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AXIS Capital Holdings Limited (NYSE:AXS)

Q1 2012 Earnings Call

April 27, 2012 8:00 am ET

Executives

Linda Ventresca – Investor Relations

John R. Charman – President and Chief Executive Officer

Albert A. Benchimol – Executive Vice President and Chief Financial Officer

Analysts

Vinay Misquith – Evercore Partners

Joshua Shanker – Deutsche Bank Securities

Brian Meredith – UBS

Jay Cohen – Bank of America Merrill Lynch

Cliff Gallant – Keefe, Bruyette & Woods

Meyer Shields – Stifel Nicolaus & Company, Inc.

Gregory Locraft – Morgan Stanley

Operator

Good day, and welcome to the Q1 2012 AXIS Capital Earnings Conference Call and Wescast. All participants will be in listen-only mode. (Operator instructions) Please note this event is being recorded.

I would now like to turn the conference over to Ms. Linda Ventresca, Investor Relations. Ms. Ventresca, the floor is yours ma’am.

Linda Ventresca

Thank you, Mike and good morning, ladies and gentlemen. I am happy to welcome you to our conference call to discuss the financial results for AXIS Capital for the quarter ended March 31, 2012. Our earnings press release and financial supplement were issued yesterday evening after the market closed. If you would like copies, please visit the Investor Information section of our website www.axiscapital.com.

We set aside an hour for today’s call, which is also available as an audio webcast through the Investor Information section of our website. A replay of the teleconference will be available by dialing 877-344-7529 in the U.S. The international number is 412-317-0088. The conference code for both replay dial-in numbers is 10012316.

With me on today’s call are John Charman, our CEO and President; and Albert Benchimol, our CFO. Before I turn the call over to John, I will remind everyone that statements made during this call, including the question-and-answer sessions, which are not historical facts, may be forward-looking statements within the meaning of the U.S. federal securities laws.

Forward-looking statements contained in this presentation include, but are not necessarily limited to, information regarding our estimate of losses related to catastrophes, policies and other loss events; general economic, capital and credit market conditions; future growth prospects, financial results, and capital management initiatives; the valuation of losses and loss reserves; investment strategies, investment portfolio and market performance; impact to the marketplace with respect to changes in pricing models; and our expectations regarding pricing and other market conditions.

These statements involve risks, uncertainties, and assumptions, which could cause actual results to differ materially from our expectations. For a discussion of these matters, please refer to the Risk Factors section in our most recent Form 10-K on file with the Securities and Exchange Commission. We undertake no obligation to update or revise publicly any forward-looking statements, whether as a result of new information, future events, or otherwise.

In addition, this presentation contains information regarding operating income, which is a non-GAAP financial measure within the meaning of the U.S. federal securities laws. For a reconciliation of this item to the most directly comparable GAAP financial measure, please refer to our press release, which can be found on our website.

With that, I’d like to turn the call over to John.

John R. Charman

Thank you, Linda and a very good morning to everyone. AXIS has had a very good first quarter, particularly considering the transitional P&C market conditions that we continue to face. Operating income for the quarter was $136 million or $1.07 per diluted share, and our operating ROE for the quarter was nearly 11%. The combined ratio for the quarter was 94.8%.

This quarter was characterized by relatively benign catastrophe activity and our estimates of aggregate Cat losses from prior years remain stable. Net investment income in the quarter benefited from strong performance of the global equity markets. This improvement in equity markets coupled with tightening and credit spreads contributed significantly to book value growth in the quarter. We ended the quarter with record diluted book value per share of $39.53, an increase of 4% from year-end 2011 and 11% over the last 12 months.

Gross premiums written in the quarter declined by 2%. Growth in our Insurance segment from accident and health, marine and property related lines was offset by continued prudent reductions, (inaudible) line where we remain judicious in our utilization available capacity. We are however, encouraged as pricing continue to firm through the quarter and into the April 1 renewals, particularly in catastrophe exposed classes.

The product lines where we maintain a meaningful participation, this trend is visible now and almost in every geography and every line. However, the rate changes we are observing are not yet enough to warn any dramatic increase in underwriting activity.

I will discuss market conditions in more detail following Albert’s remarks. And with that, I’d like to turn the call over to Albert.

Albert A. Benchimol

Thank you, John and good morning everyone. This was a good quarter for the industry and for AXIS. Capital rise by improving pricing trends across substantially all lines in market and absence of large catastrophes and a significant turnaround in results from the Cat plagued first quarter of 2011. This quarter also marked a full recovery in our diluted book value following the significant Cat losses incurred in the first quarter of last year. Just as we have done following significant Cat loss activity in 2005 and 2008, we’ve demonstrated the resilience of our franchise and in all cases book value reached a new high within 12 months.

We had offsetting trends in our insurance and reinsurance business, so I believe in best of this quarter to start with a discussion of each segment and then conclude with the consolidated underwriting results. Our Insurance segment exhibited strong growth with gross premiums written of 23% to $525 million. Approximately half of that growth came from the accident and health initiative, which grew by over 120% this quarter, driven by timing issues and the renewal of a large reinsurance treaty as well as new business.

Other than accident and health, the rest of the insurance business grew 12%, mostly due to increases in property and marine lines, which are showing some of the strongest price movement and to some extent some timing adjustment, and then also some continued expansion in our Canadian and Australian operations as well as some professional lines growth in Europe.

The insurance net premiums written were up 31% due to a smaller percentage of our insurance business exceeded to third-party reinsures as we do not buy meaningful reinsurance for our growing (inaudible). The insurance currency or loss ratio improved by 20 points from 85.9% last year to 65.8%. The absence of last year’s Cat experience accounted for 15 points of the improvement, while the remaining five point benefit is due to a lower level of large loss activity, improved pricing, and business mix changes.

The insurance acquisition expense ratio increased to 2.9 points to 15.7%. The bulk of this increase is driven by the higher proportion of accidents and health business, which are higher acquisition expense. With the balance attributable to increase sliding scale commissions on some MGA business as well as lower benefits from reinsurance sessions. The reported combined ratio of 97.5% includes a prior period reserve benefit of 3.9 points. Insurance at favorable reserve development of $15 million in both this year’s and last year’s first quarter. But the benefit of the – on the combined ratio was lower this year in light of a 19% increase in premiums earned.

On the reinsurance side, growth and net premiums written were down 11% to approximately $1 billion. this was primarily due to a reduction, of 42% in Cat and related business, as we (inaudible) capacity where markets did not meet our current views on required business asset profitability, and a 14% reduction in credit and bond business where we curtailed European exposures in light of our concerns relating to higher economic risks in a less attractive pricing environment. Other lines that increases and reductions that substantially offset each other. This reduction is consistent with the January 1 renewal update we shared with you on our last call, where we indicated that 14% reduction in premiums generated at the January 1 renewals.

Reinsurance premiums earned were down a more modest 1%, reflecting premium production in prior periods. The reinsurance current accident year loss ratio fell by 106 points from the calamitous first quarter of 2011. The absence of Cats delivered a 115-point benefit, but this was partially offset by nine-point increase in the non-Cat loss ratio.

About half the increase is due to business mix changes and higher loss activity in European credit and bond. The remaining increase is due to our decision to book higher attritional loss ratios in 2012 for property related exposures, given the experience in recent years.

Obviously, reported activity was not that high in the first quarter. But we felt that one quarter’s good experience wasn’t necessarily sufficient data to move away from our initial loss ratios for the year. As the year develops, if this favorable experience continues, we would adjust down those ratios. this is not much different from our fundamental approach to reserving.

AXIS typically puts up what it believes to be prudent (inaudible) ratios and is quick to reflect bad news and reserves, but ways for lines of business to be reasonably well developed before taking action on positive trends. The reinsurance acquisition cost ratio was also up some three points in the quarter. The bulk of the increase is explained by business mix.

We earned less excess of loss premiums in the quarter than in prior quarters and that excess of loss business carries a lower acquisition cost and we earned more of a higher cost quota share premiums. This is in a catastrophe where we reduced the book a bit, but also more preveniently in our [motor] book where as we told you on our last call, we made a meaningful shift away from excess of the loss to quota share during the quarter, given our concerns over the loss trends and judicial development and claim settlement.

To illustrate the point, quota share now makes up about 73% of our earned motor premiums up from 48% in the first quarter of 2011. But quota share motor business typically carries an acquisition cost that is twice that of excess of loss business. The rest of the increase in the acquisition expense ratio is due to higher sliding scale commissions to do excellent results on prior period, European credit and bond business.

Overall, we reported a reinsurance-combined ratio of 88.6% after a six-point, six-point benefit from favorable reserve development. The net of all of the foregoing on a consolidated basis is a 2% reduction in consolidated growth in net premiums written, a 7% increase in consolidated premiums earned, a consolidated combined ratio of 94.8, and an underwriting profit of [$52] million.

With regard to the acquisition expense ratio, we would suggest that the current mix of business. A base rate for the year would approximate about a point less than that of the first quarter’s level. but that could change to the extent that prior year favorable development triggers additional sliding scale commissions. of course, if that would have happened we would benefit from the incremental income on the reserve releases.

Moving on to that investment income, we reported a 5% increase year-over-year to $116 million for the quarter. That was due to the strong performance of alternative investments, and in particular, our hedge fund portfolios, given the robust equity markets in the first quarter.

Income from our fixed maturity portfolios, cash, and short-term investments was $81 million this quarter, on par, with a $79 million in the fourth quarter of 2001, but down from the $91 million in the first quarter of 2011, due again to lower reinvestment yields notwithstanding strong growth in the invested asset balance.

Despite the upper shift in the U.S. Treasury yield curve in the first quarter, the total return of our fixed income portfolio was positive, as spreads generally tightened. In aggregate, the total return on our cash and investment portfolio for the quarter inclusive of foreign exchange was a positive 2.1% and that includes a 5.6% total return from other investments. During the quarter, net unrealized gains on our fixed maturities and equities improved by $182 million to a total of $279 million.

Going forward, we expect net income – net investment income will remain under pressure as a fixed maturity book yield of 2.8% converges towards the yielded market of 2%. With many global central banks maintaining policies and are keeping rates low for protracted period. This pressure on investment income, we believe is one of the factors pushing improvements in the pricing of insurance products.

G&A expenses increased 6% from the prior year quarter, reflecting a 7% growth in headcount, as well as other costs related to the continued build-outs of our global platform.

The other income statement items are relatively straightforward. Our foreign exchange losses for the quarter were offset by increases in the value in our investment portfolio, which are reflected in our equity accounts. Thus the net impact of FX movements on our book value during the quarter was negligible. This is the reason we believe it is appropriate to exclude FX from our calculation of operating income.

We did have an unusual loss of $5 million under repurchase of preferred shares. This relates to the write-off of the issuance costs on the redemption on $150 million of our Series A preferred.

Note that there was no impact on our book value. As this is an accounting entry associated with the reclassification of issuance cost from the additional paid-in capital accounts to the retained earnings accounts in our equity.

The net of all these items and preferred dividends was quarterly operating income of $136 million or a $1.7 per diluted share and net income available to common shareholders of $122 million or $0.96 per diluted share. This equates to annualized operating ROE of $10.8% and net income ROE of 9.7%.

Moving on to the balance sheet, total assets grew 7% in the quarter consistent with our activities and inclusive of $394 million of net proceeds from the issuance of our new Series C preferred shares in March. The net proceeds were fully utilized in April to fund the redemption of $150 million of our Series A and $246 million of our Series B preferred. Adjusting for these transactions and use of cash our assets would have grown by 5% in the quarter.

Given the importance of the January 1 renewals, our balance sheet reflects larger balances for premiums receivable under our premiums and (inaudible). Cash and invested assets totaled $14.2 billion at quarter-end versus $13.5 billion at the end of the fourth quarter and $12.9 billion a year ago. Our fixed maturity portfolio continues to be our largest asset class comprising 80% of cash and invested assets. The strategy for our fixed maturity portfolio is to continue to emphasize spread sectors, the largest being corporates and US agency mortgage-backed securities. We continue to maintain a high average credit quality of AA-minus with a 2.9 year duration.

Our holdings of non-US government debt at quarter end totaled $1.1 billion. These holdings had an average rating of AA-plus. As we previously disclosed in January, we sold our sovereign debt holdings of France, Spain and Belgium and so, all of our remaining Eurozone sovereign holdings are rated AAA. You will find substantial detail on our investment holdings in our financial supplement.

Gross reserves aggregated [$8.4] billion while net loss reserves are $6.8 billion. Reserve growth was muted in the quarter as incremental reserves for 2012 premiums earned were partially offset by higher paid losses as payments on the 2010 and 2011 years has ramped up. On a consolidated basis, we recognized $45 million of net favorable development in the quarter.

Approximately half of the group’s consolidated net favorable reserve development this quarter was generated from short-tail lines and reflected better than expected loss emergence. The remainder related primarily to our professional lines insurance and reinsurance businesses as we continued to incorporate our own experience into our ultimate expected loss ratios. We have not yet done so in any meaningful way for our liability lines with longer development tails.

Our total capital at March 31 2012 was $6.9 billion, up 7% from $6.4 billion at year-end and includes $1 billion of long-term debt and a temporary increase in our preferred equity to $750 million. Let me explain the temporary.

As we noted previously we took advantage of market conditions to reduce the cost of our preferred equity capital through the issuance in March of $400 million of Series C shares paying a coupon at 6.875. Since we did not need any incremental capital, we issued a notice of redemption for $150 million of our Series A shares, which have a 7.25 coupon and tendered for any and all of our Series B preferred, but had a 7.5% coupon. The redemption notice on the Series A is reflected on our March 31 balance sheet with $150 million reduction in the preferred shares and an equal increase in other liabilities. The tender for the Series B could not be reflected on our balance sheet due to the timing of the closing on the tender and this is what caused the temporary $250 million increase in preferred equity.

However in April of 2012, we funded the redemption the 150 of the Series A and repurchased $246 million as a Series B shares. The equity reduction associated with the Series B repurchase will be recognized in our second quarter of 2012. Our adjusted capital at March 31 that is capital adjusted for the Series B repurchase, which was completed on April 10 is $6.6 billion. And you can find the details on the impact of these transactions in our financial supplement.

I caution those who project our income that there will be additional non-recurring charges in the second quarter relating to the repurchase of the Series B shares. However the reversal of issuance cost will have no impact on our book value just as it did not with the redemption of the Series A shares, and the modest premium we paid to repurchase the Series B preferred is still less than the funds that we would save between now and the first possible call date on the Series B. So we view these transactions as a net positive for our company.

Common shareholders equity stood at $5.1 billion at quarter-end, up from year-end 2011 due to the net income and positive performance of the investment portfolio exceeding the share repurchase activity in dividends. We repurchased 1.5 million shares at a discount to book value on the first quarter for an aggregate cost of $48 million.

Our book value per share reached a new record of $39.53 per diluted share and this seems a good way to mark John Charman’s great achievement, the founding CEO of our company. I know Charmie minds this, but he is not dead and he will remain involved as the chairman of our company, but we would be remiss, if we didn’t recognize the unique franchise that he created. I’m humbled by his accomplishments and honored to be entrusted with the leadership of one of the greatest and more successful companies in our industry.

With adjusted capital of $6.6 billion, a high quality and liquid investment portfolio, strong reserves and a global franchise in both insurance and reinsurance, we are in excellent position to take advantage of whatever opportunities are available on the markets and to continue the outstanding track record of success established under John’s leadership.

And with that I’ll return the call to John.

John R. Charman

Thank you, Albert. I’m suitably embarrassed, I’ll continue. In our insurance segment, we had our best quarter yet in terms of pricing change through this market transition with overall rates up 3%, which is ahead of the 1% increase achieved in the fourth quarter of 2011 and for the rolling 12 months.

With only a few exceptions, all lines are showing either flat or increasing rates. Further, we are encouraged with respect to the sustainability of this trend as rates steadily firm through the quarter, with March generally the strongest month in these lines. Both our U.S. and International divisions continue to experience encouraging overall rates improvement in the quarter. Rates in our U.S. division, which is heavily weighted towards U.S. property was up positive 9% overall, ahead of the rolling 12 months average of positive 6%. In our International division, which is essentially comprised of our specialty lines overall rate change was positive 3% inline with the rolling 12 months average.

Across AXIS Insurance, the large property and energy classes are showing the greatest improvement, indicating an average rate change of positive 10% in Q1 up from positive 8% in Q4 2011 and ahead of the rolling 12 months average of positive 7%.

Notably, in the quarter most in our professional lines joined the upward trend in pricing, with many more account showing flat to positive rate changes. Rate change in our professional lines portfolio overall for the first quarter is averaging minus 1%, which is the significant improvement relative to last quarter, which showed rate change of minus 5% and relative to the rolling 12 months, which was up minus 5%.

As for our newer international insurance platforms, Australia was indicating rate increases in the first quarter led by the property classes at positive 9% and the professional indemnity classes positive 5%. Canada showed some increase of positive 1% up from minus 2% in Q4.

Our renewal retention rates in our Insurance segments remain stable and high. While the market is showing stronger results to increase prices, which is obvious in the pricing data, significant competitive capacity remains available. But interestingly accounts are generally not moving. The current period is not a particularly active underwriting period for our reinsurance segment with approximately 9% of accessories, 2011 expiring premium renewable in April.

April 1 renewals have concentrated on the Japanese market, treaty renewals. Historically, we have had very close and strong relationships with a number of key leading Japanese cedents. However, we have deliberately restricted our penetration because of the very competitive pricing across the board there. Following the terrible tragedy of the Tohoku earthquake and the tsunami, coupled with the huge unmodeled losses from the Thai floods. Japanese treaty renewals were effectively re-underwritten at the 1st of April. The outcome saw a significant strengthening of margins as well as substantial tightening of terms and conditions. We will well place the benefit from this fundamental re-pricing of Japanese treaties and their underlying portfolios.

We not only expanded the scope of our underwriting there. But also significantly increased our Japan related premium. Japanese cedents behaved honorably and recognizing the need to reposition domestic and Japanese interest abroad risk and pricing. Our Japanese strategy worked well and now sits favorably within our broader Asian strategy. Asia is beginning to be meaningful to us now and I expect that the region will be a major growth area for us over the next three to five years.

In April, we’ve all seen some activity in U.S. casualty and professional lines reinsurance, where we are observing significant tension and negotiations between reinsurers and cedents. Often cedents are pushing for increased ceding commissions in an attempt to recapture the profit associated with a favorable experience of the last several years. And in our view, reinsurers are so far successfully resisting this.

This highlights the fundamental issue of the day, which is the need for continued improvement in the insurance pricing at the front-end to compensate appropriately for both the insurers and the reinsurers who are sharing the risk. Our cedents are achieving favorable rate movement on their underlying portfolios. It’s still not enough in many cases, and naturally they’re looking to their reinsurers to price on the basis of experience not exposure. History tells us that the favorable experience of the last several years will not trend forward on a similar basis. Therefore, in more and more of these specific cases in these reinsurance lines we are reducing our participations on non-renewing treaties.

The next major renewals for our reinsurance business will be the 1st of June and 1st of July renewals. These renewals are particularly important as they represent the first look into the markets approached to business that achieve rate increases one year prior. These mid year renewals are dominated by U.S. catastrophe excessive loss renewals with Florida standalone reinsurance renewals in June. We continue to see wider acceptance of RMS version 11 with variations around implementation narrowing as the market collectively identifies and manages shortcomings of the model, notably the storm search component.

Generally, for the upcoming renewals, we expect to see improvements in pricing in line with those experienced over the last several quarters. Following last year’s substantial Cat losses, the majority of which were unmodeled, we have been utilizing our Cat capacity judiciously. For us to take on much more catastrophe exposure, we would expect the risk-reward characteristics to increase from the levels they currently are at.

As governments in mature economies face widening budget deficits, we anticipate a reduction in the socialization of risk going forward. In line with this, we expect that for example, Florida will be motivated to make structural changes in the insurance market that are positive for the private market. With this in mind there may be an opportunity for us to increase our currently conservative approach to reinsurance business emanating from the Florida market.

Looking ahead, we’ve remained optimistic that the exit from the bottom of the property and casualty pricing cycle will continue a steady progress. Indeed through April, we continue to see strong pricing momentum across our Insurance segment. I have said time and time again over the last 15 months that we are in a period of cycle change for the industry.

Broadly, the rate changes we are observing are not yet enough to warrant a dramatic increase in underwriting activity. Through this transitional period for the industry, we will remain judicious with our capacity and focused on preserving underwriting margin to drive value for our shareholders. When we see attractive opportunities such as those presented in Japan during the April renewal, we react and we benefit.

I strongly believe that as the cycle change unfolds over the next three to four years, AXIS will differentiate itself from our peer group by the quality and quantity of our underwriting profitability. It is not our objective to be all things, to all people and this is exactly the type of environment where we believe an underwriting company like AXIS will strive.

Our seasoned underwriters love this type of marketplace, where they really have to fight day-by-day to gain margin and create value, and with this in mind I’m delighted to welcome Jay Nichols, who joined us on the 2nd of April to run our global reinsurance business. Jay is an exceptional seasoned industry veteran, whose skill set strongly complement our company. I’m sure that our reinsurance business will go from strength-to-strength under his leadership.

Ladies and gentlemen, as you’re aware, Michael Butt, our long-standing Chairman is retiring on the 3rd of May this year. Michael has been the wonderful Chairman to our Board and all of the staff and management of AXIS. He has been an invaluable mentor counselor and role model to us all. And my words cannot convey the depth of gratitude that I and my colleagues personal hold for him. Happily Michael plans to remain a non-executive director of the company as well as the valued advisor. Now I can get my own back on Albert.

Finally and most importantly, on the 3rd of May I’m very proud to hand over the role of CEO and President to my close colleague Albert Benchimol. Albert is very quickly fully integrated himself into the very heart of our company. He is 100% fit for our strong AXIS culture and I have no doubt that he will be extremely successful and continuing to grow our global specialty franchise and in the process build on our track record of driving significant shareholder value.

From my part, I will remain active in my new role of Chairman of the Board as well as working closely with Albert. I hope to be able to provide Albert with the unwavering support, advising council that Michael so generously gave me. AXIS will continue to be my heart and soul and I am dedicated to its on going success. In addition, my interest continue to be aligned with the success of the company as I am the significant shareholder.

Ladies and gentlemen, thank you all for your support, patience, understanding, questioning, and friendship. AXIS is now being taken to a new higher level. But I am truly excited for the shareholders, the Board, the management and all of our fantastic staff.

And with that, I would like to open the line for questions.

Question-and-Answer Session

Operator

Thank you, sir. (Operator Instructions) The first question we have comes from Vinay Misquith of Evercore Partners. Please go ahead.

Vinay Misquith – Evercore Partners

Hi, good morning.

John R. Charman

Good morning, Vinay.

Vinay Misquith – Evercore Partners

John all the best for your future endeavors.

John R. Charman

Thank you very much. It’s not a victory, Vinay I keep on saying. I’ve had some wonderful messages relating to my retirement, most of which should be actually inscribed on a tombstone, but I can assure you I’m in very good health.

Vinay Misquith – Evercore Partners

Great. First question was just looking at this big picture of this quarter, I mean if you take out the higher amount of alternative investment gains, the ROEs was around 8.5% this quarter. So I mean is this the ROE, we should be looking at for the next few quarters or is something in the numbers that I’m missing here?

John R. Charman

I don’t think you’re missing anything. But I’m not sure you caught Albert’s statement, where he reminded everyone about the remaining increase, which he was talking about accident year loss ratios is due to our decision to book higher attritional loss ratios for 2012 for property related exposures. But obviously, reported activity was not that high in the first quarter, but we felt that one quarter’s good experience wasn’t necessarily sufficient data to move off our initial loss ratios for the year. So I think that my view, Vinay is the fact that, it's a very complicated series of numbers you guys are having to deal with. But I thought we had an excellent underwriting first quarter in both insurance and both reinsurance.

Our portfolio that has been readjusted over the last 12 months, because as you know, we've been very concerned about the risk-revolved characteristics of some of the Cat business, and the Cat business started to be re-priced although, reasonably flat on an exposure adjusted basis from the middle of last year. So we really haven’t yet seen and weren’t yet seen till the middle of this year, price increase on price increase. And we expect to see some continuing firming of the reinsurance marketplace, which we will welcome and we will take advantage of in the middle of this year going through to the end of this year. So, I wouldn’t get to hung up on the ROE that you mentioned, because I will hope that we will be able to achieve reasonable ROE, double-digit ROEs as we’re going through the rest of the three quarters. Albert, I'll let, if you want to add anything.

Albert A. Benchimol

Nothing, that's right. I wouldn't make a trend on a single quarter. Obviously, we had a handful of large losses in the first quarter and those always tend to overstate the related loss ratios for those lines, because you get a large event, but you only get one quarter’s worth of earned premium to put it against. That would be the first thing. I think with regard to the ROE, and we’re obviously quite focused on the ROE, I think a number of the things that we did over the last little while is in fact looking to shifting some of the business to where we actually believe (inaudible) that we were looking at. It seemed clear to us that with some of the duration of the reserves on the one hand of volatility around that and that in fact, the right call was in some cases to actually move to what might appear to you in the near-term to be higher combined ration business, but which appears to us quite clearly to be higher ROE business. And so I think that we’re actually making the right moves to improve the overall ROE of our book of business.

John R. Charman

Yeah. But, Vinay please don’t think we fundamentally changed our underwriting plan. I think it's a sort of say, a number of different issues that have converged during the first quarter. And I think, as we go through the second and third and fourth quarters you’ll see a picture that you've historically been used to be reemerge. But as I’ve said that I personally am very comfortable with that quality of the underwriting. I thought that the losses we incurred within the first quarter were absolutely manageable. I’ve been very concerned about the weather related losses and the attritional nature of some of those weather related losses, and I think that reposition our reinsurance portfolio as we have done over the last 15 months. You will see as we go through 2012 I hope that we’ve actually taken ourselves out of a lot of that attritional stuff.

Vinay Misquith – Evercore Partners

Sure. So just a follow-up on that, do you still think that you can do a double-digit ROE for the rest of the year?

John R. Charman

Well, I hope so.

Vinay Misquith – Evercore Partners

Okay, great. And just a follow-up also on the Cat premiums, there was a very substantial reduction of course, you had already telegraphed that last quarter, so not a surprise. But going forward, second and third quarter, do you think that you’ll take – that you’ll write more premiums I see, you've already written more premiums for the Japanese business, but some color on that would be helpful. Thanks.

Albert A. Benchimol

A couple of things here of course, when we’re reporting, we tend to put a lot of different pieces of business in the same line and it might be worthwhile to breakdown what appears at first blast to be a large 40% plus reduction in the Cat business. But let’s just give you some of the components of that reduction. About 6% of that numbers, just the fact that we didn’t have reinstatement premiums for prior year Cats. The other one of the other components here that we have in our Cat book is terrorism, and you've heard us talk about the fact that terrorism which was in line of business that we were previously very active in and has given the lack of losses been coming down to the point where we just felt that we were not being paid appropriately for the return. It's wonderful to write a lot of terrorism business and if there’s no bombs anywhere, you look like you have a great quarter. But that doesn't necessarily mean than it was the right underwriting call. And so just there again, I think we've given up close to $10 million to $15 million of terrorism premium and that’s another 4%.

Another area of the reduction that John has referred to is, we took a different view on our excess ag of loss treaties in the Midwest. And as you know, that has not been a line of business that have been very attractive for the industry over the last five years or so. And you heard us talk about the fact that we felt we need to see more alignment between the [CD] companies and the reinsurers in terms of a) better pricing, b) higher retentions and so on and so forth. So when you take things like that, take some workers’ comp Cat out of there that accounts for literally 25% plus of that 42% reduction. So, I think you'll get more color when you look down into the component parts and the reduction in the Cat business doesn't appear that large.

The other comment is to again, to reinforce what John said earlier. We have an unchanged appetite or what I would say, an unchanged tolerance for Cat losses. We remain willing to expose under the right conditions up to 25% of our common equity to one and 250 PML and the statements you’ve heard me say before is the fact that we are prepared to do so, doesn't mean that we have to do so at any price. And the reaction that you’ve seen from us in the last few months is a reevaluation of required risk-adjusted returns. What happened in January was really only the first pricing increase for those treaties, you’ll recall that everybody got a buy in January ’11 and you certainly have heard our view that (inaudible), but actually a step backward if you really believed in some of the views and models about the new expectations for losses.

So January 1 of 2012 was really no better in our mind than the mid-year renewals of 2011. What's important about April 2012, June, July 2012 is that these are the opportunities where we are seeing rates increase upon a prior rate increase. And in many cases, the new rates that are being offered to us, in fact do become attractive and you saw a clear evidence of that in our doubling of our Japanese book at the April 1 renewal. And so I think if we can see another 10%, 15% or so increases in the June, July renewals, you will see us more interested depending on the structures and so on in providing some additional capacity to the Cat markets.

Vinay Misquith – Evercore Partners

Okay, that's helpful. Thank you.

John R. Charman

Thanks, Vinay.

Operator

The next question we have comes from Josh Shanker of Deutsche Bank.

Joshua Shanker – Deutsche Bank Securities

Well, I can’t let you guys to get away that easily, given that it's...

John R. Charman

Good morning, Josh.

Joshua Shanker – Deutsche Bank Securities

Good morning to you. I want to talk a little more about Vinay’s question on the reductions in the premiums, because PML really didn’t go down by all the measure. I don’t think you’re last exposed to a terrorism loss and then you would have been a year ago, but when we think about exposures in terms of your reduction from one year to the next and you sort of give better detail onto that?

John R. Charman

Well, Josh, you are looking at the peak exposures. Let me tell you that as we started to (inaudible) from the rest of the market (inaudible) towards catastrophe pricing, not only in the peak Cat zones, but in the cold zones, which there's no way that's colder at the moment in my view. And we’ve been saying this now for five quarters that we believe the market has been far too generous with regards to providing aggregate capacity, Cat capacity to either cedants in North America or cedants in Australia and against the losses that have been incurred over the last two or three years.

We still believe that the pricing for those contracts were still far too heavily weighted, Josh towards the cedant and the risk reward characteristics of those contracts were just not appropriate for our portfolio. And I absolutely believe that the market is still being far too generous to those cedants. And so, we pulled some pretty substantial portfolios of Cat act protection in both the U.S. and quite frankly in Australia, there was one major cedant proved buys over $4 billion worth of reinsurance programs that we did not participate in the total, because of pricing and yet, those programs was fully completed, which still – which shows you at a certain extend that there is a difference of opinion between ourselves about appropriate risk reward characteristics and some of the rest of the markets. But we will not, after the losses that have occurred over the last three or four years and the heightening and the strengthening of severity as well as frequency of these natural peril losses. We believe that the risk-revolve characteristics need to be improved, and we’re not prepared to put capacity capital risk unless we see what I consider the real margin improvement as opposed to just exposure adjusted increases in premiums. So, I wouldn't necessarily expect you to see a pro rata reduction in our PMLs corresponding to the reduction in our premiums, because there has been a lot of the solo – those Cat aggregate type deals. I think in the U.S., we had about $30 million worth of premium from them in 2011, they’re pretty well gone from our portfolio this year. The underwriters are just going to chase their tails I’m afraid, Josh. And that's why I’m looking forward to this year.

Albert A. Benchimol

Look Josh, the table that we have here are obviously not the only thing that we’ve look at...

Joshua Shanker – Deutsche Bank Securities

Of course.

Albert A. Benchimol

At our exposures, and I think that, but to the extent that you have that information there, you can see that as a percentage of our equity or frankly in terms of dollars, some of these PMLs are about as low as they have been in several years. And so, what it does show is that there is a substantial amount of capacity to increase when the conditions are appropriate.

John R. Charman

And they forget, Albert. These are model adjusted numbers, which is changed. So I think Josh, I hope that you’ve got a slightly different view towards these numbers and I know...

Joshua Shanker – Deutsche Bank Securities

Well. I’m just looking for a color. I mean, I don't think it's the only thing in the world that matters clearly.

John R. Charman

Well, if I have another round with you, I think I'd give you a lot more color. But I’m...

Joshua Shanker – Deutsche Bank Securities

So if you think about the last 10 years, the post ’09, ‘11 year, had the industry made money off negligently giving away capacity or have they lost that in the events like Thailand or (inaudible), which probably people weren’t thinking it was lost or quite (inaudible). Has that been a winning strategy or a losing strategy?

John R. Charman

Well, I think it’s very difficult to measure lost opportunity costs. That's the way I look at it, Josh. If you look at the reinsurance market, I still don’t think the reinsurance market is as focused as it should be on wanting to understand the quality of the cedants and the quality of the underlying portfolios, and the strength of the pricing in those underwriting portfolios. But as I said, it’s a very difficult question to answer.

Joshua Shanker – Deutsche Bank Securities

Well, that’s why because I have no idea. And just quickly just give me an answer one, it sounds I assume there was a growth in AAA and BBB, bonds in the portfolio and a movement out of A and AA, any comment there?

Albert A. Benchimol

No, that's just a typical portfolio optimization looking to cash this spread. In some case, as you know, certain securities, certain ratings tend to overreact in one direction or another, and we try to reposition the portfolio through our various managers to ensure that we're optimally positioned. There is no message there; there is no strategy there.

Joshua Shanker – Deutsche Bank Securities

Okay, thank you very much.

John R. Charman

Thanks, Josh.

Joshua Shanker – Deutsche Bank Securities

The (inaudible) John, I did in last quarter accidentally, god bless.

John R. Charman

That's fine, thank you.

Operator

The next question we have comes from Brian Meredith of UBS.

Brian Meredith – UBS

Hey, good morning.

John R. Charman

Good morning, Brian.

Brian Meredith – UBS

A couple of questions here for you, first one, John I wonder if you could talk about your thoughts on the supply and demand going into the June 1 renewals. What you obviously actually are going to get the 10% to 15% price here particularly with some of the side car and collateralized vehicles we see popping up here?

John R. Charman

Well, I’ll answer that first question. I still think that there appears to be enough supply to fill the demand. The difference is though Brian, in all cycle chains as I think I’ve said before many times. The cycle change is not led from the front-end and it was really interesting last year-end’s reinsurance renewals. Cedants were pushing very hard for improved terms, brokers were pushing hard for improved terms. But there was a lot of pushback from the market, and I think that cedants and the brokers actually recognized that they could probably sell out 60%, 70%, 75% of the programs reasonably quickly with the people who are just filling buckets rather like the side cars and still trying to pretend, they had very tight underwriting criteria. But the underwriting marketplace held back and the brokers really, really struggled to complete their placements. They did complete their placements in most of the programs that it was a struggle. And I expect that Brian to actually be more material as we go into the June and July renewals. And that allows us to put some pressure, pricing pressure for our commitment to these programs. So whilst I think the programs will be completed I think it's going to be a much more difficult process for the cedants and for the reinsurance brokers to complete them. So that's what I feel about the continuing hardening of the marketplace.

Brian Meredith – UBS

Great, thanks. And then, I start to believe that the underlying combined ratios, but just a little more color here on it. It feels like that this year, if you're getting kind of a little bit more in the frequency type businesses maybe a little bit more away from some severity type businesses. And therefore the underlying combined probably will be a little bit higher. Is that correct or might not think into that correctly?

John R. Charman

I wouldn't interpret it in that way.

Albert A. Benchimol

I think in some lines of business that may be true. but I wouldn't look at that at the overall book. Look, I think one of the things that we’ve done and we’ve caught that elsewhere. we recognized the number of the losses that people in the industry have called Cats, so we just call them large losses. So obviously, we had some tornados some people decide to exclude them, some people don’t so on and so forth. There is no question that the A&H business is a bigger piece of the business and that’s got a higher loss ratio and likewise on the motor business, the excess of lost motor versus the motor business will have a higher acquisition expense ratio. but overall, the balance of the book of business, we do not believe is going to significantly change our targets, combined ratios.

John R. Charman

Brian, I hope that the first quarter was pretty lag for us. but again, I’d come back to Albert stated remarks where he said, we felt that one quarter’s good experience wasn’t necessarily sufficient data to move up our initial loss ratios for the year.

Brian Meredith – UBS

Great. Thanks, and then on this last one, Albert can you talk a little bit about capital management and kind of thoughts there?

Albert A. Benchimol

Yeah. I think when you – as we’ve said this before, we were satisfied that we had enough capital at the end of the year for our various needs in any capital that we generated during the year. We’re either going to go towards funding new growth or essentially stopping purchases, returning capital back. Obviously, you’ve seen the numbers and between dividends, and repurchases in the quarter we gave back 64% of our net income. Frankly, we would have done more, but in abundance of legal caution given a lot of the preferred transactions back and forth, we determined that it was best to stop the repurchase earlier. We fully intend to start as soon as our window opens, and I think that you should expect us to be it towards the top end of our – of their indicated range.

John R. Charman

Brian, I’d just like to finish off on your the supply and demand point for June and July. I actually personally believe that the risk-revolved characteristics of the renewals we’re going to see in June and July are going to be substantially improved over what we’ve seen over the last 12 months.

Brian Meredith – UBS

Great. Thank you very much.

Albert A. Benchimol

Thank you.

Operator

The next question we have comes from Jay Cohen of Bank of America Merrill Lynch. Please go ahead.

Jay Cohen – Bank of America Merrill Lynch

Yes, thank you.

John R. Charman

Good morning, Jay.

Jay Cohen – Bank of America/Merrill Lynch

Good morning, John. Good morning, Albert and Linda. The A&H business, we saw obviously that has a higher acquisition cost associated with it. If you look at the underlying margins in your total combined ratio, how does that business compare with some of the other businesses you are in?

John R. Charman

It’s going to be on average higher combined ratio business, but let’s break it up. As you know right now, we’re still in growth mode and as we indicated to you earlier, we believe that we will continue to report a combined ratio of above 100 for the A&H business in 2012 notwithstanding what I would say low 90s technical ratio because of the G&A. Our view is that we should achieve a combined ratio below a 100 in 2013 as we reach break-even level. And we said before, we believe that our target combined ratio in A&H is approximately 90% and we thought that at that level we could achieve a mid-teens ROE. Very little capital requirements for that and as you know the average combined ratio of this company including all CATs and everything else for the first decade was approximately 86. So there is no question of the A&H business is going to have a target combined ratio, it’s a little higher, but in terms of ROEs, I think it will deliver just as good as our target ROEs across the cycle.

Jay Cohen – Bank of America/Merrill Lynch

That’s helpful. Thank you. And then obviously you did have some tornado activity and you did not as you rightly say characterize it as catastrophe, can you actually break that out and talk about what those losses, why similar to just to relative few number of contracts.

Albert A. Benchimol

I think that’s right. We have some in the insurance and the reinsurance all in I’d say Cat less than $25 million, [3.4] combined ratio give or take.

Jay Cohen – Bank of America/Merrill Lynch

That’s helpful. Thanks a lot.

John R. Charman

Thanks Jay.

Operator

Next question we have comes from Cliff Gallant of KBW.

Cliff Gallant – Keefe, Bruyette & Woods

Good morning.

John R. Charman

Good morning Cliff.

Cliff Gallant – Keefe, Bruyette & Woods

Just two quick questions, the disclosure on the PMLs it stated April 1, so does that mean it includes the full impact of Japan renewals or is that still developing?

Albert A. Benchimol

It is in.

Cliff Gallant – Keefe, Bruyette & Woods

It is in, okay, good. Actually and a follow-up I think to the previous questions on buyback. As long as it seems like you have plenty capacity in capital, if July renewals don’t go as you anticipate and you think it’s still not quite attractive enough for you, would you increase the pace of your expected buyback?

Albert A. Benchimol

At the end of the day, we want to find the right balance. If the opportunity makes more sense for us to be repurchasing shares rather than deploying it’s in a high-risk business then we will do so.

Cliff Gallant – Keefe, Bruyette & Woods

Okay. Could you remind us what your previous – I think another question you said something about the high end of your guidance range on buyback, can you remind us what that is?

Albert A. Benchimol

The indication we gave you is that we would essentially buyback all of our net income.

Cliff Gallant – Keefe, Bruyette & Woods

Okay.

Albert A. Benchimol

And in the first quarter between dividends and repurchases, we only gave back 64% of that capital. So arguably you could say, you could have gone to 100 and that would have been true. And I’m indicating to you that certainly given the way we look at the business and we have capital for growth too. I mean it’s not like we needed to generate new capital to grow. I continue to be of the view that unless our very attractive opportunity that pretty much most of our net income this year will go back to dividend and share repurchases.

Cliff Gallant – Keefe, Bruyette & Woods

Right, thank you very much.

Operator

The next question we have comes from Meyer Shields of Stifel Nicolaus.

Meyer Shields – Stifel Nicolaus & Company, Inc.

Thanks, good morning.

Albert A. Benchimol

Good morning.

John R. Charman

Hi, Meyer.

Meyer Shields – Stifel Nicolaus & Company, Inc.

One quick question if I can, John you mentioned that I think compare made in a [Gregory suggest] that even on (inaudible) cost trend of the past few years won’t persist. Is there any actual empirical evidence suggesting a (inaudible) in environment?

John R. Charman

Well, I introduced – I’ve been in the business for over 40 years now. And I can assure you that over that 40-year period people have had (inaudible) the U.S. casualty account, long tale of Cat. And in my 40 years of experience that has always comeback and bitten them within every 10 year period.

Meyer Shields – Stifel Nicolaus & Company, Inc.

Okay, I’m not disputing, I’m just wondering whether you’re seeing anything right now?

John R. Charman

Well what I’m not necessarily seeing an up tick in claims experience, what I have witnessed is quite frankly suicidal price reductions over the last four or five years not only pricing, but also the slashing of Self-Insured Retentions down from $1 million to a $0.25 million without changing actuarial projections. So that takes a while to see through, so you don’t necessarily have to have a substantial uplift in claims activity to actually see the emergence in the normal course of time of claims activity, because of the aggressive price reductions and changes in retentions that’s why just to remind you that we actually started to pull out of this business strongly in 2006.

Albert A. Benchimol

Let me add a couple of thoughts to that and John is right, we’ve been quite fortunate that we haven’t seen those trends in our book of business, but I think that if you look at the industry you’ll see two or things. We’re certainly hearing a lot about how in the workers comp area you’re seeing some increasing loss trends. You’ve heard some of the people who are dealing with some of the primary level D&O business talking about additional level of claims and experience, and I think even on some of the conference call that you’ve heard this quarter there is some reference to that. And if you look at some of the studies of the industry, you continue to see favorable development on some casualty and liability lines for the early part of decade, but there is no doubt, that you’re seeing adverse development for some of the more recent eight, nine, 10 years. Now not huge numbers, not across the board, but there is no question that there are some trends up there, you can find them.

John R. Charman

Well, absolutely if you’re taking to account for the last three years we’d probably had the lowest inflationary levels certainly within my business career and you have embedded liability that is going to around for 20 years, and it highly unlikely that the low level of inflation that we’ve seen over the last three or four years because of coordinated Central Bank activity is going to continue.

Meyer Shields – Stifel Nicolaus & Company, Inc.

No, absolutely agree and thank you for the clarification.

John R. Charman

Thanks Meyer.

Operator

The next question comes from Greg Locraft of Morgan Stanley.

Gregory Locraft – Morgan Stanley

Hi, thanks.

John R. Charman

Good morning Greg.

Gregory Locraft – Morgan Stanley

Good morning and congrats John, not many people have tripled book value in the last 10 years through financial crisis.

John R. Charman

Thank you.

Gregory Locraft – Morgan Stanley

I wanted to just again pursue the Japan renewals because I was surprised at how big you guys I guess went after it and I just wanted to understand how big is within your book. You mentioned I think 9% is what Japan premiums are now on a trailing 12 month basis and I wondered if that included the recent renewal where if it excluded the recent renewal.

John R. Charman

Let me talk generally about what our strategy was and then Albert will give you some numbers. As I said that we’ve had very long standing relationships with some – with the very key Japanese cedents, that we respectful, but we had really kept a very low premium volume as well as a low policy count because of the competitive nature of a lot of the P&C activity, domestic activity and, but we because of the complete re-underwriting of the portfolio, what happened is that the Japanese companies have essentially gone back and looked at their underlying portfolios and they’ve re-underwritten their own portfolios within the P&C fields, and substantially increased premiums, reduced conditions of insurance, which has really created a much better underlying portfolio from which (Audio Dip) diversify strongly our portfolio of Japanese treaties across the P&C range as well as to increase (inaudible).

So and that’s the position that we were able to take and it was appropriate because the risk-reward characteristics have changed fundamentally. The Japanese have also substantially clarified the exposures to the Japanese interest abroad and most of the Japanese interest abroad have actually been extracted from the treaties, and placed on a standalone basis or much more restricted basis. So I can’t emphasize enough have a whole portfolio that was re-underwritten and it was a very good, it’s been reset at a much higher level and that is what allowed us to participate much more strongly and in a much more diversified way.

Gregory Locraft – Morgan Stanley

Okay.

Albert A. Benchimol

I’ve been looking to your 9%, I wonder if whether or not you got your 9% from John’s comments and 9% of the book renews in April, but it’s not all Japan that renews in April I think that’s – it’s important. I think in fact, when you look at our overall Japanese premium I would say that probably under $50 million all in. So I wouldn’t over state the importance of the Japanese premium to our overall book. I mean, we’re happy to grow it, don’t get me wrong. But I’d say the 9% relates to the entire renewal in the reinsurance on the April 1 period.

Gregory Locraft – Morgan Stanley

Thank you, Albert. That’s exactly what I was doing. I was taking that 9 and [laterelling] in to Japan.

Albert A. Benchimol

All right.

Gregory Locraft – Morgan Stanley

Okay. So maybe on the $50 million that you just said, is that $50 million, because I think you were sort of backing up John’s comment. The fact that you were able to double premiums and hold the PML flat so to speaks volumes. Right?

Albert A. Benchimol

Absolutely, and that’s what the underwriting opportunity was. We had to be very patient and either because of that the earthquake and tsunami as well as the [tide] floods that was the opportunity we’ve been waiting for, for that portfolio.

Gregory Locraft – Morgan Stanley

Okay. And then on that $50 million, Albert is that after this renewal, so that you go from to 25 to 50 or did you go from 50 to 100 or is it after…?

Albert A. Benchimol

It’s only in the tad below 50 and that reflects the increases that we have.

Gregory Locraft – Morgan Stanley

Excellent, excellent. Okay, great. Thanks. And then the other one, just from earlier, I think in your commentary on the accident year, year-over-year increase you mentioned, half came from and I just missed it. I think it was higher losses in European, and then I want to say it was European credit…

Albert A. Benchimol

Yeah, credit and bond.

Gregory Locraft – Morgan Stanley

Credit bond, okay. What was that specifically?

Albert A. Benchimol

Yeah, there were two large bankruptcies that were announced in the first quarter. Now as you know in a lot of these things they generally tend to work out quite well. We work with our primary (inaudible) and they’re very good at recovering on collateral and so on and so forth. We tend not to give full credit to the collateral up front, so we did recognize our exposure to two large bankruptcies in the first quarter. That’s what I said a little earlier about the timing of the first quarter. You only get one quarter that’s worth of premium, but you may end up with your full year’s worth of losses, and there maybe some timing issues there. But that’s the factor on European credit and bond.

John R. Charman

And the portfolio is profitable, Greg.

Gregory Locraft – Morgan Stanley

Yeah, it is.

John R. Charman

So they, just as we just had a couple of individual losses pop out, which we dealt with in the manner that Albert described, but the credit and bond portfolio is still very profitable.

Gregory Locraft – Morgan Stanley

Great. Okay. Thanks a lot and again, congrats on the moves.

John R. Charman

Thank you.

Albert A. Benchimol

Thank you.

Operator

Well that is all the time that we do have for questions today. We will go ahead and conclude our question-and-answer session. I would now like to turn the conference back over to Mr. John Charman for any closing remarks. Sir?

John R. Charman

Thank you. I would just like again to thank you all for taking part in today’s earnings call. I wish you the very best (inaudible) should be listening in, notching out, but I look forward to the next earnings call. Thank you.

Operator

And we thank you sir and to the rest of management for your time. The conference is now concluded. We thank you all for attending today’s presentation. At this time you may disconnect your lines. Have a good day.

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