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RLI Corp. (NYSE:RLI)

Q3 2007 Earnings Call

October 17, 2007 11:00 am ET

Executives

John Robison - RLI Treasurer

Jonathan Michael - President and CEO

Joseph Dondanville - Senior VicePresident and Chief Financial Officer

Michael J. Stone - President,COO, RLI & Mt. Hawley Insurance Companies

Analysts

Bijan Moazami - Friedman,Billings, Ramsey & Co.

Charles B. Gates - Credit Suisse

Douglas Mewhirter - Ferris,Baker, Watts

Meyer Shields - Stifel Nicolaus& Company, Inc.

Michael Grasher - Piper Jaffray

Ron Bobbin - Capital Returns

Thomas Cholnoky - Goldman Sachs

Kenneth Billingsley - Signal HillCapital Group LLC

Operator

Good morning and welcome ladiesand gentlemen to the RLI Corp third quarter earnings teleconference call. At this time we would like to inform you thatthis conference is being recorded and that all participants are in listen onlymode. At the request of the company we will open the conference up forquestions and answers after the presentation.

Before we get started let meremind you, everyone that through the course of the teleconference RLImanagement may make comments that reflect their intentions, beliefs andexpectations for the future. As always these forward looking statements aresubject to certain risk factors which could cause actual results to differmaterially. These risk factors are listed in the company’s various SEC filingsincluding the annual form 10K which should be reviewed carefully.

The company has filed a form 8Kwith the Securities and Exchange Commission that contains the press releaseannouncing third quarter results. RLI management may make reference during thecall to operating earnings and earnings per share from operations which arenon-GAAP measures of financial results. RLI operating earnings and earnings pershare from operations consist of net earnings after the elimination of aftertax realized investments, gains or losses. RLI’s management believes that thismeasure is useful in gauging core operating performance across reporting periods.They may not be comparable to other companies’ definitions of operatingearnings. The form 8K contains reconciliations between operating earnings andnet earnings.

The form 8K and press release areavailable at the company’s website at www. Rlicorp.com. Again, at the requestof the company we will open the conference up for questions and answersfollowing the presentation. I will now turn the conference over to RLI’streasurer Mr. John Robison. Please go ahead sir.

John Robison

Thank you, good morning toeveryone. Welcome to the RLI earnings teleconference for the third quarter of2007. Joining me for today’s call are John Michael, President and CEO of RLICorp., Joe Dondanville, Senior Vice President and Chief Financial Officer andMike Stone, President and Chief Operating Officer of RLI Insurance Company.

We will conduct this call as wehave in past quarters. I will give a brief review of the financial highlightsand then Mike Stone will talk about the quarter’s operations. We’ll then openthe call up for questions and John Michael will finish up with some closingcomments.

I’m pleased to report recordthird quarter operating earnings of $59.1 million or $2.46 per share. Thecombined ratio for the third quarter was 50.6. Included in the results thisquarter was favorable loss development on prior year’s reserves of $48.5million or $1.31 per share. The company periodically reviews its loss reservesestimates and underlying actuarial reserving methodologies in order to assesstheir accuracy and suitability and to benchmark its reserving practices againstindustry best practices.

As disclosed in last quarters 10Qand our 2006 10K annual report the company has performed in the current quartera more detailed round up analysis of the actuarial estimation risks associatedwith each of its products and segments including consultation with externalconsultants and assessment of industry information.

Our analysis revealed that thecompany’s quarterly actuarial reserve estimates over recent historical periodshave shown a downward trend as a result of moderating loss trend environment,improvements in policy terms and conditions and a favorable underlying exposuremix that occurred during the hard market period from 2001 through 2004. Theimpact was most evident in our casualty and surety segments. Based on thesefactors and analysis including the current consideration of such underlyingtrends in the actuarial estimates, the result is $48.5 million pretax favorabledevelopment on prior year’s loss reserves net of bonus and profit share inrelated expenses.

Whilst reserve estimates aresubject to a high degree of variability, due to the inherent uncertainty ofultimate settlement values, periodic adjustments to these settlements may occuras the actual emergence of losses reveals itself over time. The companybelieves its enhanced loss reserving processes reflect industry best practicesand its methodologies continue to result in an appropriate best estimate ofnecessary reserve levels.

Turning to investments. Investmentincome grew 11.6% to $20.4 million this quarter. There were no significantchanges to asset allocation from the previous quarter. Our fixed incomeportfolio has a duration of approximately 4.5 years and maintains a AAA overallquality rating. Our equity investment in Maui Jim contributed $2 millio9n ofpretax income for the quarter. I’m pleased to report an update on the CMClitigation this quarter. We reached a (inaudible) with another bank. This settlement was withinour expectations and the remaining exposure on litigation is approximately 17%of the original bond penalty.

Turning to our share repurchaseprogram. During the quarter we repurchased 547,100 shares of RLI stock at anaverage cost of $58.52 or $32 million.

For the operations highlight, Iwill now turn the call over to Mike Stone. Mike.

Mike Stone

Thanks John. Good morningeveryone, another excellent quarter. Our discipline underwriters producedsuperior results in a difficult environment. We’re an underwriting company, weexpect to thrive not just survive in this market as well as our own markets.

The market is soft, casualtyrates down 12-15%, property rates off 15-20%. However we are coming off a veryrobust pricing in prior years, still nice margins though they are now undersome pressure. Our model rewards profits, our underwriters will continue toselect risks on the basis of profitability opportunity and not on volumebecause we don’t have any volume targets here. While gross premium is down youwould expect, especially a company with significant ENS presence, to be off inthis kind of marketplace.

I’ll talk a little bit about thesegments. In the casualty, I'll talk about a few products here. Our generalliability product, our primary liability exposures which have been our growthengine in the recent past, gross written premiums are off 8% for the year and9% for the quarter with rates off 11% in the year and 13% for the quarter.Still producing solidly profitable results. We would expect this area to stabilizein the coming quarters but it has been under pressure for the last couple ofquarters.

Our executive products group,D&O and E&O gross written premiums off 16% year-to-date, 25% for thequarter and rates under pressure at 14% down for the year and 15% down for thequarter. Much more competition here. And you’ll see that we will give up sharewhere rates don’t allow adequate returns.

Our personal umbrella product,the bright lights in this marketplace are standalone personal umbrella. Postwritten premiums are up 5% and we also had a rate increase of about 4%. Itcontinues to grow this product as we foster our relationship with the big IBA,the big trade association for agents and provide umbrella for other companieswho don’t have this expertise. We will expect to see this product continue togrow in coming quarters.

Transportation, our truck and busoperation, post written premiums are off 16% for the year and 25% for thequarter. Rates down 5% on the quarter, 3% year-to-date. Again we are sacrificingshare here as this market softens significantly. We also expect thismarketplace to be the first to firm, the earliest to firm as it’s a fairlyshort tail for a casualty line.

Overall casualty, markets aretough. We’ll remain disciplined as we continue to select on the basis of profitand we’ll look for new opportunities as they come forward.

On the property segment, grosswritten premiums off 14% for the quarter 11% for the year. Talk about the CATbusiness first. Price levels off 30% from 1/1 where roughly reached their peak.Wind peaked a little bit earlier in probably September of last year andyear-over-year when renewals were off about 25% on a rate basis. Earthquakepeaked around January 1st and year-over-year rate levels arebasically flat because we are not yet to the peak. The pricing has stabilizedover the last couple of months and probably because we’re in the hurricaneseason, given however it has been a benign hurricane season I don’t expectrates to recover to prior levels any time to soon.

Our EMSfire business rates off about 15%, gross written premium off 30%. Remember thatwe underwrote our habitational business that was providing a number of lossesin prior quarters and that’s driven our gross written premium down but it’salso driven our loss activity down.

We lost RLI RE, a facultativeproperty operation in the third quarter. We’re up and running and expectproduction to accelerate in the fourth quarter.

Our marine business continuing tobuild this out. Gross written premium up 40% in the quarter. We’ve writtenabout $30 million plus year-to-date. They’re executing on their business plan.We’re expecting this to be a profitable $75-100 million worth of gross writtenpremium business in the next few years.

Surety. Goods Stores grosswritten premiums up 6% for the year. Our energy, miscellaneous and commercialproducts continue to grow nicely. Our contract business lags but we’ve addedunderwriters during 07 and expect to begin growing this in the coming quarters.Surety combined ratio 33 in the quarter, 60 year-to-date. I would say verysignificant improvement from just a couple of years ago.

Overall, a tough marketplace. Allproducts where disciplined underwriters will find new opportunities, newproducts and find ways to continue tooutperform in our current businesses. That’s basically our commentary on themarket. Back to you John.

John Robison

Thank you Mike. We will now openthe call up to questions.

Question-and-Answer Session

Operator

Thank you sir. Thequestion-and-answer session will begin at this time. (Operator Instructions).And our first question comes from Bijan Moazami.

Bijan Moazami - Friedman,Billings, Ramsey & Co.

Good morning everyone. A numberof questions. When you say 12-15% rate decline on casualty is that new orrenewal business?

Mike Stone

That’s on renewal business but wedon’t see much better rate activity on new business.

Bijan Moazami - Friedman,Billings, Ramsey & Co.

Are you concerned that (inaudible)wants to expand their market share in the US because obviously as thereinsurance capacity will become more available do you believe that there isgoing to be more rating pressure going forward?

Mike Stone

Its Mike Stone again. Obviouslythey were a competitor to begin with now they are tied with a partner of oursand I think that’s just another signal that the market’s anything but firmright now. You know they paid a fairly rich price for this asset so we’ll see.

Bijan Moazami - Friedman,Billings, Ramsey & Co.

Mike finally, are you seeing anykind of totally irrational behaviour? Is there any of your products linesthat’s just not having the appropriate rates of return at this point?

Mike Stone

Bijan I think that some of theproperty businesses is getting pretty difficult and we still think we’re makinga profit in all of our products but certainly the property segment seems to bedropping quickly.

Transportation is also fairlydifficult. Again I think that these are two that will firm back up quickly aspeople recognize that where their pricing their product.

Bijan Moazami - Friedman,Billings, Ramsey & Co.

Is there anything in particularthat happened in the quarter that led to the prices dropping so much more nowas compared to the quarter (inaudible)?

Mike Stone

Bijan it’s been a decline, a decayover the last number of quarters. It seemed to be accelerated a bit lastquarter and it didn’t improve this quarter.

Bijan Moazami - Friedman,Billings, Ramsey & Co.

Thank you so much Mike.

Operator

And taking the next question fromCharlie Gates with Credit Suisse.

Charles B. Gates - CreditSuisse

Hi, good morning. What do youthink contributed Mike to the acceleration that you witnessed in thiscompetition in the last two quarters?

Mike Stone

Well Charlie again I mean there’san awful lot of capacity out there, an awful lot of capital and there hasn’tbeen a major event in a while. People have come off fairly profitable years in the casualty linesso maybe that’s some of the tort environment improving but overall I believeit’s a capital issue. There’s an awful lot of capital chasing return.

Charles B. Gates - CreditSuisse

My second question, maybe Imisheard you but I thought you said that during the period transportationpricing was down only 5%. Did I get that right? And to what extent does thatshow a diminution in competition?

Mike Stone

Charlie, you did get that right.That’s our renewal rate decrease. Also, our gross written premium was off 20%plus. So we’re pricing off market share and the market is off significantlymore than 5%. Every large renewal that we have, something gin excess of$100,000 is under very significant pressure in the transportation arena.

Charles B. Gates - Credit Suisse

I believe (inaudible) ratingsonly rose on a net basis 0.1%. To what extent does that reflect increasedcompetition and to what extent do you have an issue there with a slowingrealistic construction market?

Mike Stone

We were off, we were up justabout a percent in the quarter, but really a lot of that was our contractbusiness was off more than that so certainly as there is a slowing constructionmarket place you will see a diminution on writings on the contract segment. Ourother segments were up fairly nice year-to-date, so we would expect to see oursmall transactional license and permit bond business and also ouraccount-driven business to grow and our energy business has grown nicelyyear-to-date. So, it’s a really a function of in the contract segment. We’regoing to be careful. We’ve been through that before and we’re going to be slowto move quickly on the contract side.

Charles B. Gates - Credit Suisse

To what extent do you witness achange in the players writing excess and surplus client coverage? And what Imean by that is to what extent do you see the standard market companies comingto this market? To what extent do you see the new Bermudians?

Jonathan Michael

This is John, Charlie. Thestandardized company, that’s probably the biggest reason anecdotally (ph.Circle science) business is eroding is that the standard lines companies aremoving down into that territory and making more of that business lot businessand standard alliance business.

The new Bermudacapital certainly is getting their share of business. There’s no question aboutthat. That’s happening as well. The other thing that is happening that Mike didnot talk about is that carriers look at their, and I’m not talking about RLI,but I’m talking about in general, markets look at their forecasts andunderwriters are looking to make bonus and that sort of thing and so whattypically happens ion the fourth quarter of the year is they get moreaggressive in pricing the business in order to try to achieve their premiumforecasts.

We don’t do that, but others do.And we’re seeing some of that too.

Charles B. Gates - Credit Suisse

My final question at this time;if you guys were to go back in history, what period in time would this currentmarket environment be similar to?

Jonathan Michael

I think I’ll let Mike answer that;he’s a little older than I am.

Mike Stone

I’m old but I’m wise. I thinkthat we’re, we’ve reached probably the nadir of the marketplace in about’99-’00. So we’re not there. I’d say we’re probably around 2002 as we startedto move up, we started to move down, but we’re still in a fairly goodmarket.

Charles B. Gates - Credit Suisse

Thank you.

Operator

And moving on to our nextquestion from Doug Mewhirter from Ferris, Baker, Watts.

Doug Mewhirter - Ferris, Baker, Watts

Hi, good morning. A questionabout your reserve adjustment; did you make any of the adjustments to anythingwritten in the current accident year as well as prior accident years? And alsoif you could provide any detail at all about what the main accident years theadjustments came out of.

Joe Dondanville

Doug, this is Joe Dondanville.Primarily the reserve releases came out of the 2004, 2005 and 2006 years. Wedid have some increase in losses in 2007, which is more up trending ofprice-driven and we have some reserve strengthening in the years of 2001 andprior. So, net there was some movement through all of it, but the true releaseswere ’04, ’05 and ’06.

Doug Mewhirter - Ferris, Baker, Watts

Ok, just to make sure I heard youcorrectly. You said that there is actually some reserve increases for 2007written business?

Joe Dondanville

Well, in looking at where theloss pick for 2007, they were increased slightly. So by picking that up in thethird quarter for the first two quarters effect had an impact on moving alittle bit up, but that certainly was not even significant compared to the

activities compared to ’04, ’05and ’06.

Doug Mewhirter - Ferris, Baker, Watts

Ok. Thanks for that. And I had aquestion about your premium retention. I know that it has gone up. How much ofthat is just the changing business mix, where you would write more in linesthat you would naturally assume is risk and how much of it is general interestcompany-wide to retain more premiums, because of your capital positions or whathave you?

Joe Dondanville

Doug, I would say it’s about halfof each. Certainly lines like general liability where we are holding our grounda little bit is a high-retained line, surety is a highly retained line where wesaw growth and then some of the big decline areas on our EPG is a high area forreinsurance for us.

Doug Mewhirter - Ferris, Baker, Watts

Ok, thanks a lot. That’s all myquestions.

Operator

And the next question comes fromMeyer Shields from Stifel Nicolaus.

Meyer Shields - Stifel Nicolaus & Company

Thanks. Good morning everybody.To start off with the surety reserve release, is there any way to find how muchof that was changed methodology and how much of that was the CMCsettlement?

Unidentified Company representative

Actually, you’re description isprobably incorrect on both. The CMC, we’re settled out at about the reservesthat we had. So there was no significant impact on CMC in the quarter and it’sreally kind of incorporating the trends. There was no change in methodology inwhat we’re doing; it’s relying, putting more reliance on the trends that we’veseen.

Meyer Shields - Stifel Nicolaus & Company

Ok, and does the same accidentyear split that you talked about for (inaudible)?

Unidentified Company representative

Yes, I believe there is stillthat concentration in the four, five and six years for surety.

Meyer Shields - Stifel Nicolaus & Company

Ok, if I can turn totransportation, I guess, what are the implications of the fact that Munich is apparently not interested in Midlandstransportation book? Is that a factor at all in your strategy?

Mike Stone

It’s Mike Stone. I don’t thinkso. Munich hasbeen a fairly significant competitor in transportation business for the lastyear or so. So they’ve been in it. We’ve competed with them. We like thetransportation business, so we’ll stay. It will just be, if it’s not Munich it’s someone else,so we’ll find our spots.

Meyer Shields - Stifel Nicolaus & Company

That’s helpful. I guess, with therecent changes in the housing market and all the sub-prime issues, have you seenany infliction points at all, I’m asking I guess both with regard to surety andwith regard to property loss comp?

Mike Stone

It’s Mike Stone. Not really. Wehaven’t seen any impact there.

Meyer Shields - Stifel Nicolaus & Company

Ok, and I guess the lastquestion; Maui Jim earnings were down on a year-to-year basis. Is thereanything going on there that we should know about?

Mike Stone

Yeah, the big impact on the causeof the change is in the 2006 number Maui Jim had a sale of a discontinued operation,which there was a $1 million gain recognized and that is not repeated in thethird quarter, so there is a special item in 2006.

Meyer Shields - Stifel Nicolaus & Company

Would you use this quarter as adecent basis for projection?

Mike Stone

Yes.

Meyer Shields - Stifel Nicolaus & Company

Ok, thanks so much.

Mike Stone

And I say yes on a somewhatseasonable basis.

Meyer Shields - Stifel Nicolaus & Company

Right, I understand.

Operator

Moving on to Mr. Mike Grasherwith Piper Jaffray.

Mike Grasher - Piper Jaffray

Good morning gentlemen. Just Mikeand John; a question around capital position. You laid out a scenario wherethere is excess capital in the market place net. What about your own positionand how would you go about raising that capital position with a risk tocapital? What would be your target ratio? Could we expect some acquisition?More share repurchase, dividend? If we look back, acquisition probably isn’tthe way you’ve tended to go, it’s been more building of book and going fromthere. But has you attitude changed to that? Maybe you could give us somecommentary around that.

Jonathan Michael

We continue to, you know asyou’ve stated, Mike, we continue to grow our capital relative to the amount ofbusiness that we’re writing. At the same time we are looking for opportunities,both potential acquisition opportunities, hiring people, lift-outs of teams ofpeople, the RLI RE is an example of that. And we’ll continue to look for waysto utilize our capital. In the meantime, I’m we will continue with our buybackand once that buyback is completed we’ll have to reassess where we are and thengo from there. But in terms of target, we’re obviously below our target and weare over-capitalized. We’d like to get it to someplace around one to one. Butwe’re going to continue to look at all of those things in the future and it’s agood problem to have that we continue to make a lot of earning and are faroutstripping our ability to grow. So, we’ll continue to look at that.

Mike Grasher - Piper Jaffray

Ok, and just a follow-up, youmade a statement about lifting out the teams or bring teams on, that would seemto me to imply new or differentiated product. What areas might you be lookingat? I don’t necessarily think you have any holes that you’re looking to fillbut certainly opportunities that look intriguing out in the market place to younow?

Jonathan Michael

I don’t want to say which areasof business, but I will say they will be specialty, niche areas. That’s whatwe’re good at. We’re not going to be all things to all people. And those arethe things we’re looking for. We look at ourselves where we’re good at andwhere we have hole and we go from there. But we won’t be in the standard linesmarkets any time soon, that’s for sure.

Mike Grasher - Piper Jaffray

Thank you and congratulations onthe quarter.

Operator

And moving on to Ron Bobbin withCapital Returns.

Ron Bobbin - Capital Returns

Hi. Congrats on another greatquarter. Underwriting is really impressive and also great discipline onlimiting the top line where it’s not meant to be. I had a question; I thinkit’s a follow-up to Charlie’s question. In the transportation area, youmentioned rates were down 5% on your renewal this quarter but your volumes wereup 25%. I was wondering whether a particular large account or something that, Irecognize no one wants a 5% decline, but the 25 was obviously a prettysignificant drop in writings for the quarter. Was it just an ordinary situationof competition pulling business or was there something concentrated there?Thanks.

Mike Stone

We’re off 16% for the year.Again, we lost a number of renewals in the quarter and any renewal that comesup with sizeable premium in six figures is under quite a bit of pressure. We’revery disciplined in that business. The margins in that business are top so wewill let that business go and expect it will be back in a couple years.

Ron Bobbin - Capital Returns

Ok, I guess another question.Thanks for that. I was just curious; does Munichprovide you any reinsurance? Are they under any of your programs?

Mike Stone

They’re our largestre-insurer.

Ron Bobbin - Capital Returns

Oh, and do you have any sort ofdiffering view about they increasing insurance initiatives in growing, I wouldthink that you would, given an availability of reinsurance, you would surelyconsider (inaudible) provider, or am I wrong?

Michael Stone

That's hard to say. I thinkmaybe, really, the first reaction might be that, but the reality is all thereinsurers are competing with us, so you can go, you look at those Bermuda reinsurers and they're all competing with us, andwe seek out their capacity for some of our covers as well. If we took thatattitude we wouldn't place reinsurance.

Ron Bobbin - Capital Returns

So.

Michael Stone

Probably no change, we'll have atalk with Munichabout it, but probably no change.

Ron Bobbin - Capital Returns

Thanks a lot, and continued goodluck and success.

Unidentified Company Representative

Thank you.

Operator

Moving on to our next questionfrom Tom Cholnoky with Goldman Sachs.

Thomas Cholnoky - GoldmanSachs

Good morning. I guess I have aquestion that may or may not be related to RLI, but in your commentary I wasfocusing on your obviously commentary on rates and decline in rates, and Iguess one of the things that I struggle with in looking at either you or othercompanies in the industry is that in an environment where rates are going downdouble digit, why aren't we seeing accident year loss ratios reflect what aredouble digit declines? I mean, put simplistically, if lost cost trends areessentially flat, and you've got 10 or 15% less rate, it would imply that yourloss ratio picks probably should go up by 10%, and I'm not picking on RLI byany means, but I'm just thinking in general, what is wrong with my view ofwhere a margin should be in a declining rate environment?

Joe Dondanville

This is Joe Dondanville. I thinkpart of the phenomenon that you're seeing today is that as loss costs are relativelystable, our emergence of losses, of what we expect the losses to be, have beenmore favorable than what we've expected, so that has offset some of that pricedecline that you're seeing, and so when we're looking at our overall reservesand booking ratios, that has had a more favorable impact historically then theprice declines, and I think for us as I mentioned we are seeing a little bithigher loss picks going forward in 2007 and I would assume other companies aregoing to run in to that same phenomenon.

Michael Stone

Yea Tom, our estimated lossratios for the current accent year begin with when we're looking at thatformula, they begin with what's the price change, what price change are weseeing across the book, and that's the starting point, but then you have tobring in, as Joe said, the emergence from prior year's development to theextent that that's been positive it more or less has offset some of that.

Thomas Cholnoky - GoldmanSachs

So, when you get to a point whereyou don't have any more favorable development, let's say, you’ve come to apoint where your reserves are at adequate levels, at that point one wouldexpect either yourselves or other companies in the industry, if they're true towhat's going on with pricing, to see much more significant increases and lossratio picks. Is that fair?

Michael Stone

That's fair.

Thomas Cholnoky - GoldmanSachs

Ok, alright, that's great. Thankyou.

Operator

Moving on to Kenneth Billingsley,with Signal Hill.

Kenneth Billingsley - SignalHill Capital Group LLC

Good morning. This is kind oftaking Tom's question in a little bit different direction. He commented thatrates are down pretty significantly, but it looks like the core loss ratio isstill improving. From a reserve standpoint, what changes were made? Forexample, are you booking more to your own experience then industry experience,as compared to prior quarters?

Joe Dondanville

Again, this is Joe. Yes, that'spart of the factor, but we did have an increase in the current accent yearduring the quarter, so, but that still might be masked by the large decreasesfor prior years.

Kenneth Billingsley - SignalHill Capital Group LLC

And what I'm looking is the coreadjusting out the reserve adjustment of the whole compared to prior year’s lossratios backing out reserve releases. It still looks like quarter over quarteryou're still having improvements.

Joe Dondanville

I think it's mixed again. Are youlooking at, it depends on which segment you're looking at. Are you looking atoverall?

Kenneth Billingsley - SignalHill Capital Group LLC

Blended right now.

Joe Dondanville

I think if you look at theproperty results for example you'll see significant improvement in the propertyresults, quarter over quarter.

Kenneth Billingsley - SignalHill Capital Group LLC

And what drove the change tofocus more on your own experience over industry experience, and can you give mean idea of how much of the waiting changed?

Joe Dondanville

We can’t really give you what thewaiting change is, but if you look at our trend of favorable development overthe last several quarters, at this point we’ve incorporated more of that intoour reserve analysis, as more of a continuing trend as opposed to an anomaly.

Kenneth Billingsley - SignalHill Capital Group LLC

Great. Great quarter. Thank you.

Operator

We'll take a follow-up questionfrom Charlie Gates.

Charles B. Gates - CreditSuisse

Hi. My first question. I thinkone of you said that 17% of the commercial money center bond exposure remained.The initial commercial center bond exposure remained. Could you tell us whatthat number is, or what the initial number was?

Michael Stone

Yea Charlie, it's Mike Stone. Wehad roughly $15 million worth of bond penalty, and it depends on how you lookat this, and I think there's about $7 million left. I don't know if thatanswers 17% or not, but thereabouts. When you look at that out of pockets,that's roughly a little bit less than half of that, so there's about 7 millionleft, roughly, out of pockets, I mean, excuse me, bond penalty. We would expectit to be immaterial, going forward. We will, we expect to resolve this in thecoming quarters, hopefully by year-end, but I'm not sending any signals toanybody, but it's really going to be a non-event.

Charles B. Gates - CreditSuisse

Do you mean the future exposureis specific to that is probably a non-event?

Michael Stone

The future exposures related tothat is a non-event.

Charles B. Gates - CreditSuisse

Ok, there was my first question.My second question. If you were an analyst, following multi-line insurancecompanies, and you were trying to ascertain to what extent those companies weregrowing their exposure in excess and surplus lines, today, how would you dothat?

Michael Stone

Right Charlie, I'm glad I'm notan analyst. I think I'd talk to the managements of those companies, and that'show I would do it.

Charles B. Gates - CreditSuisse

I think some of those managementswould say oh, we don't even know how to spell excess and surplus lines. Thankyou.

Joe Dondanville

Charlie, for our company we writea lot of it on a non-admitted basis in our Maui Jim company, but when you seethe standard lines going down there's no differentiation with an admittedbusiness in the types of surplus lines they would still record with the othermore typical standard lines that they write, so it is something that you'd haveto ask and drill down through management questions.

Charles B. Gates - CreditSuisse

Is the specific area, if you reto step back, and you’re to say, what area of our business is the worst. Isthat basically commercial auto liability? Because you were sayingtransportation, and I translated that into commercial auto liability.

Unidentified Company Representative

Charlie, that's a littledifferent. Our transportation business consists of trucks and basically that'sfleet business, for hire, by and large, and busses, that is publictransportation. We have a small segment of what we commonly refer to as commercialauto which is basically private, small, five, to 25 units of a particularbusiness, but by and large our business is large fleets, trucks, over the road,and buses.

Charles B. Gates - CreditSuisse

But on statutory basis, if ananalyst was to look and say, a multi-line insurance company writing theserisks, that would show up in commercial auto liability and commercial autophysical damage?

Unidentified CompanyRepresentative

Yes, that's correct, Yes Charlie.

Charles B. Gates - Credit Suisse

Thank you Guys. A nice conferencecall. Thank you.

Operator

The next question comes fromMeyer Shields, with Stifel Nicolaus

Meyer Shields - StifelNicolaus

Thanks, just a few nit-pickyquestions, if I can. Is there any reason that short-term debt went up in thequarter?

Joe Dondanville

We like the carry trait that wehave with the short-term debt that we have right now, and it's attractive tous.

Meyer Shields - StifelNicolaus

Ok. Was there anything unusual inthe tax rate? It came in a little lower than I would have thought.

Joseph Dondanville

Yea, we had some benefits thatcame through in the quarter related to some items that were outstanding withthe settlement of our tax audit from last year.

Meyer Shields - Stifel Nicolaus

Ok, and I don't know if this isthe right way of doing it, but when we look at the general expenses and theratio of total revenues, that went up a little bit from 1.3 % to 2.1. Is thereanything unusual in terms of that?

Michael Stone

There are two things, Part of itis because of the terrific quarter, bonus compensation went up, and part ofthat goes through that line item, part of it, and then second we had a one timecharitable contribution increase of $1million for the quarter.

Meyer Shields - StifelNicolaus

Ok, that's it for me. Thanks somuch.

Operator

We'll take our next question fromMike Grasher, Piper Jaffray

Mike Grasher - Piper Jaffray

Thanks for taking my follow-up.Just a question for Mike. You were commenting earlier on the market, and whatit resembled in terms of history. Just wondering if the capital that's outthere today is it more responsible today then previous stock markets, if so,then could this soft part of the cycle be more elongated cycle, and one that maybeisn't as severe as previous cycles. Or, alternatively, is it simply too earlyto really tell.

Michael Stone

Mike, we've been tellingourselves that, the industry has, that we're better, we have better data,better governance, and we also got a heck of a lot more capital, so I don'tthink the cycle's dead. What will the (trough) be less severe, shorter, I thinkit's too early to tell.

Mike Grasher - Piper Jaffray

Ok, thanks for your comment.

Operator

If there are no furtherquestions, I will now turn the conference back to Mr. Jonathan Michael.

Jonathan Michael

Thank you all for all of yourquestions, it's always good to talk to you after the quarter. The quarter wasobviously impacted in a positive way by the reserve release, but even withoutthat reserve release the quarter was an excellent underwriting result. I'll letyou do the math, but if you look period over period, and compare the quarterversus what all the analyst estimates were, you'll see that the result was very,very good indeed, and all segments, across all segments, they performed well.Mike said we are an underwriting company first and foremost. His presentationmostly dealt with that. We are different. We seek to produce an underwritingprofit first, and we deliver. In this soft market we'll continue to grow whenand where it makes sense to grow, where we're seeing pressure and ridiculousrate reductions, we'll pull back. We are mining for opportunities. We talkedabout that. RLI RE, was one of those, that operation is up and running and ithas now produced some business, and we hope to continue to build our platformfor the future.

Through all of this we're goingto continue to be disciplined underwriters, that's one thing that you can restassured, with RLI we’ll have discipline in RLI. Thanks for listening and we'lltalk to you again next quarter.

Operator

(Operator Instructions)

This concludes our conference fortoday. Thank you for participating and have a nice day. All parties my nowdisconnect.

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Source: RLI Corp Q3 2007 Earnings Call Transcript

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