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W. R. Berkley Corporation (NYSE:WRB)

Q4 2011 Earnings Call

February 1, 2012 at 9:30 am ET

Executives

William R. Berkley – Chairman and Chief Executive Officer

W. Robert Berkley, Jr. – President and Chief Operating Officer

Eugene G. Ballard – Senior Vice President and Chief Financial Officer

Analysts

Amit Kumar – Macquarie

Vincent DeAugustino – Stifel Nicolaus

Vinay Misquith – Evercore Partners Inc.

Gregory W. Locraft – Morgan Stanley

Michael Nannizzi – Goldman Sachs & Co

Doug Mewhirter – RBC Capital Markets

Joshua Shanker – Deutsche Bank

Jay A. Cohen – Bank of America/Merrill Lynch

Howard Flinker – Flinker and Company

Robert Farnam – KBW

Operator

Good day, and welcome to W. R. Berkley Corporation’s Fourth 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 believes, expects or estimates. 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 10-K 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 obligation 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 very much. Welcome to our year end call. We were very pleased with our quarter and the direction of things. We think that our general expectations are being met and we’ll start with Rob talking about our operating results for the quarter. Rob, do you want to go ahead.

W. Robert Berkley, Jr.

Thank you. Good morning. For the industry, the fourth quarter seemed to follow the same pattern that it’s been experiencing for the past several quarters. Noteworthy catastrophe activity along with a continued deterioration amongst many of the casualty lines. While cat events such as the floods in Thailand would seem to be exceptional or perhaps unexpected. This view is questionable given the recent industry experience over the past 18 months.

Additionally, the eroding performance in several of the casualty lines should not be a surprise to anyone. There is a reality when rates are continuously cut over an extended period of times and terms and conditions are loosened, eventually it will end in tear.

Having said this, it would seem as though with every passing day, the industry continues to further set itself up for classic hard market. The attention of carriers is being fourth to migrate away from reserve redundancies and redirected towards the need for additional rates and more disciplined with selection. In fact, there is growing evidence that some carriers not only have been aggressive in their underwriting, but also may have been overly optimistic in the reserving practices and may in fact be (inaudible).

Earlier in 2011, the spotlight was primarily on the need for rates in cat exposed properties and workers compensation. More recently, it would appear there is developing recognition that brought our actions required.

Shifting to organization, the group’s net written premium for the fourth quarter was $1.09 billion. This is an increase of 19% over the corresponding period in 2010. The breakdown of this growth is approximately six points associated with increased exposures of existing insurers including audit premiums 4.2 points of peer rate and the balance from the new business.

As in the past several quarters the company’s growth continued to come about primarily as a result of how we have positioned our operations at more recently. Marketplace dislocations as many carriers continued to adjust their behavior. While the impact of these circumstances are felt group wide they are most visible in the specialty and international segments. Additionally continued gradual improvements in the US economy is providing further assistance to our insurers which in turn we are benefiting from as well.

The group's price monitoring showed an improvement on average renewal rate of 4.2% in the quarter, and just shy of 5% in December. We anticipate this trend of building momentum of rate increase to continue well into 2012. Further on the topic of price monitoring, it's worth mentioning, our metrics do not fully focus on our renewal business, but also on new business.

Our data would suggest that the group is achieving slightly higher rates on new versus renewal business. This would be an example of one of the many metrics we have that provide comfort with the respect to the margin in the new business level.

The renewal retention ratio remains again at approximately 80% providing further confirmation that we are achieving rates without undermining the underwriting integrity of the book. The group’s loss ratio in the fourth quarter was 62.7%, which includes 1.3 points or $15 million of storm. Approximately $13 million of the $15 million is associated with the Thailand floods.

The company’s expense ratio in the quarter was 34.1%. This improvement is mainly due to the gradual growth of our earned premiums. We anticipate this trend continuing throughout 2012. The combined ratio for the quarter came in at 96.8 however, when one adjust for reserve development as well as catastrophic events the current accident year remains at approximately at 99.

Our balance sheet remains strong due to our sound investment philosophy coupled with effective capital management as well as our thoughtful and measured approach to setting and maintaining loss reserves. As we have explained in the past, the group’s philosophy in setting loss reserves is to initially select cautiously and revisit these picks regularly through a rigorous actuarial process.

This approach has led to 20 quarters in a row of positive reserve development. The greater property and casualty commercial lines market has clearly entered a time of transition. There is no doubt with every passing day we are witnessing an increasing piece of change when it comes to carrier behavior.

Market participants are not only looking to raise rates, but also narrow their risk appetite. This is not only evident in the rate increases the industry is achieving, but also through the accelerating flow of business into the specialty market, as well as the rapid growth we are absorbing in the assigned risk plan segment of the market. We have seen these changes in marketplace behavior accelerated through 2011 and anticipate it will continue further in 2012.

It is very difficult for any of us to predict the future with any level of precision. On a macro level things are generally unfolding, however as we expected. The movement we have been waiting for is rapidly approaching. Years of underwriting discipline along with tireless efforts of many has positioned our organization ideally for a turn in the market. The fruits of these labors will become increasingly visible over the next few years.

William R. Berkley

Thanks Rob. Gene is now going to talk about our financial results, and then I’ll try then I'll try to bring it together with our general view of the industry and where we stand from a positioning point of view with the company. Gene, go ahead

Eugene G. Ballard

Okay, thank you. To begin with, Rob mentioned that net premiums were up 19%. Premiums actually increased for all five of our business segments and for 38 of our 46 operating companies. That growth as Rob was led by the international segment, which was 43%, followed by specialty up 21%, alternative markets 19%, reinsurance 15% and regional by 2%.

Changes in foreign currency exchange rates did not have a significant effect on those growth rates for either the company overall or for the international segment itself. The increase in our overall combined ratio of 2.7 points resulted from slightly slower favorable reserve development, as well as modestly higher catastrophe losses. Favorable reserve development overall was $40 million or 3.6 loss ratio points in the quarter, compared with $55 million or 5.6 loss ratio points, a year ago.

Loss reserves developed for all five business segments and the reserve development was inline with reserve releases for the year, which totaled $183 million and averaged $46 million for quarter. Catastrophe losses were $15 million in the quarter, compared with $6 million a year ago. The 2011 losses included the $13 million from the floods in Thailand that Rob mentioned $5 million of that was in our own international business, and $8 million was in the reinsurance segment, and resulted from our minority participation in the Lloyd's syndicate.

The expense ratio improvement by two-tenth of a point compared to the fourth quarter of 2010 and also compared to the third quarter of this year as volume has grown, and we expect that expense ratio to continue decline as the recent increases in written premium become recognized as earned premiums over the following year.

By operating segment, our combined ratios were 96% for specialty, 93% for regional, just under a 100% for alternative markets, 103% for reinsurance, and 98% for international. The increase in the combined ratio for specialty was due to lower reserve development for that segment, and the increase in the combined ratio for the reinsurance segment was also due to lower reserve development and also to higher property losses including the Thailand floods I referred too earlier.

The accident year number that Rob referred to is 99% in the quarter is exactly where it was for all of 2011. Operating cash flow more than tripled to $185 million that’s due mostly to a 10 point decline in our paid loss ratio. Our paid loss ratio is 59% in the fourth quarter and just under 60% for the full year.

Turning to investment income, our net investment income was $117 million in the fourth quarter that’s down from $138 million in the prior year quarter. The income from our fixed income portfolio was $121 million, down $7 million from a year ago. Despite the current interest rate environment, the yield on the fixed income portfolio has remained stable at 4% annualized for the fourth quarter of this year compared to 4.1% for all of 2011, and 4.2% for the full year 2010.

Income from our merger arbitrage trading account was $7 million. That’s an annualized yield of 8% and our investment funds reported a loss of $13 million that was primarily related to the decline in market value of energy related investments that are carried at fair value. Those investments are reported on the one quarter lag and based on the more recent information we have seen on that we believe fair market values have already recovered that loss.

For all of 2011 our investment bonds reported income of $11 million. Realized gains were $52 million in the quarter and $126 million for the full-year that’s primarily related to the sale of equity securities and at December 31, 2011 our unrealized pre-tax investment gains including common stocks were $660 million up $144 million from the beginning of the year.

You’ll notice that we added a new schedule to our earnings release that shows a breakdown of our foreign bonds by country and bond category. You also see that we have expanded our foreign bond disclosure by reclassifying approximately $230 million of corporate bonds into the foreign bond category also by country. Our income tax rate was lower in the quarter that’s primarily due to the realization previously generated foreign tax credits and with that we end up with net income for the fourth quarter of $118 million and an annualized return on equity of 12.7%.

William R. Berkley

Thank you, Gene. Let me just try and give you some. First of all, I have to say that I’m more positive and more certain without the returning cycle and where things are going than I have been in years. Cycles don’t change instantly, they change slowly and gradually until further events accelerate their change, I can’t tell anyone what those further events will be it could be a European insurer size having difficulty because of the euro. It could be a U.S. company who has reserve problems or an unforeseen event, I can’t tell you precisely what it would be, but there is no doubt that a number of companies have not faced out for all of the problems or potential problems in this difficult environment both financial and industry.

We think that that cycle continues to move along and the increasing pricing better terms and conditions it doesn’t always get measured December, as Rob said, we were just shy of 5% average price increases for the quarter 4.2%, but that doesn’t tell the whole story. There are lots of people who misclassify business and wrote excess and surplus lines business as bonds. So a 5% or 8% or 10% price increase doesn’t solve the problem when they really need a 30% or 40% or 50% price increase.

So we might write the business that are the [total REIT] business basis. So some of these numbers are little misleading like when you hear about price increases, in addition we ask to keep in mind that price increases go back to the pricing charge originally so if you misclassify excess and surplus lines business as standard market business you can’t charge enough marginal or any additional pricing to have the business becoming profitable, it is in the different classified example. So you have to be careful what you hear and how you react to that there is no doubt that people are looking at the past several year’s results as our which year’s loss reserves and asking whether they’re adequately reserved, what their accident year picks have been.

We don’t believe our business is worst that any other company, even though our accident year loss reserve fix or combine ratio fix sort of 98, 99 give or take. We think we are a bit on the conservative side, but that’s the strategy because we can’t judge with the certainty about loss cost trends or when and if inflation is going to be around the corner.

We are more confident today that inflation is certainly a few years away and we will be able to review our reserves with the more positive outlook going forward through 2012 because of that. So we are optimistic that just as we were able to deliver double digit returns this year that we’ll continue to do so. We’re still able to find some opportunities to invest that give us reasonably good yields, common stocks don’t represent much of our portfolio and that will probably dividend yielding common stocks all likely to represent a bigger portion of our portfolio. We’re all likely who is going to buy very high quality commercial mortgages 50% 60% loan-to-value that we think are very well skewed with constantly looking to things like that, where you don’t get instant liquidity, but not very long duration still, we are not interested in having our durations a lot substantially overall. We think that the cycle pricing wise will accelerate slightly. I have been optimistic, it took till December till we touched the bottom of my pricing expectations of just about 5% and in fact it was just with that not quite. But the signs are that those pricing expectation are little certain in 2012 and along with that we are finding that people are coming to us because of our consistent approach, so even when we maintained our underwriting standards even when we maintained our pricing we were always there as a market.

When we brought in new teams of people they didn’t close people out, they gave quotes even if they didn’t write business so we have teams of people who came to us having written $200 million, $300 million, $400 million, $500 million before and for us they wrote $20 million or $30 million of business, where they are sitting there well armed with capital and having maintained those great relationship and people are anxious to do business with them because they were always there, they were always polite they always quoted we think that we are going to get the benefit of that.

So it’s not going to be the 26 companies we had five years ago, it’s the 46 companies we have, the core are old companies that we were made up Berkley Corp shrank by 25% so while you may have seen Berkley Corp get somewhat smaller the older companies shrank by 25% not many of our competitors did that. We think we’ll regain that business and then some and we’ll have the benefit of all the new business. So we think we have a great world ahead of us and we’re extremely excited. No doubt, investment income is going to be a challenge, it’s the challenge we are most concerned with, but we are pretty confident that we can find opportunity at this point in time to do not quite as well as they have done 18 months or three years ago, but certainly as well as we have done in the past couple of years keeping that yield around 4%.

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

Question-and-Answer Session

Operator

Certainly. (Operator Instructions) And our first question comes from Amit Kumar from Macquarie. Your line is open.

Amit Kumar – Macquarie

Thanks and good morning.

William R. Berkley

Good morning, Amit.

Amit Kumar – Macquarie

Just going back to your comments regarding new business pricing and renewal business pricing, can you sort of talk about the other leg, you know which is the loss cost trends and assumptions you have for 2012.

William R. Berkley

First of all, I think that we would say loss cost trends are, 2% to 3% is our estimate so we think pricing now significantly exceeds loss costs. Number two, we think we have built into our prior year’s loss costs and inflation rate higher than what we have realized and in fact it’s one of the reasons we’re very comfortable with out reserve position now because it clearly doesn’t appear at this moment that we’re likely to have consequential inflation and we were more conservative than many of our competitors and we felt that appropriate to build in a loss cost level and for that possibility and I think that we would probably see even considering medical inflation that was certainly less than 3%.

Amit Kumar – Macquarie

Okay, that’s helpful. And I guess the other question I have is, you talked about business moving back to specialty, I know that in the past you have talked about you know losing a lot of the larger accounts. I’m just wondering has that behavior changed this quarter, are you seeing any of that flow coming back to you on the larger accounts?

William R. Berkley

I think I general we don’t see behavior changing in a broad based way – Rob (inaudible), he can talk about the (inaudible).

W. Robert Berkley, Jr.

I’m not sure if I would clearly differently it by scale of account even though that certainly will [in fact] I think that I would choose to define that accounts that seem to have more hair on them those are the ones that are more quickly turning up in the specialty market that’s how we never should have left begin with as some of the standard markets are common to their bookings and reacting so the competition around larger accounts, well that continues to a certain extent because it helps people make their budget. Having said that I think the great differentiator is really there is an issue of loss experience those are the consecutive account.

Amit Kumar – Macquarie

Got it and then I guess just finally you didn’t buyback a lot of shares in Q4 and I’m just wondering you know just based on what’s your saying about the market conditions. Would it be fair to assume that at something which is somewhat in the background; just based the new opportunities you’re seeing going forward?

Eugene G. Ballard

It’s always nice when a friend ask that question. Though here’s – let me take you through the old story about it. So then maybe be we wont’ have another person to ask the question. First of all, you all know we paid just a little over 28,000 shares to the stock we bought back; less than book value. So we were happy with the stock we bought back would have bought more back if we could have at that price.

We always try and buy stock back at an attractive price, even if it stretches our capital position; we would buy back stock. So if we could have bought a $100 million of stock back at that price, we would have bought a $100 million stock back at that price, or a price near that. We couldn’t, unfortunately. So we’re price sensitive to what we’ve had. What we do is each quarter, we sit and look and look where our premium volume is going. How much excess capital we have and we anticipate we have, what our dialog is with rating agencies and where we’re going and ensure how much capital we have that we think is excess capital and then, we move forward from there.

I could easily see if the stock sold at a big enough premium for an extended period of time to say to pay dividend, a special dividend. Even though in some way is that sort of wasted money because it doesn’t help how people look at it, it’s a way to get money back to our shareholders and it’s certainly something we would consider. I think giving shareholders their money, better than money back, was selling at a particular premium is better than buying stock back if we have a lot of extra capital. At this moment in time, I think, we will continue to look to buy back stock. It’s not that out of our price range, it’s in somewhat out of our price range. But there’s a lot of opportunities; we think there’s a lot of opportunities for growth and expansion and I’m hoping that I’ll be able to need every dollar of capital I have, but that’s a little more optimistic than even I am at the moment.

Amit Kumar – Macquarie

Got it; okay, thanks. Thanks for the answers.

Operator

Thank you. Our next question comes from Vincent DeAugustino from Stifel Nicolaus. Your line is open.

Vincent DeAugustino – Stifel Nicolaus

Good morning. I – just first starting off with the with a loss cost trend question and one follow up if I may. Looking at worker’s comp medical loss costs inflation from the likes of NCCI, it looks like medical loss costs running somewhere in the low-to-mid single digits, kind of you talked about earlier. But it kind of compares to an accelerating pace in the low-to-mid-teens in 2001. So my question is, does it – a lack of rapid medical loss costs inflations accelerations imply less industry reserving (inaudible) compared to what we had gained last time versus now going into the next hard market. Does that imply less upward pressure on work comp rates, as we kind of accelerate from here?

Eugene G. Ballard

Okay, I’d like to make sure that we understood the question. Earlier you had referenced some NCCI’s statistics, could you share those once more?

Vincent DeAugustino – Stifel Nicolaus

Sure, just looking at a different industry stats and kind of what some of the participants are talking about it; it’s medical loss cost inflation in the – say 3% to 5% range and if we look back to kind what was happening say in 1999 to 2001; we had seen quite aggressive acceleration of loss cost trends out there into the low teens. And so, if we’re only running a – let’s say a rather stable [word in] the single-digit range, I’m just kind of curious if without that accelerating very high inflation rate, does that mean that we won’t see the same level of the adverse development, pushing the industry higher on work comp rates as we kind of go into the next hard market?

Eugene G. Ballard

Look, clearly the medical inflation component is very relevant to many lines and a few more so than worker’s compensation. Having said that, I think that the fundamental issue that is driving the change in worker’s compensation, it really has more to do with how many dollars people were collecting per unit of exposure. And well, clearly medical is a significant component and people need to contemplate that appropriately and then coming up with their pricings, quite frankly, putting that aside for a moment, people just got overly aggressive as how they priced the business beyond this the medical component.

I think in addition to that, other trend factors such as frequency probably stands out in particular as far as something that people were overly optimistic about and it’s probably one of leading drivers as to the change in appetite and behavior that you’re seeing in the marketplace today. I think the medical is an important component, I would not [slowly] hitch my leg into that assumption as to what’s driving the change.

Vincent DeAugustino – Stifel Nicolaus

Okay, that’s very helpful. And I guess just kind of following along that the rate topic here. I don’t think that the lack of adequate underwriting profitability or coordinate [investment] income yields. It doesn’t seem like that is – that surprised anymore, I think that’s probably accepted. So I’m just kind of curious if you see any risks pushing the market back into soft territories. If everyone is acutely aware of the poor operating environment. So I guess what I’m asking is, if irrationality can persist in this sort of environment if we’re all kind of operating in this, the same environment expectations?

William R. Berkley

Well, there’s no one who could dial a [phone] that doesn’t know with irrationality can exist in anything at any time. So I can’t comment on that. But I will tell you that if anything at the moment people have if – have not even begun to feel the pain of the under pricing that took place in 2009 and 2010 and certainly the beginning of 2011. So I think that irrationality aside, I would expect that there will be a lot more pain. And if you’re back in history, at turning the cycle, it always looks like we did worse than everybody else, by expecting a 99 action in here when other people were expecting 95s, 92s and everyone has talked what happened to Berkley underwriting, they really have gotten sloppy and the answer is, we haven’t gotten sloppy, we just have printed the numbers more of a reflection of what they are. So I would suggest that many people in the industry have probably not adequately reflective of the current action in here is vis-à-vis their pricing and I think the pain is just beginning. So I would be surprised, but you can’t ever bet on how foolish people can wish.

Vincent DeAugustino – Stifel Nicolaus

And in terms of that pain coming down the pipe, how would you venture to take a guess on how long it is before we start to see some installment fees popping up or that really just depend on what reserve numbers – company is going to – putting out…

William R. Berkley

I think, by and large the industry is well-capitalized, I don’t – I think, if you’re going to see an insolvency, it’s going to be under – it’s going to be for something coming up that we didn’t foresee; someone who had a cap on the reinsurance and they mostly underpriced their business for someone who’s more modest-sized company with a $1 billion of capital and just lot more than they understand or someone who has investment problems because they were too aggressive. I’d be surprised if there were any (inaudible) solvencies with the exception of the exposure somehow or another to currencies or foreign exposures that people, no one anticipates.

Vincent DeAugustino – Stifel Nicolaus

All right. Thanks for all the answers.

William R. Berkley

Thank you.

Operator

Thank you. Our next question comes from Vinay Misquith from Evercore Partners. Your line is open.

Vinay Misquith – Evercore Partners Inc.

Hi, good morning. Sort of wanted to get some more clarity on the transition of business from the standard market, to the ENS market and I believe you’ve mentioned that, that was because of the risk selection, rather than just pure price. And so just around that, are you, I mean if Berkley able to charge a higher price versus the standard markets, and also why aren’t standard markets taking that business if pricings are maybe 15% to 20% as you would be charging because it’s – you know because it’s an ENS market versus standard paper.

W. Robert Berkley, Jr.

Okay, I think there were a few questions in there, so let me turn in, address them one at a time. I think, first of all, the observation that we have shared in the – and we have seen over the past several quarters is that the migration of business back from the standard market into the specialty market. Obviously, significant component of that is the non-admitted market. The driver of this is just the realities of the standard market’s appetite becoming somewhat broader than perhaps it should have been or in its own best interest is beginning to change. And not only are the standard market looking for rate increases, if you will, but they are also examining their portfolio and taking note of certain classes of business or exposures that don’t really fit within their appetite or their comfort zone.

As a result of that, they are coming through their book and they are driving the business to seek another alternative in the specialty market and often times the E&S market. I would suggest you that by and large, the specialty market is commanding a higher price than the standard market is seeking, and I would suggest that the E&S market is an extreme, if you will, both from a terms and conditions as well as a pricing perspective. So I do believe that the business that is leaving the standard market into the specialty market is commanding a higher price, the written terms and conditions are beginning to tighten and our expectation is that the flow of business from standard to the specialty market will continue to accelerate.

William R. Berkley

I think I would add one thing and that is the underwriters will have this business and are looking at it un-renewal in the standard market. Aren’t equipped to deal with changing hats and becoming E&S underwriters, and underwriter at X, Y, Z company, who has written it [as a Bob] doesn’t have the beginnings of the knowledge necessary to write it and price it appropriately, they squished it and mushed it, so would fit in their box as an E&S as a Bob policy which never should have happened. So the fact is the risk can’t fit in their area at all, so it just, it’s not like, we are a Bob underwriter and we are going to then write something they just don’t have the expertise.

Vinay Misquith – Evercore Partners Inc.

Okay. Fair enough. So I shouldn’t be looking at the plus 5% saying, pricing is not up all at much why you guys are writing business, it’s really I mean it’s really an apples to oranges correct?

William R. Berkley

Yes.

Vinay Misquith – Evercore Partners Inc.

Okay. Fair enough. The second question was I mean you certainly seem to believe that pricing will rise more this year versus last year. Just trying to get a sense of what the opportunity costs that are waiting sort of rather than growing 19% fourth quarter, why not wait for a few quarters until you get more appropriately priced product to write this year versus last year?

William R. Berkley

Well, first of all, if you look at every market turn, we start to grow before the dramatic access in price, because it’s easier to renew business once prices start to change. You can’t – this is not a speed boat, this is not a boat that turns on the dime and you say, okay, wait, wait, wait go and then all of a sudden you change how to behave. As we start to see these things changing, you got to persuade brokers; you got to persuade agents to start to give you the business. If I thought I can wait, it would be better to wait till that moment happens, but that’s not how the real world works, it isn’t like buying a security and selling it, it’s you’re starting on that parade to build the business which you then hopefully will renew at a higher price next year.

And we have the capital to do it and we think we don’t write any business that we don’t think is profitable. So the fact is that we started growing in 2011, because we thought the pricing was beginning to be profitable, and we think that’s continuing to be the case and we will renew the business that we wrote in the first quarter of last year at a slight increase and an increase on top of that increase and so forth. So it’s just how we believe you optimize the results for your business, it just doesn’t turnaround, you just don’t go into an agent or a broker and say give me the business now, here it is, so we just – that we just don’t think that’s how you run a business.

Vinay Misquith – Evercore Partners Inc.

Okay, fair enough. And so in terms of profitability on the new business, what ROEs do you think the new business is being put on your books right now?

William R. Berkley

We would hope that we would achieve our 15% return, that’s our expectation, every piece of business that we write we target that now, that having been said, there may be one – it’s one area or another that doesn’t get us to there, but that also depends on the investment returns we can get, it depends on a whole lot of things, but I can assure you that if we’re going to look back at the business we wrote at the end of 2012, you are going to see certainly an expectation that we will have had and return that would average 15% or more.

Vinay Misquith – Evercore Partners Inc.

Good, thank you.

Operator

Thank you. Our next question comes from Greg Locraft from Morgan Stanley. Your line is open.

Gregory W. Locraft – Morgan Stanley

Yeah. Hi, good morning. Actually just one of the follow-up on the ROE. Can you do a 10 ROE in 2012 and if so, how will you get there?

William R. Berkley

Well, I think that we did more than a 10 this past year. And as we have said, we’ve shifted some of our investment portfolio to realize gains. So some of our investment returns are going to come as gains as well as not gains in the bond portfolio, also gains in common stock, even though we are not investing big amount of money, we’ve been pretty successful in that. So I think we will – I think the combined ratio is likely to come down. We think that we still have some level of redundancies and we are not sure how much that is, but we are going to reconsider where we think inflation is going to be in our reserves as the year goes on, but yeah, we expect to have a double-digit return.

Gregory W. Locraft – Morgan Stanley

Okay. So I mean, I actually, I have the ROE this year as an eight and change not as a 10, but you’re saying include investment gains, so you want to – it’s a net ROE, is that what you are saying not an operating ROE.

William R. Berkley

Yes, because we’re taking out all of our funds and so forth and taking them out and we’ve told people on two calls ago, I believe, maybe three calls ago that given our investment strategy, which is shifting that – we think that that income is a better measure, but…

Gregory W. Locraft – Morgan Stanley

Okay.

William R. Berkley

I think our operating ROE was a little over 9% for the quarter; I think 9.1% for the quarter.

Gregory W. Locraft – Morgan Stanley

Okay, okay. And then I guess, again, to the last question, you mentioned a 15 on new business.

William R. Berkley

No, no, that was – the question was how do we price new business. And the answer is we price the business with a target of 15.

Gregory W. Locraft – Morgan Stanley

Okay. And when you price it at 15, are you picking it? I guess it seems to me that you’re – philosophically, given how well the releases have continued, you’re pricing it for 15 and then maybe picking it much lower, and that’s why the reported ROE is significantly below the new business ROE, after – new business target ROE after all the – after several quarters of growth. I’m trying to figure out what’s holding back the reported numbers from the target numbers.

William R. Berkley

When they price it – when they price the business, they are not pricing in cushions on reserves and so forth [and caution] that we build it. As well, there is a lag. It takes time. So the results you see now are results from probably 2010, 2009, it’s a blend of years. It’s not just – what’s reported in 2012 will be a combination of 2009, 2010, 2011 and 2012, and it’ll be a combination of – those years will be a combination of reviewing reserves as we set them up.

You have the unfortunate job of trying to make an extremely complex business into something that seems easier to analyze. But as you well know, it’s this blend of accident years that makes it a little more difficult. I’m sure if you’d like, Gene and Karen would be glad to go over on how that blends in, but…

Gregory W. Locraft – Morgan Stanley

Okay.

William R. Berkley

It’s just not one accident year that gets reported obviously.

Gregory W. Locraft – Morgan Stanley

Okay, great. And then last one is just flexing the balance sheet. You guys are crushing it on the top line now. The market’s getting better. You’ve obviously built the engine for this kind of a situation. How do we think about the upside to your top line? I guess if you continue this, you’ll be at a [$1.2 million] plus premiums are surplus by year-end. Can you – how much can you do if you love the business on the front-end?

William R. Berkley

Well, I don’t – first, I don’t think we will. I think that if we grow at that rate, you have to remember we have retained earnings we’re generating. So if we do, even taking a 10 or a 12 because net income is what generates capital. So if you do that, we’re only going to be about [$1.1 million]. But the fact is, I think that if we’re generating high returns and we love the business, we could probably run at [$1.5 million to $1 million] for a period of time. But the cornerstone there, Greg, is what kind of return can we get. If we’re not going to get over 15% reported returns of net income, clearly we’re going to be constrained to grow at a 15% or 20% after a couple of years. But we think our returns will be good and we think that we’ll have the capacity to grow as much as we’d like.

Gregory W. Locraft – Morgan Stanley

Okay. Thanks a lot.

Operator

Thank you. Our next question comes from Michael Nannizzi from Goldman Sachs. Your line is open.

Michael Nannizzi – Goldman Sachs & Co

Thank you. Just a couple questions in the regional segment. I’m trying to reconcile written premium trends there to some of the commentary. So first, what was the rate change, if you could, in that regional segment of pure price or pure rate?

William R. Berkley

Well, we don’t give it out by segments certainly, [we don’t do that].

Michael Nannizzi – Goldman Sachs & Co

Okay. So – but it sounds like it was positives. So…

William R. Berkley

Every, all segments had positive rate direction.

Michael Nannizzi – Goldman Sachs & Co

Right, okay. So then – and then exposures were also positives?

William R. Berkley

Yeah, I think exposures in the regional were – I don’t they were positive. I would say [flat or down], maybe even down a little bit.

Michael Nannizzi – Goldman Sachs & Co

Okay. I guess my drive is – so I mean just kind of listening to other folks and trying to digest what we’re hearing is, it seems like U.S. commercial line pricing, particularly at the small end, is where you’re seeing some of the better pricing and some exposure growth. But it sounds like you’re seeing rate but not a lot of – not exposure growth. I’m just trying to reconcile those trends in terms of how that – are you seeing that in your book or you’re not?

W. Robert Berkley, Jr.

Mike, it’s Rob here.

Michael Nannizzi – Goldman Sachs & Co

Hey, Rob.

W. Robert Berkley, Jr.

Let me take a crack at this. We certainly are seeing rate in the regional book. Exposure growth, it is there but new business is very difficult to come by, given what our view is to what rates need to be. So we’re able to get the rate that we would like on our renewal book, which is give or take running around 80 plus percent in the regional group. Exposures maybe up a little bit, and that’s coming through in our audits as far as the renewal book. But new business is probably the challenge really across the board, as people are trying to hold on to their books, and [technically] the distribution system, given the change in market conditions, is reluctant just to be moving accounts around.

Michael Nannizzi – Goldman Sachs & Co

Okay, I see. I see. Then I guess just probably just you kind of talked a little bit about current – your outlook for rates, and talking about pricing and earnings through. How should we think about the impact of higher prices earning thorough and offsetting the negative impact of investment yields on earnings. I mean it – are we deploying where that should be – they should offset each other in ’12 or you think that the earns-through of pricing is going to overcome the negative income of investment yields on earnings?

William R. Berkley

Well, first of fall, our fixed-income investment yields remain virtually flat, 4.1% down to 4%. So we’ve been able to find places where we’ve been able to maintain the fixed-income yields. The return on the portfolio was purely from investment funds returns. And I think Gene already said that in fact the loss under investment funds and those [their effects] are reported; it was a delay of a quarter, already have been made up. So we know the first quarter investment funds are going to effectively offset those. Also, they’re going to be positive by – I don’t know, what’s the number, Gene, the ones we know about?

Eugene G. Ballard

Yeah. Well, the loss for this quarter was $13 million. So it will be something less than that, but it might be – a lot of that’s already been recovered, so.

William R. Berkley

Right. So the fact is that the funds that we reported with a quarter lag effectively are going to be $13 million positive. So if that’s going to swing investment yield for example in the first quarter, it’s one of the problems that you have with some of the various accounting changes that are being impacted. In addition to that, we’ve been able to be opportunistic, and we still have a – while we have good cash flow, it’s still not overwhelming us yet. And we’ve been able to find things to do with the money at this point in time.

So I don’t think investment income is going to suffer at least in the first six months, which is a plus because the pricing impact take, as you well know, take five quarters to be fully reflected. They get partially reflected each quarter a little more. So it’ll be the third quarter before they’re mainly reflected and the fourth quarter till they’ll be fully reflected. So investment income will be good. There will be modest impact, but very modest in the first quarter of pricing.

Hopefully, expenses will be better, because volume will increase of earned premium because that comes in right away. So I would think that it would be an accelerating trend. So by the end of the year, things will be [better the risk] by the end of the year, the cash flow was such that we can’t find places to invest the money.

The positive is you will have all those price increases having a greater effect, plus what I expect will be [substantial] this year. So I would expect though it’s an improving trend; investment income is doing well, and certainly not going down because we’re not investing for short-term stuff for the most part. So it’ll be marginal new investments. So I don’t think that that will be the case, and I think we only have about $1.8 billion that sort of rolls out in the next 12 months.

Michael Nannizzi – Goldman Sachs & Co

Okay, great. Okay, thank you.

Operator

Thank you. Our next question comes from Doug Mewhirter from RBC Capital Markets. Your line is open.

Doug Mewhirter – RBC Capital Markets

Yeah. Hi, good morning.

William R. Berkley

Good morning, Doug.

Doug Mewhirter – RBC Capital Markets

Most of my questions have been answered. I just had a question for Gene. You gave your yield, is that a book yield? And also does that approximate new money yields notwithstanding all the previous comments that [Bill has] made?

Eugene G. Ballard

Yeah, it is a book yield, and it has approximated as you can tell by the fact that it just haven’t changed that much. So we’ve been able to achieve those kind of – nearly that kind of a return on our new earned investments.

Doug Mewhirter – RBC Capital Markets

Okay, great. Thanks. It’s all my questions.

Eugene G. Ballard

Okay.

Operator

Thank you. Our next question comes from Josh Shanker from Deutsche Bank. Your line is open.

Joshua Shanker – Deutsche Bank

Good morning, everyone. Mike asked most of my questions. The only other question was on really the numbers. I’m trying to [seeing] Gene’s methodology on ROE. You said 12.7% ROE. I’m trying to get to it myself. Can you walk us through it a little bit?

Eugene G. Ballard

That was net income. That wasn’t operating income.

Joshua Shanker – Deutsche Bank

Yeah, I still get only about 12% though.

William R. Berkley

I think that [you’re reaching] that, Gene.

Eugene G. Ballard

Yeah.

William R. Berkley

I mean I don’t think we serve the purpose.

Eugene G. Ballard

I guess the only point I’d make is we use beginning-of-the-year equity, so that just [maybe].

Joshua Shanker – Deutsche Bank

Maybe that’s it. Okay, that resolves. Thank you very much.

William R. Berkley

I might add, we have for 40 years used beginning-of-year equity, or I shouldn’t say 40 years, at least 15 or 20.

Operator

Thank you. Our next question comes from Jay Cohen from Bank of America Merrill Lynch. Your line is open.

Jay A. Cohen – Bank of America/Merrill Lynch

Yes, thank you. Many of my questions have been answered as well. But Gene I’m wondering if you can just give us the reserve development by segment. I know that comes up in the Q and the K, but do you have those numbers.

Eugene G. Ballard

All right, Jay I think it will be glad to go through them, but we don’t they don’t get tight out until the end of today. And I’m sure they can go through them what we have them in the aggregate, but they don’t get fully tied out until the end of the day with KBMG signing off. So given its year end I’d appreciate it if you would understand and let them give it you at the end of the day.

Jay A. Cohen – Bank of America/Merrill Lynch

Thank you, understand. Thanks a lot.

Operator

Thank you. Our next question comes from Howard Flinker from Flinker and Company. Your line is open

Howard Flinker – Flinker and Company

Hello everybody. I have two questions. One an extension to your comment about possible bankruptcy is would be that the markdowns on sovereign bonds in the Europe could put tremendous pressure on some of those companies. Can you just talk about it we don’t know how big the mark downs are going to be?

And the second when it comes to return on capital and return on equity Warren Buffett would have allow the insurance businesses if we did not include this capital gains. The use of the money is part of your business. And so if you include it, it seems realistic to me. The first question is minor they are both minor questions. You had a lower tax rate in the fourth quarter, did that come from because of capital gains on muni bonds.

William R. Berkley

No it came from foreign tax credits that effectively came in, in this quarter for various technical reasons but that’s all. But in fact capital gains are the same tax saving was regular. Municipals do give us a big benefit.

Howard Flinker – Flinker and Company

Okay.

William R. Berkley

But its foreign tax credit and its likely foreign tax credits will continue to be a benefit as our foreign businesses are expanding.

Howard Flinker – Flinker and Company

Yeah, sure. And second I’m curious about what I thought was a terrific gesture two years ago when BP had a blowout. You paid your clients claims I think within three days something like that. And now it’s almost two years later, what kind of responses you had from those or other clients? Have you been able to acquire other clients

William R. Berkley

I will comment philosophically after that Rob will talk about the actual business

Howard Flinker – Flinker and Company

Yeah

W. Robert Berkley, Jr.

I think the answer is that the response from the marketplace was positive. I think people appreciated our timely reaction and getting them the funds that were entitled to quickly. I think incrementally it helps us build our brand, and build our relationships and reputation. And I believe its appreciated both in a relatively small community that being the oil and gas states both by insurers as well as the distribution system and also being able to empower them to provide this service to their clients and

William R. Berkley

I talked before about why customers are willing to pay a higher price and with the hesitation of getting a pad on the back to one of our competitors why the people pay a positive premium to buy their homeowners from Chub because job pays their claims promptly and you can brought a home owners policy from Chub, you have greater to be confident of being treated fairly. Building a reputation takes a long time and doing the right thing is what we think you do and we’ve been trying to do that for a long time and that was just an example, you do the right thing and people eventually figure out that it’s worth paying a little bit more than do business with people who in fact deal with you in that way.

Howard Flinker – Flinker and Company

No doubt. I am just curious without mentioning names, but some actual oil and gas companies where drillers come to you and say we’d like to change?

William R. Berkley

We deal through brokers and agents, but it’s a small community and I think that or else being the same people know who has good reputations and bad.

Howard Flinker – Flinker and Company

No doubt. Okay, thank you.

Operator

Thank you. Our next question comes from Bob Farnam from KBW. Your line is open.

Robert Farnam – KBW

Hi, there. Thanks and good morning. Just a quick question, pardon me if I missed it, but how has your premium retention been when you’ve been raising the rates, have been able to retain the accounts that you’ve been raising rates for?

William R. Berkley

Yeah, the group’s renewal retention ratio is running at above the 80s, which is give or take a similar level towards the (inaudible) past couple of quarters that obviously gives us further encouragement that we are able to push rates potentially further and also gives us a level of comfort that the underlying book is not – is not being eroded from quality perspective.

W. Robert Berkley, Jr.

I might add that if you go back couple of years ago, when we were standing firm about pricing we were (inaudible) for a while. And we were losing business not because we were trying to raise rate, but we were trying to maintain rates and we were – our usual retention levels were lower, 75%.

Robert Farnam – KBW

Okay, thanks.

Operator

Thank you. I show no further questions in the queue and would like to turn the conference back to the speakers for closing remarks.

William R. Berkley

Okay, well, thank you all very much. We are very enthusiastic about where the market place is and where things are. Obviously there is plenty of things that can go wrong in any environment that is volatile and uncertain is the economic climate we are in today that certainly we think that certainly in the foreseeable future things are looking very positive. Thank you all very much.

Operator

Ladies and gentlemen, thank you for your participation in today’s conference. This does conclude that program and you may all disconnect at this time.

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