ProAssurance Corp (PRA) 2005 Q2 法說會逐字稿

Good day everyone and welcome to today’s ProAssurance second quarter earnings release. As a reminder today’s conference is being recorded. For opening remarks and introductions I will now turn the call over to Mr. Frank O’Neil. Please go ahead, sir.

Thank you, Augusta and we appreciate everyone being with us this morning. We’re excited about our results for the quarter. But we need to take care of a few legal items prior to our prepared remarks.

We expect to discuss historical information and make forward-looking statements and projections on this call based on our estimates and anticipation of future results and events. We expect our statements today to be reasonable, but you should review the contents of the call in conjunction with the caution regarding forward-looking statements in the news release we issued this morning, August 9, 2005. Further discussion of risk factors and uncertainties about our business are contained in our Forms S-4, 10-KA, 10-Q, and other publicly available documents. We will not undertake and expressly disclaim any obligation to update or alter these forward-looking statements, whether as a result of new information, future events, or otherwise, except as required by law.

We are webcasting this call. It will be made available for replay as described in our news release and 8-K. The content of today’s call is time sensitive. It’s accurate only on August 9, 2005, the date of first broadcast. The call is the property of ProAssurance and you may not disseminate its contents without our express written consent. If you are reading a transcript of this call you should know that we have neither reviewed nor approved that transcript.

Old bookkeeping note here, NCRIC’s second quarter GAAP results are not reflected in our discussions today. NCRIC is delisted and therefore will not file a 10-Q for the second quarter of 2005. However, NCRIC’s Insurance Company, NCRIC Inc., will file a statutory statement for the quarter, which we will post on our website just as we post the other yellow books for all our other companies. NCRIC’s results from ongoing operations will be reflected on our results as of the date of acquisition. That’s when we report our third quarter numbers in November.

Participating with me on today’s conference call are Dr. Derrill Crowe, our Chairman; Mr. Vic Adamo, the President of ProAssurance; Mr. Ned Rand, ProAssurance’s Chief Financial Officer; and Mr. Howard Friedman, our Chief Actuary and Underwriter. Jim Morello, our Treasurer and Chief Accounting Officer, is with us as well. Ned is going to lead us off with a review of the numbers. Ned?

Thanks Frank. In the second quarter of 2005 we continued to build on the success we reported in the first quarter. As we look towards the last half of the year we believe results will continue on that same track.

Given our historical focus on the bottom line, we want to highlight two key successes in the quarter.

In the quarter our return on equity topped 17% and stands at 15.5% at June 30th. These numbers represent significant improvements over the year-ago periods, which were below 12%. Higher ROEs are driven by lower consolidated combined ratios, and in this quarter we achieved underwriting profitability in both Insurance segments.

These are the levels we’ve been targeting since we began our turnaround in the Medical Professional Liability segment in 2001. In both segments we are seeing the benefit of careful underwriting and attention to adequate pricing.

In Personal lines we continue to benefit from benign weather in Michigan.

In Professional lines we are now reaping the full benefits of strong rate increases designed to maintain our financial strength and ensure our ability to serve our customers.

Long-term followers of our stock know that one of the measurements we like to focus on internally is the cash flow from operations. Operating cash flow continues to increase, reaching $181 million through the first half of the year. I think you should assume the growth in cash flow will not be as great this year as last given the dramatic jump we had in 2004.

However, strong cash flow continues to be a hallmark for us and most in the industry see it as a leading indicator of successful operations and earning power.

Our investment portfolio continues to be influenced by the range-bound interest rate markets. Our book value per share was down in the first quarter due to higher interest rates, but rose in the second quarter as rates declined in the latter part of June. Changes in interest rates are a mixed blessing for us. While rising rates do reduce book value, they add to income.

A primary focus for us has been maximizing investment income within the bounds set by a high quality and relatively stable portfolio. As a reference point, our after-tax income yield for the second quarter was 4.83%, up from 4.66% in the fourth quarter of 2004.

As I’m sure you’ve noticed, we did have favorable reserve development in both segments in the quarter, most of it in Professional Liability. Howard will talk about that in detail in a minute, but I do want to call your attention to our segment reporting in the news release. We tried to present the data so that the effect of the reserve releases is transparent.

I do want to note that even though -- even if there had not been any favorable development this would have been a very successful quarter. As it stands, the favorable development is icing on the cake.

In that same spirit of transparency we want you to know that NCRIC’s independent consulting actuary is performing a mid-year study of their reserves. We anticipate that NCRIC’s study will show adverse development somewhere between $8-$10 million for the second quarter.

Under accounting rules, this will be reflected in our purchase accounting and will not be an earnings issue. However, we are confident in the adequacy of the reserves we are assuming from the date of the acquisition and we are confident that NCRIC’s current pricing will support our ROE and profitability goals moving forward.

Frank?

Thank you Ned. Howard Friedman is now going to step up to talk to us about reserves, premiums and other actuarial/underwriting issues. Howard?

Thanks Frank. I want to make several brief points and I’ll work backwards so that I can talk about reserves as it’s still fresh in your mind.

We did see the largest amount of favorable development in our Professional Liability segment. This amounted to $5 million, which is 3/10ths of 1% of total Professional Liability net reserves. This is not from any one year and not a large amount relative to our overall reserve level, and was distributed among coverage years prior to 2003.

We don’t make decisions to recognize favorable development on a whim, so this is an important validation of our conservative business model. We did conclude an interim Professional Liability reserve study in the quarter and we’re confident that our reserves are adequate.

I do want to caution against drawing any automatic conclusions about routine favorable development going forward. As volatile as Medical Liability has been as an industry, we’re going to be reacting more to long-term trends than quarter-to-quarter swings. We would have to be confident in those trends prior to making quarterly adjustments.

As we highlighted in the news release, we do recognize that premiums are flat year over year. However, I want to be clear that we continue to price to the margins we require to support our operating goals. Several factors are at work here.

First, in reaction to higher premiums in high-cost states, some insureds are buying lower policy limits. Thus, although the risk profile is lower, our overall rate increases have kept premiums essentially flat. That’s how we have maintained our margins in those states.

Another factor at work is the loss of business in states where higher losses have pushed our rates higher over the years. Remember that we will not chase business with artificially low premiums, and to the extent that other carriers are willing to do that, we will concede the business to them.

The primary state that comes to mind here is Missouri, although we’re seeing the same phenomenon in Florida and Illinois. But this frees capital to support business in states such as Kentucky, Kansas, and Oklahoma where expected losses and those premiums are lower and we believe the long-term environment is favorable.

Again, we’re keeping our policyholder base relatively steady by adding these insureds. While they’re not paying as much in premium, the margins are there.

Our policyholder retention in the quarter was 85% and the average rate increase on our renewals was approximately 13% in the quarter, which is approximately 12% for the year. This is at the higher end of our expectations for the year and I think it’s a good indicator of our willingness to be disciplined in our pricing and underwriting.

We’ve seen no significant change in frequency or severity trends in the quarter. Frankly, the losses that have driven the industry over the past few years have been severity-driven, and those trends are moderating for the past year or two, which is reflected in the lower pace of rate increases. And there's every indication that this decision to support the bottom line and forego underpriced business resonates with many insureds. They’ve seen their colleagues without Medical Liability insurance because of an insurer’s withdrawal or failure and they’re looking for a company with long-term commitment and staying power.

Frank?

Thanks Howard. That mention of long-term focus, I think, is a good transition to Vic’s remarks. He’s going to update us on the NCRIC transaction.

Vic?

Yes, thank you Frank. We brought NCRIC into the fold last week, the merger of NCRIC into ProAssurance being effective after the close of business on August 3rd. Even at the time of closing we were well along with our plans to integrate the NCRIC operations. We’ve had the good fortune to be able to work collegially with the staff at NCRIC prior to the transaction to plan as much of the transition as we could within the bounds of being competitors. We found that there was a great spirit of cooperation at NCRIC and we’re now hitting the ground running.

In the NCRIC transaction, one of the key drivers of our interest was the ability to leverage NCRIC’s local knowledge in the Mid-Atlantic states, especially in the District of Columbia, Delaware and Virginia, with the larger platform and greater resources available to ProAssurance.

We’re about local knowledge and, as Howard mentioned, long-term commitment. NCRIC’s headquarters in Washington will be the hub for our expanding Mid-Atlantic operations. Our goal is to build on NCRIC’s knowledge of the District of Columbia, Delaware, Maryland and Virginia. The NCRIC staff as ProAssurance employees will retain responsibilities for the day-to-day operations -- that’s in Claims, Underwriting, Risk Management and Sales -- for the Mid-Atlantic states with coordination and guidance being provided from the senior executives of ProAssurance. In that manner, NCRIC’s operations will function in the same manner as all of our other ProAssurance local offices.

Conversely, NCRIC’s West Virginia business will be transferred to our Birmingham and West Virginia offices since we believe that existing ProAssurance staff have a greater knowledge base and experience in West Virginia operations.

Operationally, we found that the business processes at NCRIC are closely aligned with ours. For example, their liaison to the local medical communities, to claims and underwriting committees, closely resembles our model. And we happen to be on the same Information system so the migration there will be smooth, and, we hope, as painless as those transactions can be.

We are committed to maintaining the core of loyal and capable employees that have positioned NCRIC as a leader in its market. While we will be migrating back-room operations over the course of the next year to Birmingham, we have asked and provided incentives for the NCRIC Accounting and IS staffs to help us work through the migration. And we hope that some of these employees will accept relocation offers to Birmingham at the conclusion of the migration.

Frank?

Thanks Vic. Dr. Crowe, would you wrap us up with some remarks about the industry?

Thanks Frank. One final note on NCRIC, I know many of you are focused on growing the top line, and I have said many times, we are not. We’re focused on growing the bottom line.

With that said, we do expect to get good premium growth from our NCRIC acquisition. They wrote $87 million in 2004 and we’re confident that our underwriting discipline will produce the margins we expect from that book of business.

As many of you know, I take a very strong interest in claims and underwriting activities here at the Company. I’ve been reviewing the claims handling in the NCRIC operations and I think they will fit very well into our organization. Naturally, we’ll tweak a few things here and there. With our resources we’ll probably be able to take a few more cases to trial, so we’re excited about the possibility that this acquisition brings to us.

We’re also excited about opportunities in new states -- Kentucky, for example. It continues to be a state that we’ve made gains through careful underwriting. As other companies have pulled out they left plenty of good risk that I guess they just don’t want to take the time to underwrite. We will and we hope we’ll profit from it.

We’re also excited about opportunities involving Oklahoma. For example, we’ve been chosen to insure the facility, the faculty and students of the Oklahoma University Medical School, which will give us a solid base to build on in that state and given the financial problems of the local company. We think that this is a good opportunity.

Don’t think that all the growth opportunities have dried up. It’s just taken a bit more work and greater financial resources to find them and take advantage of those opportunities.

As we said last quarter, it’s fair to say that the hard market is giving way and that there is some definitely more price-based competition, although still only in pockets. I’m amazed to see that some competitors are going after business with prices that are 40-50% below ours.

We first saw this type of competition from the startups that were picking off insureds from our [inaudible] facility where we write a significant amount of business with a significant surcharge. We’re beginning to see more notable price discounting by some established carriers. This is creating turmoil in markets such as Missouri, Florida, and pockets in other higher-cost states, but it’s not yet widespread enough to really soften the market.

As we see this price-based competition, we are confident that it won’t be too long before reserve adequacy reemerges as a key factor in the industry again. Said another way, we believe that these startups that are buying business with low prices are also buying potential fatal problems as well.

And I’m not sure that we’ll see a soft market, soft markets like we saw in the last cycle. First of all, no company has been able to harvest the kind of interest rate based capital gains that fueled much of the low pricing in the past market. I think that many of the leaders of insurance companies that endured the pain of the last cycle are still in place and I hope that they’ve learned their lesson.

I can’t forget my old friends, the reinsurers. I hope -- I believe they will be more disciplined, but I have my doubts about some of them. I’ve already seen them providing capacity to some of these low-price startup companies.

I think insureds are more conscious of insurance companies’ stability today. The widespread publicity of the failures of companies, such as PIE, [Franco] and Reciprocal of America still lingers in the minds of many physicians I meet with around the country. They are increasingly aware that something priced too cheaply may not be a bargain, but others will still follow the cheap premiums and then they wind up getting what they deserve.

Finally, we’re convinced that having Medical Protective owned by Berkshire Hathaway is a good thing. They will bring good discipline to the market.

What else? I’m asked a lot about tort reform. We’re still waiting for the gatekeepers to swing one way or the other, and by gatekeepers I mean the Supreme Courts in the various states. If you doubt the ultimate power of these courts, just look at Wisconsin. The people of Wisconsin have enjoyed for more than a decade relative stability in their Medical Liability climate. But the Supreme Court there threw out the damage cap last month and every carrier there, including us, knows that they will produce higher losses and thus, higher premiums.

The West Virginia Supreme Court has struck down one of the 2001 tort reform laws, reinstating the requirements of the unanimous jury verdict. And they’ve gone back and liberalized some of the procedural issues related to pre-trial screening.

So, in states, such as Georgia, Missouri, Ohio, we’re not taking anything for granted. Only after we see these reforms court tested and losses affected by the tort reforms will be reflected in those changes in our rates.

We have had some questions about our capital position on the last call and I’ll try to head those off by saying we do monitor our capital levels constantly. We know that rating agents have expectations regarding capital adequacy. It may not square exactly with investors’ expectations, so we know that we have to balance both.

We believe that we are adequately capitalized right now to maintain both our current rating levels, while achieving our return on equity targets, and we are generating enough cash flow to fund the growth that we expect.

Should we ever decide that we have excess capital we would prefer to use it to make acquisitions. We’ve proven that’s the best way to grow our business. Failing that, I can only tell you that we would consider a range of options, but I’m not going to comment on this course of action on this call.

Frank?

Thanks folks. We’re going to end our prepared remarks there. Augusta will ask for any questions from our participants.

Thank you Mr. O’Neil. [OPERATOR INSTRUCTIONS]

Greg Peters with Raymond James.

Boy! Lots of questions. I’ll limit it to 2 or 3 and then re-queue. I suppose, first of all, Dr. Crowe, you talked briefly about competition, and specifically talked about some reinsurance capacity in the market, wishing that it doesn’t revert back to some prior bad habits. And I’m just curious, with -- I think your reinsurance program comes up for renewal around October 1st, and I have to imagine that you’re beginning the process of having your discussions, and I’m curious how that’s going, if some of the reinsurers are exhibiting some of this behavior that has concerned you in the past, et cetera.

We have just completed our reinsurance discussions in London. It went well. We anticipate -- and guys, you can confirm -- but we anticipate there being no great change at renewal time. The reinsurers have, not necessarily the ones we do business with, but some of them have shown the propensity to get into this new area of the marketplace. That’s their prerogative. I’m sure they’ll continue to do what they want to do, and maybe what they’ve done in the past.

That’s about all the comments I’m going to make about it, Greg.

Well, I’m just -- excuse me for just trying to get one follow-up in on that topic. Given the fact that your second quarter reserves, semi-annual reserve study is showing redundancy, I’m curious, do you expect some price cuts as we move through the negotiation process? Or is it the -- you said not much change. I assume that means policy limits stayed the same. Is there anything that’s going to give, or should we just assume costs remain stable going forward?

Howard, why don’t you make a comment on that.

Greg, on the reinsurance program, the level that we’re buying, which is in excess of a million, is driven much more by capacity and the number of reinsurers that are willing to put out the types of limits that we buy, which are $15 million on any one claim, up to $15 million on any one claim. So, that segment of the Reinsurance market doesn’t necessarily soften as quickly or as much as the level below $1 million where a lot of these captives are buying coverage.

In addition, a good portion of our program is retrospectively rated, so to the extent that experience is better, we’re going to benefit from that in the long run. The initial pricing of the program doesn’t really change that much, but we would expect that over a period of time, as we improve our results, then we’ll get a better result on our ultimate reinsurance costs.

OK, that’s a fair response. And then I wanted to circle back just on the reserve release issue. I was going through my notes and trying to put it in context with the comments you’ve just made and I know you do your semiannual studies and then there’s an independent reserve study, and then you say don’t read too much into one quarter’s reserve releases. And I guess I have to -- I’m just trying to figure out how I should be thinking about this. Should I be thinking about the loss ratio in terms of the 86.7 in the Professional Liability going forward? Or, should I be thinking about it at the lower rate, which is adjusted for the 4 point benefit from the reserve release?

I guess I’m struggling with this because I’m wondering if we’re going to get some wild swings in quarterly variations where twice a year you release some reserves and then the other 2 times a year the number is much higher as it reflects more of an accident-year result.

We’ve said over and over is that we’re not establishing targets for reserve releases, as you know, and we look at the reserves in depth twice a year. We look at them every quarter on the interim quarters in a little less depth, but still seriously take a look. And it’s very difficult right now. I know it’s difficult for you to make your assumptions. It’s also difficult for us to look at making any projections, which is why we haven’t.

What we’re seeing, and I mentioned earlier that the reserve release that we had was 3/10ths of 1% of our Professional Liability reserve. That’s really infinitesimal in terms of the overall reserve book, although it does have a significant effect on quarterly income. But these minor changes that we’re seeing in severity from years that are 3 or 4 years back as those claims close require some fine-tuning adjustments. And that’s I think the best that we can say right now.

Now, just refresh my memory. When is the independent reserve review done by your outside guys? When is that concluded?

It’s as of March 31st and as of September 30th, with an update, of course, at the end of the year. So, the process doesn’t -- the process I guess you could say impacts second quarter -- or third -- sorry -- second quarter and fourth quarter with respect to the specific results of those independent analyses.

OK. And then are you doing your own analyses the other 2 quarters? I guess you’re always doing analyses.

Yes, we’re always looking at the claims trends, the closings, the average payment on cases closed, the loss-adjustment expenses, the number of claims being reported for the current year, the number of claims being reported on hail coverage for prior years. So, yes, that is ongoing.

OK. Congratulations on the quarter and I’m going to re-queue.

Beth Malone with Advest Incorporated.

Congratulations on the quarter! Could you just update us on what’s going on from a regulatory standpoint in Florida and how you all are reacting?

Well, it’s not much different in the last quarter. The Florida Legislature passed a law, I guess an interpretive law, that I think made us more comfortable with the 3 strikes provision of the Florida Constitution. It certainly gives us some breathing room to see how that plays out. So, in terms of new news, there’s really no new news in Florida from our point of view.

OK. So you’re just sitting and waiting and see what could happen from here then.

Well, yes. I mean, it’s not a 90-day issue. The 3 strikes don’t even begin to be counted unless the events, the alleged medical negligence, occurred after November of ’04, so we won’t even be seeing those claims for awhile. So, we look at this as a long-term trend issue that we’ll have to evaluate as we go down the road.

Beth, you’re talking about Florida specifically and there are a lot of things going on in Florida. 1) The tort reform, we don’t really know where the Supreme Court is going to come down on that; 2) These constitutional amendments that were passed and what’s going to come of those; 3) There are a lot of doctors beginning to go bare; 4) Many, many, many doctors are going down to $250,000 coverage; and, 5) Competition down there seems to be able to sell products a heck of a lot cheaper than we do.

So, our retention rate down there is not that great. It’s not a state that we’re going to be expanding in if we can’t reach our margins. And there is just a hodge-podge going on in Florida. That’s not a state that we want to concentrate on.

And on the Personal lines business, what -- we’ve talked about in the past of efforts to expand that. It looks like it had another very good quarter, so the fundamentals remain good for the core business. Do you see the opportunity to expand? Are you more enthusiastic now? Or less? Or what’s your appetite to go into these other states at this point?

Our appetite is to go into other states with this business, but as we’ve said from the very beginning, it will be extremely slow because of the method of distribution. It will be very difficult and very slow to get it started up. And as we’ve said before, we did not think it would have an impact on MEEMIC’s earnings for 2 to 3 years, any significant impact. And we still feel that same way. We have not changed our enthusiasm, more or less, at all.

OK, well, I’ll re-queue.

David Lewis with Sun Trust Robinson-Humphrey.

This is actually Eric Saxon for David Lewis. Most of my questions were just answered, so I just have 2. Do you see any chance of the recent House approval of medical reform making headway into the Senate?

And also, could you provide us with any accretion guidance involving NCRIC?

I guess I’ll give you the accretion guidance. Our calculation show that NCRIC will add approximately $0.98 per share in book value. That’s all we can give you.

At this point, I think that you have to look at the prior history on Federal tort reform and we would tell you that although we are hopeful, the reality is we’re probably not very optimistic that the Senate can muster the number of Republican votes needed to counteract some of the Republicans that vote like Democrats on that issue.

Mike Dion with Sandler O’Neill.

Also another follow-up question on NCRIC. I understand that $84 million in premium in ’04, but you can just talk broadly in terms of your expectations for that book of business. I would assume that you would expect some of that business to run off, but just by manner of ProAssurance being in charge of that you might get some new policyholders. So maybe you could just, broadly speaking, elaborate a little bit on your expectations for NCRIC for the remainder of ’05 and into ’06.

Mike, I think you’ve really given our thought process here. On the one hand, anytime anybody different looks at a book of business you do get some level of reunderwriting. Although we’re generally comfortable with NCRIC’s book of business, we would certainly hope that our resources will make us a more attractive insurer to, for example, physicians in Virginia where there is a lot of competition, and now getting back to an A-rated company will make it more appealing for physicians there and agents to have us be the ultimate insurer.

So, it’s really difficult. We don’t have any very specific judgments on what that premium will be except to feel that we’re going to end up approximately where NCRIC is over the course of the next year or two.

OK. And maybe just a bit on the ongoing reserve study at NCRIC. If I heard you correctly at the outset of the call you expected $8-$10 million in adverse reserve development, which is, I guess, going to be part of the purchase agreement with NCRIC. Is that correct?

Yes. The reserve study will be as of June 30th and we will pick up the operations of NCRIC starting August 3rd, which was the date of the transaction. So any reserve development they have prior to that time will be reflected in the balance sheet that we acquire, and so will not have any impact on our earnings.

And that reserve study is still ongoing? Or that has been completed?

That reserve study is in its final stages. Still ongoing.

Adam Klauber with Cochran Caronia Brokers.

As far as -- you mentioned you had renewal rates of 12% year to date. With competition increasing, should we expect that number to go down in the back half of the year?

The 12% was the average rate increase and the retention we mentioned was 85% approximately. And I would think that it probably will. Two reasons. It’s not really competition as the primary driver. I think really it’s the issue of rate adequacy and the fact that we’re just not seeing as much of a need to increase rates at double-digit levels in many of the states because we’ve had such large increases over the past few years, but now we’re more lining up against our longer-term loss cost trends, which are still in the 6-7% range. So, we’re filing many increases that are one side or the other of that number as opposed to the double-digit increases.

And then yes, competition is there, although competition for us has more of an impact on the retention percentage than on the rate increase percentage, meaning that we are not as likely to compete on price. We’ll probably be more likely to let business go or retain business based on the degree of price competition that exists.

OK. Howard, also, you mentioned severity remains pretty consistent. Does that mean it’s right around 5-7%?

Yes.

OK. As far as claim settlement trends, with the new laws in a number of states, or potential laws in a number of states, has your settlement pattern changed at all? Or is it sticking with historic patterns?

In patterns, you mean in terms of the rate that claims close?

Right, right. Basically you obviously don’t settle a lot of claims --

Well, we haven’t really seen any changes in that regard. I mean, that’s really more of a function of what happens in the court system in a given state and the assignment of judges and how quickly cases are moved through the system, but we’re not seeing a change as a result of any of the tort reform or anything from our practices.

OK. And finally, on NCRIC, how long should it take until NCRIC gets to your historic profitability standards?

I don’t guess that we can accurately answer that, but I’ll take a guess and anybody can take a guess. What? Two years?

As we go through the book of business, from an underwriting perspective, as Vic mentioned, we don’t expect to find a lot there based on our due diligence that we would not renew, but it will take a full 12-month cycle to do that. And then again, on the pricing side, while NCRIC’s rate-making targets and goals were very similar to ours, we’ll be going through the rate-making cycle over the next 12 months too.

So, as it takes a year to earn premiums after you write them, 2 years?

OK, that makes a lot of sense.

[OPERATOR INSTRUCTIONS]. John Gwynn with Morgan Keegan.

Dr. Crowe, these pop-up competitors, the startups you referred to, most of them are RRGs this time around as opposed to trusts and funds. Is that correct?

That’s correct.

Do the docs understand that there’s no guaranteed fund backup there?

You know, John, that’s a very interesting question. You talk to most of them and they seem to understand that, but John, they’d look at prior history and the judges and the courts notoriously have protected them in the past. Of course, they had these guaranty funds, which was a low amount backing them up in their prior [inaudible]. But we just went through a situation where Reciprocal of America went down and the doctors over in those risk retention groups did not have guaranty fund backups.

Well, those doctors are now paying their legal bills and their indemnity payments out of their hip pocket. Yes, some of them have become more aware of it, but I would have to say the vast majority of them truly don’t really understand the ramifications. Congress has created this entity that, in my opinion, just creates havoc in the marketplace. And they’re all in the marketplace, taking our high-risk clients at a very low price, standard rate. They’re writing the business that we don’t want, and they will be short for this world.

And for some reason people have the impression that this is another 1975 and plenty of these startups are going to be successful like we were, and that’s not the case because we’re not going to give them the business like it was given to us by Hartford, Aetna, et cetera in the mid-70s. They’re going to have to take it with price.

Since the first year we were in business our rate was 300% above the prior-year rates for employees of Warsaw, 300%. They’re coming in at 50 and 60% of our rates and they’re just not going to make it. It’s going to be a mess and I appreciate your understanding of that, John.

I also recall in the first year or two you had that big claim and no reinsurance.

Yes.

Dr. Crowe, A.M. Best had a rather cautious response to your NCRIC acquisition. Do you think you’ll be able to bring them around? Or are they still looking for $10 of capital for every $1 of premium?

They’re still looking for a lot of capital and we alluded to that in our presentation, our discussion. We’ve got objectives that we want a return of equity and they’ve got objectives of safety.

And I’m with you. I think that A.M. Best is kind of protecting themselves and their rearends and there has been a lot of turmoil in this sector and there has been a lot of inadequacy, both in reserves and capital, and they’re afraid and I don’t think they really know how to handle those of us that have adequate reserves. And it makes our capital look like it’s a little bit low. I think in time they’ll come around.

I’d be happy to share with them my proprietary reserve model anytime they want to see it. [Laughter].

Howard, now that you’re an underwriting guy, in certain lines of business, and obviously there is mostly short-tailed lines -- Auto and Homeowners -- we’re seeing a much more sophisticated underwriting approach -- tiered pricing and risk segmentation -- much more granularity in the data. Now that you all have gotten to be a very significant factor in MedMal as opposed to 10 years ago, do you think there is room for that type of underwriting improvement in your particular line of business, MedMal? I’m not talking about MEEMIC, obviously.

I think there is room for some improvement, but I don’t think to the degree that you see in Personal lines or even some of the Commercial lines where the data is so much richer. We’re still dealing with a relatively small population pool to start with and a relatively low claim frequency.

And just as a result of that, when you start to segment the business into portions that are consistent for the purposes of analysis, I think you run into some real variability problems and difficulties. We’re doing whatever we can with a very fast database that we have, not only that the Company has had originally, but from what has been acquired over the years through the other organizations that we’ve brought into the company.

But, it’s still a very difficult process and I don’t personally think you’re going to see the kind of improvement or use of the modeling as we have in say Personal Auto.

John, I’d like to make a comment. You are correct in that is what we need to be looking at. And that is an objective that we need to strive for. I think it will be slow to come, but certainly the Automobile industry has led the way for us on that.

Well, market share increases, which obviously the increase itself is not worth a hoot, but it does give you the ability to set the tone of a legal environment in a venue, correct?

Vic?

Definitely to some extent. There are other players. I mean, certainly in some states we have more market share where we have more of the dominant force in Medical Malpractice. In other states we’re among others, but I think your comment has that validity to it.

Howard, just real quick. I’ve seen -- I realize this is a real crude approximation -- but I’ve seen actuarial statements that when rates were going down people were saying that for every 100 basis points of rate decline you needed 3.5 points of price increase. Does the reverse hold as a real crude rough rule of thumb?

I think so. We’re basically looking at something like 3.5-4 years on average if you look at it average-weighted payout. So, I think that’s where that came from and I think it still holds in the other direction. That’s all pre-tax, of course.

Right. Ned, on NCRIC, you’re going to have $8-$10 million of pre-tax reserve strengthening. Is there a tax -- is that going to be tax affected?

We’re still working through that. It will be tax affected, but to the extent that NCRIC has net operating loss territories, there will be some limitations on our ability to use those as a new acquire. And so, once we have all that data, we’ll be able to work through it. But there likely will be some limitations in our ability to use their NOLs.

OK. So, the reserve strengthening, whatever it is after tax, is going to be an addition to goodwill in addition to the hospital judgment?

The hospital judgment right now nothing has been done with that, so that just sits out there. But, yes, any reserve development -- after-tax reserve development would be in addition to goodwill.

Ned, you were going a little bit quick for me on investment income. You gave -- could you give me those yields again?

Yes, absolutely! The investment yield -- these are after-tax investment yields -- which, for us because we have such a significant portion of our investments in tax-exempt securities is what we look at. In the second quarter the after-tax income yield was 4.83%. And I was comparing that to what we had in the fourth quarter of last year, which was 4.66%.

OK. Is that invested assets plus cash and cash equivalents? Or, just invested assets?

Hold on one second and I will put that up, but I believe it’s just invested assets.

Is there anything further, Mr. Gwynn?

No --

That is just invested assets, fixed maturities.

Rob Mason (ph) with Schneider Capital.

Congratulations on closing the NCRIC acquisition! I just -- in the quarter, and you’ve talked a lot about this, but there is, by my calculation, about a 16 or 17% differential on the Professional Liability between the premium growth and the rate increases. And you’ve talked about the mix by state changing and the policy limits. Have you broken that out between the two and are there any other factors there that you think are driving that differential?

I’m not sure about any -- the factors -- just go down the list. We have the mix by state and the average premium differences, of course, by state. We have somewhat of a trend to lower policy limits, particularly for those physicians who are buying limits in excess of $1 million. They’re either cutting back to a million or buying less excess of a million than they were before.

We have still a little bit of residual growth due to the progression through claims made steps (ph) in states like Indiana, Michigan, and, to a lesser extent at this point, in Ohio or New Jersey, which would be an offset, a positive offset. We have the rate increases. And then we have, of course, just the loss of business due to retention, and then we have new business coming in.

So, there are a lot of pieces there to look at and in order to do it you have to look at it in all of those pieces in all of the states. So, I don’t have any answers for you at this point in time as to how each one of those fits into the picture.

The physician count is relatively flat overall, so you can see that the mix that we talked about is changing and that change is the average rate level. But we have approximately the same number of physicians and almost the same number of hospitals going into the mix.

OK. I noticed that the net premium to gross premium ratio was down quite a bit from the first quarter to the second quarter. Were there any reinsurance adjustments that were made in the quarter that drove that, that you’re aware of?

We’re looking.

OK. We can do that offline if you prefer.

We’re not aware of any. I mean, there were no changes to the reinsurance program and I guess we’ll just comment on that, I guess, as we get through the call. If you have other questions we can come back to that maybe.

OK. No, that was it.

Tom Van Buskirk (ph) with McMahan Securities.

Can you give us an update on how liquidity and so forth looks at the holding company level? And how the NCRIC acquisition may change that?

Was that how the liquidity looks at the holding company?

Yes.

Yes. I don’t have -- [inaudible] liquidity we have at the holding company, but we have -- we have more than adequate liquidity to meet our obligations at the holding company. And one of the things we will be looking at with NCRIC is any capital needs that it may have and we’re confident that any capital needs that it does have will be able to come out of the liquidity that we have at the holding company without causing any due harm.

They don’t bring much to the table in terms of liquidity, I would imagine.

Unencumbered liquidity?

Yes.

Most of their -- most of their invested assets are within the Insurance entity.

OK. And how much so far has been upstreamed from the operating companies to the parents this year?

Hold one second. Up to the holding companies, to the holding company there has been none thus far this year.

Mike Paisan with Legg Mason.

I just had one quick question on the premium and the growth numbers. Is the 12% on your renewals that you’re talking about, is that risk-adjusted, or is that just absolute pricing? Or does that incorporate terms and conditions as well as absolute pricing?

That would be, in your terminology, it would just be absolute pricing. It takes into account the expiring premium and the renewing premium, but we don’t make an adjustment in that for change in limits for this purpose.

And to go back on Rob Mason’s question about the first and second quarter ratio of gross to net, I just took a quick look. I mean, I think it’s probably again a function of the mix of business. We have a lot more renewals in states like Florida, Pennsylvania in the first quarter -- they are heavy January 1 renewal states. And in those states we have little or no coverage excess of our retention, so the reinsurance premium, ceded premium, would be relatively lower.

Rob, if you want to queue back in and follow up on that question that would be fine.

[OPERATOR INSTRUCTIONS].

Greg Peters with Raymond James.

I actually do have one or two follow-ups. With NCRIC, and I know you talked about the reserve increase and not flowing through the income statement. I’m wondering if you could remind us if there are going to be any expenses related to the acquisition that might flow through the income statement in the third quarter, or already have flowed through the income statement.

Nothing really that significant. We will capitalize some costs associated with the acquisition on our part. NCRIC will expense, or has expensed, those costs associated with the acquisition from their side. And a lot of the transitional-type costs related to relocation or severance benefits for employees will be accrued at the time of the acquisition, so they will not flow through the income statement.

There certainly will be some cost of the transition and those will probably occur over the next 6-12 months, but I don’t think they will be terribly material.

OK. And I’m not -- I don’t want to jump the gun here, but I know, Dr. Crowe, you did mention uses of capital and talking about other acquisitions and I’m just curious, as we look forward, post NCRIC, are there any states out there in the market where you’re not -- or you don’t have a lot of exposure or have no exposure that you, at this point in time, are just categorically against or have no interest in going into?

Yes.

OK. Could you share some of those with us?

No.

[Laughter]. OK.

[OPERATOR INSTRUCTIONS]. Mr. O’Neil, it appears there are no other questions at this time. I’d like to turn it back to you for any additional or closing remarks.

Thank you, Augusta. We will invite everybody to join us back again in November when we report third-quarter results. Thank you for being with us.

Thank you. That does conclude our conference today. We’d like to thank everybody for their participation. Have a nice day!