Validus Holdings, Ltd. Q2 2008 Earnings Call Transcript

Validus Holdings, Ltd. (VR)

Q2 2008 Earnings Call Transcript

August 8, 2008 10:00 am ET

Executives

Jon Levenson – SVP

Ed Noonan – Chairman and CEO

Jeff Consolino – EVP and CFO

Analysts

Matthew Heimermann – JPMorgan

Jay Cohen – Merrill Lynch

Ian Gutterman – Adage Capital

Susan Spivak – Wachovia

Chuck Hamilton – FTN Midwest

Brian Meredith – UBS

Ron Bobman – Capital Returns

Presentation

Hello, and welcome to the Validus Holdings, Ltd. second quarter 2008 conference call. (Operator instructions) Please note this conference is being recorded.

Now I would like to turn the conference over to Jon Levenson. Mr. Levenson, you may now begin.

Jon Levenson

Thank you. Good morning, and welcome to the Validus Holdings, Ltd. conference call for the quarter ended June 30, 2008. Leading today's call are Ed Noonan, Chairman and Chief Executive Officer, and Jeff Consolino, Executive Vice President and Chief Financial Officer.

After the market closed yesterday, we issued an earnings press release and financial supplement, both of which are available on our website, validusre.bm. Today's call is being webcast and will be available for replay. That link can also be found on our website.

I'm obliged to remind everyone that certain statements made during this call may be deemed forward-looking within the meaning of U.S. securities laws. Such statements reflect the company's current view of future events and financial performance and incorporate our perspective on risks and uncertainties. More detail on this topic can be found in our most recent Form 10-K annual report as filed with the US SEC.

Management will also refer to some non-GAAP financial measures while describing the company’s performance. These measures are described in our earnings release and financial supplement.

With that, I'd like to turn the call over to Ed Noonan.

Ed Noonan

Thanks, Jon and thank you to all for joining us this morning. I'd like to cover the headlines for the quarter. Then I'll hand off to Jeff Consolino to cover the financials in more detail after which I will come back and provide you a bit more color on our business and take any questions you might have.

(inaudible) Validus Holdings had an outstanding quarter. We grew our book value by 3.6% inclusive of dividends and generated a 22.1% annualized operating return on average equity. We think long-term growth in book value is the best measure of success and we have grown our book value by 22.6% including dividends since our IPO last July.

Our strategy of creating a globally diversified short-tail insurance/reinsurance group is clearly working.

Our Talbot’s syndicate at Lloyd turned in 86.4% combined ratio for the quarter and Validus Re insurance had a great quarter despite the number of claims in the broader market generating 52.1% combined ratio. While we were helped by the absence of major catastrophe losses in the quarter that is only part of the story. Our specialty products are performing very well and the global diversification of our portfolio has had significantly to our profitability.

I am also pleased to report that Moody’s has assigned us an A3 financial strength rating or second A category rating. We are pleased by this validation of our financial strength and risk management infrastructure.

So with that, let me turn the call floor over to Jeff and he will cover the financials for you, and then I'll come back with more commentary.

Jeff Consolino

Good morning, everyone. I'm pleased to provide additional details in the second quarter where we produced an annualized operating return on average shareholders' equity of 22.1%.

We grew diluted book value per share plus accumulated dividend by 3.6% despite rising interest rates and we produced diluted operating EPS of $1.45, which represents a 16.6% year-over-year growth and 19.8% year-over-year growth on a pro forma basis.

As a reminder, we completed the acquisition of Talbot on July 2, 2007. We have consolidated Talbot's financial results from the date of acquisition, commencing at the beginning of the third quarter of 2007. A year-over-year look at Q2 will not be comparable to only due to the Talbot transaction but also our July 2007 IPO. Our investor supplement presents pro forma income statement for Q2 of 2007 and the 6-month period to June 30, 2007. Thankfully this will be the last quarter where comparatives are not relevant, and this is the last time I am going to make this reference on an earnings call about Talbot.

With that as an overview, I will now provide further detail on Validus' second quarter 2008 results. We provided you with a number of documents to follow along with, the earnings press release, our investor supplements, and a supplemental 8-K detailing certain elements of our investment portfolio. All of these are available on our website.

Net income for the second quarter of 2008 was $75.9 million. Net operating income for the second quarter of 2008 was $111.7 million. Two major differences between net and operating income, first the interest rate driven change in the unrealized gain and loss division of our investment portfolio, which we take 100% through our income statement. Second, the gain on retirement of a portion of our hybrid junior subordinated deferrable debentures which we announced in April 29 that was an $8.8 million gain.

In the quarter, we recorded $10.2 million of loss expense related to US storm and flood events, all in the Validus Re segment. Also in the quarter we benefitted from $11.1 of favorable loss reserve development equal to 3.6 loss ratio points. The split of this $11.1 is $480,000 in the Validus Re segment and $10.6 million in the Talbot segment.

Please note that as a result of the higher syndicate profit generated by Talbot due to the prior year adjustments, the Talbot FAL expense is correspondingly higher. The consolidated benefit of prior years net of this FAL effect is $7.5 million or $0.10 per diluted share.

l will now spend a brief moment on each of our two operating segments. Validus Re had a superb quarter. The combined ratio was 52.1% consisting of a 29.7% loss ratio and an expense ratio of 22.4%. This 29.7% Q2 2008 loss ratio compared to 32.1% in the previous year second quarter. Within that again we reported $10.2 million of event losses in Q208 from US cat activity, which is 6.2 loss ratio points. Comparing to last year the UK and Australian flood events were 18 points on our loss ratio. In Q2 of 08 there was $0.5 million of favorable loss reserve development in Validus Re. Last year favorable developments in Q207 for Validus Re was 7.1 points of benefit.

Gross premiums written in the second quarter of '08 increased by $13.5 million in the Validus Re segment to $187.8 million. However, Validus Re gross premium written is $33.5 million lower in the prior year through six months. The increase in the quarter is in the property area, which Ed will describe in further detail in his comments.

Turning to the Talbot segment, Talbot also had excellent results very consistent with their 2007 second quarter. Talbot's combined ratio was 86.4% in the second quarter of '08, which was made up of a 50.6% loss ratio and a 35.9% expense ratio. The 50.6% Q208 loss ratio included $10.6 million of favorable prior year developments. This was worth 7.3 loss ratio points.

Turning to our investment portfolio, our investment portfolio was $3.23 billion at June 30, 2008. We continued to follow our conservative investment strategy, emphasizing liquidity and preservation of invested assets.

As we did in the previous two quarters, we furnished via Form 8-K additional disclosure regarding our consolidated investment portfolio. There was no meaningful change in the unrealized position, adverse or otherwise for subprime, Alt A or monoline insured investments. Other than these positions continued to reduce.

Diluted book value per share at June 30, 2008, was $25.12 including the $0.20 per share dividend we paid in the quarter, the increase in book value plus accumulated dividends equaled 3.6%. Somebody who bought into our IPO last July was buying into pro forma diluted book value per share of $20.89.

Over the last 12 months in that point, we have increased diluted book value per share by $4.23 and paid $0.40 in dividends to bringing the total return on that starting pro forma booked to 22.6%. After the repurchase of $45.7 million of principal amount of our hybrid Junior Subordinated Deferrable Interest Debentures, our financial leverage if 12.9%. It is sourced all from hybrids, which we think is very high quality long-term capital.

Finally on capital, we did the cross the one year anniversary threshold from our IPO. As a result we are now eligible to file a Shelf Registration Statement. Gaining that financial flexibility was one of our goals that led us to go public in the first place. As noted in our press release, neither we nor our qualified sponsors have any current intention to sell securities from these shelves including common shares.

I would now like to turn the call back over to Ed Noonan for further commentary on our business.

Ed Noonan

Thanks Jeff. So in terms of market conditions there is obviously lots of competition in virtually every part and we are not immune. I think it helps that we are starting from a position of relevant rate strength in most lines as we are operating in the best price areas of the global market. As you have heard from our competitors, the reinsurance market is showing good discipline and we feel very good about our catastrophe portfolio heading into wind season.

One doubt that I would offer is that the strong growth shown in Validus Re for the quarter is a bit misleading and if we had one-time premium adjustments in the second quarter of last year that did not recur and this year we had one significant contract change renewal date from July 1 to June 1. In the aggregate, Validus was up slightly year-over-year.

While catastrophe reinsurance is only 25% of our business given the time of Europe, I like to start by providing some background on our cat portfolio. While many people think that cat reinsurance is a commodity, we think that the cat market is actually highly inefficient and therefore creates the opportunity for our performance. There are deals with good data that are well priced, deals with good data that are bad priced, yields with bad data that are well priced and so on. Our job is to maximize our participations on the best-priced business with companies that have high quality data and superior secondary characteristics. We have made a big investment in technology and analytic expertise to accomplish this and that is the reason why we feel so good about our portfolio as we head deeper into wind season.

We are modeling exposures today that may of our competitors are only beginning to contemplate. As a result we're making better informed decisions. Our analytic ability and our willingness to share our insight with clients has become a competitive differentiator for us and allows us to play on a much bigger stage that we otherwise fit.

The key activity in the second quarter is the renewal of the Florida cat market. You're heard all the market commentary and so I thought I might take a different track and share with you how we approach the Florida domestic company. By way of background, of the Florida catastrophe and risk that we take on roughly 30% comes from carriers that ride only in Florida or Florida domestic. While pricing was good for most Florida-only companies our approach is to concentrate our capacity in a small number of Florida domestic players. We select based on management quality, data quality, geographic concentration et cetera as well as reinsurance. But we go a step further and look for companies that have the proven track record of claim settlements, well staffed and trained call centers, strong control over claims’ TPAs, and most importantly the financial wherewithal to survive significant events. Solvency matters a great deal to us and many Florida companies are adjusting reinsurance to meet state requirements. We believe that well capitalized companies will not only be around to more effectively settle their claims but they will also be their buying reinsurance next year. In a volatile geographic area like Florida we think it is critical to be able to trade through time with companies. There is no good will built up in paying claims for a company that goes out of business. So we have gone as far as to construct the solvency metric to contemplate our estimate of the company's exposures, their capital, and the amount of reinsurance they have in place. Not many companies satisfy our selection criteria and the result was that 70% of the aggregate that we provide for Florida only companies is concentrated on a handful of very well run and well capitalized carriers.

Our overall goal in the cat business is to maximize our expected profit relative to the volatility we take on. As part of that strategy, we purchased $87.5 million of indemnity-based retrospection against our cat portfolio this year. Unlike capital market products with capacity of very high level the coverage we purchase capacities $150 million for all natural catastrophes in the US and Caribbean. The coverage is not a straight $87.5 million above $150 million as we opted to co participate in some of the layers. Consistent with our strategic goals the retrospection we purchased materially improves the sharp ratio of our portfolio. The balance of our reinsurance business performed extremely well in the quarter. While we picked up some exposure to US catastrophes they were lower than our expected losses. We experienced no material individual risk losses of note in the quarter and we continued to be nimble in pursuing opportunities and also in exiting business that doesn’t meet our standard. Talbot underwriters at Lloyd’s syndicate saw an uptick in frequency of smaller claims this quarter, although in the aggregate the syndicate obviously performed quite well. Pricing in the direct and facultative markets continues to be overly competitive than we follow through on the commitment we described to you last year to shrink where we found rates and terms to be deficient. We are reducing both revenue and unit counts on North American direct and facultative portfolio as part of our commitment to underwriting process above all else. Our underwriters are walking away from underpriced risks and we are frankly applauding them for it.

Talbot has several significant advantages that have helped their consistent performance since their founding. The syndicate focuses on specialty lines with the disproportionately lead underwriter setting both price and terms. Talbot also targets smaller risks in most of the classes and seek to diversify their portfolio by both product and geography. As in most markets smaller accounts are somewhat less competitive and this is a clear benefit to Talbot in the (inaudible) classes.

Finally, we were at virtually no US liability business as the accident year combined ratios in this segment are creeping over 100%, and we see this trend getting worse before it gets better. When we acquired Talbot we talked about the benefits of Lloyd’s licenses, ratings, and infrastructure. We've leveraged these assets to set up shop both in Singapore and Miami this year. Both our offices are up and writing business. We find Southeast Asia to be very competitive and we don't expect rapid growth as a result. While there's clearly room for Talbot’s marine, energy, construction, and political violence products in this territory. Our office in Miami covers Latin and South America and while there's competition in the market we do see near-term opportunities in this territory. We put in place a very talented team with excellent technical skills and close relationships in the market and we're very optimistic for the future as both an insurer and reinsurer in Latin and South America. The cost and time to market is greatly reduced in both these operations as a result of the Lloyd’s licensing and infrastructure.

Another distinguishing factor in our results for the quarter is the quality of our earnings. At Validus, our earnings have grown from current performance too a much greater extent than most companies in our industry. Our holding reserve releases of the (inaudible) IBNR to a lesser extent the minor adjustments and the small number of event claims that just haven't risen to the level of our original reserves.

In the aggregate reserve releases comprised only 7% of our earnings and we continue to reserve our business very conservatively. We make our money underwriting and we see many companies across the industry allowing current accident year results to underperform as a result of subsidies [ph] from prior year redundancies.

A couple of comments on risk management. By now you have seen our investment package I hope, which includes enhanced disclosures regarding the risk we take on. We provided more data points across our catastrophe portfolio to help you gauge our risk from natural disasters. We will continue to refine our disclosures over time to try and provide the most transparency and insight possible.

We continue to steer by the same risk tolerances, keeping our maximum asset risk in any one zone to roughly 65% of capital and our 1 in 100 year PML at 25% or less of capital. I would observe that not all zonal aggregates are created equal in companies that approach them in different ways. We have taken a very conservative approach including combining Florida with the Northern Caribbean and adding the appropriate amounts from our offshore Gulf of Mexico portfolio to our onshore exposures.

In terms of risk management, I had a really interesting experience a couple of weeks ago. So, I think it is a good example of the rigorous risk management that we are building worldwide. I think you are all aware of the Qantas flight that developed a hole in the fuselage in midair. Before I even received the breaking news email through CNN, I got an email from our global aviation reinsurance practice leader in London advising me of our exposure to that particular airplane and our worst case exposure had there been total loss of life. Fortunately there wasn’t loss of lives, but that is the standard of risk management that we strive for in all of our business.

Just to wrap-up, I am obviously very pleased with our results for the quarter and the year-to-date. We built a strong operation focused on the best price areas for the global market and we continue to add to our platform. When we compare ourselves to our broader peer group on annualized return on equity, growth and book values or even simple aggregate dollars of underwriting income we are clearly in the top 2 or 3 companies in each category. In just over 2.5 years we have built a sustainable global company with top tier performance.

So, let me stop there and we have to take any questions you might have.

Question and Answer Session

Operator

Thank you. (Operator instructions) Our first question comes from Matthew Heimermann of JPMorgan. Please go ahead, sir.

Matthew Heimermann – JPMorgan

Hi, good morning.

Ed Noonan

Good morning, Matt.

Matthew Heimermann – JPMorgan

A couple of questions. First Jeff could you just quantify what is the renewal that has shifted from 71 to 61 what that will be just – in terms of growth in 3Q?

Jeff Consolino

It is around the order of $10 million Matt.

Matthew Heimermann – JPMorgan

Okay, that is fair. And then Ed, I was wondering since you have put your platform together there has been some competitors who have bought into the Lloyd’s market, are those competitors starting to have an impact in terms of competition and do you have a sense of whether or not you think if you haven’t any Florida if perhaps you will see appetites expand going forward?

Ed Noonan

Yes, Matt, I think the first thing I would say is that Lloyd’s is very disciplined these days, and I think the franchise director does a great job of kind of monitoring excess rate behavior, but we do see competition from some of the newer players. I think everybody would like to be in the global terrorism business. We’ve – clearly there are new entrants in the energy space. What we find is that we get the benefit particularly in terrorism of not only being in lead markets, but having a global portfolio so that we are writing smaller risks all around the world whereas most of the competition demonstrates is the big dollar accounts, where obviously we generate lots of premium. So, I would like to say we are not the least bit immune from competition but I think we have some competitive insulation both as a function being in lead market in much of what we do and also the nature of our portfolio.

Matthew Heimermann – JPMorgan

Fair enough, thank you.

Operator

Thank you. Our next question from Jay Cohen of Merrill Lynch. Please go ahead.

Jay Cohen – Merrill Lynch

Yes, two questions and a comment. The questions, one is, Ed you had mentioned in your remarks that you can – as you do underwriting you consider some exposures that some of your competition are just now getting to, and I want you to expand on that, what are you talking about there. Secondly, if you could talk broadly about the marine market, what you are seeing there given that is an important line of business for your company; why don’t we start with those two?

Ed Noonan

Sure. Jay in terms of some of the things that we model that other companies or competitors are getting to, a good example of that is the residual market windfalls along the US coastal states. You know, it is a very complex process to properly model the interaction of the fair plans and wind falls with individual company’s exposures. Most companies actually simply say well, I am covering XYZ company and they have got a 2% market share in North Carolina. So, I probably have 2% of the residual market pool. When in fact the way that you have to model that is to collect all of the data down to the street level address for the pool itself as well as the company, model them independently and then take the – all the events in the model and run them across the combined portfolio to come up with the actual exposure. What we see is actually in some cases that can lead to a 35% difference in outcomes. That difference falls most heavily on the reinsurers because most of the fair plans are covered under people’s cat programs. So, one of the things we find is that in a few of the coastal states there are a lot of programs that we are not competitive on because the broader market simply isn’t doing the proper job of analyzing and modelling the catastrophe exposure arising from the wind plan.

Jay Cohen – Merrill Lynch

And in the marine market?

Ed Noonan

Yes, the marine market, I will talk about it in a couple of dimensions. First the whole market rates are off anywhere from 5% to 7% at this point. We do most of that business, obviously the direct portfolio is done out of London. What we are seeing there is a bit of the flattening the Scandinavians are starting to push rates, which is good. The Scandinavia market plays a big role in the marine market and you know they have been paying some claims over the last couple of years and so we are starting to see them push rate a little bit and so I am not at a point of calling a market turn in the whole business but I am starting to see better discipline there. Cargo, as cargo typically does, the rates are off again in kind of the 4% to 6% or 7% range. Results have been good there and, you know, the cargo business tends never to get too competitive nor too attractive. And then the last thing is that you know, most marine operations also write loss for energy and there we are seeing more competition. We are seeing rates comes off anywhere from 12% to 14%. We see some excessive rate decreases on individual accounts. There are certainly some new competitors in that space. In the reinsurance of the marine market, you know, basically except the loss carriers what we are finding is pretty good discipline in the markets, and I think the one area where there is more competition is the Gulf of Mexico. It is pretty disciplined competition. I think most people still have a pretty healthy respect for the Gulf, but for example, you know, last year and the year before we were able to provide single limit cover as a reinsurer with no reinstatement and get rates online that were well north of 30% and 40%. Now, what we are seeing is more people come into the market willing to offer a reinstatment, rates have obviously come off a bit. We still think it is a very attractively priced class, but it is no longer kind of a – maybe a price market that it was in ’06 and ’07.

Jay Cohen – Merrill Lynch

That is helpful and then just a comment you had talked about this interesting experience you had, I thought you were going to say you were actually on that plane, that would have been interesting. Anyway, thanks a lot.

Ed Noonan

Thank you Jeff.

Jeff Consolino

Thankfully he wasn’t.

Operator

Thanks. Our next question comes from Ian Gutterman from Adage Capital. Please go ahead.

Ian Gutterman – Adage Capital

Hi, everybody. Just wanted to follow up on the PML and the aggregate limit disclosure. I guess my first question – u hear me okay.

Ed Noonan

Perfect Ian.

Ian Gutterman – Adage Capital

Okay, I am getting along with my question here, on the aggregate limit the I guess, the footnote mentioned it was just for Bermuda and I guess I am wondering how do you look at Talbot first why does the aggregate limits include Talbot and secondly how do you manage that exposure to make sure there is not unexpected clash?

Ed Noonan

That is actually a great question Ian. In terms of calculating zonal aggregates as a reinsurer we can simply add up our exposures under every single treaty that is involved in the zone until we can come up with a sum certain as to what our pure zonal aggregate is. As an insurer adding up policy limits exposed is I think in many ways a much less valuable exercise. What we do with Talbot in addition to running all the probabilistic models against this, Talbot had even before we acquired them come up with a kind of gate approach to the coastal exposures. So that they actually divide the east coast into I think it is roughly gates that overlap. Each one is about 100 miles wide and they overlap with the zones with a gate on either side and that restricts their amounts of absolute policy limits in force both from 3 miles to the ocean and at 100 miles to the ocean. And so – in so doing in effect, Talbot has come up with their own kind of claim size zonal aggregate by looking at absolute policy limits exposed in each gate. You can then actually do – from a risk management standpoint you can decide while we are concerned about storms that might be 200 miles wide, so let us take the two biggest contiguous gates all we are concerned about how New Orleans might affect with our offshore and onshore exposure to Validus Re. We can approach it from that perspective and manage our absolute aggregate when it is outstanding that way.

Ian Gutterman – Adage Capital

Okay that makes perfect sense. And as far as when we look at the PML, which includes both, does the Talbot have a heavy influence on any, I guess the five ones you listed, is it outside any of the five or is it pretty proportional to where the Bermuda exposure is.

Ed Noonan

No, actually Talbot – 75% of their business is non-US and they are very, very careful about US wind exposure. So, Talbot doesn’t add meaningful amounts to the PML curve for the group. We are talking about 10s of millions of dollars not hundreds.

Ian Gutterman – Adage Capital

Great, and then final question just from a capital allocation standpoint, US wind is right about 50% higher than European wind, I am looking at the 1 in the 100 year, it is about 50% higher and I guess on the 1 in 250 maybe about 25-30% higher than European wind, which is your second biggest and then it gets a lot higher than the earthquake [ph] in Japan. I guess from a capital allocation perspective, it would seem as sort of free capital (inaudible) to balance those zones a little bit more and not be so overall US wind versus European earthquake and I realize how the equation comes into that and maybe that is the answer but you just talk about how you sort of did the trade off between the most attractively priced business and the capital allocation of being so overweight your biggest PMLs on.

Jeff Consolino

Ian this is Jeff. I will let Ed speak to the business consideration. But in terms of capital allocation one of the key measures that we hold ourselves to is A&S capital adequacy and the key inputs to that model are 1 in a 100 year windstorm and 1in 250 quake. So the returns you need to be looking at for those items. Ed, I guess you are going to discuss additional comments on the business point.

Ed Noonan

Yes, Ian when we think about it is we look at everything we do on a risk adjusted return on capital and so right now North America is clearly the best price catastrophe market in the world. Europe would be next but Europe isn’t you know, nearly as well priced as the US. And so while we are looking for diversification we are also looking for diversification on a risk-adjusted basis so as to maximize our expected returns on every dollar volatility we take on. So, the rough math that I will give to you, it isn’t precise, but you know we run European aggregates which tend to be roughly 70% to 75% of the North American aggregate. Our Japanese aggregates tend to be 20% to 30% of the US aggregate. Our Australian aggregate tends to be 25% to 30% or 35% depending on pricing at any point in time. We would love to be able to write perfectly balanced portfolio globally. It wouldn’t make sense to us in terms of the risk we are taking on relative to the expected return.

Ian Gutterman – Adage Capital

Okay, very fair. And I guess just a last follow up on it is when I look Jeff the US 1 in a 100 wind is $420 million, the 1 in 250 earthquake is $258. So, they are really not that close, but your agg limit in California is reasonably high. So just wondering is that a reflection that you don’t like earthquake or maybe the agg limits are pretty high and then you just ran into that limit and it is some exposure, maybe your exposure is outside the 1 in 250, I am just trying to figure out how to think about that better?

Ed Noonan

Ian, just a couple of aspects of that. First, we don’t like earthquake like the wind business, earthquake is too competitive and prices has come down too quickly. In terms of the aggregate, we consider all California to be at one single zone. Obviously, typically if you have a San Francisco earthquake it does not affect San Diego or Palm Springs, but unfortunately as a reinsurer when you put out capacity your clients tend to ride across the whole state. That makes reinsurance a relatively inefficient way to transfer risk within the California earthquake. Primary insurers have a bigger advantage in that they can actually break up the state up into a number of zones and write meaningful diversification within those loans. So, we tend to roll up aggregate much faster than we roll up expected loss, and that is why the difference between the PML and the aggregate seems a lot.

Ian Gutterman – Adage Capital

That makes sense. Thank you very much. Very thorough answers.

Operator

The next question comes from Susan Spivak of Wachovia. Please go ahead.

Susan Spivak – Wachovia

Good morning Ed and Jeff. Most of my questions have been answered and thank you for the increased disclosure. I was just hoping that maybe at this point could you update us on any diversification plans, I know, originally one of your intentions was to go into more of the casualty lines but is the market opportunity just not there yet?

Ed Noonan

Susan, there is any number of lines of business we would dearly love to enter, but we are constrained by this notion that we are in it for underwriting profits and so when we look at the casualty business, like you, we are just looking at all the major companies release their results and you know, accident year combined ratios are reaching up to a 100 or lower, and rates are still coming down. This is a phenomena where you will accept mediocre kind of back end year results because prior years were better and you are releasing redundancy. That really doesn’t work for us. We are in this for underwriting profits. Most of the lines that we are not in today, we are looking at constantly and we would love to enter. When we see the market about to turn, hopefully we will be timely enough to jump in ahead of it, but right now we don’t see those dynamics coming together. The one thing I would say is that we are a very diversified company. When you look at our portfolio, we are diversified by both insurance and reinsurance, we are diversified by product release of the classes and we are very well diversified globally. We write business in over a 140 countries around the world. Our split between insurance and reinsurance is kind of give or take roughly in the 50/50 range. And so actually we like the diversification we have, because we are in the short sale lines that we think are still the best priced segments in the marketplace.

Susan Spivak – Wachovia

That's great. Thank you for the answer.

Operator

Thank you, our next question comes from Chuck Hamilton of FTN Midwest.

Chuck Hamilton – FTN Midwest

Hi, good morning everyone. Congratulations on a very good quarter Ed and Jeff. A couple of quick questions, I think we'd talked about earlier the renewal change that is accelerated to June 1st of being $10 million, could you also talk about the magnitude of the premium adjustments that occurred in the second quarter of '07 to flatter the increase year over year?

Ed Noonan

Sure. That amount was $11 million in total. It was because of a couple of different treaties that concentrated in one particular pro rata treaty. It did not perform as initially anticipated.

Chuck Hamilton – FTN Midwest

Okay second question comes to the retention or I guess the ceding percentage for property for Validus Re in the quarter, you actually had a positive adjustment rather than a negative adjustment as compared to prior periods. Is this somehow related to the premium adjustment we saw in the second quarter or what is it related to?

Ed Noonan

It is related to – I mean we have a sidecar in 2007 and in 2006 retro which is no longer in effect. We did replace some portion of that with a separate collateralized quarter share in the after energy business and did not replace that portion of retro, opportunity property business and so that premium adjustment would be related to the portion of retro.

Chuck Hamilton – FTN Midwest

I guess going forward then do you see your sections for the property book for Validus Re being along historical patterns or you think you're going to keep only the net book going forward?

Jeff Consolino

No, I think we're going to see the particular item in Q3, which ED referred to in his comments, which is the purchased referrals, this larger U&L [ph] retro program, which we here before have not done. So that will be a Q3 item in terms of ceded premium revenue. And we will earn that over the subsequent four quarters. And so that will have an affect on earnings going forward as well.

Chuck Hamilton – FTN Midwest

And I think the last question would be for Ed in terms of Talbot year-over-year Ed we saw that the property lines have actually decreased 24% in the second quarter and 14% year to date. How are you seeing that the property market at Lloyd’s changing at this point in time?

Ed Noonan

I think what we're seeing really is a reflection of global competition plus most importantly the U.S. large property risk market is badly in a need of supervision.. Rates just keep coming off and you know we're in this interesting period where everybody reports to investors that rates are off but their portfolio was good. And this kind of a, wait-and-will-be-gone phenomena where everybody is above average, we actually are going [ph] to just try for that. We have been shrinking the North American portfolio, everything that doesn't meet our profit targets, we simply walk away from and that really is the biggest reason why our property business is declining in Talbot so rapidly. So to say, we applaud the underwriting team for it. That's exactly what we want them to do. We're not interested in taking on risk that we're not getting paid for and if need be we'll just keep part of that portfolio until the market starts to gain some sense of rationality.

Chuck Hamilton – FTN Midwest

Great and liked that comment about the increased disclosure, very helpful. Thank you very much.

Ed Noonan

Thank you.

Operator

Thank you. Our next question is from Brian Meredith of UBS. Please go ahead, sir.

Brian Meredith – UBS

Hi, good morning. Just quickly Ed or Jeff the retro protection that is going to hit the third quarter, what is the cost of that going to be?

Jeff Consolino

I think Brian that we will have to wait until the third quarter disclosure to quantify it exactly but you assume we take a typical rate online to the $87.5 million.

Brian Meredith – UBS

Okay. Next question, I wonder if you can talk about how the risk losses that you booked in the first quarter are developing?

Ed Noonan

It is interesting – we have had no developments on those writings. We said in the first quarter that we were very aggressive in identifying claims, contacting brokerage ceding companies et cetera, not waiting for clients to send the notices to us et cetera, and as a result of that we haven't seen any movement whatsoever even as claim notices come in. We've seen a bunch of other people in their reports now start to talk about some of those claims and I think we're a bit ahead of the curve. That is what we strive for in reserving. Our goal is to identify exposures, gather as much information as we can, we will reserve them as quickly and as fully as we possibly can. So I think, most of the first quarter risk losses we tried to reserve as close to our full limit exposure as possible. I am not expecting to see any developments on them as a result. Certainly there was nothing material in this quarter.

Brian Meredith – UBS

And then last question I guess the obligatory question on capital management, any further thoughts as far as, you know, dividends or share buyback and excess capital?

Jeff Consolino

Sure. I guess starting with how we're actively managing our capital, currently we're paying a $0.20 quarterly dividend which developed a 4% yield. Puts us in the high end of our peer group and again that reflects our confidence in capital generating ability of our company. We also did purchase of $45.7 million of debt probably this year, which at this time we thought was good value. We'll continue to pay the ongoing dividends through wind season. We guess at the end of the wind season and we're blessed with excess capital we will work with our board on a plan to dispense that excess capital. We certainly have no desire to hold capital beyond what our business requires even though it is our first preference to always deploy our capital in our business given the returns we're generating.

Brian Meredith – UBS

Right thanks.

Operator

Thank you. Our next question comes from Ron Bobman of Capital Returns. Please go ahead.

Ron Bobman – Capital Returns

Hi good morning. Ed your anecdote brings the question what is the estimate loss in the Qantas loss and curious to know what that number is relative to the premium you collected?

Ed Noonan

So when I was kind of reviewing my comments with my colleagues, you know, as soon as you say that people go on and know what the number is. Our number on the Qantas is virtually zero. There wasn't really much of a loss. There'll be some loss in the whole market but at this point in time it is certainly not on the total loss for the year frame and it is early days to see what that is. So from our perspective it doesn't rise to a level of an event claim and just kind of normal expected stuff.

Ron Bobman – Capital Returns

Okay, guys, an unrelated question, and I'm sorry if I've missed if there was a commentary on the state of the Gulf of Mexico offshore energy market, if you would redo that for the first time describe the state of the market there with rates relative to renewals?

Ed Noonan

Yes, sure. We talked about it in before, I am happy to go over it for you again. Gulf of Mexico is still a very well priced environment. What we do find now is that there's more competition, more people who had fled the market are creeping back in and there are a few new entrants, and whereas in 2006 and 2007 we had the ability to provide a single limit with no reinstatements basically naming our own price at rates online that were 30% and 40% higher in some cases. Now what we're finding is that the marketplace is providing reinstatements that rates have come off a bit. Still very well priced but it is no longer kind of the shooting fish in a barrel market it was in 2006 and 2007.

Ron Bobman – Capital Returns

And do you have any sort of preference for deep water versus sort of on the shelf assets or both are at the same level of attractiveness and both suffering same level of competition?

Ed Noonan

No, I mean they are clearly risks that we differentiate in our rating models and you know deep water risks present a unique set of circumstances. Some of the risk rigs along the shelf have their own set of circumstances depending on how oil moves from the rig itself into the broader market and so every risk that we are looking at is being priced based on the individual attributes and it is reflected in the price we charge for it.

Ron Bobman – Capital Returns

I don't know if I'm pronouncing this right but is the new entity side risk Sideris having any market impact, are you seeing them at all?

Ed Noonan

I'm sorry.

Ron Bobman – Capital Returns

The new first reserve entity I think it is called Sidris or Sideris.

Ed Noonan

I think it is – Sideris (inaudible) in London. We've – actually we had worked with First Reserve. They were the capital providers in our side car in '06 and '07.

Ron Bobman – Capital Returns

Yes, go ahead. I knew that.

Ed Noonan

No, we haven't – we don't see them very much in the market yet at this point. I'm sure they'll will be over time but I wouldn't point to them as you know being disruptive in any way before.

Ron Bobman – Capital Returns

Okay, great. Thanks a lot and best of luck.

Ed Noonan

Thank you.

Operator

Thank you. At this time we have no further questions. I would like to turn the call back over to the company for any closing remarks.

Ed Noonan

Thank you, Andrea. So, I mean again just to reiterate, we are really very happy partly about having such a good quarter but more importantly about the platform that we built the quality of the team we have in London, the quality of the team we have in Bermuda, and now Miami and Singapore. We think that the strategy of building a globally diversified short-tail insurance and reinsurance operation really is working well for us and we think it is coming through in the results. We think it is coming through in our ability to diversify risk around the world. We feel pretty good about where we are and we will look forward to talking to you after wind season and hopefully feel everybody is good. Thank you.

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