XL Capital Q4 Earnings Call Transcript

123jump.com Staff
23 Feb, 2009
New York City

XL fourth quarter net loss increased 17.2% to $1.43 billion on operating income of $189.5 million. Earnings per share declined to $4.36 from $6.88 in the quarter a year ago. The company took a goodwill charge of $990 million of which $975 million was related to Mid Ocean acquisition.

XL Capital Ltd. ((XL))
Q4 2008 Earnings Call Transcript
February 11, 2009 9:00 a.m. ET

Executives

David Radulski – Director of Investor Relations
Michael McGavick – Chief Executive Officer
Brian Nocco – Chief Financial Officer
Sarah Street – Chief Investment Officer
David Duclos – Chief Executive of Insurance Programs
James Veghte – Chief Executive of Reinsurance Operations

Analysts

Joshua Shanker – Citigroup
Bijan Moazami – FBR Capital Markets
Paul Newsome – Sandler O''Neill
Jay Gelb – Barclays Capital
Jay Cohen – Bank of America
Brian Meredith – UBS
Dave Weiden (ph) – King Street Capital
Ian Gutterman – Adage Capital
Trevor Winstead – Strategic Value Partners

Presentation

Operator

Good morning. My name is Rachel and I’ll be your conference operator today. At this time I would like to welcome everyone to the XL Capital Ltd. fourth quarter and year end 2008 earnings conference call. (Operator Instructions) All lines have been placed on mute to prevent any background noise. After the speaker’s remarks there will be a question-and-answer session. If you''d like to ask a question during this time simply press * then the number 1 on your telephone keypad. If you''d like to withdraw your question press the pound key. Thank you. I would now like to turn the call over to Mr. David Radulski, XL Capital''s Director of Investor Relations. Sir, you may begin.

David Radulski – Director of Investor Relations

Thank you, Rachel. Good morning and welcome to XL Capital''s fourth quarter and full year 2008 conference call. This call is being simultaneously webcast on XL''s web site at www.xlcapital.com. We''ve posted to our web site several documents including press releases, our financial supplement and our fixed income data supplement. For your information we''ve also posted a selection of communications materials that we are sharing with our customers, brokers and employees. On our call today Mike McGavick XL Capital''s CEO will offer opening remarks. Brian Nocco, our CFO will review our financial results followed by Chief Investment Officer, Sara Street who will discuss results in our investment portfolio. Dave Duclos, our Chief Executive Insurance Operations and Jamie Veghte, our Chief Executive of Reinsurance Operations will review market conditions. Mike McGavick will return to discuss guidance, then we will open it up for your questions.

Certain of the matters we will discuss today including our guidance are forward-looking statements. These statements are based on current plans, estimates and expectations. Forward-looking statements involve inherent risks and uncertainties and a number of factors could cause actual results to differ materially from those contained in the forward-looking statements. Forward-looking statements are sensitive to many factors including those identified in our annual report on Form 10-K, our quarterly reports on Form 10-Q and other documents in file with the SEC that could cause actual results to differ materially from those contained in the forward-looking statements. Forward-looking statements speak only as the date on which they are made and we undertake no obligation publicly to revise any forward-looking statement in response to new information, future developments or otherwise. With that, I will turn it over to Mike McGavick.

Michael McGavick – Chief Executive Officer

Good morning. I have to believe that all of you feel like us here at XL. I have never been happier in my professional life to put a year in the rear view mirror. Obviously the world has gone through extraordinary change and we have faced extraordinary market conditions. Yet XL delivered solid fourth quarter and full year underwriting results that are both solid on their own and in respect to our historical performance. Our P&C combined ratio of 89.4 for the fourth quarter was in fact four points better than for the same period last year, and our overall year of a 95 combined is the kind of results you expect from XL even at the most difficult part of the market cycle. Along with our fourth quarter favorable prior year development of $268 million, this shows not only the prudence of our reserves but also the strength of our underwriting over the years and XL remains one of the few companies that can stand by its initial Gustav and Ike loss estimates as originally announced last September, losses we were proud of both in terms of our share as relative to the market and in our insight to understand the effects of those storms.

Other key metrics also point to strength. These include the retention of our customers and of our employees. Dave Duclos who runs our Insurance operations and Jamie Veghte of our Reinsurance operations will give you greater detail on these shortly. Now I know given all the noise, some of these results may surprise you. They may even displease our competitors, and that''s fine with us. These, point to a franchise at XL that is ready to take on the opportunities that 2009 presents. The fact is, that in many different parts of the insurance and reinsurance space, rates are improving and we expect with our solid franchise to be able to take full advantage of those opportunities. Our capital is not an issue in this pursuit as we have said repeatedly. We have no need to raise capital and the rating agencies tell us they agree. We have taken several steps to make that strength more obvious. We took a non cash charge against goodwill on our acquisition of Mid Ocean Ltd and let me be blunt, this is a great business. XL is the better for having bought it back in 1998, but GAAP requires that we recognize current market valuations in how we carry the goodwill that came with Mid Ocean. Simply put, reinsurance franchises of this kind were valued more highly in days gone by.

This non cash charge will remove any goodwill questions that people could have about our balance sheet, making its underlying tangible strength more evident and this has no impact on our rating agency, regulatory or tangible capital. We have also announced a reduction in our dividend to a yield closer to industry and historical norms. I can''t make any promises about the future, and it''s ultimately a decision for the Board, but we are looking forward to the day when XL can raise it again because our yield is too low. Further, we continue to de-risk our investment portfolio. You will hear from Sara Street some of the details on what we''ve been doing in the past and if you look forward, we expect the investment portfolio will generate a run rate cash of approximately $3.5 billion this year, allowing for further de-risking of the portfolio, bringing it more and more in line each day with the traditional P&C portfolio.

We have also announced today that we will take a restructuring charge of $400 million. We chose to take it in the fourth quarter, and that charge will allow us to accelerate the repositioning of the portfolio. In fact, it allows us to reposition securities worth several times that without changing the accounting treatment for the rest of the asset base. We also want to update you on our strategic review of life. As previously announced, we continue that. We had hoped to have that concluded by the end of the year but conditions in the Life space did not allow for that at that time. However, we have made a bit of progress. We have announced a recent renewal rights transaction with our GA for the Life, Accident and Health block. The balance of the book has performed in line with our guidance for 2008. So we''re pleased with the continuing performance and we will continue to examine our strategic options for the remaining blocks of our Life Reinsurance book.

Now in the end of the last year, the noise around our franchise including the ratings created the greatest challenges. We have spent a great deal of effort communicating our plans for the future as well as what occurred in 2008 to the rating agencies. I think it''s safe to say that they understand what we are doing. They appreciate the steps we have taken to do this franchise and that we continue to take, and everything that I have heard in these recent days, though they can speak for themselves, would indicate to us that there will not be any changes to our ratings. In addition, I would say that with A. M Best who has us on an A with a stable outlook, has told us they will not even take us to committee at this point which of course is a good thing, leaving the ratings in place as they are. They have also assured us as I mentioned before that we have ample capital for our ratings. We are ready to go compete and put that capital to work for our clients. We know that we must continue to improve our risk management disciplines as stewards of capital. We have real rigor around how we evaluate this and other firms.

I''ve said before that I think we could do a better job in our own firm. We have advanced considerably even in these last months not only with the adding of Jacob Rosengarten to head up our operations here, but also with the bringing online of new risk measurement techniques in our portfolio management. All of this has given us greater insight and the ability to de-risk the firm more quickly.

Another example of this is the adding of Tom Hutton to our Board. Many of you know Tom. He served on many Boards and many positions of leadership in our industry in the past. He is a co-founder of Risk Management Solutions, RMS, and he''s one of the very best in thinking through the risk that insurance and reinsurance companies face. We welcome him to the Board. Turning to 2009, I''ll offer guidance after Dave, Jamie, Brian and others discuss their business segment results, but I want you to know that the plan for next year went through a very rigorous process.

This is the first of the planning exercises that the new team has led, and that has led us to be very aggressive in saying that we must focus XL''s resources on those places where we compete best in the market place, on those places that in this particular global condition can deliver the best results and in line with the reality and this affected the budget to a lesser extent, to tell you the truth, but in line with reality of the ratings we now have.

In the end, before Brian covers our financial results, I have one other piece of important work. We''d like here at XL to extend our gratitude to Fiona Luck on her retirement from XL. All of us at XL have appreciated her exceptional efforts over the past 10 years serving as Chief of Staff and acting and interim CFO in 2007, but most importantly throughout as one of the real leaders of the franchise and a true advisor to me during these transition times. We wish Fiona all the best in her future pursuits.

With that, I''ll turn it over to Brian Nocco to discuss our financial results.

Brian Nocco – Chief Financial Officer

Thanks Mike and good morning. Turning to our summary of financial results on slide 4, P&C net earned premiums were about 11.5% in the fourth quarter primarily due to the rolling effects of prior period''s lower written premium. Total P&C underwriting income was $161 million for the fourth quarter compared to $108 in the prior year quarter. The P&C combined ratio during the fourth quarter was 89.4 and benefited from favorable prior year development of $268 million with $183 million from the insurance segment and $85 million from the reinsurance segment. The insurance segment''s favorable development included $81 million related to the actual winter truce settlement we announced in December. Foreign currency movements resulted in a gain of $120.7 million for the quarter compared to $39.7 in the prior year quarter. Operating income was $0.58 per share for the quarter with an annualized operating ROE of 12.4% compared to $0.55 and 4.1% respectively in the prior year quarter. Sara will discuss the investment results shortly.

We took a goodwill impairment of $990 million during the quarter. $975 million was related to our Mid Ocean acquisition and the balance to our Latin America Reinsurance and U.S. Life operations. The Mid Ocean impairment in particular, resulted from the requirements under GAAP that we consider current market conditions at year end. Both the increased cost of capital and decline in market multiples in the industry resulted in our belief that we could no longer justify carrying the goodwill at previously established levels.

Our book value declined from $21.65 per share at September 30 to $15.46 per share at year end, with the main drivers in the quarter being a goodwill impairment charge of $200.99 per share and the mark-to-market in our investment portfolio of $2.60 per share. Finally, as we have mentioned in previous calls and filings, our ESU''s issued in December of 2005 will settle on February 17. The forward sale portion of the ESU will result in XL showing 11.4 million shares of common stock to ESU holders. The net result of this transaction is that debt will be reduced by $745 million while tangible book value will increase by $1.75 per share, and now to Sara, to discuss her investment portfolio.

Sara Street – Chief Investment Officer

Good morning. We posted our fixed income supplement to our web site last night and I''ll highlight that we''ve added more disclosure on our U.S. High Mortgages and Hybrid Holdings. Turning to slide 5, our net investment income on the P&C general portfolio was $276 million, a decline of 16% compared to the prior year quarter and 6% from third quarter 2008. This decline has been driven by lower yields as we increase our allocation to lower yielding U.S. Treasury agencies and cash which was a prudent step to preserve capital during these turbulent markets as well as our long-term de-risking strategy. Our net investment income from investment fund affiliates was a loss of $214 million in line with our previously provided guidance. The principal driver was a negative quarterly return of 12.5% in our alternative portfolio. Our results were disappointing but favorable relative to both our own benchmark as well as institutional quality fund of fund peers.

The actual fourth quarter mark-to-market movement consisting of realized and unrealized gain movement totaled a decline of $852 million and slide 6, demonstrates that the key negative driver of the unprecedented credit spread widening that we saw during the fourth quarter was much more dramatic than the positive contribution rate through interest rate decline. The result is also favorable relative to our mid December pre-announcement as in the last couple of weeks of December, we benefited from the modest credit rally in certain U.S. corporate sectors and continuing rate declines. However, this was offset by significant year end pricing pressures on mortgage-backed securities as well as widening in U.K. corporate spreads. Additionally, we benefited from a change in the valuations on our collateralized loan obligation or CLO portfolio. Our valuation approach remains unchanged and is entirely based on independent third party pricing, but with one exception. In line with the practice guidance on evaluations for liquid assets, we determined that the market for CLOs represents approximately 1% of our portfolio, had become so irrational that we believe that what limited trades exist will result in a truly distressed fire sale and accordingly, a modeled fair value approach would be more appropriate.

Working with an external advisor, we established a valuation approach that we believe appropriately recognizes the presently elevated expectations of the losses and the liquidity risk while applying less weight to some of the currently irrational pricing that we''re seeing in the market. Our portfolio would have declined a further $212 million had we continued to use the externally soft prices. We want to be fully transparent about this change and its impact.

During the quarter, we realized losses of $569 million. This includes OTTI of $209 million on securities where we believe that the security is not likely to recover to its current cost basis. These consist primarily of $142 million of structured credit assets, $29 million of corporate credit and finally $38 million on equity holdings. Our OTTI process remains rigorous and is performed on securities by security basis with particular attention applied to those securities which allow impairment. We also took an additional intent to hold OTTI portfolio restructuring charge of $400 million which Mike mentioned and I will address them in more detail in a moment. We''ve made significant progress in 2008 in de-risking the investment portfolio. As you can see in slide 7, we have reduced our allocations aggressively to a number of these severely impacted or risk asset classes. During the fourth quarter, the largest change was our decision to reduce the size of our alternative portfolio. This now stands at $1.1 billion, down from a peak of $2.4 billion in 2007. In aggregate, since March of 2008 we have reduced our sensitivity to credit spread movements by approximately 18% which will result in less credit spread driven mark-to-market in the future. We expect that this will decline further as we take more de-risking steps.

As mentioned, we recorded a charge of $400 million in certain holdings in our core P&C portfolio in the quarter. This was solely our decision and gives us more flexibility. Our goal is to simplify the investment portfolio to one that is line with our singular focus as a P&C underwriting operation. While this could be accomplished naturally over time, since we currently believe the assets are likely to be money good, we made the decision to accelerate the simplification process by selling certain assets before their full recovery. Given this decision, we can no longer assert our intent to hold these securities until such time as they recover. As I have previously described, the majority of these actions will involve our structured credit portfolio including CMBS, ABS and non agency mortgages as well as targeted sales in our corporate bond holdings and a reduction in our equity portfolio. I''d like to emphasize that these sales will be executed in an orderly manner and we will not sell at prices significantly below intrinsic value. These sales combined with the other steps we have already taken, represent significant progress toward de-risking the portfolio.

Our $32 billion fixed income portfolio is already very high quality and well diversified. It has an average rating of double A and over 97% is investment grade quality. Over 40% is invested in the highest quality assets of government agencies and cash securities. Our de-risking activities will further strengthen this position, now over to Dave Duclos to talk about our insurance operations.

David Duclos – Chief Executive of Insurance Programs

Thanks Sara. Before getting into the insurance numbers, I''d like to briefly touch on key drivers impacting our results and the markets in which we compete. First, we''re encouraged by increasing signs of stronger pricing and we intend to be a leader in this movement. We will not chase under priced business as the industry works through this transition period. Second, we have reduced our writing of long-term agreements significantly in the fourth quarter and expect this trend to continue as we work through 2009. Third, it''s important to note that only a very small portion of our premium variance in Q4 was related to market noise given the December developments we had to fight through in which we have done so very effectively. This outstanding result would not have been achieved if not for the support received from our brokers and clients. For that, we say thank you.

The financial highlights for the quarter are as follows. Gross written premiums declined by 15% or $190 million from Q4 of 2007 due to market conditions and largely due to the reduction of long-term agreements which accounts for two-thirds or $127 million of the reduction. FX accounts for another $17 million of the variance. For the full year 2008, gross premiums written and net premiums earned were down 2.3% and 2.9% respectively which is an excellent result for this point in the underwriting cycle and in line with the guidance provided last year.

On the loss side, we completed detailed reserve reviews covering virtually all lines of business in Q4. These reviews resulted in overall favorable prior development that Brian mentioned, but also some strengthening of the 2008 loss ratio in several product lines. These actions contributed to higher loss ratios for the quarter but it''s the full year loss ratios that are most representative of the results expected for the portfolio. As such, my comments will focus on comparing full year 2008 results to the full year 2007. The full year loss ratio of 68.4% in 2008 is 5.4 points higher than the full year 2007 loss ratio. Excluding the favorable net prior year development experienced in both years, as well as cap losses, the full year 2008 adjusted loss ratio of 72.5% is 6.5 points higher than the 2007 adjusted ratio.

Approximately one-half of the increase is attributable to higher non cap property losses. The remaining difference is attributable to higher loss ratios in professional lines associated with sub prime and the related credit crisis, lower premium rate levels in 2008 versus 2007, and to a lesser degree, some changes to the earnings patterns on certain contracts. Also during the quarter, as we''ve done in the past four quarters, we completed a detailed review of potential exposures in our professional liability book from sub prime and related credit crisis claims. Policy notices stand at 71 for reported year 2008 and this level of notice activity is in line with our class loss provision. However as a further measure of prudence, we did strengthen the 2007 year reserves by another $140 million during the quarter. This strengthening was more than offset by reserve releases on the 2003 to 2006 years which continue to develop more favorably than expected.

One final comment on the losses, given that 2008 will be the second or third costliest cap year on record depending upon how final losses associated with Ike and Gustav shake out, I''m pleased to report that our total net cap losses globally stand at $138 million. Further, with a $29 million reduction in our initial assessment for Ike and Gustav in Q4, our total loss for these two storms is at $59 million, a good outcome and a strong testament to our risk management practices that work on the front end in accepting risk and also on the back end as we monitor. All in, the quarter and full year combined ratios of 94.4% and 98.4% respectively, reflect XL''s effective risk management, solid underwriting and prudent reserving over a number of years.

Looking forward to 2009, I want to share some insight into our current views on the market. In addition to the excellent 2008 retention, which Mike mentioned earlier, we continue to see strong retentions in 2009 based on January 1 renewals, specifically in continental Europe, we''re just under 50% of the book renews of January 1. We experienced very strong renewals across all product lines, averaging 87%. Indications in other regions are also at or near historical levels. The only significant impact is where you would expect, the longer tail lines that are most rating sensitive, U.S. professional lines, and U.S. and Bermuda excess casualty.

With regards to pricing, initial indications based on Q4 results and January 2009 renewals reflect continued rate improvement with positive rate movement in property, professional and many specialty lines. Even casualty rate decreases are clearly slowing. But as everyone is aware, reductions in exposure base for commercial customers, resulting from poor global economic conditions will offset, some of the rate increases, creating what one of our colleagues has recently described as the invisible hard market. In looking at the past year, I can''t think of a more challenging trading environment in which to compete, and yet we achieved strong results, a testament to the value of this franchise that''s built, the support of our brokers and clients globally and the will and determination of our staff around the world.

With that summary, I''ll now turn the call over to Jamie.

James Veghte – Chief Executive of Reinsurance Operations

Thanks Dave. Reinsurance results for the fourth quarter were once again very strong. A combined ratio of 79.6% in the quarter compared to 84.8% for the prior year illustrates XL''s ongoing commitment to core underwriting and reserving discipline. In what is generally the lowest premium quarter of the year, gross written premium declined 24% versus Q4 ''07 due to the market conditions I''ll detail in a moment, and the commutation of a structured indemnity contract which included a return premium of $35 million. Net premiums earned declined 18% year-on-year due to the strengthening of the dollar against the Euro and the decline in net written premiums over the rolling last eight quarters. As Brian mentioned, the segment had the benefit of a prior year release of $85 million in the quarter.

Excluding prior year development, our combined ratio was 97.4%. This was principally driven by development from Hurricane Ike. For the full year, we enjoyed a combined ratio of 90.4% producing an underwriting profit of just under $400 million on net earned premiums of $2.26 billion. We view these results as outstanding given the competitive market conditions and the very high level of natural catastrophe activity around the world this year. I''d also like to provide some color around the January 1 renewal season. As Mike mentioned at the outset, this franchise has faced and met some very significant challenges. Relative to the renewable premium we had entering the season we''ve lost only 11% of our portfolio due to security decisions made by clients as a result of the December rating agency actions. Not surprisingly the impact was most significant in Europe given the timing of the actions and Standard and Poor''s significance in that market.

The balance of the decline in overall premium written was primarily due to selective cancellations by us and by industry wide trends including increased retentions by clients and others expanding their reinsurance panel to dilute concentrations of securities. The January 1 renewal process reconfirmed our status as a lead market. We were asked to provide quotes on 86% of our renewal premium in the Bermuda cap book and 100% of the business that we renewed in our U.S. casualty portfolio. Our success in this regard is due to the skill and dedication of our underwriters. I would like to thank them and to express my appreciation to our customers and brokers for their support commitment they continue to show this franchise.

Turning to general market conditions, short tail lines and cat-exposed geographies showed risk adjustment strengthening between 5% and 15% and there are emerging capacity constraints around large U.S. cat programs. We would expect this tightening to accelerate as we head towards the significant amount of Southeast Wind business renewing in the second quarter. Other property lines in non cat areas were generally flat although directionally I would expect tightening in this area in the later part of 2009. While U.S. casualty rates excluding D&O are down slightly, casualty motor rates in Europe increased by up to 10% with rates in other casualty lines in that geography flat to down slightly. Aviation and marine lines of business experienced rate increases between 5% and 10%. Given the recently soft market conditions over the last several years and the current interest rate environment, we would expect to see a hardening across the markets over the next several quarters and into 2010.

In summary, XL rate had an excellent financial year, a very successful renewal season and is well positioned to remain a leader in what I believe will be an increasingly attractive market conditions through 2009. With that, I''ll turn it over to Mike for guidance.

Michael McGavick

If you turn to slide 11 in the presentation, it walks you through the specific I guess the general guidance that we are giving. I just want to reemphasize a couple of points about how this plan was built. With the fresh eyes that this management team has, we added several areas of focus. Number one, concentrate our fire power on those lines of business that are meeting or exceeding our long-term hurdle objectives. This is one of the advantages of the XL franchise being in both insurance and reinsurance and in many lines of business. We can move around our efforts to where the opportunities are best. This means we can reduce efforts where those aren''t currently good and bring them back to greater activity when market conditions change. This is exactly how this franchise should be operating, so the first was this real driven effort to focus around those businesses with the appropriate returns. Second, we want to focus in those businesses that not only have those appropriate levels of returns predicted, but we also felt will deliver well in this global environment. It''s a very difficult world out there as we all know and we wanted to make sure we were matched in both way, and then to a lesser extent, in the lines particularly that Dave mentioned that were affected at some level by renewals by the rating agencies to reflect the rating agency reality.

So what do you see? You''ll see an emphasis on shorter tail lines. In Insurance you can expect us to continue to reduce long-term agreements to capture the benefit of hardening markets. And as you''d expect, this total effect will be to reduce both our gross and net written numbers meaningfully as you see on the sheet. Obviously if you''re going to see the top lines come down, you''re going to have to do real work in terms of your expenses in order to meet the kinds of returns that are expected by our shareholders and by all who are connected to this organization. So you will see us making painful decisions. We''ve announced last night and we''ll be traveling around the world, the leadership team to meet with many of our colleagues to discuss with them in person that we will be trimming about 10% of our global work force in this year. This will be focused on the corporate and functional support areas overwhelmingly in order to give an expense base that can be afforded by our underwriters so they can go do the job as described.

You''ll see about $60 million to $80 million in restructuring costs now, and we expect to lower our underlying base of expense by $100 million to $120 million from this action from the year 2010 on. We will be communicating the details of these plans to our employees, to our clients and brokers in these next days. So I''m not going to get into greater detail on these actions on this call, but I can tell you that this plan is thoroughly developed. It was reviewed with the rating agencies as a part of our review of last year''s results and led as I described at least with A. M Best not even going to committee but leaving the ratings in place, and I understand that it''s now crossed the wire that S&P has confirmed our ratings where they stand, and we appreciate their understanding of these actions as well.

When you take all of this together, you look at the net investment income, it will move more in line with the norm for a P&C company. Obviously these are difficult times in terms of net investment income and the generally lower interest rate environment, but with the de-risking we will come more in line with what you would see from our peers which is good from all points of view as we look at it in XL. Taking it all together, we believe that we will provide operating ROE in the low to mid teens for 2009 which we think will be a terrific result driven by underwriting for this point in the cycle. Obviously when we talk about guidance we''re talking about the future and the normal caveats don''t even seem worthy of these extraordinary market conditions that we''re all facing, but you can find them of course on our regular filings and statement of all the different items that we always reference for risk into the future and uncertainty.

And with that, I think we have given you a description of what is a very powerful underwriting franchise that has continued to aggressively de-risk the noise around it to allow our strength to show to our clients and our broker partners and to our people, and our people have met great tests this year and passed them and we look forward to success ahead and with that we''ll open it to your questions.

Question-and-Answer Session

Operator

(Operator Instructions) At this time ladies and gentlemen I’d like to remind you that if you’d like to ask a question please press* followed by the number 1 on your telephone keypad, that is press * followed by the number 1. Your first question comes from the line of Josh Shanker from Citi.

Joshua Shanker – Citigroup

Yes thank you. I was curious if you could go through more slowly the moving pieces in terms of the favorable and unfavorable development. In the disclosures you labeled the favorable development rather clearly but the unfavorable development I lost a little bit. If you go through segments and the offsetting factors I’d appreciate that.

Michael McGavick

Josh, could you repeat the question because you came in late? We just heard the very last part.

Joshua Shanker – Citigroup

Yeah no problem, you mentioned it briefly in your opening remarks but can you go through more slowly the moving pieces in favorable and unfavorable development by segment.

Brian Nocco

Josh this is Brian Nocco. Let me give you the pieces. On the Insurance segment, there was $183 million of favorable prior year development. As we indicated $81 million of that is related to the actual winter settlement, so the actual settlement, not just our view of the future. There were $57 million of releases related to casualty reserves, professional releases of $35 million, property releases of $16 million, partially offset by $11 million in adverse development or strengthening on specialty lines and then there was another $5 million release related to a reserve for reinsurance credit or recoverables. On the reinsurance side, there were $85 million of total prior year development, $40 million from property and short tail classes, $32 million from casualty and $13 million of kind of other stuff in total.

Joshua Shanker – Citigroup

The way it looks to me and I''m sure you''ll correct me it looks as if the combined ratio is up about 11% from what it was a year ago stripping out the effect of cat and favorable development. Is there something I''m missing when I''m making that statement?

Brian Nocco

Josh actually the difference isn''t quite 11%, but let me walk through the loss ratio story for the insurance segment and first of all I would say there were losses in 2008 and I''ve talked about in prior calls, in fact provided an update on Q4 numbers that in Q4 we saw a continuation of unprecedented large losses attributable to the property line outside of cat activity. So that continues to impact the results.

There are also, as I mentioned in my piece of the update, the second or third largest cat activity in 2008, and then there has been a surfeit of losses in some of the other products lines, and given how we write business, we''re going to see some lumpiness quarter-to-quarter, but on a year-to-year basis, when you look at the loss ratio variance, it is predominantly driven by our property incidents increasing and by the sub prime load that we announced in the first quarter of 2008, the $50 million. Between those two product lines, the majority of that variance is in fact driven in those areas. Now you ask what''s our outlook going forward, a couple of things; number one some of what Mike alluded to in terms of actions taken that reflect our 2009 guidance, does reflect underwriting actions taken in several lines and several of the lines that have had what I''d say marginal results. We''re also driving rates very aggressively that impact and reflect that focus in terms of our retention guidance for 2009 as well. So it''s a combination of underwriting actions really geared towards specific areas that cause the losses and then also aggressive rate price actions in a number of lines. That sums the insurance story.

James Veghte

And Josh on the reinsurance side, a year ago excluding prior year releases we had a combined ratio of 94.8. This year it''s 97.5. That''s principally from development in the segment from Ike and Gustav of $35 million after the effect of reinstatement premium. As was mentioned at the beginning the overall corporation had losses from those two storms in line with the original guidance but actually it was an increase in reinsurance and a reduction in Dave''s portfolio.

Michael McGavick

I guess in some Josh, we''re saying that you should expect given the size of lines we write that there will be lumpiness in our results and the fourth quarter reflects that in the insurance base, but overall we see the same continuing underlying loss ratios that give us confidence that the results that I predict in terms of ROE will be delivered and we have taken underwriting actions to further assure that as well as continuing to move the needle on price. From my point of view the most powerful combination of statistics you can think about were our achievements of price improvement in the fourth quarter. We were really hard on the pedal on price in the fourth quarter and we have had retentions overall that were in line with our historical marks. I don''t think there''s any greater proof of franchise power than to have pricing power at a choppy time like this.

Joshua Shanker – Citigroup

All that detail is appreciated. One quick on where I don’t have an answer, going forward in the past XL has been about a 70/30 split insurance/reinsurance. Would you care to offer a future vision of the company? What split of business will be?

Michael McGavick

I think that split roughly will continue in the plan that we have for the year. You''ll see that they''re down kind of equally in percentage terms across the two businesses in the guidance we''re giving. I do think that over the long haul, I would expect in good market conditions that you would see over the long time that it would shift a bit more towards the insurance side, but of course we have this strategy around reinsurance to shrink aggressively when pricing is not where we want it and to grow aggressively when we think it is, so you''ll get some fluctuation due to that strategy. But insurance over the long-term after we get on the solid footing that this plan implies, I would expect over time to be more dominant.

Joshua Shanker – Citigroup

Well thank you for the help. Thank you.

Operator

Your next question comes from the line of Bijan Moazami with FBR Capital Markets.

Bijan Moazami – FBR Capital Markets

Good morning everyone, a couple of questions, first of all in your structured credit portfolio, the CMBS-portfolio in particular, are you pricing it to a cash spread or are you pricing into a synthetic spread?

Sarah Street

We''re pricing it to the cash spread.

Bijan Moazami – FBR Capital Markets

The cash spread.

Sarah Street

The synthetic market, the CMBX is a very different make up of the portfolio than what are existing…of what''s actually in our portfolio. We have very little overlap between what''s actually in the CMBX and the rest.

Bijan Moazami – FBR Capital Markets

Okay wonderful and I was wondering about a question that was asked about 3 months ago. Just in case if you have a downgrade, what kind of assets do you have that could lead to a collateral call? Is there anything in there that you can describe to us?

Brian Nocco

Well when you say the asset, I mean I guess the question is, what vulnerability do we have to credit rating declines? One notch decline will have a deminimus impact on us. If we fall below A minus or into the B category in particular at A. M Best, it does require us as we''ve disclosed in our filings collateralization on the various revolvers that we have that we use for letter of credit issuance. And there is a smaller amount of collateral required for things like the contract, some of our insurance contracts and some return of premium, but the largest by far of those would be the collateralization of the bank revolvers. But again, that would require downgrades of two notches.

Bijan Moazami – FBR Capital Markets

Two notches, so, at triple B or below triple B?

Brian Nocco

Well, at A. M Best, the rating vernacular is A, B. They don''t use triple B. So it would be at below A minus or in the B category at A M Best. I will tell you that our overall liquidity continues to be very strong as Sara indicated. 40% of our portfolio is in government agencies and cash and cash like securities. We have $5.8 billion in cash and short-term investments on the balance sheet, so we are very conscious of the liquidity requirements that might exist at a financial services company and pay a lot of attention to it.

Bijan Moazami – FBR Capital Markets

Thank you.

Operator

Your next question comes from the line of Paul Newsome with Sandler O''Neill.

Paul Newsome – Sandler O''Neill

Good morning. A quick follow up on the combined ratio commentary, the actuary for this year was pretty high or at least for the quarter was pretty high and just to make sure, is that because of these lumpy large losses we see in the fourth quarter or is there some sort of shifting of money around the actual years is very much the story. It does seem well north of 100.

David Duclos

This is Dave. The quarter number that you relate to there is a result of the lumpiness of the losses as I described, but also a result of an analysis of reserve review we completed that reflected in our Q4 results which for some lines increased our reserve position. In other lines it reduced it. It''s a combination of the lumpiness that we''ve referred to as well as the reserve review completed for all of our product lines. And again we have had loss activity, in particular in the property line. Just an example, we had one loss in the fourth quarter of $30 million net loss, so that''s going to have an impact on our quarterly result.

Paul Newsome – Sandler O''Neill

And a completely separate question, you''re making operating earnings in your Life operations but the assets, the troubled assets seem to be much more over there. Are we in a situation where this thing is making a low return on equity or be profitable or is the investments over there such of a nature that it really isn''t profitable even though it''s showing operating earnings? And I guess just an assessment about how much of a weight this is having on the overall returns will be very helpful.

Brian Nocco

Hi this is Brian Nocco. The overall impact of Life earnings is relatively modest on the total company as you can see in the quarter. It was $27 million. The investment portfolio I would point out, I wouldn''t call it more troubled. It does tend to have longer duration assets and a heavier concentration of credit risk and in particular the financial institution portfolio is concentrated in the Life business.

It doesn''t have any of what is commonly referred to as a topical asset, so I would say it tends to have assets that would be more out of favor today, but I wouldn''t call them troubled assets. From an earnings standpoint, the accounting for our Life Insurance business is one that tends to spread earnings over time. There is a tight match between assets and liabilities and that tends to be reflected in the accounting and we would expect the Life business absent some action coming out of our strategic review to continue to report reasonably good operating earnings and ROE''s.

Paul Newsome – Sandler O''Neill

Great and wonderful to see you guys taking more aggressive action with the investments. Thanks a lot.

Michael McGavick

We appreciate that comment. We think it’s important and it keeps us out of some constraints to allow us to be more aggressive than we have been.

Operator

Your next question comes from the line of Jay Gelb with Barclays Capital.

Jay Gelb – Barclays Capital

Thank you. I have a couple of questions on the guidance. First on the combined ratios, the outlook for 2009 would be similar to 2008 on a full year basis for the calendar year result. I was just wondering what type of catastrophe expectations and reserve releases you may have embedded in that.

Michael McGavick

First of all with respect to reserves, we do not plan on reserve movement in any direction. The cat load in total is about $220 million which is of course based on historic performance.

Jay Gelb – Barclays Capital

Okay and then I''m also wondering how you can keep the combined ratios pretty much the same level without reserve releases if premiums are going to be down pretty substantially?

Michael McGavick

Well, that''s one of the reasons we have to work so hard on our expenses in order to bring them into line. I''ve noticed a lot of the questions have to do with what one quarter, the fourth quarter shows, but we focus on the longer term trends in our loss ratios and the businesses performance in order to judge what it will do in the future, especially as we understand which of those lines we''ll be emphasizing during the course of the year and where rates stand in those lines and where that goes after rate. So that''s why we''re able to give such confidence to the kind of combines and ROE''s that we''re forecasting and I would give you one other piece of insight. We did choose to do this plan a little bit later in the cycle than we ordinarily would have because we knew that there was so much going on in the fourth quarter that we would have deeper insight if we held off on the final, putting together the plan until we had everything that happened in the fourth quarter. So we have all of that insight, kind of more insight from last year than we would normally have, to give us even greater confidence in the performances of book. One last statistic, in terms of the cat load I mentioned, it''s about $220 cat load for this year. If you look back at ''08 even with the very extraordinary level of cats, our actual was about 389, so I think that gives you a sense that unless we face another extraordinary year, if it''s not an outlier year, this is a very reasonable loan.

Jay Gelb – Barclays Capital

Okay and then on the net to gross within the P&C operations, how much ceded premium should we take into account for 2009? You gave us the gross written and the net earned but I just want to make sure I''m thinking about this the right way.

Michael McGavick

We would expect it to be about the same percentages as prior year, but we can get some statistics back to you.

Jay Gelb – Barclays Capital

That’s great thanks and then finally, could you give us your loss picks on the professional liability book D&O and E&O?

David Duclos

Yeah this is Dave. Let me give you an update. I''m not sure about the loss picks, but first of all in 2008 we did increase our class load by five points which brought the class load up to 25 points in 2008. We also have a class load of 20 points in 2007 and in 2009 we''re carrying that same class load. And I think maybe part of your question is to just ask about how we feel about our overall reserve position relative to what started out as a sub prime crisis growing into a broader credit crisis and now also involves Madoff. I can tell you we have looked at our results a couple of different ways. I remind everybody that we do have a quarterly process in place where we work with the actuaries, underwriters and claims folks and analyze our positions and I can tell you that our reserve position has been strengthened significantly. We''re actually carrying two times the reserves we had in 2003 to 2006, for 2007, 2008 and now going into 2009. Based upon recent trends notices that I referred to that actually peaked in the fourth quarter of 2007 and first quarter of 2008, we feel that our current reserve position is quite adequate. And we also feel very bullish about this business. It''s still producing very attractive returns, and that''s built into the 2009 plan.

Jay Gelb – Barclays Capital

Okay thanks for the answers.

Operator

Your next question comes from the line of Jay Cohen with Bank of America.

Jay Cohen – Bank of America

Yeah just a question, just clarifying some things, the investment income guidance that is just within the property casualty business, is that correct?

Sarah Street

Yes, that is correct.

Jay Cohen – Bank of America

That’s great and then secondly, can you talk at all? Is it at the industry level or the XL level? What kind of claims might emerge from these Australian wildfires?

James Veghte

It''s very early days or weeks. We''ve seen estimates around the $500 million Aussie dollars. The hourly cost in Australian cat covers with respect to fire is quite broad. It''s basically an event type of language, so it''s unclear how much of that may get into the reinsurance market. Again, those are very preliminary estimates.

David Duclos

From an Insurance perspective, as of yesterday we had two claims reported in less than $1 million in terms of exposure.

Jay Cohen – Bank of America

Great thanks guys.

Operator

Your next question comes from the line of Brian Meredith with UBS.

Brian Meredith – UBS

Yeah good morning, I’ve a couple of questions here. First I''m wondering if you could talk about how you''re going to be retaining some of your key people or better people in light of obviously with the stock prices and you''re going through obviously a pretty significant head count reduction, what are you doing to keep the good people? We''re seeing some press reports of some teams of people leaving of late.

Michael McGavick

First of all, why don''t we deal with these press reports. My favorite was a tabloid report out of the London market place that I think it referred to four or five people who had left that they had coupled together from different releases that those who had taken these people and then referred it to as an exodus. I''ve been looking forward to having this call so we could talk about our retention of people and if I get a chance to actually meet with that person later this week, and he and I will have a clear conversation about the definition of the term exodus. Yes look we have very extraordinary talent at XL and that''s well known in the market, so we are always being picked on. That''s an ordinary course of event for us to have people, our people preyed upon by others, and I think it is a greater testimony to the strength of the franchise that so many have stayed than it is that a few have left.

I would point out that our turnover in the last year was actually slightly below historical norms, slightly below historical norms. I would point out in the month of December for example in insurance we’ve recruited more people than we’ve lost in the month of December. I point out that we have 75 people in reinsurance that can have underwriting authority and only three of them chose to leave before the end of the year. I mean, this franchise is holding together. People want to be insured by XL and they want to work at XL because this has the kind of underwriting culture that truly respects great underwriting. Now, when I think about what''s going on right now, there''s a reality. There''s a lot of people out there wondering with all this tumult going on, with all that''s going on at XL, I''m sure there are people even in our own ranks as there are at other companies wondering what they should do next.

My message is very simple. XL has been made tougher by what it''s gone through, and as a result our view is, especially with this further de-risking that we''re going to be stronger going forward and better able to weather these storms. I''d rather be at the firm that''s already got that hard work done behind it than a firm that has yet to recognize how difficult this economic crisis is. So my view is, this is a time to be with XL and to enjoy the benefits of the comeback that we believe we will deliver. And that''s my message to our colleagues. Now, we have done some work with some of our more high profile people to make sure they have incentives to stay. We have done some work in terms of how we design our compensation schemes to make sure that people have confidence that they''ll be appropriately awarded if they deliver the results that are in line with the shareholders interests.

That''s the work we''ve done. We think that work will keep the work force together, and it''s our job to do so. It isn''t going to get harder in our view. I don''t like forecasting, but it''s hard to imagine being more difficult than it was in the fourth quarter and we continued to deliver. That''s the short answer.

Brian Meredith – UBS

Okay great. And Jamie, how much of the European book did you actually lose at the run rate renewal?

James Veghte

We lost about $119 million of business due to security concerns. 64% of that Brian was from XL Europe.

Brian Meredith – UBS

Okay great. And then Brian, the LOC facility, when does that renew and if indeed there are some issues with renewing it, what are your options?

Brian Nocco

We have a number of them but there are two large ones. The larger of the two is a $4 billion facility. It doesn''t come up for renewal until into 2012, so we''ve got a considerable amount of time to work on plans to moderate usage of that facility before we get there. In fact today our total LOC usage is less than that $4 billion. We have some small ones that just renew annually and if they renew, they renew, and if they don''t we can roll those into the $4 billion facility. We''ve got a $2.25 facility that renews in the middle of next year which we may or may not choose to renew.

Brian Meredith – UBS

Great and last question from me, looking at your internal capital models, I''m wondering if you''ve got any kind of sense what your capital cushion is at kind of current rating levels right now in the event we do have a catastrophe loss or something coming forward.

Michael McGavick

This is Mike. I mean we''ve never talked about those kinds of numbers. We would just tell you we believe we have ample capital to bring in and the rating agencies tell us so as well. With that in mind, we look forward to competing into the future.

Brian Meredith – UBS

Okay thank you.

Operator

Your next question comes from the line of Dave Weiden (ph) with King Street Capital.

Dave Weiden – King Street Capital

The $2.5 billion LC facility, is there anything drawn on that now? And also, can you explain what type of business you need these LC''s for? Is it business at Lloyd''s? Can you give a little more detail on that?

Brian Nocco

First of all it''s a $2.25 billion facility and there is no usage of that at the present time. We use letters of credit for a multitude of reasons. Some of it is supporting internal quota share. Some of it would be Lloyd''s. Some of it would be a variety of other client supporting purposes, so I would say there''s a whole multitude of reasons why a company with our business model uses letters of credit.

Dave Weiden – King Street Capital

If you do get down to triple-B plus from S&P, how would you react? Would you, just have to liquidate monies in the portfolio and post cash collateral? What''s the contingency plan there?

Brian Nocco

The first thing I would say is that it''s not tied into S&P ratings. It''s tied into A M Best ratings and only A M Best ratings. We obviously have thought long and hard about what we would do at that point in time. There are provisions to provide cash collateral in the event that we fall to those ratings which we think highly unlikely. As you might expect, we''d probably have some conversations with the banks as well, but that''s probably as much I think is relevant to say on a call like this.

Dave Weiden – King Street Capital

Thanks.

Operator

Your next question comes from the line of Ian Gutterman with Adage Capital

Ian Gutterman – Adage Capital

Hi guys first question I guess on the goodwill could you talk about, I''m curious why you wrote off Mid Ocean but did nothing to NAC. Can you talk about the difference between the NAC Re and the Mid Ocean?

Michael McGavick

We think about the goodwill that remains on it. It continues to by all of the accounting tests to perform very strongly. So it was our view that we should focus where the accounting tests showed us that there was reason to take. I''m a little confused by your comment because we don''t show that we''re carrying any goodwill on NAC. But generally what modest amounts of goodwill we continue to carry, simply continues to perform, on all the various accounting tests very strongly. The lion''s share of what we did invest was with Mid Ocean and again, that just relates to the difference in valuation of those kinds of businesses today and at the time that we bought it back in 1998.

Ian Gutterman – Adage Capital

Okay fair enough. Okay Mike, can you talk about what happened with the bank leaks in December? Do you have any comments you want to offer on that?

Michael McGavick

On which stuff?

Ian Gutterman – Adage Capital

The leaks from the investments banks in December about the company being for sale at values down here and just can you give any comments? Is the company for sale? Is it not for sale? Just anything further that you can add to that from the press release you did back in December.

Michael McGavick

Yeah we made it crystal clear at that time and it continues to be our exclusive focus that we will operate XL as an independent company and deliver these plans and results for the benefit of our shareholders and our clients and our colleague''s period.

Ian Gutterman – Adage Capital

Great and I wanted to make sure that was the case. And then just last question on the business, I guess just use the guidelines on the gross premium, the decline in the gross premium, can you give me any sense of if you broke that into pieces, part of that is lost business due to the rating, part of that is probably you guys being more disciplined in placing, and I''m wondering if there''s a part that''s partially preserving capital to give you more flexibility. Can you just give me a sense of how that breaks down in the guidance?

Michael McGavick

Yeah let me give you a couple of high level comments and ask Dave and Jamie if they want to make any further comment. At the high level, we didn''t make these decisions with respect to capital. If we saw better market conditions out there, and believed there was a better opportunity than we had anticipated, we would have the flexibility to go ahead and pursue those additional opportunities. So, that was not a driver in the design of our plan for the year. By far the biggest impact was our decisions on where we felt we were meeting or beating our hurdle rates and deemphasizing writings in those areas where we don''t. Remember, that doesn''t mean that we just walk away from lines of business. We just deemphasize them in the relative capital allocated in the plan to keep kind of a pilot light on those businesses for better economic times.

So, it''s really about how you weight the usage of capital around the business, and here and there, there are some sub lines if you will, where there may be some more dramatic action, but it''s really very modest. The driver is obtaining our hurdle rates and that''s what drove the plan. I already talked about long-term agreements. That''s one of the main effects, is we''re not going to be booking to the extent we can avoid them, long-term agreements because of course in a rising interest rate environment, a rising rate environment for the risk, why would you want to lock yourself in? That of course leaves the mast effect, but again it''s minor relative to the main planning and that is where those businesses did show some effects from the rating agency action, so we take that into account in our plans as well. Dave I think there is something you want to say further.

David Duclos

Well, just to get a little bit more perspective in terms of the delta with the insurance numbers, the $5.3 billion to $4.1 billion, actually 30% of it relates to what we assume we''re going to do relative to the long-term agreements. And again the driver here is, we''re not losing accounts. We''re not losing clients. We''re just not offering, and in some cases the clients don''t want to accept because of our pricing terms, two or three year terms. So a big piece of it, $260 million roughly is tied to LTA''s. Another impact affecting insurance number is FX. FX is about 90, so if you think about that delta at $1.2 billion 30% of it comes from just LTA and FX. As Mike said, the deemphasis of certain lines in the insurance area which ties to my comments about strengthening pricing and the progressing underwriting issues is about roughly $300 million, a little bit over that. Keep in mind $300 million against a base of $5.3 billion is about 6% or 7% of the total book, so I think it''s a normal portfolio management. The rest of that delta is associated with what I''d say pressure from a ratings perspective, but also the recognition that we believe we''re going to have probably some tougher retention ratios in the first and second quarter tied more to our pricing directives and not necessarily any kind of noise around our ratings.

Michael McGavick

Just to be clear, Dave spent so much time in the planning that he''s just given specific numbers, but really we would only forecast a range around those number because no one can predict for sure what will happen out there.

Ian Gutterman – Adage Capital

Right and this to make sure that I’m clear. If the market hardens faster than you thought or if the market came to the pricing you''re asking for, you might be able to add 10% above your plan and there''s no capital constraint on that.

Michael McGavick

We have the capacity to write more if we need to or desire to.

Ian Gutterman – Adage Capital

Sounds great, thank you very much guys and good luck.

Operator

This morning’s final question will come from the line of Trevor Winstead with Strategic Value Partners.

Trevor Winstead – Strategic Value Partners

Hi thanks for taking the call. Brian, I was hoping you could comment on where you guys stand away from ratings triggers on your credit facility covenants.

Brian Nocco

We have no covenants that we''re anywhere close to on our credit facilities so it''s simply not a concern.

Trevor Winstead – Strategic Value Partners

Would you also be able to give an update on holding company liquidity and cash up there?

Brian Nocco

We have ample liquidity at the holding company to take care of cash needs that we have for the entire year with some contingencies. We manage our upstream movements of capital largely through dividends on a regular basis and so we think we''re in a very adequate cash position at the holding company.

Michael McGavick

We gather we have now reached the end of our allotted time or gone even a bit beyond. We very much appreciate your willingness to be on this call and the thoughtful questions. Obviously our team stands ready to handle any clarifications that are necessary and I''ll just sum it up the way I left it earlier. We''re really very proud of what'' been achieved here. We have shown the power of this franchise in the most difficult of circumstances and we are prepared to weather the rest of this storm in a way that we think will be very reassuring to our clients, to our brokers, and to our colleagues. That''s the job ahead and we plan to do all we can to deliver it. Thank you very much for your time.

Operator

This concludes the XL Capital Ltd’s fourth quarter and year end 2008 earnings conference call. You may now disconnect.