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Endurance Specialty Holding Ltd. (NYSE:ENH)

Q1 2012 Results Earnings Call

May 03, 2012 8:30 AM ET

Executives

Greg Schroeter – Senior Vice President, Investor Relations and Corporate Development

David Cash – Chief Executive Officer

Mike McGuire – Chief Financial Officer

Analysts

Matthew Heimermann - JPMorgan

Amit Kumar – Macquarie

Matt Rohrmann – KBW

Ian Gutterman – Adage Capital

Operator

Good morning, everyone. And welcome to the Endurance Specialty Holdings First Quarter Earnings Results Conference Call. This call is being recorded. Your lines will be in listen-only mode during the presentation. You will have an opportunity to ask questions after the presentation. Instructions will be given at that time.

I would like to now turn the call over to Greg Schroeter, Senior Vice President of Investor Relations and Corporate Development. Please go ahead sir.

Greg Schroeder

Thank you, Jenny and welcome to our call. David Cash, Chief Executive Officer and Mike McGuire, Chief Financial Officer will deliver our prepared remarks today.

Before I turn the call over to David, I would like to note that certain of the matters that will be discussed here today are forward-looking statements. These statements are based on current plans, estimates and expectations, and include but are not necessarily limited to various elements of our strategy, business plans, growth prospects, market conditions, capital management initiatives, and information regarding our premiums, loss reserves, expenses and investment portfolio.

Forward looking statements are based on our current expectations and assumptions regarding our business, the markets in which we operate the economy and other future conditions and involve inherent risks and uncertainties. A number of factors could cause actual results to differ materially from those contained in the forward-looking statements, and we therefore caution you against relying on any of these forward-looking statements.

Forward-looking statements are sensitive to many factors including those identified in Endurance's most recent annual report on Form 10-K and other documents on file with the SEC, that could cause actual results to differ materially from those contained in forward-looking statements.

Forward looking statements speak only as of the date on which they are made. Endurance undertakes no obligation publicly to update or revise any forward looking statement whether as a result of new information, future developments or otherwise.

In addition, this presentation contains information regarding the operating income and other measures that are non-GAAP financial measures. For a reconciliation of these items to the most directly comparable GAAP financial measures, please refer to our press release, which can be found on our website, www.endurance.bm.

I would now like to turn the call over to David Cash.

David Cash

Thank you, Greg. Good morning and welcome to our call. The first quarter was a good one for Endurance. Our earnings were solid with improved exceeding results in both our segments. Strong returns from the investment portfolio and growth in book value per share.

Strategically Endurance made progress on a number of fronts. The company generated solid organic growth in its reinsurance business, achieved double-digit policy count growth in our agriculture insurance business, and improved margins in our U.S. insurance operations.

We continue to see a trend of improved pricing in our business. This trend began to emerge last year and was very visible in the business we underwrote in the first quarter ending April 1.

Looking closer in our results, Endurance produced net income of 74.4 million and operating income of 53.3 million for the quarter. We delivered a combined ratio of 96.5 for the quarter. Our net written premiums were up 5.5% on year-over-year basis. And finally diluted book value per share grew 2.7% over yearend 2011.

Later in the call I will provide further commentary on market conditions, our crop insurance business, capital management and recent management changes. But first I will pass the call over to Mike McGuire who will review our financial results in more detail.

Mike McGuire

Thanks, David, and good morning everyone. In the first quarter, Endurance generated net income to common shareholders of $74.4 million and $1.72 per diluted share and operating income of $53.3 and $1.23 per diluted share.

Our diluted book value per share ended the quarter at $51.90, up 2.7% from yearend and up 3.3% when excluding the $0.31 per share in dividends paid during the quarter. In comparison to the first quarter of 2011 the improvement in our results was primarily due to a lower level of catastrophe losses in our reinsurance segment, improved accident year results and our crop and U.S. insurance business and higher net investment income in foreign exchange gains.

Starting with premium writings, the first quarter is typically our largest written premium quarter as it includes 11 renewals in the reinsurance segment and spring crop premiums in our agriculture insurance line of business. Net premiums written in the current quarter were $843.1 million, an increase of 5.5% over the same period in 2011.

Our Insurance segment generated net premiums of 427.8 million in the quarter, down just 1% year-over-year. Premium declines in our property insurance line of business were mostly offset by growth in our agriculture line of business.

The decline in property insurance premiums reflects a reduction in the amount of capital deployed to the all risk market and capital reallocations within the DIC market to improve the ROE potential in this business. Timing differences in the accounting recognition of growth versus ceded premiums written also impacted the change in net property insurance premiums.

Within our crop insurance business, net written premiums were up from a year ago due to 11% increase in policy count, higher premiums per policy and strong growth in Midwestern states where we generally retain a higher percentage of premium.

Increased sessions of southern states exposure to the FCIC partially offset this growth as did lower commodity prices year-over-year with corn and soya prices down about 6% and cotton down about 24%.

Reinsurance segment net premiums written were $415.3 million in the quarter, up 13.3% year-over-year. Growth in property and our aerospace and marine lines of business was driven by improved pricing and successful one in our renewal season within our Zurich branch.

Our combined ratio for the first quarter was 96.5%, an improvement of 42.8 points from the first quarter of 2011. The major driver of this improvement included significantly reduced catastrophe losses, $22.5 million or 5.8 points if cat losses were recognized in the first quarter related to U.S. tornadoes, compared to $184.8 million or 48.4 percentage points of cat losses recognized in the first quarter of 2011.

Accident year margins also improved in both segments. In Insurance, both our agriculture and U.S. wholesale insurance units showed margin improvements in the first quarter. In agriculture, although drought conditions continue in some parts of the south, conditions have improved significant since last year.

In our U.S. business wholesale insurance business, attritional losses were lower and the impact of business reengineering and targeted growth initiatives have started to show improvements.

Our Reinsurance business also showed improvements in the ex-cat [tax] in the year combined ratio from lower attritional losses and improved pricing year-over-year. These accident year margin improvements were partially offset by lower levels of favorable reserve development.

The first quarter combined ratio included 4.1 points of favorable development compared to 12.7 points a year ago. The higher level of favorable development last year was primarily in our agriculture insurance line. In 2010, we experienced a lag in settling claims due to a late harvest that delayed some profit recognition until the first quarter of 2011.

Our short-tail reinsurance lines also experienced lower levels of favorable development this quarter, reflecting a more active catastrophe year in 2011.

Turning to investments, our portfolios total return was 1.38% in the quarter. Net investment income was up 8.7% driven by improved performance from our alternative investments, which generated gains of $23.1 million. Higher alternative gains were offset by declining yields on the fixed income portfolio as new money rates remain below our book yield which ended the first quarter at 2.7%.

Our fixed income portfolio duration remain short at 2.6 years. We continued to believe that the modest yield benefits that could be achieved with a longer duration portfolio do not justify the significant risks inherent in this period of historically low interest rates. We ended the quarter strongly reserved with $383 million of IBNR for short tail lines.

Excluding reserves for named catastrophes, at quarter end we maintained $122 million of short tail IBNR for the 2011 accident year and $75 million for the 2012 accident year. In addition, $1.9 billion or 73% of our long tail reserves are IBNR.

Our capital position remains strong with total shareholders equity of $2.7 billion and total capital of $3.2 billion at quarter end. Capital levels remain comfortably above rating agency requirements and at buffer grew in the current quarter. We have ample capacity to deploy into improving market conditions to expand investment risks, purchase, repurchase shares.

As the year progresses, we will continue to carefully evaluate the trade-offs of the various capital deployment opportunities we have to deliver value to our shareholders.

With that, I’ll turn the call back to David for some additional comments.

David Cash

Thank you, Mike. I’ll now take some time to discuss market conditions and recent underwriting activity. Our crop insurance business, talked about our capital management and recently announced management changes.

Starting with market conditions, we continue to see improvements in a number of areas. This has been reported elsewhere, pricing continues to be up strongly for catastrophe and property reinsurance risk. These increases have been further enhanced by improved terms and conditions on international risk. These changes represent an appropriate reaction to the string of U.S. and international catastrophe that took place in 2011 and come on the heels of the meaningful price increases that took place last year.

Conditions are also improving in casualty lines, reflecting loss trends and an increasing market focus on the impact of very low investment rates. A contract binding authority insurance business in particular has benefitted from these trends.

Looking deeper into our businesses, in reinsurance, we saw the following. In our Bermuda catastrophe severity business, loss and model driven rate increases continued in the first quarter and in 4/1. Rate increases in CAT allowed us to grow our premiums and improved the underlying risk characteristics to the portfolio.

At April 1, renewals were largely about Japan. Japanese Earthquake rates were up 30 to 40% and typhoon rates up 10 to 15%. At 4/1, we maintain a relatively stable CAT catastrophe for our Japanese clients, while reallocating some capital away from pre-risk and pro-RATA exposures towards traditional CAT covers.

Since 2010, our Japanese CAT book has improved dramatically with a 33% increased in premiums and an 8% reduction in total limits. In our international property, non-CAT business, as we discussed in our last earnings call, first quarter growth in property reinsurance came largely from our European treaty book written out of Zurich as we saw good pricing, strong renewals and new business opportunities at 1/1.

In our Singapore operation at 4/1, we meaningfully curtailed our ratings of JIA treaties in the favor of more traditional CAT covers. These reductions and reallocation of capacity to CAT improved the risk adjusted return potential of our combined property business with the negligible impact on overall premium levels.

That's the poor one. Our Japanese wind PMLs were down appreciably form 1-1 where our Japanese quack PMLs remained relatively unchanged. In U.S. casualty reinsurance pricing has stabilized. Insurers are beginning to achieve rate increases to much loss trends, but not much more than that in aggregate. We remain a cautious stance in this market and have held the line on pricing terms and conditions. Growth in this quarter came from a positive premium adjustment on a prior treaty year.

Turning to insurance, our PNC insurance businesses experienced positive trends in the first quarter, although market conditions and top-line growth was more mixed and what the case for our reinsurance segment. In U.S. wholesale, our middle market wholesale business, which includes our Contract Binding Authority business saw positive rate increases of 4% on average across the portfolio. Property rates were up 4.5% continuing the gradual increases we have seen over the last seven quarters. Excess Casualty rates were up 6% after two flat quarters, miscellaneous E&O was up 5%, while rates in our environmental program were flat.

Looking at global access in U.S. retail, our large risk in retail insurance business has showed mixed pricing trends for the quarter with average rates down approximately 2%. We continue to exercise caution in these markets and premiums have come down with pricing and non renewals.

Our healthcare and large professional lines continued to be competitive and are showing rate declines on the order of 5% to 6%. Offsetting this, our Fortune 1000 Excess Casualty business experienced rate increases of approximately 7%.

Putting the pieces together, it's increasingly evident that the pricing cycle is starting to shift upwards on that end I would echo the positive comments that haven't been made elsewhere with respect to the direction of the overall markets we operate in. Well, it's too soon to declare a hard market, but the signs we are seeing are encouraging.

Turning to crop insurance, I am take -- an excellent quarter with the 2011 crop year largely behind us, its pleasingly reflect on the year passed and to recognize that in spite of record drought conditions in Texas and some significant claims activity, our crop business generated underwriting profit for the year. More importantly, as we look to 2012, we remain very optimistic about the prospects for this business.

On the marketing front, we were able to achieve significant growth in policy counts for the 2012 crop year with strong growth in the Midwest. In a relatively mature market, this is an important achievement and it reemphasizes the point that ARMtech has a distinct value proposition in the eyes of our agents. As a result of this differentiation ARMtech has been able to grow consistently year-over-year for ten plus years.

Looking beyond our success with customers and producers, the economic returns of this business also remain strong. Even as weather conditions are still challenging in some parts of the country, 2012 growing conditions have meaningfully improved over last year.

The Texas winter wheat crop is nearing harvest and is in much better shape than was the case last year while planting spring crops nationwide is well ahead of normal for this time of year. Winter wheat harvest claims and spring prevented planting claims are much lower than this time last year.

Finally, given the drought conditions are still evident in parts of the south, we have made greater use of the FCIC assigned with reinsurance fund, which should meaningful reduce loss potential if there is a repeat of last year's drought in Texas.

Moving to capital management, as Mike mentioned, our current capital levels are above rating agency requirements and our buffer increased modestly in the quarter. Our balance sheet and capital buffers provide us with strong capacity as we enter the mid-year renewal cycle. We will continue to actively manage deployment of our capital to our businesses to deliver strong returns to shareholders.

Our current bias is to return capital in the near-term to deploy into our business as markets improve. However we evaluate this continuously. And if we can't find the right business opportunities in a reasonable period of time, we will return that capital to our shareholders.

Finally, moving to management changes, we announced yesterday that Bill Jewett would be leading Endurance to pursue new career opportunities. As part of the transition, I will be assuming Bill's Presidential role and responsibilities. I expect the transition to be a smooth one and I looking forward to spending more time working with our business and business leaders as we continue to work and build the company.

In addition, Mike Angelina announced his retirement last month from his position as Chief Risk Officer and Chief Actuary to take a position in Academia at St. Joseph in Philadelphia. To fill Mike's role we promoted one of our senior business leaders, Nick Campbell to the position of Chief Risk Officer and we're evaluating a number of candidates for the position of Chief Actuary.

We are fortunate at Endurance to have significant bench strength. And I believe that our existing teams and a strong ability to attract talent position as well for continued success. I would like to thank both Bill and Mike for their contributions to Endurance over the years and wish them and their families all the best as they embark on the next chapter in their lives.

With that, Operator, I would like to open the lines for questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) Our first question comes from Matthew Heimermann with JPMorgan.

Matthew Heimermann - JPMorgan

Good morning, everybody. A couple of questions. First, could you just give a little bit more color on the writings and casualty insurance? The contract binding business has been driving some growth and that last for couple of quarters but it looked like that abruptly stopped. So, I don't know if that, healthcare and a large risk driving that but just a little color there would be great?

David Cash

Sure, Matt. Two things I think probably dominate the numbers for the quarter. For our contract binding authority business, we have seen pretty steady growth the last year. And that is starting to pick up this year. And over the last couple of months, we have seen roughly 50% year-over-year increases in policy count there. So that trend toward growth we think will continue. Those are smaller primary geopolicies and package policies that tend to be relatively low volatility business. And at the moment that business is pricing at a lost cost modifier about 1.65 to loss trends, where you saw the decrease in the quarter was in our primary casualty book, which was more of an E&S book based out of New York which we have been ramping down over the last couple of quarters. And those two trends offset each other somewhat. But the growth is being seen in CBA and the reductions on primary casualty.

Matthew Heimermann - JPMorgan

Okay. That's helpful. And then just in terms of reinsurance spend this quarter, just a little bit more color on the comment about timing influencing the primary property writings and also just looked like the net – 1Q is always a lower net to gross in CAT reinsurance line, but it looked like that ticked down a little bit more than normal so just some color there?

Mike McGuire

Sure, Matt. Starting with the property inside, what you saw this quarter was both reductions in the gross writings from some reallocations of capital away from all risk and some adjustments to the DIC book. The ceded premiums written on that essentially come out on a deposit basis each quarter. So really what we saw in the first quarter was the – basically the last quarterly deposit ceded premium coming out as written. It's basically a CAT cover on our property book and that renews that in May. So what we really saw was a timing difference on the timing when we write the gross premium and when the ceded premiums come out as written. You will see that the earned premium was not nearly as impacted as the written figures would be.

Matthew Heimermann - JPMorgan

Okay.

Mike McGuire

And the second question was on the reinsurance side in terms of retention. In our CAT book of business, we do have a quota share reinsurance arrangement, uncapped quota share reinsurance arrangement. Last year we had about a 5% placement. This year that went up to about 7.5%. So, that would have been the dominant change there.

Matthew Heimermann - JPMorgan

Okay. And then I guess last question I had, just quickly, regarding the (Inaudible) loss ratio [lacks] cats. Twofold, one just on the crop is it fair to assume based on your comments, we're picking the year as normal at this point despite Texas and then I guess it's despite Texas better conditions as well as some mix shift. And then also any attritional losses that affected the ratio this quarter? I didn't know if -- I wouldn't expect Costa Concordia exposure as big but wasn't sure if there's anything like that that wasn't broken out as cats?

Mike McGuire

Sure Matt, it's Mike again. With respect to our crop insurance business, as you would know, the first quarter is a pretty light quarter for us in earned premium. Most of the crop premiums really come through as earnings in the second, third and fourth quarters as opposed to the first. And we're really quite early in the accident year or the crop year in terms of recognition. We did, I'd say, modestly reflect the improvement in conditions year-over-year in terms of where we set the starting loss ratio for the crop business.

But we pegged it basically higher than where we ultimately expect our year to end up for our crop business. It's about 2.5 points better than where we started it at this point last year, but the early signs we are seeing, as David mentioned in terms of the lack of preventive planning claims on spring crops and the much lower level of harvest claims on the winter wheat crop which is getting pretty close to harvest. Those are very positive signs that we're seeing that we've I'd say partially reflected in how we booked our first quarter.

It's early, we do tend to book this -- our crop business on an expected loss ratio basis as we start the year and that we'll reflect the actual experience as we get further at the end of the year, but so far a very positive start to the year.

David Cash

I think the only other kind of attritional point would be we did have tornadoes in the first quarter. They were around $20 million plus in terms of our numbers. There have been some tornadoes that happened subsequent to the quarter, particularly in Texas which at this point look to be quite small. I think the initial reporting around them was they were significant. But at least in terms of looking at our mix of business, we don't see much loss coming from those at this point.

Mike McGuire

And we did not have material losses on Costa Concordia, it was maybe $0.5 million.

Matthew Heimermann – JPMorgan

Okay. All right. Thanks for that.

Mike McGuire

Thanks, Matt.

David Cash

Thanks, Matt.

Operator

And next we'll go to Amit Kumar with Macquarie.

Amit Kumar – Macquarie

Yeah, thanks and good morning. Maybe just going back to your opening comments, you sort of talked about capacity and you said you had ample capacity. If I look at the PML disclosure on page five and I guess tie it back to your comments that you want to be 25%, I guess that that's a zonal limit. How different would these PML numbers look going forward I mean after the 6-1, 7-1 renewals.

David Cash

I think there's kind of few things to note, our -- when we think about capacity, I suppose our comments tend to be dominated by review of (Inaudible) hurricane. And they're at the beginning of the year the PML number for the [one in hundred] years is about $570 million. That doesn't reflect some of the offsets that we would include sort of reinstatement premium offsets and the like.

Those numbers include some of what we call the all risk insurance business that Mike referred to that we've been ramping down. And so I'd expect really those PMLs are lower today because of that ramping down. And where I would see us using that capacity frankly it's in Florida, where we are seeing some opportunities to write lower, layered business with pretty high premium to limit ratios. And I would certainly expect us to deploy more capital in Florida this year than last year.

And I think when the dust is settled, our PMLs will probably be same, maybe a little bit more than what you see on our page 5 numbers, and then there will be able the shift we call it from insurance to reinsurance. And really what we found was the cost of reinsurance in that insurance book just made the economics of that part of our book go upside down. So, we've moved our insurance book to being really predominantly a quake book of business and we're really looking to take the wind risk to our CAT book and in doing that we're going to put a skew in towards Florida at this point.

Amit Kumar – Macquarie

Got it. And what is your opinion on side cars. I know I think in 2009 there was some discussion on a side car and probably you were trying to ramp up on I think that is called (Inaudible) or something. Do you anticipate examining that route if things do get meaningfully better at 6-1?

David Cash

I think that we'll have to look at that. But I mean on balance, we're a risk taking organization, so our primary goal is to build a balance of CAT portfolio. And that's what it dominates the underwriting consideration. We think with a balanced CAT portfolio it then makes sense to add leverage to that with a quota share. So essentially our quota share partners are also getting the benefit of a balanced portfolio.

And then you have some of these peak risks that come along where you can arguably manage capital for someone else. And there you are in the fee taking business when you do that. And the most obvious place to do is Florida. There was obviously some questions to whether their might be some Asia-Pacific side cars that emerged after last year, but it doesn't really seem like that's the case. And so we explored a few opportunities this year for Florida. We never found anything that that quite hit. If you do something like that it probably adds a few million dollars to economics over the course of a year. So it's not something that really kind of dominates our consideration.

But I think going forward companies like ourselves will need to be able at times to bring more than their own capacity to bear on true peak zones. And so I think that's why all companies look at those side cars. I think the benefit itself more by the customer, it's almost the service delivered to the customer than it is we call it a kind of levering of your own economic results, it's the way I tend to look at it.

Amit Kumar – Macquarie

Got it. And how much do you think pricing will be up at 6-1 or 7-1? Maybe you can compare to 2011 or maybe talk about rate online. How much do you think the delta would be going forward?

Mike McGuire

I'll focus kind of specifically on Florida, first. I think Florida had sort of enormous base increases after KRW. You then had a number of small companies coming to the market that absolutely had to buy reinsurance. It was sort of a seller's market there. And you move forward to today, the buyers are become bigger. They are in some ways better equipped to retain risk than they have been before and they've gotten rate increase.

And so the balance of power is more balanced I would say now. So it's unreasonable thing of large pricing increases. That said, with the model changes and we call FHCF in a sense dropping out of the market, there's a need for more capacity than there has been sort of over the last few years. So I'd see 10%-ish plus rate increases there. It's a little bit hard to tell. You're really talking about there the single state writers. The national writers, they are less exposed FHCF they're more exposed to model changes. And I think those will drive rates there additionally.

The only other suitable, call it meaningful data point to focus on is that at 7-1, we get certain amount of Australasian business that renews. And there is some Australian business there and there is some mixed Australia and New Zealand business and I have no doubt that the market we're looking for more rate increases there. There have been a couple of significant seasons in those markets that have struggled to get their New Zealand numbers right. And it's hard for me to imagine the market won't be looking hard at pricing in that market. It's obviously not as big as Florida for a company like us but it's a meaningful. And it really puts us at a point we have almost had two solid years of price increases if we get those rate increases at 7.1.

Amit Kumar – Macquarie

Got it. Last question and I will hop off. In terms of – you were talking about the casualty book initially in your opening comments, and I'm curious, if you exclude the agriculture and property segment from your insurance segment, what sort of earned ROEs are you expecting on the book. Or may be you can – another way to look at it is, what's sort of the delta between pricing or earned pricing versus lost cost?

Mike McGuire

I'll take a stab at that. For us, it's a mixed collection of businesses there.

Amit Kumar – Macquarie

Yeah.

Mike McGuire

So we have some high attaching Fortune 1,000 business there and then we have some U.S. access and surplus lines business. And in this environment – well, historically those books have generated very attractive loss ratios and particularly the large risk business which we started writing very early on have generated for us very high returns on equities, sort of 20-ish percent returns on equity.

These days the market we're in right now, I still see the Fortune 1,000 business as producing 10% returns on equity, tends to be a little bit shorter tail against claims made. And there is sort of a capacity or kind of volatility charge you're able to extract there that's still reasonable, it's been a market that's shown a lot of margin compression, there is still real margin there.

In the U.S. access and surplus lines business, I think all the players in that market know we're sort of at bottom right now. And I think people that show strong returns in that market are really showing strong loss reserve releases in that marketplace. Since I would have to say, it's single-digit returns there and in some places it could be low single-digit returns for that casualty business.

It's something that I think particularly the companies have right sort of concentrated casualty books sort of known for a while, that margins have really compressed in that space. And that's where I think the impetus has come for increases in pricing.

It will take a while to catch lost trend and it will take a while to go beyond that to record strong margins again but there is a collective recognition of that and that's why you are seeing companies reengineer business in ways we've reflected that in our reengineer to primarily casualty book-of-business. But we're not alone in doing those reengineerings and those are certain necessary steps that have to be taken to move the market forward.

Amit Kumar – Macquarie

Okay, thanks. Thanks for all the color.

David Cash

You're welcome.

Mike McGuire

Thanks, Amit.

Operator

And moving on, we have a question from Matt Rohrmann with KBW.

Matt Rohrmann – KBW

Guys, good morning. Just wanted to follow up on one point, touched on little bit earlier. Obviously, pricing for cotton has been less favorable but been a bit better than soy. Just curious to see what your thoughts would be around shifting the business around there or take advantage of that?

David Cash

I think in terms of sort of where we see opportunity a little bit, we underwrite with – it's a geographic and a distribution model that we pursue. And so our goal is to be sort of successful and relevant to agents in different states.

And essentially, we are dominant in a state likes Texas. We have -- even this year, we saw that grow because we did a better job we got on claims handling than others. But our exposure to cotton comes from being in Texas and successful in Texas.

What we sort of acknowledge is that and a priority for us is continuing our success growing in the Midwestern states. And when you move to Midwestern states, you end up being much more exposed to cotton and soybean. And then in some ways you're in the hands of the farmers if they make their decisions to whether they're going to plant a cotton crop, and then a corn crop, or soybean crop.

And so, we don't tend to think about our distribution model as being sort of influenced by crop. It's more about trying to get to states that we're not in. When you are in the states, the sort of crop you take is – the crop you get is the crop you get in some ways.

What we are doing now is we have been steadily adding claims staff in the Midwest, and that really is – that and we'll call it good technology to kind of prime sort of tools we're getting access to that business. I think the only kind of I'll call it additional sort of crop wrinkle to offer is that in some of the areas like corn, we have seen some price adjustments by the RMA.

And what that's tended to do is reduce some of the pricing in the Midwest for something like a corn crop and in places modestly improve the pricing in a place like Texas. And so, those are the trends that are out there. The biggest thing we're focused on really is getting distribution model right, and then managing weather in Texas this year right. Those are the biggies. So I realize those sort of comment your answer somewhat obliquely, but hopefully that's helpful.

Mike McGuire

Matt, I would just add that not to confuse the commodity price change with underlying rate change for the risk. As the commodity prices go up and down, which is what I refer to in my prepared remarks, the exposure base goes up and down as well. So although we did see a pretty significant reduction in commodity prices, that would have been matched by a significant reduction in exposures to cotton. So the underlying margin with respect to that premium is unchanged.

Matt Rohrmann – KBW

Got you. Great. Thank you very much, guys.

Mike McGuire

Thanks, Matt.

David Cash

I think Mike did a better job than I did on that.

Operator

(Operator Instructions). Now we will go to Ian Gutterman with Adage Capital.

Ian Gutterman – Adage Capital

Hi, guys. Just had some other quick questions for you. First, David, I think there was – this might be early days, but there were something I think in the news last week about, in the budget talks cutting back foreign subsidies, but one of the counters to that being to actually expand crop insurance to more products to help farmers out. I assume that's tough in an election year, but is that something that you are optimistic in the next couple of years we actually may see an expansion of this market?

David Cash

Certainly, if you look at history, this is a program that's being successively expanded over time. And we now virtually cover something like 60 crops and very kind of minor crops, but there has clearly been the political will we see the program expanded.

There are a few different data points coming out of Washington. And it's always I wouldn't describe it myself as an expert in the politics of agriculture, but the Congressional Budget Office did a review of some of the initial budget proposals to see what their cost revenue impact was or their financial impact was on the budget.

It was very clear from that analysis that there was a focus on reducing direct subsidies to farmers, essentially payments made to farmers for just turning up and growing the crop and an increase in the amount dedicated towards crop insurance. And it looks like it was on the edge of a $0.5 billion to $1 billion a year of increase in money allocated to crop insurance.

And so, it's very clear in Congress there is the political will to see the crop insurance program expanded. When you put the overlay of sort of deficits on it, you have to be a little cautious about where you get to. But I think the RMA in general wants to see the program expanded. They are sort of the federal body that oversees it. Congress would like to see it expanded. The financial reality is something has got to give and it looks so far like direct subsidies points they're going to give. So I have some optimism I would say.

Ian Gutterman – Adage Capital

Okay. So, I mean, I know the past few years there has been this pressure where the RMA is trying to squeeze profitability out of the business, but I seem it's hard for them to keep doing that if they want to expand the business at the same time and have underwriters be willing to show up. Does that make you a little bit more optimistic…?

David Cash

Yes, absolutely.

Ian Gutterman – Adage Capital

Yes. Okay.

David Cash

Okay. Go ahead.

Ian Gutterman – Adage Capital

You go ahead. I finished my point so go ahead.

David Cash

Okay. No, I mean, the political will is, as I said, it has to be tempered by the deficits. But when you look at both in the U.S. and frankly when you look outside the U.S., there we do expect over the next few years to be significant growth in crop insurance and for that matter crop reinsurance opportunities. And so, I would see it's continuing our sort of [RAMtech] model in the U.S., but we are looking very aggressively now at agricultural reinsurance operation in Zurich.

And we think there is a trend towards growing use of agriculture insurance in Europe. There is certainly in Latin America and increasingly in Asia. And so over medium term period of time, I would see crop continuing to get become a larger part of our company with sort of growing geographic diversity there. And I think in many ways the political winds are aligning both inside the U.S. and outside the U.S.

Ian Gutterman – Adage Capital

Okay, great. Thank you. Next one on crop. In the Midwest, just curious a little bit more on growing conditions, I mean I know so far things look good. But I guess my one concern would be, we had a very warm winter, not a lot of precipitation. I know it's not drought like Texas, but is there more risk that, that's just ground is drier than normal when planting occurred and maybe that makes a narrow winter for the harvest if weather isn't perfect?

David Cash

It's clear there was enough water on the ground and sort of strong enough kind of solar conditions that people could plant quickly. So getting the crop in the ground early, I think does matter. I think it's a good thing. And if you look back this time last year, we were dealing with lot of preventative planting claims and we were moving towards flood conditions. There are meaningful part of the loss sort of cost associated with Midwest. It looks like we're going to avoid those totally.

When we get to the backend of the year, we'll be kind of wrestling the two things, did you just get enough rain over the course of the year to get crop from planting to maturity and commodity prices do any kind of weird things at the end of this year.

And taking the second one first, it has felt to me that 2008 was an aberration where we have this sort of substantial run up in commodity prices and sort of enormous drop off in the second half of 2008. And while I'm not sort of underestimating the potential volatility in price, I just don't think we're in a year like 2008 this year. And so then it comes down, are we going to be able to get the crop out of the ground? And the medium term forecast for the Midwest show is sort of being about level.

So I think we're going to have a fine crop in the Midwest. And looking then specifically at Texas, within a given state, we're allowed to assign as much as 75% of our risks to the assigned risk and that's the maximum. And you can keep 25% of your risks. And last year we roughly seeded about 61% of our risk to this high risk fund. It was clear, the right answer it just seeds, 75% last year. This year we're going to seed 75% of our risk and the challenge then for us is, can we find 25% of our risks that are good in Texas?

And the reality is the eastern side of Texas looks pretty good and the coastal areas of Texas look pretty good. And actually over the last few weeks we had rain. And so there will be a drought monitor released later today. And I suspect it will show improvement, certainly significant improvement over last year. So I am feeling pretty sanguine about Texas as well and just looking outside the Midwest.

Ian Gutterman – Adage Capital

Okay. And just last one on a lot of your peers who have reported so far have actually shown declines in their crop volume year-over-year. And it seems that the prices overwhelmed their ability to pick up unit and it seems you've done a much better job of picking up unit. I think you talked a little bit about Texas. Can you talk about sort of the success in picking up [tiff] in the Midwest and without naming names I guess to sort of where that came from and why you were able to do that so well when others haven't been able to, right?

David Cash

The year-over-year, roughly last year we were at about 145,000 policies, maybe a spec less. We're going to be about a 155,000 policies this year in the order of about 11% policy count growth. There is some growth in Texas but actually more of the growth came in the Midwest. And so I think we are probably above sort of 11.5% in the Midwest and we are successful in a number of places. There were one or two significant agents this year that wanted to move and some of that which we call it just dissatisfied with their carriers.

And it's hard for me to get in the minds of the agents but at the end of the day they felt it was time for change. So it’s pretty significant decision to make. One agent who particular had been with the carrier for 20 years. And there are a couple of things that we did for them that seemed to be, sort of, pivotal in their decision. Their own commission levels have been squashed pretty significantly and what we were able to do for them was – we had a strong processing hub in Lubbock Texas. And in many ways, we our model is to do a bit more work for the agents than perhaps then in some other places.

Because we’re doing it, sort of, electronically, that can be good for them, it sort of, got electronic files they have files access to. We do a lot of the kind of hard work with Washington. It allows them to shed a bit of staff in their agent's office. So its helps them on the margin side. That’s one thing we do for them.

The other thing that happened this year is the RMA changed some of the product and some of the trend calculations that are done to establish price and coverage levels. And in turn that was just a tricky thing for agents to communicate to their farmers. And we did a lot of work developing – we'll call it field apps because they are used by agents with their farmers to help them understand the impact of those changes and help them make decisions on how they ceded.

And we actually we found ourselves towards February seeing some agents that had split their book, had some of their book with us, some of their book with another carrier, starting to move the balance of the book over to us. And the reason seemed to be in part that we were able to help them just in the process and the interactions around sales to the farmer, whatever communicating with the farmer.

So, I wasn't there in person. I didn't experience it firsthand but those are the two items that seem to allowing us to differentiate right now. And this year is probably a little bit of an unusual year and we so had a pickup above historic trend, but it actually now puts us own the policy count trend line for the last six years. We were really strong until 2010. 2011 we saw one significant agent bought by a competitor. We saw policy count reduction. This year we had a big step forward. You can't sort of extrapolate to infinity. But I am feeling very good about our model and ability to garner market share in this market. Looking at the – the context is, policy count overall for the industry is being about 2 million policies, flattish for the last 10 years. So when we grow, we're taking market share.

Ian Gutterman – Adage Capital

Got it. Great. Very, very thorough answer. Thank you, David.

David Cash

You're welcome.

Operator

And with no further questions in the queue at this time. I would now like to turn the call back over to Mr. David Cash for any additional or closing remarks.

David Cash

Thank you. Thank you for joining our call today. During the second quarter, Mike will be presenting the JMP conference in San Francisco and also meeting investors at the Goldman conference in New York in a few weeks. We hope to see all of these events. And with that operator, thank you and this concludes our call.

Operator

And again, that does conclude today's conference. We do thank you for participating today.

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