Feb 26, 2008
Operator
Good morning. My name is Chastity and I will be your conference operator today.
At this time, I would like to welcome everyone to the HCC Fourth Quarter Earnings Conference Call. All lines have been placed on mute to prevent any background noise.
After the speakers' remarks there will be a question-and-answer session. [Operator Instructions] This telephone conference call relates to HCC Insurance Holdings Inc.
Before we begin, the company has requested that I read the following statement which will govern the telephone conference today. Statements made in this telephone conference that are not historical facts, including statements of our expectations, our future events or our future financial performance are forward-looking statements, made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995.
Forward-looking statements involve inherent risks and uncertainties and we caution investors that a number of factors could cause our actual results to differ materially from those contained in any such forward-looking statements. These statements and other risks and uncertainties are described in detail from time to time in our filings with the Securities and Exchange Commission.
This conference call and the contents thereof and any recording, broadcast or publication thereof by HCC Insurance Holdings Inc. are the sole property of HCC Insurance Holdings Inc.
and may not be recorded, re-broadcast or published in whole or in part without the expressed or written consent of HCC Insurance Holdings Inc. Please standby for Frank Bramanti, CEO of HCC Insurance Holdings to begin the conference.
Mr. Bramanti you may begin.
Frank J. Bramanti
Thank you operator. Good morning, ladies and gentlemen.
Thank you for joining us on HCC's fourth quarter and full year 2007 earnings conference call. In Houston with me today is John Molbeck President and Chief Operating Officer.
Ed Ellis, our CFO and we have Craig Kelbel EVP of our Life, Accident and Health Operations and Mike Schell, EVP of our Property and Casualty Insurance Company Operations, our General Counsel and our VP of Investor Relations. So we got the full crew here.
The format today will be similar today to what we have done in the past. I'll make some initial remarks, then I am going to turn it over to John Molbeck to go through operations in some detail.
And then we'll have Ed Ellis make some comments regarding our investment portfolio. In addition Ed's is going to cover a couple of couple questions that some of you have already asked regarding investment income and capital gains that were reported during the fourth quarter.
2007 was a another record year for HCC. GWP was just under $2.5 billion, up 10%.
Net Written Premium was just under $2 billion, again up 10%. Net Earned Premium very similar to net written, just under $2 billion, up 16% over 2006.
Revenue was $2.4 billion up 15%. Net Earnings for the year totaled $395.4 million, up 16% with EPS of $3.38, up 15% from 2006.
Our cash flow for the first time topped $700 million, it came in at $726.4 million. We had a GAAP combined ratio of 83.4%, again a pretty solid year in an environment that deteriorated suddenly doing the second half of the year.
Our total investment portfolio was just under $4.7 billion. That was up 19% over 2006.
Total assets topped $8 billion. Our shareholder's equity is currently at $2.4 billion, up 19.5% over 2006, and book value per share was $21.21 up 16%.
Our debt-to-cap ratio during the year continued to fall; it finished the year at 11.7%, I think pretty widely accepted as a relatively low debt-to-cap ratio and we have some room to put on additional debt, should we need to fund growth in future. Our return on equity for the year was 19.4%.
We feel like we finished 2007 in great shape. We had very, very solid results and are pretty well positioned going into 2008 even in the tough environment that we have.
We've resolved all private litigations against the company relating to our option issue. We've put out two press releases over the last six weeks or so, derivative actions have been settled, class action have been settled and working their way through finalization in the court system.
We are awaiting conclusion of the SEC investigation which began last year. We had hoped we'd get it finished by the end of the year.
We currently are hopeful that first quarter will see it behind us. We continue to believe that the company will be reviewed by the SEC to have acted appropriately and has cooperated fully, since the issue was self-discovered and reported to the SEC and therefore feel there should be no further action against the company.
However, we await their final report, which again hopefully by the end of the first quarter. With that, I am going to turn it over to John Molbeck for discussions of our 2000 [ph] operations.
John?
John N. Molbeck, Jr.
Thanks Frank [ph]. As Frank stated, 2007 was another record year.
In fact it was our sixth consecutive year of record earnings. For the fourth quarter, gross written premium was down 2%.
Net down 6% and earned 1% compared to the fourth quarter of 2006. By contrast for 2007, for the full year, gross and net written premiums increased 10% and net earned premium increased 16%.
The drivers of the '07 growth were the Allianz acquisition, organic growth in our surety and credit business as well as our Lloyd's business obviously in London. More importantly, our 2007 combined...
I am sorry, our 2007 loss ratio was 59.6% of 2007, compared to an actuarial of '06 of 59.2. The loss ratio for '07 excluding reserve leases were 61% versus '06, 58.6%.
During the year 2007, we had $26 million worth of positive development and $7 million for the fourth quarter. I believe that we will find that the current cycle peaked on a calendar-year basis sometime in the second half of 2007.
Rates will remain competitive in 08 with overall domestic premiums projected to decline by 5%, despite continued growth in our surety and credit line, stable pricing and our medical stop-loss, and positive sign in our international aviation portfolio. While margins remain excellent in our international book of business, our overall premiums are projected to decline approximately 10%.
As you'll find in the press release and as frank has referred to, we provided guidance and with respect to net premium for 2008, we estimate that to be about approximately $2 billion. Based on the conditions of the market as we see now, if we do the math, our existing book of business would generate approximately $1.85 billion in premium.
This is net of the MNU acquisition as well as a non-renewal of the Argonaut Colony three. However, during 2007, we undertook a thorough review of our reinsurance program and we looked at our reinsurances on an enterprise basis.
We here therefore, we purchased reinsurance based on our philosophy that acquisitions, we bought a company and we pretty much like the overall reinsurance programs stay in place. We received very comprehensive input from Aon, Guy Carpenter and Towers and provided them with all of the information concerning our entire portfolio.
And their conclusions were consistent. Number one, our portfolio of business is highly non-correlated.
Number two, a loss of one quarter's earnings as a result of a single event was less than one in a hundred. Number three, we can reduce ceded premium in excess of $100 million and number four, we could retain the additional premium without increasing volatility.
And this is the reason we are projecting $2 billion within that premium income as we are confident that we can write more of the business that HCC controls in our insurance companies and retain more of that premium without increasing the volatility or loss ratio. This will allow us to continue to control our reinsurance recoverables which as of year-end are down to $957 million and now represent only 37% of shareholder's equity.
Where at the end of 2006, they represented 57% of shareholder's equity and in addition, will allow us to improve our cash flow. With that...
those comment, I'd like to turn it over to Ed to talk about investments.
Edward H. Ellis, Jr.
Thanks John. First, I'd like to review there is a couple of items in the reporting to our income statement for the fourth quarter and obviously the year too that we wanted to review.
These items are related. We are reporting different lines in the income statement.
However, they are in the same amounts and they offset, there is no net effect or net income on a net basis. First, there is a realized investment gain of $13.4 million related to foreign denominated available for sales securities, that we used to hedge foreign denominated liabilities.
This gain represents the cumulative embedded foreign currency gain with respect to those securities that accumulate over the time that we held the securities. And, a related charge of the same amount in other operating expense to correct the accounting for the foreign currency...
unrealized foreign currency gains and losses with respect to available to sale securities. The gain or rather the charge represents the cumulative unrealized gain with respect to these securities.
And during the quarter, we determined that GAAP requires the unrealized foreign currency gains and losses with respect to available for sale fixed income securities to be recorded through other comprehensive income and stockholders equity, rather than through other operating expense where we have our foreign currency gains and losses and as an offset to the... opposite fluctuations in the liabilities of these securities hedged.
The unrealized gains become realized when the securities are sold and that time GAAP requires to realize the foreign currency fluctu... foreign currency gains to go through realized investment gains.
So during the quarter we also sold these securities to realize this embedded gain and so that it will offset the charge in the income statement as was originally intended with the hedge. In the future we are going to hedge our foreign currency...
our foreign currency denominator liabilities with financial instruments that allows for the foreign currency fluctuation on those financial instruments to go through the income statement in foreign currency gains and losses to offset the opposite fluctuations in the hedge securities. So bottom line, did the items offset, there is no net effect on earnings and we will continue to hedge the foreign currency liabilities.
As far as investments are concerned, we didn't have any impairment losses on HCC's portfolio for the fourth quarter or for the year. We don't believe our exposure to the credit market...
credit market term loan. Sub-prime isn't significant at all.
I think this reflects the conservativeness of our investment policies and the astuteness of our outside investment managers, who have kept us out of harm's way. We put a schedule in the earnings release related to some of the exposures or questions we had on exposures related to sub-prime and the credit turmoil.
Let me just hit a couple of high spots on it. The non-agency residential-backed securities, the sub-prime and the Alt-A are roughly $18 million at December 31st and we collected approximately 1.6 million on these securities, during the quarter.
They are all... the bulk of them are highly-rated securities.
Our commercial-backed securities are not a big percentage of our investment portfolio. The average loan to value on these commercial mortgage-backed securities is roughly 60% and they are invested in areas that there is not a high risk of default.
The insurance enhanced municipal bonds at market value of roughly $1.2 billion of our $1.8 billion municipal bond portfolio. And, our investment advisors underwrite these securities for purchase not taking the insurance into consideration.
The insurance is really an additional safety feature, but we are not relying on that for the safety of the securities and the collectibility of securities. So, we have shown the insured securities what the underlying ratings are on the insured securities without the insurance wrap.
And, they will also show the rating on the non-insured portion of municipal bond portfolio. We'll give the short-term investments that we have to show that basically, these are very short term.
Money market bonds or short-term U.S government bonds. There is not a lot of...
there is no risk, we don't think in the short-term portfolio and there are no action, right certificates in that portfolio. The corporate bond portfolio is good.
We don't expect any collectibility problems in the corporate bond portfolio. The unrealized gain in...
in our securities at the end of the year was $25 million. That went to $72 million at the end of January, as the interest rates fluctuated and of notice is that the gross losses, those are the securities that are gross have been in a loss position only is only $18 million in the portfolio at December 31st.
In investment income, we had a good investment income quarter. It is higher than the 930 quarter of 930 '07 quarter.
And in that it relates generally to a possibly to the alternative investments which had a good quarter and it will catch up just ahead on with respect to one alternative investment on some income, right into that investment. With that, I'll turn it back to Frank.
John N. Molbeck, Jr.
Before that, I just want to mention that in our press release, we've given you a page of disclosure with respect to our sub-prime liability exposure DNO and ENO, and I would also like to say that, as people look at sub-prime and they look back to the prior year for some reason they take it and they have it in their mind that they should take whatever losses you have to sub prime and add it to the loss ratio that you had in the previous calendar year. But if you look at DNO losses, for example in 2006, the big event was the stock option backdating.
If you look at 2004 and 2005, we had contingent commissions and bid riggings. In 2002 and 2003, we had mutual funds in market timings.
So as you look at the DNO business, sub-prime is just another event that causes DNO losses but its not necessarily an event that should be added to the previous loss ratio to come up with results. So with that, I'll pass it back to Frank.
Frank J. Bramanti
Thanks John. Just a couple closing remarks to reiterate some of the Ed's comments.
We believe our investment portfolio is conservatively... considerably managed by professionals that are focused in the insurance industry and they have done a tremendous job of implementing our investment policy and as I said keeping us out of trouble.
We've been watching short-term assets in the chunk that's included in some of these funds, really all year end. So we have been on top of making sure that we know many moss creep through there.
As you can see that we've turned over the easy technical issues to Ed to cover. But the point of the whole issue was is that, we try to hedge our foreign currency assets and liabilities, so that we net the amount of our income statement.
And when it was discovered that the hedge, while it might be a clean dollar hedge, so that it was fully hedged but part was running through the income statement, part was running through the balance sheet. So it gave an inaccurate position from an earnings standpoint of our hedge, and so we unwound it.
But that... you really have to put both sides together.
So either you got to exclude the hit that's in the other operating expenses or you've got to include both of those items and run them through the income statements and taking the results as they are. We think are $0.85 and earnings were true earnings for the quarter.
And then going forward and Ed said this, but this is important that we continue... we will continue to hedge our exposure completely.
We will just do it in a manner that allows the accounting take it through the same line in our income statements and that's other operating expenses. And then just one final point on what John said on sub-prime liability exposure.
Based upon our current knowledge, the company continues to believe that the entire impact of sub-prime will be contained within the loss to expect we set, period. We took a $6 million or $7 million increase in reserves during '07.
Just to be ultra conservative on our DNO and ENO loss stakes, but we are very comfortable that it's contained within the reserves that we will be setting over the course of the earnings of our DNO and ENO portfolios. And then, John made reference to this, included in our releases guidance for 2008 and our guidance is EPS of $2.90 to $3.20 for the full year.
At the midpoint however to produce a return on beginning equity of 15%, which is our target return over the entire insurance cycle. Last year 2007 was over 19%.
Year before it was 20%. Our guidance points towards 15% return.
We don't and have not included any potential reserve development changes in our guidance for either 2007 or 2008 and the actual difference between 2007 results and our 2007 guidance was basically the reserve releases that occurred during the course of the year. With that, operator I am going to turn it over to you and open it up for questions.
Question And Answer
Operator
Thank you. [Operator Instructions].
Your first question comes from the line of Beth Malone with Keybanc.
Elizabeth Malone
I just want to get some clarification on the guidance. You've provided a range of 290 to 320, but you have a combined ratio of 85 and the top line is targeted at a certain amount.
I am just trying to understand how do you reconcile the fact that you have got a range with specific combined ratio and specific top line. What is the variable that's going to range between the 290 to 320?
Edward H. Ellis, Jr.
Well, again we have given numbers as guidance, those aren't absolute. We are in a declining rate environment as John described.
We think some of our businesses are little more protected for one reason or another, but there is certainly potential fluctuations on the top line. There is potential fluctuations in the loss ratios on their business, although we think our loss picks are fairly conservatively stated.
You can get a pretty good feel for an insurance company's book of business at the beginning of the year for the next 12 months out, but to pinpoint it on the numbers, pretty tough and in a declining environment and we have added a little more range to our guidance this year and the declining rate environment, you are just not as comfortable as you are in a rising rate environment that you are going to be able to come in, at or above the number. So, I think, we are just ...
and I don't want people to read into this that we are sandbagging here. We think our numbers are conservative, we set a said guidance that we have got to work hard to achieve and we think these numbers are achievable and that's why we came out with the numbers.
But I think, every number potentially best got some range to it that, that can fluctuate actually.
Elizabeth Malone
And I know you've talked about pricing competition in the market, we also have heard that the niche or specialty nature, hard to place the nature of HCC's business tends to be a little bit more insulated as you mentioned. So has the environment in...
the pricing environment you are in, changed materially from the beginning of last year when you gave guidance for last year, which proved to be conservative to what you are seeing today that would cause you to expect a meaningful decline from 2007 and 2008 in earnings?
Frank J. Bramanti
I know a lot of things were included in earning including interest rates, which has had a meaningful impact on projections. We have said and we continue to say, if we had a 5% reduction in our overall premium base in 2007 and we have a further 5% reduction in 2008, then it just would lead one to believe that the number is going to be 5% less.
So, it is not any more complicated than that. When we look at our overall book of business domestically, we are looking at 2008 with about an average premium reduction of 5% and international about 10%.
If we run all those numbers together, we come up with a range and that's the range that we provided. We don't think the environment is materially different in 2008 than it was in the fourth quarter, but the fourth quarter was materially different from the prior three quarters of 2007.
Elizabeth Malone
Okay, thank you.
Operator
Your next question comes from Doug Mewhirter with Ferris, Baker Watts.
Douglas Mewhirter
Hi, good morning. Couple of questions.
First of all the... I know you also like the surety business and I was wondering if you are concerned at all about the distress in the construction industry and whether there might be a lot of subcontractors who would I guess walk away from business because of financial distress or et cetera.
Whether you think that is having an impact on the loss picture in the surety market?
Frank J. Bramanti
Well, if we break it down into two pieces, the domestic book and the international book of business, our domestic book has very little construction-oriented exposure in the book. We don't really write big contracts, we might limits of 6 to 12, 10 to 15 and they are pretty much sheet wall, dry wall contract as looping contractors, people like that.
With respect to our initial book of business, we write larger bonds, we write a few contractors in Europe, predominantly in the UK and Spain. We are watching it very closely, we continue to watch it very closely and so far, we haven't seen any negative fallouts from our exposure and the clients that we've worked.
Douglas Mewhirter
Okay, thanks for that answer. My second question is, another expense-related question.
I notice your acquisition expenses as a percentage of year-end premiums seemed a little higher than your run rate. It was about, I think it was about 19.5% if I am not mistaken.
Is that just more of a function of your business mix shifting to higher commission-type business? Were there any other items in one-time items or true-ups embedded in that number for this quarter?
Edward H. Ellis, Jr.
Its really a business mix issue. Given on the acquisitions cost percentage.
Douglas Mewhirter
Okay. And my last question is, it looks like you had about $11 million charge in your discontinued lines, did you do a commutation in the quarter?
Edward H. Ellis, Jr.
No, we have a book of law Medical malpractice business then our Spanish Insurance subsidiary and we noticed some development on that and when we did our actuarial review in the fourth quarter. So we increased those reserves to what we believe is a conservative level to make sure that there wasn't any new development other than book of business as they write off.
John N. Molbeck, Jr.
And that business, was acquired. We bought a Spanish Insurance company from St.
Paul that has written medical malpractice. It was discontinued at the point that we acquired the company and we have been watching those reserves very carefully.
We think they, think I repeat and we are running them off. We just wanted to kind of get ahead of the curve on that when we think we have got it.
Douglas Mewhirter
Okay, thanks. That's all my questions.
Edward H. Ellis, Jr.
Thank you.
Operator
Your next question comes from Chris Neczypor with Goldman Sachs.
Christopher Neczypor
Hi good morning. One of your specialty lines peers made the comment that competition in certain areas of the market was partly being driven by some Bermuda companies looking for share.
I was hoping if you could comment on what you are seeing in this regard and maybe where you see the most pressure coming from in your U.S. specialty book?
Frank J. Bramanti
Chris, I think in 2006 there was a lot of pressure put on specialty lines from Bermuda and Lloyd's Syndicates coming into Bermuda and then to United States. A chasing premium in 2006.
I don't think it was as much of an impact in 2007. Having said that, just about every Bermuda company has announced that they are going to come into United States and get into the specialty business but we haven't actually seen there's any significant competition from them at this point in time.
Christopher Neczypor
Okay. That's helpful, thank you.
And then could you also talk a bit about how the Allianz book looks relative to your expectations, now that you presumably completed the majority of that reunderwriting of that book?
Frank J. Bramanti
Yes we are going to have Craig Kelbel to address that.
Craig J. Kelbel
While I think its performing as expected. So we have re-underwritten it, and I think we spoke to last quarter, the one last lock of it that didn't get re-underwrited was a January business, because when we did the acquisition it was late in 06.
That's now being reunderwritten in January of 08. So performing pretty much right on budget and as expected.
Christopher Neczypor
Okay. And then, given that it looks like 60% to 65% of the year muni-bond portfolio has enhancements.
I understand the point that you are making about looking at the underlying credit et cetera, but simply from a market-value perspective could you let us know what you are seeing in terms of the decline in valuation, whether it's temporary or whatever just simply given what's going on with the guarantors. You should be in a pretty unique perspective to give some commentary on what you are seeing in terms of the valuation of these securities?
Frank J. Bramanti
Well, to respond and not answer, one thing that Chris I think is important not our portfolio is that, the insured portfolio and the non-insured portfolio, if you look at the underlying ratings ignoring the insurance wrap are basically the same kind of portfolio, same relative spread of ratings, same overall rating at AA and we don't expect a material impact if all of the insured rating disappeared overnight and obviously that's not going to happen. I haven't seen the numbers, Ed have you seen what the...
what's happened to off very late. I haven't seen any market value impact.
Edward H. Ellis, Jr.
I have not seen the market value impact either and I am facing is there haven't been a lot of negative fluctuations.
Christopher Neczypor
Okay.
Edward H. Ellis, Jr.
We are trying to see it.
Frank J. Bramanti
We'll look at that and it's really a current kind of thing so, certainly we'll give color on that next quarter as we keep going through. But we haven't seen anything material come through.
We don't anticipate anything material and it was really the underwriting the securities as they were written ignoring the insurance that kind of protected the portfolio and kept fairly consistency between the insured and non-insured portfolios.
Christopher Neczypor
Understood. And then just one last one, just to be clear, and maybe I missed this but just a line of same that the off settings facts of the hedging position you mentioned basically, if there was 13.4 in the realized gains but then there was 13.4 in the other expenses.
Is that correct?
John N. Molbeck, Jr.
Correct, 13.4 gain in investment gains, realized investment gains and 13.4 million of expense in other operating expenses.
Christopher Neczypor
Okay. Great, thanks guys.
John N. Molbeck, Jr.
Okay, thank you.
Operator
Your next question comes from Dan Johnson with Citadel Investments.
Dan Johnson
Great, thanks and good morning. Another question if I could on the Allianz acquisition, maybe even more broadly on that stop-less marketing in general.
Can we talk a little bit about what you see going on there in terms of pricing competition, loss activity anything in that regard could be helpful. Thank you.
Frank J. Bramanti
Again on the Allianz lines of business, in total they have performed according to what we expected. So we haven't seen really anything unusual.
Dan Johnson
So let's talk maybe more about the broader... the whole book have done?
Frank J. Bramanti
The whole book I think at this point as John stated in his comment is we would... we identify book of businesses relatively stable in the current environment.
It's still competitive and stable. We have made in our January 08 which is considerable portion of our block renews, we are very pleased with the result.
It's very much on budget and we don't see anything unusual continuing. We think the block of business is performing at a pretty flat basis meeting from our loss ratio standpoint.
It's been pretty consistent, really for the last two years.
Dan Johnson
Thank you very much.
Frank J. Bramanti
Yes.
Operator
Your next question comes from Josh Shanker with Citi.
Joshua Shanker
I want to run through a few lines of business that, the first thing I have thought on aviation, every one hates aviation and on this conference call. This is not point figures on particular but given that characteristic whose is riding all this aviation, who is driving you away from that market, if you can describe those participants?
Frank J. Bramanti
Well, remember our aviation book is a specialty aviation book and the aviation book that people hate include airlines, aircraft products and the like. We write a very special book of business.
There is a few more Lloyd's competitors in the business. The international competitors of the same players that Lloyd's always been there and they will continue to be there year in and year out.
We have had a consistent loss ratio in the overall book of business over the past five years and the only thing that fluctuates is our premium income and as we have said many times in the company, we focus on the loss ratio and if the premium income has to go down to achieve a loss ratio then that's what we are going to do and that we will continue to do. We find aviation business, the only major line of business that we have from 1997 to 2008 that we still continue to write on the same basis as aviation and we are very happy with it.
Joshua Shanker
How does that jive with the decline in premium from this quarter?
Frank J. Bramanti
Because we wrote less international aviation business because the international aviation business was continues to benefit extremely competitive and if you look at the losses, in 2007, the industry published statistics where there was $1.5 billion in premiums and $1.8 billion of losses in 2007. And then you look at January and in January you had, I guess it was a pretty share ways Mike.
The pretty share ways loss on top of that. So, there is move in the marketplace.
We have seen at least on the international side and not on the flying carriers but on the rest of the worldwide aviation business, we have actually seen prices begin the form up and we think, sometime in '08 we might actually see price increases on the international aviation business. The domestic aviation business remains competitive; we are leader in that business.
The kind of business that we do right and we have seen rates go down about 5% in 2007 and they may go down as much as to 5% in 2008, but then again they maybe pretty flat. So, it's also early to tell but the initial signs are promising.
Edward H. Ellis, Jr.
Josh there is one thing I would add on the aviation is that when rates get to the levels that they currently are on the international side, we tend to walk away from significant business. So, that's the reduction that you see and that's the reason why our loss ratios have held up, they are not accepting the rates, they are just walking the rate and so we've got two quality business that we are on and we walk away from the static's or also competitive.
So, our volume has then reduced over the last couple of years.
Frank J. Bramanti
I think it was six international losses last year of substance. We wrote four to six in previous years, in this year out of six, we wrote one.
So, that and that's just a testing to what Frank said, we tend to just non-renew the business as the price gets to low.
Joshua Shanker
In terms of your London market business, your marine property was not given the fall from premium there. Where do you see yourself as a participant in that market in 2008?
Frank J. Bramanti
Well, on the marine and energy book, predominantly energy book, we remain a leader in that book of business. Mike Onslow is our overall underwriter and Simon Button does the day-to-day underwriter...
day-to-day underwriting. We write typically lines in the 5% to 10% area and that makes us a leader in that business.
On the property side, we are a fall low, we write the business we want write. We typically write access of the BI deductible.
When you look at the overall book of business, we find the results the margins are very, very satisfactory as I mentioned earlier but we are facing 15% price reductions.
Joshua Shanker
And finally following up on Dan Johnson's question with the medical stop-loss business. Slightly premium declines in first quarter where the Allianz acquisition is compared total with our prior quarters.
Are you reading out some of the small piece of business that aren't necessarily or what you are looking for?
Frank J. Bramanti
I think you have seen the prime decline really related to what's re-underwriting the Allianz book and keeping what we want for the full year. So, initially when I wrote it, it was all enforced and has the 12 months evolved, we've renewed what we wanted to and as a result the overall premium will have a little bit of decline.
Our organic book of business actually had a little bit of growth, but the Allianz business clearly is less onus than they are used to be because some of it didn't fit into our underwriting box.
Joshua Shanker
Okay, I appreciate the disclosure. Thank you.
Operator
Your next question comes from Kenneth Billingsley with Signal Hill.
Kenneth Billingsley
Good morning. A few questions on fee income in general.
You made comments initially that retentions are likely to increase in your business. Is that going to move some fee income out in 2008 that maybe we had initially expected as you retain more business?
John N. Molbeck, Jr.
We think that roughly in 2007 we retained 81 % of business. In 2008 roughly we are targeting about retaining 83% of book of business and we think our commission income is going to be flat, is our projection looking at 2008.
Kenneth Billingsley
You said that the fee commission you expect it will be flat compared to '07, at around 140?
John N. Molbeck, Jr.
Well, there is a couple of dynamics going on. One is that retentions, the other is one of the things that impacted is preceding commissions that we got from quarter shares and while we don't give out completely details about what reinsurance program we've, we got slightly less quarter share in some instances.
So, it's likely that the restless mind [ph] will come down a little bit during the year be supplemented by acquisitions that we may make in that line of business.
Frank J. Bramanti
And the other thing that we hadn't projected in our numbers. Commissions are made up of multiple things but one of them is profit commissions and because we had reserve releases in 2007, we picked up some profit commissions that we didn't budget and same thing could happen in 2008 but we don't plan reserve releases because we knew there were reserve releases, we would have booked it in 2007 but if that happens then our commission income will increase accordingly.
Kenneth Billingsley
On following up on some of the A&H business. From an infrastructure, do you have the ability and the people and the capacity to do quite a bit more business with some recent acquisitions.
Will that be fair?
Frank J. Bramanti
I think we can clearly, our systems don't have any capacity limitation; so I think that's why Allianz deal made perfect sense to us. We could take the book of business and not appreciably affect our expenses to run that book.
So, our systems have really no limitations the way they're put together, we could double the size, it would obviously be a few more people but it wouldn't be related to our systems.
Kenneth Billingsley
Then on the people side, would you say that the infrastructures implies to do more?
Frank J. Bramanti
Clearly we can go about our business with the current staff... the executive staff that we have, it would be more the staff that would manage the business day-to-day which we've had no trouble in finding them to properly manage our business.
Kenneth Billingsley
And what's your comment there, if they're competitive but stable. Do you see that with re-underwriting in 2008 as some of the Allianz business.
Do you see that continuing to decline in 2008 just as opportunities on an organic basis don't present themselves? Where do you see the acquisition driving?
Frank J. Bramanti
Well I think at this point, the Allianz book of businesses is being re-underwritten. So I don't think that there is a premium would decline any further because its meshed in with the rest of our block of business in A&H division.
So we would consider our premium to be relatively stable, if we would continue to see our market stable but yet competitive and if the right acquisition came along, we clearly would be interested in it.
Kenneth Billingsley
And my final question is one I know that you really don't like the answer, too much as regarding use of capital, share buyback. Could you talk about expectation and use of capital and I am assuming some of its going to be opportunities for acquisitions?
But you also mentioned using debt from the little ratio that you have there. Do you need as much capital as you have right now considering that you are expecting flat top line in 2008 and you have the capacity to borrow potentially?
Frank J. Bramanti
Well, we're... At or around year end we've had our annual reviews with the rating agencies and we're waiting for them to come back on their views of our capital structure and the adequacy of that.
If you just assume that we started out 2008 with just enough capital. Then we're not going to be employing any within our business based upon our guidance and current projection.
So whatever we earn this year will be excess capital and there may be some excess capital at year end, may be its $100 million. We're, again we're having conversations with rating agencies literally on a daily basis trying to get the models right in trying to get the answers.
But what we believe and have said a number of times is that, if we were to reinvest in our businesses, be it internal growth, be it acquisition of things that people that allow us to grow our top line over time, or acquire businesses that are either complementary or add additional lines of business to our specialty mix. That, that is the best use of our capital and that would generate the highest return for our shareholders.
And that is what we are out to do. HCC has always kept a certain amount of powder dry, so that we can take advantage of opportunities that come along that you really have to be prepared for and don't have lot a lead time.
Now, we said the same kind of things in 2007. We believe there were going to be opportunities for acquisition.
There were plenty of opportunities if you wanted to overpay and we chose not to and those were the right decisions for the right reasons. I think the environment's getting better.
I think, expectations are more. Or sellers expectations are more aligned with reality.
And I think they're going to get more real as we get through this cycle this cycle. But if we can't deploy it, we will as we are doing on a regular basis, analyzing what our returns would be if we give the money back to shareholders here through, buybacks or dividends and...
and if we don't have an opportunity to invest it at higher returns, then we are going to invest it at the best returns that we can, because we are properly forced to manage our capital account so that we can generate the highest returns for our shareholders. And, we're not going to sit around and do nothing, even if that's the right decision from an acquisition standpoint and where our capital build up, and dilute our return on equity.
So, we have shied away from this subject matter for two reasons, number one we have never been in a position where we had too much capital. Number two, we all...
the people around this table recall the days where it was very difficult to get sufficient amount of capital in order to fund our growing businesses. And so the mind set around here is grow, grow, grow and not shrink, shrink, shrink.
Now, are in an environment where you can't grow top line, you have to be very careful about what you do on the acquisition side. So, we...
but we are in new waters for us and we are going to be slow to react to buy that capital because it's very low down on our list of things to do with our capital, but it's not off the table. But right now, it's not in the cards because we think there is plenty of opportunities out there for us to grow our capital in a more effective manner.
Kenneth Billingsley
And last, is there a price over your stock that you guys already have identified that you would start buying back, given that the opportunities for M&A are not as if attractive as you would like?
Frank J. Bramanti
I am sure there is, but we are... again we are focused on the M&A side and not on the buyback stock side.
Kenneth Billingsley
Alright. Thank you.
Operator
Your next question comes from Kyle Kavanaugh with Palisade Capital.
Kyle Kavanaugh
Hi, good morning. I have a couple of questions and the first one is could you repeat what you said about the guidance you said something about the difference being related to reserve releases?
Edward H. Ellis, Jr.
What I have said was that, the difference between our 2007 actual result at338 and our guidance for 2007 was basically the amount of reserve releases we had during the year. So, that the guidance we offered last year was pretty accurate, excluding the reserves which we didn't include in the guidance numbers that we gave.
So the point being that we had a pretty good feel for our business in that period of time where earnings were peaking and the teeter was starting the cart or the other way.
Kyle Kavanaugh
Okay. Alright, thanks.
And then the other question was with regard to other operating income what are your expectations in terms of 2008 for that line and how the back go into your guidance and also the interest rate component on the investment portfolio?
Frank J. Bramanti
On the other operating income what we said during the course of last year and what we've anticipated for 2008 is that we think the run rates $3 million -$4 million is based upon the components that make that up and that is minority investments we have in different entities. We have a couple derivatives coming out of our Financial Products Division that run through there and just some other stuff.
That's kind of $3 million to $4 million run rate per quarter and that's we've anticipated. I'm going to ask Ed to address the interest rate and projections for current year?
Edward H. Ellis, Jr.
Yes, I really don't... I don't have that rate available that be projected in the budget.
What I do recall in detail is that we took our short-term interest rate expectations down about 20% over what we had. So we had a current year of nearing 5 and we have projection of nearing 4 and the current run rate yield of our portfolio is pretty much indicative of what we used, I think in general going forward now.
Obviously, there is a lot of moving parts to the financial managements and we gave it our best shot after talking to our managers of what they expected during the year. Again, we take a pretty plain de novo approach, so there is not any yield enhancement kind of vehicle going in our portfolio that we are trying to stretch things.
We buy predominantly... in the money market, we have some predominantly agency focused asset-backed securities in our portfolio.
Again, pretty plain de novo. We haven't been paid to go down the quality rankings, we haven't gotten paid to go out the yield curves over the last couple of years.
So, we took in a pretty tight box where we bought and that kept aside a trouble, kind of maybe yield just kind of average market, but we're very happy with where we ended up with that approach.
Kyle Kavanaugh
Thank you.
Operator
Your next question comes from David Lewis of Raymond James.
David Lewis
Good morning, thank you. I just want to clarify a couple of numbers, and I think earlier, you indicated that you benefited from alternative investments in the fourth quarter net investment income.
Can you give us a general idea of what that benefit was in the period that we might want to back out as kind of look forward?
Edward H. Ellis, Jr.
Yes, it was about $4 million.
David Lewis
Okay. And Frank following up on the Kevin's question, I guess I wasn't sure in your assumption, you said you went from 5 to 4, are you talking about percents, so you are only using a 4% investment yield?
Frank J. Bramanti
On the short-term investment portion of our portfolio.
David Lewis
So, you probably have some conservative that are build in there?
Frank J. Bramanti
Well, we will see what happens to short-term rates they were heading ... as we were doing the budget they were heading down to the floor.
So, we are trying to down a little bit. We would hope that we beat our numbers, but given the volatility that we have experienced in the marketplace it's kind of hard to say where you going to be and we have a portfolio that is relatively short.
I mean we have a five duration on it. And so we have got significant cash flow coming from the investment portfolio and considerable cash flow coming from our operating cash flow.
We want to make sure that what we include in our budget is something that is reasonable given the volatility of the interest rates. So, hence our numbers, I mean maybe there is a little bit of conservatism in there, but and if you can predict the interest rates, we will be glad to use the right number.
David Lewis
Sure, I understand, all right. And since this hedge sale was total offset, we should really look at the quarter's operating EPS as being $0.85, correct?
Frank J. Bramanti
Well, that's what we believe.
David Lewis
Yes
Frank J. Bramanti
It really isn't a capital... if it weren't for this hedge that we had to unwind and put it on in a more appropriate manner that capital gain would not have occurred and the --
David Lewis
Offset.
Frank J. Bramanti
If that weren't to the interim stage it wouldn't have been incurred either so.
David Lewis
Right. And tax rate in the quarter was little lower than I was anticipate [ph] is there any thing funny going on there and what might we assume for 2008?
Edward H. Ellis, Jr.
Yes, the tax rate was down because we had one on the FIN 48 we had one adjustment on for a some we had on some tax issues that was positive for us. And then in the fourth quarter we always adjust our prior year accruals based upon by a file of the tax returns and that impacted this quarter positively too.
And for a run rate, I think it roughly was between 31% and 32% we are investing more heavily in municipal bonds which is tending to reduce the effective tax rate.
David Lewis
Okay that's helpful. And just finally on the stop-loss side.
Frank I think you have not had this conversation but you still feel that you may actually start to see some improved rates out of that business?
Frank J. Bramanti
I am going to repeat what I've said since I came back in November of 06. Part of the reason that we did the Allianz acquisition was that we felt that there was going to be some rate change ultimately by the first dollar riders, hasn't happened, didn't happen in 07 and haven't happened yet.
Our people are optimistic that their numbers are dictating that they are going to have to do some thing. But we haven't finished yet.
But more importantly on our business, it really we been able to hold trend we have a very positive feeling about the one, one renewals and where we are at on the current business. We have able to hold trend we got stable margin and loss ratio on our business, so we are very comfortable with where we are in net of stop-loss.
David Lewis
That's helpful. Thank you.
Operator
Your next question comes from Beth Malone with KeyBanc.
Elizabeth Malone
Follow-up on the acquisition; what... is there a traditional catalyst that you are anticipating seeing that would increase the probability of acquisition is there a tipping point for these smaller MGAs or other players in the market place you think that we're getting close to?
Frank J. Bramanti
I think historically, certainly the action that set many of the MGAs out into the market place looking for all kinds of alternatives was when the market finally hardens and people start getting out of things that cost them money, notice as the cancellation, programs being cancelled, paper being pulled, tends to be a big catalyst. But as we head down the backside of the cycle, it's the MGAs with the foresight to start looking out into the horizon and saying there are clouds out there what am I going to do if this happens and if that happens.
And people that look around for alternatives or back stocks to their current operating arrangements potentially look around to... is there another solution to my problem and that's kind of where we come in.
We attended a seminar that had, I think it had 16 or more companies there trying to sign up new programs, okay and we were there looking to come up with other arrangements i.e. we don't write program business, we don't give our pen away, but we do require MGAs and give them our paper and that's us with our paper.
We didn't have a lot of people knocking on our doors, but I think that's going to happen overtime. More importantly though from the pricing standpoint, when you have people trying to sell their business is at the peak of the earnings, you're going to get the peak of expectations from a seller's perspective and I think to the extent that our industries earnings will have peaked then reality is going to start drifting away from that and people's expectation that something higher than the peak just have to go away.
We've seen it on some recent deals, albeit in tougher lines of business, but expectations of value on a multiple basis have come down dramatically versus where they were a year ago and that's great. That's keeping in a right direction.
But more importantly, you've got to have a fit and this is for anybody that's buying anything. Anyone that is a successful acquirer they got to have a fit, be it a cultural fit, the businesses fits, the direction that they are trying to drive their companies.
There have to be some kind of natural connection with that acquisition for it to work and when you got people that are really expecting over the top dollar, it's tough to make that connection. A lot of people have that problem, if there is lot of would be buyers out there that say no thank you when they get into it.
So you just have to find a right deal and that is you are out there on the street every day looking at every deal trying to get all the flow running through your office, so you can pick and choose the ones you want to look at and then we're out beating the streets to come up with our own cross bags and that's where the best ones come from, because you find people that aren't for sale, that aren't flogging their business, they're working for how do they grow their business into the future and you find the right businesses, you make the deal on and we think those opportunities are still out there
Elizabeth Malone
Hey thank you.
Operator
Your next question comes from Howard Pointer from Pointer and Company [ph].
Unidentified Analyst
Hello everybody. Please tell me what side A means.
John N. Molbeck, Jr.
Those are claims that are not indemnifiable as for the most part by the corporation. So big companies who are the...
sheer exposure to a big company, I wont name any big companies but you can figure out any of the big companies, its when they go bankrupt, Enron would have been a... would have been a side A client for example.
Frank J. Bramanti
Basically I think the real defining it reimburses directors and officers for payment that they didn't get reimbursed from the corporation and as John said the most likely situation there is the corporation can't reimburse them because of bankruptcy so its highly and likely you have any side A claims in the situation where the company's non-going, going concern. As opposed a full coverage that the company may well give me imbursed for claims against the directors and officers on the side A coverage, the company wouldn't get reimbursed.
It would only be paying the liability of the directors when the company could not pay.
Unidentified Analyst
Directly to the directors.
Frank J. Bramanti
Or directly to whosever are suing the directors.
Unidentified Analyst
Oh I see, Okay thank you.
Operator
There are no further questions at this time.
Frank J. Bramanti
Ladies and gentlemen, thank you very much for participating. We will talk to you in May in our first quarter call.
Thank you.
Operator
Thank you for joining today's HCC Insurance Holdings conference call. You may now disconnect.