XL Group CEO Discusses Q1 2011 Results - Earnings Call Transcript

May. 5.11 | About: XL Group (XL)

XL Group plc (NYSE:XL)

Q1 2011 Earnings Call

May 04, 2011 8:30 am ET

Executives

David Duclos - Chief Executive of Insurance Operations and Executive Vice President

David Radulski - Senior Vice President and Director of Investor Relations

Irene Esteves - Chief Financial Officer, Principal Accounting Officer, Executive Vice President and Director

Michael McGavick - Chief Executive Officer and Director

James Veghte - Chief Executive of Reinsurance Operations and Executive Vice President

Analysts

Jay Gelb - Barclays Capital

Keith Walsh - Citigroup Inc

J. Paul Newsome - Sandler O'Neill + Partners, L.P.

Gregory Locraft - Morgan Stanley

Jay Cohen - BofA Merrill Lynch

Ian Gutterman - Adage Capital

Doug Mewhirter - RBC Capital Markets, LLC

Michael Nannizzi - Goldman Sachs Group Inc.

Operator

Good afternoon. My name is Shirley, and I will be your conference operator today. At this time, I would like to welcome everyone to the XL Group First Quarter 2011 Earnings Call. [Operator Instructions] Please be advised that this call is being recorded. I would now like to turn the call over to David Radulski, XL's Director of Investor Relations. Please go ahead.

David Radulski

Thank you, Shirley. Welcome to XL Group's First Quarter 2011 Earnings Call. This call is being simultaneously webcast in XL's website at www.xlgroup.com. We posted to our website several documents, including our quarterly financial supplement. You'll note that beginning this quarter, rather than publish a separate fixed income data summary, we've integrated investment information into our financial supplement.

We hope you find the tabular format useful. We're hosting this call from our offices in Dublin. And on our call today, Mike McGavick, XL Group CEO will offer opening remarks; Irene Esteves, our CFO, will review our financial results; followed by Dave Duclos, our Chief Executive of Insurance Operations; and Jamie Veghte, our Chief Executive of Reinsurance Operations, who will review their segment results and market conditions. Then we'll open it up for your questions. Sarah Street, our Chief Investment Officer; and Susan Cross of Global Chief Actuary, are with us today, and available for Q&A.

Before they begin, I’d like to remind you that certain of the matters we’ll discuss today are forward-looking statements. These statements are based on current plans, estimates and expectations. Forward-looking statements involve inherent risks and uncertainties, and a number of factors could cause actual results to differ materially from those contained in the forward-looking statements, and therefore you should not place undue reliance on them.

Forward looking statements are sensitive to many factors, including those identified in our annual report on Form 10-K, our quarterly reports on Form 10-Q, and other documents on file with the SEC, that could cause actual results to differ materially from those contained in the forward-looking statements. Forward-looking statements speak only as of the date on which they are made, and we undertake no obligation publicly to revise any forward-looking statement in response to new information, future developments or otherwise.

And with that, I'd turn you over to Mike McGavick.

Michael McGavick

Good afternoon from Dublin. The first quarter of 2011 was one of great devastation from catastrophes, and we all mourn the many individual tragedies that came from the events in New Zealand, Australia and in Japan. It's impossible to not be moved by the vast suffering that we have all witnessed. We, in the industry and XL, can be very proud of our role in helping these communities and even countries, rebuild. It's a reminder of the terribly vital role Insurance and Reinsurance play, and it's important to give you an update, of course, how it affected our business specifically.

To do this, I'll again refer to our 5 drivers for creating shareholder value that we introduced last quarter: underwriting excellence, strong risk management, strategic growth, an optimum investment portfolio and operating in capital efficiency. After covering these areas, I'll also comment on some of the market implications that we see from this quarter of high catastrophe activity.

I'll first take underwriting excellence and strong ERM together because at the time of large catastrophes, they really do work together to tell the story of how the business is performing. If you look at our results for the quarter, the obvious comes right through. Like others in the industry, we experienced meaningful property catastrophe losses, totaling $387 million in the quarter. We then, at XL, look internally at our loss estimates for these events as a percentage of our shareholders equity prudent risk. We look at our experience relative to the limits that we had in those territories, relative to limits we've allocated in those territories, and we look at our experience relative to others, who similarly compete in those territories when an event of this scope and scale occurs.

What we believe is that when these happen, we should experience what we expect to experience, and that our losses should not be outsized either in reference to the markets or the limits we have established. We are pleased with how our book has performed. It performed as it should in these events, on both an absolute and relative basis, and within our stated appetites and internal limits.

Another way of looking at catastrophe as an experience is how do our estimates hold up over time. I'll take New Zealand as an example, because it's a more mature loss. Our estimates were reasonable in terms of how quickly we were able to share with the market our experience. And in fact, as they stand now, the actual experience has come in slightly lower than that which we initially forecasted. To us, this means our strong risk management processes allow us to know what's going on. And when the large events happen, we can say something accurate about it. This has been repeatedly true since this management team has been assembled, and we are driven to keep this true.

With respect to underwriting, there is one other area I would like to address at this time. And that is the one number that really sticks out in the quarter as it relates to our non-CAT Property book. We had a handful of large Property losses in the first quarter, including 2 very large losses that accounted for most of this total, and that's what makes this particular number stick out. On review, you should note that each time something like this happens, we do an internal review, we also work with our reinsurers to review the quality of the book again and reassure ourselves. And I will tell you that once we were done with that work, we continue to be very comfortable with this historically profitable book of business.

In fact, we're excited for the future with this book of business for a couple of reasons. Number one, as you have noted, both in North America and in International Property & Casualty, we have recently added new leaders to these books of business. You should know, by the way, that their fresh eye reviews also affirmed that these are good books of business. And so we're looking forward to what is likely to be some changes in those markets, with fresh leadership behind our solid underwriting. Now, so that's the things I wanted to comment on in terms of the underwriting and ERM.

And I want to turn to our strategic growth initiatives. XL did have a good quarter from a premium perspective. In fact, quarter 1 over quarter 1 of last year were up 9.2%. We've said all along that given our breadth of products and global nature, we should always be able to find pockets, where our technical expertise can be applied profitably. That's just the job. And as we turned our attention more to that part of a job and away from just fixing the balance sheet that we had trouble with a couple of years ago, we're really starting to see the progress, and that really is pleasing to us. We're already seeing traction from recently announced Insurance initiatives, several nice wins in our North American Construction business, the first accounts for our new Surety business, and we also celebrated the opening of our China office. This is the beginning of a very positive journey to be able to again expect profitable growth over time.

Turning then to our fourth lever, our investment portfolio. Here, we continue to be well positioned to support our P&C [Property & Casualty] operations. We have maintained a short duration to take advantage of rising interest rates, with almost 20% in floating rate assets. We have minimal exposure to non-core European sovereign risks. In the first quarter, we continue reducing our holdings in European bank hybrids and non-agency RMBS [Residential Mortgage-Backed Security]. So we're very pleased with where that fourth lever stands as of right now, and we don't think there's much more to say.

With respect to capital efficiency, this is obviously a topic very much on folks' mind. We have taken a pause in our share buybacks, so that we can review where the market stands, so that we can make sure that we have all of the flexibility to react to what may be a changing market. So as I said, we have taken a pause in terms of share buybacks. Also, related to the strength of our balance sheet, we would know how important reserving is to your analysis of our success. And we would look forward to later in a week. You're getting the chance to review our global loss triangles for 2010, which will be -- and headlined we believe will be, and that with your analysis, that our reserving continues to show its appropriate and prudent nature.

Now the final comment on operating efficiency and capital management. You will also notice that the expense ratio continues to run in line with the fourth quarter of last year. As we told you, there are some opportunities to gain additional efficiencies in the business over time, and we will invest to capture those efficiencies.

And finally then, commenting on the market itself. Well, we're certainly seeing lots of pockets of quickly improving pricing. What's more important to me is the conversation has changed. If you were one of our underwriters 6 months ago, the conversation almost always started out, how about down 5 or how about down 10? And the conversation now is very different. I think what has happened is on the market side of the house, on the underwriting side of the marketplace, these events have reawoken the underwriters to the real risk out there, and to be more driven to capture appropriate pricing.

So we see that unevenly across the market, but it's an important change of attitude, and the very fact that the conversation has changed is entirely noteworthy. Now whether this leads to an entire market turn or not is simply unknowable at this time. I know there are debaters on both sides of the topic. But the change in conversation and the change in attitude is real, and it is noteworthy. And it isn't just what's going on with respect to catastrophes. You also see modeled changes that are terribly relevant to how the marketplace will play out, and it affects everybody differently, which makes it a particularly interesting time in the market, because different organizations are at different places with respect to their capacity to continue to compete as they have before. So no one can say for certain what will happen next, but it is a much more pleasant and interesting market to be competing in today than it was before.

Now one final thing, it's a good time to mention, you're all invited to XL's Investor Day, scheduled for the morning of the 7th of June in New York. This will not be a simple recap of where we've been or even where we are exactly today. We'll also be sharing with you our roadmap for creating shareholder value across these 5 dimensions we have discussed before by providing our customers with the Insurance and Reinsurance solutions they need to cover their most complex risks.

XL is celebrating its 25th anniversary this year. Obviously, some of the companies we've acquired have quite much longer histories than that, but the XL, as you know it, is 25 years old this year. And as investors, we're hopeful you will be as excited about our plans for the next chapter in our history as we are. So we look forward to seeing you in June in New York City. With that, I'll turn it over to Irene Esteves.

Irene Esteves

Thanks, Mike. Operating net loss for the first quarter was $163 million or $0.52 per share on a fully diluted basis compared to operating income of $150 million or $0.44 per share in the first quarter of 2010. This was driven by catastrophe losses, net of reinstatement premiums, which totaled $387 million compared to $181 million in the prior year.

Turning to our summary financial results on Slide 3, you'll see that P&C gross premiums written were up 9.2% versus the first quarter of 2010. We demonstrated that even in a soft market, disciplined underwriters can find opportunities for profitable growth. The largest contributors to this expansion were new business in Reinsurance, and an increase in our Insurance exposure base.

P&C net premiums earned increased marginally, reflecting the rolling effects of slowly increasing levels of gross premiums written. Our P&C combined ratio for the quarter was 125.8, or 25 points higher than the same quarter last year. As already mentioned and further detailed on Slide 4, catastrophe losses in the quarter is accounted for 31 loss ratio points.

Prior-year development in the quarter was a favorable $71 million or 5.5 loss ratio points. Development was favorable in both Insurance and Reinsurance segments by $7 million and $64 million, respectively. Favorable Insurance development was largely in Property lines. Favorable Reinsurance development was reported in both long and short-tailed lines. Specifically, these included Property risk professional for 2001 and prior European casualty, several European CATs and 2005 hurricanes.

Our combined ratio x CATs and x prior-year development was 100.9, which is a 7.8 loss ratio points higher than 2010, driven by the large non-CAT Property losses in the quarter. Our $261 million of operating expenses for the first quarter of 2011 was up 13.7% year-over-year, but in line with the last quarter on a sequential basis. The increase arose principally from costs supporting our strategic initiatives, as well as some redundancy costs.

Turning to Slide 5, investment income on the P&C portfolio of $203 million in the first quarter was 11% below the prior year due to lower U.S. interest rates and cash outflows from the invested portfolio. The average new investment rate on our P&C portfolio was 3.1% and as of quarter end, our gross P&C book yield was 3.4%. Our duration temporarily decreased from the fourth quarter's 2.9 years to 2.8 years, as a result of higher cash balances generated from sales activities near quarter end, which we anticipate will be redeployed in the second quarter.

The P&C portfolio book yield net of expenses was 3.0%. Net income from investment fund affiliates was $27 million, up $19 million from the prior year. Private investments returned $16 million as a result of year-end fair value markups within a number of the funds. The mark-to-market was essentially flat in the first quarter, as higher government rates were offset by modest spread tightening.

Slide 6 shows our book value per share, down $0.75. $0.61 of this reduction was due to the net loss in the quarter, and the remainder due largely to the increase from the dilutive impact of our rising share price had on our accounting for equity security units scheduled to divert in August of this year. Share buybacks increased book value per share by $0.14. During the quarter, we bought back 7.3 million shares at an average cost of $22.83 for a total of $165.6 million. This brings our total buybacks over the past year to 33 million shares, and leaves $690 million under our current authorization.

I'll now turn it over to Dave to discuss our Insurance segment result.

Michael McGavick

Dave, before you start, I'd just like to note that we're experimenting with becoming a more interesting show. Dave is our correspondent live at RIMS in Vancouver, meaning he's only half alive because it's 3 or 4 in the morning there. But obviously, Dave needs to be with our clients during this week, while the rest of us are with our board at Dublin. And I think it's great that we can give some additional perspective to what's going on in the pricing with firsthand reports from our clients and colleagues there at RIMS. Dave?

David Duclos

Thanks, Mike. And good morning, Vancouver. Insurance results for the first quarter were driven by the industry, the worst catastrophe loss quarter since 2005's KRW, and by some large non-CAT Property losses I'll discuss shortly. The Insurance segment's combined ratio for the quarter of 121% was 19.4 points higher versus the same quarter last year, and 16.5 points higher after adjusting for prior-year development.

Current year net cap losses accounted for 6.4 points of the increase, with losses rising to $133 million from $80 million a year ago. The Japanese earthquake and tsunami, Australian flooding and to a lesser degree, the New Zealand earthquake losses, far exceeded those from the Chilean earthquake in Q1 last year. While the suffering and economic loss from all these events was terrible, XL Insurance's estimated exposure was within expectations. The largest element of the Insurance variants, which was 8.6 points, came from our Property lines, where we experienced some high severity non-cat Property losses, and you've heard Mike's comments on these, and we only do about these losses. I share this excitement about the potential these books provide.

Operating expenses grew by 1.7 points, which we anticipated reflecting our continued investment in talent, to support selective expansion, along with some redundancy cost, as we continue to better align our people with more profitable opportunities. Insurance gross premiums written in Q1 increased 8% or $91 million year-over-year, with most of this growth coming from increased exposure bases tied to improving economic conditions. We renewed 2 multiyear accounts, which had zero written premiums in Q1 2010, and saw benefits from selective new business initiatives. These initiatives, include international professional line, North America and international construction, Continental Europe of upper middle markets, and various professional and PC programs.

In late March, our leadership team attended the opening of XL's new office in Shanghai, and it was a thrilling expense for all involved. More than 1/3 of our 1,100 global programs that we lead have operations in China, and adding local presence and capabilities to this vibrant market is a great step in providing the service our clients expect from XL. We are delighted in the quality of the professionals from all around the world. We're working together to make our Chinese Insurance operations succeed.

We continue to strengthen the rest of the team that is pursuing opportunities across the globe. Mike mentioned the Property talent we have attracted. Specifically, Matthias Horntrich, as Chief Underwriting Officer for International Property and Joe Tocco, as Head of our North American Property and XL GAP Operations. We also appointed Cristiana Báez-Safa as Chief Underwriting Officer Professional Lines and Commercial Risk. Pete Purvis took over as Head of our North America Programs. And most recently, Kadidja Sinz, is our new Country Manager for France. All these activities and additions are driven by our commitment to efficiently focus underwriting risk management talent toward the global opportunities we see.

Now to market conditions. As I said here, Wednesday morning, on my last day at RIMS in Vancouver, I'll provide the following observations. And first, I would say this RIMS has a different feel from the previous 2 since the financial crisis was first evidenced in late 2007, early 2008. Instead of balance sheet challenges, with synergies finally facing up to core earnings being impaired by a combination of almost a decade of declining price and recent cap losses.

As Mike mentioned earlier, I choose to sense a different attitude among underwriters, frankly losing money doesn't sit long. Secondly, while clients will gladly be the recipient of irrational pricing, in my discussions, they are better prepared for a correction in cores on rate both mentally and financially. Of course, like all of us, they don't expect to pay for someone else's loss. Third, brokers seem to be, some anyway, at work trying to benefit from keeping the market as competitive as possible as they retain and win clients. That's interesting. So how does this translate to what we see? Some early signs in this effort are favorable, as market participants increasingly recognize the need for more rational pricing. Our pricing for the past year plus have been stuck in the minus 1% to 2% range, including what we saw on our Q1 2011 results. But on April 1 renewals, we started achieving some meaningful rate increases, low to mid-single digit improvements, largely in the Property and Casualty lines and also, our Marine business. This is certainly encouraging.

Now back to RIMS quickly as I wrap up my comments. This is a very important event to XL, especially, but not limited to our North America Insurance businesses. But last year event in Boston, there was a clear sense that XL was back. This year, I've heard from brokers and clients alike that they can see and feel that XL is a company very excited about its future, and all of us from XL here at RIMS would agree. Our underwriting expertise and capabilities have never been stronger, and we firmly believe we have the operating discipline and global platform we need to deliver valuable risk management solutions to clients around the world. And now to Jamie to discuss Reinsurance.

James Veghte

Thanks, Dave, and good morning. The Reinsurance segments' financial results for the quarter were heavily impacted by the extraordinary level of global cat activity. Our combined ratio of 136.3% was driven by catastrophe losses of $271 million, partially offset by prior-year reserve releases of $64 million. Excluding the impact of cat losses in prior development, our combined ratio was 87.7%. This compares to a combined of 84.8% in the first quarter of last year. The deterioration from last year resulted from the Griffin North Sea Marine loss, which was $17 million or 4.3 loss ratio points.

Turning to top line, as Mike mentioned, gross written premiums in the quarter were $877 million, a 10.9% increase from the first quarter of 2010. This increase was virtually entirely driven by XL Re Europe. During the quarter, we capitalized on significant pricing improvements in the U.K. motor market, and wrote a new contract for $45 million in annual premium. We also saw new opportunities in the London marine market, as conditions improve there and wrote some new Property Cat [Catastrophe] business in Continental Europe.

In summary, our losses from these major cat events were in line with our expectations for events at these levels. The underlying book continues to perform well, and the prior-year releases demonstrate the continued strength of our overall reserve position.

Turning to market conditions, I think there are 2 dynamics in the quarter that deserves some comments. As you all know, the entire Japanese market turns over at April 1, and the earthquake loss obviously impacted these discussions. In addition, and perhaps more importantly, we are of the view that the events in the quarter are a game changer for the market, although we would caution we expect the impact to be combined to the short tail lines in the Reinsurance market. As respects for renewal in Japan from our perspective, it was a mixed bag. We did have some companies, particularly the cooperatives, extend their program for up to 2 months. On excess of lost business that did renew, earthquake excess programs impacted by the quake had rate increases in the 50% to 60% range. Non-impacted earthquake excess programs had increases of 20% to 25%. And finally, wind and flood cat programs had increases of 5% to 7%.

With respect to proportional placements, much of it simply renewed as expiring, given how close the event was the renewal date. Other than the expected improvement in underlying rates, not much has changed. Broadly, we still consider the Japanese market underpriced, particularly on the primary level, and far too reliant on proportional Reinsurance and swaps structures and less on indemnity-based cat programs, our preferred product. Over the last 10 years, we have reduced our exposure to a considerable degree in that market. In the year 2000, we had $600 million of direct cat aggregate in Japan. Today, we have just under $200 million. And we've focused our participation in that market to a relatively small group of customers.

In the U.S. market, we saw a significant impact at April 1, both from the events in Japan, and the international cat markets, and the new RMS Version 11.0. There was an increase in the interest for and cost of retro protection. We saw a number of direct cat firm orders reprised with revised firm orders, shortfall covers in the market, and then pricing environment improved over January 1. We expect this momentum to accelerate going into the mid-year U.S. win renewals, and we're quoting material price increases on submissions where the exposure changes warrant them. The long tail side of the business remains very competitive, with pockets of exception such as the previously referenced U.K. motor market. We remain disciplined in the face of this environment. With that, I'll turn it back to David for Q&A.

David Duclos

Shirley, can you please open the lines for Q&A.

Question-and-Answer Session

Operator

[Operator Instructions] And our first question comes from Michael Nannizzi with Goldman Sachs.

Michael Nannizzi - Goldman Sachs Group Inc.

Just a little bit more color on the non-cat losses in the Insurance segment. For Mike or Dave, can you talk a little bit more about what those were, the business, the new business you wrote, was it in those same areas? And I'm still not sure if I understand if that's in a cat book, or if it's not in a cat book.

Michael McGavick

Dave, would you go ahead with that question?

David Duclos

Sure, Mike. And Michael, the losses, the 5 losses that we have in Insurance in the first quarter, I would tell you, that they're from all different types of classes of business. There's not any correlation or overlap from a class standpoint, or from a geography standpoint. It's fairly diversified. As Mike had mentioned, anytime we have a large loss, we do a fairly thorough post-mortem, and we can very confidently state today that all of the accounts we wrote, we would've written again. And we don't see any systemic underlying concern. It's just one of those things where we had a frequency of large losses in a particular quarter that is unusual based upon our history. I would point out that this was the highest frequency event in 10 years. So we do consider it quite an anomaly. I would also mention that over the 10-year period, the book is profitable. We've got a 53% net loss ratio over that 10-year period. And this was the worst quarter for both cat and non-cat since KRW, as we mentioned in our prepared remarks. As far as your question about new business, and does it get into the same area that we just had some losses, I can tell you that the new business that we're writing on a Property basis is primarily in the U.S., and of all the losses that we had in this first quarter. One was in Canada, and the rest were outside of the U.S. So the answer to that question is no. But we do feel good about the quality of the book, as Mike had mentioned. And I would just add that in addition to the fact that we've got Matthias and Joe in place now. We've got the strong teams that have been in place, and we are in the midst of going through a business review that's really focused on how we can profitably grow and diversify the book out farther. And so we're looking at all aspects of how to do that most effectively. But I can tell you that we have a high degree of confidence in the quality of our Property book.

Michael Nannizzi - Goldman Sachs Group Inc.

And just if you were to back out those, if it's possible, if you would look at the book x those losses, I mean, can you talk a little bit about what the underlying loss ratio look like just outside of those?

David Duclos

Well, these losses account for 8.6 points of our variants. So without those losses, we would've been comparable to the Q1 2010 results, which would have been sort of in line with our expectations around this book's performance.

Michael McGavick

A couple of other points I'd like to add if I could, one is that in these cases, these are losses that are securitized or shared across the market. So these were market losses, not just XL losses. And our shares on these would kind of range from 5% of the loss to 14% of the loss. So we felt good about our relative position, and the selection of the lines that our underwriters have taken. You asked a question about whether these were cat books or in Property, these are with our ordinary Property programs, not in the cat side of the house. And one of the reasons -- this has not been a growth area for us here before. We would expect this to be an area that we'll be looking closely at for growth in the future, with a combination of some of the fresh views of the new leaders we've hired, and the changing we see going on in the Property marketplace. So there's really -- but it isn't a driver of the growth during the quarter.

Operator

Our next question comes from Jay Gelb with Barclays Capital.

Jay Gelb - Barclays Capital

Two questions. First on capital management, Mike, I'm trying to get a sense, is the slowdown in share buybacks, does that reflect less excess capital for XL, or more of a situation for market opportunity going forward?

Michael McGavick

Well, perhaps Jay, you typically ask a very artful question that tries to get me to tell you things we won't tell you. So that -- we certainly continue to believe that we have capital beyond the margin for safety that we prefer to have to what the rating agencies and regulators require. And that's why we put it in the frame of a pause, because if you were needing to stop, you just be stopping. So we still have choices here for what we recognize is there's a lot of uncertainty in the marketplace right now, and that there's going to be really different reactions across the various players amongst the market. And we wanted to be very flexible at a point in time like this to be able to fairly examine what opportunities are being created in the market and what is the very best way for us to create value for our shareholders. But clearly, among the choices for how to continue to create value for the shareholders is to resume buybacks. So we will be examining those. We don't -- we're very cautious not to move markets with our decisions, which is why we give no color to when and amounts and all of that kind of thing, but we thought given the significance of the events in this quarter, it is very wise to take a pause and examine the state of things. And just for reference, I would remind you that we have about $690 million remaining in the current authorization.

Jay Gelb - Barclays Capital

Okay that's helpful, Mike. And then for Jamie, one of the questions I often get nowadays from investors is if there's no large hurricane losses in the U.S. this summer, are we going to be in a property reinsurance situation in the U.S. similar to after KRW, where things firmed up for a while and then it kind of went back to the way it was? What are your -- what's your perspective on that?

James Veghte

Jay, I wish I had that much control over the market, I could tell exactly what's going to happen. I do think that the confluence of events, both last year in the international markets and the first quarter, are sort of changing the environment, the pricing environment in the cat market. And we'll see going into July 1, between that and the new version of the cat model that's just come out, I just think there's a momentum for some price increases. Obviously, if we have an active storm season, I think that, that momentum will accelerate. What happens if it's quiet, I'm not entirely certain. I wish I was.

Operator

Your next question comes from Jay Cohen with Bank of America Merrill Lynch.

Jay Cohen - BofA Merrill Lynch

Two questions. First is you mentioned some redundancy cost, I guess, they sound somewhat temporary. Can you quantify that, and talk about the potential for further redundancy costs?

Michael McGavick

Yes, there are -- the expense bump that you see is related to 2 pieces. One, some investments that we're making in new technologies that we think can make us a more efficient growth platform over time, and others are in some modest restructuring that's going on, particularly in our international Property and Casualty operations in the Insurance segment. So there was some cost from those restructurings that were also in the quarter. So you're getting both, and we would view that as how things should be. I mean, we would hope that investors would take that as a very positive sense that we're not just taking the binders off and just starting to spend a lot of money, because we're healthy again. We're trying to be very selective where we can invest, and where we can also take cost out as a result of investments or improvements in process. So it's really -- we're trying to keep those 2 things constantly in mind.

Jay Cohen - BofA Merrill Lynch

Would you expect the direction of the overall expense ratio to be down or up over the next 4 quarters?

Michael McGavick

We said last year that we would expect some in-tick in order to accommodate these investments. As you know, as we've already told you, in this quarter, it was basically flat to fourth quarter of last year, but up quarter one over quarter one, and I think quarter one is a good indicator of level of expense. It could go up some, but let's get more into those details at Investor Day. I think that's where it's best put in its total context.

Jay Cohen - BofA Merrill Lynch

That's helpful. And the second topic is the second quarter catastrophe losses in the U.S., I guess the question is do you expect these storm and tornado losses to impact the Reinsurance market, not necessarily you but the Reinsurance market in general?

James Veghte

It's very early days. My own sense is that it will be concentrating in a fairly small number of carriers in the Southeast. There will be some Reinsurance involvement as a result of that fact. But it's unclear right now what sort of market loss we'll have to the Reinsurance market in particular.

Operator

Your next question comes from Greg Locraft of Morgan Stanley.

Gregory Locraft - Morgan Stanley

Mike, just wanted to -- again, back on the share buyback front, can you give us some color as to when you actually stopped buying back stock in the quarter? Was it after one of the events or how did you, at some point, decided to go from buying back to not buying back?

Irene Esteves

It was a gradual decision. This is Irene. Based on what we were seeing in the marketplace, we also were looking at other opportunities to grow the business, as you heard, our growth during the quarter was very good. So we're looking at opportunities for internal growth as the cats happened. So we can't really point to one single event that created the pause.

Gregory Locraft - Morgan Stanley

Okay, great. And then the other one is just on, I'm trying to sort of project out into '12 and '13 and to me, the only reason your stock valuation makes sense is if you guys are earning your cost of capital or below over the longer term. And so from an ROE trajectory perspective, perhaps, this is something we'll get into more in June at the Investor Day. But I'm wondering it seems like about a year ago, we were talking about double digits and now, even with an improvement in the underwriting environment, it seems hard to get to that level. What needs to change or happen to kind of get us to a double-digit level that at one point was on the table?

Michael McGavick

Yes, first, I think it's really important that we don't get into -- back in the business of giving you some kind of absolute forecast for our performance, then which we, as you remember, we got out of that business at the beginning the year, and I'm not going to get back into it. I will say though that there are several -- and this really is an Investor Day question to be fair to us. But there are obvious levers for how you get from here to there. One, and most importantly, is what you do in terms of your underwriting, whether under risk selection, your pricing or your ability to profitably grow. Those are the levers that, in our minds, matter the most. Because we have been, as you know, over time, very aggressive with respect to expense management, 2 ways of reorganization to capture efficiencies. Early in my tenure, we've had some pockets of continued improvement. This quarter, we would expect that to always be a theme. But the big low-hanging fruit's gone. Mostly, it's going to be a little bit of improvement here, a little bit of improvement there, a system that allows more efficiency here. It's really -- we're in the part that's the hard good work of a well-run company constantly paying attention to being efficient. And we're just committed to that forever, as far as I'm concerned. So the real levers that can move it, or how that underwriting process works, how we're able to improve our insight, how we're able to gain profitable growth by realizing that there are opportunities within our appetite to attract profitable customers, or by seeing changes in price relative to exposure. Clearly, one of those levers is starting to move. And a couple of the others are amongst the things we're working on that we look forward to talking with you in more detail in June.

Gregory Locraft - Morgan Stanley

Okay. And I guess one of the things I'm struggling with though is it seems like even if underwriting comes through and performs, it seems like it's more of a investment income and book equity issue. In other words, you need to shrink book equity, and get investment income moving in the other direction to get the ROE up. What you're saying is you're saying fixed -- not even fixed, it is fixed, but improve underwriting into sustainable profitability, and that should get the trajectory moving in to where you want it to be?

Michael McGavick

That's the lever I'm most focused on, because that's the hardest work at hand. The lever that I wouldn't, that I -- so going back to the 5 levers that we've talked about, right, you're not going to see a sudden return to the kind of reach per yield creative behavior on the Investment side, that you saw out of XL 2 or 2 years ago, because we all know how that bitter fruit tasted. We're very pleased with where our investment portfolio is positioned. You have heard us make some comments about some asset classes that we do think are better relative trades right now, and you've seen some movements towards those, but the kind of heavier reach per yield that you saw 2, 5, 8 years ago, you're not going to see. So switching to the other lever, expense. As I said, there's actually some investing we'd like to do. It's fairly modest and disciplined, and it will reflect. Over time, it'd be offset by some savings along the way, too. But we don't think that there's a big opportunity in the expenses space. We think that's going to be a constant diligence. The place where the lever has the most power is what we do with the underwriting, whether to grow the book, to get better pricing for the risks we do have, be more insightful about how we choose risks or more creative in how we design products. Those are the places where there is the best absolute value creation for firms like ours. And then the last piece that you have to modulate over time, but always with your eye on the horizon, not just a point in time, is your absolute capital levels. And clearly, we are not fully using our capital today. That's an obvious, well-known aspect of our company right now, which is partly why we've been buying in shares. But in a changing market and with those 2 levers, clearly, the places we create value, that's the pieces we got to get right to give the market the long-term sustainable outcome it expects from an underwriting company like XL. So I know that I haven't answered your question narrowly, which one here, which one there, but those have to come together to create a great Insurance company, and that's what we're all about.

Operator

Your next question comes from Ian Gutterman with Adage Capital.

Ian Gutterman - Adage Capital

I wanted to circle back on the large losses and the repurchase. First, Mike, on the large losses in Insurance, you said these are market events. But to be honest, other companies have reported, and haven't discussed this issue. And I've asked on this a few other calls, the only large losses out there that we know about are the 2 energy losses. So can you tell us a little bit more about what's going on, because it seems like you're the only one who's been reporting this? And I look through my notes here, and it's 2 quarters in a row of large Property losses in the Insurance segment and again, your peers haven't been seeing that.

Michael McGavick

Yes, we did -- we have talked in a couple of prior quarters about an unusual level of Property losses. But I would remind you for about the year before that, we were talking about unusually light large Property losses. So that comes and go in the market. And when you're dealing with markets that are securitized like this, you may have one player on one, one player on another. It's just kind of a kaleidoscope of players. From all that we can tell when we examine these risks, again, to use Dave's phrase, we have written them again. We feel comfortable with the lines we took. These books are historically profitable for XL. So with those things in mind, we continue to be pleased and I particularly like it. The reinsurers have a deep interest and insight into our book of business. They are in very deeply with us, and they've had the same reaction to these events. So they are on the hook, too, and they continue to be comfortable with these 5 particular losses. But there could be a number of explanations, but our focus is on where do we go from here, and our focus remains that these are risks worth writing, and that the book is underwritten well. We do not, as you probably know, name losses in our Insurance segment. We never have and we're going to stick to that protocol on this call.

Ian Gutterman - Adage Capital

Is it possible that you take larger net lines than your peers, and maybe your peers are passing more than onto the Reinsurance, but we don't see it? I'm just trying to think of why you guys have looked different the past few quarters?

Michael McGavick

No, I don't -- look, our retention strategies were among the things that we've examined in reviewing these books. Again, if there was something that was systemically wrong, like a class and business was running wrong, if there was one particular pocket of underwriters that were getting -- if there was something along those lines, we'd tell you, and we'd tell you what we're doing to fix it. As we look at these books, again, they're historically profitable. There's been no change fundamentally in how they're being managed or underwritten, and when we did the individual risk reviews that have produced that historical profitability over time, we couldn't find any reason to change our appetites and therefore, are not. But it's not lost on us that we're talking about this. But again, we've done all of the steps that we have done to create what have been historically profitable books, and we'll keep adding it.

Ian Gutterman - Adage Capital

Fair enough. Just on the repurchase, I guess what I'm struggling with a little bit is when I look at your restraint on repurchase capacity, right now, it's debt to capital and not operating leverage. And if the debt to capital were lower, arguably, you have a couple of billion dollars of excess capital to write premium. And therefore, if there were a growth opportunity, the easiest way to take advantage of it would be to pay down some debt because that would create excess -- essentially allow you to take advantage of the underutilized operating leverage. So I don't understand why you have to slow down the repurchase if you think there might be a better market opportunity than we've seen, the alternatives to keep repurchasing it and look to pay down some debt when the re-marketing comes through to free up your capacity that way.

Michael McGavick

Yes, no, we do have -- so I think that's well observed. Clearly, the greater constraint on our -- the capital, our balance sheet design is where we are on leverage. That is something because we're on the higher end of the range, we'd like to be at. That is something we do look at managing down, and would have to do so in concert with anything we do meaningfully on the capital side. So we're well aware of that. None of that, at this stage, has affected any decision we'd like to make relative to how to create value for our shareholders. But this is one of the things we'll obviously be considering during a pause like this.

Ian Gutterman - Adage Capital

Okay. I know I won't get a direct answer on your plans for the remarketing side, so I guess I'll just rub in my opinion, which is I really hope you'll choose to pay off the debt when the re-marketing comes.

Michael McGavick

I appreciate that, and I'm sure that I can be confident that -- and your confident, that you can accept that from our point of view, there are things we can be extremely transparent about, and things where we don't think it serves our shareholders any benefit to be so transparent as to injure their outcomes. So we're very careful on what we say with that lens in mind.

Ian Gutterman - Adage Capital

Well understood.

Michael McGavick

We strive for transparency and long-term value we're creating.

Operator

Your next question comes from Doug Mewhirter with RBC Capital Markets.

Doug Mewhirter - RBC Capital Markets, LLC

I just had 2 market-related questions both on the reinsurance side. First, I noticed you -- I guess you increased somewhat your European catastrophe exposure. From, I guess, an overall risk management perspective now that the -- I guess the catastrophe business looks like it's the pointy end of the spear in terms of where the market might be hardening. Since you already -- you did take, I guess, a medium-sized bite at January renewals of increasing your catastrophe exposure. Are there any issues with taking full advantage of any direct market hardening on the Catastrophe business, or do you feel you have some ample spare capacity for that kind of risk?

James Veghte

No, it actually represents a great opportunity for us. As you know, our published risk appetite for what we call Tier 1 exposures, which includes U.S. wind is 15% of tangible shareholders' equity, out of 1%, our current exceedings probability. As of 12/31/2010, our most recently calculated 1% U.S. wind exposure is $915 million, which is about 9.5% of shareholders' equity. We have not calculated the full impact of the new model on our portfolio, but I find it very, very difficult to believe that we won't have plenty of capacity to take advantage of the market turn at July 1, which I think puts us in a very good position relative to some of the competition.

Doug Mewhirter - RBC Capital Markets, LLC

My second question, still on reinsurance, is the UK motor opportunities, I have heard that rates have become much more favorable. I guess I'm a little concerned that there might be a bit of a value trap there, where the rates might be up well into the double digits, but maybe the true rate increase you need is double or triple of that, because of the legal or regulatory environment. I've heard anecdotal evidence of lots of fraud and lots of, I guess, unscrupulous attorneys taking advantage of the primary market, which may directly accrue to reinsurance. I mean, do you think you're pretty comfortable with the way that conditions are, that that rate increase is actually an opportunity rather than just maybe playing catch-up?

James Veghte

Sure. We wouldn't have done it if we didn't think so. And I would say our attitude towards U.K. motor is very much opportunistic, probably as much in that line as any portfolio you would find within XL Re. We will grow it dramatically and shrink it dramatically within 2 or 2 quarters, depending on what we see in the primary marketplace. The vast majority of that increase, as I mentioned in my early remarks, came from one contract with a counter party that we have a lot of confidence in, and the rate increases they're getting are a lot more than low-double digits. So again, we feel confident that these will be profitable relationships, and we will not hesitate to shrink the portfolio very, very quickly if we're wrong about our assumptions.

Operator

Our next question comes from Donna Halverstadt with Goldman Sachs.

Donna Halverstadt

You've already touched on bits of it, but I was wondering if you could share with us what your vision might be for your entire capital structure over the next year or 2. You've already talked a lot about the share repurchase and the pause in the market review, you've talked about the ESUs and the debt re-marketing. But there's also the contingent capital deal for which you need to make some decisions this summer. There's $600 million of debt that matures in less than a year. So without saying anything too specific, can you share with us a general vision of what you would like your entire capital structure to look like a year or 2 hence?

Michael McGavick

The only thing that I think would be appropriate to additionally comment on is that the efficiency of capital utilization and the debt ratio position we'd like to be in are very much in kind of the middle of the pack. What I would tell you is we don't want to be known as anything other than -- we don't want to be known as over or under leveraged. We don't want to be known as over or under stretched. We're really seeking to make our ultimate difference in the quality of our underwriting, because that's where we think we create the most value. So the sort of more creative approach is kind of financial engineering style approaches on the balance sheet are not much in favor, unless there is something that is a very specific risk that we're trying to address. Then we're very interested in tools that might address it. You could think about inflation. You could think about a lot of things and say, "Is there any tool you might want to use in those?" And then we pay attention when folks from other parts of your company, come around with brilliant solutions. But the general attitude is that we are not so much financial engineers, as we are thoughtful middle-of-the-road managers of debt and capital in order to give our balance sheet an efficient platform from which to work, and then we have the hard work of using appropriate and sophisticated models to move the capital behind the right segments of the business at the right time to achieve the profitable growth of the right portfolio. So you want an efficient capital structure, but we're not looking to out-engineer everybody, we're looking to be a pretty straightforward company.

Donna Halverstadt

Okay, that's helpful. One quick follow-up, if I may, and I'm still trying to keep it big picture in general. Could you talk about some of the considerations that you might weigh as you think about whether or not to extend the Stoneheath Reinsurance contract?

Michael McGavick

No, again, getting to an efficient capital structure that has appropriate flexibility for the growth of the business in any opportunities we see, while being an amount of capital that is appropriate to the amount we see in the foreseeable future, right. But those are the things that matter, and I think that's really enough said.

Operator

Your next question comes from Paul Newsome with Sandler O'Neill.

J. Paul Newsome - Sandler O'Neill + Partners, L.P.

Any thoughts about how long your pause will be in the sense of -- not so much your pause, but how long do you think we should be sitting around and thinking about whether or not there really is something going on, or it just remains signs?

Michael McGavick

Well, we review our sort of decision matrix, the three parter that I won't bore you with, because you've heard it so many times, you can say it to me. But we review our three-part decision matrix for capital on a regular basis. We will continue to do it regularly, and when we see that there's obvious evidence for a particular direction or another, we will act on it and where appropriate, and when appropriate, talk about it. But I apologize, but that's not an area we're being, as you might think, more transparent would be helpful to our shareholders.

J. Paul Newsome - Sandler O'Neill + Partners, L.P.

I disagree, but I guess that really wasn't what I was trying to ask. Obviously, the market is in sort of flux. The question I'm asking is how long do you think it is before we know which way it goes? Do we have to get past the your lines renewals, should we...

Michael McGavick

That's a very different question, and...

J. Paul Newsome - Sandler O'Neill + Partners, L.P.

Get past the hurricanes or...

Michael McGavick

Yes, right. Well, so what I don't want to do is create a direct association, okay? So if I tell you I don't think I'm going to be certain -- or certain's the wrong word, but I think we'll all have a very good sense of where this market is headed by the end of the hurricane season for a couple of reasons, you're going to bend through the Property Cat renewals, you're going to bend through wind season, which is another big variable for the year. If Greg Hendrick were on the phone, he'd remind you, an earthquake can happen anytime. There's no season for earthquakes. But when we get into the last 1/2 of this year, you're going to have a lot of evidence with which to work with beyond just these first quarter events. Having said that, I wouldn't want you to then say to yourself that, that is somehow code for: We won't look at how to make decisions around repurchases before then. We look at these questions regularly as against again the opportunities we see in the market place, what's going on with pricing, what's going on with other players, all [indiscernible] as they shape or how we make that decision, so don't take from that. But that's the timing by which we would or wouldn't reengage in share repurchases. We'll make that -- we could make that decision at any time. But as it corresponds to your direct question about when we would really be able to sit here, and each of us tell each other with confidence about what direction the market's going, I think that it's unlikely you'll have a modest certainty until you get to the end of that wind season.

Operator

And your final question comes from Keith Walsh with Citi.

Keith Walsh - Citigroup Inc

I guess, Mike, you mentioned underwriting improvement several times on the call. And I just want to get some context around, absent pricing, what's the kind of timing you're talking about on that type of improvement? And then I've got a follow-up.

Michael McGavick

Yes, books of business, as you sure know, can be improved in a number of ways. You have, of course, selection. You have the contract terms and design itself. You have the pricing, exposure change. You have all kinds of variables. So we would like to think there's never a time when you aren't thinking about how you can prove your underwriting result. The underwriters should be constantly looking for a way to serve the client better, and to serve the shareholders at the same time. That's a constant exercise. What I would tell you and again, I'm going to point you to Investor Day, as you probably suspected that I would, but I would tell you that we're very excited by that lever. We think there's a lot of potential in that lever at XL. I'll just leave it at that, and we'll get into that in more detail why that would be -- when we all get together. But there's just a remarkable opportunity ahead.

Keith Walsh - Citigroup Inc

Okay. The second question just around investments. You've talked about in the past about some of the people you've added recently. Maybe you can just give us a sense update of some -- what are some of the areas still -- geographically and product lines you'd still like to add to in the franchise?

Michael McGavick

Yes, I'm going to ask Dave Duclos in Vancouver -- actually, I'm actually going to do this myself, because I was just told that Dave had to run to a meeting, so that would be very foolish to ask him to comment. Okay so, Dave, let me start it out then. The bottom line is no matter where you look, I can only identify 2 places in the -- 2 activities of our activities, and I'm not going to get into them, because they will give our competitors advantage. But there's only 2 places in the world where I feel like our book of business is about where it should be, and I wouldn't be excited to see it to grow. Well, if you stepped back and look at the world like we look at it, there's an awful lot of places where we have business activities. And I'm identifying a couple of them, that I feel really right about the right part of the market for our strategy. So we, I think, have the blessing of being very opportunistic across product, across geography, to decide where is the best opportunity in the medium term. So I -- there's some obvious observations. People have often observed we're underweight on a relative basis in the U.S. on our Insurance side, that's true. Relative to the size and scope of that market, we're underweight. In some of the emerging markets, our activities are still relatively young, although I would tell you we were awfully proud of the fact that we got that China license in the shortest amount of time yet by a primary insurer. So having that absolute primary license, and the operation now ready to write premiums is very exciting to us. But we could, by no means claim to be the first there or the most established. So there are places where there's clear opportunity ahead. But again, there's only a couple of product lines in a couple of geographies, where I'd tell you, I think we're about full. So we have the -- I think, the real blessing of really being opportune, and being able to pick them among a great harvest of choices. We have made a couple of choices that are about macroeconomic bets. We made a choice around the construction play in the U.S. That major construction market, we think, whether it's from government spending or the relighting of the economy in either way, it can come back to our benefit. And we felt that to make that really fly, it was a really opportune time to enter the Surety business. That was a fabulous combination of macro thinking about where to play of finding the right talent, of being able to get the right talent, and the right leadership and we're extremely excited about what that portends kind of in the medium horizon. We're very excited to give another illustration around professional lines over in the international European market, and you see us already writing some additional business there. And I don't -- maybe we could underscore this just a bit more, we wrote our first global program in the professional area during the quarter. That's a big deal, because that's another way to approach professional lines that is becoming increasingly demanded by a global client, and that relatively few players can deliver, and especially not with the kind of insight that our underwriters have. So we're building out an organization to take advantage of that, and they're already delivering some premium. But these are the things that really excite us, and you'll notice, there's not a particular thing except for extending where we seek the best advantage. It's an opportunistic thing, but it gives us great growth potential over time even during a market that is still uneven in terms of its pricing. Sorry, Dave, I probably stole all the thunder, but you may want to add something.

David Duclos

No, you did a very good job, Mike. I think the key point that Mike's made is we have a lot of opportunity. The only, I guess, thing I'd add to this is we have, as Mike said, a couple of places where we're satisfied with our existing market share, and a whole bunch of opportunities either on a product geography or segment basis to expand. And in addition to new products and new teams that are getting us into new spaces, we're constantly looking to bring in the good professionals in existing practices and believe it or not, we're able to grow those books significantly. So we feel very bullish about our ability to grow the premium in a profitable way within the broad global platform that Insurance utilizes. Mike picked up on the key points of it, and we feel very good. I'll tell you what, we've just had tremendous success the last 6 quarters now, attracting really good underwriters to this firm.

Keith Walsh - Citigroup Inc

And then, Mike, if I could just follow-up on one last question, I mean just on the share repurchase, it's been dialed down here. It either leads you to believe that, a, you don't have as much excess capital as we thought you did; or b, you think the incremental returns on new business are better than share repurchase, which I find hard to believe at the levels your stock is at. So maybe if you could just address that a little bit?

Michael McGavick

No, I think -- I'm sorry to say, I think, we probably talked about this as much as we can. The only thing I would encourage you to focus on is it's always about the trade-offs across different activities to create shareholder value. So we intend to be focused on generating shareholder value, and you've identified the right way to think about it. Trading where we are, the economics of share repurchases are obviously very strong. So at any given time, to do something else, it would have to be a very strong idea. But these are times, this is a moment in the marketplace that is a rare possible point of inflection. And we think the best stewardship, as I said, was to take a pause, see what's going on, and then do what we think is the right thing, and that's the appropriate time to explain why we thought whatever course we choose, I mean, is the right thing. We think that's just purely prudent, and think it's the right way to steward your company.

Operator

Okay. So I'm going to turn the call back over to the speakers.

Michael McGavick

Okay. I'd just like to thank everybody for the time and attention. We appreciate that having to have people around the world makes us a little clumsier than usual, but I hope you got all the answers you were seeking. Obviously, Dave Radulski and the team are available to make sure to clarify any questions that somehow we weren't effective in communicating on the call, or that require a bit more technical explanation. And we're looking forward not only to the next quarter of XL but particularly to seeing -- to being with you in June. So with that, thank you very much, and I hope you have a good day.

Operator

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

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