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W. R. Berkley Corporation (NYSE:WRB)

Q2 2011 Earnings Call

July 26, 2011, 09:00 a.m. ET

Executives

William R. Berkley - Chairman and CEO

Rob Berkley - President and COO

Gene Ballard - SVP and CFO

Analysts

Michael Nannizzi - Goldman Sachs

Keith Walsh - Citi

Michael Grasher - Piper Jaffray

Josh Shanker - Deutsche Bank

Bob Farnam - KBW

Meyer Shields - Stifel Nicolaus

Jay Cohen - Bank of America/Merrill Lynch

Brian Meredith - UBS

Scott Frost - Bank of America/Merrill Lynch

Gregory Locraft - Morgan Stanley

Amit Kumar - Macquarie

Kenneth Billingsley - BGB Securities

Operator

Good day, and welcome to the W. R. Berkley Corporation Second Quarter 2011 Earnings Conference Call. Today’s conference is being recorded. The speakers’ remarks may contain forward-looking statements. Some of the forward-looking statements can be identified by the use of forward-looking words including without limitation “believe,” “expects,” or “estimate.” We caution you that such forward-looking statements should not be regarded as a representation by us that the future plans, estimates, or expectations contemplated by us will in fact be achieved. Please refer to our Annual Report on Form 10K for the year ended December 31, 2010, and our other filings made with the SEC for a description of the business environment in which we operate and the important factors that may materially affect our results.

W. R. Berkley Corporation is not under any obligation and expressly disclaims any such obligations to update or alter its forward-looking statements, whether as a result of new information, future events, or otherwise.

I would now like to turn the call over to Mr. William R. Berkley. Please go ahead, sir.

William R. Berkley

Thank you. Good morning everyone. I was pleased with our quarter and I think that all of our expectations for the turn cycle and for all in operations are coming about. Certainly things are happening if it's slower than we anticipated and we are pretty excited about where things are going. I’m going to let Rob talk about our operations firsts and Gene will talk about our finances and I’ll be there talking about overall of the business and where we stand. So, with that Rob please.

Rob Berkley

Thank you. Good morning everyone. Capacity activity during the second quarter following on the heels of the events of the first quarter is certainly the clear reminder of the value that the insurance in which we brings to the society. Additionally, the cat activity over the past six months has provided a strong wake up call to the industry for the need to appropriately price for the infrequent event. The recent natural disasters have compounded the pressure that the industry has already been facing.

This existing pressures stems from a modest investment income, evidence of increasing frequency trend and an overall lack of underwriting discipline that has existed for the past several years. The greatest level of competition continued to be found in accounts over $100,000. Additionally, excess casualty lines in particular excess workers compensation remains under significant pressure. These longer tail lines of business are typically slower to turn given the duration of the liability and consequently it takes more time for underwriting missteps to be recognized.

While industry conditions remains challenging and certainly by no means are we in the froze the of a hard market. There is a growing amount of evidence that would suggest we are in the early stages of hardening market. Much of these changes coming about as many standard markets in particular National Carriers are actively adjusting their appetite as they feel the pain resulting from over reaching during the past several underwriting years. The greatest supporting evidence of this change is the return of pricing leverage without the sacrificing of a renewal retention.

Additionally, our specialty companies are beginning to see some account they have not seen in years. Furthermore, in certain regions of the country we are observing an increasing population in several assigned risk plans. Historically, this has been an early to get accurate sign of a hardening market. The modestly improving U.S. economy is also providing assistance due to fewer insurers going out of business as well as continued strengthening in audit premium.

Net written premium for the quarter was $1.06 billion, this represent an increase of 10% over the second quarter of 2010. While the main drivers of this growth continue to come from our younger operations, we are experiencing improving contributions from our more mature companies as the market begins to turn. The specialty and international segments again led the growth as we continue to benefit from those domestic industries that have not been impacted by the slowdown in the general U.S. economy. As well as our presence in the international markets with economies continue to prosper.

The group's price monitoring report for the quarter indicated an improvement over the corresponding period in 2010 of approximately 2%. Though 2% may not be overly exciting for some, this is in fact the second quarter in a row that we have achieved in aggregate [wage] increase. Additionally, this represents more than twice a level of rate increase we achieved in Q1 2011.

Our renewal retentions remains in the 80s consequently providing evidence of pricing leverage rather than adverse selection. The loss ratio for the quarter was at 66.3 which includes 6.2 points of storm. The unusually high level of storms contributed an additional $35 million of losses beyond what we would normally anticipate in the second quarter. The lion’s share of the loss activity was in our regional segment which stem from PCS 46 in Alabama and PCS 48 in Missouri.

Our expense ratio for the period was at 34.8, this result is generally in line with our expectations given the investments we have made in starting new operations as well as where we are in the cycle. We anticipate a gradual improvement in the goods expense ratio as our earned premium continues to build, consequently enabling us to further leverage our existing platform.

All in we delivered a combined ratio of over 101.1 for the second quarter. While this result is below our goal we believe that it is tolerable in light of the level of catastrophes during the period. Having said this (inaudible) and adjust for a normal level of cat activity as well as back out our reserve takedowns our current accident year combined ratio remains at approximately 99.

Our balance sheet remains robust and we continue to be convinced that the strength of our aggregate loss reserves are comfortably sufficient to allow us to manage our ways to even an unforeseen event. Overall, there is growing evidence that the moment we have been waiting for is approaching. There the market does not turn overnight, there are ever grown number of signs that we are headed towards an improved environment.

Thank you.

William R. Berkley

Okay Gene, give a numbers a bit please.

Gene Ballard

Okay. Thank you. I’ll start with just a few more details on those catastrophe losses. As Rob said that second quarter eight quarter catastrophe losses were 63 million or 6.2 loss ration points. That represents our net loss after reinsurance recoveries and reinstatement premiums and compares with 30 million or 3.1 loss ratio points in the second quarter of 2010.

Losses from the tornado center in Alabama in Missouri were 36 million in the aggregate and losses from 10 smaller but still significant tornadoes and hail storms in the quarter were another 27 million.

We had originally estimated our losses could be 60 million, 65 million for April and May, however, our actual losses turned out to be slightly less than that estimate and fortunately the month of June was relatively benign compared with the first two months of the quarter. Four of our business segments reported cat losses in the quarter, 44 million for regional, 9 million for specialty, 7 million for reinsurance and 3 million for international.

Partially offsetting the catastrophe losses was favorable reserve development of 35 million of 3.5 loss ratio points in the quarter. The favorable reserve development was primarily related to the specialty, reinsurance at regional segments and emanated from accident year's 2005 to 2009.

Our underlying loss ratio excluding catastrophes and storms was 63.5 points down a half a point from the prior year. The specialty and international accident year loss ratios before were about 2 points lower due to the combined impact of rate increases and changes in the mix of business and that was partially offset by 1 to 2 point increase than the initial losses for accident year 2011 for the other business segments.

Our second quarter expense ratio was 34.8 that’s up six-tenth of a point from the second quarter of 2010 and three-tenth of a point from the first quarter of this year. There are two reasons for that; first, written premiums were up 10% in the quarter and only a part of the cost related to that increase goes in deferred acquisition cost. And second, we include higher profit commissions for the reinsurance segment as a result of favorable reserve trends. That gives us a combined ratio including the impact of cat and reserve releases of 101.1 for the quarter compared to 94.4 in last year's second quarter. Nonetheless, our paid loss ratio decreased to 59.6% down from 64% a year ago. And our net loss reserves increased by 74 million as a result operating cash flow was up 25% to 161 million.

Just one other comment to add to Rob’s remarks on the premium growth and that with respect to the alternative market segment. You will see that the alternative market segment reported a 22% increase in gross premiums and a 4% increase in net premiums. We talked about this last quarter that again is due to the increase in premiums on the signed risk plan that we managed for a number of state, and that business is a 100% seeded to the respective assigned risk pause with no net retention for us.

Net investment income was a 149 million up 15% from 130 million in the prior year quarter. The increase was attributable to higher income from investment funds and from merger arbitrage trading, income from investment funds was 17 million compared to 1.5 million a year ago due to strong results for both energy and real estate related funds. And merger arbitrage income was 4 million compared to 1 million a year ago. The overall annualized yield on the portfolio was 4.4% up 50 basis points from last year's second quarter. And that represents an annualized yield of 4.1% for the core portfolio 3.9% for the arbitrage account and 13% for investment funds. We also reported realized gains from the sales investment of 23 million in the quarter. And at June 30, our unrealized investment gains before tax was 600 million and the average duration of our fixed income portfolio was 3.5 year's down from 3.6 years at the beginning of the quarter.

Finally, our net income was 83 million for the quarter which is an annualized return on equity of 9% and after taking into consideration that we purchased 1.1 million shares of our stock of book value was $27.77 at June 30, up 6% from the beginning of the year.

William R. Berkley

Thank you, Gene. So, I’m quite pleased with where things are going. As I’m sure many of you recall I expected the cycle to start to turn in the fourth quarter of last year in fact pricing didn’t really change until the first quarter of this year. It's continuing to improve although at a somewhat slower rate. Part of that slower rate of improvement comes from this slow economic activity and the lack of the robust economic improvement. We still expect 5% plus rate improvement year-over-year by the fourth quarter. The one negative is you are also seeing this loss cost development which is certainly gone from where it's been totally benign where you noticed the trend is changing. It's not that we are seeing exclusive trend but it's now a noticeable trend in the wrong direction. So, if I were to choose a number it might be 2 or 3% at the moment, but the signs of that trend cause you to pay attention. It's one of the things that we try to take into consideration when we are establishing our reserves and looking at the adequacy of them to be sure that we reflect those trends and maintain reserves that assume those things continue.

One thing, long-term benefit of being in the industry has gained for our company is that you have to always try and look ahead for these negative things, because they always appear when you least expect them. Our businesses are gaining traction, people are thinking about why they buy insurance and who is going to be there, people are beginning to recognize expertise is really important, people are concerned about financial strength to build, people are concerned that you have consistent approach. And brokers and agents are conscious of the fact that they need a ready market. And as people start to withdraw here and there they step back and say who is going to be around.

I don’t serve my customer well if I have no one who wants to provide them coverage. And those thoughts are beginning to enter people’s minds it isn’t a trend. It's isn’t where everyone is worried. But there are number of places where people are asking those kinds of questions. And there are number of people who are still searching for price especially on large risks, but as many of you remember we have lost most of our largest a long time ago. So, it doesn’t affect us much but in large risks it's still a very competitive world.

I think that our international business is doing especially well. We are quite pleased with our ability to seek our opportunities and we continue to think that there will be more opportunities that we will be able to find in that area. The most difficult part of our business the moment the most competitive has been our facultative business where people just don’t want to pay the appropriate price and we are really pleased that our fact people have been disciplined and we are perfectly happy we provide our expertise, but only if we think we can make money. And some people value that and are prepared to pay a fair price, but we can’t offer our expertise in our capital without it and our fact markets have suffered in this market especially and that’s one of the reasons to our reinsurance area volume is down is substantially.

From looking at the rest of the world from our perspective we think that we have got into the hurricane season, a tough hurricane season can clearly have a real impact on a lot of people who may not have the ability to buy another reinstatement, who may not in fact had the capacity to meet their liabilities. So, we are here, we are well positioned, we think the world is planning a pretty much as we thought although had a slower pace. And we are starting to get the traction that we expected.

So, with that Jerome, I’m happy to take questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) And our first question comes from Michael Nannizzi with Goldman Sachs.

Michael Nannizzi - Goldman Sachs

Thanks. Gene one quick question on the development, it sounds like there will be about 3.5 points but my math will get that to about 93 on a ex-cat ex-development combined is that right or is there am I doing math wrong?

Gene Ballard

Are you talking about combined ratio for the quarter?

Michael Nannizzi - Goldman Sachs

Yes.

Gene Ballard

Yes, about 90.5 exactly.

Michael Nannizzi - Goldman Sachs

I was sure it 90.5 okay. Got it. Okay, thanks. And then just one question Bill or Rob if I could.

Rob Berkley

The combined ratio without the benefit of (inaudible) releases and without the cost of catastrophe losses is around [1 million, 0.5 million].

Michael Nannizzi - Goldman Sachs

And then just one question on international for Bill or Rob. What type of insurance is driving that growth and is these newer ventures primarily just further coming online and is there an area that we are focused on that you feel is continuing to allow tailwinds to go more?

William R. Berkley

Rob will give you the specifics, but I’m going to just talk in the broader sense and part of it is the general economic environment. So, go ahead.

Rob Berkley

Well I think it is what was just (inaudible) a moment ago it's the economies that we operate in outside of the United States that enjoy the most momentum. It is predominantly focused around commercial lines. And if you look at where we do things outside of the United States you look at what economies are prospering you are going to see that. So, whether it be Canada or Brazil or Australia or parts of Asia those are places where we are benefitting from the macro underlying economy and our insurers are doing well and the economies are growing. So, we are able to grow along with them. Our operations in Europe and specifically the UK as far as they have felt a little bit more of a headwinds with the exception of parts of Europe that they serve such as market like Norway which because of their natural resources continue to boom. And then of course, our (inaudible) to operation is doing well part of that has to do that it's still getting traction because it's relatively young. And part of that it has to do with the lines of business that it offers.

Michael Nannizzi - Goldman Sachs

So, is that, you are up 15 to 20% of premiums there. I mean do you feel like that’s the number that you could see grow, would you want to see that get 20 to 25, 30. And second real quick is all those risks written outside of the U.S. on the risks that are also written within subs outside of the U.S. on the risks that are non-U.S.?

William R. Berkley

Yes, they are. There may be one off that doesn’t but in principal that some of our business that (inaudible) is written by U.S. businesses, but all of the rest is outside of the U.S. Then I think that I’d expect that our U.S. which is where we have had many of our new specialty will start to grow. And therefore, while the international business will probably be somewhat of an increasing portion of our business, it won’t grow to be as much of increase as you might think, because we would expect our domestic business will start to grow a lot more rapidly. So, I wouldn’t surprise if it got to be 20%. That we sort of have said that we would be really happy if our international business represent a 20% of our overall, but I think that in the next couple of years we think our U.S. business is most likely to grow substantially. SO, our international business is not likely to be a huge increase in its proportion.

Operator

Our next question comes from the line of Keith Walsh with Citi.

Keith Walsh - Citi

First for Rob, in your commentary you mentioned you are getting priced without sacrificing retention I believe in, it seems new business is very strong, maybe if you can talk about how the hit rate on wholly new business has trended over the last several quarters and then I have got a follow-up.

Rob Berkley

I didn’t mean to suggest to that new business is particularly strong, I was suggesting that our renewal retention is particularly strong even though we are achieving rate. The growth that we are seeing as they group in 10% that is pretty concentrated amongst certain operating units that I tried to at least to get in with some of our newer companies in the specialty segment as well as outside of the United States. So, I don’t think that newer business or is plentiful across the board. I think once again it's pretty concentrated.

Keith Walsh - Citi

Okay, very helpful. And then Bill, just getting back to loss costs, where are these loss costs specifically, give me a detail where the comment from in. And just historical view or higher loss costs consistent with the sluggish economy can you just talk to that a little bit? Thanks.

William R. Berkley

I think our trend the actuaries that pointed out to us directionally loss costs have turned from what’s been a long-term decline to where they have directionally moved upwards slightly not a lot but definitely a directional change and though they generally don’t in the sluggish economy. On the other hand where we were having a very good economy they were coming down which isn’t something one would have expected (inaudible). So, I think that lost costs has huge move in ways that we can’t predict at the moment. It's though different than inflation. We didn’t have inflation when the economy was doing well mainly because it effectively Chinese low cost production was subsidizing our cost of goods here and at the same time inflation was being eating up by people who are willing to invest in U.S. securities which may not be (inaudible). But the fact is that I wasn’t suggesting that I know I was nearly commenting of what the numbers are saying at the moment. And we are cautious. I think if you look back at our annual report from the first month now we always have said what you worry about is the unforeseen event. You look at the numbers and say what may they be telling me that I can’t see out there and I would say we don’t have any worry about inflation. That is just not happening. The economy is (inaudible), but that’s the unforeseen event that’s why we are not buying long-term bonds, that’s why we are reserving things loans costs trends. They felt the numbers have turned the corner and start to move in the other direction. So, I wish I could be more specific regard to that, I love to see more specifics. And this not a case of me trying to keep information for competitive reasons, I’m telling you everything that I know at the moment.

Operator

Our next question comes from the line of Michael Grasher with Piper Jaffray.

Michael Grasher - Piper Jaffray

Just a couple of questions, just with regard to the loss costs issue. Can you share with us in terms of, do you believe it's driven more by the duration of claim or is it more of a frequency matter?

Rob Berkley

Our view at this stage is what we are seeing is a tick up in frequency. What we have had all long particularly in worker’s compensation is you have this medical trend or headwind that we have been finding for a while and it's a social issue, a political issue and then industry issue as well. But really the change that we are noticing most recently would have to do with frequency, (inaudible) head in a more clear way and worker’s compensation but we are seeing signs of frequency just in the general causality lines overall ticking up as well but it's really comp that we are seeing in the previous level of activity.

Michael Grasher - Piper Jaffray

And then if you look at your accident year combined ratio at 99, would you all agree that the industry probably is tracking closer to a 107 to 110 range?

William R. Berkley

I’d actually say the industry is probably higher than that. If you look at the numbers and the where the industry is in a mix of business, I’d say the industry is probably closer to 110 at this point. And the reason for that is we have lost all our large accounts, large accounts are probably doing significantly worse at this point in time. So, I’d think that our spread right now between what we do in the industry is probably at the maximum, so historically that would so at 10 points. When we are assure of doing average industry business we would be served about the same between 5 or 6 point. Rob would like to add.

Rob Berkley

One comment that I’d add is that if you look at the commercial lines space and the largest line in commercial lines as worker’s compensation, according to NCCI, 2010 combined ratio ran at somewhat between 110 and 115, I believe it actually look at 115 combined ratio for the accident year. So, that on its own is the largest commercial line is probably pointing you in a direction that things are running hard.

Michael Grasher - Piper Jaffray

And then with regard to Workers' Comp in the pricing environment there, obviously driven by the states, but relative to the class of risk, what do you experience there in terms of the change in the pricing dynamics?

William R. Berkley

You mean pricing dynamics today?

Michael Grasher - Piper Jaffray

Yes. Relative to the class of risk that the worker’s comp the exposure would be to.

Rob Berkley

Generally speaking we don’t get into the specifics of class of business within a line of business as to what we see going on and we don’t necessarily get (inaudible) telling the specifics as what leap were achieving within classes within a line, but what I can tell you is that we were seeing certainly encouraging signs in the primary if you will or comp market as appose to the excess comp market which seems to be a very different circumstance where they doesn’t seem be any noteworthy discipline entering that part.

William R. Berkley

In the excess comp market people are just making incredibly optimistic statements or assessments as to what they think future interest rate should be used to discount their loss. So, we are having people use 5 and 6% discount rates on establishing loss reserves for excess comp and as appose to the current interest rates on 30 year treasuries. We think excess comp is still incredibly competitive.

Rob Berkley

As far as primary comp goes the market does not march in lock step it really depends on the territory if you will how the market is shifting.

Operator

Our next question comes from the line of Josh Shanker with Deutsche Bank.

Josh Shanker - Deutsche Bank

Sorry to keep on this loss cost thing, and I realize I'm splitting hairs a little bit, but if your rate is up 2%, and loss costs are up 2 to 3%, is it right now at this moment loss costs are exceeding rate, or are they about the same? Where are we right now?

William R. Berkley

I think you are trying to be more precise about loss cost than I can be. And loss costs aren’t something we can measure it especially because the loss cost trends are based on frequency and it's literally one quarter whereas for pricing we have quarter-to-quarter measures with a lot of consistency. Those numbers have some level of accuracy. And loss costs as I’ve said is sort of you look at a trend and directional changes what I’m really telling people. And I’d say that we are gaining a little we are losing little, I’m not excited about [pricing because loss costs are actually going the wrong way. So, I’d still say we are net price positive but it's not significant and I’m concerned about loss costs directionally. But you are asking for precision Josh, but I don’t have any yet. And I’m trying to tell people who follow our company about why we are little more cautious in our reserving why we are little more cautious about how good the pricing is.

Josh Shanker - Deutsche Bank

That's totally understandable. Can you give a little detail on the excess worker’s comp market that you already did. If you listen to a lot of primary layer comp writers, they're talking about rate increases and the brokers surveys seem to confirm that. But obviously one of the primaries is that these loss costs are rising at worker’s comp, they took a small charge on it. What is going on in the excess market and how does pricing compare in the competitive marketplace?

Rob Berkley

The excess markets while the primary comp market and the excess comp market while they maybe to a certain extent showing the same underlying exposure if you will and many cases the same customer base. The fact of the matter is that the markets do not march in lock step at all. Clearly, there are regions within the United States where the comp market is beginning to turn in our opinion having said that once again it is our view that the excess comp market has yet to show any signs of turning and it remains a very competitive segment to the industry.

Josh Shanker - Deutsche Bank

Along those lines, if people say that primary is up 1%, do you have an idea about pricing the excess market, the rate move at this point?

Rob Berkley

The answer is that we are seeing many without getting overly specific we are seeing many competitors in the excess comp space operate in a more aggressive way today than they did yesterday.

William R. Berkley

I think also the customer in the excess comp market are widely varying it's a very long tail line of business. And there is some modest pretty aggressive well established companies have in there a new people who are wildly aggressive. So, I think it's a very wide range of competitors some who think it looks so attractive, please get all the money long time and some who are just making what I define as irrational but judgment as to interest rate returns. So, from our point of view I think prices are just inactive when you compound interest rates at 2 points higher for 17 year's which is the average duration of excess comp. So, a lot money in pricing.

Operator

Our next question comes from the line of Bob Farnam with KBW.

Bob Farnam - KBW

Talking about the new ventures, how much additional momentum should we see from the new ventures? I'm trying to get an idea of how much capacity is being used for the new ventures thus far.

William R. Berkley

When you mean additional capacity, I’m trying to understand what are you trying to answer Bob?

Bob Farnam - KBW

You're getting pretty solid growth from the new ventures. I'm trying to figure out, will that continue? Will it grow even more?

Rob Berkley

The answer is I guess we need to define the environment, Bob, assuming there is no turn in the market even though it is our belief that the market isn’t in the early stages of turning but the purpose of discussion let’s assume that there is no turn in the market. It is our expectation that you will see some reasonable level of growth certainly for the balance for this year. Having said that as we get into 2012 if we do not see a turning in the market and we do not add additional new ventures to the group, I think well I would not suggest we will plateau or shrink I think it is likely that our growth rate would slow. Having said that I think our expectation is we are in the process of returning market and we would expect the growth rate to continue well into next year.

William R. Berkley

I mean I think that critical element here has to with both the economy and the insurance marketplace. So, at this point our fast judgment is growth continues as it is maybe even accelerating. However, it's a lot of uncertainty and there is no question with the economy on edge like it is, you can’t feel good about where all that takes us for the moment and therefore, we would be stepping in the wrong direction if we continued our expectations unchanged as we feel a bit less certain about economic activity.

Bob Farnam - KBW

Fair enough. And a question on any change in terms and conditions? I don't know how that terms and conditions have held up over the past couple of years. Are you seeing them starting to tighten or are they still deteriorating?

Rob Berkley

As far as terms and conditions go the placements that you are seeing them tightening a little bit is just when you see business migrate from the standard marketing with specialty or non-standard market inherently in that transfer ownership that you are going to see (inaudible) we are seeing a bit of that but not an overwhelming on that. Putting that aside we are not seeing any tightening of terms in any significant way to where it has been recently.

William R. Berkley

I think by the way I’d add, as part of the reason e have been losing business in our specialty business, specialty pricing we have most, because we haven’t been willing to change our terms and conditions, and we lost business because of it.

Operator

And so our next question comes from Meyer Shields with Stifel Nicolaus.

Meyer Shields - Stifel Nicolaus

I was hoping we could, I guess this is for Gene, the reserve releases and reinstatement premiums by segment.

Gene Ballard

It was other leases that e normally don’t talk about that on the call we will have that in our 10-Q.

Meyer Shields - Stifel Nicolaus

With regard to the quarterly results, did the natural catastrophes you incurred have any impact on acquisition expense?

Rob Berkley

The catastrophes?

Meyer Shields - Stifel Nicolaus

Right. In other words, basically did the division compensation change because of the outside level of catastrophic losses?

Rob Berkley

No.

Meyer Shields - Stifel Nicolaus

One big picture I was hoping to run by Bill, is it too early to tell how good this market will ultimately get? You've given your expectations.

William R. Berkley

The biggest issue that’s sitting out here is the economy as a whole and where we will fade I think that we are going to have, every cycle changes gradually until some events take place. Whether it's 9/11 or Reliance and Frontier going broke. If we were to have two severe hurricanes you would change this market dramatically because reinsurance capacity would disappear because there are number of people who have no capacity to buy reinstatements who are in the reinsurance business. They use their one reinstatement towards out there already. And there is not a market for it. And therefore, that would change the market dramatically. It's clear that if you look at Katrina, a number of reinsurance in fact really went bankrupt but they forgot to tell me buddy and investors put a lot of money in it. Between the time they decided to help people that were bankrupt and the time they raised the money. Somehow they forgot. I think that there is a lot of stuff out there. And I think that we sit here and wait for the unforeseen events and how that it hurts our competitors and doesn’t hurt us, because we hopefully are prepared for it. And we go forward. But I think that based on pricing and pricing all, you need 15% increases in the average price, 20% increases in the average price. And even then the return on capital in the industry will be probably only 8% after-tax. That’s based on where I see the combined ratio now for the industry. Now there are lots of companies they are doing better than that. And then there are plenty that are doing worse. So, if I were to give you a forecast I’d say that by the end of 2012 we will get 5% this year and we will need 10% more next year. And then maybe even a little more certainly by the rate changed by the end of next year needs to be higher.

Operator

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

Jay Cohen - Bank of America/Merrill Lynch

I've got a couple questions. The first is, you mentioned in the Specialty business the accident year loss ratio ex-cats improved by a couple points, and I guess I'm assuming that the earned price impact is still either flat or negative, and you mentioned claims beginning to go up. I know the business mix is changing. Maybe that's a big part of it, but if you could explain that. And the second question, I'm wondering, Bill, if you could comment on the debate now about the debt ceiling and how you see it playing out?

William R. Berkley

First of all, I think the comments are pretty straight forward about the specialty lines business. I mean I think that business is increasing volume is increasing mainly from new businesses. And pricing is up a little bit. That’s one of the places where we had some positive impact on pricing.

Jay Cohen - Bank of America/Merrill Lynch

I guess I just wouldn't expect the earned effect of those price increases at this point to be outpacing your loss costs, especially when you say loss costs seem to be increasing, maybe it's just too modest at this point.

William R. Berkley

I think what I was trying to say is loss costs are giving us signs that signs give us concern because they have changed directionally. And we feel we just have taken the view, I should say always. But certainly through the more than the past 10 years we have taken the view that you don’t better than everybody else by retrospective analysis, you do better than everybody else by looking for signs that give you a directional point of view. SO, we got a little bit cautious. We can always become less cautious if 3 or 6 and 9 months down the road we were too cautious. For the moment we would rather be a little more cautious. As to the debt feeling, (inaudible) who voted against the raising the debt limit along with every other democrat on a number of occasions is just a little worse than we pointed out that we had 17 votes to increase the debt limit for Ronald Reagan which tells you that Congress only gave Ronald Reagan a little bit at a time, but this President (inaudible) little bit at a time. Look it's a terrible problem, we have become so politicized that no one seems to put our nations interest first. Individually you talked to these people I think Congressmen, senators are really extraordinary people who are devoted to our country. And then they all get together and they are worried more about reelection and it's unfortunate. I think it's a serious issue, optimistic that we will get at least some temporary solution. It is a philosophic breakdown of the two extremes in our nations and not much from the middle which says, get this off, no one has thought about the fact that every other nation restricts healthcare costs through restricting funding. Every other nation restricts their expenditures by controlling how much they spend. I don’t mind about taxes, if they want to raise taxes some of that sign. But the fact is it has to be irrational taxes and it has to let our country be a competitive force in world which will become (inaudible) unless, but right now we need to snap to an act like a single country that’s sophisticated and intelligent and that means we should get together and ask something and have a plan for how we are going to resolve this. And for a Warren Buffet is a great idea that said if we have deficit more than a certain amount and no one in Congress would be allowed to stand for reelection. I think that was a wonderful solution.

Operator

Our next question comes from Brian Meredith with UBS.

Brian Meredith - UBS

Bill, I just want to follow on Jay's question for a second there, if the U.S. credit rating is downgraded from a AAA to a AA+, what would be the implications for the property-casualty insurance industry and also on W.R. Berkley. Specifically, you do have municipal bonds, some probably AAA rated, what are your thoughts on that?

William R. Berkley

First of all we have a relatively our duration is not long and we haven’t been tempted to go out and buy yield by going out along or buy yield by getting lower quality securities. So, I don’t think that that’s really going to be a significant issue for U.S. We have lots of liquidity and it's kept in places that we won’t be restricted from having all of that liquidity. I think that the issue will be the same severely issue we all face and that is today America and treasury securities are the reserve currency in the world. And it's an unquestioned issue in all of our securities are priced off of that. I think it will raise the issue about the quality of (inaudible). But from a real day-to-day operating point of view since what come in everyday is more than what goes out every day. It shouldn’t have any consequence and while in the very short run, there might be a slight hick up I don’t think it's going be a consequential one. We There aren’t many AAA securities and I just don’t imagine it would have a very significant impact.

Brian Meredith - UBS

And then for Rob, are we seeing any impact at all from RMS 11 on some pricing in the industry yet, on the primary side?

Rob Berkley

I think we are certainly seeing it in the reinsurance marketplace and you are seeing it attempts of both to try and push rates on the primary side, but it's really not materialistic at this stage in our opinion or certainly not significantly material as far as changing market conditions are rates for property, but we will see as the year progresses and rating agencies take more of a position as it relates to RMS 11.

Operator

Our next question comes from Scott Frost with Bank of America.

Scott Frost - Bank of America/Merrill Lynch

I was wondering if you could go over any exposures to European credits, specifically peripheral's. I saw the foreign government agency exposure, but I was curious about your corporate portfolio, if you have any credits in the Euro zone that you're worried about?

William R. Berkley

No, we were based most of our credits are really what I will tell you managers know we don’t, we have done that weren’t concerned about at all. And most of our non-U.S. credits are Australia, Canada, UK and Brazil.

Operator

Our next question is a follow-up from Michael Nannizzi with Goldman Sachs.

Michael Nannizzi - Goldman Sachs

If I could, one question on you mentioned the facultative market is tight, is that on the property cat side or just general facultative?

William R. Berkley

No, not tight. It's very soft.

Michael Nannizzi - Goldman Sachs

Soft, sorry, right.

William R. Berkley

Yes, it's very soft. And then soft on both left soft on the property side than on the casualty side, but casualty side is very soft because the problem is on facultative business you price it independently of the originating price. So, if you charge a rate of 2% than the facultative people think the rate should be 6%, they give you 4 to 6% for whatever they are taking, which may leave you nothing for your primary business. So, you say I can’t buy I can’t afford to I guess I don’t have paid anything for what I retain. So, that’s the problem. On the property frequently people get the property quote before they make their primary property quote so they take into consideration.

Michael Nannizzi - Goldman Sachs

I see. So what would have to happen on the property side for you, or is there something that could happen on the property side that would cause to you take more property cat risk or is that something that you don't want to do?

William R. Berkley

I think we are prepared to take more property cat risk but not domestic property cast risk. We think on a global basis we will consider it, but we are not going to do it domestically, we have plenty of property cat exposure on a primary basis. So, on a reinsurance basis e wouldn’t take it domestically at all.

Operator

Our next question comes from Gregory Locraft with Morgan Stanley.

Gregory Locraft - Morgan Stanley

I wanted to just better understand, I'm having a hard time modeling the investment funds side of the equation, and I know roughly half the portfolio is in real estate and about a quarter is in energy. What would you do if you were in our shoes to try to get a handle as to modeling that? Obviously it's going to be somewhat lumpy, but any help would be appreciated in terms of how you think about it.

William R. Berkley

I’m sure Greg that Gene will be happy to go through, but it's not very easy to marvel over a short-term basis, because first of all oil prices are volatile, and as to the real estate that is more predictable. Gene can go through with you, we know more real estate to market so that’s a bit more predictable, but the energy funds it's a volatile is a market first for oil and energy related things, but I’m sure Gene will go through as much detail as you want but it's very hard quarter-to-quarter to build the model.

Gregory Locraft - Morgan Stanley

So I guess, Gene, should I just follow-up offline then?

William R. Berkley

Yes, give in a call offline and he will with as much detail.

Gene Ballard

I’d be glad to, also it's hard to predict but we can go through kind of what we have.

Gregory Locraft - Morgan Stanley

With regards to real estate, do you have visibility? Do you sit in the third quarter and have an understanding as to what the fourth quarter is somewhat looking like for that part of the portfolio?

Gene Ballard

To a degree we book these funds on a lag basis the one quarter lag basis, so we talked to them all the time, but we don’t really have their actual earnings until the subsequent quarter.

Gregory Locraft - Morgan Stanley

Another question, just shifting gears a bit. On the reserving side, the reserve releases dropped from the 4, 8, and 12-quarter averages. How does that tie to your loss costs commentary? Did you all change anything in the reserve?

William R. Berkley

We began a bit more cautious until we see how loss costs develop further.

Gregory Locraft - Morgan Stanley

So that is a sustainable, the trend which you've called out, you've actually reflected in your reserving, that resulted in less releases, and therefore that's probably the new level that we should be assuming?

William R. Berkley

I wouldn’t say we changed trend I’d say that we have said let’s understand that’s a little better, let’s see where that takes. It’s better in any quarter to be cautious and get your footing and understand the knowledge you have than to continue blindly moving ahead. So, I wouldn’t say that we are just examining everything, so I don’t think we have directionally change anything, let’s be sure we understand what’s going on does it change it better to be cautious at the moment there is so many uncertainties out there caution is better. We think we will have a better understating at the end of the next quarter and we may revert back where we were, we may stay where we are, we may get more cautious. It's a constant revaluation. Our job is not to be the same our job is to use our best judgment each quarter.

Operator

Next online we have Amit Kumar with Macquarie.

Amit Kumar - Macquarie

Just one quick question in regards to capital management. Just what we had a modest buyback, and I'm wondering, based on where the stock is trading, should we expect that going forward or has been any change in the capital management philosophy here?

William R. Berkley

Mr. Kumar, have I ever told anybody what I’m going to do about buying back stock?

Amit Kumar - Macquarie

I want to keep on trying.

William R. Berkley

The answer is that it's always the balance between what we see our needs for capital and price to stock at any moment and time. And we will have to make that judgment than we do each day and we are how we see things coming along for the moment of use haven’t changed but they didn’t changed in the first quarter we didn’t buyback.

Operator

And next online we have Meyer Shields with Stifel Nicolaus.

Meyer Shields - Stifel Nicolaus

Bill or Rob, are the early signs of an uptick in workers compensation frequency, are you seeing anything like that in medical malpractice?

William R. Berkley

I think the difference medical malpractice is moving incredible profitable line of business, more profitable business we would have expected. And while it's been competitive worker’s compensation never got to the levels of profitability, you got from worker’s compensation. And it was just never as profitable as malpractice. I think that malpractice business is seeming to be getting a little more stable at the moment, but there is not any dramatic increase in pricing outlet.

Meyer Shields - Stifel Nicolaus

And the liability property split right now, is that about 60/40?

William R. Berkley

No, we are still probably I’d have said 75/25, and that’s down from probably (inaudible) 80 plus casualty 3 years ago in about 82, 83% casualty 4 years ago. And today we are probably 75% casualty.

Operator

And next online we have Kenneth Billingsley with BGB Securities.

Kenneth Billingsley - BGB Securities

Just a question for Gene. Looking at the diluted share count for the second quarter, it went up from the first quarter despite the little over 1 million share buyback. Can you just talk about what else is going on in that line?

Gene Ballard

Yes, well a lot of that just has to do with the timing of when share transaction take place so we did have some stock exercises and option exercises in the first quarter that took place late in the quarter. So, came through on a full quarterly basis in the second quarter and some of the buy backs I’d drove in the second quarter came in later and didn’t get reflected. So, it's really just more than timing of those transactions.

Operator

And sir, I’m showing no further questions at this time.

William R. Berkley

Okay, well thank you all very much we are concerned about the economy, concerned about Washington, but enthusiastic about our business and the position we are in going forward. So, thank you all very much and have a great rest of the summer.

Operator

Ladies and gentlemen, thank you for your participation in today’s conference. This concludes the program, you may all disconnect. Have a great day.

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