Erie Indemnity Co (ERIE) 2005 Q4 法說會逐字稿

Hello and welcome to the Erie Indemnity Company fourth quarter and year-end earnings conference. At the request of Erie Indemnity the conference is being recorded for instant replay purposes. At this time, all participants are in a listen-only mode. Following prepared remarks from management, we will open the call for question and answers.

Now I'd like to introduce your host for today's conference call, Karen Kraus Phillips, Vice President and Manager of Corporate Communications and Investor Relations. Please go ahead, ma'am.

Thank you, Linda, and good afternoon everyone. We apologize for delaying the call today and appreciate that you've arranged your schedules to join us.

On today's call, management will discuss our fourth quarter and year-end 2005 results. Joining me are Jeff Ludrof, President and CEO, Executive Vice President and Chief Financial Officer, Phil Garcia, and Brian Bolash, Associate General Counsel. Today's prepared remarks will be approximately 30 minutes. Following those remarks, we will open the call for questions, would ask that you please keep to one question and a follow-up.

As you know, we issued a revised earnings release and additional supplements to reflect a change to earnings per share diluted results for the fourth quarter 2005. This was due to having an incorrect weighted average number of shares outstanding diluted for the quarter. Corresponding annual earnings per share amounts reported for the full year 2005 were not affected by this revision. The revised press release and supplements were issued this afternoon at 1:30. If you need a copy of the release or any of the exhibits you can find these in the investor section of our web site at www.erie-insurance.com. We also filed form 8-K A and 10 K with the SEC.

On today's call the management Erie Indemnity Company will share important information about current and future initiatives being undertaken at the Company. As a result, certain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 may be incorporated into their comments. These forward-looking statements reflect the Company's current views about future events and are based on assumptions subject to known and unknown risks and uncertainties. These risks and uncertainties may cause results to differ materially from those anticipated as described in those statements. Many factors that will determine future events or achievements are beyond our ability to control or predict. For information on important factors that may cause such differences, please see the safe harbor statement in our latest 8-K A filing with the SEC dated February 23rd, 2006, and in the related press release.

This call is being recorded and the recording is the property of Erie Indemnity Company. It is not intended for reproduction or rebroadcast by any other party without the prior consent of Erie Indemnity Company. A replay will be available on our web site at 8:00 a.m. Eastern time tomorrow, Friday, February 26th. Your participation on this call will constitute consent for the recording, publication, webcast, broadcast, and use of your name, voice and comments by Erie Indemnity. If you do not agree with these terms, please disconnect at this time. Thank you. I'd now like to turn the call over to Erie's president and CEO, Jeff Ludrof. Jeff?

Good afternoon and thank you for joining our call today. As Karen said we had a change in 2005 earnings per share diluted results moving from $0.66 per share to $0.64 per share. This change did not effect our year-end 2005 results. Today I'm going to talk briefly about our accomplishments and challenges in 2005, and where the Company's headed in 2006 and beyond. Phil will share the fourth quarter and full year financials with you.

In 2005 we continued our disciplined approach while also challenging and encouraging new thinking around the way we do business. For our shareholders, that means preserving long-term value and profitability. Our focus has been to leverage our people centered business model that relies on the strength and commitment of our employees and agents to grow and sustain our business. Over this past year we've worked to put the infrastructure in place to support our model while at the same time continuing to strengthen our strong foundation. Our aim is to be a regional gem. Simply the best insurer wherever we do business, now and in the future. I'll comment more about our plan later after Phil reviews the financials with you.

Before I go through Erie Indemnity's performance, I'd like to reflect on the total financial performance of the entire Erie Insurance group of companies in 2005. All in the companies of the Erie group earned after tax $1 billion on a $4 billion plus premium base, which is a truly outstanding financial result. In addition to the results at Erie Indemnity Company we have significantly strengthened the surplus position of our property and casualty group, and specifically the Erie Insurance Exchange, which is a prerequisite to future growth.

As we indicated in our earnings release, Erie Indemnity Company's fourth quarter net income was $44.2 million, down 28% from the fourth quarter 2004. This result is due to two primary factors: a reduction in management fee revenue, which decreased by 3.1% compared to the same period in 2004, and realized losses on investments of $0.8 million versus realized gains on investments of $11.7 million for the fourth quarter of 2004. Net operating income was $44.7 million, a decrease of 16.8% from the fourth quarter of 2004. That equates to $0.65 per share. Overall for the year, net income was up 2.1% to $231.1 million from $226.4 million at the end of 2004. Net operating income was up 3.1% to $221 million with net operating income per share increasing to $3.19.

As you know, there are three segments to the company's business: management operations, insurance underwriting and investments. Our results for 2005 in both the underwriting and investment segments were strong. Underwriting operations gained $15 million in 2005 as compared to a loss of $4.4 million in 2004. That $15 million profit equates to about the same net management fee income generated from $120 million in direct written premium. And it was a record year for underwriting profitability in our property and casualty group where we finished the year with an adjusted statutory combined ratio of 85.7. The company's investment operations returned net revenue in 2005 that exceeded the previous year's net revenue by 26.8%. Again, both segments performed well.

Our challenge lies with management operations where premium growth will continue to be a challenge. And we need to manage our expenses more in line with our revenue growth. The company's board of directors took action at the December meeting to support revenue growth by voting to increase the management fee rate to 24.75 effective January 1, 2006. The management fee rate was 23.75% for the period of January 1 through December 31, 2005. This action was due in part to the outstanding results we've achieved in underwriting profitability. These underwriting results have also allowed us to moderate our pricing for the best customers, which makes us more competitive.

Early in 2005, we introduced segmented pricing, using insurance scoring. As we expected, this action, coupled with our emphasis on underwriting profitability further slowed our policy growth. Agents are becoming more comfortable with our new pricing model and we are selling more new business in our lower pricing tiers, which is desirable from an underwriting perspective. To further enhance our competitive position during the third quarter 2005 and again in January 2006, we introduced new rate interactions to stimulate growth among our most desired prospects. Our new safe driver discount is rewarding new policy holders with our favorable driving records. Since it's introduction in July 2005, 56% of new policy holders have qualified for the discount.

In January 2006, we introduced three additional pricing interactions. A new multi-policy discount, which allows drivers and home owners with qualifying policies from Erie family life to benefit from an additional discount on their auto and home policies. A new interaction from private passenger auto based on the number of drivers and vehicle in the household. And, a new program that provides discounts for a broader range of payment options. The insurance industry has become extremely competitive. Continued refinements in pricing such as these are helping us charge the most appropriate price for the risk. Based on our steady retention ratio at 88.6 at December 31, 2005, and the upturn in applications we've seen so far this year, our collective strategies are showing positive results.

To further support growth, we accelerated agency recruitment goals for 2006. We expect to nearly double the 65 new agents appointed in 2005 by adding 125 new agents in 2006. I'm pleased to report that we're off to a great start and on pace to reach our 2006 goal. We've also adopted new branding and marketing strategies and are incorporating customer segmentation into our approach. Service enhancements from policy processing to claims are also becoming more sophisticated. Understanding our most valuable customer's needs in staying ahead of this rapid curve is a challenge, but it's one that our agents and employees are facing with enthusiastic response.

For the second year in a row, Erie was the number one carrier rated by J.D. Power and associates in their collision repair study. And Erie is ranked in the top five of all carriers for auto insurance satisfaction. Erie was also singled out as the number one independent agent represented carrier and the third overall in a national study of home owners satisfaction by J.D. Power and Associates. To win in the marketplace, we have to wow our customers, not just in our claims service but with every customer experience. Our new customer service division completed its first full year of operation in 2005 with impressive service improvements and with an understanding that we have more work to do. Erie's above all in service attitude has distinguished us in the industry for years. And we have continued plans to assure we maintain our reputation for providing superior personal service.

Technology is a very important aspect of our success and in some ways our biggest challenge. Our new policy processing and agency interface system, Erie Connection is operational for back office processing. But we continue to have challenges on the agency interface side. As we work through these challenges, we have also maid enhancements to existing systems so our agents can continue to effectively service policy holders.

Concurrent with our efforts to grow and enhance our service delivery, we continued our efforts to manage the cost of operations. Our low cost model has always given our company an advantage in the marketplace. And we are committed to continue to leverage that competitive edge. For example, we slowed employment growth in 2005 with the goal of managing employment levels down in 2006. Together with our employees we have also made progress in containing increases in our employee health care expenses while maintaining a program that continues to rank high on a national level in meeting employee needs.

Some of the investments we have made in underwriting profitability such as the use of insurance scores as an underwriting tool have resulted in increased up front cost but are contributing significantly to our underwriting profitability and have a positive impact on our ability to compete for business in the marketplace. Another such investment is in the agent bonus program. Significant changes to our bonus formula were made in 2004 so that now we are rewarding truly profitable agencies resulting in a mutually beneficial reward that aligns the profitability of the company with that of the agencies. A growth component was also added to the program. The bonus estimate is modeled on three year rolling agency profitability, which means Erie Indemnity will continue its investment in the bonus in 2006 and beyond. These are investments that are necessary for the long-term health of our property and casualty business.

Recently our board of directors took actions to further enhance shareholder value. At our December meeting, the board of directors increased the regular quarterly dividend, from $0.325 to $0.36 on each Class A share. And from $48.75 to $54.00 on each Class B share. The dividend increase is the result of the company's continuing strong financial results in capitalization. Based on the current market price, the new dividend results in a dividend yield of about 2.7% and represents a 10.8% increase in the payout per share over the previous dividend rate. At the February meeting, the board reauthorized our share repurchase program with an additional 250 million authorization. Phil will talk more about that in his remarks.

At the close of 2005, the court of common pleas in Erie, Pennsylvania decided a long standing case to select a new Corporate Trustee the H. O. Hirt Trust. In its decision, the court selected Sentinel Trust Company to replace Bankers Trust, a subsidiary of the Deutsche Bank. The role of the Corporate Trustee is to serve as an administrator of the trust H. O. Hirt, the founder of the company established in 1967 for his children F. William Hirt and Susan Hirt Hagen. The trust comprised a majority of Class B stock of the Erie Indemnity Company. All the decisions affecting the trust are made by a majority of the vote of the three trustees: Mrs. Hagen, Mr. Hirt and the Corporate Trustee. From management's perspective we stand ready to work with Sentinel Trust. Our focus remains on running a successful company and meeting and exceeding the needs of our customers. We don't expect this in Corporate Trustee to alter our mission to protect and serve customers at the lowest possible costs. Now I'll turn the call over to Phil.

Thanks Jeff and good afternoon everyone. For the fourth quarter 2005 net income decreased 28% to $44.2 million compared to $61.3 million for the same period in 2004. Net income per diluted share decreased to $0.64 in the fourth quarter 2005 compared to $0.87 per share in the comparable quarter for 2004. As we've said, we originally reported fourth quarter 2005 earnings per share diluted at $0.66. Full year results were uneffected by that revision. Net income excluding the effects of net realized capital gains or losses on investments and the related federal income taxes on those gains declined 16.8% in the fourth quarter of 2005 to $44.7 million or $0.65 per diluted share from $53.7 million or $0.76 per diluted share for the same period one year ago.

Our full year results were up slightly in 2005. Net income was up 2.1% to $231.1 million from $226.4 million at the end of 2004. Net income per diluted share increased 4% to $3.34 cents per share at December 31st, 2005, from $33.21 at year-end 2004. Our net income excluding the effects of net realized capital gains or losses on investments and the related federal income taxes grew 3.1% to $221 million and 5.4% to $3.19 per diluted share.

Now I'd like to elaborate on the company's fourth quarter and year-end 2005 results beginning with our management operations segment. Our management fee revenue decreased 3.1% to $213.8 million for the quarter ended December 31st, 2005, from $220.7 million for the same period one year ago. The direct written premium of the property and casualty group on which the management fee revenue is calculated decreased 2% to $894.5 million in the fourth quarter 2005 from $912.9 million in the fourth quarter of 2004. Our fourth quarter management fees in 2005 were based on a rate of 23.75% compared to the fourth quarter 2004 management rate of 24%. A 2% decrease in direct written premiums combined with that lower management fee rate resulted in a 3.1% decrease in management fee revenues.

Management fee revenue for the full year 2005 with his down .5% from a year earlier to $940.3 million. In 2005 direct written premium upon which the management fee is based was down 1% from 2004 to $4 billion. In 2005 the management fee rate was set at 23.75% for the year. As Jeff said earlier, at its December 2005 meeting, the Company's board set the management fee rate at 24.75% beginning January 1st, 2006.

The 12-month moving average policy retention rate increased to 88.6% at December 31st, 2005, from 88.4% at September 30th, '05. The policy retention rate was 88.4 at December 31st, 2004. In the fourth quarter of 2005, our new premiums written declined 2.2% to $83.4 million from $85.3 million in the fourth quarter of 2004. In the fourth quarter of 2005 personal lines new premium written declined 6.5% while our commercial lines new premium written increased 7.4% compared to the same period in 2004. Improved underwriting allowed the property and casualty group to initiate rate reductions in 2005 to be more price competitive for potential new policy holders and improve retention of existing policy holders. The effect of rate actions effective in 2005 resulted in a net decrease in written premium of $9.9 million. Our pricing actions approved, filed and contemplated for filing during 2006 will result in an estimated net decrease in direct written premiums of $96.7 million in 2006.

The cost of management operations increased 5% to $181 million in the fourth quarter of 2005 from $172.4 million for the same period in 2004. Our commission costs, which comprise over 70% of the cost of management operations increased by 5% to $128.1 million in the fourth quarter 2005 from 121.9 million in the fourth quarter 2004, primarily driven by increased agent bonus costs of $20.6 million versus$13.9 million in the fourth quarter of '05 and '04 respectively. For the year, the cost management operations increased by 3.8%. Commission costs rose 1.6% to $539.5 million in 2005 from $531.2 million for 2004. The provision for agent bonuses totaled $71.1 million in 2005 compared to $46.2 million in 2004.

Normal scheduled commissions were $18.2 million lower in 2005 compared to 2004, primarily as a result of reduced commission -- commercial commission rates that became effective on premiums collected beginning January 1st, 2005. The fourth quarter cost of management operations excluding commissions increased 4.9% to $52.9 million in 2005 from $50.4 million in 2004. Our personnel costs totaled $31.5 for the fourth quarter 2005 versus $29.1 million the same period in 2004, an increase of 8.1%. Attributing to this increase was an increase in salaries and wages of 10% to $24 million in the quarter from $21.8 million in the fourth quarter of 2004. The cost management operations excluding commissions increased 9.8% in 2005 to $212 million from $193.1 million in 2004, mostly as a result of increased personnel and underwriting costs.

Salaries and wages and other personnel costs of employees increased $10.2 million in 2005 driven by increased staffing levels and normal pay rate increases. Our contract labor costs increased $3.2 million, primarily related to information technology projects. Also contributing to the increase in the cost of management operations were the cost of obtaining insurance scores on new and renewal personalized business of $4 million during 2005. The company began using insurance scores in the latter half of 2004 on renewal personal lines business only that had incurred $0.5 million in 2004 for insurance scores.

Now I'll discuss our underwriting performance for the fourth quarter and full year 2005. The company's insurance underwriting operations recorded a gain of $2.1 million in the fourth quarter of '05 compared to a loss of $0.9 million in the fourth quarter of '04. The company's reported GAAP combined ratio was 96.1 in the fourth quarter of '05 versus 101.7 for the same quarter in '04. The reported statutory combined ratio of the property casualty group for the three months ended December 31st, '05, was 96.8 compared to 100.7 to the same period in 2004. When adjusted for the profit portion of the management fee paid to the Company, the combined ratio for the property and casualty group was 93.1 the fourth quarter of 2005 compared to 95.4 for the fourth quarter of 2004.

Development of prior accident year loss and loss adjustment expense reserves contributed 2 points to the fourth quarter 2005 property and casualty group stat combined ratio. The adverse development of the fourth quarter resulted from additional increases in reserves related to pre1986 automobile catastrophe injury and noncatastrophic injury liability claim for higher estimated costs of future [inaudible] or services and additional workers' compensation reserves for prior years. For the year, the company's 5.5% share of the property casualty group underwriting gain totaled $15 million in 2005 compared to underwriting losses of 4.4 million in '04, yielding a combined -- a reported GAAP combined ratio of 93.1 for 2005 compared to 102.1 in 2004.

The reported statutory combined ratio for the property casualty group was 90.5 for 2005 compared to 95.6 for 2004. The 2005 adjusted statutory combined ratio for the property casualty group was 85.7 compared to 90.1 for 2004. The improvement in '05 underwriting results on direct business reflects the impact of the focussed management efforts on improving our underwriting profitability.

Catastrophe losses that are below the property casualty groups normal experience and continued favorable development of prior accident year losses also contributed to the improvement. The Company's share of cat losses totaled 0.4 million and 0.5 million for the three months ended December 31st, '05 and '04 respectively. The Company's share of catastrophe losses totaled $1.2 million and $4 million for the years ended December 31st, 2005 and 2004 respectively. Catastrophe losses of the property and casualty group were $6.8 million for the fourth quarter 2005 versus $8.8 million during the fourth quarter of 2004. The property and casualty group experienced catastrophe losses of 21.1 million and 73.3 million in 2005 and 2004 respectively. In addition, the property and casualty experienced positive development on losses on a direct basis of prior accident years of $11 million in 2005 and $71.6 million in 2004.

The favorable underwriting results required reversals of previously recorded charges under the excess of loss reinsurance arrangement with the exchange of $0.1 million in the fourth quarter of '05 versus charges of $1.7 million in the fourth quarter of '04. Charges under the excess of loss agreement with the exchange for the year totaled $2.2 million in 2005 compared to charges of $7.7 million for 2004. Both the 1999 and 2000 accident years under this agreement were commuted in 2005 resulting in net charges to the company of $0.7 million. The annual premium paid to the exchange under this agreement totaled $3.3 million and $3.6 million in '05 and '04 respectively. The policy owner surplus of the exchange has shown strong growth in the past years, rising from 2.1 billion in 2002 to 3.4 billion in 2005, further strengthening the exchange's financial position.

Finally, some highlights of our investment operations. Net revenue from investment operations for the fourth quarter of 2005 reflects income of $23.6 million compared to $31.6 million in income for the same period in '04. Net investment income increased by 3.1% to $16.4 million for the quarter ended December 31st, '05 from $15.9 million for the same period in '04. The company recorded a net realized loss on investments of 0.8 million during the fourth quarter of 2005 compared to net realized gains on investments of 11.7 million in the fourth quarter of 2004.

Fourth quarter 2004 net realized gains were generated as the equity portfolio was being transferred to external equity managers. The equity and earnings of limited partnerships generated $7.3 million compared to $2.9 million in the fourth quarter of '04. Our private equity, our mezzanine debt and real estate limited partnerships generated earnings of 4.4 million, 1.2 million and 1.7 million in the fourth quarter of '05 respectively. For the year ended December 31st, 2005, net revenue from investment operations increased by 26.8% to $118.9 million compared to $93.7 million for the same period in '04.

As part of the company's capital management plan, the company repurchased almost 1 million shares of Erie Indemnity Class A common stock at a cost of $52 million during the fourth quarter of 2005 for an average cost of $52.78 per share. During all of 2005, 1.9 million shares of Erie Indemnity Class A common stock were repurchased for a total of 99 million dollars at an average cost of $52.36 per share. And as Jeff already talked about, we've also issued a separate press release, an 8K yesterday, announcing the board's reauthorization of an additional three year $250 million repurchase plan. The reauthorized stock repurchase program becomes immediately after the available funds from the current repurchase program are expended. As of today, approximately $56 million of the original $250 million authorization remains from the the current purchase program, which was scheduled to conclude December 31st, 2006. Under the additional newly approved program, the company may repurchase up to $250 million of its outstanding Class A common stock through December 31, 2006.

Now I'd like to turn the call back over to Jeff to talk about our Regional Gem strategy. Jeff?

Thanks, Phil. Let me just make a few remarks about our strategy before we get into your questions. In March 2005, Erie embarked on the most comprehensive strategic planning process in our history. he result is a strategic plan to create a Regional Gem, simply the best insurer, wherever we do business now and in the future. We plan to do this by developing our I.T. capabilities, expanding our products and services, strengthening and expanding our agency network and excelling through expanded accountability, productivity and performance management. This will help us grow in the areas where we do business now.

And later we'll expand into new states, so wherever we operate we'll be able to deliver personal service, products and pricing that outmatch our competitors. We'll offer the same superior service we've always offered with more options for policy holders and prospects. With a renewed commitment and continuous innovation, our strategy expands on our legacy of success and builds on our historically strong ability to execute.

We will grow Erie into a top performing competitor, differentiated by our strong underwriting, claims and service disciplines, and our product price and service value proposition. We will build strong relationships with policy holders, agents and employees. In the past several years we have focussed our attention on our core strengths and addressed areas that need attention. We are confident that we have the right strategy and the right people to execute it.

Now, I'll turn the call back over to Karen.

Thanks, Jeff. That concludes our prepared remarks. Linda, if you could open the call for questions from our phone audience.

Thank you, Ms. Phillips [OPERATOR INSTRUCTIONS] And we will go to Meyer Shields with Stifel Nicolaus.

Let me start, in reviewing the [inaudible] trend data it seems fairly consistent that Pennsylvania has higher, I would say, severity trends and not as favorable [sequency] trends as the balance of the country. Have you been observing that and do you have any idea as to why that's true?

Yes, we have observed that Meyer. Pennsylvania does has loss ratios higher than many states in the rest of the country. Some of it goes to the regulatory environment in Pennsylvania, particularly in automobile, which has just recently changed. I'll let Jeff talk to you about that. But we realize that Pennsylvania does have a higher loss ratios than other states. And of course we're predominant in Pennsylvania.

Meyer, this is Jeff. One of the provisions that Phil was referencing that's recently change was the provision for mandatory arbitration within the uninsured and underinsured motorist coverage. With that change, we expect to see a reduction in these UM/UIM type claims. Of course, keep in mind, it's going to take a few years for those type of claims from years past to roll off.

Okay. That's helpful.

Yes, that's one of the factors that was -- that effects Pennsylvania loss ratios.

Okay. And if we can switch gears briefly, looking over, I guess, market share changes over the past couple of years, have you adjusted the roster of companies that you compare your rates against in addition to standard actuarial indication analysis?

We continue to use the national companies as a barometer for the most significant credibility in rate making. But we do not ignore the regional players who oftentimes are in the marketplace also competing for quality business. So, to the extent that we have modified it, we've modified those regional carriers that we also look at in terms of setting our competitive position.

Some of which are new entrants in some of our states.

Okay. Is it your sense that we're still seeing a rational competitive marketplace when these new folks are included?

So far, yes.

Okay. Thanks so much.

Thank you. Next we'll hear from [Blake Phillips] at Fox-Pitt Kelton.

Hi, Blake.

Hi, good afternoon. On Erie Connection, do you guys have any update on the time line for when the front end of that's going to be done?

Blake, this is Jeff. I don't have a specific time frame. Our commitment all along has been, we're not going to continue to roll it out until we're satisfied that it will provide for the needs of our agents. We do have, as you know, agents that are currently using the Erie Connection system. We've made enhancements to that system, as well as other systems that the majority of our agents are using. And we continue to challenge the development of solutions for the front end for Erie Connection. But I do not have a specific time frame for you, because quality is driving our efforts in that area.

Okay. And do you know what the cost was specifically related to the Erie Connection in the quarter?

It was very small in the indemnity company, negligible amount.

Okay. And then on the share repurchase in the quarter, 1 million quite a bit higher than previous quarters. Is there some thought behind that?

Well, couple of factors. Remember we use, we kind of stay within the safe harbor rules for buying back our stock. We're allowed to buy 25% of the 30-day moving average. Now, our volume has gone up slightly. Under that rule we've been able to buy on a daily basis a little bit more stock. We also, under that safe harbor rule, are allowed to buy one block of stock per week on days where we're not active in our program. And we have been buying, as you can see in the fourth quarter, we have been buying more larger blocks of stock during the quarter. So they've just been coming to us and we've been buying them.

We are -- we're still -- this program is still accretive to our earning. There's an implied yield. We're buying back $3.19 of operating earnings in the 52s, which is an implied yield of over 6%. After tax. So if you put that into bonds after tax, the yield's way south of that. So we're buying a 6% north of 6% yield when we buy back our earnings. It's accretive to our earnings. So you can tell that -- we're encouraged by the program because we've just reauthorized another $250 million.

So volume permitting, you would elect to continue this?

Right. You can see that from year end, you can tell from the numbers that we disclosed that in the first two months of '05 -- of course, February is not over yet, first two months of '06, excuse me, we bought about $40 million worth of stock. We're down to about 56 million in the original authorization.

Okay, great, thanks a lot.

Thank you. [OPERATOR INSTRUCTIONS] And we'll go next to Ron Bobman at Capital Returns.

Hi.

Hi, Ron.

It's a long wait with all those prepared remarks and all that reading. [Laughter] I question the merits of rereading so much of the release. But in any event, I wanted to ask about the underwriting results in private passenger auto. There was significant increase in the combined ratio Q4 '04 versus Q4 '05. And I thought weather was reasonably mild this winter. But can you -- and obviously year-over-year the underwriting results have picked up, but I think that's sort of been, unfortunately, a consistent quarter over quarter trend in that line. Can you talk about why the adverse directional change there?

Sure, Ron. First of all, recognize that we have seasonality in our underwriting results. And, in our private passenger auto business, the fourth quarter is always our worst quarter.

Of course -- understood.

All right, so that's understood. Also, so we reported a 107.5, in there is 11 points of adverse development. So to normalize that on an accident year basis would take us down to about a 96, 96 and change. Okay? Now we reported 2 points of adverse development overall, but there was 5 points related to what we call our pre-'86 catastrophe and noncatastrophe liability losses. So we added about $53 million in reserves to those lines.

I'm sorry, were those those sort of total loss medical cases that also were a third quarter issue or is it something different?

No, same thing. Only we looked at -- remember, we talked about this is a fairly small number of cases in the third quarter.

Right.

And we put some reserves up? We also looked at the ones below those, which is another 2 or 300 cases, what we don't consider catastrophe cases. Catastrophe case is a paraplegic or quadriplegic injury. These are less severe injuries. But, we looked at those additional cases 250 to 300 cases and boosted reserves on those during the quarter. So you've got to back out this $50 million on that auto book of about 500 million in earned premium, that's about 11 points.

Okay. So company wide you have 2 points of adverse development in the quarter. But for this line of business there was 11 points associated with $50 million increase in PPA reserves, is that right?

Yes.

Now, obviously I thought we were done in the third quarter, and maybe I misunderstood. Maybe it wasn't complete. So, is there going to be a phase three next quarter of the next year of claims, or is this item as far as a category put to bed for at least, hopefully for good, but at least for the near term?

Well, first of all, the third and the fourth quarter, these boost and reserve on this pre-'86 reserve is related to the attendant care aspect of them. What we refer to the top case with some litigation around this attendant care issue. So, that case was resolved. We took what we learned from that case and applied it to these reserves. So, I can't say that we'll never add to this reserve ever again.

Of course you can't.

Like in the third and fourth quarter it was around the attendant care and around the resolution of the top case. Now, that being said, there are a couple of factors that influence this reserve. If you read our 10 K from last year and the 10 K which we filed this year, we talk about the variability around this reserve and our reserve estimates are fairly -- have a fairly wide ceiling and floor on this item. And it's driven by medical cost inflation, medical care cost inflation and mortality of these groups of people.

But there's not a, right now, an ongoing study internally of the claims department of another trench of open claims focussed on this attendant care, for example, or you know medical cost inflation, or what have you?

No, we feel that we've put up the reserves necessary around the top case, the attendant care issue.

Okay. So if you were -- so -- thanks a lot for the color on that -- my next area of question was on -- relates to Meyers and the stock buyback. If you provided the liquidity and the block buy opportunities, is it conceivable that not only will you exhaust this 56 million of remaining dollar buys potential from the first program as well as the 250 in a more accelerated fashion? The new 250, I think you said has a 2009 sort of a term date. But if you have the balance sheet, obviously, and the stock has sort of been stuck here for some period of time. How eager would you be to get aggressive, to put it to work if the liquidity was there?

Well, first of all, we're opportunistic. There is a point at which -- I kind of went through the calculus of we're buying back $3.19 of earnings and paying 52 and change for it.

That was last year's, right? You're doing better this year?

Right, well, I won't [laughter, inaudible]. And it's relative to where we can put that capital, putting it into a 5% taxable bond that yields 3.5 is the calculus here.

Let me put it to you this way, if the liquidity were provided to you, would you buy in the coming 4 quarters at the same rate that you bought last quarter?

Well, it depends on the price. We're going to be opportunistic and we're not -- we're going to pay what we think is a reasonable price for our stock and given the alternate uses of the capital.

Okay. My last question -- thanks -- my last question relates to the technology and the Erie Connection. What's been spent on that sort of since inception? Is there any risk that you need to take some sort of reserve or -- I assume some meaningful portion of it's been capitalized. Is there sort of risk that -- because I remember it was a big number.

Yes. If you look at our 10 K, we actually disclose this number. Erie Indemnity Company has about 2 million on its book that is capitalized.

Oh, I thought it was higher.

First of all, it's only paying 5.5% of the costs, and some of those costs it can't capitalize. You can only capitalize under GAAP certain costs. So a lot of them have already been written off.

Okay.

And there's only $2 million on Indemnity's books.

Okay. I thought -- I didn't realize there was a cost sharing.

Yes, there's a cost sharing.

And what was the cumulative spend on Erie Connection?

Well, we talk about the eCommerce program being a $200 million program. But we made investments other than in this system as part of our eCommerce program. AIF, the system that we currently have installed, our investment is about between 80 and $90 million.

And that's group wide?

That's group wide. Now, 2 million resides on the books of -- on the balance sheet of Erie Indemnity Company at [12 31 05]. Some of those expenses get expensed, those are the things that could be capitalized and depreciated. On the books of Erie Insurance Exchange is about $35 million of capitalized expenses.

Okay.

And it's not in a surplus because those expenses -- those capitalized costs actually are a nonadmitted asset under statutory accounting so they're not in the surplus, the 3.4 billion. I know that's kind of a lengthy explanation, Ron.

How far behind are you on having the agency interface operating? When you started this project the goal was to have this thing in place at what point. My impression is that we're well behind schedule.

Oh, yes. The program was -- our original intent was to have this, I believe, in 2003 or early 2004. Of course, we have a personalized interface called [DSPro] with our agents which we are enhancing, we moved all our agents to it, and we think it's a terrific interface for agents to submit business and endorsements and those sorts of things. What we're trying to leapfrog beyond that and come up with this new internet solution for them.

Right. Okay thanks a lot, for all your help. Best of luck.

Thank you.

Thank you, and at this time it appears that we have no further questions. Ms. Phillips, I'll turn the conference back over to you.

Well, thank you all again for being with us today. That obviously concludes our call. As a reminder, the recording of the call will be posted on our web site, Erie-insurance.com by 8:00 a.m. Eastern time tomorrow morning, and that would be Friday, February 24th. If you have any questions, please call me at (814) 870-4665. Thanks again and have a great day.