Selective Insurance Group Inc (SIGIP) 2009 Q4 法說會逐字稿

Good day, everyone, welcome to the Selective Insurance Group's fourth quarter and year-end 2009 earnings release conference call.

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

You may begin.

Thank you.

Good morning.

Welcome to Selective Insurance Group's fourth quarter 2009 conference call.

This call is being simulcast on our website and the replay will be available through March 5, 2010.

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

Selective uses operating income and non-GAAP measures to analyze trends and operations.

Operating income is net income excluding the after tax impact of net realized investment gaines or losses as well as the after tax results from discontinued operations.

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 this 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 and subsequent Form 10-Q's 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.

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, Ron Zaleski, Chief Actuary and Kerry Guthrie, Chief Investment Officer.

Now I will turn the call over to Dale to review the quarter results.

Thanks, Jen.

Good morning.

2009 was a challenging year given the economy, volatile financial markets and soft market conditions.

In spite of those difficult head winds, we are pleased with the fourth quarter and full year results and all that we have accomplished.

Surplus was up to $982 million.

GAAP equity was back over $1 billion.

Commercial pricing was a positive 2.7% for the quarter as it continues to move higher.

Investment income improved 78% in the fourth quarter from a year ago.

For the fourth quarter, we reported strong operating income for diluted share of $0.47, more than triple last year.

Earnings were driven by a significant improvement in alternative investment income, good property results and favorable prior year liability reserve development.

The fourth quarter statutory combined ratio was 103.7%, a point higher than a year ago.

I will remind you the normal seasonality of premium written is such that the fourth quarter is always lower than the other three, putting pressure on the statutory expense ratio.

By comparison, the GAAP combined ratio was 100.2% for the quarter, down slightly from a year ago.

For the year, the statutory combined ratio came in slightly better than our expectations at 100.5%.

The GAAP contained ratio was 99.8%.

Overall, prior year statutory loss and LAE favorable reserve development on a pretax basis for the quarter was approximately $11 million or 3.2 points on the combined ratio compared to $9 million or 2.3 points in the fourth quarter of 2008.

For the year, favorable reserve development on a pretax basis was approximately $29 million or 2 points on the combined ratio.

Commercial lines premium growth continues to be a challenge given the tough economic and competitive conditions.

Commercial lines premium declined 4% in the quarter driven by the $17.5 million in return audit and endorsement premium compared to $13.2 million a year ago.

We expect to begin seeing easier year-over-year comparisons for audit and endorsement return premium and we did see slight improvement from the third quarter.

If unemployment rates don't deteriorate from the current 10% levels, we anticipate the return premium trend will reverse in 2010.

New business declined 10% in the quarter while renewal premium increased 2% and retention improved to 76%.

We are one of the few carriers who have been successful getting positive commercial lines pure price since the second quarter 2009 when pricing increased to 0.6%.

We achieved 1.5% in the third quarter and 2.7% in the fourth quarter which reaches a level where we are covering our projected loss cost trends.

We reported a commercial lines statutory combined ratio of 103.3% in the fourth quarter and 99.8% for the year.

Commercial property performed very well again in the fourth quarter with a 76.2% statutory combined ratio and 83.9% for the year.

The fourth quarter workers compensation statutory combined ratio of 130.1%, there's a lot of moving parts related to reserves, and audit and endorsement premium which makes it difficult to draw any conclusions.

Workers compensation policies are initially rated based on estimated exposed payroll and are then audited three months after the policy expires to determine actual payroll.

Given the poor economy, particularly for contractors, we had substantial return premium this year.

The full year combined ratio of 107.6% gives a much better view of the performance of this line.

For the full year, the impacts of favorable development and excess audit and endorsement return premium generally offset each other.

Personal lines net premium written grew 11% in the quarter to $57 million.

The personal lines statutory combined ratio for the quarter was 107.1% compared to 105.6% a year ago and for the year was 104.4% versus 103.7%.

Homeowner results were in line with expectations in the quarter.

The personal lines combined ratio was negatively impacted in the quarter by 2.2 points due to $1.2 million of unfavorable development in personal auto.

On the reinsurance front, we successfully renewed our property catastrophe treaty, our Surety and Fidelity Access of Loss treaty and the National Workers Compensation Reinsurance Pool Quota Share treaty all on January 1, 2010.

The Surety and Fidelity treaty structure remained the same as 2009 and renewed with a moderate price decrease.

Due to our effective catastrophe management strategy, we were able to reduce the rate on line by 8% for our catastrophe program.

We believe Selective's reinsurance programs continue to be well diversified with a slate of financially strong reinsurers distributed between broker and direct markets.

Turning to investments.

The fourth quarter net investment income improvement was primarily driven by after tax alternative investment income which increased $15 million from the fourth quarter 2008 to a $3.3 million gain.

The improvement in the equity and credit markets in the latter half of the year drove the improvement for alternatives.

As a result, six of the seven alternative strategies had positive investment income in the quarter.

The outlier continues to be commercial real estate which we expect to be weak for the foreseeable future.

In the third quarter, due to the one quarter reporting lag, alternative investments underperformed the S&P 500 index by 1200 basis points.

However, since we initiated the strategy in 1997, alternative investments have returned 9.4% on an annualized basis compared to 1% for the S&P 500.

Partially offsetting the positive impact alternative investments had on investment income was a decrease in fixed income due due to lower yields and lower dividend income as a result of the pruning we did in the equity portfolio in 2009.

Our fixed income portfolio after tax yield was 3.3% for the year.

For 2009, our unrealized loss improved from $55 million to an unrealized gain of $37 million after tax driven largely by our available for sale fixed maturity securities.

Other than temporary impairments, or OTTI, in the quarter were recorded at $7.5 million after tax primarily reflecting the continuing credit crisis and the associated securitized problem loans.

Invested assets were up 7% for the year to $3.8 billion, reflecting an unrealized gain during the period of $133 million pretax.

The financial market's recovery from its lows earlier in the year is the driver of this game.

Market amortized costs on the whole fixed income portfolio remain strong ending the year at 101.8% up from 97.1% a year ago.

As the financial market volatility increased early in 2009, we took a number of steps to protect surplus and minimize risk while maintaining a well diversified portfolio.

Our municipal portfolio totals $1.6 billion and has an average rating of AA+.

We carefully minimize our exposure to states with challenged economies.

Our fixed income portfolio overall maintains a very high credit quality of AA+ and a duration of 3.5 years.

We believe we are conservatively postured for any additional market volatility as the economic and political environments remain in flux.

We continue to watch for inflationary trends and feel we are well positioned to weather potential increases in inflation.

Our cash position is higher than we have kept historically but believe it is still appropriate.

However, given the steep yield curve, we carefully monitor market opportunities to increase yield.

We completed the divestiture of our HR outsourcing business to AlphaStaff of Fort Lauderdale, Florida effective January 1.

As we said when we announced the sale, we have agreed to continue to support AlphaStaff's business growth through our agency plan.

Note that on the cash flow statement, a cash outflow of $12.5 million was recorded related to the sale of the subsidiary.

This merely represents the cash on Selective HR's balance sheet at closing required to settle the outstanding payrolls they were processing at that date.

Over the second half of the year we experienced solid growth in surplus levels.

Surplus rebounded to $79 million in the fourth quarter ending the year at $982 million.

In the fourth quarter we implemented a statutory accounting announcement, SAP10R which governs tax deferrals and their admissibility for surplus purposes.

Instead of looking at just the referrals that would reverse in one year, SAP10R allows a three-year view which provided an additional $34 million to be added to surplus in 2009.

Stockholders' equity also improved substantially to cross back over at the $1 billion mark at year end.

Book value per share increased 12% from $16.84 in 2008 to $18.83 in 2009.

The improvement in our capital position resulted in a year end premium surplus ratio of 1.5 to 1, down from 1.7 to 1 in 2008.

Historically, we have been comfortable at a higher operating leverage, but given the still turbulent economy we think it prudent to run at this current level of operating ratio for the foreseeable future.

With that in mind, we have no immediate plans to repurchase shares.

We expect to maintain excess capital to be prepared for the inevitable market hardening and to be positioned to fully realize our growth capabilities whether through organic means or acquisition.

Now I will turn the call over to John Marchioni to review the insurance operation.

Thanks, Dale.

Good morning.

Our inside and field underwriters held their ground in 2009 despite a difficult market.

Premium declined but policy accounts grew and the quality of our book continues to improve boding very well for long-term profitability.

Our superior agency force has worked with us to minimize the impact of the soft market and write business with us in a very disciplined and targeted way.

Despite a difficult year in which we tightened underwriting discipline and pushed rate ahead of the market, our agents again rated us an 8.5 on a 10 point scale for overall satisfaction on our annual agency survey which is conducted by an independent third party.

In fact, agency participation for the annual survey increased 7% over 2008's participation rate.

Agents also rank our field underwriters, or AMSs, very high for professionalism.

This is validation that our high touch business model and superior agency relationships matter.

We aim to be the partner of choice and we are succeeding.

Our inside renewal underwriting teams are working hard to balance price increases with retention levels.

With the success we have had in driving price on a targeted portion of book of business, we ended the year strong with commercial lines retention up 76%.

On a point of renewal basis, overall retention for the year was 87%, essentially flat with a year ago.

When we look further into our retention, it is clear that we are driving improvement in overall mix.

At year end, retention at the point of renewal for the lower quality 1 and 2 diamond business was 78%, as we achieved rate increases on this business of 6.5%.

Indicating the progress we are making, we achieved 10% price increases on this portion of our book in the fourth quarter.

On the other end of the spectrum, our best performing 4 and 5 diamond business retained at 90% and pricing remained essentially flat.

We believe this demonstrates that our underwriting expertise and predictive modeling tools are working as intended.

It also demonstrates the support of our agency force in selling these necessary price increases.

Needless to say, we truly appreciate their efforts.

Our field underwriters are writing the majority of new business in the highest quality 4 and 5 diamond range.

The shift in quality of new business since we introduced modeling is noteworthy.

Four and 5 diamond business now represent 66% of new business versus 53% premodeling.

One and 2 diamond business now represents only 8% of new business compared to 17% premodeling.

We believe our strong relationships with our 960 agents provide our AMSs with the best new business opportunities.

New business pricing was down 2.5%, a strong result when considering the improvement in mix by diamond.

In addition, submission activity from our agents remains strong while there continues to be pressure on hit ratios.

Together, these factors demonstrate the discipline we have instilled in our operations.

For 2009, commercial lines new business was essentially flat.

By segment, One & Done automated small business was up 7% to $74 million.

Middle market, or AMS generated business, was down 4% to $169 million.

Selective Risk Managers, our large account business, was up 4% to $23 million.

We provide our agents with a variety of programs that support our commercial lines diversification efforts such as sales, developmental training, and active leads for writing good business within our appetite.

The leads have been prescored through our models and target pricing is provided to best ensure profitability.

We continue to see the shift in our commercial lines book of business away from contractors to our other more profitable classes.

At year end, contractors accounted for 39% of commercial lines premium down from 43% at year end 2008.

The noncontractor's classes of business performed, on average, about 7 points better on the combined ratio than the contractors' class.

The noncontractors classes are manufacturer and wholesaler business, specialty which includes social service, golf courses and public entities, and mercantile and service.

We grew policy counts in the noncontractor segment by 7% in 2009 while contractors accounts declined 2%.

As we grow these classes faster than our contractors, our profitability should improve.

Personal lines results are clearly not where they need to be but the personal lines team has worked tirelessly to implement pricing, product and technology changes to grow the book with granular pricing capabilities through our MATRIX modeling.

We expect these capabilities to drive future profitability.

Unlike commercial lines, the personal lines market began to harden in 2008.

Over the past two years we filed rate increases that could generate over $20 million of premium on our in force book of business with additional increases already effective in early 2010.

Personal lines new business is up 27% for the year and the quality of the book has improved substantially since the implementation of MATRIX.

When you are simultaneously fixing and growing a book of business as we are in personal lines, it takes longer for the improvements to show through to the bottom line results.

This is particularly evidenced by the fact that the actuarial new business penalty in personal auto drops by 12 points by the fourth year we write a policy.

As mentioned, we have been very successful getting rate filings approved as we grow this book with actuarial sound pricing through MATRIX.

We are successfully diversifying our personal lines book as evidenced by the new business increase of 41% outside New Jersey.

We are also seeing significant improvements in the quality of both homeowner and automobile business into higher insurance scored and multi-line policy sectors that have better claim experience and retain at higher levels.

We believe that predictive modeling through MATRIX together with the substantial rate increases already approved on this book will allow us to achieve our goal of being profitable in the third or fourth quarter of 2010 with a full year expected personal lines combined ratio of 100%.

Now I will turn the call over to Greg.

Thank you, John, and good morning.

I am very proud of what our dedicated employees and agents accomplished in 2009 in a very difficult economy and competitive environment.

2010 will continue to present its share of challenges.

We have strategies in place that competitively position us to take advantage of a changing commercial lines market place.

Industry wide, commercial lines pricing discipline continues to be elusive due to customer push back in a weak economy.

Some companies are using undisciplined market share growth strategy because they believe that is what shareholders want, but they could ultimately be destroying shareholder value.

Under pricing new business in this market coupled with the with limited ability for prices to move higher at renewal is, in our opinion, irresponsible.

Most commercial lines pricing surveys are showing pricing decreases while the industry CPI as reported by the Triple I is up approximately 4%.

The exception is Tillinghast's CLIPs which we have repeatedly said is the more accurate survey because it is based on commercial lines renewal per pure price and not based on anecdotal information.

We in no way control a market share leadership position; however, we are successfully driving rate in a very difficult market.

Through targeted rate increases on approximately 15% of our commercial lines business, we generated overall pure price increases as follows, October 2.5%, November 2.4%, and December 3.1%.

In the fourth quarter we covered our projected loss trend with higher pricing.

In January 2010, our largest renewal month, pure price increased 3.5%.

As we continue to drive higher prices and we see the benefits of our underwritings and claims initiatives, we believe underwriting results will improve.

In addition, we are non-renewing underperforming business which other carriers write willingly below our expiring price.

We find this most difficult to understand.

Industry fundamentals point to a need for higher commercial lines pricing in 2010.

One, investment returns have declined by approximately 40 basis points over the past year.

Two, at some point, the well of favorable development will run dry.

Three, the insurance aspect of CPI was approximately 4% in 2009.

And, four, on level accident loss ratios projections in 2010 should trend higher.

All of which lead to a need for higher commercialized pricing.

I personally want to thank each and every agent for their assistance in helping us achieve our pricing strategy.

In 2009 the top line continued to be under pressure due to the economy, high unemployment rates and a competitive commercial lines marketplace.

We returned $73 million in audit and endorsement premium and generated $266 million in new commercial lines business, $55 million of new personal lines business and we successfully grew our overall policy count by 6%.

We leveraged our strong agency relationships with initiatives that will facilitate organic top line premium growth.

Over the past two years, we have added over 200 agents in unpenetrated territories providing extra capacity for growth.

We have been very successful in 2008 entry into Massachusetts and Tennessee.

In 2009, we wrote premium of $22 million in Massachusetts and $15 million in Tennessee.

And we have introduced new products and continue to research additional product opportunities that will provide expanded premium potential.

We have the ability to grow with confidence due to our strong underwriting and claims personnel, great agency relationships and our predictive modeling capabilities.

We have a series of initiatives to enhance our claim handling processes.

These initiatives focus on improved work flow, litigation management, reduced cycle time and medical expense management.

We can assess the quality of a piece of business and price it for profitability, including the ability to tell our agents the reason why scores and the pricing are what they are.

This is an important facet of the relationship approach to writing modeled business with our agency partners.

We are not just using a black box approach and our agent's truly appreciate that competitive difference.

We believe we have taken the right steps to set the stage for personal lines growth and profitability.

We have the right people, the right automation, the right leadership and the right strategies in place to return this book of business to profitability.

With the changes that Dale outlined in our high quality investment portfolio, we have been rebalancing and we have reduced the level of risk.

We continue to approach our investment strategy with an eye towards reducing investment earnings volatility as price valuations continue to improve for certain asset classes, we will assess their impact on our portfolio and act accordingly.

We ended 2009 in a strong surplus position of $982 million and all of our leverage ratios improved.

As we continue to add organic surplus growth in 2010, we increase our capability for more aggressive premium growth, including acquisition opportunities.

Before I provide 2010 guidance, I wanted to re-emphasize the process that we go through for budgeting on an accident year basis.

We bring the last four years of lost ratios up to the current rate level in order to project the 2010 loss ratio by liability line of business.

This provides a longer term view which we believe is appropriate and more conservative way to establish the 2010 loss ratios.

Since overall pure price for 2009 was 0.9%, our early 2010 earned premium is still below our projected loss ratio trends.

With this in mind, we provide the following 2010 guidance, full year combined ratios of approximately 101.5 on a GAAP and statutory basis.

Combined ratios do not include any assumptions for reserve development either favorable or unfavorable.

Catastrophe loss expectations of approximately 1.6% which is our historical average and weighted average shares at year end of approximately 54 million.

In building your earnings models you should consider the following.

1 point of GAAP combined ratio equals approximately $0.17 or 1 point of ROE and, two, if you refer to the investment exhibits on page nine of the supplemental investor package, you will see investment income by component for the fourth quarter and full year 2009 with related yields and tax rates.

We believe this information will allow you to create your 2010 models building in your own assumptions for interest rate and financial market movements.

Now I will turn the call back over to the operator for your questions.

(Operator Instructions) First question comes from Joe DeMarino.

You may ask your question.

Please state your company name.

Thank you.

I am with Piper Jaffray.

Just a couple of questions.

Can you explain how the return of audit premiums impact -- incurred losses?

Sure.

What happens is the way we do our loss projections by year what happens is this return premium is really a diminishment of exposure that we thought we wrote in this year and prior year so what happens in the current year we are putting up the losses for this year but this premium reduction is actually going back in schedule P development in to the 2008 year, so it does have an impact on schedule P development.

Okay.

Thank you.

My other question is based on your comment that I think you said you expect easier comps soon in terms of premium audits.

If you could maybe just share some of the details of your assumptions regarding that statement.

Yes.

I will let some of the other folks, but when you look at our audit premium adjustments and how -- and you have to understand as we recalibrate the reaudit premium, we are also fixing the endorsement and getting the current term of the policy down to the right exposure level, so when you look at how that has ramped up over quarter by quarter, it's not until you get really to the fourth quarter 2008 that you saw that number get in to the double digit level.

So we hit about $13 million, $13.5 million in the fourth quarter 2008 and then pretty much every quarter of 2009 has bounced around between $17 million and almost $19 million per quarter, and actually averaged out to about $18 million a quarter.

So what happens is you have your recalibration of your business down to this new, let's call it, 10% unemployment rate.

That doesn't mean we are not going to have any audit and endorsement premium in 2011, but as you recalibrated your exposure down to your new workforce level or new sales level, when you get in to 2010 and you compare it to 2009, just as long as we don't see any real deterioration in level of unemployment, we will be comparing our 2010 numbers up against the 2009 number that have an audit premium adjustment really for the 2008 year.

So, I don't mean to get overly complicated but that's the improvement.

When we say the comps will get better, we are going to be comparing a 2010 premium level on an exposure book that already has been recalibrated to approximately a 10% unemployment rate and we are going to be comparing that premium level up against first quarter, second quarter, third quarter, fourth quarter of 2009 that has an audit premium adjustment for the prior year in it.

So it has got 2008 adjustments in 2009 and that's what we mean by that.

Okay.

Thank you, that is very helpful, that's it.

Thanks.

Thank you.

Our next question is from Mark Dwelle.

You may ask your question, please state your company name.

RBC Capital Markets.

My first question, how many points of cat loss did you have in your results this year?

It is by 0.6.

0.6.

Testing my memory, Mark.

It is 0.6 points for the full year, that compares to 2.1 points in 2008.

Okay.

So, to maybe put this year's actual result in the context of your guidance, if you had a couple of points of reserve releases this year and you were basically one point better this year versus the baseline assumption for cat losses, that is three points in total, so if I add that back to your actual GAAP combined ratio of 100.2, I like guidance basis, this year you would have done 103 give or take and your guidance then is 101.5.

Is that the right way to do the math?

That's the absolute correct analysis that you should do, Mark, yes.

What we are saying is embedded in the improvement is what has happened relative to price and underwriting and other activities, the change in the mix of business and a whole plethora of other underwriting initiatives that are embedded in that, including a change in mix of business.

John, go ahead.

You hit the major points.

This is John Marchioni.

It is the various underwriting improvements that we talked about in terms of our improving mix of business by diamond, by SBU and also the improvement we are seeing on the line side which will help in the year-over-year comparison.

Okay.

I guess as you talk through the various lines and initiatives, I guess one of the things that kind of came through loud and clear to me was the potential for improvements in the personal line segment.

I presume most of that must be on kind of the auto side, that was obviously the area that had the rougher go this year?

Well, I would say it is on both sides.

When you look at our roll out of MATRIX, auto came first and you are seeing it fully earn its way through the book now.

And MATRIX for homeowners came out about a year and a half after that.

If you look at the price we are taking, it is pretty consistent, in fact probably a little bit higher on the homeowners side.

You would expect -- we would expect to see improving mix in terms of distribution as we said on the insurance score which helps us both on the frequency side but also on the retention side and better retention is obviously going to drive long-term profitability but in addition to the mix you are overseeing overall rate levels continue to go up industry wide but also in our book of business, so the combination of those two factors is what we expect to drive the improvement on personal lines.

Mark, when you really look at that you are seeing the benefits of three years of rate level working their way into that book.

These rate level changes started in 2008 in ernest so you saw a good, hefty rate level in 2008 as well as 2009 and now what we are prognosticating in terms of 2010.

So, it is everything we talked about and everything we do on a regular basis and in terms of underwriting, pricing, getting our right market share in terms of an agency by agency basis.

Now, you will see in 2010 and into 2011 an improving overall personal lines book of business.

Okay.

That's helpful, thank you.

Dale, you commented in terms of the impact of the payroll audits and similar adjustments had on the workers comp line.

It seems like the BOP business was also pretty negatively impacted.

Are the same sort of effects rolling through there as well?

No, the BOP line isn't auditable.

So you don't have the same kind of audit premium adjustments impacting there.

And we routinely have discussions.

One of the problems with the BOP line is that it is so much smaller.

It doesn't take but a few larger losses to put a lot of fluctuation through the particular line.

John, anything else you want to add?

In addition to audit and endorsement premium, obviously as your book renews and you retain business, the impact of the economy is felt in other places as sales receipts go down in retail sectors, number of power units begin to drop and you are renewing business and as business continues it does decline.

So that is going to impact your overall exposure level even in those non-auditable lines of business.

I guess I would add that although it is not going to come through on the audit endorsement way that it does in workers comp, the BOP line, obviously those are small businesses and small businesses are hurting pretty badly so you definitely see decline in business there and there is going to be some effects of the economy showing through there.

Okay.

I guess the last question.

I lied, I had one more, were fourth quarter results particularly effected by the fairly large winter storm late in December?

And similarly, have you seen early effects from the storms already on the East Coast this year?

We really don't, at this point, comment about 2010 results but what we did see in 2009 in terms of the 4Q property results, they pretty much performed in line with our overall expectation and that line kind of gets pushed around with a certain amount of severity.

You've seen that severity evidence itself sometimes in the first quarter or in other quarters and when you look at the performance of the line overall, it performed at or better than our expectations.

And fourth quarter catastrophe losses were zero.

Okay.

Well, that answers that question then.

All right.

Just so you understand, there are a lot of losses you can get in a deep freeze just so you understand that don't evidence itself at a PCS event but can create problematic situations in areas that aren't sensitive, a lot of frozen pipes, unusual snowstorms down in areas can create way to snow problems but, generally speaking, our property books perform very, very well.

Okay.

Thanks.

Thank you, the next question comes from Amit Kumar.

You may ask your question.

Please state your company name.

Thanks.

Amit Kumar, MacQuarie.

Just going back on the comment regarding the buy back.

I think you said you don't plan to buy back stock.

I am just wondering what sort of premium to surplus level do you feel like you need to get to sort of revisit this decision?

Well, we are not making any prognostication it is on that but I would say that we are very comfortable 1.5 to 1 premium to surplus which would indicate that we have an appropriate level of capital for doing what we want to do in term it is of our strategic plans and how we want to grow.

We will obviously continue to assess that over time.

Okay.

That is helpful.

Moving on.

In your opening comments you mentioned that some companies are still being undisciplined.

Not taking any names, is it more so in the regional space, large public companies or large nonpublic names?

Yes.

All of the above?

No.

What I would say is that I will be careful on this one.

It is a few carriers, it's not as broad based, and I don't want you to misinterpret that comment.

It is coming in certain directions but it is more focused than just holistically across the board.

You just see that in the market place and it just makes it more difficult for our people to do what they need to do on the renewal book when agents are constantly concerned what other company may come in on the other side the trade and just way under price a piece of business.

It makes everything that we are doing that much more difficult in this kind of market.

It is also important to note that I think where we see it most particularly is on new business pricing.

It is maybe a tad more disciplined on the renewal but if you think about that, it is very difficult for a company to evaluate the quality of their new business pricing and we put a lot of time and effort into doing that ourselves so that we can maintain the discipline and have a pricing strategy on the new business side that matches the renewal.

I think other companies aren't as far along the on their capabilities there as we are.

And then when you talk about these pricing decreases, are they meaningfully below you or is it maybe a 5% to 10% range.

It is all over the board.

Generally speaking, with our relationships and our service model and product capabilities, we don't lose the accounts for small percentages.

You are seeing, in certain cases, lesser quality accounts that we thought were maybe thinly priced that we would try to get some rate on going for 15% to 20% below our expiring, sometimes -- it varies.

Wow.

That is a huge number.

I think in terms of your discussion.

If I go back and look at your Q3 commentary, you said that you expect there will be a change in industry behavior in 2010.

Now that we are in 2010, if you were to sort of compare your thought process between Q3 and now, would you say that you are relatively sort of pessimistic on that or is it unchanged?

I would say, we are not pessimistic on it.

I would say that when you look at the weight of evidence and the fact that insurance CPI is 4% and you look at some of the core fundamentals in terms of where investment rates are and the pressures on the other aspects of the fact that the industry will be possibly in 2010 the fourth year in a row that it is not going to grow and that is the first time we have seen a top line in the industry decline since, I think, 1943.

So, four years in a row of premium reduction, I think when you add up all the factors that point to a much higher need for rate level, particularly when you start to back out of these companies the amount of favorable development they are releasing in their combined ratios, so when you look at those combined -- I'm not a fan at all of knocking weather out.

Weather is what weather, you price for it and you get the benefits when it doesn't blow just like you get the detriments of it when it does happen.

When you start to add back in the development, it's pretty significant and you readjust some of the combined ratios, they are pretty stratospheric.

And the only way that you can improve those over the long term is through higher price.

We feel that market should be moving, we see it.

It is not happening holistically but yet it is, I would say that I feel about the same or maybe a little bit better than I did before.

But at the same time if you sort of compare the premium leverage pre 9/11 to now, the industry does have a meaningful level of excess capital.

Right?

Well, you defined -- okay, so let's talk about excess capital.

You're talking a world now where the goal posts are being moved sometimes right when the play is going on in the field, forget about between quarters.

So even as you are playing the game, the goal posts are being pushed around in terms of I think there is a whole different recognition of volatility in your investment portfolio.

There is a whole different concern about risk adjusted filings, inflation and how that may affect your numbers and where you need to position yourself and your product in terms of how you price your product relative to these inflationary measures.

That may evidence themselves and we already talked about the fact that we are talking about an industry where everyone is saying inflation overall is not there but yet the core insurance inflation is running at 4% when you look at the underlying medical trends and car repair and other aspects of it.

These are the things that point you to the fact that things are more volatile than they were before.

Rating agencies are constantly retooling their models for the higher volatility and potential worsening results and price diminishment, so all of those things kind of get baked into an overall cake.

And understand where we are at $3.77 of invested assets per dollar at a 1.5 premium surplus ratio, we feel we are properly tuned to take advantage of both sides of the equation.

Got it.

Okay.

That's quite helpful.

That's all for now, thanks.

(Operator Instructions) Our next question comes from Peter Seuss .

You may ask your question, please state your

Lincoln Square Capital.

Good morning.

Not to beat a dead horse, but just to fully understand the impact of the audit endorsement premiums.

So, if you had $73 million of adjustments in 2009, does that mean your earned premium was $73 million less than otherwise it would been?

If you want, here, I will break out the pieces.

With respect to the audit premium, yes.

With respect to endorsement premium, it is not a one to one, I don't have a separation of those.

So, to the extent it is audit premium, yes.

Audit premium when it is booked, I got paper shifting around there, Peter, and then with respect to endorsement premium, you are adjusting the term of the policy, the current term.

It just depends on when you are making that adjustment and what is the expired versus non-expired term of the policy with respect to what came through earned.

Of that $73 million, $50 million of it is audit.

$50 million came through the premium.

Okay.

So basically your earned premium was reduced by $50 million but your losses, the dollar losses are not effected at all?

The $50 million of adjustment is theoretically in the earned premium, I just want to make sure everyone understands, is in the 2009 calendar year the losses that you are adjusting for that in the most part are in the 2008 year.

Okay, so results in a little bit of favorable development.

So, for this year I guess you had, if you do 50, if you add the earned premium, the $50 million to your earned premium and then you take your losses from this year, it kind of implies you had a 3.4% negative impact to the loss ratio from just the audit premium adjustments.

Right, if you just do the math on the current calendar year, it has a negative impact on the combined ratio.

So you are saying this will reverse next year meaning it basically won't have any impact or it will have a positive impact?

Every year you have some level of audit and endorsement premiums.

You go back to 2008 we had a $22 million number for the full year of 2008, obviously the $73 million this year is pretty high.

I would say the $22 million for 2008 was a bit on the high side.

There are years, if you go back when the economy is growing robustly, where the audit premium number is actually a positive in a given year.

So, what we are saying is that once you stabilize the economy, you don't see as much negative audit premium activity because basically the businesses that we underwrite stay roughly at the same size over the course of the year as opposed to overestimating payroll at the beginning and then having a return premium at the end of the period.

So that's also one of the main reasons why to the earlier question, I guess the combined this year was 103 on an apples to apples basis with guidance, but you have a 3.5 point improvement essentially just from the audit adjustments going away, so that kind of gets you back to 100 on an apples to apples basis.

Then I guess you have your underwriting initiatives in place which could then further improve it.

Is that the right way of looking at it?

The one thing to keep in mind is when you have an audit that is less exposure than you thought you were going to have, you got less exposure on the other side, too.

It is not as simple as doing the math the way you have done it there.

Sure but the reserve releases were 2 points for the year and 1.3.

points for the prior year.

But, I understand what you are saying.

It seems to provide a little bit of cushion.

Okay.

I think I understand it.

Next question, just a couple of clean up questions.

The other expense line was $3.7 million in the quarter and I guess it was $6.1 million in the priority quarter.

Can you give some dollar on what the run rate is there?

Actually, there is not a run rate for that just because you have got a volatile piece coming through there which is any long-term equity awards to our employees get mark to markets so it all depends what is going on with our stock price and that impacts the other expense line for the particular quarter.

Okay.

So that's really the main change is the equity expenses?

That's the big one that causes that number to float around.

Then lastly on your tax rate, I guess for the quarter the effective overall tax rate was 17%.

Looking at your guidance, what do you think the number should be for 2010?

The best way that we can tell you to do that, you need to decompose the overall operating earnings and if you apply a 35% rate to everything but investments and then calculate your investment earnings expectations and apply that, then you will be able to come up with a run rate for the 2010 year.

What is the tax rate on investments right now?

If you go to page 9 of the supplemental information, you will see the tax rate by category.

Yes.

28% or 27%.

You will need to make your calculation based on how you think each of the respective investment categories will perform.

The Munies performed at a lower tax rate.

Got it.

Okay.

Sorry, just kind of an overall question probably for Greg.

When you look at growth potential in 2010, what are some realistic expectations in terms of I guess you are getting some rate.

Do you expect to grow your PIF?

Well, Peter, we did put in there we grew our PIF by 6% overall.

We did grow -- another point, when you listen to everything Dale was saying, we lost $73 million of audited endorsement premium off the top line or approximately 5 points, 4-1/2 points of the last year's premium, and we didn't lose a policy.

Theoretically, you can sit there and say not one policy walked out the door, but we lost all of this premium on exposure.

So, in theory as the economy picks up you have the opportunity to grab some of that $73 million back to increase exposure.

That's one issue.

We didn't put out growth guidance so I'm just kind of helping you understand the pieces.

Rate level changes that John articulated with respect to the earned line.

We have rate change in the lines that we're working on.

You heard what we did in the first quarter, 3 points -- I'm sorry, the month of January.

First quarter is not over yet.

It is hard to do that, although I am trying to get clairvoyant.

I am working on that skill.

But that's a pretty good price level for 3.5 points on commercial lines of business.

You heard what we've done in terms of greenfield efforts in terms of how successful we have been in Massachusetts and Tennessee.

We added a lot of agents.

We have done a lot in terms of what John's talked to you about in terms of various lead programs and trying to target best performing business.

We look at the quality of the business.

We write -- we don't want to write it at underpriced levels.

We look at market conditions ultimately start to improve and that depends on how you look at -- how much you look at overall economic growth, we positioned ourselves well to take advantage of that.

Great, thanks a lot.

(Operator Instructions) At this time I am showing no further questions.

Okay.

Thank you, Operator.

I want to sincerely thank our dedicated employees and professional and agency partners for what we accomplished in 2009 and helping us implement our strategies designed to deliver long-term performance.

I also want to thank the shareholders for the investment you are making in our dynamic organization.

We continue to implement the strategies and maintain underwriting discipline while at the same time improving our competitive position for the inevitable market hardening.

If you have any further questions, please contact Jennifer and Dale.

Thank you very much.

Thank you, this does conclude the conference.

We thank you for the participation.

At this time you may disconnect your lines.