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XL Group plc (NYSE:XL)

Q2 2011 Earnings Call

August 02, 2011 5:00 pm ET

Executives

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

David Radulski - Senior Vice President and Director of Investor Relations

Susan Cross - Global Chief Actuary and Executive Vice President

Sarah Street - Chief Investment Officer and Executive Vice President

Simon Rich - Senior Vice President, Global Treasurer and Director

Michael McGavick - Chief Executive Officer and Director

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

Analysts

Ian Gutterman - Adage Capital Management, L.P.

Jay Gelb - Barclays Capital

Keith Walsh - Citigroup Inc

Jay Cohen - BofA Merrill Lynch

Arun Kumar - JP Morgan Chase & Co

Brian Meredith - UBS Investment Bank

Matthew Heimermann - JP Morgan Chase & Co

Michael Nannizzi - Goldman Sachs Group Inc.

Joshua Shanker - Deutsche Bank AG

Operator

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

David Radulski

Thank you, Shirley, and good evening, and welcome to XL Group's Second Quarter 2011 Earnings Conference Call. This call is being simultaneously webcast in XL's website at www.xlgroup.com. We posted to our website several documents. These include our quarterly financial supplement, which we are reposting to ensure the file is complete and readable. Our apologies for the inconvenience.

On our call today Mike McGavick, XL Group's CEO, will offer opening remarks. Susan Cross, our Global Chief Actuary, will do our reserving process; followed by Dave Duclos, our Chief Executive of Insurance Operations; and Jamie Veghte, our Chief Executive of Reinsurance Operations, who will review the segment results and market conditions. Then we'll open it up for questions. Sarah Street, our Chief Investment Officer; and Simon Rich, our Treasurer, 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 we've filed with the SEC, and could cause actual results to differ materially from those contained in the forward-looking statements. Forward-looking statements speak only as of the date of 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.

With that, I turn it over to Mike McGavick.

Michael McGavick

Good evening. As we have discussed on previous calls, and shared with you during our recent Investor Day, we are keenly focused on the 5 drivers that build value for XL's shareholders. These are: underwriting excellence, strategic growth, strong enterprise risk management, optimized investing and operating in capital efficiency. We feel good about our progress across these 5 drivers as each has contributed to our results in this quarter. Have you seen the quarter produced $0.75 in operating earnings. And we grew our fully diluted book value per share by 6.3% and generated an annualized operating ROE of 10.3%.

Now first, as to our pursuit of underwriting excellence. Our P&C operations produced a combined ratio of 94.9% for the quarter, a solid result for this stage in the market cycle. Our top line growth of 16.9% year-over-year came from the business initiatives in both Insurance and Reinsurance, favorable FX movements and better pricing and account lines, particularly in Property Catastrophe. Market conditions continued their gradual improvement, and we saw pricing in several of our most important lines rise or, at least, bottomed out. RMS 11 has had a positive impact on Florida pricing already, and we also saw increases in several loss-driven markets, notably property, excess casualty and marine lines. Markets with very good recent loss histories like primary U.S. D&O and Reinsurance Aviation were exceptions to these positive trends.

We've already been taking advantage of what we've been learning both from our reinvigoration of our existing businesses and our strategic growth initiatives, the second of our value-creating levers.

With respect to strategic growth, we continued to add capacity and capability in markets we consider attractive and profitable, especially in lines that complement our existing strengths like construction and surety, and we expanded product offerings in environmental and excess in surplus.

A key part of our growth strategy is our focus on attracting and enabling the best talent in the industry. And we continue to add top teams and leaders in the second quarter to our already fine crew. And particularly, we are very pleased that Pete Parrino will be joining XL as our new CFO. Pete has a wealth of finance accounting and strategic leadership experience. He knows the insurance industry, and he knows XL. We look forward to him joining us full time at the end of August, so you can expect him to participate in our next earnings call.

We also recently announced that Paolo Ribotta will become the Head of our Global Distribution. This new position should build on the success we're already seeing from increased cross-selling among our businesses and will play a key role as we expand to new markets and geographies.

With these 2 levers in motion, underwriting excellence and strategic growth, our strategy relies on the third value creating lever, a strong ERM foundation. This was again demonstrated by our Cat performance in the second quarter. Industry's observers have reported that the 2011 tornado season, taken as a single event, would be among the top 10 costliest events in global insurance history. Now we measure our loss performance in several ways. But one significant metric is losses as a percentage of shareholders equity. Using this metric, we have performed exceptionally well on both an absolute and relative basis. But second quarter Cat losses representing 0.7% of March 31 shareholders' equity and year-to-date Cat losses were a very manageable 4.5% of year end shareholders' equity.

Our own implementation of RMS version 11 is complete, and we believe we have sufficient headrooms within our limited structure to take advantage of market opportunities. A key reason that we have this capacity is that we have already anticipated some of the model changes, and we're already applying additional loads to the version 10 methodology, where we felt it was warranted, particularly around the issue of storm surge.

Effective reserving is another key to our prudence. We have performed our comprehensive semi-annual actuarial reviews on XL's P&C risk portfolio in the second quarter. This review resulted in prior year releases of $128 million, split evenly between Insurance and Reinsurance.

Favorable insurance development was largely in professional lines, while favorable Reinsurance development was most significant in North American Property & Casualty lines.

Turning to the fourth lever, optimized investing. We took advantage of higher rates early in the quarter to deploy funds, particularly into agency RMBS and corporates, achieving a P&C new money yield of 3.4%. There was no change to duration in the P&C portfolio at 2.8 years. The increase in P&C net book yield this quarter, compared to the first quarter of 2011, was due to a couple of nonrecurring items. The underlying yield was more in line with the first quarter's net book yield of around 3%.

We ended the second quarter with a favorable mark-to-market of $180 million, largely driven by the fall in U.S. interest rates.

In terms of the fifth lever, operating and capital efficiency. Our operating expense run rate was in line with the last 2 quarters. The increase on a year-over-year basis largely supported the strategic initiatives we discussed in our quarter one call and throughout our Investor Day. These plans include important improvements to increase the scalability and insightfulness of our underwriting platform.

With respect to capital management, we restarted our share buyback program in mid-June, buying back 4.3 million shares for $92 million in the second quarter, and another 7.3 million shares for $158 million, so far, in the third quarter. Since August 2010, we have bought back a total of 45 million shares for $935 million, which has increased our book value per share by approximately $1.

We are also acting on our intention to reduce financial leverage. We announced our tender for the remaining Series C preference shares and the remarketing and intended buying in of the senior notes associated with our equity security units.

All in all, we are pleased with our progress. Our underwriting capabilities are continuously improving. Our risk management continues strong. Our reserving prudence was demonstrated once again, and we maintained our discipline in managing our debt and equity capital.

We know how important all these elements are to delivering the returns shareholders expect from XL, and we are committed to generating such solid returns.

Now I'll turn it over to our Global Chief Actuary, Susan Cross, for some comments on our reserve review process. Susan?

Susan Cross

Thanks, Mike. During the second quarter, we complete detailed reviews covering virtually all of our reserves across our P&C business lines. This is consistent with our normal semi-annual process, and there were no material changes in approach or methodology. As Mike mentioned, these reviews resulted in favorable prior year development of $128 million, split evenly between the Insurance and Reinsurance segments.

The insurance releases of $64 million are primarily attributable to professional lines in the 2006 and prior years. Primary casualty, marine and aerospace also contributed favorably. The favorable development was partially offset by strengthening related to a discontinued surety program and excess in surplus business, as well as strengthening in excess casualty. On a year-to-date basis, the favorable development of $70 million for Insurance is in line with the releases of $66 million for the first half of 2010. The Reinsurance releases of $64 million dollars are comprised of $25 million for property and other short-tail lines; $25 million for Casualty lines, including Professional, primarily in years 2004 and prior; and $40 million related to whole accounts release written on Lloyd's Syndicate.

The total favorable prior development of $64 million is $15 million more than the prior year quarter, largely driven by the releases on the whole account treaties. In the past, we have generally recorded the Reinsurance to close on this business, which has generated favorable prior year development in the third quarter. This year, we have received sufficient information to allow us to reflect at least a portion of the Reinsurance to close in the second quarter. So this reflects a timing difference between the second and third quarters.

Overall, we continue to see favorable actual loss emergence relative to expected levels across most areas of our business. Loss cost trends continue to be moderate, with no discernible changes in those trends thus far in 2011. That said, it's important to keep in mind that it can be difficult to discern such changes for many of our product lines due to their low frequency, high severity characteristics. As such, although loss trends have been moderate in recent years, we continue to factor in long term views of loss trend into both our pricing and reserving as we consider this a more prudent approach.

And now to Dave to discuss Insurance segment results.

David Radulski

Thank you, Susan. Insurance results for the second quarter were on track despite the U.S. -- significant U.S. storm activity Mike mentioned. The segments combined ratio for the quarter of 97.9% compared to 97.6% during the same quarter last year. Losses in our offshore energy and satellite books were more than offset by prior year reserve releases of $64 million, primarily from our U.S. D&O business.

Insurance gross premiums written in Q2 rose by $204 million, or nearly 19% from previous year. While this growth benefited from some one-off gain, premiums were materially stronger as a result of targeted growth initiatives. Several expiring long-term agreements, which were not reflected in last year's premiums, were re-underwritten and renewed as annual policies for a total of $38 million. And favorable true-ups of various premium accruals and other adjustments accounted for $32 million.

Adjusting for these factors, the real growth for the quarter was 8% and benefited from the continued build-out of targeted initiatives we discussed at Investor Day. This included North America and international construction, North America surety, U.S. general aviation and international upper-middle markets. For example, in Q2 this year, we wrote $12 million in North American construction business, compared to 0 in 2010. And we grew out international upper-middle market book from $17 million in the second quarter a year ago to $31 million in Q2 2011.

Foreign exchange adjustments made up the balance of the growth. Net premiums earned were up 4.5% or $39 million largely reflecting the earn through of higher gross premiums written. Our Q2 loss ratio of 67% was actually 1.2 points better than last year. But when you adjust for both Cat and prior year development, our underlying loss ratio rose 2.4 points due to the offshore energy and satellite losses mentioned earlier. We expect and plan for significant losses in these lines, though in light of the second quarter activity, we were acting on the side of prudence and have not fully absorbed them in our IBNR.

On a similar topic, after reporting large property losses during the past 3 quarters, I did want to mention that despite the Q2 storm activity in the U.S., our combined property book, International, North America and Bermuda, performed at historical levels with a loss ratio including Cats in a mid-40s. Acquisition expenses of 12.5% were 1.9 points above prior year as Q2 2010 included favorable one-off for premium taxes and guaranteed fund assessments. Excluding these adjustments, the unfavorable variance of 0.4 points is made up of plan changes and mix of business and a reinstatement premium related to last year's Gulf disaster. Generally speaking, a good financial results for this stage in the cycle.

Now the market conditions. The favorable pricing trend we began to see with our April 1 renewals continue to the second quarter. While average pricing across all lines had been declining in the 1% to 2% range for the prior 12 months, for Q2, it appears to have stabilized. As Mike mentioned, U.S. D&O was an exception, where prices continued to decline in the low-single digits, given the industry profitability levels. And we have, accordingly, reduced our exposures written in this line.

Excluding U.S. D&O, we have seen pricing strengthened by just under 2%. It's largely that property, Excess Casualty and Marine lines driving this improvement, although we are taking actions to push rate in other lines as well. We are guardedly optimistic by the rate strengthening seen in Q2 results. So while we expect to see continued opportunities for selective profitable growth, we remain diligent in our underwriting activities as we see how this market plays out over the next several quarters.

And now to Jamie to discuss Reinsurance.

James Veghte

Thanks, Dave, and good evening. The Reinsurance segment had a solid quarter of underwriting results with a combined ratio of 87.9%. These results were impacted by prior year reserve releases of $63.9 million, and Cat losses in the quarter of $57.4 million. Excluding the impact of these items, our combined ratio was 90%. This compares favorably to the combined of 92.7% in the second quarter of 2010, also excluding Cats and prior year development.

The prior year releases we took in the quarter were largely from our U.S. business unit. And as Susan mentioned, we remained cautious about long-tail reserve releases generally and very diligent regarding recent underwriting years in these lines.

With respect to top line, gross premiums written in the quarter were $472 million, up 12% from the second quarter of last year. This increase was virtually entirely driven by XL Re Bermuda and Europe. In Bermuda, we enjoyed a nice improvement in pricing and utilized additional capacity in the North American Cat renewals. In Europe, we wrote one new professional indemnity treaty for $20 million of annual premium, and also had the benefit of increased premium sessions on U.K. motor treaties that had been booked at low-written premium levels.

As we've often said, top line variations and a treaty portfolio can often cause anomalies in year-on-year premium levels that do not reflect larger market trends. That is, this growth does not signal either broad market turn or weakening underwriting standards. We've simply found some selective opportunities to write business in key markets.

Turning to market conditions, we were broadly pleased with mid-year renewals. We were in a great position to take advantage of improved pricing in the U.S. Cat market, selectively write new business and expand our lines on programs we liked. On Florida-concentrated business, pricing was up 7.5% to 12.5%, and on other U.S. business, an improved 5% to 7.5% on a risk-adjusted basis.

The renewal process in the Cat market was a bit of a game of chicken, with some clients instructing their brokers to place as much as they could at prices below the levels quoted by the recognized lead markets. In these cases, programs struggle to achieve full placement, and we had the benefit of writing shortfall covers in a number of instances where this took place. Those that purchased at market-leading consensus pricing found abundant capacity to place their programs.

In the International market, loss impacted property programs have seen price increases of 5% to 10%. Loss-free programs were generally flat to down slightly. In specialty lines, aviation was down 5% given favorable loss experience and loss-driven markets such as marine energy, the retro market and Asia Pacific Cat renewal saw a positive movement.

On the long-tail side, the environment remains competitive across most sectors of the market. Other than limited pockets, we see continued pressure on pricing. Broadly, the Reinsurance segment now prefers professional lines over standard lines and prefer the write excess of loss over quota share. We do see occasion opportunities to write business like we did in London this quarter. But overall, the market remains very competitive, and our underwriting posture highly defensive.

With that I'll turn things back to David for Q&A.

David Radulski

Shirley, can you please open the lines for questions?

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from Keith Walsh with Citi.

Keith Walsh - Citigroup Inc

Anyway, just first question on net written premium, looking at primary property and reinsurance property Cat seemed very, very strong growth there. And by my math gone from about 26% to 29% of total NWP. Is there a limit or a target on how large a percent of the total book you want this to account for?

James Veghte

Keith, it's Jamie. On the Reinsurance side, we've spoken about this before. As the long-tail markets have weakened, we have increased the percentage of our writings in property, particularly Cat which has gone from about 10% of our portfolio in 2005, to almost 20% today. I don't think we ever have any absolute target percentage split. We tend to allocate our capital where we think we can generate the best returns.

David Duclos

Keith, this is Dave. I'll just add that in addition to the capital utilization comment that Jamie just made, the production that you saw on the second quarter for Insurance property is reflective of actually strengthening of the team. We've got a new leader, Joe Tocco, who's working with the existing team. And frankly, we're getting more shots at good opportunities and pricing the business as we were earlier in 2011 and also 2010. So we feel really good about that being a sign of us being a bigger factor in the property market in North America.

Keith Walsh - Citigroup Inc

Great. And then a follow-up around expenses. Two-part question. You mentioned in the press release, operating expenses elevated and the build-out of the office of strategic growth and other initiatives. Maybe, how meaningful is this to the quarterly run rate, if you could put some numbers around that? And then I've got a follow-up to that.

Michael McGavick

Yes, this is Mike. As we commented on the Investor Day up in New York, we'd expect this to be a continuing -- we expect this to be a continuing additional cost which really began to build in, in earnest in the fourth quarter last year and has continued at about the same rate at this stage. I would expect that we will continue to see it at this level for the foreseeable future. It could go up or down depending on particular activities that are going on at any given time. But we've expected this really to be a continuing activity, because we think that investing in new technology and approving your platform is simply a constant need of a company that wants to rely this heavily on technology to improve its underwriting basis. The actual run rate increase in the quarter was about $20 million on a run rate basis over a year ago. And I think that's probably a good proxy to use at this stage.

Keith Walsh - Citigroup Inc

And then the other piece on the expenses is increased acquisition costs. So what does this mean exactly? Where are these broker characters out there? What are they doing to you guys? They're taking a bigger cut of the pie, it sounds like. If you could just...

Michael McGavick

Actually, Keith, it's not what it seems. Jamie?

James Veghte

Certainly, part of it comes out of our portfolio, Keith. And it is an indirect result or a direct result of the prior year reserve releases. So if we release reserves on a casualty quota share, for example, very often there's a profit commission associated with that treaty. And we have to increase the accrual on the profit commission that drives the acquisition ratio up.

Operator

Next question comes from Jay Gelb with Barclays Capital.

Jay Gelb - Barclays Capital

I realized the midyear reserve review came in the second quarter, and that resulted in a bit more reserve releases certainly than we were modeling. What's the sustainability of that trend?

Susan Cross

Jay, as I mentioned, we continue to see favorable actual loss emergence relative to our expected levels. And loss cost trends continue to be moderate. So we don't have any reason to believe that's not going to continue. We continue to apply the same prudent reserving approach. So I'm not going to forecast for you, but I don't see any reason to expect it not to continue.

Michael McGavick

Jay, this is Mike. I would also note that a couple of the independent analysts that a look at our reserve loss triangles released back a few months ago, actually, judged reserves to have come out a bit stronger, which is not what we've been seeing generally across the market. So that gives us even more comfort with the quality of the processes we use.

Jay Gelb - Barclays Capital

Okay, on separate issues, deployment of excess capital. Mike, when we had you on the call 3 months ago, you seemed to pull back a bit in terms of the desire to buyback stock and even during Investor Day, but it seems to have shifted gears a bit. Can you tell us what changed in terms of your decision to go back into share buybacks?

Michael McGavick

We have never changed our philosophy. We do believe that -- I don't want to bore you with the 3-part decision-making process again, we first make sure that we have excess capital to a buffer to our rating agency required capital. We then -- if we have excess capital from that buffer, we then consider ways in which we could improve the value of the firm for our shareholders by investing in the firm or through acquisitions or other activities such as that. And if when those things are complete, we don't think we can add value in that way, but we believe that it's the shareholders' money we should find the most efficient practical means returning it to them. That 3-part test has been, I think, quite effective over the years I've been in these chairs. And I can tell you that as we watch the events in the first quarter unfold, we thought it was most prudent to take a pause, because we considered that there could be some very unusual market dynamics that would emerge. And actually, I think we're seeing around us some unusual activity in the end markets. Having said all, including both a much -- an improved pricing environment, particularly in property casualty -- property catastrophe, particularly we're seeing, of course, the implications of RMS model 11. And of course, you are seeing sort of stepped up, both rumored and real M&A activity. So there's a lot going on right now. We thought it was right to take a pause. We went through our 3-part analysis. And our conclusion was, in the end, that we should be returning capital to share repurchase at this time, and that's the program that I've updated you about. I would note that we have another 440 million or so of authorization remaining on our existing $1 billion authorization.

Jay Gelb - Barclays Capital

What's the timeframe to complete that?

Michael McGavick

As you know, we have never forecast our decisions around amounts or specific activities, because to do so would be to the detriment of the effectiveness of the program.

Operator

Our next question comes from Michael Nannizzi. [Goldman Sachs]

Michael Nannizzi - Goldman Sachs Group Inc.

Just a question on loss ratios year-over-year. So could you kind of tell us, both in Insurance and Reinsurance, if you adjust for those items that you talked about, what does the year-over-year look like?

David Duclos

Let me start, this is David, with Insurance. And those large losses I alluded to in the satellite and marine areas account for over 5 points of a loss ratio on an accident year basis. So when you normalize those, i.e., you just take the losses that would've been contemplated within our large loss load, that actually represents the entire negative variance on an accident year basis. Now I have to tell you, it's tiring to talk about lumpy losses impact quarter-to-quarter. But I do want to say, with both the marine and aviation satellite business, these are profitable businesses for us. But the good news is, is that on an accident year basis, we would have a slight improvement year-to-year if it wasn't for the anomaly around the large losses associated with those 2 businesses.

Michael Nannizzi - Goldman Sachs Group Inc.

And then on the Reinsurance side?

James Veghte

Yes. On the Reinsurance side, year-on-year, we had a 2.7 point improvement in the combined ratio if you strip out Cat losses and prior year reserve releases. That delta is entirely driven by the Deepwater loss in the second quarter of last year, which was about 3, 2.7 loss ratio points.

Michael Nannizzi - Goldman Sachs Group Inc.

Great. Just a quick follow-up then. If you're seeing -- you say you're seeing better pricing in property Cat. I noticed non-Cat property, mostly on the primary side, premiums were up higher as well there. How should we expect to see that flow through? I realized it's on a written basis, so it's going to earn through. Like, how should we think about that flowing through the income statement in the next couple of quarters as you earn those dollars through?

James Veghte

It's hardly precise. But I think broadly, you should assume that the expected margins in the Cat business would be significantly higher than you get in the property non-Cat business.

David Duclos

Yes. And from an assurance standpoint, Mike, our -- and a lot of this growth in the second quarter came from North America property, where for the past several years we've been running combines in the low 80s. So it would have a favorable impact in terms of earnings.

Operator

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

Jay Cohen - BofA Merrill Lynch

I guess on the Reinsurance side, did any of the growth -- you mentioned growth in Florida in the property Cat side. Did any of that of that come from simply moving down to lower layers and thus having a much bigger rate online? Or were you pretty much even where you were last year relative to the layers that you participated on?

James Veghte

A bit of both, Jay. We did write down a little bit lower below the Cat fund, which we historically haven't written a lot of. And in addition, we just increased our limits overall. As Mike mentioned, we were in a very good position relative to our published risk appetite going into the renewal season. We've been holding out power [ph] there, and we saw some great opportunities across the market. So we increased our overall aggregate quite materially.

Jay Cohen - BofA Merrill Lynch

Got it. And then, I guess, a numbers question. The conversion of the ESUs, I guess, occurs in mid-August. Could you just -- I think I have it right in my model, but can you just remind us how many shares will be added to the share count?

Michael McGavick

And I thought there might be some question on ESU, so we brought along our Global Treasurer, Simon?

Simon Rich

As you know, the exact number of shares will depend upon the average share price for the period running up to that date. But if it's where the share price is today, we'd expect 30.45 million new shares to be issued on August 15.

Operator

Our next question comes from Matthew Heimermann with JPMC.

Matthew Heimermann - JP Morgan Chase & Co

Mike or Jamie or Dave or everyone, I guess, just on -- you qualitatively talked about in your opening comments that the model changes were relatively modest. I was curious if you could just put some numbers around what relatively modest is? And then I've got a follow-up.

Michael McGavick

This is Mike. I presume you're talking about the RMS model 11 impacts? Yes, Jamie?

James Veghte

Well, I think we had anticipated and built in some loadings in the old model particularly for storm surge. We now believe, based on the changes in the new model, that we can reduce our own sort of subjected loads on that. So we're not saying that the impact, overall, in the model change was not material. Certainly, it was. But it may have impacted us less than some others because of some steps we took in adjusting the old version ourselves.

Michael McGavick

Yes. And, Matthew, from Insurance standpoint, it'd be the same explanation. We certainly try to load up some of the areas that we knew were deficient with version 10. And I'd also say that from an insurance standpoint, we were quite below our limit. So we've got some room to maneuver.

Matthew Heimermann - JP Morgan Chase & Co

I guess I was looking for -- that all makes sense. I guess I was looking for maybe if you could quantify what the change would be because I suspect when you next update your PML disclosure, it's likely going to be up, but some of that's probably going to be the growth you saw in the quarter. So I just was hoping you could give that to us so we could separate one from the other.

David Duclos

We haven't finalized all the July 1 renewals. But as you recall, at the end of the first quarter, we reported that our Tier 1 1% OEP was at about 10% of our shareholders equity with our risk appetite of 15%. We believe we'll still have material room above our -- below our risk appetite.

Matthew Heimermann - JP Morgan Chase & Co

Okay, so no answer. I'll move on. Just with respect to the Japan renewals, did you have any delay of premium into the third quarter or did all the contracts you we're on get booked in 2Q?

David Duclos

We, I believe, had a couple of Cat programs renewed at July 1, so it'll be a Q3 event.

Matthew Heimermann - JP Morgan Chase & Co

Is that tens of millions? I mean just order of magnitude, is that something that we should think about consciously building in, or is it less material than that?

David Duclos

It's less material than that, but I'm not good to be precise about anything relative to the third quarter.

Operator

Our next question comes from Josh Shanker with Deutsche Bank.

Joshua Shanker - Deutsche Bank AG

This is a question for Jamie. You made a comment about property Cat going from 10% of the portfolio to 20% today. A lot of that shrinkage of the portfolio was following Katrina and had some capital issues associated. I wonder, in terms of thinking about that time line, how much of the size of the property Cat portfolio today is due to your capital adequacy? How much is it due to increasing based on where rates were? Arguably, rates have been attractive almost every year since 2005, so I'm just trying to understand how you're allocating capital to the property Cat model?

James Veghte

I think it's as much a reflection of the reduction in our appetite for Casualty business than any of the components of what you've just describe. I think, basically, what we're saying is, we are not at all reluctant to reduce our Casualty writings, and we don't think that the returns are attractive. And Cat, even if we do nothing, is going to become a bigger percentage. So the precise break between rate and aggregate, I don't have with me. But it's as much as a reduction in Casualty as it is in writing additional Cat.

Joshua Shanker - Deutsche Bank AG

And by portfolio, you're meaning premium volume?

James Veghte

Correct.

Operator

Our next question comes from Brian Meredith from UBS.

Brian Meredith - UBS Investment Bank

Most of it asked, but one quick one here. Just looking at the investment affiliate number really, really high this quarter. Anything unusual going on in that number this quarter?

Michael McGavick

No. We had at least one of our gang out there really had a terrific quarter. That's essentially the difference. That's always moves around a bit, but we're very pleased to see this kind of performance.

Brian Meredith - UBS Investment Bank

So that number doesn't -- I thought that number kind of tracked to your alternative funds and that's why it just looked kind of unusual how large it was.

Sarah Street

Hi, Brian, it's Sarah. One of our managers starst to hit the high watermark, so the leverage that you get on that in terms of starting towards [ph] performance fees can drive a significant [indiscernible] like that.

Operator

[Operator Instructions] Our next question comes from Ian Gutterman, Adage Capital.

Ian Gutterman - Adage Capital Management, L.P.

I just want to start with a couple numbers question. Can you tell me what the share count was for earnings -- kind of the number in the press release didn't seem right to me.

Michael McGavick

Yes, the number in the press release is right. But it's as if converted, so that's the big difference.

Ian Gutterman - Adage Capital Management, L.P.

What is it the way you normally show, because I think last quarter it was like $311 million, and you're showing me $342 million in this press release?

Michael McGavick

That's the $30 million on the conversion, I believe, being added in, so you would just back that out. The number that Simon gave you earlier.

Ian Gutterman - Adage Capital Management, L.P.

Got it, okay. Second numbers question, Mike, when you're talking about expenses earlier, I want to make sure we're talking about the same thing. Corporate expenses, your corporate expense line, is that where the increase happened because for all of 2010, that was about $90 million, the corporate expense is $75 million already in the first half. Or were you talking about inside the P&C operations earlier?

Michael McGavick

These strategic expenditures, we're keeping at the top of the house, that's why it's in corporate expense line.

Ian Gutterman - Adage Capital Management, L.P.

Got it, okay. And similarly, the investment income improvement, the sequential improvement, can you talk a little bit more about what drove that? Was there anything onetime? Or is it a good run rate?

Sarah Street

No -- yes. This is Sarah again. Mike did mention in his prepared remarks that actually there were a couple of nonrecurring items in there. On the positive side, association [indiscernible] sort of some noise around in expense allocation against net investment income. And then, a tips [ph] adjustment on our investment portfolio on the tips [ph] side, that came through. So in fact, the run rate or the underlying yield is nearer 3% level on a go-forward basis.

Ian Gutterman - Adage Capital Management, L.P.

And were those one-timers more weighted towards the P&C portfolio or the Life portfolio or a little bit of both?

Sarah Street

Mainly P&C.

Ian Gutterman - Adage Capital Management, L.P.

So is sort of the run rate better than Q1? About the same as Q1? I mean, it that a better way to think about it?

Sarah Street

It's about 3 basis points higher on yield.

Ian Gutterman - Adage Capital Management, L.P.

And do we still that -- given where reinvestment rates are versus maturities, should that be reasonably stable now or do we still have some downside to that?

Sarah Street

No. We still have some downside because, obviously, we have bonds that we bought 5 or 6 years ago that are maturing. I reckon based off some analysis that we've done, if rates don't -- if they stay at this current level, it could be about sort of 18 months to 2 years before it completely stabilizes.

Ian Gutterman - Adage Capital Management, L.P.

Got it. Okay, great. And then, Mike, just my last question, a follow-up, I guess, with Jay's question on the repurchase. I understand how you look at it, and I'm not trying to re-ask that. I guess, I'm just confused on what changed between Investor Day on June 7 and mid-June during the buyback where on Investor Day, it seemed like you weren't ready to repurchase yet.

Michael McGavick

Again, we make those judgments really independent of those events. We do it by our own analysis of where we think we are. We had completed our reviews and as soon as we completed that work, we made a decision. And in this case, as you saw, as we've now announced, started repurchasing.

Ian Gutterman - Adage Capital Management, L.P.

So it was just coincidence on the timing. I guess, I'm surprised you didn't tell us at Investor Day that you might be resuming in the very near future.

Michael McGavick

Yes, it really was quite coincidental. We have set Investor Day dates some significant time before, and the processes we were using to evaluate our alternative opportunities just took as long as they took, so that was just a coincidence in the timing.

Operator

Your next question comes from Arun Kumar with JPMC .

Arun Kumar - JP Morgan Chase & Co

This a question on the fixed income side. Given the degree of comfort that you have with your capital position as evidenced via buyback and other items, you do have a contingent capital, now called Stoneheath, which is callable in 2011, I think, in October. I think this question came up in the last call as well from someone else. But could you give us the intentions towards that security. Clearly, a bunch of different perils [ph] that are covered by that. But given your excess capital, your earnings during the first 6 months of this year, what are the intentions towards either keeping that outstanding or converting into preferred of the holding company or some other outcome?

Michael McGavick

Yes. We have extended the Reinsurance claim until September 30, 2011. We're still looking at our options with respect to this structure, and don't have an announcement to make now. To try and understand the range of options, I would just refer you back to the original transaction documents.

Operator

Your next question comes from Michael Nannizzi with Goldman Sachs.

Michael Nannizzi - Goldman Sachs Group Inc.

Just a quick follow-up on the debt side. You have some debt coming due early next year. I thought that you'd mentioned that you were either participating this current year as related offering or that one. I'm just wondering, do you have any thoughts about how about that offering next year?

Michael McGavick

I would just give you a general answer on this. Our general intention, as we discussed at Investor Day, is to bring down our absolute leverage ratio and, of course, also, as market conditions allow, to lower our cost of leverage. And we have considered and continued to think through various actions that will help with that. That's why we took the action on this Series Cs that we did during the quarter. That's the context of which we're evaluating the Stoneheath instrument, and we're well aware of that maturity and its particular costs, and how it might fit into that general theme. But we continue to consider the best way to get to the right level of leverage over time if the market would allow a lower cost.

Michael Nannizzi - Goldman Sachs Group Inc.

And so that would still be an option currently if you chose to repurchase that as well? Or to restart that?

Michael McGavick

Sure, sure.

Operator

[Operator Instructions] And I'm showing no further questions. I'll turn the call back over to the speakers for closing comments.

Michael McGavick

This is Mike. I just want to thank everybody for being with us this evening. I know it's a busy season, and been a long earnings season. We're very pleased with this quarter. We're pleased with the signs of our strategy coming into place, and we're working hard to advance it further. Thanks again for the time, and I'm sure David and the crew will be available for your further questions.

Operator

That does conclude today's conference. We thank you for your participation. At this time, you may disconnect your line.

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