Executives

Michael S. McGavick - CEO

Peter R. Porrino - EVP and CFO

Gregory S. Hendrick - EVP and Chief Executive, Insurance Operations

Jamie H. Veghte - EVP and Chief Executive, Reinsurance Operations

David R. Radulski - SVP and Director of IR

Analysts

Michael Zaremski - Crédit Suisse AG

Jay Adam Cohen - Bank of America Merrill Lynch

Jay Gelb - Barclays Capital

Gregory Locraft - Morgan Stanley

Joshua Shanker - Deutsche Bank AG

Meyer Shields - Keefe, Bruyette, & Woods, Inc.

Brian Meredith - UBS Investment Bank

J. Paul Newsome - Sandler O'Neill

Vinay Misquith - Evercore Partners Inc.

Amit Kumar - Macquarie Research

Ronald Bobman - Capital Returns

Ryan Byrnes - Janney Montgomery Scott

Josh Stirling - Sanford C. Bernstein & Co.

Ian Gutterman - Balyasny Asset Management L.P.

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's Fourth Quarter and Full Year 2013 Earnings Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. Please be advised that this conference is being recorded.

I would now like to turn the call over to David Radulski, XL's Director of Investor Relations. Please go ahead.

David R. Radulski

Thank you, Shirley. Welcome to XL Group's fourth quarter and full year 2013 earnings conference call. This call is being simultaneously webcast on XL's website at www.xlgroup.com. 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, who will offer opening remarks; Pete Porrino, XL's Chief Financial Officer, who'll review our financial results; followed by Greg Hendrick, our Chief Executive of Insurance Operations; and Jamie Veghte, our Chief Executive of Reinsurance Operations, who will review their segment results and market conditions. Then we'll open it up for questions.

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 for the date on which they're 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'll turn it over to Mike McGavick.

Michael S. McGavick

Good evening. Tonight, we are pleased to share with you XL's fourth quarter and full year 2013 results. 2013 was a good year for XL with many important metrics demonstrating our continuing year-over-year improvement. As regards to fourth quarter itself, our assessment is a bit more mixed.

While we like a lot of what occurred including the strong performance in many of our businesses, we did see large loss activity in the fourth quarter as occurred in the third diminish the result. More on the fourth quarter in a moment, but overall we feel good about the year now in the books and very good about how we are positioned for 2014 and for the future.

I'll start with some highlights of the year. Our operating return on equity, ex unrealized gains and losses, increased to 12.5% for the fourth quarter and to 10.2% for the full year. Our overall P&C combined ratio improved by close to 4 points versus 2012. Total P&C gross premiums written increased for the fourth straight year as we continue to implement our plans for each of our businesses. For the fifth consecutive year we grew our tangible book value per share delivering increased value to our shareholders. These are solid indicators of our progress.

From a segment perspective, we also saw good practice. For example, Reinsurance delivered a very strong 81.4% combined ratio for the year and an underwriting profit for the eight consecutive year, and suffice it to say in the midst of tough market conditions and international CAT activity in the quarter which Jamie will discuss more later in the call, we are very proud of what our Reinsurance colleagues produced for the year.

In Insurance, 2013 marks the first year since 2009 in which the Insurance segment delivered an underwriting profit. The segment's total combined ratio of 97.1% is the best result in five years. The segment's accident year combined ratio of 96.7% and the loss ratio of 65.9% are also the best performance in these metrics since 2007.

Now as I noted at the opening of my remarks, there was a contrary note on the fourth quarter, as you've seen in our release. In the fourth quarter as in the third quarter, we experienced mutual losses; in this quarter mainly in our North America property book that affected the Insurance action quarter combined and loss ratios.

As you know, these metrics are the focus of much of our attention and the slowing of our progress here does temper on our overall assessment, though only a bit. It is tempered by the fact that the 96.7 insurance accident year, ex combined ratio we delivered in the fourth quarter is no where we wanted or expected to be at this point. But as we have reviewed the second half of the year, we find this level of loss activity to be an aberration when viewed against our full year performance.

For example, for the full year 2013, the combined ratio for our North American property book on the same accident year, ex CAT basis, was 74.3% and the combined ratio for North American P&C was at 91%, continuing their march to our overall target. The fact is that the property group experienced one bad quarter and essentially a year's worth of large losses in the fourth quarter which capped on an otherwise strong year. This isn't going to cause us to change our plans.

As we continue to remix our portfolio, very much a work in progress, we will be even better able to absorb losses like this as they might come and we can see where this balancing effort is already at play. For example, throughout the year we grew our highest margin insurance businesses by over 10% while reducing our lowest margin businesses by 4%, further improving our mix. And to continue the trend we've reported last quarter, year-to-date 70% of insurance businesses had improved loss ratios versus the prior year on an accident year ex CAT basis.

Even in Reinsurance we are seeing the same effect. While we had a degree of CAT losses in our international book in the quarter, the Bermuda reinsurance business produced a combined ratio of 26.2%. And when you look at it from the top of the house, like we do, the total mix of all of our insurance businesses is moving us in the direction we want with a total P&C accident year ex CAT combined ratio of 92% for the 2013 year.

So already we are seeing the effect of a diversified portfolio and more books of business that are producing profit for the enterprise as a whole. We expect benefits from this to only increase as our remixing produces a higher number of margin expanding and less correlated businesses. This will reduce the impact of these outlier quarters.

Turning back to the financials for a moment, and Pete will have more detail on this in his section, we were helped by the strong performance of risk assets in both the fourth quarter and throughout the year, leading to significant earnings from our investment affiliates. In fact both the P&C and Life investment portfolio strongly outperformed their benchmarks during the year helping to dampen the impact of rising interest rates.

As we continue to gain traction from New Ocean, our joint venture with Stone Point Capital, in the end we are consistently looking to our progress over time and from this perspective, we saw a lot of what we like in 2013; a continuing success for Reinsurance, the first underwriting profit for the Insurance segment in four years, the achievement of a double-digit net ROE, it is the direct accumulation of the various actions we have taken to build a solid and strengthening foundation.

It is because we are seeing profitable contributions from an increasing number of businesses and other sources, it is because of our continued prudence in reserving and overall, it is the product of the right and consistent behaviors we've been working towards, over time we expect this progress to continue in 2014.

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

Peter R. Porrino

Thanks, Mike, and good evening. Operating net income for the fourth quarter was $287 million or $1 per share on a fully diluted basis compared to $39 million in 2012 or $0.13 per share. Operating net income for the full year was $943 million or $3.23 per share. Our net income attributable to ordinary shareholders was $1 million or $1.05 per share for the quarter and $1.06 billion or $2.63 for the full year.

Our P&C combined ratio for the quarter was 93.3%, 12.6 points lower than the same quarter last year while our accident year combined ratio for the quarter was 97.3% lower by 14.9 points. These improvements were due to lower natural catastrophe losses and the impacts of our underwriting accidents that Greg and Jamie will discuss further.

For the quarter, our natural catastrophe losses totaled $94 million or 6.3 loss ratio points which stood $24 million and $70 million between our Insurance and Reinsurance segments.

By comparison, net losses from natural catastrophes in the same quarter of 2012 totaled $352 million or 23.3 loss ratio points, due primarily to the impact of Storm Sandy. For the full year, natural catastrophe losses were $317 million compared to $464 million in 2012.

Prior year development in the quarter was a net favorable $61 million or 4 loss ratio points compared to $98 million or 6.4 loss ratio points for the same quarter in 2012. This reflects favorable development of $40 million in Insurance and $21 million in Reinsurance resulting from our fourth quarter detailed ground-up reserve review. Greg and Jamie will cover this in more detail in their comments.

Our operating expenses for the quarter were higher than Q4 2012, largely due to added headcount from expansion in the Insurance segment during the year and lower variable compensation in the prior year quarter due to Storm Sandy partially offset by ongoing efficiency efforts.

Overall, fourth quarter expenses were comparable with the third quarter of 2013. Our Insurance operating expense ratio in the quarter was up from the prior year quarter due to the timing of distribution of expenses between corporate and segment initiatives as well as a change in the buying of proportion of reinsurance in the Insurance segment.

Our purchase of increased quota share reinsurance, particularly in the U.S. professional business line, lowered net written and earned premium in the quarter resulting in approximately 0.5 percentage point increase in the insurance operating expense ratio in the quarter, more offset by the inverse impact on the acquisition expense ratio.

Consistent with our previous disclosures, full year operating expenses for 2013 were 3.3% higher than the prior year, allowing us to improve the company's overall operating expense leverage while continuing our investments in strategic and infrastructure projects.

Our operating tax expense was $4.9 million for the fourth quarter and $77.2 million for the full year. Our full year 2013 tax rate on operating income was approximately 7.6%. This was lower than the 10% tax rate through the first nine months of 2013 as we continue to benefit from the distribution of profits and losses across our global platform, in particular lower levels of catastrophe losses in jurisdictions with lower tax rates.

Turning to investment performance, our investment portfolio delivered a positive total return of 0.6% in the quarter and 0.8% for the year as credit spread tightening, equities and alternative fund gains more than offset the negative effects of higher risk-free rates. We had a negative mark-to-market of $47 million in Q4 and $685 million for the full year 2013. Unrealized net gains in the portfolio were $741 million at the end of the fourth quarter.

Our P&C fixed income duration remained unchanged at 3.6 years and remained short, our neutral duration. Net investment income on the P&C portfolio in the quarter was $169 million matching the prior year quarter. P&C net investment income in the prior year quarter was reduced primarily by accelerated premium amortization on our Agency MBS holdings due to lower government rates in an environment of ongoing quantitative leasing at that time.

Prepayments on our mortgage holdings continue to create some net investment income volatility. We experienced slower prepayments in our agency mortgage portfolio in Q4 2013, which increased net investment income as the book yields on that portfolio is greater than current new money rates. The P&C gross book yield at the end of December was 2.7%.

We estimate that approximately $3.2 billion of P&C assets with an average gross book yield of 2.8% will mature and pay down over the next 12 months. This compares to our average new money rate on our P&C portfolio in Q4 of 2%. We expect net investment income to remain under pressure of the increases in government bond yields that we saw in the second half of 2013, it's the same throughout 2014, we'll have to offset the impact of maturities and paydowns.

Net income from investment affiliates in Q4 was $78 million, up $46 million from the prior year quarter. The returns for alternative funds which we all know as the hedge fund portfolio were very strong in the quarter at $49 million with strong results of $23 million in the quarter from our investment manager affiliates augmented the increase.

Net income from investment affiliates for the full year was $272 million in 2013 compared to $87 million in 2012. The overall rate of return on our alternatives portfolio including the non-equity portion was 12.2% in the year. While we do not view this as a long-term run rate, these types of non-correlated returns represent an important part of our overall investment strategy and continues the growth in book value.

Net realized gains on investments were $12 million in the quarter and $88 million for the full year. This compared to net realized gains of $11 million in Q4 2012 and net realized gains of $14 million for the full year 2012. These figures include a total OTTI charge in 2013 of $16 million down from $81 million in 2012.

With respect to capital management, during the quarter we issued $300 million of 2.3% five-year senior notes and $300 million of 5.25% 30-year senior notes. The net proceeds from the sale of these notes were intended to be used for the repayment at maturity of the outstanding $600 million 5.25% senior notes due in September 2014.

We continue to execute on our share buyback program and during the fourth quarter, we purchased 4.9 million shares for $150 million at an average price of $30.85 per share. For the full year, the company repurchased 22.5 million shares for $673 million at an average price of $29.86. This amount included the $98 million repurchased in January 2013 that was delayed from 2012 because of Storm Sandy. At the end of the quarter $275 million remained available for purchase under our previously announced $850 million share buyback program. We continue to view such purchases as an effective use of surplus capital.

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

Gregory S. Hendrick

Thanks, Pete. Good evening. Today, I'll cover the fourth quarter and full year results for the segment, provide insight on our continued progress and finish with an update on pricing.

Beginning with the results, our calendar quarter combined ratio of 96.7% was nearly 10 points better than the fourth quarter of 2012 which was adversely impacted by Storm Sandy. On an accident quarter basis, excluding CATs, our combined ratio of 98.2% was 1.7 points higher than the prior year, driven entirely by our expense ratio which Pete detailed in his comments.

The accident quarter ex CAT ratio of 66.7% was essentially flat relative to the prior year quarter and better by 1.3 points relative to the third quarter of this year. Adverse large loss experience of almost $80 million in our North American property and global energy books offset the favorable experience we saw in the remainder of the portfolio.

To offer perspective, the North America property business experienced its worst quarter since the first quarter of 2011 and its second worst quarter in over seven years. In fact, a number of these property losses emerged very late in December and led to our worst month since 2001. Despite this quarterly outcome, the team still delivered a full year accident year loss ratio of 54%, its best since 2009.

When you exclude the two property books, the fourth quarter accident quarter ex CAT loss actually improved by more than 7 points compared to prior year and 3 points for the full year, reflecting several of the underwriting actions we have taken over past 12 to 24 months.

As Pete noted, the segment released 40 million of prior year reserves. The primary driver's a positive movement from our aerospace and excess casualty portfolios as well as prior year catastrophes, partially offset by strengthening in our U.S. professional portfolio.

Insurance gross premiums written were down by $68 million or 5% in the quarter driven almost entirely by our previously advised underwriting decision to non-renew our small solicitor schemes in the UK and Ireland.

Turing to full year results which we view as the best way to measure our progress, we demonstrated continued improvement with an accident year ex CAT combined ratio of 96.7% or 1.8 points better than 2012, our best result in more than five years. All metrics include the expense ratio by 0.8 points, the loss ratio by 0.7 points and the acquisition ratio by 0.4 points.

For the year, gross premiums written were up by $356 million or 7%. Growth was particularly strong in North America where premiums grew 17% for the year with Construction, Property, Primary and Excess Casualty businesses experiencing the largest growth. We shrunk our Lloyd's middle market programs, solicitors and aerospace writings for the year. These businesses all faced difficult market conditions and we had no hesitation to shrink our top line or target pricing that couldn't be achieved.

Shifting to progress, we continue pulling on four levers to improve our combined ratio; mix of business, underwriting actions, operating leverage and rate. In terms of business mix, we made measurable progress in shifting our portfolio to more profitable lines. As Mike noted, during 2013 we grew our high and medium return businesses by 10% and reduced our lowest return businesses by 4%. And we continue to successfully build out new businesses.

In 2013, our North America construction team delivered $200 million of gross premiums and producing underwriting profit in their third year of operation. And we have more new businesses in flight as crisis management, political risk and surety grew 32% to $100 million of gross premiums written this year.

Regards to underwriting actions, we delivered roughly 1 point of loss ratio improvement in 2013 from a number of initiatives across the segment, and we continuously identify and execute on new actions as we view our portfolio. For example, in response to difficult loss experience in our international property and casualty middle market property book, we reduced long sizes for additional treaty and specialty reinsurance and of course pushed increased rate on accounts as needed. With treaty reinsurance fully in place and half the portfolio remain in the first quarter, these improvements will be felt quickly.

We continue to demonstrate improved operating leverage with nearly 4 points of operating expense ratio improvement in 2013 as net interim premium grew by 9% whereas expenses grew by less than 4%. Improvements on our operating as well as ongoing investments in infrastructure are beginning to bear fruit that will further improve our gross operating leverage. Combined with reduced acquisition cost, we believe we will see further improvement in our total expense ratio.

On rate, we once again achieved rate increases that exceeded trend in the quarter and a full year price increase was 3.1% versus 2.7% in 2012. While we see some slowing, particularly in North America and short tail lines, our diversified portfolio allows us the benefit from rate increases in medium and longer tail lines in all geographies.

In the fourth quarter, all of our businesses in our international P&C operation have positive rate in excess of loss trend as well as rate on rate. Our North American and professional businesses both had rate increases over 3%, offset by our specialty business which was down 2%, driven entirely by a very competitive aviation renewal. For the segment, 75% of our portfolio achieved positive rate in the quarter.

In closing 2013 was another step forward for the insurance segment with our best full year underwriting profits since 2007. While this validates the actions we've been taking over the past two years, there is no mistake that we have much to do in 2014. Given our talented team and determination, we believe we are positioned to make even more progress towards our ultimate goal combined ratio of 90% or better.

Now to Jamie to discuss Reinsurance.

Jamie H. Veghte

Thank you, Greg. Good evening. I'd like to cover two 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.

As Mike mentioned, 2013 marked our eighth consecutive year of underwriting profits with the segment producing an outstanding combined ratio of 81.4% which compares to the 86.9% combined in 2012. This result was impacted by catastrophe losses of $198 million and prior year reserve releases of about $188 million compared to 2012 where we had CAT losses of $241 million and reserve releases of $176 million.

Excluding the impact of both CAT losses and prior year releases, we had a combined ratio of 80.6% compared to 83.1% in 2012. Our year-to-date gross written premium were down 5.7% to $1.9 billion as we continue to manage our way through very competitive trading conditions.

With respect to the fourth quarter, we had a combined ratio of 85.1% producing an underwriting profit of $66.2 million. This compares favorably to the combined of 104.4% in the fourth quarter of 2012, though that particular quarter was obviously heavily impacted by Storm Sandy.

During the quarter, we had the benefit of prior year releases of $21 million and CAT losses of $71 million net of reinstatement premiums. The major contributors to the CAT activity in the quarter were typhoons (indiscernible) and Haiyan and deterioration from storms Manuel and Ingrid in Mexico and the German hailstorms from prior quarters this year. Excluding the impact of prior year releases and CAT losses, the segment produced a combined ratio of 73.6% which compared to 72.9% in the fourth quarter of 2012.

Turning to top line in the quarter; gross written premiums were $165 million, a 4.4% increase over the fourth quarter last year. The increase came from our North American crop facility, increased renewal on timing issues on our U.S. A&H book and new international casualty business.

With respect to the prior year releases, you will note the magnitude of the releases are significantly below last year; $21 million compared to the $55 million a year ago. Virtually all of this reduction, $30.6 million, was due to deterioration in the quarter from the Tramel One surety loss in Spain.

You will recall this loss was mentioned in our last earnings call during Q&A with the phrase I used was, if everything went to hell we would have less than $20 million of additional exposure beyond the $11 million we posted through the third quarter. I was obviously wrong.

The deterioration exceeded our expectations in this quarter and resulted from several factors including more clarity around the potential numbers of claimants from our ceding companies and refinement of the potential impact of statutory interest on the underlying settlements. Given the ruling from the Spanish Supreme Court on this matter was not rendered until late in the third quarter, perhaps it's not surprising that our initial assessment was wrong. Nevertheless, I am embarrassed by the error. We always seek to give you what we know and be as candid as we can on these calls. I think you will note our track record in this regard has been pretty good, but in this case I got it wrong.

Turning to market conditions. You have no doubt heard on a number of earnings calls this quarter how competitive the recent renewal season was. Given the substantial amount of capacity in the CAT market, prices not surprisingly adjusted down 15% to 20% on the U.S. business and 5% to 15% in the international market, though loss impacted geographies such as Germany and Canada had more stable trading conditions.

In addition to price, we saw terms and conditions loosen. There was pressure on hourly causes, reinstatement provisions, increased use of multiyear contracts, expanded geographic scope and more replacements with aggregate features although the market did successfully resist some of these coverage expansions.

Given these challenges, I'm more than pleased with the steadfast result of our underwriting teams and the resulting portfolio. We continue to monitor rate adequacy on this portfolio in the same fashion we have for over a decade. And the profile of the book indicates we expect to generate a very satisfactory return.

In addition, we spent a good deal of time developing strategies for our individual trading partners prior to the renewal season. There is no question the market operates less and less on a pure syndication basis and we see some catastrophe placements akin to the vertical marketing environment we've seen in the aviation market for years. That is preferred reinsurers with long relationships and lead capacity get better signings and in some cases differential pricing on individual placements.

Our status as a first tier market in this environment was confirmed during the CAT renewal season. While not a perfect barometer, our signings relative to authorizations actually improved on the Bermuda CAT book from 87% a year ago to 89% in this renewal season. While the strength of relationships is something universally claimed by reinsurers as a core advantage, there is no doubt in my mind our performance during this renewals validated XL re-status with our producers and customer base.

With respect to long tail and specialty markets, the theme remains the same, I've been reporting for quite some time. Other than pockets of the market and select opportunities, the environment is extremely competitive and pressure remains on both reinsurance pricing and terms and conditions. This is particularly true with commission structures on proportionate placements. We continue to navigate our way cautiously through this phase of the market and our trading with long-standing clients with proven track records.

Finally, I would like to highlight one operational note. You would recall we announced the hiring of Chris McKeown as the CEO of our joint venture with Stone Point New Ocean Capital Management. Chris was up and running, deploying capital, burning renewals, launched two funds and attracted two significant new investors for the funds. We are very pleased with the reception this venture has received from the market and look forward to its continued build out and development.

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

Shirley, please open the lines for questions.

Question-and-Answer Session

Operator

Thank you. We will now begin the question-and-answer session. (Operator Instructions). Our first question comes from Michael Zaremski with Crédit Suisse. You may ask your question.

Michael Zaremski - Crédit Suisse AG

Hi. Thanks. First question on the operating expense ratio kicking up this quarter. It sounds like you guys are confident there'll be improvement next year, but why is that given market conditions appear to be more competitive and top line growth is apparently slowing a bit?

Michael S. McGavick

Yes. This is Mike. Thanks for the question. I'm going to start off and turn it over to Peter. First of all, even with the uptick in the year which Pete likely had both the timing aspects and also aspects related to our reinsurance placements and the like, in the end what we forecast for the year came in at the low end of the range that we forecasted here. So, I'm very pleased with the way we control expenses and continue to gain operating leverage. We continue to expect to be able to achieve both in these lines that we've been remixing towards and I continue to be confident that that will outstrip our expenses. But this is the time of year when we try to give you some perspective on how we look at expenses for the coming year.

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

Peter R. Porrino

Yes, Mike, as you well know there's two basic factors into that ratio; the premiums earned and then what the actual expenses are. And I'll let Greg and Jamie go through premiums. Well, obviously we don't forecast premium activity. When I think about losses – when I think about expenses, I'd say our expectation for next year would be sort of normal expense growth that you would expect and then a little bit more for some of the new business initiatives that both Greg and Jamie had in mind. As I think about it sort of in total, I'd have a mid single digit number in mind. I mean certainly – again depending on our premium growth, we would expect that you would see some continuing benefit of operating leverage there.

Gregory S. Hendrick

Yes, Mike, it's Greg. Look, I'm not going to forecast premium growth, I'd just point to what I've said in the past that a number of our businesses whether it's in programs, we talked about the solicitor scheme which is a block of business that all renews in October 1, the same date our primary casualty, our large property, I can go on, they are very lumpy businesses. To do it quarter-to-quarter growth, I know this quarter was down flat when you adjust for that solicitor's program. It is very lumpy and you're not going to have smooth gross. I'd point you back to the year where we did a pretty good job of growing into that upper single digits in the year 10% over the past couple of years.

Michael Zaremski - Crédit Suisse AG

That's helpful. I guess lastly, on some of the large non-CAT losses, I think you guys said it was mainly North America primarily in December. Anything there you think – you'd like to quantify for us or name?

Michael S. McGavick

Well, we don't talk about specific insurance, so I won't get into that. I quantified in the remarks the $80 million delta year-over-year. We had three losses that were over 10 million and then – kind of what I would call midsized, the collection of midsized losses contributing as well.

Michael Zaremski - Crédit Suisse AG

Thank you.

Operator

Thank you. Our next question comes from Jay Cohen with Bank of America Merrill Lynch. You may ask your question.

Jay Adam Cohen - Bank of America Merrill Lynch

Yes. Thank you. I guess if you look at 2013, looking at your buybacks and dividends, it seems to be a little less than your operating earnings. Can you talk about what that relationship might look like in 2014, especially with the stock pulling back and trading notably below book value?

Michael S. McGavick

Yes, so I'll start again and pass it to Pete, but Jay I appreciate the question and the observation. In total, the year came in strong and with more than $1 billion on net income for the year, obviously that was a bit more than the 575 we repurchased and the dividends combined. And that is not our goal, as you know. Our goal in essence is to not have a buffering to our rating agency capital and our regulated capital growth. So we are taking that in mind as we go before the Board in February and set the program for this year. But I'll ask Pete to get a little more granular about that.

Peter R. Porrino

Sure. I'll just cover (indiscernible) so when we do our share repurchase authorization. Typically we do that every year. We'll do that in the February Board meeting, so you will likely see an announcement that comes out after that. And I would say, Jay, as your comments are clearly not lost in us with our stock ticking down relative to build value. Certainly with the progress that we're making in the business, we feel really good about where this is going down the road and trading at 80% of full value doesn't feel very good. And the only thing I would add would be and consistent with what we said in some other prior years is we think about buybacks. You look at the 575, it's sort of from the baseline. You can never predict the future but our hopes will be that certainly (indiscernible) very well could see a number above that.

Jay Adam Cohen - Bank of America Merrill Lynch

Great. Thanks, Pete. I appreciate it.

Operator

Thank you. Our next question comes from Jay Gelb with Barclays. You may ask you question.

Jay Gelb - Barclays Capital

Thank you. With regard to the underlying insurance combined ratio of 97 to 98 for the past three quarters, I know that target is still 90% and I was just thinking perhaps you can give us an update in terms of when you think that might be feasible?

Michael S. McGavick

This is Mike. We've never forecasted a specific landing on that in terms of plan. We note that we were making very significant progress. I do think as I noted in my comments, the last talk [ph] of this year didn't add the momentum we expected, but when we went back with them – we do this on an extremely granular basis, we basically said – but this is an average. We are not going to change how we're handing this book given how we put those losses in the context of everything we are doing. And we believe that as that kind of unusual activity normalizes which we fully expect it will, we're going to see the benefits of the increasing profitability of the portfolio. And as that starts to kick in, I think the progress towards where we're going fundamentally reignites. Greg, you might want to add something.

Gregory S. Hendrick

Yes, let me talk about the trajectory that we're on kind of some of the parts of the business I'm excited about and just reiterate the lever that we're pulling on. As I look at where we've been the last two years, I like the path we're on. Over the last three years, right, we always try and steer you to the annual route and the quarter-by-quarter. We've seen accident year ex CAT combined ratio improve from 112% in 2011 to 98.5% in 2012 to 96.7% last year, so our best year since 2007. And as I said in my remarks, we produced our first calendar year underwriting profit since 2009 which is a testament to what we've been working on underneath as well as prudent reserving. Is this where I'd like us to be? Absolutely not. We are on the right path and with the right team. We talked to you about where I'm excited. I see strong momentum across North America in P&C, particularly our risk management, excess casualty, construction and property businesses. As I noted in my remarks, we continue to successfully build out crisis management, political risk, surety and also inland marine, lines where both the industry and our leaders have demonstrated superior returns in past years. Also, during the year, we brought in new leadership in our marine, international and professional businesses two books that caused us somewhat earlier in '13. And our specialty business had a stellar calendar year result, in fact far better than the profitability goal for the year. Finally, I'd say as I discussed we are executing on our levers of improvement. Rates are ahead of trends for the segment. We continue to identify on the right actions to execute on those plans quickly and we're improving our mix both in the business and across the portfolio. If I put those three together, the trajectory where I'm excited and how we've been disciplined, I'm sure we're going to be able to deliver improved results over time.

Jay Gelb - Barclays Capital

All right, thank you for that. And then on the reinsurance side with rates coming in, I'm just trying to calibrate what we should expect the impact to be on the underlying combined ratio going forward?

Michael S. McGavick

Well, certainly rates were off, Jay. We don't forecast combined ratios. Obviously the reinsurance book is much more volatile than an insurance book, but I think it's fair to say with the CAT market coming off substantially as it did and the CAT portfolio representing now well north of 25% of our book of business, it would not be unreasonable to expect an uptick.

Jay Gelb - Barclays Capital

Okay. And then last one for Pete, what's the best effective tax rate to use for modeling?

Peter R. Porrino

So, I would have preferred you probably worded that slightly differently. So what we said in the past is that we've been looking at a 10% to 12% effective tax rate if you look at it over a number of years that's what you would see. As I said in Q3, the first nine months had indicated that we were doing better than 12% and so the nine-month number that we use was 10. And again, as I said we had again things in the right place (indiscernible) with the effective tax went up for the same – opposite reasons. I can't give you a number per se but the potential 12 range is pretty much where we've been coming at recently.

Jay Gelb - Barclays Capital

All right, thank you.

Operator

Your next question comes from Greg Locraft with Morgan Stanley. You may ask your question.

Gregory Locraft - Morgan Stanley

Thanks. I wanted to get some color on the professional lines both in the Insurance segment – especially in the Insurance segment but also Reinsurance. Specifically grossed in that, looks like you guys are buying a whole lot more Reinsurance, can you talk about why that is, the trends you're seeing? You had some issues there in the second quarter where you took your picks higher, maybe you can update us on the progress as well?

Michael S. McGavick

I'm going to turn it to Greg but I just want to emphasize. I saw the unsolicited offer by one of our leading reinsurers as in incredible validation of the talent of our team and I was pleased with the transaction. I think it lowers risk and it certainly have a very important point in time and I really expect in the end that both we and our reinsurers will benefit from this transaction. But Greg, would you please…

Gregory S. Hendrick

Sure, Mike. Let me review kind of the – if I can get at your question, Greg, some of the underlying dynamics of that book, how we kind of got the decision to purchase a quota share and how we look at the portfolio going forward. So, as a reminder, our Hartford team has built a well diversified portfolio over the last decade and the recognized market leader for public D&O. That seems known for solving the more difficult risks, often in the primary layer through a combination of coverage, structure and price. In the past few years, we've seen security class action lawsuits continue to slow but regulatory investigations and M&A related losses have picked up. These types of claims tend to occur with a higher frequency and a lower severity and develop at a faster pace. As you noted, Greg, we've been watching this closely and you are right, we did increase our loss ratio for 2013 during the second quarter and we also discussed the corrective actions we have been taking as well as significant rate changes that are put in place starting at the end of 2012. Over the past few years, we've protected that book with a per risk excess to loss with a sizable retention. This protection just wasn't responding to loss activity we've been experiencing and this led us to consider other reinsurance protections. At the same time if you were looking at that efficacy of that purchase, as Mike noted, one of our long time reinsurers approached us on an unsolicited basis and offered attractive quota share terms. This allowed us to place the 50% quota share of our Hartford professional line on an enforced new and renewal basis. The treaty is diversified across the panel of top reinsurers and almost all of them have reinsured this portfolio in the past either with the same firm or the same individual underwriter at a different firm. Looking forward, we remain very bullish about this book for 2014 and beyond and anticipate a return to sub 90% combined ratio for the calendar year matching our 2013 accident year performance. It is rewarding that our view of the possibility is shared by our reinsurers and we believe this will be a mutually profitable relationship. As always, we remain fully committed to achieving our targeted underlying margins on a gross basis and are not changing our underlying appetite or integrity due to treaty reinsurance arrangements. In summary, given the terms and conditions available in our reinsurance market and occupancy activity we observed in 2013 – shares a prudent approach to protect our 2014 underwriting year.

Gregory Locraft - Morgan Stanley

Okay, great. Very thorough, I can see exactly what you did. Just from an accounting perspective going forward, how should we be thinking about that? I don't know if it's a question for Peter or somebody else, just premiums and then other parts line as the quota share comes through just so we can get our models correct?

Peter R. Porrino

Sure. This is Peter. Certainly our premiums ceded in that line of business are going to go up materially net premiums written and our net premiums earning would go down materially not on the same time. For example, in this quarter we only had just under $30 million of and a much bigger number of written. When you get down and look at the ratios that reduction in the net premiums earned will impact for example our insurance operating expense ratio, right. There is no offset dollars but there is a big offset in the denominator. So the numerator stays the same, the expenses and the denominator changes materially, the premium. On the commissions and brokerage, on the acquisition expense ratio, you have an offset in the dollars. So the commission, the ceding commission that we receive from the reinsurers goes against that line. And so it's to an extent that the ceding commission is above our acquisition cost ratio, you will see in essence a negative acquisition cost for that business more than offsetting the reduction in the premium range.

Gregory Locraft - Morgan Stanley

Great. And last this is a go-forward contract only, right, a quota share for current business being written, this doesn't cover previous accident years at all?

Michael S. McGavick

It doesn't cover previous accidents, it covered the book at November 1, but not back to '12 and prior accident years.

Gregory Locraft - Morgan Stanley

Okay, perfect. Thanks for the color guys.

Michael S. McGavick

You're welcome.

Operator

Thank you. Our next question comes from Josh Shanker with Deutsche Bank. You may ask your question.

Joshua Shanker - Deutsche Bank AG

Thank you. Good evening, everyone. When you look at your overall business, you went through a bunch of changes looking at businesses that you thought were under earning or potential unattractive, if you look back on 2013, what percentage of your businesses are earning an attractive return on equity, what percentage aren't? And can you give us some guidance on what that goal is today on allocated capital?

Michael S. McGavick

The allocated capital will be a little bit more difficult. Let me tell you what I think about where we're headed. This is, from my perspective, when you try to look at where the book – what part of our book is in the performing versus improvement, if you will, you got to step back and it's more than just last 12 months of performance, right. We look at our longer time of results, then we blend it in with the future concepts that we can deliver in the future. As I look at it from a far, one thing to note is we're not talking about whole businesses here, we're talking about sub portfolios that reached the business. And so as I aggregate those out and look and blend that historical with the future of forward-looking, we're looking at roughly 20% of our portfolio needing to improve returns to a more acceptable level as we come out of '13 into '14.

Joshua Shanker - Deutsche Bank AG

And that's based on normalized loss adjusted basis?

Michael S. McGavick

That is a very substantial change from where we started in '10.

Joshua Shanker - Deutsche Bank AG

I would agree. But those businesses that you're talking about are not because of one-off losses and unusual. That's on a run rate basis, you're saying?

Michael S. McGavick

Yes, we're looking through those. When you get these – you have to make a lot of decisions about whether can recur, whether we should buy down or that should change your strategy. Now, we've been through all those assessments and we're comfortable with where we are. But that's really about is when we look at the business side on an ongoing basis and the trends we see on them. And as you might guess when we have something that's underperforming that's where a lot of love [ph] goes. That's where you tend to see leadership changes and we're very driven to get it right. We'll never be where all of them – well, maybe we'll have that from time to time but generally speaking, there will always be something that's a little down. It's a cyclical business and there's a bunch of sub cycles that we're dealing with. But I'd have to tell you that as we enter '14, this is a confident bunch and one that is very committed to take the actions necessary to continue to expand our margins.

Joshua Shanker - Deutsche Bank AG

How should I think of the allocated capital involved versus the unallocated capital?

Peter R. Porrino

I'm sorry, Josh. We were having a hard time following the question. Could you repeat?

Joshua Shanker - Deutsche Bank AG

Sorry. So I assume that your ROE on applied capital is higher than we were actually achieving because there's plenty of capital in the business that isn't being allocated. That would be a correct assumption I would think yes?

Michael S. McGavick

The bottom line is we look at it both ways. So we're well aware of what the required capital is in our business and then we also look on a total allocation of capital, and we run it through our models, internal model basis. And then we do go back too and allocate all the capital because in the end it's a total return for the business. So we look at it on all three of those basis, not just the one view you're describing.

Joshua Shanker - Deutsche Bank AG

Well, I'm just saying that if you could get your – the rating agencies on board and get your capital to where you think it ought to be, how much better would your returns be today than they are?

Michael S. McGavick

Well, (indiscernible) has been mentioned there to look at it. I do believe that – let me give you three pieces. This is a great question and a gift to our focus on improving the ROE which we are well aware is kind of the next generation of jump for us. The core of improving our ROE is improving these operating results. That is the heart of the matter. That's why we put so much focus on giving you all this color commentary around accident year ex CAT results. So that is the heart of the matter for this business. That's the thing we're most focused on. At the same time, you're right in observing that we have because we haven't been delivering at the level we would like. On the operating side, we have been carrying more capital because we believe that until we get – than we should be. And so we are driven to start seeing that kind of buffer come down over time as the business results go up. So those are two pieces you can think of as a motion and you've already heard Pete say that when we think about that in capital repurchase terms, we're talking about what we bought back last year as something of a minimum. We don't want to forerun our Board. We talked about it in several ways but that's how we think about it. And then there's a third piece that you have to keep in mind is as we said before, when you get the P&C businesses continuing to move on the trajectory they are moving, over time the life block becomes a bigger and bigger driver on the ROE because – you can do the math on what's it returning right now given its capital and earnings and it's very clear that that's a drive right now relative to where the book is headed. And that it's magnified over time as the P&C operations improve. So those are the three blocks that we're thinking about and then we have nice additional potential benefits from the nice block of affiliated investments that we built and everything else. So that's how we're thinking about it. We continue to believe we can drive the ROE to consistently better levers and those are the levers we're thinking now.

Peter R. Porrino

Josh, the only thing I would add is that that majority is allocated in that calculation.

Joshua Shanker - Deutsche Bank AG

That's a very good answer, I appreciate it. And just one suggestion to you and Mr. Radulski there. I think you guys could benefit from giving us eight quarters of information on severe non-CAT losses if we had the numbers. I know you give us the delta but I think it would be a benefit to your disclosure.

Michael S. McGavick

Yes, I appreciate that. We will look at that hard because I really do think – he gets the benefit of looking over long periods of time and that's why we're able to make judgments about whether to react or not react or how severely to react to what we see and that's why you're hearing probably – and maybe I hear you saying that you find us a little more common. He might be (indiscernible)

Joshua Shanker - Deutsche Bank AG

Thank you.

Operator

Thank you. Our next question comes from Meyer Shields with KBW. You may ask your question.

Meyer Shields - Keefe, Bruyette, & Woods, Inc.

Thanks. Good afternoon. I guess I want to go back to the severe non-CAT losses and I can understand how an analysis would suggest that there's been a flaw in the underwriting, but having ascertained whether the rates are appropriate or the frequency of severe losses?

Michael S. McGavick

So I'll start on that. I'm going to guess that Greg will want to add some more color. But we do a number of exercises to try to satisfy our expected losses in different buckets size of loss. And then we add that altogether and so roughly in a given year based on history and we have long data sets in books. We can analyze what's the rough expected number of each kinds of losses relative to the rates we've been charging because that's the moving target, an improving one over the last few years as you know in property but that is slowing as everybody has commented on. And then we kind of engineer what we think with all those pieces in motion, we would forecast for the next year. And obviously you see because we're dealing with specific losses and generally speaking large lines out there. Then you go back and you see how do you feel about the pattern that emerges. Right now, I'm really pretty pleased with what I see and the discipline of these underwriters in several respects. First of all, beginning several years ago and I realized I'm going to turn to Greg because I'm about to steal his thunder, but we really changed a lot of our limit strategy, we changed reinsurance. We just made so many changes that got us out of some of the really spiky losses that we were seeing. And so in that regard, I'm very pleased with where the portfolio stands. Then to go back when you have a spiky quarter like this, you try to put it in your longer term context to try and understand. And when we went through the numbers in-depth on a quarterly basis and interesting in this case a month ago, just cause it turned out that one month really packed the wallet, you just saw this – it just stood out so prominently over time that you realize you could buy down this spike that you'll be doing a good service to your shareholders because you would have to buy it down with giveaway expected profit from our point of view. So instead rather expect the normal and react only if future quarters change our view of what's normal. I'd note a couple of other things and turn it over to Greg because I know Greg will want to get into the detail on this, but – it's already a dead end to the earnings season and unlike say the third quarter, I mean it was clearly a noisy fourth quarter in terms of additional losses we saw by reinsurers, we've seen it come in, in our other markets and that's another indicator that we would take heart from. But Greg, I'm sorry…

Gregory S. Hendrick

That's all right, Mike. A little bit about where we've been, the actions Mike referred to in our international book we've been putting out, is in the combination of '12 and '13, right. So there is international limits on CAT are lower. We've been executing on a strategy and we were very successful, may not be the best review but we're very efficient at removing our poor performing lower tier business. At the same time in our international, we've been generating some new business in less volatile industries like healthcare and real estate. So that's one piece of our international. On North America we just had some really good results and I'm very pleased with where we've been. We've been reducing sub limits along the way. In fact on one of the losses we had, it had reduced our share by 50% because we're worried about the business interruption exposure and so we're proactively getting after the book. I touched a little bit on the international middle market property. In terms of specifically on the frequency, in the two big large property books which is in our North America property and our international property, our large plan frequency was in line with what we expect. It was just the severity as we've already talked about a few times. It was higher on a few of the claims that really drove a lot of this action. I don't see anything in the culmination of all the activity we've been at and the frequency being or find what we'd expect that makes us thinking of anything other than a strong book in our property. One last thought, rate adequacy; in North America I think we're near or at rate adequacy. Clearly on the international book and we've talked about this on numerous times in the past, we've got some more work to do to get that book closer to full rate adequacy.

Michael S. McGavick

This is Mike. And I know we're timing this topic hard and I appreciate that not all of you may be as deeply interested in it as we are, but obviously we view these calls as our job is to represent to you as best as we can and as accurate as we can what we are feeling about the book and where we see it going. That's the job we have. And so we thought a lot about this because we know it could stick up and be a subject to questions and we were afraid that that could in essence misinformed because we know enough about this book to not believe that's where it's headed. Does it mean we know the future, we could be wrong, but we don't think this is a lesson of the strength of the book that's emerging and that's why we're spending so much time on it. Let me give you one more thought about that. We had emphasized several times that our goal is to get to 90 combined and we've also emphasized that we'll do that as a fully developed target. And one of the reasons that we emphasize that so much is in our prudent approach when we are studying reserves. When you get a bunch of large losses right at the end of the quarter, you're getting your earliest perspective on those losses. Can you book prudently in accordance with your earliest view? But I would point that even in property, a short tier line over the last three years, we've released $100 million in PYD. So that prudence has a benefit that comes to the firm over time. And while that may not happen in the future, we are in a business and lots of things can happen. That approach of the business we think holds up well for our shareholders even if it doesn't always express the accident year in the way we really believe it's performing – to perform.

Meyer Shields - Keefe, Bruyette, & Woods, Inc.

Okay, that was very helpful. As a quick follow-up, Greg, you mentioned that there was some adverse development in U.S. professional liability and I was hoping you could sort of ballpark for us or talk about what's going on there?

Gregory S. Hendrick

Sure, absolutely. For the year in our Hartford or U.S. based professional book, for the full year we had adverse about $110 million. It's across multiple accident years but it's focused primarily on the 2009 to 2011 accident years. It's generally speaking a reduction and the need for reserves to be held against large events. I'll take to you about the offset by an increase in the higher frequency loss – the very losses I referred. And as a trend, we observe both in our second quarter and fourth quarter reserve units. For perspective on that, the 2009, 2011 accident year for that book had 2.1 billion of net earned premiums, so these are small loss ratio changes affectively representing that shift. We're seeing lower events that we're able to reduce the portion of the reserves that we allocate there, but we're increasing on those kind of higher frequency, lower severity claims. And from me anyway because -- and something we've been on for about 18 months now.

Meyer Shields - Keefe, Bruyette, & Woods, Inc.

Okay, thanks very much.

Operator

Thanks. The next question comes from Brian Meredith with UBS. You may ask you question.

Brian Meredith - UBS Investment Bank

Yes. Thanks. A couple of quick questions here. First, Mike and Greg, you mentioned that pricing up about 3.1% in excess of trend, what is trend running and I'm just curious Mike what are your thoughts on kind of the outlook for lost trends your going for at professional liability because you kind of talked about that?

Gregory S. Hendrick

So for the segment and the way we look at tends here on the short tier lines, you look at trend as zero because we will pick up that exposure trend increase in the base that writes the premium. So we would blend out across the segment. We're just under 2% or 1.8% trend for the segment in '13. From where I sit at the moment, I don't see us with any significant change in that moving over time. You asked about professional, I'm just trying to fit the number here and it looks like it's about a little over 2% for our global professional business.

Michael S. McGavick

This is Mike. There's no seismic change out there on what's going on in right now. Remember that we're not a terribly large writer of guaranteed customer comp, so that's one of the ones that you see out there with a lot of noise because of what's going on in the health care system. We do see the big Supreme Court cases that everybody's waiting on and class action and stuff like that, which will be a positive on the trend although quickly point out that I don't care what the Supreme Court decides on that, in the end I don't see managements and boards getting less accountable over time. I see it as more accountability whatever the mechanism is. So I in the end can't pick out any trend that I'm profoundly worried about as we sit here right now. Those can emerge, you never know, but nothing sticks out. And as a result, the blended rate that we're getting, I'm very pleased by it. And then when I break it down and look at the different books of business and their difference performance, I get even more optimistic. For example, the rate in this last quarter was pulled down some by what we saw in terms of our specialty book of business and which was actually below – a downward rate pressure on that block mainly related to what's going on in aerospace kind of environment there. But when I look at the combined ratio that that business is delivering, it's terrific on an all-in basis on a calendar year basis, it's just terrific. And you know our competitors and our clients can see that because we're dealing with a lot of that being priced centered out of life, there's an awful lot of transparency to that performance. So, we're going to expect some downward pressure there but we are in a very good position to deal with that. So when I kind of break it down and then I say, well, that's a 3.1 versus 1.9 on a rate versus trend but I have that negative impact on a good chunk of our block good performance, we're getting the rate that we need it. We're under pressure. There might be some – for the pressure all day long and I'm willing to shed business from (indiscernible). I like the way the book kind of adds up as a whole.

Brian Meredith - UBS Investment Bank

Great. And then just one quick one for Pete. I mean you guys are talking about how the Life business has continued to be a drag here. Any updates and thoughts on kind of what the market is – potentially do something with the Life business?

Michael S. McGavick

There's nothing to share at this time. We have said continuously that that's not a business we seem to be in. It's in runoff and we're open to ideas and when ideas come in then believe me, we…

Brian Meredith - UBS Investment Bank

Okay. Any good ideas lately?

Michael S. McGavick

You're always wondering what's going to come in the door.

Brian Meredith - UBS Investment Bank

All right, thanks.

Operator

Thank you. Our next question comes from Paul Newsome with Sandler O'Neill. You may ask you question.

J. Paul Newsome - Sandler O'Neill

A lot of M&A and M&A type question but I'd like to be kind of big picture. I personally think we're going to see sort of a natural increase in M&A given the market softening, but you folks have obviously been asked and talked with this stuff and I want to ask how would XL handle when someone approaches management with any sort of offer. I'm interested in sort of the procedures, does the Board get involved early in the process or is it later? How do you look at hurdle rates for M&A and has that changed any time recently?

Michael S. McGavick

I'll start with the second question first because it's the easiest one. There's been no change in how we view it, the hurdle rates, for acquisitions we might make. We're looking for things that – when we evaluate ideas and we see ideas flowing increasingly across the business, we tend to focus on things that will either build out a geography or a product or something like that in terms of how we're building this more diversified book of business. So I'm really – we haven't changed in our attitude towards what kinds of returns we would expect or what kind of strategic advantage we'd expect to gain. We have tendered over time but we've always said this is not a rule but rather kind of a guideline in our mind. We tendered towards things that would be on the smaller side because we don't want our culture disrupted. We think we have a fantastic and strengthening underwriting culture and we're only interested in adding things that are consistent with that or that are small enough that it gets us by our culture and made like us and doesn't change how we operate. And what hurdle rate we would entertain, it's not going to improve the business. We tend not to be interested. So it's pretty straightforward. In terms of how we would react as things come toward us, look, a couple of notes. We choose to operate in an extremely transparent way with our Board and that's the way we would react to anything that happened in the ecosystem that we thought they should know about. I would tell you that I generally agree with your observation that the preconditions for M&A are higher all the time. I think that you've missed what I think will be one of the biggest drivers whenever and that is what I think are going to be the increased demands of the regulators and the less efficient use of capital that will create and I think that will also be another cause of increased potential to M&A. But in the end the way this management will respond to things that come at it whether ideas for us or people who might have other visions for our future is the way you would expect us to look at it. What is in the long-term interest of our shareholders and how do we achieve the best result for our shareholders. And I can assure you that there's nobody at this table and I'm referring to the management table that's I'm sitting at that will analyze that from a personal point of view or even from shareholders point of view.

J. Paul Newsome - Sandler O'Neill

Kind of what I expected. And separately – I apologize, this is definitely a question someone wanted me to ask which was in the life insurance book, is there some structural issues in terms of where the book arrived that makes it more or less challenging to spin it off? Is has been sort of easily carved out of your rest of the book or is it on the same paper intertwines sort of from a legal entity perspective with the rest of the book and I probably should have known this already, but – so I apologize if it's a stupid question but it's my question.

Peter R. Porrino

Hi, Paul. It's Pete. It's definitely not a stupid question. Let me put that into two segments. The first one is the nature of the business which we've spoken about on prior calls where the bulk of the asset to liabilities is in the premium annuity blocks that is written in Europe, most of it is written in the UK. There's a fair amount of it as well written in Ireland. That is a reinsurance block, not a primary block that is a much more typical transaction than most of them, not all of the ones that you have seen so far around the world. That's the first part of that answer. The second part of your question on the legal entities, it would be difficult to do a legal entity sale that would remove us from the primary responsibility of those policies. Okay, so any transaction that would happen would likely have some reinsurance element assigned to it.

J. Paul Newsome - Sandler O'Neill

Got it, interesting. Thank you. That was interesting and appreciate it. Great quarter.

Operator

Thank you. The next question comes from Vinay Misquith with Evercore. You may ask your question.

Vinay Misquith - Evercore Partners Inc.

Hi. For the professional liability reinsurance treaty, could you remind us about the size of the treaty? You said there's a 50% quota share on that, correct?

Michael S. McGavick

Yes, that's correct, 50%.

Vinay Misquith - Evercore Partners Inc.

Right, and what is the size – what are the dollars or the premium that you'll be saving because of that?

Peter R. Porrino

Vinay, this is Pete. We've never disclosed – since we've told the percentage, right, we've never disclosed specifically to that – what that book of business is. And so I gave you the number for the treaty, you would certainly have the number for that book on a direct basis but we just never disclose that.

Vinay Misquith - Evercore Partners Inc.

Okay. Just curious if we should take down our net premiums on the next quarter substantially and it maybe by about $300 million to $400 million or is that too high a number?

Peter R. Porrino

Vinay, I don't quite know how to answer that. That's a pretty narrow range. We just don't forecast the premium. That rate is not out of the ballpark but I can't get more scientific than that.

Vinay Misquith - Evercore Partners Inc.

Sure, fair enough. The second question just a follow-up on the large property losses, so fourth quarter was about 80 million, third quarter was about 30 million, so we add these two up, there's about a 110 million. So is it the right way to look at the 20, 30 numbers, 30 accurate and the combined ratio was 96.7. So take away 2.5 points from large CAT losses and is that the right way to look at it? And Mike has this changed your view to excel the ability to get to a 90% combined ratio by '15?

Michael S. McGavick

I'll start with your last question, no. Greg.

Gregory S. Hendrick

Vinay, those are deltas year-over-year. I'd say 2012 was a very good year, 2013 was not as strong in property and so I still think it's somewhere in between those two numbers and similarly happened what you have in 2.5 points, but it's a very subjective thing. You got to go back and look over time. As you go back over time, you see – that is the outcome on the property book. You're going to have very, very good years and you're going to have some tougher years, so it's hard to give you – it's not a straight line business like a small commercial or a homeowners' book, but you frame the delta from one year to the next. I'd like to think we're a lot closer to a 12 but being prudent…

Vinay Misquith - Evercore Partners Inc.

Thank you.

Operator

Thank you. Our next question comes from Amit Kumar of Macquarie Research. You may ask you question.

Amit Kumar - Macquarie Research

Hi. Very quickly one follow-up on the 110 million development, was that for the quarter or was that for 2013? And do you have the number for 2/4/2013? I'm talking about the professional book which you mentioned?

Michael S. McGavick

Yes that 110 was for the full year. The majority of it was in the fourth quarter. What had transpired in the second quarter was still the level of reduction that we took in the large event portion of the reserves was offset almost identically with the increase in the attritional. So this is the quarter where we – after we got another six months. We took a full hard look at it in our semiannual reserve review that we've changed the attrition loss ratio reserves much more than the class release.

Amit Kumar - Macquarie Research

Got it, that's helpful. And then I guess the only other question would be was there any adjustment to NV1 and NV2?

Jamie H. Veghte

Hi, it's Jamie. Let's cover Littleton in 2011 was driven by the deterioration in one large program. We had our full limits reserved up, so none there. On the 2010 again one program had a $500 million increase in the round up loss. We had a $7 million line on that program. The impact from the quarter was $2 million.

Amit Kumar - Macquarie Research

Got it. Thanks for the answers and congrats on the results.

Michael S. McGavick

Thanks.

Operator

Thank you. Our next question comes from Ron Bobman with Capital Returns. You may ask you question.

Ronald Bobman - Capital Returns

Yes, I feel as a shareholder, I shouldn't be last in line, but I think I'll discuss that with Mr. Radulski at some other time. I have two questions. This solicitor's reinsure that is fond of your D&O book also now employs a large professional liability team also that came from another Hartford company and I was wondering so we don't face the same fate, did you get additional protections that the same fate with that other professional liability team doesn't happen to ours?

Michael S. McGavick

We were so focused on your beat down on Radulski. I'm sorry, Ron, can you help us with that last bit.

Ronald Bobman - Capital Returns

Sure. So this solicited reinsurer that is fond of our D&O book and that KPU and he's reinsuring that he isn't taking I guess a lead position or the only position in reinsuring the professional labiality D&O book for you, also hired a whole team of people from other Hartford-based company a few years ago. And so I was just wondering so we don't face a similar fate, I'm curious whether you got any sort of supplemental protections that the [XL D&O team doesn't make its way to this reinsurer?

Gregory S. Hendrick

Let me speak solely to what our relationship is with the team at Hartford. They've been with us…

Michael S. McGavick

Our team at Hartford…

Gregory S. Hendrick

Yes, our team at Hartford Connecticut that writes our U.S. public D&O book they've been with us for over a decade. We have a long-term relationship with them and in fact we have just renewed it for another – basically it's never green and we just reset the contract starting January 1, 2014. We are incredibly happy with them. They are incredibly happy to be here and I'm not at all worried about the similar situation that all the other folks happening to us.

Ronald Bobman - Capital Returns

Okay, thanks for that. A question for Jamie, just so I understand so this hell in the hand basket increase, is the incremental 30 that you took in the Q4 of '13, is that the hell in the basket scenario or candidly does the 30 not relate to that worst-case target and things could get worst is my parting event?

Michael S. McGavick

Obviously after last quarter, I'm never going to give absolute. I would say that there's a fair amount of complexity to the claim. If there was to be further development I think it would be around the interest component of the claim. Basically the interest rate charge is 4% from the date of judgment, allotment of funds into the development project until they made a claim with the insurer. If the settlement is within two years of that claim, interest is 6% in that interim period. If the settlement goes beyond two years, the interest goes all the way up to 26%. We've taken very conservative assumptions around the rapidity of the settlements from our clients but frankly as a reinsurer we have less control over that than our clients and we've obviously as always done a prudent job of making the judgment and putting the reserves up.

Ronald Bobman - Capital Returns

Sure. Two related follow-ups. What years do these relate to as far as I guess reinsurance treaty years? And then can you in any way extrapolate to what this new sort of industry's loss from this problem then? Thanks.

Michael S. McGavick

I think it was from the early 2003, 2004, 2005. There aren't a large number of ceding companies involved in this and I've heard numbers of $1 billion.

Ronald Bobman - Capital Returns

Okay. Thanks. Good quarter and best of luck.

Michael S. McGavick

Thank you.

Operator

Thank you. Your next question comes from Ryan Byrnes with Janney Montgomery Scott. You may ask you question.

Ryan Byrnes - Janney Montgomery Scott

Great. Thanks for taking my question. I just had one question. As we try to calculate the Life's drag on the ROE, how should we try to allocate the affiliated returns and also alternative returns?

Peter R. Porrino

This is Pete. None of them would go towards that Life business. They're all on the P&C side.

Ryan Byrnes - Janney Montgomery Scott

Great. That's all I had. Thank you.

Operator

Thank you. The next question comes from Josh Stirling with Sanford & Bernstein. You may ask you question.

Josh Stirling - Sanford C. Bernstein & Co.

Hi guys. Thanks for fitting me in and you guys get a gold star for sticking through all the questions. So two quick questions really, big picture. I think maybe they're either for Mike or Jamie. There's a lot going on in reinsurance today. You made some comments about rate still being adequate in property CAT. You guys obviously have visibility to practically every market in the reinsurance business. You've got your New Ocean Re in the third party side and you're doing long tail, short tail property CAT, and you're buying reinsurance. So thinking about all the things that go into the mix, I'm wondering I guess, first, if you have a sense of how long pricing pressure could continue before rates are no longer adequate for traditional reinsurers, and if you could go past that point, given that some of the new entrants have lower cost of capital? Second, I'll give you my other question just so we can in the essence of time – your point on the casualty reinsurance deal you guys did sounds like, Mike, that could have been a great move. But at the same time, it sort of sounds like it's a sign of a competitive market if you're getting unsolicited bids for quota shares for your professional book. The question would be, are we seeing the pricing pressure that began in property CAT, are we seeing that gravitate to other longer tail lines, either because incumbent reinsurers are feeling pressure to drive the top line or whether actually you're seeing the new entrants, the new capital sources decide to want to play in longer tail lines where they can get some stability, don't have to take the risk in property CAT. Thanks so much.

Jamie H. Veghte

On the long tail question, I think Greg's purchase of this business although it is with very strong reinsurer and so forth kind of validates what I've been saying for quite a long time and that is I believe the reinsurance market on long tail lines has been weaker than the insurance market for several years. And I think that continues. As far as the CAT market goes, we look at it the same way we have for a long, long time. We use rate agency capital to denominator in the calculation. We believe we're still at a fairly attractive rate adequacy levels on the U.S. portfolio. I do not expect the midyear renewals to endure the same sort of cuts that we had at 1/1. My guess is if we see another round like that either it's June and July or 1/1 next year, we will take appropriate actions because the hurdle rates will be less than ideal for us. You'll recall we talked about reaction to the Japanese market over the years prior to the 2011 quake, we've reduced our aggregates by 65% over the course of the prior 10 years. So we're not afraid to reduce the book. And my guess is if we have another 20% down in the U.S., you'll see not only us but a lot of the major leads start to cut their books back as it will kind of walk over the edge I think.

Michael S. McGavick

This is Mike. I would point to a couple of other thoughts as well. The more I learned this last renewal season, it actually made me a little more comfortable not a little more frightened and here's why? While there was a great deal in our frenzy of activity going on, generally speaking it wasn't so much what the alternative capital guys were pricing at, it was the frenzy among the existing players not to lose share in reaction to the projection of what those guys were going to do and they were a bit more disciplined than I think some are thinking. Some are thinking that the alternative guys just came in and whacked the market. No, what happened was the traditional players were so focused on keeping those shares that they got engaged in their own little frenzy. So I don't feel the alternative guys and I certainly know – I don't expect our alternative guys are going to be somehow irrational. I think they have a different set of costs, I understand. They have two different appetites and they'll play that card. But based on what I saw, I'm a little more sequined than I think I've heard some of our competitors' comments and I particularly like the way that Jamie's team dealt with this. They were very firm on the condition side, they really focused their capital on reasonable treaties. They said no when things got irrational. And we've been cutting back on the long tail quite for a long time because of what Jamie has described in concentrating our capital where believe there's not only the return is the best but the relationships are the most longstanding and the most likely to endure. So I understand why everybody 's hairs on fire given all the press reports but based on what I saw in terms of the performance of our own book and I like the way our guys are able to handle it and I think that's because we been effective and trust in partners for a very long time .

Peter R. Porrino

That's really helpful, Mike, Jamie. Thank you guys. Good luck.

Michael S. McGavick

Thank you.

Operator

Our final question comes from Ian Gutterman with BAM. You may ask your question.

Ian Gutterman - Balyasny Asset Management L.P.

Hi. Thanks for keeping the line open. On the North America property, can we get a little more color on the size of that book as a percent of your total insurance property book, just to help understand what 80 million means and to put that into some context?

Michael S. McGavick

Ian, I'm going to ask Greg to do that. But before we get to that I should point out one thing that hasn't been mentioned in the flurry of words on this. Interestingly while the losses originate are assigned to our North American books, many of the losses internationally make sure they were in international locations but rolled up to programs that were written in North America which is kind of interesting because the international book generally or the international portfolio of property risk is where we've seen weaker performance over the couple of quarters. So, it may have showed up in North America but where it originated isn't unfamiliar to us.

Gregory S. Hendrick

Sure. On a net earned premium basis, the global property book is about 12.5%, the North American book is about 7%.

Ian Gutterman - Balyasny Asset Management L.P.

Got it. And can you give us any sense of what 80 million is versus budget or – last year it was low, but maybe a five-year average large loss number? Is there anything we can do relative?

Michael S. McGavick

No, this is not something we have practiced disclosure. I did hear a request for more views over time and as we work through how to do that, we'll see if we can find a way to give some color to that. But I don't want to get too close because it could get into information that could help those we compete with. So we'll try and think of a way to give you a little more color around that.

Ian Gutterman - Balyasny Asset Management L.P.

Understood. I understand the challenge.

Michael S. McGavick

We're getting near the end (indiscernible)…

Ian Gutterman - Balyasny Asset Management L.P.

Can I squeeze one last, on professional lines, the quota shares? I just want to understand better, Pete, the economics and how we'll see it play through. And I know this has been asked, but if I can push a little more. So obviously, you're going to have less dollars or premium. That means you're giving away profitable loss dollars, so that hurts income. As you said, it hurts the G&A ratio, so that hurts income. You get help from income from the ceding commission. Net-net, how do we see the benefits to you play out in this? Is this neutral, positive or negative to dollars of income? And if it's negative, is it made up for in less capital? How are we going to actually see the benefit? Because my concern is, if you just do it simplistically, is this actually, if you don't think it through all the way, it seems like it actually hurts earnings, not helps. And intuitively, it seems like it must help, if it's a good deal.

Peter R. Porrino

Right, so Ian this is Peter. I'll start and then Greg can add more color. So the easiest one is the capital release, right. I mean this is very clear a de-risking action. As far as the underwriting results go, that depends on what loss ratio you're going to pick and we're not going to get into specifics as to the size of the override, but it was significant and it was significant enough that I'll be honest, when we measured the trade economically, it did not take us a really long time to evaluate that.

Ian Gutterman - Balyasny Asset Management L.P.

Understood. When I try to model based on what I had heard, I got it being – maybe it's not that great per dollars of income in the numerator. So it would seem the impact comes more from increased share repurchase. Is that a reasonable way to think about it?

Peter R. Porrino

Well, I hadn't talked about share repurchases, so this is a one-year transition that we have. So depending on how the economics play out we may or may not renew it. I don't think that that would probably be the type of transaction that you would then do a share repurchase on the back of.

Ian Gutterman - Balyasny Asset Management L.P.

Got it. I'll follow up later. Thank you.

Peter R. Porrino

Okay.

Operator

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

Michael S. McGavick

Listen, we're going to jump through a bit here and we're always happy to stay and answer the questions. This is important to us. We know that through these calls, we're communicating to many audience not just those who analyze us but also terribly important to our shareholders and of course our colleagues who are often on the line. And paying attention to those colleagues, I want to say this is a good way to end the year. We're making good progress, keep it up. We're going to make good rational decisions and we're not going to overreact. We think this is an improving book of business. We've communicated effectively why it is that we have that confidence. And while we remain a work in progress, we feel very good entering 2014. We appreciate your patience, we appreciate your questions. Dave and team will look forward to follow-ups as necessarily. I know that Pete and I are headed to some conferences where we'll get other opportunities to emphasize these messages as well. With that, I think we're at the end. Thank you very much.

Operator

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

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