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Executives

Dinos Iordanou - President and CEO

John Hele - EVP and CFO

Analysts

Mike Zaremski - Credit Suisse

Greg Locraft - Morgan Stanley

Jay Gelb - Barclays Capital

Vinay Misquith - Evercore Partners

Matthew Heimermann - JPMorgan

Ian Gutterman - Adage Capital

Arch Capital Group Ltd. (ACGL) Q4 2011 Earnings Call February 14, 2012 11:10 AM ET

Operator

Good day, ladies and gentlemen, and welcome to the Fourth Quarter 2011 Arch Capital Group Earnings Conference Call. My name is Keisha, and I will be your operator for today. At this time, all participants are in a listen-only mode. Later we will conduct the question-and-answer session. (Operator Instructions). As a reminder, this conference is being recorded for replay purposes.

Before the company gets started with its update, management wants to first remind everyone that certain statements in today’s press release and discussed on this call may constitute forward-looking statements under the federal securities laws. These statements are based upon management’s current assessments and assumptions, and are subject to a number of risks and uncertainties. Consequently, actual results may differ materially from those expressed or implied.

For more information on risks and other factors that may affect future performance, investors should review periodic reports that are filed by the company with the SEC from time to time.

Additionally, certain statements contained in the call that are not based on historical facts are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. The company intends the forward-looking statements in the call to be subject to the safe harbor created thereby.

Management also will make reference to some non-GAAP measures of financial performance. The reconciliations to GAAP and definition of operating income can be found in the company’s current report on Form 8-K, furnished to the SEC yesterday, which contains the company’s earnings press release and it’s available on the company’s website.

I would now like to turn the conference over to your host for today, Mr. Dinos Iordanou and Mr. John Hele. Please proceed.

Dinos Iordanou

Thank you, Keisha. Good morning ladies and gentlemen and thank you for joining us today. We are finally closing the 2011 year, which was challenging from a natural cat point of view. It was our worst year ever surpassing even the 2005 Katrina year for us. Fortunately, we have started the 2012 year with a more positive outlook as market conditions are showing signs of improvement. Taking all that into consideration, our fourth quarter performance was acceptable.

On an operating basis, we earned $126.8 million or $0.92 per share, which on annualized basis represents at 12% return on equity. Our investment performance for the quarter including the effects of foreign exchange was a total return of 82 basis points and our underwriting performance was very good at 90.1 combined ratio.

This was aided by reserve releases from prior years predominately from short-tail lines. John will give you more of a breakdown in a few minutes.

Cash flow for the quarter was $110 million, which on an adjusted basis was slightly higher than the 2010 fourth quarter numbers. A book value for common share was $32.03 at 2.7% increase from September 30, 2011 and it was due mostly of our operating results.

The broad market environment continues to show improvements across the board. From a rate standpoint, most lines of business moved into positive territory. The exceptions were in executive assurance and healthcare where we’re still seeing rate reductions, a bit less than in prior quarters but they’re in the range of 1% to 7% for healthcare and approximately 6% for executive assurance.

Even with these improvements in the rate environment, we believe that significant more rate is needed in many lines in order to achieve rather good returns. In our view based in part on the level of increased rates currently available for new money invested, the long tail lines require quite a bit of improvement in premium rate to become attractive.

We view primary casualty, umbrella liability, excess liability as areas requiring the most significant rate improvement. Workers’ compensation on an industry-wide basis is achieving high single-digit rate improvements, but this is still not enough to bring this line of business to quite a good returns.

In our reinsurance sector, rate improved significantly on a risk-adjusted basis in the property cat area while all other lines remained basically unchanged. From a premium production point of view, on a consolidated basis our gross written premiums were up 5.3% and our net written premiums were up 5.8%.

The insurance group was up approximately 2.5% on both a gross and net basis. The reinsurance group was up 16.5% on a gross basis and 14.7 on a net basis. The increase resulted from new opportunities in UK Motor based on current operating conditions in that marketplace and increase in accident and health business as well as from property cat backup progress due to the storms.

We’re always looking for opportunities to expand our underwriting capabilities organically. In the past six quarters, we were successful in attracting management teams in life and accident and health, mortgage insurance and reinsurance, (inaudible) insurance in Canada, global crop hail business as well as tidal insurance in Canada. All these are investments in talent and capabilities for the future.

In some of these lines, we're already producing business and in some, we're in the process of building the needed infrastructure and obtaining the necessary licenses. While the degree of success of these opportunities in the short term will be dependent on market conditions, we are confident that over the long term, these will prove to be successful profit centers contributing to the value of our enterprise.

During the quarter, we essentially did not purchase any of our shares. This decision was influenced by several potential opportunities that were presented to us in the last quarter. This activity was unusual and if successful, these transactions would have had their potential to utilize a significant amount of capital. These opportunities emanated from the property and casualty sector, life and health reinsurance sector and mortgage sector.

Unfortunately, only one of these transactions has closed. The biggest obstacle to closing some of these deals has being the widespread between the bid and ask. We continue to work on some of these opportunities and on new ones that we receive in the first quarter of 2012.

In general, our philosophy on capital management has not changed. We prefer to deploy our capital in our business first and absent the ability to do so, to returning to our shareholders. Although, the current operating environment is improving, we still do not have clear visibility on the degree of improvement in market conditions or on our ability to close on some of the unusual deals that we have been working on. As a result, we will take a wait and see attitude with respect to share repurchases until we have more clarity.

Before, I turn it over to John for more commentary on our financial results, let me touch up on and update you on our cat PMLs. As of January 1st, 2012, our 1-in-250-year PML for a single event was 881 million or 20% of common shareholder’s equity in the Gulf and 842 million in the Northeast. Our Florida Tri-County PML now stands at only 638 million, which gives us ample capacity for the upcoming Florida renewal season.

With that, let me turn it over to John for more commentary on our financials and after John, we’ll back and- have you ask your questions. John?

John Hele

Thank you, Dinos. Good morning. On a consolidated basis, the ratio of net premium to gross premium in the quarter was 73%, the same as a year ago. Our overall operating results for the quarter reflected a combined ratio of 90.1%, compared to 92.7% for the same period in 2010. 2011 fourth quarter included $78.8 million, or 10.5 points of current-accident-year cat activity net of reinsurance and reinstatement premiums, compared to $31 million, or 4.9 points in the 2010 fourth quarter.

The 2011 fourth included 60.6 million for the Thailand flooding, where we’re reserving towards the higher end of our preannounced range of 35 million to $65 million, corresponding to a total industry estimated loss of 10 billion to 20 billion. In addition, the 2011 fourth quarter reflects an estimated 5.4 million for the Christmas Day Australian hail storm.

The 2011 fourth quarter combined ratio reflected 15 points or $101 million of estimated favorable prior year reserve development net of related adjustments, compared to 6.1 points, or $38 million in the 2010 fourth quarter. The net favorable prior year development in the 2010 fourth quarter is comprised 64% from property cat, property and other short-tail lines, 20% from medium tail lines and 16% from longer tail lines.

The 2011 fourth quarter net release in general, reflects the better-than-expected claims emergence that we experienced throughout 2011 across most of our lines. The 2011 fourth quarter current-accident-year combined ratio, which excludes names, cat events and prior year development was 101% in the insurance segment slightly better than the 102.9% in the 2010 period primarily due to lower expenses.

In the reinsurance segment, the 2011 accident-year combined ratio was 83.7%, higher than the 77.9% from the 2010 period due in part to a change in the mix of earned premium towards medium tail other specialty lines, which generally have a higher booked combined ratio than property lines.

The 2011 fourth quarter expense ratio of 33.9% was lower than the 34.6% in the 2010 fourth quarter reflecting lower operating expenses and incentive compensation charges which more than offset a higher level of commission expenses related to prior year favorable development.

On a per-share basis, pre-tax and investment income was essentially flat at $0.59 in the 2011 fourth quarter compared to $0.60 for the same period a year ago and $0.60 in the third quarter of 2011. Our embedded pre-tax book yield before expenses was 2.98% in the 2011 fourth quarter, down from 3.09% in the 2011 third quarter and 3.52% a year ago, which primarily reflects lower reinvestment rates.

The portfolio duration was 2.99 down from 3.17 at the end of the third quarter. We continue to be cautious with the duration of our investment portfolio due to the risks in our global economy. The total return of the investment portfolio was 0.82 basis points in the 2011 fourth quarter compared to a minus 7 basis points in the corresponding 2010 period. Excluding foreign exchange was a positive 95 basis points in the quarter. The total return in the fourth quarter benefited from the recovery in equity markets and stable returns on US treasuries, offset by a negative return on some alternative assets. Our alternative assets include bank loans, global and emerging market bond and multi-asset funds and energy investments. These alternative assets drove the 14.7 million in net losses in equity method accounted investments. We expect that these funds will more volatility quarter-to-quarter, but we also expect that over the longer-term we will gain an acceptable return. We continue to maintain the vast majority of investable assets in a very high-quality fixed-income investment portfolio.

Starting this quarter, due to the ever-changing views of the rating agencies, we are reporting the average quality of our investment portfolio from both S&P at AA and Moody’s AA1 and we have split out our US government and government-sponsored securities in a separate category in our disclosures. In the past, our average credit quality was calculated as an average of the three primary rating agencies.

In addition, we added an exhibit to our financial supplement on our Euro zone investments including sovereign debt, corporate, covered bonds and other sectors. Our exposure to troubled Euro zone countries is minimal and we have no exposures in Greece.

We recorded net foreign exchange gains of 13.2 million during the 2011 fourth quarter mainly due to the strengthening of the US dollar against the Euro. These gains resulted from revaluating our net insurance liabilities required to be settled in the foreign currencies at each balance sheet date. However, this should be compared to the minus 13 basis points, total return from foreign exchange on our investment portfolio, which essentially then offset this income statement gain in the equity section of our balance sheet.

For the 2011 year, our effective tax rate and pre-tax operating income was a benefit of 3.7% and 2.2% on pre-tax net income. The cat activity this year, low investment returns and the relative mix of income or lost by jurisdiction have resulted in a beneficial net tax position.

Our preliminary estimate of the implementation of the new DAC accounting standard required on January 1st, 2012 that we communicated last quarter, is still the same and the new standards to reduce our book value by less than 1% and should not have a material impact on operating earnings in 2012.

Our balance sheet continues to be conservatively positioned with total capital of 5.03 billion at December 31, 2011, up from 4.9 billion at September 30, 2011. In the quarter, we had no material share repurchases. Our debt plus hybrids represents 14.4% of our total capital, well below any rating agency limit for our targeted rating. As we announced last quarter, in the calculation of our target capital position, we have now implemented our version of RMS 11. As of December 31, 2011 our actual capital is in excess of our target capital.

With regard to subsequent events to year-end based on current information, we expect to record a loss of $8 million to $10 million on our investment in Aeolus LP which we report on a one quarter lag and is included in other income. We also expect the loss net of reinsurance and reinstatement premiums up between 18 million and $35 million for the January 2012 Costa Concordia marine event corresponding to a total industry loss of $815 million to $2 billion.

Reflecting on the 2011 full year results, the after-tax operating profit was $204 million, which reflects the significant level of catastrophic activity during 2011. The year combined ratio was 98.3%. The insurance segment had an action year combined ratio excluding cats in prior year development of 100.6% and the reinsurance segment produced an 80.6% ratio. For the year, the operating ROE was 7.2%. Our book value per share ended the quarter at $32.03, up 2.7% from the last quarter and 6.8% from a year ago.

With these comments, we are pleased to take your questions.

Question-and-Answer Session

Operator

(Operator Instructions). Your first question comes from the line of Mike Zaremski with Credit Suisse. Please proceed.

Mike Zaremski - Credit Suisse

Regarding the unusual deals that closed, the one deal that closed in 4Q, is that the U.K. Motor deal?

Dinos Iordanou

Yes, that’s the one, yes.

Mike Zaremski - Credit Suisse

So, what was the size of the U.K. Motor deal? And then I guess, can you just a number of questions around this, why are deals unusual, what type of returns do you feel these opportunities offer and are they similar size for the U.K. Motor deal?

John Hele

A lot of questions; let me start with, the U.K. is not unusual. It was an opportunity for us to partner with some people that they have an existing book of business and they’re looking to expand the market conditions. They’re attractive for the time being and we can achieve double-digit ROEs. And the deal size depends how successful that you are in growing their business is going to be in excess of a $120 million for the year. It’s a 2012 event for us.

Some of the other transactions that weren’t as usual meaning that you might put them in the category of either renewal right deals with books of business offered to us to pick up underwriting teams and their renewal rights. We had a few of those. We’re still working on some. We’ve seen opportunities in the mortgage space that is a re-insurance behind, either bank portfolios and/or building societies portfolios. And the size of these deals can be anywhere from $100 million to $300 million, $400 million in range and in essence depending on the line and the capital attraction or the capital utilization can be anywhere from $50 million to $250 million. So, looking at that, I wanted to be cautious in the way that we were deploying our capital because you can get in the batter's box and hit a few more runs or you can get into batter's box and strike out, but you can always do share repurchase at a future date. So, that was what was driving our decision making.

Mike Zaremski - Credit Suisse

Okay, and that’s very helpful. And lastly the (inaudible) loss and what drove that and its $35 million the maximum loss potential in this investment?

John Hele

Well, the investment is being a very, very successful investment for us. We invested $50 million. We received already $67 million in distributions and we’ve a carrying value as of the end of the year of $35 million. So, when you add it all together, this investment almost double our money independent of the loss that we’re going to take in the first quarter. The loss is emanating from the worse Cat year in the history of insurance. Its fourth quarter Cat losses and is coming from mostly the floods in Thailand.

Operator

Your next question comes from the line of Greg Locraft with Morgan Stanley. Please proceed.

Greg Locraft - Morgan Stanley

I wanted to just understand on the buyback just if you could just remind us of the philosophy and sort of your appetite going forward with the stock of 1.2 bucks?

Dinos Iordanou

If you go on our website I think we have a grid that tells you as to when we decide and on what level to do the buybacks. And basically it's a combination of what we anticipate the current business ROE to be, versus how long will it take for us to recover and if it's three years or less because if you’re paying above book you got a recovery period. If the period is three years or less than we chose buybacks. If it’s going to be more than and we have excess capital and we don’t think there is potential in the future to utilize it, we’ll probably use some other method maybe an extraordinary dividend et cetera. So, this has been a philosophy consistent now for the last five years. So, no change in that John anyone add or...

John Hele

While I think the point is that has been offset we’re going to wait and see and we make the decisions when we get there in that quarter at that time what the trading is, what the outlook is for business. So we will make those decisions when we get there.

Greg Locraft - Morgan Stanley

Okay again you guys, few in the entire industry have been as aggressive as you in returning capital last five years and with the share account not moving down last several quarters I guess what I’m wrestling with is do I take the organic earnings as because you’re right at the upper end of where of that threshold, the chart to which you’re referencing I’m wondering if you’re going to do any in 2012 or if it’s sort of over for now?

Dinos Iordanou

I don’t know if I would like to do none because the market is so good. I’m deploying my capital in the marketplace. But having said that, when I said the business was we had a white spread to it. We were pricing a lot of our deals and I wouldn’t say all of them at 15% ROE, some of them it was even at 12% ROE, expected ROE, and even with that we couldn’t get the buyers to agree with that.

Some of the buyers they were looking for us to deploy capital of 5%, 6%, 7% ROE. We’re not going to do that. So, I’m not saying we’re not going to work on the deals. We’re going to work. We put a price out that we’re comfortable with. It’s going to be in a double-digit ROE. That’s what we tell the market, that’s when we tell the brokerage communities, that’s when we tell the buyers, but now do I have clarity if the market will respond to that or not, no if I had that clarity I can give you more of a precise answer. So, not knowing that that’s why I said I’m going to have a wait-and-see attitude.

We’ll continue to work on these deals, some of them they have a long lee-way, some of them they might take two quarters, three quarters from beginning to end. It was successful, its music to my ears. I’m deploying capital for what I’m getting paid for in our business. If not then we’re going to revisit excess capital what do we do with it.

Greg Locraft - Morgan Stanley

Okay, perfect thanks. And then one last one, totally different area, but just the reserve releases was definitely much, much better than peers; obviously your balance sheet continues to be in excellent shape. Can you give us I mean you did provide some color in the commentaries to where it came from and stuff? Can you maybe be a bit more granular and obviously what we’re all trying to figure out is the sustainability of that going forward, so again any comments or thoughts?

Dinos Iordanou

I thought John was pretty granular. It’s 64% of a property Cat which means that, I think we have a better record in reserving Cats than most. At the end of the day if they don’t materialize, would it be conservative? You’ve seen what we’ve done with the Thai losses too, because the contingent business interruption is so difficult to estimate. Even though we never wrote excessive loss cap business in the country of Thailand. We have no direct traditional excessive loss cap business in that territory.

We are anticipating losses coming from both our insurance group and reinsurance on large industrial risks that done on a global basis. But because the contingent business interruption is such a difficult measure we became very conservative. And at the end of the day, I’d rather be on the high end of the reserving range than the low-end.

You might say we’ve done the same in prior years in ‘05, in ‘04 et cetera and if you look at our history we had consistent reserve releases from short-tail lines, this is not the first year. It just happened to be unusually higher. But on short-tail lines you know what you got, its either you got a loss or you don’t and you don’t have to wait for many years to figure it out. Now the 16% on long-tail lines which is just about 16 million bucks out of the total came from the very good years in the casualty business ‘04, ‘05, ‘06 this is no reserves from any of the later years and the medium term it might be a few years after that but is mostly medium-term.

John Hele

It’s in that professional liability.

Dinos Iordanou

Claims may professional liability business with low limits that usually within three, four, five years where you are.

Greg Locraft - Morgan Stanley

So any more color…

John Hele

And Greg we have seen and I think some others have seen in the industry through 2011, trend has been less than we have built in for this year. So, that allows some of these releases across many of our lines to flow out, whether or not that trend continues or not, we keep assuming trend is on a long-term basis. It will come back some day to that, we can’t tell you when and we have to look at that quarter-by-quarter.

Greg Locraft - Morgan Stanley

Okay, that’s really good. And then just one follow up in the short-tail lines and perhaps you actually said this already, but which events did this come from?

John Hele

Not many and it’s also a source of (ph) property, as well as property Cat...

Dinos Iordanou

Right. From all events starting with ‘08 and don’t forget ‘08 it was a very heavy year with earthquakes, floods et cetera, it’s all events, it is not just one event.

Operator

Your next question comes from the line of Jay Gelb with Barclays Capital. Please proceed.

Jay Gelb - Barclays Capital

Just want to catch up on a couple of points. Dinos, at year end how would you tag the level of excess capital for Arch?

Dinos Iordanou

A little stronger than one we told you last quarter because we then do share repurchases. Our premium growth hasn’t been that dramatic yet.

Jay Gelb - Barclays Capital

Regarding the premium growth in reinsurance, I think you mentioned the potential for a couple of one-time deals. Were they in the reinsurance segment because that...?

Dinos Iordanou

Well, the one that we did it was in the reinsurance sector and we set the size of it, it is about figure of $25 million at quarter, it’s about $120 million and it’s a 13-month deal.

Jay Gelb - Barclays Capital

Okay. So that’s going still flow through in 2012, not just earned?

Dinos Iordanou

It will flow through the 2012, yes.

Jay Gelb - Barclays Capital

In written?

Dinos Iordanou

Written, yes.

Jay Gelb - Barclays Capital

Got it, okay. And then on the pace of investment income which on the recurring investment income which has been slowing each quarter and is that 80.5 million, is that the right run rate that we should take into account lower reinvestment yields going forward, so it might continue to drop?

Dinos Iordanou

Well, the reinvestment yield is less. We look to always find opportunities, but also what I want to point out to you the number that you mentioned is before expenses, right, you said what they embedded yield, you said it was what, 2.98?

Jay Gelb - Barclays Capital

I suppose, yes.

Dinos Iordanou

Well, that’s before expenses. So you got to take, if you are putting in on your new model, you better take out investment expense out of that too.

Jay Gelb - Barclays Capital

Right, so I mean directionally would there be sort of a continued?

Dinos Iordanou

Yes, I don’t think it’s going to move more further down because we’re finding enough products with still high credit quality and enough spread from treasuries to continue maintaining approximately in the 2.5% to 3% yield and we’re going to try to stay there. So, I don’t expect that to move dramatically. We have a...

Jay Gelb - Barclays Capital

The yield notes or the investment income?

Dinos Iordanou

The investment income.

Jay Gelb - Barclays Capital

And then I just want to understand a little better structurally on the share buyback. I mean the reason to hold back a bit on share buyback, is that more because there is potential to become to deploy more capital in the business as the market continues to firm and as well as kind of these one-off deals, I mean there still seems to be so much excess capital on the balance sheet?

John Hele

It was both. We have the ability to grow the business quickly. If you go back in our origin, ‘02, ‘03, ‘04, we went from zero premium to $3.5 billion gross in three years. So, our ability to deploy quite a bit of capital, as a matter of fact, our first year on a policy year basis, on an underwriting year basis, reinsurance group grew at $1.2 billion in ‘02. So, given a market trend that we can sense giving us good opportunities and good pricing. We can deploy capital very quickly. Now, you put on top of it, some unusual opportunities, somebody presenting us with $100 million renewal book of business that we would like to take over. If we take over any one of these deals, we’re starting to use big chunks of capital and why not be cautious in the way you’re having your, but if some of these deals don’t materialize that means we’ll continue to have excess capital.

And I am even surprised that you guys keep asking questions on how we manage capital, because I think our track record has been phenomenal. We’re not trying to hold on to it, we’re only trying to deploy into the market as best as we can and if we have excess, we’re not shy of giving it back to shareholders.

Jay Gelb - Barclays Capital

We understand. And then on the transactions, so you’re looking at potential, not just traditional, large insurance or reinsurance deals. Is this also in the market the potential for renewal rates transaction?

Dinos Iordanou

Absolutely.

Operator

Your next question comes from the line of Vinay Misquith with Evercore Partners. Please proceed

Vinay Misquith - Evercore Partners

The first question is on the opportunities you’re seeing, are you seeing them in the normal P&C insurance markets or...?

Dinos Iordanou

We saw them on three sectors, Vinay. We saw them on the P&C sector, we saw them on our new initiative, which is the mortgage space, and then we see them also on new initiative which is our life and A&H reinsurance sector. So we’ve seen them. And don’t forget you bring powerful teams, good underwriting people with market connections even though we believe, at least we believe that will conserve underwriters, the market is responding and sending us these opportunities.

Now it’s up to us to find the right ones with the right profitability and bring them home and close, but I’m an optimist. I’m a patient optimist. Market is moving in our direction, we probably can utilize a little more capital over time. We’re seeing these kinds of opportunities. If we hit on some fine, if not we will go back to our old ways.

John Hele

Vinay this is John, just want to add that the mortgage is, the main focus is international, where there is good opportunity there, say in the U.K. and some of other places, Australia. So, there is a proven opportunities there.

Vinay Misquith - Evercore Partners

And how are you getting these opportunities now. Why are you getting these now? So do you see more stress in the market or have you hired new teams that have helped you to get these opportunities now?

John Hele

Yes and yes. There is more stress in the market because the traditional players lack capacity and/or ability to do that. And of course you got to have the right team in order to get the opportunity. So the combination of both is what’s presenting us with these opportunities.

Vinay Misquith - Evercore Partners

Now I believe on the auto deal, you said it would be a double digit ROE. Is that what you’re targeted for?

John Hele

Yes, we believe we’re going to produce double digit ROE. We have good partners there. We like the people. We have partnered together and we like the sector for what’s happening in the UK market.

Vinay Misquith - Evercore Partners

Okay and what other competitor actually pulled out of excess of loss of business for the UK market? I’m just curious as to how you got some….?

Dinos Iordanou

This is not excessive loss, this is a partnership. This is a primary deal with side-by-side.

Vinay Misquith - Evercore Partners

Just once more, if I may. What’s your accident year sort of ROE on the business that you’re writing right now for your normal P&C business?

Dinos Iordanou

Right now on a policy basis, we think we are still in the around 9% range. That’s how we’re calculating it. A lot of that influence comes depending if you are going do you own calculations. I can run you through pretty quickly. On an accident year, this is not policy; on an accident year basis, this way you can follow the numbers; we produced 7.2 for the year, the cap losses, there were a 200 million more than normal and then we had about $275 million of prior year reserve releases. So that will bring your ROEs slightly below seven on an accident year basis.

Now why is my policy a better; first there is some rate increases that is going to improve the book and second I think our mix is changing to higher ROE. So the percentage of business with the higher ROE for the 2012 year is a little higher than what we had in the prior year.

So when you push that we’re getting somewhere in the high 8% and change 9%. And we do those calculations, that’s why I can speak to them because are we're happy with it. You don’t see my comments to be too enthusiastic that hey, we're going to go and write a lot of business. Our growth is still predominantly emanating from one-off opportunities rather than across the board improvement but I’m more optimistic than I was last quarter because I think the market environment is moving in a good direction.

Operator

Your next question comes from the line of Matthew Heimermann with JPMorgan. Please proceed.

Matthew Heimermann - JPMorgan

A couple of questions. I was hoping you could help me understand if you execute on some of these new opportunities how will it all affect your ability to write other business if market conditions improve. So, I guess, I can appreciate that it would take up absolute capital. I’m just wondering in terms of how much kind of diverse dry powder you have left from diversifying type lines? What’s the casualty or other things?

Dinos Iordanou

I’m having difficulty deploying my excess capital. I’m not worrying about capability because when you look at the balance sheet, it has very low leverage 14.4%. I have approximately three quarters to a $1 billion of hybrid capacity that I go out without having to dilute my common and raise either debt or perpetual prefers or whatever form we decide to do.

So at the end of the day, the instructions that I have given to all of our operating units is operate in the marketplace as if you have unlimited capacity. I’m not talking from a rich point of view but from a capital point of view. And once you utilize whatever I’m allocating to you and we need more, I’ll go out and find it. So, we’re operating with an ability that we have a lot of capacity and a lot of dry powder for us, given the right opportunity in the marketplace to capitalize.

Matthew Heimermann - JPMorgan

That’s fair. So just to make sure I fully understand what you’re saying effectively. If you execute on these things it’s more about using the existing capital you have, and then any incremental growth and appetite or business would then be funded by some of debt hybrid?

Dinos Iordanou

Well, it’s our first choice, yes, absolutely. I didn’t buy all those shares back to go back and dilute my common.

John Hele

And Matt, it’s John. Also the earnings that flow throughout the year, it also creates capital as well.

Matthew Heimermann - JPMorgan

Yes, absolutely. I think I snuck in retained earnings on my list, but I would agree. The only other question was around the development. One of the things that has kind of muted the net reserve development, you’ve been showing over the last couple of years, there’s just been a little bit of adverse push on some credit crisis exposed lines. I’m just wondering whether or not you’re seeing some of those pressures dissipate as well?

Dinos Iordanou

We do at granular analysis by profit's centered, by (inaudible) and depending what you wrote it on insurance or reinsurance, some things will pop up a little bit on one and go down on others et cetera. All I can tell you is, I spent as much time with the actuaries to the point that I think they don’t like me a lot because I ask too many questions and I spend too much time with them.

I feel that our reserve position today is as good as it was a year ago or two years ago and that’s basically also the opinion of outside people that they advice us and they do independent reviews on what we have. We have a very good methodology in how we reserve the company and I think I’ll let the track record speak for itself.

Matthew Heimermann - JPMorgan

That’s fair. And then just one last numbers question, just on the retention change, you mentioned in the surety line, is kind of the magnitude delta we saw this quarter the right way to think about it. I know it’s not a huge premium line but just want to make sure I got that right.

Dinos Iordanou

It’s not, I wouldn’t read too much into it because let say it’s a line we like to grow cautiously because let’s face it, it’s a credit line and in the economic conditions we are is something that you need to be cautious. But also it depends how you buy your insurance protections on the surety and we’re switching more from a quarter share to excess of loss which in essence it allows us to retain more of the net premium to us.

Operator

Your next question comes from the line of Ian Gutterman with Adage Capital. Please proceed.

Dinos Iordanou

Ian, we’re going to fail you again, you seem to be always in the back of the room.

Ian Gutterman - Adage Capital

One of these days I’m going to surprise you and go first.

Dinos Iordanou

Go first, okay I’ll see the sunrise from the west.

Ian Gutterman - Adage Capital

I guess first on the CT Motor, can you talk a little bit more about what it is? I guess that line from what we understand has been a pretty miserable performer for some of the U.K. companies these past few years. I think there has been some average court rulings or regulatory rulings that have caused a lot of trouble. So why is that attractive? I thought that was a pretty poorly performing line these days.

Dinos Iordanou

Listen, motor insurance, I don’t care if it's auto in the U.S. or Motor, it's a predictable line. When you under price it, you’re going to find a lot of excuses why you're not making money and when you price it appropriately, you are going to make money. Rates have improved in the last couple of years. Some of the pricing challenges have been resolved and if you have good partners, and we think, don’t forget, you also got to look at the partners that you’re partner with. We like the people; we felt it was a very good deal for us to do.

Ian Gutterman - Adage Capital

Fair enough. And just in terms of the opportunities you are looking at, are they more opportunistic things that you’re in for a year or two and then you get out or are these sort of businesses that you might still be in five or ten years from now?

Dinos Iordanou

We'd like to be in for as long as we can. I don’t like to be doing all this work and go in and out at the end of the day. But on the other hand, we're not going to stay there and take losses. I mean that’s not what we get paid for. We get paid to make money for shareholders. So it’s a combination.

Ian Gutterman - Adage Capital

Okay. The reason I was asking was I was wondering if it’s something you hope to be in for a while, and that if you are optimistic on the cycle turning soon that maybe you’d want to pursue things often and wait and go look to maybe build more longer term franchises like some of your competitors are doing, hiring their teams to get in front of the cycle and things like that. Is that something on the radar, or does that somewhat make sense?

Dinos Iordanou

Our attitude on talent has not changed. I spent a little time on my prepared remarks just to tell you what we’ve done and usually we don’t go out and put press releases if we hire some people et cetera, but we’ve done enough that I thought for a lot of the analyst it would have been important for them to know, because some of them, they hear about this, they hear about that and they ask us the questions. We will hire talent independent of cycle. We don’t care if you get a Michael Jordon come knocking at our door, you’re hired right.

Now is the market allowing them to deploy their talent and show a lot of revenue and profit immediately, in some cases yes, in a lot of cases no but we’re very patient. I’ll give you two examples. We brought a very strong property fact team. They're doing fabulous, Steve Franklin and his team et cetera.

The market allow them to operate and do well for us and we let them do. We brought David McElroy and his team. They’re fabulous people, probably one of the best underwriting teams. The market did not allow. We're patient. We told them, listen, we hire you for your brains, we hire you for your capability and one day the market will allow you to display what you can do. So we’ll be patient along with you.

So our attitude is we find the right people, independent of cycle we hire them. We warehouse then. I never saw a company go bust because maybe their expense ratio is a point or two above what it should be, but I’ve seen every single case that you do that when the right opportunities come these teams more than pay for themselves and, we're very, very patient about that.

Ian Gutterman - Adage Capital

And then just my last one. Some of the lines you mentioned that were disappointing, casualty, executive insurance, things like that. It looks like you showed modest growth in those lines, not anything scary, but I was just kind of wondering if those lines aren’t where your targets are shrinking as opposed to growing a little bit?

Dinos Iordanou

Well, a little bit of growth was in Europe and it was mostly on small to medium sized enterprises and that sector both in U.S. and in Europe we like. So even within a line, even though we don’t write the large financial institutions, the large FI business or commercial D&O, it’s not in the best of shapes for us to be enthusiastic about significant growth. Things are improving, but not fast enough for us. There is other sectors that we do like and there if we can grow, we’re going to grow.

Operator

Your next question is a follow up from the line of Mike Zaremski with Credit Suisse. Please proceed.

Mike Zaremski - Credit Suisse

In regard to the cruise line accident, is 35 million, is that based on a $2 billion loss and do you think the loss could reach $2 billion?

Dinos Iordanou

Yes, and we don’t think it’s going to reach there, but I don’t have to make a judgment yet as to what I’m going to reserve it for next quarter. The industry experts, I am not one of them, but they think that the loss is going to be somewhere between $850 million to $900 million.

There is a good logic around how they estimate that. You got about $0.5 billion which is the whole, then you have the 32 debts and then you have the evacuation, and then you’re going to have the removal of debris and wreckage. All that is going into go on the liability side. We estimate that $350 million to $400 million, that’s not an unreasonable number.

Now, what things can change that is if we have a spill and then you have an environmental disaster, there is about $1 billion of cover the liability side for pollution that if they run into some very difficult problem in removing, that might escalate, they don’t anticipate that but I have to give you a range and in that way of thinking, both with town floods or this one, we give you a pretty broad range and we tell you what it's going to cost us if it happens at $850 million versus $2 billion.

Now, do we believe $2 billion? No. I’m not sitting here and telling you that that loss is going to be a $2 billion loss. It probably is a very high probability that is going to be in the $850 million to $1 billion and then would be on the low end. By the end of the first quarter I've got to make that judgment and put a reserve up and as we get more information and more information we’re going to refine that number. But right now, that’s our range, $18 million (ph) to $35 million (ph).

Operator

There are no further questions in queue at this time. I’ll now like to hand the conference back over to Mr. Dinos Iordanou for any closing remarks.

Dinos Iordanou

Thank you all for attending and we’ll talk to you next quarter. Have a wonderful day.

Operator

Thank you for your participation in today’s conference. This concludes the presentation. You may now disconnect your lines. Good day.

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