ProAssurance Corp (PRA) 2007 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to today's ProAssurance Second Quarter Earnings Release Conference Call. As a reminder today's conference is being recorded.

At this time for opening remarks and introductions, I will now turn the call over to Mr. Frank O'Neil. Please go ahead, sir.

Thank you, Justin. Thanks, everybody for joining us. We'll present our thoughts on the quarter and the market as soon as I remind you during this call we'll be making forward-looking statements and projections based on our estimates and anticipation of future results and events. Please review the contents of this call in conjunction with the caution regarding forward-looking statements in the news release that we issued today, Wednesday, August 8, 2007. You should also consult the detailed discussion of Risk Factors and uncertainties about our business in our forms 10-K and 10-Q. We will not undertake and we expressly disclaim any obligation to update or offer forward-looking statements, whether as a result of new information or future events except as required by law or regulation. The content of this call is accurate only on August 8, 2007, the date of first broadcast, and is the property of ProAssurance. You may not disseminate the call in any form without our express written consent. If you're reading a transcript of this call, please note that we have neither reviewed it nor approved it. On the call today is our new Chief Executive Officer Stan Starnes, our President Vic Adamo, Chief Financial Officer Ned Rand, Chief Underwriting Officer Howard Friedman, and Chief Claims Officer Darryl Thomas. Ned will kick us off with short prepared remarks highlighting a few important numbers. Ned?

Thanks, Frank, and good morning, everyone. Our numbers can speak for themselves, and I believe we turned in another solid quarter. In the very competitive market in which we find ourselves, we are pleased to report modest top line growth for the year-to-date and note that Second Quarter year-over-year is down just 1%. As other medical liability companies have reported, premium growth is challenging right now for those of us who are behaving responsibly in the marketplace. Our PIC Wisconsin acquisition is serving to stabilize our top line which we think validates our M&A strategy. The line we pay the greatest attention to, the bottom line, grew nicely in the quarter and is up correspondingly for year-to-date. Net income from continuing operations was up 25% from a year ago in the quarter and 27% for the year. There are are several factors at work here. There was $20 million of favorable net loss reserve development in the quarter. For the year, the total favorable development stands at $35.6 million. Net investment income continues to be important. Strong cash flows over the last several years have boosted investment income to a prominent place in our revenue stream. It's equal to approximately 32% of net earned premium year-to-date. A quick note about cash flow from operations. In comparing last year's Second Quarter numbers to this year, please remember that last year's cash flow was affected by a tax payment of $55 million related to the MEMIC sale and a trading portfolio investment that was about $50 million. Those items can skew your analysis if you don't account for them.

In this quarter we saw an increase in loss and loss adjustment payments. This relates both to the natural maturation of the loss reserves we had established over the last several years of growth along with an increase in the number of large indemnity payments paid during the quarter. The timing of indemnity payments can fluctuate significantly from period to period depending on a variety of factors, including the speed at which cases work themselves through the trial and appellate process. Overall, loss payments are within our historical payment patterns. We also had timing issues with regard to reinsurance payments versus billings which had a limiting effect on cash flow. Just be aware that neither this year's Second Quarter nor last year's were run of the mill. Our combined ratio continued to show improvement principally resulting from the favorable development mentioned earlier. The increase in the accident year loss ratio is attributable to the addition of PIC Wisconsin, where the effects of the rate increases we have implemented are still working their way into earned premium, and an increase in our estimate for losses in excess of policy limits given the increasing power of large verdicts we are seeing industrywide. The combined ratio was also affected by the modest uptick in the expense ratio caused by a higher stock based compensation expense in the quarter as compared to last year. I want to remind you that there will be some compensation based impact in the third quarter as we expense the full value of the 100,000 shares of options granted to Stan Starnes on July 22nd. These options will result in a pre-tax charge of approximately $1.8 million.

I know there has been a lot of discussion around subprime exposure. As a backdrop at June 30, our $3.1 billion fixed income portfolio had an average rating of AA plus, and 99.5% of this portfolio is investment grade. The average tax equivalent yield was 5.3%. Our exposure to subprime mortgage backed securities is $36 million in the market value with $30 million of this exposure in investment grade securities and $6 million in below investment grade securities, a minor percentage of the portfolio. And ours is well seasoned with 80% coming from 2005 and earlier. We are are seeing a ripple effect across other markets, especially in the high yield area, where we have an additional $17 million of investments, and we are are are closely watching the so-called Alt-A securities. Our exposure there is only $18 million and is rated AA minus or better and is performing as expected. We see a disconnect between the current bid price and the underlying fundamentals, especially on below investment grade structures. While there is no doubt there are areas for concern, we believe the market has overreacted. This overreaction is exhibited in the large spread between the bid and ask on many of these securities. Given the small exposure relative to our portfolio and our strong financial fundamentals we see no reason to panic.

Finally, a word on share repurchases. We've repurchased 560,900 hundred shares since the buyback was authorized in April. Our average cost is $54.79 per share. We have $119 million left in this authorization and will continue to deploy that once we emerge from the quiet period following this Conference Call. Frank?

Thanks, Ned. A couple of the items that you mentioned probably need a little color from Howard, so I'll look to Howard and ask him to talk about the marketplace in general from an underwriting standpoint and then to explain the reserve development from his actuarial standpoint. Howard?

Thanks, Frank. The reserve development is probably the most important but the easiest to explain. As you mentioned, there was $20 million of development in the quarter. This continues to come from accident years 2003 through 2005. Those were the years that mark the turning point in medical liability. It was then that the full effect of rate increases from the early part of the decade came into play. In other words, rates had finally become adequate. Those years have continued to develop favorably, and the regular analysis we undertake each quarter showed that the reserves should be taken down. That analysis looks at results and trends and we can say that the trends in frequency and severity continue to look good although we're less optimistic than some of our competitors as reflected in the difference between our loss [picks]. It's fair to say that our geographic dispersion gives us a broad look at the jury awards and settlements, and there continues to be a disturbing trend towards higher and higher shock verdicts. In the past few weeks alone, Florida has seen another verdict above $20 million. There's been a similar verdict in California and a striking verdict above $30 million in Michigan. None of those are are our verdict, by the way. While these verdicts may appear isolated in terms of geography, we're concerned there is a win or lose big reality emerging. We continue to price and underwrite in a responsible manner and we're pleased to note the existing policies are renewing with premiums essentially equal to premiums charged in 2006. Our retention rate on existing core business, which excludes PIC Wisconsin, remains at 85%. PIC Wisconsin retention is a bit higher at 89% for the quarter and 90% year-to-date. We think that these two facts speak well of the value we provide policyholders and we're especially pleased with those figures given the softness in the market.

We see that softness primarily in terms of pricing. Policy terms and conditions are largely holding. The companies that we've referred to as start-ups really aren't start-ups anymore, and they are no longer a force in the market. Many of them are trying to survive due to their small size and limited market share as the pricing environment has softened. As we've said in the past, these companies were not created because of an availability crisis. They came into being strictly due to a desire for a lower price. As a result, they haven't developed the loyal base of policyholders that will stay with them as prices for more established companies with superior ratings move downward a bit. We're examining our filed rates on a continuing basis, and given the loss trends it's likely that we will see a continuing downturn in those filed rates. But we're still confident that we'll be able to hit our ROE targets. Frank?

Thanks, that's helpful. You had mentioned PIC Wisconsin, so I'm going to ask Vic to comment on PIC Wisconsin specifically and how they are are fitting into the financial picture and I guess general integration. Vic?

Thanks, Frank. Ned mentioned the important role that PIC Wisconsin is playing in our strategy. The PIC Wisconsin contribution to gross premiums was just under $12 million for the quarter. In looking ahead, we'll have the benefit in the third quarter of the July 1st renewal period for PIC Wisconsin. After the January 1st stage, July 1st renewal is PIC's heaviest and was not a part of our results last year. So we're getting growth and it's coming from well seasoned, well underwritten business we added through M&A activity, not through pricing action. And we definitely feel that M&A is the more prudent strategy, especially in this market. Our integration of PIC's operation is going well. This Company has a similar heritage and philosophy, so the cultures have meshed as well as in any of our past 12 transactions. We have now moved the accounting, investment and systems operations to Birmingham while underwriting claims, sales, and risk management operations remain in Madison to serve the PIC Wisconsin customers. This is the ProAssurance model geared towards using the infrastructure resources of a larger organization while remaining customer focused through service delivered at the local level. All in all, PIC Wisconsin has been a very smooth transaction, and as we approach the one year anniversary, I'd have to say we're very pleased with it. Darryl Thomas is closest to the claims end, and I'll ask Darryl if he can comment on PIC Wisconsin as well as claims in general.

Vic, I agree. The Claims Department was functioning more like our Claims Operation than maybe any other transaction we've done. As a result, the claims staff has embraced our defense philosophy and the position to work with us on claims and are pleased with our defense strategy and our defense commitment. Across virtually all our states, we're seeing consistently good trial results. We're projecting at least 750 cases tried this year, and we're seeing a win percentage that's equal to or better than our historical rates. Regarding Columbia Hospital, I generally get asked a question each call regarding the Appellate opinion. We have not heard anything yet, but we are expecting to hear shortly. Frank?

Thanks, Darryl. That was a good head-off on that question. Given the overview of the quarter that we've had, I'd like to ask Stan if he would want to offer any comments about the results and to give us his thoughts after about a month on the job as CEO. Stan?

Frank, I'm not sure what more I can add about the quarter except to emphasize the benefits of a disciplined strategy. I've been close to this organization for 30 years and I've never known it to waver from a core devotion to maintaining a strong balance sheet and driving every business decision off of that imperative. That same devotion is at the center of our vision for the Company and its future. As we've seen in cycle after cycle in this business, the strong survive and the weak let their policyholders down sooner or later, sometimes in a catastrophic fashion. We understand that our policyholders expect great things from us. They want an unchallenged balance sheet that permits them to practice medicine and deliver healthcare in a personal, caring manner. They expect the level of service commensurate with the premiums they pay, and they expect us to maintain balance sheet strength and all that goes along with it. We've been a public Company for a month shy of 16 years, and in that time, we've proven that taking care of our insureds and guarding our balance sheet Will produce great results. Our annualized stock returns since September of 1991 is 17.6% and we've grown book value at an annualized rate of 15.6%. So no matter where we are in the cycle, we're confident that we can be a leader. Almost any Company can be a success when business conditions are great, but the truly exceptional companies such as ProAssurance prove their worth when things are challenging. This Company was great before I ever sat in the CEO's chair. You can look at ProAssurance's recent inclusion in the Ward's 50 for proof beyond the numbers.

But I don't want anyone to think we're going to stand on our reputation alone. As Dr. Crowe said when we announced this transition, ProAssurance will benefit from a fresh set of eyes, albeit eyes that are are intimately familiar with the Company. Those of you with whom I've had the pleasure of meeting and talking, our insurers -- particularly those on our advisory boards and committees, our agents and our employees -- have heard me say that every company and every person should reinvent itself or himself or herself every five years or so. The reinvented company or person may look very similar to the old one, but the process is healthy and invigorating and that's what we're doing now. We're challenging almost every convention within ProAssurance, and in many cases -- indeed most cases -- what we've been doing is right, and we may not tweak it much at all. In some cases, everyone has looked around and said there's got to be a better way. But the reality is that as I work to become familiar with the daily activities here, I'm more encouraged than ever that we have the right people and the right priorities to move ProAssurance forward at a pace that will reward shareholders and benefit policyholders.

Before you ask for details, I'm going to ask you to understand that I've been on the job only since June and I've been CEO only since July 1st, about six weeks, so I'm not sure we've made any decisions worth reporting at this level. I can tell you that we're not abandoning this company's long held belief that our insureds deserve a passionate defense of meritorious claims against them. We're certainly not going to start buying market share through widespread price discounting in the market. We'll price our product to reflect current loss trends, which is fair to our insurers. At the same time, we will price to achieve the overall margins we expect on our business, which benefits our shareholders and our policyholders who demand a strong company. And we're going to continue to be as active in the M&A area as the market will allow. Frank?

Thank you, Stan. Justin, I think that wraps up our prepared remarks. If you'll open the lines for questions, we'll be happy to take some.

Certainly, Mr. O'Neil. Thank you. Ladies and gentlemen, the question and answer session will be conducted electronically. (OPERATOR INSTRUCTIONS) And we'll pause for just a moment to assemble the questions queue. Our first question comes from Amit Kumar with Fox-Pitt Kelton. Please go ahead.

Hi, guys. Congrats on the quarter. Just a few quick questions, I guess, starting with the PIC Wisconsin and your mentioning of some of the loss trends. Can you just elaborate on the increase in the underlying accident loss ratio and are you seeing specific trends for that?

I think, Amit, the main thing with respect to PIC Wisconsin is that there are rate increases that have been put into place at the beginning of 2007 that have not fully earned their way in as you would imagine. We're still earning premium from 2006, and PIC Wisconsin had previously priced to a higher loss ratio or you would say a lower ROE target. So we're in the process of making those adjustments or have made those and they are working their way through the process. So that is one and the main factor with respect to the PIC Wisconsin loss ratios.

Okay, and I guess moving on, your discussion on some of the shock losses. In terms of those losses, are they mostly towards the mutuals or are you seeing any public companies -- publicly traded companies having those losses?

I think it's all across-the-board. Some of them have been self-insured entities, Amit. Some of them have been what we understand against the subsidiaries of publicly traded companies. It's across-the-board. I don't think you can single out one state necessarily. I mean, this was coast to coast in this past quarter.

Okay, that's all for now. I'll requeue. Thanks so much.

Moving on, we'll take our next question from David Lewis with Raymond James. Please go ahead.

Thank you, good morning.

Good morning, David.

Stan, welcome to the new position.

Thank you very much.

Howard, can you talk a little bit more about just what you're seeing on the claims frequency and severity trends? I think the last call we talked about frequency being relatively flat, severity up 3 to 4%. Given these shock losses beyond what you're seeing historically, can you tell us what, if any, changes you made to your loss picks?

Yes, David. I think the frequency continues to be similar to what we saw last quarter, actually in some cases maybe a little bit better -- in other words a little bit down in a number of states, either to a greater extent than we saw previously or starting to drift downwards from where we might have saw it as flat before. Yes, there are still isolated instances -- at least in our data -- and we don't necessarily have all of the data for any of the states in which we operate. But there is still isolated instances where we see a little bit of an uptick in frequency, but that's normal variation. But overall we can say that frequency on the whole or our experience as a Company is down. Severity continues to move along at a relatively moderate level and similar to what we have talked about previously of 4 to 5% annually on the whole varying by State and certainly varying in the excess layers at a higher severity trend. In terms of our rate levels as I mentioned, we have had some filed rate decreases and I wouldn't be surprised if we continue to see those as we go through our annual reevaluation and we -- as you know from the past, we don't do all of the states on one date. It's a constant process as we go through the year. But given the frequency flat to down and severity at a moderate level better than what we had anticipated in the past, decreases are -- have been and are likely going forward.

But still maintaining our margin?

Well, sure. I guess I should repeat that every time, but we use the same model all the time. It really is a matter of the data that feeds into it. But the model in terms of the return on equity target that we have built into the rate filings of 13% continues unchanged.

If I recall correctly, historically you would price for 92 to 93% combined and reserve at somewhere in the 102% range. Has that changed?

No. The only thing that really changes that to be honest from period to period is the investment yield that we assume going into the rate filing. Again, the model is the same, so if investment yields that are are expected over the course of time that will hold the premium before we pay the losses go up, that would push the combined ratio up a little bit. And it may be more at this point in time more like 94 and 102 to 104, in that range. But that also varies by state because the payout pattern differs from state to state. We hold the money for longer or shorter period of time depending on the court system.

That's helpful and just one final question. Has there been any change in geographic focus or the competitive environment? Gross written premium is a little better than I would have anticipated here in the Second Quarter despite the continued pricing challenges. Any opportunities or focus changes that you want to address?

There are no dramatic changes. Every state is incrementally different but we're -- I guess I'd say the patterns are following what they have been in the last couple quarters, and there aren't any surprises as we see it. Very good, thank you.

And our next question will come from Mike Paisan with Stifel. Please go ahead.

Yes, good morning, everybody. Just sort of a broad picture view, and I also want to welcome Stan as a long time observer of ProAssurance. I guess as I sort of, as somebody that's followed this space for awhile, it seems as if this is basically a rehash of the 90s just before everything really tanked pretty severely. As competition heats up and severity starts to increase, jury verdict awards start to go through the roof. I guess what I'm trying to do is get comfortable that we're not headed back toward the scenario where these companies trade below book value and kind of sit there for another year or two because everything really just tanked. Is there some level of comfort you can give us that that's not going to happen again in the next year as we sit here and talk a year or year and a half from now, is that scenario is going to play out again, is it not going to play out again? If not, why, what's different this time around? That's my first question, if you could just address that.

Mike, let me take the first shot. This is Howard and then others may want to add.

Okay, thanks.

I think -- well one thing is we certainly have learned things, and obviously for those of us sitting around the table for the most part, this is not the first time through the cycle. It's probably more like the third time, and we learn each time. Unfortunately, from what we see in the market, maybe some others haven't learned or are new to the scene. So we are seeing a lot of the same behavior out there that you pointed to from the 1990s. We're studiously trying to avoid that and you can see in the way that we're pricing -- I think those that are out there in the marketplace would tell you that we're not the low price competitor on the block and we've made a very careful attempt to try to avoid those same mistakes. We do see frequency continuing at a very favorable level for us, as I mentioned earlier. We don't see any kind of frequency increase -- just the opposite. And we see severity remaining moderate. So those are the two key factors that drove the cycles in the past and we don't see those indications. But at the same time, those particularly frequency is very dependent on the maintenance of tort reform legislation that was passed in a number of states and that hasn't for the most part been adjudicated yet. So we're keeping a pretty cautious and conservative position until we see some concrete evidence that it's going to stay in place.

I think the other thing that I'd point out is that when we mention these shock verdicts, I don't think we're trying to communicate to you that they are happening once a week or that they are becoming the norm, but we do want you to understand that these are out there and any one Company is subject to being hit with them. And we don't want you to be surprised if it happens. Darryl Thomas, I'm looking at you. Anything?

Yes, I would agree. You're seeing an increased frequency in shock verdicts, but it's happening across-the-board in all states, in all venues. It's not targeted to one area.

And again, it's not one a week or two a week.

No, it's not. Not the shock verdicts, no.

Okay, that's great. Thanks a lot.

(OPERATOR INSTRUCTIONS) We'll take our next question from Ron Bobman with Capital Returns. Please go ahead.

Good morning, and congrats.

Thanks, Ron.

Frank, you lead this call like an orchestra conductor.

Well, you remember the production background.

I just had a couple of questions. You've mentioned the severity jury verdicts for at least a couple of quarters now. Is it causing you to change your reinsurance program logically by a taller tower or do you feel that you're adequately protected already? Any changes there as a result of this observation?

We're not planning to make any changes in the program that we have. We felt that it was adequate and still do.

Okay, thanks, and then I had a couple unrelated questions. Could you comment on the M&A environment? And then again unrelated, are you -- Ned made some comments about subprime, I think he used the word overreaction or disconnect or both. Are you guys so bold to try to be a little bit opportunistic and be a market to buy some of these bonds or tranches if your outside managers thinks the risk reward is there?

Let me get Ned to answer the subprime first and then we'll let Vic and Stan if they want to talk about M&A.

Sure.

Ron, on the subprime, we do absolutely think there are are opportunities out there, and we and our managers are are evaluating those opportunities. And while we would not add to our exposures materially relative to the overall size of our portfolio, we certainly are looking at opportunities to add to our positions.

And with respect to the M&A, I would simply say we intend to be opportunistic. We have a balance sheet that permits us to do that and we're alert to the opportunities as they present themselves.

And inventory really isn't the right word, maybe pipeline. Is the potential deal pile any larger now than it was three months ago -- the number of candidates that you have any sort of real sincere sort of interest in pursuing something with any change there?

Well, I'm not sure we can comment directly on size or lack of size of pipelines. I think Stan's point is the main one. We try to be positioned so that from an economic as well as a company due diligence resource point of view we can jump on opportunities as they arise and we look to do that. It's really not governed by our side of the table. It's governed by companies who feel for whatever reason they would like to look into an M&A transaction, and we just want to be prepared to do it whenever available.

Okay, thanks, and best of all, best of luck.

Moving on, we'll take our next question from Beth Malone with KeyBanc.

Thank you. I just wanted to ask another question about the frequency experience. I know it's hard to quantify exactly why that may be occurring, but do you think that the mild frequency experience you've had is due to a change in the deductibles and how the policies are being written more than just market conditions?

No, Beth, this is Howard. No, not at all. First, if there was a deductible and if there are deductibles on the policy -- we do have some -- we still get report of a claim, so that would not have any effect. We're not writing any policies that would have retentions or self-insured retentions that are so high that we wouldn't know about the claims being filed. No, I think it's not a matter of counting. It's something more in the environment. I don't know if anybody else wants to comment on that?

Well, my own sense of the frequency is that it's multi-factorial in cause. I don't think there's any one cause. I think it varies from state to state and we may never know exactly all of the causes, but I don't think we should be overly confident that it's a permanent thing.

Okay, well, do you see frequency and severity trends -- since it's a state by state thing- - where you have well established long term tort reforms in place? Is the frequency and severity -- is that obviously going to be better than in other states where you don't? Is there a direct relationship between the two?

We've seen frequency declines in the states that have had tort reform for many years as well as states that have had tort reform passed in the last two to five years and in states that have never had tort reform. This seems to be more of a widespread phenomenon than anything that's particularly related to specific tort reform. It may be the overall publicity related to tort reform in the country and the availability of healthcare and the concern that continued lawsuits against physicians and hospitals might diminish the availability of healthcare, but that's speculation again. But it doesn't seem to be keyed directly to the presence or absence of tort reform or in a particular time period.

Okay, all right, thank you.

Next, we have a follow-up question from David Lewis with Raymond James. Please go ahead.

Thank you. I've got a couple of additional questions -- but first, back on the frequency. I think someone speculated that the declining frequency may have been reflective of attorneys' more rightful approach to lawsuits than the sho gun approach, and I think some within your organization may have thought that had been a factor in the frequency declines. Do you feel that that is a factor or have you kind of analyzed that enough to determine whether that's a portion of it?

It could account for some of it in some states. Bear in mind the tort reform is very very important, but its main value doesn't have anything to do with frequency. Its main value has to do with access to healthcare and permitting doctors to feel like they are going to be treated fairly in the courtroom. It is true that over the years, the past several decades, many lawsuits would include as defendants a large number of physicians who had some contact with the patient. You see case after case in which there are are four, five, six physician sued. Today in some areas, more plaintiffs' lawyers are being judicious in who they sue and they only sue one or two doctors. That would cause a drop in frequency and I think that may be part of what we're seeing in this drop in frequency, but I don't think it's the total cause in the drop.

That's helpful, and a couple final questions. PIC Wisconsin did about $30 million of written premium in the First Quarter, I think you indicated $12 million in the Second Quarter. The third quarter tends to be the largest. Would we guess that's in the $35 million to $40 million? Can you give us any range that might be helpful?

I don't have numbers off the top of my head. I think I said the the third quarter tends to be their second largest quarter. I believe the First Quarter is their largest. But if you were to look at their statutory filings and we do have them posted on our website, they would give you an idea of historical trends on premium.

All right, and Ned, excess capital probably even despite the repurchases in the latest period, still in the $250 million range, is that accurate?

I'm sorry, repeat the question.

Excess capital still near $250 million?

Yes. We had to void some of that capital, obviously -- about $40 million of it, $30 million to $40 million of it -- but yes, I think it's still a decent, it's as good a number as any.

All right, and finally, do we get any more detail on just pricing trends, what you're seeing right now? Is it down in your overall book 3 to 5% and what your guess is maybe on filings, if you care to share that as we kind of go into the second half of the year?

Well, I guess I'll start David, maybe either questioning or correcting you. What we said was that in the Second Quarter, the overall pricing was flat as compared to last year. That means renewals versus expiring was zero. Is that what you were referring to?

Yes, I missed that. And then any guess on what average rate filings might be down as we look forward over the next six to 12 months?

There are some up and some down and some that are essentially zero, but we're making changes in specialties or territorial factors. No, I don't think I would make a prediction on that. I think just looking back over the last six months, we've had a variety that have been in that vein and I think we'll continue to see those.

Okay. Howard, final question, on the prior year favorable development, is there traditionally a certain period where you'll have to do a external actuarial review that might cause a greater release of what we've seen in the previous several quarters?

We continue to do the reviews the same as we have for many years on a semi-annual basis. It's done by [Fillinghalf] and we look at the interim quarters on our own and we reflect whatever we're seeing on a quarter by quarter basis. So I guess the short answer to that is no, I don't think there will be any single review or certain event that takes place that is going to result in a different type of analysis that we do each quarter. If the analysis indicates larger we'll do larger, and if it indicates smaller we'll do smaller.

To go at it a different way, Howard, the redundant reserve releases have developed and have accelerated since the First Quarter of 2006. Is there a potential we might see higher redundancies in the second half if all the factors that you saw stay steady if not improve on the frequency side?

I guess the explanation to the increasing development, if you will, the favorable development that you've seen over the last eight or nine quarters -- is that we're now maturing the years where our rates have become adequate. And as you I think had mentioned earlier, we tend to establish an initial reserve that is higher than our pricing estimates. So as those years 2003, 2004, 2005 and so forth move towards maturity -- and maturity meaning that we have a better read on what the ultimate cost is going to be, not that they're done -- then we would see favorable development. So 2002 didn't contribute much. If anything, 2003 more, 2004 additionally. So I think it's just a function of the time and maturity that you're seeing that, not so much a particular formula on our part. So I'm not going to make a prediction for the second half of the year, but I think all else being equal, we will continue to see those years where we had good rates and we're seeing good experience come out of those develop favorably.

That's helpful. Thank you and congratulations on a solid quarter.

And our next question will come from John Gwynn with Morgan Keegan. Please go ahead.

Hi, John.

Howard, I apologize. There was a technical glitch on my end, but if you have already discussed this just tell me and I'll read the transcript. But have you given color on your accident year quarterly outcome as opposed to the calendar year?

Well, no. I guess not specifically, we have not.

You know where I'm coming from. Is there some message there that other than your normal conservatism?

John, I guess you didn't hear our prepared remarks, I'm guessing then. You came in late. What we said is that there were a couple contributing factors to the increase in the calendar year -- or excuse me the accident year loss ratio. And the two primary factors, one is PIC Wisconsin. And with PIC Wisconsin we've implemented rate increases. However, those rate increases are still in the process of earning themselves into our results. And secondly, we have established some additional reserves for losses in excess of policy limits, just given the fact that we've begun to see an increasing number of large verdicts industrywide. Not necessarily in our book, but just industrywide.

Right, okay. Thanks a lot.

(OPERATOR INSTRUCTIONS) We'll move on to a follow-up question from Amit Kumar with Fox-Pitt Kelton. Please go ahead.

Thanks. Just going back to your comment in regards to the policy limits, can you perhaps comment on what you might be seeing out there on terms and conditions. Is there still discipline or do you see that sort of loosening up a bit. And also what about the policy limits? Do you see that changing as well? Thanks.

Well, terms and conditions, I think we'd maybe just divide our book of business in a gross way into physicians versus hospitals and facilities. Physician business, which makes up the vast majority of what we do, terms and conditions really aren't much of an issue. Most physicians and physician groups buy a pretty standard policy from us or anybody else and there isn't much variation in that from year to year. Most of the policies are first dollar, no deductible and most of them have pretty standard coverages. So we haven't seen the kinds of things that maybe we saw in the late 90s in the marketplace of companies offering two or three year rate guaranties on a regular basis. But other than that there really isn't a big terms and conditions difference in any market. Of the hospital side of the business, yes, there's certainly some deterioration, but we haven't and we don't write that much hospital business, and the deterioration there is reduction of required deductibles or self-insured retentions or higher credits for those deductibles. And that again has not had a significant effect on us because typically, we're writing the smaller to mid sized hospitals that didn't carry large deductibles or retentions anyway. So I think that on your second part of the question regarding limits, I think the limits being purchased have pretty much stabilized in most areas. Certainly on the whole lower than five or six years ago, mainly because of lack of affordability, at least among our insureds. We've continued to offer policy limits consistently over the last 10 years. We haven't cut back on the limits we've offered, but we have seen insureds purchase lower limits in part due to rate increases and maybe to some extent due to their optimism about the effects of tort reform.

But that's pretty well baked in?

Sure, that hasn't changed probably in the last year or two, so I wouldn't see that as having a significant impact one way or the other on what we report as our rate level.

Okay, and I guess just one final question in terms of M&A, and I apologize if you already answered this. Is there any specific size you might be targeting, or are you pretty much open to a large or a small potential M&A candidate?

No, we'll take the opportunities as they come and evaluate them and what seems appropriate for us given the time and space in which we find ourselves, we'll move on it. But we intend to be as opportunistic as our balance sheet permits.

Let me just add if I might, as the fourth largest Med-Mal carrier, really the opportunities that come up are generally speaking digestible opportunities in terms of size.

Got it. Okay, thanks so much.

And Mr. O'Neil, at this particular moment there are no further questions from the phone audience.

Thank you very much. I guess in closing, I want to give a salute to our employees for the accomplishments that really is their doing, our inclusion in the Ward's 50. We see that as a recognition of good operations here, and again we want to salute our employees for their part in that. And with that, we will tell everybody goodbye and expect to see you next quarter. Thank you.

And Ladies and Gentlemen, that does conclude our presentation. We thank you very much for your participation. You may now disconnect. Have a great day.