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Executives

Alex Maloney – Group CEO

Paul Gregory – Group Chief Underwriting Officer and CEO, Lancashire Insurance Company (UK) Limited

Elaine Whelan – Group CFO and CEO, Lancashire Insurance Company Limited

Peter Scales – CEO, Cathedral

Analysts

Maciej Wasilewicz – Morgan Stanley

Tom Dorner – Citigroup

Olivia Brindle – Deutsche Bank

Ben Cohen – Canaccord Genuity

Joanna Parsons – Westhouse Securities

Chris Hitchings – Keefe, Bruyette & Woods

Will Hardcastle – Bank of America Merrill Lynch

Lancashire Holdings Ltd. (OTCPK:LCSHF) Q2 2014 Earnings Conference Call July 24, 2014 8:00 AM ET

Operator

Hello, and welcome to the Lancashire Holdings’ Q2 2014 Results Call. For the first part of this call, all participants will be on a listen-only mode, so there is no need to mute individual lines. And afterwards, we will have a question-and-answer session. Just to remind you, the call is being recorded.

I’ll now hand over to our host, Alex Maloney.

Alex Maloney

Hi, good morning, ladies and gentlemen. Today, we have on the call Elaine Whelan, our CFO; Paul Gregory, our CEO. We have Darren Redhead, CEO of Kinesis; Peter Scales, CEO of Cathedral and Denise O’Donoghue, who is our Chief Investment Officer.

I’m delighted to say we grew fully converted book value per share by 2.4% in the second quarter with a healthy combined ratio of 74.6%. In addition to the impact of Richard’s retirement package on ROE, this quarter has seen a number of moving parts across different areas of our underwriting business. And I believe this result demonstrates the underlying quality of our core portfolio in a market which is one of the most difficult in our history.

We are working hard to maintain our position in a market which is changed rapidly and this has led us to change tactics accordingly. We have been very active in the second quarter, optimizing our portfolio to ensure we only write business where the risk reward dynamics are acceptable.

The silver lining in a falling market is the cost of reinsurance when we are the client and we now purchase more reinsurance than any other time in our history. We’ve always said that we will write the most exposure in a hard market and the least in a soft market, and this remains true.

We have reduced our PMLs significantly from our take in April 2012. We have 30% reduction in Gulf wind and a 20% reduction in Cal quake. Our risk PMLs have also reduced considerably over the same period. We’re comfortable with volatility but we only accept volatility when we’re getting paid for it. We can accept more potential volatility when conditions improve.

We are working closely with our colleagues at Cathedral, who continue to produce consistent results as they have done for a number of years. Obviously at the time of writing, we are still digesting the terrible period for the aviation industry, but as somber as it is, these events create opportunities for us. We are already well positioned in aviation reinsurance and this is augmented by our new team of aviators joining Syndicate 3010 to write aviation war.

Our industry is changing rapidly, and those who can change with it will have nothing to fear. Good companies will adjust for the future, and our history shows we have no fear of adopting, but we will stick to our core principle of underwriting comes first.

I’ll now pass over to Paul Gregory.

Paul Gregory

Thanks, Alex. As Alex has already alluded to, there is almost an unprecedented level of competition in nearly all our business lines at present. Traditional reinsurance and retrocessional capacity is being displaced by alternative capital and trying to find a way into our core primary insurance markets.

Fortunately, our insurance clients like the high value and our leadership skills, our experience and above all our pragmatic and seasoned claims paying history. When setting a complex offshore energy or marine loss, clients want to know that accounts party has a real understanding of that business or safe to adjust claims fairly following the intent as well the letters of contract.

We’ve had a real demonstration of that loyalty in this quarter since we’ve gained Lloyd’s approval to begin writing terrorism and energy businesses in Syndicate 3010. We’ve got tremendous support from some of our long standing clients and brokers who’ve not only renewed the shares with Lancashire, but also given new additional shares to Cathedral. As a result, we’re already well ahead of where we expected to be on the energy line.

The major milestones for the quarter were the Japanese and Florida catastrophe renewals at $1.4 million and $1.6 million respectively. Not anything I can tell you that’s any different from what you’ve heard already. Consolidation in Japan reduced opportunities, alternative capacities took larger shares in Florida where price is the main driver, and pricing was down anything between 10% and 30%.

We’ve reduced risk levels in Japan not at least through the use of additional reinsurance and our small exposure to Florida homeowners got smaller. In New Zealand, we also reduced exposures as the post loss pricing finally started to come under pressure following the tragic earthquakes in 2011.

The energy portfolio has thrived as we have maintained our preeminent position on deepwater Gulf of Mexico wind product, and as noted received great support from our clients for the new capacity in Syndicate 3010 for marine and both, cargo and hull lines, although most of the business is adequately priced. We did not renew some business where clients set overly ambitious reduction targets.

On terrorism, our submission levels continue to rise allowing us to select the optimum portfolio for our risk appetite. Pricing here is cheap and we make no bonus about that, so risk selection is key and the daily call continues to support that process.

For aviation, satellite portfolio experienced a launch loss although I should point out we allowed for the current levels of losses in our loss picks. Pricing is stable and further losses would be needed to galvanize any significant outwards write movement.

AV52 rates remain under pressure, and on the Cathedral aviation reinsurance portfolio, income is at a relatively low level as rate continues to struggle. Although, we were able to make substantial savings on the outward purchases.

As Alex has mentioned, our new aviation teams arrival at Syndicate 3010 will allow for access any priceless opportunity that may arise in the aviation war market as a result of the recent round of losses that market has experienced. We’re very please to say that Lloyd’s have already given us business plan approval for these new aviation classes effective August 1.

At Kinesis this year, we made a mid-year draw of around $50 million for new opportunities and we’re very happy with the progress made to-date. Darren and his team will be marketing heavily once we get into September, and we’ll have a much better picture to present for 2015 at the end of next quarter.

There are couple of areas where some explanation of this quarter’s numbers may help. Political and sovereign bound premiums are down substantially compared to the same quarter last year, but if you look at submission numbers, they are in fact slightly up.

The binding of these lines will make them entirely dependent on the specific project financing that’s been agreed between governments or their agencies and lenders. And this process can take longer than anticipated. We have a substantial number of deals in the pipeline so there is no significant long-term shift here.

Second, there was an increase in both AV52 and satellite, which drove an increase in the overall aviation sub-class at Lancashire. On satellites, as with political and sovereign, there is no real renewable book for the launches and timetables are subject to change. So the book has lumpy quarters and this is one of them. Again no long-term trends.

On AV52, we’ve seen a number of U.S. airlines buying excess coverage in the private market in advance of an anticipated decision by the U.S. government’s stop providing the coverage. This is a new source of income for the AV52 market, and to-date three major U.S. airlines purchased from the commercial market.

The other big story has been the outwards reinsurance and retrocession, where both Lancashire and Cathedral have been able to improve terms and coverage on renewals, and provide substantial and well priced new capacity. As well as securing reduction in pricing on the core portfolio, we’ve been able to buy additional limits for our risk and catastrophe programs with some wide coverage and clean pricing.

The bulk of our risks in core catastrophe placements remain with long-standing traditional capital relationships, but we have accessed alternative markets where they are compelling opportunities especially on the cat side. We expect to continue to find excellent opportunities on the outwards to mitigate the pressure on the inwards portfolio in the current market cycle.

Again, we will stick to the strategy of keeping net risk levels lower during the soft market. And as Alex has referred to, we have reduced both our cat and non-cat PMLs which is exactly what we should be doing into those markets.

So that’s the underwriting picture for this quarter. It is hard work but given the strength from our leadership capabilities, our significant line sizes, the strength from our client and broker relationships and the quality of our underlying portfolio, we’re well equipped to handle this stage of the cycle. And it is a cycle, and there will be future opportunities that Lancashire, Cathedral and Kinesis will be well positioned to take.

I’ll now hand over to Elaine.

Elaine Whelan

Thanks Paul. Hi everyone. Our results are in our website as usual. We’ve produced an ROE for the quarter of 2.4% with 0.7% of that coming from Cathedral. Acquisition adjustments reduced ROE by 0.1% again this quarter. Before acquisition adjustments, Cathedral has now contributed 1.3% to the Group’s ROE of 6.4% for the half year.

As you can say, the majority of the increase in premium this quarter comes from Cathedral. We picked up $82 million from this quarter. Their D&F book was a little bit behind the Q2 last year and also due to rate reductions, but that was more than offset by new premiums written in the energy and terrorism lines that Cathedral now writes.

For Lancashire’s own book, we’re actually bit ahead of last year. Our property cap book was relatively stable with the increase from our energy Gulf of Mexico book. There was still a number of contracts written on a multiyear basis.

Of the $70.5 million of energy Gulf of Mexico premiums written this quarter, $64.5 million of that related to multiyear dues, about 20% of that will end this year with most of the rest earning out over the next two years. Otherwise as Paul mentioned, our political and sovereign risk book is down compared to the second quarter last year, primarily due to long-term contracts written last year that are not yet due to renew.

For the rest of the year for Lancashire’s own book, I expect a slight reduction in Q3 and Q4 premiums. The same is true for Cathedral, although we expect to see further growth in the energy and terrorism lines.

On ceded premium, Lancashire continues to buy additional reinsurance opportunistically. With that additional spend, pretty much decreasing other programs last year that were renewed. Most of the increase ceded premiums for the quarter comes from Cathedral as we purchased a new energy and terrorism cover to shed those new business lines.

It was another fairly quiet quarter in terms of cat losses, there was nothing major to speak of. Our net loss ratio of 34.9% was a good result. We have some small risk losses in the current accident year and a bit of a mixed bag on older years.

Last quarter, we booked adverse development on a 2013 accident year energy claims. This quarter we were pleased to reduce that, but we saw some adverse development on a 2012 energy claims. We also decided to increase our reserve in relation to one particular marine loss, given the updated useful or not known [ph].

We also booked a little more on Costa Concordia as well, but the increase is fairly small of $2.8 million for the quarter. Other movements in claims were pretty insignificant and our reserves for these large events were fairly stable overall. Our accident year loss ratio was 39.4%.

On investments, we had a decent result returning 60 basis points for the quarter, as we benefited from further spread narrowing in the quarter. This continues to allocate some more funds to our hedge fund portfolio and now have $99.5 million invested in that. That’s working well for us and we reallocate a little more later on this year.

Our hedge fund strategy is a low volatility one and gives us a nice diversification with to the rest of the portfolio on their interest business, and which has also pick up a bit more income from that. The hedge fund portfolio returned 1.1% during that year.

On KCM, and capital deployed to-date we ended at $6.2 million of underwriting fees this year. Just a remainder, there were earned fees in line with the underlying risk profile portfolio of Kinesis Re. So the bulk of it would be earned over the U.S. hurricane season.

Profit commissions could be around $9.6 million depending on loss activity, but we won’t receive any of those until Q1 2015 at the earliest. $0.8 million of our other income is this quarter’s share of the underwriting fees. The remainder of our other income is managing agency fees and profit commissions for Cathedral.

Our G&A includes $6.6 million of Cathedral cost. The incremental impact of Richard’s contractual retirement package and we also continued to amortize our finite life intangible assets. We booked a further $2.5 million G&A this quarter and we have about another $1.5 million coming through in Q3. It will be fully amortized at the end of the third quarter.

The deferred tax liabilities that relates to intangible assets will also be fully released next quarter. $1.5 million of the tax credit seen in our income statement this quarter, relates to the release of the deferred tax liability of the intangible.

In addition to Richard’s salary and benefits entitlement, his RSS awards of the dividend equivalents that had accrued to the awards were settled. That amounted to close to shareholders equity of $9.8 million. The total impact of Richard’s retirement package is therefore $11.6 million, which reduced our ROE by 0.7%. Richard also exercises warrants and that reduced our ROE for the quarter by 0.6%.

As per last quarter, around $4 million of our financing costs related to cost of our debt and LTE [ph] facilities and the like, with the balance due to the mark-to-market on our interest rates swap from Lancashire’s subordinated debt.

Lastly on capital. We’re not seeing much change in the market. If anything we’re little more pricing contracting so we’ll manage our risk levels down a bit and continue to service core clients. If that continues and there is no change in the market, then we’ll be returning to substantially all, if not all of our earnings for the year.

It’s too early to call our outlook for Jan 1, but we certainly don’t anticipate needing more capital than we need for this year from where we stand right now.

With that, I’ll hand over to the operator for questions.

Question-and-Answer Session

Operator

Thank you. We’ll now begin the question-and-answer session. (Operator Instructions) There will be a brief pause now as the questions are registered. Okay. Our first question comes from Maciej of Morgan Stanley. Go ahead. Your line is open.

Maciej Wasilewicz – Morgan Stanley

Hi. It’s Maciej from Morgan Stanley. So I’ve got two questions, if I may. The first question is just on your satellite losses. I know you had one last year as well. I think if I remember correctly, this isn’t a business line that you’ve been writing for that long. I’m just wondering whether or not, there is any second thoughts about that business line at all or whether you think you’ve got an edge in that business still and you’ve just been a little bit unlucky? Or maybe if you could just comment on whether or not maybe the overall profitability of that line is actually good, but I just can’t see it in the figures? And the second question is more about the aviation market. I understand there has been lot of losses in the market recently, and that should lead to an improvement in the conditions and rates in that market. I’m just wondering how much you think that that market can truly dislocate in the kind of environment that we’re in where basically there is a lot of hunger for margins, and if the inherent risk of aviation losses hasn’t actually changed, do you think you’ll actually get dislocation in that market and it will pay back the recent losses or not? If you could comment on those two please.

Alex Maloney

Okay, Maciej. Paul Gregory will answer the satellite losses and then Peter Scales is best positioned for the aviation question.

Paul Gregory

Okay. You’re right. We have only been writing satellite line of business relatively recently out two years now. We do when we started writing the class, we did tend to expect one launch loss a year, and in fact that’s exactly how it’s played out. We’re comfortable with the book as expanding the portfolio. We have – obviously everything we write, we constantly review in terms of its profitability, but as it stands today, we’re happy with the portfolio as it stands in the rates that we’re get in. Obviously we would prefer for these losses to move right upwards. They do remain stable, so as it stands we’re comfortable where we are.

Peter Scales

The aviation market you may have seen this morning’s terrible news as well. It comes in several parts. It’s slightly more complex issue. The backdrop is the airline market, which is substantial part of probably about 250% capacity for all the risks in it, and inherent it’s been very competitive over many, many years and many entry points.

On the side of that market, there is obviously – they are relying from the reinsurance market which has been more disciplined over a period of time of which we’re majorly in it. There are also our new hires are probably the preeminent lead in the aviation of the war market, which involves insurance of physical aeroplane rather than people on it, in the event of a malicious act. There is the AV52 for us in which Lancashire remains to lead which is basically the third-party element of a malicious act affecting somebody else’s property with the said airline.

So there is a whole bunch of moving parts. Apart from the war things, I’ll give you huge metrics as these are all very sub-numbers because a lot of things haven’t been turned up yet. So this leaves to suggest on the war area, the market premiums are, let us say, 60 million pound piece of reference with market premiums. We think the war losses so far this year, Tripoli, probably may pan out as $600 million, $700 million; Malaysia two probably $110 million; Malaysia one $50 million, and Mozambique $40 million and Karachi Airport $25 million.

You can’t see the sums on that. Historically when there is some accident in the war market which hasn’t happened for about a decade, prices tend to react reasonably violently and it’s a very, very specialist area. A lot of it is controlled either by a broker line slips which are basically your NOI or other market leaders which there are very few and we probably have the preeminent ones, who will start buying lines down as of 1/8. However that will actually pan out till yet, we don’t really know because there is no renewal market business where you renew it up in small GA pieces, whereas the airline market tends to renew 1/9. 1/10, 1/11.

So perhaps on the next call by the time we get round it rather much clearer picture, all the way things are going on that.

From the aviation reinsurance market standpoint, we are in a pretty good position. We clearly have losses on the two Malaysia losses, but they are both manageable in our attention, we’ve got lot of cover and have a lot of residual cover left. And again we would be in a position to do something after a period of managing a period of very light claims experienced over the last few years.

As for the central core where all our specialists classes play around that on the airline market, the economics even before going into this year were pretty thin I would suggest, although it’s one of the more capital efficient classes. And it will be interesting to see whether that is resolved in the market to move the thing forward, but looking at the simple economics of what the exposures clearly are, the costs of this clearly are, the client experience over like here and what’s likely to happen to retentions and reinsurance costs, the economics of it would need at least some part of thought by the management. And I think this probably the reality of it is, it’s a next quarter question when you’ll see people want to make some decisions and you’ll get some clarity of it by the year-end, and we’ve been through the major renewal cycle of all those various pieces.

Maciej Wasilewicz – Morgan Stanley

Thanks.

Alex Maloney

Thank you.

Operator

Okay. Our next question comes from Tom Dorner, Citigroup. Go ahead. Sir, your line is open.

Tom Dorner – Citigroup

Hi there. Yes, I’ve got a few questions. The first one is on the increased reinsurance purchases that you’ve made. I just wondered how much lower can you take the PMLs. I know you say in the Cathedral portfolio, it’s always bought a lot of reinsurance, but for the old Lancashire book, like how lower can you take the PMLs before it becomes economic to do that? The second question is on the increase in the hedge fund allocation. You may have mentioned this at Q1, but I remember in the past you dabbled in equities and then sort of moved out of that asset class and then moved into emerging market debt and have moved back out. So I just wonder whether this doesn’t – the increase in the hedge fund allocation doesn’t somewhat underline some of the risk reduction you’re doing on the underwriting side? And then the final question I had is on capital return. And specifically I think you might have mentioned in the past that you would consider buying back stock, if the valuation fell to something like 1.2x book. I just wanted to make sure is that still the case, and if that’s the case, what book value you actually using to judge that against? Thanks.

Alex Maloney

Okay, Tom. I’ll start with the reinsurance question. We’ll move onto Elaine for the hedge fund. Just for clarity, we’re not going to dabble any more on the investment portfolio. We’ll actually have a real strategy and capital aligned with that. So on the reinsurance front, we had seen very, very attractive rates in the market. We have seen pricing for certain parts of our portfolio at historic lows or historically low since Lancashire’s inception. And that leads us to obviously see that as a good trade to buy more reinsurance.

So if you look at how much reinsurance we bought today is the biggest amount in our history, whether that’s on the cat side or on the risk side. So we will – all our reinsurance is cancelled January 1. So I want to say if the wind season goes clean, we will probably cancel the reinsurance and start again and have to improve those terms.

How far can we take our PMLs down? I think there is almost going to be a limit to how far we can go down, because a line will tell me that there is a minimum capital requirement we have to hold to keep the rating agencies happy etcetera. So yes there is a limit. I don’t think we’re quite on that limit yet, but in this market, it makes perfect sense to us just to have less exposure on our books.

And if you look at our industry, we believe that the people that have made it through the tough cycles have effectively taken on all their risk of their own balance sheet and given it to someone else and obviously you can do that. You’ve come up with business or you can buy more reinsurance where company buying more reinsurance. You just going to be risking by the market you’re in. Now is not a time to be taking bigger net positions dumping reinsurance cover, now the chance to be buying more reinsurance cover and bringing your exposures down.

Elaine Whelan

I am not sure why I always get the blame for everything [indiscernible]. And in terms of, let me start with the capital return. We do have RSS awards that we need to deal with. We also have a depleting stock of treasury shares. And I think if our share prices are in the 1.2x level, then we’d be quite happy to buyback at that level to make sure that we build our back up to deal with those awards. There is also the awards overhang, so that’s more likely to be dealt with by share issues rather than treasuries stock given the size of the holdings in there.

And as far as the hedge fund goes, and really isn’t dabbling if we’re much more comfortable with the volatilities in market, and the moment it’s reduced from where it was. And as you can note the equities was a much more volatile time and the hedge fund allocations should give us a little bit more income, but there is also there is part of our risk management strategy in terms of taking the rest of our portfolio, and on the interest rate risk that us and most of our peers will be facing at the moment.

Tom Dorner – Citigroup

Okay. Thanks.

Operator

Okay. Our next question comes from Olivia Brindle of Deutsche Bank. Go ahead madam. Your line is open.

Olivia Brindle – Deutsche Bank

Hi there. I’ve got three questions. Firstly, on the accident year loss ratios and you said that’s just over 39%, which is a bit high actually. Are there any adjustments that we should be making to that, or if not, does that reflect a trend, how should we think about that number looking forward? Secondly, on the top line. Elaine, you mentioned that you’d expect for 3Q and 4Q maybe a modest decline in premiums, I guess at the gross level. Given all the different movements you’ve had on the reinsurance buying side, just wondering if you could help us to work out how to think about the net to gross ratio. Were there any particular changes we should be factoring in on that side? And then finally, on the expense ratio. I think even if you take out some of the remuneration costs that you mentioned, it still looks a little bit high including on the acquisition cost side of things, again just wondering if there is anything we should be extrapolating on that front? Thank you.

Elaine Whelan

Okay, sure. You’re talking about the lumpy quarters. We do get lumpy quarters. It’s the nature of our business. 39% is probably a little bit higher than I would class normal attrition at. And I think if you look at the year-to-date ratio, it’s been 34%. And that might even be a little bit in the punchy side, but it’s little bit of more reasonable place for your forecasting. And it is just a reflection of where we are in the market cycle.

And in terms of third and fourth quarter premium, you heard about the pricing I think in our property cat premium will come down a little bit. You’ve also have the political risk as lumpy and things compared to last year, we had quite a bit jump in there for the second half of the year, so that might come up a bit. Maybe the main things changes but I would see an overall good.

In terms of our full year premium earnings, I don’t think they would be that far removed from where they were last year. There is obviously the Cathedral premiums coming soon as well that will just got up a little bit. So I think if you adjust this for those two lines of business, you’re probably going to get something that’s fairly sensible.

And in terms of the expense ratio, the amortization charge that we have is a big part of that, and it isn’t everything that’s in there. There are also costs in there for KCM. And I think we’d be focusing on the underwriting income and proper commission potential that – Darren is also playing expensive to have around. So we have to pay for him and some legal fees. And also aside, there is a slightly different structure from what we’ve done with our vehicles before.

We pick up all the costs for the vehicle and charge back as appropriate, so we need to cover that so you will see a higher G&A coming through from that, but its offset – more than offset by the underwriting fees that we get.

Olivia Brindle – Deutsche Bank

Okay. So just to clarify on two of those things. So 34% accident year is probably where your run rate more or less at this point in the cycle? And then just on that expense ratio point. If we adjust for the one-offs from compensation, that’s the kind of run rate we should be looking at, is that right?

Elaine Whelan

Yes, I think so.

Olivia Brindle – Deutsche Bank

Okay. Thank you.

Operator

Okay. Our next question comes from Ben Cohen of Canaccord. Go ahead sir. Your line is open.

Ben Cohen – Canaccord Genuity

Hi. As most of my questions have been asked, I just wanted to ask in terms of sort of new business and specifically, you have the new team coming on board. I just wonder where you are with discussions with any other people, and whether there are opportunities in the market in terms of new hires? And maybe secondly, also you said that Lloyd’s has approved the business plan for the new lines. I just wonder if you have any early view in terms of their view towards your capital requirement going into 2015 when – now that the business will be better bedded down together? Thank you.

Alex Maloney

Well Ben, I’ll just make a general statement and then I’ll hand over to Pete. We are always open to business for new underwriting teams. It’s hard to find top quality people, which is why we are so delighted to get the aviation war guys. So we’re always open for new teams, but in this market unless we can find the absolute leaders in any cost of business, we won’t even entertain it, because the market is difficult pretty much across every line of business. The very best people will make you money in this stage of the cycle. So we’re interested in those, but to have any grand plans or strategic views on entering lines of business just because you need to or because you’ve got huge expenses or guys out of control and this market is quite. So yes, we’re always open for business.

We do have people knocking our door whether that’s Cathedral, Kinesis or Lancashire quite a lot. We have – you think about those guys you took from Atrium, that’s really the only reason we got them was because Atrium as an entity was sold. So we’re benefited from M&A and we expect to see more of that in the market. So I’ll hand over to Pete now.

Peter Scales

Well, the new teams come into two pieces. There is obviously the aviation war piece which we’ve spoken about to get the focus at the moment. We also have second team who are the market lead of equal preeminence in helicopters and GA market who live in Lloyd’s who going forward will produce a bigger income as slug than the aviation war line which we would be take to our balance sheet, because the aviation war guys will also operate a consortia followed by other Lloyd’s markets, which will put up effectively 60% or 70% piece of the line going forward.

Both of those areas are tremendously excited, the guys are very excited to be here. They’ve worked very hard. The two team leaders are both from their garden, so I will not let too far at the moment, but the two deputies have done a fantastic work in getting through the Lloyd’s approval process.

As far as the capital setting goes, which goes hand in hand, we have supplied multiple business plans, i.e., one for the shank end of ‘14 and one for ‘15. As far as the capital at the moment is we – Lloyd’s aren’t really interested in the capital charge, because we have some ongoing solvency credits that look only our funds at Lloyd’s. And they are happy to basically take that to go forward and do an assessment in the ‘15.

We haven’t had our ‘15 funds at Lloyd’s confirmed on our business plans, so that drops another month or so down the line. However, because Lloyd’s franchise board do recognize these guys that at all, they are preeminent market leads in a dislocate and typically very much London market Lloyd’s business. They’ve been seeing to as long as they’ve been through the proper hoods, help get the people back in the market because the marketplace has been lacking some leadership in the lifecycle going forward. And there is a value in people this will cause it.

So going forward – and again it’s probably a next quarter question. We’ll be more stabilized. We will be through the planning process and signed up by Lloyd’s on the capital side, but within that, it’s quite hard to tell whereas Lloyd’s is a black box environment. We, from Syndicate levels will calculate our own capital and that will be improved under Lloyd’s guidelines. And then that may plug into the corporate member, where there is some sort of diverse location between the classes of businesses within it, and that’s not a calculation that’s visible to us when we get it.

So we suspect, we will get a reasonably good bang for a buck in terms of any additional capital versus additional business coming in, but even though they are serious market leaders in areas where there has been a bit of a dislocate. Moving forward, it is very much a greenfield sign that need to build out again, and they will take probably a year or two months to get the books back up to where we want to do them or depending on where the market says. But at least we are in a position where we have the market lead, the brokers are very keen to getting back to the market and we have no aggregate in position.

Ben Cohen – Canaccord Genuity

Okay. Thank you very much.

Operator

Okay. Our next question comes from Joanna Parsons of Westhouse Securities. Go ahead. Your line is open.

Joanna Parsons – Westhouse Securities

Thank you. Actually most of my questions have also been asked, but perhaps we could just touch a little bit on the energy loss deteriorations that you’ve had in the previous quarters, just what’s causing those? Is it a trend that one should expect to see on a regular basis?

Paul Gregory

Hi, Joanna, it’s Paul here. As we’ve spoken about before, energy losses can be complex. Up until recently, we haven’t had a huge amount of deterioration. We have had a couple in a row, while we had the one we announced last quarter as Elaine mentioned has improved quite significantly this quarter. It’s not a trend that we would expect to continue. It is a very complex area of insurance and the claims that we see can take a little while to manifest sometimes.

So while it is disappointing to get one, it is the nature of what we do. We have not a huge amount in our history. We just had a couple in row.

Elaine Whelan

Yes. And I think I would answer that. There is quite a bit of moving around within some accident years, but overall for the quarter we’re still favorable. And our overall reserve balances remains good, remains strong.

Joanna Parsons – Westhouse Securities

Okay. Thank you.

Operator

Okay. Our next question comes from of Chris Hitchings of KBW. Go ahead sir. Your line is open.

Chris Hitchings – Keefe, Bruyette & Woods

Thanks very much. Chris Hitchings here. Couple of things, couple of questions. One, it may be that I’m just stupid or too old not to give up, but the – can you just tell me how much of the cost of Mr. Brindle’s departure fell through the P&L account and how much went through the equity in dollar terms? Secondly, what is the position with Mr. Brindle around the non-compete clause, i.e., when is he technically able to set up? Thirdly, just can you – I know there is a lot of – I know it’s very early days, but can you give us some help as to what we owe to have in forecasts for the third quarter events, so far the aviation ones, just give us some help, orders of magnitude. I’m finding it rather confusing at the moment. Thanks very much.

Alex Maloney

Chris, Elaine will do one and three and I’ll do two. Start.

Elaine Whelan

Sure. If you have the press release handy, then it’s probably easier to just explain the numbers in that to you. The salary and benefits costs of $1.8 million is there. I think the statement charge and that goes into other operating expenses. The RSS costs of $8.2 million on dividend equivalent that relates then to $1.6 million. They both go through shareholders equity.

Chris Hitchings – Keefe, Bruyette & Woods

So $8.2 million and $1.6 million are both shareholders equity?

Elaine Whelan

Yes. And the $1.8 million is income statement. And those the numbers combined impact ROE for the quarter.

Chris Hitchings – Keefe, Bruyette & Woods

Yes, okay.

Elaine Whelan

The last number that’s in there is essentially an accounting charge, acceleration of IFRS 2 charges. So although it goes through the income statement and the equity comp lines there, it goes the other side, it goes to the shareholders equity. So it’s out of the initial.

Chris Hitchings – Keefe, Bruyette & Woods

Fine. Sorry, but there is a debit to profit and loss account?

Elaine Whelan

Yes.

Chris Hitchings – Keefe, Bruyette & Woods

And a credit too. So there really was – so what’s the actual negative impact on the P&L account? It’s $1.8 million plus this accounting charge?

Elaine Whelan

It is. The negative in the P&L is $5.3 million. The negative to ROE is $1.6 million [ph].

Chris Hitchings – Keefe, Bruyette & Woods

Fine. Okay. That’s fine. Thanks very much indeed. Okay, and for 3Q cuts or competition for Mr. Brindle?

Alex Maloney

Yes, sure Chris. Richard is by the terms of his contract, he cannot do anything between now and the end of the year. Technically he could start a new company on the January 2. I think that may happen, it may not. I would be surprised in this market. So Richard has got a fantastic brand name. I am sure he could get capital in this market, how do you get the business, how do you get the right underwriters. I think it could be very, very difficult.

Yes, I mean that he could start up in the January 2. I’ll be honest to you from our point of view, we have to compete with so many people everyday anyways. It’s just not another person out to compete with. And we’re going to have to stop that and I am very relaxed about to keep people we have. Yet he could start with take January 2 to in this market.

Chris Hitchings – Keefe, Bruyette & Woods

And the 3Q cut?

Elaine Whelan

Yes. It’s a little bit early to put any numbers around it. And Cathedral’s reinsurance program will look [indiscernible].

Operator

Sorry, I am just going to mute your line Chris whilst the answer is being given. There is a bit of background noise that’s cutting the line of speakers.

Elaine Whelan

Yes. Again just to repeat that, the short story is we’re not expecting anything that’s new at this stage.

Paul Gregory

I mean we can help, if you’re worried about the big aeroplanes Chris, both the Malaysian Airlines are pretty much the same thing liability one on the second maybe higher than the first who knows, we don’t know about that. Both of the numbers were the same ones we would last time which is on a 100% Cathedral basis. It will be about 5.8 million bucks net before you could get into the program, but Lancashire of that is only 58%. They also – I don’t know how much cover do we have basis, we renew that program which I think we did the 16% saving at 1/7. And so it drops across two different programs as well.

So there is tons of cover we still have in place in the future. The only other piece we’ll have in aviation airline will be on the reinsurance side. We have a small amount of war XLs [ph] and again there isn’t much clarity on what’s happened in Tripoli, the quiet weather falls in the reinsurance side of that. As now is closed in the contract for 24 hours and there will be the usual shenanigans of how many events that was. And you frankly are a brave man to go and have a look right now to see which shenanigans stand behind the various losses been there.

So I will come back to you on that but again none of this is, as Elaine says is anything to really worry about, and it’s definitely manageable in the context of the account.

Chris Hitchings – Keefe, Bruyette & Woods

Thank you.

Operator

(Operator Instructions) Okay. So we have one further question. That’s from Will Hardcastle of the Bank of America. Go ahead sir. Your line is open.

Will Hardcastle – Bank of America Merrill Lynch

Hi there guys, Will Hardcastle. Just a quick one. Could you just mention again what [indiscernible] on the finance costs and the deferred tax [Technical Difficulty] Thanks.

Elaine Whelan

Sorry Will, we find it really hard to hear it. Could you say that again for us please, maybe speak about…

Will Hardcastle – Bank of America Merrill Lynch

Yes. Could you just repeat what you said on the finance costs and the deferred tax please? My phone broke up at that point.

Elaine Whelan

Yes. On the finance costs, our debt in the LTE [ph] are running the low cost are going to be $4 million, it’s subject to interest rate obviously, but there are $4 million this quarter. So that’s kind of ongoing cost.

Will Hardcastle – Bank of America Merrill Lynch

Yes.

Elaine Whelan

And the rest of it is mark-to-market on the interest rate swaps that we have in the Lancashire subordinate to debt. So you get some volatility off of that, but the underlying trend is $4 million plus that movement.

Will Hardcastle – Bank of America Merrill Lynch

Okay. And you mentioned something on the deferred tax, obviously not on tax gain. Did you say it was next year is the last year you – next quarter is the last quarter you expect it to happen?

Elaine Whelan

That is right. There is a deferred tax liability that relates to that and the intangible asset has the finite lines to be amortized out. That’s done by the end of next quarter. So it should make our tax numbers look a bit more sensible.

Will Hardcastle – Bank of America Merrill Lynch

That’s great. Thanks.

Operator

(Operator Instructions) Okay. So there is no further questions coming through. I’ll hand back to our speakers for the closing comments.

Alex Maloney

Okay. Thank you for your questions. And we’ll see you next quarter.

Operator

This now concludes the conference call. Thank you all very much for attending. You may now disconnect your lines.

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Source: Lancashire's (LCSHF) CEO Alex Maloney on Q2 2014 Results - Earnings Call Transcript

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