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SeaBright Holdings, Inc.

Q2 2010 Earnings Call

July 28, 2010; 04:30 pm ET

Executives

John Pasqualetto - Chairman, President & Chief Executive Officer

Richard Gergasko - Chief Operating Officer

Scott Maw - Senior Vice President & Chief Financial Officer

M. Philip Romney - Vice President - Finance, Chief Accounting Officer, Assistant Secretary

Analysts

Mike Grasher - Piper Jaffray

Bijan Moazami - FBR Capital Markets

Michael Nannizzi - Oppenheimer

Robert Paun - Sidoti & Co.

Dustin Brumbaugh - Ragen MacKenzie

Adam Klauber - Macquarie Securities Group

Robert Farnam - KBW

Operator

Good afternoon ladies and gentlemen and welcome to SeaBright Holdings second quarter 2010 earnings conference call. At this time all participants have been placed in a listen-only mode. Following formal remarks the call will be open to questions.

It is now my pleasure to introduce the host of today’s call M. Philip Romney, Vice President of Finance and Principal Accounting Officer for SeaBright Holdings. Please go ahead sir.

Philip Romney

Thank you Cynthia and welcome to SeaBright second quarter 2010 conference call. Joining me on the call today are John Pasqualetto, Chairman, President and Chief Executive Officer; Richard Gergasko, Chief Operating Officer; and Scott Maw, Senior Vice President and Chief Financial Officer.

Before I turn the call over to John for opening remarks, I’d like to remind you that statements made during this conference call that are not based on historical facts are forward-looking statements. These statements are made in reliance on the Safe Harbor provision of the Private Securities Litigation Reform Act of 1995 and are subject to uncertainties and risks.

SeaBright’s future results may differ materially from those anticipated and discussed in forward-looking statements. Some of the factors that could cause or contribute to such differences have been described in the press release issued today and in SeaBright’s filings with the SEC. We refer you to these sources for additional information.

I’d also like to point out that remarks made during the conference call are based on information and understandings that are believed to be accurate as of today’s date, July 27, 2010. This call is the property of SeaBright Insurance Holdings, Inc. Any distribution, transmission, broadcast or rebroadcast in any form without the expressed written consent of the company is prohibited.

With those announcements complete, I give you John Pasqualetto. John.

John Pasqualetto

Thank you, Phil. Good afternoon and welcome to today’s call. Before turning the call over to Rich and Scott for a review of our operating and financial results, I’d like to provide some comments about SeaBright’s overall performance for the second quarter, the dynamics behind them and the actions we have instituted to improve future quarters.

At the close of the market today we issued a Q2 earnings release, reporting an uncharacteristic operating loss for SeaBright. Clearly, it is important that we explain why SeaBright took such decisive action during the second quarter to strengthen our reserves by $30.6 million, most of which was related to California and accident year 2009, reflecting loss experience from the other states.

Not only are we currently encountering adverse development for 2007 through 2009, but we believe the pattern will continue into 2010. Recognizing these emerging trends, we have chosen to significantly bolster our IBNR reserves to reflect our ultimate clam cost. While no one can guarantee that SeaBright won’t require additional reserve strengthening, we have chosen the course of action to fully address the situation.

This action was not taken lightly. In addition to our regularly scheduled, quarterly internal actuary review and the routine valuation by our retained independent actuary, we saw the involvement of the second independent firm. We added as a resource the second outside firm to increase our confidence in the overall conclusions and to fully reflect our best judgment on our needed reserve balances.

Our reserve strengthening was cased by California Worker’s Compensation environment, currently threatened by a combination of increased medical cost trends and a prolonged economic downturn in the state, manifested best by its persistent double-digit unemployment.

This presents challenges for SeaBright, as well as the entire industry. As we have stated in the past, SeaBright worked diligently to underwrite any profit. When each of the policies were originally written, pricing was based upon our experience and the information we had at that time, supported by the past historical development trends.

We have been successful in achieving rate increases in California. To recap, we’ve increased rates by 8.3% in Q3 of ‘09, 11.2% in Q4 of ‘09, 10.5% in Q1, 2010 and 12.8% in Q2, 2010. The average rate increase for all California policies renewing over the past 12 months was plus 10.7.

Despite these positive changes, earnings information indicates we will need to raise rates in the future, but we ought to keep pace with the rising loss cost trends in that State. You may have seen our press release yesterday announcing that we filed another California rate increase of 15.3% that incorporates our most recently loss data. Although the frequency of claims has decreased during recent years, the industry is experiencing unbroken upward trend in claim severity, specifically related to greater medical costs and extended case duration.

In a more normal economy employers actively support early return to work programs that manage their workers comp expense, but in leaner times employees become less diligent in these efforts and are less motivated to offer light duty employment. Sometimes workers don’t have a job to return to because of downsizing, insufficient project for contractors with a small pipeline and similar recessionary factors.

Result of these conditions is that claims remain open longer, and the longer they stay open the higher they cost. The longer claim durations have a variety of negative impacts on claim expenditures. When injured workers have prolonged periods of disability, they often seek additional medical treatment much later in the development of the case. There is also greater use of higher priced diagnostic surgical procedures and post surgical treatments. In addition, prolonged disability tends to increase litigation and resulting related cost.

To address these issues head-on, SeaBright has taken the following actions. As I touched on earlier on July 26, we filed a 15.3% rate increase with the Commissioner’s Office at the California Department of Insurance. We expect to have the increase in place by September 1 of this year.

Some of you maybe aware there are two ways to impact the California pricing. One is filing increased rates as we did yesterday. The other avenue is our underwrites use of rating plans that allow us to adjust for individual risk characteristics. Overall, California rate increase was 12.8% for the second quarter of 2010, exemplifies our use of both of these mechanisms.

As you may recall, another recent SeaBright press release in which we announced the launch of Brightcure PDQ. PDQ stands for Physician Directed Quality and it refers to our new medical management claim model, employing physicians to more effectively manage the medical cost of certain claims that represent the greatest cost potential and the most serious return to work challenges.

These are identified soon after the initial injury using our predictive modeling techniques. With the doctors driving medical decisions from the start on these selected claims, we expect that high quality and more appropriate medical treatment will be delivered in a more cost-effective manner.

The ultimate goal of this new process is to properly return the engine work to productive employment. In addition, the Brightcure PDQ model ducktails nicely with our medical management subsidiary, total healthcare management, which specializes in medical utilization review and medical bill review for its sister company SeaBright Insurance, and other outside clients.

We introduced this Brightcure PDQ in California last month, filing completion of our research and development, which took place throughout 2009. We ultimately intend in the future to expand it nationwide. Further, we are currently enhancing our Brightcure PDQ play model with an addition of return to work specialists. These individuals directly assist our policyholders to promote and facilitate early return to work again and the reducing claim duration and cost.

Moving onto the competition, the market environment remained soft, consistent with prior quarters. At this point, we certainly do not expect any significant market tightening during the remainder of 2010.

As we discussed during our Q1 conference call, SeaBright is committed to doing the right things. In the case of the most loss experience, we have taken a difficult but bold step to address the situation.

New business and renewals for the remainder of 2010 to be undertaken with enhanced levels of diligence and firmly committed to improving the profitability of our business, and if necessary, willing to sacrifice market share in the process. As a companion effort, we remain extremely focused on expense management and continue to explore ways to run our business more efficiently.

I’ll now turn the call over to Rich for a review of our operations. Rich.

Richard Gergasko

Thank you John. Let me start with a look at our in force book of business. Our in force premium has basically been flat over the past 15 months. The second quarter 2010 in force premium of $304.4 million is within 2% of the in force premium at the end of the first quarter of 2009. However, our in force customer count has been growing during the same time period.

Our customer count increased 21% year-over-year, to nearly 1700 customers at the end of the second quarter. Our higher customer account did not come from premium growth, but rather from a change in the mix of policy holders, driven by our alternative markets program business and small maritime product. Actually, our core business customer count decreased by 6% year-over-year with the majority of the lost customers coming from the construction division.

As a reminder, in force premium refers to our current annual gross premiums written for all customers that have active or unexpired policies and represents estimated annual premiums from our total customer base. I want to emphasize that in force premium is calculated using estimated payrolls available to the underwriter at the time the account is evaluated, which is usually one to two months prior to the inception date of coverage.

As we discussed previously, in a declining economy, these payroll estimates tend to be less reliable than during more robust times. Consistent with our experience over the past 21 months, from the policies audited after expiration, it is not unusual for the payroll estimates to be high with the actual payroll coming in lower than the initial estimates.

Prior to the current economic downturn, our policies typically earned out at around 103% of the original estimated premium. For the past 18-plus months the policies have been earning out at 88% for all policies, with our construction book running about three points lower than the overall averages. We have seen some improvement in this measure, with policies expiring in the past six months, earning at 93% of the original policy estimates.

However, keep in mind that the original estimated payrolls on these policies are still below their historical levels with an average drop of 18% from 2007 levels. We expect the trend we’ve seen over the first half of 2010 will continue through the remainder of the year.

In his earlier comments, John emphasized our ongoing commitment to underwriting profitability and doing the right thing. As evidence of this commitment, we’ve continued to successfully increase the average rates in our renewal business. The average rate change for all policies renewing in the second quarter 2010 was plus 2.1%, compared to minus 1.7% in the second quarter of 2009, that’s nearly a four-point turnaround.

Though the last quarter, our positive overall rate change was driven by our California business, where we achieved an increase of 12.8% in the quarter. For the maritime jurisdiction, the average renewal rate was essentially flat and for State Act business excluding California, the average renewal rate change in the second quarter was minus 4.6%.

You may recall from our prior two quarterly conference calls, we’ve changed our underwriting guidelines as they apply to Illinois construction business in order to drive improved results in the State. These changes included a plan to increase our rates.

During the second quarter 2010, our quarterly rate change for Illinois policy renewals was plus 8.3%, compared to plus 7.5% in the first quarter of 2010 and plus 15.7% in the fourth quarter of 2009. As a result of our underwriting efforts, we’ve reduced our construction industry exposure in Illinois by 38% and we expect it will continue to decrease for the foreseeable future.

Let’s now take a moment to look at our production from a geographic perspective. Our in force premium distribution by state as of June 30, 2010 was led by California, which increased modestly from 46.5% as of March 31, 2010 to 47.8% as of June 30, 2010. Given the increasing loss cost trends in California, I thought it would be instructive to provide additional information about our writings in the State.

I want to point out that all of our recent growth in California is being produced by our program business, specifically in the agriculture and healthcare space. Program business makes up nearly 28% of our total California writings, up from 19% at second quarter 2009. This represents premium growth of 74% over the past 12-months.

In contrast our construction writings in California have decreased from 64% over our total California writings at June 30, 2009 to 56% at June 30, 2010. While construction as a percentage of total writings has decreased, the actual premium writings for the division have remained relatively flat in California over the past three quarters, partly aided by the impact of the rate increases on the renewal book.

As John also stated earlier, we will price our California business to generate an adequate return using the updated anticipated loss trends. As demonstrated by our Illinois results, we are prepared to reduce our market share in California as appropriate. Remaining states are Louisiana as our second largest state at 9.3%, followed by Illinois at 6.1%, Alaska at 5.7%, Texas at 5.4% and Florida at 3.4%.

Another way that we look at our book is by business division, which provides a means for analyzing our book by industry focus as well as distribution channel. At June 30, 2010 the industry focus divisions in total account for 81.2% of our total in forced premium, down from 83.5% at the end of the prior quarter.

The in force mix continues to be led by construction at 46.4% of total in force premium, down from 55% at the end of the second quarter 2009. This reduction is the result of the disproportionate impact of the economic downturn on the construction industry, our underwriting action in Illinois to reduce our exposure in the State and increased premium contribution from our alternative market program business. Our maritime division comprised 22.2% of our in force business at quarter end, with energy at 7.5% and wrap ups and other miscellaneous business at 7.6%.

As mentioned earlier, our alternative markets division program business was comparatively strong during the second quarter and grew from 14.3% of our total in force premium at the end of Q1, 2010 to 16.2% in the second quarter. This business is made up of a number of industry focused programs, with the majority of its premium currently coming from agriculture and healthcare business in California, adding better industry balance to our portfolio of accounts.

I’ll now turn the call over to Scott for a review of our financials.

Scott Maw

Thanks Rich. For the second quarter of 2010, SeaBright recorded a net loss of $15.5 million or $0.74 per diluted share, compared to net income of $4.3 million or $0.20 per diluted share in 2009. As John mentioned, the primary driver behind the results was the $30.6 million in reserve strengthening.

The second quarter also included the $1.9 million impact of increasing our current year expected loss and allocated loss adjustment expense ratio, which I will refer to as the ELR and a $1.5 million goodwill impairment charge. I will cover each of these three items in more detail.

Reserve strengthening was primarily related to California across years 2007 to 2009 and accident year 2009 more broadly in other States. The initial net ELR for each of these years compared to the current loss ratio for each year is as follows. 2007 started with a 58% ELR and we are at 57.8% as of June 30. 2008 started with a 57.5 ELR versus 66.1% at June 30, and 2009 started with 60% and as of June 30 we are seeing 64%. It is important to note that for 2007 we released reserves in previous years and have subsequently adjusted our ratio close to the initial ELRs.

As for 2010, you may recall that the net ELR was initially set at 61.5% in Q1. Because 2008 and 2009 losses have been significantly higher, we are using this most recent trend data to adjust the 2010 net ELR to 64.5% as of June 30. While price increases will clearly help 2010, we believe that the ELR is appropriate at this time.

We also recognized a relatively small goodwill impairment of $1.5 million. Accounting rules consider recent stock price, cash flow estimates and other factors when analyzing goodwill impairment. Given the performance of our stock over the past six months and our current quarter underwriting results, we decided to write off all of the goodwill related to the insurance company purchase in 2003. We still carry a total of 2.8 million of goodwill related to point share and total healthcare management operations and have not recognized any impairment on those amounts.

Shifting gears a bit, net premiums earned in the second quarter 2010 increased 9.3% to $65.6 million, compared to $60 million in 2009. Second quarter 2010 was higher, primarily due to a $3.3 million adjustment to premium on retrospectively rated policies, in conjunction with the prior year upward reserve changes.

Our year-to-date underwriting expense ratio is 28.3%, two points lower than the same period last year. This is a result of both higher earned premiums and our cost management efforts that John mentioned earlier, including a 6% year-over-year decline in headcount.

Now, let’s review a few of the key metrics for our investment portfolio. Realized investment gains were $3.9 million for the quarter and $10.4 million year-to-date as we continue to take gains to help realize a specific net operating loss tax asset.

Net investment income for the second quarter of 2010 was $5.9 million compared to $5.7 million for 2009. At June 30, 2010, our investment portfolio in cash totaled $686.9 million, an increase of $47.4 million from December 31, 2009, driven by strong operating cash flows. The net unrealized gain in our investment portfolio was $21.8 million as of June 30, 2010.

The effective duration of the fixed income portfolio was 4.8 years, unchanged from the prior quarter, with a pretax book yield of 3.8%. Our portfolio reflects our conservative investment approach and has an overall average credit rating of AA, excluding any secondary insurance on the municipal portfolios. We continue to manage our municipal exposure through diversification by individual issuer and by geography.

Finally, I’d like to make a few comments about SeaBright’s capital position. Our tangible book value per share decreased by 2.8% from December 31, 2009 to $15.87, and statutory surplus decrease by $7.9 million to $298.9 million over the same period. It is important to note that statutory surplus is relatively flat from year-end despite the current quarter results. We are confident that our surplus remains well above the minimum needed to maintain our current A.M. best rating.

I’ll now turn the call back to John.

John Pasqualetto

Thank you, Scott. Before turning the call over to questions, I’ll make a few closing. While we are disappointed to every quarter substantial reserve increases during the second quarter, we know that it’s the right thing to do to ensure a successful future for SeaBright. We are prudent and thorough in our response to loss development in California and believe we are currently operating at the proper reserve level following the actions we have taken.

Also I mentioned earlier, we’ve launched proactive measures to meet these continuing pressures head-on. We are going to exert greater control over their impact in the future results. We will continue to monitor California very closely and approach the market with the increased awareness of the unique conditions, barely affecting workers compensation.

To restate what we told you during the last quarterly conference call, pricing discipline, vigilant claim management and prudent reserve levels will be consistently our prime areas of focus for the foreseeable future.

With those comments complete, operator, would you please open the call to questions.

Question-And-Answer Session

Operator

Absolutely. The question-and-answer session will be conducted electronically. (Operator Instructions) And we’ll go to Mike Grasher with Piper Jaffray.

Mike Grasher – Piper Jaffray

Thank you. First question I had is just, can you give us a little bit more insight on the evaluation that was conducted. Obviously, you did it internally; you had your independent auditors and then the second outside firm. I guess what I’m trying to figure out is sort of what sort of out of those $30 million are we looking at in terms of what’s already occurred versus sort of what expectations are going forward, in terms of this same environment continuing with a combination of the claim activity and the medical inflation.

Richard Gergasko

Yeah, hi Mike. This is Rich. I think for the 2009 and prior accident years, we have factored in what we are seeing from a claim severity standpoint. All of the drivers we are seeing are coming or not all, predominantly from the medical side, although we are seeing some indemnity drivers. But we’ve anticipated those trends and built them into the ultimate claim cost.

For 2010, by moving the expected loss ratio up to the 64.5, I think that’s where we are referring to where we would expect those trends to continue into 2010, but despite the rate increases, we still believe the need for that 64.5 for the current accident year.

Mike Grasher – Piper Jaffray

So, I’m sorry, the 64.5, the previous had been 60, is that right? But what was the previous for 2010?

Richard Gergasko

61.5.

Mike Grasher – Piper Jaffray

Okay, so we are raised to 300 basis points and that’s in addition to the rate increases that you are putting through this year.

Richard Gergasko

Correct.

Mike Grasher – Piper Jaffray

Okay. Then the other question, just in terms of the premium earned number improving here, is that resulting from the premium odds or returned premiums slowing? Can you talk any at all about what you are seeing in that regard.

Richard Gergasko

Yeah, the return audits or slowing, but we are still seeing where they are coming in below the initial policy estimates. So to some degree, because they are slowing we are going to see a little bit of an uptake in the earned premium, and then additionally in the quarter we have that $3.3 million retrospective rating adjustment. Once again, as we increase the IBNR reserves on the older accident years, that will have impact on that book of business rated on the retrospectively policies.

Mike Grasher – Piper Jaffray

Okay and than just a final question around the reserves. Other States outside of California, can you give us sort of a breakdown of what those were or who they were?

Richard Gergasko

Yeah, if you recall, when we do our analysis we look at California, then we look at States outside of California together kind of as one block and then we look at our maritime. So in total, California the amount was about 54%, the State excluding California about 30% and you [USO and Asia] makes up the remaining 14%, 15%.

Mike Grasher – Piper Jaffray

Okay. Thank you. I’ll get back in the queue.

Operator

And moving onto Bijan Moazami with FBR Capital Markets.

Bijan Moazami - FBR Capital Markets

Good afternoon. So we know that a lot of these reserve charge was 2009. We know a lot of it is California, but we don’t know how much of that relate to the new products, like the program that you guys were having out there.

And the second question relates, the pick up in the loss cost, we heard that also in the fourth quarter when the reverse addition was taken for Illinois. What happened between the fourth quarter and now that led to the this dramatic change in the way of your reserves?

Richard Gergasko

Yeah, this is Rich again. I think Bijan it’s the, just the continuing observation of the medical trends and what we are seeing and it’s an industry phenomena. We’ve seen industry data come in as well. The CWCI has posted a number of reports that shows the same trends. So from California stand point it’s that medical trend being pervasive in the second quarter.

As far as the new products, the experience in the new products is very green. We just starting writing those back in 2008, so certainly they are not impacting anything more than the most two accidents years and the experience in that book has been similar to the construction booking California.

Bijan Moazami - FBR Capital Markets

Is price increase the answer to everything or do you need to re-underwrite your entire book of business. You have to refocus and figure out what are the products that are working and what are that are not working. Obviously the company grew very rapidly in the relatively soft market environment, maybe just withdrawing from certain lines from certain geographies the right way. I jus want to know, how much of the reaction will be just pricing versus re-underwriting?

Richard Gergasko

Yeah, part of it is pricing, but you are correct, there is under writing activities that has to take place at the same time. We are certainly evaluating all of our product line or the segments that we operate within, and we are certainly look at the geographies we operate in, Illinois being the example from the fourth quarter, to make sure that the pockets where we are continuing to underwrite and write business are the right areas. So it’s a two pronged attack, pricing as well as underwriting.

Bijan Moazami - FBR Capital Markets

So is it fair to assume that despite price increases we should see some premium pressure going forward?

Richard Gergasko

Yeah. There will be premium pressure going forward.

Bijan Moazami - FBR Capital Markets

Thank you.

Operator

And Michael Nannizzi with Oppenheimer & Co. has our next question

Michael Nannizzi - Oppenheimer & Co.

Thanks. It’s just a little more on the unfavorable development. So, can you say how much of the development was due to the pure California construction book, and maybe break it down between the medical and the duration expectations. Then also just from a loss ratio prospective, that particular book realized its about 140 combined or 120 for all your business, but that book in particular, can we get an idea of what the loss ratio is there?

Richard Gergasko

Yeah, this is Rich again. I’ll address the second part of the question first and we’ll continue what we have stated in the past and that we have not provided the loss ratio information within the various states and segments, so I think we’ll continue that response going forward.

As far as the medical versus indemnity, the increase in California was primarily driven by the medical side, I think probably close to 70% or so, the reserve increase with medical. We are seeing some pressure on the indemnity side as well within that. So I think that addresses your question.

Michael Nannizzi - Oppenheimer & Co

Okay, and then as far as the new business, I think in the answer to the last question you said your experience in the program business is similar to the California construction business. So does that mean that some of the development is related to some of the new program business in California as well?

Richard Gergasko

Yeah, I think all the California business is going to be subject to the drivers on the medical side, this increased medical utilization and the increased medical cost. The difference between the program book and the construction book potentially is the ability for return to work, because the construction book has been hit harder by the economic downturn, but we wouldn’t see the same impact there on the program business, but certainly the medical trends are going to be across the Board.

Michael Nannizzi - Oppenheimer & Co

But the medical trends being a majority of the reserve is out there. So that [Inaudible]. Okay, so I guess just a broader question, when looking at the alternative business, so that business is I think you had said in the comments or maybe Scott had said in the comments that that business is up year-over-year, something like 70%.

So how you get comfortable growing so rapidly in this relatively new segment and within California, and how should we think about your growth outside the California in this program business?

Richard Gergasko

Yeah, we got comfortable with the growth within the program business, I guess driven by, we are dealing with NGU’s that understand those books of business. They are books that they’ve controlled for a number of years, particularly in California being the two programs, one agriculture and one health care.

So it’s the comfort level from that aspect, as well as what we are doing from a safety stand point and monitoring the underwriting and the pricing on that book of business. I will tell you that obviously we are looking at all the business in California in terms of the pricing disciplined that we alluded to, based on what we are seeing from the medical trend and the indemnity trend stand point.

Outside of California we have see minimal growth on the program business. What we have seen is the health care program coming out of the North East, predominantly New Jersey, Pennsylvania, New York and Connecticut and that book to-date has come on starting in September, October of 2009. So we are not even at the first set levels of renewals on that book of business, but today that book looks to be performing very well.

Michael Nannizzi - Oppenheimer & Co

And then just a capital question, have you spoken with the rating agencies about this quarters results already?

Richard Gergasko

Yes.

Michael Nannizzi - Oppenheimer & Co

Okay, and then have you made a decision regarding the dividend for this quarter?

Richard Gergasko

We will continue with the dividend.

Michael Nannizzi - Oppenheimer & Co

Okay.

Richard Gergasko

I think the thing that I made in my comments that I think is just important to point out is our statutory surplus at December 31, 2009 was $306.9 million and its at $298.9 million now, and so relatively a small decline year-on-year. So our capital position from a statutory standpoint hasn’t changed that much.

Michael Nannizzi - Oppenheimer & Co

Right, but I mean it’s just in light of the current quarter’s performance. I mean I just wondered if you can talk about the response, about what that might mean from here or if that’s a conversation that you had. Because I realized maybe statically it hasn’t changed all that much, but the performance during the period was such that maybe the view might surface.

John Pasqualett

This is Pasqualetto. I think it’s been our practice in the past to have a constant and consistent dialogue with the rating agencies. In light of the result for the second quarter, we certainly continue to follow that same pattern. As you maybe aware, the rating agencies on their own take their own independent view of both growth and losses and then in the real sense have factored some of the change in their rating models, just as a matter of routine.

So we have engaged in that discussion, we have understood the change. They have also understood that we plan to continue the shareholder dividend and we demonstrated a strength of the capital base, whereas you can see we are pretty well under leveraged to start with, that those combination of things have allowed us to follow-up with the rating agency in a positive way.

Michael Nannizzi - Oppenheimer & Co

Okay. Thank you very much.

Operator

And moving onto Robert Paun with Sidoti & Co.

Robert Paun - Sidoti & Co.

Good afternoon. In terms of the rate increases that were recently filed, it seems like the quarter results had a significant impact on the decision. Can you just walk us through how you came up with the 15% increase? Was it specifically this quarters results or was it medical cost inflation?

Richard Gergasko

Yeah, hi Robert. This is Rich again. If you recall, last august we filed for a 10.3% or a 10.6% rate increase, and just given the data that we provided on the call today, we have been achieving that, pretty much that average rate change over the past 12 months.

We have seen the increase in trends coming through from the medical side in the second quarter. We would have been looking to file an annual change anyway, considering that the rating bureau did not make any kind of a filing for 07/01. It would be something that we would typically do in our state, is to look at annual rate filings, so that was in the works to begin with.

What we will do is, through the actual unit we will take a look at the rates that we are charging today against the experience. We certainly reflected in that calculation the increase in reserves that went through in the second quarter, so that was part of the calculation. They’ll trend it based on current trends for medical, indemnity and wage inflation and project where they think the cost will be at the midpoint of the coming policy period, the 12 month period from September 1 to September 1.

So that’s kind of the mechanics behind the rate change. Looking at a couple of different actuarial message, the plus 15.3 was determined to be the appropriate filing amount at this time.

John Pasqualetto

A big part of that 15.3 of course was reflecting the medical trend and case duration and then a part of that 15.3 was also related to the increase of severity for claim that results from the combination of both those trends.

Robert Paun - Sidoti & Co.

Okay, and if you are filing and charging for, seems like higher rate increases than the rest of the industry in California, do you expect renewal rates to decline and possibly total business in California to shrink?

Richard Gergasko

That is a possibility. A renewal retention has been shown, has been under pressure for the past two quarters while we were getting the rate increases. I can tell you from our market intelligence, we are not the only ones getting rate increases. We are getting information from across the Board that carriers are getting the increases through the rating plans, maybe not necessarily from a rate filing standpoint.

So while we are not the only ones getting it, we do expect that there will be continued pressure on the renewals and if we are not in a position to price it where we need it, we will see some reduction in that renewal retention ratio.

Robert Paun - Sidoti & Co.

Okay thanks, and just a final question on the portfolio, maybe for Scott. Where is the new capital or some of the cash sort term investment? Where is that being invested in today?

Scott Maw

Primarily we were going with new money; it’s into corporates and municipals, tax exempt municipals and I would say over the last quarter it’s been more heavily corporates than tax exempt muni’s and obviously well up in credit quality. If you just take municipals and you look at the total BBB, we don’t have anything in the entire portfolio below investment grade, and only 1% of the muni’s are even rated BBB. So we are staying way up in credit quality.

Robert Paun - Sidoti & Co.

Okay thanks. That’s all I had.

Operator

And next is Dustin Brumbaugh with Ragen MacKenzie.

Dustin Brumbaugh - Ragen MacKenzie

Good afternoon guys.

Richard Gergasko

Good afternoon.

Dustin Brumbaugh - Ragen MacKenzie

I’m trying to make sense of putting a couple of comments together. One is that obviously you have seen the development on the ’09 California business in your filling for a 15% rate increase, and putting that together with the comment that you are also seeing similar trends in severity across the industry. Why if that’s the case and your raising rates there? Why do you expect to loose market share?

Richard Gergasko

Well unfortunately, I think a few things relate to that question. One of which is, my feeling is this is an entire industry phenomena and we have reason to believe clearly if you evaluate the bureau data, the WCARB data, you will see that the trends that we just portrait that cost us the change reserves were the main three drivers behind the 22% rate increase that the bureau filed and that the department saw fit to reject.

I think that we have been more timely and are more timely in reflecting those trends in our IBNR reserves and perhaps some of the industry competition is perhaps a little bit behind the curve on this. They may not have a process to be so timely with respect to reserve changes.

Many companies perhaps might even wait till year-end to do this kind of work, while we do it on a quarterly basis. So perhaps they maybe kind of waiting for the data to mature and for making adjustments, consequently their pricing may not be as timely. I don’t know, that’s just one person’s opinion, but irrespective of that we incorporated it in our 15.3.

On the other hand, although our renewal ratios have been eroded in California, there is uncertainty dropping off the table. I think there is a recognition on the part of the broker community and a recognition even on part of the competition that California has passed the inflexion point and that costs are increasing.

The bureau has estimated on a preliminary basis, that in California the combined ratio for the industry in ’09 is 122. Now that compares to a similar number countrywide, all of about 107. So those pressures do exist. I think the rest of the market is going to reflect those pressures in their pricing and if they don’t, then our market share will drop.

Dustin Brumbaugh - Ragen MacKenzie

Okay, and thanks for the color on that and then this one for Scott I guess. Would you be willing to put a number around what you think your available capital might be, in light of what the rating agencies are looking for on risk base in this subsidiary?

Scott Maw

We have been renascent to do that for obvious reasons. I think the only thing I’ll tell you that’s in beat building on what John talked about it. We did take our best through this quarter before we announced today and they ran it through their model. We have the ability to run it through their model and our conclusion is, we have plenty of room before we have any concern about our rating. It’s hard to put a specific number on that.

Dustin Brumbaugh - Ragen MacKenzie

Okay, thanks and then finally just want to talk about muni’s as an investment class. I know you mentioned new money was being -- perhaps it sounded like you were saying it was being more heavily weighted toward cooperates as opposed muni’s, maybe then new money was going in the past. What were your views on that asset class in general? I know you guys outsourced the investment function, but just curious what you are doing as some of those maturities come up.

Richard Gergasko

We are looking at it more closely. Obviously as I am sure everyone is given what’s going on with municipal finances, we’ve done a lot of work around our exposures and we are comfortable with our portfolio and I think that’s evidenced by the fact that we are still putting new money to work there, but we have been very careful about marking sure we stay high up in credit quality and diversified by geography and also spread between both revenue and then GO, both state GO and local GO.

So we were watching all of those trends, and particularly if the credit starts to decay a little bit from a market standpoint, we take a hard look at whether or not we want to stay in it.

Dustin Brumbaugh - Ragen MacKenzie

Are there any new concerns or comments from regulators or rating agencies on the same subject?

Richard Gergasko

I haven’t had any. John?

John Pasqualetto

No, we haven’t had any context in connection with it.

Dustin Brumbaugh - Ragen MacKenzie

Okay. Thank you guys for the color, I appreciate it.

John Pasqualetto

Thank you.

Operator

(Operator Instructions) And we’ll move on now to Adam Klauber with Macquarie Securities Group. Mr. Klauber, please go ahead.

Adam Klauber - Macquarie Securities Group

Thank you. Sorry if you already said this, but what’s the break down by accident year of the $30 million between 2007, 2008 and 2009?

Richard Gergasko

Yeah, this is Rich. 2007 is about 18.5% of the total, 2008 close to 34% of the total, and 2009 is 37% of the total, and then there is little bit in 2006 and prior. It makes up the difference.

Adam Klauber - Macquarie Securities Group

Okay, and you said most of IBNR. Could give us a rough idea, how much IBNR?

Richard Gergasko

Of the 30.6, all of it is IBNR, expect for $0.5 million of UE.

Adam Klauber - Macquarie Securities Group

Okay, and then could you give us a rough estimate of how much is medical cost/utilization versus longer duration of the claims?

Richard Gergasko

Yeah, as I said earlier. This is Rich again. I think that the vast majority is going to come out of that medical side, while the duration has a dual impact. The duration will impact the indemnity and increase indemnity, but at the same time its also going to increase the medical, because there’ll be longer medical treatment taking place, but that’s why we say that that’s going to have the bigger impact on the medical.

Adam Klauber - Macquarie Securities Group

Okay, and could you give us an idea, what was the actual change in the utilization and the cost trend from end of 2009 to what you are seeing currently.

Richard Gergasko

Yeah, I don’t have that number in front of me, I don’t think. Scott do you have that?

Scott Maw

No I don’t.

Adam Klauber - Macquarie Securities Group

But it was significant I take it.

Richard Gergasko

Certainly on the medical cost trends, I think in terms of the duration, probably not as big an impact. This is really coming from drivers on some of the permanent disability ratings and the utilization of the medical treatment.

Adam Klauber - Macquarie Securities Group

Okay. Thank you very much. That’s helpful.

Operator

Moving onto Robert Farnam with KBW.

Robert Farnam – KBW

Hi, just a couple of questions. One follow-up on the reserve development. So there was no, you had nothing here for case reserves. I am curious why that would be the fact.

Richard Gergasko

No, this is Rich again. There was a case increase during the quarter as well, but we typically haven’t discussed the case reserve increases, but the claim department has been active in monitoring, looking at the cases. So this is IBNR on top of what we did from case standpoint.

Robert Farnam - KBW

Okay, alright, and the second one is more -- you see the WCRB data and your own data, obviously the trends seem to be deteriorating quickly. The commissioner doesn’t seem amendable to helping out the worker comp industry. You know you have elections coming up. Do you see any relief coming from the commissioner of legislature in trying to deal with the trends that are getting up there?

Richard Gergasko

Well, it’s a difficult question. I am not a political [Indiscernible], so I think it more or less revolves around the government rates, rather than perhaps what the commissioner may or may not do.

I think the bigger concern for us would be whether a labor oriented governor might perhaps look at the world comp system and decide to take it even more with the reforms that were put through some years ago, where perhaps we are public and the governor might be a little more radicand to do much change, trying to induce the environment to be more positive for business. We are more concerned about the government turn over rates and right now I think that’s pretty much a dead heat, so it would be worth watching.

Robert Farnam - KBW

I am not even talking about trying to telling them to address the prior reforms. I am thinking about future reforms, if these trends continue to get out of control like this.

John Pasqualetto

Right exactly. I think unfortunately the open rating launch in California, does allow carriers to price. So in some cases the commissioner’s action is more of a notation than it is a directive.

While having said that, I still think they need to behave more responsibly, but we are still free to price. The big major concern would be whether the competitors understand the need to do the same or not or might be in fact not fully recognizing the trends that we recognized. We have Katrina but the governments watching that very closely.

Robert Farnam - KBW

Okay, very good. Thank you. That’s it from me.

Operator

And we have no further questions in the queue at this time. I will turn the conference back to you Mr. Pasqualetto for any closing remarks.

John Pasqualetto

Thank you. While the financial results in Q2 were difficult, they serve to set the stage for the needed focus management action to improve profitably in the future. We believe the timely recognition of current loss trend is prudent and allows us to directly reflect the new information in our pricing and also in our underwriting actions. All aim to delivering improved results in future quarters. Thank you.

Operator

And this does conclude our conference call today. We’d like to thank you for your participation.

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Source: SeaBright Holdings, Inc. Q2 2010 Earnings Call Transcript
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