Assurant Inc (AIZ) 2004 Q4 法說會逐字稿

Welcome to the Assurance fourth quarter and year-end 2004 financial results conference call. [OPERATOR INSTRUCTIONS] I'd now like to turn the call over to Mr. Larry Cains, SVP, Investor Relations. Please go ahead, Mr. Cains.

Thank you, operator. Welcome to Assurant's 2004 fourth quarter and year-end conference call. Joining me are Kerry Clayton, our President and CEO; and Rob Pollock, our CFO. Today's prepared remarks will last approximately 20 minutes, after which time we will open the call for questions.

Before we get underway, I'd like to make the following remarks. This morning we issued a press release announcing our fourth quarter and year-end 2004 financial results. The press release, as well as corresponding supplementary financial information, may be found on our website at www.assurant.com.

Now a word about forward-looking statements. Some of the statements we may make during this call may contain forward-looking information. Our actual results may differ materially from such statements. We advise you to read the discussion of risks and uncertainties associated with our business and results of operations contained in our SEC filings, which can be accessed on our website.

Additionally, this presentation will contain non-GAAP financial measures which we believe are meaningful in evaluating the company's performance. For more detailed disclosures of these non-GAAP measures, the most comparable GAAP measures and a reconciliation of the two, please refer to the supplementary financial information posted on our website.

Now I'd like to turn the call over to Kerry.

Thank you, Larry. Good morning, everyone, and thank you for joining us today. This month marks the end of our first year as a publicly traded U.S. company. We continue to increase shareholder value and generate profitable growth through our leading specialty insurance businesses. I'm pleased with our accomplishments and optimistic about our future. We believe the events of the last 12 months have demonstrated the strategic balance and inherent strengths of our diversified specialty insurance approach and we're delighted to report our 2004 results to you today.

Our net operating income for the fourth quarter was $86.5 million, 62 cents per share, and $345 million for the full year, $2.44 per share. These figures are after a one-time tax charge of $8.7 million or 6 cents per share related primarily to the repatriation of $110 million from our Puerto Rican affiliate. Our pro forma return on equity was 10.9 percent for the year.

Major milestones for the last 12 months included our initial public offering, which was the second largest of 2004, and our highly successful secondary offering in January of this year. After more than 25 years with Fortis, we wish them well and thank them for our rich and shared history.

Excellence in risk management, one of our core capabilities, was exhibited by Assurant Health's excellent 92.4 percent combined ratio but also by improvement in Assurance Employee Benefits loss ratio and by our ability to mitigate the unprecedented level of hurricane losses due to the efficient use of reinsurance. And our employees and on-site field adjusters, many of whom live in Florida and personally know the impact a hurricane can have on the lives of its victims, were on the ground working around the clock to deliver on our commitment to policy holders and bring peace of mind to thousands of affected home owners.

During 2004 we were able to renew many of our strategic relationships with large distribution partners, including State Farm, and we expanded several partnerships, such as those with General Electric and Best Buy's Canadian affiliate, Future Shop.

Our actions over the past year also confirm our commitment to disciplined and focused capital management. We maintained in each operating entity the capital which is required to maintain its rating, adding any needed capital or removing any excess capital on a timely basis.

In 2004 dividends of $362 million were paid from our insurance subsidiaries to the parent company, significantly in excess of their ordinary statutory dividend capacity of $302 million. Including the Puerto Rico repatriated amount, we currently have approximately $300 million of excess capital on hand and we should accumulate an additional $100 to $200 million by the end of the year.

We have clear priorities for redeploying the capital. Our first priority is to reinvest it-- the capital in our businesses to finance their growth. However, in 2004 most of our growth came in less capital-intensive businesses. Our second priority is to make prudent and opportunistic add-on acquisitions, most likely in the $100 million to $300 million range, to further build each of our specialty insurance businesses. Our third priority would be to enter a new niche business.

Nonetheless, if we are unable to deploy capital in these ways, then we will return capital to our shareholders through share buy-backs and/or dividends. In 2004 our board authorized a share buy-back plan and we bought back 2.4 million shares for $63 million, an average price, including commissions, of $26.04. However, the share repurchases were suspended in early November when Fortis gave us notice of the secondary offering.

In 2004 we also began paying a quarterly cash dividend of 7 cents per share and, as we announced last week, we will pay our fourth quarterly 7 cent dividend in March. We anticipate that our board will review the level of the dividend this spring.

Our strategy for 2005 remains to further strengthen our diversified specialty insurance platform and to focus on delivering disciplined, profitable growth. Assurant Solutions is poised to benefit from improvements in the economy, including increases in consumer spending and retail sales, leveraging our strong momentum in extended service contracts. We are also encouraged with the growth in our international operations, particularly in the UK and Canada, and we have high expectations for further expansion in selected countries in Europe and Latin America.

Assurant Health finished the year with record net operating income and is well positioned to grow in individual health insurance and HSAs. We will continue to use our risk management skills to maintain profitability. We will leverage our existing national marketing arrangements and hope to add new ones. We are optimistic about the prospects for our second-generation HSA product and for further penetrating the direct-to-the-consumer market, both of which we invested in heavily during the fourth quarter.

Favorable economic trends and our disciplined underwriting approach are working in Assurant Employee Benefits, with both life and disability showing significant sales growth. The improving employment picture, although modest in small businesses, will help to grow our premium base as existing employers add additional employees. The increasing cost of medical insurance is causing employers to resist adding new employer-paid benefits and we are well positioned to offer voluntary or employee-paid benefits to their employees.

Assurant Preneed, our most asset-intensive business, continues to maintain its market-leading position in this specialty insurance business and is poised to benefit over time from an increase in interest rates.

We are pleased that in 2004 we demonstrated the success of our diversified specialty insurance strategy and are well positioned to take advantage of an upturn in a variety of key trends.

Now I'll turn it over to Rob to review our financial results in more detail.

Thanks, Gary. Overall, we had very good performance in both the quarter and year, despite the claims from catastrophes that totaled $60.5 million, net of reinsurance and taxes, for the year. The fourth quarter includes $10.4 million of catastrophe losses after tax.

In the fourth quarter net operating income, defined as net income excluding investment gains or losses and other unusual items, increased 16 percent to $86.5 million from $75 million in 2003. For the year, net operating income increased 5 percent to $345 million from $329 million in 2003. We were able to remove $110 million of excess capital from our Puerto Rican subsidiary as a result of the American Jobs Creation Act.

Net operating income was negatively impacted by a one-time tax provision related to this repatriation. We had some favorable tax adjustments during the quarter, but we incurred a net charge of $8.7 million, or 6 cents per share, from tax items. This was reported in our corporate segment.

As Kerry mentioned, net operating income per share was 62 cents in the fourth quarter and $2.44 for the year. Total net catastrophe losses of $60.5 million reduced 2004 earnings per share by 43 cents compared to catastrophe losses of about 14 cents per share in 2003.

Net earned premiums grew 1 percent to $1.6 billion for the quarter and 5 percent to $6.5 billion for the year. Net investment income increased 8 percent to $163 million for the quarter and 5 percent to $635 million for the year. The yield from our portfolio declined to 5.46 percent from 5.61 percent last year. However, invested assets were up 5 percent from the previous year-end to $12.4 billion.

Now let's turn to our core businesses. Assurant Solutions reported net operating income in the fourth quarter of $45 million, up 35 percent from the fourth quarter of 2003, and net operating income of $126 million for the year, down 5 percent for the year. Catastrophic claim activity totaled $60.5 million, after tax, for the year.

Our reinsurance coverage remains strong as a significant portion of recoveries will be from the Florida hurricane catastrophe fund. Annual renewals of our reinsurance contracts will be conducted in the spring and we expect there will be ample availability of coverage in the market.

Results at Assurant Solutions were very strong, driven by excellent loss experience, excluding the catastrophes, in our specialty property businesses. One reason for the improvement was our success in reducing claim costs by building our claims department so that we were able to reduce the use of independent claim adjusters. At the same time, we improved customer satisfaction by settling claims more quickly.

Net earned premiums for the quarter decreased 2 percent to $612 million and increased 4 percent to $2.45 billion for the year. Assurant Solutions quarterly earned premiums can fluctuate as revenues can be allocated between premiums and fee income.

Growth came from international extended service contracts and creditor-placed homeowners businesses. This growth was partially offset by declines in our manufactured housing and domestic credit insurance businesses.

Fee income was up 29 percent for the quarter at $39 million and up 5 percent for the year at $136 million as a result of a continued growth in our consumer protection business. Much of this growth was in our extended service contract business, where we utilize a different approach, an integrated model where we do both the administrative servicing and the underwriting. This approach is gaining favor in the market, as demonstrated by our clients such as GE and Future Shop, Best Buy's Canadian retailer.

Assurant Solutions recently announced a jury award in our favor of approximately $70 million from Progeny Marketing Innovations for breach of contract and breach of fiduciary duty. The verdict is subject to appeal and will not be recorded in our financial statements until we receive payment.

Let's turn next to Assurant Health, our leading individual medical insurance business. Here again we saw very strong results for the quarter and full year. Net operating income in the fourth quarter of 2004 grew 19 percent to $34 million, compared to $28 million in 2003. For the year, net operating income grew 31 percent to $158 million from $121 million in 2003. These improvements were driven by growth in individual medical premiums and excellent combined ratios of 92.4 percent for the year and 94.1 percent for the quarter.

The fourth quarter loss ratio was similar to results for the first half of 2004, but fourth quarter-- but the fourth quarter expense ratio was higher due to approximately $13 million of development expenses. These expenses were primarily associated with product development costs of our second-generation health savings account and pilot testing of direct-to-consumer marketing programs for our individual health products.

Net earned premiums increased 5 percent to $558 million compared to the fourth quarter of 2003 and 11 percent in the year to $2.2 billion. Individual medical insurance continues to be the growth driver of this business, although growth slowed in the fourth quarter. We continue to see premium declines in our small group business and remain focused on profitability.

Individual medical insurance sales with an HSA represented 37 percent of new sales for the year because of our planning for the enabling legislation. We've introduced our second generation of the HSA, which includes features such a debit card and online account access. In addition, we have established asset management and administration relationships with partners. While HSAs are only one year old, we believe they will improve persistency of the business.

Individual medical insurance membership decreased in total from the third quarter to the fourth quarter. This decrease was attributable to the seasonal membership we see in short-term medical.

Membership in our individual comprehensive major medical product flattened during the fourth quarter from continuing competition. Our direct marketing efforts have been launched to counteract this trend.

I'll now turn to Assurant's Employee Benefits, our group dental, disability and life insurer for small to mid-sized employers and their employees. Assurant Employee Benefits had good net operating income in the fourth quarter of 2004, which increased 54 percent to $20 million, compared to $13 million in the fourth quarter of 2003, and increased 1 percent to $62 million for the year. Excluding the 2003 benefit of a reserve release of $11.5 million, after tax, net operating income for the year increased 24 percent.

In the fourth quarter, we saw continued improvement in our loss ratios. Disability loss ratios have improved from fewer new claims and continued strong recoveries from our return-to-work orientation that has been the cornerstone of our claims operation for years.

Life loss ratios were favorable in the quarter, continuing the favorable mortality trend we have observed throughout the year. Dental loss ratios have deteriorated slightly, primarily in voluntary dental, while true group dental loss ratios have shown modest improvement. As we mentioned on prior calls, quarter-to-quarter comparisons may show variability, given the low frequency and high severity nature of the group life and long-term disability business.

Assurant Employee Benefits net earned premiums are showing some growth. In the fourth quarter of 2004, net earned premiums grew 2 percent to $344 million compared to $336 million in 2003 and grew 2 percent for the year to $1.3 billion.

Premium growth has been driven by improved sales over 2003, particularly in disability products. We continue to see growth in disability risk management solutions, our turnkey disability solutions we provide other insurance companies.

Voluntary sales slowed in the fourth quarter, particularly in dental, but we are pleased to report that voluntary sales are up 16 percent for the year.

Persistency also improved in our disability products. As we discussed in earlier calls, we increased disability rates earlier than many competitors who are now taking pricing actions.

Elsewhere, we have experienced flat premium growth in dental and term life, where our pricing discipline has made us less competitive in a challenging market place. We are hopeful sales will improve in 2005.

Assurant Preneed continues to focus on managing policy crediting rates and expense control. During the fourth quarter we saw a positive result with net operating income up 6.6 percent for the quarter at $8.7 million, but down 5 percent at $34 million for the year.

Interest rates have continued to stay low and the investment spread we earn remains at low levels. At these levels, the portfolio rate will continue to decline. To counteract low interest rates, we have reduced crediting rates by 150 basis points over the last two years on the one-third of the business where we can take action. We have also carefully managed our expenses and have not renewed contracts with independent funeral homes that were not meeting our return targets.

Net earned premium decreased 3 percent to $125 million for the quarter and 1 percent to $526 million for the year. Sales through independent funeral homes, which represents almost half our business, slowed for the quarter and year as a result of the reduced policy crediting rates.

We have seen strong sales growth in Canada, which has offset some of the slow growth in the U.S.

Next, I'll briefly comment on our corporate and other segment. Corporate and other reported a net operating loss of $20 million for the fourth quarter, compared to a loss of $1 million in the fourth quarter of 2003. For the year 2004, corporate losses totaled $35 million versus net operating income of $7 million in 2003.

As I previously mentioned, fourth quarter 2004 includes a one-time tax provision for repatriating capital from our Puerto Rican operations and other tax adjustments resulting in a net charge of $8.7 million. Expenses also increased due to the costs of becoming a public company.

In addition, we charge expenses of our stock appreciation rights against our income statement. We follow accounting guidelines which require the expense charge to vary based upon the change in our stock price. Since our stock performance has been strong since the IPO and during the fourth quarter, in particular, the corporate segment includes higher expenses related to our stock appreciation rights.

Recently, new regulations have been enacted regarding stock-related compensation plans. As a result, we are in the midst of changing both our plan design and the way we account from a variable to a fixed-cost approach. We anticipate these changes will begin to report in our third quarter.

Amortization of deferred gains from businesses sold through reinsurance declined consistent with the runoff of policies associated with these businesses. Interest expense in 2004 declined as a result of recapitalizing the company in conjunction with our IPO.

Our overall balance sheet remains strong. Total assets were $24 billion. Total invested assets in cash and equivalents were $12.4 billion, a growth of approximately 5 percent in 2004.

Our total shareholders' equity at year-end was $3.6 billion, $3.3 billion excluding accumulated other comprehensive income. Pro forma return on average equity was 10.9 percent for the year. Our pro forma book value per share grew 10 percent to $23.57 from $21.37, again, excluding AOCI.

We continue to be committed to providing more information on our business model. We plan to add additional data elements to our statistical supplement during 2005.

In closing, we are pleased with our achievements during our first year as a public company. We believe our results reaffirm our specialty insurance strategy, built on diversified businesses. We are gratified by the support of our investors and hope to continue growing in a disciplined and profitable manner.

Now I'd like to turn it back to Kerry to open the floor for questions.

Thanks, Rob. Operator, we're ready for questions.

Thank you. [OPERATOR INSTRUCTIONS] David Lewis, Suntrust Robinson.

I've got a couple of questions on the health side, but first I just want to make sure I'm clear on the-- if I looked at kind of the earnings run rate for the quarter, even before the $13 million of higher expenses, I guess I come up with 75 cents taking the 62 cents, adding back the 6 cents for the tax side, and then 7 cents of higher cat losses really attributed to third quarter. Is that accurate?

It would be-- you can look at it that way, David. You all have your own way of looking at the results.

But there's no really favorable unusual items in the quarter that you would break out similar to the other factors, would you?

Other than what we talked about, the very favorable loss ratios on our property business.

Right. And just on the health side, can you discuss the competitive environment for the small group? I mean, is that going to continue to heat up or has it changed over the last three months? And if California requires residents to have mandatory coverage, how do you see Assurant benefiting from that trend?

I think we've seen the decline in small group pretty consistently now for the last four or five quarters and we don't see any let-up in that. It's an opportunistic product line for us and, again, our core business here that we feel we're-- really have a differentiated approach on is in the individual medical and we write the group opportunistically.

On the California front, I would preface it by saying that things aren't always what they appear to be in California. But we certainly look at the overall favorable environment for HSAs and for other methods of encouraging people to have health insurance as being favorable to us since we're well positioned in those markets.

Certainly if-- if there become some mandatory requirements, depending on exactly how they're instituted, it could present some opportunities. On the other hand, it might not.

Again, we feel that our strength is in the individual medical area and particularly with the health savings accounts and really look very favorable towards, for example, ultimate tax deductibility of the premium for individuals as being a very favorable development.

William Witt (ph), Morgan Stanley.

I'm wondering if there are regional differences in sales of HSAs and if that is the case if your distribution arrangement is set up to take advantage of that?

I don't know that we've looked at it exactly that way, Bill (ph). I think that's a good question. I think, as Kerry mentioned, we're very focused on the individual medical business, which we believe is where most of the HSA sales have occurred. And in HSAs you are combining a rather complicated tax sale with the sale of a major medical product and having a distribution system that knows how to sell that is very important.

We think we have many different ways to reach distribution through our different distribution channels. State Farm has shown great success in selling this product as have many of the people who were previously trained in the-- its predecessor, the MSA.

Thanks for that. A second question, if I may. Could you comment in both Health and in Solutions on the actual versus expected experience? If you'd be willing to share specifically releases in the quarter that'd be helpful. Otherwise, general commentary on the-- now that, especially in Health, we're one year into the major medical coupled with the HSA, some general comments on the pricing adequacy for that?

Sure. First of all, I think when-- when our K is out, it'll give you the detail of reserve developments on 2003 year-end, Bill (ph), so I'd defer to that because I haven't seen all the compiled numbers. But I don't think-- I think the key issue is our results this year are not going to be as a result of having weakened the balance sheet at all. We think the balance sheet is still quite strong.

On an actual to expected basis, as we've mentioned previously on the Health side, we continue to see favorable actual to expected results. A lot of that is driven by our discipline of trying new things but not reflecting them in the pricing until they actually show up in the results. That's been a real key there.

On the-- on the Solutions side, we do think that hiring in our own claim adjusters and training them in the way we want to do business has been a contributor toward lowering our loss ratios in the business. We hope that will continue to develop. There's also another theory out there, though, that says when you have catastrophes it's hard to have other claims and I don't know if there's truth to that or not, but there certainly might be validity to that theory.

Jimmy Buhler (ph), J.P. Morgan.

Hi, I just have a couple of questions. First, if you could just discuss on when the GE contract will start flowing through your premiums? And then second, just how much room do you have on the one-third of the business that-- where you have some flexibility on crediting rate actions in the Preneed business? How much further room do you have for crediting rate reductions in that business?

Yes, on the GE contract, I would say that GE is just really at its beginning and will not be in a fully mature contract state until I believe its 2007.

OK.

All right. So we think you'll see growth coming from that relationship over the next few years.

On the crediting rates, it depends on the particulars. We have a bit more room but we're very cognizant that changes in rates also impact new production and if you take rates down too far you also turn off the new production. So you're balancing those two issues when you look to change rates.

OK. And then just to follow up, you did mention that you're moving from-- on options and stock appreciation rights you're moving from a fixed-- or a variable expense structure to fixed cost structure in the third quarter, I think you said. Do you-- are you willing to sort of quantify what the impact of that would be? Would it be positive/negative, or--?

Well--

Depending if you just assume that the stock goes up, maybe, on a variable structure, if the stock goes up 2 percent a quarter?

Well, I guess the big key is we've got to evaluate how the fixed cost accounting method would work. I guess what I would say is that I'll go out on a limb and say that had we used the fixed cost method in 2004 our total expenses would have been lower.

OK. That's partly because the stock was so strong?

Exactly.

Blaine Marder (ph), Lowe Partners (ph).

It seems to me -- and maybe I'm not looking at this correctly -- the way you give us your excess capital number, your $300 million plus incremental in '05, understates the company's flexibility on the balance sheet. I'm just looking at your tangible-- your tangible net worth as a percent of your total assets and comparing it with other players in the industry and it just seems to me that perhaps you have more flexibility than the excess capital number you're giving us. Is that not the way I should be looking at it?

No, I think we have a very strong balance sheet. Our debt-to-capital ratio is quite low, about 23 percent, I think, and could certainly be much higher for our BBB+ bond rating. So we certainly have the ability to raise funds to do acquisitions or other activities in excess of the $300 million of cash that we have available. And that certainly gives us flexibility should opportunities come up. I think, as you can see, we can finance quite a bit before we would have to go back to the equity markets.

Right. And can you give us, perhaps, and give your investors a timeframe with which you would like to deploy some of this capital or with which you'll decide whether you want to retire a substantial amount of your own stock or raise the dividend? And this is-- you mentioned kind of, well, we're going to either do tuck-ins or we'll add a whole new niche business. Maybe give us some criteria, pay-back periods or returns that you would consider when making acquisitions?

Sure. Well, first let me say that a new niche certainly is a goal, longer term, but is very unlikely for 2005. The-- I think we have a lot of flexibility and we want to build each of our specialty businesses. We see a greater flow of activity in the M&A market right now and I would say reasonably priced or deals with reasonable expectations. It's still early, but I would say we are optimistic about the possibility of doing some acquisitions this year. Again, it's a bit of an unpredictable thing, but we would certainly hope to have some results during 2005.

In terms of criteria, we're obviously looking on things that can help improve our ROE. We want to do things that create value for our shareholders and will be viewed that way. So we're certainly going to be disciplined in terms of looking at, over the long term, how any acquisition can add to that.

OK. So you weigh it against the ROE factors of taking out, say, 5 percent of your own stock or 10 percent?

Well, certainly-- now you've shifted to share buy-back and how we make decisions on share buy-back and that-- that's an equally interesting question, but, yes, that all has to be considered in the mix.

But I would say, in terms of priority, I mean, our first priority is to build the businesses, invest in the current businesses and build-- build them with M&A. And, obviously, if we can't do that on terms that are favorable then we'll look at the other alternatives. But building the company is a clear first priority.

John Madow (ph), Fox-Pitt, Kelton.

A quick question for you on the expense levels in the fourth quarter and I understand from your commentary about the $13 million in development costs in the Health segment this quarter and that's helpful. I just wanted to get a sense for, one, out of that $13 million, do we expect some of that to continue, going forward or is that kind of that's our investment for the second generation? And then-- on the HSA product.

And then the second question is, in terms of corporate, expense levels really jumped sequentially from about $12.8 to $26 million and I just wanted to get a sense-- I mean, you guys have talked about public company costs, but I assume that was in the third quarter already and probably doesn't impact you much sequentially. I just wanted to get a sense for what drove the numbers there?

Sure.

Well-- Go ahead, Kerry.

Just on the health front, let me say, first, most of the $13 million, I think, were sort of one-time expenses and that's sort of why we itemized them and they really related, on the HSAs, for us creating the interfaces, a certain amount of capability acquisition to do debit card processing and things like that. Again, there may-- there certainly may be other items like that that come up in the future, but I don't see those expenses as like continuing quarterly expenses of any sort.

Thank you.

On the direct-to-consumer, which was the other part of the $13 million, that also was kind of a big pilot program including development of ad spots and so forth and I would say that to the extent that continues it would be part of producing new business as opposed to experimentation. So, again, I see that as largely non-recurring.

That's helpful. Great. And on the corporate side?

Yes, on the corporate side, well, we're quite focused on increasing shareholder value and we felt that the opportunity that came about from the Jobs Creation Act to repatriate capital was well worth paying the tax charge to get that money out for redeployment. As I mentioned, the charge was $8.7 million, net of some other positive tax adjustments we had, but that should be a non-recurring item.

Oh, Rob, does that come through in the G&A or does that come through in the income tax expense line?

It's in the tax line.

Oh, OK.

OK? And the other one is, obviously, SARs, which was-- as I mentioned, we had, I think, over the course of the year we went public, we closed the year at $30.55 and $4.61 of that appreciation occurred during the fourth quarter. So the SARs-related expense charge was particularly heavy as a result in the fourth quarter.

Got it. OK. And then maybe turning to top-line growth and some of the investment made in the fourth quarter for the second generation HSA product in the Health segment and top-line growth in Solutions, I guess, in various products was maybe up and down and overall down for the quarter. I just want to get a sense-- maybe specifically in Solutions, could you give us a sense for how much the runoff of the U.S. credit insurance business is dragging that growth rate from the-- from the product lines that you're actively growing?

And then the Health side, is competition really going to impact the growth rate there? Do you expect this new product development to give you a boost in '05?

Sure. If we start with the credit insurance business, we believe we are now in a situation where the growth in our international credit business should be offsetting the decline in our U.S. or domestic credit business. So we experienced a continued-- a bit of a decline this year, but we think that will stabilize as we move forward, which we think will be quite a positive.

If we move over and talk about the health insurance side, there's clearly more competition. I think another interesting trend we've seen is that in certain states a number of the Blues organizations, which are non-profit organizations, have made decisions to pass on rate increases in the business. Now the reason that's quite important is, one of the things that generates new sales activity is people who are dissatisfied with their current plan and that dissatisfaction can often come about from the rate increase. So in certain selected markets we're seeing situations where there's just less new business available.

OK. OK. And then just one final question and that was, again, kind of going back to Solutions, could you give us a sense for, it looks like in the specialty property business premium growth was down quarter-over-quarter and maybe a little bit of commentary about trends in the manufactured housing sector and what you might expect to see there in '05?

Sure. In the specialty property business, as you know, we-- a big part of our strategy has been to align with industry leaders. We did not see some of the consolidation by those leaders in 2004 that we've seen-- that we've seen in prior years and so our growth in the creditor-placed business was more modest.

On the manufactured housing side, there was still a decline in new manufactured homes sold. We're hoping that's going to change, but it still declined last year. We're hoping that that will start to build with Berkshire's commitment to the business, but until it does, that business is a bit in decline, as well.

Joan Zief, Goldman Sachs.

I had a couple of questions, as well. First of all, you said that you were-- on the property/casualty side you had hired your own claims adjusters and that was helping with the loss ratio. Does it have any implication to the expense ratio, however? Or is it pretty much a wash?

Yes and it's a good question, Joan. I think that in the evaluation overall we concluded that we had-- that risk management was a key part of this business and we had better control of the risk management by having our own adjusters in. When you combine the two, I think it-- we found it to be both less expensive on the expense ratio side and to lead to lower claims cost.

Now you can look at the actual claims people as being a bit more of a fixed cost and there's certainly appeal in having the variable cost nature of outside adjusters. But we've actually seen a gain on both pieces.

OK. All right. Another question I had was about this push for your second generation HSA product. I mean, the HSA product has only been around for one year. I didn't think that competition was that intense. I guess my question is what pushed you to invest and move forward? Did you find that the way the product was originally designed wasn't fitting the needs of the individuals? Did you find that you needed to find more ways to sort of get more profitability out of the products? Or was it really just my perception of competition was just incorrect and you really did need to push forward?

Well, I think we were-- actually wrote the very first HSA back at the beginning of 2004. HSAs were up to 40 percent of our sales as the year progressed and we were a real market leader with the HSA in the individual market.

We really want to keep that leading position in the HSA market and certainly to do that it was necessary to develop some of the additional features that are becoming part of the HSA offering. We certainly did want to let our leading position deteriorate.

So the debit card, offering online access and so forth. We spent money on segmenting our buyers, determining exactly which features they want and which features they use and, again, we want to keep momentum in this product. It continues to get heavy support from the Bush Administration and we look forward to it being a continuing source of growth for us.

OK. My last question is, you said somewhere out in the future you would consider adding a new niche. I mean, what type of new niche would you consider adding, somewhere in the future?

We certainly would want to continue to add any business that would build our specialty portfolio, our leading positions, use the kind of strengths that we have, our risk management skills, our administration and technology skills, our large partner management skills.

We haven't added a new niche since 1991. I can't give you any candidate list. We're going to be very careful about that, but--

I know, but how about just-- I mean, is there really another business out there that meets those criteria?

We certainly hope there is and if I knew about it we would have probably already pursued it but we believe some-- it could be a business that spawns out of something we're in already, development closely related to something that we do. I mean, frankly, the last business that we had identified was-- and this was, obviously, before its acquisition by AIG, was Hartford Steam Boiler. That was a hard-core property/casualty business, which was not what Fortis was interested in. But it's-- I think they are few and far between, but we will look for those opportunities if they're out there.

Greg Lapin (ph), Sarena Capital (ph).

Some of the main questions here just kind of trail off some of the other ones, more for modeling purposes. On the Solutions business, the premium reduction was nicely replaced with fees and that resulted in a margin on a pretax basis climbing above the 9 percent level for the first time. With this premium stabilization and this other factor, is this new area something that we should become accustomed to?

Well, it's interesting. As you know, we-- with our large client relationships we often have a situation where we-- the contract can get modified as we learn more about how it works with them. That can often result in us moving things from an earned premium to a fee income basis, Greg (ph), and we like when things move to fee income because largely they don't require nearly the capital charge the insurance premium side does.

But we try and be responsive to client needs as we renegotiate contracts and when we get them working our way, as well, we're quite pleased.

OK. The tax rate, what should we expect for '05?

And then, going back to the Health segment, then we-- the 29 percent expense ratio has been pretty consistent over time and it-- just to clarify, those were one-time ramp-up costs and 29 is the right number?

And then, just lastly, the-- was the reserve release greater in the third quarter for the health loss ratio than it was in the fourth quarter?

OK. Let me take each of those. On the tax side, I think you can take out the one-time and that would give you a better indication of what our run rate would be on taxes, Greg. So if you took out that additional $8.6 million or $8.7 million charge--

For trailing four quarters or for this particular quarter?

It was in this particular quarter.

No, the-- when you compute it, over for the year or just this quarter and use that?

I'd use it for the year, OK?

OK.

On the expense ratio in Health, I think you're-- you're on to the right issue and accounting-- if we can get direct-to-consumer working, we need to be in a situation where we have a method that can be supportable to take the expenses that you spend on the front side and capitalize them and charge them over the lifetime of the policy. Once-- if we have success there and get that established, you'll see the expense ratio come down to the more normal levels on the Health side.

And your last question was related to, I think, the Health reserve developments. I haven't looked at it quarter by quarter, but-- We'll have to get back to you on that one. In the 10-K you will get a report of the overall year development. I just don't know quite what the third or fourth quarter looked like.

Joshua Shanker, Smith Barney.

I'm calling, first of all, about the unfavorable development from the hurricanes. How does that fit in with your reinsurance arrangement? I know you have the first $20 million of retention and then, I guess, you have a $30 million excess cover and you pay beyond that?

Well, a couple things. First, as the storms continued to develop out, we had $20 million. After we reinstated one time, we chose not to reinstate after the second storm. Things continued to develop which then put the third and fourth storms into a $25 million excess position. So it kind of turned out to be $20, $20, $25, $25.

OK. And did you hit your limits? On which of the storms?

I don't have the particular storms with me, but I think we hit them on every storm.

I'm sorry. I'm not sure. By limits, we entered the reinsurance--

Right. Right. Right.

That is, we passed our deductibles but just to be clear, I mean, our limits of our reinsurance are way beyond where any of these particular storms hit.

Right. And none of the losses are associated with having to pay beyond a limit that you have reinsurance for?

That's correct.

Very good, very good. And additionally, walking through the corporate again with the Puerto Rican tax items, the other tax items and the stock expense, given that the SG&A line had that pop, I guess following on John's (ph) question, could you walk us through a little bit where the different items hit the income statement in the corporate?

Yes, I think the-- If I'm looking at the corporate and other, the SARs hit the selling, underwriting and G&A expense.

OK.

The taxes hit the-- let's see. Yes, the income tax-- Is that right? Hit the income tax line, yes.

OK. So-- and the $8.7, the majority of that is Puerto Rico with just a handful from other small details?

Yes. I mean, the charge related to Puerto Rico and there were some positive adjustments that offset the tax on Puerto Rico.

Adam Klauber, Cochran Caronia.

You mentioned that the HSAs are up to roughly 40 percent of sales. Could you give us an idea of how much they contribute to the overall individual? And related to that, you also mentioned that they do tend to show improved persistency. Could you give us any data around that?

I'd say on that last one that's a hypothesis, Adam, and we'll find out as they renew this year. But we believe that will be the case and we don't have the data now, but we'll report on it when we can support that hypothesis. OK?

OK.

And in terms of how much the HSA results of our new business, I just don't have the figures with me, but that's certainly something we can report on.

35 percent of total sales for the year were in HSAs and, obviously--

In individual.

In individual. And that was the first year of it.

OK. As far as Solutions, you mentioned that international should help growth next year. Could you give us an idea of how much that segment is growing and just how big that segment is, in total?

Sure. I think that we've talked about, in the past, international representing in the neighborhood of 10 percent of Solutions. That number has actually grown and I think it's more in the 12 to 14 range for the total for 2004. We would expect that will continue as we move forward.

Let me give you the exact numbers, because I've just found them. International represented 12 percent of net earned premiums in 2003 and it grew to 15 percent in 2004.

That's a pretty good jump.

Patrick Fushlow (ph), Credit Suisse First Boston.

I was hoping to get a little more detail on the individual and small group health membership. Can you give us exact numbers for what that sits currently and what the trend was, quarter-over-quarter?

Hang on just a second. I'll see if we have some of that information.

In the supplement.

OK. If we look at membership for the small group line, it dropped from 348 at the end of the third quarter to 333. We kind of hit our high water market there at the end of last year and we've had some decline over the course of this year.

For the individual side, we ended last year at 761,000. We ended this year at 782. We actually had 807 as of September.

In individual, it's important to remember we have a combination of three things in that line -- the individual major medical expense, which constitutes the bulk of the premium, then we have both the student and the short-term business. There's a lot of members in that business, but much less premium.

As I mentioned and Kerry mentioned, we saw a seasonal decline in some of those specialty Health businesses.

OK, fair enough. Now you talked about some, let's call it aggressive pricing on the part of some of the Blues plans. Are you also just seeing some new participants in these markets in the individual and small group area?

Sure.

I mean, does it continue to be the usual suspects, some of the big guys like United through their Golden Rule subsidiary and Aetna, et cetera?

Yes, I mean, realize, we've been in this business for 50 years. We're certainly one of the acknowledged and consistent companies in the individual medical market place. There are certainly companies that have been in and out of the market over the years. We have certainly seen some of those companies over the last year, 18 months, come back into the individual market.

I think it's important to realize that in the individual market the key skill is individual medical underwriting. We assess, ask health questions, get information on the health of each individual applicant and that's not a skill that is really required in the group market or the HMO market. So I think competitors quite frequently, we believe, misjudge what's needed to win in the individual market and come in to the market and then some number of quarters later will tend to withdraw.

Again, we've been a consistent player in this market for a long time. We think we have the risk management skills, the distribution arrangements that are necessary to win in this market.

Do you think there's any impact or have you seen any impact thus far this year from the fact that a number of the larger health insurers didn't really offer an HSA product until January 1 because the tax regs hadn't come out until mid last year, whereas you were ahead of the game? Are you seeing, in general, some catchup by them in the HSA and the HRA area?

Well, they're trying. I think the big thing is how will HSAs develop in the group market. They're going to be in the individual market because they have appeal. We've sold the people who understand high deductible plans, which are required to have an enabling contract for the HSA. That's a much more difficult selling proposition in the employer market and I think that's what these big guys are seeing.

When you go in and tell your employees that I've got a great deal for you. Let's have the HSA. Oh, by the way, I'm taking your deductible from $500 to $1100. It's a tougher sale. That being said, we think anything that would help grow that overall HSA market would be a positive for us.

Charles Gates, Credit Suisse First Boston.

I tried earlier but I guess I didn't work. Hey, I have two questions, I guess. Question number one is if you look at the rate of growth -- and I realize this was asked about three questions ago or a variation of this -- in your specialty property net earned premiums, in the second quarter of '04 it was up 12 percent, in the third, 9 percent, in the fourth quarter, I believe it was down 7 percent. What are the factors in play there?

Hang on just a second. I think that in the business we have all of our large clients who have large blocks of business in this thing. They-- I've got to look. I think this may be as a result of our relationship with Chase and how things got reported across quarters, Charlie. We're going to have to get back to you on that one.

OK.

I don't think-- I mean, we haven't lost any of our clients, et cetera. We think this is more just how things got accounted between the quarters rather than any trend there.

OK. That was my first question. I guess my second question, someone asked about the vitality of the credit insurance business. If one was sitting here to try to assess the vitality of the credit insurance business, he would be looking, basically, at the change in net earned premium for consumer protection. How else would you monitor that vitality on an interim basis?

Yes, well, you've also got the debt deferment. I mean, I don't know if you're considering that as part of the credit insurance, Charlie, but--

OK, so the fees and other income, good comment.

Yes.

What else would I be looking at?

Well, I think that we'd have to see some additional client acquisition in the area and we're working hard. We've worked very hard to reduce our expenses in this area. We think we now have quite a compelling value proposition and we're talking to clients who haven't made that change yet and trying to land them.

And consumer protection also contains the extended service contract business, which is a very fast growing business for us and is also the line that houses the international business, which is primarily credit-related insurance and extended service contracts. So both of those fast-growing portions of the business are also in that sort of sub-segment.

What would be-- If you look at the extended warranty business, and I'm just looking, say, at your fourth quarter statistical supplement and this is my last question, what would be-- is there any conclusion that you can take from your fourth quarter supplement or what would be the most important trend in that business now?

In which one, Charlie?

I'm sorry, extended warranty, sir.

I think -- and we'll have to get to this -- it's really going to be the buildup in our unearned premium and some of that is, obviously, masked by the decline in unearned premium in the credit business. Given the credit business has stabilized, I think you'll start seeing an increase in the unearned premium there.

[OPERATOR INSTRUCTIONS] Kelly Nash, Keybanc Capital Markets.

First, could you get the percentage that HSAs were of new business for the fourth quarter?

Sure. Yes, they were 41 percent and that was relatively consistent with the third quarter. So we're continuing to see strong sales in the HSA product.

OK. And as we look out into '05, is this a figure that could easily exceed 50 percent in terms of a percentage of new business?

We certainly think that's a possibility. There undoubtedly will be some people in the individual market that HSA will not appeal to for one reason or another, but, again, we think with the heavy support from the government, with the continuing publicity for HSAs, the enhancements we've made in our own product, which make it even more appealing to individual buyers we would certainly hope to see that percentage go up.

And then can you provide any more detail as to the timing or the new features on the HSA that you're planning to launch this year, the new version?

Yes, well, the features in the product are primarily allow check writing or draft writing, allow online account access. We have a debit card, which is not a feature we've offered before. And I believe most of these features are in effect for new sales now.

And how does this compare with what's generally being offered by the competition?

I believe that we are ahead of the competition, for the most part, in the individual market. The-- again, some competitors are offering some of these features. We've seen them, I would say, more so being offered in the group market, but I believe that our product, with the combination of features that we have, is the most advanced in the individual market place.

And then just finally, can you provide some more commentary on the pipeline of new business that you see potentially coming in line on the extended service contract?

Sure. Well, our pipeline is quite robust. Our sales people are out talking to people all the time. We were just out at the consumer electronics show and there seemed to be quite a bit of interest out there. We don't talk about specific clients until they're added, but we would hope that we would be reporting to you over the course of this year on important new client additions.

Great. And then how-- Just one final question, sorry. Looking at the fluctuation of premium volume in Solutions, there's obviously a lot of things going on in there. But is there anything else -- and I think this was touched on before -- that can give us more confidence in the top-line potential there?

Well, I think it's important to understand that, over the course of this year, we renewed on the mortgage hazard business seven of our top clients during the year. We did not lose any of our clients during the year, so, again, as the industry leaders grow, we think that will benefit us. We're out talking to people who are not currently clients and trying to extend things. We're also talking to existing clients about additional programs. So we're very focused on how we can create additional profitable growth, moving forward.

At this time, I'd like to turn the floor over to Mr. Clayton for any closing remarks.

OK. Thank you for your questions. We're very pleased with our fourth quarter and our year 2004 results and we look forward to continuing to demonstrate, in our second year as a public company, the strength of our diversified specialty insurance strategy. Thanks, again, for joining us and we look forward to updating you next time.

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