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Meadowbrook Insurance Group, Inc. (NYSE:MIG)

Q3 2008 Earnings Call

November 4, 2008 9:00 am pm ET

Executives

Robert Cubbin – President & CEO

Karen Spaun – CFO

Analysts

Beth Malone – KeyBanc

Analyst – RBC Capital Markets

Tom Spiro – Spiro Capital

Brian Roman – Unspecified Company

Operator

Good morning ladies and gentlemen and welcome to the Meadowbrook Insurance Group, Inc. third quarter 2008 conference call. (Operator Instructions) It is now my pleasure to introduce your host, Ms. Karen Spaun, Chief Financial Officer for Meadowbrook Insurance Group Inc. Ms. Spaun; you may now begin.

Karen Spaun

Welcome to Meadowbrook's third quarter 2008 earnings conference call. I will lead off today's call with a review of our financial results. Robert Cubbin, our President and Chief Executive Officer will then follow with a review of our financial outlook and current market conditions. The call will conclude with a question-and-answer session.

During this call, we may make certain statements relating to future results and expectations. These statements constitute forward-looking statements as defined under the Private Securities Litigation Reform Act of 1995. We therefore must state actual results may differ materially from those projected and may involve risks and uncertainties that are outlined in our Forms 10-K and 10-Q that are filed with the SEC.

Please note Meadowbrook undertakes no obligation to update or revise any forward-looking statements. If you have not received a copy of our earnings release, it is currently available on our website, www.meadowbrook.com or you may give me a call and I will be happy to fax a copy to you.

Now for our results, while there are many factors that are incorporated into our results for the quarter ended September 30, 2008, we are pleased with our core operating results.

For the third quarter of 2008 we reported net operating income of $10.9 million or $0.23 per diluted share and net income of $4.2 million or $0.09 per diluted share. Net operating income for the nine months ended September 30, 2008 was $26.5 million or $0.65 per diluted share, and net income was $19.7 million or $0.48 per share.

Because the merger closed on July 31, 2008, our combined results include only two months of ProCentury. ProCentury’s results include property losses from Gustav and Ike, but the incremental premium base that those losses were spread over is relatively small because it consists of only two months of earned premiums.

Despite this and because of diversity of Meadowbrook’s combined book of business we still reported profitable underwriting results of the third quarter and year-to-date periods. These hurricanes had an after-tax impact of $5.4 million or $0.11 per share.

The 2008 third quarter GAAP combined ratio was 96.7% and includes 8.1 percentage points of property catastrophe losses for the two hurricanes. The third quarter also includes 5.1 points of favorable prior year development.

This compares to a combined ratio of 93.8% for the third quarter of 2007 which includes no catastrophe losses and 5.4 points of favorable prior year development. The loss ratio for the third quarter of 2008 was 65.7%.

Excluding the impact of catastrophes the loss ratio would have been 57.6% and compares to 59.9% for the third quarter of 2007.

The 2008 third quarter combined ratio includes an expense ratio of 31% compared to 33.9% for the same period in 2007. The expense ratio improvement is due primarily to the reduction of fronting fees and the company’s ability to leverage fixed costs over a larger earned premium base.

For the third quarter of 2008 gross written premiums grew by 48.2% to $134.4 million which includes $37.8 million from ProCentury for the two months following the closing on the merger.

Excluding ProCentury gross written premium grew by 6.5%. Included in our third quarter results are $6.7 million or $0.14 per diluted share of realized investment losses. These impairments were primarily related to the preferred stock investments in Fannie Mae, Freddie Mac, and Lehman Brothers.

We also recorded an impairment on GMAC and Lehman Brothers Bonds. We spent a lot of time analyzing our portfolio and we believe that the recent systematic factors such as the contraction of liquidity and general supply and demand and balances for fixed income securities are influencing the value of our investment portfolio more then any isolated credit issues with any individual securities.

We believe that these conditions are temporary and we have the ability and intent to wait it out. The duration of our assets and liabilities match up well and we have historically strong cash flows so we are under no pressure to sell securities in order to meet liquidity needs.

Additionally it is our intent to hold our investments to maturity. We have historically not sold securities [inaudible] liquidity needs and we do not intend to do so currently. We believe our portfolio exhibits appropriately conservative characteristics.

The duration on our portfolio is 4.5 years, pre-tax yield is 4.3%, after-tax yield is 3.3% and our reinvestment yield is 4.7%. Approximately 99% of our fixed income portfolio is investment grade. We take this in our insurance operations therefore our goal is to limit the amount of risk we take in our investment portfolio.

For the third quarter fee for service pre-tax income increased to $5.8 million from $2.8 million in 2007. For the third quarter of 2008 we reported a pre-tax margin of 19.5% compared to 10.5% for 2007. This increase reflects the elimination of the USSU management fee upon executing the buyout of this agreement in the first quarter of 2008.

During the third quarter of 2007 there were $1.4 million USSU management expenses, also variable compensation in the third quarter of 2007 was $3 million compared to $829,000 in the third quarter of 2008. The reduction in expenses were somewhat offset by a decline in fee for service revenues due primarily to our small Workers’ Compensation business in New England.

These fees are based on premium levels and there were mandatory rate reductions in Workers’ Compensation.

Before turning the call over to Robert, I would like to highlight some of the more significant points related to purchase accounting on the ProCentury merger.

During the quarter we issued 21.1 million shares for $122.5 million of new equity in conjunction with the merger. Total consideration for the transaction was $220.2 million. Due to the transaction our balance sheet reflects goodwill of $48.8 million and an increase in other intangible assets of $30.6 million.

The book value per share at September 30, 2008 was $7.33 or $7.57 per share if you exclude unrealized losses on our investment portfolio. The book value per share excluding goodwill at September 30, 2008 was $5.45 per share or $5.69 per share if you exclude the net unrealized losses on our investment portfolio.

Now I will turn the call over to Robert Cubbin.

Robert Cubbin

Thanks Karen, good morning everyone. This is the first quarter that we are discussing actual results of the post merger Meadowbrook. There have been many well-documented events that have occurred in the global economy and in the financial markets in the last three months, many of which have led to there being a lot of noise and distortion in our third quarter results.

Among those events, the impact of the two major hurricanes on our combined third quarter results of only two months of premiums from ProCentury. The impact on our investment portfolio from US and world markets experiencing a myriad of credit and liquidity challenges and a massive deleveraging that have contributed to declining and in most cases for us, temporarily depressed values of our fixed income securities.

In spite of these unusual factors on a quarterly and a year-to-date basis our core operating results are quite good. In addition we have made a lot of progress on the merger integration and in implementing new opportunities for growth. All in, year-to-date net income from operations was $26.5 million.

The combined ratio was 94% and book value per share as Karen said, $7.33 if you include the impact of the unrealized losses in the portfolio. We continue to realize the benefits of our AM Best upgrade to A minus both in new business prospects and in lower expenses. We have realized several revenue growth synergies created by the merger and we are maintaining the underwriting profitability of our book.

In addition there are indications that point to a shift toward more adequate pricing. Although to date there has been continued price competition in some of the markets that we serve and our rates have declined somewhat in 2008, because we primarily work with smaller accounts, the changes have not been as severe as those reported elsewhere.

Overall for Meadowbrook historic business rates are down around 3.5%. Workers’ Comp is down around 7% and lines other then Work Comp have declined by 1.5%. In the surplus lines business rates are off but the available market has also shrunk as admitted carriers have taken some of that business during the soft market.

The Century business, the rates are down around 6%, more so on liabilities, slightly up on other lines. Our goal is to compete on service, long-term stability and loyalty and we remain committed to profitable underwriting.

We believe that our measured rate responses reflect this disciplined philosophy. As I said there are indications and recent events that may signal a stabilization and/or a turn in the pricing cycle. Overall industry profitability remains challenged. Investment performance and the impact of 2008 storms will likely pressure capacity at the primary carrier level.

It is estimated that between the two hurricanes and investment losses in the quarter the industry has lost over $40 billion in surplus. Fortunately we are positioned to grow as and when the market cycle turns and we do not need new equity to do so.

Rating agencies are also encouraging lower premium to surplus leverage ratios for reinsurers and as a result there will likely be less reinsurance capacity and very few sources to raise new capital. There is still a lot of uncertainty surrounding the challenges faced by AIG as a result of the credit default [clause] in the sale of subsidiaries.

So the market is likely to react by raising prices. When is the issue. Our investment portfolio post merger is now over $1 billion and as Karen said, the portfolio is well diversified primarily in fixed income investments and is conservative. Nearly 99% of the bonds we hold are investment grade.

Along with ongoing positive operating cash flow and a well-matched duration between assets and liabilities we have the ability to hold any temporarily impaired securities to maturity and realize their full value.

With the merger we picked up some exposure to preferred stock and we have realized some unexpected losses on those securities. Our philosophy has always been to maintain a conservative investment posture. Our plans are to gradually migrate the portfolio to conform to Meadowbrook’s more conservative guidelines but this will take some time.

However at this point there is a much smaller downside risk. We are under no pressure to liquidate any of our securities. Not only are the durations of our assets and liabilities well matched, but we have no significant debt that is callable and due in the near future and we have an untapped $35 million line of credit.

We have a long history of strong operating cash flow and we have the ability and intent to hold those securities in an unrealized position to recovery or maturity. We are working from a very strong capital position. Our balance sheet is solid with adequate reserves and we are liquid.

Working through a position of strength we expect to have some choice and flexibility in the way that we deploy our capital. We are also making good progress on the integration with ProCentury. With the addition of Century the company’s geographic footprint and reach across product and distribution channels has improved.

Numerous revenue growth opportunities are taking shape. Even before the merger was finalized our teams were working together to target the most immediate opportunities. The combined management team has participated in various underwriting and key producer meetings to talk about how the combined capabilities of the companies can better support the needs of our distribution partners.

Following the merger we launched a new wholesale relationship in the Mid West. This wholesaler works with other agents who have a need to access markets that Century and other specialty carriers can provide. This new operation has been quoting business for Century since early in the summer.

One of Meadowbrook’s long-term Workers’ Comp partners in New England was able to expedite Century’s surplus [client] relations approval there to provide a needed and complimentary market for that agent and its distribution network.

The synergies go both ways. One of Century’s top five distribution partners has identified an opportunity to take advantage of Meadowbrook’s program capabilities in their region and we expect this relationship while clearly valuable prior to the merger, will emerge as a larger and stronger partnership.

We have been able to use Meadowbrook’s admitted market licenses in various states that were previously unavailable to Century and as a result we are expanding our reach in the [garage], ocean marine, and surety segments.

The benefits of the merger will continue to build over the next several quarters. During the last half of this year we have been and will continue to work on identifying our best opportunities and implementing them.

Next year we will see some of the top line impact and the results will begin to fully emerge toward the end of 2009 as the initiatives gain traction. In the latter half of 2009 and in 2010 we’ll see meaningful earned premium influence our bottom line results.

There is still a high degree of uncertainty in the marketplace which creates opportunities for company’s like ours. We have a strong capital position and high quality reserves, no liquidity challenge, a diverse business model, talented people, a disciplined underwriting philosophy, and a proven ability to execute.

While there are indicators that suggest that the market will change, how quickly it will change is difficult to predict. With an assumption that the market remains slightly down to flat, we have established targeted ranges for our operating results for 2009.

We expect gross written premiums to grow to a range of $725 million to $740 million or the combined ratio of between 95 and 97. We expect operating income in 2009 to be between $0.80 and $0.90 per share on 57.6 million shares and excluding amortization expense, cash operating earnings of between $0.90 and $1.00 per share.

Achieving the high end of the range of our estimate contemplates a return on beginning equity of over 12%. As I said, the range of estimates contemplates a down to relatively flat rate environment. If rates do go up we should see better results. The year 2009 is a transitional year and because of our strong capital position we have the ability to grow without the need for more capital.

During the next harder phase of the cycle we expect that our ROE will grow towards the 14% to 15% range target, but by thoughtfully choosing our opportunities to deploy capital, we can make meaningful progress toward our target now and are positioned to exceed the target during more favorable pricing environments we see on the horizon.

We have reason to be optimistic. The merger integration is going well, we have a strong capital position, solid cash flow and high quality reserves, we are working from a position of strength and market uncertainty and disruption, create opportunities for us.

We are confident that the merger synergies will position us to protect our business from competition, develop new opportunities, and aggressively use our newly diverse capability to take advantage of a stabilizing and then firm pricing environment.

Thank you for your interest in Meadowbrook. We’ll now open the call for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Beth Malone – KeyBanc

Beth Malone – KeyBanc

The guidance that you’re giving, its $0.80 to $0.90 for 2009, correct?

Robert Cubbin

That’s correct, operating earnings that includes the amortization expense.

Beth Malone – KeyBanc

And excluding amortization it would be $0.90 to $1.00, is that what you’re saying?

Robert Cubbin

That’s correct.

Beth Malone – KeyBanc

It sounds like pricing is a major factor for what you’re looking for in 2009, and I’m curious when you look, do you see further deterioration or unexpected deterioration in pricing on the book of the ProCentury’s book once you close the transaction? Has the trend deteriorated since the time you agreed to purchase back in February to when the closed quarter?

Robert Cubbin

The pricing has deteriorated somewhat and as I said their rates are down around 6% overall, but on the liability side they’re still seeing some increase in prices in certain segments of their business. Property is up a little bit but overall they’re down and that’s pretty consistent throughout the year.

Beth Malone – KeyBanc

Is there an opportunity to offset some of that pricing pressure with new, expansion into new markets, there’s a lot of cross selling at the quarter, but there’s seem to be a lot of opportunity for cross selling into new markets, do you see that being an offset to the some of the price decreases?

Robert Cubbin

We’re seeing some fairly significant opportunities to increase the footprint of Century in New England as I mentioned, we already have them up and running with our wholesale partners. Here in the Mid West we have a new wholesale operation that didn’t exist for ProCentury before so we are going to see some growth in the Century business.

We’ve also gotten them licensed admitted markets now. Their garage, ocean marine and surety markets that they didn’t have before. So we are expecting to see 2009, an uptick in their buying as a result of the merger.

Operator

Your next question comes from the line of Analyst – RBC Capital Markets

Analyst – RBC Capital Markets

Given the merger with ProCentury which has slightly a different book and different risk profile and also maybe the rumblings of firmer markets in reinsurance particularly on the property side, have you shaped up how you’re going to approach your reinsurers and how much you might want to retain in 2009? Is it still going to be in the low 80s or are you going to retain a little more, little less or are you just going to wait and see?

Robert Cubbin

Our first treaty that is up for 12/01 is our property treaty, on the Meadowbrook side. ProCentury’s property reinsurance would generally have come up January 1, so we’ve moved that up to 12/01 to combine that with our treaty. The early indications are that the combined book and the diversification will help us to achieve good reinsurance pricing and we don’t really expect to see that on our book of business go up dramatically.

Our reinsurers have done quite well on the book of business and even the two hurricane losses in the quarter had a very, very minimal impact in the access or for our property cash treaty. So we’re really looking at overall some potential cost savings there. We’ve been able to in some cases look at increasing our retention but not dramatically. ProCentury’s property catastrophe attaches at $4 million. Meadowbrook because we had so much less property attached at $750,000.

So for the size property book that we have and the geographic spread that we have, we think we’re probably going to be more likely to adopt their property cat retention. On an individual basis both companies are on relatively the same type of retention and we would expect to keep that relatively the same.

Analyst – RBC Capital Markets

Moving onto your agency business, I could see with the Workers’ Comp both with the medical cost declines and maybe the economy that at least on the Workers’ Comp side that that’s declining a bit, are you seeing tangible impacts of a soft economy on business like that, whether its just straight pass throughs of Workers’ Comp premiums or maybe companies who want to restructure their captive agreements because of internal problems?

Robert Cubbin

In the soft market the fee business is not as impacted but as pricing continues to come down, fewer people create new self-insured programs and fewer people join existing self-insured programs because the market pricing is depressed versus what it had been. On the agency side, that absolutely happens right off the bat. In our agency business which focuses on slightly higher average premiums then in our insurance company, they have seen a downturn pressure on rates which then reduces their commission income.

So the economy itself, I don’t know that its simply the economy but if you look at certain pockets of the country where economic pressures are greater, like Michigan, we are seeing a greater impact.

Operator

Your next question comes from the line of Tom Spiro – Spiro Capital

Tom Spiro – Spiro Capital

Given the financial pressures out there are any of our risk-sharing partners themselves having financial difficulty?

Robert Cubbin

No we’re still in very good shape and as we said in the past when we have reinsurance relationships we over-collateralize trust agreements so that we have a margin for error both on their investment portfolio but also on their loss ratio so we remain in very good position there and have not seen any increase in our exposure to uncollectible reinsurance.

Tom Spiro – Spiro Capital

Is the collateral that we have in satisfactory shape?

Robert Cubbin

Yes, we monitor those investments on a monthly and quarterly basis so they’re primarily in fixed income securities just like our portfolio, and we keep close oversight of those because we are the beneficiary of those collateral accounts.

Tom Spiro – Spiro Capital

You mentioned that there’s some possibility for pricing to firm a bit, I was curious whether your thought at this early stage is that the primary and reinsurance markets might experience that roughly to the same degree or differently.

Robert Cubbin

Well I think the first thing that will happen, and again when this happens is subject to debate, but the reinsurance pricing is likely to firm up based on the conversations we’ve had at industry meetings with all of our major reinsurers, they’ve had their investment portfolios shock tested. They’ve had the rating agencies requiring them to decrease their premium to surplus ratios and there really is not a readily affordable source of new capital like there usually is after kind of a major hurricane. A lot of those reinsurers go out and raise new capital. That’s really not available right now, so we expect to see some firming in the reinsurance market which will then impact the primary carriers.

But even at the primary carrier level, the impact of both the decrease in their surplus from realized losses on their investment portfolio and the property cat losses this year, including second quarter which had some fairly significant Mid West storms that impacted the primary market, the primary market should follow suit thereafter.

Our plans for 2009 however do not contemplate a firming market. We really believe that based upon projections and estimates and trying to speculate on that we’re better off taking a more conservative view and positioning ourselves for a continued flat to slightly down pricing environment and if pricing does come back we can then take advantage of that and hopefully do better then our expectations.

Tom Spiro – Spiro Capital

On the investment portfolio apart from the bonds, could you remind us what else is in that investment portfolio of any consequence?

Karen Spaun

Actually, currently very little. There is some preferred shares in the ProCentury and that’s about on the market value, its about $10 to $13 million.

Robert Cubbin

Yes, that’s really the only equity that we have in there. The balance of the portfolio is municipal bonds, high quality, investment grade corporate securities, and so we’ve really stress tested that whole portfolio this quarter and working with our outside professional asset manager we believe that the combined portfolio is now in very good shape and that anything that has occurred with respect to a decrease in the valuation of those securities are temporary and are largely due to the strange case that we have right now which is where there’s a supply/demand mismatch where there are sales going on and that it doesn’t really reflect the true value of the portfolio.

And despite all that, even if the recovery of the unrealized losses does not occur in the next 30 or 60 days we have very strong cash flow. We have no need to create liquidity out of that portfolio and have demonstrated the intent and ability to hold that portfolio to maturity and or recovery back to a capital neutral position. We’re very confident in the portfolio and if it was ever going to be stress tested, it was during the last 60 days.

Operator

Your next question comes from the line of Brian Roman – Unspecified Company

Brian Roman – Unspecified Company

When you talk about firming and stabilization, you overlap a lot with AIG on both the Workers’ Comp and the excess and surplus lines, can you talk about what you’re seeing right now?

Robert Cubbin

Yes, we do have a lot of lines of business in segments where AIG is a strong competitor. In addition to the two places that you mentioned, they also are in the excess Work Comp arena which we are a participant in and in that arena we’re already starting to see some impact of concerns that client’s have over the insurance subsidiaries of AIG.

Brian Roman – Unspecified Company

I would assume its submissions at this point? People poking around making inquiries as opposed to specific new business.

Robert Cubbin

Actually its both. On the larger size accounts we have seen some inquiries about mid term changes so they may want to cancel and rewrite but primarily on renewal we have seen some clients who are looking for alternatives. On the smaller business, I don’t think we’ve seen really much impact of that yet and when you’re dealing with a small local retail agent and a small average premium size account, I don’t think they are as concerned about, or even maybe knowledgeable about what’s happening with AIG despite the rampant discussions in the news media.

So I think more would likely move at renewal as opposed to mid term.

Brian Roman – Unspecified Company

Smaller case, does that renew evenly through the year as opposed to larger case which tends to be [bulked] up around the beginning of the year and the middle of the year?

Robert Cubbin

No, you still see some cyclicality in the business. The excess Work Comp for example, July is a big month. January and July tend to have a lot of accounts even in the smaller sized business. But there is a lot of business that just renews over the course of the whole year. In Work Comp you do tend to see more January 1 and July. On our public entity business which is also another area that AIG competes heavily on, that also has a fairly large renewal in the third quarter into January.

So I think the January renewals will be more indicative of what’s happening with that uncertainty in the market.

Brian Roman – Unspecified Company

I guess we’ll get a better read on all your businesses in early February?

Robert Cubbin

Yes. Now with respect to ProCentury, on the excess and surplus line side, that market tends to move more quickly when it starts to turn. So we’re hoping to get some indications on movement in the markets even sooner then January 1 on the surplus line side.

But right now we really haven’t seen any dramatic shift in that.

Brian Roman – Unspecified Company

Let’s just spin reality here for a second and just say if you hadn’t done the ProCentury deal, that clouds up the numbers this quarter, as you did with USSU, that’s now, we’re about 15 months into that or longer, what would you say were this quarter’s benefits from that transaction?

Karen Spaun

On the USSU transaction, if you saw the increase in the margin on the fee per service, you’d see that both $2.8 million to $5.8 million, a good portion of that was the elimination of management expenses with USSU.

Brian Roman – Unspecified Company

That was the back end of the deal, right?

Karen Spaun

Correct.

Brian Roman – Unspecified Company

Where are the benefits of the ratings upgrade which I think was early last year?

Karen Spaun

Yes, April.

Robert Cubbin

There’s two areas, we’ve added significant new business. Its very difficult to quantify specifically how much new business we got because of the A minus upgrade, there are several programs though, multi million programs that would not have moved to us but for the A minus upgrade.

So there’s definitely benefit on the top line and then existing programs have also seen some growth but again its difficult to say an individual account within a program that moved because of that. But we have seen greater opportunities and actually we’ve gotten a look at a lot of other programs that we probably would not have seen but for that.

On the expense ratio side, that was the impact of the front fee in the expense ratio is about a 1.5 point in the expense ratio. And you saw our expense ratio year-over-year drop from almost 34% last to 31% this year so about half of that benefit was derived from the elimination of the front fee and then other—

Brian Roman – Unspecified Company

Which is a, in fact that you now have a higher rating to take that business onto your books.

Robert Cubbin

That is correct.

Brian Roman – Unspecified Company

You continuously on the ProCentury transaction talk about the benefits and the New England business, the moving into new markets, is there anything you’ve lost as a result of this transaction?

Robert Cubbin

That’s a valid question because in a lot of mergers there is a downside risk because you have overlapping distribution systems or you have conflicting programs or you have kinds of business that don’t match up with each other. Fortunately for us the fit and the complimentary nature of the two companies really did not result in any overlap in the distribution system nor any significant potential marketing conflicts so we’ve not seen anything that we’ve lost.

Obviously we would have preferred not to have had a Fannie Mae and Freddie Mac and Lehman Brothers preferred stock hit, but I would say that’s really the only area that was a negative from the transaction and certainly I don’t think anybody either on this call or anybody would have anticipated those events in September.

Operator

Your next question is a follow-up from the line of Beth Malone – KeyBanc

Beth Malone – KeyBanc

Could you talk a bit more about there has been a lot of movement in the ratings of insurers in this quarter. The rating agencies are becoming much more cautious about the outlook and a number of companies have their ratings affirmed but the outlook has gone from stable to negative. Could you just speak to where you think Meadowbrook is in terms of their relationship and how confirmed you are with the ratings that you currently have.

Robert Cubbin

As we mentioned the rating agencies are looking at reinsurers and others to make sure that they don’t have liquidity issues and I do believe that AM Best for one had sent out a questionnaire inquiring as to any near-term debt that is callable so that they could examine whether or not companies had adequate liquidity in order to meet their capital needs going forward. So that’s the only direct impact that I’m aware of.

And as we’ve said more then once, our liquidity position is very strong. Our assets and liabilities are well matched and we have not had in the past nor do we anticipate any requirements for unusual liquidity calls and don’t have any debt that’s callable, and we don’t really have any, and we have access to our non-regulated free cash flow and right now we have excess capital that we are hoping to deploy in a more firmer market that we are expecting on the horizon.

The rating agencies I think are cautious with respect to investment portfolios and liquidity and when you see in the decrease in underwriting profitability from this year versus last year, underwriting profits are about half of what they were last year. I think they’re duly cautious but in our case we feel very strong in our capital position and don’t expect anything from the rating agencies.

Beth Malone – KeyBanc

On acquisitions, you’re still on the topic of merging with the acquisition of ProCentury, is there any possibility that we would see another acquisition from you in the next six months?

Robert Cubbin

No I don’t believe that that would be something that we would be interested in. We do always want to be mindful that there are fee-based opportunities in the marketplace and certainly we would not be looking at any insurance company acquisitions. We’re not a serial acquirer. So we don’t really have that as one of our strategic initiatives. So you can rest assured that there will be no acquisitions by Meadowbrook in the next six months.

Beth Malone – KeyBanc

Since capital won’t be deployed to make an acquisition, would there be a possibility with the stock where it is that we would see more share repurchase and would you be, do you think that that would be possible given the [inaudible] that we’re getting from rating agencies regarding companies that are buying back their own stock?

Robert Cubbin

We did purchase 500,000 shares in the quarter. We have an authorization to purchase an additional 2.5 million shares and as we determine that our capital needs are going to be met for writing new business, then repurchasing shares is definitely something that we would want to do particularly at these very depressed levels that we’re trading at right now.

Beth Malone – KeyBanc

So you mentioned that you have more then adequate capital to, let’s say this cycle does turn and pricing strengthening, you would want to grow the business I would think in that environment and you have more then adequate capital on your books right now, but the accelerated growth in 2009—

Robert Cubbin

That is correct.

Beth Malone – KeyBanc

Do you define what your excess capital position is right now?

Robert Cubbin

Presently our growth premium to surplus ratios are below two to one, and on a net basis I think they’re at about 1.4. I haven’t done the numbers yet and projecting out we have earnings from our investment portfolio and underwriting profitability and non-regulated cash flow for next year that should be more then enough to support the anticipated growth.

The numbers that we are expecting for next year as you know, on our top line we don’t include in our budget or our expectations any new unidentified business and so if the market does turn, there should be a significant opportunity for additional new unidentified business. So we really haven’t quantified the amount of the excess capital at this point.

Another thing that we have to be cognizant of is that in our bank financing we have a pricing grid that is based upon debt to total capital and we would like to be able to move lower in that pricing grid to save money if its possible. So we’re trying to balance our cash flow, our capital needs, and our bank financing so that we can maximize the return on that.

But there certainly is room for us to repurchase shares.

Operator

Your final question is a follow-up from the line of Brian Roman – Unspecified Company

Brian Roman – Unspecified Company

Excess Workers’ Comp, how big a business is that for you and was that part of USSU?

Robert Cubbin

Yes, the excess Workers’ Comp is part of USSU’s business and they will write somewhere between $50 and $60 million in premiums. About $10 million of that will be on our paper and the balance is on a non-affiliated carrier’s paper so it’s a combination of fee business and underwriting profitability that we have from USSU.

Brian Roman – Unspecified Company

Are you going to get the, eventually get the other $40 million or so?

Robert Cubbin

No, we have a long-term relationship with that carrier and we want to maintain that relationship for as long as we and they agree to do so. But we have in addition to that, we have our public entity excess business so for our size company, we’re very mindful not to have too much exposure on the excess side and so really from a balanced standpoint we really do not want to have a whole lot more of excess type policies on our books.

That relationship is intended to be a long-term one and we will participate in the risks because we do believe in it significantly but it also helps support the balance that we like on the fee side.

Brian Roman – Unspecified Company

You’re saying that, obviously there’s fees there and there’s some nice underwriting income on part of the business, what I didn’t understand, you implied that there’s some sort of conflict between other parts of your business and how much excess business you take on—

Robert Cubbin

No, not really. Its really the risk profile of it. The excess business has a greater potential of volatility to it. Its much longer tail, which is a benefit but we just don’t like to have too much of that in our overall risk profile. So its really not a conflict, its really our own judgment that we don’t wan too much exposure to a more volatile if you will, line of business.

Operator

There are no additional questions at this time; I would like to turn it back over to management for any additional or closing comments.

Robert Cubbin

Thank you all for your interest and the questions and we will continue to work hard for your benefit.

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Source: Meadowbrook Insurance Group, Inc. Q3 2008 (Qtr End 09/30/08) Earnings Call Transcript
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