Tower Group, Inc. Q1 2010 Earnings Call Transcript

| About: Tower Group, (TWGP)

Tower Group, Inc. (NASDAQ:TWGP)

Q1 2010 Earnings Call Transcript

May 10, 2010 10:00 am ET


Thomas Song – Managing VP

Michael Lee – Chairman, President and CEO

Bill Hitselberger – SVP and CFO


Adam Klauber – Macquarie Research

Bijan Moazami – FBR Capital Markets

Mike Grasher – Piper Jaffray

Beth Malone – Wunderlich


Good day, ladies and gentlemen. My name is Chuck and I will be your conference facilitator today. At this time, I would like to welcome everyone to Tower Group first quarter 2010 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer period.

It is now my pleasure to turn the floor over to your host, Managing Vice President, Mr. Thomas Song. Please go ahead, sir.

Thomas Song

Thank you, operator. Good morning. Before I turn the call over to Tower Group President and CEO, Michael Lee and the company's Senior Vice President and CFO, Bill Hitselberger, I'd like to remind you that some of the statements that will be presented during this call will be forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Actual results could differ materially from those projected in these forward-looking statements.

For more information on the risks and other factors that may affect future performance, investors should review periodic reports that are filed by the company with SEC from time to time. In addition, a replay of this call will be available in the Investor Relations section at Tower's website.

Now, I'd like to turn the call over to Michael.

Michael Lee

Thank you, Tom, and good morning, everyone. I'd like to thank all of you for joining us on this conference call to discuss our first quarter operating results. As described in this morning's press release, Tower Group has produced another quarter of profitable underwriting results and growth despite the storm losses that affected Tower and the industry in March.

Our operating income was $17.8 million or $0.39 per share compared to $28.3 million or $0.84 per share during the same period last year. As we previously announced, we experienced an unprecedented number of claims as a result of this storm activity during the weekend of March 13th through the 15th. These storm losses were the most significant catastrophe losses that we have experienced during our 20-year history.

We previously provided guidance for the storm losses to be in the range between $7.2 million to $9.1 million, but increased our estimates based upon our actual adjustment of these losses. The actual storm losses were $12 million on an after-tax basis or $0.27 per share and added 6.5 points to the first quarter's loss ratio. This increased our combined ratio to 96.8% for the quarter. Excluding the storm losses, we had a strong quarter with an operating income of $29.8 million or $0.66 per diluted share and a combined ratio of 90.3%.

On this morning's call, I will provide you with the updates in several areas of our business including our views on the insurance market and our strategic response to the current market conditions, as well as status update on acquisitions including the pending acquisition of OneBeacon's Personal Lines Division. Bill will then provide a detailed overview of our financial performance and earnings guidance. We will then conclude this call with a question-and-answer session.

As we've been mentioning in prior quarters, we are continuing to see soft insurance market conditions across the industry, but we are also seeing strength in some of the core areas of our business. Our strategic response to the current market conditions has been to consolidate renewal business rather than competing for new business in competitive market segments.

Through acquisitions, we have also successfully broadened our commercial lines business, added to our specialty business, and with the OneBeacon acquisition, we will further expand our personal lines product offering. Our underwriting strategy is to use our diversified business platform and allocate capital to profitable markets, while aggressively re-underwriting on profitable segments of our renewal business.

The success of this strategy is reflected in our premium growth and profitability. Our premiums – our total premiums increased by 34.4% to $283.9 million from $211.3 million during the same period last year, while maintaining a very favorable combined ratio of 90.3% excluding the storm losses.

During the quarter, we derived our growth primarily from the CastlePoint, Hermitage, SUA, and AequiCap acquisitions that we have completed in 2009. As a result of the growth from these acquisitions, we were able to – we are able to remain conservative with respect to our organic growth and in fact, in the Northeast, we reduced our premium volume by 1.7% during the first quarter as compared to last year due to the competitive conditions in commercial lines.

In our brokerage insurance segment, with regard to the new business, we continue to focus on underwriting small policies, generating less than $25,000 per policy, expanding geographically as well as into specialty classes of business that we believe are less vulnerable to market competition. We were also able to take aggressive underwriting actions on middle and commercial – middle and large commercial accounts, which we are gradually reducing due to the competitive pricing environment.

Our underwriting discipline is also reflected in our premium change on renewals, as well as the high retention rate on renewal policies. During the quarter, our premium change on renewals increased by 0.3% for the commercial lines and by 3.1% for personal lines and 1.3% overall.

As I mentioned before, our overall pricing change on commercial accounts benefitted in part from a shift in the mix of our business into small policies. Our premium change for workers' comp renewal policies increased by approximately 2.7% on average, driven by pricing environments we are implementing in California and also by rate increases in New York for restaurants, a class in which we have a significant share.

The strength of our core business is also reflected in the renewal retention rate, which was very strong for the quarter with 80% in commercial lines and 90% for personal lines. In our specialty business, the first quarter concentrated on consolidating CastlePoint and SUA programs, resulting in terminating three programs and focusing on existing programs that have better profit potential going forward.

Much of the growth was due to the introduction of a minus paper for existing SUA programs and a strong first quarter for several existing programs. For example, due to the access to Tower's rating and financial strength, we anticipate that the public entities program that SUA started in 2009 will make a meaningful contribution to our growth throughout this year. We are also in the process of expanding into other specialty classes of business by reviewing new programs produced by program administrators or developing these products internally and distributing them through retail and wholesale agents.

As a result of the acquisitions that we have made in 2009, we have a very large base of profitable renewal business to meet our growth objectives. Our high retention rate on this renewal business allows us to be more selective with new business opportunities and affords us the luxury to take appropriate underwriting actions on underperforming parts of our business.

Now, let me provide you with an update on our acquisitions. During the first quarter of last year, we completed the acquisition of CastlePoint Holdings and announced our plans to eliminate CastlePoint's reinsurance business and allocate the capital to make acquisitions, to create a larger, more diversified primary insurance company. After one year, we have effectively eliminated almost all of the third-party reinsurance business that we have inherited from CastlePoint.

We also acquired Hermitage Insurance Company, Specialty Underwriters Alliance, and AequiCap Program Administrators in 2009 and announced the acquisition of OneBeacon's Personal Lines Division during the first quarter of this year.

As a result of the CastlePoint and SUA acquisitions, we now have a specialty business unit that contributed $70.3 million in gross written premiums during the quarter. More importantly, we are using the Specialty platform to expand into niche, focused – focus class – classes of business that we believe are less vulnerable to the pricing – competitive pricing environment due to the unique aspects of this business and the specialized industry expertise necessary to underwrite this business.

As a result of the Hermitage and AequiCap acquisitions, we have significantly expanded into the Southeast region, which contributed $29 million in gross written premiums during the quarter. Through the Hermitage acquisitions – acquisition, we have also strengthened our E&S capability throughout the country.

Finally, the OneBeacon acquisition, which we announced in February of this year, will significantly expand our personal lines capability by adding personal auto to our line of business, as well as providing us with access to reciprocal that will enable us to generate management fee income. Based upon the feedback we have received from the various regulators, we anticipate the closing of the acquisition of the OneBeacon's Personal Lines Division to take place sometime in the latter part of June of this year.

In addition to the acquired books of business that are helping us to manage through this market cycle, they are significantly contributing to our territorial expansion. As compared to five years ago when the majority of our business production was concentrated in New York and entirely in the Northeast, we now have 40% of our business produced outside the Northeast with the West contributing 23% and the South contributing 11%. Our specialty business has become nearly a quarter of our total production.

Also, as a result of the CastlePoint and SUA acquisitions which we acquired using our stock as currency, we increased our shareholders' equity from $335 million at the year-end 2008 to $1.1 billion as of the end of this quarter. We also increased our book value per share from $14.36 at the year-end 2008 to $23.88 at the end of this quarter. In the process, we increased our diluted number of shares from approximately 23 million shares at year-end 2008 to approximately 45 million shares at the end of this quarter.

As in the past, with our capital raises and acquisitions, we anticipate – anticipated a certain amount of time for the deployment of additional capital, as well as the need to generate sufficient earnings to offset the dilution resulting from the additional shares that we have issued.

During the past four quarters, we have gradually been making progress in deploying this capital and executing our strategic plan. This lag time, as well as our decision to take aggressive corrective underwriting action in view of the current market environment and the use of a higher loss pick for 2010 caused us to revise our earnings estimates for the first two quarters of this year. With the OneBeacon transaction, however, we will be able to successfully complete our plan to fully leverage the capital that we have acquired from the CastlePoint and SUA acquisitions to generate higher earnings.

In summary, after more than one year since the CastlePoint transaction, we have successfully implemented our business plan to significantly increase our capitalization and diversify our business platform through various acquisitions that we made in 2009. With the acquisition of the OneBeacon transaction, we will also be able to restore our hybrid business model, capable of generating underwriting and investment income from utilizing our own capital, as well as generating reinsurance commission and fee income from managing the reciprocal insurance companies. As a result, we believe we will begin to fully realize the benefits of these initiatives, beginning in the first quarter of this year.

With that overview, I would like to now turn it over to Bill to provide financial details on this quarter. Bill?

Bill Hitselberger

Thank you, Michael and good morning, everyone. I'd like to speak to the financial highlights for the first quarter, followed by Tower's earnings outlook for the second quarter and for the full year.

As Michael mentioned, we experienced a $12 million after-tax loss from the Northeast storm occurring during the weekend of March 13th to the 15th. The storm produced a unique set of weather problems in the Northeast which included a saturated ground from recent snow melting, very high wind gusts and four inches of rain in a short period of time.

Most of our losses were caused by falling trees and branches. The loss translated into a 6.5 point increase in our loss ratio or $0.27 per share. Excluding this event, our combined ratio would have been 90.3% and our operating earnings would have been $0.66 per share for the quarter.

Our net loss ratio for the quarter was 63.2% or 56.7% without the catastrophe loss compared to 53.7% for the same period last year. We did not have any catastrophe losses in 2009. Our gross expense ratio was 31.2% customer 32% for the same period last year. The $12 million after-tax loss from the storm includes the impact of additional losses that were not included in our March 31st announcement. We do not anticipate any additional losses from the storm. And in fact, over three-quarters of storm claims filed have already been paid.

While we did substantially increase our total premiums during the quarter, much of the increase in brokerage insurance premium written resulted from the acquisitions we made last year. Our gross premiums written grew by 88% for the first quarter when you include the premium we produced for CastlePoint during the first quarter of 2009.

Overall, our policies in-force, which in 2009 includes business produced by Tower Risk Management on behalf of CastlePoint Insurance Company, increased by approximately 14.5% this quarter compared to the same period last year. But as Michael mentioned, our organic growth in the Northeast was actually slightly negative. In addition, our retention ratio for the quarter was 90% in our personal lines business and 80% in our commercial lines business, which continues to demonstrate the stability of this segment.

Net premiums written increased by 32.7% as compared to the same period last year. For the quarter, consolidated revenues increased by 51.5% to $303.5 million as compared to the first quarter of 2009. The net combined ratio was 96.8% for our insurance business this quarter as compared to 86.7% in the first quarter last year.

The net expense ratio was higher this quarter due to the reduction in ceding commission revenue on quota share reinsurance from $13.6 million in 2009 to $10.2 million in 2010. The reduction was a result of the acquisition and consolidation of CastlePoint that had provided ceding commission to Tower in 2009 and our decision to utilize the additional capital arising from the acquisition to retain more of our business in 2010.

I'd now like to provide additional details on the operating results for the brokerage and specialty segment. While insurance services segment was not utilized as much as we've done in the past, we anticipate that the acquisition of OneBeacon's Personal Line Division will provide us with additional fee opportunity.

The brokerage insurance segment is written primarily through retail and wholesale agents. With the Hermitage acquisition, we've been able to expand our product offering to our wholesale distribution on both an admitted a non-admitted basis.

The brokerage net loss ratio increased by 10.6 points for the three months ended March 31st, 2010 as compared to the same period in 2009, primarily as a result of the winter storm losses in the homeowners' line and to a lesser extent, in the commercial property line of business. The storms added 9.3 points to the loss ratio for the segment. Excluding the winter storm losses, the level of reported claims in the homeowners and commercial property lines were relatively better than the level of reported claims for prior accident years at the same stage of maturity.

Although renewal prices increased modestly for the first quarter of 2010 as compared to expiring prices, lower pricing from 2009 continues to affect the current year loss ratio. Our gross underwriting expense ratio was 31.8% for the first quarter of 2010 as compared to 32.1% for the same period last year and the net expense ratio was 35.3% and 32.9% for the three months ended March 31st, 2010 and 2009, respectively. The increase in the net underwriting expense ratio was due to an increase in catastrophe reinsurance premium ceded which reduced the net premiums earned, as well as a reduced ceding commission income as compared to the first quarter of 2009.

Let me now discuss the operating results in the specialty business segment. During the quarter, the specialty business segment wrote $70.2 million of gross premiums as compared to $29.1 million in the first quarter of 2009. We anticipate continued growth in this business segment, especially in light of the SUA acquisition, which allowed us to further strengthen our specialty business by creating a separate and distinct underwriting infrastructure for this business.

The net loss ratio in the specialty business increased 1 point from the prior-year period due to the inclusion of SUA business which was acquired in the fourth quarter of 2009. The prior-year period includes Tower's participation on CastlePoint's specialty business, as well as a partial period reflecting Tower's ownership of CastlePoint after February 5th, 2009. The gross loss ratio increased by 5.1 point from the first quarter of 2009, primarily due to the acquisition of SUA where the book of business has traditional had higher loss experienced in Tower's specialty business.

Our gross underwriting expense ratio was 29.6% for the first quarter of 2010 as compared to 30.7% for the same period last year. The improvement in the gross expense ratio was the result of lower commission expenses resulting from the withdrawal from third-party reinsurance, offset in part by a higher operating expense ratio associated with the specialty direct business. Our net expense ratio improved by 4.2 points year-over-year.

Total revenues in our insurance services segment were down as expected, given the completion of the CastlePoint transaction in February 2009. Insurance service revenues decreased by 87% to $600,000 for the quarter compared to $4.3 million in the first quarter of 2009. The decrease in total revenues resulted from a reduction in business produced on behalf of CastlePoint Insurance Company.

Michael reviewed the progress that we made in territorial diversification and I'd like to point out the equally significant product line diversification we've also achieved. Last year, in the first quarter, commercial package business represented 37% of our direct premiums as compared to 30% in 2010. Commercial liability was 14% of our total production in the first quarter 2009, but now it's been reduced to 8%.

Looking forward, with the contribution of the Personal Lines business of OneBeacon, our product lines will be well balanced between commercial package, workers' comp, homeowners, commercial auto and personal auto, and we don't expect too much concentration in any single product.

I'd like to take a few moments now to discuss our investment results, cash flow, and share repurchase program. In the first quarter of 2010, our invested asset base, including cash and cash equivalents grew by 40.3% to $2.1 billion compared to $1.5 billion in the first quarter of 2009. In the first quarter, net investment income increased by 59.5% to $23.2 million as compared to $14.5 million for the same period last year. The tax equivalent investment yield including cash in the first quarter was 5.7% compared with 5.5% at March 31st, 2009.

We have been modestly increasing our investment in lower-rated corporate bonds to offset the effect of lower new money rates in 2010. Net realized investment gains were $700,000 for the three months ended March 31st, 2010 compared to a loss of $700,000 in the same period last year. Included in these amounts are $2.9 million and $3.2 million of credit related OTTI losses in the first quarter of 2010 and 2009, respectively. The duration of our fixed income portfolio was approximately 4.6 years.

Net cash flows provided by operations were $36.8 million during the first quarter. Last quarter, we announced our stock repurchase program. During the first quarter, we repurchased $7.4 million or over 337,000 shares. This leaves $92.6 million outstanding in the program.

Now, I'll turn to our earnings outlook for the second quarter and the full year of 2010. As we continue to implement our business plan, we anticipate our earnings and return on equity to gradually increase throughout 2010 and into 2011. Tower expects second quarter 2010 operating earnings per share to be in a range of $0.55 to $0.60. For the full year 2010, Tower projects its operating earnings per share to be in a range between $2.60 and $2.70. We have revised earnings guidance for 2010 to reflect the effect of the reported catastrophe losses in the first quarter and to reflect the closing of the OneBeacon Personal Lines Division transaction, which is now expected to close at the end of the second quarter of 2010.

With that, I’ll turn the floor over to the operator for questions. Chuck, if you can open the lines?

Question-and-Answer Session


Thank you. (Operator Instructions). One moment for our first question. And our first question comes from Adam Klauber of Macquarie research. Go ahead, your line is open.

Adam Klauber – Macquarie Research

Thank you. Just a couple of different questions. So if we exclude the weather losses, taking a look at that on your loss ratio, I get an (inaudible) your loss ratio of roughly 57%. Is that a pretty good number going forward, given the mix of business?

Michael Lee

Good morning, Adam. We feel comfortable with that mix for this quarter, but we are using a projection of 61% in our estimate for the year, anticipating the higher loss ratio from the OneBeacon transaction. That transaction will have personal auto line of business, which runs at a slightly higher loss ratio. But for our book of business that Tower has, we are looking at a 57% to around 58% in that range, possibly to 59% and our model contemplates that for the year.

We ran – when you exclude the storm losses, we had a very good quarter and that explains why we had a lower loss ratio than we projected, excluding the storm losses.

Adam Klauber – Macquarie Research

Great. Was there any reserve development in the quarter?

Michael Lee

No reserve development. We feel pretty comfortable with the actions that we have taken last year. But we haven't had any adverse development, I guess, since 2002. So we are continuing with that track record.

Adam Klauber – Macquarie Research

Okay. And then on the expense ratio, with CastlePoint moving on your books and some third-party business being non-renewed, I think you expect the expense ratio to come down. But I guess what's – timing wise, I guess, is that over the next couple of quarters or is that more 2011?

Michael Lee

No. I think we are going to see some substantial benefit in this third and fourth quarter and I think during this – my presentation, I explained what's essentially going on. We added substantial number of shares, which with the substantial increase in capital that is a drag on our earnings per share, but you would expect that and then we increased our loss pick for the year 2010.

So our earnings are somewhat depressed and we explained that for the first two quarters. But as we leverage the capital fully and restore the hybrid business model and generate reinsurance commission, as well as management fee income, as we have done in the past we anticipate our earnings to increase.

So I think what's lost on many people is what has happened during the past year. We decided to change our business model and add substantial amount of capital, we issued substantial number of additional shares, it's just going to take time. In the first two quarters, we are feeling that effect. But we've – has happened to us in the past as with every capital raise, as well as acquisition. It's just that we pushed it out two more quarters because we increased our loss pick, and of course this quarter, we had the storm losses. But our run rate is very good, we feel very positive about what went on in the quarter.

We took some drastic underwriting action, not that we were running poorly in terms of loss ratio, but we wanted to take a precautionary measure and we are re-underwriting our book of business and with the actions that we have taken and we think that we are getting ahead of the market and we feel very comfortable with where we are. We also have – in addition to increasing our capitalization, we built two other business segments. In addition to commercial segments, we built the specialty segment and we are also expanding our personal lines division.

So we've done a lot to diversify our business, make our company larger to fit into that larger capitalization and it's just going to take time, but if you look at the core fundamentals, we are very happy. I mean, not too many companies are running in the low-90% combined ratio. I just want everyone to understand that. So we went from about a little over $800 million in premium volume to project a $1.6 billion. We've substantially increased our capital base and we added two other segments.

So we've done a lot and without really increasing our combined ratio. Now, it's going to take us time to leverage that capital, implement the strategy that we have – that I just outlined, but at the end of the day, we feel very comfortable and we are doing a lot of things to make sure that our business is running profitably and that we are on track to produce the type of results that we anticipated when we acquired CastlePoint.

Adam Klauber – Macquarie Research

Okay, thank you. Thank you very much.

Michael Lee

Thank you, Adam.


One moment for our next question. And our next question comes from Bijan Moazami of FBR Capital Markets.

Bijan Moazami – FBR Capital Markets

Hey, good morning, everyone.

Michael Lee

Good morning.

Bijan Moazami – FBR Capital Markets

A number of questions. First, if you can talk about your growth rate – organic growth rate, 14.5%, where is it coming from, what product lines and the geography?

Michael Lee

We are not really – well, our strategy, as I mentioned, is to consolidate renewal business and a lot of the growth is coming from acquisitions or we are adding renewal business and that's the first thing. And as a result, we are growing based on the fact that we are consolidating, not writing new business. However, we are growing with the businesses that we have acquired. So most of our growth is coming from the growth from the acquisitions, not only in terms of renewal business, but also from the fact that we acquired new businesses.

For example, our growth is coming from specialty. What we have done is to trend back the writings, but yet a lot of the growth after we have done that is coming from the growth of the specialty business. We are also growing in the Southeast and in the West. So our organic growth is really coming outside of Northeast, which is exactly what we have intended. But again, we are, I think, one of the few companies that are publishing positive premium changes.

So we feel that that's a very important metric and with a high retention rate, we think that our business is trending very well and we think we – despite the soft market conditions, we are doing all the right things we believe to make sure that our business is profitable and to eliminate any risks that are associated with our book of business and we are going to continue with that because of the significant premium volumes that we are obtaining from these acquisitions. We have the luxury to be selected and to take the underwriting corrective action and that's what we are doing.

Bijan Moazami – FBR Capital Markets

Okay, great. I have a quick question, if you can clarify that to me. If I look at your brokerage business about a year ago, you were running at significantly better net combined ratio than gross combined ratio on that. And this year, that has reversed. You are running a 98% combined net, but the gross is 91%. If you could explain why that dynamic changed so dramatically year-over-year even though the product margin gross business is good?

Michael Lee

Okay, well. The reason for that is that we had CAT losses, which hit our deductible or we haven't gotten any reinsurance recoveries. So we are paying the CAT reinsurance cost, but yet we are not recovering from the reinsurance that we paid to the reinsurers.

So therefore, we are paying out the reinsurance premium to protect us in the event of catastrophic losses, but the losses were not at a level where we would recoup from the reinsurers. As a result, our direct losses – loss ratio is fairly good, but our net loss ratio is running worse as a result of the fact that we are not getting any benefit from the reinsurance premiums that we are ceding for the protection.

So on a gross basis, we are doing well. On a net basis, we have the premiums – reinsurance premiums sucked out of our base of net premiums earned and as a result of that, you are going to get a higher loss ratio, hence you are going to get a higher combined ratio. However, let me point out a couple of things.

As we ramp-up the writings and we achieve a better balance of premiums relative to our capital, which we anticipate happening in the third quarter, we are going to generate commission – reinsurance commission income on the quota share reinsurance, which will reduce our net expense ratio because we are getting the reinsurance commission, which will restore back that – the sort of the dynamics that you saw in the previous quarters or previous years when we had Tower's hybrid business model. In addition to that, we are going to generate management fee income from managing the reciprocal companies.

So we are going to get back the hybrid business model that everyone is accustomed to seeing from Tower, but again that's going to take time. We just went from a little over $300 million in capital to $1.1 billion. It's just going to take time to leverage that capital and as we leverage that capital, first by leveraging that capital and generating underwriting income as well as investment income from retaining that business using our own capital and then generating premiums in excess of that at which point we would cede that business to reinsurers and get the commission override that we have gotten in the past and then from managing other insurance companies, we would generate management fee income.

And when we have those three aspects of our hybrid business model working, we will be able to generate higher earnings. And what you are seeing in the first two quarters is the lag time, especially after we added SUA again and we issued additional number of shares. So we are in the period of digesting that. But our core fundamental is strong as ever and I think that's the most important thing and it’s just a matter of time to leverage the capital and then we will restore the type of earnings strengths that we all have seen in the past.

Bijan Moazami – FBR Capital Markets

Okay. One last question. In the prepared remarks, you guys mentioned that you've been buying lower-grade corporate bonds. Obviously, that has a positive impact on the yield. Could you elaborate to us what makes you comfortable doing that and what are the kind of securities that you are buying in terms of corporate bonds?

Bill Hitselberger

It will be primarily – Bijan, it's Bill. Their corporate moderate duration – when I say below investment-grade, they are a higher end of the below investment-grade, so BB on average, BB, BB plus, duration really doesn't go out beyond – I mean, maturity is really three to five years. Our view is that at this point, given what we see in terms of the economy, we feel more comfortable taking those educated credit bets than we certainly do taking duration bets. So I think that's our solution right now to what we see as a continued challenge in the current environment for new money rates.

Bijan Moazami – FBR Capital Markets

And did you guys get any kind of consulting firms evaluate the value of this security as compared to your position? As I know Michael historically has used consultants to figure out whether it's a good idea or not.

Bill Hitselberger

We – I mean, we certainly have outside portfolio managers, Bijan, that work with us. And we've been discussing our strategies with them to get their concurrence on it. We've been very fortunate in that the market value of the fixed income securities continues to experience very positive results. We had unrealized appreciation again first quarter of '10.

Bijan Moazami – FBR Capital Markets

Thank you.

Bill Hitselberger

You're welcome.


And our next question comes from Mike Grasher of Piper Jaffray. Go ahead, sir. Your line is open.

Mike Grasher – Piper Jaffray

Thank you. Good morning, everyone.

Michael Lee

Good morning.

Mike Grasher – Piper Jaffray

A couple of questions, I guess. With the CAT experience that you saw in the quarter, I guess, it begs the question, should we concerned that the change in the mix of business through these acquisitions has not changed sort of the – I guess, the nature of your reporting or invite more volatility to the quarterly earnings.

Michael Lee

I don't think so. We are very diversified and for that reason, I think you've seen the worse – I mentioned that the storm losses were the worst in 20 years. I think you saw other companies reporting much higher numbers. So I would differ with you as far as that assessment is concerned. I don't think our business is very volatile. I think you've seen the worst and it had relatively minimal impact on the year. So we just don't have that kind of volatility that other companies have.

So I would say – please look at other companies and what they have reported, especially companies that are doing business in the same region and I can tell you that we are one of the – we had one of the lightest CAT activities out of all the other companies. So I don't think that our business is volatile. In fact, our business plan is designed to eliminate that volatility. The fact that we had such limited losses despite the fact that the losses represented the largest single catastrophe event in our history indicates that our book is in fact non-volatile.

Now, going forward, we are going to increase our personal lines business. However, we like the reciprocal model, lot of the businesses in this area is going to be written through the reciprocals. It's not really adding to our CAT exposure. I think the reciprocals would absorb these losses.

So we are not compounding our position, our volatility by adding OneBeacon business. And in addition to that, when you consider the buildup of other businesses, we think that the personal lines division is going to be supported by these other segments' results and therefore, any type of spike-up that we would see in any quarter will be mitigated by the countervailing effects of the operating results from the other business segments.

So I think in summary, we are well diversified and I think we have a very good plan to manage the catastrophe risk associated with expanding into personal lines business.

Mike Grasher – Piper Jaffray

Okay, that's helpful. Thank you. And then if you think about the OneBeacon transaction and moving forward, do you anticipate similar renewal retention levels, say 90% area that you've been experiencing?

Michael Lee

Yes. I think the retention for personal lines is about 90%, but I will – I do want to mention that some of the underperforming business as with any acquisitions, we will try to re-underwrite that book of business. So I think you are going to see some business not necessarily being renewed as a result of the fact that we demand greater profitability, but other than the business that we are intentionally not renewing or we are taking any corrective underwriting action on, we would expect similar retention rates that we have experienced at Tower.

Mike Grasher – Piper Jaffray

Okay. One final question, just as a follow-up to your comments around the hybrid model taking time in that and I'm just curious as to what sort of time frame investors should look for in terms of seeing that ROE accelerate, not just to sort of the 13%, 14%, but into the high-teens. And then if you could just comment on what you see peak ROE being for the organization after we get past or get through a lot of this downtime? Thank you.

Michael Lee

Thank you, Mike. Well, we gave our guidance. So we think that we are going to be doing much better in the third and fourth quarter of this year and I think you are going to see the continuation of that. And we feel very comfortable about our earnings after the third quarter and into 2011. As far as the ROE, we think we feel comfortable with 14% to 15% ROE and I think based on the fact that we have substantial amount of capital, I don't think we can expect the ROEs that we experienced when we had much lesser capital during the early part of Tower's history after it went public.

So I think we feel very comfortable with about 14%, 15% ROE and that’s what we will strive to achieve going forward. And if you project that out into 2011, I think you are looking at very good earnings going forward.

Mike Grasher – Piper Jaffray

Okay. Thank you.

Michael Lee

You're welcome.


Thank you. And our next question comes from Beth Malone of Wunderlich.

Beth Malone – Wunderlich

Thank you. Good morning. Couple of questions. First, on the OneBeacon and the more on business in the Northeast, do you anticipate that this – the weather related losses that were incurred in that market will result in higher rates going forward and will you be able to participate in that with taking on OneBeacon by the second half of the year?

Michael Lee

Well, good morning, Beth. I think we study the personal lines segment very carefully. We like what's happening fundamentally. We showed 3% premium change on our renewal policy for personal lines. I think OneBeacon's Personal Lines Division probably has similar type of pricing trends as does most companies in the industry.

So I think personal lines is doing better. Certainly the storm activity is going to help, but I wouldn't categorize the storm activity that we have witnessed as something that would turn the market. I think the homeowners business is very profitable, the rates is sufficient, and I think fundamentally there is a need for capacity in the homeowners market, as well as personal lines market.

So I think that pricing is going to be stable and we are going to be able to generate the type of results that we have projected. So we feel pretty comfortable about our acquisition of OneBeacon's Personal Line Division and more so than the market dynamics there, I think we will be able to increase our premium volume by about $400 million and be able to leverage our capital and that will have the kind of beneficial impact on our company as I described in that we will be able to generate commission and fee income and be able to achieve higher returns as a result of that volume coming in.

Beth Malone – Wunderlich

Okay. And then – thank you. And then on the guidance, you provided prior to quarter the idea that in the second half you would be generating earnings in the realm of $3.50 to $3.70, your original guidance 18 months ago. And my question is if you are going to give about $0.55 in the second quarter, that would indicate that the second half would be generating on an annualized rate of around $3.20. Does that suggests that the fourth quarter should be more in the – more close to the higher end, like it's going to ramp up second – third to fourth, based on the guidance you just provided, as well as the guidance your provided at year-end last year?

Bill Hitselberger

Yes, that's absolutely correct, Beth. I mean, I think what we see is the acquisition of OneBeacon, we expect it to be accretive and we expect to see continued improvement from the integration of SUA. And those two factors are going to – we believe those will result in increasing trends in our operating earnings per share in the third into the fourth quarter and we do expect that trend to continue into 2011.

Beth Malone – Wunderlich

Okay, thank you. And then one last question. On the share repurchase program, (inaudible) the $100 million and then so far you've bought not quite $10 million. So my question is, do you anticipate that this – that you will ramp this up, do you have a time frame for when you are making these purchases or – and should we anticipate a higher pay than what you afforded in the first quarter?

Bill Hitselberger

Well, I think, in my view on buying back the stock, Beth, is we are going to continue to evaluate our price relative to our expectations for price. We certainly have discussions with our Board on an expected price range, where we would make investments in our own stock. We think our stock is a good price – it's a good buy rate now. So I would expect us to be buyers, certainly when we have opportunities. As you know, we are in a quite period right now. So I think once that concludes, we will evaluate where the price is and what we see in terms of volume.

Beth Malone – Wunderlich

Okay, all right. Thank you.


Mr. Lee, at this time, I'm showing no further questions. I would like to turn the call over back to you for any closing remarks.

Michael Lee

Thank you, operator. Despite the storm losses, we are pleased with our operating results for the quarter in terms of the growth and profitability of our core business. We believe we are on track to successfully execute our business plan for the rest of the year.

Thank you, everyone for joining this call, and look forward to talking with you again next quarter. Thank you.


Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program, you may now disconnect. And have a great day.

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