Horace Mann Educators Corp (HMN) 2003 Q4 法說會逐字稿

Good morning and welcome to the Horace Mann fourth quarter and year-end earnings release conference call. At this time, all participants have been placed on a listen-only mode and the floor will be open for questions following the presentation. At this time, it is my pleasure to introduce Dwayne Hallman. Dwayne, the floor is yours.

Good morning. And welcome to our conference call. Early this morning, we released our fourth quarter and year-end earnings including financial statements, as well as supplemental business segment information. If you need a copy of the release, it is available on our web site under the investor relations section. Today we'll cover our results for the fourth quarter and year-end in our prepared remarks.

The following senior management members will make presentations today and, as usual, will be available for questions later in the conference call. Lou Lower, President and Chief Executive Officer, Pete Heckman, Executive Vice President and Chief Financial Officer, Doug Reynolds, Executive Vice President Property and Casualty and Dan Jensen, Executive Vice President and Chief Marketing Officer.

The following discussion may contain forward-looking statements within the meaning of the United States securities laws. Our actual results may differ materially from those projected in the forward-looking statements. These forward-looking statements are made based on management's current expectation and belief, as of the date of this conference call. For a discussion of the risk and uncertainties that could affect actual results, please refer to the company's public filings with the SEC and in the earnings press release issued this morning. We undertake no obligation to publicly update or revise such forward-looking statements to reflect actual results or changes in assumptions or other factors that could affect these statements.

As a reminder this call is being recorded and is available live on our web site. An Internet replay will be available on our web site until March 17th, 2004. Now we'll turn the call over to Lou Lower for his comments.

Good morning, everybody and welcome to our year-end call for 2003.

You may have noted the absence of George Zock as a participant on this call. As I wrote to those of you who have worked with him over the years, George elected to retire in December after 30 years of service with Horace Mann. We have reallocated his area of responsibility with Information Technology now reporting to Doug, while Client Services reports to me. Life and annuity is also reporting to me on an interim basis while we search for a new leader of that area.

In today's call, Pete is going to report on life and annuity financial results. Today we're going to spend a fair amount of time discussing the fourth quarter property casualty reserving action we've taken and in conjunction with that we'll discuss underlying results in our Property Casualty segment and help you connect those two in order to facilitate your modeling of results for 2004.

We'll also provide commentary on our healthy sales results, together with enough elaboration on Life and Annuity trends so you can develop a run rate for those segments for 2004. With respect to the reserving actions in the quarter, the complete findings of Deloitte's review of claims and reserving practices as well as their actuarial review have been incorporated in our reserve estimates. And as you'll hear in booking our year end reserves, we're in agreement with the select estimates for most coverages but have selected a higher point in the range for auto liability.

The combination of incorporating Deloitte's analysis and our higher pick for auto liability does improve our confidence level going into 2004, a year in which we're striving to have recorded results reflect the improving accident year results we're seeing in the Property Casualty operations.

We had a good quarter in sales, despite a modest decline in agent count; annuity sales were up 34%. Homeowners increased 30%. And life was up 17%. Auto was flat, as it continued to reflect pricing and underwriting actions, plus our emphasis on curtailing lower quality non-educator business.

As we have noted our drive to achieve margin adequacy has put pressure on property casualty PIF most noticeably in homeowners but educator PIF in both auto and homeowners continues to grow.

Although we had a rough start to the year in the first quarter of sales, momentum has built over the subsequent quarters with total sales for the year increasing 15%, including double digit increases coming from annuity, life, and property. Our full-year property casualty results were obviously significantly impacted by reserving actions and above average catastrophes. The underlying trends, however, give us optimism for a good year in 2004.

Ultimate accident year loss ratios in auto have improved 3 to 4 points per year in both 2002 and 2003. In homeowners ultimate accident year results ex caps improved 11 points in 2003 and close to 30 points over the past two years. We're also encouraged by improvements in both claims and underwriting expenses which in the quarter improved relative to both prior year and our expectations going into the year. And we certainly expect the initiatives we put in place, aimed at expense control and claims efficiency to continue gaining traction and momentum throughout 2004.

Both life and annuity net operating income are consistent with expectations, and our run rate guidance, cash value of fixed and variable accounts increased 17% for the year, indicative of strong sales and an improving equity market as our variable funds and aggregate continue to track the performance of the S&P 500.

As we have discussed the fixed annuity business has been adversely impacted over the past few years from both historically low interest rate levels, and an unfavorable credit environment, which combines to drive rather significant spread compression. However the rate of decline in portfolio yields that we have experienced has slowed. In addition, our exposure to further credit deterioration has been greatly mitigated through the impairment and sales actions we have taken, and the risk concentration guidelines that we have put in place. Those factors, coupled with the growth in assets we're expecting should lead to growing investment income in 2004.

As we think about prospects for 2004, we take into consideration improving accident year results and property casualty, stabilizing investment income trends, and benefits from improvement initiatives that we put in place. As we have disclosed our preliminary guidance for net income, excluding realized gains and losses for the year, is $1.20 to $1.30. We would acknowledge that the lower end of the range may be on the cautious side. The fact is we're still going through a considerable change.

We are confident we're doing the right things to improve the company's margins, but payback is definitely there. What the exact timing of realizing those benefits argues for some caution as we provide you with guidance this early in the year. Having said that, we will certainly be pursuing upside opportunity throughout the course of the year.

For the team here at Horace Mann, 2004 is all about focus, execution, and delivery. We're absolutely focused on the execution of those critical initiatives that will deliver the greatest impact on bottom line results and shareholder value in the upcoming year. And now here's Pete.

Thanks, Lou. In my remarks this morning, I will add just a few comments on the key drivers of our fourth quarter results, provide more detail on the Deloitte reserving and claim study, touch briefly on investments, discuss our capital position and some related actions we took during the quarter, and then conclude with some comments on our 2004 earnings guidance.

When we disclosed our loss estimate for the California wildfires in early December, we revised our guidance range for full year 2003 net income to 15 to 25 cents per share, excluding realized gains and P&C reserve impacts from the Deloitte study. Our 2003 reported net income of 44 cents per share included after-tax realized gains of 38 cents for an adjusted 6 cents per share. Adverse prior years property and casualty reserve development and additional reserve strengthening recorded in the fourth quarter reduced income by approximately 18 cents per share.

Further adjusting for these reserve actions brings pro forma earnings to 24 cents per share, consistent with our guidance. Strong performance in the financial markets set a positive impact in the quarter.

Market appreciation contributed to an income benefit in the annuity segment of approximately 4 cents per share from DAC and BIF unlocking and a reduction in guaranteed minimum death benefit reserves. Annualized mark returns of 30% in the quarter also increased variable annuity cash values along with the fees we earn on that business.

In property and casualty, our homeowners results are certainly worthy of mention. On the one hand, catastrophe losses were significant during the quarter, totaling $14 million pretax. The bulk of that related to the California wildfires, which we are now estimating at a net cost of $12 million. On a very positive note, however, we had an outstanding ex cap homeowners combined ratio of 55% in the quarter which Doug will comment on in just a moment.

Turning now to P&C reserves, as we previously disclosed, the independent consulting firm of Deloitte & Touche was hired at the end of the third quarter to conduct a detailed review of the company's claim handling practices, and their integration with our reserving practices. D & Ts claims and actuarial specialists reviewed claim files as well as past and current claims handling practices and procedures including case reserving practices in each of our six claims offices. They also performed an assessment of the company's actuarial practicees to establish IBNR and supplemental reserves.

An additional component of Deloitte's review was that preliminary actuarial analysis of certain segments of the reserves, as of September 30th, 2003, with enhanced focus on our automobile liability reserves. The quality and depth of the review conducted by Deloitte and the insights it has provided regarding recent adverse developments, as well as their perspective on the future development risks and reserving implications was excellent. They devoted a significant amount of time analyzing our data and substantially enhanced our understanding of the complex relationship between changes being implemented in our claims organization, and the resulting actuarial data and patterns.

The company subsequently engaged Deloitte to provide independent actuarial consulting services to evaluate P&C claims reserves as of December 31, 2003. This was extremely beneficial to the company as Deloitte was able to incorporate all of its findings, both claims and actuarial, into their year-end reserve estimate. The combination of the claims and reserve processes review and lost reserve evaluation, made for a more extensive analysis than normally would have been conducted.

Our year-end actuarial analysis and reserve estimates incorporate the complete findings of Deloitte claims and reserving practices reviewed, as well as their actuarial review as of December 31.

As mentioned in the press release our year-end reserve levels are consistent with their select estimates for most coverages but we have moved up in their range for auto liability. Our selection of the higher auto liability estimates accounted for about 8 of the $12 million in prior year reserve development in the fourth quarter.

We are pleased with the work that Deloitte has done, the knowledge transfer that occurred, and the involvement they will have in our reserve analysis process going forward. That, coupled with the additional strengthening done in the fourth quarter gives us a heightened degree of comfort as we enter it 2004.

Before leaving P&C I wanted to comment on the relatively small total premium increase reported in the fourth quarter. During the quarter, we completed adjustments to our process for estimating the level of involuntary auto and property business that we anticipate receiving from state reinsurance facilities. While this reestimate had a negligible impact on P&C underwriting income, it did result in a reduction of total property casualty written and earned premium in the quarter of approximately 5.1 and 3.8 million dollars respectively.

Adjusting for the involuntary lines reestimates, total P&C [audio drops] would have been 4.6, and 6.9%, respectively for the fourth quarter, instead of the 0.7 and 4% reported figures. Our core lines, voluntary auto and property premium growth rates, which were in the 6 to 7% range, were not affected by these adjustments.

Turning to the investment portfolio, total pretax net investment income of $46.2 million in the fourth quarter, while below prior year, was up sequentially over the third quarter by about 1.7%. Although the quarterly numbers can bounce around a bit, we would expect investment income to grow in 2004, although at a very modest pace. With regard to capital gains, we had a rather active fourth quarter, as we realized gains to bolster statutory surplus in light of the P&C reserve strengthening and cap losses in the quarter.

These gains also enabled us to begin utilizing the next tax loss carry-forwards that were created largely from the investment losses we incurred in 2002. We ended the year with unrealized investment gains of about $135 million pretax.

In addition to capital gains we took some further steps in the fourth quarter which enabled to us maintain capital and leverage ratios consistent with rating agency expectations. First, we replaced our existing life reinsurance treaty, with a comparable new agreement, which had the effect of increasing our statutory surplus by approximately $6.5 million. Essentially maintaining the same level of surplus benefit we realized in the fourth quarter of '02, from the original treaty.

In addition, we drew down our $25 million bank credit facility at year-end.

These actions enabled to contribute $27.5 million in capital to the property casualty operation, which should allow us to maintain P&C statutory surplus at a level comparable to prior year.

In light of the full utilization of our credit facility, we filed and obtained approval in December for a $300 million universal shelf registration to provide additional capital management flexibility. We are currently considering various debt issuance options, and/or expansion of our bank credit facility to potentially make some modest adjustments to our capital structure.

In summary, I believe we have appropriately addressed the P&C reserving situation, along with the related capital issues and that we are well-positioned to deliver positive results consistent with the 2004 earnings guidance that has been provided.

To offer some perspective on our '04 guidance, if we were to adjust the 2003 net income, excluding realized gains of 6 cents per share, for three items, the prior year's P&C reserve strengthening, which would add 85 cents per share, the above average P&C catastrophe losses which would add 20 cents and the life and annuity unlocking and GMDB reserve benefits which would subtract 5 cents per share we would get an adjusted EPS of about $1.05.

The midpoint of our 2004 guidance range, of $1.25 would represent a 19% increase over that normalized prior year base. This is a relatively healthy increase but one that can be achieved based on the underlying trends we're seeing in the property casualty business. Speaking of which, I would like to now turn it over to Doug Reynolds. Doug?

Thanks, Pete. We are all well aware that 2003 was an especially challenging year with significant impact from catastrophes and the need to substantially strengthen reserves due to prior accident year development; however, we are seeing positive results from the initiatives we put in place to restore profitability.

We are very pleased with our property results, and have successfully created a foundation for continued profitability. Our auto line, although improving in success of accident years and reflecting positive quality trends still needs further improvement during 2004.

Written premium for our core lines of voluntary auto and property increased 6% for the quarter, and 7% over prior year. Claims improvement initiatives are gaining traction and we expect additional contributions in 2004.

As you know, our property segment began deteriorating in 2000 along with the industry as a whole. Our prescription to restore this line of profitability targeted rate adequacy and a return to solid underwriting practices. Both of which have been effectively deployed.

In 2001, our property accident year loss ratios, excluding catastrophes was 88.3. We made good progress in 2002, achieving a loss ratio of 70.3. Our progress continued in 2003, with our property accident year loss ratio, excluding catastrophes at 61.6.

This is over a 26 point or 30% improvement in two years. This was accomplished, as we have stated previously, by tightening property underwriting guidelines deductible management, our aggressive reunderwriting programs and rate changes. These programs have reduced our property frequency by nearly 24% in two years. Despite 2003 being our worst catastrophe year, our frequency, including catastrophes, was our lowest in over five years. Our average deductibles to increase.

In 2002, 25% of our business had a deductible of less than $500. In 2003, this figure was lowered to 14%. As a result of the reinspection programs, I have mentioned on earlier calls, we have now renewed over 5,000 homeowners policy.

We also remained aggressive in our property pricing. Our average written premium increased by over 13% in 2002. This was followed by another 12% increase in 2003. We achieved these gains even with a couple of states mandating rate rollbacks or rate controls.

In the fourth quarter our average file rate change for property was over 20%. We mentioned earlier that 2003 was our worst catastrophe year and in the fourth quarter catastrophes represented over 37 points on the property loss ratio or 13.7 million. Nearly all of which was the California wildfires.

For the full year 2003, catastrophes added almost 21 points to our property combined ratio of nearly $29 million. Our underlying property business performed very well with a 2003 property combined ratio of splitting catastrophes at 84.5%.

Our auto line showed positive trends, but requires further improvement in 2004, which we are pursuing. Our combined ratio in the fourth quarter was 116.5. And 112.8 for the year. These results were disappointing and were greatly influenced by prior year accident. Despite these results, we are optimistic about auto as we go into 2004. Our educator book of business is our most profitable segment.

Educators represent over 67% of our in-force business at year-end. Up almost two points from 2002.

Another key leading indicator of quality and future profitability, the percentage of business in our top three tiers has increased almost one point.

Another key to drive auto profitability is improving retention of our best business. Our highest retention comes from automatic monthly payment business. At year end, 24.1% of our auto clients paid via automatic monthly payments up [.4] points from 2002 and it contributed to a .6 of a rise in auto retention. In addition, our retention rates for educator and better tiered business also continued to increase.

Our 2003 auto frequency declined modestly from 2002, and was our lowest in five years. Frequency has been helped by shifts in comprehensive and collision deductibles. At year-end 2003, 7% more of our clients had deductibles of at least 250 comprehensive and 500 collision, compared to the previous year. Our average principle premium increased about 5%, following a 6% increase in 2002. Although the competitive pricing environment is getting tougher our average rate filing in the fourth quarter was 9%.

While auto reserve strengthening has been a recurring drag on earnings we are encouraged to see the improvement in auto accident year results.

While reserve strengthening drove our calendar year auto loss ratio to 89.7% which is 12.7 points higher than 2002, our 2003 accident year loss ratio is approximately four points lower than 2002.

Our claims operations have undergone massive changes in the last year. In the past, we have discussed our advanced claim environment initiatives and our field claim office consolidations. The bank loans to our advanced claim environment is our claims work station system; it has been successfully deployed in three offices and we expect all offices to be fully operating on this platform in the second quarter.

In addition to the claims work station, we have installed supporting software to assist our claims operation. Med data to control medical expenses, at fault to help determine negligence in an accident, litigation advisor to control the legal costs and ADP auto estimating as well as an updated version of COLOSIS; all will help to improve the efficiency and control severity in 2004.

A significant portion of our claims activity in 2003 was reviewing every liability file and establishing new case reserves. We designed and deployed a comprehensive procedurals manual aimed to both standardize operations and provide extensive reference material to our employees.

Deloitte has completed their visits to all six of our claims offices. While we were not surprised to learn that all of the offices were not yet at best practices we were pleased to have confirmed that all offices are improving and moving in the right direction.

We believe 2004 will be the year all this preparation comes together to make a solid contribution to success in P&C results. We received positive signs already. Our loss adjustment paid expense is declining as we expected. A 3% drop in 2003, versus 2002, primarily reflecting a 14% decrease in the fourth quarter.

Our employee adjustors are settling more of our losses, which we expect to yield solid severity claims. This is a long-term process, although we have experienced some of the benefits in 2003, we anticipate additional benefits in 2004 and beyond.

So what are we looking for in 2004? We expect our auto rate changes to be around 7%, while property increases should be around 10%. Those objectives are in line with our indicated rate needs with the exception of states with political controls on rate levels like Texas, North Carolina and Florida.

As we mentioned earlier, we are getting some isolated resistance to our rate filings. When this occurs, we explore other options, such as tightened underwriting.

Our 2004 reinsurance lines have been placed our catastrophe reinsurance rates have increased in 2004 over 2003, as a three-year treaty at favorable terms expired, which had to be replaced at current market terms. Our 2004 quote at 2003 coverage levels was 25% higher than 2003. As we reviewed our coverage we decided to mitigate some of the price increase by changing our catastrophe retention from 8.5 million, to 10 million, and eliminate our 250 ex 250 property coverage.

We believe it provides the most efficient utilization of the reinsurance marketplace and resulted in a net increase over 2003 of approximately 5%. We continue to annualize our book of business to identify areas of concentration or segments not covering the reinsurance costs.

Our game plan for 2004 is very straight forward. Extract value from our exchanges and stay aggressive on the rate activity and maintain underwriting discipline. As a result of all of this activity, I would expect our combined ratio to be in the 95 to 97 range for 2004, including improvement in our expense ratio of about one half to one point over 2003's results of 23.2. And now back to Pete for life and annuity comments.

Thanks, Doug. Just a few comments on life and annuity. In the life segment, modest growth in premium and contract deposits was offset by a decline in group premiums.

Life sales, however were up 10% in 2003, driven by the rampup in the third and fourth quarters of universal life sales through our partner company Jefferson Pilot. While business we write through JP [indiscernible] and other partner companies is not recorded as Horace Mann premium, the marketing allowance we receive is comparable to our normal underwriting margin, with no corresponding capital requirement.

Reported fourth quarter pretax earnings on the life segment were below prior year by $2.3 million. Adjusting for the impact of DAC unlocking in both periods, pretax earnings were down 4.2 million, primarily due to three items: Higher mortality accounted for 1.5 million of the decrease, lower investment income and fees related to our surplus relief transaction contributed a little over $1 million each to the variance, the decline in full year life segment earnings was due to essentially the same factors.

Looking to 2004, we would expect life segment earnings to stabilize at about the same level as 2003, excluding DAC unlocking, with an investment income run rate comparable to recent quarterly experience.

Now, with regard to the annuity segment, 2003 total cash values grew by 17% over prior year, driven by a 31% increase in variable deposit values due to the strong equity market performance. Variable annuity net funds flow was $47 million in 2003, up 40% from prior year.

Total contracts in force grew by 4% and cash value retention for both variable and fixed business increased by about a point. Annuity pretax income of $7 million reported in the current quarter was slightly higher than prior year.

Fourth quarter 2003 earnings included a DAC BIF unlocking benefit of $2.5 million, driven by favorable market performance and persistency. Market appreciation during the quarter also resulted in a $400,000 reduction in GAAP guaranteed minimum death benefit reserves.

Adjusting for the difference in unlocking and GMDB impacts the current quarter pretax income was $1.2 million below 2002. This was essentially due to the difference in mortality and change in reserves between the two periods, with the increase in earned contract charges during the quarter offset by the impact of fixed annuity spread compression on net interest margin.

For the full year 2003, the decline in annuity pretax income excluding unlocking and GMDB differences was largely due to the decrease in net interest margin. Looking ahead, while annuity segment pretax income is not expected to return to 2002 levels, we do anticipate earnings to rebound somewhat in 2004, driven by growth and assets and a bottoming out of thick spreads. Now I will turn it over to our Chief Marketing Officer, Dan Jensen.

Thanks, Steve. The fourth quarter continues a strong sales momentum from the prior couple of quarters. Total sales for the quarter and year were up 25% and 15% respectively. These increases were driven by strong gains in three of our four core lines.

Property sales were up 30% for the quarter and 23% for the year while auto was up fractionally at 2% for the same time period. Annuity continues to lead way with all-time record quarter and full year results. Annuity was up 34% for the quarter and 22% for the year, even with prior year production being at the previous all-time highs.

The full year increase in annuity sales came from a 4% increase in career aging sales and over 250% increase in independent agent sales.

Life sales finished the year strong, thanks to the introduction of Jefferson Pilot's UL in the middle of 2003. We finished 2003 with total life sales for the quarter up 17% and for the full year up 10%, compared to the same periods in 2002.

We ended the year with 888 career agents versus 922 at prior year end, even though the average number of agents throughout the year was up 4% compared to last year. We saw both new agent and base [indiscernible] retention drop in 2003. To address this issue, we rolled out a new agent retention program in October. We significantly tightened the selection process with higher standards and a longer precareer training period. We added marking plan requirement for all new hires and resequenced new agent training to get off to a quick start.

We also reduced the number of hires allowed in 2004 compared to last year. We are placing a large number of these hires with managers who have excelled at developing and retaining agents and in high priority markets where the opportunity is greatest. Consist with expectations, we should see a dip in the number of agents at the beginning of year as we weed out producers not meeting minimum standards but expect to end 2004 north of 900 agents.

Growth and career agent productivity was significant during 2001 to 2002. While not losing ground, additional career agent productivity gains were fractional in 2003. To address this, in December of 2003, we rolled out a pilot for solutions our end-to-end sales systems. Solutions is designed to is significantly increate the productivity of our agents. It will give our agents the tools they need to be called a trusted advisor that our clients and future clients deserve. Solutions gives them a track to run on and the technology necessary to compete with anyone in our industry.

It has been rolled out to a diverse group of 50 agents for the pilot. We look to roll it out to the top 20% of our agents during the first half of the year and to all new agents who start with the company after July of this year.

Our high priority market initiative continues to be a focus. In 2003, in our targeted markets, we grew the number of agents by 28%. In our high priority markets compared to prior year, new life and annuity units were up 8% and new auto units were up 23%. The number of auto educator policies in force grew by 3%, while seeing good improvements in both percent educator and percent cross sold during the same time period. Our independent agent distribution channel continues to gain momentum.

We finished the year with 465 independent agents compared to just 167 at the end of 2002. Independent agent annuity sales ended the year at over 38 million, up from 21 million at the end of the third quarter, and just over 10 million for all of 2002.

Going into 2004, we will be looking to focus our independent agents more on variable annuity deposits from what is now mostly fixed deposit production to improve our returns on casual. In summary, on the career side, sales continued to improve as well as the quality of the business being written. Independent agent distribution continues to grow and with solutions and high priority we are well positioned for a strong 2004.

Thank you. The floor is now open for questions. If you have a question, please press the numbers one, followed by four on your touch-tone phone at this time. Please hold while we poll for questions. Our first question is coming from Alison Jacobowitz with Merrill Lynch.

Good morning, actually it's Jay Cohen. Regarding the reserve study and what Deloitte & Touche found, were there any -- maybe just a few number of issues that were identified that were fixes that had to be made in the process? Is there anything that you can point to that would change going forward?

Jay, this is Doug Reynolds. The -- some of the work that the Deloitte team, when they did look at the claims was really geared towards identification to just some of the improvements that we were starting to make around documentation of the claim files and utilization of the software that we were putting into place.

And some of their commentary was geared towards making sure that those -- those processes continued. They definitely saw -- they looked at some of the older files, versus the files in '02 and '03, improvements being made over that time, and more of their commentary was around how to continue to strengthen those processes.

Okay. Second question: You mentioned in the fourth quarter, the average rate filing being 9%. What percentage of your business does that represent? Again, this is on the auto side, as I recall. Is that just a couple of states? Was a wide --

No, that would have been a few states. I'm trying to think of what the -- it's loaded more towards the beginning -- the states are more loaded towards the beginning of the year than the end of the year. So I -- I'll see if I can find that number before the end of the call but it would probably be less than eight states.

Okay. And then just a numbers question. An answer I should know, but the goodwill in the balance sheet; what is that related to?

Well, that was related to when the company went -- in 1989, when the company went public, in its IPO.

Okay. And that -- obviously you did the test of that goodwill and it satisfied all the measures?

Yes that's correct.

Okay. Great. Thanks.

Thank you. Our next question is coming from JF Tremblay of Credit Suisse First Boston.

Good morning. I'd like to get back to Doug's comments regarding the rollout of your new systems that all six offices will be using, that improved claim handling platforms. So first of all, I was wondering if you expect any improvements in your expense ratio based on the rollout of those new platforms or is it something that's more minor in terms of earning projections?

Really for the claims platforms, it's two things. One is, yes, we do expect improvements in processes and we do expect, as a result of that, better management of the severitys.

Second, we do expect to have greater efficiencies and we would expect -- we already are seeing the loss adjustment expense component come down over what it was running two years ago. And we would expect that to continue through 2004.

Does your earning guidance include improvements from -- does it improve processes or --

Yes. The Earnings guidance would include anticipated -- the earnings guidance would include anticipated improvements on the controls around severity, as well as a lower loss adjustment expense component in 2004.

Okay. And then I would like to circle back to the productivity question. I was wondering if have you any kind of breakdown between productivity for the new agents relative to the agents who have been there two years or more.

This is Dan. We're digging out that information as we speak. Anecdotally what we're seeing is total productivity only up slightly. We have been -- we put on a significant number of agents over the last two years compared to prior years, and we have seen pressure on the lower performing agents and we have been losing more of those lower performing agents.

We have seen new agent productivity was down with the significant number of increase of recruits this year compared to the prior year, and career agent or experienced agent improving. But we have, as we mentioned and started in October for put in place -- put in a program to manage that.

Okay. So you mentioned you saw some improvement in career agents' productivity? Is that a significant improvement or --

Not significant. Single digit improvements.

Okay. Thank you.

Thank you. Our next question is coming from Mark Singlestien of Cochrane Caronia.

Good morning. I have a couple of quick questions. One going back to the auto ratio for the fourth quarter. If I adjust out for the a adverse reserve development, I come down to 106% combined. The first question on that number is: As a result of the reserve study, was there any favorable or adverse development coming from the first three quarters that was reflected in the fourth quarter? And if so, what impact did that have on the 106%? The second question is: Just thinking about that again, if I take the -- kind of the 7% rate increase that you mentioned in the call that you needed, will that 7% get me to rate adequacy across the -- across the auto book or do you anticipate further rate increases needed a year from now? And then I have one follow-up question.

Let me take first one, Mark. This is Pete Heckman. I think my calculations on the auto combined ratio excluding prior year strengthening for the fourth quarter gets it down to about 103 or so, which is is maybe a little different than the numbers you had. But there was about $5 million of '03 accident year strengthening that we did as well in the quarter, and that would have had about a 3.5 point impact on the combined ratio during the quarter.

Okay.

And then the second question on the rate -- the rate changes for 2004 or the 7% for 2004 on auto; the -- that is at indications across as many of the states as we can get it into. There's a couple around -- as I mentioned Florida and North Carolina, two of our larger ones, where there are some-- I will call it rate controls that are in place that do impact our ability to get full indications.

We would -- we would see, though, that that rate change would be able to allow us to get into that 95 to 97 and then we would take -- make other actions, like I mentioned other underwriting changes to ensure that we are being able to achieve that result going forward.

As we look out to 2005, the rate changes that we take in 2004 would not mitigate the need for -- or eliminate the need for rate changes in 2005, but we would certainly expect, as we're -- as we're lowering that combined ratio that that level of rate change depending on inflation, et cetera would begin to come down a little bit more.

Okay. And then one follow-up question. Just given the kind of more competitive auto rate environment, if you're going to look for, call it 7% rate increase, do you have any forecast on what impact that will have on your policy in force count?

Not as far as an estimate as to what we would expect to see in 2004 overall. However, what we have seen, even with the rate changes that we have taken over the past two years, is our educator, which is the focus of our business, the educator business is retaining that higher level and the retention is growing versus the non-educator.

Our rate changes are more geared towards that non-educator book of business, as well as the higher tiered or the more unprofitable segments of our book of business, so that educator lower tier business we continue to be very competitive as well as profitable in that segment, in that book of business.

Okay. Perfect. Thank you.

Thank you. Our last question comes from Adam Eggleberg of Silver Crest Assets.

Good morning. I actually have a couple of questions. The first one is, at least as I look at the numbers, it looks like your accident year loss ratio, excluding caps fell in the fourth quarter and I'm wondering -- I know you took, like an $8 million increase to the '03 business you were writing in '03 -- in Q3. You added 8 million to the current year. I'm wondering did you do some type of reversal or a trueup or anything, just to bring in sort of your full-year loss pick for '03 down to some level that you think is right?

Yeah, I think we -- we did look at the relationship between our selected ultimates in the '02 and '03 accident year and made sure that we maintained a reasonable relationship between the two. So as I indicated, we did strengthen '03 accident year picks slightly in the fourth quarter as well.

Okay so you strengthened them in the fourth quarter in addition to the third quarter.

Correct.

Okay. Because it looked to me like it was reversed that you actually might have lowered the loss pick for the '03 year. But it could just be the way my model is shaking out.

Not in auto. We may have slightly in property.

Oh, I'm looking overall, like what would be the net impact between property -- property and auto together. Would there have been a net reversal?

No, it still would have been slightly up, even on a net basis.

Okay. The second question was just -- could you just repeat. Did you say that paid loss claims -- paid losses had actually fallen for the year and fallen significantly in the fourth quarter?

I'm sorry, I -- I didn't understand the question.

Paid losses in P&C, year-over-year, were they down -- did you say they were down 14%.

The loss adjustment expense component was down in the fourth quarter 14% over prior year and down 3% for 2003.

Oh, okay. The LAE. Okay. Thank you. Then the last question, just overall operating expenses for total P&C, they did look like they ticked up in the fourth quarter. Is that a -- sort of a seasonal thing or was there also kind of a year-end trueup there or what would account for that?

One of the things we did and it shows up in total operating expenses as well, where we recorded a 9% increase in operating expenses in the fourth quarter. We recorded about 1.8 million in severance charges in the fourth quarter which is really kind of an usual one-time item. If you exclude that, severance cost--- that 9.2% increase in total operating expense, would be down in the 4% range. And P&C's obviously gets a fairly large portion of that as well on an allocation basis.

Okay. So overall, there was one claim charge in this year's quarter.

Yes.

For severance.

Correct.

Okay. That would account for a lot of it. Well, that's it. That's great. Thank you and I look forward to '04.

So do we.

Thanks.

Thank you. At this time there are no further questions. I turn the floor back over to Dwayne Hallman, for any closing remarks.

Thank you. Thank you for participating if our call this morning and have a good day.

Thank you. This does conclude today's teleconference. You may disconnect your lines at this time and have a great day.