PMA Capital Corporation Q3 2008 Earnings Call Transcript

PMA Capital Corporation (PMACA)

Q3 2008 Earnings Call Transcript

November 3, 2008, 10:00 am ET

Executives

Bill Hitselberger – EVP and CFO

Vince Donnelly – President and CEO

Analysts

Randy Binner – FBR Capital Markets

Beth Malone – KeyBanc

Matt Rohrmann – KBW

Michael Nannizzi – Oppenheimer

Presentation

Operator

Good day, ladies and gentlemen, and welcome to the third quarter PMA Capital Corporation earnings conference call. My name is Sandy and I will be your coordinator for to today. At this time all participants are in listen-only mode. We will be facilitating a question-and-answer session towards the end of today’s conference. (Operator instructions) I would now like to turn the presentation over to your host for today’s conference Mr. Bill Hitselberger, Chief Financial Officer, please proceed.

Bill Hitselberger

Good morning everyone and thank you for joining us for PMA Capital’s third quarter 2008 earnings conference call. Joining me on the call today is Vince Donnelly, PMA Capital’s President and Chief Executive Officer.

Before we begin, I have an important reminder for you about our earnings release. Our earnings release and statistical supplements, which are available under the Investor Information section of our website at www.pmacapial.com provides detailed reconciliations of our operating income by business segment to our net income or loss computed under Generally Accepted Accounting Principles.

Although operating income does not replace GAAP net income or loss, operating income is the financial measure that we use to evaluate and assess the performance of our businesses. As we define it, operating income is GAAP net income or loss excluding net realized investment gains and losses and the results from our discontinued operations.

Today, Vince and I will be discussing PMA Capital’s third quarter 2008 financial results and following our prepared remarks, Vince and I will be available to take questions.

As a reminder, any comments we make regarding future expectations, trends and market conditions, including premiums, revenue, earnings, cash flow, pricing, loss cost trends, and return on equity are forward-looking statements under the Private Securities Litigation Reform Act of 1995.

These forward-looking statements involve risks and uncertainties that could cause actual results to differ materially from our current expectations. These factors are described in the cautionary statement disclosures in our most recent reports on Form 8-K and Form 10-K filed and furnished with the Securities and Exchange Commission, including our Form 8-K file this morning, which contains our third quarter 2008 earnings release.

I would also like to note that we posted the details of our investment portfolio at September 30, 2008 and December 31, 2007 on the investor section of our company website.

With that I’ll turn the call over to Vince.

Vince Donnelly

Thanks, Bill, and good morning to everyone and thank you for joining us today. I would like to start by discussing the company’s overall performance in the third quarter of 2008 and after that, Bill will speak in detail to our operating results and financial condition.

We produced another quarter of improved operating results with profitable growth in both our insurance and fee-based businesses; while continuing to maintain our underwriting standards. Our focus on outstanding customer service and continued diversification of products and services has contributed to our financial performance.

Our achievements in our ongoing operations including the following, at the PMA Insurance Group, the combined ratio in the third quarter improved to 95.2% from 97.3% in the third quarter of last year and the year-to-date combined ratio, when 2008 improved 96.5% from 99% in 2007.

We increased operating earnings by $1.6 million to $13.3 million in the third quarter of 2008 and by $7.9 million to $38.3 million for the first nine months of 2008. Direct premium production excluding our fronting premiums and premium adjustments increased 10% in the third quarter to $151 million, an increase of 5% during the first nine months of 2008 to $394 million.

Due to increases in larger account business, primarily captive accounts and we entered into two fronting arrangements, which we expect will generate fees that will fully replace those from the expiring agreement with Midwest Insurance Companies. Our fee-based business revenue increased of $52 million which represented 14% of our total operating revenues for the first nine months of 2008, compared to 7% for the same period last year.

Organic revenue growth at PMA Management Corp. was 34% in the quarter and 25% year-to-date. Our current growth was also impacted by the inclusion of Midlands Management Corporation, which contributed $7 million of revenue in the third quarter and $21 million of revenues during the first nine months of 2008, and PMA Management Corp. of New England, which we acquired in June of 2008, added $2 million in revenues.

Despite the recent volatility and uncertainty in the financial markets our operating returns continue to improve and our financial condition remaining strong. Our conservative investment strategy help mitigate the impact of market disruptions on our investment portfolio.

In the third quarter, we’ve recorded $9.1 million in pre-tax realized losses for other than temporary impairments. Our result of writing down investments that we had Lehman Brothers senior debt and Fannie Mae preferred stock. These write downs represented 1% of our total investment portfolio at September 30, 2008. We had insignificant credit write downs in the first two quarters of 2008 and also for the full-year 2007.

In overall, we are pleased with the continued progress of our businesses during the first nine months of 2008. Let me provide some additional details for that. The PMA Insurance Group grew profitably an increase premium production despite continuing competitive conditions in our marketing territories.

The current environment has a number of challenges there is softness in the insurance market, which is characterized by increased pricing pressure, both from new business and for renewals and clients are generally looking for more liberal terms. Pricing continues to trend downward in worker’s compensation in other commercial lines. We continue to maintain our underwriting standards and differentiate ourselves from our competitors by delivering a high-quality level of service.

Direct premium production growth in the third quarter reflected an increase in larger account business primarily, captive accounts we’re profitability is less impacted by pricing pressure. For business written in the first nine months of 2008 our pricing rate-sensitive worker’s compensation business decreased by 7%, nationally according to the counsel of agents and brokers worker’s compensations pricing for the first nine months of 2008 is decreased by a 11%.

Approximately 60% of our worker’s compensation business is written on a rate-sensitive business and as we have previously noted, the two states that have accounted for a significant part of our overall pricing decreases were from New York and Florida.

For business written in the first nine months ending September 30, 2008 our pricing on rate-sensitive worker’s compensation business decreased by 23% in New York and by 18% in Florida. The pricing reductions in both New York and Florida are mainly driven by manual loss cost changes filed by each respective states rating bureau, which we believe are consistent with the loss trends in each state.

These two states collectively represent about 18% of our overall rate sensitive worker’s compensation business written in the first nine months of the year. Our pricing on rate-sensitive worker’s compensation business written outside of New York and Florida decreased by 4%.

Pricing on our rate sensitive worker’s compensation business in Pennsylvania declined 6% during the first nine months of 2008. In Pennsylvania we’re affected by a 10.2% reduction in loss costs at the Pennsylvania Insurance Department approved earlier this year. While this resulted in lower file loss cost in Pennsylvania we will continue our practice of underwriting our business with a goal of achieving a reasonable level of profitability on each account.

We continue to determine our business pricing through scheduled charges and credits that we file and use to limit the effect of file loss cost changes and have not experienced a decrease in premiums equal to the level of the loss cost reductions. We also believe the nature of our loss-sensitive broker business, which represents about 45% of our Pennsylvania Worker’s compensation business mitigate the impact of reductions in file loss costs.

Direct premiums written increased 1% for the quarter were declined 7% for the first nine months of 2008 compared to the same periods in 2007. For the quarter the increase in direct premium production outpaced the reduction in fronting premiums and direct premiums written for the first nine months of 2008 were down due to lower fronting premiums of $34 million and higher return premium adjustments of $14 million primarily from retrospectively rated polices that we write for loss-sensitive accounts. This year-to-date decline was partially offset by an increasing production.

Fronting premiums decreased in the third quarter and first nine months of 2008 as a result of the termination of our agreement with Midwest in March 2008. Although, this termination resulted in a decrease in direct premiums written, this business will continue to have a positive impact on our 2008 operating results. As we earn commissions until the underlying policies expire.

In during the third quarter of 2008, we entered into two fronting arrangements with Appalachian Underwriters and Arrowhead General Insurance Agency, who underwrite and service workers’ compensation policies using our approved forms and our guidelines. The business produced with Appalachian is primarily located in the southeastern part of the United States, while the production with Arrowhead is limited to California. We retain approximately 10% of the underwriting results on the business written with Appalachian and 20% of the underwriting results on the business produced with Arrowhead.

We also earn an administrative fee-based upon the direct premiums earned under each agreement as well as fees for providing claims services on the business placed through Appalachian. Total direct premiums written under these arrangements were $2 million during the third quarter of 2008 and we expect that direct premiums written under these arrangements will be between $70 million and $100 million on an annualized basis.

The premium adjustments that I referred to primarily reflect favorable loss experience on loss-sensitive products with the insured shares in the underwriting result of the policy. Return on premium represents favorable loss experience on these accounts approximately 40% of our workers’ compensation business is written on a loss-sensitive basis. In these types of policies the customer shares in the underwriting result of the policy both favorable and unfavorable with us. These policies provide us with a greater degree of certainty in achieving our profit margin on an account-by-account basis.

The combined ratios at the PMA Insurance Group improved 2.1 points in the quarter and 2.5 points in the first nine months compared to the same period last year. The lower combined ratios for both the quarter and first nine months of 2008 compared to the same period last year reflected lower acquisition expenses and policyholders’ dividend ratios, partially offset by higher loss and loss adjustments expense ratios. The loss and loss adjustment expense ratios increased for both periods as pricing changes coupled with payroll inflation for rate-sensitive worker’s compensation business were below overall estimated loss trends.

Our current accident year loss and loss adjustment expense ratio benefited in 2008 from changes in the type of worker’s compensation products selected by our insurance. We estimate that our medical cost inflation to be 6.5% in the first nine months of this year, compared to our estimated 8% for the first nine months of 2007. This decline reflects a decrease in utilization as well as an enhanced network and managed care initiatives that we have.

The year-to-date loss and loss adjustment expense ratio benefited from favorable development in our loss-sensitive business, which resulted in the first quarter retrospective premium adjustments and as I commented in prior calls, we continue to focus on maximizing our preferred provider networks, individualized case management, prescription drug cost containment programs and the evaluation of charges that are incurred outside of those preferred provide networks.

We are pleased that these containment techniques have tempered the impact of medical inflation and continued to contribute favorably to the loss ratio. We have seen some new market entrants in the TPA sector and the soft insurance market is slowing the number of new self-insured clients. Increased price competition also exists in all our fee-based businesses. Despite these challenges, we have and expect to continue to organically grow our fee-based businesses.

To the first nine months of the year, organic growth of PMA Management Corp. has been robust to 25% and the inclusion of Midlands Management Corp. and PMA Management Corp of New England has raised our total fee-based revenues to 14%, up from 7% of the overall operating revenues of the company and not to similar to our insurance businesses we compete on delivering a high level of service to our customers and let me add that the initial transition of the PMA Management Corp. of New England operation into the overall organization has been very smooth for our employees and our clients.

We previously announced the execution of the definitive stock purchase agreement to sell its Run-off Operations and the filing of the Form A with the Pennsylvania Insurance Department. We are assisting the buyer to ensure the Pennsylvania Insurance Department has the information it needs to review the transaction. As we’ve noted in earlier release we have agreed with the buyer to extend the termination date in the stock purchase agreement to December 15, 2008 or such later date as may be mutually agreed of us.

During the third quarter, we’ve reduced the amount of cash we expect to receive at closing by $3.5 million to $2.5 million, to reflect development of loss reserves at the Run-off Operations.

We are closely monitoring the impact of the current economic environment on our businesses. Claim frequency in our insurance operations continues to trend favorably and insure payrolls grew 3.3% to the first nine months of 2008 and 3.6% throughout 2007.

We realized that such growth maybe challenge if at prolong recession occurs.

Before I turn the discussion over to Bill, let me say that we are pleased with our progress in the first nine months of 2008. We are continuing to profitably grow our insurance and fee-based businesses in a competitive marketplace and we believe that we are continued to be on target to achieve an operating return on equity between 5.5% and 6.5% on our ongoing business in 2008.

With that, let me turn the discussion over to Bill for a more detailed look at our operating results as well as our review of our capital position. Bill?

Bill Hitselberger

Thanks, Vince. For the quarter of 2008, we reported a net loss of $1.1 million were $0.03 per share compared to a net loss of $8.8 million or $0.27 per share for third quarter of 2007. Operating income increased to $6.4 million or $0.20 a share for the third quarter of 2008 compared to $5.1 million or $0.16 per share for the same quarter of last year.

For the first nine months of 2008, we reported a net income of $9.8 million, or $0.31 a share, compared to a net loss of $5 million or $0.15 a share for the same period last year. Operating income increased to $18 million to $0.56 a share in the first nine months of 2008 compared to $11.6 million or $0.35 a share in the same period a year ago.

In my discussions of segment performance, I will focus on operating results. Please see page three of our earnings release for the reconciliation of segment operating results to GAAP net income or loss.

Now let me turn to the specific results of the PMA Insurance Group. The Insurance group reported pre-tax operating income of $13.3 million for the third quarter compared to $11.7 million for the same period last year. Year-to-date, pre-tax operating income was $38.3 million compared to $30.4 million for the first nine months of 2007.

Direct premium production increased 10% in the third quarter to 5% during the first nine months of 2008 compared to the same period last year. However, the year-to-date direct premiums written were down due to reduction and fronting premiums and higher return premium adjustments of $14 million. The premium adjustments primarily reflect favorable loss experience and loss-sensitive products where the insured shares in the underwriting results of the policy.

The increases in direct premium production in 2008 primarily reflected increases in larger account business and in captive accounts. Our captive arrangements allow larger clients to assume more risk and with our traditional insurance products. We provide the underwriting, claims processing, risk control and we place to reinsurance lot of client’s shares in the underwriting results and investment income of the captive.

Captive account business provides us with a greater degree of certainty in achieving our profit margin on an account-by-account basis as compared to traditional first dollar business. Direct premiums written were $148 for the third quarter of 2008 compared to a $147 for the third quarter of 2007. For the nine months ended September 30, 2008 direct premiums written were $388 million compared to $419 million for the nine months in 2007.

Fronting premiums were $3 million in the third quarter of 2008 and $13 million in the first nine months of 2008 compared to $14 and $47 million for the same period a year ago. Excluding fronting business we wrote $39 million of new business in the third quarter of 2008 up from $27 million in the prior year quarter and we’re $100 million for the first nine months of 2008 up from $91 million during the same period last year.

Our renewal retention rate on existing worker’s compensation accounts was 88% in the third quarter of 2008 compared to 89% for the same period last year and our renewal retention rate for the first nine months of 2008 was 86% compared to 87% for the same period in 2007. Net premiums written were $124 million in the third quarter of 2008 up from a $116 million in the prior year quarter and $317 million for a nine months ended September 30, 2008 compared to $324 million during the same period a year ago.

The increase in net premiums written for the quarter primarily reflected an increase in direct premium production. Net premiums written for the first nine months of 2008 were down due primarily to the first quarter returned premium adjustments until lesser extent an increase in the amount of worker’s compensation business sold to captive accounts, where a substantial portion of such direct premiums are ceded to the captive. The year-to-date impact of these items was partially offset by increased direct premium production.

The combined ratio for the third quarter of 2008 was 95.2% to compare to a 97.3% for the third quarter of 2007. The year-to-date combined ratio on 2008 was 96.5% compared to a 99% in 2007. The increases in the loss in LAE ratios for both periods were primarily related to an offset by the declines in the policyholders’ dividend ratios for the quarter and year-to-date periods. The policyholder dividend ratios were lower in the third quarter and first nine months of 2008 compared to the same period last year.

The current year periods reflected slightly higher loss experience in captive accounts which resulted in lower dividends on captive products. Again, were the policyholders may receive a dividend based to a large extent on our individual loss experience. Commissions earned under our fronting agreements reduced the current year acquisition expense ratios by 0.4 points for the quarter and 0.7 points for the first nine months, compared to 0.8 points and 0.7 points for the same periods in 2007, as the ceding commissions earned on this business reduced our commission expense.

The 2008 acquisition expense ratios also benefited by 2.5 points in the quarter and 1.9 points year-to-date from reductions in premium-based state assessments. Net investment income was $8.8 million in the third quarter of 2008, compared to $9.4 million in the prior year quarter. For the first nine months of 2008, net investment income was $26.8 million compared to $28.5 million in the first nine months of 2007. The decrease was primarily due to lower yields, which were approximately 40 basis points lower for the quarter and 30 basis point lower year-to-dates. The declines for both periods were partially offset by an increased in the invested asset base.

Now, I’ll comment on the results of our fee-based businesses. For the third quarter of 2008, our fee-based businesses reported pre-tax operating income of $1.9 million compared to $661,000 for the same period last year. For the nine months ended or September 30, 2008 pre-tax operating income was $5.3 million compared to $2.1 million for the first nine months of 2007. The increase is related primarily to the inclusion of the results of Midlands, which we acquired in October 2007.

For the third quarter of 2008, total revenues increased to $9 million, up $11 million from the same period last year. For the first nine months of 2008, total revenues increased to $52 million compared to $23 million for the first nine months of 2007. The increase in revenues related primarily to our acquisition of Midlands, which accounted for $7 million of this growth in the quarter and $21 million on the year-to-date basis and to organic growth in revenues at PMA Management Corp., which increased 34% for the quarter and 25% year-to-date compared to prior years.

The total increase in revenues in the third quarter of 2008 primarily reflected in $8 million increased in claims service revenues and $3 million in commission income compared to the third quarter of last year. The total increase in revenues during the first nine months of 2008 primarily reflected in $18 million increase in claims service revenues and $10 million increase in commission income compared to the same period last year. The segments operating results for the third quarter of 2008 also reflect the results of PMA Management Corp. of New England, which we acquired in June 2008.

Now, I would like to make a few comments on our discontinued operations. The discontinued operations, which are formerly our Run-off Operations in consists of our former reinsurance and excess and surplus lines businesses, recorded after-tax losses of $2.3 million and $4.9 million for the three and nine months period ended September 30, 2008, compared to after-tax losses of $14 million and $16.5 million for the same period in 2007.

The loss for the first nine months of 2008 was due to an after-tax charge of $4.9 million for adverse loss development. Including $2.3 million recorded in the third quarter, which contractually reduces the amount of cash and contingent consideration that we will receive at closing. The expected cash to be received has been reduced to $2.5 million and the value of the contingent consideration has also been reduced to a face amount of $2.5 million. Again we reflect only the expected cash amount in our financial statements. Results in the third quarter and first nine months of 2007 included an after-tax charge of $14.3 million for adverse loss development.

Now I would like to turn your attention to our overall financial condition. Our book value was $11.20 a share at September 30^th, 2008 compared to $11.92 a share at December 31^st, 2007. The decrease in book value per share was primarily due to a decline of $0.82 a share or $26 million related to the change in the unrealized hold position on our available for sale fixed-income securities portfolio. Of which $15 million or 57% of the decreased occurred in the third quarter of 2008. The unrealized position on our investment portfolio decreased largely due to widening credit spreads on fixed income securities.

Book value per share was also reduced by $0.23 a share or $7 million, as a result of the decrease in a value of the investments in our pension plan portfolio. The impact of the decline in the unrealized position of our portfolio and in our pension investments was partially offset by our earnings to-date in 2008. We continue to review our investment portfolio in light of recent changing market condition. The fair value of our total invested assets from continuing operations was $790 million at September 30^th, 2008, which represented 96% of amortized costs. The portfolio’s average credit quality was AA+, contained substantially all investment grade securities and at a duration of 3.6 years.

Of the $790 million, $416 million or 53% of our investment portfolio was allocated to mortgage back and other asset back security and collateralize mortgage obligations. Of this $416 million, $17 million or 4% were residential mortgage-backed securities whose underlying collateral was either a sub-prime or Alternative A mortgages. The $17 million, which includes $15 million of Alternative A collateral, and $2 million of sub-prime collateral had an estimated weighted life of 2.1 years, with $5 million of this balance expected to pay-off within one year and these portfolio had an average credit quality of AAA.

Also included in the $416 million of structured securities, were a $182 million or 44% of our total structures are residential mortgage-backed pools in collateralized mortgage obligations issued by either U.S. Government agencies or U.S. Government sponsored enterprises. We also held non-GSA issued CMOs with a fair value of $167 million or 40% of our total structured securities that were either the super senior or senior branches of their respected mortgage pools at a weight average life of 5.2 years in an average credit quality of AAA.

During the first nine months of 2008, the non-GSE issued CMOs generated cash flows which totaled $12.4 million in principle pay downs of the underlying mortgages. Delinquencies of the underlying mortgages remained well below to credit support structure of the trenches that we held.

The portfolio also held securities with the fair value of $30 million or 4% of the portfolio, whose credit ratings were enhanced by various financial guarantee insurers. Of the credit enhanced securities, $13 million were asset-backed securities, none of which were wrapped asset-backed securities or CDO exposures with an average life of 3.9 years and the underlying collateral had an imputed internal rating of A.

Approximately 45% of or reinsurance recoverable’s balance of $825 million is collateralized and 2% of these recoverable balances are due to PMA for losses that we have already paid. A $29.5 million in cash and short-term investments that are holding company and are non-regulated subsidiaries at September 30 of 2008, we believe there are current funds, combined with our other capital sources will continue to provide us with sufficient funds to meet our foreseeable ongoing expenses in interest payments.

Statutory surplus for insurance companies in the PMA Insurance Group was $336 million at September 30, 2008 compared to $335 million at the end of 2007. PMA Insurance Group companies have the ability to pay $29.2 million in dividend during 2008. Without the prior approval the Pennsylvania Insurance Department. This statutory surplus of PMA Capital Insurance Company our wholly owned run-off reinsurance subsidiary which is being reported as discontinued operations, was $26 million at September 30, 2008 compared to $48 million as of December 31, 2007.

That concludes our prepared remarks. Vince and I would now welcome your questions and Sandy if you could please open the lines for any questions.

Question-and-Answer Session

Operator

(Operator instructions) And your first question comes from the line of Randy Binner of FBR Capital Markets. Please proceed.

Randy Binner – FBR Capital Markets

Hi, thanks everyone. I have a question on the fronting business, you indicated in Vince’s comments in the press release that between Appalachian and Arrowhead I think there will be $70 million to $100 million annualized direct premiums written. Just from a modeling perspective I guess first of all, can we breakout the production from each because it looks like the retention is different for each?

Bill Hitselberger

We will consider disclosing that Randy in the fourth quarter by then we’ll probably have a better sense of where believe the reduction is going to come from each of those sources.

Randy Binner – FBR Capital Markets

Okay, and so the retention for one, I guess Arrowhead is 10% and Appalachian is 20%, so if we cannot blend it to 15%, is that would that be an inaccurate – because these are real number?

Bill Hitselberger

It’s probably going to a blend down slightly lower in that Randy, because we believe that the, we will probably get more part production from Arrowhead than from Appalachian.

Randy Binner – FBR Capital Markets

Okay, and then so the, your retention –?

Bill Hitselberger

We also need our attention to be higher in that Randy, I apologize as I spoke.

Randy Binner – FBR Capital Markets

So, tough higher than that –?

Bill Hitselberger

Yes, yes my mistake.

Randy Binner – FBR Capital Markets

Okay, no worries and so that part goes obviously to underwriting income that’s retained and then on the fronting business, do you have an estimate of what kind of fee you would collect, the business comes in and then its earned and then you collect some kind of fee against it, is there an estimate…

Vince Donnelly

The fees will probably be consistent with what we have had with Midwest Randy.

Randy Binner – FBR Capital Markets

Okay, that is enough on that. Just one another question, I’ll drop back in queue. I mean Vince you mentioned, a lot of negative pricing trends from what you’re seeing out there which is obviously consistent with the soft market, but recently there’s been a lot of talk about the P&C market turning.

I’m just be curious and I’m sure you’ve read all of those sources, you are an admitted business workers compensation, so more color on that, I think would be very interesting for me and other investors. In the regulated businesses and then in the fee for service business as well as if you are seeing signs of market hardening and then if so what kind of timeframe that would be? Thanks.

Vince Donnelly

Well, Randy we are, I am excited to hear with some of the I guess larger insurers and re-insurers have been speaking about what 2009 may bring and I guess, we’ll sort of wait and see. What I can tell you is, while pricing continues to be downward is over the last couple of months is neither improved nor declined. So, I think we have seen at least in our businesses sort of flattening of the rate declines.

With that said, is our rate-sensitive business or worker’s compensation, the states played enormous role in that and for example when in Florida we just announced another 18% rate decrease effective 11. Now, we do think that while that will go in effect, that we’re expecting some other action, the other way given the recent Supreme Court ruling in the state that roll back some of the reform, so and we’re still in the midst of a evaluating Florida. So, you do have while that maybe in extreme. You do have states influencing what the market is going to do as well especially again for the rate-sensitive business.

So, we’re expecting in the short-term that the market is going to continued to be soft and as I said we’ll see what 2009 brings, if in fact the talk that larger insurers and reinsurers or if those actions are going to be first of all come to fruition and will they be broad-based across the entire market in terms of lines.

For example some of the commentary has been first and foremost about property, which generally property rates generally move up and down a lot faster depending on how the catastrophe world is and as you know while we have not been impacted by it. It has been a very, very challenging year for the industry, mainly the insurance industry, but the reinsurance industry was impacted in the third quarter by Ike, it has been a very tough year. So, I am not surprised to hear the commentary about property rates.

Randy Binner – FBR Capital Markets

Great, thanks.

Operator

Your next question comes from Beth Malone, KeyBanc. Please proceed.

Beth Malone – KeyBanc

Hi, thank you. Good morning. A couple of question, one kind of a follow-up on what, Randy was asking about on the regulatory front, in a recession. As I think everybody has admitted that we are in now. Do you regulators tend to be more onerous on their rates trying to support their local economies?

Vince Donnelly

No, Beth that is a difficult question to answer in terms of getting in the minds of the states. I mean, I think I know in our, for example Pennsylvania, which is our largest state. I think the process in terms of the evaluation that the state as done with the Pennsylvania Comp Rating Bureau has been very consistent probably for the last 10 or 15 years, then I have been involved in the organization.

So, I can’t comment how they superimpose their view of the economy, but there is very specific documents that are filed and models that are filed about historical experience as well as what they believe the trend lines are going to be for frequency duration of claims and medical. So, again I take comment with the states, I do think and I fully expect that the process will be consistent going forward as it’s been in the recent past in that evaluation process.

Beth Malone – KeyBanc

Okay and then question on the acquisition of the Run-off business. As you said, there was some development and in addition the state has note approved the transaction yet. I just want get an update on, does this unfavorable development in the third quarter treat any kind of uncertainty about the willingness of the buyer to complete the transaction or does it have any bearing on how the regulators might view the transaction?

Bill Hitselberger

Beth, the regulator have had a Form A, it was filed at the end of May by Brevan Howard folks. Certainly, we discuss with them the reserve adjustment and I believe they remain a committed buyer that the states is going through it’s process of reviewing the Form A and concurrently with that it’s performing triennial examination of our statutory financial statement. So, I don’t think that the reserve charge has any direct bearing on that, but certainly the states needs to conclude its review before it can make a formal decision.

Beth Malone – KeyBanc

Okay thank you and then on the investment portfolio, have you made any changes to how you’re investing or you just caught up in the market conditions that everybody else is suffered from?

Vince Donnelly

Well actually it’s a really good question Beth. We see some opportunities out there now in both some of the structures and then some other corporate names. We are working with our portfolio managers to make decision. I think I would characterize the unrealized losses that we have as spread driven.

I mean certainly you did not any particular names other than the Lehman and the Fannie Mae that we had to take OTTI charges on and then certainly the other thing is we’ve posted those investments on our website, so we encourage anybody who is interested in our portfolio or modeling our portfolio, I guess you put it out there in an excel format, so that any analyst that they would like could model in an acuities level so you’re encouraged to take a look. I think my final comment Beth would be that, we continue to remain pretty conservative and have a pretty conservative investment policy at PMA.

Beth Malone – KeyBanc

Okay that’s helpful and then on the Florida and New York reductions it sounds like the changes they’ve made don’t necessarily affect the margins on the business you’re riding, but I would guess that as times goes on if these reductions continue or become more prevalent in the marketplace it’s going to be difficult for you to maintain (inaudible) grow even though your margins the same, your revenues were coming down, isn’t that the right way to look at it?

Vince Donnelly

Well, I think you’re right Beth, certainly in fact that in New York and Florida till now. Okay, believe that there is a correspondence between what’s going on with the rates and where the trends have lost cost, but absolutely even though the margins stay the same is the top line goes down.

The other thing I would add to that and I think I said this in the comments responding to Randy’s question is the 18% reduction that was just approved by Florida for 11. We’re evaluating that in terms of, can those loss cost trends absorb another 18% and certainly the fact that it was the Supreme Court decision that’s basically overturned a portion of the reform that was put in place in 2003.

We expect that the National Council of Compensation Insurers based on everything we’ve heard publicly that they will be evaluating and potentially make it filing to offset that and I think even the Florida, Insurance Department made a comment that they expect that now.

We will be evaluating, what we thing that number should be and we’ll look very closely, how the Department responds to that. So, we are certainly looking closely at Florida and making sure that we’re comfortable that the margins remain consistent with what we expect, but certainly the 18% reduction and the Supreme Court decision have us in evaluation mode.

Beth Malone – KeyBanc

Okay and then just one last question, sorry for so many. On the outlook for the captive or for fee-based business, you have been fairly successful in building up that business rapidly and I’m just making sure the interested to know, is this a growth rate that we can anticipate going forward? Is the environment favorable for this kind of structure going forward?

Vince Donnelly

Well, Beth thanks for the complement. The growth has been especially this year very, very good and when I think in my comments I said, in continued repeat that we fully expect that we can organically growth that business without giving your percentage, I would say that it would be very, very challenging to continue to grow at 25% a year. We’ve had some success this year, some unusual positive success with some very large accounts.

With that said is, at least in the PMA Management Corp., which has been is the building block, the foundation of our fee-based business for the last six or seven year. We have grown that business at a double-digit pace and in the teens, not in the 20s and I expect that, while it’s a competitive business and as I said there are some new entrants in that business and we still believe that there is room for us to growth, especially in the Southeast part of the United States, where our relative market share is very, very minimal there and certainly in PMA Management Corp. of New England, the formerly Webster Company and having Midlands come on Board.

We see that there continues to be opportunity and I think not to similar to our insurance operation. We are not the cheapest price that we try to distinguish ourselves based on the service level that we are going to bring to our customers and I’m very pleased for example and PMA Management Corp. of New England, it’s only been a quarter, but our clients I think very, very comfortable with us.

They like the service they had before and understand are coming to understand that PMA is a very service oriented organization, so that is not going to change in landscape. So, that’s how we have competed, we are going to continue to compete and I am confident that we can continue to grow at pretty good pace. Again not at the pace we’ve gone in the first nine months of the year though.

Beth Malone – KeyBanc

Okay, thank you.

Operator

(Operator instructions) Your next question comes from the line of Matt Rohrmann, please proceed, of KBW.

Matt Rohrmann – KBW

Bill and Vince, good morning.

Vince Donnelly

Hi, Matt.

Bill Hitselberger

Hi, Matt.

Matt Rohrmann – KBW

I have just a couple of questions. First, I know we are all kind of waiting for the state to approve sale of the Run-off. Is there anyway to gauge where we are? I mean we are like in seventh inning, eighth inning. Does it still seem on track to be closed up by the end of this quarter?

Bill Hitselberger

Matt, it’s hard for me to assess it. I think certainly they have gotten the Form A. They are going through the triennial examination, I mean those are both that they have to complete the triennial before they can go through their approval process. So, it’s an innings analogy I’m not exactly sure, where I would say, I certainly believe that we are committed and buyers committed to timely getting the insurance department whatever information they need.

Matt Rohrmann – KBW

So, it still generally on track as far as you see it?

Bill Hitselberger

Yes.

Matt Rohrmann – KBW

Okay and then what’s the value of deferred tax assets on the book rate now?

Bill Hitselberger

The deferred tax asset that’s on the books; hold on for just one second, I need to get that of the balance sheet is at $131 million.

Matt Rohrmann – KBW

Okay.

Bill Hitselberger

And then there is roughly about $60 million Matt, of the valuation allowance that’s not on the books.

Matt Rohrmann – KBW

Okay and then last question. You guys have done a great a job with specialty medical networks, keeping utilization down. Any other partnerships you see that you might be able to take advantage of going forward?

Vince Donnelly

Well, Matt. We continue to look at specialty networks and dialogue with even partners today, how we can refine and improve what they have. I agree with you we are very pleased and while medical costs are still going up 6.5%. We’re focused how can we drive that rate of inflation down and one way to do that is to be looking at, make sure we have the right networks and second is internally, constantly trying to figure out, how do we monitor the utilization because really in most of our states, our major states, there are fee schedules.

Now not every charge is associated with this fee schedule. There are things incurred outside of that fee schedule. So, there is some control, if you will to unit cost that we negotiate with our networks to do better than that certainly, but I think the big driver going forward is managing utilization.

One of the ways to manage that is to have specialist. For example, one of the networks I have talked about before is MedRisk, which is really a specialist in physical medicine and we’ve seen both improvement there in our unit cost, but we’ve also seen improvement in the utilization of that. So, we’re going to continue to look at it. I guess, I described, this is we’re going after this is Nickels and Dimes and every little bit that we can take-off that certainly help. So, we continue to work at it, we’ve not rested on our laurels with respect to that.

Matt Rohrmann – KBW

Okay, thanks a lot guys.

Vince Donnelly

Thanks, Matt.

Operator

Your next question comes from the line of Michael Nannizzi, Oppenheimer. Please proceed.

Michael Nannizzi – Oppenheimer

Hi, just one quick question actually about the alternative business you wrote in the quarter. In terms of comparing it your legacy book, can you just talk about average policy size? And whether or not the structure on the reinsurance side is similar to what you guys have booked in the past? Thanks.

Bill Hitselberger

Yes, Michael the captive business and I think that’s what you are talked when you mention the alternative business?

Michael Nannizzi – Oppenheimer

Right.

Bill Hitselberger

Yes, I mean I think that the general terms of them are consistent with the business that we previously produced around captives. Generally the captive is a group of company that will take a fair amount of the first dollar risk. What we get from that is, and we get a fee for producing the policy form. We also get claim service fees for taking care of the first dollar losses that are associated with the program.

Now, we get a risk margin for taking some of the accept loss that exist above the program and then what we generally do is we reinsure out and once we get to our risk parameters we reinsured that business out to a third-party. So, yes the business has been pretty consistent. There is different types, we have restaurants that are in captive, and there are some fast food things that are in captive. There is different types of customer bases, but I’d say that the overall, the business element of them is very consistent with what we’ve seen previously.

Michael Nannizzi – Oppenheimer

And in terms of you, I think Vincent mentioned, that you had a one or a couple of large accounts. I mean in terms of policy size are kind of the same ballpark and just related question. On the self-insurance side, are you seeing similar type of growth as well?

Bill Hitselberger

Well on the self-insurance side, we’ve been very fortunate. I mean, PMA Management Corp. has grown over 25% on the year-to-date basis. So we’ve seen extraordinary opportunities on the TPA side for our self-insured customers and with respect to what we call the risk management service business, which is our large account business. I’d say overall the policy sizes are consistent and certainly most of that business is written on the loss-sensitive basis.

So, the loss cost trends that Vince had mentioned too earlier and the pricing trends, we’re more immunized from that with respect to that large account business. Now having said that, standard policy or standard premium rates will go down because as pricing changes are made, the pricing around that business may go down, but our margin should generally remain pretty consistent.

Michael Nannizzi – Oppenheimer

Great, thanks.

Bill Hitselberger

Thanks, Michael.

Operator

Ladies and gentlemen, this concludes today’s conference call. Should you require additional information about PMA Capital Corporation, please contact to the Investor Relations Department at 601-397-5298. And thank you for your participation. You may disconnect at this time.

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