Amy Jordan - Assistant Vice President, Investor Relations
James Gober - Chairman, President & Chief Executive Officer
Roger Smith - Chief Financial Officer
Mike Grasher - Piper Jaffray
Caroline Steers - FPK
Doug McGregor - RBC Capital Markets
John Gwynn - Unidentified Company
Infinity Property and Casualty Corp. (IPCC) Q4 2008 Earnings Call February 5, 2009 11:00 AM ET
Good day, ladies and gentlemen and welcome to the Q4 2008 Infinity Property and Casualty Corporation Earning Conference Call. My name is Antwone and I will be your operator for today.
At this time, all participants are in a listen-only mode. We will conduct a question-and-answer session towards the end of this conference. (Operator Instructions) I would now like to turn the call over to Amy Jordan, AVP of Investor Relations. Please proceed ma’am
Thank you. Good morning and thank you for joining us in Infinity’s fourth quarter earnings conference call. The live event link on our website does contain the slide presentation for this morning’s call if you would like to follow along. We also have an Excel spreadsheet on our website under the quarterly reports tab that provides more detailed quarterly financial data and page 10 of this report does contain the definition and reconciliation of any non-GAAP items that we discuss this morning.
Certain statements made during this call may be deemed to be forward-looking statements that anticipate results based on our estimates, assumptions and plans that are subject to uncertainty. These statements are made subject to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. All statements in this call not dealing with historical results for current facts are forward-looking and are based on estimates, assumptions and projections.
Statements that include the words believe, seeks, expects, may, should, intend, likely, targets, plan, anticipates, estimates or the negative version of those words and similar statements of a future or forward looking nature identify forward-looking statements. Examples of such forward-looking statements includes statements relating to expectations concerning market conditions, premium, growth, earnings, investment performance, expected losses, rate changes and loss experience.
Actual results could differ materially from those expected by Infinity depending on changes in the economic conditions and financial markets including interest rate, the adequacy or accuracy of Infinity’s pricing methodology, actions of competitors, the approval of requested form and rate changes, judicial and regulatory developments affecting the automobile insurance industry, the outcome of pending litigation against Infinity, weather conditions including the severity and frequency of storms, hurricanes, snowfalls, hail and winter conditions and changes in driving patterns and loss trends.
Infinity undertakes no obligation to publicly update or revise any of the forward-looking statements. For a more detailed discussion from the risks and uncertainties, which could cause actual results to differ from those contained in the forward-looking statements, please see the Infinity filings with the SEC.
With that, let me turn the presentation over to Jim Gober, our Chairman, President and CEO.
Good morning everyone and welcome to our conference call and webcast for the fourth quarter of 2008. Roger Smith, our CFO is also with us this morning and as usual we’ll open the lines for questions after our comments.
Let’s begin with the highlights on slide three. Operating EPS for the quarter were $1.78 up from the $1.16 we reported for the same period last year and better than expected. Underwriting income climbed about $12.3 million pretax for the quarter as a result of an improved accident year combined ratio and reserve redundancy releases from prior accident years.
Reserve releases in the fourth quarter of ‘08 were $15.9 million pretax were about $0.71 per share. Those releases were partially offset by approximately $1.5 million of strengthening on the first three quarters of 2008. We booked about $900,000 of favorable development in the fourth quarter of ‘07 for about $0.04 per share.
In addition, we had about $4 million pretax of expense accrual releases in the fourth quarter of this year. If you exclude these items, our 2008 accident year combined ratio was running about 96% which is about 60 basis points up from that in ’07, but down about half a point from a quarter ago.
We had a net loss of $0.77 for the quarter as compared income of $1.14 in the fourth quarter of last year. The big difference between operating and net EPS was the losses from other than the temporary impairments on investments. During the fourth quarter of ‘08, we booked capital losses of $36.6 million for about $2.52 per share, which included $40.3 million of OTTI charges. Roger will give you more details on these charges and the overall investment portfolio a little later.
Regarding capital management actions, we purchased 858,500 shares for an average price of $39.63 during the fourth quarter. Those purchases represent about 5.7% of the outstanding shares at the beginning of that quarter. Since the beginning of 2008, we have repurchased $2.1 million shares of our own stock, which represented 12.9% of a number of outstanding shares at the start of the year. We still have approximately, $41.4 million of repurchase authority under our current program, which expires at the end of this year; and we do plan to continue to repurchase shares opportunistically throughout 2009.
As for our capital, in spite of the loss for the quarter, our capital position remains very strong. Lastly, on Tuesday, our Board increased the annual dividend to $0.48, a 9.1% increase over the annual dividend paid in 2008. Now, let’s take a deeper dive into our operating results.
On the slide four, overall premiums were down 12.8% in the fourth quarter and down 12% for all of ‘08 as compared with that of ‘07. We had expected premiums for the year to be down 9% to 12%. However, general economic conditions continued to worsen in many of our urban zones, which certainly have dampened demand for new cars, which in turn lessens the demand for auto insurance.
As in the third quarter, we continued to observe increases in unemployment, in greater levels of consumer uncertainty in many of our major markets. All of which combine to reduce demand for our products. I’ll give you some more details of our thoughts regarding the premium trends a little later. For the fourth quarter, premiums in our focus states failed 13.6% as compared with the fourth quarter last year and 11.8% as compared with all of ‘07. Within these states, business in our target urban zones failed 11.9% for the quarter and 9.6% for the year.
During the fourth quarter, four of our 22 targeted urban zones grew as did our commercial vehicle and classic auto programs; and for the year ’09 of 22 urban zones grew as did CB and Classic Auto. Without question, the impact of the economic recession has hurt our top line. Economic conditions in all of our focus states, which had worsened in the third quarter continued to decline in the fourth quarter.
Our agents and brokers continue to report that their overall business was down substantially. Most of them attribute the fall-off to a weakening economy. In addition to the effects of the poor economy on our top line, we have increased rates in certain under performing states; this has had the effect of reducing our premium writings although the business we’ve retained will be much more profitable. As for the bottom line, after-tax operating income for the quarter was $25.8 million, which is up $6.7 million from the fourth quarter of ‘07.
Regarding overall industry market conditions, I have to say that the market remains very competitive. So, we are seeing more and more responsible competitors rising rates. Of course, there are some smaller undisciplined competitors that have not taken actions to address the poor underwriting results.
However, we are getting the sense that a number of these smaller companies are starting to feel the financial strain of writing business at inadequate rates. We think it’s just a matter of time before they too will have to take rate increases to address their unfavorable underwriting results.
Overall, for the industry, according to both the consumer price index and insurance.com in their latest rate watch analysis, Auto Insurance rate increases in the quarter have slowed to less than 1% company-wide. Overall, rates appear to be going up in several of our focus states, including Connecticut, Georgia, Illinois and Pennsylvania. Again, this is consistent with what we’re seeing in the marketplace, aside from the irresponsible companies.
Given the recent improvement in claim frequencies, overall rate increases are still a little short of covering the average inflation rate for medical cost and auto repairs. We believe that, given the capital that has been depleted by the decline in the equity and fixed income values a number of competitors may want to booster profits to offset falling high quality bond yields. In short, we believe disciplined companies will likely pursue rate adequacy in lieu of market share expansion over the next 12 to 24 months. For companies that are currently under processing business, this means that they will be compelled to take rate increases or face some dire financial consequences.
On slide five, I’ll begin with an update on our personal auto business. Overall, personal auto premiums were down 14.4% for the quarter and 13.3% for the year. However, during the quarter, we continued to see positive growth in Texas, Nevada and Illinois.
As for the detail on each of our top markets, let’s start off with California, in this state gross written premiums were down 13.4% for the quarter and down 13.5% for the year, the economic slowdown in California’s major reason for this drop in premium. The state’s overall economy continues in recession with losses in most job sectors. Furthermore, there remain competitors in this marketplace that continue to compete based on inadequate rates.
One of those markets operates from a neighboring state of ours. I would describe their rates as grossly inadequate. The industry loss cost trends in California are flat year-over-year, although average earned premiums per car here are down almost 3.5 percentage points more than the average loss cost increases for the industry.
Our own data reflects flat year-over-year loss cost trends with single-digit increases in frequency and negative trends in average severities. We continue to experience modest declines in our own average earned premium per car here on a year-over-year basis given our rate reductions last year. As compared with the third quarter, average earned premiums are down about 2.7%. As a result, our overall combined ratio here is up about 3 points versus that of ‘07.
In Florida, gross written premiums were down 22.3% for the quarter and 16.6% for the year, much of this decrease is by design. In order to improve the profitability of this state, we implemented five rate increases in 2007 totaling 13.5% along with rate increases on two programs in January ‘08 and smaller rate increases on two programs in April of ‘08. We follow these adjustments for rate increases in our value-added and low cost products in late November of last year.
We have also taken actions to slow the new business volume in Miami, given a combined ratio there that is above our target. As a result of an improving risk profile, the average earned premiums in Florida for the year are down slightly through the fourth quarter versus those in all of ‘07, but the good news here is that we’ve seen our loss cost decline about 8.7%, with ultimate claim frequencies falling offset by slight increases in optimum average severities.
This has resulted in a five point improvement in Florida’s fully developed accidental ratio for the year. These rate increases haven’t been the only factor that is pressured our top line growth. The weak Florida economy has created an additional drag as well. From a competitive standpoint, while companies for the most part are beginning to tighten up on rates and/or underwriting.
We still see some less responsible companies trying to buy share with inadequate rates. So, all-in-all it’s been a challenging environment for non-standard auto. As for trends, loss cost for the industry are fairly moderate with increases in severity offset by a decline in frequency, overall loss costs are flat.
In Texas, our third largest state gross written premiums were up 9.8% for the quarter and 20.6% for the year. We wrote $53.9 million of premiums in 2008 in this state, as we continue to execute a marketing strategy designed to take advantage of the electronic enforcement of the mandatory auto insurance loss. Competition in Texas has been relatively well behaved.
As for trends, industry loss costs for the third quarter are now flat with modest decreases in frequency offsetting modest increases in severity. As for our trends, as compared to the fourth quarter of 2007, our calendar quarter loss costs have fallen along with our average earned premiums, as policy holders are attracted to our new monthly low cost product.
On an accident year ultimate basis, the reduction in loss costs is more significant. As a result, the 2008 accident year through December, improved three points since September and improved almost eight points compared with the 2007 accident year. Most of the improvement was in the loss ratio. Nevertheless, our business in Texas continues to run a slight temperature on the combined ratio.
So, to improve the underwriting results in early November, we implemented mid single-digit rate increase on our low cost and value-added programs. For our monthly Flex product, a 5% rate increase was filed in early December. We’ll continue to monitor trends and results to determine whether additional actions are needed to achieve our overall targets.
In Pennsylvania, gross written premiums were 5.9% for the quarter and down 2.5% for the year. In terms of premium volume, Pennsylvania was our fourth largest state behind California, Florida and Texas. The combined ration in this state is down slightly from what we experienced at the end of the third quarter as underwriting expenses moderate. Since, September ultimate claim frequencies are up slightly, offset by slightly lower average claims severities.
For the year, our business in this state improved its accident year combined ratio by over three points, a really good result. As for trends in the third quarter, industry loss costs were up modestly in the low single digits with modest decreases in claim frequency more than offset by increases in average claim severity, as a result of these escalating trends larger more established competitors have recently taken low to mid single-digit rate increases in the state.
Even the largest auto insurer in Philadelphia whose rates in that city have been very competitive appears to be experiencing combined ratios over 100% and has recently taken a mid single-digit rate increase. We ourselves have filed two lower single-digit rate increases on our low cost and value added programs followed by a mid single-digit rate increase on our renewal only program effective in early 2009.
For Georgia, our gross written premiums were down 33.8% for the quarter and 22.1% year-to-date. The 2008 accident year combined ratio for this state remains unacceptably high. If we think of a state like Florida where we’ve been working for two years to improve underwriting results as being in the fifth inning of a 9 inning game.
We see Georgia as a state in about the second inning for our starting pitcher was pounded in the first inning and we have to bring in a reliever to takeover, but the reliever we brought in a very experienced and talented product manager from a major competitor has now taken control of the game and is repositioning the book to focus on our core Hispanic customers in the North-East section of the city as well as in Dalton and Gainesville.
In addition to repositioning the book to focus on Hispanic customers, RPM plans to file mid single-digit rate increases early this year in order to return this business to an acceptable profit margin. Competitively, while the larger more disciplined carriers have made more modest rate changes, less disciplined smaller players are lowering down payment requirements raising agency incentives in reducing rates. These smaller players like business at pretty high combined ratios. So, these actions are unsustainable in the long-term.
However, in the mean time they disrupt the market and make it more difficult for us to gain traction and grow our business. Much like conditions in California and Florida, Georgia’s economy is currently in a recession.
Arizona, our gross written premiums were down 21.4% for the quarter and 14.1% for the year. Competitor rate decreases worsening economic conditions and anti-immigrant actions have cumulatively put downward pressure on our efforts to grow in this state.
As an example, for most of the year competitors were aggressively pricing business here and while our competitor pricing actions have now seemed to settle down, they are now lowering down payment requirements and fees. Also some competitors are offering commissions of size 20% new business and 20% renewal business.
Finally, there are also new entrants in the sate with artificially lower rate structures. As for trends, industry loss costs for the third quarter are falling faster than average earned premiums per car year. So, we’re likely to see continued aggressive competitor actions in 2009.
Economic conditions including higher food and fuel cost as well as a declining construction employment have dampened the growth in the Hispanic population and some fall off continues in this population due to an early an exit of Mexican immigrants as a result of legislation enacted in early last year.
Moving to Nevada, where we wrote $5.8 million of premiums in the fourth quarter of ‘08 and $23.7 million for the year. For the quarter and for the year, we grew to 28.7% and 36.2% respectively. The accident year combined ratio for the state is above our target, so our product manager plans to file from low to mid single-digit rate increases in early 2009 for our value added and low costs programs.
As for Connecticut, gross written premiums were down 34.1% for the quarter at $2.5 million and down 46.9% to $11.9 million for the year. This state has performed poorly from an underwriting standpoint. So in 2009, we will continue to take aggressive actions which may lead to continued declines in premiums in this state.
Accordingly, giving its much reduced size and its poor near-to-term prospects for growth, Connecticut will be removed from the group of focused states this year, the state will be moved to the maintenance category.
And lastly, Illinois is the newest focus state for us. Again writing business there in the first quarter of 2008. We wrote $1.2 million in the fourth quarter and $3.1 million for the year. Initial marketing efforts are through independent agents with support from three company-owned retail stores.
We believe that this state has lot of potential given a population of over 800,000 Hispanics. As for our commercial vehicle and classic auto businesses, both showed solid growth in the fourth quarter. For commercial vehicle, premiums rose 19.9% overall for the fourth quarter as compared with the fourth quarter of ‘07.
Premiums for 2008 were up 14% to almost $43 million and we posted a very good accident year combined ratio for the year. Even with the ongoing recession, we continue to find opportunities to grow this business in focus states such as California, for our products and services have been well received by agents and brokers. And in classic auto, we enjoyed 3% premium growth in the fourth quarter and 5.8% for the year at a very good combined ratio.
Now, turning to slide six. Looking back to 2008 for the insurance industry, what started as a year with promise of hardening rate environment gave way to a severe recession and a weakening demand for insurance products. Our primary target markets, which are comprised on non-standard drivers in the Hispanic, immigrant and urban markets were hit especially hard by the economic downturn. This of course hurt out ability to grow our top line in most states, although we did manage to grow in states like Texas where the recession was less fear.
Furthermore, we maintained our operating margins by hearing to our processing discipline in all of our states, while evaluating our infrastructure in the face of the economic downturn. We also look to our future capabilities by investing in new claims and customer service technologies, as well as in a new 300 seat state-of-the-art call center in McGowan, Texas.
All of these important investments should allow us to better serve our customers for years to come and in spite of the horrendous conditions in the equity and bond markets, the wisdom of a conservative investment mix with the focus almost exclusively on high quality fixed income securities allowed us to eek out a small positive total return on our investment portfolio for the year even as other companies lost upwards of 10% or more.
So, in spite of the very difficult insurance and investment environment, we maintained a strong debt-to-capital ratio, a strong capital position in the insurance business and a healthy $137 million cash and investment balance in the holding company. Year-over-year, we even grew our book value per share a little and we did this even as we repurchased almost 13% of our shares. Needless to say, all this leaves us in a very, very strong position to compete in the future.
Now turning to a discussion about future, we do expect the current economic recession to last throughout 2009. Consequently, consumers will continue to be under financial pressure throughout the year given the negative real growth in job creation in GDP. Consumers in the working and lower middle classes including our core Hispanic customers are likely to suffer disproportionately from this downturn as this strata typically suffers more in times of recession.
The soft personal auto insurance market we have experience over the last 4.5 years did show signs of moderating in 2008 and we expect this to continue in ‘09. As a result of the failing investment markets, insurance capital and surplus have been depleted. Counting in company estimates that year-end 2008 statutory capital and surplus dropped 11.5% for the personal auto insurance carriers. Companies will therefore need to focus on rebuilding capital with underwriting profits.
So, we expect the more disciplined competitors to re-double their efforts to insure their rates are adequate. As for less discipline, irresponsible competitors that have inadequate rates and depend heavily on reinsurance, I would expect them the keep making the same intentional mistakes. I wouldn’t be surprised to see insolvency here this year.
The challenge for us in 2009, will be to successful navigate through a very difficult economic environment by playing to our strengths, which include a strong balance sheet, our low expense structure and our brand value in the Hispanic segment of the marketplace.
Our current Hispanic and urban non-standard auto insurance customers are more susceptible to the economic downturn. So for them, it will be incumbent upon us to keep our rates affordable while providing good value for the hard earned dollars. We have already demonstrated the discipline to keep our operating expenses inline with premium volumes by rationalizing infrastructure and staff levels. And our investment and customer service and claims technology should allow us to better serve our customers at the same lower expense.
In addition, we are expanding our product offerings in our focused states to include a viable personal auto insurance product for the second generation, more acculturated Hispanic customers who seek standard auto coverage with higher limits and broader coverage.
We have already introduced this product in Los Angeles on the basis of market research that underscored the strength of our brand in the Hispanic community and the current unmet need among the more acculturated in and affluent members of that community.
Our viable standard product will also allow us retain those non-standard drivers who will overtime, improve their driving record, which permits them to move into the standard market place. Today, we lose many of these customers to a standard auto insurance carrier. On average, policy retention ratio today ranges between 55% and 60%, if we can retain just 5% more customers, we can certainly have a positive impact on our top line.
We expect to file this new standard product in most of our focused states by the end of June. As for our focused states in 2009, let’s begin with the largest, California which accounts for over 50% of our business will continue to be a challenging state for us this year, but we do see opportunities. We will continue to roll out our new standard auto product under the Hillstar brand to new agents and brokers.
We will also begin new marketing and sales campaigns that include sales incentives in order to increase our market share in targeted agencies and we will continue to refine our price segmentation to attract and retain profitable customer segments.
For the year, even with these efforts, the weakness of the economy in this state will create a drag on our top line. At this point, we expect premiums to be down 5% to 10% for the year in California. The good news is as the economy begins to improve and we suspect it will late this year; we should see some positive growth late in the year and then in early 2010.
The combined ratio in the state is expected to rise only slightly as the cost of sales incentives and the slight decrease in premium volume put upward pressure on the underwriting expense ratio. In Florida, the poor economy and our ongoing efforts to improve the combined ratio will put some pressure on premium growth. Expected rate increases by competitor should somewhat mitigate their impact on our business. At this point, we expect Florida’s premium volume to be down 2.5% to 7.5%.
With the pricing in underwriting actions we have taken today and have planned in ‘09, the combined ratio in this state should continue to improve. In Texas, as municipalities roll out electronic enforcement, we have an opportunity with our marketing efforts and new monthly policy to grow our market share. It still remains to be seen how aggressive individual municipalities will enforce the law particularly in light of the current recession.
Further, the expected downturn in the economy and our rate increase efforts to improve underwriting margins may dampen our opportunity to grow significantly in this state in ‘09. We expect premiums to be flat to down 4% in Texas this year. The combined ratio in this state is expected to continue to improve.
In Pennsylvania, rate increases by competitors will make it easier for us to grow, but once again the economy will dampen that opportunity. We expect premiums in Pennsylvania to be flat to down 3% for the year, with a slight up tick on what will remain a very good combined ratio.
Georgia’s premiums are expected to fall 12.5% to 17.5% in ‘09 as we retool our programs and reposition the geographic mix to cater to target segments. This is the case of taking one step back in order to take two steps forward. Our actions to-date and planned in 2009, are expected to bear fruit in a much improved combined ratio in Georgia. These steps should position us for growth in 2010.
Arizona is expected to have flat to slightly positive premium growth in ’09, as we refine our price segmentation for our non-standard auto products and as we roll out our new standard product in Phoenix and Tucson. The combined ratio here is expected to tick up slightly with still a very good result.
Nevada’s premium is expected to fall double digits as a result of the recession in rate increases we have taken to improve the combined ratio. If things go according to plan, we should see 5 to 10 point improvement in that combined ratio, which will position us to grow profitably in 2010 when the economy is expected to improve.
Illinois, as a new focused state, is expected to continue grow rapidly as our underlying results improve. Overall, we expect premiums in the focus states to be down between 4% and 8% for the year, as we seek to improve our underwriting margins and pricing accuracy in order to position ourselves to growth in 2010 when the economy is expected to recover.
We expect a continued decline in our maintenance states premium volume this year, as we strive to retain only profitable pockets of business in these areas. As for our other products, we expect commercial vehicle to grow about 5% in 2009 and classic auto was expected to decline in volume this year, since two of our larger producers move to a rival company. We expect to replace this loss premium over the next two years.
In total, for the company we’re expecting premium growth to be down 5% to 10% for the year. We really view 2009 as a year to build on our strengths to pricing accuracy, efficient operations and improved customary claim service as well as launch on new standard personal auto insurance product in order to position ourselves for growth in 2010 when we expect economy to recover from recession.
From an underwriting standpoint, we expect our overall 2009 accident year combined ratio to be between 95.5% and 97%. Other key assumptions include a 4.5% book return on investments and an effective tax rate of 33% to 34%. We also assume that approximately $20 million to $41 million of share repurchases will take place in ‘09. All this should generate an operating EPS of $3.25 to $3.75 for this year. So, with that I’ll turn the presentation over to Roger.
Thanks, Jim and good morning. I’m going to discuss the financial results for the fourth quarter of 2008. Slide seven, summarizes Infinity’s financial performance for the quarter. My discussion of the results is summarized on slides eight and nine; so let’s first turn to slide eight. Infinity’s quarterly revenues were down 25.1% primarily as a result of 10.9% decline in earned premiums as well as a $36.5 million increase in realized capital losses in the quarter resulting from the $40.3 million of OTTI’s versions.
For the year, revenues were down 15.2% primarily as a result of the 10.6% decline in earned premiums and an increase in realized losses of $48.3 million, resulting from $61.8 million of OTTI charges for the year. Earned premiums were down for the quarter as a result of decreases in written premiums in 2008. As Jim has discussed, gross premiums were down for the quarter following 12.8%.
For the fourth quarter, investment income for the quarter was down $2.5 million over that of the fourth quarter of 2007 are about 15.6%. The average investment balances have decreased $98.1 million or about 7.3% as a result of share repurchases in 2008 and a decline in the overall business since 2007.
Pretax current returns for the fixed income portfolio were down 40 basis points as compared with those in the fourth quarter of 2007. Under pretax, total return basis or fixed income, equity and short-term investment portfolio, earned 1.1% both from current income had a loss of 1.0% from realized and unrealized capital gains and losses including the OTTI charges, which netted to a total return of a positive two-tenths of 1%, these figures are not annualized.
For the year, the return from current income was 4.5% offset by realized and unrealized capital gains and losses. Again including OTTI charges, a 4.0% for a net positive return for the year or four-tenths of 1% by historic standards for total returns. However, in light of the conditions in the equity and bond markets in 2008, a less conservative portfolio would have done much worse.
At December 31, 2008, book and market yields on the fixed income portfolio were 4.81% and 5.29% respectively. The duration of the fixed income portfolio is approximately 3.0 years, lower than the 3.5 years at the end of the fourth quarter of 2007.
On slide nine, regarding the investment portfolio; our fixed income portfolio is a high quality portfolio with an average credit quality of AA. During the fourth quarter, as we’ve discussed, we incurred $40.3 million of OTTI losses. For GAAP accounting, as you aware, companies are required to take a P&L charge for securities that are deemed to have impaired values that are other than temporary.
The accounting guidance does not define [Audio Dip] outline tests, what is other than temporary, but the SEC has clarified in one of its staff accounting bulletins that the magnitude and length of time of the impairment as well as the Company’s ability and intent to hold the security until its market value fully recovers should be considerations.
The significant downturn in the bond and equity markets over the past 18 months have resulted in unrealized losses on several of our securities, making them candidates for impairment.
For all our investments, we evaluate the individual circumstances of each investment whose market value was below book value, being especially mindful of the magnitude and length of time the issue has been underwater. Those that were materially underwater, say more than 5% to 10% and have been underwater for significant length of time, we view particularly skeptically and have had fairly compelling reasons not to impair the security.
While the OTTI charges we incurred in the fourth quarter much as a reflection, are the overall state of the credit markets in the United States, which except for U.S. Government Securities, GSEs and high quality municipals have been frozen in some cases for 18 months. Market yield spreads by sector certainly reflects this. Approximately $18.6 million of the OTTI charges for the quarter was related to our investment in the U.S. broad-based equity exchange traded fund.
As you’re well aware, prices in the overall stock market in the United States fell almost 40% in 2008. In the fourth quarter alone, prices on the equity markets fell approximately 22% from September’s closing prices. As I foretold last quarter, given the magnitude and length of time, the market value of our investment in this ETF was below cost according to the accounting guns we were compelled to take the OTTI charge on this in the fourth quarter.
Of the $18.6 million OTTI charge for this security, this quarter over $10 million of this charge reflected the market price decline in the fourth quarter alone. A breakdown of the $40.3 million of the OTTI charges shows that nearly $29 million of this was due to market price declines on the impaired securities in the fourth quarter alone. As I mentioned, this includes the $10.1 million price decline in the broad equity market ETF investment that we have.
Impairments for fixed income securities were $21.7 million for the quarter. Of those impaired, 67.3% of these were investment grade securities. Although one bond that was impaired was rated below B minus, 43% of the charge, the OTTI charge and fixed income securities was on corporate securities, 32% of the charge was on non-agency CMOs, mostly which were PAC’s and the remainder was on asset-backed commercial mortgage backed securities.
For other securities that didn’t want impairment, but whose market value was below book value, the pretax unrealized losses at December 31, were only $16.9 million as shown here on slide nine in this aging schedule, which represents only about 1.6% of the market value of our investment portfolio at December or about 3.2% of our GAAP equity at December.
In order to assist your analysis and in the spirit of transparency of disclosure this morning, we posted to our IR website, a list of [inaudible] of our entire consolidated portfolio. Those securities with book values exactly equal to the market values are; in all probability those that we took impairment charges on in the fourth quarter.
Turning to slide 10, in regards to profitability as Jim, has discussed. Operating profits were solid in the fourth quarter. Operating income was $1.78 million per share for the quarter, this compares to $1.16 for the fourth quarter of 2007. Underwriting income for the quarter increased $12.3 million as a result of decrease in accounting quarter combined ratio. As Jim mentioned, we are currently booking the accident year at about 96%, this was down slightly from that which we reported in the third quarter earnings call.
In addition, we had about $15.9 million of pretax release of redundant reserves from prior accident years offset by about $1.5 million of pretax strengthening of reserves from quarters one, two and three.
This trend, the 2008 accident year, mostly on loss adjusted expenses as compared with 900,000 release in the fourth quarter of 2007. 96.0 accident year combined ratio through December is approximately 60 basis points up from that of 2007 accident year combined ratio through developed through the year-end of 2007 of approximately 95.4%.
The action in quarter ending December 31, 2008 performed better then the year-to-date period as a result of lower underwriting expense ratios and better loss ratio particularly on collision coverages, expenses are down in the quarter as a result of the reduction in advertising spending, reduction in bonus accruals for quarters one, two and three of this year as well as other reductions.
One-time accrual reductions in the fourth quarter amounted about $4 million pretax or about $0.18 a share. Total account loses for the quarter in year-to-date 2008 were $61,000 so very, very little and $1.8 million for the year pretax and that compares to about $125,000 in the fourth quarter of 2007 and $655,000 in the full year 2007, so very modest cash [inaudible] for Infinity.
We incurred less than $307,000 of pretax charges for our service under consolidation efforts, which began in late 2007. We are completed with the consolidation of service centers and should incur no additional cost related to that consolidation. The overall affected tax rate for the quarter was greater than 100% this is really a result of the $36.6 million of capital losses for which we set up 100% valuation allowance on the tax benefit for those loses and that’s the policy we followed in the past and we continue to follow it.
On an operating income basis, excluding capital gains and losses, the effective operating tax rate for this quarter was about 33.8% and it’s about 32.6% for the year. I would expect the effective operating tax rate for 2009 to be around 33% to 34%. As Jim mentioned, we repurchased 858,500 shares for an average price of $39.63 during the fourth quarter of 2008. Throughout 2008, we have repurchased $87.7 million of shares, [leaving] $41.4 million of repurchase capacity from the 2006 repurchase program as amended.
We continue to have adequate capital to support either future growth in the business or to fund additional share repurchases. For example, our debt-to-capital ratio is 27.5% with current statutory capital levers, our insurance companies are currently writing business at a 2.1 to 1 premium with surplus ratio, which is well below the 2-and-a-quarter to 2.5 times surplus needed to maintain our current AM Best rating of an A. The holding company has a $137.4 million of cash in investments which certainly is available to infusing to the insurance companies should they need additional capital.
Although, as I pointed out, they have plenty of capital right now and our operations continue to have positive cash flow, so certainly our liquidity is good. So in short, we are well positioned with current liquidity and capital to weather the current severe economic downturn and support future growth of the business. So this concludes our formal presentation, so at this time, we’d like to open it up to questions.
(Operator Instructions) Your first question comes from the line of Mike Grasher - Piper Jaffray.
Mike Grasher - Piper Jaffray
A few questions I wanted to go back over with regard to Texas and the growth that you are experiencing there. Is that in any one particular area or are you really getting some strong penetration throughout this state?
Mike this is Jim. It’s primarily in the target urban zones of Houston, the Dallas; Fort Worth area, Austin and probably San Antonio to a lesser extent, but these are all areas that we’ve targeted that have fairly high Hispanic populations and have fairly high percentage of uninsured drivers, so we’ve got a pretty good campaign going on right now to get that message out there and we have actually cooperated with some of the government authorities to do a little branding with them when they are giving out public service announcements regarding the new mandatory enforcement.
Mike Grasher - Piper Jaffray
Okay, thanks for that and then Jim you also had some comments around coming into the market with a standard product and just a couple of questions behind that. How do you see yourself differentiating your product from competitors and do you expect the standard product to maintain different margins in what you are currently producing?
Yes, in terms of the standard product our focus will be the Hispanic community. I have talked and I know Mike you have heard me in years past talk about all the involvement that we have in that particular community, the community supports local school efforts, the activities and the community events they have over weekends, we do advertise heavily on Hispanic television and radio stations.
So, at those community events and when we do advertise, we get a lot of people calling us warning a quote and these individuals maybe insured with state farm or all-state or another standard company and quite frankly, we have to turn them away and we’ve stuck with our core business of non-standard drivers, but when you look at the current economic conditions and again as I mentioned, our strata that particular strata rather is being hit the hardest, it just makes sense for us and the timing is good as well to try to move into that market.
Our brand value is what really is going to give us the leverage to be able to be successful, I mentioned we’ve got a program in California today that has already kicked off and we’ve been pleased with the results and we think we’ll be able to have the standard product filed and/or implemented in all of our top 8 focused states by the end of June this year.
With regard to the target as far as the profit margins, we will target the same in 95% to 96% combined ratio regardless of whether it’s non-standard or standard business.
Mike Grasher - Piper Jaffray
Okay and then do you have any perspective for us in terms of how much you expect to add on through this product?
We haven’t publicly talked about it yet Mike, I would want to get a little more detail and get a few of the products out there on street agents appointed before I speak to that. The thing that we do know however is, when you look at the demographics, and when you look at the un-acculturated Hispanic population, it is actually declining.
Some report said maybe flat, I mean everything we’re looking at tells us maybe on the decline, when you look at that second-generation Hispanic, more acculturated Hispanic, that particular segment of the population is growing and is projected to grow even given the economic conditions that we’re experiencing today over the next three to five years.
So for us, it just makes sense to move into that standard product and again, we’re talking about more of a standard product. We are not talking about something that [Chuck] would write whether out there with multi-million dollar liability vendors, I think so.
The other thing the product does for us is it gives us an opportunity to improve our retention ratio, because as non-standard customers approve the driving record, it gives us an opportunity to offer them a viable product and I’m not sure if our premium projections assume a major lift from the product in 2009, it’s really getting the product started and introduced, we have to pull-in agents, acceptance in the marketplace et cetera. So, it will take some time to build up some momentum, but we see a lot of longer-term prospects.
Mike Grasher - Piper Jaffray
I assume on a per-policy barrier regardless that it’s going to utilize or command less capital than what the non-standard would?
Yes, just it depends, certainly would be higher limits, but probably a lower standard deviation around the loss ratio. So, almost you’re probably right.
Mike Grasher - Piper Jaffray
Okay and then just a final question Roger, around your new cash flows where you’re investing those new cash flows?
We’re still taking a conservative approach on our portfolio, we are not going to go crazy and dump a lot, although the margins right now and asset backs and CNBS’s are very attractive. If you want to take the risk, but again we’re going to adventure far from our conservative approach. So, we like high quality profits, we like high quality municipal bonds where there will be pretty much consist with the mix that you’ve seen in the past.
Your next question comes from Caroline Steers – FPK.
Caroline Steers - FPK
I was actually just wondering what you guys are seeing in regards to uninsured motorists’ coverage and if this is becoming a problem and all just given the economy?
Yes, Caroline, this is Jim. I think it will be an issue; we’re looking at some of the trends. I think the Insurance Research Council is projecting the uninsured motorist population to rise. So, we do see it as being an issue and certainly our product managers have this information and they can make some projections in terms of how that may impact our business.
However, keep in mind our limits are still pretty low limits. So, it shouldn’t be anything materially, certainly long-term, but yes we’re very much aware of it and are keeping our eye on it and are anticipating that there maybe an up tick in terms of UM claims, no doubt.
Caroline Steers - FPK
And then just one more, I know we’ve sort of talked about acquisitions in the past and I was just wondering if there is still any activity going on out there people still looking around, looking to buy or sell. What are you sort of seeing on that front?
Well, we’re getting more call from bankers, I’m not sure if that means they aren’t that [neat]. Deals are going on are a lot, but we’re certainly hearing from a lot of bankers. Personally, this is just my opinion, but and I mentioned in the prepared remarks that I got on my soap box a little bit and complained about some of the smaller competitors that continue to do irresponsible things by way of their pricing and the commissions that they pay and again I’m pretty simple when it comes to math, when I add up the components it doesn’t come out to an underwriting profit. It comes out to a loss.
So, I can’t see how these companies can sustain these kinds of rate levels. Again, responsible companies are already taking rates up and reacting to the trends and the conditions, but I do think that there will be some smaller companies that are going to be in trouble. I said in my prepared remarks that I think there maybe and insolvency here too, I’ll stick by that. I think there are some smaller companies that maybe looking for a buyer and who knows, I mean the price could be very much an attractive price. If it’s accretive for the company and if it strategically fits in terms of what we are trying to accomplish long-term as well, but I think there are some decent activity going on.
Your next comes from Doug McGregor - RBC Capital Markets.
Doug McGregor - RBC Capital Markets
I just had two questions, one related to the economy. Obviously, it looks like customers are buying less insurance or maybe going uninsured, but I’ve also either heard or seen or implied that maybe people are also driving less, less miles driven, but that doesn’t seem to be showing up in frequency trends. You fake or loss cost trend in general, they seem to be down just a little bit or flat or even up in some states? Do you think maybe there is more fraud might be making up for that or maybe just higher severity per accident? Why wouldn’t loss cost be going down in tandem with miles travel?
I think for the fourth quarter the loss costs relative to the third quarter at least improved. So, I think Doug we did see some improvement, certainly on our book of business. In most all-states, now regarding fraud you can anticipate an up tick in two areas probably bottling injury where there maybe a little bit more of an exaggeration of the type of injuries, but also even more so, on the personal injury protection coverages such as what’s offered down in Florida.
Within that coverage you’ve got wage loss as well as medical expenses that can be paid and we would expect that there would be an up tick in theft claims. I mean the law has written such that if you’re entering into allotting from the vehicle, I’ve always said, if you are within ten feet of the car, you can lag some type of injury and file a claim. So, in my years of experience, I’ll go back to mid 80s, when I was a product manager for Florida and we went through some tough times.
We definitely saw an up tick in the theft claims and we’re anticipating that in Florida as well. Beyond that, as Roger mentioned, our collision coverages have been very solid. They actually improved; it’s very difficult to add an element of fraud to collision. You are looking at repairing the vehicle and it is what it is. But overall, I think the trends are still flat-to-favorable without question.
I think we’re well positioned only just given our experience in Florida and we’ve dealt our SIU units. I think we’re well positioned to and we are anticipating an up tick in fraud. So, it’s not needs to us, we’ve been in this business for a long time and through recessions and recoveries, I think we’re anticipating and we are ready for it.
Yes, one thing Doug. I received a nice e-mail this morning of a press release by the California Department of Insurance where we worked with the California Fraud Unit within the department uncovering a fairly significant fraud going out there. So, we’ve got some nice publicity from that, but we’ve got some top notch people in our fraud area, not just California but in the other states as well. So, we think we are on top of that, pretty good.
Doug McGregor - RBC Capital Markets
Actually relating to SIU’s and fraud, actually relating to your new standard lines of product. How are you going to change the way you handle claims, are you meeting the same people in the same infrastructure. I guess the issue is that I’ve heard that standard bond companies often have a very hard time in non-standard auto because of the claims process is so different.
There is a lower level trust between the claims adjusted and the customer and I would imagine there maybe some growing pains going in the other direction too where maybe the customer will think you are giving them a unusually hard time when it is a pretty straightforward claim. Are you changing your procedures around that or do you even think that’s even an issue?
Well it’s something that we are aware of, we have implemented in the claims organization, some predictive analytics SPSS, we work with them, I think we were the first company to do it on the claim side and it is implemented in a number of areas in claims today that basically red flags claims that we think there maybe something there, there maybe some element of fraud and what we’re trying to do Doug is, we want to provide fair and fast claim service for all policy holders and third party claimants.
We think if we can use this productive analytics tool that we have and really isolate those claims and do more investigating on those claims and really move along the other claims that should be handled promptly and fairly, we want to do that and we think that is good business regardless of whether you are non-standard customer or a standard customer and again I think that is something I mentioned in my prepared remarks, the type of tools and investments that we have made in the claims and in the customer service area.
The customer services are we invested about $2 million in Genesis Software to give our CSR’s popup screens; the ability to answer questions quickly and take care of that customer will bode well for that standard market as well.
Your next question comes from John Gwynn – Unidentified Company.
John Gwynn – Unidentified Company
The OTTI charges that ran through your GAAP P&L, do they also run through your stat P&L?
John Gwynn – Unidentified Company
So, your dividend paying capacity, do you have an idea what that is?
It is approximately $43 million for 2009, the ordinary capacity.
John Gwynn – Unidentified Company
43, is that what you said?
John Gwynn – Unidentified Company
And Jim, the one-month policy that you sell in Texas, is that more of a reflection of the competitive landscape in Texas than a product we may see in other states?
It is John, Texas is kind of unique; it’s either a 12-month policy or one-month policy, there doesn’t seem to be in the middle ground of that six policy term. Again the one-month policy, the reason that we designed that and introduced that product there, it was very popular with the Hispanic community, they have a little bit of distrust in terms of financing and making payments whereas the one-month policy was sort of again a month-to-month affair that they felt very comfortable with.
So, we were able to design that product and roll it out and I have to tell you it’s kicked off a quite nicely and it hasn't cannibalized our existing book of business in Texas, it really opened up another door for us that was there previously. So, we’re very happy with it, and it maybe a Texas-only product, you probably right about that.
There are no further questions at this time. I would now like to turn the call back over to Mr. Jim Gober.
Thank you very much. We all appreciate you listening into the conference call and participating and hope you have a great day. Thanks.
Thank your for your participation in today’s conference call. This concludes the presentation. You may now disconnect. Good day.
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