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Tower Group (NASDAQ:TWGP)

Q2 2011 Earnings Call

August 09, 2011 9:00 am ET

Executives

Michael Lee - Chairman, Chief Executive Officer and President

William Hitselberger - Chief Financial Officer, Principal Accounting Officer and Senior Vice President

Analysts

Richard Mortell - Piper Jaffray Companies

Robert Paun - Sidoti & Company, LLC

Randy Binner - FBR Capital Markets & Co.

Elizabeth Malone - Wunderlich Securities Inc.

Adam Klauber - William Blair & Company L.L.C.

Operator

Good morning, ladies and gentlemen. My name is Tyrone, and I will be your conference facilitator today. At this time, I would like to welcome everyone to Tower Group's Second Quarter 2011 Earnings Conference Call. [Operator Instructions] It is now my pleasure to turn the floor over to your host, Bill Hitselberger, Executive Vice President and Chief Financial Officer. Please go ahead, sir.

William Hitselberger

Thank you, Tyrone, and good morning, everyone. Before I turn the call over to Tower Group President and CEO, Michael Lee, I would like to remind you that some of the statements that will be presented during this call will be forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Actual results could differ materially from these projected in the forward-looking statements. For more information on the risks and other factors that may affect future performance, investors should review periodic reports that are filed by the company with the SEC from time to time.

As we noted in our earnings release, in October 2010, the Financial Accounting Standards Board issued new guidance concerning the accounting for costs associated with acquiring or renewing insurance contracts. We have adopted this guidance effective January 1, 2011, and have therefore adjusted our previously issued financial information. Adoption of this guidance reduced the carrying value of our deferred acquisition costs as of December 31, 2010, by $78.7 million and Tower Group Inc.'s stockholders' equity by $42.6 million. Diluted operating earnings per share for the second quarter 2010 and for the 6 months ended June 30, 2010, were reduced by $0.06 and $0.16 per share, respectively, as a result of this change in accounting.

A replay of this call will be available on the Tower website at www.twrgrp.com. Also during the course of this call, Michael and I will be referring to slides that are available on our website in the Investor Relations section under the caption Events. Now, I'd like to turn the call over to Michael.

Michael Lee

Thank you, Bill and good morning, everyone. I'd like to thank all of you for joining us on this conference call to discuss our second quarter operating results. As described in last night's press release, we continued to see positive trends in our business during this quarter despite significant industry catastrophe losses and challenging market conditions. As shown on Page 2, our operating income increased by 15% to $26 million in the second quarter from $22.6 million during the same period last year. Our diluted operating EPS increased by 24% to $0.63 per share compared to $0.51 per share during the same period last year. As we previously announced, we experienced $4.6 million or $0.11 per share of losses from the tornado activity in Alabama and Massachusetts. The storm losses added 1.8 points to the second quarter 2011 loss ratio of the combined segments. Tower reported no severe weather losses in the second quarter of 2010. Excluding the cat losses, our second quarter 2011 net income and operating EPS would have been $30.6 million and $0.74, respectively. Our book value increased by 4% to $1.07 billion from $1.03 billion even after repurchasing $60.8 million of shares since the second quarter of last year and after making $23 million in dividend payments. Our book value per share increased by 8% this quarter from the second quarter of last year even after making $0.56 per share in dividend payments since the second quarter of 2010.

As shown on Page 3, we continue to see positive trends in our operating results as measured by growth, combined ratio and return on equity. The most significant positive factor that we are seeing is our ability to continue to grow our business profitably despite the challenging industry market conditions. Our gross premiums written and managed increased by 41% in the second quarter to $468 million from $332 million for the same period last year. This growth was driven primarily by the acquisition of the OneBeacon Personal Lines division and the organic growth from new business units, customized solutions and assumed reinsurance and risk sharing. I will provide more details on these initiatives later on this call. In addition to achieving an impressive top line growth rate, we were able to maintain our underwriting discipline as demonstrated by a 94.9% combined ratio this quarter compared to 94.5% for the same period last year. Excluding losses from the storms, our combined ratio for the quarter was 93.1%. Finally, our return on equity was 9.9% this quarter compared to 9.4% during the same period last year. Excluding the storm losses, our return on equity was 11.7%. We project our ROE to increase gradually throughout the rest of the year, mainly driven by the lower combined ratio and higher investment income.

Page 4 outlines our new organic growth strategy that we developed in the latter part of 2010. In response to challenging conditions created by the sluggish economy, competitive property and casualty market conditions and low interest rate environment, we spent most of 2010 carefully thinking about how to improve our business. We've developed and then began implementing a 2-pronged strategy to improve our existing business units and create new ones to generate profitable organic growth. For our existing business units, we decided to moderate our growth and attempted to increase the profit margin of those units. We sought to accomplish this goal by separating them into autonomous businesses, improving their efficiency through product improvement, automation and cost reduction. We believe these business units will gradually increase their profitability as we implement these initiatives throughout this year and next year. Meanwhile, to offset the lack of growth in our existing business units, we decided to allocate our capital and resources to create new business units, focus on markets with strong growth potential and higher profit margin. During the quarter, we had benefited from this strategy as reflected in our strong top line growth, generated by our customized solutions and assumed reinsurance business units. As a part of this strategy, we have substantially improved our internal business development, product development and corporate marketing capabilities to support these new organic growth initiatives. We're also focusing on talent acquisition to improve our existing business units and create new business units. We have hired or plan to hire several senior executives to execute this strategy. We have also begun to form strategic alliances with external business partners to jointly develop new products.

As outlined on Page 5, we continue to see stable performance in our commercial and personal lines segments. Our commercial business, comprised of small business and middle market business units, grew a little more than 5% to $185 million this quarter from $176 million during the same period last year. Our commercial specialty business comprised of national programs, excess and surplus and the 2 new business units, customized solutions and assumed reinsurance, grew approximately 26%. Our commercial lines business segment continued to show strength as reflected by a 77.4% retention rate and positive renewal change of 1.3% with a 93.8% combined ratio.

In our small and middle market business units, we're continuing to focus on improving our profit margin by improving our automation capability and enhancing our products to strengthen our competitive position. In our commercial specialty area, we have completed our reunderwriting our program business from program underwriting agents, retaining only those programs in specialty markets less vulnerable to competition. As I will further discuss later, we're also encouraged by the growth that we're seeing in the 2 new business units. In our personal lines segment, we also tripled the $52 million that we wrote in the second quarter of 2010 to $152 million this quarter as a result of the OneBeacon Personal Lines acquisition that we completed in July of last year. Our combined ratio was 97.1%, driven by the storm losses, which added to the personal lines combined ratio and the higher expense ratio spending from the payments that we're making to OneBeacon to utilize their system to process this business. We're making good progress in building our new technology platform to replace OneBeacon's legacy system and expect to begin utilizing our new system early next year. In our insurance segment, we generated $7.6 million in fee income from managing the reciprocals. We are planning to expand the licensing of the reciprocals beyond New York and New Jersey to increase our fee income.

Page 6 provides details on our customized solutions business units. This unit is different from our national programs unit that focuses on underwriting program business from program underwriting agents. The customized solutions units focuses on developing new products or programs from retail and wholesale agents, using our internal staff to perform most of the underwriting product design and servicing rather than outsourcing those functions to program underwriting agents. While the industry continues to be soft in many market segments, we believe many agents are hungry for new product ideas and customization to compete effectively in the marketplace. So we think we're filling a void in the marketplace, and as a result, we're seeing growing opportunities using this concept. During the quarter, we generated $11 million in our customized solutions business unit and $24 million to date.

As indicated on Page 7, we're seeing significant growth opportunities in the reinsurance and risk-sharing business unit due to the favorable pricing trend in the reinsurance market after the significant industry catastrophe losses suffered during the first half of this year. As discussed during the last earnings call, our strategy in this area is to opportunistically shift our underwriting capacity into markets with favorable pricing trends and support underwriting organizations with superior track records. This allows us to avoid the start-up cost of entering into these markets on our own as a primary insurance company. We're maintaining proper underwriting controls and mitigating the risks by supporting only a few underwriters of catastrophe-exposed property business whose philosophy is to afford coverage at loss levels triggered only by significant industry losses. We're also limiting the maximum loss on any one event to an amount equivalent to what we would normally experience in a winter storm in our primary business. So we do not believe we're materially increasing our risk to catastrophe losses as a result of our entering into this business.

In addition, we rigorously monitor accumulations, imposing appropriate probable maximum loss limits in any one single geographical region. All of our assumed reinsurance business, whether catastrophe exposed or not, undergoes thorough research and due diligence performed by an extremely seasoned reinsurance executive. We're very pleased with the progress we have made this quarter, successfully participating on covers for several reinsurers and Lloyd's syndicates. Based on this progress, we established the reinsurance and risk-sharing practice as a separate business unit. We generated approximately $30 million of annualized writings from this business unit during the first 6 months of this year and expect strong growth for the balance of the year. We believe our entry in this market was opportunistic and well timed and expect it to improve our risk-adjusted return on our overall business.

Turning to Page 8. I would like to provide more color on what we are seeing in the acquisitions and strategic investments area. From an acquisitions standpoint, we are continuing to see a robust pipeline of acquisition opportunity. Many companies faced with difficult market conditions are now seeking to exit from the marketplace through a sales process. Given our revamped organic growth strategy and after having made several acquisitions over the last few years, our strategy in this area has become more selective and focused. We're looking to make acquisitions to increase the scale of our existing business units as well as to enter into specialty markets less vulnerable to competition. We're also continuing to evaluate opportunities to make strategic investments in distribution sources and underwriting managers to expand into specialty classes of business that are less vulnerable to pricing competition and to properly align our interest with these potential partners. Now I will turn the call over to Bill to provide additional financial highlights. Bill?

William Hitselberger

Thank you, Michael. Slide 9 details our loss ratios for the quarter and 6-month periods ended June 30, 2011. Since we began public reporting in 2004, Tower has recorded modest, favorable accident-year development. Through June 30, 2011, our consolidated reserve developed favorably by $3.2 million in large part because of favorable development in personal automobile business in both the stock companies and our reciprocal exchanges. In the first half of 2011, we reported $7.6 million of adverse of prior year development in our stock companies. However, this development included $6.1 million from winter storm losses incurred during the last week of 2010 and $3.3 million from a partial settlement that we reached with one of our reinsurers in the second quarter. Now to discuss our loss reserve position for year-to-date June 2011, let me discuss the second quarter loss experience. The consolidated net loss ratio was 61.2% in the second quarter of 2011, up from 58.6% in the second quarter of 2010. The second quarter 2011 net loss ratio was impacted by 1.8 points from claims related to tornado events and by 80 basis points from the partial settlement of the reinsurance dispute. Absent these events, our loss ratio was relatively flat in the second quarter 2011 compared to the second quarter of 2010. We have increased our 2011 loss ratio for the severe storms and tornadoes that occurred in the first half of the year. We believe our recent accident year loss ratios fully reflect the current business mix and the pricing environment and are fully adequate. Even with the increased loss ratio and without the benefit of the reserve releases that other companies may be using to offset deteriorating accident year loss results, we are continuing to significantly outperform most of our peers.

Page 10 of the presentation details our expense ratio for the stock companies for the second quarter and year-to-date 2011 as compared to the same periods in 2010. Consolidated operating expenses were $69.7 million and $136.1 million for the 3 and 6 months ended June 30, 2011, increases of 40% and 35% from the same periods in 2010, respectively. While operating expenses for stock company were $54.7 million and $107.8 million for the quarter in year-to-date periods ended June 30, 2011, an increase of 12% and 9% from the same periods in 2010, respectively. The main driver of the aggregate increase was costs associated with the acquisition of OneBeacon Personal Lines business. In addition, the company has incurred costs through the first 6 months of 2011 under the transition services agreement with OneBeacon. These transition costs are for moving the personal lines technology platform from a mainframe environment to Tower's server environment. As Michael mentioned, we are making good progress on this initiative. The net commission portion of the expense ratio was 17.8% and 17.7% for the quarter and 6 months ended June 30, 2011, respectively, slightly down compared to 18.4% and 18.1% for the same period since 2010 as we continue to see an increase in business flow from retail agents. Our board's, bureaus and taxes are down 60 and 100 basis points to 3.9% and 3.7% for the second quarter and year-to-date 2011, respectively, due to higher workers' compensation assessments recorded in 2010. The other underwriting expense component of the ratio was 11.3% and 11.5% in the second quarter and year-to-date 2011, respectively, improved from the same periods in 2010, largely attributable to economies of scale from earned premium growth in 2011. The organic growth initiatives that Michael mentioned earlier should lead to increased growth in earned premiums over the balance of the year, and we expect to see a reduction in our other underwriting expense ratio throughout the remainder of 2011 from the increase in scale.

The Slide 11 details. In the second quarter of 2011, our invested asset base was $2.6 billion, comparable year end. Average invested assets increased $535 million during the second quarter of 2011, up over 25% from second quarter of 2010, primarily from $365 million of net invested assets acquired from the OneBeacon Personal Lines acquisition and from operating cash flows of $150 million generated during 2010. The significant increase in invested assets has been deployed in a period of depressed new money rates and has reduced our tax equivalent investment yield from 5.2% at second quarter 2010 to 4.7% at second quarter 2011. The lower yield at the end of the year is the result of the significant increase in investable assets combined with the lower interest rate environment. Tower's rate of growth in invested assets over the past year has led to a decline in tax equivalent yields that we believe is beyond that of the industry. We have seen a flattening of tax adjusted book yields since year end, which is a result of deployment of investment assets into higher-yield corporate securities. We have also been deploying funds into dividend-paying equity securities, which we believe will improve our tax equivalent portfolio yield. We have made some alternative investments in real estate in 2011 and expect that these investments will help our yield over the remainder of the year. We are continuing to look at real estate and private investments as alternative asset classes to enhance our investment returns. Despite the decrease in tax equivalent yields, our net investment income increased by 33% from second quarter 2010. We expect that the actions we are taking in different asset classes will allow for our tax equivalent yields to start improving.

In summary, after declining yields for the past few years due to the deployment of a significant amount of new money at low rates, we are beginning to see stabilizing fixed income yields and an upward movement in our total portfolio investment yield into our revised asset allocation and alternative investment strategy.

Page 12 of the presentation provides additional information regarding the impact of the accounting change that we made regarding deferred acquisition costs and how this change affected our 2010 reported numbers. As a reminder, the impact of this accounting change will be mandated for our industry by the end of 2011, and we believe that the effect of the accounting change will be more significant for companies such as Tower that have been growing their books of business. While our operating results were adversely affected by our early adoption of the rules on deferred acquisition costs this year, we are now in a position to enter 2012 having this issue behind us. We reduced our year end 2010 book value per share by $1.03 as a result of adopting this guidance. And as I mentioned earlier, reduced the second quarter 2010 operating results by $0.06 to reflect the consistent presentation with 2011. As this exhibit details, our operating earnings in 2010 restated for the effect of the accounting change, are $2.23 per share, and we expect our growth rate in operating earnings in 2011 based upon our current guidance, to be about 20% year-over-year. As you can see, adjusting for the effects of the change in accounting, the growth rate in operating earnings continues to be strong.

On Page 13, I will conclude by summarizing our second quarter results. During the quarter, we continued to profitably grow our business, benefiting from the OneBeacon Personal Lines acquisition as well as organic growth initiatives. We expect our operating results for the second half of the year to continue to improve as we leverage our expenses with higher premium volume resulting from the new growth initiatives and realize a lower loss ratio than we did in the first half of the year. We expect our investment income to be strong throughout the year. Despite the storm losses that we experienced during the second quarter of this year, which totaled $0.11 per share, we are maintaining our guidance of $2.70 to $2.90 per share, although it will be at the lower end of this guidance. Overall, we are pleased with our progress in executing our advanced business strategy to generate organic growth in profitable specialty markets while improving profitability in our existing commercial and personal lines units. We are also encouraged by the opportunities we are seeing in the acquisitions market. So with that, I'd like to open the lines for any questions. And Tyrone, if you would, please open the lines.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question is from Randy Binner of FBR Capital Markets.

Randy Binner - FBR Capital Markets & Co.

I guess the first one is on the new assumed reinsurance business or kind of more severity-exposed business. And you indicated in the slide deck that you have to have a major event there to really affect your results given the reinsurance you've put in place, but I was hoping to get a little more color on that, kind of size of event and geography just because the guidance affirmation for the year relies on a better loss ratio. So as we watch the hurricanes come in this summer, just wondering what kind of storm we will think that will be large enough or located in a geography enough that would impact Tower.

Michael Lee

Okay. Well, first of all, I want to point out that the assumed reinsurance book is probably around $20 million to $25 million out of probably, this year, we're expecting about $1.8 billion in premium volumes. So we're looking at a very small book of business. So it's calibrated to probably affect both either positively or negatively by about 1% to 1.5% on the loss ratio. So let's not -- if we gave you the impression that it's a lot more than that, we probably didn't do a good job in presenting this -- the catastrophe business that we have entered into. And the primary reason for doing that is to reduce our seeded reinsurance costs, which is about in excess of $80 million. So we're primarily in the Northeast. Our cat exposure is in the Northeast, and we want to offset our reinsurance costs by taking assumed reinsurance in other parts of the world. So we're not increasing our exposure in the Northeast, and we're taking -- assuming reinsurance in other parts of the country and throughout the world at upper layers. And in the event that we do experience a major catastrophe event that probably is in excess of, depending on where we are, let's say, $30 billion, $40 billion or $50 billion, then we'd be exposed to about $20 million or $25 million or so, which is pretty much what we would experience in our primary business should we suffer some type of storm losses. So we've had storm losses and our base of premium, large base of premium, can absorb these losses without affecting our results. So we think that we're making prudent bets or getting into these areas in a very, very careful and prudent way in order to, first, reduce our ceded reinsurance costs and to spread our risk from the Northeast to other parts of the world. And in that way, we think we will achieve a better risk-adjusted return for our overall business. However, we do not think we're changing the risk profile of our business, and I don't think that we're exposed to any cat losses in a way other companies would be, that other companies are exposed to by participating as a catastrophe reinsurer or as a primary insurance company focusing on writing catastrophe business. We're still maintaining our strategy of being a primary company focused on producing stable and steady returns.

Randy Binner - FBR Capital Markets & Co.

That's very helpful, and just one other one if I could on the reinsurance dispute that added 80 basis points on the loss ratio. Could you -- is there any detail you can provide on that and should we -- can we assume that that's resolved, or could that be something that lingers?

Michael Lee

We have a dispute that, probably, if worse comes to worse, would probably add another $3 million. We think it's a small dispute, but we did make some payment to progress as far as that dispute is concerned. So we don't think this is a major issue, but it did come up during the quarter. So maximum sort of a potential -- additional loss that we can suffer is about $3 million or so.

William Hitselberger

And Randy, it's Bill, and I know that you just came on to the story. We've been disclosing this in our 10-Q. We will be filing the 10-Q tonight, and you'll see an update in our disclosure on this.

Operator

Our next question is from Beth Malone of Wunderlich Securities.

Elizabeth Malone - Wunderlich Securities Inc.

A couple of questions. On the reciprocals, you're seeking licensing in other states. Would there be any impediment, or is that just a regulatory process you have to go through?

Michael Lee

We have recently made a decision to sell one of our stock companies that has licensing in many other states other than New York and New Jersey. So by the reciprocals acquiring this company for a nominal price, it will be able to expand its licensing throughout the Northeast as well as some other states. And our strategy here is to provide additional capacity in other states. We like the reciprocal model. We like generating fee income and not to increase our cat exposure in regions where we have already a strong presence. So by introducing the reciprocals into these states, we'll be able to add additional capacity as well as generate additional fee income.

Elizabeth Malone - Wunderlich Securities Inc.

And then on the reinsurance, that's not being -- is that sold through the Bermuda -- do you still have a Bermuda subsidiary that you can access from a tax benefit or is that gone now?

William Hitselberger

It's gone now, I'm sorry. We still own CPRe, which is our Bermuda subsidiary, but that company, because of the tax election we made is fully taxed as a U.S. subsidiary. So we'll run most of this reinsurance business through our domestic pool.

Elizabeth Malone - Wunderlich Securities Inc.

Okay, so there's no difference there. Okay. And then on the...

William Hitselberger

[indiscernible].

Elizabeth Malone - Wunderlich Securities Inc.

When you're talking about the expense ratio and this chart, which is helpful, it illustrates that the OneBeacon, I guess -- or the BB&T expenses declined meaningfully year-over-year. In terms of OneBeacon, are we -- I don't know that that's not the same thing, but are you on track for where you thought you would be in terms of that got delayed a bit because of the conversion? Is that still on the same timeline you had anticipated when you updated us at the beginning of the year?

Michael Lee

We are making progress, but what we decided to do, and I think I mentioned this in one of my calls, was to delay the implementation to be able to use this particular situation where we're developing a new system and to include other lines of business as well as well as other functionalities such as improvement of claims as well as billing and agency management systems, so it's not only the OneBeacon system that we're replacing, but we're using the opportunity to improve our capabilities in other functional areas. And as a result of that, we are -- we have decided to push out the timetable for getting off of OneBeacon system. I think we could have probably focused on just getting off that system, but we thought it would be prudent to use the opportunity along with the system conversion to improve our other functional areas, and this ties with our 2-pronged strategy that I've outlined of trying to make our existing business units a lot more efficient, and we are undergoing significant systems conversion as well as making significant investment right now because we think that in order to improve the profitability of our existing business units that we have to make additional investment in technology. I think we're one of the few companies that are making significant investments at this time. And I think this will push the timetable getting off of the OneBeacon system until probably at the end of 2012, but we have factored that into our projections, and we don't think it will have any adverse impact on what we're seeking to achieve in terms of financial performance in 2011 and 2012.

Operator

The next question is from Richard Mortell of Piper Jaffray.

Richard Mortell - Piper Jaffray Companies

First question is on the investment side. How much is the move to alternative impact the yield all else equal? And how quick does that phase in?

William Hitselberger

I'm sorry, Richard. All else equal, it's going to mean a very minimal amount of basis points in 2011. To date, we've probably deployed let's say about $20 million, $25 million into alternative investments. And we believe that those investments on average should generate about 600 or 700 basis points of our performance relative to fixed income investments. Given that small size, it's not going to really move the needle too much, and the deployment of them has actually been occurring into the second quarter. So the impact is relatively minimal for this year. We expect to see slightly bigger amount committed in 2012, and we think that will have a bigger impact on our performance.

Richard Mortell - Piper Jaffray Companies

Okay, and if you're looking at what your, I guess, your guideline right now, where do you expect to ramp it up to, ultimately? Is it predicated on the environment, or is there a target that you want to get to?

William Hitselberger

Well, I think that we -- the discussions we've had in our valuations, we would be reluctant to increase any alternative commitment beyond about 5% of the investment portfolio.

Michael Lee

And let me just add to what Bill said. This is Michael. You have to understand that we've had a fairly conservative investment philosophy, and we don't have too much allocation to equities. So private investments or alternative investment is really taking the -- really replacing -- or it's pretty much doing what other companies are doing by allocating certain portion of their investment portfolio to equities. We just -- while we made investment in the equities market, we think that allocating a certain percentage of portfolio to alternative investments, especially private equity investment, suits what we're trying to accomplish. So in summary, I think, overall, what we're trying to do is to get the high yield on our investment, but the way we're doing that is not to go into equities but into private investments. So overall, I think whether it's alternative investments or investment into equities, probably we'll-- overall, we'll probably limit our allocation to those types of investment to not more than 10% of our overall investment and maintain a fairly conservative portfolio for the remainder -- remaining amount of our portfolio.

Richard Mortell - Piper Jaffray Companies

Okay, that makes sense. And then more generally, you talked a lot about the M&A environment, and you're seeing a strong pipeline. What do you guys think in terms of how competitive bidding is getting for the assets that are out there?

Michael Lee

I don't think it's getting competitive. Quite frankly, I think the valuation is very good right now, mainly because most companies are facing significant challenges. As a result, they're not generating much earnings and as a result, the valuation is down. Also, because of the challenging market conditions, you're seeing a higher combined ratio and some concerns about balance sheet issues. So therefore, those types of distress on these companies are allowing us to look at these companies at a much more reasonable valuation than we have seen in the past, but as I mentioned during the presentation, our strategy has become more selective and focused, mainly because we're seeing alternatives, better alternatives in acquiring teams of underwriters as well as using our internal staff to create new products and enter into new markets. We're starting to see a lot of opportunities in those areas, and we think that we can generate growth without making acquisitions. But we still believe acquisitions is the right way to go in this marketplace. But now, we have organic growth as well as acquisitions to fuel our growth.

Richard Mortell - Piper Jaffray Companies

So if we look at it from -- going from the first quarter to this quarter, there's more of a focus on the organic initiatives, starting to see more on that front?

Michael Lee

Yes. I mean, I think one of the things that we highlighted was the emphasis that we're making to creating new business units and the success of the 2 business units that we've created, and we're going to keep focus -- we're going to keep on focusing on that initiative while improving the profitability of our existing business units. So I think you can expect that to happen, and we're committed to that strategy and then to be more selective and cautious with respect to acquisitions that we're making. But I think we are seeing opportunities on the acquisition front, and we are still committed to making those acquisitions if it matches the criteria that we have set up for making those acquisitions.

Operator

Our next question is from Adam Klauber of William Blair.

Adam Klauber - William Blair & Company L.L.C.

With your guidance at the end of the year, does that assume the expense ratio improves from the first 6 months to the second 6 months?

William Hitselberger

Yes, Adam. What -- it assumes that the absolute dollar growth continues, which has been relatively modest in the stock companies. But the growth will be outpaced by the growth in our premium, so the ratio should decline.

Adam Klauber - William Blair & Company L.L.C.

Okay, that's helpful. And then you mentioned development for the 6 months. What was it for the second quarter? Was there development either way?

William Hitselberger

The second quarter development -- well, year-to-date, it was favorable in aggregate and modestly adverse in the stock companies. For the second quarter, what we had is the stock companies had about $0.5 million of adverse development -- I'm sorry, favorable development. [Indiscernible] very modest movement, yes.

Adam Klauber - William Blair & Company L.L.C.

Okay. So it looks like your non-cat loss ratio is running close to 59.5%. How did that compare to last year?

William Hitselberger

Well, it's like -- in the second quarter last year, Adam, the commercials that -- well, absolute basis, it's about flat year-over-year on a quarter. What you'll see is movements between the 2 segments in the quarter, and that's due to more in 2010. What we did is we had -- we had recorded the storm loss in the first quarter in terms of closing the book on personal lines, and we trued that up in the second quarter. And what that had -- what that did is it increased the loss ratio in our commercial segment in the second quarter, decreased it in the personal lines segment. The year-to-date numbers are right on and the year-to-date numbers in aggregate are basically flat year-over-year relative to what we're seeing in 2011.

Adam Klauber - William Blair & Company L.L.C.

Okay. Another question is with the loss ratio, again, there's some movements back-and-forth, but it's seemingly relatively flat. What are the underlying loss trends in commercial and personal lines? Are they also flat? Because pricing is -- if you could just address that, that would be helpful.

Michael Lee

Sure. This is Michael. I think it was in the fourth quarter of 2009 we decided to increase our -- the pricing -- I'm sorry, increased our loss tick going forward starting in 2010 to about 60%, 61%. Prior to that, our accident year loss ratio is showing, I believe was around 55% or 56%. So we increased our loss tick by almost 4%, 5%, and we put a ring fence around 2009 in prior accident years, and we've been very cautious with the potential adverse development. And the way that we have addressed that is to cut our claims expenses, and we've been very successful in reducing our claims expenses, bringing a lot of legal work in-house as well as reducing our overall claims expenses. And fast forward, I guess, a little more than 1.5 years and we're seeing the 2009 and prior-accident years holding up very well, and our decision to increase the loss tick to about 60%, 61% has been, I think, very, very prudent because of the changing business mix. And because of the pricing environment, we think that, that decision was very prudent. So you have to remember that we've already been conservative, and we have factored in the pricing trends as well as change in business mix and also have reserved for cat losses at the beginning of the year. That's how come we're not really taking down the guidance, and we've been a lot more conservative. And we did that in the fourth quarter of 2009, I believe. And as a result of that, we think that we're very well positioned, and we believe that we're doing everything that our company should do when -- at this particular phase in the market cycle where you see deteriorating underwriting results. So we think that we've already made that adjustment, and we think we're moving beyond that. So we think that we're very well positioned going forward. And in addition to that, we are also not growing in competitive market segments, and we're rotating and shifting our capacity into markets that we believe has better pricing trends. For example, we moved into reinsurance sector, and we're seeing positive pricing increase across all the clients that we're reinsuring. So we think that we're rotating very effectively our capital into market segments with much better pricing and profit margins. And for those reasons, we think that we're seeing stability, and we think that we will continue to see our loss ratio between about 60% to 62% depending on the cat losses. But the catastrophe losses should not add more than 1% to 1.5% to our overall loss ratio. So we think we have very stable book of business anchored by very, very good, solid renewable book of business that we have developed over 20 years, as well as acquired those renewable books of business from various companies that we acquired throughout -- during the last 2 years. So what we have is a very seasoned renewable book of business that's producing very good loss ratio for us, and I think as I mentioned, going forward, we think that it's going to be very stable because of the actions that we've taken since the fourth quarter of 2009.

Adam Klauber - William Blair & Company L.L.C.

Great. And one follow-up question. Now we're -- we've seen a fair amount of weather losses in the Northeast for several years now. Are you seeing some of the larger competitors in the personal lines area being more conservative or pulling back, significantly raising prices in the homeowners areas, homeowners products?

Michael Lee

Yes. I mean, there's definitely going to be companies exiting from the marketplace, especially in the Northeast, as well as other parts of the country. But I don't think you can really push the pricing up too much given the economy and the sluggish real estate industry. And for that reason, I think what companies will do is not to -- I mean, I think they will push the rates up, but they're going to probably exit from the marketplace, and we've seen that, especially the larger personal lines carriers that are focusing on writing primarily auto, personal auto, passenger auto, and they're really joint venturing with other companies to write homeowners for them. So I think there's going to be continuing pressure in the homeowners lines of business, but we've always been prudent. We've always focused on writing homeowners business in areas that are not prone to frequency in terms of catastrophe losses. So our results are fairly good in homeowners mainly because of our focus on states that are less prone to catastrophe losses. That's how come we limited the amount of cat loss -- catastrophe losses during the first and the second quarter. So we're going to continue with that strategy and grow our homeowners and property book of business, but we're not going to be in volatile states with volatile catastrophe activity. And we're going to focus on the Northeast as well as the West Coast where we see some stability from a loss ratio standpoint.

Operator

We have a follow-up from Beth Malone of Wunderlich Securities.

Elizabeth Malone - Wunderlich Securities Inc.

Okay. Just, again, on the acquisition outlook, do you see yourselves looking at businesses outside the insurance space?

Michael Lee

I don't think so, but I do think that we will look at making strategic investments to help our capabilities in areas that we think that we could -- it would be helpful to bring in a strategic partner such as in asset management area or to make strategic investments in other underwriting managers, whether it be Lloyd's syndicate or other underwriting agents that focuses on specialty business that we want to get into. So I think our investments are going to be in our core business. But from time to time, if we see that we could be successful in going outside of that area, we'll make a strategic investment and -- rather than directly owning another business in a different industry. So I think to answer your question, we may go outside the industry, but we would do so as a strategic investment rather than a direct investment and get into that business as an operator.

Elizabeth Malone - Wunderlich Securities Inc.

Okay. And then on the real estate, is that part -- do you consider that part of the alternative investment pool that you have, or is that something separate?

William Hitselberger

Yes, yes, we consider the investments in real estate to be part of our alternative structures.

Elizabeth Malone - Wunderlich Securities Inc.

So in total, that would not be greater than 5% of invested assets?

William Hitselberger

That's correct.

Operator

Our next question is from Robert Paun of Sidoti & Company.

Robert Paun - Sidoti & Company, LLC

I just had a question on the workers' comp business. Can you just talk a little bit more on how that business is performing? There's been a lot of discussion on increasing loss frequency and severity trends. What's your experience been in recent quarters, say, compared to about a year ago?

Michael Lee

We're -- our rates are going up in California and other areas in New York, but I want to highlight the fact that we have a totally different strategy. We've been in the workers comp business for 15 years, writing low hazard classes of business, small policies, guaranteed cost policies. So we're not in hazardous classes of business like construction or large policies where pricing is deteriorating. So what you're hearing is really about deterioration and the results for those carriers that focuses on large policies where the pricing competition is fairly significant and where the claims trends are deteriorating because a lot of these carriers are in very hazardous classes of business where you're seeing severe accidents. So all that -- what that does is increases the claims activity and also the medical inflation does impact those classes of business because you have workers that are injured severely, and as a result, the health cost associated with taking care of those employees are going up. What we're seeing in our business is pricing integrity as well as the type of claims that would not cause us concern. What we're seeing is slip-and-falls, cuts and burns and as a result of that, we're not seeing those factors that are adversely affecting workers' comp business affecting us. So just to summarize, we are seeing rate increases across-the-board. Our results have been very good, probably about 15%, 20%, historically better than the industry average, and we are focusing on classes of business that we think generates very good results because we're focusing on very low hazard classes of business. And regardless of what you may be hearing, our strategy has focused on very -- on a niche market that has performed historically very well. But we've heard this throughout our history sort of the gloom and doom that's associated with this business, sort of coloring the judgment on our book of business, and I don't think that's the case. If anything, I think the pricing trends are favorable in the markets that we're in, and we're getting rate increases. But you're talking about the underlying results being good to begin with along with rate increases helping our results, which is already about 15%, 20% better than the industry average. So I don't think that we will be expanding our workers' comp business. But at the same time, we see this book of business probably performing better, mainly because it's one of the few lines of business where we're seeing rate increases.

Operator

Thank you ladies and gentlemen. This ends the Q&A portion of today's conference. I'd like to turn the call over to management for any closing remarks.

Michael Lee

Well, thank you, everyone, for participating on this call and we look forward to getting together with you next quarter. Thank you very much.

Operator

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program. You may now disconnect and have a wonderful day.

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