Validus Holdings' (VR) CEO Ed Noonan on Q2 2016 Results - Earnings Call Transcript

| About: Validus Holdings, (VR)

Validus Holdings Ltd (NYSE:VR)

Q2 2016 Earnings Conference Calls

July 27, 2016, 11:00 ET

Executives

Ed Noonan - Chairman & CEO

Jon Levenson - EVP

Jeff Sangster - EVP & CFO

Kean Driscoll - CEO, Validus Reinsurance, Ltd.

Analysts

Amit Kumar - Macquarie Research Equities

Sarah DeWitt - JPMorgan

Josh Shanker - Deutsche Bank

Ryan Byrnes - Janney Montgomery Scott

Al Copersino - Columbia Management

Meyer Shields - KBW

Ian Gutterman - Balyasny Asset Management

Michael Nannizzi - Goldman Sachs

Operator

Welcome to the Validus Holdings Limited Second Quarter 2016 Earnings Conference Call. [Operator Instructions]. I would like to introduce your host for today's conference, Executive Vice President Mr. Jon Levenson. So, please go ahead.

Jon Levenson

Thank you, good morning and welcome to the Validus Holdings conference call for the quarter ended June 30, 2016. After the market closed yesterday, we issued an earnings press release and financial supplements which are available on our website located at validusholdings.com. Today's call is being simultaneously webcast and will be available for replay until August 10. Details are provided on our website. Leading today's call are Ed Noonan, Validus Chairman and CEO; Jeff Sangster, Validus Chief Financial Officer; and Kean Driscoll, CEO of Validus Re.

Before we begin, I would like to remind you that certain comments made during this call may be deemed forward-looking statements as defined within U.S. federal securities laws. These statements address matters that involve risk and uncertainties, many of which are beyond the Company's control.

Accordingly, there are or will be important factors that could cause actual results to differ materially from those indicated in such statements and therefore you should not place undue reliance on any such statements. More detail about these risks and uncertainties can be found in the Company's most recent annual report on Form 10-K and quarterly report on Form 10-Q, both as filed with the U.S. Securities and Exchange Commission.

Management will also refer to certain non-GAAP financial measures when describing the Company's performance. These items are reconciled and explained in our earnings release and financial supplements.

With that, I turn the call over to Ed Noonan.

Ed Noonan

Thanks, Jon. Good morning and thanks to all of you for taking the time to join us today. In the quarter was a significant number of events both big and small. We're pleased to have generated net income of $95 million, net operating income of $54.9 million and growth in book value of 1.7%. Through six months, we're running at a 14.2% annualized return on average equity and we've grown our book value per share including dividends by 6.6%.

In light of losses of hours and from Canadian wildfires, Texas hail and flooding, the Kumamoto earthquake and Jubilee oil platform, we're really pleased with our combined ratio of 89.9%. We're significant players in each one of these classes and territories and feel quite comfortable with the level of net losses we have sustained. This is due to strong underwriting, excellent risk management and effective use of reinsurance, retrocession and third-party capital to protect our balance sheet.

So just thanks to a couple of our financial results in more detail, after which Kean Driscoll and I provide more color on our results. Jeff?

Jeff Sangster

Thanks, Ed and thank you all for joining the call. The second quarter produced a strong financial result for Validus, despite incurring a notable loss event and three non-notable loss events totaling $60 million net loss attributable to Validus. In line with our goal of providing transparency and best practices in disclosures, we pre-announced our notable and non-notable loss events on July 11. Our disclosed losses at 1.6% of shareholders equity are well within expectations considering the events occurred in areas of focus for us, being North American property, the Japanese market and marine.

As has been our historical practice, we have reserved these events conservatively and our industry loss estimates are at the high end of published ranges. Our performance in these events is further evidence of our ability in our core cat specialty. I will provide more details on the quarter's loss events later.

Turning to the highlights of the quarter's financial results, net income available to Validus common shareholders was $95 million or $1.14 per diluted common share. Net operating income available to Validus common shareholders was $54.9 million or $0.66 per diluted common share.

Annualized return on average equity for the quarter was 10.2% and annualized net operating return on average equity was 5.9%. Book value per diluted common share was $44.41 at June 30, an increase of 1.7% from March 31, 2016, inclusive of dividends. Speaking in more detail to the quarter's results, total gross premiums written were $764 million in the quarter, an increase of $37.9 million or 5.2% from Q2 2015. The increase in premiums is driven by AlphaCat, Western World and Talbot segments, offset by a decrease in premiums in the Validus Re segment. Gross premiums written on behalf of our AlphaCat variable interest entities increased by $36.1 million over the prior year's quarter to $98.9 million from $62.8 million, due to an increase in the capital base of the AlphaCat ILS funds.

Gross premiums written in the Western World segment increased by $7.4 million over the prior year's quarter to $87 million from $79.6 million. The increase over Q2 2015 was driven primarily by a $10.3 million increase in the property lines. The second quarter is generally the largest production quarter for the segment and we're pleased to see this level of growth in only our second year in the short tail lines of business. Gross premiums written in Talbot segment increased by $3.1 million over the prior year's quarter to $296.1 million from $293 million. Gross premiums written in the Validus Re segment decreased by $11.6 million over the prior year's quarter to $285.8 million from $297.4 million.

The Validus Re decrease was driven by a decrease in the property lines of $30.6 million, offset by increases in the Marine and Specialty lines of $1.3 million and $17.7 million, respectively. The decrease in the Property lines was driven primarily by non-renewals, timing differences on the renewal of certain contracts and increased AlphaCat sessions which contributed a combined $26.2 million to the overall decrease in Premium. The increase in Specialty lines was driven primarily by new casualty business of $23 million written during the quarter and continued growth in the Composite lines. Offsetting these increases are decreases in Other lines, notably agriculture. The decrease in Agriculture lines of $8.2 million was driven by the movement on earned premium adjustments year on year.

As noted on previous earnings calls, final contract estimate adjustments on our ag book come through in the second quarter of each year. Contributing to the discussion of losses, our quarterly combined ratio of 89.9% including a loss ratio of 53.5%. As mentioned earlier, we incurred one new notable loss event, the Canadian wildfires, with a net loss of $36.9 million or 6.4 percentage points on the consolidated loss ratio. Net of noncontrolling interest and reinstatement premiums, the net loss attributable to Validus was $26.9 million.

We also incurred three non-notable losses in the quarter, the Texas hailstorms, Kumamoto earthquake and the Jubilee oil loss. These non-notable loss events resulted in aggregate net loss to the Company of $48.3 million or 8.4 percentage points in the consolidated loss ratio. Net of noncontrolling interest and reinstatement premiums, the net loss attributable to Validus from the non-notable events was $33.1 million.

Net favorable development from prior years was $62.8 million, equal to 10.9 loss ratio points. Our favorable development was from both event and nonevent reserves, in the amount of $6.5 million to $56.3 million, respectively. The net favorable development by segment was Validus Re, $30.9 million; AlphaCat, $0.4 million; Talbot, $28.3 million; and Western World, $3.2 million. The overall accident year loss ratio, excluding notable and non-notable loss events and changes in prior accident years for the quarter, was 49.6% compared to 53% in Q2 2015.

Beyond the underwriting results, I will comment on the AlphaCat segment, the quarterly investment results and our capital position. AlphaCat had total assets under management of $2.5 billion July 1. $2.2 billion of which is managed for third parties, an increase of $176 million from April 1. Losses incurred by AlphaCat from the notable and non-notable loss events in the quarter were $13.4 million. Including smaller event losses and IBNR totaling $8.4 million, AlphaCat incurred total losses of $21.8 million, of which $2.5 million was retained by Validus through our investment in the underlying funds. Including these losses, AlphaCat contributed $4.9 million in income in the quarter, net of noncontrolling interest which is comprised of the following components.

AlphaCat earned management fees of $3.4 million in the quarter, of which $0.3 million were earned from related parties. The overall decrease in fees of $2.1 million from $5.5 million in Q2 2015 was driven primarily by a decrease in the performance fees earned on the higher risk ILS bonds as a result of loss events incurred in the quarter.

Offsetting the fees are expenses incurred by AlphaCat managers of $3 million. Expenses decreased by $2 million from $5 million in Q2 2015, primarily as a result of reduced placement fees incurred in relation to raising new capital. Including investment income from AlphaCat sidecars and ILS funds of $4.4 million, AlphaCat contributed $4.9 million to Validus.

Our consolidated investment portfolio included cash and cash equivalents and restricted cash is $8.9 billion at June 30, 2016. Of this, our managed portfolio is $6.4 billion and the non-managed portfolio is $2.5 billion. Excluding the nonmanaged investment component, managed net investment income of $36.8 million contributed to quarterly annualized effective yield of 2.34%, an increase of 55 basis points from Q1 2016 annualized effective yield of 1.79%, an increase of 32 basis points from the Q2 2015 annualized effective yield of 2.02%.

The higher yield from prior quarter and prior year was primarily driven by a single fixed income fund that is booked on a one-month lag. You will recall that this fund underperformed in the first quarter, as the return was based on the volatile months from December to February. As expected, the fund realized much improved returns in the month of March through May which are reflected in the second quarter results.

As a result of this timing anomaly, investment returns this quarter were unusually high and by contrast, unusually low in Q1. Going forward, we would expect investment income in the low $30 million quarterly, resulting in a yield around 2%. Net of our nonmanaged portfolio, we recorded $2.5 million in realized investment gains in the quarter and $30.1 million in unrealized investment gains.

Now turning to our capital structure, as a reminder, on June 6 the Company announced the commencement of an underwritten public offering of depository shares, representing Series A preference shares. On June 13 the preference shares were issued at a coupon of 5 7/8%. After underwriting discounts and expenses, we received net proceeds of $144 million and $852,000.

We're very pleased with the such of our first-ever preferred share offering, allowing us to upsize the offering and priced at the low end of a range. Total shareholders equity available to Validus common shareholders at June 30 is $3.72 billion and total capitalization available to Validus at June 30 is $4.65 billion. Excluding noncontrolling interest, debt to capital at quarter end was 5.3% and debt, hybrids and preferreds together as a percent of capital were 20%. Our one-on-100 U.S. windstorm PML is 15.7% of total capital, excluding noncontrolling interest and has increased by $15 million from Q1.

During the quarter, we repurchased 1,453,842 shares at an average price of $47.27 per share for a total of $68.7 million. As of market close on July 25, we repurchased 382,548 shares at an average price of $48.18 per share for a total of $18.4 million in the third quarter, leaving $385.2 million remaining in our existing share repurchase authorization. The level of repurchases in the second quarter reflects a relatively conservative view as we watch the various loss events unfold. That said, we continue to believe net income represents the best estimate of capital we plan to manage during the year through dividends and share repurchases.

With that, I will turn the call over to Kean.

Kean Driscoll

Thanks, Jeff and good morning, everyone. Today I would like to cover the reinsurance market rate environment in our key classes of business at June 1 and July 1. In previous quarters we discussed the value we have received from our investments in analytics and research. We continue to see these benefits manifest in a variety of ways. Our performance in the face of the second quarter events is a result of both our ability to identify the best price risk and utilize retrocessional protection and third-party capital to optimize our net portfolio. Our analytical capabilities are an advantage, not only in the assumption of risk, but also in allowing us to shape and optimize our net result through different sources of external capital.

In June, we conducted a research symposium for 80 of our most important clients, sharing our latest insight into the perils of hurricane, earthquake, flood and terrorism. This has resulted in several new private reinsurance opportunities that we're pursuing. It also cements our position as a leader in the market in providing solutions and insights to our customers. We directly associate the insight we provide to our customers with the fact that our signings on our property cat account continue to be exceptional with over 90% of our offered capacity being utilized. This compares to an average utilization rate of 75% for the market based on figures provided by the major brokers. In a market feeling the effects of excess capital, our ability to access low-priced risk is a true differentiator for both Validus Re and AlphaCat.

Now, on to the renewal market, the U.S. property market renewal is very orderly and rates were down low single digits, a continuation of the rate trends observed at January 1 renewals. Terms and conditions were generally unchanged and there was the modest upward trend towards locking in more multiyear capacity. We generally maintained about 20% of our U.S. cat capacity on a multiyear basis, a level we're comfortable with as it provides stability to our renewal portfolio.

In the Florida market renewal, rates were down low single digits. We anticipated demand for cat capacity with increase, but ultimately demand for capacity was flat. However, we did observe a shift in demand from residual markets to domestic riders. There were a number of deals that had to be repriced to clear capacity, driven by two factors.

Price, particularly at the top end of programs and a significant pullback in offered capacity by our large ILS market. The assignment of benefits issue continues to be a concern, but we mitigate our exposure to claims inflation by focusing our capacity on quality Florida riders who have better policy language and more robust claims adjusting and legal capabilities.

The international property market is experiencing more acute rate pressure than the U.S., as market participants actively pursue diversifying exposure, often at the expense of profit. Rate reductions were down on average about 10%. We shrank our international portfolio, focusing our capacity on our longer term key partners and allocating capacity away from layers where we believe the market is trading dollars. The second quarter is relatively quiet for marine and energy renewals, but it's worthwhile briefly discussing the loss activity in the energy market. The Jubilee rig loss is anticipated to be a $1 billion to $1.25 billion industry loss, given the latest claim advices.

This compares to an energy liability industry premium estimate of $2 billion, down from its peak in 2013 of $3.75 billion. There have been several other midsize events recently that won't broadly affect the reinsurance market, but will heavily impact the profit of the energy sector. Given our market share in the Marine and Energy segment, we're satisfied with our net loss position on Jubilee. It positions us well to capitalize on anticipated rate increases which will be further believed should oil prices rise. Our Marine and Energy portfolios performed well through time, as a result of our experienced underwriting team, our strong relationships in the market and our efforts to optimize our net portfolio.

We recently entered the mortgage guarantee market in the U.S., covering both PMI and GSCE business. Limits on placements for Fannie and Freddie recently surpassed $5 billion. We expect this market to continue to grow. We're investing in our analytical capability for this class and we see good opportunity to achieve measured growth in this attractively priced market. The buildout of our U.S. casualty portfolio is on pace with our expectations. We remain pleased with our response from our cedents and brokers. Acceptance for our product has been terrific and we're seeing a broad spread of opportunity across classes and buyers. We see clear signs of reinsured discipline emerging in the market and placements with poor underwriting performance are struggling to get done and there's no evidence of a broad deterioration in terms and conditions.

We worked on a number of shortfall covers as brokers and cedents look to patchwork capacity together. We continue to prudently approach the market, leveraging existing relationships at the corporate and individual level. Now, briefly commenting on the retro market as both a buyer for Validus Re and as a seller throughout AlphaCat, as noted in our fourth quarter call, at January 1 we were able to purchase the most comprehensive and affordable program in our history.

We were pleased with how the program responded to events this quarter, reducing our net loss position from both midsize industry events like the Canadian wildfires and larger non-elemental losses like the Jubilee marine plant. We only eroded a very small amount of our property retro protection from second quarter events and thus have significant capacity remaining on our cover to protect us during the remainder of the year and we have replenished any eroded retro limit on our marine and specialty portfolios.

As a retro seller, we saw a very different rate environment at June 1 and July 1 than what we saw at January 1. New placement struggled to get completed and overall pricing was flat to up. I have noted on previous calls the retro market is largely controlled by a few markets, with close to 70% of global capacity originating from four markets. Most of that capacity is collateralized and was fully deployed or accounted for going into midyear renewals.

Now a few comments on AlphaCat, we deployed nearly $990 million of limit through AlphaCat during the midyear renewals and have $2.4 billion of limit in force. Our ability to leverage our analytics and portfolio management skills with our balance sheet strength and our capabilities as an asset manager firmly positions us as a global leader in cat and a go-to solution provider for our customers. Working in concert with AlphaCat has not only produced excellent returns for AlphaCat investors, but has allowed Validus to improve the ROE on our capital portfolio.

Now back to Ed for additional comments.

Ed Noonan

Thanks, Kean. Let me start with Western World's results for the quarter. The trend lines of Western World are all going in the right direction. Western World has shown good growth in its core binding authority business, up 18% in the quarter and 13% year-to-date. This is being driven by the addition of a property product, new agency appointment and the addition of our team in Scottsdale. We're also seeing strong growth in brokerage products underwritten through Validus specialty underwriters on behalf of Western World and our flood products continue to gain traction. We're importing Talbot products and making good progress in the use of technology and the data and pricing distribution and risk selection around products.

Property business is now 28% of Western World's total premium, up from 19% last year. As we have described in the past, growing the short tail components of Western World's business is one of our key goals and so we're making good progress. Perversely, it was the short tail classes which adversely impacted Western World's results this quarter. Our goal is to get Western World's runway combined ratio below 100% by year-end and we continue to see that as achievable. Western World's combined ratio in the quarter was affected by hail and flood losses, as well as one-time severance costs related to staff reductions earlier this year.

In total, these items added about 7.5 points to the combined ratio in the quarter, above the normalized run rate. When we normalize for weather losses and expense, the combined ratio was right around 101% for the in force portfolio. On the same basis, the Binding Authority portfolio was at a 97% combined for the quarter. Western World's success is predicated on its strong scalability. In the Binding Authority segment, we're adding significant business with very little incremental costs and that will continue to bring down expense ratio over the next two quarters. In the Brokerage segment, growth is predicated on new products and the additions to our underwriting teams.

We're more cautious in this area, as we're not willing to front end expenses for future business growth in too many areas. If we were to see a better rate environment ahead, we would be more willing to make broader investments in this area. For the second consecutive quarter, we saw very significant flooding in Texas. The Harris County flood event was extreme, with 10 inches of rainfall in a very compressed time period. Out of 1,100 policies we had in the affected area, we experienced 18 claims. Based on our radar-derived rainfall totals for the event for each policy with a claim, we had only one policy in which we would not have expected a claim. This represents another fully validating event for our flood model, as a 1.6% claims ratio is an excellent outcome given the extreme nature of the event.

Our research team continues to be a competitive differentiator. The growth rate and flood product is picking up quickly and we continue to see this as an attractive opportunity. We continue to have favorable development in Western World loss reserves which is consistent with our expectations. Talbot underwriters had another good quarter, despite heightened competition in London. Talbot had a 96.9% combined ratio, despite $19 million of event losses in the quarter. In addition to the various catastrophes around the world and the Jubilee energy loss, Talbot had $8 million in political violence claims related to the Brussels airport bombing.

Year-to-date rates were up 6.2% across our portfolio, but it's driven largely by the energy market as a result of the turmoil in the global energy sector. We're not seeing an increase in our attritional loss ratio in Talbot. The underlying reason continued to be the overall subdued level of claims activity across most classes. We don't write a frequency driven book and so our attritional loss ratio continues to benefit from this lack of activity. Talbot had $28.3 million in favorable loss development in the quarter, driven by 2013 in prior claims.

The biggest driver of competition in the London market is the ongoing trend of broker facilities. We have agreed to a small number of class specific arrangements where we maintain underwriting control and where we've negotiated very hard for data and services that have real value. However, the trend is toward very broad agreements with little, if any, underwriting control. Data that is of no real value and little, if any, incremental service. The value to insureds and premium savings is nothing they wouldn't derive from ordinary competition and the disclosure of fees received by brokers lacks genuine transparency.

We continue to believe this is one of the dumber ideas we have encountered and we're increasingly confident that will end in tears or worse for many underwriters and brokers. There are two ways that most of these agreements will come to an end. The first is a simple pressure on underwriting profits for Lloyd's syndicates. These additional fees will become unsustainable. The second is the intervention of a controlling authority that uses arrangements in different light. Having lived through the Client 9 era, my concern is the potential collateral damage that will accompany the end of these arrangements. I think some may be blind to the legal and reputational risk they are taking on.

In summary, we generated a good return on average equity for the quarter, despite loss events. Some quarters the losses miss our classes. This quarter, they seemed to seek us out.

Competitive pressure is abating in our Reinsurance segment, but not Lloyd's. Western World continues to make a progress with strong growth. Our reserves continue to be very strong, with no change in our carry position relative to our actuaries central estimates and our estimates for recent industry events were at the high end of market ranges. Our risk management and use of retrocession and third-party capital showed clear strength in the quarter and we continue to perform well in a very competitive world.

So with that, we will be happy to take any questions you might have. Michelle?

Question-and-Answer Session

Operator

[Operator Instructions]. Our first question comes from the line of Amit Kumar with Macquarie. Your line is open. Please go ahead.

Amit Kumar

Just a few questions, the first question I want to go back is to the discussion on the AOB crisis which seems like becoming a bigger deal every day. Do you get the sense and I know that Citizens recently filed for a report and everyone is trying to get their arms around this issue. Could we be surprised into this turning into a much bigger deal than what it is right now? Or do you get the sense that with all the legislative actions being contemplated, we will be able to address it and hence, it does not turn into a big problem for the reinsurance markets?

Ed Noonan

Let me address this by talking about how we think about, from a qualitative underwriting perspective, who we choose to provide capacity to. So our portfolio in general has very little attritional loss. We're in Florida predominantly at cat ex as a loss rider. So when we're considering deploying capacity beyond price, beyond the requisite capital required to support a transaction, the critical element in managing AOB as a potential claims inflation exposure is the professionalism and the competence of the carrier.

And so historically and continued through today, we allocate the vast majority of our capacity to insurers in Florida that have significant infrastructure, that are addressing the potential inflationary issues through enhanced policy language. It's really a legal issue, legal cost issue. And you can mitigate some of that through language that pushes towards arbitration rather than legal costs. And so, we're very conscientious in underwriting and asking those questions. I think today, it's more of a problem for quota share reinsurers and driving up attritional losses.

But we're very sensitive to the potential for there to be excess volatility coming into the market from certain cat events. So it's a very, very important part of our overall underwriting process. So, to answer your question simply, I do think there is potential for certain carriers to underperform and thus surprise. Those are the ones we're trying to avoid.

Amit Kumar

It's amazing how quickly things can change. We were talking about the sinkhole crisis a few years ago and now we have another problem in this marketplace. The second question I have is maybe just going back to the opening remarks and market conditions and we're sort of seeing this team.

Can you talk a bit about the July renewals? I know you talked about it. I guess the question is, do you think we're on the trajectory that this thing actually reverses at 1/1/2017 even if it's a benign hurricane season? Or do you get the sense that we sort of amble along at this bottom for quite some time in the absence of a large loss?

Ed Noonan

A lot can happen between now and the next renewal. The July 1 renewals in terms of general characterization were very similar to the June 1 renewals. And that's typically the case. It's obviously difficult to project where rate environment will be at next January 1. I think in the absence of the significant dislocating event, the way we view the market is just given cost of capital and general rate levels, we would anticipate it would sort of amble along, to use your phrase or flatten out through the remainder of the year without something precipitating a change in that view.

Jeff Sangster

The one thing that might affect it is the retro market suddenly tightening up a bit and increasing rates. There is an extreme reliance on the retro market at this point and it's a pretty small fragile market. Any dislocation there or a strong movement there will immediately ripple into the traditional market. Or I should say directly insurance market.

Amit Kumar

So if I sort of step back and think about the opportunities, does that sort of altered the thought process on buybacks during the win season or is it too early?

Kean Driscoll

No, I don't there's anything in that that would change our positioning on buybacks at this point. I think what we said throughout the year still continues to hold. That we're, as I said in my prepared remarks, then we're still focused on earnings as the right benchmark for what we would plan to manage through share repurchase and dividends in the year.

Amit Kumar

So no slowdown during the win season?

Kean Driscoll

No, as you noted we were active in the first half of July and will continue to be active as we see fit.

Operator

And our next question comes from the line of Sarah DeWitt with JPMorgan. Your line is open. Please go ahead.

Sarah DeWitt

On the underlying combined ratio for all of Validus, it sounds like there were a number of unusual items in there, like elevated weather and Brussels. Given your comments that Talbot's attritional loss ratio isn't deteriorating, Western World could improve and cat prices seem like they are bottoming, do you think the underlying combined ratio should remain roughly stable from here on out going forward?

Jeff Sangster

Yes, so Sarah, just to figure a couple of those, well spotted. If you look at the normalized loss ratio on page 34 of the [indiscernible], obviously the notable and non-notable loss events are taken out of there. But the items that still stay in the normalized loss ratio notably are the couple you mentioned which is if you look at Talbot, there was the March 22 Brussels airport bombing which we had very little reported at the end of Q1, but throughout Q2 we put out $8 million against that, so that's about 4 points on the Talbot standalone loss ratio. And then in Western World, they had $6.9 million of weather-related events, including the $0.6 million for the hailstorm that we pre-announced. And so that equates to 10.5 points on their standalone loss ratio.

So yes, there is a couple of events in the overall number, causing it to be slightly higher. Though, those types of events happen every quarter, so to exclude those and assume that's a run rate is probably unfair. That said, if you look back across the last five quarters, back to June 30 last year, 53, 50, 50, 48, 49, that loss ratio has been -- normalized loss ratio has been very consistent. And if anything, we do feel like the rate pressure is going to put upward pressure on that ratio. We don't see that changing drastically.

Ed Noonan

Your question is an interesting one. There is mild rate pressure in the U.S. and over time that has to filter in to the loss ratio somehow. There is a bit more pressure in London and we keep expecting that show up in the loss ratio, but our portfolio is somewhat unique. When it's made up of things like terrorism, oil risk and offshore oil rigs, you still need events to have an attritional loss ratio.

So I think that defines why we're not seeing any upticks in Talbot's attritional. And Validus's attritional loss ratio is very, very static over -- frankly, over the entirety of the cycle at this point. And so, there is different conditions in each one of our markets. When you aggregate all of them, I think the influence is a Validus attritional loss ratio being our largest business is a big moderator, combined with the Talbot kind of attrition being event-related. And so in general, I think we're not surprised at the attritional loss ratio continues to be relatively stable.

Sarah DeWitt

And then just to clarify on your comments on Western World, that's a run rate combined ratio could be below 100 by year end, is not the accident year combined ratio?

Ed Noonan

I'm glad you asked that, because this question came out last quarter in regard to the same -- it is always the same question. What we're looking at is the run rate on the in force portfolio and so candidly, it's more of a policy year or underwriting year view that we take, because that reflects all the actions that management has taken, as well as the business that we're writing. So, it's not an accident year per se. The accident year results lag underwriting year or policy year.

Unfortunately, neither we nor anybody else who discloses underwriting or policy or data would be a massive undertaking. But that's really what we're looking at. That's what we want to see out of the Western World portfolio and that's where the trend lines are all pointing in the right direction. It's currently running at a few points better than the accident year numbers are showing, but we do expect on a run rate basis that that should turned profitable in the fourth quarter and that the accident year lag will mean that sometime next year that will -- that should also mirror the same result.

Sarah DeWitt

And then just last if I could squeeze one more in on Brexit, do you see any impact to your business from that?

Jeff Sangster

Not really. The reinsurance market, I think we have none. We're not reliant on any UK European Union agreements for that. Talbot would be the place where there would be an impact, but frankly, when you parse through everything that Lloyds does and that Talbot does, it's a very, very small percentage of the premium that is in play. And these are long-established relationships and cases date back to decades. I wouldn't expect there to be much disruption in those relationships.

And then the last thing is, Bermuda has solvency to equivalency with Europe. And so from that standpoint, it has no effect on our trading relationships anywhere or approvals anywhere. So, I think de minimus is probably the best answer I can give you as to what our exposure to Brexit is.

Operator

And our next question comes from the line of Josh Shanker with Deutsche Bank. Your line is open. Please go ahead.

Josh Shanker

Let's talk about one of my favorite topics, Western World. Can you talk about the personnel changes going on there in terms of getting the right size in the business and hiring on new teams and maybe some multiyear guidance in terms of where we can see this go?

Kean Driscoll

First, the personnel changes took place in the first quarter and I think we talked about them a bit on the last call. Western World, their business is not hundreds and thousands of people. They have a couple of hundred employees and so the staff reductions were relatively small. I guess it was about 5% of staff at the end of the day. Where we're adding people, we've added a few people in Western World, but that tends to be more around risk management and actuarial and things like that.

Where we're adding some people is in Validus specialty underwriters which is the MGA that underwrites brokerage business for both Talbot and Western World. There, we're being very careful. We do note some competitors have hired lots and lots and lots of people and made quick entries into the market. We don't feel like that's the right strategy for us at this point in time. We think the pricing trends would suggest that waiting a bit makes more sense.

And so when we start to get a sense that pricing is reaching a bottom and about to make a turn, we will probably be more ambitious in that regard. But what we're doing is we're rolling out new products and Validus specialty underwriters that are underwritten on Western World's paper. And these would be things like our flood product. We rolled out a new U.S. terrorism product this week.

Obviously we have our energy and marine liability and other classes that we're writing. And little by little, we're importing Talbot products and expertise to Validus Specialty to underwrite in the U.S. predominantly on Western World's paper. So, as to the growth rates to that, right now we're hitting singles and doubles. We're not hitting home runs and that's again a reflection of where we see market conditions.

We don't see a big opportunity anywhere. Our FI team was probably the biggest investment of people we've made and we've been very happy to have them keep a relatively low-profile and grow slowly in this environment. So it's a little hard to give you a forward projection of where that might go, but our expectations are that we will be over -- I don't want to pick a timeframe, but over three or five years, that business should double or better. And I think we feel pretty comfortable in our ability to do that and if we catch a good market, then the upside is considerably greater than that.

Josh Shanker

And given your initial intentions, you couldn't control the market, but are you surprised that this isn't a moneymaking business in 2016?

Kean Driscoll

No. When we did our diligence, we had a pretty clear view of the Company. And Western World brought us a great franchise in the wholesale market and I would not underestimate the value of that. In terms of our ability to roll out new products, we have a very receptive market amongst all the relationships that Western World has built over decades. They had a very sound management team running the business. They are very good at it. Their use of technology is outstanding. They brought us the licenses and infrastructure that we needed to transact in the U.S. and their technology makes the business completely scalable.

But we also knew there were a few products in there that they had entered into that weren't performing well and they were going to have to exit. And so no, I don't think -- we're not radically surprised with what we're seeing. I think actually, as I mentioned, all the trend lines at Western World are going in the right direction. I think management is doing a really fine job of pushing the business forward. And so we did not get into this to win the market in a year. We tend to take a longer view of it and we feel really pretty good about where we're and what the potential and future for this business is.

Josh Shanker

And on the Canadian fire, how well do you think the industry understands the loss currently? And if the loss goes up, what happens in reinsurance versus primary markets?

Jeff Sangster

Josh, there are two elements of the loss itself. There is the area that was clearly impacted by significant fire damage and technology and transparency of information gives the industry a very clear idea as to quantum of loss associated with that. I think where there is more uncertainty, is the Central Business District. It was immediately adjacent to the affected fire area. And what's the potential impact from smoke damage and contamination. And some time has passed and I think there's more transparency around that. We, as we do with our all of our events, take guidance from our customers who typically provide losses and ranges and we generally tend to gravitate towards the top end of that range.

And then we do an extensive analytical exercise, based on exposures in our book, utilizing damage factors and our numbers are based on the higher end of industry loss ranges. Now if the loss goes up, my expectation is that the predominance of that loss will be borne by the reinsurance industry. Canadian companies are typically buying to a 1-in-250 earthquake number, so most of the losses are in first or second layers for most of the indigenous Canadian reinsurers. So I think it's largely borne by reinsurers, but we're not seeing anything at this point that would indicate that lost numbers are migrating upwards or they are still early in the process.

Operator

And our next question comes from the line of Ryan Byrnes with Janney. Your line is open. Please go ahead.

Ryan Byrnes

I just wanted to get a little more color. I think on the ILS retro market, you guys had mentioned that one of the major players pushed back a little bit at the midyear renewals. I just wanted to get a little more color as to what that was. Was it pricing, capacity? Just wanted to get some thoughts there.

Kean Driscoll

Just to clarify, rather than push back, pulled back. And late in the process, so I don't know the exact numbers, but there is one big historical participant in ILS market and in the Florida market and very late in the process, 11th hour, elected to significantly cut back capacity on a number of programs. They are also competing directly in the Florida market; and accordingly, we were pushed back or pushed off of a number of placements. And so it was an unanticipated, perhaps idiosyncratic shift in the supply/demand balance late in the renewal season and it drove up pricing and created a number of shortfall placements during the Florida renewal.

To that end, a lot of the capacity was with carriers whom we don't currently support. But overall, I think it was a positive sign. And any time capacity is withdrawn from the market, if it is done sensibly, I think it's a good thing for the market. In this case, it was done in a way that was unfortunate, I think, for the carriers and unfortunately for the brokers. But ultimately, the reinsurers benefited.

Ryan Byrnes

And then just quickly moving to Western World here, you guys also know there was nearly 10 points of non-cat weather in the quarter. Just trying to figure out, again if I look at kind of the U.S. cat market, it seemed like it was fairly normal for second quarter event. So I am just trying to figure out, where you guys adversely impacted here? Or this could be kind of a normal run rate for non-cat weather impact for Western World going forward as you guys grow at the property book?

Ed Noonan

It's above what we think of as the normal run rate. But Texas is a big state for the E&S market in general and it's a big state for both the binding authority business as well as the flood product. So neither one was particularly large on their own, but the two added up to be significant. But of course, as we grow our short tail writings in the States, we will end up with more weather-related events and so, in that sense, I think this quarter was probably a bit exceptional, but directionally, this is part of the future of writing the property business in the U.S.

Operator

Our next question comes from the line of Al Copersino with Columbia Management. Your line is open. Please go ahead.

Al Copersino

You all were talking about underwriting the primary underwriter with regard to Florida property. You've also talked about your view that we might be nearing a bottom as far as the overall property reinsurance pricing level goes. I wonder if you could put the two together. Are you starting to see your competitors do more of underwriting the underwriter the way you all do? Or are you seeing there would be differences in the prices offered primary insurers based upon their track record because it seems like that's sort of fallen by the wayside most recently.

Kean Driscoll

Yes, that's a good question. I agree with everything you just said. Historically, we've always scratched our head as to why there isn't a more significant price differentiation between the carriers that we think do an exceptional job and invest heavily in analytics and operational excellence versus more of what we would refer to as virtual companies.

So that dynamic has existed, albeit this past renewal was probably the first time in recent memory that companies that we would characterize as the haves and have-nots actually really did start to see some pricing differentials.

So I would attribute that to improved underwriting acumen and maybe a focus on AOB or assignment of benefits or it could just be idiosyncratic impacts from who this particular ILS market had chosen to support. But we're hopeful it's the former. We hope that the market has a more keen eye towards both the quality developments in addition to the quantitative component of pricing risk.

Ed Noonan

One observation I would make, I think our better competitors do underwrite the Company first and foremost. I think Florida is a bit unique, because there are so many different companies of so many different types there and at different times it's price driven to such a great extent and there is so much capacity to be deployed there. I think that Florida is unique in that regard, but sometimes you kind of scratch your head over as Kean says, the lack of differentiation between the house and the have-nots. But I do think our best competitors typically do underwrite the companies.

Kean Driscoll

Yes.

Al Copersino

I have one other, if I could. You have fairly recently entered the mortgage insurance, sorry, mortgage reinsurance space, as you said. Are you more interested in the back end risk-sharing transactions with the GSEs? Or are you more interested in doing more traditional reinsurance contracts with the primary MIs?

Kean Driscoll

Simply put, the GSEs we believe offers a more attractive return profile for us. Some of the structural mechanisms that are embedded in the proportional contracts were the PMIs limit some of the upside potential should they perform well. And so, thinking about the diversity of the underlying portfolios in the GSEs, the motivation in particular from Fannie and Freddie in terms of trying to create a robust risk transfer market, we can create a dynamic where the GSEs offer a better risk reward scenario. That said, we may do some PMI business, but if there was going to be an element that was certainly more heavily weighted towards, it would be the GSE piece.

Operator

And our next question comes from the line of Meyer Shields with KBW. Your line is open. Please go ahead.

Meyer Shields

If we look at Validus Re and that is a growth losses for notable in non-notable, sort of phenomenal use of retro there. Is that representative of sort of the current exposure that we have there?

Ed Noonan

It was a little bit hard to hear you. Could you repeat the question?

Meyer Shields

Yes, no, that's fine. I'm having a hard time getting anything out. When we look at Validus Re, it's exposure to the notable and non-notable much lower on the net side than on the gross side, so strong use of retro. I'm wondering if this data point is a good representation of its overall exposure to catastrophic events.

Jeff Sangster

Just to give you a little more data on the Val Re specific exposure by event on a gross basis, probably just focus on the wildfires and Jubilee oil. The other two were less impacted by the retro. The Canadian wildfires gross exposure was at $54.2 million at Validus Re. And the Jubilee oil was $54.6 million.

And so fully net-net of the reinsurance retro, the AlphaCat session and the reinstatement premiums, wildfires went down almost $40 million from $54.2 million to $14.8 million. And the Jubilee oil events went down even more significantly from $54.6 million to $3.7 million. The vast majority of that in both cases was the retro, as you can see from the table in the earnings release.

The recoveries there that you see on those two events were almost entirely Validus Re retro. And maybe I will turn over to Kean to give a little more color on how the program impacted those two losses.

Kean Driscoll

Okay, so there's essentially two different programs that responded. This year, last year as well, but this year in addition to buying a significant worldwide aggregate protection or significant worldwide aggregate cover which is really providing capital relief and an earnings relief probably in that order, we have an underlying program that we purchased that is more geared towards earning protection and designed to take out volatility from nonpeak areas. And in particular, that is a segment of the market that we struggle sometimes with, whether we're being appropriately remunerated. But you have to take some of that risk on in order to write certain transactions that we think in the aggregate are attractive.

So we're trying to mitigate that and that's, I think, really what you are seeing entrance the response on the Canadian wildfires. So, is that typical of the type of response? Yes, we hope so, but how losses flow through and how retro responds isn't always as predictable as, say, first tier reinsurance. On the marine platform loss, we purchased non-elemental industry loss warrantee protection that triggers based on certain size industry losses and, in this particular case, our gross and net losses highly aligned -- our net loss position was very satisfying relative to our gross loss position and the size of the overall industry loss.

Ed Noonan

Let me give you the simple answer. It is in the current environment representative of the retrocession and protections we have built as part of a soft market strategy. If prices were better, we would probably be happy to retain more risk. But for the time being, this is probably representative of what you should expect from us.

Meyer Shields

Separate question, how are you sizing up the opportunity for nongovernmental reinsurance as France? Is that something that's going to be relevant industry-wide?

Ed Noonan

Sorry, again, I'm having just a little trouble hearing you. Ask the question again.

Meyer Shields

Sorry, the opportunity to write catastrophe reinsurance in France, is that something that is going to have an impact on the market?

Ed Noonan

This is the score CCR suit.

Meyer Shields

Yes.

Ed Noonan

Yes, I think it does have an impact on the market.

Kean Driscoll

Yes, I think it's a wait-and-see. Right now, our indigenous nat cat exposures in France are modest. We're very supportive of the approach that Score is taking. We would love to see a more open market. That would apply really to any territory anywhere.

We're doing what we can to the supportive of enhanced private market role in public/private partnerships. We've been active in trying to get the NFI/PETA buy. We were very supportive of the FHDF and Citizens and the same would apply in France. So we don't have an idea yet of what the ultimate outcome is, so we would not be able to quantify that. Any new capacity, any new demand obviously we think is a net benefit.

Ed Noonan

One cautionary note is particularly the French mutual business, tends to be very competitively priced and so that, I think, limits the upside in the near term.

Operator

Our last question comes from the line of Ian Gutterman with Balyasny. Your line is open. Please go ahead.

Ian Gutterman

So I was going to ask, most of my questions on the gross versus net were just answered, but just to clarify one thing, just to be sure. So all the recoveries you show in the table, those are all third parties or does that include anything from AlphaCat?

Jeff Sangster

That's all third party.

Ian Gutterman

That's what I thought, okay. I just wanted to make sure. And when you said that you bought more earnings protection this year, but earlier you talked about not to bring too much into the aggregate retro, are those two separate treaties, then? So is there less earnings protection, if you will, left? But there is still plenty of ag protection left? Is that the right way to interpret that?

Jeff Sangster

I would say yes, exactly right. I think all of the aggregate protection is still there and technically it is attaching a little bit lower now that we've had some erosion of the -- retention. But a very modest portion of the earnings protection cover and yes it is a separate treaty, has been eroded. So all of the aggregate capital protection and most of the earnings protection is still in place.

Ian Gutterman

And then on Western, with the flood loss $6 million is not that big a deal, but just wanted to understand a little bit better and I know you talked about the model performed pretty well, but last quarter seemed to perform better. I mean it seems there weren't really any losses that popped up and this quarter went to $6 million on a similar event. So, sort of any learnings about what was different from San Antonio versus Houston?

Ed Noonan

No, actually there were three different events this quarter, so the biggest of them, I think, was the Houston flood and I think that was $2.8 million. No, the model actually performed really, really well. Extraordinarily well and I don't want to declare that the model is validated everywhere for all time, but each one of these events is actually validating the model probably better than we expected. So we're really excited about that product. We've got no competition. We're only competing with the NFIP. And based on superior analytics and data, we're able to outprice and outselect, so each event that the model gets validated just gives us more confidence and pushes us harder.

Ian Gutterman

And just last one, Turkey -- the aborted coup, does that -- for the industry does that cause any potential war or political violence or anything like that on the radar? Or is it too small?

Ed Noonan

It causes potential political risk claims. There haven't been any because nobody has defaulted on anything. But if the situation continues to deteriorate, you could end up in circumstances like that. Certainly, the war on land risk in Turkey has a different profile today than it did before the attempted coup and Turkey has a problem in their southeastern part of the country dealing with the Kurds and now increasingly, Syrians and Isis launching terrorist attacks as far as Istanbul. And so the risk profile in Turkey is higher. It may well be the coup leads to a military crackdown that reverses that trend, but certainly in the near term, our view is that risk for political violence, war and political risk is heightened in Turkey.

Operator

[Operator Instructions]. And our next question comes from the line of Michael Nannizzi with Goldman Sachs. Your line is open. Please go ahead.

Michael Nannizzi

So I just have sort of a question about just risk-adjusted returns in the cat business. Kean, when you are looking at that book, today as it stands when you look at whether the business overall -- I am talking about North America, in Florida in particular and Validus's book specifically, are returns there the way you see them attractive on a risk-adjusted basis?

Kean Driscoll

Michael, there are plenty of transactions that are quite attractive on a risk-adjusted basis. I mean, certainly, the levels are down from the peak. There's no surprise there. What we do to create uplift in our portfolio is invest and that's what I was talking about earlier in terms of analytics and research. We think we have a distinct advantage in the market in identifying the better price risk than our relationships with customers and our ability and willingness to share that insight then gives us another advantage in terms of getting better signings.

And then if you overlay the work that we do in optimizing our portfolio which is a very complex, highly rigorous process, the hedging that we do on the portfolio and our interaction without the capacity uplift that that provides, we can work towards producing risk-adjusted returns that are better than the peer group in our mind. But, still down from relative levels, but, we're pleased that we continue to mine attractive margins and sculpt and attractive portfolio in what is otherwise a difficult market.

Michael Nannizzi

So then I guess I was trying to reconcile. We've heard from a few players now that rates seem like they have found a floor or close to a bottom. But we're seeing people grow cat books in this environment as well. And so just sort of trying to reconcile if margins are attractive enough to grow, then why shouldn't they naturally see pressure downward until rational players like yourselves just say, enough is enough and actually stop writing the business and then force the 'hand at that point. And it sounds like you are saying it's this data, but generally, is that right? Or when you look at the market overall, how should we think about those, reconciling those two points?

Kean Driscoll

I think directionally your comments are on point with how we would think about it. So we have not been, nor would we necessarily intend to grow in the recent market and if rates stabilize we don't look at that as a market where we would actively want to grow. Now, the nuance for us is we're matching different costs of capital. We've got $2.5 billion of AUM. We're able to maintain a consistent gross footprint for our most important partners by utilizing alternative forms of capital.

And so we feel like our ability to monetize the inevitable rate uplift that comes from a dislocating event or events, we're in a much, much better position than the market as a whole. But no, we would not be looking to grow our net position in any material fashion in this type of market. But we still think we can mine attractive returns. But that's probably more often than not results in either flat to a trending downward portfolio.

Operator

I am showing no further questions and I would like to turn the conference back over to Mr. Ed Noonan for any closing remarks.

Ed Noonan

Thank you Michelle and appreciate everybody making the time for us this morning. I know it's a very busy day. As I say, good quarter for us. Not a great quarter because of events around the world, but still a very solid quarter. And the trend lines in our business we're comfortable with, but more than anything this quarter showed, I think, the commitment to risk management and cleverly managing our portfolio in a difficult environment and the benefits of it.

So next quarter, we will all get together and hopefully we will talk about how there were no catastrophes and what that will mean to rates going forward. But, we will look forward to it. So thank you.

Operator

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program and you may all disconnect. Everyone, have a great day.

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