Selective Insurance Group Inc (SIGIP) 2008 Q4 法說會逐字稿

Good day everyone welcome to the Selective Insurance Groups, Fourth Quarter, 2008 ,earnings release conference call.

At this time, for opening remarks and introductions I would like to turn the call over to Vice President Investor Relations, Ms.

Jennifer DiBerardino.

Thank you, good morning and welcome to Selective Insurance Group's Fourth Quarter, 2008, conference call.

This call is being simulcast on the website and replay will be available through February 27th, 2009.

A supplemental investor package which includes GAAP reconciliations of non-GAAP financial measures referred to on the call, is available on the investor page of our web site www.selective.com.

Also we posted on the our website the fourth quarter GAAP income statement in the investor package as it was inadvertently omitted yesterday.

Selective's operating income, a non-GAAP measure to analyze trends and operations, Operating income is net income excluding the after tax impact of net realized investment gains and losses.

We believe that providing this non-GAAP measure makes it easier for investors to evaluate our insurance business.

As a reminder, some of the statements and projections that will be made during the call are forward-looking statements as defined by the Private Securities Litigation Reform Act of 1995.

Forward-looking statements are not guarantees of future performance and are subject to risks and uncertainties, We refer you to Selective's annual report on form 10k filed with the US Securities and Exchange Commission for a detailed discussion of these risks and uncertainties.

Please note that Selective undertakes no obligation to update or revise any forward-looking statements.

I would like to take this opportunity to mention we will be hosting an investor day on March 24 in the New York City metropolitan area, please watch for more details in February.

Joining me today on the call are the following members of Selective's executive management team.

Greg Murphy, CEO, Dale Thatcher CFO, John Marchioni,Chief Underwriting and Field Operations Officer, Mary Porter, Chief Claims Officer, Ron Zaleski, Chief Actuary, and Kerry Guthrie Chief Investment Officer.

Now, I'll turn it over to Dale to review the quarter results.

Thanks Jennifer.

Good morning, as results indicate the fourth quarter was difficult, largely due to the current volatility in the financial markets.

As we indicated to you last quarter we expected fourth quarter reductions in alternative investment returns dividend income and the master limited partnership mark-to-market adjustments.

These were, in fact, the drivers of the fourth quarter earnings down side; however, the magnitude was larger than we anticipated given the state of the financial markets and the fact that the majority of our alternative investments report on a one quarter lag.

While we consider our investment portfolio to be conservative and well diversified, nearly all asset classes became correlated in 2008.

Severely undermining the benefit of asset diversification efforts.

Our portfolio, including cash and short-term, excuse me, has a relatively short duration of 3.5 years, we maintain a laddered maturity structure in our highly rated AA+ average quality fixed income portfolio.

100% of our fixed income portfolio, is performing according to contractual terms and less than 1% is below investment grade.

We view these declines in value to be temporary, given the high quality of our portfolio.

That said we have taken steps to limit portfolio volatility.

Early in 2008 we trimmed about $50 million of equities from the portfolio.

At year end our total equity positions stood at $132 million or 3.7% of investment assets.

Limiting the potential downside of further equity market declines, but maintaining a commitment to this historically profitable asset class.

In the quarter, we reduced our master limited partnership trading portfolio to minimize earnings volatility.

Despite the negative impacts we experienced in 2008 our equity portfolio has out performed the S&P 500, for the past nine years.

We adopted our alternative investment strategy in 1997, to provide additional yield in an equity-like portfolio.

This was not correlated the S&P 500.

This strategy has been very successful as it has out performed the S&P 500 by approximately 1000 basis points on an annualized basis since inception.

We employ six strategies within our $165 million alternative investment portfolio.

$57 million in energy private equity, $30 million in distressed debt, $24 million in secondary market private equity, $23 million in real estate, $23 million in mezzanine financing and $6 million in venture capital.

In the fourth quarter we sold our only hedge fund that provided near term liquidity in which we had a capital balance of $14.5 million.

Although the accounting for alternatives adds earnings volatility, their continued out performance of the S&P 500 builds more value for shareholders over the long-term.

Another by-product of the continued turmoil and ill liquidity in the financial markets, was a fourth quarter after tax net realized loss on the investment portfolio of $19.7 million, including after tax other than temporary impairments of $5.5 million.

Certain equity investments were sold in the fourth quarter at a loss to take advantage of financial and tax planning strategies.

For the full year the non-cash pretax OTTI write downs were $53.1 million, or 1.5% of Selective's total investment portfolio.

Only one fixed income issuer in the OTTI was due to a bankruptcy, the rest for market valuation driven and may be amortized back into income in future periods.

The OTTI also included $6.6 million in equities and $4.8 million in alternative investments.

It is also possible that future write downs including securities that we believe have strong underlying fundamentals, may be required in accordance with generally accepted accounting principles.

As one would expect, the severe pressure on investment valuations caused significant changes in our book value per share which was down 15% for the year to $16.84.

Book value per share reflected unrealized losses in our fixed income portfolio of $1.39, a decline in our equity portfolio's unrealized gain position of $1.21 and a pension charge of $0.72.

For the fourth quarter we reported operating income per diluted share of $0.10 compared to $0.60 in the fourth quarter of 2007.

The decline was mainly due to other investment income decline of $17.4 million after tax, or $0.34 per diluted share driven by our alternative portfolio; an after tax underwriting loss of $3.1 million, a decline of $0.08 per diluted share from a year ago; an after tax goodwill impairment charge of $2.6 million or $0.05 per delude share for selective HR solutions.

As a result of a slowing economy near term income expectations did not support Selective's HRs prior carrying value.

It is important to note that although the turmoil in the financial markets put extreme pressure on investment returns and earnings, our core insurance operations continue to perform well.

We are satisfied to report a profitable 99.2% statutory combined ratio for 2008, given the 104.8% industry estimate from Fitch Rating Service.

For the quarter, our statutory combined ratio increased 0.8 points versus a year ago, driven by higher non-Cat property losses of $2.4 million or 1.2 points.

Cat losses were flat compared to the fourth quarter 2007.

Over all, prior year statutory loss and LAE favorable reserve development on a pretax basis for the quarter was $8.6 million, or 2.3 points on the combined ratio compared to favorable development of $4.9 million or 1.3 points in the fourth quarter of 2007.

This quarter's favorable development was primarily driven by accident years 2005 and '06.

Partially offset by accident year 2007.

For the full year, favorable reserve development was $18 million.

Our reserve position is strong at 54%, above the midpoint of the actuarial range.

As a result of the various expense savings initiatives we implemented in 2008 and despite the 4.5% decrease in statutory net premiums written, the statutory expense ratio for the year was relatively flat compared to a year ago at 31.7%.

We acted early in 2008 to manage expenses with a work force reduction, agent commission changes and redomestication of two insurance subsidiary to Indiana.

These initiatives kept the expense ratio in line with 2007, but will also continue to benefit expenses going forward.

For the fourth quarter, the statutory commercial lines combined ratio increased to 102.4% from 99.4%, driven by higher loss costs which were partially offset by the aforementioned expense savings.

The impact on the combined ratio from catastrophe losses in the quarter was 0.5 points, 0.2 points higher than the fourth quarter 2007.

Commercial lines statutory net premium written declined 6.5% in the quarter and 5.8% for the year, reflecting our unwillingness to write aggressively in a soft pricing environment.

New commercial lines business was down 6% in the quarter and 15% for the year.

Despite the decline, policy quotes were up approximately 2% compared to 2007.

Audit and endorsement premium declined $38 million in 2008, due to the economic impact on our contractors book of business.

However, commercial lines renewal retention remain strong at 77%.

Renewal pricing including exposure was down 2.6% for the quarter, and just 1.5% for the full year.

Pure price was down 3% in the fourth quarter, and 3.1% during 2008, compared to much deeper declines in the industry.

This result, in a difficult market, reflects the underwriting tools and the discipline our underwriters employed throughout the year.

In the quarter, the commercial property and workers compensation lines performed well.

We continue to see pressure in commercial auto due to pricing competition as well as rising severity trends.

The general liability lines saw pressure as we decreased auto premium accruals reflecting the weakening economy.

Personal lines excluding our flood operations posted a 110% statutory combined ratio for the fourth quarter.

When comparing our combined ratio to the industry which generally includes flood in their personal line results, our combined ratio is 105.6%.

We believe our underwriting improvement strategies are beginning to take effect and expect to significantly improve underwriting performance over the next year.

Personal lines premiums grew for the sixth consecutive quarter with $51 million in the fourth quarter, a 2.4% increase compared to 2007.

We were successful in 2008 getting approval for personal lines rate increases and have plans to implement additional rate increases in 2009.

We continue to see impact of our rate actions on the old auto book.

In New Jersey our agents have been rewriting our book into the new MATRIX program.

New Jersey auto count declined to 65,000 cars at year end.

The roll out of MATRIX for homeowners is on schedule as we transition business into MATRIX our personal lines book could see some modest downward pressure on retention which currently stands at a strong 81%.

On January 1st, 2009, we renewed three reinsurance treaties.

The Property Catastrophe treaty, the Surety Access of Loss and the National Workers Compensation Reinsurance Pool Quota Share.

We were extremely pleased with the solid diversification and over all pricing given difficult market conditions.

The property catastrophe treaty came at an increase of $1.3 million or 7.8%.

The structure remained the same with 95% of $310 million in limit in excess of $40 million retention.

But the coverage improved to a one and 171 year event, up from a one and 159 year event based on last year's modeled losses.

This coverage improvement is directly due to our catastrophe strategy implemented in 2008 to reduce coastal exposure.

Surety Access of Loss treaty rates increased 5.4%, in line with market conditions.

We renewed our National Workers Compensation Reinsurance Pool Quota Share with a net increase of $0.3 million in cost.

This treaty now includes sessions for traditionally poorly performing New Jersey residual workers comp business.

We are conservatively managing our liquidity position and end of the year with $60 million in cash at the holding company and $140 million in cash in the insurance subsidiaries.

The holding company has access to a $50 million syndicated line of credit which expires in June, 2011.

Operating cash flow in 2008 was $241 million.

We maintain a conservative reinsurance program designed to preserve liquidity.

Additionally we maintain a laddered maturity schedule in our fixed income portfolio, which provides predictable liquidity to operations.

Capital preservation is paramount in the current environment.

Despite the decline in equity over the course of the year we feel we are adequately capitalized with premium surplus ratio at 1.7 times.

The average life on our debt outstanding is 36 years.

We have only $12 million in private placement debt maturing at the end of the next two years.

Our sustainable growth rate is approximately 5%, and we believe we are well positioned to take advantage of any potential price hardening in the commercial lines market.

If pricing conditions improve more dramatically than we anticipate, we will explore other contingencies to deploy such an opportunistic equity issuance or a quota share arrangement.

Now I will turn the call over to Greg.

Thank you Dale, and good morning.

In 2008, we experienced the most extreme confluence of economic and market events since the Great Depression.

The investing world seemingly lost confidence in risk management and risk modeling as diversification efforts collapsed when nearly all asset classes became correlated.

We manage Selective to mitigate risk associated with the various financial market scenarios.

We will; however, take prudent risk to enhance our overall long-term results while managing a conservative, well diversified investment portfolio to support underwriting activities.

We think that's the right way to manage the Company, to maximize shareholder returns while maintaining financial security.

The P&C industry had challenges in 2008, beyond financial market turmoil.

Commercial lines pricing continued to soften, although there were early signs of rate stabilization as the year wore on.

While Selective has seen less rate decline than any pricing survey shows for the industry, growth remains elusive.

The cycle management tools that we have in place protected us from writing business that is sure to be unprofitable.

While the short-term downside was a 5% decline in net premiums written, we believe we are in a better position to generate targeted return on equity levels over the long-term.

Underwriting profitability becomes ever more critical focus for the industry given a low interest grade environment, higher catastrophe losses, investment portfolio write downs and closer rating agencies scrutiny.

While many of my industry peers are banging the table for higher pricing, we don't believe that's registered yet with the underwriter at the street level.

Within the context of the current interest rate environment pricing becomes fundamental to improving return on equity.

When the pricing surveys are finally collected, we believe you'll clearly see that in 2008 Selective gave up much less rate than our competitors.

Pure commercial lines renewal pricing declined only 3.1%, a remarkable achievement in the current competitive environment.

We believe that's a direct result of the tangible evidence of Selective's successful strategy of maintaining close relationships with our agents and consistently giving them tools that enhance ease of doing business.

Early in 2009 we expect commercial lines rates to become less negative, and move in to positive territory later in the year.

We are already driving higher prices on targeted sectors and have incorporated those efforts into companies performance goals for 2009.

While this presents -- while this presents the possibility that we will drive away business in the short-term, we believe these actions will improve long-term profitability.

In January of 2008 we rolled out our last predictive model for commercial automobile.

We now have a full compliment of models in use.

Additionally we revised our first internal model for workers compensation, which is demonstrating a much better lift than the original model.

In personal lines we achieved significant rate increases in 2008 that will generate an additional $15 million in annual premium, most of which will occur in 2009.

We have more rate increases planned in 2009 and will generate about an additional $9 million in premium.

Reflecting the current competitive market environment, commercial lines new business was down 6% in the fourth quarter and 15% for the year.

New business growth by segment for the year is as follows-- One and Done automated small business $69 million, up 7%, middle market or AMS generated business, $176 million, down 17%, Selected Risk Managers our large account unit $22 million, down 38%.

Our cycle management efforts are best reflected in the large account arena, this is the segment of the market that continues to be the most competitive and where we've seen the steepest decline in new business.

However, we are getting opportunities to quote as demonstrated by a 7% increase in 2008 new business submissions.

We haven't been able to make sound actuarial pricing stick so the business goes to lower priced competitors.

We gave up only about four points of rate in 2008 on our large account business, less than we budgeted.

Retention remains strong with renewal premium retention at 81% and customer retention at 87%.

The middle market is still competitive but with our Knowledge Management tools in place we have the ability to identify business that can be priced for profitability.

Our field underwriters have tools to make discipline decisions even if it results in lower premium growth in the short-term.

We are pleased that we continue to grow small business with the expansion of our One and Done platform to include more business classes and a broader appetite within each class.

This will continue to be focused on in 2009.

As we reflect on our accomplishments in 2008, we believe we have done the right things to generate growth in profitability for the long-term.

The short-term set backs in 2008 financial markets may have slowed our progress but not stopped it by any means.

We will continue to focus on growth opportunities and saw solid success in our state expansion efforts.

We began operations in Tennessee which generated $6 million in premium in the first seven months of operations.

Our successful 2007 entrance to Massachusetts generated $15 million of commercial lines premium growth in 2008.

We increased the number of agents to relationships by 60, to approximately 940 agents at year end.

We are providing our agents with business leads to help them work with our field underwriters to generate more business.

All of these initiatives are designed to take advantage of the market as it turns.

We have innovative experienced and energetic work force and we leverage these strengths every day to serve our agents and insurers.

Our relationship skills combined with ease of doing business is why we highly rank in overall satisfaction in the agency survey.

This year was no different with a strong 8.5 on a 10 point scale with 83% agency participation.

Due to continued uncertain financial market conditions, we decided not to provide investment income and earnings guidance per share for 2009.

However, we are providing in the fourth quarter supplemental investor package an exhibit on page 11, that shows investment income by component for the fourth quarter and full year 2008, with the yields and affective tax rates for each class.

We believe this will allow you to build your 2009 models with your own assumptions on how the markets will behave.

Although we gave up less rate in 2008 than many competitors, we will still experience the impact of the 3.1% commercial lines rate decrease as premiums written in 2008, are earned in 2009.

The pricing impact, combined with normal loss cost trends will push our 2009 combined ratios over 100.

Although we believe underwriting improvements will help offset some of these affects.

That being said we are providing the following financial guidance for 2009.

A GAAP combined ratio below 103.5%, a statutory combined ratio below 102.5%, catastrophe losses of 1.4 points and flat diversified insurance services revenue and return on revenue of approximately 9%.

As you build your models, I'd like to remind you that every one point of combined ratio represents approximately $0.18 per share on a diluted basis.

Although a tough year, we are pleased with our core operations and the accomplishments we made in 2008.

Our efforts will continue to actively manage investment volatility risk.

We believe we are in a good competitive position to take advantage of a hardening market.

Now I would like to turn the call over to the operator for your questions.

(Operator Instructions) Your first question is from the line of Ben Heir of Raymond James.

Good morning.

I'm calling on behalf of David Lewis.

I just have a question for either Greg or Kerry, if you can talk a little bit about how you are investing new capital and if it's going to kind of -- for 2009, it's going to follow how your investment portfolio looks right now.

I will let Kerry talk a little bit, I'd say generally you'll see some modification maybe between on the fixed income side, slightly different allocation, slightly away from maybe Muni bonds more into the taxable arena and then I think you'll continue to see a very guarded approach with respects to any increase in equity exposure or on the alternative side.

Kerry, what would you like to add to that.

My only other addition to those comments probably are focused in this environment, are high quality corporate bonds and government agency bonds, those are two asset classes that we feel at this time offers pretty good risk adjusted returns.

Thank you very much.

Your next question is from the line of Michael Grasher with Piper Jaffray.

Hey Mike.

Good morning everyone.

Dale, first of all, thanks very much for the overview on the investments, alternative investments and also on your capital position.

Second, I wanted to ask on the alternative investments you mentioned distressed debt about $30 million, I believe.

Is there any particular concentration within the distressed debt?

Kerry do you want to---

There is no concentration within the distressed debt.

Those are limited partnerships that we participate in that all have very diversified portfolios and I think what you are seeing there is a lot of -- due to FAS 157, a lot of mark-to-market pressures as high yield bonds, which they are using as comparables to value their portfolios, have come down in price, especially in 2000-- in the latter part of 2008.

Okay.

Then can you give us any further color on your exposures at the mezzanine level, VC in the private equity.

Mezzanine similar story to distressed debt.

That is, for all intent and purposes, private high yield.

We feel that a lot of that is the same FAS 157 pressure, we feel it's temporary, these are loans that are made and are now being mark-to-market during the interim part of the life of that loan, unless there is a credit event in which those loans aren't repaid, those values of those loans will gravitate back up towards par just like a bond does.

A lot of the fluctuations we feel are temporary and mark-to-market in nature.

But in terms of concentration, any specific industry pretty diversified again?

Very diversified.

Many, many different at the loan level, many different loans.

And ,Mike, I just like to add to that too.

When you look at the core fixed income portfolio, only one less than 1% is below investment grade, and several years when we sat back and looked at how we wanted to get a little more exposure into some other sectors, this is how we kind of got into the higher yield space, it's a very small segmentation of our portfolio on a overall basis.

So, I think you've got to look at the investment class relative to a $3.3 billion fixed income portfolio that's rated double A plus, where 99-point something percent, is all investment grade.

These are some of the different strategies that have been deployed over time.

Understood.

And then, I guess moving to the capital position, Dale, did you happen to highlight what you thought the ceiling might be in terms of how high you could go on a risk to capital basis?

The point we made we have a 1.7 premium to surplus ratio, we've indicated for some time we are comfortable up to a 1.8 to 1.

Obviously the capital is at a lower position than we started the year, and there is pressure.

We'll be having discussions, obviously, with the rating agencies, but we still feel very comfortable with our capital position, comfortable that we are well within the appropriate rating ranges for AM best, which is the most important rating for us.

We feel pretty good where we are.

Okay, then I guess there is a lot going on out there, Greg and Dale, as you sit back and look at all of this, what is your biggest concern?

We got potential for more adverse investment results, we got combined ratios going higher in '09, there's change in the market cycle going on.

What of those, I guess, is your biggest concern regarding your capital.

Let's go through in terms of capital position, in totality, what we have done to better insulate ourselves as we significantly size down our equity exposure, so, obviously, a large decline in market, particularly, (inaudible) statutory surplus and then there's GAAP equity,and only the equity securities go through statutory surplus and GAAP equity versus fixed income only go through GAAP equity unless there is a OTTI charge, and then that would go through surplus.

So, really what we've done, is we're looking at our statutory surplus position and Kerry has done a number of trades, sized down our exposure relative to the S&P 500, we done some, two pretty good sized trades out of there, that portfolio now is only $135 million.

So obviously we've taken that exposure down quite a bit.

We will look at maybe other strategies maybe to better insulate any real significant down side exposure on that.

That's one issue as we look out.

There are other things that with respect to GAAP equity that we may explore in terms of our fixed income portfolio, and the potential movement from securities out of an available for sale-- out of available for sale category in to a held to maturity style account.

Those are some issues that we look at and try to make sure that we reduce some of the heavy volatility as a result of what is going on.

So those are surplus issues, but from a pure core pricing strategy, I will tell you that our John Marchioni and his staff have clearly articulated a plan for 2009 that integrate the efforts that we've worked hard on from a predictive modeling and other efforts, a) to grow the business in terms of better lead generation, better identification of high quality risk, and added a lot to our agency and selling force to get us back into an organic growth mode.

But also trying to pick the classes that will be more profitable and while at the same time, in an effort to limit some of the drag of the price reductions and normal loss cost trends, try to make sure we're going to be harder on the under performing business.

And, we feel we have a very good, comfortable handle on what that business is and how we are transacting that business in 2008 so much so that it's dialed into our 2009 incentive plan that everyone in the company participates in.

Okay.

Thank you very much

And your next question is from the line of Mark Dwelle of RBC Capital Markets.

Good morning.

Couple of questions.

In the general liability line, looked like there was a pretty significant combined ratio deterioration there compared with some of the recent quarters.

Could you drill down in to that line a little bit and give us a sense on what is happening.

If you look at line in just the quarter in fourth quarter 2007 we had significant favorable development that time gave benefit of about 8 or 9 points to that line.

In addition to that in the fourth quarter of 2008, you had a drop in the accrual for audit premiums, because obviously as we have seen the economy deteriorate, you're seeing less frequency of additional premiums on audit and now you're starting to see return premiums on audit.

So, we had to drop accrual there and then that comes straight through.

That costs a couple of points in the quarter.

Then beyond that is with the fourth quarter just being a normally lower quarter in terms of premium volume, you had statutory combined ratios float up because the expense ratios get higher than over written premium as opposed to earned premium.

Again, the biggest difference in comparison is just the favorable development that we had in 2007.

We had only minimal favorable development in 2008 on that particular line of business.

So there was actually a little bit of favorable development.

Sounds like it's a numerator problem than a denominator problem.

If you look at fourth quarter 2007 we had $10 million of favorable development.

The fourth quarter of 2008 we had $400,000 of favorable development.

Okay.

Second question I had was with respect to investment portfolio, I think this has been talked about in the past, but I just wanted to revisit the discussion in terms of alternative investments and how those impact your results on a quarterly basis, and traditionally selective results have been very steady and very understandable, but as a result of those investments now there is actually a significant amount of quarterly volatility built in to our results.

I would say that level of volatility is not something that you are being paid for in your multiple.

Have you as a company or has the board revisited that as an investment class and taken any thoughts about how you want to continue to hold those in your overall portfolio.

Yes, and I would say for instance, this is an active class that we looked at, we like the diversification, we like the returns that it brings long term it's significantly-- we view this-- if you step back and look at a high level, we view this as a subset of our equity exposure.

So, we've taken a equity tolerance and then subdivided it into equity and alts.

Then when we look at the alt performance, like Dale mentioned in his prepared comments, significant out performance on annualized basis relative to the S&P 500.

So these have added an enormous amount of stockholders equity over the long-term.

To get to your question unfortunately in -- and it's well diversified, uncorrelated so you figure that certain sectors are going to go down, some other sectors are going to go up, and you get counter balance.

I think this quarter obviously tested the extremes where unless you were invested in gold, cash, and probably guns, everything went down and and that's the -- everything became correlated everything went down at the same time.

What we have discussed with the board where we have rethought is how can we protect maybe some extreme events to protect some of the volatility in our portfolio overall, to protect some of the P&L portfolio.

More so than maybe the equity -- moreso than the stockholders equity as aspect of it.

So that is something that we have discussed, we are looking at alternatives today in the marketplace, but I will tell you that in some cases the frictional costs of those things are extremely expensive and-- but yet we are looking at other ways to protect more of the down side in there.

I think that no one really when you look at the confluence of events, these are absolutely the extreme events that you are seeing today.

The only other thing I would add is don't forget with FAS 157 that was adopted by both most general partners in 2008.

So that was a rule that was changed during the game as we built these long-term assets.

Many of these strategies are private securities that are held for the long-term, and now some of this volatility is coming through in the form of mark-to-market accounting, in which you're forcing these managers to mark assets at, let's say, exit values that in the normal course they would never do.

So, don't forget 157 was added kind of late in the game and it was a rule changer.

That's added some of the volatility that we, prior to this, have not seen.

I appreciate that point in particular.

That's what motivated my question as much as anything is the rules did change.

Greg's comments are well made in terms of how you're evaluating that.

One last question if I may.

Your guidance for 2009 suggests some further slippage in terms of the combined ratio.

I don't know that that's tremendously surprising given the state of market prices over the last-- over the last few years.

The last time combined ratios were kind of at this level in general was sort of 2001, 2002 time period.

Do you feel as though, as you look in to your marketplace and your potential to generate the price increases that were talked about in opening comments, do you feel you will have the ability to generate the same sort of increases over the next year or two to allow you to move back in the same sort of time frame to being in a solid underwriting profit position again.

It's difficult to say what will happen from a competitive stand point.

Because obviously your ability to move markets is limited by what happens in the competition because of the fungibility and the lack of switching costs in the core commercial lines product, if it can be easily be moved from company A to company B.

What I will tell you, which is different from our standpoint today versus the time frame you articulated, is the fact that now we have a lot more specificity of our business in terms of performance.

We have it relative by sector, relative by account, and this is where we are going to be much more aggressive in the under performing aspect of the business.

So this is where we will be-- have the capability and if our competitors are not moving price higher then we will lose those accounts.

We will lose those accounts to competitors, though, that will be under pricing at business and they'll be further deteriorating their business than where they are today.

That's the comment that I really share with you, maybe the difference between this market and that is the fact that the level of information that we have, the tools that are renewal underwriters have and on the a new business basis what they have to be able to go out and write the best performing business.

So we will drive business out if we can't get the price increases that we feel are meritorious, relative to what we need to do to generate the returns long-term.

That's the difference between today-- now whether the prices stick, will depend on what the rest of the world does in terms of competition.

Okay, thanks very much, A well made point, thanks.

Next question is from Doug Mewhirter of RBC Capital Markets.

My questions have been answered, thank you.

Your next question is from the line of Amit Kumar of Fox Pitt Kelton

Thanks, good morning.

I guess, just going back to the discussion on the unrealized losses and how much of it is lagged.

I'm still trying to figure out how much of the Q-4 reversal in some markets have been flowing to Q1 '09 numbers, can you go back and refresh us on what is lagged and what is current as of Q-4.

I can tell you that most of the alternative investments report on a one quarter lag.

There are a few that are that report to us monthly, and therefore we don't have a lag, but most are on a one quarter lag.

So, you've got $165 million in alternative investments.

So fourth quarter activity is what will be reported to us during the first quarter and reported in our numbers in the first quarter.

That's helpful.

I was just going back to the combined ratio guidance.

And, if I go back and look at 2008 guidance, that was 98%, you talked about, I guess, a 3% rate pressure flowing into '09.

If I look at the down cut that's roughly 5.5%, could you walk us through the components of the delta?

I'm sorry could you repeat that question relative to the price--

Yes, if you look at the combined ratio guidance and if you go back and look at 2008 guidance, it was 98% for 2008, it's 103.5 for 2009 that's a 5.5% delta.

Okay, right, right.

I will tell you that, first of all we are saying that generally combined ratio will be below that, so there's a tolerance band that we put around that.

That's the first point I would like you to make is a collar around that.

So, if you were to dial down to more higher held level specificity in there, you got three core moving parts in the overall performance.

You got a 3.1% pure price reduction in the 2008 year that will be substantially earned in 2009.

You got that drag on a pure price basis.

In addition to that, then, you've got, if you are doing intellectually honest evaluations of where your year is going to be, then you have normal lost cost trends whether frequency severity, from our standpoint severities-- frequencies continue to be down, severities up a little bit, but it's more in moderation relative to year on year.

So you have normal lost cost trends on your book of business that affect your performance.

Then the third part of that entire process then are all of your underwriting activities that are deployed and which include, but not limited to, activities in the result of predictive modeling, in the case that was mentioned before about our AAL strategy, what we are doing relative to the type of business that we are writing that might have been different before, that may have a less new business penalty and then you go into the area of claims in terms of other initiatives that going on in that aspect of the business.

And so, that becomes really the third leg of the stool.

And then, on top of that, then you've got what is generally happening year on year and just overall expense levels, how are you managing those expense levels relative to premium growth and so-- Those are kind of the three kind of core aspects when you look at the delta.

So when you're looking at the year to year, we got a collar around that -- that ratio.

That's the aspect of all of those things you need to consider.

That's helpful.

One final question, I meant the adverse development number.

Could you repeat that and explain what line it came from?

Sure.

Are you talking for the quarter or the full year?

For the quarter.

For the quarter we had favorable development of $8.6 million.

We didn't articulate all the different lines, the only line we really talked about as the question came up was on general liability, had $400,000 of favorable development.

There was no adverse in any of the lines right?

The catch all, all other lines we did have some adverse development of $7.6 million.

And that came from?

Again, it's a mixed bag of a bunch of different lines.

Okay.

Thanks for answers.

You do have a follow up question from the line of Michael Grasher of Piper Jaffray

Great, just wanted to follow up quickly, I think Mark addressed his questions around what was going on in the marketplace.

Have you experienced change in underwriting behavior out there, so far here in the new year?

Not as much as I like to see.

I let John Marchioni comment on that.

Good morning.

This is John Marchioni, it certainly hasn't firmed up as we would have either hoped or liked to see.

I will tell you that our own pricing indications though did get more favorable as the fourth quarter went on in terms of lower reduction.

No, as it firmed up at this point, not as early as we like to see it.

Our indications are we have been able to give up a little bit less price later in the quarter than we did in prior quarters.

Unfortunately as long as you continue to have players out there on any given account, willing to go lower than it should be on pricing, you're going to see a challenge in terms of market firming.

But, not quite there yet but I think our expectation, as Greg indicated in his prepared comments, is continued pressure in the first part of the year and as the year goes on start to see it really start to firm up.

Thanks very much.

And Mike, the one thing I would add to that, when you look at-- there is four pricing surveys that we track.

The two that we put the highest degree of credibility in, are Advisen and the Tillinghast Clip Survey.

When you look at those surveys quarter after quarter after quarter, those price reductions are still in the 5, 5.5% range, and you sit there and go, so when you look at the rest of the competitors, off of the drag on 2009, isn't the 3.1 that we're talking about it's 4, 4.5, 5 or whatever.

So you would think that at some point that has to manifest itself into the numbers and at that point then maybe you will see some change in philosophical approach to what happens at the street level where people are more disciplined.

You see a lot of grab for premium particularly in the early part of the year and as companies try to help themselves get on the right track for growth to make their premium growth targets and may not necessarily be as focused on profitability.

We don't want to let ourselves fall in to that trap and we are not, based on the things that John and his folks are doing.

Understood.

Thank you.

You have a follow up question from the line of Amit Kumar of Fox Pitt Kelton

Thanks so much, my apologies for not asking this earlier.

In terms of the pricing change we are talking about obviously the offset is the general economic conditions , there is meaningful chatter out there, that if we keep on seeing these recessionary forces, a lot of the policyholders will trend the coverage and change the terms.

What sort of impact are you seeing on that

On the type of business that we write I don't think you are going to see a lot of T&C changes.

Our exposure is pretty much down the middle.

What you will see in terms of economic ramifications is anything that is waiver based for instance, our workers compensation book, a portion of our GL book and other aspects that are labor sensitive, you will see exposures drop and that will drop premium levels.

As you know, a good part of our commercialized business is in the contracting area.

It is 43% of our business in total.

It's well diversified in a whole host of different classes.

But I think-- so you may not see a lot of top line growth per se, but you will see on account by account basis that we are striving for price increases.

The exposure aspect of what you're talking about will probably more manifest itself in less exposures and obviously when you drop labor, it affects the comp and to some extent general liability and then it does have some overflow into the commercial auto space where an insured man less power units.

So, if you got 20 employees and 17 power units, you may have 15 employees and only 13 power units and obviously if you have less power units, your exposure base is going to go down.

So, I think that's more of the elements of the business that will affect our ability to grow premiums in 2009.

Okay.

Thanks so much.

There are no further questions at this time.

Thank you very much for participating in our call.

The market environment continues to be challenging, but we will weather the storm with the financial strength to further differentiate ourselves from the competition.

If you have any questions or follow up matters, please contact Jennifer or Dale, thank you very much.

This concludes today's conference call, you may now disconnect.