Argo Group International Holdings Ltd (ARGO) 2006 Q4 法說會逐字稿

Good day, ladies and gentlemen. Welcome to the fourth quarter 2006 Argonaut Group earnings conference call. [OPERATOR INSTRUCTIONS] I would now like to turn the presentation over to Mr. Michael Russell. Please proceed, sir.

Thank you, Lisa, and good morning. Welcome to Argonaut Group's 2006 fourth-quarter earnings conference call. With me today is Mark Watson, President and Chief Executive Officer; and Mark Haushill, Senior Vice President and Chief Financial Officer. We are pleased to have the opportunity to review the Company's results for the fourth quarter as well as Management's perspective on the business. No earnings guidance will be provided in this call. Before I turn the microphone over to Mark Watson, I would like to inform you that this conference call is being recorded and that all participants are in listen-only mode. Following management's discussion, the operator will provide instructions on how you may ask questions. Let me remind everyone as a result of this conference call Argonaut Group management may make comments that reflect their intentions, beliefs, and expectations for the future. As a result, these forward-looking statements are subject to certain risk factors which could cause actual results to differ materially. These risk factors are listed in the Company's filings with the SEC, including Argonaut Group's 10-K for 2005 and Form 8-K the Company filed this morning which includes the 2006 fourth quarter news release. Finally Argonaut Group may make references during the call to operating income which is a non-GAAP measurement of financial results. With that I would like to introduce Argonaut Group President and Chief Executive Officer, Mark Watson. Mark.

Thank you, Mike, and good morning. We appreciate everyone being on the call today. After my opening remarks, our Chief Financial Officer Mark Haushill will discuss in detail our 2006 fourth quarter and full year financial results before we open the call for your questions. By now I am sure most of you have reviewed our earnings release distributed this morning, so I will lead off the call with some general comments about our 2006 results, things to look for in 2007 and the market environment.

On this call last year I suggested that 2005 had been a watershed year for our company. You may recall we had put behind us a number of legacy issues, successfully navigated our way through a severe hurricane season, and entered 2006 stronger than ever and with a fair amount of optimism.

I am pleased to say we maintained our positive outlook as we guided Argonaut Group to even higher levels of performance in the year just passed. During the year 2006 we set a number of new company records in nearly every measure of performance. Our return on equity was 14.8% for the year. We set new highs in gross, net and earned premiums, with gross written premium now greater than $1.15 billion. We also grew net written premiums as we increased our net retention from 72% of premiums to 75% of premiums in the fourth quarter. Total revenue was up nearly 20% over last year's record to approximately $940 million this year. Underwriting income was up five fold exceeding the $50 million level. Operating income rose 81%, also reaching a new high. Our net income increased to $106 million, $9 million of which came from the gain on the sale of one of our strategic investments, and our combined ratio of 93.8% was the lowest in company history as we continued to run off what remains of risk management. And our book value per share grew almost 17% to $25.34. It is also worth noting that our book value per share has grown approximately 14% on a combined annual basis from the end of 2002 when it was $15.17.

Nearly all of the gains generated in 2006 were driven through organic growth, demonstrated by the growth rate in gross written premiums on our continued operations of about 17.3%. Our underwriting team produced outstanding results by penetrating new geographic markets, expanding our exposure to industries with risk profiles similar to those we already write, and taking advantage of cross-selling opportunities between our business segments. Also, we added top notch industry veterans who focused on expanding opportunities with new products and in a number of new niche market areas as well as strengthening relationships with existing and new sales channels. These factors have made Argonaut Group a much stronger organization today from top to bottom. I should also say none of these initiatives were pursued haphazardly as we continued to abide by our core principle of disciplined profitable underwriting. We did an excellent job of maintaining that standard particularly as the overall market was challenged by increasing competition in 2006, more of which I will talk about a little bit later.

Next I would like to introduce Greg Vezzosi as our new chief operating officer. Given the growth of Argonaut Group over the past six years and the operational complexity of our company now, we all thought it was time for me to hand off the operational responsibilities to a proven leader. Greg has a very broad underwriting background in both the admitted and non-admitted markets, and after searching for over a year Greg is the first person I met that possessed the underwriting experience, leadership skills and a personality I was looking for in a chief operating officer. Greg spent several months getting to know our management team before joining the Company, so we all know one another at this point, and the management team is all very supportive of Greg in his new role.

Each of our primary business segments performed well in 2006. Let me address the performance of each business segment just a little bit. Mark will have more financial detail in his portion of the call. Our Excess and Surplus Lines segment increased gross written premiums over the last year by nearly 23% and earned premium by 40%. The E&S segment also delivered more than $100 million of operating income in 2006, a 77% improvement over last year. We continue to be optimistic regarding initiatives under way in areas such as professional liability and environmental. As we mentioned last quarter, we have added new leadership and expertise in these area to help us aggressively pursue business in these and other attractive niche markets. As you'll recall in November, we named Dale Pilkington president of our E&S segment, which allows Dale to apply his strategic vision end experience in the wholesale market channel.

Select Markets had another banner year as well, achieving new highs in premium volume, underwriting income, and operating income. We believe our small admitted business programs underwritten through this segment's retail agents and brokers should provide continued opportunities through this stage of the market cycle. Additionally, we have identified several new products and services for which we are actively marketing. Examples of these initiatives include our branching out to small retail furniture stores as well as geographically in mining operations, some of those other than coal. Increasingly we hear that small business customers appreciate the services that accompany our policies such as safety and loss control services as well as efficient claims management on the back end. Finally our public entity segment gained increasing momentum as the year wore on, reestablishing premium growth more characteristic of levels we believe can be sustained over the long term. Last year Trident, our public entity MGA, did an outstanding job of marketing new products such as environmental impairment liability and inmate medical coverage, as well as expanding its public schools program into additional states. The result was an increase in pretax income of 44% to $13.5 million.

I am pleased with the performance of each of these businesses in 2006 and believe there is additional upside for each of them in 2007. We also expect to see additional organic growth opportunities as we continue to pursue business that is slightly beyond the core niche industries we currently serve. Regarding our capital position, our profitable operations in 2006 generated capital at a rate where we were comfortable. Additionally, as time moves on we're focused on managing down claims and loss reserves from our risk management run-off policies. As we do it should free up additional capital that we can redeploy to ongoing operations, or use for attractive marketing opportunities as they present themselves.

We finished 2006 with assets of more than $3.7 billion, our debt to total capitalization is now down to approximately 14%, and we continue to enjoy an A.M. Best rating of A and Standard & Poor's financial strength rating of A -, and investment grade counterpart credit rating. In a moment Mark Haushill will discuss reserve development in more detail, but I'd just like to say up front the reserve releases from prior years and reserve additions to the current year is hopefully an example of our level of conservatism that we've exhibited over the last several years in running our company. Given the strength of our balance sheet coupled with continued positive P&L results, we believe that prudent capital management strategy calls for taking more risk net, as you've seen in the fourth quarter, thereby reducing premium dollars we pay to reinsurers. Obviously reinsurance rates are a big variable in this decision and depending upon how they move up or down over the year, that may change our mind about what retention levels we keep going forward. As respects our property CAT renewal, it will be interesting to see what happens this year come May 1 when we renew our program, but I would be surprised to see our rate go up given our reduction in TIV [total insured value] and the range in Florida that's going on right now.

Let me conclude my opening remarks by saying a few things about the market. We continue to see increased competition in the marketplace with rates generally flat to down 3% to 5% as compared to 2005. The exception of course being wind-exposed business, where we saw large rate increases on fourth quarter renewals. Focusing on our casualty book, we're losing a very modest amount of E&S business to the standard market, but because the average size of our policies is small and because we write in many specialized classes of business, our E&S book has not generally been a prime target for larger standard market competitors. In our Select Markets and Public Entity segments, there is also competition albeit not yet irresponsible competition.

In the markets that define Argonaut, whether they're coal mines, dry cleaners or small townships, our brand remains strong driven by a superior service model and customer focus. We've given back a couple of points of rate, but the playing field still allows us to remain disciplined and deliver excellent underwriting results. I will provide some closing remarks after the Q&A, but first Mark Haushill will review our financial results in more detail. Mark?

Thank you, Mark. Mark has discussed this year's accomplishments, so I will review the quarter, add a little more detail to the year-end financial performance, and then we'll take your questions.

To reiterate what was in the press release, for the quarter ended December 31, 2006, our net income was $31.4 million or $0.92 per share to a fully diluted basis. These results compared to net income of $25.4 million or $0.76 per share on a fully diluted basis for the quarter ended December 31, 2005. As we've noted on previous calls, comparability of net income in the fourth quarter of 2006 versus the fourth quarter of 2005 was significantly impacted by the change in income taxes. Net income for the fourth quarter of 2006 includes income tax expenses of $17.9 million while a comparable period in 2005 includes income tax expense of $2.3 million. The lower tax expense in 2005 was related to the reduction of a previously established deferred tax valuation allowance, which was reduced to $0 in 2005. Fortunately this will be the last quarter I will have to discuss this issue. Therefore, we think it is important to focus on pretax operating income when comparing 2006 to 2005.

Pretax operating income for the fourth quarter increased to $40.6 million compared to $26.1 million in the same quarter of last year. The 56% increase was the driven largely by increased underwriting profitability as well as investment income. Underwriting income increased to $15.9 million for the fourth quarter of 2006 compared to $6.1 million last year. 2006 results reflect a 10% increase in net earned premium and a loss ratio of 56.9% [sic -- see press release]. I will discuss the loss ratio in more detail in a few moments. The majority of the growth in premium occurred in the E&S segment. Recall our Denver office and Argonaut Specialty began writing business in the second quarter of 2005.

Let me speak to the combined ratio in each component. The combined ratio for the quarter was 92.3%. Our consolidated loss ratio was 56.9% in the fourth quarter of 2006, compared to 55.6% for the same quarter of last year. Favorable development related to prior year loss reserves totaled $28.6 million during the quarter. There are several components to the development, so let me touch on the larger numbers. E&S favorable development totaled $28.2 million. Risk Management totaled $6.3 million, and Public Entity added another $2.9 million. Partially offsetting the favorable development was adverse development of $9.2 million associated with our run-off segment. Also in the fourth quarter we added $15 million for the current accident year. The majority of the increase was in the E&S segment and relates to the entire year and not any specific events in the quarter.

If I can digress for just a moment to ensure I make an important point, Mark had mentioned this earlier. We have historically taken a conservative approach to the most recent accident years, as the majority of our book is casualty driven.

I will now turn to the run-off segment where we strengthened prior year loss reserves by approximately $9.2 million. Last quarter we discussed that we had strengthened these by approximately $700,000. This was comprised of development in asbestos of $7.7 million which included $4.7 million of ULAE. This was virtually offset by a reduction in medical malpractice liability loss reserves of $7.0 million. In the fourth quarter we continued our ground up A&E analysis by reviewing all of our larger accounts which resulted in $9.2 million of strengthening. Certain accounts required modest strengthening while the majority of the accounts were reserved adequately. This reiterates our philosophy of reacting quickly to information and we believe further strengthening our balance sheet.

In summary, the loss ratio for the quarter included favorable development of $28.6 million, and that was partially offset by $15 million in the current accident year. But on an accident year basis, the loss ratio for the entire year is in the low 60's. The expense ratio for the fourth quarter of 2006 was 35.4% as compared to 41.1% for the same period in 2005. During 2005 underwriting expenses include a $6.0 million charge related to an increase in our allowance for doubtful accounts for a reinsurance treaty we commuted. Net investment income increased approximately 20% to $27.7 million for the fourth quarter of 2006. This increase is reflective of an increased invested asset base resulting from strong operating cash flows during 2005 and 2006 as well as increased interest rates. The book yield of the fixed income portfolio is now approximately 4.8% as compared to 4.6% a year ago.

Now I will turn to the year-to-date results. For the year ended December 31, 2006, our net income was $106 million or $3.13 per share on a fully diluted basis. These results compared to net income of $80.5 million or $2.53 per diluted common share for 2005. Again, comparability of net income for 2006 versus 2005 is impacted by income taxes. Pre-tax operating income increased approximately 81% to $141.8 million versus $78.2 million in 2005. The increase was driven largely by increased underwriting profitability from our three core business segments as well as investment income. Mark touched on gross written premium. Important to note -- our gross written premium totaled about $1.2 million and is an increase of 17% year-over-year exclusive of the Risk Management premium we generated in 2005.

E&S grew 23%, with Argonaut Specialty driving most of the percentage increase year-over-year. The consolidated combined ratio for 2006 was 93.8% compared to 98.7% in 2005. For the year ended we recognized favorable development relative to prior year loss reserves of approximately $45 million spread across all the segments with approximately $35 million attributable to E&S. Recall that in 2005 we were impacted by $15.3 million related to the hurricanes and $10.2 for the commutation of the legacy reinsurance agreement. The expense ratio improved to 35.1% [sic, see press release] compared to 37.6% for 2005, as the renewal rights acquisition and Argonaut Specialty are now at critical mass. Net investment income was up approximately 25% for 2006 versus 2005, reflecting a larger investment portfolio and higher interest rates. Interest expense on the other hand decreased by $2.0 million from 2005 primarily due to a reduction in interest expense on funds held related to a commutation of an adverse development reinsurance treaty in the third quarter. Cash flow remained strong and for 2006 totaled $299 million versus $331 million in 2005. Recall that in 2005 the $331 million included $45 million of positive cash flow as a result of settling a longstanding lawsuit that we discussed last year.

I will touch on the balance sheet briefly and then we'll open it up for questions. The investment portfolio was $2.5 billion at 12/31/2006 versus $2.2 billion a year ago. The unrealized gain of $65 million compares to $45 million at December 31, 2005. Both numbers are pretax. Duration remains consistent at 3.7 years.

Operator, that concludes our prepared remarks. We're ready for questions.

[Operator Instructions] The first question is from the line of Greg Peters with Raymond James. Please proceed.

Good morning, everyone.

Hey, Greg.

Three areas that I was looking for additional color. First, and probably the easiest for you would be the run-off for the asbestos. I was a little bit surprised it was up in the end of the fourth quarter versus the fourth quarter last year, but the trend for the year is down, so I am just wondering if there is anything that we should be reading into the up-tick in the fourth quarter as we look forward, or if the trend for the full year which is down on a year-over-year basis is something we should expect?

You know, I am not sure how much more there is to say. I think Mark summed it up pretty well, Greg, which is whenever we've seen any data movement we've reacted quickly in putting numbers up, and I think if you were going to pick a time to be conservative on A&E, the fourth quarter this year is a pretty good time to do it. All of our claim numbers are trending down. We want to make sure we've got enough money in that bucket, should things change.

Greg, this is Mark Haushill. I think it is important to realize that our evaluation of A&E is certainly a lengthy exercise, but we don't just put it down in the third quarter after we complete the review, so we continue to look at data throughout the fourth quarter.

Right. I just ordinarily assumed that any effect of the third quarter review would have been reflected in the third quarter results, so I guess this is somewhat surprising in that regard. That's okay. I appreciate you don't want to provide guidance on the call or in your prepared remarks, so in the past, Mark, you've been willing to talk about return on equity targets that the Company might have on a longer-term basis, and I think even as we reflect back on 2006, I think you were willing at some point to talk about what you thought the 2006 result might look like in advance of the final year coming in. So I am just wondering if you're willing to step forward and give us a snapshot of what you think return on equity might look for 2007, and I suppose I'd tie that in the with the commentary regarding what you were saying regarding pricing, because if taken alone that might mean with flat to down pricing that the top line might be flat to down, so perhaps you can comment on those two observations.

Well, that's the real challenge. On the one hand we have growth opportunities. On the other the question is what does that do to the margin which of course will affect ROE. We made a number of investments over the last few years, both inside the Company and outside the Company, and I think that this year and in particular the fourth quarter have been good examples of that. We've seen new products and services come online in the fourth quarter, and we'll see more coming online in 2007 that are the result of investment initiatives we've made internally over the last several years, and some of them have a fairly long gestation period. Likewise, we've made some external investments. In the case of the investment that I alluded to in my opening remarks, that was an investment that was made back in 2002 with the strategic business partner.

That's the realized gain, right?

That's correct. And so that was a nice addition to income this quarter, and we have a number of other investments like that which at some point in the future hopefully will have a similar financial benefit. And at this time a year ago, I suggested that our ROE target was 15%. That hasn't changed. Our ability to get there will as you pointed out a minute ago be a function of how much we can continue to grow, the margin on the business we write in the future and our ability to efficiently use our capital. We're now sitting at a place where we're generating capital as fast as we're growing, or in this case now finally a bit faster. Our year end GAAP book value is just shy of $850 million, and if you look at where it was a few years ago when we were growing faster than we had capital, we're now in an enviable position I think of trying to make sure we use that capital prudently. So now we're generating, I still think, good growth with good margin. Remember that because most of the businesses we're in are small account in nature, we're not seeing the hyper-competitiveness that others might be in their markets, so we have the opportunity to keep moving ahead but now we have to generate more R because we have more E. And as I think I pointed out in my opening remarks, our debt to total capital is now down to 14%, so Mark and I will be spending a lot of time this year looking at the capitalization of our company as well as the growth in the top line.

Well, one of the ways you certainly can manage the R is by adjusting the E, so I guess the follow-up question is you used to pay a dividend. Is there anything on the table that the Board or you have been thinking about in that regard, or share repurchase maybe even?

Well, I think my answer to that is we always talk about whether it is time to reinstitute a quarterly dividend. I have a number of vociferous shareholders who call frequently, and I suspect we will be getting to a point in time pretty soon where we take that under consideration.

The last question I guess, and I was listening to Mr. Haushill's comments regarding the reserve development, and I guess one of the areas that's come up is the addition to the 2006 loss picks if you will, or the current accident year, I am wondering if you can provide just a tad bit more color there, specifically somewhat consistent with the request regarding A&E. Is there in the trend you were seeing in the information that was coming through that led you to be concerned about some of the business you had been writing in 2006, or was this just more part of the normal process that you guys have been using over the last several years of -- you know, with respect to your approach on loss pick assumptions?

Greg, actually I couldn't have said it better myself. It's more the process. We didn't see anything significant in the trends that would suggest that we would -- we needed to change any of our loss picks, so it is part of our process, and I will repeat what I said before with a casualty-dominated book of business, and our philosophy here is to be conservative as opposed to aggressive. We just thought at this point in time, again with the mix of the book of business it was in our best interests to just put up $15 million dollars which on $850 million of earned really didn't move the needle that much.

Right. Okay. Thanks for your answers. [Operator Instructions]

Your next question comes from the line of Mark Finkelstein with Cochran Caronia Waller. Please proceed.

Good morning and congratulations on a good quarter. I have a few things. I think in the opening remarks, Mark Watson, you talked about growth opportunities, a couple of which were not quite in your current niche if I got that correct. Can you just talk a little bit about what those opportunities are, and I guess whether there is additional expertise you need to gain to participate in those markets?

Yeah. Mark, actually what I was trying to get at was that the growth opportunities we see in front of us are almost the same thing that we're doing today, but just slightly different, and I think I used the retail furniture store program as an example. It may not be big, it may not be sexy, but it is the process we went about getting into the business that matters, so it is worth using it as an example for a minute. Grocers, which is our company based in Portland, Oregon, primarily insures independent grocery stores around the United States, and a couple of years ago they said, "You know, we're sitting here looking at the risk profile of the typical insured, or policyholder, and, you know, really our market segment here probably ought to be more like retail shopping centers than grocery stores, given that half the grocery stores we insure are in retail shopping centers." And it was really a classic situation of repositioning a company in its market and recognizing that the marketplace for Grocers is more than just grocery stores, it is other retail operations, and by looking at a whole list of risk analytics, they concluded and convinced me, that the business profile they put together for a retail furniture store was not terribly different than the type of grocery store they were insuring. And I would also make the example -- given the geographic example on the mining business, right now Rockwood enjoys a 60% market share of the Pennsylvania coal mining business, for independent miners and an equal or greater market share in Maryland. We've successfully transported that expertise to other states like Illinois and Indiana, and have now seen some similar opportunities in other states. So we've been slowly transporting that expertise geographically across the country over the last couple of years. Those are just two examples of probably 20 different initiatives that we've got going on within the group. Does that help?

Yes. That's a very, very good answer. I guess just following on your -- the prior comment as well, then, so your expectation is the ability to grow organically in each of the businesses. Is there any way that using your own targets, you might be able to give us benchmarks for what you're thinking about in terms of organic growth, knowing that pricing is under pressure, 3% to 5% down, et cetera?

You know market really depends on line of business. Our core strategy for the last several years has been to grow organically. We've supplemented that organic growth with a number of strategic assets -- or I should say tactical asset acquisitions over the last several years, and so for some of our business products right now, our growth rate will probably be in the 20% to 30% range, and for others it may be flat to down. Would I like to continue seeing the growth rate we've had for the last few years? Sure, but I think that a growth rate in the 10% range is probably more reasonable than the 20% to 30% annual growth rate we've seen for the last six years. I still think we have plenty of opportunities to keep growing. We have a number of products and services that are coming online this year based upon investments that we've made a year ago or two years ago, and I think those -- the question isn't can we continue to roll out new products and services, the question is for the businesses that we're in how much more new competition will we have and how much will we have to pull back. And I think it is a case by case basis. This last year we had as many businesses up as down, and that's really the beauty of the group. I think the real opportunity right now is not actually on the E&S side. I think it is more on the retail side where a lot of our growth is coming from right now.

Okay, and then I guess just a couple of detail questions. Mark Haushill talked kind of about some conservative approach in terms of booking higher loss ratios in the current accident year in the fourth quarter, and I guess the follow-up question to that is when you look at your reserve levels at year end, consistent with what you kind of stated at the beginning of the year, at the end of last year, how do you compare relative to the independent actuary's range, and where do you feel about that?

I think, Mr. Haushill is shaking his head that's not something we disclosed in the past, and we shouldn't, so what I would rather do is direct your attention to the 10-K which we'll be filing in a couple of weeks, and you'll note that in the 10-K that we filed for 2005 there is a fair amount of reserve redundancy, and it is my expectation you will see a similar number when we file our 2006 10-K.

Okay. And then just do you have a corporate RBC ratio at year end?

We haven't calculated that yet, Mark, the tax statements aren't complete.

Okay, fair enough. All right, thanks, guys. [Operator Instructions]

The next question comes from the line of Ron Bobman with Capital Returns. Please proceed.

Hi. I guess it is good morning there and congrats on excellent underwriting results.

Thanks, Ron.

And to a lesser extent real top-line growth as well. I had a question, Mark, you mentioned in the E&S segment the competitive impact of sort of the mid markets on the appeal of what of late have been considered E&S risks. Do you have some retention figures to sort of show the impact of that factor? I am curious to know sort of the order of magnitude of that, at least impacting Argonaut?

Well, again, let's focus on where we see that competition. Most of our accounts are small accounts meaning the average premium is $3,500 to $4,500 for our binding authority business, our average brokerage style E&S account has an average premium of $20,000. We certainly write $100,000 accounts and million dollar accounts, but those are more the exception than the rule, certainly on a policy count basis. Where we see the competition is on the larger accounts, and I will define larger as $20,000 really closer to $50,000 on up. So the reason I am hesitating a bit is our -- keeping in mind the type of business that we have, meaning E&S --the renewal rates tend to be pretty low in the first place, mid-50's to mid-60's, so our renewal retention is only up or down a few percentage points. It is not substantial, and as I think I said we're not seeing that much migration at this point from the non-admitted to the admitted marketplace. Now, having said that, if we're going to lose an account we're more likely to lose it to an admitted market than we are to another E&S player, so in most cases when we lose an account we just never see it. It is not something that we get to compete for, when it goes back to the admitted marketplace.

Okay. So if the mid-50's to the mid-60's is sort of the traditional range for renewal rates for E&S accounts of this size, when you look at your book, whether it be this quarter over the year ago's quarter and compare retentions or this quarter over the trailing quarters, it is not translating into a meaningful --

No.

--- movement in whatever that baseline was?

No. At this point it is not.

Okay. Okay. That's all I had. Thanks a lot, and congrats again.

Thank you.

Your next question comes from the line of Mark Dwelle with Ferris Baker Watts. Please proceed.

Yes, good morning. Just a couple other items that hadn't been quite touched on yet. Can you give us an update on the status of the run-off operations with the workers comp business and so forth, how that's proceeding against your plans and any sense of when you might move towards more final resolution there?

Well, Mark, final resolution is kind of -- if we knew that, then we would be competing against Berkshire Hathaway for some of these loss portfolio transfer deals. Most of that business is -- well, it is almost all long-tail in nature. It is workers' compensation, and it is excess workers' compensation. I will be retired and my children may be retired before all of that is run off the books. Having said that, when you look at the loss reserves for Risk Management going back when Mark and I joined the Company, my recollection is that they were $650 to $670 million, and at the end of 2005 the reserves were down to about, Mark, what was the number?

Last year it was about $360, $365 (million).

And now they're down to?

They're about stagnant due to the commutation.

Oh, that's right. So my guess is in 2007 we may see them drop another $30 or $40 million or 10%, and so there will be probably for the next couple of years we should expect $30 to $40 million, and then it may slow down from there. So it will be a few years before the meaningful part of those reserves are gone.

Have you been able to generate any expense synergies, though, as those -- I would presume the volume of moving more towards closing up cases rather than generating new claims.

Well, that's right. At this point the majority of the payroll is on the claims side which is accrued for, so if the next question is, "...are you accrued properly?", the answer is we think so or we would have adjusted in the fourth quarter.

Right. The only other question I had, you commented to some degree the hiring of Mr. Vezzosi, if I got the name right, what his role would be. Sounds like he is taking up some of the duties that you had primarily taken up. What does that free you up to do?

Well, hopefully it gives me an opportunity to spend more time thinking strategically about what our next opportunities are.

Not prepared to be more expansive at this point?

Well, I mean I am going to do what CEOs do, and he is going to do what Chief Operating Officers do. The operations of the company now report to Greg. That includes the claims in underwriting, and our chief actuary, Steve Math. Our General Counsel, our Chief Financial Officer, our head of human resources continue to report to me, and we've got more opportunities on our plate than I have time to focus on right now, and hopefully Greg will be able to free me up to spend some more time on that, and I think I am leaving the operations in good hands with Greg. Let's not forget that we have got some very strong people running each of our three business segments, and they have some equally strong business people under them running the actual day-to-day business operations of each business unit.

Fair enough, thanks for the insights.

Mark, this is Mark Haushill. I just wanted to add one more note on Risk Management. If you see the numbers or have a chance to go through them, you will see quite a bit of favorable development during the year. 2003, '04 and '05 have developed fairly favorably for us. We never contemplated California reform when we booked the reserves, and a majority of that business came out of California, so my summary to you certainly with respect to expenses are down year-over-year, but the business that we put on the books and certainly in the '02, '03 and '05 for that matter have developed favorably.

That's a good point. Thanks.

The next question is a follow-up from the line of Mark Finkelstein with Cochran Caronia and Waller

One follow-up quick question. You talked about Dale taking over kind of more of the businesses within the E&S segment which I assume to be mainly Argonaut Specialty. I am just curious if his assumption of that business has resulted in any changes in kind of underwriting appetite, or businesses that unit is writing in policy sizes and anything along those lines and how we should think about that?

The answer is no, nothing has changed. Dale is not taking over the management of Argonaut Specialty. Argonaut Specialty will continue to be run by its leader Kevin Brooks, who is the president of Argonaut Specialty, but rather it was a strategic recognition earlier this -- well, in 2006 that there are a lot of similarities between Colony and Argonaut Specialty particularly on the distribution side, and I thought that it made a lot of sense to have one person responsible for the strategy of our E&S operation, particularly given that it's all wholesale driven, and so Dale's role is really more of a strategic role. I think I also mentioned in our third quarter call that we have a search under way to replace Dale as president of Colony, and in fact we've interviewed a number of candidates since the last call, and hopefully within the next month or so we'll be announcing a new president of Colony.

Okay. Thanks.

Mark, it is Mark Haushill again. I kind of feel like I put Mark in a box when you asked about reserves. Reserves are -- I am extremely comfortable where we are year-over-year, and the (10)K will obviously add more detail on that.

Okay. Thank you.

[OPERATOR INSTRUCTIONS] Your next question is a follow-up from the line of Ron Bobman with Capital Returns.

Hi. I had a question about the $15 million addition for the current year accident -- current year loss picks, and I think Mark Haushill, earlier you said that the Company always maintains a conservative approach towards booking and estimating loss reserves. You also said there were no trends identified in, I guess in the quarter that drove the increase in the loss reserves for the prior quarters of I guess of '06. But I am still confused because was there some sort of data that prompted you to add a little cushion because presumably this approach to always being conservative and coming up with your best estimate was practiced at Q1, Q2, and Q3. Could you add some more descriptions? I am missing --

I think Mark was being a bit vociferous. Always is a strong word, and of course you're now keying on that, Ron. I think a better way to say that is we endeavor to always try to be as conservative as we can, and most of the time I think we have been proven correct in that over the last seven years, and I think when we sat down and looked at the numbers at the end of the year we thought that there was an opportunity to be a bit more conservative given all of the changes taking place environmentally, and that was really it. There wasn't any one thing we saw blowing up that scared us. It was just a combination of things.

Okay. And, Mark Watson, when you said environmental, you mean in the broad landscape, not environmental exposure?

Correct.

Okay. Okay. Okay. Thanks a lot for that little bit of help. Appreciate it.

There are no additional questions at this time. I would now like the turn the presentation over to Mr. Mark Watson for final remarks.

Thank you. I would like to thank everyone for participating in the call today. In particular I would like to thank our employees who are listening to the call. The financial results of 2006 are in part a reflection of everyone's hard work in 2006, but as you can see from some of the positive reserve developments there and some of the growth opportunities that we've been able to capitalize on in 2006, and what I believe will be growth opportunities to capitalize in 2007, that's really all a result of the hard work of everyone over the last several years. It is not something that just happened in the fourth quarter of 2006, or 2006. It is really the hard work of everyone for the last several years, and I just want to thank everyone for all of their hard work, and I look forward to reporting our first quarter results later on this year. Thank you very much.

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Good day.