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AmTrust Financial Services, Inc. (NASDAQ:AFSI)

Q2 2013 Earnings Conference Call

August 6, 2013, 9:00 AM, ET

Executives

Hilly Gross - Vice President, Investor Relations

Barry Zyskind - President and CEO

Ron Pipoly - Chief Financial Officer

Michael Saxon - Chief Operating Officer

Beth Malone - Senior Vice President, Investor Relations and Corporate Developments

Analysts

Randy Binner - FBR Capital Markets

Mark Hughes - SunTrust Robinson Humphrey

Ken Billingsley - Compass Point

Operator

Good day, ladies and gentlemen, and welcome to the AmTrust Financial Second Quarter 2013 Earnings Conference Call. At this time all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will follow at that time. (Operator Instructions). As a reminder this conference call is being recorded.

I would like to introduce your host for today’s conference, Hilly Gross, Vice President of Investor Relations for AmTrust. Please go ahead.

Hilly Gross

Thank you. And thank you everyone for taking the time to join us this morning for this AmTrust Financial second quarter earnings conference call 2013. With me this morning are Mr. Barry Zyskind, President and CEO of AmTrust; and Mr. Ron Pipoly, Chief Financial Officer of AmTrust. As always it’s a pleasure to acknowledge the presence of Mr. Michael Saxon, Chief Operating Officer of AmTrust and Ms. Beth Malone, Senior Vice President of Investor Relations and Corporate Developments.

Before I call on Mr. Zyskind and Mr. Pipoly to give you their review and analysis of the second quarter 2013 results I would with your indulgence read into the record the obligatory paragraph on forward-looking statements.

Since members of our management team may include in today’s presentation statements other than historical facts such statements may include the plans and objectives of management for future operations, including those relating to future growth of the company’s business activities, availabilities of funds, and these statements are based on current expectations and involve assumptions that are difficult or impossible to predict accurately, many of which are beyond our control.

There can be no assurance that actual developments will be consistent with these assumptions. Actual results may differ materially from those expressed or implied in these statements as a result of significant risks and uncertainties, including the factors set forth in our filings with the Securities and Exchange Commission.

The projections and statements in this presentation speak only as of date of this presentation and we undertake no obligation to update or revise any forward-looking statement, whether as a result of new information, future developments, or otherwise, of course, except as may be required by law.

Finally in the prepared remarks and responses to questions in today’s presentation our management will refer to financial measures that are not derived from Generally Accepted Accounting Principles or as it is known GAAP. Reconciliations of these non-GAAP financial measures to the most directly comparable GAAP measures and related information is provided in the press release for our second quarter 2013 earnings, which is available on the Investor Relations section of our website at www.amtrustgroup.com, I repeat, www.amtrustgroup.com.

Thus having dispensed with the legal niceties it is now my pleasure to introduce to you Mr. Barry Zyskind, President and CEO of AmTrust Financial. Barry?

Barry Zyskind

Thank you, Hilly. Good morning. I am pleased to announce that we had a very strong second quarter and first six months of the year. All of our segments continue to perform very well; our small commercial business, our Specialty Risk and Extended Warranty and Specialty program. As you can see from the press release our fee business continues to grow and contribute significantly to both revenue and bottom line.

Our investment income has also benefited from over 3.5 billion in invested assets. Rates in our lines continue to grow, workers compensation we see nice increase in submissions and binding and we continue to take market share as some our competitors continue to have issues because of stock pricing that they did years before.

Being a disciplined carrier we now have the opportunity to take advantage of what we are seeing in the marketplace. We continue to see opportunities for acquisitions. We believe we are very uniquely positioned. Larger companies than us don’t look for the acquisitions that we are looking for and the smaller companies really do not have the capital to do the acquisitions that we are doing.

Recently we announced the acquisition Sagicor of London and Lloyd's. We hope that this will give access to the Lloyd's market and key licenses will allow us continue expanding our presence in international markets. There's really not much more to add to what is in the press release. We had a strong quarter in every line of business. Our return on equity is very high. We believe that these first six months of the year we will continue to see strong growth in both revenue and profits for the remainder of 2013 and into 2014.

And with that I would like to turn it over to Ron Pipoly.

Ron Pipoly

Thank you, Barry and good morning. The second quarter of 2013 was the first quarter in which we surpassed $1 billion in gross written premiums. Gross written premiums for the quarter was $1.04 billion, an increase of $103 million or 63.2% from the second quarter of last year.

All of our operating segments experienced growth during the quarter. AmTrust gross written premium over the last four quarters was $3.5 billion. Unless otherwise noted my comments this morning will evolve around the discussion of our results this quarter compared with the second quarter of last year.

For the quarter we generated net income of $80.1 million or $1.14 per diluted share. Included in net income was approximately $20.7 million of net gains related to the acquisition of Sequoia and First Nonprofit insurance company. These net gains accounted for earnings per diluted share of $0.30.

Additionally we recognized a gain of $5.6 million related to the successful 144A offering completed by National General Holding and our subsequent conversion of our preferred shares into common equity. This gain accounted for earnings per diluted share of $0.08.

We had operating earnings of $60.4 million or $0.86 per diluted share. Included in operating earnings of approximately $500,000 or than $0.01 per diluted share of income associated with gain on life settlement contracts. Included in the diluted share count are approximately 906,000 of additional shares related to our convertible notes. The additional shares were based on the average share price for the quarter.

Annualized return on equity for the quarter was 25.5% and annualized return on equity for operating earnings was 19.2%. For the six months we generated net of 164.2 million or $2.34 per diluted share. Included in net income was approximately 40.6 million of net gains related to the acquisition of Car Care, Sequoia and First Nonprofit Insurance Company. These net gains accounted for earnings per diluted share of $0.58. We had operating earnings of $117.6 million or $1.68 per diluted share.

Our small commercial business segment produced gross written premium of $389.9 million, an increase of $175.8 million or 82.1%. The growth was driven primarily by an increase in worker compensation premium. Our worker compensation policy counts increased by 27.8% during the quarter.

Additionally we continue to experience increase in rates on our renewal book of business. We wrote $24 million of premium this quarter as a result of our acquisition of Sequoia and First Nonprofit Insurance Company. Both transactions closed in May of this year.

Specialty Risk and Extended Warranty segment produced gross written premium of $447.9 million, an increase of $175.3 million or 64.3%. The segment’s premium growth was affected by two one-time premium events which totalled approximately $100 million in second quarter. One of these transactions involved [ensuring] payment of certain contractual liabilities. We received funds of $143 million in addition to the policy premium that will be utilized to pay these liabilities.

Additionally the Car Care acquisition which closed in February accounted to $28.6 million of premiums. Without consideration of the one-time events premium growth would have been $73.6 million or 26.9%. 78.3% of the gross written premium was generated outside of United States this quarter, which compares to 64.1% for the second quarter of 2012.

Our Specialty Program segment produced gross written premium of $173.8 million, an increase of 51.9 million or 42.6%. Growth for the quarter was primarily driven by non-workers compensation programs. The majority of that growth came from existing programs. We continue to see firming rates within this segment.

We also recorded $28.9 million in premium in our Personal Lines Reinsurance segment. As a result of National General successful capital raise our reinsurance relationship will be terminated on a one-off basis effective August 1st.

For the year our gross written premium increased by 745 million or 60.2% from 1.24 billion to 1.98 billion. Specialty risk and extend warranty gross written premium totalled 776 million, an increase of 270 million. Small commercial gross written premium totalled 766 million, an increase of 319 million, specialty program gross written premium totalled 383 million, an increase of 156 million.

On a consolidated basis without consideration of the previous mentioned one-time events growth in gross written premium would have been $643 million or 51.8%. Regardless of segment we have written $1.26 billion of workers’ compensation gross written premium over the prior four quarters.

Our net written premium for the quarter rose to $640 million from $392 million. We retained 60.8% of our gross written premium for the second quarter compared to 61.4% in the second quarter of 2012. For the quarter we ceded $283 million of premium to Maiden.

For the year our net written premium was $1.17 billion compared to $751 million for the six months ended June 30, 2012. We retained 58.7% of our gross written premium for the year, compared to 60.6% in 2012. For the year we ceded $589 million of premium to Maiden.

Net earned premium totalled $536.5 million for the quarter, up over 60% in the second quarter of 2012. The largest contributor to our earned premium with our Specialty Risk and Extended Warranty segment which accounted for 39% of the total earned premium followed by small commercial business at 35%, Specialty Program and Personal Lines Reinsurance at 21% and 5% respectively.

For the quarter we ceded $252 million of earned premium to Maiden. For the six months net earned premium was $945 million and we ceded $479 million of earned premium to Maiden.

Our combined ratio came in at 91.3% for the second quarter compared to 88.9% last year. The loss ratio totalled 67.9% this quarter compared to 63.4 for the same period last year. Our expense ratio for the quarter was 23.4% which compared to 25.5 in the second quarter of 2012.

Our service and fee income totalled 88.1 million which is an increase of approximately $55 million from the prior quarter. The increase for the quarter was a result of the CPPNA acquisition, CPPNA has been subsequently renamed AmTrust Consumer Services and it generated fee revenue of $11.3 million.

Additionally the acquisition of Car Care generated fee revenue of $9.5 million. The December 2012 acquisition of First Nonprofit Companies generated fee revenue of $5.3 million as well as our 2012 acquisition of Case New Holland's insurance operations, agency operations which generated fee revenue of $11.9 million.

Additionally fee revenue increased quarter-over-quarter for AMT Warranty by $6 million. And the assigned risk administration that we do increased by $4.5 million and our IP servicing and licensing fees for National General Holdings increased by $2.3 million.

We earned $67.2 million of ceding commission from Maiden for the quarter compared to $44.6 million for the second quarter of 2012. We grew our total revenues by 66.4% from the second quarter of last year and 52% for the year.

We generated $22.6 million investment income for the quarter and had 1.3 million of net realized gains after tax. For the year we have generated investment income of $40.7 million and had net realized gains of $12.6 million after tax. Our effective tax rate for the quarter was 27.7% and 25.5% for the year.

Our total shareholders’ equity of $1.3 billion, which represents a book value of $17.78 per share. The increase in book value per share since December 31, 2012 has been $0.65. We also declared two quarterly dividends totalling $0.28 per common share.

As I mentioned earlier we converted our preferred shares to National General Holdings into common equity. Despite this conversion we are still required to report our investment using the equity method.

Under the equity method our current carrying value was $91 million. Based on recent trades in the total market the market value for our 12.2 million common shares of National General Holding is valued at $148 million which is 57 million higher than our current carrying value.

Our total assets as of June 30 were approximately $9.1 billion. Total invested was $3.5 billion, fixed maturities comprised 78% of the portfolio. Cash and short term investments 18%, equity securities, 1% and other investments 3%. Our other investments include our holding in National General Holdings.

The average yield on our portfolio is 3.34% at the end of this quarter. Our expected discount rate for the life settlement portfolio for 2013 is 17.3%. The gross carrying value of the life settlement portfolio is $208.7 million. Our portion of that value is $104.3 million.

Since the first quarter conference call we have had two additional mortality events and have collected benefits on both of those policies. The total benefit collected was $5 million. Associated with those policies we have paid $185 of premium and carried the policies at a carrying value of $400,000. These policies resulted in a cash gain of $4.9 million.

And with that, I will turn it back over to Hilly.

Hilly Gross

Thank you, Ron and thank you Barry. Both Mr. Zyskind and Mr. Pipoly have indicated their willingness to entertain questions from those of you listening to our earnings conference call. In order so you can access us I am going to momentarily turn this back to our moderator for specific instructions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from the line of Randy Binner from FBR. Your line is open and you may proceed.

Randy Binner - FBR Capital Markets

Great. Good morning. Thank you. I just wanted to start off with a couple of modelling questions. I guess first on the fee income. I appreciate the color on all the contributions from the acquisitions but it seems like the related parties were maybe a little bit higher than they normally would be with maybe Nat Gen technology build out. So can you help us understand maybe kind of how we want to run rate that forward and if there was any unusual kind of fee for service revenue in the quarter.

Ron Pipoly

Hi, Randy it’s Ron. Related to those fee income there was really nothing in the second quarter that would consider anomaly. The fees related to our IT services it just is really a function of us concluding the build out and having all the premium written on National General transition to using our system. So that was just the natural evolution of that fee revenue stream. So really there is nothing within the 88.1 million that occurred in second quarter that I would consider a one-time event or an anomaly of any nature.

Randy Binner - FBR Capital Markets

Okay, so that’s basically a run rate of a number adding on continued growth within each business line. Is that fair?

Barry Zyskind

Yeah, that's fair.

Randy Binner - FBR Capital Markets

Okay and then can you share with us how the EBITDA margins are coming through in that business? Can we still think of that as kind of 25% to 30% EBITDA margin business?

Ron Pipoly

It’s Ron, Randy, yes you can still consider that.

Randy Binner - FBR Capital Markets

Okay and then moving to warranty. You know it sounds like there was some unusual items there, that’s spiked up the premium so we should take those down going forward that’s the first question.

The second question is I think first is my modelling other peoples to you are probably a little bit higher there on like a combined ratio basis or a loss ratio basis. Is there a business mix change going on or was that higher loss ratio, anything to do with the higher premiums in the quarter?

Barry Zyskind

Hey, Randy this is Barry. First of all you should take out the one-time and we over the years once in a while we will get a one-time. It’s the nature of the business so if you winning a new account people have you take over their old liabilities and to make it easier so you are the one administrator. So we always try to point that out so you could take that out of the modelling.

In terms of loss ratio it's just really the mix of business. As we earn more of some other lines for example, as medical liability which we run at a higher loss ratio, is a higher percentage on some of the liability lines as well. You see a little bit higher also some of the European business, some of the Car Care plan because of the mix of the business model having fee business involved. So their loss ratio tends to run a little bit higher.

Depending on the quarter and depending on the mix of business how the business is being earned, you could get a little bit higher loss ratio.

Randy Binner - FBR Capital Markets

Okay and then just I will sneak in one more on the modelling and get back in the queue. On California account can you share with us the current quarter price increases you were able to get in and kind of where how your underlying loss ratios are developing there?

Ron Pipoly

From a, Randy this is Ron, from the California account perspective we continue to see a solid mid-teen rate increases on a year-over-year basis. And from a loss ratio perspective, California and all lines of business something we discuss on a monthly basis. And we’re certainly encouraged with what we see related to the trends in frequency and average severity and the average cost of medical owner claim. We’re certainly encouraged, but from a loss perspective, I think we’ll continue to remain very conservative as we continue to gain more experience in California that we’re actually very encouraged by what we see.

Randy Binner - FBR Capital Markets

So can you remind us where your loss pick was for California account in the first half of the year?

Ron Pipoly

Yeah we’re still holding California at about a 70% loss ratio.

Randy Binner - FBR Capital Markets

Okay, perfect. Thanks so much.

Operator

Thank you and our next question comes from the line of Mark Hughes from SunTrust. Your line is open and you may proceed.

Mark Hughes - SunTrust Robinson Humphrey

Thank you very much, good morning.

Ron Pipoly

Good morning.

Mark Hughes - SunTrust Robinson Humphrey

Ron, could you walk through again the one-time items, the effect on growth and then if you could, the impact on earned and on net income? Obviously we’re going to take those out of our model, but what was the impact, up and down on P&L?

Ron Pipoly

From a gross written premium perspective, the two one-time events totaled about a $100 million and both of those events in terms of premium and effective dates of the transactions were late in the second quarter. So really from an earned premium perspective on that $100 million, this quarter was only about $4 million associated with earned premium. So really did not significantly impact earned premium. I mean we will earn that premium over the duration of the contract.

So really not much effect on earned premium at all and is about $100 million from a gross written premium perspective.

Mark Hughes - SunTrust Robinson Humphrey

Okay, but just in subsequent quarters that $100 million would not be earned in, so to speak?

Ron Pipoly

I think it will be earned over natural duration of the policy. I mean, and again because it’s extended warranty, especially with the extended warranty it’s not a traditional 12 month earnings. Right now specialty extended warranty average duration's something around 20 months.

Mark Hughes - SunTrust Robinson Humphrey

Okay, all right. Got you. And then when you look at the workers’ comp pricing or just at P&C overall the issue of whether it’s decelerated in mid-year, which is that you’ve seen a sustained trend? Are they decelerating a little here lately?

Ron Pipoly

We’re seeing continued -- the trend is very healthy. We’re not seeing any deceleration at all. I mean if you look at the growth of the business that’s really coming from some of the bigger carriers pulling out, we continue to see a lot of submissions, we continue to see a lot of opportunities. We’re still seeing some carriers even recently the last few days having issues. So we think that’s the workers’ comp market, so at least where we play in, we continue to think that there is lot of opportunities to grow it, through the end of ’13 end of the ’14.

Mark Hughes - SunTrust Robinson Humphrey

Then one final question here, the access to the Lloyd's market, could you talk about why that’s important? Does it help you from a cost perspective? Is it going to lead to new top line opportunities?

Ron Pipoly

I think it’s both. I mean it can be top line and bottom line. We have a pretty significant operation in Europe as well. So there will be some consolidation efforts of working together with the teams we have and the teams they have. They do have some good lines of business that we’re not in, some niche lines that they have done very well.

But in addition to that it gives us the opportunity to Lloyd's platform, which as we can continue expanding with the Car Care plan and having operations and opportunities to grow in Asia and into Latin America and thus growing some of those markets it's key to have a Lloyd's platform that allows you to play in those markets. So the actual business, we think there is an opportunity of the platform that we bought. Good business there and talented people as well the opportunity to use that platform to expand our other lines of business internationally.

Mark Hughes - SunTrust Robinson Humphrey

Thank you.

Operator

Thank you. And our next question comes from the line of Ken Billingsley from Compass Point. Your line is open and you may proceed.

Ken Billingsley - Compass Point

Good morning. I just wanted to follow-up on a couple of questions. Regarding the $100 million, I know you called it more of a one-time gain in premiums, but is this business that’s expected to be retained now?

Ron Pipoly

There are two portions of the one time -- I'd say two one-time events that totaled $100 million. Approximately $78 million of it is what I would consider a one-time event, a unique transaction. So that would be a one-time event. The other $20 million is a program that we put together and as Barry said on certain extended warranty program when you take something over you are inheriting an earned premium portfolio. So you can ensure customer service.

So nearly of the $100 million $78 million is something that I consider truly one-time. The other is continuing program that we don’t have the lump-sum unearned premium as we did this quarter.

Ken Billingsley - Compass Point

Definitely understand so $20 million of the approximately $100 million we expect that business is obviously something you will be able to continue to bid on and expect to keep.

Ron Pipoly

That’s correct.

Ken Billingsley - Compass Point

The other question I have is related to the California Workers’ comp. I know you talked about -- you raised there but there is a company there that was growing about the same time you were and they didn’t seem to be getting that right. Without giving away all of your proprietary tools could you just talk about what you might have been doing differently that your results are obviously kind of running more positive than some of your competitors?

Ron Pipoly

Well first of all I don’t know the company you are talking to but I have a sense and that company actually was pretty aggressive in ’08, ’09, ’10. We didn’t get into California until the second half of ’11. If you look at the rates and trends of (inaudible) that’s when the market start moving right in the second half ’11 and ’12 and ’13.

So if you look at when we got in we really benefited from the '11 year obviously being still needed a lot of the PLAs which you got. And then you got to '12 and '13 but if companies were writing in when I think probably the toughest time ’08, ’09, ‘10 and the first half of ’11 you cannot compare that it's someone starting to write ’11, ’12 and ’13 writing the dramatic increase in rate in those years.

Ken Billingsley - Compass Point

And to that point I mean know some of the people that were before you got even more aggressive kind of writing more in the ’11, ’12 and ’13 despite pricing being good it obviously was not good enough to offset what you are saying was a very core market ’07 to ’09?

Ron Pipoly

Yeah, I think if you look at ’08, ’09 and ’10 and you are talking -- looking about loss ratios, I mean industry standpoint I think was the 90s, high 80s, 90s may be even high 90s. It will take a while for you to see where the market’s priced now. We clearly we’re in 70s we clearly believe that it could be better than that. And we'll wait to see how that performs and the trends look even better than 70s, we are being conservative.

There is no question about it, you get 20 on 20 on 20 or 15 even top of two years of 20 you are about talking significantly different rates. Workers’ comp is very predictable if you get the right rates and you go after the right hazard class, it is question of pricing and under writing and you can’t compare someone writing today to someone having a lot of baggage from ’08, ’09 and ’10 and the first part of ’11.

Ken Billingsley - Compass Point

Last two questions, as Ron you said was personal lines reinsurance terminates and expires August 1, is that correct?

Ron Pipoly

That’s correct and it’s on a run-off basis so obviously we will earn the remaining premium over the duration of the contract that built but effective August 1st there will be no more insurance premium.

Ken Billingsley - Compass Point

Then it will be the fee income business, the fee income that you’re generating…?

Ron Pipoly

That relationship in terms of the IP licensing and servicing fee, yes, that will continue.

Ken Billingsley - Compass Point

And you gave a percentage break down of I think you said international versus U.S. business could you give me that percentages again?

Ron Pipoly

Yeah, for the quarter 78% of the premium was outside of the U.S. which compares to -- that’s for the second quarter which compared to 64.1% for the second quarter of 2012.

Ken Billingsley - Compass Point

Right. Thank you very much.

Ron Pipoly

Thank you.

Operator

Thank you. And at this time I am not showing any further questions. I would now like to turn the call back over to Hilly Gross for any closing remarks.

Hilly Gross

Thank you. And there being no further questions I think it’s a conclusion on this our second quarter 2013 AmTrust earnings conference call. On behalf of all of us at AmTrust, we thank you for taking the time and trouble out of your business schedules to join us this morning, and we wish you all a pleasant day.

Operator

Ladies and gentlemen, thank you for your participation in today’s conference. This does conclude the program and you may all disconnect. Everyone have a great day.

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