Old Republic International Corp (ORI) 2007 Q2 法說會逐字稿

Good afternoon, ladies and gentlemen, and thank you for standing by. Welcome to the Old Republic International second quarter 2007 earnings conference call. Today's call is being recorded. At this time, all participants are in a listen-only mode. Following the presentation, we will conduct a question and answer session. Instructions will be provided at that time for you to queue up. I would like to remind everyone that this conference is being recorded. Now I would like to turn the conference over to Ms. Leslie Loyet of the 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 2007 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 online who did not receive a copy, you may access it at Old Republic's website at www.Old Republic.com, or you may call Liz Dolezol at 312-640-6771 and she would be happy to send you a copy immediately. Before I turn the call over to Al Zucaro, Old Republic's Chairman and Chief Executive Officer, please be advised that this call may involve forward-looking statements as discussed on the [add] 5 and [add] 6 pages of the press release. Risks associated with these statements can be found in the company's latest SEC filings. With that, I would like to turn the call over to Al for his opening remarks. Please go ahead.

Thank you, Leslie, and good afternoon, and welcome, everyone. Once again to our quarterly chitchat on our business. Although I got to say that given the way our stock is getting pounded, I feel like hiding under my desk, but there she goes. As we said on several recent calls, we've expected our business to experience some duress, to say the least, during the current housing and mortgage tribulations and of course the results we've provided this morning have lived up to those warnings. In the most recent quarter, operating earnings, as you've seen, came to about $0.45 per share, or 13.5% less than last year, and the tally was about, what, roughly 10% lower at $0.91 on the year to date basis. It's interesting to look at the contributions to that bottom line, because it tells a lot about what's driving our business. And roughly 62% of this year's operating income so far has come from the investment side of the business, investment income, and the rest from the basic insurance underwriting and service operations. By contrast, when you look at the first half of 2006, net operating income was just about evenly divided between those two sources. For the first six months of '07, the consolidated underwriting account reflected a 31%, or thereabouts, decline in profitability, and in the second quarter that we just posted, for that quarter by itself, the underwriting contribution was down by 37%. So substantially from a consolidated standpoint, substantially all the deterioration in the underwriting performance has come from our mortgage guaranty and title insurance coverages. On the other hand, as you can tell from the composite underwriting ratios we published, our general insurance business continues to perform exceedingly well and is providing the expected good counterbalance that's inherent to the business model and the overall book that we've constructed over the years.

Looking at mortgage guaranty first, the higher loss ratio and the trends it's exhibited of late tell basically the entire story about what's happening to this part of our business. Beginning in, what, midyear 2005, the loss ratio for this business began to inch up in earnest. This morning I put down on a piece of paper, and if you have a piece of paper you might jot this down, a few numbers. In the first half of '05, the loss ratio in MI averaged 45.5%, and then in the first half of '06, six months later, it trended down a bit to 37.5%. In the second half of '06, it rebounded bigtime back to the 40s, namely 48% or so. And of course this year in the first six months, it has grown measurably -- to wit, 54.5% roughly in 1Q of this year and now in the second quarter, 65.9%, as you see in the release. And as we speak, nothing has changed relative to the reasons that have led to this rising trend in loss costs.

In this morning's release, we identified the same culprits we've cited before, and those are, of course, higher loan defaults, higher insured values the last few years, and of course fewer loss mitigation opportunities in that business due to the combination of declining home values on the one hand and reduced refinancing opportunities, which had the effect over several years when refinancings were rampant, to perhaps postpone the recognition of problems. But absent the high level of refinancing, as I say, the opportunities to, to sweep under the rug, so to speak, some loss issues is no longer available to any significant degree. Most of the damage, incidentally in, these regards, is being sustained in our traditional, or what we categorize as our traditional book of business, which when you look at the stats, currently accounts for about 85 to 86% of our total risk in force. And, and the causative factors I just cited are of course a reflection of what's happening to housing and the related mortgage lending industry. And I don't need to tell you what's happening there because I don't think you can pick up the Wall Street Journal or any other business magazine or newspaper without having details of woes in the so-called subprime arena being repeated over and over again. And of course those, those tales of woes are affecting overall MI claim experience, particularly since it promotes a, as I say, a much reduced ability to mitigate lost costs by virtue of the lessened refinancing opportunities and/or lack of housing appreciation. As a matter of fact, to the contrary, as you know, we are experiencing deappreciation of housing in many markets and that's having, again, this counterproductive effect in terms of controlling loss costs in our business.

I suspect that doesn't take a mental giant to figure this out. I suspect that a current question on many lips may well be how much of our MI risk exposure at Old Republic falls in the subprime category. And in answer, in anticipation of that question, if we use 620 -- a 620 FICO score as a determinative benchmark, our answer is that we currently have about 10.2 to 10.25% of our total risk in force that can be so categorized. So when you look at the FICO score statistics we've been publishing in our 10-Qs and 10-Ks, you can see that roughly 70% of that 10.25% is lodged in the so-called traditional primary category. So leaving aside the current loss cost situation in mortgage guaranty, it's clear that, that given that most of the losses are emanating from the traditional book of business, that we are likely to experience some further upside trend in that regard.

Still, though, we have to look at the business from a longer-term perspective and from that standpoint, the longer-term fundamentals of the mortgage guaranty segment for us, we think are reasonably positive. We are retaining, as you can see, again, in some of the statistics we're publishing, we're retaining more of the in force as persistency rates continue to move up. And we feel we're writing more traditional and bulk business in an atmosphere that's a lot more conducive to adherence to much higher underwriting standards.

Expense-wise, again, you can see in the stats that our mortgage guaranty expense ratio is resting comfortably at a lower level than in prior years and together with a little more zip from investment income, which is providing something of an offset to the damage that's being caused by the claims account. Still, whether we focus on mortgage guaranty or title insurance for that matter, our current expectation is that we aren't likely to be out of the woods much before year end 2008, and that any significant profit uptick in these lines is probably going to be deferred into 2009. As we said a number of times, this ongoing saga of accelerating mortgage defaults, riding on the backs of declining home prices and much more stringent underwriting standards, simply has got to run its natural course over the -- we think over the next 18 months or so. Or at least that's our feeling at this moment.

Again, it took quite a number of years, three, four years, I guess, for this, for this lending industry, mortgage lending industry and housing industry to reach fever pitch, as we said the last time we spoke. And you got to figure it's going to take at least something along those lines for the fever to come down and for the business to resume, or to acquire a greater level of normalcy.

Looking at our title segment very briefly, there isn't much that can be said at this juncture that we've not said or reported before. If ever there was a transaction-driven business title is it, and with both new and used home sales in the doldrums, again, as you see in all the press recountings of what's happening in the business. And also with lending standards moving into hard nosed territory, title transactions are likely to follow suit. So in this line as well, we're anticipating a very gradual pullout of the cyclical low we're experiencing. The issue in title versus mortgage guaranty for us, of course, is a little different in as much as the business is more driven, as I say, by transactions, top line, and the related general administrative and production expense feature of the business rather than loss ratios. Title loss ratios have been heading north to a very slight degree now for several quarters, but we don't expect loss cost to be a particular issue in this down cycle. The issue has been and remains one of an inability to adjust fully for the expense, general expense content, production expense content of the business relative to the input at the top line.

Let's see, moving, as we like to say, moving to the sunnier side of the street at Old Republic, our general insurance segment has continued to perform exceedingly well. As we noted in the press release this morning, the end of this year's second quarter marks the 21st consecutive quarter of underwriting profitability. This is shaping up, not just for us, but for the general insurance industry, as one of the longest positive underwriting cycles we've experienced in a great many years. And our current view is that that's going to -- that's likely going to continue even though companies that are involved in the property side of the business, which we're not, are necessarily going to be subjected, we think, to a great deal more choppiness than liability insurance companies such as ourselves. There is, of course, tell-tale evidence that property liability insurance pricing has been on a moderate down trend. There are indications in from certain quarters that some people are looking at 14 to 15% price declines in some lines. In our case, for a variety of reasons, most of which have to do with the makeup of our business and the concentrations we have on relatively few industries and types of coverages, we still are experiencing, on an average -- and this is not scientific -- but on an average, we think we're experiencing about a 2 or 3% decline in overall pricing, and that's about the same level as last year. And of course when you start compounding that over a couple of year period, you start looking at some real numbers and perhaps we are now looking over the last two years or so. We're probably looking at a 10 to 11% decline in overall pricing in this business.

So that's bound to have an effect on loss ratios and -- but so far, the -- our loss ratio has held up very nicely. As we reported in the last two quarters, our top line, of course, is benefiting from the new book of business, mostly, or I should say substantially all of which is liability insurance-oriented and is targeted at the construction and building industries. Of the total increase in earned premiums that you see there in general insurance of about $129 million for the first six months of this year, approximately $116 million came from that book. So that leaves just about $13 million that came from the preexisting book, which implies obviously organic growth of about 1.25% or thereabouts. At the beginning of this year, we had expected organic growth of earned premiums at about 2% and we think that that's still achievable through year end 2007.

Among the various coverages which we write, which in our case, of course, include very little by way of insurance for consumer or commercial property exposures, premium trends basically have reflected the overall results I just mentioned. By virtue of the new book of business that we've been writing effectively since January of this year, we did write a lot more, as you might expect. We did write a lot more workers' compensation and general liability business, and among the, what you might classify, categorize as consumer products -- premiums grew at a somewhat greater than average rate for the automobile extended warranty line, as well as our consumer credit line. Loss ratio wise, most coverages pencilled out at about the same level that we posted for all of 2006, and that you can see in the statistical tables included in our 2006 10-K. A few exceptions to this relate to what we categorize as financial indemnity coverages, wherein we include errors and omissions and directors' and officers' liability and a combination of those produced very low loss ratios relative to last year. But on the other hand, again, in the same category of financial indemnity coverages, our consumer credit indemnity portion showed the opposite effect. But when you meld all of the coverages together, you can see that the balance of our book produced a loss ratio of about 66%, which is slightly below the average loss ratio we booked in the three preceding years.

Expense-wise, we're doing okay in this segment, and of course investment income is growing very nicely. As I indicated before, it's contributing both for general insurance, as well as the rest of our business is contributing most of the juice to the bottom line. And in general insurance, it's growing in particular because we're still experiencing very positive operating cash flows that continue to add to the invested asset base. And when you marry that with a somewhat rising yield trend that all of us benefit from, that our investors -- it does serve to produce the higher investment income that we are experiencing. Consolidated wise, operating cash flow, as I say, was about, what, 25% year to date, with just the title business contributing a negligibly negative due to the current difficulties in that business. But the other lines, the other segments of our business were all cash flow positive this year to date, as they have been for many years now. The asset side of the balance sheet remains for us as clean as ever, and it is truly unburdened by any questionable assets, and our claim reserves -- our position relative to claim reserves -- continues to reflect very good adequacy of prior years of reserves. So we don't have a problem with prior years' reserves coming back to bite us, and undermine the current year's premium flow.

Let's see, I guess if -- in conclusion, I guess it's time for us to perhaps indicate where we think we're going for the rest of the year, and we're still of a mind that our general insurance business is going to post very respectable underwriting as well as overall operating results. We think that the 92 to 94% combined ratio -- underwriting ratio for this year that we're aiming for is very achievable. As you see, we're below that range in the first half of the year. In title insurance, we don't expect to see any further meaningful further significant deterioration from the current state of affairs, though as we've said, we think that any material uptick in profitability in title will have to wait for several quarters. I think for what it's worth, I think we may have reached bottom, but the ability to grow that top line and/or reduce our production and operating costs is pretty limited -- is going to remain pretty limited for a while longer. Production-wise, we should continue to do reasonably well in our mortgage guaranty business. There's an old saying goes, you tend to write some of the better business when, when blood is flowing on the street and of course today with a -- for a company such as ourselves, it's very much oriented towards the underwriting side of the business. I think we've got very good opportunities to put some good books of business in our accounts. But -- and while claim costs, as I indicated earlier in the mortgage guaranty insurance are more likely than not to incline as opposed to decline, I think they can be reasonably contained so the business can remain reasonably profitable even in the down cycle that we're experiencing. That's about the gist of it. And so therefore, as was indicated before, we'll open this visit to any questions that some of you may have.

Today's question and answer session will be conducted electronically. (OPERATOR INSTRUCTIONS) We will go first to David Lewis from Raymond James.

Good afternoon, thank you.

Hi, David.

Al, thank you for your thoughts, but couple additional questions. If we can talk a little bit about the mortgage insurance business and what profitability trends might develop over the next several quarters, is there any way first of all to correlate the delinquency ratio to any kind of loss ratio deterioration or any factors that might help us there as we kind of look forward?

Well, as we've said on many occasions, the determination of claim costs in mortgage guaranty is a somewhat imprecise exercise, but it is driven by, as you point out, the level of defaults, but the changes that affect the reserving for the business are very fluid from period to period. And currently, we're looking at the housing situation and what's happening to prices, home price appreciation, what the effect of all the issues in subprime is going to have on, again, on housing inventory. And of course, the last number of years in particular we have been writing higher -- we have been insuring higher valued loans. And of course that creates -- when losses emerge, that creates a severity issue for us, and the severity has become much more accentuated in the past two or three quarters, and is a big part of what's driving our loss ratio. So, again, I -- there is no -- there is no simplistic answer to the question, and we basically reserve -- the paid loss ratios are not what's driving our overall loss ratio and mortgage guaranty insurance. It's the reserve element that is rising and driving up that loss cost. And the best we can say right now is that our feel is that given the difficulties in both housing and mortgage lending, that it is more likely than not that you -- that the loss ratio will be inclining as opposed to declining or even stabilizing for the next couple of three quarters, at the least.

Is there a way to correlate this to other periods and figure out where the loss ratio may have peaked? Is it a business where you might see that get to a 75% loss ratio, or do you think it stays in the 60s, or any guess you could help us with there?

Well, I'm reluctant to say. Again, the caveat in this business is that the accounting for it does not allow -- GAAP accounting in particular, does not allow you to reflect in your reserves what you think, what you fully believe is going to happen in the future. You can only react to what is in the pipeline and then dress that up with your best assumptions as to how much of the losses you're going to be able to mitigate, how severe they are, or are going to continue to be, et cetera. The other, the other part of the answer to your question, I think, has to do with where are the losses coming from, particularly if you try to estimate what your current situation is going to be relative to where you've been in similar down cycles in the business. And today, I mean -- while California is a big culprit, but you do have Florida, for example, and you do have the Midwest as another example currently, which we're not part of the equation to this -- at least to the same degree in prior down cycles. And that's creating a situation where you don't really have true comparables to go by in order to figure out where you're likely going to go. So the long and the short of it is that the answer to your question has to be a necessity -- one of limiting ourselves to suggesting that, as I say, it is more likely than not that the loss ratio is going to be on the incline rather than a decline. How far up? I don't know. Is it going to be 100? No. Is it going to be 90? I don't think so. Is it going to be below 90? Probably.

That's helpful. One final question -- with the stock now trading below book value, is there any thoughts to revisiting a repurchase program?

Well, we look at that, very -- on a real time basis. And we are obviously very aware of what the stock price and the stock tables is telling us and what we believe the real value of our company is. So I can assure you that we will go through the same exercise as we always do, which is to make a determination of whether the continuing long-term shareholders in Old Republic are better off receiving excess cash we may have in the form of greater dividends, regular or otherwise, versus a stock buyback.

And is there an authorization in place?

Yes.

What is that amount?

$500 million.

I'm sorry? $500 million.

Thank you.

(OPERATOR INSTRUCTIONS) We will go next to Mark Finkelstein from Cochran Caronia Waller.

Hi, Mark, how are you?

Well, thank you. Just a couple of quick questions -- actually, David asked the question I had on repurchases. But in the MI business, have you triggered any recoverables from the captives, and are they included in current results?

Have we triggered any recoverables? You mean commuted anything?

No, have you seeded any losses to the lender cap--

I think we have, but they have not been so significant as to affect the net loss ratio we're posting. That's not become an issue yet.

Okay. Do you, do you foresee that becoming a bigger issue or do you think that --

Well, it could -- I mean if the loss ratio keeps growing, there's no question. As you know, Mark, most of the reinsurances in mortgage guaranty are in the form of what we refer to as excess of loss protection.

Right.

And that implies that you need to have a trigger and that trigger is going to vary depending on the kind of reinsurance agreement you have with individual captives. So that one, one type of book may not be acting similarly and with another type, and therefore the trigger may not be reached at the same time for everybody. So I would suspect that if and when some of these recoverables get triggered, there's not going to be a particularly consistent approach to it. I could be wrong about it, but that's my gut right now.

Okay. Do you know off the top of your head what the flow percentage of your book is in Florida and California?

No, I don't have that in front of me, Mark. Let me just take a look here quickly. No. We're going to have to answer that question offline.

That's fine.

If it's important, okay.

Okay. Thank you.

We will take a question from Michael [Sentilly] from [Alliant] Asset Management.

Hi, good afternoon.

Yes, sir.

I have a bunch of questions on mortgage insurance business. Let's start with pricing on the new business that you're writing currently. How does that compare with where they have been historically, i.e., an equivalent loan 12 months ago versus that same loan, if you can imagine that today -- what kind of pricing differential would you be incurring on that?

I take it your question is mostly, is addressing the so-called bulk type of business, right?

Actually both; the bulk and the flow.

Well, I mean the flow is more automatic pilot type of business.

So you're not adjusting price there?

No. When you go to the, when you go, when you go to the bulk business, there, as we've said repeatedly over the years, we are very opportunistic. If you look at the statistics that we published this morning and compare them to competition, you'll see that we've been somewhat more aggressive in writing that business. And while I cannot quantify for you in terms of what you're asking, the specific question you're asking, I can say as I tried to indicate before that we are -- we believe we're operating in a much better environment in terms of lending, underwriting standards, et cetera. And that as a result of that, we are better able to obtain better pricing on the product than we have, than we did, let's say, through mid year last year.

Okay. So in your -- for new insurance written, and what percentage has been bulk recently since you're saying you're more aggressive -- how much more aggressive in terms of the mix shift are you going to get?

Well, if you looked, there's a table -- let me flip to it in the press release this morning. Isn't there a table on how much we've written? Yes, new insurance written? If you look at that, that's on Page [add] 9 there. And it shows that new insurance written in bulk was $4.5 billion in 2Q '07 versus $981 million, short of $1 billion dollars in the same quarter of '06. And year to date it's $8.5 billion versus $4.2 billion. Now, I have to say that some of this production for us and everybody in the business tends to reflect a lagging effect in that you have stuff, let's say, at year end in the pipeline that doesn't get booked and solidified until the first quarter and so forth and so on. So you've got some '06 production that was, that pertains to that year. But most of this is this year and -- and I have to say that from a quality standpoint, our feeling is that we are -- irrespective of when we've written it in the last nine months or so, that we have written better quality business.

Okay.

As you know, I don't know what your level of comfort is with mortgage guaranty, but as you know, pricing, particularly when it comes to bulk, is very much -- is much more art than science. And all of us in the business have got some proprietary techniques and that's why I'm tending to be general in my response to you.

Okay. I'm trying to get a feel for how attractive the new business is versus the old business in terms of pricing or in terms and conditions -- I got to believe terms and conditions are also much tighter.

Yes.

You're getting it on both ends, is that right? You're getting better pricing and better terms?

That's right. I have to say we would not be doing this -- I mean, again, we are fundamentally much more of an underwriting long-term underwriting company. And particularly when it comes to bulk insurance, we've always been -- we were late to come to the dance as a company. But when we did come, we assumed a very opportunistic position in the business, and I can assure you that we would not be doing what we're doing if we did not have a very high level of comfort that we're writing quality stuff.

Okay. Now, on the flow side, has anything changed? The pricing has not changed?

Not to my knowledge, not to any significant degree. I mean their pricing is driven, as you know, by loan to value ratios, the levels at which you're attaching. It is also driven by the FICO scores. It's driven by the level of documentation that you have and so on, and so forth. And therein lies the subjective aspect of some of that pricing. So you have some of the same pricing issues when it comes to flow and bulk.

Right. It's a risk-based pricing kind of model.

Yes.

The thing is now that no one has an appetite to write any piggybacks or any of the stuff that was going on before, and you guys are gaining -- you guys as an industry are gaining market share, if you will.

Right.

Back to the old days. I got to believe that you have some pricing power. You could probably say, hey, you know what, yesterday's price is no good.

Yes.

We got to go 10% or 20% higher, whatever the number is.

And we think we do, okay.

You're not getting that, you're saying?

No, we think we have pricing power.

On the bulk side, but not the flow side?

No, I think we do as well. I think we do as well. You also have the issue there, as you know, of captive reinsurance and the extent to which you seed various types of business has got an effect on what you retain, right?

Right.

And that also has to do with pricing power in the final analysis, right?

Right.

So what I'm trying to say is that we have, I think we have more pricing power on the bulk side of the business because that type of business tends to have more difficult loans attached to it. But on the other hand, the power seems -- I think, pervades the entire book in varying degrees.

Okay. Now, on the captive programs, have the originators been less likely to want to enter into these captive reinsurance programs in the last six months versus '05 and '06?

Not to my knowledge. It's been --

Steady as she goes.

Pretty stable.

Okay. Just wanted to kind of get more color on the point at which a captive reinsurers starts to kick in. You said some of them might be starting to kick in. How do you define a pull? I guess you have relationships with each of the lenders, the originators, I should say.

Right.

And so each of those have a block.

Right.

And then is it like everything you produce in July, for example, is a block and then August is a new block and September is a new block, or is it the whole '06 vintage is one block?

Yes, these are basically ongoing treaties. Once you enter them, until one of the parties cancels it, you stay with the business, right? Cancels it for whatever reason, because they don't want to give you any more business or found somebody else or what have you, right? But there is a determination made at the front end as to the types of loans and what the qualifications of those loans is going to be that are going to be included in the pool that's subject to the treaty, to the reinsurance treaty.

Okay.

You do have variability in these treaties in that not all reinsurers assuming companies attach at the same point. And that's what I was trying to -- the point I was trying to make earlier. It is very much like the property and liability business written on an excess basis. Each seeding company and/or assuming company have got different appetites as to the level of risk they want to attach to. And that level dictates the amount of premium that will be seeded or charged as the case may be.

So--

That's why you don't have a uniform flow of claims recoverable in these various arrangements.

Okay. So the standard one out there that I've, I'm aware of is the so-called 4/10/40s.

Yes.

You're saying it could be anything, it could be 3/12/30 or whatever you want it could be.

It varies.

But take the 4/10/40 as an example. To get back to my pool question, as I understand it, the 4/10/40 is -- the first 4% of the losses in the pool go to you. The next 10 go to them and you seed them 40% of the premium.

Or -- well, it's not necessarily 40% of the premium. That's one of the points I'm trying to make.

Okay. In the 4/10/40, it would be 40% of the premium, but my question is if the pool is kind of undefined and it's open-ended they keep pouring more loans in there, at what point is the 4% attachment--

It's on the --

-- triggered?

It's on the year to year basis, okay?

So is it not like the Q1 loans that I reinsured for '06, that's one pool. Once that pool hits 4%, then you start seeding losses? It's not that simple?

I -- now you're getting me into an area where I feel kind of vulnerable in answering the question because I am not on top of it. And I would have to get back to you as to the mechanics -- the specific mechanics that you're asking for. Although I have to say with all due respect, that I don't know that it makes that much difference, because you're either on a treaty or you're off on a treaty. And once you're on a treaty, you're going to take whatever comes with it, regardless of where the business came from or when it came to you.

Right, I understand that, but if--

It's a continuous -- there's more of a continuous aspect to those types of reinsurance treaties, whether they be in the property and liability or the mortgage guaranty business.

Okay. Maybe--

The out --

Maybe I'll call you offline and get more.

If I sense the thrust of your question, the out is if you -- let's say in our case, as the seeding company -- or on the other side, as the lender's captive -- sense that you have, that the losses are other than what you expected, you're going to come back to the table and ask for some sort of rate change. And at that point you're going to bargain at arm's length, as to how much of a rate relief or what have you is needed to correct the perception of what the losses are going to be.

Okay.

So in fact, it's not like guaranteed renewable business. You can get out and you can in fact stop the music for a while and take another look at it.

Okay. Let me go on to another question here. The loss pick versus the distribution of expected losses, like you said, you can't really -- with GAAP accounting related to MI, you can't kind of reserve for your lifetime losses. You have to look at what's in the pipeline, et cetera. But even so, there are some assumptions you make in terms of loss of verities, roll rates from 30 to 60, 60 to 90, 90 to foreclosure, et cetera, and so you come up with a distribution of expected losses, if you will, right?

Well, you come up with -- in our case, in the case of mortgage guaranty, what you end up with -- what you start with, I should say, is the length of time basically over which different types of loans have been in default. And then based on your past experience, which in fact leads you to make assumptions as to what percentage of those loans are going to ultimately result in an actual claim, you apply those factors to each of those aged groups of claims that are reported loans in default. On top of that, then once you've done that exercise, then you start talking about what you refer to in terms of the severity at each, again, at each level, and that, of course, is going to be driven by an analysis of the book of business, when you wrote it and the size of the loans that you underwrote, et cetera.

Okay, so based upon your assumptions with respect to, I guess, severity of the losses, what you're saying are increasing, is it because of the large loan size and whatnot?

Yes.

As well as the role from one delinquency bucket to the next. Have your assumptions gotten more conservative, kind of quarter to quarter, as the housing market's deteriorated, or are your assumptions the same because they are based on historical analysis over long, long periods of time?

I would say that the answer to your question is both. One, we obviously always look in the rearview mirror because that's the best evidence we have. That tells us something about the likely course of events in the future. But secondly, we do also look at what's actually happening in our business and what's happening to that business in the context of the market we're in -- whether that market is defined as housing or mortgage lending or what have you. And therein lies some, as is the case in all reserving, therein lies some objectivity as to what you do in terms of making a determination as to whether the severity's likely going to worsen, whether your mitigation efforts are going to be as good in the past or not.

Have those assumptions changed this quarter versus last quarter?

Well, they changed -- that's my point. They change every quarter.

Okay.

But the issue is that they can only change on the quarterly basis because as I think you said before, and as I tried to say also, the business, the accounting for the business doesn't lend itself except to react only from a reserving standpoint -- react on a quarterly basis.

To what's in the pipeline already.

Right. Plus what you know. Plus the facts that you know at this point in time, right?

Right.

You're not allowed, again, as I think you say, to make estimate of what your ultimate loss costs are going to be on a book of business, let's say, that you wrote in 2007 and book that in anticipation of receiving Y dollars of premiums, right? Which would be an alternative way of doing it.

Okay.

But GAAP accounting doesn't allow it.

Okay. That's really the matching principle, right, because you're not getting all your premium up front either.

That's right. And the ultimate premium that you get is not equally divided among the periods, right?

Right.

Because as loans get lopped off and are no longer insured, for whatever reason, you obviously don't get any premium. So you get the most premium--

Up front.

-- up front in the year 1. And then from that point forward, the premiums on a particular book of business, a particular block -- let's say the block that you wrote in '07 -- starts to decline as loans, as I say, get lopped off for whatever reason. They get refinanced, blah, blah, blah.

My last question is related to capital adequacy. At what point -- how bad do losses have to get for capital adequacy to become an issue?

Are you still on mortgage guaranty?

Yeah, on mortgage guaranty.

I believe, and I can stand corrected, I believe that the rules right now from a regulatory standpoint, which is the basis upon which we run all of our insurance business, not GAAP, but statutory. On a statutory basis, I believe that in mortgage guaranty today -- well, first of all, let's start with the fact that from a regulatory standpoint, we have to set up 50% of each year's earned premiums regardless of which book of business they pertain to in a so-called contingency reserve. And that that reserve has got to stay up there for a 10-year period before you take it down. That's under the normal course of events. However, the rules do permit that if the loss ratio in any particular year exceeds X percent, and I'm going to say that that X percent is 35%, that you have the ability to go back to the regulator and say: allow me to release a part of that accumulated contingency reserve to offset the hit I've taken in the income statement and the balance sheet by virtue of the loss ratio exceeding 35%. Now, again, though, that is a regulatory, statutory exercise, which has -- which obviously impinges on capital adequacy, which is the thrust of your question. On the other hand, when it comes to GAAP, that has no bearing on it, because in GAAP, we eliminate the contingency reserve and the losses are whatever it is, que sera sera. And that's what you book, and there is no offset by virtue of any takeback or clawing back of any previously established premium reserve. Make sense?

Okay, yes. I think I understand that. So back to my original--

To your question -- yes.

How much worse do things have to get before you eat into that contingency reserve, if you will, then?

Well, again, if the question is on the regulatory basis, I believe that the loss ratio, if it hits 35%, you have the ability to get some of that contingency reserve back into your capital account, okay?

Right.

However, given how we run the business in mortgage guaranty, that contingency reserve is always included, let's say by the rating agencies, it's always included as part of your capital. So the point I'm trying to make is whether you put it in capital by calling it back, or whether you leave it up there, you are still operating with the same amount of capital, so it's only the excess losses that eat into your capital.

Okay.

Make sense?

Yes.

Okay.

Okay. That's, those are my questions. Thank you.

Okay.

And we will go next to Bill Laemmel from Divine Capital Markets.

Hello Al.

Hello, Bill Laemmel. How are you, sir?

Well, that was quite a discussion about mortgage guaranty.

Well, that's right.

Now--

For an old accountant like me, it's pretty exciting.

That's right. However, there was a lot of talk about pricing power. That curve rising, and then you come down to the point that Old Republic could double any company and I think you have the strongest capitalization ratios in the business. Now, do you see where that can put you in a position to gain market share as we move on here and work through this housing correction?

And your question is addressed in terms of our mortgage guaranty business?

Yes, sir.

Well, I have to say, Bill, I wish I could respond in the positive, but our understanding is that the other -- that our MI competitors, or at least the vast majority of them, are in a very good capital position. All you have to do is look at the risk to capital ratios that these companies are supporting currently. And to the extent that you have consistency in the accounting, particularly from a regulatory standpoint, it does appear as if there is a lot of firepower in those balance sheets. So I think the answer to the question in terms of gaining additional market share in the mortgage business relies more on the ability to accentuate the value of your relationships, accentuate the value of your service, the service you provide to lenders and so forth, rather than the absolute capacity from a dollars and cents standpoint. So I would say that our ability to increase market share is at least as good as everybody else's, but I don't think it's any better from if you -- if the question is strictly posed from a capital adequacy or capital resiliency standpoint.

Well, thank you very much.

And that concludes our question and answer session. At this time, I would like to turn the call back over to our speaker for any additional or closing remarks.

Well, I don't have any more. I think this was a very interesting discussion and I appreciate the interest that all the questioners had in raising those questions. So in that light, I will bid everybody a good afternoon.

That concludes today's conference call. Thank you for your participation. You may now disconnect.