HCC Insurance Holdings Q4 2007 Earnings Call Transcript

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 |  About: HCC Insurance Holdings, Inc. (HCC)
by: SA Transcripts

HCC Insurance Holdings Inc. (NYSE:HCC)

Q4 2007 Earnings Call

February 20, 2008 9:00 an ET

Executives

Frank Bramanti - CEO and Executive Director

John Molbeck - President and COO

Edward Ellis - CFO

Craig Kelbel - EVP of Life, Accident and Health Operations

Mike Schell - EVP of Property Casualty Insurance Company Operations

Analysts

Beth Malone - KeyBanc

Doug Mewhirter - Ferris, Baker Watts

Chris Neczypor - Goldman Sachs

Dan Johnson - Citadel Investments

Josh Shanker - Citi

Kenneth Billingsley - Signal Hill

Kyle Cavanaugh - Palisade Capital

David Lewis - Raymond James

Howard Flinker - Flinker and Company

Operator

Good morning. My name is Chasity, and I will be your conference operator today. At this time, I would like to welcome everyone to the HCC fourth quarter earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks there will be a question-and-answer session (Operator Instructions)

This telephone conference call relates to HCC Insurance Holdings Inc. Before we begin, the Company has requested that I read the following statement, which will govern the telephone conference today. Statements made in this telephone conference that are not historical facts, including statements of our expectations of future events or future financial performance or forward-looking statements made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements involve inherent risks and uncertainties, and we caution investors that a number of factors could cause our actual results to differ materially from those contained in any such forward-looking statements. These statements and other risks and uncertainties are described in detail from time-to-time, in our filings in with the Securities and Exchange Commission. This conference call and the contents thereof, and any recordings, broadcast, or publications thereof by HCC Insurance Holdings Inc., are the sole property of HCC Insurance Holdings Inc. and may not be recorded, rebroadcast or published in whole or in part without the expressed written consent of HCC Insurance Holdings Inc.

Please stand by for Frank Bramanti, CEO of HCC Insurance Holdings to begin the conference. Mr. Bramanti, you may begin.

Frank Bramanti

Thank you, Operator. Good morning, ladies and gentlemen. Thank you for joining us on HCC's fourth quarter and full year 2007 earnings conference call. In Houston, with me today is John Molbeck, President and Chief Operating Officer; Ed Ellis, our CFO; and we have Craig Kelbel, EVP of our Life, Accident and Health Operations; Mike Schell, EVP of our Property Casualty Insurance Company Operations; our General Counsel; and our VP of Investor Relations. So we've got the full crew here.

The format today will be similar to what we've done in the past. I'll make some initial remarks then I am going to turn it over to John Molbeck to go through operations and some detail, and then we'll have Ed Ellis to make some comments regarding our investment portfolio. In addition, Ed is going to cover a couple of questions that some of you have already asked regarding investment income and capital gains that were reported during the fourth quarter.

2007 was another record year for HCC. GWP was just under $2.5 billion, up 10%; net written premium was just under $2 billion, again, up 10%; net earned premium, very similar to net written, just under $2 billion, up 16% over 2006; and revenue was $2.4 billion, up 15%.

Net earnings for the year totaled $395.4 million, up16% with EPS of $3.38, up 15% from 2006. Our cash flow for the first time top $700 million and came in at $726.4 million. We had a GAAP combined ratio of 83.4%, again, a pretty solid year in an environment that deteriorated certainly during the second half of the year.

Our total investment portfolio was just under $4.7 billion that was up 19% over 2006. Total assets top $8 billion. Our shareholders equity is currently at $2.4 billion, up 19.5% over 2006 and book value per share was $21.21, up 16%.

Our debt-to-cap ratio during the year continued to fall and finish the year at 11.7%, I think pretty widely accepted as a relatively low debt-to-cap ratio and we have some room to put on additional debt should we need to fund growth in the future. A return on equity for the year was 19.4%. We feel like we finished 2007 in great shape. We had very, very solid results and a pretty well position going into 2008, even in the tough environment that we have.

We resolved all private litigation against the Company relating to our options issue. We've put out two press releases over the last six weeks or so, derivative actions have been settled, class action have been settled, and working their way through finalization in the Court system.

We are awaiting conclusion of the SEC investigation, which again last year we had hoped we were going to finish by the end of the year. We currently are hopeful that first quarter will see it behind us. We continue to believe that the Company will be reviewed by the SEC to have acted appropriately and have cooperated fully since the issue was self discovered and reported to the SEC. And, therefore, feel there should be no further actions against the Company. However, we await their final report which is again, hopefully, by the end of the first quarter.

With that I am going to turn it over to John Molbeck for discussions of our 2000 operations. John?

John Molbeck

Thanks, Frank. As Frank stated 2007 was another record year, in fact, it was our sixth consecutive year of record earnings. For the fourth quarter gross written premium was down 2%, net down 6% and earned 1% compared to the fourth quarter of 2006. By [account rest] for 2007 for the full year gross and net written premium increased 10% and net earned premium increased 16%.

The drivers of the '07 growth were the Allianz acquisition, organic growth in our surety and credit business as well as our Lloyd's business obviously in London. More importantly our 2007 loss ratio was 59.6% for 2007 compared to an actual of '06 of 59.2. The loss ratio for '07 excluding reserve releases was 61% versus '06, 58.6%. During the year 2007, we had $26 million worth of positive development and $7 million for the fourth quarter.

I believe that we will find that the current cycle peaked on a calendar year basis sometime in the second half of 2007. Rates will remain competitive in '08 with overall domestic premiums projected to decline by 5%. This might continue growth in our surety and credit line, stable pricing in our medical stop-loss, and positives signs in our international aviation portfolio. While margins remained excellent in our international book of business, our overall premiums are projected to decline approximately 10%.

As you will find in the press releases and as Frank has referred to we provided guidance, and with respect to net written premium for 2008, we estimate that to be about approximately $2 billions. Based on the condition of the market as we see it now, if we do the math, our existing book of business we generated approximately $1.85 billion in premium. This is net of the MNU acquisition as well as a non-renewal of the Argonaut Colony treaty.

However, during 2007 we undertook a thorough review of our reinsurance program and we looked at our reinsurances on an enterprise basis. We purchased reinsurance based on our -- for lawsuit and acquisition. We bought a company and we pretty much led the overall reinsurance program to stay in place.

We received very comprehensive input from Aeon, Benfield, Guy Carpenter and Towers, and provided them with all of the information concerning our entire portfolio. And their conclusions were consistent. Number one, our portfolio of business is highly non-correlated. Number two, a loss of one quarter's earnings as a result of a single event was less than one in a hundred. Number three, we do see the premium in excess of a $100 million. And number four, we could retain the additional premium without increasing volatility.

And this is the reason we're projecting $2 billion worth of net premium income, as we are confident that we can write more of the business that HCC controls in our own insurance companies and retain more of that premium without increasing volatility or loss ratio. This will allow us to continue to control our reinsurance recoverables, which as of year end are down to $957 million and now represent only 37% of shareholder's equity, where at the end of 2006, they represented 57% of shareholder's equity and in addition, it will allow us to improve our cash flow.

With those comments, I'd like to turn it over to Ed to talk about investments.

Edward Ellis

Thanks, John. First, I would like to review there are a couple of items in our entire income statement for the fourth quarter and obviously the year too that we wanted to review. These items are related -- that reported different lines in the income statement. However, they are in the same amounts [and they offset]. They are doing that to net effect on net income on a net basis.

First, there is a realized investment gain of $13.4 million related to foreign denominated available for sale of securities, that we use to hedge foreign denominated liabilities. This gain represents the cumulative embedded foreign currency gain with respect to those securities that accumulate over the time that we held the securities.

There is a related charge of the same amount in other operating expense to correct the accounting for the unrealized foreign currency gains and losses with respect to available for sale securities the gain or the charge represents the cumulative unrealized gains with respect to these securities.

And during the quarter, we determined that GAAP required the unrealized foreign currency gains and losses with respect to available for sale of fixed income securities to be recorded through other components of income and stockholders equity rather than through other operating expense where we have our foreign currency gains and losses and as an offset to the opposite fluctuations and the liabilities of these securities hedged.

The unrealized gains become realized when the securities are sold and at that time GAAP requires the realized foreign currency gains to go through realized investment gains. So during the quarter, we also sold these securities to realize this embedded gain. And so that would offset the charge in the income statement as it was originally intended with the hedge.

In the future, we're going to hedge our foreign currency. Foreign currency denominated liabilities with financial instruments that allow for the foreign currency fluctuations on those financial instruments to go through the income statement and foreign currency gains and losses to offset the opposite fluctuations in the hedge securities.

So bottomline, the items are offset. There is no net effect on earnings and we will continue to hedge the foreign currency liabilities. As far as investments are concerned, we didn't have any impairment losses on HCC's portfolio for the fourth quarter or for the year. We don't believe our exposure to the credit market turmoil and subprime is significant at all. And I think this reflects the conservativeness of our investment policies and astuteness of our outside investment mangers who have kept us at an arm's length.

We put a schedule in the earnings release related to some of the exposures or questions we had on exposures related to subprime and the credit turmoil. Let me just hit a couple of high spots on it. The non-agency residential backed securities, the subprime and the Alt-A are roughly $18 million at December 31st. And we collected approximately $1.6 million on these securities during the quarter. They are all -- both of them are highly rated securities.

Our commercial backed securities are not a big percentage of our investment portfolio the average loan-to-value on these commercial mortgage backed securities is roughly 60% and they are invested in areas that there is a not a higher risk of default. The insurance-enhanced Municipal Bonds at market value are roughly $1.2 billion of our $1.8 billion Municipal Bond PORTFOLIO. And our investment advisors underwrite these securities for purchase not taking the insurance and the consideration of the insurance is really an additional safety feature. But we're not relying on that for the safety of the securities and the collectibility of securities.

So we've shown the insured securities, what the underlying ratings are on the insured securities without the insurance rep and then we'll also show the rating on the non-insured portion of Municipal Bond Portfolio.

We gave the short-term investments that we have to show that, basically these are very short-term money market funds or short-term US government bonds. There is not a lot of -- there is no risk, we don't think in a short-term portfolio and there are no action's [right] certificate in that portfolio. The corporate bond portfolio is good. We don't expect any collectibility problems in the corporate bond portfolio.

The unrealized gain in our securities at the end of the year was $25 million, that went to $72 million at the end of January as the interest rates fluctuated and [if notice is that] the gross losses, those are the securities that are in a loss position only, is only $18 million in the portfolio of December 31st.

In investment income, we had a good investment income quarter. It is higher than the 9/30/07 quarter, and that relates generally to -- principally to the alternative investments, which had a good quarter and a catch up adjustment we had on with respect to one alternative investment on some income related to that investment.

With that, I'll turn it back to Frank.

John Molbeck

Before that I just want to mention that in our press release, we've given you a page of disclosure with respect to our subprime liability exposure DNO and ENO. And I'd also like to say that as people look at subprime and they look back to the prior year, for some reason they have it in their mind that they should take whatever loss you have to subprime and added it to the loss ratio that you had in the previous calendar year.

But if you look DNO losses, for example, in 2006, the big event was stock options backdated. If you look at 2004 and 2005, we had contingent commissions and bid-riggings. In 2002 and 2003, we had mutual funds and market timing. So as you look at the DNO business, subprime is just another event that causes DNO losses, but it's not necessarily an event that should be added to the previous loss ratio that come up with the results.

So with that, I will pass it back to Frank.

Frank Bramanti

Thanks, John. Just a couple closing remarks to reiterate some of Ed's comments. We believe our investment portfolio is conservatively managed by professionals that are focused in the insurance industry and they have done a tremendous job of implementing our investment policy and as Ed said keeping us out of trouble.

We've been watching short-term assets in the junk that's included in some of these funds really are yearend so we've been on top of making sure that we don't have any mass creep through there. So you can see that we turned over the easy technical issues to add the cover but the point of the whole issue is that, we tried to hedge our foreign currency assets and liabilities so that we -- so we net amount of our income statement.

And when it was discovered that the hedge, while it might be a clean dollar hedge, so that it was fully hedged but part was running through the income statement, part was running through the balance sheet. So it gave an inaccurate position from an earnings standpoint of our hedge and so we unwound it. You really have to put both sides together, so either it got excluded the hit that's in the other operating expenses or we've got to include both of those items and run them through the income statement and take the results as they are. We think our $0.85 in earnings were true earnings for the quarter.

And then going forward and Ed said that this is important that we will continue to hedge our exposure completely. We will just do it in a manner that allows the accounting take it through the same line in our income statement. And that's the other operating expenses.

And then just one final point on what John said on subprime liability exposure. Based upon our current knowledge, the Company continues to believe that the entire impact of subprime will be contained within the law sticks that we set. We took $6 million or $7 million increase in reserve during '07, just to be ultra conservative on our "Do you know when you know" law sticks, but we are very comfortable that it's contained within the reserves that we will be setting over the course of the earnings of our "Do you know when you know" portfolios.

And then John made reference to this, included in our release it was guidance for 2008 and our guidance is EPS of $2.90 to $3.20 for the full year. At the midpoint, that we were to produce a return on beginning equity of 15%, which is our target return over the entire insurance cycle. Last year, 2007 was over 19% year before it was 20%, our guidance points towards 15% returns.

We don't and have not included any potential reserve development changes in our guidance for either 2007 and 2008 and the actual difference between 2007 results and our 2007 guidance was basically the reserve releases that occurred during the course of the year.

With that, operator, I'm going to turn it over to you and open it up for questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) Your first question comes from the line of Beth Malone with KeyBanc.

Beth Malone - KeyBanc

I just want to get some clarification on the guidance. You provided a range of $2.90 to $3.20, but you have a combined ratio of 85 and the top line is targeted as a certain amount. And I am just trying to understand how do you reconcile the fact it got a range with specific combined ratio and specific topline. What is the variable that's going to range between the $2.90 to $3.20?

Frank Bramanti

Well, again, we've given numbers as guidance. Those are in absolutes. We are in a declining rate environment, as John described. We think some of our businesses are a little more protected for one reason and another. But there are certainly potential fluctuations on the top line, and there are potential fluctuations in the loss ratios on their business, although we think our loss picks are fairly conservatively stated.

You can get a pretty good feel for an insurance company's book of business at the beginning of the year for the next 12 months out, but to pinpoint the number is pretty tough. In a declining environment, we've added a little more range to our guidance this year. In a declining rate environment, you're just not as comfortable as you are in a rising rate environment that you're going to be able to come in at or above the number.

So I think we're just -- I don't want people to read into this that we're sandbagging it. We think our numbers are conservative, and we said a set guidance that we've got to more to achieve and we think these numbers are achievable. And that's why we came out with the numbers. But I think every number potentially that's got some range to it is that that can fluctuate actual.

Beth Malone - KeyBanc

And I know you talked about pricing competition in the market. We also have heard that the niche or specialty nature, and hard to place nature of HCC's business tends to be a little bit more insulated, as you mentioned. So has the pricing environment at your end changed materially from the beginning of last year when you gave guidance for last year, which proved to be conservative to what you're seeing today, that would cause you to expect a meaningful decline from 2007 and 2008 in earnings?

Frank Bramanti

Well, there are a lot of things were involved in earnings including interest rates, which has had a meaningful impact in projections. We have said and we continue to say if we had a 5% reduction in our overall premium base in 2007 and we have a further 5% reduction in 2008, then it just would lead one to believe that the numbers are going to be 5% less. So it's not any more complicated than that.

When we look at our overall book of business domestically, we're looking at 2008 about an average premium reduction of 5% and internationally about 10%. We run all those numbers together and we come up with a range and that's the range that we've provided. We don't think the environment is materially different in 2008, as it was in the fourth quarter but the fourth quarter was materially different from the prior three quarters of 2007.

Beth Malone - KeyBanc

Okay. Thank you.

Operator

Your next question comes from Doug Mewhirter with Ferris, Baker Watts.

Doug Mewhirter - Ferris, Baker Watts

Hi. Good morning. A couple of questions. First of all, I know you also like the surety business and I was wondering if you are concerned at all about the distress in the construction industry and where there might be a lot of subcontractors who would, I guess walk away from business because of financial distress or et cetera. But do you think that is having an impact on the loss picture on the surety market?

Ed Ellis

Well, if we break it down into two pieces, the domestic book and in international book of business, our domestic book is very little construction oriented. It's fully here in the book. We don't really write big contract. We might have limits of 6 to 12, 10 to 15 and they are pretty much [drive well] contractors, looping contractors people like that.

With respect to our international book of business, we write larger bonds. We write a few contractors in Europe, predominantly in the UK and Spain. We're watching it very closely and we continue to watch it very closely. And so far we haven't seen any negative fallouts from foreign exposure and the clients.

Doug Mewhirter - Ferris, Baker Watts

Okay. Thanks for that answer. My second question is another expense-related question. I noticed your acquisition expenses as a percentage of yearend premium seemed a little higher than your run rate, it was about -- I think it was about 19.5%, if I am not mistaken. Is that just more of the function of your business mix shifting to higher commissioned-type business? Were there any other items in one-time items or true-ups embedded in that number for this quarter?

Ed Ellis

No. It's really a business a mix issue. Generally, on the acquisition costs percentage.

Doug Mewhirter - Ferris, Baker Watts

Okay. And my last question, it looks like you had about $11 million charge in your discontinued lines. Did you do a commutation in the quarter?

Ed Ellis

No. We have a book of run-off medical malpractice business in our Spanish Insurance subsidiary. And we noticed some development on that when we did our actual review in the fourth quarter. So, we increased those reserves to what we believe is a conservative level to make sure that there wasn't any new development off that book of business as it ran off.

Frank Bramanti

And that business was acquired. We bought a Spanish Insurance company from St. Paul that had written medial malpractice. It was discontinued at the point that we acquired the company and we've been watching those reserves very carefully. We think they think they've peaked. And we're running them off. We just wanted to kind of get ahead of the curve on that and we think we've got.

Doug Mewhirter - Ferris, Baker Watts

Okay. Thanks. That's all are my questions.

Frank Bramanti

Thank you.

Operator

Your next question comes from Chris Neczypor with Goldman Sachs.

Chris Neczypor - Goldman Sachs

Hi. Good morning. One of your specialty line peers made the comment that competition in certain areas of the market was partly being driven by some Bermuda companies looking for share. I was hoping you could comment on what you're seeing in this regard and maybe where you see the most pressure coming from in your US specialty books?

Frank Bramanti

I think in 2006, there was a lot of pressure put on specialty lines from Bermuda and Lloyd's Syndicates coming into Bermuda and into United States, chasing premium in 2006. I don't think it was as much of an impact in 2007. Having said that, just about every Bermuda Company has announced that they are going to come into United States and get into the specialty business, but we haven't actually seen there is any significant competition coming at this point in time.

Chris Neczypor - Goldman Sachs

Okay. That's helpful. Thank you. And then, could you also talk a bit about how the Allianz book looks relative to your expectations now that you've presumably completed the majority of the re-underwriting of that book?

Frank Bramanti

Yeah. We'll have Craig Kelbel to address that.

Craig Kelbel

Well, I think it's performing as expected. So we have underwritten it. But I think we spoke last quarter. The one last block of it that really didn't get re-underwritten was the January business because when we did the acquisition, it was late in '06. That's now being re-underwritten January of '08, so it's performing pretty much right on budget and as expected.

Chris Neczypor - Goldman Sachs

Okay. And then, given that looks like 60% to 65% of your muni-bond portfolio has enhancement. I understand the point you're making about looking at the underlying credit, et cetera. But simply from a market-value perspective, could you let us know what you're seeing in terms of a decline in valuation, whether it's temporary or whatever it is. Simply given what's going on with the guarantors, you should be in a pretty unique perspective to give some commentary on what you're seeing in terms of the valuation of these securities?

Frank Bramanti

Well, to respond and not answer, one thing that Chris I think is important about our portfolio is that the insured portfolio and the non-insured portfolio. If you look at the underlying ratings ignoring the insurance rep, they are basically the same kind of portfolio, the same relative spread of rating, and the same overall rating at AA. And we don't expect a material impact if all the insured rating disappeared overnight. Now obviously that's not going to happen. I haven't seen the numbers. Ed, have you seen what's happened to of very late. I haven't seen that market-value impact.

Ed Ellis

I have not seen the market-value impact either. Of course there haven't been a lot of negative fluctuations.

Chris Neczypor - Goldman Sachs

Okay.

Ed Ellis

We haven't seen it.

Frank Bramanti

We'll look at that and you know it's really a current kind of thing. So certainly we'll give color on that next quarter as we keep going through, but we haven't seen anything material come through, and we don't anticipate anything material. It was really the underwriting the securities as they were written ignoring the insurance that kind of protected the portfolio and kept fairly consistency between the insured and non-insured portfolio.

Chris Neczypor - Goldman Sachs

Understood. And then just one last one, just to be clear, and maybe I missed this, but just so I understand. The offsetting effects of the hedging position you mentioned basically if there was $13.4 in the realized gains, but then there was $13.4 gain in the other expenses. Is that correct?

Frank Bramanti

Correct $13.4 gain in investment gains, realized investment gains and $13.4 million of expense in other operating expense.

Chris Neczypor - Goldman Sachs

Okay. Great. Thanks, guys.

Frank Bramanti

Okay. Thank you.

Operator

Your next question comes from Dan Johnson with Citadel Investments.

Dan Johnson - Citadel Investments

Great. Thanks, and good morning. Another question if we could on the Allianz acquisition, maybe even more broadly on that stop-loss market in general. Can we talk a little bit about what you see going on there in terms of pricing competition, loss activity anything in that regard would be helpful? Thank you.

Frank Bramanti

Again, on the Allianz lines of business in total they've performed according to what we expected. So we haven't seen really anything unusual.

Dan Johnson - Citadel Investments

So let's talk maybe more about the broader, the whole book would be?

Frank Bramanti

The whole book I think at this point, as John stated in his comment as we identified our book of business is relatively stable in the current environment. It's still competitive, but stable. We have made on our January '08 which is considerable portion of our block renewals, we're very pleased with the result. It's very much on budget and we don't see anything unusual continuing. We think the block of business is performing at a pretty flat basis. From a loss ratios standpoint, it's been pretty consistent really for the last two years.

Dan Johnson - Citadel Investments

Thank you very much.

Frank Bramanti

Okay.

Operator

Your next question comes from Josh Shanker with Citi.

Josh Shanker - Citi

I'll let you to run through a few lines of business. The first thing is foreign aviation. Everyone hates aviation on this conference call. This is not your [point] in particular, but given the characteristics of who's is writing all this aviation, which is driving you away from that market, if you could describe those participants?

Frank Bramanti

Remember, our aviation book is especially aviation book. And the aviation book that people hate include the airlines, aircraft products and alike. We write a very special book of business. There are a few more voyage competitors in the business. The international competitors are the same players of the voyage which have been there, and they will continue to be there year-in and year-out.

We have had a consistent loss ratio in the overall book of business over the past five years. And the only thing that fluctuates is our premium income, and as we have stated many times in the company, we focus on the loss ratio. If the premium -- income has to go down to achieve a loss ratio, then that's what we're going to do and that's what we'll continue to do.

We find aviation business, the only major line of business that we have from 1997 to 2008 that we still continue to write on the same basis as aviation and we're very happy with it.

Josh Shanker - Citigroup

How does that drive with the declining premium from this quarter?

Frank Bramanti

We wrote the last international aviation business, because it continues to be extremely competitive. And if you look at the losses, in 2007, the industry published statistics where there was $1.5 billion in premium and $1.8 billion in losses in 2007. And then you look at January, and in January you had, I guess, was it British Airways, Mike?

Mike Schell

Yeah.

Frank Bramanti

The British Airways loss on top of that. So there is move in the marketplace, we have seen at least on the international side and not on the flag carriers, but on the rest of the worldwide aviation business we've actually seen prices begin to firm up. And we think some time in '08, we might actually see price increases on the international aviation business.

The domestic aviation business remains competitive. We are a leader in that business, the kind of business that we do right, and we've seen rates go down about 5% in 2007. And they may go down as much as 5% in 2008. But then, again, they maybe pretty flat. So, it's also early to tell, but the initial signs are promising.

Mike Schell

Josh, one thing I would add on the aviation is that when rates get to the level, they currently are on the international side, and we tend to walk away from significant business. So, that's the reduction that you see and that's the reason why our loss ratios have held up. They are not accepting the rates. They are just walking the rate. And so we have got good quality business that we are on, and we walk away from that stuff. It is ultra competitive. So, our volume has been reducing over the last couple of years.

I think it was six international losses last year, of substance. We wrote four of the six in previous years and this year, of the six we wrote one. That's just testament to what Frank said we tend to just non-renew the business as the price gets too up.

Josh Shanker - Citigroup

In terms of your London market business, your marine property, we're not given the fall from premium there, where do you see yourself as a participant in that market in 2008?

Frank Bramanti

Well, on the marine and energy book, and predominately energy book, we remain a leader in that book of business. Mike Onslow is our overall underwriter and [Simon Button] does the day-to-day underwriting. We write typically lines in the 5% to 10% area, and that makes us a leader in that business.

On the property side, we follow though. We write the business that we want to write. We typically write excess to the BI deductible. When you look at the overall book of business, we find that the results and the margins are very, very satisfactory, as I mentioned earlier, but we're facing 15% price reductions.

Josh Shanker - Citigroup

And finally, following up on Dan Johnson's question with the medical stop-loss business, slight premium declines in the first quarter where the Allianz acquisition is compared with the prior quarter's, are you reading out some of the small pieces of business that aren't necessarily what you're looking for?

Ed Ellis

I think you've seen the premium decline and really related to us re-underwriting the Allianz book, and keeping what we want for the full year. So initially when we wrote it, it was all in force. As the 12 months evolve, we've renewed what we wanted to, and as a result the overall premium will have a little bit of a decline. Our organic book of business actually had a little bit of growth, but the Allianz business, clearly there is less [audit] than they are used to be because some of it didn't fit into our underwriting box.

Josh Shanker - Citigroup

Okay. I appreciate the disclosure. Thank you.

Operator

Your next question comes from Kenneth Billingsley with Signal Hill.

Kenneth Billingsley - Signal Hill

Good morning. A few questions, on fee income in general, you made comments initially that retentions are likely to increase in your business. Is that going to move some fee income out in 2008 that maybe we had initially expected as you would retain more business?

Frank Bramanti

We think that in 2007 we retained roughly 81% of the business. In 2008 we're talking about retaining roughly 83% of the book of business. And we think our commission income is going to be flat, and this is our projection looking at 2008.

Kenneth Billingsley - Signal Hill

So you expect regarding fee and commission, for them to be flat compared to '07 at around 140?

Frank Bramanti

Well, there was a couple of dynamics going on. One is retentions, the other is that one of the things that impacted the exceeding commissions which we got from quarter shares, and while we don't give out complete details about what reinsurance programs we have, we got slightly last quarter's sharing some instances. So it's likely that this line will come down a little bit during the year, and then we will supplement it by acquisitions that we may make in that line of business.

John Molbeck

And the other thing that we haven't projected in our numbers, are commissions are made up of multiple things, one of them is profit commissions and because we had reserve releases in 2007, we picked up some profit commissions that we didn't budget and same thing could happen in 2008. But we don't plan reserve releases because if we knew they were reserve releases, we would have booked it in 2007. But if that happens then our commission income will increase accordingly.

Kenneth Billingsley - Signal Hill

Very good. And following up on some of the ANH business, from an infrastructure, do you have the ability in the people and the capacity to do quite a bit more business with some recent acquisitions, would that be fair to say?

Frank Bramanti

I think we can clearly say that our systems don't have any capacity limitation. So I think that's why the Allianz deal made perfect sense to us. We could take the book of business and not appreciably affect our expenses to run that book. So our systems have really no limitations. The way they are put together we could double the size. It would obviously be a few more people, but it wouldn't be related to our systems.

Kenneth Billingsley - Signal Hill

And on the people-side, would you say that the infrastructure is in place to be more…

Frank Bramanti

Clearly, we can grow our block of business with the current executive staff that we have. It would be more of the staff that would manage the business day-to-day, which we've had no trouble in [finding] them to properly manage our business.

Kenneth Billingsley - Signal Hill

And with your comments saying that it's competitive but stable, do you see that with re-underwriting in 2008 some of the Allianz business? Do you see that continuing to decline in 2008, just as opportunities just on organic basis don't present themselves, or do you see acquisitions striving?

Frank Bramanti

Well, I think at this point, the Allianz book of business has been re-underwritten. So I don't think that the premium would decline in any further because it's meshed in with the rest of our block of business in the ANH division. So we would consider our premium to be relatively stable. And we would continue to say our market is stable but yet competitive, and if the right acquisition came along, we clearly would be interested in it.

Kenneth Billingsley - Signal Hill

And my final question is one I know that, you really don't like to answer too much, regarding the use of capital share buyback. Could you talk about expectations on the use of capital? I am assuming some of it is going to be opportunities for acquisitions, but you also mentioned using debt from the low ratio that you have there. Do you need as much capital as you have right now, considering that you are expecting flat top line in 2008 and you have the capacity to borrow potentially?

Ed Ellis

Well, we are at or around year-end. We've had our annual reviews with the rating agencies and we're waiting for them to come back on their views of our capital structure and the adequacy of it. If you just assume that we started out 2008 with just enough capital, then we're not going to employ any within our business, based upon our guidance in current projections.

So, whatever we earn this year will be excess capital and then maybe some excess capital at year-end, maybe $100 million. Again, we are having conversations with the rating agencies, literally on a daily basis, trying to get the models right and trying to get to the answers.

But what we believe and have said a number of times, is if we were to reinvest in our businesses, whether it be in internal growth; in acquisitions of teams of people that allow us to grow our top line over time; acquire businesses that are either complimentary; or add additional lines of business to our specialty mix, that is the best use of our capital which will generate the highest return for our shareholders. That is what we're out to do.

HCC has always kept a certain amount of permanent drive so that we can take advantage of the opportunities that come along that you really have to be prepared for and don't have a lot of lead time. Now, we said the same kind of things in 2007. We believe there was going to be opportunities for acquisitions. There were plenty of opportunities if you wanted to overpay and we choose not to. Those were the right decisions for the right reasons.

I think the environment is getting better. I think expectations are higher. Our seller's expectations are more aligned with reality and I think they're going to get more real as we get through this cycle. But if we can't deploy it, we will as we are doing on a regular basis, analyzing what are our returns would be if we give the money back to shareholders either through buybacks or dividends.

If we don't have an opportunity to invest it at higher returns, then we're going to invest it at the best returns that we can. We are properly forced to manage our capital account, so that we can generate the highest returns for our shareholders. And we are not going to sit around and do nothing, even if that's the right decision from an acquisition standpoint and let our capital build up and dilute our return on equity.

So we have shied away from the subject matter for two reasons. Number one, we've never been in a position where we had too much capital. Number two, all the people around this table recall the days where it was very difficult to get a sufficient amount of capital in order to fund our growing businesses, and so the mindset around here is grow, grow, grow, not shrink, shrink, shrink.

Now, we're in an environment where you can't grow topline. You have to be very careful about what you do on the acquisition-side. But we are in new [waters] for us, and we are going to be slow to react to buy back capital. It's very low down on our list of things to do with our capital, but it's not off the table. Right now it's not in the cards because we think there are plenty of opportunities out there for us to deploy our capital on a more effective manner.

Kenneth Billingsley - Signal Hill

Is there a price of your stock that you guys already have identified that you would start buying back, given that the opportunities for M&A are not as attractive as you would like?

Ed Ellis

I am sure there is, but we are again focused on the M&A side and not on the buyback stock side.

Kenneth Billingsley - Signal Hill

Alright. Thank you.

Frank Bramanti

Thanks.

Operator

Your next question comes from Kyle Cavanaugh with Palisade Capital.

Kyle Cavanaugh - Palisade Capital

Hi. Good morning. I have a couple of questions. The first one is, could you repeat what you said about on the guidance? You said something about the difference being related to reserve releases.

John Molbeck

What I said was that the difference between our 2007 actual results is 338 and our guidance for 2007 was basically the amount of reserve releases we had during the year. So the guidance we offered last year was pretty accurate excluding the reserves, which we didn't include in the guidance numbers that we gave.

So the point being is that we had a pretty good feel for our business in that period of time where earnings were peaking and the teeter was starting the totter the other way.

Kyle Cavanaugh - Palisade Capital

Okay, alright, thanks. The other question was with regard to other operating income. What were your expectations in terms of 2008 for that line and part of that going to your guidance and also the interest rate component on the investment portfolio?

Frank Bramanti

On the other operating income, what we said during the course of last year and what we've anticipated for 2008, is that we think the run rates $3 million and $4 million are based upon the components that make that up, and that is minority investments we've in different entities. We have a couple of derivatives coming out of our financial products division that run through there, and just some other stuff that's kind of a $3 million to $4 million run rate per quarter that we anticipated. I'm going to ask Ed to address the interest rate and projections for the current year.

Ed Ellis

Yeah. I really don't -- I don't have that rate available that we projected in the budget.

Frank Bramanti

What I do recall in detail is that we took our short-term interest rate expectations down about 20% over what we had. So, we had a current year of nearing five and we've a projection of nearing four. And the current run rate or yield of our portfolio is pretty much indicative of what we used I think in general going forward.

Now obviously there is a lot of moving parts to the financial managements and we gave it our best shot after taking to our managers of what they expected during the year. Again we take a pretty plain de novo approach. So, there is not any yield enhancement kind of vehicles going in our portfolio that we're trying to stretch things.

We buy predominantly in the muni market. We have some predominantly agency-focused asset-backed securities in our portfolio again pretty plain de novo. We haven't been paid to go down the quality rankings, having them gotten paid to go out the yield curve just over the last couple of years.

So, we put stayed in a pretty tight box around where we brought and that kept aside of trouble kind of maybe yield just kind of average market. But we're very happy with where we ended up with that approach.

Kyle Cavanaugh - Palisade Capital

Thank you.

Operator

Your next question comes from David Lewis with Raymond James.

David Lewis - Raymond James

Good morning, thank you. I just want to clarify a couple of numbers. Ed, I think earlier you indicated that you benefited from alternative investments in the fourth quarter net investment income. Can you give us a general idea of what that benefit was in the period that we might want to back out as we kind of look forward?

Ed Ellis

Yeah, it was about $4 million.

David Lewis - Raymond James

Okay. And Frank following up on Kevin's question, I guess I wasn't sure, in your assumption you said you went from five to four, are you talking about percent? So, you are only using 4% investment yield?

Frank Bramanti

On the short-term investment portion of our portfolio.

David Lewis - Raymond James

So, you probably have some conservatism built in there?

Frank Bramanti

Well, we'll see what happens to the short-term rates. As we were doing the budget they were heading down to the floor. So we're trying to down a little bit. I mean, we would hope that we beat our numbers. But given the volatility that we've experienced in the marketplace, it's kind of hard to say where you are going to be.

And we have a portfolio that is relatively short. I mean, we have a five duration on it. And so, we've got a significant cash flow coming from the investment portfolio and considerable cash flow coming from our operating cash flow. We want to make sure that what we included in our budget is something that's reasonable, given the volatility.

David Lewis - Raymond James

Yeah.

Frank Bramanti

So, hence maybe our numbers. There is a little bit of conservatism in there. But and if you can predict the interest rates, we'll be glad to use the right number.

David Lewis - Raymond James

Sure and I understand. Alright. And since this hedge sale was totally off that, should we really look at the quarter's operating EPS is being $0.85? Correct.

Frank Bramanti

That's what we believe.

David Lewis - Raymond James

Yeah.

Frank Bramanti

It really isn't a capital. If it weren't for this hedge that we had to unwind and put it on in a more appropriate manner, that capital gain would not have occurred. And the…

David Lewis - Raymond James

Offsetting…

Frank Bramanti

The income statement wouldn't have been -- wouldn't have been occurred either. So….

David Lewis - Raymond James

Right, okay. And tax rate in the quarter was a little lower than I was anticipated is there anything funny going on there and what might we assume for 2008?

Ed Ellis

Yeah. The tax rate was down because we had one on -- under FIN 48. We had one adjustment on for a [seven]. We had some tax issues that were positive for us. And then in the fourth quarter we always adjust our prior year accruals based upon the filing tax returns and that impacted this quarter positively too. For the run rate, I think it's roughly between 31% and 32%. We're investing more heavily in municipal bonds, which is tending to reduce the expected tax rate.

David Lewis - Raymond James

Okay, that's helpful. And just finally on the stop-loss side Frank, I mean, you and I had this conversation, but you still feel that you may actually start to see some improved rates out of that business?

Ed Ellis

I'm going to repeat what I've said since I came back in November of '06. Part of the reason that we did the Alliance acquisition was that we felt that there was going to be some rate change, ultimately by the first dollar writers which hasn't happened -- didn't happen in '07. It hasn't happened yet. Our people are optimistic that their numbers are dictating that they are going to have to do something, but we haven't seen it yet.

But more importantly on our business really we have been able to hold trend. We have a very positive feeling about the one, one renewals and where we'll add on the current business. We've been able to hold trend. We've got stable margin and loss ratio on our business. So, we're very comfortable with where we are net of stop-loss.

David Lewis - Raymond James

That's helpful. Thank you.

Operator

Your next question comes from Beth Malone with KeyBanc.

Beth Malone - KeyBanc

Well, upon the acquisition is there a traditional catalyst that you're anticipating seeing that would increase the probability of acquisition? Is there a tipping point for these smaller MGA's or other players in the marketplace? Do you think they were getting close too?

Frank Bramanti

I don't, I mean, I think historically, certainly the action that set many of the MGA's out into the marketplace looking for all kind of alternatives was when the market finally [hardened] and people start getting out of things, that cost their money notices or cancellation, programs being cancelled, paper being pulled tends to be a big catalyst.

But as we head down the backside of the cycle, it's the MGA's with the foresight to start looking out into the horizon and saying there are clouds out there. What am I going to do if this happens, and if that happens and the people that look around for alternatives or back stocks to their current operating arrangements, and potentially look around to is there another solution to my problem and that's kind of where we come in.

We attended a seminar that had I think it had 15 or more companies there trying to sign up new programs, okay. And we were there looking to come up with other arrangements. We don't write program business. We don't give our kind of way. But we do acquire MGAs and give them our paper and that's us with our paper. We didn't have a lot of people knocking on our doors. But I think that's going to happen overtime.

More importantly though from a pricing standpoint, when you've people trying to sell their businesses at the peak of the earnings you're going to get the peak of expectations from a sellers perspective. And I think to the extent that our industries earnings will repeat then reality is going to start drifting away from that and people's expectations, as something higher than the peak is just have to go away.

We've seen it on some recent deals albeit in tougher lines of business. But expectations of value on a multiple basis have come down dramatically versus where they were a year ago and that's great that's getting into right direction.

But more importantly you got to have a fit and this is for anybody that's buying anything. Anyone who is a successful acquirer they are going to have a fit albeit a culture fit, the goodness fits the direction that they are trying to drive their companies. There have to be some kind of natural connection with that acquisition for it to work. And when you got people there I really expecting over the top dollar. It's tough to make that connection, lot of people have that problem. But there is a lot of would be buyers out there that say, no, thank you when they get into it.

So, you just have to find the right deal and that is you're out there on the streets everyday looking at every deal trying to get all the flow running through your office, so you can pick and choose the ones you want to look at. And then we're out beating the streets to come up with our own prospects and that's where the best ones come from because you find people that aren't for sale, that aren't plugging their business. They will confer how did they grow their business into the future? And you find the right businesses it make the deal and we think those opportunities are still out there.

Beth Malone - KeyBanc

Okay, thank you.

Operator

Your next question comes from Howard Flinker with Flinker and Company.

Howard Flinker - Flinker and Company

Hello, everybody. Please tell me what Side A means?

Frank Bramanti

Those are claims that are not indemnified for the most part the corporation. So, big companies who are -- the true exposure to a big company. I won't name any big companies. But you can figure out any of the big companies, is when they go bankrupt. Enron would have been a Side A claim for example.

Ed Ellis

Basically, I think the way of the planning is -- it reimburses directors and officers for payments that they didn't get reimbursed from the corporation. And as John said the most likely situation there is the corporation can't reimburse them because of bankruptcy. So, it's highly unlikely you have many Side A claims in a situation, where the company is an ongoing concern

Frank Bramanti

As opposed to full coverage that the company may give me reimbursement for claims against the Directors and the Officers. On a side A coverage the company wouldn't get reimbursed. It would only be paying the liability of the Directors, when the company could not pay.

Howard Flinker - Flinker and Company

Directly to the Directors.

Frank Bramanti

To or directly to -- who is ever assuming the Directors?

Howard Flinker - Flinker and Company

I see, okay. Thank you

Operator

There are no further questions at this time.

Frank Bramanti

Ladies and gentlemen, thank you very much for participating. We'll talk to you in May in our first quarter call. Thank you.

Operator

Thank you for joining today's HCC Insurance Holdings conference call. You may now disconnect.

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