Everest Re Group Ltd. Q2 2008 Earnings Call Transcript

Jul.22.08 | About: Everest Re (RE)

Everest Re Group Ltd. (NYSE:RE)

Q2 FY08 Earnings Call

July 22, 2008, 8:30 AM ET

Executives

Elizabeth B. Farrell - VP, IR

Joseph V. Taranto - Chairman of the Board and CEO

Craig E. Eisenacher - EVP and CFO

Thomas J. Gallagher - President and CO

Analysts

Thomas Cholnoky - Goldman Sachs

Jay Gelb - Lehman Brothers

Joshua Shanker - Citigroup

Susan Spivak - Wachovia Securities

Matthew Heimermann - JPMorgan

William Wilt - Morgan Stanley

Vinay Misquith - Credit Suisse

Operator

Good day, everyone. Welcome to the Second Quarter 2008 Earnings Release Call of Everest Re Group. Today's conference is being recorded.

At this time, for opening remarks and introduction, I would like to turn the conference over to Ms. Beth Farrell, Vice President of Investor Relations. Please go ahead.

Elizabeth B. Farrell - Vice President, Investor Relations

Thank you. Good morning, and welcome to Everest Re's second quarter 2008 earnings conference call. With me this morning are Joe Taranto, our CEO; Tom Gallagher, our President; and Craig Eisenacher, our CFO.

Before we begin, I will preface our comments by noting that our SEC filings include extensive disclosures with respect to forward-looking statements. In that regard, I note that statements made during today's call which are forward-looking in nature, such as statements about projections, estimates, expectations and the like, are subject to various risks. As you know, actual results could differ materially from current expect projections or expectations. Our SEC filings have a full listing of the risks that investors should consider in connection with such statements.

Now let me turn the call over to Joe Taranto.

Joseph V. Taranto - Chairman of the Board and Chief Executive Officer

Thanks, Beth. Good morning. I'll comment on the marketplace and our portfolio and then turn it over to Craig to review the financials.

Our core book of business continues to perform well, and even though we are seeing increased competition, our ratings and established platform help us to attract the best clients and the best deals. Our international reinsurance book, including our one in the European operation, represents about 38% of our worldwide portfolio.

Overall, we found major treaty reinsurance to be disciplined. Price reductions on catastrophe and the risk excess programs to clean records have been on the order of 5% to 10%. Price increases have been attained on programs that have been affected by losses, which includes clients in Mexico, Australia, Chile and Peru.

Proportional reinsurance terms have remained stable. We are pleased with our July 1st renewals. About 15% of the international business renews in July. We were able to increase our business in 2008 over 2007 as we obtained increases in Latin America, the Middle East, Asia and Canada.

We continue to benefit from our strong long-term relationships with ceding companies and our solid ratings. Our U.S. reinsurance business, including business written out of our Bermuda branch operation, represents roughly one-third of our worldwide business with property reinsurance being about 20% and casualty reinsurance being about 12%.

Regarding the property business, the bulk of our midyear activity is June, where we fared extremely well in securing our positions in the Florida market. This block of business is about $300 million in total with roughly 250 million being pro rata and 50 million being excess. Whereas excess rates were off, perhaps 15%, this in fact increases the profitability on the pro rata business and leaves the potential profitability on the overall portfolio undiminished.

On the commercial property business, despite mounting risk losses for the industry, rates continue to go down, perhaps on the order of 10%-ish, 2008 versus 2007. Here, we continue to maintain our portfolio of highly select industry leaders that historically will outperform the market.

U.S. casualty reinsurance continues to experience rate reductions on underlying insurance, coupled with reductions at the reinsurance level. We also see a continued trend to our company's keeping more net. This activity has reduced the available business with reasonable profit potential. Accordingly, we continue to reduce our premium as we maintain our disciplined underwriting approach.

As mentioned, this segment in 2008 represents only 12% of our overall portfolio. The only prominent exceptions to the market softening have been in the E&O and D&O coverage written for risks exposed to the subprime crisis. Our focus is to maintain our most profitable relationships. Our ratings are particularly valuable on casualty deals where payments were made over many years.

Our insurance operation represents 23% of our worldwide premium. It's mainly niche oriented casualty business. Even the orientation of our portfolio, we are more resistant to the softening taking place in the market. Still we see increased pressure for reduced rates and higher retail commissions. Programs that we recently added kicked in for the second quarter and helped premiums to rise 18% in the quarter and 6% year-to-date.

Our specialty reinsurance book represents 8% of our worldwide book and includes our marine, aviation, surety accident and health book. Whereas we have experienced increases competition in all of these areas, we have taken this book down in recent years to the core profitable clients and don't expect much overall change in 2008.

In summary, the marketplace is getting temperature, particularly in the U.S. Our portfolio will be affected, but -- given our international reinsurance composition, our insurance business composition, which is highly specialized, our position in the Florida property reinsurance marketplace, and our quality client base, which includes many long-term relationships. Now I'll turn it over to Craig.

Craig E. Eisenacher, Executive Vice President and Chief Financial Officer

Thanks, Joe, and good morning. Our second quarter net operating income was $180 million, compared to $213 million in the second quarter of 2007. Net operating income for fully diluted share was $2.90, compared to $3.36 in the second quarter of 2007. Net income including net after-tax realized gains and losses, and fair-value adjustments was $153 million, down from $283 million in the second quarter of 2007. On a per-share basis that's $2.47, in this year's second quarter, compared to $4.45 in last year's second quarter.

During the quarter, our book value per share decreases slightly to $90.32 from $91.01 at the end of the first quarter. The quarters operating earnings were slightly more than offset by changes in the fair-value of both our fixed-income and equity portfolios, share repurchases and dividend payments. On a year-to-date basis our book value per share is almost flat, reasonable result given that the S&P index was down almost 13%, [inaudible] aggregate was down by 1.4% and we paid out $0.96 per share in dividends.

For the six months net operating income was $371 million, compared to $481 million for the first six months of 2007. Realized capital losses and fair-value adjustments year-to-date were at loss of $141 million after-tax, almost all of which derived from our common stock portfolio, and almost all of which is mark-to-market related. In contrast, we had a realized gain of $99 million during the first half of 2007.

Net income including after-tax realized gains and losses was $231 million for the first half of this year, compared to $580 million for the first half of last year. Our operating ROEs were 12.8% and 13.2% for the second quarter and first half of 2008. Looking at the top line, in total our gross written premiums were $905 million for the quarter, 3% lower than the second quarter of last year. Our year to date gross written premium at $1.8 billion is down 9% compared to the first half of 2007, about in line with our expectations.

By segment, U.S. reinsurance at $200 million was lower by 26% for the quarter, both treaty property, and treaty casualty were lower. Treaty property was lower for the quarter due to increased common account reinsurance protections on some Florida business and non-renewal of several agreements. However, we do expect more favorable comparisons in the third quarter.

We continue to see less casualty business that meets our term requirements and our casualty book continues to shrink but at a slower rate than in prior periods. U.S. insurance recorded gross written premium of $191 million, up 18% compared to the second quarter of 2007. Our newer programs, most notably the brownstone program, plus growth in the CV stock program more than offset declines in our [inaudible] programs principally the workers comp and contractor-related books.

International at $219 million was up 8% compared to the second quarter of last year, we saw increased new business in Latin America and the Middle East, and some growth from existing business in Asia. Canadian premiums were down somewhat as we continued to see our Canadian retain more premium net. The Bermuda segment brought $211 million which was lower than in the second quarter of 2007 by 6%. The London and Europe book was up by 11%, compared to the second quarter of 2007, aided by the weaker U.S. dollar. The Bermuda book on the other hand was down due to a discontinued account and conversion of a large casualty quota share to an excessive loss cover.

Specialty segment gross written premium was $84 million for the second quarter up 10% from last year's second quarter. Remaining premiums were up significantly, primarily due to two new accounts. A&H was slightly lower and Surety was slightly higher.

Looking at underwriting results, the group combined ratio was 94.4%, for the second quarter of 2008 compared to 89.2% for the second quarter of 2007. The increase for the quarter results from a 2.2 point increase in the loss ratio, and a 3 point increase in the expense ratio. Most of the expense ratio increase is driven by commissions, which are moving higher because of competitive conditions, higher contingent commission payouts, and the structure of several quoted share agreements.

An increase in the reserve for the Centrix subprime auto loan credit insurance program, which is in runoff contributed 7.4 points to the group's loss ratio for the quarter and I will talk more about that in a moment. Absent discharge, the loss ratio would have been 56.8%, compared to 62% in the second quarter of last year, a decrease of 5.2 points, the principal drivers of the improvement were very low catastrophe losses in the second quarter of 2008 compared to the second quarter of 2007, 1.9 points in this year's second quarter versus 8 points in last year's second quarter, a 6-point improvement. This was partially offset by a 2.6 point higher accident year attritional loss ratio, that's excluding catastrophes, which was at 56.5%, compared to 53.9% last year. Most segments experienced increases in their accident year attritional los ratio; this is driven by changes in market conditions as well as changes in business mix.

Excluding the Centrix charge, we experienced $16 million or 1.7 points of favorable development across the remainder of our reserves in the second quarter of 2008. This compares to a deminimus amount of adverse development in last year's second quarter.

Our ongoing results are developing fine -- the accident year loss ratio is attractive, albeit slightly higher as one would expect given market conditions and trends. Our reserves are strong and ran off a little favorably in the quarter, exclusive of the Centrix strengthening.

On the subject of Centrix, the quarters and six-month operating results were negatively impacted by reserve additions for the Centrix subprime auto loan insurance program, which after taxes totaled $45.5 million for the quarter, and $55.4 million for the six months. Our previous reserve actions on this program were reasonable, given the actual historical loan-default rates and the claim amounts. However, the recent deterioration in general economic conditions and apparent adverse impact on loan performance, particularly subprime loan performance overall has resulted in unforeseeable in loan default base and claim amounts.

This program is our only exposure of this type, and it has been in run off since December of 2005, so I want to be clear that we're not in this business on a continuing basis. Moreover, we have commuted our remaining liability with our largest policyholder who represented about one third of the outstanding insured portfolio prior to the commutation that took place this quarter. Therefore given the magnitude of the current reserves, maturity of the remaining insured portfolio, and the reduced principal exposure, future loss development if any will not be material.

We believe this reserve strengthening is sufficient for several reasons. First, adjusting for the commutation, we had $51 million of reserves remaining to cover future losses on the remainder of the portfolio as of June 30th. This amount anticipates claims on 100% of the loans currently known to be in default, and contemplates claim payments attributable to future defaults on an additional 30% of the active loans.

Second, as of June 30, only 7% of the remaining insured loans were over 60 days past due. Looked at another one, 93% of the portfolio was current to less than 60 days past due. The portfolio by now is mature and seasoned. The average loan is 47 months old, and therefore the average borrower is obtaining for almost four years and demonstrated a strong propensity to pay.

Finally the oldest loans are 57 months old with only nine months remaining. Putting all of this in to perspective, our reserve now provides for defaults on 30% of the active loans, and as I said, we believe this is a very strong provision. Even in the highly unlikely event that the default on the remaining loans were to reach 50%, the after-tax impact would be just $15 million. So at this point there is just not enough remaining exposure for this to have a material effect on our balance sheet or the financial results in the future.

Moving on looking at cash flow. Cash flow for the quarter was $18 million, negative for the quarter, compared to $100 million for the second quarter of 2007. We paid out the arbitration loss we reported last quarter, plus premium collections have fallen somewhat as our premium bases declined. In addition, last year's second quarter cash flow benefited from reinsurance collected on prior accident year coverage that has since been fully exhausted.

Quarterly cash flows can be quite variable. Looking at year to date cash flow from operation, it's $232 million, compared to $263 million for the first half of last year. And that's probably more in line with what one would expect. Moving on to the investment portfolio, cash and invested assets were $14.6 billion at June 30, 2008, compared to $14.9 billion at year end. That's a decline of about $300 million. Year-to-date, operating cash flow was $232 million, and we've repurchased $126 million of our common stock, plus paid out $60 million in dividends, leaving $46 million that flowed into our investment portfolios.

On a year-to-date basis, we have experienced $150 million of market value loss on our public equity portfolio and $215 million on our bond portfolio, generally in line with the financial market's performance overall.

Given the Fed-driven decline in short-term rates, we've trimmed our short-term portfolios quite significantly, redeploying close to $1 billion into short duration or zero duration floating rate instruments, the intent being to increase our book income without significantly increasing our interest-rate risk. We estimate that this has mitigated what would have been about $20 million decline in our annualized investment income.

Our charge for other than temporary impairments for the quarter was $5.6 million, relatively immaterial, as our conservative portfolio continued to hold up well in the face of very volatile financial market conditions. The average quality rating of our portfolio remains very strong at AA2. The duration moved out just a bit to 4.4 years from 4.1 years as of March 31st.

As I noted, we redeployed about $1 billion in short-terms. As well, we've bought some longer muni bonds where the yields are going to be quite attractive relative to historical levels.

Looking at investment income, pre-tax investment income was $176 million for the quarter. That's down $3.8 million from the second quarter of last year. The decline was driven by short-term… lower short-term interest rates more than anything else. Our limited partnership investments after… for our first quarter performed much better than in the second quarter, producing an annualized return of about 15%.

If I may summarize, our gross written premium was down just slightly from last year's second quarter. Our current accident year results were strong. Catastrophe losses were light. And investment income was much stronger than in the first quarter.

Despite the charge for the Centrix program, our GAAP net operating income was $180 million and our combined ratio was under 95%. The Centrix runoff is well reserved at this point. And if there is any future development, it won't be material. So, that's behind us, which we view as a plus. On the other hand, the stock and bond markets have been both volatile and in decline since late last year and thus has constrained our ability to grow book value.

We continue to have a strong balance sheet. Our reserves are solid. Our capital position is strong with low operating and financial leverage. We have a well-diversified underwriting platform that's generating attractive combined ratios. So despite a tougher marketplace, we expect to continue to produce attractive results.

We now have authority to repurchase up to an additional 6.1 million shares of our common stock, which enables us to add further to shareholder value. While all of the markets in which we operate have become tougher, we will continue to run the business for the long term. We will continue to exercise underwriting discipline and we will focus on maximizing shareholder value.

That concludes my prepared remarks. And now, we'd like to open it up for questions.

QUESTION-AND-ANSWER

Operator

Thank you. (Operator Instructions)

And we'll take our first question from Tom Cholnoky with Goldman Sachs.

Thomas Cholnoky - Goldman Sachs

Good morning. I have a couple of questions. First, if I could just focus on Centrix for a second. Craig, in your 30% default assumption rate, are you assuming any recoveries in that forecast?

Craig E. Eisenacher - Executive Vice President and Chief Financial Officer

Not other than collateral value on the loans. So basically what we're doing is we're looking at an ultimate default rate. We're looking at the collateral value to come down to a net amount per claim and the reserves developed by the numbers of claims times the estimated average value of the claim. So, there is no recovery for anything else.

Thomas Cholnoky - Goldman Sachs

So if the value of the cars go down or you don't get the cars back, you are not assuming anything on that?

Craig E. Eisenacher - Executive Vice President and Chief Financial Officer

Yeah. If we don't get the car back, there is no claim. Part of the process of funding a claim in this situation is for the automobile to be auctioned off.

Thomas Cholnoky - Goldman Sachs

Okay. So, if auction values decline significantly from these values, could that raise your loss assumption?

Craig E. Eisenacher - Executive Vice President and Chief Financial Officer

Yes, it could. We've forecasted, you know, based upon the existing collateral value and forecasts are continuing to decline over time.

Thomas Cholnoky - Goldman Sachs

And how much… what is the balance of the loans outstanding? Is it about 170 million?

Craig E. Eisenacher - Executive Vice President and Chief Financial Officer

The loans outstanding after the commutation I mentioned?

Thomas Cholnoky - Goldman Sachs

Yes.

Craig E. Eisenacher - Executive Vice President and Chief Financial Officer

It's about 270 million, and we would estimate that exposure, that is the gap between the loan value less the collateral or what we are could pay for loan, is about 165 million at this point.

Thomas Cholnoky - Goldman Sachs

Okay. Okay. Got you.

Craig E. Eisenacher - Executive Vice President and Chief Financial Officer

So, our exposure -- I guess, another way to put it is our exposure at this point is $165 million. And it's going down as the loans either pay off or pay down.

Thomas Cholnoky - Goldman Sachs

Right, right, right. Okay. Some other people may have more questions on that. Two other quick questions if I can. In looking at the U.S. insurance business and the way the C. V. Starr business has kicked in, and I know there can be quarterly fluctuations in your premium volume, but 18% was very strong growth. How should we think about that going forward? Are you going up against some tougher comparisons, or is this a bit of anomaly in the quarter in terms of absolute growth?

Joseph V. Taranto - Chairman of the Board and Chief Executive Officer

Tom, I would say that you should look at the quarter it anomaly 18% is -- my guess would be much higher than what we would expect for the year. I think we're looking at something like 6% for the six months, and that would be, I think, probably a better gauge as to what you might expect for the year. But we do have a lumpy second quarter in terms of CV Starr premium, and even to a degree the brownstone premiums.

Thomas Cholnoky - Goldman Sachs

Okay. And then I guess on the buyback, if I can just real quickly, given, you know, how under -- much under pressure the stock was in the second quarter, why weren't you more active in buying back stock?

Joseph V. Taranto - Chairman of the Board and Chief Executive Officer

Tom, we have been buying back quite a bit of stock for the last year, as I suppose the -- as a whole industry has, you know, it's hard to say that we've seen an immediate result on that, although all of us believe that we'll see a quality long-term result, having invested in our ourselves, and we plan to continue to do that, which is why we've opt the authorization. But I will tell you, as we bought some in the beginning of the quarter, you know, we continue to look at what was happening in the -- in the financial markets. We saw the trends that were going on that were just, you know, causing the numbers to be read for everybody that was in the financial sector.

Candidly, I thought we could just pause, take a step back, see where the market was going because we certainly couldn't change it in and of ourselves. Having said that, yes, we have dropped to appoint -- and I think many other companies would say the same thing that we think is irrational, and we're very happy to start repurchasing and investing in ourselves for the long term once again. By not buying sooner, that just means that we have more to buy with at this stage of the game. We're going in to the third quarter, which typically is you know, hurricane quarter, and in the past we decided not to purchase and put that message out, we're not taking that approach here. We will maintain flexibility and frankly we expect to be purchasing in the third quarter.

Thomas Cholnoky - Goldman Sachs

Okay. Great. And sorry one last, just number's question, IBNR is a percentage of total reserves, where does that stand now roughly?

Craig E. Eisenacher - Executive Vice President and Chief Financial Officer

Off the top of my head, I can't answer that. I can check and let you know offline.

Thomas Cholnoky - Goldman Sachs

Okay. Great. Thanks.

Operator

And we'll take our next question from Jay Gelb with Lehman Brothers.

Jay Gelb - Lehman Brothers

Thanks and good morning. On the reinsurance businesses given the difference in growth trends between primarily insurance and reinsurance, can you sort of give us your outlook for '08 for gross written premium growth? If we should expect, say, 6% for the year in insurance?

Joseph V. Taranto - Chairman of the Board and Chief Executive Officer

Well, let me start with, you know, it's hard to be precise about this. So, I don't want everybody leaving with 6% in their mind. That's only precise, and it's a very, very a changing marketplace, and challenging marketplace, but, you know, it's been tougher on the reinsurance side than it has on the insurance. As I have mentioned in previous calls, we're well established and then seasoned on the reinsurance side, whereas, we're relatively young company on the insurance side.

Casualty reinsurance, we have a tough situation with people keeping more net with reinsurance terms getting more favorable for CD company, and so that continues to become a lower percentage, and even on the property side, you know, it is certainly getting a bit tougher. So, I would expect that we would decline in the second half of 2008, relative to what we wrote in the second half of 2007.

Jay Gelb - Lehman Brothers

For reinsurance overall?

Joseph V. Taranto - Chairman of the Board and Chief Executive Officer

For reinsurance over overall. For our U.S. reinsurance.

Jay Gelb - Lehman Brothers

Okay.

Joseph V. Taranto - Chairman of the Board and Chief Executive Officer

On the international side, we continue to do quite well, and as I mentioned, in July, we were really pleased with the results that we achieved. Now, we're pleased with what we did on the property reinsurance in June and July as well, which is mainly the Florida marketplace, but I still see casualty reinsurance kind of reducing in the U.S. and probably taking down the amount of U.S. reinsurance in the second half, again, relative to last year. International, probably would be modestly up in the second half relative to last year. That's my best guess.

Jay Gelb - Lehman Brothers

Okay. And if I kind of pull that all together, I think initially at the beginning of the year, Joe you were talking about a 5% to 10% decline overall in gross written premium, you still okay with that range?

Joseph V. Taranto - Chairman of the Board and Chief Executive Officer

I am, I mean obviously, we were higher in the first quarter, lower in the second quarter, and I guess what we're 9% at this stage of the game, so we fallen in to that range. But yes, given the climate, and we put our whole book together, the whole composite, I would still expect us to fall in that range.

Jay Gelb - Lehman Brothers

All right, thank for that. And then the partnership income showed that a sharp rebound in 2Q. What was that driven by given a tough market for the industries overall?

Craig E. Eisenacher - Executive Vice President and Chief Financial Officer

Really what happened in the first quarter is the limited partnerships with public equities did terribly, and in the second quarter that wasn't the case. So, the rest of the portfolio performed about the same.

Jay Gelb - Lehman Brothers

And how are things looking so far in 3Q?

Craig E. Eisenacher - Executive Vice President and Chief Financial Officer

We -- you know, we get reports on -- you know, monthly or quarterly basis from our LPs, so, you know, at this point I would anticipate that it's probably more of the same.

Jay Gelb - Lehman Brothers

Great. And then just a final quick one, on the -- does Everest Re have any exposure to crop reinsurance in the US for reinsurance?

Joseph V. Taranto - Chairman of the Board and Chief Executive Officer

No, we don't have any.

Jay Gelb - Lehman Brothers

Okay. Thanks very much.

Operator

And we'll take our next question from Josh Shanker with Citi.

Joshua Shanker - Citigroup

Good morning.

Joseph V. Taranto - Chairman of the Board and Chief Executive Officer

Good morning.

Joshua Shanker - Citigroup

My first question regards the retentions on the primary side. They have doubled from what they were a year ago, 19% now from 10%. Of course you had the growth of 18% from CV Starr and Brownstone. I am trying to understand in terms of business mix, are you ceding that CV Starr and Brownstone business or ceding your legacy business and retaining a lot of that CV Starr and Brownstone business?

Craig E. Eisenacher - Executive Vice President and Chief Financial Officer

There is more reinsurance being purchased on the primary side.

Joseph V. Taranto - Chairman of the Board and Chief Executive Officer

And there is an increase because of CV Starr. CV Starr is more volatile, bigger limit program than many of our other programs, and so it -- it requires us to get some partners on the reinsurance side.

Joshua Shanker - Citigroup

And how do you feel about the terms, the pricing of the reinsurance that you are buying, versus the reinsurance that you are selling. Do you see -- do you see that softening compared to where it was a year ago?

Joseph V. Taranto - Chairman of the Board and Chief Executive Officer

Well, yeah, I mean the trends that we are seeing as we are reporting, is it's getting tougher for reinsurers, so we are seeing people asking for more commission and better terms and certainly the market is headed that way.

Joshua Shanker - Citigroup

Okay. And coming back to Centrix, I know it's a sore subject but I got to keep with at it little longer.

Joseph V. Taranto - Chairman of the Board and Chief Executive Officer

Okay.

Joshua Shanker - Citigroup

In terms of -- of your confidence and your current level of adequacy with regards to it, are you saying that you were so adequately reserved that there's the possibility of being meaningfully over reserved at this point? Have you -- Is there any reason to consider that?

Craig E. Eisenacher - Executive Vice President and Chief Financial Officer

I wouldn't go there at this point. I think the experience has been -- it's continued to deteriorate for sometime if we take a heavier hand this quarter than we have in prior quarters. Absolutely we have, but that's -- that's not to say that we're, you know, expecting to have a significant redundancy here. I think we're in good shape with it.

Joseph V. Taranto - Chairman of the Board and Chief Executive Officer

Let me add to that, and -- and you are right, Centrix has been a painful experience for us in the past that we don't just dislike. We hate. So, let's get that clear. But we are trying to very clearly communicate to you that its -- the good news is it's in the past. You know, I think Craig has taken you through a host of numbers, and went through Armagedon, at least in our minds, which 50% to both on loans that don't have much longer to go that have been paying for four or five years, and that comes down to net-net after tax $15 million. So clearly, you can see, you know, this is a past item. This is not a future item. So, that part is -- is the good news, and we're looking to move on to talking about what will our affect our business in the future.

Joshua Shanker - Citigroup

Well, is there any IB&R in the reserving for Centrix, or is it really all case?

Joseph V. Taranto - Chairman of the Board and Chief Executive Officer

No, it includes, these are all defaults -- ultimately, this is not the way some companies do it, where they don't post the reserve until there is a default. This is ultimate, if you will.

Craig E. Eisenacher - Executive Vice President and Chief Financial Officer

Our lag from when a loss is reported to us, we paid is very short. So, actually it is almost all IB&R.

Joshua Shanker - Citigroup

Okay. Thank you.

Operator

And we'll take our next question from Susan Spivak with Wachovia.

Susan Spivak - Wachovia Securities

Good morning. I guess a lot of questions have been answered, but Joe and Craig, couple more. I was hoping on a net-net basis in Florida versus a year ago, could you tell us how much you did increase your exposure there? That's my first question. And then second, and this is broader, Joe, your stock looks like it is going to test the valuation lows of 1999 at this point, or at least come close, and, you know, I'm very happy to hear that you are -- will be repurchasing chair shares, even in the midst of hurricane season. But could you compare and contrast the fundamental reinsurance market now versus then, and Everest position now versus what you were like back then at this time when the stock trade at this point?

Joseph V. Taranto - Chairman of the Board and Chief Executive Officer

Let me start with the second part, Susan. You are correct. In 1999, I think the stock fell to something like 72% of book. We felt that made no sense. We went in, we bought 10% of the stock at that particular point in time, proved to be the best investment that we could -- we could make. If I had to contrast -- and we thought it was an irrational price then, and frankly, we think it is an irrational price now. If I had a contrast, the market in 1999, the reinsurance market, was terrible, and frankly is much better today than it was in 1999. There's plenty of deals to be found today that are adequately priced or more than adequately priced. It was very difficult in 1999 to find much of anything in any line in any country that was reasonably -- reasonably priced. I would add to that that the balance sheet of most of the companies in the industry in 1999 were -- were not very good, and when you think about 1997 and '98 and '99 that ran off very poorly and that wasn't fully appreciated at that point in time. But if you really throw that into the thinking process, the balance sheet today for us and most people in the industry are just much, much stronger than they were in 1999.

So, yes, some comparisons be made in the sense that in 1999, during the dot-com boom, we were labeled old economy, and for that reason, traded to levels that made no sense. And frankly when you start throwing in the balance sheets today and the marketplace today and our strength today, frankly it doesn't make a lot of sense to us today either.

The Florida market, on balance, I would say that our increase in exposure in Florida has been just over 5% in cat capacity.

Susan Spivak - Wachovia Securities

Okay. Well, it won't be so bad if your stock performed the way it did in 2000 from here. So, that would be great. But another just follow-up question.

Could you talk about a little bit about whether you are starting to see some additional business on the casualty reinsurance side, coming out of, say, the woes of other companies we saw yesterday that there is talk of State [ph] bringing excel reoff of their approved lists? I would think that you'd be the one of the primary markets to benefit, you know, as we see problems at other companies.

Joseph V. Taranto - Chairman of the Board and Chief Executive Officer

Well, I would just say that we're pleased that, you know, we're A+ Best and AA S&P, and that really does mean that we see all the best deals. And obviously, as ratings change for others, that can be helpful to us.

Susan Spivak - Wachovia Securities

All right. Okay. Thank you, Joe.

Operator

And we'll take the next question from Matthew Heimermann with JPMorgan.

Matthew Heimermann - JPMorgan

Hi. Good morning, everyone.

Joseph V. Taranto - Chairman of the Board and Chief Executive Officer

Good morning, Matt.

Matthew Heimermann - JPMorgan

I had a… Joe, I was just wondering if you could clarify something from your earlier comments. You made the comment that, I think if I heard it right, that with excess pricing and profitability falling, quota share profitability was up. And I don't know if you were just… that was a relative comment or absolute. And if it was absolute, I was just wondering if you could explain why that would be the case.

Joseph V. Taranto - Chairman of the Board and Chief Executive Officer

Sure. Let me take through that. Roughly 80% of the premium dollars that we get from Florida are actually share proportional. So, you know, we're in there with the underlying insured and pretty much experiencing the same loss ratios that they do.

If they are suddenly paying excess rates that are 15% lower than the rates they were paying the year prior, then on that basis alone, you would expect their loss ratios to be better. And therefore, our loss ratios would be better. So, it's kind of a good news-bad news thing.

With excess rates going down when we're an excess reinsurer, we're getting paid less. We're not thrilled about that. But as a proportional reinsurer, which is 80% of the business, our loss ratio is actually improving.

And I think when you put it all together, I really see our profitability picture and potential going forward being much the same. As Tom noted, our exposure maybe up on some of the proportional deals. We did have to offer some more capacity. But you can see how just excess rates coming down actually work to our betterment.

Now, it gets a little muted. It's a little more complicated than that, because now the insurance companies have to get approval from the insurance department with regard to rates and they do have to factor in, in part their reinsurance costs and certainly the State may want them to take rates down a bit, because they're paying a bit less.

But still I think on balance when you put it all together for our portfolio, I don't really see the potential profit diminished.

Matthew Heimermann - JPMorgan

Okay. And does the excess add [ph] on to your benefit in all cases on all quota shares?

Joseph V. Taranto - Chairman of the Board and Chief Executive Officer

Yes, unless we choose not to buy or participate with the client. But if we are participating with the client in essentially what they've bought and our net loss ratio will be the same as their net loss ratio, and suddenly they are paying less for reinsurance, then yes, it works to our benefit.

Matthew Heimermann - JPMorgan

Okay. And then just a numbers question. Can you give us the P&L as it stood at June 30?

Joseph V. Taranto - Chairman of the Board and Chief Executive Officer

The P&L for what?

Matthew Heimermann - JPMorgan

Just your 1 and 100 P&L, as a percentage of… I think you guys gave it as a percentage of shareholders' equity.

Craig E. Eisenacher - Executive Vice President and Chief Financial Officer

I think we disclosed it as of January 1st in the 10-K. I would say it hasn't changed this time. I think as Tom indicated, we're up maybe 5% in Florida, but there is not a significant change in that.

Matthew Heimermann - JPMorgan

Okay. And then, Craig, on that… you made the comment about the reallocation out of short-term investments.

Craig E. Eisenacher - Executive Vice President and Chief Financial Officer

Correct.

Matthew Heimermann - JPMorgan

And you were a bit quantitative, and that that was going to save 20 million of NII. Yet, NII looked a bit lighter than I would have expected even with the move in rates. So, I'm guessing is… was there something about the allocation in 1Q that depressed NII relative to run rate or it was the --.

Craig E. Eisenacher - Executive Vice President and Chief Financial Officer

The portfolio… the short-term portfolio was much larger in the first quarter. And short-term rates, of course, were lower in the first quarter of this year than the first quarter of last year. So, that was part of it. And then we basically made most of the move from short-terms into floaters, some longer-rate paper, et cetera, in the second quarter. So, you don't really see the full impact in the second quarter, because it took place during the course of the quarter.

Matthew Heimermann - JPMorgan

Okay. That is fair. And then the only question on Centrix that I had was just you know, on subprime there's been a delineation in terms of vintage, I mean, kind of '06, and later is worse than '05 and prior. Now obviously you stopped originating the business kind of at that demarcation point, but I was just curious within your book, do you notice any difference in performance for old versus new?

Craig E. Eisenacher - Executive Vice President and Chief Financial Officer

Generally speaking the newer the origination month or vintage as you call it, the worse the experience is.

Matthew Heimermann - JPMorgan

Okay.

Craig E. Eisenacher - Executive Vice President and Chief Financial Officer

Generally speaking, it's not universally true. I mean we're looking at these things on a month-by-month basis. That's kind of generally speaking the trend on the newer worsen the trends on the older.

Matthew Heimermann - JPMorgan

Okay. All right, thank you very much.

Operator

And we'll take our next question from William Wilt with Morgan Stanley.

William Wilt - Morgan Stanley

Hi, good morning. Craig, a question for you, staying with the investment scene, in the first quarter call you mentioned that you -- that Everest has purchased lots of Fannie Mae and Freddie Mac, and I was wondering if you could quantify that, describe what those securities are, maybe just give an update on their performance.

Craig E. Eisenacher - Executive Vice President and Chief Financial Officer

Lots for us -- I think we hold $130 million, so lots is maybe not lots in the context of some other companies and basically, those securities are at-cost in our portfolio at this point no debt securities.

William Wilt - Morgan Stanley

And there are senior debt of Fannie Mae and Freddie Mac?

Craig E. Eisenacher - Executive Vice President and Chief Financial Officer

Excuse me.

William Wilt - Morgan Stanley

I'm sorry. There was senior debt of in your data of Fannie and Freddie.

Craig E. Eisenacher - Executive Vice President and Chief Financial Officer

They are debt securities of Fannie and Freddie, yeah.

William Wilt - Morgan Stanley

Okay. Thanks for that. And the question on commissions, you commented that commissions are going up is that the natural sort of cycle. Could you quantify how much they have gone up thus far and maybe relative to past cycles where you are in terms of work, where the market is in terms of upward pressure on commissions?

Thomas J. Gallagher - President and Chief Operating Officer

Commissions right now are -- I think as Craig suggested there about 3% higher than they have been in the past. I don't know if I can give you an answer this relates to other segments of the market in different times, but it's a fairly good-sized increase 3 points over a year. So I don't know if it will go much further.

William Wilt - Morgan Stanley

That's fine. I appreciate that. So it's 3% higher than a year ago?

Thomas J. Gallagher - President and Chief Operating Officer

Yes.

William Wilt - Morgan Stanley

Average? Okay. Thanks very much.

Operator

And we'll take our next question from Vinay Misquith with Credit Suisse.

Vinay Misquith - Credit Suisse

Hi, good morning. On your Florida exposure, would it be fair to say that you are more exposed to frequency rather than severity events? And what sort of losses maybe should we expect from a smaller storm, say a storm that cause around $5 billion worth of losses?

Joseph V. Taranto - Chairman of the Board and Chief Executive Officer

Well, I guess you would say yes that we would be more than people are just doing excess exposed to smaller storms and frequency on that, but when you start getting in to the smaller-storm scenarios, frankly the modeling that we do with most of our clients, they still come out profitable for the year. I mean, in the main -- I think you see something like 50 is combined on most of these insurance companies in Florida if there's no hurricanes. So there is certainly room for small hurricanes and even more than one, so, yes, you would see some losses where if you were only excess, you wouldn't have any losses, but we believe we would still be look at a profitable scenario, even for the pro rata unless you get into a big loss scenario.

Vinay Misquith - Credit Suisse

Its fair enough. Is most of your exposure with the home owner's or do you also have some amount of commercial in there?

Joseph V. Taranto - Chairman of the Board and Chief Executive Officer

We have both, but most of it with the home owner.

Vinay Misquith - Credit Suisse

All right, fair enough. And a question on the investment portfolio, I noticed that the mixed move from -- you know, lower AAA to more A and AA, was it a function of the financial guarantors being downgraded, or did you actually move some securities from AAA to A and AA.

Craig E. Eisenacher - Executive Vice President and Chief Financial Officer

The biggest factor was the monoline downgrades. It affected about $1 billion of our muni paper. So, that was all AAA and its now basically AA and A in category. I would point though that our A and higher -- the A and higher portion of the investment portfolio, was 91.6% at December 31st, and its 91.3% now, so it's not like we have taken the stops out in terms of our quality buys.

Vinay Misquith - Credit Suisse

Sure. Fair enough. One last question on U.S. insurance, you are accident -- your combined ratio was 101% this quarter, I was just wondering whether there was something special this quarter or -- and what would you expect the run rate normally to be within U.S. insurance?

Craig E. Eisenacher - Executive Vice President and Chief Financial Officer

I thought it was like 98.

Joseph V. Taranto - Chairman of the Board and Chief Executive Officer

Let me get in to what the run rate is. We really expect on the ongoing programs to be achieving an underwriting profit, something in today's market that would put us in to the probably low 90s combined, worse-case scenario, mid-90s combined. It's getting tougher to get huge margins but most of our programs are still rated that way, and we believe will produce those kinds of results.

Thomas J. Gallagher - President and Chief Operating Officer

Yeah, and there's some distortion in the numbers you see because of the Centrix going through the insurance portfolio.

Vinay Misquith - Credit Suisse

Fair enough. All right. Thank you.

Operator

And we'll take our final question, it is a follow-up from Jay Gelb with Lehman Brothers.

Jay Gelb - Lehman Brothers

Thanks, I said one follow-up on Centrix. You said that the reserve going forward assumes 30% delinquency on remaining loans. What has the historical delinquency trends been and also for the more recent vintage years?

Craig E. Eisenacher - Executive Vice President and Chief Financial Officer

That's default, so we're assuming that 30% of the remaining loan portfolio will result in claims. That -- you know, that portfolio is fairly mature at this point. I guess the way to compare it and contrast it might be that as of the end of the first quarter, we assume that 38.5% ultimate default rate on the portfolio, and it's now up to 44%. And that's on the portfolio as a whole based on the original loans. And basically, if you look at the trends in terms of how the default rates develop, we see very little development beyond 48 months. Now, I have to say that, you know, there's not a lot of experience, and we don't have any loans that have actually gone all the way to maturity. So it looks to us, based upon the historical data, like there isn't an awful lot of development from 48 months to maturity, based upon what we can see at this point. It's the younger loan, is the loans from 36 months to 48 months, which is where we have seen development in the past. Does that make -- does that help you.

Jay Gelb - Lehman Brothers

Right. And you said even if it goes to 50% default rate, it's a $15 million hit?

Craig E. Eisenacher - Executive Vice President and Chief Financial Officer

After tax, yes.

Jay Gelb - Lehman Brothers

Okay. Thanks.

Craig E. Eisenacher - Executive Vice President and Chief Financial Officer

I don't want to say that's inconceivable, but it seems almost inconceivable.

Jay Gelb - Lehman Brothers

Separate issue, on the effective tax rate that was lower in the first half of '08 than '07. What is the right run rate for the effective tax rate?

Craig E. Eisenacher - Executive Vice President and Chief Financial Officer

If you look at the year to date tax rate, that's based on your expectation for the year. The quarter, of course, was impacted by the Centrix loss, which was all deductible in the US.

Jay Gelb - Lehman Brothers

So around 15%?

Craig E. Eisenacher - Executive Vice President and Chief Financial Officer

More or less. That's pretty close.

Jay Gelb - Lehman Brothers

Okay. Thank. And then the final one, on M&A, Joe, we have seen a couple -- well, we have seen increased activity sector wide in mergers and acquisitions, how does Everest Re potentially plan trying to take part in that?

Joseph V. Taranto - Chairman of the Board and Chief Executive Officer

Well, you know, we've answered this before. I think in terms of agency books, we have ongoing discussions. Those ended up being smaller deals. We have some -- some interest on the insurance side to amplify our platform. We don't have too much interest on the reinsurance side. Where stocks are trading at right now, should really reduce the number of potential deals that certainly our point of view as well. But most of our history has-- has been -- you know, we eat our own cooking and -- so we don't want to dismiss acquisitions, but it would have to be strategic. It certainly would be not for the sake of just growing top line.

Jay Gelb - Lehman Brothers

Great. Thanks very much for the answer.

Operator

And that concludes our question-and-answer session. I would like to turn it back over to our speakers for any additional or closing remarks.

Elizabeth B. Farrell - Vice President, Investor Relations

Okay. This is Beth Farrell. Again, thank you for participating. If you have any further questions, please feel free to call.

Operator

That does conclude our conference for today. Thank you for your participation, and have a great day.

.

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