Philadelphia Consolidated Holding Q3 2007 Earnings Call Transcript

Philadelphia Consolidated Holding Corp. (PHLY) Q3 2007 Earnings Call October 25, 2007 3:00 PM ET

Executives

Joe Barnholt - Director of Investor Relations

Sean Sweeney - Executive Vice President and Chief MarketingOfficer

Craig Keller - Executive Vice President, Secretary,Treasurer and Chief Financial Officer

Jamie Maguire - President and Chief Executive Officer

Analysts

Mike Grasher - Piper Jaffray

Alison Jacobowitz - Merrill Lynch

Mark Serafin - Citadel

Scott Horsburgh - Seger-Elvekrog

Amit Kumar - Fox-Pitt Kelton

Operator

Good day, everyone, and welcome to today's PhiladelphiaConsolidated Holding Corp.'s Third Quarter 2007 Earnings Conference Call.Today's call is being recorded.

At this time, I would like to turn the call over to JoeBarnholt, Director of Investor Relations. Please go ahead, sir.

Joe Barnholt

Thank you. I would also like to welcome you to PhiladelphiaInsurance Companies' third quarter 2007 earnings conference call.

Please be advised that certain information included in thispresentation and other statements or materials published by the company are nothistorical facts, but are forward-looking statements as defined by the PrivateSecurities Litigation Reform Act of 1995.

Please refer to the company's annual report on Form 10-K forthe year ended December 31, 2006 and its past and future filings and reportsfiled with the Securities and Exchange Commission for a description of thebusiness environment in which the company operates and the important factorsthat may affect its business. Philadelphia Consolidated Holding Corp. does notintend to publicly update any forward-looking statements except as may be requiredby law.

I would now like to introduce the members of our managementteam who are joining me this afternoon. First of all, I would like to introduceJamie Maguire, our President and CEO, who I will turn the conference over toshortly. Also joining me is Sean Sweeney, Executive Vice President and ChiefMarketing Officer; Craig Keller, Executive Vice President and Chief FinancialOfficer; and Chris Maguire, Executive Vice President and Chief UnderwritingOfficer.

A replay of today's conference call will be available from5:00 p.m. today until November 8, 2007. You can access the replay by visitingthe company's website, phly.com. Additionally, our supplemental financialinformation has been posted on our website.

In order to access this information, click on InvestorCenter followed by Reports. Please feel free to contact me with any follow-upquestions or requests. My direct dial is area code 610-617-7626 and my e-mailaddress is jbarnholt@phlyins.com.

I now will turn the conference over to Jamie Maguire, ourPresident and CEO.

Jamie Maguire

Thanks, Joe, and welcome to everyone listening in on theconference call and those of you listening in over the web. Hopefully, you'vehad a chance to review our press release, which we put out earlier today. We dohave supplemental financial information also, as Joe mentioned, on our websitethat details the quarter. And it also includes the presentations that I'm goingto go through during this call.

I would like to just thank our employees for another greatquarter. We had an excellent quarter. Great execution, great teamwork in whathas become a more competitive market, and we'll talk more about that throughoutthe presentation.

Moving to page three, the agenda for our presentation. As iscustomary, I will talk about the financial highlights for the quarter,including some of the financial results, segment information, touching on ourinvestment portfolio, looking at some of the selected operating statistics forthe company and then talking about the drivers of the future for our company,our 2007 expectations and then taking your questions and providing someanswers.

Moving to page four, third quarter highlights. $504.6million of gross written premiums in the quarter compared to $456.6 millionthis time last year. That's a 10.5% increase quarter-over-quarter. We did havesome continued dehydration in our personal lines of business, which I'll gointo, which, if you remove that, we grew about 15% in the quarter gross writtenpremiums for our commercial segments.

Included in the gross written premiums for the quarter were$35.6 million of new products. So we had new products that contributedmeaningfully to the quarter versus roughly $9.5 million of new product premiumthis time last year. Included in those new products are religiousorganizations, health and fitness business and entertainment package, amongmany others. And I'll touch on that later on in the presentation.

We had about a 26%, 27% growth in our net investment incomein the quarter, very good cash flow in the quarter, roughly $141 million, whichcontributes to this income growth. We invested primarily in municipal bonds.That's where we saw the opportunities in the quarter. And then to a lesserextent, in mortgage-backed securities and asset-backed securities, primarilytriple A-rated instruments.

We had a 7% increase in net income, and I'll get into thatin a little detail. That's a little misleading. We did have significant reserveredundancies last year, which I'll touch on. When you normalize, we had anexcellent growth year-over-year on our net income.

For the quarter, we had a 40.3% loss ratio. That includes 11points of reserve releases from prior accident years compared to a 28.6% lossratio in 2006. We had roughly 14.4 points of reserve releases in the thirdquarter of last year. We had a 28.2% expense ratio, which compares favorably tothis time last year, which was 30%.

The decrease in the loss ratio came as a result primarily oflower reinsurance, cat reinsurance costs, which we negotiated in June of thisyear. They were significantly down from this time last year, and that hasbenefited with us a lower expense ratio.

Moving to page five, our operating income, $94 million in2007 compared to $94.4 million in 2006. And this is where I want to talk alittle bit about the reserve releases last year versus this year. Last year, wehad $27.8 million of redundant reserves. In addition, we had $9.6 million ofbenefit by reducing our accident year loss ratio, which, when you normalize theoperating income for those two items, it's $57 million in 2006.

We had, this year, $94.4 million, with $25.7 million ofreserve releases, normalized $68.7 million of operating income, so $57 millionlast year versus $68.7 million this year, a 20.5% increase in our operatingincome quarter-over-quarter. And I think that's what we need to focus on hereas the organic engine continues to generate profitable growth to the tune of20.5% for this quarter.

So clearly an excellent result. This is a real tribute to ourdifferentiated approach to bringing business in. We've talked about this anumber of times. The fact that we drive the pipeline, we drive the submissionflow, and we're seeing net growth come through to the bottomline in the way ofsolid operating earnings.

That also translates into a 20.8% increasequarter-over-quarter in our operating earnings per share. 128 normalized is$0.93, removing the redundancies and it's $0.77 this time last year. So it's a20.8% increase in our operating earnings per share quarter-over-quarter. Andyou can see an excellent job at underwriting with a combined ratio of 68.5%this year versus a 58.8% combined ratio last year.

Moving to page six, some balance sheet highlights. We grewour shareholder's equity from the end of last year by 24%. Total shareholder'sequity is just shy of $1.5 billion. The book value per share is now $20.23, a22% increase from the end of last year. And I should point out ourquarter-over-quarter increase of 32%.

This time last year, our book value was $15.24. $So we'veincreased our book value significantly quarter-over-quarter, a 32% increase.

Shares outstanding have remained relatively constant fromthe end of last year, and we had a solid return on equity of 24.9%, whichincludes the reserve releases. Excluding reserve releases, we were roughly 22%.

So clearly, we're making very good use of our capital, andwe're going to continue to need our capital as we see opportunities in themarket and as we see the need for the A-plus rating for our insurancecompanies.

Page seven, the third quarter events, which reconciles ouroperating income, a very simple slide this year -- or this quarter, $25.7million of favorable prior-year reserve development, which was $0.35 in thequarter.

And moving to page eight, it details exactly where thosereserve releases came from, primarily in professional liability for 2006, '05and '04, and then to a lesser extent, including general liability, for 2004 and2003.

So we've seen very good trends in our professional liabilitybook. The prior-year accident loss ratio picks that we had made were veryconservative, and we've seen positive trends. As a result, we've been able totake down reserves for those products in those accident years.

Page nine, year-to-date highlights, topline growth of 15.2%.Again, I will get into the personal lines segment in just a minute, but again,a very solid growth number for the company, especially in view of what hasbecome a very competitive marketplace, especially for larger accounts in excessof $100,000. We're seeing quite a bit of competition for the greater than$100,000-sized accounts, which admittedly is a small part of what we do.

Roughly 3% of our business is in the larger accounts. Sowe're primarily below that level. So the competition for the larger accounts isa smaller part of what we do. Net investment income, 30.6% growth over thenine-month period last year and 19% growth in our net income. And then you cansee the combined ratio year-to-date, 73.3% versus 68.3%.

We've had an increase in our property losses for the yearand that's attributed to a little bit higher loss ratio for this year versuslast year. We don't see any trends there. We see that really is related toweather-related incidents throughout the year.

Page ten, reconciling our year-to-date highlights for anoperating income, $235.4 million of operating income versus $221.5 million.When you remove the reserve releases and the adjustments for the accident yearloss ratios, we have roughly a 17% increase in our operating income for thenine-month period year-over-year.

And that goes as well for the earnings per share. So wecontinue to see very good growth in operating income. Again the organic enginecontinues to fuel our growth, and the new products are beginning to take holdand contribute to that topline growth.

Page 11, year-to-date events reconciling our operatingincome from a year-to-date perspective. The reserve releases totaling $47.6million equates to $0.64 for the nine-month period. And then we had realizedinvestment gains, primarily last quarter, as a result of moving to a new equitymanager, $14.4 million, which is $0.19 for the nine-month period.

Page 12, the reserve releases for the year basically arecoming from professional liability, property, general liability and auto, soprimarily across all lines of business for prior accident years. We're seeingfavorable claims development as a result of negotiating very big claimsettlements by our claims department professionals and just better experienceoverall in our book of business.

Page 13, gross written premiums by segment. These are threereportable segments. Our commercial lines segment grew by 15.6%quarter-over-quarter to $425.1 million. The specialty lines segment grew by9.4% to $68.5 million, and we continue to dehydrate our personal linesoperation, 58% negative growth down to $11 million, most of which is floodpremium, where we administer the flood insurance on behalf of the NationalFlood Insurance Program.

The overall growth for the three reportable segments, 10.5%,but you can see in our key commercial segments, we've got an average of 14.4%between the commercial and specialty lines segment, which continues to be verygood growth.

Page 14, on a nine-month basis, on a year-to-date basis, thecommercial lines segment has grown by nearly 21% over the same period lastyear. Our specialty lines business grew at 18.1%, and we de-emphasized thepersonal lines business. 34.2% year-over-year growth for that particularsegment. Looking at just the commercial and specialty again, 19% growth forthose two segments year-to-date, year-over-year.

Page 15, our commercial lines segment, which is most of whatwe do, 84% of our third quarter gross written premium. We've had a compoundannual growth rate in this product from 2001 to the present of roughly 30%. Sothis has been a significant area of growth for our company.

15.6% growth quarter-over-quarter, as we've gotten to be alarger company, 20.9% year-over-year growth for the nine-month period. We'veseen growth in a lot of areas with the commercial lines segment.

The condominium associations, we saw a roughly 93% growthquarter-over-quarter to $36 million. Our homeowner's association product grewby 75% to $9 million, and we've seen some growth in our health club packagebusiness, 23% growth to roughly $8 million in the quarter.

I'd take out a few of the products that are noteworthy.We've had growth across most of our product lines. The new products thatcontributed growth from the commercial lines segment, religious organizations,93% growth to $13 million in the quarter.

Our Collector Vehicle Program where we basically went from adead start contributed $9.1 million in the quarter, and entertainment packagewas roughly $4.5 million from a dead start. So we've got some new contributors,which are going to help to fuel the growth as we move into 2008 and beyond. Thetotal new products, as I mentioned earlier in the call, $25 million versusroughly $9 million for the third quarter of '09.

Speaking a little bit about the commercial lines segment,with the fires out in the West Coast and the Southwest, we obviously do havecommercial buildings in Southern California.

So far we have one claim that's been reported to us as aresult of the fires in Southern California. I think it's too early, really, totell what our ultimate exposure is going to be there. We've monitored thelocation of our accounts. But I think over the next few days, we're going toget a better sense of what our actual losses will be.

Moving to page 16, our specialty lines segment, professionalliability is roughly 14% of our third quarter gross written premium. We've hada compound annual growth rate of 24% roughly in this segment over the last fiveyears, 9% growth quarter-over-quarter, 8% year-over-year.

Non-profit D&O seems to be a real good grower in thisparticular area, 16% growth quarter-over-quarter to $24 million. Our privatecompany D&O product grew by 14% to $12 million in the quarter. And our BOP,our Business Owner's Policy, where we had no production this time last year,contributed roughly $2.2 million in the quarter. So we're getting some goodgrowth out of our professional liability products.

This is smaller, transactional business, where it's a lotmore difficult to move the topline, but I have to give due credit to ourspecialty lines department who has done a great job, turning the quotes around,being very responsive to our producers and growing significantly from asubmission count standpoint.

Moving to page 17, our personal lines segment. We continue,as I mentioned, to dehydrate this business, our mobile home and our homeowner'sbusiness. We've de-emphasized that, and you can see that by this chart here.And we continue to grow the Flood business. We've been very fortunate thisseason.

We've had no hurricane activity. The weather activity hasbeen very cooperative. But it still continues to be very challenging regulatoryenvironment down there. So we continue to de-emphasize this particular segmentof the company.

Moving to page 18, our investment portfolio continues to bevery conservatively managed. The total value of the portfolio was just shy of$3 billion as of the end of the quarter. Fixed income securities have anaverage quality of triple A. That's been consistent quarter-over-quarter. Ourportfolio duration is just under five years at 4.9, and we've got a taxableequivalent yield on the fixed income portfolio of 5.5%.

Our stock portfolio, which is roughly 12% of the totalinvestments, our quality long-term gross stocks, we have four managers, agrowth manager of value, a small cap and an international manager. So wecontinue to look for opportunities within the common stock area to help buildour book value for the company.

Page 19 drills a little deeper into the phenomenon of thesub-prime issue, and the sub-prime issue is not an issue for PhillyConsolidated. As you can see in the middle of the page, we have $9 million ofsub-prime loans. They are triple A-rated primary cash flow tranches. They havea weighted average life of 1.8 years.

As of the end of the quarter, there have been no downgrades.There are none under surveillance. So we're very confident that this small partof our portfolio will continue to perform without any kind of hiccups and anykind of problems.

Page 20, the investment income. We had good growth, 27%quarter-over-quarter, contributing to our earnings in the quarter. That came asa result, as I mentioned, of good operating cash flow, $141 million ofoperating cash flow in the third quarter compared to $88 million in the secondquarter of '07. That's a 60% increase from the prior quarter. And we put mostof the new money into municipal bonds, as I mentioned, and to a lesser extent,mortgage-backed and asset-backed securities.

Page 21, our operating statistics. Our renewal retentioncontinues to be very good. It's a competitive market. We have a number ofcompanies that have identified Philly as a target, but we continue to renew ourbusiness. We have good loyalty from our producers and our policyholders.

We have an excellent service model that provides thepolicies on a CD, where we can e-mail the policies as PDFs, and I think theoverall offering by Philadelphia Consolidated of better service, a betterproduct and our high-quality securities helped us hold on to our business.

The rate changes, obviously, are coming down, 3.8% decreasequarter-over-quarter, a 1.8% decrease for the professional liability products.As I mentioned, we're seeing more competition on larger accounts. The newbusiness growth, excluding personal lines on a policy basis increased by 67.8%.We saw a lot of growth in our condominium product.

The fitness and wellness acquisition, which our smallerpolicies contributed significantly to that policy growth, and then to a lesserextent, our non-profit directors' and officers' liabilities saw good policygrowth in the quarter.

Page 22, some more operating statistics. Our preferredagents now number 204. That's up roughly 19% from this time last year when wehad 172 preferred agents. These are our key partners that have our interests inmind. We've sold out $49 million of gross written premium growth in the quarterfrom this group, which is a 33% increase quarter-over-quarter.

Renewal retention was at about 95%, which is consistent withour overall book, and then we saw 41% increase in new business from this groupto $13.4 million. As of the end of the third quarter, we're just over 1,300employees coast to coast versus roughly 1,200 this time last year.

So we've increased our employee count by roughly 12% fromthis time last year, but we've remained efficient. The measure of efficiency isour gross written premium per employee. That's remained at $1.2 million. That'swhere it was this time last year.

So again, I have to give credit to our employees, who aredoing a super job at making it happen, executing everyday and delivering thesekinds of results that I can report to Wall Street on the earnings call. Ourturnover has also declined. We're at 12.2% versus 14.7% this time last year.

Page 23, the drivers of the future will continue to be ournational presence in our mixed marketing, our proactive approach to controllingthe distribution, controlling the growth, and that's going to become a realdifferentiator as we move into a competitive market, being able to control ourdistribution and then also having the benefit of prescreening the business, sothat we have hit ratios in the commercial lines area of 50%-plus and in ourprofessional liability area of 30%-plus.

So it becomes a more efficient model by incorporating thedistribution into the company. We'll continue to look at new product offerings,but I think the focus is going to be to continually enhance our existingproducts, at least in the short-term. We have a number of new products thatwe've rolled out. So we want the new products to take hold.

We're going to continue to enhance the existing products,and I think that will help continue to drive the topline. We see consolidationin the industry with ample capital with good, combined ratios from othercompanies. We think there is going to be consolidation, and we'll be thebeneficiary of that consolidation to the extent there are lines of business orproducts that the consolidated entity wants to get out of, we'll be there topick that up as it presents an opportunity.

We have our experienced management team. Obviously, we'revery disciplined from an underwriting and pricing perspective. We continue toinvest in our technology platform because we think that that's a differentiatorfor the company, being entirely web-based company, which helps improve from aspeed of service standpoint will translate into higher retention ratios for ourrenewal business and better new product opportunities for new business.

We're going to maintain our A-plus rating from AM Bestbecause we believe that, as the market consolidates and as our regulatoryactions, having the strong rating will make us the clear choice for producersto place their business with. And then our goal for our preferred agents is togrow the premiums 15% quarter-over-quarter, which we've done.

Page 24, expectations for 2007. Our operating earnings pershare range was $3.63 to $3.78. We have upped that range to what you see here,$3.95 to $4.02. This includes the reserve releases that I talked about and thehigher property loss ratio for the year, which I've mentioned. It also assumesone catastrophe loss for each of our two cat towers, $10 million for ourcommercial lines, $3.5 million for our personal lines business.

We anticipate organic growth approximating 15% for thebalance of the year. We're looking at a combined ratio approximating 80%. Wethink our renewal retention levels will remain above 90%. The investmentenvironment is clearly in transition, especially with what's happened intoday's market. And we anticipate increased competition, mostly on the largeraccounts to a lesser excellent in the lines of business that we do.

That concludes my presentation. At this point, myself, andmy team would be willing to take your questions.

Question-and-Answer Session

Operator

(Operator Instructions) We'll go first to Mike Grasher withPiper Jaffray.

Mike Grasher - Piper Jaffray

Good morning. Congratulations on the quarter. Goodafternoon. Excluding the large accounts, what would growth have been?

Jamie Maguire

Excluding the large accounts?

Mike Grasher - Piper Jaffray

Yes. So if you back out -- I guess, how much did youactually lose in large accounts?

Jamie Maguire

I'd have to get that number for you, Mike. I don't have --do you mean over $100,000 in premium?

Mike Grasher - Piper Jaffray

Exactly.

Jamie Maguire

I mean I think we're holding on to most of them. I wouldhave to get you a firm number on that. I don't have that at my fingertips.

Mike Grasher - Piper Jaffray

Okay. And then, Sean, can you talk about the new businesses?There's a couple I think that you have recently introduced. I mean how much areyou looking to do when you get a new line established in, I guess, the firstyear?

And then how do you think about the, I guess, the growthrates after the first year? So by year two, you would like to see it growing Xamount, and how much total premium by the end of, say, year three or year five,whatever it may be?

Sean Sweeney

We introduced museums, zoos, botanical gardens andaquariums, if that might be what you're referencing. We'd like to see a productaggregate about a $5 million range within the first 12 to 18 months and thengrow at about 15% a year thereafter with the caveat that it has to beprofitable and meet the underwriting criteria that we've established.

Mike Grasher - Piper Jaffray

Okay. And then a final question around the expense ratio dropping,I mean, does it go any lower than where we are right now? Is this kind of abase?

Jamie Maguire

I think it's a good base to go with. I mean we're hopingthat we're going to see some efficiencies from some of our technology thatwe're going to implement over the next year or two. So I think in the shortterm, this is a good run rate.

Mike Grasher - Piper Jaffray

Okay. Thank you.

Operator

We'll next go to Amit Kumar with Fox-Pitt Kelton.

Amit Kumar - Fox-Pitt Kelton

Good afternoon. Just starting with the market conditions.Jamie, I think you mentioned that a number of companies have identified Phillyas a target. Could you just expand on that?

Jamie Maguire

Well, I think in the markets that we play, there is AIG, St.Paul Travelers, Chubb, Hartford and -- you know, we're clearly on their radarscreen. We've got very good results. You know, the initiatives that we're in,we're doing well. So they've identified us as a good target to go after, a goodmarket to go after. I don't think it's not singling us out, per se. We're justseeing competition from those carriers in various different niches.

Amit Kumar - Fox-Pitt Kelton

Okay. And I guess moving on to the new business growth, I'mjust thinking that at this stage of cycle, I wonder if those accounts arelooking for customization or if they're more price sensitive? If you aregrowing at this stage of the cycle, who would be losing those type of accounts?

Jamie Maguire

For example, in the religious organizations, there wereprograms that were put together on a national basis, and they had been hurtwith the Katrina-type losses. So we would be taking them away from specialtyprograms where maybe an Arthur Gallagher had a program with a particular insurancecompany.

You may have a niche underwriter like a GuideOne, who wemight have some opportunities with. Brotherhood Mutual, Church Mutual arereligious organization competitors, so we might be taking business away fromthem.

On the smaller accounts, taking business away from ourcompetitors -- there is value add in our "ten reasons why" in thecoverages that we're offering. So there is a reason why they might move, andthat's kind of what we're focusing on. A lot of our competitors are managinggeneral agents that might have depend from markets. So I think with ourfinancial result and the "ten reason why", that is a reason for themto consider us.

Amit Kumar - Fox-Pitt Kelton

Okay. Got it. In terms of the loss on large accounts, canyou just give some more color in terms of what type of accounts are these?

Jamie Maguire

It would be retail shopping centers where there's a largeschedule of property, office parks, office buildings, hotels. And typically,you're looking at a real estate schedule in excess of $20 million. And that'susually where you see the big players like Azurich, Travelers competing.

Amit Kumar - Fox-Pitt Kelton

Got it. Final question on reserve releases. You know, if Ilook at the quarterly trend, it seemed to be in like a $15 million, $20 millionrange in the past, I think, three quarters. I'm just wondering, what changedfrom Q2 to Q3, which resulted in such a large reserve release?

Craig Keller

Amit, this is Craig speaking. You know, we do what actuarialdepartment does full quarterly reviews each quarter, and a lot of the releasesin this quarter were expected case development and professional liability linesthat had been expected and they just weren't coming.

And it gets to the point that during these actuarial reviewsand where they are in their trending, if their trends aren't correct, they needto be adjusted. And I think that's what happened, at least in the specialliability lines this quarter.

Jamie Maguire

I mean the experience is just coming in much better thanwhat we expected, and at some point, you have to bring those reserves intoincome when you only have a handful of claims and you have a lot of reserve up,and that's what's happening. The claims have not materialized that we'veexpected, which is a good thing.

Amit Kumar - Fox-Pitt Kelton

So the Q4 -- would the Q4 reserve review be similar to theQ3 reserve review? Or would that be more comprehensive in nature?

Craig Keller

No, they're not comprehensive. We do a full reserve revieweach quarter.

Amit Kumar - Fox-Pitt Kelton

So similar in process every quarter?

Craig Keller

Yes.

Amit Kumar - Fox-Pitt Kelton

Okay. That's all for now. Thanks so much.

Jamie Maguire

Okay.

Operator

(Operator Instructions) We'll next go to Alison Jacobowitzwith Merrill Lynch

Alison Jacobowitz - Merrill Lynch

Hi. Thanks. I missed some of it on the property loss ratio.So maybe this might be partially redundant. But first of all, for the earningsoutlook you gave, your own earnings outlook for '07 and you talked about thecat load, doesn't that sort of imply maybe a decent amount of cats or a lot ofcats for the fourth quarter? I mean what exactly are you building in the fourthquarter?

I don't know if you're counting the -- you're probably notcounting that property, the weather-related property losses from the firstquarter in the cat load. So it seems like you're building in a decent amountfor cats for the fourth quarter.

And then the second question is, the accident year lossratio combined ratio was, I think, around 79%. Given the way everything hasworked out besides the property issue, as you look forward, I know we're not --I'm not asking exactly for '08 numbers. But as you look forward to '08, willyou be making any changes in how you book your -- other than that, the currentyear accident year combined ratio because of the great results this year?

Jamie Maguire

Taking the second question first, I think it's too earlyright now. I think what we think is that the property loss ratio ticked up as aresult of some weather events. So we're going to watch that through the fourthquarter. And I think that will be a decision we may get for the fourth quarter.

In terms of the cat, I think we've got that pretty clearlylisted on the page here. We're still -- we haven't -- we're still in catseason. We're in cat season through November. So we have a $10 million pre-taxnet for our commercial tower and a $3.5 million pre-tax net for our personaltower. And that's -- we have not taken that out of our numbers yet.

Alison Jacobowitz - Merrill Lynch

Okay. Thanks.

Jamie Maguire

Yes.

Operator

We'll go next to Mark Serafin (ph) with Citadel.

Mark Serafin - Citadel

Good afternoon. On the net and loss adjustment expenseexhibit in the supplemental information, in your prepared remarks, you wentthrough it maybe a little bit too quick for me to follow, but if you can justwalk me through a couple of these numbers, specifically the commercial linesand the specialty lines numbers on the incurred loss for the three months. I'massuming a big portion of the reserve release came out of the professionalliability lines in the specialty segment, but if you could just help me sinkthe 146 to the 54 a little bit better, that'd be appreciated.

Jamie Maguire

You want a little detail on the reserve releases?

Mark Serafin - Citadel

Well, I'm assuming that the reserve releases that you havementioned came in professional lines came from specialty, and that's whythere's a negative incurred number. And in your prepared --

Craig Keller

Mark, this is Craig. That's correct. There was a largereserve release in the specialty Lines. I think approximately -- I don'tremember exactly, approximately maybe $27 million. On page eight of thepresentation is the reserve release, not only by accident year, but it doeshighlight which lines also.

Mark Serafin - Citadel

I'm afraid I'm running blind without the PowerPointpresentation. The commercial lines you mentioned in your prepared remarks, lastyear, the incurred ratio benefited from a prior quarter release. If you couldrun through that once again, that would be appreciated.

Jamie Maguire

I think the reserve releases for -- as Craig mentioned,primarily are coming from the professional liability lines in 2006, 2005. Andthen at 2004, it's from both the professional liability lines and thecommercial lines, primarily general liability. We had $9.2 million of pre-taxdecrease in our reserves for 2004, which came from the professional liabilitylines and the general liability lines.

And then in 2003, we had $7.4 million of pre-tax reserves,which we released again primarily from professional liability and generalliability products. So, it's really '04 and '03 where the commercial productscame into play, and it was '05 and '06 that they were exclusively professionalliability.

Craig Keller

Mark, is your question also -- were you referring to the2006 year third quarter?

Mark Serafin - Citadel

When I look at the 146 next to the 54, I believe you saidthe reason that the 54 is so low is that also included a prior quarter releasein the calendar year in '06?

Craig Keller

Yes. What occurred in '06 was in the third quarter, we hadsuch good results in prior years that caused the actuarial department to relookat the '06 year. And in the third quarter, we actually adjusted the '06ultimate loss ratio for the entire year with some benefit in doing that thatreally was attributed to the first and second quarter results of '06 because wehad reported a higher loss ratio initially for those first two quarters, andthat benefit ran through the third quarter of '06 and those two prior quarters,which was, I think, approximately $14.4 million.

Mark Serafin - Citadel

Great. That's helpful. And then the expense ratio in thequarter, I know you had mentioned earlier. Can you articulate what the top 2drivers are of the expense improvements?

Jamie Maguire

I think first is the cat reinsurance. We negotiatedsignificantly lower cat reinsurance in our June renewal. So that means thatwe've got more net earned premium coming through as a result of lower catcosts. And then to a lesser extent, there was some guarantee fund assessmentslast year, which didn't appear this year, which was a benefit and helped lowerthe expense ratio.

Mark Serafin - Citadel

Thank you very much.

Operator

We'll take our next question from Scott Horsburgh withSeger-Elvekrog.

Scott Horsburgh - Seger-Elvekrog

Congratulations on another terrific quarter. The question Ihad related to pricing by segment.

Jamie Maguire

Okay. I think we have a slide on that, if you go back toslide -- page 21 of the presentation. It looks at the rate changes for each ofthe two segments.

Scott Horsburgh - Seger-Elvekrog

Got it. Thank you very much.

Jamie Maguire

Okay.

Operator

(Operator Instructions) And it appears there are no furtherquestions at this time. Mr. Maguire, I would like to turn the call back over toyou for any additional or closing remarks.

Jamie Maguire

Great. Thank you. I just want to thank our employees againfor a great quarter. It's obviously getting more difficult out there from acompetition standpoint, and I appreciate and really thank you for challengingyourselves to do better and help us post such great results. I want to thankour producers and our agents for their profitable business, and ourshareholders and analysts for your support and confidence, and we will talk toyou next quarter. Thanks.

Operator

Thank you, ladies and gentlemen, for your participation ontoday's conference call. You may disconnect at any time.

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