Old Republic International Corp (ORI) 2004 Q2 法說會逐字稿

Good afternoon, ladies and gentlemen, and welcome to the Old Republic International Second Quarter 2004 Earnings Conference Call. At this time, all participants have been placed on a listen-only mode, and the floor will be open for your questions following today's presentation.

I would now like to turn the floor over to [Leslie Loyat] of Financial Relations Board. Please go ahead.

Thank you. Good afternoon. And thank you all for joining us today for Old Republic's conference call to discuss second quarter results.

This morning we distributed a copy of the press release, and hopefully you've all had a chance to review the results. If there is anyone on the line who did not receive a copy, you may access it on Old Republic's website at www.oldrepublic.com, or you may call my colleague [Semir Patell] at 312-640-6771 and he will send a copy to you immediately.

Before I turn the call over to Al Zucaro, Old Republic's Chairman and CEO, please be advised that this call may involve forward-looking statements as discussed on the add four page of the press release. Risks associated with these statements can be found in the company's latest SEC filings.

Additionally, we wanted to let people know that the information and statements made during the call are made as of the date of this call, Thursday, July 29, 2004. Listeners to any replay should understand that the passage of time by itself will diminish the quality of the statements. Also, the content of the call is the property of the company, and any replay or transmission of the call may be done only with the consult of Old Republic International.

With that said, I'd like to turn the call over to Al for his opening remarks. Al, please go ahead.

OK, thank you, [Leslie]. And as you've just heard [Leslie] say, the press released was faxed or e-mailed to all of you. And hopefully by now you had a chance to take a look at it.

As usual, I'll just speak to what I believe are key trends as well as our current expectations for our business. And again, as indicated, we'll leave some time for any questions you may have out there.

In total, the quarter shaped up pretty much as we expected. There were some unexpected variances in some of--in our three major operating segments. But basically, this has been the case for quite a long time now. These variances have tended to negate each other and, in a final analysis, the overall results were very much in line with expectations and very good in the circumstances, we believe.

Our General Insurance groups, starting with our largest segments in terms of revenues and capital allocation, continued to surprise us, I must say. But, the surprise was a positive one in as much as most of what occurred in the quarter in the year-to-date so far has been on the upside, particularly when it comes to premium growth, as well as the related current underwriting results.

Year-over-year, as you can see, premiums were up about almost 17% in this latest quarter, and almost 18.5% year-to-date. Leading this growth among our various coverages were Workers Compensation, which was up about 18% and 33% in the second quarter and year-to-date periods.

Our Financial Indemnity coverages, which we define as inclusive of Fidelity and Surety, Errors and Omissions, Directors and Officers Liability, as well as Credit Indemnity, those coverages in their totality were up almost 30% for both the quarter, as well as the year-to-date period.

Our Commercial Automobile business, which in our case, of course, is inclusive of our Large Trucking line, which we write both on the traditional risk transfer basis as well as risk management alternative market approach, that line, both the liability as well as the physical damage portion in combination was up about 13% end of quarter, and just about 11% in the year-to-date period.

And our General Aviation and Home Warranty lines grew in the 20 to 30% range in both the latest quarter and the first six months of this year.

I might note that a lot of our workers comp premium growth came from coverages that are associated with both our Aviation as well as Trucking insurance operations and, most importantly, with our Risk Management or Alternative Market part of the business.

Underwriting-wise, we had uniformly better results in Workers Compensation, in Trucking, in Home and Automobile Extended Warranty lines, as well as in our Financial Indemnity coverages in the aggregate. The only area of continuing concern for us has been in the General Liability area, which accounts for some 5% or so of our General Insurance group's earned premium base. And that line has continued to elude us from the standpoint of achieving underwriting profitability. The composite ratio in this line is still well an excess 100%, as it's been for about the last three or four years in particular. And it continues to be driven by continued deterioration in the Environmental as well [unintelligible] claims reserves or from greater expected payments in those particular types of plans.

And while this A&E area is not a big deal for Old Republic as it--it still represents less than 3% of our total General Insurance Group claim reserves. But, we keep getting nipped periodically as a result of usually negative legal judgments made or awards that come out of the blue.

So going forward, we still think that we're going to have a reasonably tough time getting our arms around this line, as is the rest of the American insurance industry, as you know. But fortunately for us, it's not a big deal. But nonetheless, it is watching and is being noted, as I am now doing.

Leaving these few negatives aside, therefore, I must say we are quite pleased with the operating results we are posting in this segment. We continue to feel that a full year combined ratio in the very low 90s is still very much in the cards for all of 2004. And we also think that 2005 should be a good underwriting year for us. It's the business that we've been renewing or writing for the first time in the past six months, as well as the--towards the end of last year, that that business is not showing any stress from either pricing or deterioration of trade terms. So, we believe that all systems are go, so to speak, for this part of our business and we feel good about it.

As we noted in the press release and the statistical exhibits that are appended to it, our Mortgage Guarantee business continued to sport a basically flat top line, which was matched to a rising claims cost line, as well as a moderately declining expense structure. Earned premiums on the net basis have been growing a little more slowly than the gross amount, as you can see in the stats again, and that's due, as it has been for quite a number of quarters now, to the continued growth in captive reinsurance sessions. Quarter-over-quarter, those sessions are about, what, roughly 16% in 2004 compared to about 14.5, 14.75% in the same quarter of last year.

So, our Mortgage Guarantee, bottom line, is driven mostly by those higher claim costs, which have been in a reasonably consistent up-trend since the first quarter of last year. And as we've indicated in the past, as well as in this morning's press release, this is largely a reflection of higher loan defaults on the one hand, as well as, particularly in the last couple of quarters, more conservative assumptions on our part about the percentage of recorded defaults that may cure themselves and ultimately eliminate our exposure to loss.

If we take out some non-repairing expense items, such as those we've mentioned, that--in the first quarter that are associated with the stock option vesting acceleration costs, there is a positive trend to the expense portion in our Mortgage Guarantee combined ratio.

Persistency rates continue to improve very slowly, as you can tell again from the stats. And there is a likely--a likelihood that any improvement or continuing improvement in the job picture on the strength of the reasonably growing U.S. economy should provide opportunities to generate better MI bottom lines from that standpoint. I suspect, as we've indicated, that starting in the third or fourth quarter we should see an accelerating up-trend in that regard, but time will tell.

Moving to Title Insurance. You can readily see that the drop and direct title lowered. It is closed of about 24% in 2Q 2004, and about the same thing or some 25% year-to-date. It did not have an apparent effect on our top line. And as, again, as we've pointed out in the past, this is of course due to the fact that we now get some 60+% plus of our revenues from independent agents. And we are getting the benefits of a slow tack in tracking reporting set up insofar as independent agent production is concerned. So then, a lot of this stuff that got booked by our independent agents in 1Q '04 got reported to us in the second quarter and, therefore, amplified our top line.

We've been surprised throughout the year, however, by the strength in housing generally, and by some continuing level of loan refinancing activity. As a result, our title bottom line, as you can see, has weathered the softening of housing related financing activity remarkably well, certainly a lot better than we anticipated going into 2004.

Claim costs in this segment have remained within the 5 to 7% range. We've assumed we would prevail for some time now. And of course, operating expenses have been contained pretty well. As you may recall, those of you that listened to the first quarter report, we've shied somewhat from putting the foot to the break pedal, so to speak, when it comes to expense reduction in the first quarter as we saw housing and refinancing activity be better than we had expected. And as a result, our expenses have not come down as much as they could have. But I think, given the level of top line growth that we're seeing, I think that will turn out to have been a good decision on our part from a long-term perspective.

Our expectation, therefore, is that our Title segment will fare much better than we assumed going into the year. Our fear had been that the first half comparisons would be pretty bad. They have not been as bad as we feared. And of course, the second half of last year was rather tender and, therefore, this year should compare--this year's results in the second half are likely to compare reasonably well with those softer results we booked in the second half of last year.

Consolidated-wise, our results are exactly as you see them, and they continue to benefit from the balanced approach to the assumption of underwriting exposures that we have followed for many years. It is obvious that the various cycles that attach to our three major segments operate--do not operate in tandem and, therefore, the negatives in one part tend to be offset by positives in another part, and do result--does result in a reasonably stable business, as opposed to one that would be otherwise marked by quite a bit more volatility.

There isn't much to report in terms of our tax position. It is we're still paying between 32 or 33% in taxes, or I should say incurring as apposed to necessarily paying, since we do have some deferral of income from a tax standpoint.

Our operating cash flow is very strong. It was up almost 47% in the second quarter of this year and about 30.5% as I see here for the first half of the year. And as yields on the fixed maturity securities continue to improve, as is likely, we should be able to get the benefit of that improving yield picture in as much as we have, as you know, maintained a very short maturity portfolio with roughly 25% almost turning over every year, and with the added cash flow that we're getting from operations. As I say, our investment income lines should start to reflect those benefits to a greater degree as the year goes on, and certainly next year.

From a balance sheet standpoint, there's no change to speak of. Our investment policy continues as it has been, very conservative, no funny securities. The portfolio remains as pristine as it's been. We've had no need to write down values of our equity portfolio in this past quarter and, therefore, that has had a salutary effect on the realized investment gains and loss picture that we've painted so far this year.

Our capital structure remains very strong. As I said, our cash flow is in great shape. And our reserves, our overall reserve picture, remains on the redundant--small redundant side, so that we are not penalizing this year's results by any adverse development of prior years total results.

That's the extent of my comments and, as we said, we'll open it up to questions you may have.

Thank you. The floor is now open for questions. If you do have a question, you may press *, 1 on your touchtone phone. If at any point your question has been answered, you may remove yourself from the queue by pressing the # key. We do ask that if you're using a speakerphone, to please pick up your handset to provide optimum sound quality. Once again, if you do have a question, you may press *, then 1 on your touchtone phone at this time.

Your first question is coming from Geoffrey Dunn of KBW. Please go ahead.

Thank you. Good afternoon, Al.

Hi, Geoff.

Could you give a little color under the mortgage insurance new business? There was a large piece of business written in the other line. What did that--what was that composed of?

You're talking about the--?

The $5.3 billion of new business.

Yeah. That's usually the--some pooled stuff that we have in there. Nothing, you know, that comes to my mind that's out of the ordinary, other than the amount.

As you know, both the bulk as well as the other line have bounced around for us, you know, every quarter, every year. So, I don't think there's anything unusual here. It's just a reflection of better market opportunities in some pockets of the market we're in.

Okay. And then two quick questions on Title. First, given the levers that you might have to pull on the expense management side and what looks to be a somewhat soft landing developing in the mortgage market, do you think you can maintain a double-digit margin for the second half?

And then also, can you give us an idea of maybe where your market share might have been on the Title side?

On the Title side, there's been very little change in our--in market share, both for us as well as our competitors, Geoff, from what we can tell.

In terms of margins, as I tried to say before, you know, last year the second half did get penalized by the drop in activity in the refinancing area from, you know, June or so of last year until the end. And therefore, we, at the beginning of this year, felt that the second half comparison of this year would be pretty good. And given what we've been able to achieve in the first half relative to expectations, we think that, from both a bottom line as well as margin standpoint, the second half is going to look pretty good for our Title business relative to last year.

All right. Thank you.

Thank you. Your next question is coming from Mike Dion of Sandler O'Neill.

Good afternoon.

Hi, Michael.

A couple of questions. One, just kind of a clean up on the stock option expense. If I heard you correctly, that is entirely in the Mortgage Guarantee segment?

Oh, no. No.

No?

What we do is we allocate those costs, whatever they may be, to each of the segments in proportion to the number of options that are allocated to each segment. So, given the fact that our segment--our Mortgage Guarantee segment over the years has produced, you know, roughly 50% or more bottom line for at least a couple or three years now or there abouts, it stands to reason that it got, you know, more stock options allocated to it. And therefore, when time came to allocate the related cost, it bore a--it's proportionate share of it. So, roughly 40, 45% of the total cost got attached to the MI segment and the remainder got attached to the General Title and the corporate sides of the income statement.

Okay. Great. Thank you.

And all of it was in the first quarter, incidentally, since, as you may recall, that was primarily driven by a vesting acceleration issue, which is going to be non-recurring since it no longer exists in our current stock option plan.

Okay. Fair enough. Just a couple of other questions, though I guess just staying with the Mortgage Guarantee segment. You know, it had a blip in the claims ratio this quarter from last quarter, which, you know, just coincidently was the same as the fourth quarter. Would you--I guess, given your--what, you said last conference call that you only expected 25, 30% loss ratio for the year, is that something that, you know, is probably--?

Still sticking with that.

Still sticking with that? Okay. So we would expect that to kind of trend down, I guess, third and fourth quarters then?

I would hope so. Yep. That--at least that's what we're anticipating right now. I think we've been a little heavy. We've been surprised by some of our prior assumptions on cure rates. And as you know--and by that I mean that we were perhaps less conservative than we should have been. And maybe, as can happen sometimes, we may be overreacting now to some degree. But, I don't expect that--particularly with the economy and the job picture improving pretty steadily now quarter after quarter, I don't expect that we're going to need to keep our foot on the break pedal to the same degree that we have.

OK. Fair enough. And then just moving to the General Insurance segment, you know, kind of reach the--you know, 89 and change combined ratio.

Great times.

Yeah, that's to be congratulated. You know, would you expect the kind of, you know, things that are going to be at this level for the next couple of quarters?

Well, as I tried to say before, Michael, I think, you know, the low 90s is still our expectation for the year as a whole. So therefore, that would imply that perhaps in 3Q and 4Q it might be higher than 89.2. I mean, the second quarter and the summer months tend to be our best quarters in General Insurance, given the fact that we've got a big exposure in the Trucking line, which is affected, from a claims standpoint, adversely, typically in your late fall and winter months. So therefore, the third quarter might still look very good. But the fourth quarter, as is typically the case, we know should take over the [inaudible]. And therefore, we'll rebalance the books, so to speak, when it comes to the loss ratio.

OK, great. Thanks a lot, Al.

Thank you. Your next question is coming from Nancy Benacci of [Key McDonald].

Thank you. Good afternoon, Al.

Hi, Nancy. How are you?

Good. How are you doing?

OK.

Wanted to follow up a couple more on the General Insurance side. As you talked about your Trucking line, are you starting to see some more competition in price in that market? And maybe just talk a little bit about the different competitive factors you're seeing in the main line.

Nothing has changed from what we've said in the past, Nancy, in response to questions, as well as comments that were volunteered by us. We're seeing very little, if any, pricing down trend anywhere except, as I said, in the Errors and Admissions and Directors and Officers Liability. So that, as a minimum, we're keeping pricing intact.

In terms of terms of trade, same story. There is a little bit of give on the [ENO/DNO] area, but not in the other areas. And so therefore, with respect to the major coverages that drive our business, or the major types of General Insurance activity we have at Old Republic, whether it be the Risk Management or Alternative Markets area, where as you know there are relatively few players, or whether it be in the Trucking area or the Forestry and the Contractors area, or the General Aviation area or the Home Warranty area, or the Automobile Extended Warranty area, all of which, as I say, are drivers of our top line and the underwriting results we're achieving. We're not feeling any pressure to cut prices right now, no. Just as I said before, we're not having any ability to increase prices, but at least it's very stable.

I know in the last call you indicated some of the growth comes from just expansion within the customer base. Are you still--?

There is still some of that taking place, that's right.

Is there any rate going on there at all or is it most being renewed flat?

No. Well new customers, obviously, you don't have a comparison to go with. But obviously, based on the pricing elements we use, we think that our new business is being put on the books at the same pricing structure as our renewed business. Now of course, you have to remember that no two account is the same and we don't treat all accounts the same. We do give pricing benefits to accounts that deserve it and we do give pricing penalties to those accounts that deserve that. But, in the totality of our business, whether it's new or renewal, we're not seeing pricing deterioration except in the one area that I mentioned.

OK. And in terms of the overall combined ratio averaging roughly a 90 for the year, I'm assuming you're still seeing--.

--I said low 90s.

Low 90s, excuse me. You're still seeing a solid frequency in severity trends across the board?

Yeah, there's no change in that. There's very little change, as I said, in our loss reserve redundancy picture. You know, everything is pretty stable. Nothing unusual happening in the loss area.

Well, as you look a little bit further out into '05 in terms of what type of volume growth you could anticipate and combined ratio, would you anticipate the combined ratio moving up from low 90s?

I don't know at this point in time.

OK.

As I said, Nancy, the business we've been putting on the books since let's say the fourth quarter of last year throughout this year which, as you know, will earn itself out throughout 2005 for all types of purposes, right, that that business is priced in the same fashion. And all other factors being the same, I think it's a reasonable expectation for us to assume that our combined ratio for this year should pretty much replicate itself next year.

OK.

You know, particularly given the fact that, as you know, Old Republic is not exposed to any significant degree to property types of coverages, which can blow up in your face pretty quickly and without any advance notice, we feel pretty good about the expected stability of the underwriting account.

Talk a little bit more on the Mortgage Insurance side, as we saw some changes in cure rates and paid loss ratios going higher again. What you're seeing there, is it just more being overly conservative or are you just really seeing some trends that are bothersome?

Well, I think the conservativeness is in the expectations on cure rates. With respect to paid losses, you know, paid losses are what they are. And sometimes admittedly, from one quarter to the next in particular, you may have a speed up in a block of claims that you've been holding in abeyance for whatever reason, so that sometimes that paid loss ratio can lie to you. But, there's no question that the paid loss ratio has been trending up for a year and a half or so now. And therefore, that does add pressure to the incurred loss ratio.

In terms of what you're anticipating, have you seen any real change by geographic area or industry that has caused more of a delinquency to come through?

No difference, no change from what we've reported before, Nancy, being mainly--that being the fact that a lot of our claims--a rise in our claims cost is emanating from some of the furniture manufacturing, textile manufacturing states, which have suffered by the way of competition. And it's, you know, it's going to take awhile for those economies to find new things to do and for people to be gainfully employed elsewhere and, therefore, repair some of the economic damage to their housing budgets.

OK. Thanks very much, Al.

Thank you. Your next question is coming from Greg Peters of Raymond James & Associates.

Good afternoon, Al.

Hi, Greg. How are you?

Fine, thank you. I have about six or seven questions, so I'll try and go through them quickly here.

First of all, I think in your opening comments you talked about unfavorable results. Was it in the Other Liability line?

General line.

General Liability line. Was that all coming-- I assume it's in the loss ratio side.

Yeah.

Is that all paid or is it IB&R?

Well, it's a combination of paid. You know, some of it, as I think I said or tried to say, was that we do get surprises by awards that come out of the blue, or mis-assessments, if you will, of exposures and then the claim finally goes to a judge or a jury and you get a big fat surprise. Now, we've had a couple of claims, you know, in several million bucks that we've had to eat. And particularly since you've--you know, you're talking about a relatively small line of business for us, at least from a premium standpoint, you know, our General Liability line is not huge. And as a result, a couple of claims can play havoc with your loss ratio.

I assume that's skewing the survival ratio, too.

By survival ratio on the General Liabilities?

Yeah.

I think you were the one who has asked that question in the past.

Yeah, also in the first quarter because I've noticed that your survival ratio has tracked down, which is very uncharacteristic for you. I know it's a small line, but I've always envisioned it staying at some level that's significantly higher than where the industry is.

Right. Right. And I think the answer we gave, which is the answer I'm going to give you now, is that to some degree, that's going to be repaired by some sliding of IB&R from unallocated to an allocated situation insofar as A&E is concerned.

I see.

There's going to be some damage, but it's going to be mitigated by some reallocation which we can do.

And would the damage be a year-end event or a third quarter event?

No, the damage is occurring.

Oh, OK. So, it's just your bleeding it in.

It occurred--well, I wouldn't use that word. It's occurred in the first quarter based on our first quarter assessment during the quarter, and it's happened in the second quarter based on our second quarter assessment during that quarter.

OK. So I'm--I'm sorry to carry through on this--.

No, that's OK.

So, I'm--.

Irrespective though, Greg, this line on average earned premiums for the last three years, let's say, has been about $60m.

Right.

It's about $41m as we speak for this first half of this year, so it's a little more. So, even if that doubles to $80m, and even if you assume that you've got, you know, 10 point of adverse development or what have you based on the earned premiums, that's $8m for the whole year. You're not talking about big dollars, but you are talking about a line which is not performing like the other lines.

I guess the way I was looking at it, which obviously is wrong, was just looking at the pure survival ratio, looking at what it was in '02 based on where it was in '03 and adjusting it to get it back up to where it was in '03, it was like a $30m pre-tax, $20m after tax adjustment.

I don't believe that's the cause at all.

OK. So, I was--.

I don't believe that that's right.

I was off line. All right--.

Particularly if you're talking underwriting effect.

Yeah.

If you're talking reserve effect, which is different as you know.

Well, that's-- I think I was more reserving effect.

Yeah, OK. Reserving effect might be.

Might be.

But it's not bottom line effect.

And so, when the difference between the two is--.

Reallocations [inaudible].

Reallocations.

Right.

And so-- OK. I follow you. Sorry for that.

In the past, Al, we've had conversations on pricing in Trucking. And you have commented in the past on pricing by power unit, etc., or given us some indications of rate of growth or rate of increase. And I'm concerned in the marketplace, not necessarily for your company, but for some others regarding some noise I've been hearing regarding pricing per power unit on some of the smaller account side of the Trucking business. And I'm wondering-- and your comments certainly don't seem to square with that concern, so I'm curious if you might provide some incremental color there that might help unconfused me.

Well, I don't know whether I can unconfused you, but all I can say, Greg, is that from our standpoint, I'm going to repeat what I said. We are not seeing any deterioration in terms of either pricing or in terms of trade in that business or the other businesses we're in other than, as I mentioned, the [ENO/DNO] item.

OK. What about by region, like Canada versus the U.S.? Because you've had problems--.

No. Yeah, our Canadian business, thank God, is finally showing good results, which are reflective we think of all the actions we've taking in the last two and a half years or so. We were a little bit slow on the uptake, as you may recall, in that part of our Trucking business. But, we seem to have caught up and that business now is performing like our U.S. business.

You have to consider also, Greg, that some 60, 70% of the claims attaching to our Canadian business are really incurred in the U.S., given the nature of the commerce traffic flows between the two countries, so that we are able to control claim costs emanating from Canada in the same fashion as we are with respect to our U.S. based customers.

With respect to your question as to smaller account versus larger accounts, I can say that, with respect to larger accounts, which have more power units by definition, they tend to be priced on an account by account basis to a much larger degree. And we are still getting great persistency in that business which, to us, is indicative of the fact that, since large accounts tend to be very price sensitive and will tend to shop their business a lot more often than smaller accounts will, that the competition is not there to accommodate their appetite for the lower price.

With respect to the smaller accounts, that part of our business is growing for us, which is what we want it to do. And that's the 0 to 10 power unit type of business. And as I say, we're not giving the store away there. I mean, we're able to get our price. And as I say, that business is not as price sensitive as the other, but nonetheless--.

Does your rating-- your S&P rating or anything influence your ability to attract business, or is that just--?

I think with respect to large accounts, there is no question today, the last two or three years, that good sound financial ratings are a big help with well managed companies. With poorly managed companies that are very price sensitive or do not use the word "loyalty" in their vocabulary, the ratings don't do very much for you any time.

OK. That-- thank you for those answers. I have a couple more questions, unfortunately.

That's OK, Greg. I'm accustomed to your long-winded questions. Go ahead.

I'm not sure they're long-winded, just a large number of them. OK. You referred to the results in the Title segment in the second half of last year being tender. Is that right?

Uh-huh. Yeah.

Are you looking at it from a pre-tax basis? Because if-- I may have the wrong numbers in my model, but it looks like the second half of last year it was $67m pre-tax versus $62m in the first half.

Yeah. But you had, again, what happened though last year is that-- as it happens every year, you had the lag effect of our Agency business, which now accounts for some 60+% of our business. OK? And therefore, eliminating that lag effect is what I'm saying, you know, the business should compare favorably.

So, you-- I mean, by-- implied--.

What you're looking at in the third quarter basically was second quarter production insofar as the agency business. And of course, through June or thereabouts of last year, you know, we were going like gangbusters.

Right.

OK? So I'm saying if you eliminate that particular pattern from the business, our second half this year should compare favorably with last year.

OK. I'm going to follow up with you after the call on that matter.

OK. Well--.

And then I wanted to ask one other question, and then I'll let everyone else chime in.

Fine.

The Mortgage Insurance. Someone asked earlier regarding the loss ratio and some general targets that you might have talked about in terms of the mid-20s for this year. And it was unclear to me whether you meant for the full year or by the fourth quarter, as in gradual improvement to that level. And I needed a clarification on that.

Yeah. I believe I've been saying that we should see a gradual improvement starting in the third quarter or fourth quarter of this year. I believe I said that the Mortgage Guarantee business should improve gradually as the year wears on, particularly in the second half of the year.

Thank you very much for your time.

Yep.

Thank you. Your next question is from Ira Zuckerman of Nutmeg Securities.

Are we doing this alphabetically, Al? Yeah, most of my questions have been answered. Just, on the Workman's Comp business, are you running any significant volume in California? And if so, what do you think of the situation out there?

We've always written a significant volume of Workers Comp business in California, Ira.

Yeah.

But, it's always been written on a loss-sensitive risk management alternative market approach. We write very little, if any, California Workers Comp business on a traditional risk transfer basis. We've always felt that the California market is a very dicey and tough Workers Comp market because of the presence of the fund, you know, state-sponsored Workers Comp fund, which accounts for some 50% or so of the market out there. And we've always found that to be something tough to compete against and that's why we've never touched that market, other than on a risk sensitive-- loss sensitive basis.

Are you there?

Yeah, yeah. OK. Thanks, Al.

Thank you. Your next question is coming from Stephan Petersen of Cochran Caronia.

Good afternoon, Al.

Stephan, how are you?

Good. Good. You've done a great job in terms of guiding us a little bit in terms of what you're expecting for margins. Just a couple of quick top line questions, if I may. In Mortgage Guarantee, with I believe you said it was a 16% captive reinsurance session this year versus 14 last?

Yeah, it was about 16 this quarter; almost 15 the same quarter last year. Year-to-date, if my calculations are right here, is about 16% and last year was 14.0%. So, it's been inching up a little bit. And I believe we said in the past that we thought it would be, you know, in that 15, 16, maybe 17% range before it levels out.

So, given where we're seeing persistency generally trend, I mean, should we kind of expect rather flattish top line, with most of the growth coming from margin expansion generally as we go through the year? Or might we see that pick up a little bit as persistency increases?

I think we're going to-- if persistency increases, by definition, you're going to get at least a direct earned premium top line benefit, OK? If on the other hand our expectations are correct, that we may be reaching the zenith insofar as captive reinsurance sessions are concerned, then more of that top line growth that's driven by improving persistency is going to stick to our ribs.

Then you're asking the question about margins and that is, in turn, obviously driven by the combination of the loss ratio and the expense ratio. And what we've seen on the expense ratio is that we've done a pretty good job, if you eliminate these "this and thats," such as the stock option expense allocation. You know, our expense ratio has been generally trending down, which is a good thing. Our expense ratio, on the other hand, has been trending up since 1Q of last year. And we're still saying that, you know, 25 to 30%-- you know, as I said in answer to Greg-- Peter's question, that we should see some improvement there, but it's going to be a higher loss ratio than we had last year.

OK, sure. Terrific. And in the General Insurance segment, you don't disclose net written premiums. Should we generally expect that earns are going to follow generally the same trend that we saw in the first two quarters as we progress through the year?

Yeah. Well, the reason we stopped announcing the net written premium some time ago, what, a year and a half, two years ago, Stephan, is because of the impact of having to make estimates of booked, but unbilled premiums, which were required by virtue of changes in the NIC's accounting requirements. And that line bounces around. And that's why we're very shy about putting out that number. And we believe, in our case at least, that net premiums earned are the best proxy that we have or that you have for determining the level of growth in our top line.

OK, terrific. And last quick, sort of technical question. There's a bit of a note in the first quarter 10Q about the 30-day letter with the IRS. And I don't know if you can provide any particular update on where you stand with that?

Nothing has happened other than we obviously are going to stick to our case. And the issue, of course, with us is that, with respect to that letter, is that you're talking about a timing difference, you know, because the IRS in this case is alleging that we overstated reserves and, therefore, should have paid taxes at an earlier date than we ultimately have paid them.

So, fundamentally, what you're talking about is having an interest issue to deal with since, you know, by the-- their situation or what they're alleging occurred is now three year old. And by now, if there were reserve redundancies, those have been reflected in subsequent years' tax returns and the taxes have been paid thereon so that, therefore, you have the interest on the timing difference to deal with and not a tax as such.

Well, I'm actually pretty happy to see that you were so over-reserved between 1998 and 2000. So [inaudible] a letter in the first place.

Thank you. [Inaudible] over-reserve. We don't agree. We [inaudible]. Historically, we've always had a level of redundancy. It's been a moderate one. We've said that on average it's 3, 4% and we're sticking to that story because we think that that's the case. And we're just going to have to battle it out with Uncle Sam in a very respectful fashion.

OK, thank you. Appreciate it.

Yeah.

As a reminder, if you do have a question, you may press *, one on your phone at this time. Your next question is a follow up from Nancy Benacci of [Key McDonald].

Al, just a follow up on one of Greg's questions regarding, again, sort of the mid-20s kind of level as we get to the end of the year. Again, just to clarify, are you referring to the full year number at that level, or just as we get to the fourth quarter it gets toward a, you know, mid-24, kind of 25 level?

I think it's an incremental thing. I have to say to you again that the level that we have reached now, expense ratio wise in our Mortgage Guarantee business, is somewhat higher than I would've thought would be the case by this time early this year. And I think it's a reflection, as I put it, of having our foot on the brake pedal when it comes to our expectation of cure rates in particular. And I have to believe that-- maybe this is a misplaced expectation. I have to believe that, as the U.S. economy improves very gradually, people's job prospects improve and therefore their ability to make payments improves as well, and that we should see some improvement.

But, you know, I've said that by the third quarter, and fourth quarter in particular, persistency should be improving. That's more a reflection of what's happening on the refinancing area than it is on the loss ratio side. The loss ratio side, I think, you know, 25 to-- the 25% was my expectation for the full year and I would expect that that's where we should end up. But, it's going to be a tough row to hoe given that we've reached 30% through June. So, I'm keeping my fingers crossed. I'm not giving you as clear an answer as I'm sure you world like, but it's the best I can give you.

No, that helped to clarify that. I appreciate that. Anything new in terms of books of business you could purchase or that you've done before? Anything out there that you've been looking at?

We're always looking. As a matter of fact, we're looking at two books of business right now. And I don't know what will come of it. I mean, you know, our record for the last 10 years or so is pretty poor. I mean, we've been very picky and I think properly so. I mean, there just isn't that much good merchandise out there. Every time you turn around and see somebody else buying a company, it tends to blow up in their face as soon as they've bought it.

So, you know, we're approaching any purchase with a great deal of trepidation, with a preference being-- as it has been with many other companies, to buy no books of business as opposed to stand-alone operations, where you have to acquire the possibility of reserve redundancies or some other problem.

Great. Thanks, Al.

Uh-huh.

There are no other questions at this time. I would like to turn the floor back over to Al Zucaro for any closing comments.

Well, I appreciate as always the interest and I hope that whatever answers I gave were as acceptable as they can be in the circumstances and we look forward to visiting with all of you next quarter. You all have a good day.

Thank you. This does conclude today's teleconference. You may now disconnect your lines and have a wonderful day.