AmTrust Financial Services Management Presents at the J.P. Morgan 2013 Insurance Conference (Transcript)

Mar.21.13 | About: AmTrust Financial (AFSI)

AmTrust Financial Services, Inc. (NASDAQ:AFSI)

J.P. Morgan 2013 Insurance Conference

March 21, 2013 9:00 AM ET


Ronald Pipoly, Jr. – CFO


Brett Gibson – J.P. Morgan

Brett Gibson

Good morning everyone. Extend a warm welcome to the first presentation of today, kicking off our 13th Annual J.P. Morgan Insurance Conference. My name is Brett Gibson, part of the research function here at J.P. Morgan.

Pleased to introduce AmTrust. AmTrust Financial. AmTrust is a specialty insurer focused on workers comp, extended warranty and other lines. We are pleased to have Ronald Pipoly Jr., the Company’s Chief Financial Officer with us today. He has been with the company since 2001.

With that, I will turn it over to Ron. Thanks again for being here.

Ronald Pipoly, Jr.

Thank you and good morning. First, we’ll just dispense with the forward-looking statements. A quick over in background on AmTrust Financial. AmTrust Financial was formed in 1998 by two brothers, George and Michael Karfunkel and our current President and CEO Barry Zyskind.

And the origins of the company were in extended warranty. The background on that was Wang Laboratories which for those you that don’t remember, Wang Laboratories was a manufacturer of – with the large pieces of data processing equipment.

In the mid-1980s they formed for the purpose of offering their clients extended warranty in a product called Disaster Recovery. They formed insurance operations here in the US, Bermuda and Ireland to support their clients. When Wang ran into financial difficulties in the 1990s, they stopped being a manufacturer and more of a service provider.

They no longer had a need for the insurance operations and George and Michael Karfunkel along with Barry were presented with the opportunity to acquire them, which they did. When they bought that, they brought with them about $10 million book of extended warranty and disaster recovery business, which they continue to maintain.

They brought the underwriting staff over and were successful in acquiring some additional extended warranty clients, did some limited products for Sony, CompUSA, HP. So they were successful, but it was a slower growth trajectory.

And they decided that they wanted to be contrarian and what was going on in the workers comp market at the time was I guess a state of crisis in the wake of Unicover which was very cheap reinsurance and a lot of primary carriers moved away from underwriting concern and pricing concern and began to grossly underprice product with the idea that it was completely reinsured.

That obviously didn’t work out as they planned, but it created an opportunity. And Barry saw that opportunity as a way to focus on workers comp with really what has always traditionally been an underserved niche, very small average policy size. The idea being extended warranty is kind of the ultimate high volume low dollar transaction, you need to be able to process the business very efficiently and very effectively and you could take that mentality and apply it to workers comp.

So you could underwrite from an expense ratio perspective, you could underwrite small policies and do it very efficiently and very effectively. And that’s what we did and that’s when I joined the organization, officially in 2001, but really started working with them in late 2000 on developing this small comp platform.

And the success we’ve had there and the success that we had in growing our extended warranty has led us to move into other lines of business and we’ll touch that as we move further through the slides. You can see from this slide, obviously we’ve had tremendous growth from a gross written premium perspectives and what I will say about growth within the insurance industry is, is that, it’s not difficult to achieve, it’s not rocket size.

So at the end of the day, if you want to grow your premium, reduce your price, expand your risk appetite or make the really bad mistake and do both at the same time and you are going to increase your premium. So having said that, looking at this chart, what I will say is that the growth we’ve experienced I believe has been achieved in really one of the most conservative manners you can.

We’ve grown organically when the market has allowed us when prices have allowed us to grow organically and then we’ve grown significantly through acquisitions that we’ve done over the years. And just to put this slide into reference from a gross written premium perspective, when I joined the organization in 2001, we wrote $25 million of premium.

And you can see that last year, we wrote $2.75 billion. And, another point of takeaway from this slide is the fact that you know, the increase that we’ve had in our shareholders equity has outpaced our growth in gross written premiums. So certainly our growth has not come at the sacrifice of any of our profitability measures.

From a backbone of who we are at AmTrust, I mean, our origins, we’re a technology company. In fact Technology was the name of the US insurance company that Wang had formed and we still operate. In fact, it’s our largest surplus based US operation. But technology plays a key in who we are organizationally.

It’s what allows us to process the significant volume of transactions we need to process. And just to throw out statistics that our Chief Information Officer likes to cite, we have over 30 million extended warranty contracts in force. We have over 95,000 quickly approaching, 100,000 workers compensation policies in force.

We process or have submissions to us from a worker’s comp perspective of 50,000 submissions a month. Our earnings routine associated with our extended warranty products is 1.3 billion lines of data. So we really have a significant dedication and devotion to Technology and then it just goes beyond.

It goes to the extent that all of our proprietary platforms, the software our organization runs on is internally developed and we like to say that we are a software company with inside of an insurance company. We have 150 dedicated programmers who are consistently working at our next generation applications.

Expanding capabilities of our current system and we certainly feel that technology is the backbone that allows us to control our expenses, while at the same time very efficiently and very effectively underwriting all of our risks. I mentioned small workers comp with an average policy size of 6500.

There is nothing glamorous about those types of policies, they are very kind of benign main street risks, restaurants, physicians, florists, small boutique retailers. But the fact that the matter is, we have underwriters looking at every one of those risks and we believe that is part of what differentiates us from our peers in terms of what we’ve been able to achieve in terms of a loss ratio on that line.

And I will touch on more on that as we go through the slides, but needless to say, technology is a significant part of who we are organizationally. Michael Karfunkel, George Karfunkel and Barry Zystkin own about 58% of AFSI’s shares. So obviously shareholder value and improving shareholder value is something that’s near and dear to them.

It’s some that we take a lot of pride in and our ability to deliver very solid ROEs. Last year it was right around 19% and we went public in 2006 during our roadshow we guided that we would achieve an ROE we believe we had built a business model to achieve an ROE of 15 plus.

And I still firmly believe that today that the model that we built focusing on these niche specialty property and casualty products will continue to allow us to achieve that. So needless to say whether we are looking at opportunities to grow organically, whether we are looking at acquisition opportunities, our overall capital structure, shareholder value and how our structure affects EPS and book value per share.

It’s very, very significant and it’s something that is obviously thoroughly discussed every step of the way. Just from a gross written premium perspective, I don’t think it’s a surprise that we outpace our peers in terms of growth. I mean, we have been a growth story and as I said, from a growth perspective, significant growth has occurred through acquisition.

We’ve grown when we have been able to organically and last year we grew substantially organically. It’s an improving environment from a price and competitive landscape, from a small workers comp perspective in particular. We are able to grow our policy comp by 10.5% last year with achieving average rate increases on a nationwide basis of nearly 6%.

But our three largest states, which are New York, California and Florida, we were able to achieve our largest rate increases of all the states. So clearly, we are excited about our opportunities to continue to grow organically and we’ve been as acquisitive as ever.

And I think for those of you that are familiar with us over the past several months, we’ve been very active with press releases, talking about acquisitions we’ve made. We recently closed on one in the UK called Car Care Holdings. We anticipate that we’ll close on two more sometime in the early second quarter, Sequoia, which is a Monterey based insurance operation as well as first non-profit insurance company which is based in Chicago.

I mentioned the ROE before; again, you can see the comparison with us and our peers. And again, I think what differentiates us and our ability to achieve these ROEs, there is a consistent focus on underwriting profitability. We’ve never been a cash flow underwriter and when we are on one-on-one meetings or in group settings like this.

People say what keeps you up at night is the interest rate environment and I said, not at all. I mean, at the end of the day, organizationally we’ve never been through a high interest rate environment. So, I don’t think that we’ve ever been tempted to be a cash flow underwriter ever within our history.

But we certainly never had the opportunity since we began our growth trajectory in 2001, first and foremost, we are an underwriting company and that is the most significant contributor to ROEs, our ability to write at very profitable combined ratios. Again, I mentioned the combined ratios and its segue into this slide.

You can see where we are at relative to our peers. Last year, we were 89.5%, the year before that, we were 89%. And again from a – if you would look at a 10-year horizons, I would say that, with our current product mix, we are an 88% 89% combined ratio.

Again, focusing on very predictable non-cash profit, non-volatile risks that we think that we have a weight and advantage from an expense ratio perspective, are going to be able to running with very solid loss ratios. Our book value growth, I mentioned earlier that, shareholder value is something that’s near and dear to us.

One of the things that we take a lot of pride and it’s that the height of the financial crisis in 2008, you can see that overall, the industry had a decline in book value. And we had a very modest but it was an increase modest 0.4% increase. And then you could see our ability to outpace the industry from our overall growth in book value.

Obviously the growth in gross written premium translates to growth within earned premium. You can see on a five year basis, the average has been 26%. You can see what the growth is, if you just do a quarter-over-quarter comparison at 28%. So clearly from a revenue perspective, we have momentum behind us, because we continue to grow from a gross written premium.

Now I’ll spend some time on our operating segments. We have three main operating segments. Small Commercial business, which we wrote nearly $1 billion last year, is a segment that really focuses on primarily workers comp that’s the largest line within that segment.

In the workers comp that we write as I mentioned is just imagine yourself on any 75,000 city main street USA and walk down Main Street and those are the types of businesses we are going to want to write. Whether it be a Dentist, a physician, a small financial planner, the florist, the coffee shop, the mom and pop restaurant, the boutique retailers, those are the types of risks we like to write.

As I said, average policy size about $6500 which equates to about nine employees. And we clearly think that the advantage that we have within this space is that, our systems have allowed us to develop an agent portal and interface that makes it very easy for agents to place business with us. It makes the renewal process virtually seamless to the agents.

So our business is very, very sticky. What I mean by that is, is that every year of the policies that we are going to offer renewal on, we are going to retain anywhere between 80% and 85% of those. So it gives us a very strong base which to build from each year as we look at on a go-forward basis. But also within this segment, we write commercial package, we write BOP.

We have some specialty types of programs where we do some E&S business. But again, it’s all focused on very low hazard, very niche business and the commercial package came about is a way to really counteract or position ourselves within our agency plan. Last year we did business with over 8000 agents in this segment.

And what we found is, is that, some of the larger national package writers, when comps out of vogue, they don’t want to write comp, when comps into vogue, they want to be back in the space. And to counter that or their ability to say well, we’ll quote the package, but we have to take a look at the workers comp, what we did is we developed a package policy and a BOP policy.

We’re very cognizant of the fact that we don’t like to write property, so we certainly stay away from the wind exposed areas and that property that we would write as part of the packages, marquee buildings to us to would be a three storey wood frame traveler lodge with a $3 million value.

That’s marquee to us. So clearly, from a risk perspective, again it focuses on very small, very predictable losses. Our second segment would be specialty risk and extended warranty and that’s really kind of three products within one, extended warranty in the US, as consumers were all familiar with standing in line at a retail store and having an either sales person before you, check out.

So you want to buy the extended warranty or having the individual on cash register sale, did you know that there for $399 a month you can buy a one-year extended warranty on this $40 product. So those of you that are tested or inconvenience by that, we apologize, because it’s I think our effective training of the sales staff that allows them to do that.

But it’s something that we focus on. We are the third largest writer of extended warranty in the US. Probably our most recent marquee name that we’ve added is HH Gregg. For those of you that aren’t familiar with HH Gregg, it’s kind of a scaled down version of BestBuy focusing on home appliances and electronics.

We do their extended warranty offering. But we have relationships with West Marine for example and some national retailers and also deal directly with manufacturers. But in addition to that, and I don’t want to leave anyone in the room with the impression that all we do is consumer products or consumer electronics.

We also have some unique offerings within this extended warranty and Case New Holland is a good example of that. Case New Holland is the manufacturer of large commercial construction or agricultural equipment. And for several years, we did insurance for them on a mechanical parallel brake perspective, meaning certain aspects of the equipment, multi-million dollar pieces of equipment.

But typically our exposure was limited to $75,000 would be the maximum claim for something like a breakdown of a transmission or a failure of hydraulic system within a – say a front-end loader for example. And we recently last year bought Case New Holland’s insurance agencies from them.

So it was really a way to solidify our position and our ability to continue to distribute our products to their 1600 North American retailers, their distributors. And actually it was a way so that we could internalize fees as well and it was a substantial pick up in fee income which is something I’ll touch on a little bit more.

Moving to extended warranty in the UK, very similar kind of point of purchase of relationships with retailers and manufacturers over in the UK. And then in addition to that in the UK, well primarily the Europe, our European footprint, we do specialty risk. Specialty risk is very similar to US casualty business and it really runs the gamut of the types of exposures.

In the UK we’re, I believe the fifth largest writer of legal expense coverage. And legal expense coverage in its simplest form is, if you are involved in a motor vehicle accident, you claim the other party has liability. If you are unsuccessful in your litigation, you have to pay the other side’s attorney’s fees. So people will buy a legal expense coverage product.

We don’t pay damages if damages are part of the award, what we simply pay is the other side’s attorney’s fees. And it goes from many things, it’s simple is the motor vehicle accident up to more a complicated corporate litigation which is underwritten out of our London office. Things that would involve patent infringement and those types of things.

So again, a very successful product that we’ve carved out in the UK. We’re one of the largest writers, if not the largest writer of hospital liability or med-mal in Italy. Very opportunistic play for us in 2009, we were presented with the opportunity to hire a team of underwriters, really when a lot of capacity was leaving the Italian hospital liability market and what we are able to do is go in there and get substantial rate increases, make substantial changes to kind of form of coverage, meaning the introduction of deductibles or self-insured retentions.

We’ve reduced the reporting tales on these policies and we were able to go in there and price the product that really makes lot of sense. Now when I say it’s opportunistic, if competition comes back to Italy and prices start to erode, terms and conditions change, we will pull back and we will redeploy our capital.

But right now, as we look at the renewal cycle in early 2013, we are certainly encouraged with what we see with pricing. Our third segment is small commercial, I’m sorry, specialty program. That segment is, really from a risk perspective very similar to small commercial business in the average policy size and the types of risk we are writing.

But the differential is and why it’s separate segmentally is that, I mentioned we distribute small commercial business to 8000 independent agents and we have all the underwriting authority within specialty program, we have about 46 programs that are controlled by about 26 MGAs. Those MGAs do have limited binding authority within certain pricing and risk parameters.

Such lives differentiate us from a segmental perspective but from a risk standpoint, very similar, very small average policy size, very predictable risks. The lines of business we write in our specialty program segment will be workers compensation, which accounts for roughly 30% of it. Then you have general liability which would probably be about 4% and the rest would be a mixture of commercial vehicle and some other ancillary coverages.

Just touching on some of the financial highlights of where we are. You can see specialty risk and extended warranty is our largest segment at little over $1.1 billion small commercial business, about 934 million. Combined ratio, extended warranty or special risk and extended warranty has consistently led from segmentally and this is really driven by a lower expense ratio.

And at the end of the day, you have lower expense ratio because this part of extended warranty you are not dealing with agents or MGAs that place business on for you. You are just dealing with direct relationships that we’ve developed with either retailers or manufacturers.

Workers compensation and I know, we’ve touched on it quite a bit, as we’ve returned as a company and we’ve made more presentations and fielded more questions. One of the things is that, workers comp is a line that’s written about a great deal and analysts or people that cover workers comp tend to speak in very broad strokes about, what’s the state of the industry and how are things performing.

And we’ve been asked on several occasions, what differentiates your product? And I guess the biggest thing to take away from this slide is that, when you focus on the small risks.

You are writing low hazard business that has a higher propensity to be just a medical-only claim, meaning, an interim worker, works at a restaurant, cuts his finger, he goes to the urgent center, gets two stitches and he is back at work that day or the next day. It’s not a severe injury. He is not going to seek any indemnification of lost wages. And you insulate yourself on those claims from the phenomenon of development of a claim because the claim virtually has no life.

I mean, average medical-only claim is open for five months. So then you have the other population of your claim for should be indemnity claims and more severe injury in which a worker is going to seek indemnification for lost wages but have higher medical bills and maybe out for an extended period of time.

Of those claims, you can see that we are able to close those more quickly, because they are less severe claims and if you look at the chart, if you look at 2008 through 2010, an area where prices were a little bit softer. At the end of the day, 86% of our indemnity claims for those you’ve already closed and our philosophy from a claims perspective across all lines of business is the best claim is a closed claim.

You insulate yourself from the development associated with that and we take a lot of pride that we adjust all of our workers compensation claims internally and we do it from a regional office approach, because we recognize that you need regional expertise to adjust claims effectively.

You have to have people that are familiar with the state’s laws, because each state is slightly different from a workers’ comp perspective. Just another kind of graphical representation of what I talked about. I mean, you can see that, we’ve consistently outperformed the industry from a loss ratio standpoint from workers comp.

This is kind of key in why we’ve been able to outperform the industry is, when I said we are an underwriting company, we are never going to be the cheapest paper on the street. We are never going to win on price. What we are going win on is the fact that, we are a specialized in small workers compensation which is an area that is underserved.

When agents place business with us, I believe we provide outstanding customer service to not only the agent, but also to the insured, we treat small business like they are big business. For a $6500 policy, the vast majority of insurance companies out there will require either pay in full or have a premium financed.

We will bill a $6500 workers comp policy over 10 equal installments. And then when it comes to renewal time, we will elect the agent know here are the policies we’re renewing and we will start the billing cycle again. So we try to build the mentality of a personal lines auto that you just get your next bill and it just moves forward.

So we have a very high, as I mentioned earlier, very high renewal retention rate. Our consistency in pricing, we didn’t grow organically in 2008, 2009, 2010, because we were willing to move down on pricing. But what you are seeing now is that, competition has alleviated, either people have moved their LCM to a higher level to make up for past pricing mistakes or they have moved away from the space.

But we went consistently there and that’s the message that we drive home with our agents is that, we are dedicated to the small comp space. This is our pricing philosophy. It’s going to remain consistent and if you are going to place the business elsewhere. Our view is eventually you are going to end up putting it with us.

International operations. International operations is a significant part of who we are. It represents about a third of our premium. It’s headed up at our London office by a gentleman named Max Caviet. Just move forward on the slide. He joined us in late 2003 from a company called Trenwick.

And our international operations is an area that we are excited about the growth opportunities not only in Europe, but looking at opportunities in Southeast Asia and Latin America. And now within Europe, December 2011, we opened in Madrid. We hired a team of surety bond underwriters that specialize in a certain surety product that had connections to Latin America and that dovetailed nicely with our acquisition of the Case New Holland agencies, which obviously sell a tremendous amount of agricultural equipment to Brazil and into South America.

So it’s opening up opportunities for us to evaluate that expanding market and that growing middle-class. We recently closed a car care transaction where we acquired a company called Car Care Holdings, which is based in Leeds, England, that gives us our firs office in China, because they had a presence in Shanghai, they have an office in Moscow.

And what Car Care did, really outside of the US primarily Europe, Canada, Latin America and China is, they offered vehicle service contracts. And again, from a consumer perspective, those things tend to be very pesky, because you go in and lease a car, buy a car, you sign all your finance documents and then they slide all the other papers over.

Do you want to buy a tire and wheel protection, do you want to clear coat protection, do you want to buy interior protection. Those are the types of things that Car Care sells. They sell vehicle service contracts plus all of those ancillary coverages.

Our expectation is that, a year from closing which was about two weeks ago, we’ll write about $120 million of premiums through them and then generate about $25 million of fee income, because they have an administrator that takes the product registration on a fee-for-service basis.

So we are certainly excited about the close of that transaction and the additional expertise that they bring to us from a vehicle service contracts perspective. But needless to say, we are going to explore opportunities in emerging markets and expanding middle-class as they have the capabilities of buying home appliances and consumer electronics for the first time.

And we’ll be cautious and we are going to make sure that we have local presence and partner with the right people where necessary and we are certainly very excited about what we see in terms of growth potential in our international operations.

Just a quick outline of premium by country. This is something I want to touch on in the service and fee income. I think this is something that again differentiates us and it certainly contributes to our ROE. Last year, we generated service and fee income of about $172 million, which represented about an 11% of our overall revenue of the organization.

That was up from about 9% the year before and it was about $108 million in 2011. Our expectations this year is that, service and fee income will be probably close to $240 million, $250 million. And what’s very attractive about that is, the service and fee income is generated outside of our insurance operations.

And it’s done at very attractive margins. Our pre-tax margin on our service and fee income is about 30% and I would expect that probably to be pretty consistent going forward into 2013. So it creates tremendous cash flow outside of regulated entities.

Obviously, it gives us the ability to service the debt that we currently have. Obviously the shareholders’ dividend, which we just few weeks ago increased from $0.10 a share up to $0.14 a share and it’s an exciting opportunity and it’s certainly a contributor to our overall ROE.

And I think it shows kind of a insight into the mentality of management in that, not only do we think that we will be able to successfully grow our insurance franchise, we certainly believe that we will be able to successfully attract additional service and fee income.

And the nice thing about service and fee income is, we constructed it, there is none of the service and fee income is really a carve out, meaning we are going to take lower insurance premiums in order to classify something as fee income. That really additive services that we are able to do.

And some of the largest sources of our service and fee income is doing warranty administration. Someone has to take the product registration and there are warranty providers out there that use third-parties to take the warranty registration, that’s an expense to them or it’s an expense to either the retailer or to the manufacturer.

We’ve internalized this. We have a 300 seat call center down at Bedford Texas that does a wonderful job of doing these product registrations, whether it’s HH Gregg or vehicle service contracts or what had you.

Assigned risk is – for those of you that are not familiar with the workers comp industry, there is an organization called National Council on Compensation Insurance, which administers markets of last resort in certain states, meaning those people that can’t get insurance in the private market, it’s a mandated cover.

So you have to get it somewhere. So you’ll go to this market of last resort. We issue their policies. We bill it, we collect it. We adjudicate their claims but we don’t take any of the risk. The risk is reinsured back through the NCCI and then redistributed to the industry.

But we do that on a fee basis. And now we are currently in 11 states and that market as prices are firming as expanding.

So it’s certainly a good time to be in that business. BTIS, we made that acquisition in December of 2011. They focus on very small policies. Victory GL is their kind of private-label product. The average policy size is $1000, but they generated $200 policy fee on those.

So again, a significant source of fee revenue outside. Car Care as I mentioned we expect $25 million of fee there. So I think fee income is a significant part of who we are. We would anticipate that as a percentage of total revenue this year, that it will be – maybe 12% to 13%.

I mean, we are always going to be an insurance company and earned premium is always going to be the most significant source of revenue with fee income is really the way we can differentiate ourselves and then you can see that, just graphically. And then from an acquisition perspective and I’ll just touch on this briefly.

So I want to take after I answer any questions is that, we really believe it’s the core competency and sometimes it gets referred to internally as a segment. We have people within our organization that that’s what they do. They wed opportunities, they make initial decisions that just makes sense and does it clear the initial internal hurdles.

Those hurdles being things such as has it been a profitable underwriting book. We are not interested in going out and being involved in a rehabilitation project. If someone is running at a 100% loss ratio, they know why they are running at a 100% loss ratio and the changes that we would have to make are going to end up with the same results that they are going to have. So we are not interested in those.

What we want to do is, find opportunities to acquire either premium revenue streams or distribution or fee income in which there is some kind of catalyst. Something is it an expense ratio that they can control, lack of reinsurance, those types of things. And I think that we’ve been very successful in that.

And I can tell you that our acquisition strategy will remain the same. I mean, our bottom-line is, is that it has to be accretive from day one and we have to be able to integrate into our operations. We are not carrying around legacy systems. WE are not carrying around legacy data systems. It has to be able to be integrated into our operation and it has to be accretive to our EPS.

And with that, there is a few more slides on this, but I see that I only have a few minutes left. And then some of the financial highlights. So I don’t want to gloss over this one, $2.7 billion in total invested assets, 95% of it is cash and short-term and fixed maturities.

You could see the breakdown, 19% being cash and short-term, 76% being fixed maturities. We manage our investment internally and what I can say about this is, we look at investment income as additive meaning, we are always going to be conservative with our balance sheet and conservative with our portfolio.

We expect our Chief Investment Officer to maximize yield within very conservative confines. And I think that he has produced very solid results for us since he has been here. So, with that, the appendix are just financial highlights which as you can see these slides either on our website or pick up a presentation.

And with that, I’ll open it up to questions.


Unidentified Analyst

Kind of a big picture question. I am not diminishing your favorable comparison of a combined ratio to your peers. But that has trended up over the last few years and you are mentioning increases in rate and so forth. It doesn’t appear to be a change in your business mix. But what is driving the combined ratio up and secondly, given that increase, how do you improve your ROE?

Ronald Pipoly, Jr.

There has been a slight change in business mix and in December of 2009, we entered the Italian med-mal. While we write it profitably from an underwriting perspective, traditional extended warranty at time you could write at an 80%, Italian med-mal, you may find in years and which we are able to do that but generally you are going to write it at a slightly higher combined ratio.

Still very profitable and still very accretive to the overall ROE. But that’s been a part of it. And then in addition, I mean you have to remember that, at the end of the day price is determinant of loss ratio. And when I say that, that we held our LCMs, rates there has been promulgated rate, what the states say we are allowed to charge. There was great pressure from a comp perspective, from 2008, 2009, 2010.

So the rates we are able to charge were lower than they were the previous year. So then net, we saw a slight movement up in our overall loss ratio from comp perspective still much better than the industry, but still higher. So, combined ratio with our current product mix, I think is in 88%, 89% combined ratio.

And I still, - my hope is, is that the trend that we’ve seen with workers comp continues and maybe that could lead to having individual years where we fall below that. But I would say, like over a 10-year horizon, that we are in 88%, 89% combined ratio. We are going to have years that are going to be lower, years that are going to be little bit higher but down in average that’s where you will be.

But I think, from a rate perspective on the curves by what I see, not only from workers comp, but certainly package policies in the US and certainly in specialty program, that’s why we are able to successfully grow that last year as we felt comfortable from a pricing standpoint that we are getting the rate necessary to meet what our targets were from return and from a combined ratio perspective.

Unidentified Analyst

A quick follow-up for the workers comp business. Can you talk about your expectations on the sustainability of rates? How long can they keep leading the commercial lines in terms of price and increases? And then as a separate follow-on question to that, talk about expectations for inflation for your workers comp business, obviously with closing claims that becomes less of an issue, but still how do you think about that in a context to your business?

Ronald Pipoly, Jr.

The first part of the question, how long? I mean, I hope it continues indefinitely, but I guess what we have to be cognizant of is, what our competitors are going to do? I certainly think that from a kind of a promulgated state rate perspective, meaning either a workers’ comp bureau or a board in the state or a state department insurance.

I think that we are in an environment in which you are going to see substantially more states have rate increases year-over-year in terms of what we’re allowed to charge. Then the concern becomes what’s competition going to do, because a state can give you a rate increase and a carrier can give it right back by saying well, I’m going to lower my LCM by an equal amount.

But I think we’ve seen alleviation of that kind of competitive LCM pressure. So hopefully that continues and hopefully people realize that the idea that you can burn your way into a market or that you are going to lower your LCM and you are going to get all this business this year and then you are going to increase your LCMs in the following year and that’s how you make up for your losses.

I mean, it’s been tried over and over and over and over again hopefully from an industry perspective, we learn that that’s not the way to approach it. You have to approach it that you have to make money underwriting the risk. So that’s a significant part about that.

In terms of lost cost inflation California I think is an example that it is a state that from a comp perspective, I’ll use that as an example, we think that we will achieve somewhere probably between a 12% and 15% rate increase in California and I think, last week at the Investor Preview Conference that they guided that they felt lost cost in California might increase by 6%.

And then again, that’s speaking and I said I won’t like to speak in broad strokes and people do that, but I just did it. I think that’s pretty consistent with small comp. Maybe our lost cost increase will be slightly less than that again because you are going to factor in.

The biggest driver of lost cost increase is medical inflation. And at the end of the day, as I said, we have fewer indemnity claims that have significant medical exposure to them. Let’s not say, we don’t have any, we certainly do. So maybe our lost cost instead of being if the industry is averaging 6, maybe we are 4.5. But certainly I think the increases that we are seeing in rate outpace the increases that we are seeing in lost cost from a comp perspective.

Unidentified Analyst

Can you talk or give an example of how technology is an enduring competitive advantage for you? I think, you said that at the beginning of the presentation.

Ronald Pipoly, Jr.

Yes, I mean, at the end of the day, I think that, you talk about warranty for example and what’s the barrier to warranty and we get asked that question, if you guys are writing it successfully, why are going to be able to sustain or why isn’t there going to be an influx of people.

Warranty agreement really isn’t that complicated from a conceptual standpoint. You develop a relationship with a retailer and you load their SKU numbers in and you develop a price based on what you expect a failure rates to the offer. So you have to have a significant amount of data to actually accurately predict failure rates.

But then how, what backbones you have to support that? I mean, you are talking about we have 30 million warranty contracts in place. How are you going to support a system that’s going to deal with a point-of-purchase sales system which is totally different from your system.

How are you going to gather that data on a daily basis? Analyze that data so you can tell what products are performing well, what aren’t because the advantage you have in warranty is we can revise our pricing every day. If we see that we miss the mark on a failure rate for a particular product with a particular store or at a manufacturer, we have the ability to revise the pricing the next day.

But if you don’t have that information coming to you on a daily basis, where you can have your analyst making the decisions, you are going to get behind the – and another thing that we exclude from warranty is epidemic failure, meaning, if there is a process there that what is bad within a digital camera.

If we certify it as being epidemic failure, we don’t have to pay those claims. We don’t honor those claims that’s not covered. But if you are not gathering the data and you don’t have to – you have the ability to identify the nature of those claims how are you ever going to certify something as being epidemic.

So I think at the end of the day, it’s just – really just a focus on the technology and 150 people of that deal everyday in developing and improving our overall systems. And we recognize at the end of the day, we are a frequency-driven company across all of our lines. And we have to do it very efficiently and very effectively.

Brett Gibson – J.P. Morgan

And I think that’s it. Thank you.

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