Validus Holdings' (VR) CEO Ed Noonan on Q2 2014 Results Earnings Call Transcript

Jul.25.14 | About: Validus Holdings, (VR)

Validus Holdings, Ltd (NYSE:VR)

Q2 2014 Earnings Conference Call

July 25, 2014 10:00 ET

Executives

Jon Levenson - EVP

Ed Noonan - Chairman & CEO

Jeff Sangster - CFO & EVP

Analysts

Amit Kumar - Macquarie

Matthew Carletti - JMP Securities

Josh Shanker - Deutsche Bank

Ryan Byrnes - Janney Capital

Meyer Shields - KBW

Jay Cohen - Bank of America Merrill Lynch

Ian Gutterman - Balyasny Asset Management

Operator

Welcome to the Validus Holding’s Limited Second Quarter 2014 Conference Call. My name is Christine and I will be the operator for today’s. (Operator Instructions). I will now turn the call over to Executive Vice President, Jon Levenson. You may begin.

Jon Levenson

Thank you. Good morning and welcome to the Validus Holdings’ Conference Call for the quarter ended June 30, 2014. After the markets closed yesterday, we issued an earnings press release and financial supplement which are available on our website located at validusholdings.com. Today's call is being simultaneously webcast and will be available for replay until August 8th, 2014. Details are provided on our website.

Leading today's call are Validus' Chairman and Chief Executive Officer, Ed Noonan; and Validus' Chief Financial Officer, Jeff Sangster.

Before we begin, I would like to remind you that certain comments made during this call may be deemed forward-looking statements as defined within U.S. federal securities laws. These statements address matters that involve risks and uncertainties, many of which are beyond the company's control.

Accordingly, there are or will be important factors that could cause actual results to differ materially from those indicated in such statements and, therefore, you should not place undue reliance on any such statements. More detail on these risks and uncertainties can be found in the company's most recent annual report on Form 10-K and quarterly report on Form 10-Q, both as filed with the U.S. Securities and Exchange Commission.

Management will also refer to certain non-GAAP financial measure when describing the company's performance. These items are reconciled and explained in our earnings release and financial supplement. With that, I turn the call over to Ed Noonan.

Ed Noonan

Thank you Jon. Good morning and thank you all for joining us. I’m pleased to report another very solid quarter for Validus with net income of $153.4 million, a 16.5% annualized return on average equity and 3.4% growth in book value per diluted share inclusive of dividends. Through six months we have generated $316 million in net income, a 17% annualized return on average equity and 8.1% growth on book value per share including diluted share -- book value per diluted share inclusive of dividends. Strong underwriting, the benefit of conservative reserving practices and good diversification between insurance and reinsurance continue to drive our results as Validus posted and an overall combined ratio of 68.6% despite competitive pressures in the marketplace and more loss activity in the market than many may have appreciated, all three of our segments Validus Re, Talbot and AlphaCat performed strongly.

In addition to the results for the quarter we made an important announcement a few weeks ago Validus’s agreement to acquire Western World Insurance Group. Both the Validus and Western World management teams will be working hard to put us in the best possible position to hit the ground running once this transaction closes later in the third quarter. As regards to loss activity, the world’s political turmoil and subsequent tragic loss of life over the past few weeks will directly impact the reinsurance and insurance industry in a number of ways and I will discuss that in a more detail later in the call.

But now I would like to turn the call over to Jeff Sangster, who will talk about financial results in more detail. Jeff?

Jeff Sangster

Thanks Ed and thank you all for joining the call today. The second quarter produced a strong financial results for Validus due to another relatively catastrophe quarter and the continued earnings power of our increasingly diversified global platform. Our second quarter net income available to Validus common shareholders was a $153.4 million or $1.61 per diluted common share. Net operating income available to Validus common shareholders was a $132.6 million or $1.39 per diluted common share. Annualized return on average equity for the quarter was 16.5% and annualized operating return on average equity for the quarter was 14.3%.

Book value per diluted common share at quarter end was $38.55, an increase of 3.4% from March 31, 2014 inclusive of dividends. Speaking in more detail to the quarter’s results of operation and financial position. Total gross premiums written were $655.7 million for the quarter, a decrease of $46.6 million or 6.6% from $702.3 million in Q2, 2013. The decrease was primarily driven by a decrease in the Validus Re segment of $43.1 million or 12.2% over the prior year’s quarter from 353.4 million to $310.3 million.

The decrease in gross premiums written in Validus Re was driven by a decrease in the property lines of $29.1 million primarily due to a reduction in catastrophe excess or of loss treaties and a reduction in the marine mind of $11 million due to non-renewals and a decrease in reinstatement premiums.

Our quarterly combined ratio was 68.6% including a loss ratio of 34.1%. During the quarter we incurred no loss events over the $30 million notable loss threshold. Catastrophe loss is not reaching the notable loss threshold including $15 million from the South Korean ferry sinking and a $18.4 million from an earthquake in Northern Chile.

Net favorable development from prior years was $72.7 million primarily from non-event reserves despite $15.9 million of adverse development from the Costa Concordia wreck. We have once again increased our industry loss estimate to a value of 200 million above the latest reported industry advice. The net favorable development by segment was Validus Re $26.7 million, AlphaCat $3.7 million, and Talbot $42.2 million.

The prior period development benefited the loss ratio by 15.6 percentage points. Accident loss ratio excluding changes in prior accident years for the quarter was 49.7% compared to 55.9% in Q2, 2013. Our gross IBNR at quarter end stands at $1.43 billion which is 49.9% of our $2.9 billion total loss reserve and our net IBNR is $1.26 billion.

Beyond underwriting results I will comment on the AlphaCat contribution to earnings, the quarterly investment results and our capital position. Turning to the results of the AlphaCat segment, AlphaCat contributed $13.1 million to net income in the quarter net of non-controlling interest. AlphaCat’s contribution to Validus is net income is comprised of the following components. Validus’s share of manager fees earned in the quarter by AlphaCat is $4.3 million.

On the AlphaCat sidecars and ILS funds contributed $8.1 million of income in the quarter. This contribution is a combination of income from operating affiliates and consolidated AlphaCat entities.

PaCre contributed $3.8 million in the quarter which includes our share of realized and unrealized gains on the PaCre investments retained by Validus of $3.7 million. Offsetting the above components are expenses incurred by AlphaCat managers of $3.1 million which brings the total net income contribution to $13.1 million.

Our consolidated investment portfolio is $7.9 billion as of June 30th, 2014. Net investment income for the quarter was $21.3 million for a quarterly annualized effective yield of 1.19%, a decrease of 10 basis points from the Q1, 2014 annualized effective yield of 1.29%. Our yield dips slightly this quarter as we broadly reduced our bank loan exposure including selling approximately a $100 million of bank loans to invest in a fund of high grade structured products.

This fund is accounted for on a one month lag thus we incurred a timing difference in the quarter amounting to one month yield on the balance. Duration of the portfolio is 1.67 years at June 30, up from 1.61 years at March 31.

In the quarter we recorded $7.9 million in realized investment gains and $45.4 million in unrealized investment gains on a consolidated basis. Unrealized investment gains were driven by the PaCre investment portfolio which contributed $31.3 million. This is offset by a 90% non-controlling interest of $28.1 million leaving a net unrealized gain attributable to Validus of $3.1 million from PaCre and $17.3 million in total.

Total shareholders’ equity available to Validus at June 30 is $3.78 billion and total capitalization available to Validus at June 30 is $4.5 billion. Debt to capital at quarter-end was 4.7%, and debt and hybrids together as a percent of capital were 15.1%, a marginal decrease in financial leverage for March 31 due to earnings in the quarter.

During the quarter, there were no share repurchases made as we have blacked out for most of the quarter as we finalize the acquisition of Western World. Thus our remaining share repurchase authorization stands at $356.7 million.

As stated in prior calls, barring any unusual events is our intent to utilize this authorization within a year of the February 5th, 2014 announcement date. As we consider our capital position, it's important to note that our net peak zone catastrophe exposures are currently at the lowest level in our history. 1 in 100 U.S. Windstorm PML is 16.6% of total capital excluding non-controlling interest and our peak zonal aggregate is 42.3% of Validus Re capital.

Both of these metrics are well inside our internal limits of 25% and 65% respectively. As our track record is shown we will prudently manage capital while maintaining the capital buffer and flexibilities, pursue market opportunities as they arise.

With that I will turn the call back to Ed.

Ed Noonan

Well thank you Jeff. The market place remains competitive across both insurance and reinsurance, although the competition continues to be more significant in our reinsurance segment. The reinsurance market dynamics are driven both by continued excess supply of capacity as well as some reductions in demand from buyers. Rates are down in every territory and we continue to reshape our portfolio accordingly. In terms of the mid-year Florida renewals the most interesting observation is that the market finally did begin to push back when rate decreases and broadening of terms got too far out of hand.

There were a number of deals which had to be either repriced and there were quotes that were retracted in response to pricing that was acknowledged as insufficient for the risk. This was true for both traditional reinsurers and surprisingly ILS managers.

While their outlier deals, eye popping price reductions make for great headlines. They don’t necessarily reflect the entire Florida market and certainly they are not representative of Validus’s book of business.

Florida has historically being a great price takers market, today it's an underwriters market and that plays to our strength. The ability to access data quality and accuracy through very deep analytics allows us to identify the best risks among a declining pool of attractively priced business.

Our size in the analytic work we do for clients to help them understand that improves their risk attributes allows us to obtain the lines we want the best deals even in a heavily oversubscribed market.

In the aggregate rates were up 13.7% in Validus Re’s Florida portfolio, materially better outcome than the market as a whole. The other issue I mentioned is that the pressure to broaden coverage is being resisted at least by the better underwriters. One very large buyer who thought to include cyber risk in their catastrophe program ended up having to buy on split terms as some reinsurers are sales included were not willing to provide the coverage. The same holds true for the inclusion of terrorism with catastrophe treaties. Typically this coverage can be obtained for regional carriers but larger companies cannot gain full market acceptance and in some cases this too has led to split terms of placements.

Beyond the obvious price issues these throw-in coverages tend to find all the weak spots in reinsurers risk management and they only realize when there are major events. We’re simply not willing to roll those dice.

The marine reinsurance market is also worthy of note this quarter. Based on what we have seen, although rates are declining, marine reinsurance market is the best price class of business during 2014. I base this comment on pure technical pricing metrics. Marine reinsurance rates for the year are down 5% to 10%, but these reductions span the full gamut of haul, cargo and energy and liability.

Within each of these subclasses there are differences, with offshore energy being the most competitive but also the best priced. The absolute in risk adjusted rate levels in the energy market remain high following the deep water horizon in Hurricane Ike losses.

Three remarkably good underwriting years, 2011, 2012, and 2013 have taken some of the fear out of the market and led to increased competition for new entrants some of whom left the market after deep water.

Non-energy marine reinsurance rates are competitive but generally adequate. International property cat reinsurance in Europe, in the UK is competitive with rates of 10% to 15% and some expansion of hours clauses.

As Jeff noted in his comment, Validus has now increase our industry estimate of losses for Costa Concordia by another 260 million above the advice loss. We have shut our reserves assuming the industry loss would increase by $200 million and so this latest advice would have had little if any impact to us.

However given the way the claim settlement process is gone we believe it's prudent to assume that this may not be the last increase to the loss, therefore we have increased our estimate again to assume the industry loss will deteriorate by a further $200 million. Should the loss go beyond that we have a total $20 million of remaining limit across the group.

Moving to insurance conditions for our book and loan are also competitive but less so than reinsurance. Talbot total account rate index is down 4.1% for the year-to-date reflecting a quarter-to-quarter decline of 6/10ths of a percent.

Most classes continue to show rate declines primarily driven by new capacity. Our leadership position in our key classes continues to give us some but by no means complete competitive inflation. The biggest declines we’re seeing in the property treaty accounts and the North America Energy class each of which were off 12% to 13%.

The largest rate gains are in political risk which was up 11% in the month of June. We’re seeing an increasing flow of political risk opportunities as a result of geopolitical turmoil. There is a large flow from Russia and the Ukraine and we’re obviously very selective about these risks but there are some opportunities in those territories.

Other territories that are showing increased demand are Argentina, Egypt and Libya. This class is not for the faint of heart and while there have been a number of new entrants we see them exhausting their capacity rather quickly. Let me talk about the most recent Malaysian air disaster the last few weeks.

The destruction of Malaysian airlines flight 17 will have implications to the aviation and more market. The tragic loss of life will result in a significant payout. This event is the second large loss this year to a market with total annual premium of less than $100 million and I’m referring to the aviation more market. Major airline renewals takes place in the fourth quarter and we expect that these events will have a material impact on aviation rates both war and standard.

Airlines purchase coverage in two different markets, the all-risk market covers the value of the plane and liability arising from a crash. However damage to the aircraft itself arising from acts of war and terrorism are excluded under the all-risk policy and purchased separately in the war on terrorism market of which Talbot is one of the largest players in Lloyd’s.

We had declined the Malaysian airline all-risk policy due to what we saw as an adequate rate. However we do participate on the terror on war coverage which is the source of our claim. We will also pick up some exposure to the liability coverage to our treaty account. Our preliminary estimate of net loss for the Validus Group arising from this event is likely to be in the area of $15 million. There was a second very large loss in the aviation war market over the last few weeks arising from the damage to aircraft and infrastructure at the airport Tripoli from the ongoing civil insurgency in Libya.

Our preliminary estimate loss from this event is in the $15 million to $18 million range primarily from our treaty account. There is an important story behind this claim, as the leader of a major aviation war line slip in the Lloyd’s market, Talbot had declined to write the key account involved in this loss. This loss will generate 100s of millions of dollars to the line slip. Talbot will pick up a small loss from some private aviation that was damaged in the event, but we avoided the big market claim.

As in the Westgate Shopping Mall attack in Nairobi last year discipline around pricing and terms and conditions caused us to avoid a large market loss. We view this underwriting discipline as the antidote to market subscription deals that accept risk blindly based on everything a broker places in the market. If you’re looking for differentiated performance arising from active and prudent underwriting these are two perfect examples.

While our war on terrorism account remains on track to generate good returns for the year, there are very few if any other underwriters that are in a similar position. We expect to see rate rises in the war on terror in aviation market as a result of these claims. There is nowhere near enough premium in the market to sustain these events. Additionally the all-risk aviation market should have just hit the bottom of it's pricing cycle and we expect major airline renewals in the fourth quarter to reflect this dynamic.

Finally we do not expect to have materially losses from either of the two commercial aviation losses this week in Taiwan and Africa.

One of the key contributors to our results this quarter is the favorable run-off of our business written in prior years. It's an unusual quarter and that both Validus Re and Talbot were relative peaks in terms of favorable development. However there was no change in our reserving practices and our reserve position remains at the same level relative to indications even after having seen this strong favorable development.

Jeff mentioned our inability to be in the market repurchasing shares during the quarter as a result of the Western World transaction. While that was terribly frustrating given where our shares are trading, we continue to believe that returning excess capital to our shareholders is critical to our success as a company. We fully expect to complete the current authorization within the timeframe we originally described.

The acquisition of Western World is an exciting move for us and we expect that we will close the deal in the late third quarter. Since announcing the acquisition everything we have seen reinforces our original thesis. This is terrific company with a high quality committed management team and a unique niche. We’re absolutely convinced that the ability to offer our short tail products will reinforce the existing Western World brand and business while giving us broad access to U.S. wholesale distribution.

Western World’s previous owner had a limited risk appetite. With Validus’s greater willingness to take risk where we see attractive prices we believe the company can really flourish. Western World will continue shift Validus from it's origins as a short tail reinsurance writer to a more diversified writer of short tail insurance and reinsurance.

The contributions from both Talbot and Western World will account for 51% of Validus’s total gross premium written being in the insurance sector as measured on a pro forma basis for 2013.

We have long believed that we need the flexibility to take risk that meets our written criteria in whatever form it's presented. Overtime our mix will shift based on the relative attractiveness of reinsurance versus insurance.

As we detailed in our call a few weeks ago our plan is to focus on short tail growth at Western World. Some of the more recent Validus initiatives notably the expansion of our property team in London are directly transferable to Western World once the company is formally part of the group.

We believe that there are very good niche opportunities in the U.S. market that play to our analytical strength in natural terror risk. There is also a great deal of business that fits Talbot’s appetite but never makes it to London as it's fully placed in the U.S. market. The combination of new products, adding value to Western World’s existing relationships, the expansion of our Talbot class of business and astute capital management should allow us to generate attractive returns on our investment over a reasonable time period.

While we’re awaiting closing we’re working closely with management on the steps needed for integration as well as post-closing strategy. We’re limited in what we can do until closing, but we’re extremely confident that our ability to quickly and efficiently assimilate Western World into the group. In closing our business model is working well and our performance in a difficult, competitive environment is very encouraging. We head into win season with an excellent first six months behind us and in an extremely well-constructed portfolio including the most comprehensive protections we have ever used.

So with that we will be happy to take any questions you may have.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Amit Kumar from Macquarie. Please go ahead.

Amit Kumar - Macquarie

Two quick questions, the first question is on the discussion on capital position. I’m kind of wondering can you sort of talk about the potential upside to the number which you had, I think you mentioned 356.7 million. If you don’t have any major cats in Q3 and Q4 would it be fair to say that there would be an upside to the number just based on the market conditions anticipated at 1/1/2015.

Ed Noonan

Yes absolutely when we think about our capital position and when we layout our share repurchase authorization for the year, we consider obviously when our budgeted income is for the quarter and that includes our cat load which is heaviest in the third quarter. So obviously if there is a relatively clean third quarter and fourth quarter in terms of cat losses then, that would increase our excess capital position and we would reconsider that as we get through the upcoming months. In terms of looking at Q1, as we have expressed in the past our cycle around setting, our excess capital position and enhance the share repurchase authorization for the year, really starts as we budget and we’re in the early stages of that budgeting now, go through that through the fall and looking at 1/1 and what we expect to write-up 1/1 and then really firm that up early in the early usually at our February Board meeting and once we have a better sense of what the 1/1s look like.

Amit Kumar - Macquarie

I guess the only other question I have and just sort of blends into what Ed was talking about in terms of the push back and in terms of pricing. In isolation what impact on loss ratio did the decline in property cat rates have on your book? One of the other underwriters mentioned 1 to 2 points. So I’m wondering what you saw in your book?

Ed Noonan

Yes actually we’re generally in-line Amit -- we think that the decline in rates across entire portfolio will amount to roughly 2 points in deterioration and the loss ratio. You’ve to look at change in rate but also the reshaping of the portfolio that we did on the assume side as well as the benefit of outward retrocession. So it's all a projection based on our pricing but 2 points is probably a pretty good proxy.

Operator

Thank you. Our next question comes from Matthew Carletti from JMP Securities. Please go ahead.

Matthew Carletti - JMP Securities

I just wanted to follow-up on your comment about how I guess the market did seem to find it's pain level and push back on a handful of renewals at the June renewal and I think we have seen now in some of the publications and that might happen at July as well. What’s your take on what’s causing that? Is it just the magnitude of the change? I know your book fared better but the down 20, down 25 and just that magnitude some people just drew the line. Was it more terms and conditions that throwing in a cyber or other things are extending hours clauses was what triggered it? Or do you think it was more just absolute technical rate levels that we got to a certain point and I guess what I’m trying to get at is reading forward to kind of next year if it's what implies for magnitude of direction. Thanks.

Ed Noonan

Yes. It's a great question Matt. And you have to bifurcate. Florida, the push back was almost entirely around ridiculous rate decrease expectations. The whole quoting process in the market has broken down. Instead of brokers canvasing canvassing the lead reinsurers and getting their indications on price and what it will take to clear the market, brokers are having pretty cursory conversations and they and the clients are simply coming to market with what they think the terms ought to be, and the price ought to be and so you do have some who frankly just got carried away. I think reinsurers are pushing back around that price, catastrophe risk does have a capital charge associated with it and that’s inviolable.

The rating agencies hold you to it and so you can point to a level of what you say this far no further. That doesn’t suggest that every deal from here forward will be renew as is or an increase but I think as we get closer to whatever a bottom in the market is you start to find accounts where more selectively underwriters are going to say, gee, this one the rate is too cheap, doesn’t fit my portfolio, not interested in participating.

So there is, I think that discipline in the marketplace. As far as terms and conditions that’s bit of all over the place. Cyber risk is a great example, reinsurers can’t simply take on cyber risk and cat covers. If you think of the accumulation that you would build up from untold sources and you know the coverage is still so new in the market it belongs in the specialty reinsurance product not just getting thrown into the cat product.

So to us that was kind of a buyer being very, very opportunistic, almost to the point of offence and we simply said no, not willing to do it as there are number of other reinsurers and they ended up having to do the placement on a split basis.

The same thing with terrorism, for regional companies you know if you’re a mid-western regional company with no major urban concentration -- yes okay, terrorism can be covered, it has to be charged for but it can be covered in the cat program. But when you have large company, some multinational companies coming into the market saying, yes, we’re going to include terrorism in the cat program. It's frankly ludicrous to think that reinsurers can take on terrorism risk in a standard cat product. You build up these concentrations in major urban centers to quickly use up all of your terror capacity. And so it's frankly it's a crazy way to do it and I would also note that for the buyers that’s a terrible way to buy terrorism coverage.

The cat treaty is not designed to respond to terrorism events the way a true terrorism coverage should be. So again that’s just opportunistic buying and we’re not offended by it we just refuse to go along with it, as do a number of other underwriters.

So I don’t know how that will play out. Whether that pressure will begin to evade or not but there is I guess different reasons around it.

As far as forward rate, we don’t really make predictions and I think I said in the fourth quarter call last year I thought the market was starting to find it's bottom and the market clearly proved me wrong. So I won't make any prognostications but you know the trend line we’re feeling somewhat better about at this point this year that we did last year and we will just have to see how it plays out.

Operator

Thank you. Our next question comes from Josh Shanker from Deutsche Bank. Please go ahead.

Josh Shanker - Deutsche Bank

I want to congratulate you probably once again on getting Costa Concordia right before a lot of people did. But you still seem high on your number and we have gotten down to the point where the boat is sailing again, what are the chances that you mark your books too high?

Ed Noonan

It could be. It really could be. I mean sensibly we’re nearing the end of this three hour cruise.

Josh Shanker - Deutsche Bank

Three hours?

Ed Noonan

Well it's kind of like SS Minnow right, the way the whole thing has played out. The claim settlement process in this has been politely described as a debacle. The political influence over the process has been played to the loss 100s of millions of dollars and without pointing fingers at anyone I don’t think anybody in the industry would say this was our finest moment in claims settlement.

So the Italian government has continued to make demands, the final one towing it to Genoa at a cost of $80 million more than the original plan to tow it to Turkey and cut it up. So I don’t know when we get to Genoa, will the Italian government decide that we need to move the port slightly to the left and that will increase the industry loss, it could happen.

We just at this point are saying we keep seeing this movement on the claim, we would rather be proven wrong because we’re too high and hopefully that will turn out to be the case.

Josh Shanker - Deutsche Bank

One other thought, you know obviously we see what you’ve done with your PMLs. When we are thinking about midsized cat disasters, the $10 billion storm and things like that, to the extent that you bought retrocessional protection and that your total premium complex has a lot of investor participation there? If I think about the impact of a $10 billion storm call it in the pre-Validus – call it a ’04, ’05, ’06, ’07 to now. To what extent is that a significant deal from a P&L standpoint and how has that changed over the last couple of years?

Ed Noonan

It's much less of a big deal from a P&L standpoint for few reasons. Firstly we have significantly higher retentions by customers and that just takes a lot of loss out of the market. It obviously also matters where that $10 billion claim is. In Florida there are lots of people who write quota shares, we don’t but lots of people who write quota shares and so $1 goes into the reinsurance market whereas in much of the exposed coast line you don’t have that phenomenon and so it's all excess of loss with client retention absorbing dollars before it gets to the reinsurance market.

So it's less of a big deal, you’re also able to buy protections in the retrocession market at rather low attachment points these days. And so the claim will be vertically spread right at into the retro market at a pretty early point relative to 2004-2005 and so I think for the reinsurers there is probably better protection on the frontend and customers and the ability to obtain better protection on the back side of the loss from retrocession and therefore those small events probably have meaningfully less impact on the reinsurance community than they would have had 2004 - 2005.

Operator

Thank you. Our next question comes from Ryan Byrnes from Janney Capital. Please go ahead.

Ryan Byrnes - Janney Capital

I just had a couple of quick questions, the first one on the Talbot segment, I guess also with Western World going forward, would you guys ever think about ceding more business there obviously with reinsurance rates becoming more favorable. Is that something that you guys would seek to do in the near term?

Ed Noonan

I’m not sure I understand your question, could you ask it again?

Ryan Byrnes - Janney Capital

Yes sure. Would you guys look at potentially ceding more business from your insurance segments be it Talbot or Western World going forward just because of reinsurance pricing being so favorable in terms of being able to purchase it.

Ed Noonan

Absolutely. Undoubtedly, right now the market dynamic tends to favor the buyer in the reinsurance market. As a big seller of reinsurance and a big buyer of reinsurance, we observed that phenomenon and so any time the arbitrage is in your favor you have to take advantage of it. We certainly did that in our retrocession purchases, we did it in our reinsurance buying for the Talbot insurance account and we will certainly do that in the Western World account.

We’re fairly agnostic, the idea is to wherever we can get well-priced risk we want to be able to accept it and wherever we can find people who are willing to take risk off our hands for less than what we see is the price because of different cost of capital, we’re more than happy to cede it to them.

Additionally on Western World, obviously part of the attraction of that transaction is for us to be able to provide capital to the Western World from the Bermuda parent, so that is clearly part of the plan in the Western World transaction.

Ryan Byrnes - Janney Capital

And then just quickly one another clarification one, you guys had noted reinsurance pricing was potentially deteriorating the underlying loss ratio by two points and is that two points impacted now or is that two points when all these pricing -- when the current price decrease is earned through. I just want to see if it's two now and guess potentially worse later or is it two points later?

Ed Noonan

It's not the exact time to come up with that number but that’s -- we’re seeing it heading towards that two points might not be quite there yet but that’s our estimate, kind of the impact on - especially Validus Re loss ratio where it's being most significantly felt.

Operator

Thank you. Our next question comes from Meyer Shields from KBW. Please go ahead.

Meyer Shields - KBW

Ed, with regard to Western World is there -- I’m trying to understand what the plan is for the lines of business and longer tail lines that Western World currently writes. Are you planning on keeping that steady, growing it, exporting it to other Valdius’s offices?

Ed Noonan

Western World currently writes -- what we think of it is kind of a mid-tail casualty book. They write very small police limits, $1 million police limits for the most part and it's a general liability predominant book without heavy products manufacturing. There's no pharmaceuticals and medical devices and all that. So it has low volatility plain-vanilla liability portfolio as you can find. They are very good at it, they have got a 50 year track record of excellence in it and so if with the addition of Validus’s product that allows them to grow that business we’re more than happy to see that happen. We think that’s a key part of the Western World brand and skill-set.

So no plans to shrink it, management at Western World is very disciplined and we know from our conversations where they see areas of the portfolio they are performing where they want, they take corrective action just as we would hope and so if the portfolio can expand in attractively priced areas we’re happy to see that happen.

Meyer Shields - KBW

You mentioned cyber risk is something that buyers are or try to be aggressive on. Can you compare the standalone cyber reinsurance market with standalone terror in terms of how evolved these markets are?

Ed Noonan

At the risk of potentially embarrassing myself I don’t think there is much of a standalone cyber risk market. The product is so new, we have lots of conversations with people and there are some reinsurance deals here and there that cover cyber risk. Often times just on a quota share basis with the original writer of it. There are relative few companies actually providing the coverage directly and so not much of a reinsurance market there. The terrorism reinsurance market is more evolved, it's not a huge market but I think the distinction I would draw is that the terrorism market actually has a product that is designed to respond to terrorism events with very clear wording and language targeted to those events. So the buyer knows what they are getting and can buy what they seek. Just throwing terror into a cat contract doesn’t accomplish any of those things. And so the buyer ends up with a lousy product and the reinsurer ends up with exposures they probably would be much better served writing on a standalone basis.

But the cyber market is still in it's infancy.

Meyer Shields - KBW

And Jeff real quick, are the third quarter aviation losses, are those basically in Talbot’s specialty?

Jeff Sangster

There is a bit of a split, most of the war is sitting for Malaysia. It will come from Talbot. However, the Tripoli airport situation is more sitting in Validus Re.

Operator

Thank you. Our next question comes from Jay Cohen from Bank of America. Please go ahead.

Jay Cohen - Bank of America Merrill Lynch

I guess first I’m going to follow-up on earlier question, on your retro buying can you talk about where that kicks in? What your retention would be? It may vary by type of risk, I’m sure but is there any details you can give us on that?

Jeff Sangster

Yes. So Jay, the retro we bought this year is aggregate UNL and truly worldwide, so a much more comprehensive program than we have ever been able to buy in the past at a very similar dollar spend. So very happy with that. By and large just kind of as an example, what we have is a $400 million that attaches it to $250 million with a $25 million per event deductible. And so once we get into that, above that $250 million point any additional events will -- we take $25 million net and the rest will go to the retro program.

Jay Cohen - Bank of America Merrill Lynch

On AlphaCat, what kind of demand are you seeing from investors for the products you’ve to offer?

Jeff Sangster

The interest in that space continues to be extremely strong. There is probably across the industry, there is probably more investor demand than there is supply of business to feed that demand. If you take just simply the growth in the ILW market but then in addition to that the hedge fund reinsurance concept that is just emerging but lots of interest there. So yes I think it's fair to say that there continues to be significant investor interest in that space.

Jay Cohen - Bank of America Merrill Lynch

And should we expect this to be a growth area for you?

Jeff Sangster

If you look at our assets under management and specifically the third party over the last year, we have grown our AuM at AlphaCat by over $200 million and that continues to tick up and so we would anticipate that level of increase to continue.

Jay Cohen - Bank of America Merrill Lynch

Just a comment. I’m not surprised to hear Validus has refused to cover cyber liability, what surprising is that anyone would do that based on what I know about the business, pretty surprising.

Ed Noonan

Put on your underwriters

(Technical Difficulty)

Operator

Thank you. Our next question comes from Ian Gutterman from Balyasny Asset Management. Please go ahead.

Ian Gutterman - Balyasny Asset Management

I have I guess few numbers questions. First Ed, I chuckled a little bit in a good way but when you talk about how attractive the marine reinsurance market is and then I looked at your gross written premiums for the quarter were zero. So I figured you loved it so much you didn't write any of it. So I assume there is a better explanation that maybe Jeff can give me but--

Ed Noonan

Actually it's very attractive but we’re just not very good at it apparently that way. The marine reinsurance market, most of what we write gets written in the first quarter of the year. There is a few deals that come up later in the year but the vast majority of what we write gets written in the first quarter and I was really, the reason for making the comments is that there was a report put out by some independent party, one in a couple weeks ago suggesting that the marine reinsurance market was in a free fall and that the direct haul market was in free fall and all that. And that’s just not our experience and so I wanted to kind of highlight that to the contrary particularly as regards to offshore energy, marine reinsurance is still a very attractively priced class.

Jeff Sangster

Ian, in respect to the specific numbers, if you’re comparing to the Q2, 2013 numbers and the premium written, that number is primarily driven if you recalled a very big increase in cost in Q2, 2013 and so that’s primarily reinstatement premiums which kind of supports Ed's comment that actual premium written in the quarter is very minimal.

Ian Gutterman - Balyasny Asset Management

And then a similar question on the property re. Net premium was up double digits -- down about 10% gross. I would have thought given the trends in retro, it would've been the opposite way. So, why did net premium grow so much in property re?

Jeff Sangster

Yes Ian, that’s just really a timing issue. Historically we had bought most of our retro in Q2 and this year we bought almost all of it in Q1. And so if you flip the page 16 of the sup, the six month we -- our premium ceded for Validus Re was a $173 million this year.

If you blackout the 35 million of ag premium that we ceded last year, the total for 2013 for the six months was a 178.3 million. So the number is relatively similar on the six months basis. Though as we mentioned earlier I think we believe for that dollar spend we have got a much more comprehensive program but then moving back to the three month you will see that the split on that is very different whereas of that 173 million for the six months only a little over 30 million was written in Q2 this year whereas of about 87.5 million of that was written in Q2 last year.

Ian Gutterman - Balyasny Asset Management

I guess the next one when you talked, Ed, about two points profitability drag on the loss ratio from lower pricing. Should I assume there is also an expense ratio impact just if we’re getting less premium for the same amount of work, still the same number of employees, the same number of offices and do we get a little bit of pressure on the expense ratio too?

Jeff Sangster

Yes, that’s a straightforward mechanical calculation and you are exactly right. As rates come off or we decline and get off business we write less premium and hence we’re amortizing the fixed expenses over a smaller base.

Ian Gutterman - Balyasny Asset Management

And then last one, any -- just on the couple of the cats in the quarter. Well first you didn’t mention any tornadoes. Was that just because they're too small to matter, or did you not pick any -- I know a few other people picked up some bits and pieces.

Ed Noonan

Yes kind of small single-digit millions. Nothing to -- worthy of discussion.

Ian Gutterman - Balyasny Asset Management

And then the Chile, a number of people have mentioned that. What size industry event was that? I guess I was under the impression that that was pretty sized, surprised it's sitting in everyone’s cat covers.

Ed Noonan

Yes. The industry loss size is about $450 million we’re estimating of that.

Ian Gutterman - Balyasny Asset Management

Okay. And that's enough that -- I mean, I think we have already got 50 million to 100 million reported just from few companies or probably getting into maybe half of it being reinsured by the time everyone reports, does that sound right?

Jeff Sangster

Well there is really two pools of buyers in Chile. You’ve the big international companies, the Allianzes, and Zurichs, et cetera., who have local operations and this isn't getting to their cat programs. But the local companies tend to buy -- the local Chilean companies and Latin American companies are smaller and tend to buy either very low attachment catastrophe covers or pro rata reinsurance. And so that's why I think you’re seeing more of it come into the reinsurance market. There is more proportional reinsurance purchased and cat covers attach lower.

Operator

Thank you. We have no further questions at this time. I will now turn the call back to Ed Noonan for closing comments.

Ed Noonan

Well thank you very much and thank you all for taking the time to join us and for your interest in the company. We have spent a lot of time talking about aviation losses this morning and sometimes we get very focused on the numbers just express our most heartfelt sadness to the surviving family members of all those lives lost in the various crashes. It's more than financial event. And so with that we look forward to talking to you after what will hopefully be a quite wind season. Thank you.

Operator

Thank you. And thank you ladies and gentlemen. This concludes today’s conference. Thank you for participating. You may now disconnect.

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