ProAssurance Corp (PRA) 2017 Q4 法說會逐字稿

Good morning, everyone. Welcome to the conference call to discuss ProAssurance's results for the fourth quarter of 2017. These results were reported in a news release issued on February 21, 2018, and in the company's yearly report on Form 10-K, which was also filed on February 21st. These documents are intended to provide you with important information about the significant risk, uncertainties and other factors that are out of the company's control and could affect ProAssurance's business and alter expected results.

We also caution you that management expects to make statements on this call dealing with projections, estimates and expectations and explicitly identifies these as forward-looking statements within the meaning of the U.S. federal securities laws and subject to applicable safe harbor protections.

The content of this call is accurate only on February 22, 2018, and except as required by law or regulation. ProAssurance will not undertake and expressly disclaims any obligation to update or alter information disclosed as part of these forward-looking statements.

The management team of ProAssurance also expects to reference non-GAAP items during today's call. The company's recent news release provides a reconciliation of these non-GAAP numbers to their GAAP counterparts.

Now as I turn the call over to Mr. Frank O'Neil, I'll like to remind you that the call is being recorded and there will be a time for questions after the conclusion of prepared remarks.

Mr. O'Neil, the floor is yours, sir.

Thank you, Mike. Our call today is joined by Chairman and CEO, Stan Starnes; our Chief Operating Officer and Chief Financial Officer, Ned Rand; Howard Friedman, the President of Our Healthcare Professional Liability Group; and Mike Boguski, President of Eastern, our Workmen's Compensation writer. Stan, will you start us off?

Thank you, Frank. As pleased as we are with our continued progress across all of our lines of business, we also remain very excited about the future. For the first time in many years, we are seeing signs of change in the loss environment, and consequently, the pricing environment in Healthcare Professional Liability. It's still too soon to make definitive statements, but if that proves to be the case, market conditions will ultimately favor companies such as ProAssurance that had maintained underwriting and claims discipline, have a strong balance sheet and have expanded their capabilities to meet the changes in health care. Coupled with the ability of Eastern, our Workers' Compensation writer, to continue to produce excellent results in the midst of price competition in that line and the growing sense of a degree of pricing discipline maybe returning in the Lloyd's market, we are optimistic about what lies ahead.

I'd like for Ned, Howard and Mike to discuss those things with you. Gentlemen?

Thank you, Stan. We've been competing successfully in a rapidly changing market in all of our lines of business. Over the last 10 years, we have transformed the company and are positioned to serve the shifting landscape around healthcare professional liability buyers and their representatives.

I think we have done that successfully, as demonstrated by our increased penetration in the vertical market, submissions were up 22% in 2017 over the prior year, and we added a number of complex multistate or multispecialty risks on our books.

If indeed the markets do begin to firm, we believe our financial strength, geographic reach and deep expertise will serve us well in this changing landscape.

And that's why I think Howard can add some valuable color. Howard?

Based on both our own data and what we are hearing and seeing in the broader market, severity may be picking up a bit. We have heard it within the industry and reports of the number of headline-grabbing shock verdicts seem to confirm it.

In our book, we have seen limited evidence to date, but enough that we feel the need to take this into account when setting case reserves for clients with potentially higher losses.

We've continued to maintain our pricing discipline and have not wavered from our reserving philosophy, so we believe we are well prepared for any increased severity on the horizon. In that scenario, beyond realistic premiums many companies have charged in order to maintain market share, will not be sustainable. We know that in several jurisdictions, one of our major mutual competitors is already filing for rate increases and is forcing insurers to choose between policyholder dividends or contributions of a loyalty program that they have long-touted and used as a retention tool.

We also know that higher frequency also accompanies higher severity. Plaintiff's lawyer always follows the money. As a writer of claims made policies, we can adjust relatively quickly to rising frequency as compared to our currents policies that lock insurers into coverage that can prove to be unprofitable in a worsening wealth environment. We also have built-in flexibility in our rate structure, given the debiting and crediting capabilities in our filings.

So again, I feel like the market is changing, but gradually. As Ben has said on more than one occasion, any change will not be as if someone flipped a light switch, but more like turning up the dimmer until things are a lot brighter.

Thanks, Howard. I'll give you a minute to just catch your breath, but against that backdrop, will you discuss the results in Specialty P&C?

Sure, Frank. I think my prior remarks gave a great deal of directional color, so I'll be brief in discussing the underlying details. Gross premiums written group, 2.5% in 2017 as compared to 2016. The 2 largest components and the ones most indicative of our progress are premiums for physicians and health care facilities.

Year-over-year physician premiums grew 5.9% on strong renewal retention and higher renewal premium that I'll discuss shortly.

Facility premiums were down approximately $12 million, but as we mentioned several times in our news release, a large single premium policy that we wrote in Q4 of 2016 skews the comparison. And just a reminder that, as we continue to penetrate the larger risk market, the size of the premiums associated with these individual accounts can cause difficulty with period-over-period comparisons.

Our premium retention in the physician line, which is the single-largest line in this segment, was 90% for the year, a 2-point increase, and importantly, 92% in the fourth quarter, a 5-point increase over Q4 of 2016.

Facility premium retention was 86% for the year, a 7-point increase over 2016. Retention in all the other lines in Specialty P&C was greater than or equal to 2016.

Pricing on renewing physician business, a key benchmark for us, was up 1.3 points year-over-year and was unchanged quarter-over-quarter. In the facilities line, renewal pricing was 8% higher year-over-year and 6% higher quarter-over-quarter.

The increases in renewal pricing and our ability to maintain strong retention appear to support our perception that the healthcare professional liability market seems to be a little less price competitive and may lead to greater opportunities for us.

Our current accident year net loss ratio for 2017 was 89.9%, up modestly by a little more than a point over 2016, primarily due to changes in the mix of business.

In the fourth quarter, our current accident year loss ratio was 93.4%, almost 4 points higher than Q4 2016, primarily due to our view of coming litigation trends as well as an increase in our reserves for the death, disability and retirement, or DDR provisions, in individual physician policies and changes in the overall mix of business.

Favorable reserve development was strong, if a bit lower than last year due to the factors I have previously cited. In 2017, we recognized approximately $119 million of favorable net loss reserve development in Specialty P&C. Every line in the segment experienced some level of favorable development. As you would expect, the majority was in the healthcare professional liability lines at $104 million, with an additional $10.1 million coming from the life sciences and medical technology line and $5.2 million from legal professional liability.

In a quarter, net favorable development was $37.4 million. Again, the majority of which was from the healthcare professional liability lines.

Frank?

Thanks, Howard. Now we're going to turn to Mike Boguski for comments about the 2017 results in Workers' Compensation. Mike?

Thank you, Frank. The Workers' Compensation segment operating results increased to $15.1 million for the year ended December 31, 2017, compared to $5.9 million for the same period in the prior year, driven by an increase in net premiums earned and a decrease in both the net loss ratio and underwriting expense ratio.

Gross premiums written increased 6.2% to $263.4 million for the year ended December 31, 2017, compared to $247.9 million for the same period in '16, an increase of $15.5 million. In both periods, the increases were driven by growth in each operating region and by increased new business writings, which were $47.7 million during the year compared to $33 million in 2016.

The new business result in 2017 were enhanced by the Great Falls Insurance Company renewal rights transaction in our newly-established higher hazard unit, Eastern Specialty Risk. These 2 important strategic initiatives contributed new business writings of $8 million during 2017.

Order premium was $4.1 million in 2017 compared to $6.3 million in 2016. Renewal pricing decreased 3% during 2017 due to continued price competition in the Workers' Compensation marketplace that has reflected both improved claim trends in recent years.

Premium retention was 87% for the year, a 2-point improvement as compared to 2016, and was especially strong in alternative markets at 92%.

We were successful in renewing all 23 of the available alternative market programs during the year. The decrease in the 2017 calendar year loss ratio reflects strong claim closing trends, resulting in an increase in net favorable loss reserve development in 2017 compared to 2016.

During 2017, we successfully closed 64.6% of 2016 and prior claims, one of the best claim closing results in the -- Eastern's history, and indicative of the short-tailed nature of our Worker's Compensation business model. We recognized a net favorable prior year reserve development of $14.3 million for the year compared to $6.1 million in 2016. This includes $5.7 million in our traditional business during 2017 compared to $1.6 million in 2016. In alternative markets, net favorable development was $8.6 million in 2017 compared to $4.5 million in 2016. The 2017 net favorable loss reserve development in our traditional business reflects better-than-expected claim results, primarily related to accident years 2015 and 2016.

Additionally, the net favorable loss reserve development includes $1.6 million related to the amortization of purchased accounting fair value adjustments for our traditional business in both 2017 and 2016.

A decrease in the full year 2017 underwriting expense ratio primarily reflects a 1-point reduction in intangible asset amortization and the continued effective management of general expenses, partially offset by an increase in underwriting acquisition expenses.

The combined ratio of 91.1% includes 1.3 percentage points of intangible asset amortization and 0.9 percentage points of a corporate management fee.

We were pleased with the strong finish in 2017. I want to highlight a few items on the Workers' Compensation results for the quarter ended December 31, 2017. Gross written premium increased 12.4% over the same period in the prior year, and the combined ratio was 89.8%, including a calendar year loss ratio of 57.3%.

The Workers' Compensation segment operating results increased to $5.8 million for the quarter compared to $1.3 million for the same period in the prior year, an increase of $4.5 million.

Finally, we are extremely pleased with our strategic progress in 2017, highlighted by the successful close of the Great Falls Insurance Company renewal rates transaction in the third quarter, which now serves as our New England regional office. In addition, the launch of our higher hazard unit, Eastern Specialty Risk, in the first quarter of 2017 provides an additional product and service strategy to our valued agency partners. Both initiatives contributed to profitable growth to the organization during 2017.

Thanks, Mike. Let's go back to Howard now for an update on the Lloyd's segment. And as we do, please keep in mind our usual preface that the results reflect our 58% participation in Syndicate 1729. We normally report those results on a 1-quarter lag and that's what we're doing this quarter, but as was the case in Q3 of this year, where already in 2017 when there is an event, which we believe will have a material impact on the segment and thus should be the disclosed to investors for the sake of transparency, we'll do so in that quarter.

Howard?

Thanks, Frank. We're pleased with the top line growth of the Syndicate, up almost 8% year-over-year to $70.2 million, mainly due to new business written and volume increases on renewing business.

Remember that much of the Syndicate's premium is initially recorded based on estimates of business to be written by the primary insured. In the case of law-sensitive treaties, estimated losses also play a role.

In the fourth quarter, we revised estimates of storm-related losses and associated reinstatement premiums reported with our third quarter results. Thus, gross premiums reported in Q4 were $13.2 million, down a bit, more than $1 million, quarter-over-quarter.

The full year net loss ratio was approximately 14.9 points higher than 2016 and 11 points of that increase was due to storm-related losses. However, largely due to revisions made in Q4 2017 to estimates of storm-related losses, the net loss ratio in the quarter was 28 points lower than the prior year's fourth quarter.

Just a few housekeeping items to wrap up. Starting in the second quarter of this year, due to the quarter lag, we will be including the results of Syndicate 6131 in our Lloyd's segment reportings as it started writing business on January 1.

As we explained in our second quarter call in 2017, Syndicate 6131 is a special-purpose arrangement, an SPA, alongside Syndicate 1729. Client premium is approximately $22 million and will target a portfolio of contingency and specialty property business to leverage the expertise of 4 new underwriters. Syndicate 1729 benefits by retaining approximately 40% of the business written and ceding the remaining 60% to the SPA. ProAssurance is the sole capital provider to the SPA using capital already committed to Lloyd's.

On that subject, we have increased our 58% participation in Syndicate 1729's results to 62% as of January 1st of this year. Maximum underwriting capacity for Syndicate 1729 for 2018 is approximately $178 million based on year-end exchange rates. Frank?

Thanks, Howard. Ned, would you bring us home with the discussion of corporate segment, consolidated results and it would probably be appropriate if you would add any comments on the effects of tax flow?

Sure, Frank. You've heard details on our operating segments from Howard and Mike, and there are a few additional items I'd like to highlight. Our coordinated sales and marketing efforts continue to bear fruit, generating approximately $16.3 million of new business in 2017. Our consolidated net investment result was $103.7 million, 10% higher than in 2016. That included a $4.4 million year-over-year decline in net investment income, more than offset by a $13.8 million increase in equity and earnings of unconsolidated subsidiaries.

Lastly, I do want to mention a few of the impacts of the new tax law. For 2017, the primary impact was around the reevaluation of our net deferred tax assets, which are now valued using the 21% tax rate rather than the 35% rate. This resulted in a $6.5 million charge in the quarter. In addition, we reduced deferred taxes related to anticipated future deductions for certain executive compensations that were no longer be deductible under the new law, resulting in an additional $3.5 million charge.

Looking forward to 2018 and beyond, and there are a number of impacts, some of which offset the impact of lower tax rate. The Base Erosion and Anti-Abuse Tax or BEAT has a potential impact on our Cayman Island operations, and we're currently exploring our options to address this very punitive measure. We're also reducing our exposure to municipal bonds within our investment portfolio given our current tax credit holdings and the fact that the tax preference from these investments are less valuable given a 21% tax rate.

Frank?

Thank you, Ned. Stan, any final comments to wrap up?

Thanks, Frank. A month ago, we gathered many of our colleagues at ProAssurance for a meeting to discuss our plans and expectations for 2018 and beyond. I said to them that when our current management team took over almost 11 years ago, our main operational task was to broaden our ability to offer the coverages that would accommodate changes ahead in the markets we now serve. I told them the results from the past 2 years show that we are accomplishing that goal, and importantly, this comes at a time when we believe a world of opportunities will open up for us due to our size, scope and expertise. We're confident that bodes well for our shareholders and for our future.

And as on the side, permit me one moment to congratulate Ned Rand on his promotion to Chief Operating Officer. I have great confidence in Ned, a trusted adviser and a skilled executive who has been instrumental to the success of ProAssurance during his 13 years here. I have equal confidence in the line of business presidents who have proven their ability to effectively lead organizations and who will retain broad responsibility for their operations as they report to Ned. In addition to strengthening our day-to-day operations, this move will give me more time to focus on developing strategic initiatives and seeking opportunities for future growth.

Frank?

Thank you, Stan. Mike, that wraps up our prepared remarks. If you'll open the lines for the questions, we'd like to hear what people are asking.

(Operator Instructions) The first question we have will come from Arash Soleimani of KBW.

Congrats to Ned as well. So first question I wanted to ask, just back to the comments on the tax rate. How should we think of the effective tax rate going forward? I mean, just given the favorable investments that you have, does the tax rate end up just basically staying sort of flat? Or should we actually look for it to come down a bit in 2018?

Arash, that's a good question. I think we're still trying to work through a few of the nuances of it all. I mentioned the Base Erosion and Anti-Abuse Tax, and that is essentially an excise tax on payments to foreign affiliates. And with our Cayman Island operations, we currently see it somewhere in the neighborhood of $100 million, $120 million to our eastern reaffiliate in Cayman. And under the provisions of the BEAT tax, that would be exposed to a 5% excise tax. We're currently looking at different alternatives and different structures in the Cayman Islands that will alleviate that exposure, but we have not finalized our plans in that regard, and that's probably the biggest offset to the 21% tax rate that we have. And there are a number of other things that will impact it more around timing. How losses get discounted is impacted and will have a detrimental impact on the current tax expense, but that'll be offset by a deferred tax expense. There's some small things around the non-deductibility as entertainment expense proration rules that are a little more punitive. So -- and dividends received deduction, that's a little more punitive. So all those go to kind of offset the impact of the 21% rate. And when you put on top of that the tax credits that we hold, it's a lot to try and figure your way through. I do not expect that our effective tax rate will go up in 2018, but I think it's too early to give a clear indication exactly where it's going to land.

The other question I had. You had made some comments about seeing some signs of increasing severity and you know, you said you were kind of -- you're reflecting those in your reserves. Should we expect favorable development to be a bit lower as a result of that? Or it doesn't really have a meaningful impact?

This is Howard. I think you've probably seen over the course of the past year, or even longer than that, that favorable reserve development has gradually reduced. And we've talked about the reasons for it, smaller base of reserves, less benefit from the loss severity trends that had been lower as compared to years in the past. And I think we'll continue to see that type of gradual movement. If claims severity indeed picks up, well, then certainly, favorable development will reduce because it -- severity has an effect of working backwards through the open inventory. We're not necessarily saying that at this point. We're just saying that we see some signs out there, and we're being cautious about what we're doing right now.

Okay. And just my last question. In the comments you've mentioned, in terms of the competitor making the rate increases and potentially seeing the market firm a bit more. I think you guys have been disclosing something in the 2% range. Where -- based on what you're seeing, I mean, is this something that you would think would take it to kind of a 5% range or what type of magnitude are we talking about here?

And you're referring to severity trend, I presume?

Sorry, I was referring to the rate increases that -- I guess you seem to imply an indication that rate increases may accelerate.

Sure. I just wanted to clarify. But you know, what we talked about with the -- we track our renewal pricing, and as we said, it was 1.3% increase for the year. I would expect that we and others in the marketplace will be looking to have moderate increases in the effective rates that are charged, whether that's through explicit rate changes or reduction of rate credits or just reflection of loss experienced on the experience-rated accounts that will be gradually picking up as we go through the year. We don't have an explicit target for a rate change at this point in time. We take one state and product at a time as we go through the process. But as you've seen over the past several quarters, we've been able to maintain pretty high retention and still get positive rate.

Stan, something there?

You know, Howard plays very close attention to the direction of the statistics to loss cost to trends, and we are a very data-driven organization, and I don't want anything I say to detract from that. I will tell you that, anecdotally, it's very difficult for me to see how a rational competitor could regard the soft market as continuing. I think we'll look back and say that we have turned the soft market around. Now, that's nothing more than my opinion, and I am not the expert that Howard or Ned or others are in this. But I think that is a significant thing, and I think it's incumbent on me to share it with you. And frankly, I've been waiting 11 years to say it.

Next, we have Greg Peters with Raymond James.

And I guess, I'll throw in my 2 cents. Congratulations, Ned. Can we just step back and focus on the specialty side? Howard, I know you don't break it out by product or group, but maybe you could provide some color around the underwriting results of the facility business versus the physicians’ business? And I guess, ultimately, what I'm trying to get at here is, you noted in your results and in your commentary that the accident year loss ratio was up in '17 versus '16, and I'm just trying to gauge whether we should expect it to go up further in '18 or if it's going to stabilize or how to read your color in your commentary?

Sure. I think there's a number of pieces to this, as you probably know. First, it's facilities versus physicians, then you have large accounts versus smaller accounts. You have business that is priced with commission and business that is priced net of commission. So it all plays into that. The last point, obviously, if it -- a large account is on a fee basis then more of the premium is expected to go to loss costs, and you get a higher loss ratio even if your results don't change on a net basis. So it all gets into incident mix. What we have observed in the industry, probably a little bit more so than what we have observed in our own data, is that larger facility accounts that have taken on a good bit of additional exposure, that is the large hospitals that have acquired smaller hospitals or hospital groups that have acquired physician practices, have added a good bit of exposure in and had increased their potential for loss severity, in part due to the fact that there are higher policy limits available. For example, a physician's practice that's part of a hospital now is exposing the entire hospital and its limits to losses, whereas in the past those physicians might have only had $1 million policies. So we see potential there for severity to go up, and that is driving some of our expectations, if you will, about loss ratio. So we are recording some higher loss ratios on the larger account business and on the facilities business in anticipation, if you will, of what might be coming down the road and what we have observed or heard about in the news reports.

Is it fair to say on the physician side that the loss ratio -- the accident year loss ratio is stable and not necessarily seeing the same type of pressure that you're referring to on the facility side? Or should I just go back to Stan's original comments about severity picking up and assume that it's also hitting the physician side of the book?

I think the way I'd say it is that, if you would be able to look at apples-to-apples physician -- what I'd call traditional physician, smaller-group-type business, very stable in terms of our results. As you get into larger and -- accounts, larger groups of physicians and physicians that are part of larger health systems, increasing severity.

Great, great. Great color. Appreciate that. I guess, Mike, a question in your direction. You referenced renewal rights transaction, and at the same time you also highlight, what I would in my words, not yours, intensely competitive market conditions. When you think about 2018 and '19, how do you set your budgets for growth not only in terms of revenue, but also in terms of earnings, considering the competitive headwinds that you've referenced?

(inaudible)

Go ahead, Mike.

Now, I was going to say -- let me just start with the growth side of it. One, we were pleased with the 6.2% year-over-year growth. And a couple of important points there: one, our renewable retention -- we really like our book of business, and our renewal retention was 80 -- 87% this year, a couple of points better than it has consistently been. And we are particularly pleased with our alternative markets business that was at 92%. And it tends to be a sticky business for us, Greg.

The other thing to take a look at is, we have a really good client service model that has really helped us with retention on our -- particularly our midsized to larger accounts. And then there's been real nice consistency across our operating third parties. Our original business executives are doing a very nice job of running our region. So we have some consistency there. I look at Great Falls, strategically as, one, we believe it's an attractive transaction. It provides us with scale in our small business book of business. It provides us with geographic diversification. The ability to take our middle and larger products up into the region. Keep in mind, we renewed about 3.4 -- we had new business but came off of the renewable book of about $3.5 million in 2017, but the overall book of business is roughly $13.6 million. So we still have a long way to go on transitioning that business, and I would say that we're delighted with how the companies are simulating and integrating. Secondly, the Eastern Specialty Risk. We had a good year. We had $5 million in writings, a solid loss ratio and we're off to a good start. And it's one of those businesses that turns nicely as the cycle changes down the road. So at the end of day, I think, we have a well-diversified operating region, broad product spectrum. We expect the 2 new initiatives to be attractive for us on the growth side. And then, we believe we have very, very strong agents across our geographic footprint.

So we're encouraged directionally where we can go on that side. Related to the profitability, we keep a really, really close eye on frequency trends, severity trends. We're an individual account underwriter, and we think we're going to continue to perform nicely across the different economic and insurance cycles. So we're encouraged as we go into 2018.

And then Ned, I just wanted to come back to the tax rate issue as it relates to 2018, and you referenced the captive and the other challenges that you're facing. Is it possible that we could see a -- the early quarters, the first and second quarter, with a higher consolidated tax rate for ProAssurance? And then, as you make the adjustments, have it lower in the subsequent quarters? Or -- how should I -- is there any additional color you can provide around that? It would be helpful.

Sure, Greg. I don't think that we would expect that the tax rate in the first couple of quarters necessarily to be higher. I think we'll work out a good solution on the BEAT tax that will not have a significant negative impact to us. I mentioned in my prepared comments that we're lightening up our municipal bond holdings. We're doing that because the tax credits we hold are kind of more than sufficient to absorb most of the taxable income that we'll generate. So my expectation is that, again, it won't be any higher than it was this year. But I don't think there's going to be -- unless some rules get written to make that preference. Unless some rules get written -- as the rules actually get rolled out for the law that we've not anticipated, I don't see it where there would be a lot of volatility. I guess, one thing to do keep in mind, I mentioned that we had about $3.5 million charge because of the lack of the future deductibility of some executive comp now under the law. We did have a sizable deduction in the first quarter of last year that stems from the equity stock awards that we grant, and to the extent those are being granted to our executives, we'll lose some of that deductibility. So on a comparison basis, we'll not get as big a benefit out of that in the first quarter, but that's the only kind of volatility that I would anticipate in the tax rate.

Next, we have Mark Hughes of SunTrust.

In thinking about the loss pegged for 2018, your full year, for 2017, and the Specialty P&C was 90%. Your fourth quarter though was 93%. Should we tend more to the 93%?

Mark, at least from the perspective of looking at it quarterly, the fourth quarter was always a, if you will, a bit of a true up for the year. And we mentioned in there that we had an adjustment to the death disability retirement reserves. We also go back and look at the loss ratios that we're applying to each component of the business with the perspective of having a full year. So there's -- I think I would say look at the year rather than the quarter.

Right. And I'll ask the same questions with workers' comp. The workers' comp loss was higher in the fourth quarter. Should we just sort of use the full year as a good proxy or maybe increase that a little bit if pricing is down?

Thank you, Mark. The current accident year in the workers' comp business, we did see some increase, particularly in our alternative markets business in the fourth quarter, which we adjusted accordingly. And we also looked at the decreases in the rates of approximately 3% during the year. So it presented us with a view to record higher accident year loss ratio in 2017. And to the degree that those 2 trends continue, we'll have to, obviously, be conservative and book a slightly higher accident year loss ratio.

The outlook for the Lloyd's gross written premium. I know you talked about the potential -- or a price discipline returning to Lloyd's market. Is that going to be a growth business this year?

I think we're optimistic about what the market can bring. From a growth perspective, keep in mind that we also have the SPA that will add premium, I think the commentary is that we've -- everyone has seen coming out of the market is perhaps the pricing hasn't been as strong as the market had hoped. But still a lot of renewable business, especially on the property side, to come in the summer. But the initial trends that we are seeing in the marketplace are better pricing discipline, which should've at a minimum will lead to stability in that book and, hopefully, lead to some growth in the book.

And then the underwriting expenses likewise were a little higher, it seems like in the Specialty P&C and the workers' comp that's in the fourth quarter. Am I reading that properly? And is there any change there or it's just a variability?

So on the Specialty P&C, we've had a number of IT initiatives underway, and we're beginning to see some of those come through as depreciation expense that are impacting the expense ratio. I think that's probably the most significant. The other thing, just to the point Howard made earlier is that as we write larger accounts, we also have a mix of business where there is low or no commission or brokerage fee, it's all written on a net basis, and that's going to add some volatility and up and down to that expense ratio as well. Mike, you want to comment on the comp side?

Yes, absolutely, Ned. You know, on the comp side, we are pleased with the -- where we're at on the general expense side. I mean, the team did a very nice job of managing those expenses. We did see some -- a kick-up in underwriting acquisition expenses, slight commission pressures, but primarily regular -- regulatory expense pressures on that side of the business. For example, we had our Pennsylvania state audit exam this year. That was in those expenses. But overall, I'm optimistic that we're going to continue to manage expenses very well going forward.

The -- is there any pattern to the increase in the severity? Is this a function of the kind of a knock-on effect of the consolidation of the big groups and hospitals that has -- that's happened. And Howard you pointed out that there's additional exposure, higher limits associated with that? Or is this higher jury verdicts? Some of the old -- I guess, is social inflation. Is that coming back a little bit?

It's hard to say at this point. It may be ultimately hard to say even with more information, but I think it's both of those things. Certainly, the availability of larger, in short, limits, in the bigger accounts. And I'm talking in general for across the industry now, I think it has an effect on it, just in terms of taking the same case and making it more valuable from an insurance perspective. And then, yes, I think the improving economy probably has a psychological effect on juries. You know, what we saw 20 years ago, in the late '90s, I think that was a big part of it then.

And then a final question. This -- big picture, how does this play out? I think Stan you would suggest that you'd been waiting 11 years and that's -- it gives you some enthusiasm about the business. But do you got to endure a few lumps in the meantime, you know, higher current accident years? Maybe you got to look at your reserves and sharpen up your pencil a little bit there. And so, therefore, are you -- at least in terms of financial performance, if things turn out well, you end up taking a little bit of a near-term haircut and then it pays off down the road. Is that a -- the more likely scenario?

Well, I don't know that I would describe it exactly like that. But what I would say, Mark, is that a return to historic norms will only benefit ProAssurance over the next number of quarters and years. And by that I mean, that if everything is low-hanging fruit then it's no -- there is no difficulty in picking it. If when the water gets choppier, if people have a more difficult time navigating through an environment, particularly when they've never experienced it before. And my own view is that while you may see severity go up, you may see the consequent price increases, that we're in a better position to deal with that because of our underwriting expertise and experience, because of our claims underwriting expertise and experience, because of the broad geographic diversity we enjoy and because of the size of our balance sheet. So while nothing is going to happen at least so far as I can see. As Ned said, like throwing a light switch, I think the direction of the rheostat has changed, and I think it's going in a different direction and I think, all-in-all, that will be to our benefit, because I think we can manage through it well. Remember what Doctor Crow used to say, "You don't have to outrun the bear, you just have to outrun everybody else trying to get away from the bear."

So I guess, I'll summarize and say, if it's a sort of a steady acceleration, then that's good for your bottom line and it's more predictable. If there is some sharp turns and maybe it becomes a little -- there is more volatility in the financial performance.

And I don't have any reasons to suggest to you that that's inaccurate or unfair.

Next we have Paul Newsome of Sandler O'Neill.

I just want to make sure I do -- I have it right. Your -- it does sound like you're guiding towards higher accident year loss ratios because of the specialty book severity. And is there any way we could think about sort of magnitude of that? It's been sort of gradually creeping up, at least in the last couple of years, but is the trend really changed that much recently? Or is it something we should just continue to see what we've seen in recent years?

I'm going to let Howard give you the actuarial answer to that question, but I would offer the following. At the end of the day, severity is driven by loss cost. Loss cost are driven by lost wages and medical inflation and medical cost. Those are knowable and, to a certain extent, predictable. But there's another component for lost cost and that's the softer damages. At the end of the day, severity is a most highly influenced by jury verdicts, because, while there are not a lot of jury verdicts in this area, the jury verdicts that come down have an impact on the expectations of the plaintiffs' bar, and that causes plaintiff's settlement demands to go up, and that's what produces the upturn in severity. But there's nothing about what we're seeing that's going to dampen the expectation of the plaintiff's lawyers. But that's why I think we have such an advantage here. Because of our cadre of lawyers across the country, because of the excellence of our claims department and because we've been through this before. On a number of different occasions. That's sort of the street view of severity. Now I'll let Howard give you the actuarial view of it.

Sure, Paul -- and I agree with everything that Stan said, and in terms of the -- I'm not sure that -- I wouldn't say that we're giving guidance here in terms of higher accident year loss ratios. What we're trying to point out is that, we are seeing what we think are some signs of increasing severity. We're trying to react to them. The other part of the loss ratio, of course, is the pricing, and we're making progress on that as well. So the denominator is going up just as the numerator might, and those 2 don't always exactly line up. You have to earn the premium once you write it. The pricing that we talk about is based on the renewals that we see. So it may be a little choppier, depending on what we see on the loss side, but we're certainly making the efforts on the pricing side to stay as current as we possibly can.

The next question we have will come from Amit Kumar of Buckingham Research Group.

Congrats, Ned, on your promotion to COO position. I guess, just a few follow-up questions. And maybe this again goes back to the discussion on loss cost trends and your discussion on jury verdicts. I'm still trying to understand what exactly is going on? We've heard that an increase in loss growth trends from other companies, but it seems that your view is a bit more stringent compared to other companies of what have we've heard. I'm curious, do you think that the market is still a bit late to the game or are you just being very cautious on this trend line?

Amit, it's Howard. I think -- I don't know how to handicap what the other companies in the marketplace, or even throughout the industry, are seeing versus talking about. I think we're trying to be transparent about what we're seeing. We're trying to be careful about the indications and not get caught short or caught late to the game, so to speak. That informs what we established for our loss costs. It also informs what we established in our pricing. So rather than try to say we're ahead or behind or what others are saying and how many others are reporting specifically on healthcare professional liability in a public call. So a lot of what you may hear is pretty anecdotal, coming out of a conference or coming out of some type of a news article, but I think we're trying to be pretty transparent and explicit about it.

And then -- and most of this discussion is related to actual trends you're seeing in your book versus an industry analysis overall, correct?

No. What we tried to say -- what I was trying to say earlier is, we are seeing some signs in our case reserve -- case reserving, in other words, as the individual claims that are reported or being evaluated and reserved, and this is done by experienced claim specialists across the country for us in our various offices. They're seeing signs of increasing damage potential in some cases. They're seeing in the environment, as Stan pointed out, other jury verdicts that are higher. So they're being a little bit more cautious about establishing those case reserves. This has not translated into payments at this point in time. This is really what we're seeing, and we're reacting to those indications.

Got it. That's helpful. I guess, the second related question was, Howard, when you were, I guess, segregating the discussion between the behavior of smaller physician groups versus larger physician groups, could you refresh me? I know there used to be a number -- an approximate number in the past. What percent of your book would be larger physician services?

Getting into definitions here by what's large and small and all that. You know, I -- and I don't have the net percentages at my fingertips, even if you had a definition of what falls into each category. I guess, what I'll say is that, over -- certainly, over the past 10 years, the proportion -- as you probably will know, the proportion of physicians in groups of 5 or less, which probably was 75% or so of the total at that point in time, has diminished significantly. That's been a result of continuing to insure the same physicians but in larger practices, as they've consolidated, and also as the consolidation has taken place through acquisition. We've talked in different points in time about in maybe more than half of the physicians now in The United States being in some type of an employment relationship as compared to maybe 15% or 20%, 20 years ago. So I can't give you an exact answer. I think that it certainly has gravitated for us and probably most others in the industry as well to larger groups.

That's helpful. I guess, the only last question I have is, just going back to the discussion on the DD&R reserve adjustment. If you could refresh, and I remember this was on the tail coverage, and I think there was some adjustment a few years ago. What results in an adjustment, and is that like a year-end review? I know this shows up after like every few years. So let me just remind us what would result in a reserve adjustment on that book?

Sure, and we actually -- I mean, there is some adjustment every year. It's just a matter of whether it's up or down and how large. There are 3 factors that make up that reserve, as the name implies. The expectation of death, the expectation of disability and then the expectation of retirement, plus a few other things. In other words, what proportion of the physicians will remain insured to ultimately receive that benefit, the lapse rate. So it's a little like a life insurance-type calculation. We're looking at the probability of each, and as the average age of the physician book changes, that can affect the reserve. The potential lapse rate, in other words, more physicians that may go into, say, hospital employment, and leave us if they're no longer insured with us, that benefits the reserve. So we go through that whole process. And it is also influenced, obviously, by the expectation of loss costs. So those 4 or 5, 6 factors get into it, and when all the numbers have been compiled, literally on an almost a person-by-person basis, we come out with the reserve. So this year, with the higher current accident year loss ratio, that had an upward effect on it, and the slight aging of the book of business also had an upward effect on it from a depth and retirement perspective.

(Operator Instructions) Our next was a follow-up from Arash Soleimani, KBW.

I also wanted to just touch base on the DDR as well. So just to be clear, is that something that'll continue to impact the current accident year loss specs in the coming quarters?

It always has an impact, but isn't always an upwards impact. Again, depending on what we're seeing in terms of the current accident year loss ratio and the lapse rates are probably the 2 biggest factors there. If lapse rate increases then DDR reserve goes down, current accident year loss ratio moves up and DDR reserve indication goes up. It's a very long-term reserve, obviously, and it moves slowly, but it can move either way. We mostly do the analysis at the end of the year, candidly, because it doesn't change that much quarter-to-quarter.

So just to be clear, the reason I am asking is, in the release I think you said that the current accident year loss ratio increased because of this. So just to be clear, like this isn't an adjustment that you're making at all to prior-year reserves. This is all within the current accident year?

The way that the reserve is recorded and carried, it's always in the current year. So any changes to the reserve are always recorded in the current year. It's a bulk reserve that's out there and any adjustments flow through the current accident year line.

Perfect. And then just a quick one for Ned. On the tax rate this quarter, if you back out all the adjustments for tax reform and all of the other adjustments you have for realized gains and everything, it looks like the operating tax rate comes out to about 21%, if I'm calculating it correctly. I'm just wondering that, that seems a bit higher than normal for you guys. Is there any reason for that?

Yes. That seems -- I have to look at your math. That seems high. Hold on one second. Let me just take a look. So we come up with, for the year, an effective tax rate of 10.9% for 2017, when you take out the impact of the TCGA -- TCJA, excuse me.

I was backing out -- I was looking just for the quarter, and backing out not only tax reform but I was looking at the tax rate only on the underlying items. So assuming there was 0 realized capital gains and 0 backing out the SPC(inaudible)?

That becomes very challenging, because the way the tax credits work, it interplays with those. So it's hard to just call out in isolation, kind of, what you're trying to do. I appreciate what you're trying to do, but because of the tax credits, and if those tax credits go against realized gains as well as earnings, it can be a challenge to try and say what it would have been without the realized gains and losses.

Next, we have a follow-up from Mark Hughes of SunTrust.

The premium seated ratio was up a bit in the quarter, more mid-teens rather than low- to mid-teens. Is that a good ratio going forward? Or was that just normal variability?

I think probably -- again, for something like that, looking at the full year is probably more meaningful.

Okay. And then the favorable development within the workers' comp book. What accident years was that in?

Mark, it was primarily 2015 and 2016.

Well, at this time, there appear to be no further questions. We'll go ahead and conclude today's question-and-answer session. I would now like to turn the conference back over to the management team for any closing remarks. Gentlemen?

Thank you, Mike, and thank you all for dialing in. We appreciate your interest and we will look forward to speaking with you again in May.

And we thank you, sir, and to the rest of the management team also for your time today. The conference call is now concluded. At this time you may disconnect your lines. Again, we thank you all for participating. Take care, everyone, and have a great day.