Donegal Group Inc (DGICB) 2008 Q1 法說會逐字稿

Good day, ladies and gentlemen and welcome to the first-quarter Donegal Group earnings conference call. My name is Erica and I will be your coordinator for today. At this time, all participants are in listen-only mode. We will be facilitating a question-and-answer session towards the end of this conference. (OPERATOR INSTRUCTIONS). As a reminder, this conference is being recorded for replay purposes. I would now like to turn the presentation over to your host for today's call, Mr. Jeffrey Miller, Senior VP and CFO. You may proceed, sir.

Good morning and welcome to the Donegal Group earnings release conference call for the first quarter ended March 31, 2008. I am Jeff Miller, Senior Vice President and Chief Financial Officer and I will begin the conference call by highlighting our quarterly financial results. I will then turn the call over to Don Nikolaus, President and Chief Executive Officer, for his comments on our results and a discussion of the business trends we are experiencing.

Certain statements made in our earnings release and in this conference call are forward-looking in nature and involve a number of risks and uncertainties. Please refer to our earnings release for more information about forward-looking statements. Further information on risk factors that could cause actual results to differ materially from those projected in the forward-looking statements is available in the report on Form 10-K that we submitted to the SEC. You can find a copy of our Form 10-K on the Investors portion of our website under the SEC Filings link.

We are pleased to report a 6.9% increase in net premiums earned during the first quarter of 2008 and a substantial increase in net income over the prior year first quarter. However, our net earnings were significantly impacted by weather-related claim activity in our operating regions, as I will discuss in more detail in a few minutes.

Our net income for the first quarter of 2008 was $6.7 million or $0.27 per share of Class A common stock on a diluted basis compared to $5.5 million or $0.22 per share of Class A common stock on a diluted basis for the first quarter in 2007.

Total revenues for the first quarter of 2008 were $89.8 million, an increase of 7.3% over the total revenues of $83.7 million for the first quarter of 2007. Net premiums earned for the first quarter increased 6.9% to $82 million compared to $76.7 million for the prior year period. Our net premiums written for the first quarter of 2008 increased significantly as a result of several contributing factors.

As of March 1, 2008, Atlantic States Insurance Company received a non-recurring $13.6 million transfer of unearned premiums pursuant to the previously announced change in the pooling agreement between Atlantic States and Donegal Mutual. Since the pooling change was effective for one month of the quarter, our allocation of net premiums written and earned from the pool increased by approximately $2.5 million.

We also benefited from lower reinsurance rates in the first quarter of 2008, largely due to an increase in our per-loss retention from $400,000 to $600,000. Adding all of these factors together, we reported a 24.7% increase in net written premiums, of which 17.1% was related to the nonrecurring unearned premium transfer.

Our investment income was $5.7 million for the first quarter of 2008, increasing 3.4% over the $5.5 million we reported in the first quarter of 2007. Net realized investment gains were $695,000 in the 2008 period compared to $105,000 a year earlier.

As we have stated previously, we have no subprime exposure in our investment portfolio. The aggregate market value of our available-for-sale municipal bond portfolio declined in the current quarter. On the surface, this may seem inconsistent with the decrease in general market rates during the quarter, but municipal bond yields moved in the opposite direction of taxable bond yields in late March, resulting in overall market value declines in our municipal bond holdings.

We have very low credit default risk in our portfolio because our muni holdings carry high underlying ratings even without regard to insurance and we buy primarily unlimited general obligation bonds.

Moving to the underwriting results, our first-quarter 2008 loss ratio was 65.3%, slightly less than the 66% reported for the first quarter of 2007. We experienced significant weather-related claims activity from widespread winter weather events in the southern and mid-Atlantic regions. Comparing the weather patterns experienced in 2008 versus the first quarter of 2007, we had many more property claims resulting from high winds and hail throughout the quarter as compared to the first quarter of 2007 when there were few large snow and ice events. The hail losses were related to the storm system that produced a tornado in downtown Atlanta in March. We also experienced increased severity in our workers' comp and private passenger auto liability lines and while it is more difficult to link casualty claims with weather events, we did have a number of localized snow and ice events in several of our regions that resulted in auto accidents and an increased number of bodily injury claims reported.

Our expense ratio was 31.9% for the first quarter of 2008 compared to 32.1% reported for the first quarter of 2007, with both periods reflecting reduced underwriting-based incentive compensation costs due to the elevated loss ratios. Our combined ratio for the first quarter of 2008 was 97.5% compared to 98.4% for the first quarter of 2007 with the difference primarily due to the increase in earned premiums exceeding the increase in losses and expenses.

Our book value per share increased to $14.02 as of quarter-end, representing an 8.4% increase over the $12.93 book value as of one year ago. In March of 2007, we initiated a share repurchase program authorizing the repurchase of up to 500,000 shares of our Class A common stock. Pursuant to this plan, we repurchased approximately 88,000 shares during the first quarter of 2008, bringing the total number of shares repurchased to date to 355,000 shares.

At this point, I will turn the call over to our President, Don Nikolaus, for his comments on the quarterly results. Don?

Thank you, Jeff and good morning to everyone. Thank you for joining our earnings conference call. You, of course, heard the financial results announced by Jeff and possibly you also had a chance to read the press release. We are pleased with the results given the amount of weather activity that we experienced and that is, of course, reflected in the numbers that Jeff has discussed.

One of the topics that has always been of interest to participants in the calls over the last year and a half is what is the competitive environment and certainly there may be follow-up questions, but in anticipation of that, what I will do is cover our assessment of it.

We are seeing early signs of rate increase activity selectively in certain states by a competitive company and I know that you folks probably that follow insurance have read in various insurance journals and other publications about the industry that there are early signs of that, including what has been embedded in some of the press releases of some other competitive companies. So we are beginning to see that. I will talk about our own activity in that regard in a moment.

From the standpoint of personal lines aside from what we see with regard to some companies and their increases of personal lines rates, we do not, at least at the present time, have not experienced any further deterioration of the personal lines market from a competitive standpoint. Assessing it, one would have to conclude that it is fairly consistent in the first quarter with what we would have experienced in the third and fourth quarter of '07.

On the commercial side, commercial business, of course, has been significantly more competitive over the last year and a half in personal lines, but our indications are that our renewals are flat, that we are issuing them flat to down, low single digits and low single digits being defined as somewhere between 3% and 4%.

Having said that, there will always be some renewals where there are increases and there will be some renewals where the decreases are more than the low single digits. It is a sort of an overall assessment. We have had reasonable success in attracting new business from the standpoint of the commercial side. Although the marketplace is competitive from a pricing standpoint, what we have focused on in the first quarter, as well as historically, is that it is one thing to say that you're going to price a piece of business from a competitive standpoint from the pricing side; it is a totally different perspective if you are going to be inclined to write something that you previously wouldn't or to loosen your guidelines. We remain committed to rate adequacy and also the quality of the book of business to us is paramount and we are continuing to endeavor to do that.

I made reference earlier that, with regard to personal lines rate increases, we ourselves have begun to participate in that process. And during the first quarter and into the very early parts of the second quarter, we have approved and have made rate filings in about five states for home and auto. In some states we would be filing auto increases; other states, it would be home. Some it would be both and the averages of those increases would be in the 4% to 6% range. That gives you a little bit of the tone of it.

Now we do business in 14 states, so it is about one-third of the states, but we will continue to do reviews in terms of assessing where we see rate trends needing to be and we will try to balance the need for rate adequacy against certainly having a focus on wanting to write additional increased business. And there is a balancing act there and we, I think, are prepared to do what is appropriate. If you have followed our Company historically, you will know that if we have to make a choice between writing increased business or writing profitable business, we will always choose profitability.

From the standpoint of some other continued goals that we have been pursuing in the first quarter, we continue to work actively for the appointment of new agencies, which is part of the expansion of our distribution system. I am able to tell you that, in the first quarter, we appointed 59 new agencies and that would be, of course, for the various regions of the country and the various subsidiaries and affiliates. It is somewhat higher than we would have appointed in the fourth quarter. I believe it is fairly consistent with what we would have done in the third quarter.

On the technology side, as we have said previously, that we view competitiveness as being more than just the low price. We believe that the quality and comprehensiveness of a company's technology is very important. We are working to roll out in the second quarter basically what we call PXL, which is the personal excess policy, which some people call it umbrella policies, but we issue an excess policy. And we will have that being part of the automated features of WritePro, which is our platform for the automatic and real-time quoting of business. We would also anticipate that, before the end of the second quarter, we would have either gone live with or close to going live with our boat program being as part of our WritePro. And we have also added -- in at least one state, we are rolling out additional pricing tiers, which does not mean we have lowered the premium. What it means is we have provided additional segmentation to what we believe is already a robust program.

WriteBiz, which is on the commercial side, we have gone live in three additional states with our WriteBiz program in the end of the first quarter and the very early weeks of the second quarter. And we are about to roll out the package, the [DPT] package as distinguished from the BOP as part of our WriteBiz. And when we accomplish that, we will have all commercial lines of business being able to be electronically quoted at our agents' desks and interfaced into our systems here.

We continue to focus on managing expenses to reduce our expense ratio. I know that you probably took note that Jeff announced that we did have a modest decrease in our GAAP expense ratio. We will continue to work actively in that regard. We are certainly focused on capital management and certainly the activity that we took in terms of increasing the retention on reinsurance is in our judgment part of the management of your capital, because where you have adequate capital to support increased retention, there is a balance between that and paying out reinsurance premiums, but it has to be based upon a sound balance sheet.

And speaking about balance sheets, as we all know, there are lots of issues in the financial services industry, primarily with banks and investment banking firms and the issues that they have had. Fortunately, our conservative investment philosophy has shielded us from that. And we think that it is very much a time to be focused on balance sheet strength. And we believe our balance sheet is quite strong and going forward, we think that it would be helpful to us in a number of ways, including being in a position at the right -- to access the right opportunities in any acquisition that we might become involved with.

Speaking of acquisitions, we continue to have a very active program in terms of trying to identify potential acquisitions. Once again, we will only do them if they make sense, if they fit our business strategy, if they are in the right geographic parts of the United States and if we can see that it helps to move the ball forward.

We are encouraged that with the competitiveness for premium and combined ratios increasing for property and casualty insurance companies, we are beginning to see more opportunities to have discussions. And as you know from the past, we have talked about having discussions with other companies. Many times those discussions do not lead anywhere or that we identify that there probably may not be a transaction for us, but we are encouraged by the environment in which we find ourselves to be at the current time.

At this point, I will turn it back over to Jeff and we will be prepared to discuss questions.

Okay, thank you, Don. Erica, if you could open the line for questions, please?

(OPERATOR INSTRUCTIONS). Michael Phillips, Stifel Nicolaus.

Good morning, thanks. A couple of questions. Jeff, you mentioned seeing the severity tick up in comp and auto. Could you speak to kind of the magnitude of that?

The magnitude is -- it is not a significant number; it is just an increase. And specifically in our Southern subsidiary, we saw some increases in the severity of particular cases and claims that were reported in late 2007 are of a severity that we would not have seen previously. So it is nothing that we at this point can really draw any conclusions or say that we are seeing any trends, but that did have an impact in the current quarter, to the tune of an additional $1 million or $2 million.

Okay, good. That's helpful. Unless I am missing it, you didn't mention for the first time anything about reserve releases. Is it just fair to say that it was about what it was in the past couple of quarters?

The first quarter is generally -- we don't talk too much about reserve releases because there is so much -- so little time between the end of the year and the end of the first quarter. We would not have seen as many favorable settlements of open claims and that is a function of our case reserves being settled quicker in 2007, but as far as our bulk reserves, there were no releases of bulk reserves in the quarter.

Okay, thanks. I am curious how you monitor I guess changes in consumer shopping, specifically for auto insurance. Typically folks like to think that, well, if there is a slight uptick in prices, maybe that means more shopping, maybe more quote activity, whatever. How do you monitor that and what are you seeing there?

Let me answer that, Mike. Good morning.

Good morning.

We have a very excellent, what we call, WritePro auditor system and we are able to know on a daily, weekly, monthly, quarterly basis quote activity, whether it is up or down, down to the agency level, territory marketing, state level and also we can monitor hit ratio. So many times the quote activity will be telling you one thing and hit ratios will be telling you another. So we try to monitor it very closely because it can be very helpful in a number of regards, including whether there is increased activity in the marketplace where people are looking around getting quotes.

Also, if you see that your hit ratios are too high, you probably want to take a look at your rate structure on a competitive basis to see whether you are too competitive. And certainly if it is an area where you want to do business and your hit ratios are quite low, you might want to take a look at those to see, well, is there something that just isn't right in the way you were pricing certain types of risk. So we have methodology for it and we use it very actively.

Any comments on kind of trends there, what you're seeing in the past couple of quarters, is it ticking up or ticking down in those --?

Well, our quote activity is about level with what we would have seen in the fourth quarter. It has not gone up and it has not gone down. Hit ratios are about the same, but that varies as a general statement, but that varies by state. We have seen some states where our hit ratios are better. We have seen some states where they may have contracted a bit. But on balance, we are pleased with where our activity is.

Needless to say, we are always anxious to see increased quote activity and what generally would happen if there are any companies in the marketplace that, for whatever reason, has to take somewhat more aggressive rate increased activity, that will be generally helpful to increase quote activity because, in a down premium environment or a flat environment, consumers are not nearly as inclined to be checking quotes because generally that approach on consumer's part is sometimes motivated when they get a premium notice in the mail that is higher than the last one.

That's great. Thanks, Don. Just clarification, you are defining the hit ratio as actual sales over quotes, is that correct?

That's correct.

Okay, thank you. And lastly, just a quick numbers question I guess for Jeff. Could you give the premium growth split, personal/commercial? I don't know if you can give that without the effects of the kind of nuances as of the March pooling arrangement. Just kind of the pure changes there?

I can. I'll give you a further breakdown on the premiums. Personal lines would have been up for the quarter and if you pull out the pooling effect, it would have been around 2.8% and commercial lines are basically flat. They were up just slightly, so that would be on a direct basis prior to the pooling change and the reinsurance savings.

If you factor in the reinsurance savings and the pooling change, not including the portfolio transfer, personal lines would have been up 10.4% and commercial lines 3.7% increase. So there is a lot of moving pieces there to try to get your hands around, but we expect to see some nice premium growth over the remainder of the year because of the reinsurance savings, as well as the pooling change.

And from those statistics that Jeff quoted with regard to commercial, we have seen an improvement in our ability to attract new commercial business, which would be reflected in the fact that, in the fourth quarter and third quarter, we would have actually had down direct premiums written in commercial; whereas, it is up slightly in the first quarter, which we felt was a positive.

Great. I appreciate all the answers, guys. Thanks.

Joseph DeMarino, Piper Jaffray.

Thank you. Good morning. Just to follow-up on the earlier question, the higher severity claims in the southern states you mentioned for auto, that was on the casualty lines?

Correct. The casualty lines, as well as the -- we had -- especially in the Georgia region, we had some hail losses. Those would have been auto physical damage losses. So we kind of look at the auto as one component, not just splitting out the casualty and the physical damage, but the severity comments that I made were related to the casualty side of the business.

Okay, thanks.

As a follow-up on the severity issue, as Jeff mentioned earlier, we are reflecting it because it did occur. We don't believe that it is significant, but it did occur and it is certainly something that we need to monitor. We are aware from what we see from reading press releases of other companies that companies basically have seen some activity on severity. So we are not necessarily surprised by it, but it is like anything else, we need to monitor it.

Okay. I just wanted a little bit of clarification on that. And then my other question is the weather-related claims in the quarter, how did those compare to weather-related claims last quarter and in prior year's quarter in terms of dollars?

The weather-related claims would have been comparable to the first quarter of 2007. We actually had a higher number of claims reported, but they would have been smaller claims, a little bit different in character with a lot more wind claims. We had a number of days where we received 50 to 100 claims and some days, even over 200 and 300 claims just from winds that were blowing.

That was not the case in the first quarter of 2007 when we had some bigger ice events that were prolonged over a number of days where we had more weight of ice type of claims, freezing pipes and that type of thing. They were different levels -- different types of claims, but quantitatively, they would have been fairly comparable in the $4 million to $5 million range for weather-related property claims.

It is a little more difficult to say how many claims or what magnitude of the auto liability claims that we would have received or the general liability claims, slip and fall types, those are a little bit more difficult to attribute to the weather. But compared to the fourth quarter, we had very mild weather. In the fourth quarter, very few weather losses, would have been more normalized. And I don't know that I have the number right in front of me, but certainly the first quarter of each year would have had a much higher level of weather-related losses than we normally would see.

Okay, thanks. Then your tax rate I noticed, do you have any expectations as to what your tax rate will be going forward, how long you can sustain the current tax rate?

The current tax rate, of course, reflects a lower pretax income. So the current quarter, I believe the effective tax rate is 23.2% where we were in the 28% range at the later part of 2007. Certainly we continue to invest in tax-exempt municipal bonds, so that is going to help our tax rate, but I would expect -- we would expect the loss activity return back to what we've historically seen. And in that case, our net income should return to the levels that we saw in 2007 and we would expect the effective tax rate to be in that 28% -- high 27%, low 28% range.

Thank you. And last question, can you quantify the impact on premiums from the reinsurance costs? You touched on it a little bit earlier, but just -- not in percent terms, but in dollars.

Dollar terms, it was in excess of $2 million.

[Scott Laura], Private Investor.

Hi, Jeff. How are you today?

Good morning, Scott. Doing fine. How are you?

Good. We have $15 million in debt coming due in 25 days. The interest rate is 9% on that debt. Do you plan on paying it off?

Well, the interest rate actually has come down. It is tied to LIBOR, so it is actually down around 7%. We are looking at that. We have the option of paying that down in any quarterly period between now and the next 30 years actually; so we are looking at it. It will probably be paid off within the year. Whether we pay it off in May, that decision has not yet been made.

All right. As you know, Jeff, Donegal has grown since 1986 by acquisitions. The environment during the conference calls in the past year is ripe and ready. What is taking so long?

Scott, this is Don Nikolaus. Let me address that. And I tried to address it in my earlier comments about acquisitions. As you know, over the last several years, we have talked about acquisitions. We -- our mutual company is doing a modest size one in the state of Wisconsin, which presumably at some point Donegal Group may very well be the owner of. We have continued a very proactive outreach through various investment banking firms that deal with property and casualty insurance companies. We have had contacts that we have initiated on our own with both mutual and stock companies. We have had various conversations with the various companies and the only thing that I can say is that acquisitions it is a process. It is not the same as being able to say, well, we are going to acquire a company and you do it tomorrow.

I can only say to everybody on the phone call it is very much a part of our business strategy and that we are going to clearly endeavor to do acquisitions. They are going to have to make sense. We are not going to want to overpay, but they have to make sense. I do agree that the environment that we are currently in is a better environment than we have seen in a while for those types of transactions. We have the financial capital, we believe, to do appropriate acquisitions. And we can't give anyone any assurances that it is going to happen. I can only tell you that we are going to work to see whether we can make some good acquisitions happen.

Well, let me make it simple, are you getting close? Certainly after a year and a half, are you getting close on a significant acquisition, Don?

We do not answer those kind of questions, Scott, because close is a nebulous word. I am not going to say we are close; I am not going to say we are far away. We just continue to have the process and you will know when we announce it; that's the only thing I can tell you. Whatever it might be, whenever it might be or it might not happen.

It could be tomorrow?

No, it won't be tomorrow. That I can tell you.

All right. At the annual meeting day.

And it won't be next week.

Well, hopefully, tomorrow you up the dividend at the meeting.

Thank you, Scott.

You are welcome.

(OPERATOR INSTRUCTIONS). Dan Schlemmer, FPK.

Hi, I want to go back -- I hope you don't mind. I will be the third person now asking on the casualty severity trend, but I think what a lot of people wonder about is whether this is some statistical blip or if it is the start of a trend. And I guess my question is can you talk about where you are seeing the severity trend? And I'm thinking about it in terms of layers that if you see a handful of large claims that are higher severity, then that's more likely a statistical blip, a few $100,000 claims or whatever that are moving up versus if you have a whole bunch of your smaller claims that all just seem to be moving in that direction. Can you give us any background in terms of that? Is it a small number of claims that is driving it or is it broader than that?

Thank you for that, Dan. We certainly would not want to make more of my comments about the severity than what they really should be. There were a small number of claims that ended up being more severe than what we expected. So it is, as you would have qualified, what we believe is a blip in the statistics. At this point, there is not enough data or enough of an increase in severity to say that it is a start of a trend or that we are seeing anything different globally in our book of business. It was just a handful of claims in those specific lines that were severe. And the only reason I mentioned it is because it was part of the -- a factor that drove the increase in claims for the quarter. But it is not something that we would say at this point is an alarming trend or something that we are concerned about, other than that we will be watching it to see how things develop in the coming quarters.

But the emphasis needs to be on what Jeff answered that it was a few claims that developed larger needed reserves than we had anticipated and -- but as we have always tried to do, we have always tried to disclose both positive things that happen and also something that may have a negative element to it. But we would not want anybody to overexaggerate what we have announced in that regard.

Great, thank you. Staying on the severity, I think I heard you say it is mostly '07 claims you are looking at. In other words, there is no chance that it was the increased retention on your reinsurance that is making you see higher severity. Is that accurate?

That is accurate. The severity that we saw was in the 2007 claims. And it may not be that it is that unusual for the first quarter because the lifecycle of a claim and the increases in reserves would generally be within the first four to six months after a claim is reported and so this may not be that unusual of a situation. It is just that, as it related to those specific lines of business in that specific subsidiary, it looked like an anomaly.

As an example, you can have a BI automobile claim that occurs in November of a given year and in the end of January or February, you get medical information that makes it clear that that person is injured more severely than what would have originally been anticipated. It can be that simple, which would be not unusual and once you have those facts in front of you. So the first quarter you would expect that you're going to have a certain number of claims that were given average reserves towards the end of the prior year where you learn more information in the first quarter of the new year and as a result, it causes the reserve to be appropriately increased. Our guess would be that it is no more complicated than that.

Great. Thank you. Also on the reinsurance, really not on -- I guess it is somewhat related to the severity question, but not intended to be, really on the reinsurance moving up from $400,000 to $600,000 and I guess I am assuming you are just talking about casualty. That is not a change -- you're not changing the property program or property coverages, but looking at that going forward, how does that impact on your -- maybe the variability in the loss ratio that we are going to see going forward? And how many claims historically do you have in that layer? Is that something you commonly see in the layers that you are writing?

Let me answer part of it and Jeff can answer the other part. The increase in retention is multiline. All of our -- for years, our retention has always referred to both casualty and property. So it is both. Needless to say, we would not have increased retention if we did not do an analysis that would, in our opinion, represent a good business decision that, given our levels of capital and given the premiums that we may have been paying for lower levels of retention. And it is also a periodic exercise that you go through. We would have, if you go back five years or seven years, the retention would have been $300,000. If you go back 10, 15 years, it would have been $250,000 or $200,000. So it is a logical progression in terms of what you do with your retention.

In terms of the number of claims that historically would go above those levels, I don't know that we have that information at hand here. We can only say to you that we have certainly analyzed it and that we believe that it was a good business judgment that we will benefit financially from it if you look at it not only in the short range, but over time. Jeff, do you want to add anything to that?

I would just say that I concur with that, that we did an extensive analysis in determining whether or not to make that change and the reinsurance rate environment was conducive to it and we looked back over the last five to ten years and felt that, in that longer timeframe, it made sense to do it and that it would be profitable going forward. So that all remains to be seen. And certainly in the first quarter, we did not see any significant increase in losses as a result of the increase in retention, but time will tell if that ends up being the case for the rest of the year.

And certainly in subsequent quarters where we have a little bit more history, we would certainly be in a position to be more definitive about what early signs we may have as to how beneficial it actually is.

Thinking about it just in terms of the -- I guess I am thinking about it -- you're thinking about it as beneficial, and that is the right way for you to think about it, of course. I am thinking about it in terms of whether it introduces higher variability in the results. I mean is that a fair way for me to be thinking about it or not?

I would say no, because we are only talking about a difference of $200,000 on any individual loss, and we do not have a significant number of losses that exceed $400,000 in a year. So we don't expect it to add any significant level of variability to the loss ratio.

At this point, it is improving the top line, it is improving the base of the earned premiums. So if anything, we expect it to reduce the loss ratio.

As an example, to put a little bit of perspective on it for you, a high percentage -- and I don't have the statistics in front of me -- but I would say probably 80% of our personal auto book of business, the liability limits would not be above $300,000, either $300,000 or $300,000 single limit. So that most of our -- unless there is some kind of stacked coverage on UM or UIM. But to put it in perspective, we would have a lot of policies that by the terms of the policy that there would not be the potential for a loss above $400,000.

It would generally be applicable to commercial losses, generally. It could have some personal lines losses, and it could relate to larger properties where you have a coverage A above a certain dollar amount.

That's helpful. Thank you. Last question, and this is quick and simple, I think. Just on the interest expense, it dropped it down quite a bit. I think you already hit on it. I am assuming that is just a LIBOR reset. Can you -- well, I guess first confirm that, and then how often does that reset or what is the dynamic we can expect going forward on that? Thank you.

Certainly. The LIBOR does reset on a quarterly basis. We have three separate trust preferred issues, and each one of those reset on a quarterly basis, and they are a premium over LIBOR. So the interest expense reduction in the current quarter is exclusively related to the reduction of those rates.

Gerry Heffernan, Lord, Abbett & Co.

Hello, gentlemen. Thank you for being here on the call this morning. Let me just upfront apologize if you hit any of this in your opening remarks. I missed those, so I beg your forgiveness.

In regards to the investment portfolio, were there any impaired assets or assets that are part of a market that is currently locked or not trading auction rate securities, meaning bonds, things of that sort?

No, we have none of those.

Okay, great. Could you just review the portfolio a little bit? I am just looking at the seemingly significant changes in some of the numbers on the balance sheet as you provided where the held to maturity balance dropped pretty significantly, whereas the available for sale is up and short-term investments down. Just what is the mindset of the asset management here?

Certainly, I would be glad to address that. With the interest rates dropping, we have a significant number of calls in our held to maturity portfolio, and those are being reinvested into the available-for-sale. For the last number of years, we have classified the majority if not all of our bonds as available-for-sale, just to give us further flexibility.

So the shift that you are seeing is basically a result of maturities and calls of bonds that were held for a number of years and are being reinvested into agencies or municipal bonds in the available-for-sale portfolio.

Okay. Have you been able to take advantage of the municipal bond market issues that have occurred in the last couple of months here? And if so, are you seeing any uptick in your overall portfolio yield?

We are. We have seen that we are able to invest the proceeds of some of the bonds that are maturing and being called at higher interest rates than the bonds that are running off the portfolio. So we are seeing some increases in yield on an after-tax basis, and I would characterize those as modest, but certainly over time we would expect to see increased benefit from that.

Okay, and you were commenting on an after-tax basis. Certainly the two bonds at like rates if it is moving into a muni, that is going to benefit you at the tax line.

Correct.

Okay, anything else that would be important to tell us about the investment portfolio?

Only that we put a lot of money to work in the first quarter. We have reduced some of our cash positions as we feel opportunity to do that and as we saw rates starting to decrease, we locked in some of those returns. So we are carrying a lower level of cash, but we continue to have cash coming in from calls and from maturities and investments. We continue to look to ladder the portfolio to make sure that we have consistent cash flows and income that's adding to the bottom line.

Just a general comment, Gerry, this is Don Nikolaus, that over the years, we have probably been viewed as having a very vanilla, conservative investment portfolio and of course now, we are very pleased that that was in fact the case. And as you know, these are interesting times as far as investments are concerned. So we are being opportunistic in terms of the tax-affected yields and the quality of what we are able to buy.

Well, that is great. Ever since a child, my favorite flavor was vanilla, so that is good. A number of people have questioned about the comment that you made towards claims as far as frequency and severity and seeing a bump-up in the quarter. And certainly when you are comparing quarterly periods, there is a lot of stuff that can affect each one, and particularly between and somewhat hard to compare. I would like to ask the question on a prospective basis. If we are heading into a prolonged economic trough, and I am not talking about a depression, but if we have a very tough economic period here coming up that extends for more than just two quarters, and my thought of the insurance industry in that claims, both frequency and severity, have a tendency, while not perfectly correlated, to increase as economic situations decrease. Are you considering that in your underwriting right now? Have you been using the economic backdrop as a -- to question your current PIK rates and may you think that perhaps we should be increasing our PIK rates given where the economy might be going?

Let me try to start addressing that, Gerry. It is a good point. I think that your observation is I think a reasonably accurate one. However, it certainly can vary depending upon what is the product mix of a particular company. For instance, if we were, which we are not, but if we were heavy in workers' comp, one would have to be concerned about, in a down economy where unemployment is up, you would have to be concerned about return to work trends.

In our own case, we are seeing an actual decline of indemnity workers' comp losses over the last several quarters, which we would find to be a positive trend from our standpoint.

Following up on the point of increased loss activity potentially in a down economy, anyone who knows about P&C companies, you know that the moral hazard, the moral risk comes into play with property exposures where there sometimes can be an increased incidence of questionable claims.

We have reemphasized our SIU, our special investigative unit, processes to make sure that we are very alert to any claims that may have some questionable issues as to their origins. We also inspect a high percentage of our business and we also monitor the credit quality of all business, whether it be on the personal line side or the commercial side.

So I think that part of the issue that you refer to depends a lot upon the quality of the book of business to start with and then secondly, how you manage through the process. So hopefully that is helpful. We would not anticipate a lot of increased severity because of a recession; nor would we anticipate a lot of increased frequency because of a recession.

On the automobile side, if the price of gasoline continues to go up, what you will find is the miles driven will begin to decline. And most of the national statistics on frequency of automobile claims, there is a correlation between that and miles driven so that you could -- I don't want to be perverse -- but you could be a bit perverse to say that higher gasoline prices will actually help the property and casualty side from the standpoint of automobile loss ratios. But all that will need time to prove.

Okay. Going back to the comments you made on casualty about the investigation aspects of your claim processing and the underwriting, the credit checks, all very smart, good business processes. Though I would say when business is good, those are the little things that seem to get lost and not remembered again until after the mistakes show up in the numbers, adverse numbers. Can you just comment to that, assure us that none of these things have been reduced or if you are picking up the effort here?

Well, what I would say is this, it goes to the particular philosophy of a company. We never ever back off of inspections of risk. For instance, every commercial risk, unless it is something very tiny, we physically inspect. We have done that for 25 years and certainly are not reducing it currently. So no. If anything, you become more conservative as you see some cloudy skies. So I can assure you that that is reinforced on an ongoing basis. It is audited. We have audits of what underwriters do to make sure that all the requirements are being followed. And if we see any aberration, it is dealt with very promptly and in a very serious manner because, at the end of the day, the quality of your book of business over time will determine whether you have good combined ratios or you don't. And there is really no other way of looking at it.

That's right, yes. Poorly written business is the gift that keeps on giving. Okay, thank you very much.

Joseph DeMarino.

Thank you. One last question. The $2.5 million in the quarter from the pooling allocation arrangement, is that a one-time thing or will that be built into premium numbers going forward? How do we understand that number?

I am glad you asked the question, Joe. The pooling change for the month of March added between somewhere around $2.5 million I think is the number I quoted to our net premiums written. In the second quarter, that will be -- it will be three times that; it will be $7.5 million. So if you recall the announcement we made related to the pooling change, it was going to add $30 million on an annual basis to our premiums and so $7.5 million per quarter is a pretty good estimate of the top-line growth related to the pooling change.

Got you. Thank you.

Mr. Miller, you have no further questions at this time.

Okay, well, thank you very much and we appreciate all the good questions and the participation on the call. Have a nice day, everyone and thank you for participating in our conference call.

Thank you for your participation in today's call. This concludes the presentation. You may now disconnect and have a wonderful day.