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W.R. Berkley Corporation (NYSE:WRB)

Q1 2012 Earnings Call

April 24, 2012 9:00 am ET

Executives

William R. Berkley – Chairman and Chief Executive Officer

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

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

Analysts

Amit Kumar – Macquarie Research Equities

Keith Walsh – Citigroup

Joshua Shanker – Deutsche Bank Securities

Vinay Misquith – Evercore Partners Inc.

Larry Greenberg – Langen McAlenney

Michael Nannizzi – Goldman Sachs Group Inc.

Doug Mewhirter – RBC Capital Markets

Meyer Shields – Stifel Nicolaus & Company, Inc.

Jeffrey Cohen – Bank of America/Merrill Lynch

Robert Farnam – Keefe, Bruyette & Woods

Dan Johnson – Citadel

Operator

Good day, and welcome to the W. R. Berkley Corporation’s First Quarter 2012 Earnings Conference Call. Today’s conference is being recorded. The speakers’ remarks may contain forward-looking statements. Some of the forward-looking statements can be identified by the use of forward-looking words including without limitation believes, expects or estimates. We caution you that such forward-looking statements should not be regarded as a representation by us that the future plans, estimates or expectations contemplated by us will in fact be achieved.

Please refer to our Annual Report on Form 10-K for the year-ended December 31, 2011 and our other filings made with the SEC for a description of the business environment in which we operate and the important factors that may materially affect our results. W.R. Berkley Corporation is not under any obligation and expressly disclaims any such obligation to update or alter its forward-looking statements, whether as a result of new information, future events or otherwise.

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

William R. Berkley

Thank you very much. Good morning everyone. We were pleased with our quarter. We were pleased with how business is going. We are glad all of you are here, so you’ll get the opportunity here about our loss reserves and so forth, we don’t put it in our press release about our development and things in order to get a better audience on the call.

With that, and we’ll start with Rob talking about operations, and then will follow with Gene talking about the financials, and then I’ll talk a little bit about what’s going on, and then we’ll take questions.

So with that Rob, why don’t you go ahead?

W. Robert Berkley, Jr.

Okay, thank you. Good morning. Market conditions continue to improve during the first quarter. While our cycle term may not appear visible during any 90-day period when one reflects back and where we were a year ago, it is clear there has been significant improvement. Evidence of the change can be seen in many ways, including the increasing number of carriers publicly announcing significant rate increases.

Additionally, we are seeing many market participants adjusting their risk appetite resulting in a gradually increasing flow of submissions into the Specialty markets. This increase in flow predominantly tends to be [risk] with poor loss experience or other competitions.

Furthermore, the distribution system seems to have recognized and accepted that we are generally exiting the soft market. Consequently, they are becoming ever more successful and selling the rate increases that many carriers are required.

Lastly, the continued accelerating growth of the state defined risk plan populations clearly supports the notion that market discipline is returning. Having said this, life is not perfect and that includes the insurance industry. There are a few carriers in both the standard and specialty insurance market, as well as the reinsurance market that don’t seem to fully appreciate that things are changing. As a result of this circumstance, there is somewhat a lopsided barbell in the marketplace between those that are seeking late adequacy and those that don’t get it.

Having said this, the market is turning in spite of this limited number of irresponsible companies that are serving as a hindrance, not a barrier. Primary workers’ compensation and cat exposed property continues to lead other lines with regard rate increases. the reality of increasing loss costs combined with cat activity over the past several years have clearly caught peoples’ attention.

Additionally, the impact of recent revisions to cat models as well as the growing consequence of lower new money rates continues to apply added pressure. While change in behavior may vary by territory and product lines, clearly the general trend is definitively upward.

Having said this, for the moment, there are certain lines such as excess workers’ compensation and parts of the professional liability market that it remains more resistant to increase the prices. fortunately however, it would seem as though pricing has bottomed out in even these lines and is generally no longer deteriorating.

As we have suggested in the past, there is a correlation between the duration of the tale – excuse me, and the time it takes market participants to recognize a change in behavior is required. Additionally, the lack of frequency can also experience a similar delay in recognition of underwriting issues.

However, even longer tail lines in business that has become exceptionally competitive can overshadow these rules of thumb. As our Chairman says, even long-tail lines of business can become short-tail if they are sufficiently underpriced.

The company’s net written premium for the quarter was $1.2 billion; this represents an increase of 11% over the corresponding period in 2011. More than half of this growth came about as a result of improved rates. While all five of our business segments grew during the quarter, the lion share of the increase came from our International and Specialty segment.

The performance in these two segments continued to be driven by their exposure to strongly performing industries, as well as strongly performing economy. Additionally, some of the operations in these two segments are amongst the most leveraged in the group and greatly benefit from a hardening market. Finally, a significant number of our younger operations are in these two segments.

The group’s rate monitoring for the quarter indicated an increase of approximately 6.5% over the same period in 2011. It is worth noting this is a significant increase from the 4% that was achieved in Q4 2011.

Furthermore, it is also worth mentioning that this is the first time in several years, the group has achieved rate increase on top of rate increase for corresponding period. This is significant given it suggests we have reached a new level of momentum, where we’re truly to build upon itself.

Additionally, with our renewal retention ratio remaining at approximately 80%, it provides comforting evidence that we are not sacrificing the quality of the book while achieving improving rates. Margin on new business also appears to be headed in the right direction. The company’s new business rate relativity metric would suggest we are charging a 104.2% for a new versus renewal business. Put another way with light exposures, we are charging 4.2% more for new versus renewal business. The company’s general philosophy continues to be that one should be charging more for new business given the additional knowledge we have about our existing book.

Our loss ratio for the quarter was 61.8, while this is a similar performance to the first quarter of 2011. The result was achieved in a different manner due to varying contribution from the different operating units in the group. This result also includes $4 million of natural cat losses in addition to $2.5 million associated with the Costa Concordia loss.

The expense ratio for the quarter was at 34.7, while this performance was in line with our expectations we anticipate, it will improve as the year progresses. Gene will be providing more detail on this topic along the others shortly.

In the aggregate, the company delivered a combined ratio at 96.5. This result was achieved through the contribution of all five business segments generating in underwriting process. However, when you adjust for the performance to an accident year basis, we believe the business is running in the high 90s.

We continue to have great confidence in the soundness of our balance sheet and in particular the strength of our aggregate loss reserves.

As we have explained in the past, the company reviews each of our operations’ reserve in a detailed manner every 90 days. this allows us timely insight into how the book is performing. We would caution observers not to lead to the conclusion that the lower level of reserve redundancies recognized in the first quarter will be the new norm going forward. While it would be pre-matured to declare we are on a hard market. there is undoubtedly sufficient evidence, both in our results as well as those of others in the industry to support our view that we are clearly in a hardening market. The underwriting discipline that our organization has exercised throughout the sales market, combined with the investments we have made in new and existing platforms will undoubtedly offer increasing returns as the trajectory of the market turn continues to steepen and accelerate.

William R. Berkley

Thank you, Rob. Gene, you want to go through the numbers simply?

Eugene G. Ballard

Okay, Bill. I'm going to start first with a brief summary of the impact to the change in accounting for deferred acquisition costs. I’m sure you’ve all heard enough of this by now. but in the past, we issued new guidance that limits the deferral of acquisition costs, those costs that are directly related to the successful acquisition of new and renewal insurance contracts. we adopted this guidance on January 1, 2012 and we retrospectively restated our previously issued financial statements to reflect the change in accounting. the impact of that change to our balance sheet at December 31 was a reduction in [dark] asset of $84 million and a reduction in our common stockholders equity of $55 million or $0.40 per share.

The impact on our income statement for the first quarter of ‘11 was to increase underwriting expenses by $1.3 million and to increase our overall expense ratio by two-tenth of a point. There is a schedule on our Investor Relations section of our website that shows the details of the impact of this change in accounting on our financial statements for each of the past four years.

We expect this accounting change to cause some delay in the improvement and the recognition of improving expense ratios especially when business is growing, and to have the opposite effect when business is shrinking. I’ll cover this further when we get to the details of our expense ratio for the quarter.

Turning to our results, with a solid quarter with respect to both underwriting and investment income, our net premiums written overall up 11% to $1.2 billion. As Rob mentioned, that growth was led by the International segment, which was up 50% with strong growth and the Asia-Pacific, European and Lloyd's businesses. That was followed by 9% growth for Specialty, 6% for Reinsurance, 4% for Regional and 1% for the Alternative Markets segment.

The overall loss ratio was unchanged from a year ago with 61.8, losses from natural catastrophes where $4 million, it doesn’t include the Concordia loss compared with $24 million a year ago, which is an improvement of 2.1 loss ratio points.

Prior year reserve releases where $25 million down from $51 million a year ago, which is a difference of 2.9 loss ratio point. Most of the favorable reserve development in the quarter was related to the Specialty and Reinsurance segment and was related to accident years 2009 and prior. The 2012 accident year loss ratio excluding cats and reserve releases were 63.7 in the first quarter down nine-tenth of a point from a year-ago as price increases exceeded our reserving assumptions regarding loss cost trends. In addition our paid loss ratio was down slightly from 59.1 to 58.5, but as a good sign of that beginning to move in the right direction.

The expense ratio was 34.7 in the quarter unchanged from the restated expense ratio for the first quarter of ‘11. As I mentioned under the new [debt] policy expenses are recognized earlier than before, which will slow the recognition of improved proving expense ratio somewhat. Another way that we look at expenses internally, and I know some companies’ actually report this in their earnings releases is on a written basis, which compares expenses incurred during the period without any (inaudible) deferral with business written in that period. This takes out the process of trying to reallocate expenses from one quarter to another and an attempt to match them with earned premiums.

The written ratio varied a little bit more from one quarter to the next due to the seasonality of premium writings, but it provides a very objective measure of the year-over-year expense trends. And on a written basis our expense ratio was 32.7% in the first quarter of 2012, down nine-tenth of a point of 33.6% in the first quarter of ‘11.

Net investment income was $158 million, up 8% from a year ago. Income from fixed income securities including cash was $119 million that represents an annualized yield of 3.9% compared with 4.1% in the first quarter of 2011. Income from investment funds was $28 million, up $16 million from a year-ago with strong earnings from energy and real estate funds, and the merger arbitrage trading account earned $6.5 million, which is an annualized yield of 8.5%.

Realized gains primarily the sale of equity securities were $47 million in the quarter compared with $29 million a year-ago, and unrealized investment gains to after tax were $452 million at March 31, up from $430 million at the beginning of the year.

We have a summary of our investment portfolio on page nine and 10 of the earnings release. You’ll see the total invested assets were just over $15 billion at March 31 and we’re up $555 million from the beginning of the year. That increase includes $350 million of proceeds from a senior debt offering that we completed in March, and of that amount $200 million will be used to repay senior notes that are maturing on February of 2013.

So all that adds up to a very solid quarter with net income of $135 million and annualized return on equity of 13.7% and an increase in our book value per share of 3.8%. Thank you.

William R. Berkley

Thank you, Gene. So overall, we're pretty happy with the quarter. Our results are reflective of what I think are the discipline we’ve shown over prior years and substantial improvement in our performance, as we gain market position, we’re pleased with what we see. we measure our reserves carefully as both Rob and Gene mentioned. We are comfortable and in fact, our reserves as we measured in which as we look back at the prior three years’ earned premium, and then look at our total reserves outstanding, we choose three years’ earned premium, because that serves the duration of our loss reserves and our reserves are in an all time high, compared to where there has been any measuring point we’ve used in the prior periods.

So, we’re pretty happy about where we stand reserve wise. Inevitably, our on-going accident year loss ratio is going to improve, its going to improve only because of price increases exceeding loss cost. So, as that 4% from the fourth quarter starts to come into earn premium in the 6.5% in the first quarter, as it becomes earned, we’re going to see improving result. So by the end of the year we would expect 3% or 4% improvement in that underlying accident year loss ratio. That setting aside, all the unusual variables you can see quarter-to-quarter in the property casualty business. But in fact with price increases where they are that improving loss ratio is certain to come into play.

We think that while in individual lines of business you still are seeing people compete aggressively here and there, it doesn’t take long before people figure out what they’re doing is stupid. But stupidity is not limited to any one company or any one underwriter, it pops up in all markets, we just notice it more when most companies are beginning to be disciplined and understand what’s going on. So, yes it is the unusual behavior becomes more visible. I think that the cyclical change is always the same exactly how it implemented they will be different, but it isn’t going to be a hockey stick and it never has been a hockey stick until some particular event happens, which drives a dramatic change.

It can be a hockey stick; dramatic rate increases in a particular line of business or a particular segment of the market. But overall, we’re seeing good strong price increasing and the business is moving towards profitability. We don’t think interest rates are going to dramatically move up. We think it is still one world and the difficulties in Europe are going to impact the investments opportunities, and we think lots of the marketplace has capital embedded in Europe. So it’s going to keep pressure on the overall market.

So we’re excited, we think we’ll have an excellent year. We would expect that we will be able to deliver on our book value increasing by 13% to 15% for the year and we expect that we will be able to have additional capital gains, if some of the things at Berkley capital and some of our other investments will deliver we’d be honest gains for the balance of the year.

With that Kevin, we’ll be happy to take questions.

Question-And-Answer Session

Operator

(Operator Instructions) Our first question comes from Amit Kumar with Macquarie.

Amit Kumar – Macquarie Research Equities

Thanks and good morning. Just going back to your comment regarding pricing versus loss cost; did I hear that correctly, did you mentioned that 3% to 4% delta maybe just expand on that in terms of your thoughts on the earned premium rates versus loss cost and how you got that…?

William R. Berkley

No, I don’t think it was the delta. I think what I said is, we would expect that by the end of the year, we would start to see an improvement in accident year loss ratio possibly as much as three to four points. So, for example, by the end of the year, if my expectations are correct, let's just say by the end of the year, you have 8% or 9% increases in your premium rates. If you have 8% or 9% and you have, let's just say a 3% loss [product] increase, part of that would come through and then you waited for each quarter prior to that and I’m just saying that’s likely to give you by the fourth quarter up to 3% or 4% or a decline in Europe, accident year loss ratio.

Amit Kumar – Macquarie Research Equities

Okay, thanks. Thanks for that clarification. Maybe, I guess, touch up on California comp and where do you think those trends are now as it relates to the workers’ compensation, do you think the rates are finally increasing loss costs?

William R. Berkley

I’m going to let Rob talk about that. I think the answer is trying to get your head around California comp loss cost is a pretty slippery slope, given that they're willing to change benefits at a jump of a hat and make it retroactive. Having said that, I think the market realizes that they have significant catching up to do. I think the rate increases that we are getting at this stage in that book are certainly keeping up with our belief as to where our lost costs are going or we’ll be over a period of time and we’re reasonably comfortable. Having said that, I think that the average pricing in the marketplace overall, they find themselves in a hole and even the rate increases that they are trying to get today I don’t think is getting them to an underwriting profit in general.

Amit Kumar – Macquarie Research Equities

Got it. That's helpful. And I guess, one other question, just going back to your opening comments regarding increasing flow in Specialty. In terms of – can you talk about the – what’s the pricing differential between ENS versus, non-ENS entities for W.R. Berkley company on an average.

W. Robert Berkley, Jr.

I think the tricky part here is that, its not just about, it is an individual risk what a regional company with price adverse at Specialty Company, because it turns its conditions, it’s a lot of moving pieces, it’s not just purely priced. What I would suggest to you is this, and I’m not to speaking about our businesses, but I’m speaking about the market place if you will, is that – as I suggested earlier, it’s the risk that have a bit of hair on them, whether there would be property or casualty for whatever the reason may be or other issues are complications with – they are looking back over the wall into the specialty market and to the extend that they actually drift all the way over to the ENS market, the rate increase that exposure would be experiencing is quite material.

William R. Berkley

I think and you have to understand how we got here. And that is, what we really gets us to a softer market is standard market rates, first they get cut a bit, and then what happens is they loosen their underwriting standards. So they say, we’re riding all those and not cutting rates anymore and what they’re doing is they’ve loosen their underwriting standards, so business that historically was in the ENS market place or otherwise starts to move to the standard market. Then they had – injury, then they cut prices even more, because they compete for that (inaudible). So the sequence of things that happen is, first people start to raise their rates and then they figure out, they can’t raise their rates enough to pay for this business that never belonged in the standard market at all, and then they – their standards that goes back. So that’s how we got there and that’s how it reversed itself, and that’s how the cycle moves and the cycle moves and as far as terms and conditions all of a sudden, because when you realize you can’t charge enough you just stop riding the business. So we represent the worst business in the standard market and it’s the business that they don’t want to renew.

Amit Kumar – Macquarie Research Equities

Got it. Okay, thanks. Thanks so much for all your answers.

Operator

Our next question comes from Keith Walsh with Citi.

Keith Walsh – Citigroup

Good morning everybody.

William R. Berkley

Good morning, Keith.

Keith Walsh – Citigroup

The first question for Gene, you alluded to this in your commentary around the expense ratio, maybe if you could talk about when do we start to see more leverage in that number? And maybe if you could even talk about that number currently excluding the start-up, so we see leverage there currently and then I’ve got a couple follow-ups for Rob.

Eugene G. Ballard

Yeah, well I mean we’re already seeing in our written expense ratio, the leverage come through. I think like I said before that that calculation, that policy kind of slows that down a bit. But we’re seeing it today and expect it to continue not so much as a result of the start-ups anymore, but I think more so as a result of the fact that the top line is growing as much as it is.

W. Robert Berkley, Jr.

Keith, in some ways growth now with this new (inaudible) calculation is a penalty again, and that is, you’re not even recovering all your costs on the financial business. So growth is now once again, especially real growth, significant growth is not only not beneficial or breakeven it’s a penalty. So the faster you grow, especially once you pass some single-digit number, it starts to have an adverse impact, because you’re not deferring even your real cost. So the faster we grow, the more adverse that’s going to be at least for the short run.

Keith Walsh – Citigroup

Okay. And then Rob, I’m just curious, why is that net earned premium growing faster than the gross and the net written if rate continues to improve sequentially, I would have thought the opposite?

W. Robert Berkley, Jr.

Could you repeat that (inaudible) make sure you understand that, Keith.

Keith Walsh – Citigroup

Why...

W. Robert Berkley, Jr.

Why is the net return different than the growth written as far as growth rates?

Keith Walsh – Citigroup

No, the net earned is growing faster than the net written, and I would have thought the opposite if rate is improving sequentially quarter-over-quarter.

W. Robert Berkley, Jr.

Turning to Gene...

Eugene G. Ballard

Yeah. Well, I mean, the earn is a reflection of the growth not just in the quarter, but over the last 12 months of the growth rate.

W. Robert Berkley, Jr.

Typically, insurance premiums over that.

Eugene G. Ballard

Yeah. And we have some policies that are even longer than 12 months, so you can’t really tie them directly to the change written in the quarter.

W. Robert Berkley, Jr.

There’s nothing that’s changed if that’s what you’re asking Keith. It maybe, because our reinsurance fee...

William R. Berkley

Reinsurance is probably the big differentiator, because now we will, as Gene suggested obviously the timing of the earn coming through versus the written, now we will change our reinsurance purchasing over a period of time.

W. Robert Berkley, Jr.

Yeah. I mean we’ve got different kinds of reinsurance that covers this year, which may have had an impact on it.

Eugene G. Ballard

Yeah. That of course will affect the difference between the written – gross return and net return, and we have had some of that, but in terms of the earned, that’s more just a different time period that we’re measuring there.

Keith Walsh – Citigroup

Okay. And then just last one for Rob. on your commentary, sill few carriers don’t get it. Does that imply a highly competitive market for new business and would you expect your retention as a result of that to dip below the 80% level that’s been running at? Thanks.

W. Robert Berkley, Jr.

When I say a few carriers, I guess what I’m trying to suggest is that they are the minority, and the greater marketplace, if you will is not only as a realized or recognized action needs to be taken, but it's actually translating into their behavior. So from our perspective, you are seeing a change and they are serving as – some of these folks are serving as an obstacle in front. I think the reason why you’re seeing renewal retention staying in there for ourselves and presumably for some others is because the distribution system recognizes that market is changing and they are less inclined to try and shop business solely on price. So, I think all things being equal it's becoming a less competitive or an aggressive market compared to where it was having said that, it can vary by line of business.

Keith Walsh – Citigroup

Okay. Thanks a lot.

Operator

Our next question comes from Josh Shanker with Deutsche Bank.

Joshua Shanker – Deutsche Bank Securities

Good morning everyone. I wanted to talk a little bit, Bill, for a couple of years you’ve been concerned about the industries reserves. When you look at competitors and peers in the industry, they still seem to be releasing a lot of reserves. do you standby your concerns about industry reserve positions and when do you think that has become an issue?

William R. Berkley

The answer is, I think that some people in the industry have been more aggressive than they probably would have been. And like I don’t know that I can tell you when that’s going to happen, I think you’ve already seen several companies have deficiencies and by and large smaller companies have already had to address those, AIG had to address and has. But my guess is there will be more to come. but I can’t tell you how soon that will happen.

Joshua Shanker – Deutsche Bank Securities

And do you have (inaudible) on the pace of loss cost trends of where we’ve been one year ago, where we are today and where we’ll be in a year, you can talk to a yearbook or you can talk to the industry broadly depending on how you think is it appropriate?

William R. Berkley

I think the loss cost trends are no longer totally benign. they’re certainly increasing modestly. The global economic picture always has an impact on how these things happen and come down. and clearly, I think the issues that are being faced in Europe overall will impact the economic picture every place. That being said, I think we passed through the period in the United States at least with the benign loss cost picture, but I don’t see anything running why – some of you saw loss cost grow at 2% to 3%, I think that would be my expectation. Look at that in some point, the United States just like the rest of world is going to have to face up to the ultimate issues of how do you deal with deficits that have accumulated over a long time and inflation and all that goes with that. but we sitting here today, that’s certainly more than 18 months away.

Joshua Shanker – Deutsche Bank Securities

Thank you very much.

Operator

Our next question comes from Vinay Misquith with Evercore Partners.

Vinay Misquith – Evercore Partners Inc.

Hi, good morning. The first question is on the top line, whilst strong this quarter that seen to sequentially decline for their some sort of one-time items this quarter and how do you foresee your top line over the next two quarters?

William R. Berkley

I think first of all, last quarter there was a particularly beneficial item that caused some of the increase. But I think the turn cycle is not a nice, predictable straight [earned]. Candidly, we were more optimistic about that growth at the beginning of the quarter than we are today. we didn’t know why we were surprised that it was in the point or two higher. but only when you sit and write numbers on a piece of paper can they be very predictable Vinay, it’s not –I’m not trying to be cute, I don’t really know precisely why, where, we had some companies that move much faster in the first quarter than in the fourth quarter. And then we had some that just sort seems to snap their growth. we had a couple of companies where because they were disciplined in their pricing and we were really pleased they were disciplined in their pricing. they actually contracted in the first quarter and we were okay with that. It only takes a couple of companies in the narrow marketplace on [one-one] business or another to make the business competitive for the short run. And that happened in a couple of lines of business. So I don’t think it’s a trend and we’re in a position where we saw growth at this level, we thought we’d be more aggressive in buying back our stock for instance. but we’re going to have to wait and see ourselves. We, at this turn of the cycle and at that moment in time, are predicting how much you’re going to grow and how much price increases are going to happen, hard to tell. We’re still very positive and we would still expect certainly growth at least the level we’re at now maybe a little more.

Vinay Misquith – Evercore Partners Inc.

Okay, fair enough. The follow-up is on the loss cost trends now you mentioned that Berkley is looking at a 3% loss cost trend, some competitors out there are seeing it’s about 4%, that still seems to be, I mean not very high. how would you look at pricing in the industry, going forward and I believe you mentioned about 8% to 9% in the next two quarters. But so if in the absence of significant spike in loss cost trends, do you still see pressures building within the system for rate increases?

William R. Berkley

First of all, I think a couple of (inaudible). I said, I felt loss cost trends were 2% to 3% and I felt and hit by the fourth quarter, I thought price increases would be in the 8% to 9%. I don’t think that they’re now, I think that but continue to get a little better. I might point out that every 1% decline in interest rates. For the Reinsurance business you need 7% on price, for the standard property casualty company business you need about 3.5%. You’ve had a 150 basis points decline in interest rates over the past two years, maybe or it depends who you want to use and how you want to measure and what you want to say. But just to offset interest rates, you need substantial rate increases without giving consideration for the fact that in Specialty lines prices have to come down 25% and in Standard lines, probably 15% or 17%.

So, yeah, I think that right now, people who were to print their accident year results honestly, a lot of people would have for company results operating losses on a marginal basis. So yeah, I do think you’re going to have to have pretty significant price increases. For a while, before the companies get to where they’re, on a marginal basis making money. You can’t look backward to your portfolio, you have to reinvest the money each day and you have to look forward. I mean some of the people were going to be in the most trouble are the people will price their underwriting margins and build them based upon their average portfolio yields as opposed to the marginal portfolio yields, and they’re going to find out that companies are losing money. So I think price increases are essential for the industry just to get the breakeven.

Vinay Misquith – Evercore Partners Inc.

Okay, that’s good. Thank you.

Operator

Our next question comes from Larry Greenberg with Langen McAlenney.

Larry Greenberg – Langen McAlenney

Thank you and good morning.

William R. Berkley

Hey, Larry.

Larry Greenberg – Langen McAlenney

I’m just curious with the new business pricing at 104.2 versus renewals, does that allow you to basically make a loss [picks] consistent new and renewal business?

William R. Berkley

I’ll let Rob answer that. I think that precision to something that we’d like to have. But I’ll let Rob answer.

W. Robert Berkley, Jr.

The answer is that what you’re suggesting is what we target and when we think about our design loss [picks] and we revisit them every 90 days, we’d certainly contemplate what the mix in the contribution is a new to renewal business. Having said that, our approach to (inaudible) on the side of caution a bit was new business versus renewal business is not just in how we price the business, but also and how we book the business. From our perspective, as I suggested earlier, a whole lot more about your [enforced] book than you do about new business. So we look for a higher rate for new business and we probably air a bit on the side of caution as to how we book it from a design ratio pick. Having said that, when we look at the book that has been written, we are cognizant of what percentage is new versus what is renewal, as we revisit those loss picks once again, every 90 days.

Larry Greenberg – Langen McAlenney

Okay, great that’s helpful. And then with regard to your comment on the reserves, the favorable reserve development for the quarter, and that we shouldn’t assume that the drop this quarter is indicative of anything in the future, was there anything unusual in that or is that just to suggest that one quarter doesn’t make a trend?

W. Robert Berkley, Jr.

I think we’re trying to get across the message, and the message is, which I follow-up on that when I made the comment that our reserves relative to the average three years earned premium is at a high level or higher actually than they’ve ever been. And they’ve gotten higher in each successive year for the past five and despite of reserve releases and that no one should think that the amount of reserve releases was indicative in somewhere another of our concern of our reserve position. we do a review, we conclude where we think we are, but we didn’t want people to get the wrong impression. and frequently, people think that the amount of reserves you release is a reflection on your reserve position. I now think I can speak from our company as well as a number of others. I don’t think it necessarily is, some companies who are deficient, still release reserves, they even – they released record amounts of reserves, it doesn’t change the fact that they’re deficient, it’s just they’re more anxious to show better earnings. Some companies that are redundant are cautious in what they release and they may be getting more and more redundant. I think investors tend to read too much in about reserve releases reflecting upon a company’s overall reserve position.

Larry Greenberg – Langen McAlenney

Great, thanks. And then finally, just reading between the lines Bill, I mean I know you’re talking about kind of a gradual up tick in pricing this year, it’s still relatively moderate loss cost growth. But I sense that you still believe at some point in time, this is going to turn into a more traditional hard market. Is that an accurate assumption?

William R. Berkley

The hard markets always start this way and then something happens, something happens, because someone [cheated] more than they thought they were, and gets into [dyer] financial difficulties. I mean it happened to AIG, but AIG got bailed out by the government. I mean, look at all the billions of dollars of deficiencies they had to make up forth. And we don’t know if that’s done or not, they do have very honest guys running the business now and I’m sure they will get there. but the fact is, none of us know where and what is sitting out there. and all I can tell you is that every time we go into the beginnings of an upward cycle, it takes people a long time to get through paying for their past sins. and usually, someone doesn’t have the ability to make it through. I don’t know who that’s going to be and I can’t tell you for sure. But there certainly are a lots of issues and risks to that situation. and I think that you can have other kinds of problems out there. We certainly don’t know who might be impacted by the European issues and the financial issues of the European banks.

Lot’s of the capital that supports the overall industry is based in Europe. But I think, there are a lot of uncertainties. I think the fact that is profitability increase is very dramatically with 8% or 9% price increases in this year, and with the same next year, you see dramatic increases in return on capital – return on capital in the high double-digits certainly for us high – excuse me, high teams. and certainly, in the second year of 8% or 9% both increases, our returns will be in the 20. But I can’t tell you or help any more than that. But yeah, I do think prices will continue to go up and I think that those price increases will get to be more substantial, just like today, a few companies can restrain price increases by their aggressive behavior. those few companies end up going both; I mean this is what happened with the Reliance and Frontier. They caused a lot of people a lot of money, because they restrained prices in a couple of areas and then they were broken, and literally in one month prices in commercial transportation in October of 2000 went up 28% on average. So that will happen, there will be a couple of what I would call smaller to mid-sized companies with a lot of business.

Larry Greenberg – Langen McAlenney

Great. Appreciate your thoughts.

Operator

Our next question comes from Michael Nannizzi with Goldman Sachs

Michael Nannizzi – Goldman Sachs Group Inc.

Thank you. First question I guess is, so if we backout the International segment, trying to understand what happened to exposure trends, relative to that the pricing change I’m assuming this may not right, but I’m assuming that price change outside of International in your segments was better than the pricing change in the International? and just one follow-up.

William R. Berkley

Mike, we typically don’t get into the detail of the pricing so to speak by segment, I would tell though that the International segment while rate play the component, it had more to do with additional units if you will of exposure driving the growth there as opposed to some of the other segments where [lead] played a more significant component in the growth.

Michael Nannizzi – Goldman Sachs Group Inc.

Right, if that’s so, if we back out the International in Thailand, you just focus on everything excluding that, I think net written premiums were up just under 5%, and so if the 6.5% price change that you saw year-over-year I’m just trying to figure out how to think about what happened to exposures and whether it’s regional or specialty given those sort of the bigger remaining segments?

William R. Berkley

Say that, I want to make sure I was following you. Gene was sending me a piece of paper, which was of not much help.

Michael Nannizzi – Goldman Sachs Group Inc.

So if we take the consolidated results and we take out International written premiums, if math is right, net written premiums were up 4.7% excluding international. And you said that in the International more of the growth was exposures not rate, so I’m assuming that 6.5% is probably just fair as a starting point for the business outside of international. So it looks like if rates were up, if you had a $100 of business last year and then you lost some, and then you wrote some new business, you’re getting 6.5% rate on the business you kept. I’m just trying to understand, why the exposure line actually increased less than the rate change? So 4.7% versus 6.5% I guess, is my question

William R. Berkley

Well, first of all I think you have to breakout (inaudible) it’s a longer question and we’re going to answer you. But a big part of that is impacted by alternative markets, which grew at a very low rate, barely grew at all, and that was because of one particular area that in fact declines, because how competitive price their business and we had substantial decline in premium in that one area. So when you take that out, I think that’s probably a little misleading so, for example Specialty grew at roughly 9%. It’s a lot more complicated than we can answer on this call.

Michael Nannizzi – Goldman Sachs Group Inc.

I understand.

William R. Berkley

But I think you’re underlying assumption is by adding up of how many dogs do you have. If you have 17 animals, it’s hard to give you an answer that will make sense, but I think that in the specialty business. And by the way, you also have to weight it by amount of premium as it’s not just adding up the pieces. So I think that the answer would be that the units of exposure in the alternative markets declined and price increase in Specialty business, but price increases still drove most of it and as I said, I’m sure if you want to go through the details of it, we can try and to do that and Gene will go through with you Michael later on. But it’s not something you can sort of aggregate and just sort of add up, it’s a fairly detailed thing. I think it’s one of those cases where the mathematical conclusion is correct, but I think it doesn’t give you the correct aggregate conclusion, because as I say, the biggest section in the Specialty prices were up 8.8% (inaudible) was up 8.8% and unit exposure were up slightly.

Michael Nannizzi – Goldman Sachs Group Inc.

Got it. That’s helpful, thank you very much. And then just one question about some of the new businesses either in Specialty or International. Did you add any new teams or new platforms during the quarter? And in terms of the capacity of focus that you’ve brought online, I guess particularly International where we’ve seen the most growth. What sort of percentage of the business that they were writing before they came online here, are the writing now? Just to kind of get an idea of pipeline of potential business there? Thank you for your answers.

W. Robert Berkley, Jr.

Mike, we added one new team, and they’re going to be focusing on the public entity space and at this stage they have not even begun to write business, or there is nothing that’s been down. We expect that to be happening later this quarter so, there has been no impact from what we did as far as starting new businesses in the first quarter on the income statement. We do think that over time it will be a meaningful contributor to the group, but certainly at this stage there’s been no impact.

Michael Nannizzi – Goldman Sachs Group Inc.

Okay. Thank you very much.

Operator

Our next question comes from Doug Mewhirter with RBC Capital Markets

Doug Mewhirter – RBC Capital Markets

Hi, most of my questions have been answered. Just two quick questions. First, I noticed if my calculations are right, your wholly-owned investees reported a pretax loss, is that I guess a seasonal swing or is there any particular issues?

William R. Berkley

It’s just a seasonal swing they expect to meet their budget for the year.

Doug Mewhirter – RBC Capital Markets

Okay. And my second and last question, you talked about how primary workers comp rates been going up industry wide, although loss costs have been kind of unpredictable as well. But you said that excess workers comp isn’t following and you talked about how there is still some competition in the alternative markets, why do you think there is a disconnect and do you think that logjam would eventually break loose this year or do you think it will take a while – going through the (inaudible) market, I mean?

Eugene G. Ballard

Yeah, I think what you’re really seeing is just as we have suggested earlier, the difference in [KL] or duration of KL as we had suggested earlier, excess comp has a much longer tail than primary comp, and as a result of that it takes a bit more time from insurance carriers or market participants if you like recognized that they have an issue. So I do expect that you will see a shift in excess comp and as we also suggested earlier is probably give or take bottoming out. But there is a bit of a lag or a delay before the reality comes into focus and you’ll see the same type of momentum, building in the excess comp line that you are seeing in primary comp.

Doug Mewhirter – RBC Capital Markets

Okay, thanks. That’s all my question.

Operator

Our next question comes from Meyer Shields with Stifel Nicolaus.

Meyer Shields – Stifel Nicolaus & Company, Inc.

Thanks, good morning. Two quick questions if I can. First, for Rob, when I guess cost (inaudible) not to extrapolate too much from the first quarter’s as they are releases…

W. Robert Berkley, Jr.

That’s right.

Meyer Shields – Stifel Nicolaus & Company, Inc.

Where you saying the $25 million is lower or higher than I guess the expected run rate?

W. Robert Berkley, Jr.

I think I was trying to suggest to you that I wouldn’t hang my hat at that is the number or the level going forward. I think it would be very problematic if I answer to your question more specifically.

Meyer Shields – Stifel Nicolaus & Company, Inc.

(Inaudible) I’m sorry.

William R. Berkley

I think if you put that together, what I said you should have the answer.

Meyer Shields – Stifel Nicolaus & Company, Inc.

Yes, now I think I do.

William R. Berkley

Which is our aggregate reserves have never been stronger.

Meyer Shields – Stifel Nicolaus & Company, Inc.

Right, that’s why (inaudible) I think this is interpretive Rob, the first time that’s why I was asking.

W. Robert Berkley, Jr.

Okay.

Meyer Shields – Stifel Nicolaus & Company, Inc.

In general, Bill when you think about the mix between property and casualty, it looks like you’re a little bit more heavily focused on the property side than historically, is that a reflection of rates or change in approach because as a larger company you can afford a little bit more volatility?

William R. Berkley

I think there is several things that happened. First of all, with interest rates down the difference in expected return for short-tail line and I don’t mean property lines, but short-tail lines has changed, because you’re now no longer getting the benefit of that higher investment return on longer tail reserves. So on marginal business that we write new business out, the improved return from casualty business is less than on shorter tail lines of the business.

So, yes, we have shifted whereas longer tail lines of business used to represent let’s just say between 85% and 87% of our business today and probably represents 82% of our business, still very predominantly casualty focus, very predominantly long-tail, but yes, consciously a decision that says, we’re willing to shift. Number two, pricing on some of those lines of business have gotten much more attractive. And number three, some of those specialty lines in fact do have some volatility that when we were a lot smaller company we couldn’t take and now we can afford to take it, things like marine business where we can afford to have an adequate and that to make money on line of business. So, all of the above that you mentioned.

Meyer Shields – Stifel Nicolaus & Company, Inc.

Okay, thank you very much.

Operator

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

Jeffrey Cohen – Bank of America/Merrill Lynch

Good morning. Just one question, it’s just something you guys have talked about and that was in the quarter the underlying loss ratio was better than a year ago. I guess as I thought about it, I expected that the earned premium for the first quarter still reflected obviously business written last year, when price increases did not keep pace of claims inflation. So while I think you’re right, you certainly should see improvement later in the year. I was surprised to see it in the first quarter, anything else going on there?

William R. Berkley

Jay, there are a couple of things going on there, but probably the most noteworthy what have to do with a benign first quarter as it relates to property losses, and obviously that drops right through. So relative to what our expectation would be for property loss activity in Q1 versus what it turned out to be things were a little bit better and while there are a couple of different moving pieces, I would suggest you, the lack of property loss activity was the leading contributor.

Jeffrey Cohen – Bank of America/Merrill Lynch

That was my second question, (inaudible).

William R. Berkley

But overall, I think that the trend of loss costs again were less than 4% probably, slightly less than 3% of the third quarter rather. So there is a slight benefit of those price increases in the third and fourth quarter of last year.

Jeffrey Cohen – Bank of America/Merrill Lynch

Got it. And then on the fixed income portfolio, can you talk about the difference between the new money yields and the expiring yields or your book yield, I should say?

William R. Berkley

Well, first of all we have been pretty cautious about reinvesting. In the past 45 days, you’ve could in a 10-year guess anywhere from 240 to 197 and we’ve been cautious in what we’ve done. So we have more cash than we’ve ever had I should say ever had. We have more cash than usual. We have, I think $1.4 billion cash give or take.

So, I would say a couple of things we’re doing, Jay. Number one, we’re looking to try to buy highly protected mezzanine mortgages where we can get 5% or 6% that have sort of three to four year duration, five year at most that will help us offset by lower yields on our fixed income marketable securities. So I’d say overall, we’ve started to invest between 3.75 and 4 in a quarter. So we don’t – we think it’s going to have a slightly adverse impact. We hope that’s going to be offset by common stock dividend yields, which we could have invested probably $400 million of common stocks based on (inaudible) yields and attractiveness for what we think will be gain, but not what I call a dynamic stock portfolio, but a conservative one. And in addition finding – the particularly small niche thing that we bought some housing bonds that give us tax credits that will give us effectively 7% or 8% yield. But it doesn’t appear in the investment income, it’s going to appear in a lower tax rate.

So for now we think we’re okay. Still sort of maintaining this give or take 4% boggy and our yield. But as I say, I’m very comfortable as the market changing. There is no doubt in my mind about price increases and where they’re going. My biggest concern is the harder the (inaudible) turns and the greater our cash flow where we’ll be able to keep finding niches to invest and then opportunities to invest at the current portfolio level. And I think that certainly the situation we’re seeing in Europe, which is the populous movement not to face facts of economic discipline, physical discipline is an issue we’re going to face here too. And if we don’t, we’re going to have inflation and with inflation you don’t want to lock in higher rates for longer terms, which we actually have not done.

Jeffrey Cohen – Bank of America/Merrill Lynch

Got it. And then one last quick question, I guess for Gene. Can we assume the catastrophe losses were all in the regional segment?

Eugene G Ballard

That’s right.

Jeffrey Cohen – Bank of America/Merrill Lynch

Great thanks a lot.

Operator

Our next question comes from Bob Farnam with KBW.

Robert Farnam – Keefe, Bruyette & Woods

Question on the excess workers comp piece, so with AIG pulling back in that space, have you seen any changes thus far and do you see that as a good opportunity to have that market change more quickly?

William R. Berkley

AIG has reduced their relative competitive position before they had gotten more sensible, they’re pulling was certainly helpful. There is one company that we think was a very aggressive price in the business. They didn’t price their discount on their investment yields and excess comp is average duration of the portfolios price by 17 or 18 years. And it’s enormous impact would rate assumption interest rate assumption and they based discount on their average portfolio yield, not based on current marginal interest rates, because of that share prices were from 40% less than ours and that’s the one place in our industry where we loss business, substantial business. That company is in the process of being sold, so we’re hopeful their new owners will get sensible.

Robert Farnam – Keefe, Bruyette & Woods

Okay, thanks.

Operator

Our next question comes from (inaudible) with Capital Returns Management.

Unidentified Analyst

Good morning, guys. How are you?

William R. Berkley

Good morning.

Unidentified Analyst

I just wanted to ask about the 4.2% higher price increase you are achieving higher than your renewal business. How is that comparison of pricing for these two buckets trended over say like the (inaudible) quarters? And could you also comment on what the down versus quarter trend has doing in the same time period for the new business?

William R. Berkley

Let me answer the first one and then I will – then if you could ask the second piece, I didn’t catch the whole thing. Relatively speaking within the certain number of basis points that delta between new versus renewal has been pretty consistent over the past several quarters. So that is not a new phenomenon we decided to start to bring that to people (inaudible) because A.) We think it’s relevant and B.) Surprise us how the industry in general doesn’t really seem to talk about new pricing that tend to focus only on renewal pricing, which we didn’t feel as appropriate. So the short answer is that it’s been pretty consistent.

Unidentified Analyst

Okay. And the second question was actually just how is your down versus quoted metric has been trending in your new business and say in the same time period four quarters?

William R. Berkley

As far as those ratios by the group or by segment or by operating unit that’s just not the stuff that we typically get into. I would tell you that new business is a bit more competitive today than it was in prior quarters, at the same time we are finding opportunities. And it has once a year as become a bit more competitive for new business and that’s more I think a reflection on a change in the attitude of the distribution system as much as anything.

Unidentified Analyst

Great, thank you.

Operator

Our next question comes from Dan Johnson with Citadel.

Dan Johnson – Citadel

Surprising, almost all have been answered, maybe just one question. As you move from more into mortgages on the asset side, you gave some good statistics there. But what sort of loss assumptions you’re using in those sorts of assets relative to what you might be using when you think about corporate investments? Thank you very much.

W. Robert Berkley, Jr.

The mortgages we’re buying are all less than 50% debt to value. So we’re not really using anything with significant leverage and we’re all – the mortgages we’re buying have relatively short duration. So the things we’re using is fairly frankly, we don’t think there is any consequential risk that was, we’re not in the open market, we’re not buying just stock as a marketplace.

Dan Johnson – Citadel

Do you (inaudible) underwriting these or are you buying products from others?

William R. Berkley

I’m not going to talk about the specifics. We’ve had relationships with people who have done this for a while

Operator

And I’m not showing any further questions at this time. I’d like to turn the conference back over to the host for closing comments.

William R. Berkley

Well, thank you all very much. We are very enthusiastic and well, clearly we felt we will grow more in this quarter than we did. I think one of the things it happens in a cycle (inaudible) the distribution part of our business is sort of sitting and adjusting to price increase environment and not out shopping the business that also means until some of the companies start to – that higher standards or terms and conditions there is not as much business outlook I think that’s going to start to change more dramatically. I think right now what we would expect to have price increases continue when to accelerate somewhat and as we said, by the end of the year we’d expect 8% or 9% may be a little better and we’d expect [growth] to get somewhat better than it was in the first quarter. So thank you all very much. Have a great day.

Operator

Ladies and gentlemen that concludes today’s presentation. You may now disconnect and have a wonderful day.

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