Delphi Financial Group Inc. Q1 2008 Earnings Call Transcript

Apr.23.08 | About: Delphi Financial (DFG)

Delphi Financial Group Inc. (NYSE:DFG)

Q1 2008 Earnings Call

April 23, 2008 11:00 am ET

Executives

Robert Rosenkranz - Chairman of the Board and CEO

Bernie Kilkelly - Vice President of Investor Relation

Donald A. Sherman - President and Chief Operating Officer

Robert Smith - Executive Vice President

Analysts

Beth Malone - KeyBanc

Michael Grasher - Piper Jaffray

Eric Berg - Lehman Brothers

Jukka Lipponen - KBW

Leo Harman - FMA

Mark Finkelstein - FPK

Randy Binner - Friedman, Billings, Ramsey

Operator

Ladies and gentlemen thank you for standing by. Welcome to the Delphi Financial Group First Quarter Earnings. At this time all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will be given at that time. (Operator Instruction). As a reminder this conference is being recorded.

I would now like to turn the conference over to Mr. Robert Rosenkranz. Please, go ahead.

Robert Rosenkranz – Chairman of the Board and CEO

Welcome to Delphi Financial's first quarter 2008 conference call. Our earnings release was distributed last evening and posted on the company's website along with our first quarter financial supplement. This call is also being broadcast live on our website at www.DelphiFin.com.

Participating in the call this morning with me are Don Sherman, Delphi’s President and Chief Operating Officer; Bob Smith, Executive Vice President; Anita Savage, Vice President of Finance; Bernie Kilkelly, Vice President of Investor Relations, and our colleagues at Reliance Standard Life, Safety National and Matrix.

Bernie will now read Safe Harbor Statement.

Bernie Kilkelly – Vice President of Investor Relation

Thanks Bob and good morning everyone. For those listening to a replay of this call, it is being held on April 23, 2008. It contained time sensitive information that is current only as of this date.

Statements made in this call relating to the future operations, performance, goals and expectations of the company as opposed to historical facts are forward-looking statements under the Federal securities laws. These statements are based on assumptions and estimates by the Company that are subject to various uncertainties and contingencies.

Discussions of these risk factors can be found in our first quarter earnings release yesterday and our 2007 Form 10-K. These factors could cause the company's actual results to differ materially from those expressed in any forward-looking statements made during this call and should be considered carefully. The company specifically disclaims any duty to update forward-looking statements made in this call.

In addition, certain non-GAAP financial measures will be discussed on this call. The comparable GAAP financial measures along with reconciliations to such measures are contained in our first quarter earnings release and financial supplement accessible on the company's website.

Now, I'll turn the call back to Bob.

Robert Rosenkranz – Chairman of the Board and CEO

Thank you, Bernie. Well this was a solid quarter for coinsurance operations, but obviously a disappointing one for investment results. We worked very hard over the past seven years to build and run our company to deliver study predictable growth.

Historically, we provided earnings guidance in naval range and have been able to meet our exceeded guidance nearly all the time. No financial institutions however is swiss watch and all are subject to occasional messes. Nevertheless, it’s very disappointing to me personally and to our management teal to report the earnings decline we have in the first quarter. Even now we believe that decline was caused by extraordinary market conditions, I want to underscore our commitment delivering on the earnings guidance that we do provide. This morning in our remarks I am going to ask first Don to review our results for the quart which included very positive results for our insurance businesses. Then I am going to provide more information on our investment results, and finally I will discuss the revised guidance for the remainder of 2008. After our remarks we will be available to answer your questions. Now I will turn it over to Don.

Donald A. Sherman – President and Chief Operating Officer

Thanks Bob, and good morning everyone. Our insurance businesses had a very strong quarter with solid growth in premiums and continued improvement in our combined ratio. Our core employee benefits premium rose 8% in the quarter to $324 million. Our combined ratio was 91.3% down from 93.2 in the first quarter of 2007, and down from 92.4 for the full year 2007. We achieved continued improvement and our lost ratios from our disciplined pricing and underwriting at both the Standard Life and Safety National.

Turning to RSL for a moment, premiums increased 13% in the quarter, driven by 13% growth in its two main products Group Disability and Group Life. RSL’s production decline 6%, as the strong increasing group life sales was offset by a decline in disability sales. Last years first quarter disability production included a larger contribution from our IEB clients new sales in that quarter.

Our traditional products RSL continue to focus most heavily on the attractive small case market. We had a solid increase in code activity and in the number of new cases sold compared to last years first quarter. RSL’s production continued to benefit from an emphasis on voluntary product which represented 19% of the core production in the first quarter.

Premium from our RSL turn key disability division CDS will level with last years first quarter at 12 million. While the premiums were level, we’re pleased with the growth we’ve had with some new turn key partners signing on in the past year. CDS continues to provide a significant alternative distribution in the small case market.

Turning to Safety National, excess workers compensation premiums and production declined in the first quarter as the market continues to flat now after seven years of hard market conditions. Rates in the quarter which included the important January renewal period decreased by a low single digit, while we achieved modest increases in the average self insured retention level which is now right at $500,000. Safety National continues to have high renewal ratios which demonstrates the ongoing strength of our market position. Safety National will remain disciplined in pricing and underwriting and continue to emphasize the longstanding relationships and reputations and that we build over more than 65 years to attract and keep good business.

In our Asset accumulation segmented RSL operating profits in the first quarter was $4 million compared to 8.3 million in the same quarter last year. This decrease was due to decline in the investment income from asset allocated to this segment which Bob will discuss in a moment.

Funds under management in this segment were basically flat at about $1.1 million. New sales of fixed annuities increased to 52 million from an unusually low 19 million in last years first quarter. We had a small contribution in sales in the first quarter from our new index annuity product keystone which was launched in the fourth quarter of last year. We expect the larger contribution of sales in the second of the year as the product gets established in the marketplace.

Turning to our balance sheet, book value per share excluding mark-to-market adjustments was $24.52 at the end of March, up 8% from the $22.68 a year ago. Our debt-to-capital ratio was 16% and we had unused borrowing capacity of 250 million on our $350 million bank line. We also had $90 million of financial assets in the holding company. So we continue to have excellent financial flexibility to support the growth of our insurance businesses and return value to our shareholders.

Now I am going to turn the call to Bob Rosenkranz to talk about our investment results. Bob?

Robert Rosenkranz – Chairman of the Board and CEO

Thank you gentlemen. We will go again to this years first quarter. We were expecting investment income to be lower than last years first quarter, which was unusually strong at 71.3 million. Our target for investment income was similar to fourth quarter 2007 level around 67.4 million. We ended up 35 million below this target. Impart this was due to our conscious decision to raise unusually high levels of cash, some 437 million at quarter end. In anticipation of some excellent investment opportunities which we are currently taking advantage of, but the very environment that creates those opportunities was the most punishing one in recent memoir for virtually all types of financial assets and investment strategies. While substantially all of Delphi's assets are marked to market on the balance sheet, in some cases, those marks flow through the income statement as well. These assets include among others, our investments in limited partnerships and limited liabilities companies and our trading account portfolio. Those assets were about $360 million in total at the end of the first quarter. We also have a $190 million in principle protected notes in our fixed maturity portfolio whose yield is based on the performance of limited partnerships that invest in a variety of strategies. So, altogether there are about $550 million invested in assets that are marked to market through the income statement.

Delphi has historically allocated a portion of our investment portfolio to these types of assets, and these investments have been a solid contributor to Delphi's investment income overtime. We’ve typically budgeted returns from this category at around 10%. Until 2001, we’ve earned average investment returns in the 12% to 13% range. Our yields have benefited from these returns, and because the results have largely been uncorrelated with bond market returns, these assets provided the added benefit of a reduction in the volatility of our total return performance of our portfolio. We’ve gradually increased the percentage of our total portfolio to allocate into these assets, because in a period of extremely tight credit spreads in fixed income markets, we weren’t paid enough to take credit risk. Many financial institutions with household names that sought incremental yields and credit intensive mortgages or complex structured products are now fighting to survive. We sought incremental yield through these marked to market assets, which have over the past 7 years exceeded budgeted income level 75% of the time, and in the shortfall quarters did not meaningfully impact overall results. But in the first quarter, returns on these assets were down as much as they usually are up and that variance was the largest contributor to our investment income shortfall. Many market participants characterize the quarter as the most challenging I have seen in decades, as it has proven to be.

Now, we would love to find investment opportunities which can provide the kinds of returns we have enjoyed historically, but would love the levels of income statement volatility. The silver lining in these tempestuous markets is that such opportunities seemed to be increasingly in evidence. We are very comfortable with our current portfolio which has over the past 7 years offered an excellent combination of high total returns and well controlled risks, but the current environment may well enable us to improve our mix and we are working very hard to be sure we seize any opportunities to do so.

Now, I would like to turn to our final topic. I have advised guidance outlook for 2008. We believe the strong first quarter results of our insurance businesses are definitely sustainable, particularly the combined ratio improvement. Based on a shortfall in the first quarter and a less predictable environment, we have lowered our earnings guidance for the year. Assuming that the financial stressors of the first quarter proved to be as unusual as they appear, we currently expect our operating earnings per share in 2008 to be at a range from $3 to $3.30.

Looking beyond this year, we continue to be optimistic about the growth prospects of our insurance businesses. Delphi continues to have a strong balance sheet, which gives us excellent financial flexibility to create value to our shareholders through share repurchases. In the first quarter of 2008, Delphi repurchased 568,000 shares on an average price of $29.95. We have a remaining authorization to repurchase 965,000 shares. Stock repurchases at current levels can produce meaningful accretions in earnings per share. So, I feel very good about our ability to create value for our shareholders and support the growth of our insurance and asset accumulation businesses.

In closing our first quarter investment results were disappointing, but we believe we have a good insurance businesses and strategies in place and interesting opportunities that have been presented by these tumultuous market condition. And now, I would be very happy to take any questions. Operator?

Question-and-Answer Session

Operator

Thank you. (Operator Instructions).

And we will now go to the line of Beth Malone with KeyBanc. Please go ahead.

Beth Malone

Yeah, thank you, good morning. Could you provide some more color on exactly what the limited partnerships and limited liability companies that cause the investment income decline. How many do you invest in? What kind of strategies are they? Is there is a risk? I think investors are concerned and the stocks reacting because people are concerned that maybe there is a Bear Stearns kind of investment in here that will wipe out the 300 million you have invested. Could you give us a little bit more comfort on exactly what's there and what risks you see?

Robert Rosenkranz

The underlying investments here comprise probably 35 or 40 different managers, a very board array of strategies. What they have in common is almost all of the underlying assets are marketable. Almost all of the strategies involve long and short positions. Almost all of them have low or negative correlations with the bond market. And very few of them use any material amounts of leverage as part of their approach.

So as far as I'm concerned, I don't think we have anything like the kind of risks that you've identified, and the proof of the pudding is we've been doing this for a long time and always been able to provide earrings guidance in a narrow range and with this one exception of 7 years been able to meet those expectations.

Beth Malone

Okay. And then on your guidance you have reduced the bottom end of the guidance from 345 down to $3 and the shortfall at least based on analyst projected my own included for the first quarter was around $0.33, which would suggest that the next three quarters could include more weakness compared to what we were originally anticipating. And I'm just wondering is that what you intended and also is there any visibility, now we've had a couple of weeks into the second quarter. Has any of this valuation recovered at all from where it was in March 31st?

Robert Rosenkranz

While the first couple of weeks of April have actually been pretty good, couple of weeks down the quarter make. So I wouldn't get too excited about that. But I think to answer the more fundamental question the range that we've given is now a 10% range, it’s a wider range then we gave at the beginning of the year, and that simply reflects the fact that markets are simply more volatile. And there are greater uncertainties out there, so we just felt like the kind of ranges that we've given in the past which were more in almost 5%ish area for annual results. Simply not a range that makes much sense in an environment where finical assets are as volatile as they are today. So that was the reason for broadening the range out.

Beth Malone

Okay, I'll get back in the queue. Thank you

Robert Rosenkranz

Thanks Beth.

Operator

And next we'll go to the line of Michael Grasher with Piper Jaffray. Please go ahead.

Michael Grasher

Okay. Thanks for the commentary there Bob, and just to follow up on those question. You mentioned the low negative correlations with the bond market with this investment portfolio or these investments. What would you consider a stronger benchmark or these investments to be correlated to, if there is, I mean, I understand there are numerous strategies, but in general can you provide us with any transparency around what might make an appropriate index?

Robert Rosenkranz

The goal really is to be un-correlated to the bond market. And I think when you look at enterprise risk management which the rating agencies focus on and others of our constituencies are focused on. That’s a very important one and maybe I can turn this over to Bob Smith to kind give a little color on that and then I'll come back to try to answer your benchmarking questions.

Robert Smith

Sure.

Michael Grasher

Hi Bob.

Robert Smith

Hi Mike, how are you? We've looked at this portfolio over the last 5 and 10 year period. And in fact it has shown negative correlation with the investment grade bond market, the Lehman Ag. And as a result the total portfolio with the percentage contribution from this particular effort shows less volatility than the bond market and it shows greater expected returns. So we think that’s been actually a significant value at from this effort. And we're going to continue to look for portfolio that has those sorts of characteristics. It's difficult to come up with a model or an equation to give you or anybody else any comfort on how this might correlate positively to overtime, because those correlation shifts somewhat as capital market conditions.

Robert Rosenkranz

Well also the goal in constructing the portfolio is to avoid any correlations to obvious indices. I mean, what we're trying to construct here is strategies which are individually not highly correlated and collectively as lowly correlated as we can to other things in our world. I know it's not a really great answer from your perspective. But the goal here is to create a mix which doesn't correlate to anything obvious in the world and frankly we've been pretty successful in doing that. Witness the kind of reported results we've achieved over the last seven years with this one exceptional quarter.

Michael Grasher

Yeah, that’s all I understood, and understood the goal especially. And just knowing the majority investment portfolio is focused on bond markets. I would think that there would be something that we can draw from on this particular area? I would like to turn over than to the safety business. A couple of questions. One you did mention that production was down. Can we talk about that a little bit more? Just, I don't believe it was necessarily difficult to comp in Q1, but is there anything else that you can add to the quarter results?

Donald Sherman

Mike this is Don Sherman. I think what we are seeing is that the market participants us included, are looking primarily at renewing the business. And as the market has flattened out here we want to try to be out ahead of the renewal cycle and secure our relationships with our existing business as promptly as we can. And what we are seeing is not only lower production, but lower levels of shifting in the market. By that I mean fewer account going out for bids. So we may have lowered production we also have lower opportunities to quote on new productions, but that has a nice corollary with it which is we have a much higher retention ratio going on in our own business. And we think that’s not unique to us. We think that’s what's happening in the market place.

Michael Grasher

Okay. So with modestly lower retention is it a function of prices, is it a function of competition?

Donald Sherman

I hope I said higher retention. Our retention rates are higher, so the pricing is modestly lower and so, you may see a modestly lower premium number. But we are holding our account base at really record levels of retention.

Michael Grasher

Okay fair enough. I was looking at the renewal ratio coming down a bit at 12.31. And I don't know what it would it be?

Donald Sherman

I think we may have mentioned this on the previous call Mike, I don't know, but clearly our January renewal rates were higher, they were they were in the low 90's. So that pick up is reflective of the trend I was describing.

Michael Grasher

Okay, Okay that’s helpful. And then any – and maybe this to (Wayne), but any reserve development at safety in the quarter that you speak to?

Unidentified Company Representative

No Mike there was, really there were no reserve releases and the last was right align with expectations, we did have improvement in the loss ratio primarily driven by the more recent years where we run a little more business or more profitable, as well as we have looked full of any adverse development from the stock market units.

Michael Grasher

Great. Okay. Alright, I will jump back in the queue. Thank you.

Operator

Alright. Next we will go to the line of Eric Berg with Lehman Brothers. Please go ahead.

Eric Berg

Hi. Good morning to everyone.

Robert Rosenkranz

Hi, Eric.

Eric Berg

Few questions first, why are the securities marked to market in the sense that – the reason I ask the question is, it is my sense that there is a bit of discussion in that, some of your competitors have partnership investments, they accounts them under the equity method of accounting, picking up a proportionate share of earnings, so that would be my first question, is this is just a choice that you make or do you feel like you are budge to do so in the US accounting rules?

Unidentified Company Representative

I think it’s pretty clear and I think Bob under US GAAP and equity accounting that you have pickup there for rather share of changes in the capital account of these particular partnerships. So…

Eric Berg

Are you marking this, I am little bit unclear. Are you value – are you picking up your share of the earnings of the partnership, are you valuing your ownership in the partnership?

Robert Rosenkranz

It's all the same thing basically you are picking up your share of the change in value.

Eric Berg

Okay.

Robert Rosenkranz

So that is all marked to market on the books of these partnership in LLC, so they may have interest and dividends and change in realize or unrealized securities positions, just pickup the whole, you pro rata share the whole thing in effect?

Eric Berg

Okay. So here is the big question that I still don’t feel like I fully understand. I don’t think, I mean, I don’t think the balm market, do the ball market do that much in the quarter in the sense that – while certainly of course, I am aware that effected credits spreads continue to widen, they did not widen by as much they did in say the December quarter or in the 4 and of course, interest rates fell in the quarter helping out balm prices. With respect to the stock market it’s my sense that there was basically on average a 5% decline, immediately a significant decline, but I am not sure what it was relative to the average in the December quarter. I guess my question is, I am sort of surprised that w e have this dramatic drop in net investment income sequentially when the – what would be appear to be the changes in the capital markets were significant, where they – I am I focusing on the wrong statistics to understand the extent of the change in capital market? I hope my question is quick.

Robert Rosenkranz

Yeah I think I get the nature of the question, I think you really have to look into the various pieces of the capital markets for instance, but Lehman Ag, which is the investment grade bond market was up 217 basis points for the quarter. The credit portion of that was not up as much. But if you look at CMBS,ABS and certain parts of the mortgage backed arena, if you look down in the credit spectrum into BBBs and single AAS lower categories, you get a much different picture, if you look at the S&P 500 it was 9.5%.

Eric Berg

Right.

Robert Rosenkranz

So from a lot measures it was a very stressful period, and look at all events I mean, the sub prime events of late last year moved into different arenas, in the first – late last year and into this year eventually we had a $150 billion or more of write downs from various capital financial institutions as well as some offsetting capital raises and other crisis for the financial guarantors and the mortgage insurers out there, and then – the ultimate event I think was the one in the middle of March when Bear Stearns was build out. And so, there was huge dislocation and all sorts of aspects of the market. Deleveraging continues out there among financial institutions, margin call, I mean, it’s a very difficult environment for most markets. Now we happen to be in the long treasuries, that’s great, but that doesn’t really put on the lights very well.

Eric Berg

Bob with last question and then I will get back in the queue so other guys questions, if your partnership managers were invested in the asset classes that you have referred, you know the lower some CMBS low rated RMBS and so forth. Why should we think there is going to be recovery here in the sense that if these securities have depreciated dramatically in the way that you’ve described because of everything that’s been going, why should we think that this could come back? Why isn’t this a permanent loss and that would be my last question. Thank you.

Robert Rosenkranz

I think the determination creates the opportunity set for one.

Eric Berg

Okay.

Robert Rosenkranz

I think the feds aggressive actions with respect to Bear Stearns had a very significant shift in a marketplace were financial institutions were under pressure to sell things and now that they can go to the window and then they’ve got other sources of backup financing, its less stressful for them, but I think that in stressful environments like that capital tends to move the opportunities bottoms form things recover, and I think we are hopeful, that’s the situation.

Donald Sherman

And also I think you should take Bob’s description or discussion, more as a reference to the general financial markets conditions that led to liquidations to drying up of liquidity, drying up of credit, with that kind of stress that was triggered by those things, sort of effected every kind of financial strategy whether it’s equities or a distress securities or macro investing almost all strategies and we have a very diversified mix represented of which CMBS and the like are not a material portion at all. But always what I think Bob is trying convey was that these would simply tumultuous time that have made it difficult not matter what strategies you’re pursuing, not to so much that we had exposure to those particular ones that triggered the kiosk.

Eric Berg

Both comments were very helpful, thank you.

Operator

And next we will go to the line of Jukka Lipponen with KBW. Please go ahead.

Jukka Lipponen

Good morning. I guess I am still a little confused and I apologize. But trying to get out this, are these marks that potentially could reverse if the assets values and for example, if the assets of the some of your managers are CNBS and they’re marking based on now where the index might be. It is possible that in the next quarter if the index value improves that you have a mark going the other way?

Unknown Company Representative:

Yeah

Robert Rosenkranz

Yes, I mean, what I was trying to convey let me just say it again is that, this package – almost all of Delphi’s assets in mark to mark at. We don’t have much in the way of private placements directly on real estate or direct mortgages that are halibut at cost or held to maturity; almost everything that w own is mark-to-market. So when you look at our financial statements you see the market value of everything, are substantially every time.

Now most of those marks don’t go through the income statements, most of them are just balance sheet adjustments. So they have -- if you will a lower profile but they are still expressed in our financial statements. Certain classes of the assets because of the way the economy rules are written, the changes in their mark-to-market value do go through the income statement and it’s always been less Those assets happened to be among the highest yielding assets on average that we all know, I mean, we budget 9 or 10% they actually return 12 or 13% which is like something on a ballpark of 3% a quarter. While this quarter they’re down 3%, that’s a kind of biggest swap, and a 3% decline doesn’t seem like that bigger deal, but compared to what the earn on average, that was really the just of the shortfall, and that’s what I was trying to convey perhaps not with complete clarity in my initial remarks. So, yeah, I mean, there is no, I mean all that has to happen is just a kind of normal times that I mean, that the last 7 years haven’t have lots and lots of opportunities stresses in market, some corrections and volatility and movement in one segment or another, but we’ve been able to manage around those very, very well and not reduce excessive volatility of uncertainty in our quarter end results and we expect to be able to do that in the future.

The other point I want to reemphasize again from my earlier remarks is that part of which led us to a gradual increase in the kinds of strategies that do get mark through the income statement in this way, is that bond market opportunities were terrible, I mean, credit spreads were just too tight, you weren’t getting paid for taking credit risk, people who financial institutions that strove to maintain yields by buying structured product, by buying credit intensive mortgages or securities related to those are in deep, deep trouble now fighting for the survival. We took a different route, and, yeah, we have a quarter that would disappoint then, but relative to the alternatives that were available out there I have no – I think even the 20-20 eye sight we chose the right way.

Jukka Lipponen

And going back there was a question about benchmarking earlier it go any kind of benchmark that we can look to from the outside to try to get a better feel for performance of these assets in any given quarter?

Robert Rosenkranz

I think its hard because they’re consciously constructed in a way that they shouldn't be benchmarkable. They are consciously constructed in a way should not be correlated with obvious banks, and I know that’s not, it doesn’t to your job as an analyst, but it’s a core of what we are trying to accomplish here, but I did want to just continue to emphasize a point which is that the situation I described that led us to gradually increase this type of assets has changed. I mean, right now, we’re beginning to see some really interesting opportunities in categories of fixed income, investing where we think we’re being paid very, very handsomely to take credit risk. And, as we move into those kind of asset crisis we will have the benefits of high returns, attractive returns without the determent if you will of the volatility in quarterly reports. So the income statement, we’re still going to have quarterly volatility reflected on the balance sheet, that’s just inevitable. But we’re in a environment right now that has a lot more alluding alternatives for investments in the environment that we’ve been for the bulk of last year and for years.

Jukka Lipponen

And my last question I would say, can you give us a little more color in terms of premium growth expectations for both RSL and Safety National?

Donald Sherman

Jukka this is Don Sherman, we’re still seeing what we would consider to be against the background of the public comments about economy, the economy pretty attractive payroll growth still in the 3 that 4% range depending on the products we’re looking at in the geographies, but still we have checked the payroll growth that’s helping us out there. And, from our sales perspective, we think that the premium growth that we have been able to post and the double digit range looked to continue to be achievable if you combine the payroll with what we are able to do on production and attractive pricing we’ve been getting. We are confident about that kind of payroll that kind of premium growth at RSL on the safety side with the flatter market, we’ve had to dampen our expectations there somewhat on what we’re going to see on premium growth and we think the kinds of circumstances that you see in the first quarter may be indicative. We would like -- we believe we can do somewhat better than that, but we think that may be indicative of where we are compared to 07, I should say not that those are continual decrease from here, but compared to '07. And, on the other hand we definitely like the terms of trade at which we’re riding the business in safety. We think it continue to show very good long term profitability potential, and we intend to stay focused on that.

Robert Rosenkranz

One thing I would like to add, and there is a comment I have made in the past. So you forgive for being repetitious. But, safety does have a very unusual business model which can sustain for longest period of time, very good bottom line growth even with a flat or slightly down top line; and the reason for this is two-fold. One, over the past five years, we've achieved 60% increases in premiums. We've gotten 60% further raise from the fire if you will by increasing the attachment point from 300,000 to 500,000, i.e., the point at which we start paying claims. So, we're taking a lot more premium for a lot less risk and yet we're reserving based on just historical or reserve factors that are a mix of hard year's, soft year's historic results and it is only when the actual results of these strong market years emerge over a three, or four, or five-year period that the income is built in to the strong market flows through the income statement. And, so we can have very good underwriting growth even with flattish or declining top line. The second factor here is that with the $500,000 attachment point in a typical claim where we're responsible, the employer is going to take 12 or 13 or 14 years to run through that $500,000 that is his responsibility before we start paying out $1 under that claim. And what that implies is that our investment income and our investment assets grow for a long-long time before things start flattening out and actual cash payments of losses catch up with you to impact your investment portfolio or your losses. So, there is a lot of built in growth in investment income, in assets, and in the realization of profits for the build in to or inherent in the kind of pricing strength that we've had over the last five or six years. So it is a very unusual business model that this company has. Its hard to get a grip on if you are only thinking about it once a quarter, I mean we live it day in and day out so it is sort of second nature of us. So, I think I hope you forgive me repeating myself on this point.

Unidentified Analyst

Thank you and that's very helpful.

Operator

And next we go to the line of Leo Harman with FMA. Please go ahead.

Leo Harman

Hi good morning.

Donald Sherman

Good morning.

Leo Harman

What was the actual mark in the quarter?

Donald Sherman

You are talking about mark on the assets?

Leo Harman

Yeah, what was the mark-to-market on the assets during …..

Donald Sherman

It was down about 108 million which goes through AOCI. That's a pretax number so that's 2.5% on the portfolio.

Leo Harman

There was a 108 million mark. I'm trying to put together the delta of the sort of a 40 million or 35ish million quarter to quarter if you have a marked to market on your investment companies. You are also losing the income that would've been derived from that. What is the impact of that sort of quarter-to-quarter?

Donald Sherman

I think we've talked on that in two different things. I think you are looking for the delta between the quarters on this part of the portfolio….

Leo Harman

Right. On the 300 million piece of the portfolio.

Donald Sherman

All right, I think Bob kind of gave you the math. But to go through it again, our expectations or our historic performance for these classes have been 12 to 13% annually…

Leo Harman

All right.

Donald Sherman

So on a quarterly basis it is 3 to 3.5% and as I said it was down by as much as we typically expect. So, that's 6 point swing, 6.5, 7 point swing and $550 million is your delta.

Leo Harman

So, should I assume that there's a total of 3 to 4% income mark and a 3 to 4% valuation mark? Would that be the proper to look at that?

Donald Sherman

Well that was the income mark on those assets whose mark flows through the income statement. The separate mark that we had was the 108 on the balance sheet that flow through AOCI that does not go through the earnings income statement. This separate mark we had was the 108 on the balance sheet that flows through AOCI that does not go through earnings.

Leo Harman

Okay. If I were to look at this sort of on a long-term basis, and you guys said you rate about 12% or so annual return on that piece of the portfolio. What part of that would be considered sort of investment income and what part of that would be sort of capital gains income, if you want to break it out inside of those LLCs?

Robert Rosenkranz

It was mostly, I mean, most of these strategies are pretty trading oriented. So most of that would be sort of look at t as trading profits.

Leo Harman

Okay. Is there a way to segregate that within the portfolio to create a segregated line so that we get a better idea of what the underlying businesses is doing? It seems to me, certainly this quarter, if I were to adjust your underlying business that you would have outperformed our expectations on an underlying basis. How can we get a better idea of what that underlying business was doing; and if I were to ex out this 550 million piece, what would have been the interest income on rest of the portfolio?

Unidentified Company Representative

Well, I think you can do the math.

Robert Rosenkranz

Yeah, I mean, on this, lets say, if you say that that’s sort of plain vanilla investment assets might be earning 5 or 5.5. That’s $25 million annualized from a portfolio that this quarter had a loss of around $15 million or $17 million.

Leo Harman

Okay, makes sense. And I guess the last thing is, certainly as a frustrated shareholder looking at your stock trading below book value today implying that there is no franchise value for a company that has generated double-digit earnings growth and double-digit ROEs for the past five years, how do you look at that from the standpoint of a management and certainly management needs to take some responsibility for that, but how do you begin to work through the disconnect between what this company is from a franchise standpoint and what the market is looking at?

Robert Rosenkranz

Well, frankly we think the market is presenting us with a terrific opportunity. I mean, we have been steadily buying back our stock at higher prices than this. We've a lot of financial flexibility to do so. We only have 16% debt to capital. We've got $250 million in unused credit lines. We bought about $65 million worth of stock last year. can buy more than that this year and buying stock at current prices has a highly accretive effect on earnings per share and on enterprise value per share. So, we are looking at it as our partners in public sphere. We’re offering to sell their interest back to us at substantial discount and that really creates an opportunity for us to seize the moment and build value. I also fee, and I've said this a couple of times in this call that the credit markets for the first time in the past three or four years are offering very significant opportunities to put money to work at very attractive rates of return' I mean, you have to be very careful and you've got to do a lot of analysis. This is not something that we can do overnight. But if I think about the company in longer term, I think we're going to be able to reduce earnings volatility, we're going to be able to maintain the investment yields that we've earned historically, and we're going to be able to be able to take advantage of stock price weakness to repurchase shares and build value for those of us that are longer term committed to this business.

Leo Harman

Thank you.

Operator

And next we go to the line of Mark Finkelstein with FPK. Please go ahead.

Mark Finkelstein

Good morning. I've got a few questions. I guess, I would just want to take a step back and make sure I understand the comment on negatively correlated as a basis for some of these holdings. I guess, and just thinking about this, if the vast majority of the assets are supporting insurance liabilities, and you generally a buy-and-hold investor, why do you need to invest in areas where you characterizes negatively correlated to the market? I kind of want to understand little bit.

Robert Rosenkranz

A part of that is in the little book I would say, of enterprise risk management. One of the things that the rating agencies look for in evaluating enterprises is the overall risk. And one of -- you if you have for example, an insurance company which invest in bonds, and you have an environment with unanticipated high rates of inflation. Well, that guy is – that company is going to be hurt on the claims, at least to the extent that the claims cost certainly link to inflation or its happen not be, but in a typical insurance enterprise claims cost will be inflation related. At the same time, interest rates are going up, bond prices are going down, everything is working against it in the same way. Well this is the something that from enterprise risk management point of view don’t want to do. So even though your core asset is going to be bonds, to put some portion of your equity in assets that are not correlated with bonds has been with the effect of reducing your overall enterprise risk and creating a better picture in terms of enterprise risk management. It has the advantage from the income statements standpoint of also increasing your reported returns and your income overtime. It has the disadvantage of introducing some greater element of volatility into reportable results, that’s a challenge for management to make that trade-off properly. We have clearly done so over the last seven years, been able to pick the right spot in that kind of a trade-off. This quarter was a little disappointment, but it was a very much of an outlier quarter in terms of what was going on in financial markets I mean, very, very possibly the most stressful markets that anybody underscore to remember.

Mark Finkelstein

Okay. And you talked about maybe redeploying some of these assets into other areas of the opportunities present themselves I guess, what would be those opportunities, do you have a target for maybe where that $550 million of all in alternatives goes to?

Robert Rosenkranz

Well I certainly will elected to kind of commit ourselves to targets, because these are pretty uncertain market conditions, you don’t know, you just don’t know what’s going to be out there, what exactly the opportunities are going to be. But, I may outsight something really very plain vanilla. If you look at municipal bonds which were core holding for property and casualty company which can benefit from tax free status. Municipal bonds typically sell at 80%-85% in the yield that’s comparable treasures. We were selling at a 120% or 130% of treasury yields, and I mean, I think if the demographic is wins and in Novembers its pretty clear that marginal tax rates are going to go up which make many bonds even more valuable. I mean, there is a kind of a plain vanilla asset class that’s being priced in today’s environment at just historic good values. There are other ones that are may be more proprietary and more complicated and I do not think it’s appropriate first to get into, but now just talk to any trading desk and you will find that and there is a lot of stuff out there at pretty distressed kind of levels does require you know really well up your sleeves and do the credit work though, and its not something that I would say, we’re working on very auditors and that’s a real priority, but I do not think we can project exactly what opportunities are going to appeal or how targets, because the markets are not friendly to that kind of thing, they are friendly to the people who are opportunistic, not the people who were sort of rigidly committed to one particular program or another.

Mark Finkelstein

Okay. I guess that just thinking about the rating agencies a little bit. You know, you’ve been upgraded certainly down at reliance some of the bond ratings et cetera. I guess that just thinking about the quarter’s volatility and may be the allocation of assets to this area, are there any applications that we should be thinking about from the rating agency prospective on capital or kind of ratings et cetera?

Robert Rosenkranz

Well interestingly a lot of the rating agencies focuses on the statutory earnings and statutory earnings were actually very strong in the quarter. And even with very, very disappointing results we still have excellent coverages of interest in the quarter. So these are -- in terms of marked to market, through the balance sheet there is nothing particularly unusual here in terms of statutory, our statutory capital and statutory earnings nothing unusual in terms of coverage’s still in the weakest quarter what we’ve had in memory excellent interest coverages. So I don’t see any reasons why the rating agencies should be concern, I can’t speak for them of course, and we clearly have to manage the rating agency process just like we manage all the other relationships. But substantively I certainly don’t see any bases on which rating should be under any pressure all.

Mark Finkelstein

Okay. And then finally a question for safety to hear, doing one of the safety. Is the combined ratio in your view sustainable at these levels, or do you care and should we model that going forward or was that normally positive in the quarter?

Unknown Company Representative

Hello Mark this is Mark (Inaudible). No we think it’s sustainable. And so, kind of what we said before there wasn’t a reserve release, its really reflecting on a more profitable business that we’ve written in a more recent years, and really there was little penny adverse development on the soft marketers.

Mark Finkelstein

Okay alright thank you.

Unknown Company Representative

One we talked about in the past.

Mark Finkelstein

Okay.

Donald Sherman:

And Mark this is Don, I just would add a little color to that in the sense that well its early to declare victory, we continue to be optimistic about what the developments might be out of these more recent years in the book that haven’t shown in our combined ratio at this points. So we will see how that bears out, but we are cautiously optimistic on that front.

Robert Rosenkranz

We are just about at the hour I think we have time maybe for one more question..

Operator

Alright. And our last question will be from the line of Randy Binner with Friedman, Billings, Ramsey. Please go ahead.

Randy Binner

Thanks for taking the question. Two quick questions, Bob Rosenkranz, can you please just break out the components of the 550 million again, they did at the top of the call, and just again provide color on how much of those is equity versus fixed income?

Robert Rosenkranz

Yeah. There is -- it’s investments and limited partnership, limited liability companies, and trading account were 360 million, and then we have $190 million in a principle protected note, and I would say if you look through all, that’s a total 550 million of assets where the changes are marked to market through both the income statements, and if you look through those underlying assets these strategies are mostly equity related there, is some debt related strategies in there, but the bulk of them would be equity strategies because part of the goal is really to have results which particularly correlated with bond type of terms.

Randy Binner

Okay perfect. And then just -- could you provide color there on the realized loss in the quarter, my assumption is that portion is that come from the rescue invests that outlined in the quarterly financial sub. Can you provide color on what percentage of it came from sub prime or CBS?

Robert Smith

Yeah Randy its Bob I mean, a number was 6, 6.5 pre tax and that was across a couple of different sectors as there is little sub prime in there which deteriorated there is home loan mortgage that we broke down modestly and it was a sprinkling around some private offered security or two in a private mortgage. So it was across a couple of different sectors.

Randy Binner

Was there any FAS 137 pressure on the private placement, Mark?

Unknown Company Representative

No. I mean, that’s really you know fair value methodology in categorization on a level one, two and three. I mean our level one, two and three is our basically 15, 70, 30. Just to give you a clue as you know that all depends upon observable data points in the active markets. So there aren't a lot of bonds that are in the "A" category. Let me just re-state that. Its 15, 70, 15, if I…..

Randy Binner

Okay. So 15 (Multiple speakers). I was going to say a 30 seems like a lot of level three. So 15% is the level three number?

Unknown Company Representative

Yeah my sense is based upon discussions with some of the accountants out there. It's pretty typical of what you are going to see.

Randy Binner

Yeah and I think that’s' right. So sub prime commercial mortgage and then product placement on the realized. Any color on, I mean, do you have any feeling for how that's going to progress as we move through the year. You’re thinking of that as a kind of a run rate because we are going through apart of credit cycle?

Unknown Company Representative

It may well be we have to keep our eye on it. We've disclosed in our 10-Qs and 10-Ks a higher number historically that it might be. So 6, 7 pre-tax is a lot smaller than what we had to put in some of our public materials. But you know, corporate spreads have widened out, CMBS has widened out, but underlying performance there of corporate's and commercial mortgages still are pretty strong by enlarge. So we haven't see the contagion in those assets classes that we've seen in some of the residential mortgage arenas in the ABS so far. So, we are going to keep our eye on out for it I mean, spread widened out a lot. I would say that’s spreads have come in a little bit since the Fed rescue of Bear Stearns, but, I mean, everyday seems to be a big right off from some bank around the world.

Randy Binner

Right. And so, okay, well that’s all very helpful. Thanks for the comments.

Operator

Thank you and I'll turn it now back to Mr. Rosenkranz.

Robert Rosenkranz

Okay. Well I am sorry that if there are any question that didn’t get responded to, we’re kind out of time. But do call Bernie Kilkelly if there are any follow-up questions that you would like to ask. And thank you for participating.

Operator

And that does conclude our conference for today. Thank you for your participation and for using AT&T executive teleconference service. You may now disconnect.

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