ProAssurance Corp (PRA) 2003 Q4 法說會逐字稿

At this time I would like to welcome everyone to the ProAssurance conference call to discuss fourth quarter and year end results. All lines have been placed on mute to prevent any background noise. After the speakers' remarks that will be a question-and-answer period. (OPERATOR INSTRUCTIONS). Thank you. Mr. O'Neil, you may begin your conference.

Thank you. Good morning everyone. Thanks for joining us. We have no surprises for you today but we do plan to give you a sense of where ProAssurance is heading in 2004 after we review 2003, the year in which we believe we restored some of the luster to the Professional Liability segment of our business.

We'll be discussing historical information today and making forward-looking statements and projections based on our estimates and anticipation of future results and events. We expect our statements to be reasonable, but I want to remind you to review the contents of the call in conjunction with the caution regarding forward-looking statements in the Company's February 23, 2004 news release, as well as forms 10-K, 10-Q, and other publicly available documents, which set forth risks and uncertainties related to the Company's business. These documents are available from the Company on request. We will not undertake and expressly disclaim any obligation to update or alter forward-looking statements, whether as a result of new information, future events, or otherwise, except as required by law.

We are webcasting this call, and it's going to be available for replay in various forms as described in our news release and 8-K. The content of the call and the webcast are time sensitive; they are accurate only on February 23, 2004, the date of first broadcast. The property -- the call is the property of ProAssurance and may not be redistributed, retransmitted, or rebroadcast without our express written consent.

Participating with us on the call today are Dr. Derrill Crowe, our Chairman; Mr. Vic Adamo, the President of ProAssurance; Howard Friedman, our Chief Financial Officer; and Jim Morello, our Treasurer And Chief Accounting Officer. Howard will start the call with a brief numbers review and will highlight a couple of items we want to be sure that you understand as we move forward. Howard?

Thank you, Frank. As you know, our primary goal this year was to reach a consolidated combined ratio of 1.02 to 1.03 in the fourth quarter. We have done that, and we expect to continue making progress towards a consolidated combined ratio of approximately 100 for the full year of 2004. We've emphasized the consolidated combined ratio go because we have to make everything else work to get to that number.

As you would expect, Professional Liability is the primary driver in our increasing momentum toward acceptable levels of profitability. I don't want to slight our Personal Lines segment by focusing only on Professional Liability, but the fact of the matter is that MEEMIC, our Personal Lines subsidiary, has been producing industry-leading numbers every quarter. So in the past 2.5 years, we've concentrated on Professional Liability, and now we're really starting to see results.

With our program of raising rates to proper levels and underwriting to eliminate unacceptable or underpriced risks, we've seen a dramatic drop in the Professional Liability combined ratio, down almost 13 points for the full year and down almost 12 points compared to last year's fourth quarter. And remember, in the third quarter of 2001, our Professional Liability combined ratio was almost 131.

For the second year in a row, our Professional Liability rates were up 28 percent on an overall weighted average basis in 2003. That is an effective rate increase year-over-year on policies that actually renewed, not just rate filings that we made. It builds upon weighted average increases of 28 percent in 2002 and 23 percent in 2001. We believe now that our rates are at appropriate levels, and with severity having leveled off -- albeit at a higher level than we in the industry would like -- we expect our need for higher rates to diminish somewhat this year. Our average rate increase will likely be in the mid to upper teens, but I have to caution you that is a broad average, and we'll not hesitate to ask for indicated rates in any state.

And while our Professional Liability gross written premiums are up 18 percent year-over-year and the revenue per unit of risk is higher, in accordance with our goals, our reunderwriting continues to eliminate some of the risk in our book of business. Other policyholders have chosen to non-renew because of pricing or because of our elimination of occurrence coverage. All told, our retention rate for existing business continues to be approximately 80 percent. We are adding insureds at appropriate rates and with appropriate underwriting, so that our overall policyholder count is only nominally higher. We will talk in a minute about that dynamic will change going forward.

But while we're talking about premiums and income, I want to mention the increase in gross written premiums in medical liability for the quarter. I think it illustrates just how disciplined we have become in executing our pricing and underwriting strategy. You may have noted that our gross written premiums in Professional Liability were up 5 percent in the quarter, a lower rate of growth than from second quarter to third. Here's why.

First, we lost some Indiana hospitals in December. These were hospitals that came to us two years ago in the market turmoil that surrounded the collapse of FICO Insurance Company. We knew those hospitals were price-sensitive, and even then we cautioned that we would likely lose them as they gained time to shop around. I want to use this to emphasize our discipline in not chasing market share. Certainly, we could have lowered our premium to meet the competition, but that goes against our policy of setting adequate rates and sticking to them.

The second and primary reason is our conversion of occurrence business to clients made. In prior calls, we've described our plan to be out of the occurrence business by the end of the third quarter of 2004. The business that stays with us and does convert comes to us at a lower rate, because they are in the first year of claims made coverage, and we have no prior liabilities under those policies. So there is some fall-off in premium for that reason. We estimate that to be about $6.3 million for the year. And there has been some attrition because of the conversion itself, although not as much as we had feared. We believe that loss could be about $9.5 million of premium.

So all told, the effect has been about 15.8 million for the year, much of which occurred in the fourth quarter. We could have retained most if not all of that business by continuing to offer occurrence coverage. However, we believe it is in the best interest of our policyholders, and in turn the Company, not to sell occurrence coverage, and we have been disciplined in sticking to that decision.

As far as the conversion itself, we finished in Ohio, New Jersey and Pennsylvania. We are over halfway through our conversion to claims made in Indiana, and we'll wrap up Michigan by September 30th. In dollars, we have 9 million in Indiana occurrence premium that will expire by June 30th; in Michigan we have about $6.5 million in occurrence. Overall, we believe that we have retained about 70 percent of our occurrence business to date.

Our excess and surplus lines carrier, Red Mountain Casualty, had an excellent year. In 2003 Red Mountain wrote $18 million in premiums, and even though there is new competition on the horizon, we expect Red Mountain to write as much as 30 million in 2004.

In Personal Lines, we are up 13 percent -- premiums were up 13 percent in both the year and the quarter. There are several factors at work here. Automobile premiums increased October 1st of 2003, but less than 1 percent, and the average value of the cars we insured went up. Homeowners premiums increased 2.6 percent in April of 2003, and the value of the homes we insure was also up, in part because of our program to be certain that homeowners are insuring to value. In addition to this premium growth, the number of policyholders also increased. We saw growth of 12 percent in homes insured and 6 percent in autos insured.

Now I would like to focus on the loss and expense side of the earnings equation. On a consolidated basis, our loss ratio was down 5.5. points year-over-year and dropped 3 points quarter-over-quarter. Professional Liability saw a decrease of almost 9 points quarter-over-quarter, and a marked decrease over 10 points year-over-year. The decrease in the fourth quarter continues a sequential quarter trend that shows we are continuing to make progress in continuing to realize the benefit and wisdom of disciplined pricing.

Loss trends are continually being monitored. Frequency continues to be generally flat and severity is increasing at the expected level of 5 percent to 6 percent per year. We don't see anything to suggest that conditions are worsening significantly, and we believe we are well-positioned -- we are positioned to do well in this environment.

Personal Lines returned to a more normal loss ratio, 63.6 percent, after moving up slightly last quarter due to the summer blackout. For the year, the loss ratio of 65.8 percent is a phenomenal outcome, and one that underscores the value of MEEMIC and its ability to outperform its industry peers by virtue of its superior underwriting in a preferred market. On a consolidated basis, the expense ratio decreased, down a point for the year and down especially in the fourth quarter. In an environment of rising premiums, you would generally expect that to happen. Although our variable cost dollars, mostly commissions and premium taxes, did rise in tandem with premiums, fixed expenses are holding the line. That is a product of our corporate focus on lean operations. As you know, we pay attention to cash flow from operations. In the quarter, cash flow was $70 million, which gets us to $288 million for the year. That is especially impressive when you realize that cash flow for 2002 was $177 million.

Finally, I would like to focus on loss reserves. First, let me say emphatically that we are comfortable with the adequacy of our reserves. As you know, our independent actuary for the Professional Liability statement is (indiscernible), one of the most conservative actuarial firms doing medical liability work. They have approved our reserve level, as have the actuaries at our auditors, Ernst & Young.

Let me highlight one item that we have noted in our actuarial analysis. Pay attention on this one, because the result of the accounting is a bit unusual. Over the past several years, we became concerned about loss severity, particularly in what we refer to as the excess layers -- that is coverage for losses in excess of $1 million per client. Remember this is in the layers we reinsure, and has little bearing on losses and severity in the first $1 million layer which we retain.

Our loss reserves for these excess layers became more conservative, primarily due to what we were seeing and hearing about multimillion dollar verdicts across the country. In performing our analysis this year, however, we have seen that those excess layer losses that we anticipated have not affected us quite as much as we expected. We still see evidence that these higher layer losses are affecting the industry, but we believe our stricter underwriting has served us well by not bringing the risks that generate those losses into our book of business.

We reduced excess layer loss estimates for prior coverage years by about $64 million. Because we had anticipated and reserved for these losses, we also had them in the amounts we showed as reinsurance recoverable. Therefore, when we reduced our gross (indiscernible) reserves, we also eliminated similar amounts of expected reinsurance recoverable, and there was almost no net effect for prior coverage years related to these changes.

However, when you look at the 2003 calendar year, the results appear unusual. Normally, reinsurance recoveries will reduce gross losses, which means lower net losses for the year. But because we reduced expected reinsurance recoveries for prior coverage years, current year net losses appear to have gone up. It's just one of those odd results of insurance accounting, but when you dig into the schedules and see something unusual, we wanted you to be aware of the change and the reason for it.

For the quarter, we did see $800,000 of favorable reserve development in Professional Liability. This offsets the $750,000 addition we made to Professional Liability reserves in the second quarter. I can't tell you that this starts a trend toward recognition of Professional Liability reserve savings, but I think it is fair to say that we could see favorable Professional Liability reserve development at some point in 2004 if -- and I want to stress if -- there are new changes in the loss climate or trends. And it is impossible to predict at what level reserves might develop favorably, so we won't even try. Let me emphasize that our ability to reach a consolidated combined ratio of approximately 100 for the year is not predicated on favorable reserve development in Professional Liability.

We saw favorable development totaling $10.8 million for Personal Lines in 2003. $3.7 million of that was in the fourth quarter. If you're looking to factor Personal Lines reserves into your equation, just be aware that we can't control the weather, which is a primary driver of Personal Lines results. To the extent that we continue to enjoy good weather quarters and we receive no legal surprises, there's no reason to expect 2004 Personal Lines reserves to develop any differently then they did in 2003. Frank?

Thank you, Howard. Vic is now going to touch on a few operational highlights, and then Dr. Crowe is going to wrap us up with some remarks on the industry and our future. Vic?

Thanks, Frank. As we are at year end and year end numbers have spoken for themselves, I would like to look at the year and its high points from the perspective of operations.

For ProAssurance, 2003 was the year the merger was finally put behind us, and we quit testing our legs and started running as a unified organization. We believe that our steady performance has shown again the value of stability, stability in management and approach to business, and especially stability in our financial results and balance sheet strength. This has allowed us to keep our promise to our insurers and extend the promise of solid insurance protection to policyholders who were cast adrift by failed companies, and those who have begun to wonder about the financial strength of others in our sector.

We know that 2003 was the third year in a row that we have seen major premium increases, and we understand how that affects our policyholders. We are hopeful that we have caught up with loss trends and that rate increases will moderate in 2004. But 2003 did serve up fresh reminders of the need to maintain premium adequacy. The recent reserve announcement by mix further underscores this lesson. We as an insurance organization make promises of insurance protection with every policy that we sell, so we cannot mortgage the future by charging less than the adequate premium rate.

In order to support our growth in 2003, we were able to raise capital on a stand-alone basis, something others in our niche have not been able to do. As you know, we recently filed a $250 million universal shelf offering registration in January. I want to reiterate that while we have no immediate plans for an offering, we do believe in being prepared, given the opportunities that we see in the market for 2004.

Our access to capital allows us to be positive about the prospects for growth in 2004. I'm speaking of both of our insurance segments when I say this. While Professional Liability is getting most of the attention right now, MEEMIC is more than holding its own, with steady year-over-year profitable growth in its premiums and in the number of insureds.

We believe that the hard market will continue in Professional Liability through 2004 and into 2005. With our capital and access to additional funds as needed, we believe we are the only specialty medical liability writer -- and indeed, perhaps the only physician-focused medical liability writer, public or private -- that is positioned to take advantage of growth opportunities that are presenting themselves in the market.

Our systems and our people are in place to allow us to grow, as and where needed. We believe that we are well positioned to build on the successful foundation we have laid since our merger in 2001. We have shown that we can integrate operations while continuing to build our business. We said then, and it's more true now than ever, that insurance companies need to have size and strength to survive long-term.

It is clear that our merger has been good for our policyholders, who don't now have to worry about the long-term survival of their insurance company. The merger has been equally good for our shareholders, who have been benefited by strong stock performance, as well as for our employees, who are now part of a growing company with new opportunities. My appraisal of the year past is meant to be upbeat. We have accomplished a great deal and believe that we will see even better things in 2004 and in 2005.

Dr. Crowe will close our prepared remarks by doing a little more looking forward. Dr. Crowe?

Thank you, Vic. Frank asked that I address your expectations for 2004, and I know you all want me to forecast our earnings to the penny, but you know that I'm not going to do it. There are still too many variables, but let me focus on our goals, and I believe that our track record of reaching our goals will help you make an informed decision about where we will end up 2004.

As Howard mentioned, we achieved our intermediate goal of a consolidated combined ratio 102 to 103 in the fourth quarter. That brought us to 105 for the year. In 2004, we expect to continue to making progress in ultimately lowering the combined ratio below 100. In 2004, we believe we can achieve an overall consolidated combined ratio of around 100 percent for the year.

Let add these caveats. First, this assumes that there are no sudden changes in loss, cost or trends, and we don't foresee that happening but we can't control it. That also assumes that we continue to get the same level of contribution from MEEMIC. If we experienced a major loss due to weather in Michigan, that could throw us off. The forecast is as close as we will come to any type of guidance.

In our present premium volume, every 2 point improvement on the consolidated combined ratio will add approximately 25 cents EPS on an annual basis and increase ROE by approximately 1.4 points. Howard did say that that favorable reserve development may become a reality in Professional Liability this year, and it may. Those of you who know our company also now better than to expect that we will force that favorable development. Again in 2003 we have seen the wisdom of insuring adequate reserves and maintaining a good, strong balance sheet.

I would rather be honest with you about earnings and reserves than build up our results, only to have to take it back with a massive reserve addition. We spent years building and maintaining credibility, and we are not going to sacrifice it for a quarter or two of earnings.

I think 2004 will be an interesting year for this company. Red Mountain continues to be a real star in our Professional Liability side. As we have become more comfortable with that business -- and remember, it's only been in operation since October of 2002 -- we are finding new ways to use the power and reach of an excess and surplus lines carrier. Red Mountain is allowing us to respond quickly to unique liability needs and one-off situations that provide real value for our insureds, while providing a new revenue and profit stream for ProAssurance.

We continue to see emerging competition. I don't think trend will stop, but the capacity just isn't there now to make a huge dent in the marketshare of the established companies. Competition, again, will likely come to the market at the high end and the excess layers first. We have seen that to a certain extent, but none of the Bermuda companies or larger companies such as AIG seem to be interested in the niche that we're in. Frankly, it's just too much trouble for these companies to handle the claims against individual insureds, but for us it's our bread and butter, and we excel at it.

You always ask me about tort reform. We still hear a great deal about it at the state and federal level. We continue to think it will be more likely at the state level, but there's a renewed interest in Washington right now. Those reforms that have passed in various states are still some years away from full court test, so we're still sometime away from seeing if those hold up, and if indeed they will bring down losses. But you have to start somewhere, and we applaud those states where legislators have taken the courage to do something about runaway (indiscernible).

Finally, I want to talk about the star, MEEMIC. MEEMIC is an earning machine for us, and while it's worth underscoring the fact that we can't predict the weather, we are confident in our ability to underwrite at a profitable level that outpaces the industry. In 2004 we are laying the groundwork to expand MEEMIC into adjacent states. As you know, one of the main reasons of the MEEMIC success is the peer-to-peer selling, and that is the main barrier to expansion, in locating and training a sales force. I want to take just a minute to say the President of that company, Lynn Kalinowski, and Chris Schmitt, the CFO of that company, have done an outstanding job. And these two are the very reasons that we're doing so well, and we look forward to progressing well this year also.

The M&A climate continues to bubble. As I said last quarter, the level of chatter has been there for a while and it's getting even higher. Let me caution you that not every M&A transaction involves entire companies or blockbuster deals. As capacities continue to be constrained, we are likely to see pieces of business become available, and so smaller transactions may occur along with the larger deals that you all expect. I think with our financial strength, experience, and access to capital, we are a logical participant in any transaction discussions.

It's going to be a very interesting year. I believe it will be a profitable one for us, and we will look forward to visiting to you each quarter. Frank?

Thank you, Dr. Crowe and Vic. Now we are going to open the lines for questions, and look forward to answering those.

(OPERATOR INSTRUCTIONS). David Lewis, SunTrust Robinson Humphrey.

Could you discuss what the outlook is for the insured count? If you're running 80 percent persistency, then obviously there's still competition out there taking business away at cheaper rates. So do you really think that the insured counts will start to tick up in 2004? If you want to give us any outlook, that would be helpful.

Howard?

There is still competition out there, and we are amazed that companies are writing business at certainly lower prices than we think are appropriate. But two things are happening. Capacity is really beginning to catch up with a number of the companies in our market segment and our market space; they're just getting very constrained. Their best ratings are tightening up, and they will not be able to be as aggressive as they have been in the past. And we also from our end, now that we feel we are stable and the finances are in order, are looking to become perhaps a little more competitive in some of our markets, especially in the Midwestern markets. So I think there is a combination of things that are causing us to look at the situation optimistically for 2004.

Let me say, if you will look at the earned premiums for the last year and the past quarter, you will say that we are having capacity problems ourselves with the increased rates. We just experienced a little bit of concern about our capacity. For that reason, we've taken this opportunity to dramatically review our book of business. We have dropped a number of insureds. The other thing is we converted to a claims made from an occurrence, Howard mentioned that, and that has cost us some business. And we anticipated that. But still, the renewal rate has been much higher than we anticipated. If you look at just the absolute numbers, yes, it is flat -- relatively flat. If you look for the next year, our anticipation, due to the problems that the industry has with capacity and the lack of ability to raise capacity, we think we are going to see not only some increase in rates this year, but this is the year that we'll start seeing the numbers grow.

Would you guess that maybe it's low to mid single digits?

I wouldn't guess.

Okay. (indiscernible) can you talk about the MEEMIC expansion, and is that going to continue to focus just on the future market or are you going to broaden that?

It's going to focus on the teacher market.

Mike Dion, Sandler O'Neill.

Good morning everyone. My question is related to the guidance that you gave for '04. Just so I'm clear, when you said that with MEEMIC you expected similar results for 2004, does that also include the approximately 11 million in favorable reserve development, assuming the weather is the same in '04 as it was in '03?

I think what we said, and I'm going to just go back to that, is that we don't see any reason, barring weather, that it would develop any differently overall in 2004 versus 2003. Howard, you may want to amplify on that.

I think if you look back at MEEMIC over the past several years, the track record on favorable reserve development has been quite consistent dollar-wise, percentage-wise, however you want to look at it. And again, we would not expect anything to dramatically change in that area, barring some catastrophe.

I know historically you have said you look for an overall combined at around 94, and obviously the last couple of years have come in roughly 87 combined. And granted, there has been favorable weather. But are you still looking at a 94 as a good kind of ballpark at where you look at it? And assuming weather is favorable, then obviously you would see some reserve releases during the course of the year? And secondly, with your expansion into new states, are you going to be reserving for that at a more conservative level than what you have historically?

I think on the first part there, we believe that the 94 target allows MEEMIC to make the contribution to our overall return on equity that is equivalent to Professional Liability's target, and will allow us to achieve that 12 to 14 percent long-term ROE. So to the extent that it is better than 94, then it improves the result beyond our target. So yes, I guess I would say we are sticking to 94 as the target for pricing. And based on the track record, we certainly would hope that it is better. In terms of other states, I think, yes, there would be more conservative reserving; however, we have yet to write the first policy in other states, and there would be a very slow ramp up, I would expect. So on an earned premium basis in 2004, it would be negligible. And even in 2005 in comparison to the 100 -- almost $200 million of MEEMIC written premium, I would expect very little to be coming out of the other states.

Thank you. Just a follow-up if I can, also related to reserve releases and/or additions in general. Are you seeing any difference with the actuaries and accountants with respect to reserves in terms of being more proactive, in terms of releasing or adding to reserves, than you have in the past?

No, I think we're still operating. And they are under the same rules, in that we look at the overall level of reserves and that is what drives the decision. The projection of ultimate losses is still the main focus. And to the extent that that has an income statement effect one way or the other, then that is a byproduct or and end result of the reserving process, not the other way around. And the scrutiny is, I would say, the same as it has been for the past several years.

John Gwynn, Morgan Keegan.

Howard, the reinsurance recovery reduction of 64 million, was that spread among your various balances, or was there any asymmetrical reduction there?

It wasn't spread in any particular way towards reinsurers, it basically came out of a series of coverage years, therefore, reinsurance contract years. And I would say that for the most part, it came out of the 1997 through 200, maybe 2001, coverage years. So to the extent that the individual reinsurers had participations that differed from year-to-year, then it might be asymmetrical as a result of that. But it really affected those coverage years and it affected the loss layers above $1 million per client.

And that will be on schedule F?

The end result of it, sure, would be in schedule F, because you would be able to see it then by reinsurer. You would also certainly see it in schedule P when you looked at the gross losses by coverage year.

Okay. Anything new on the Gerling front?

No. Gerling continues to pay us on a regular and timely basis. We have not had any difficulties in making the collections from them. They seem to be well-staffed, and handling their operations on the claim side well. As a result of another year passing by, and as a result of some of these favorable developments on the excess layers, our overall balance from -- recoverable balance from Gerling, like other reinsurers, will decline. Any of the reinsurers that are no longer on the program are, just by the nature of another year going by, will have fewer recoverables from them. We don't -- we'll be publishing the table again in a 10-K that itemizes all the recoverables for the major reinsurers.

Will your K be out soon?

Yes, shortly after March 10th, or around that. We have a Board meeting on March 10th where the Board would approve it.

Howard, just a small point. How do you generate a guarantee fund credit? Is that a premium tax recapture or something?

No, it's an odd situation where the Ohio Guaranty Association determined that they had over-collected on prior year assessments, because they had generated more out of the estate of at least one of the insolvent companies than they expected, so they actually returned money. It was a very pleasant thing to see.

Howard, one last question for you. The tax rate during the quarter -- is there any unusual movement there?

No.

Vic, Dr. Crowe talked about MEEMIC's challenge in terms of geographic expansion being primarily peer-to-peer selling, infrastructure questions. Does MEEMIC not have its own claims infrastructure?

Yes, MEEMIC has its own claims infrastructure, and that would certainly have to be expanded into our new state. I can't speak with specific authority, but on the Personal Lines side, obviously, it is different. Say for example you go to the more remote areas of Michigan, our claims adjusters work out of their homes, they go out and see the vehicle or the home. We have contracts with bump shops and glass shops that we trust. So I think it will take some development, but they will be able to expand that portion of it. If it's a front end sales ramp up, that's probably the most difficult.

Howard, one more question. On net investment income for the fourth quarter, it was up for the first time in eons. Anything unusual there?

I think it's the function of the continuing strong cash flow; in other words, the portfolio just having more money to invest. Rates were pretty stable.

And no big structural changes in the portfolio itself?

No, not at all.

Dr. Crowe, is there any geographic focus to what Red Mountain writes?

Mostly in the footprint that we do business. There's one or two states where we do some business that Red Mountain does not write, but it concentrates in the areas where we do business and we have got an infrastructure claims handling facilities and that type of thing.

Beth Malone, Advest.

Good morning, and congratulations on the quarter. I have two questions. One is on -- can you talk a little bit about -- are there opportunities now, or more opportunities as you look out for expansion geographically because of the changes that are taking place in the market? Or do you just want to focus on the markets you're already in and kind of penetrate those more?

I think that we can say that we certainly want to stay within that footprint that we have been on primarily. But on the other side of the coin, we are moving into North Carolina a little bit, some other states that we have not been into. You know we have been going into Arkansas, Virginia. And we're making some headway into Kansas, Iowa. Any expansion outside of our footprint as we know it in the past will be in adjacent states. We're really not that interested in making a leap over to the West Coast or New England or anything like that.

In these expansions, are they primarily -- are you doing this organically, or do you see opportunities for acquiring books of business?

It's mostly -- in the adjacent states it's an organic growth. But -- make a comment. We had one of our peers a year or so ago that developed capacity problems. And they came to us and wanted to know if we would take a book of business that they had in a given state, because they just needed to pull out of a state. And we said -- two states, two states that's happened. And we've seen some of that, but mostly it's organic.

Okay. And also, when you talk about capacity issues, I guess because of the pricing that has grown now, doesn't cash flow relieve that capacity issue? Or do you think that with the pricing continuing to, it looks like it's going to continue to remain very strong in many of your markets, are you going to want to complement that capital through outside measures?

(indiscernible) insurance -- capacity is really a reserve in premium writing matters as it relates to the statutory surplus of the Company. So although cash flows are good, and they help build investment income down the road, they actually don't help much on the capacity end if the company is putting up reserves that are related to the new premium it's writing. So it really doesn't -- it's not cash flow. It doesn't really help on the capacity front, per se.

Do you -- I don't know if you'll want to comment on this, but Nicric (ph) got a very unfavorable judgment against them by a hospital. Do you see that as any kind of trend in terms of litigation or tort issues in the marketplace, or would that be unique? Does that concern you at all in terms of your own markets?

We don't know much about that case, we know a little bit. That seems to be an aberration to me and it's not something that bothers me, it's not a trend line. We don't know exactly what the circumstances are. From what we know of the case, we're not quite sure how that verdict happened, to be honest. But it's not something that we have been -- that we are concerned about.

Joshua Horowitz, CBI Capital.

Back to the Professional Liability side, you guys talked about two reasons why you're gaining market gaining marketshare, the capacity constraints and the financial stability of the competitors. Can you describe specifically which states you are experiencing each of these items?

No.

No? Okay.

I think we also want to make it clear that we are talking about a forward-looking statement as it relates to 2004. We have certainly -- we pick up business, we lose business in every state as part of an ongoing process. But we are looking forward into 2004 as we see capacity tightening up increasingly in our footprint (indiscernible) Southeast and the Midwest.

I think the other thing that, to make his point, is that I think all of those are happening to a certain degree in each of our states. So to single one out would give it more emphasis than it needs.

So there's no state in particular where one of these issues is more predominant than another, then?

Right.

Okay, thank you.

Greg Peters, Raymond James.

This is Erin Archer for Greg Peters. I have two questions. First, Howard, I was hoping you might be able to give us some color on whether or not we'll see any change in the average reserve per outstanding claim in the '03 statutories when they come out, versus '02?

On an overall basis there's a lot that goes into our overall average reserve, as you know, because of the mix in states, the changes from year-to-year in the mix, the fact that our reinsurance program has evolved over the years. And 15 months or so ago we increased the retention. So it's a little bit difficult to talk in generalities about what the reserves will be. I think what you will see is roughly just a small increase, probably more of what I would consider a trend-oriented increase in average reserves, probably in the 5 percent range on an overall basis. But you need to be aware, of course, that that takes into account all of those changes, plus probably a number of them that I am not mentioning even right now.

If I could just ask one quick question on that. You said a trend in average reserving of about 5 percent. Can I imply that you mean you are increasing the manner in which you are reserving by 5 percent? Is that what you meant?

I guess in short, yes. Claims adjustors who set reserves, and then ultimately when those reserves get adjusted through the actuarial process at the end of the year, everybody has information to work with in terms of what we are seeing in increased loss cost. That's what we build into our rate filings, it's what we see in the settlements and the verdicts. So everybody's horizons or sites get adjusted to some extent, from a year to year basis. And what we are seeing, as I mentioned in the script, was a continued 5 to 6 percent overall severity change, and that ultimately gets translated into the reserving process, too.

Great. And then my second question is -- and I'm sorry if I missed this -- but from (indiscernible) accident years did the fourth quarter med mal reserve release pertain? And I was hoping I could get the same information for the second quarter adverse developments?

Most were pretty small, and I don't know the specific year right offhand. I guess we would have to take -- when you see schedule P, you will see some ups and downs, which always happen as we reevaluate years. It probably came from the '99 or 2000 year. But in itself it's not that significant, because at every year end we reevaluate all of the prior accident years and make adjustments as necessary. So really that's kind of a netting out process of a combination of years.

Rob Meton (ph), Schneider (ph) Capital.

I just had a question for Howard. You talked about the potential, if the current trends continue, for some favorable development in the Professional Liability area. Based on discussions I had with you before on reserving philosophy, is it mainly going to be the older accident years that you would be looking at to potentially take down reserves? What would be kind of the cutoff point in years that you would be looking at in '04 to potentially take down?

Typically, as we get more comfortable with the year, that's when we get towards a final value and start to make the adjustments. And those would come from the earlier years, just by the nature of the process. I think at this point in 2004, we probably see more coming out of 2000 and prior than we would out of the more recent years, unless there was just some particular adjustment that was glaring that we needed to make in the more recent years. But typically, we start to get pretty comfortable with an accident year after about four years or so goes by.

(OPERATOR INSTRUCTIONS). David Lewis, SunTrust Robeson Humphrey.

Go back, I'm talking about the capital position of the Company. Are the rating agencies being any more lenient that your capital and surplus strains are really reflective of better rate?

David, Vic Adamo. The rating agencies are -- as an industry, as a med mel industry -- are looking at the capital issue. They are giving companies some credit where the companies can demonstrate that growth is a result of premium growth rather than unit growth. So yes, there is some of that going on. And I think also, given our larger balance sheet size now, we probably get a little bit of credit for that. But by and large they will say capacity is capacity, so it's still a tough nut. And we are very conscious at our end of making sure that our capital stays up with our rating level.

Where is the capital and surplus at the end of the year, and what's kind of a comfortable high end of the level that you could maintain ratings?

On a cap basis, the --

Statutory capital.

Statutory capital is about 3 days away. We filed a yellow book to be in the insurance department's offices on March 1st, and to be honest they're still being finished. So it's going to be an increase over 2002, but -- and it has to wait until Monday when we get them up on the website to get a good luck.

Okay -- and comfortable written premiums to capital and surplus levels?

I think last year we were at 400 million of statutories combined our consolidated surplus, and we were writing at about 1.2 to 1, I guess. So that seemed to be an acceptable level. And I think, based on Vic's comments, it may be able to go a little bit beyond that.

And also we have the advantage in our overall structure that MEEMIC's premiums do not have the same capital demand from a rating and a risk-based capital point of view as the medical professional liability, so we're able to average up a little bit over, say, a pure med mal company.

And the 2004 tax rate outlook -- I think the comment earlier was there wasn't anything unusual in the fourth quarter, but it did tick up a little bit. Should we assume something in the 27, 28 percent? What are you recommending for 2004?

I don't know that we really can project a rate itself at this point for 2004. I think if you looked at the full year rate for 2003, that probably would be as representative as anything -- you know, mid-20s. But whether it's 24 or 26, plus or minus, that's a little tough to say right now. It's going to depend a lot on the attractiveness of the tax exempt market and the yields that we can get there, which has the biggest affect on our tax rate.

Final question for Dr. Crowe. I guess I have mixed feelings about tort reform. If it were to occur on a national basis it seems like it might put some predictability into the claim trends. However, you may get some irrational pricing coming into the market, believing that it's an easier business today. And that could ultimately be a negative for the business. What are your thoughts?

I agree with you completely. I do think that the main thing it would bring to the table is predictability. I don't think it will bring rates down very much, because what they are talking about doing will only lower rates -- and you've seen this -- 8, 9, 10, 12 percent. And we are seeing frequency that will at that up -- not frequency, but severity, within a couple of years. So it's not really something that is going to correct the premium problem. But nevertheless, I think you are right, there are certain players that will decide hey it's time to come back into the market. And yes, we will then begin to see irrational pricing, and that's when the guys who have got good sense have got to learn to fold their tents.

Mike Dion, Sandler O'Neill.

Following those same lines, you had indicated earlier on the call that frequency has been flat. I was just curious, have you seen any uptick in frequency in states in which tort reform has been passed? And if that is or is not the case, would you expect that that may be a factor in your frequency outlook going forward?

We definitely see an increase in frequency in a state that passes tort reform when they pass it prospectively, that it will have a time certain in the future that it takes effect, yes. You have a dramatic increase. But then you have a drop off after that date, so it tends to level out. We have seen some increased frequency in one or two states, but most of the states are flat. But overall, it's a very minor increase in frequency for all of us.

John Gwynn, Morgan Keegan.

Howard, I am rising to the bait on this reinsurance recoverable.

We knew you would.

The impact on schedule P, which is -- schedule P is net of reinsurance, right?

Schedule P has the columns that show -- if you look at the schedule, the middle section of (multiple speakers) schedule P has gross direct and assumed, then (indiscernible). And it doesn't exactly sum up direct and assumed, but if you just do the additions of the columns, you can get a total direct and assumed and then a total ceded (ph).

Right. But there will be no impact on paid amounts, right?

No.

At this time there are no further questions. Are there any closing remarks?

Just to thank everybody for their participation, and we will speak to you at the next call. Thank you.

This concludes today's conference call. You may now disconnect.