Executives
Joe Barnholt - Director of Investor Relations
Sean Sweeney - Executive Vice President and Chief Marketing Officer
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
Philadelphia Consolidated Holding Corp. (PHLY) Q3 2007 Earnings Call October 25, 2007 3:00 PM ET
Operator
Good day, everyone, and welcome to today's Philadelphia Consolidated 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 Joe Barnholt, Director of Investor Relations. Please go ahead, sir.
Joe Barnholt
Thank you. I would also like to welcome you to Philadelphia Insurance Companies' third quarter 2007 earnings conference call.
Please be advised that certain information included in this presentation and other statements or materials published by the company are not historical facts, but are forward-looking statements as defined by the Private Securities Litigation Reform Act of 1995.
Please refer to the company's annual report on Form 10-K for the year ended December 31, 2006 and its past and future filings and reports filed with the Securities and Exchange Commission for a description of the business environment in which the company operates and the important factors that may affect its business. Philadelphia Consolidated Holding Corp. does not intend to publicly update any forward-looking statements except as may be required by law.
I would now like to introduce the members of our management team who are joining me this afternoon. First of all, I would like to introduce Jamie Maguire, our President and CEO, who I will turn the conference over to shortly. Also joining me is Sean Sweeney, Executive Vice President and Chief Marketing Officer; Craig Keller, Executive Vice President and Chief Financial Officer; and Chris Maguire, Executive Vice President and Chief Underwriting Officer.
A replay of today's conference call will be available from 5:00 p.m. today until November 8, 2007. You can access the replay by visiting the company's website, phly.com. Additionally, our supplemental financial information has been posted on our website.
In order to access this information, click on Investor Center followed by Reports. Please feel free to contact me with any follow-up questions or requests. My direct dial is area code 610-617-7626 and my e-mail address is jbarnholt@phlyins.com.
I now will turn the conference over to Jamie Maguire, our President and CEO.
Jamie Maguire
Thanks, Joe, and welcome to everyone listening in on the conference call and those of you listening in over the web. Hopefully, you've had a chance to review our press release, which we put out earlier today. We do have supplemental financial information also, as Joe mentioned, on our website that details the quarter. And it also includes the presentations that I'm going to go through during this call.
I would like to just thank our employees for another great quarter. We had an excellent quarter. Great execution, great teamwork in what has become a more competitive market, and we'll talk more about that throughout the presentation.
Moving to page three, the agenda for our presentation. As is customary, I will talk about the financial highlights for the quarter, including some of the financial results, segment information, touching on our investment portfolio, looking at some of the selected operating statistics for the company and then talking about the drivers of the future for our company, our 2007 expectations and then taking your questions and providing some answers.
Moving to page four, third quarter highlights. $504.6 million of gross written premiums in the quarter compared to $456.6 million this time last year. That's a 10.5% increase quarter-over-quarter. We did have some continued dehydration in our personal lines of business, which I'll go into, which, if you remove that, we grew about 15% in the quarter gross written premiums 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 contributed meaningfully to the quarter versus roughly $9.5 million of new product premium this time last year. Included in those new products are religious organizations, health and fitness business and entertainment package, among many others. And I'll touch on that later on in the presentation.
We had about a 26%, 27% growth in our net investment income in the quarter, very good cash flow in the quarter, roughly $141 million, which contributes to this income growth. We invested primarily in municipal bonds. That's where we saw the opportunities in the quarter. And then to a lesser extent, in mortgage-backed securities and asset-backed securities, primarily triple A-rated instruments.
We had a 7% increase in net income, and I'll get into that in a little detail. That's a little misleading. We did have significant reserve redundancies last year, which I'll touch on. When you normalize, we had an excellent growth year-over-year on our net income.
For the quarter, we had a 40.3% loss ratio. That includes 11 points of reserve releases from prior accident years compared to a 28.6% loss ratio in 2006. We had roughly 14.4 points of reserve releases in the third quarter of last year. We had a 28.2% expense ratio, which compares favorably to this time last year, which was 30%.
The decrease in the loss ratio came as a result primarily of lower reinsurance, cat reinsurance costs, which we negotiated in June of this year. They were significantly down from this time last year, and that has benefited with us a lower expense ratio.
Moving to page five, our operating income, $94 million in 2007 compared to $94.4 million in 2006. And this is where I want to talk a little bit about the reserve releases last year versus this year. Last year, we had $27.8 million of redundant reserves. In addition, we had $9.6 million of benefit by reducing our accident year loss ratio, which, when you normalize the operating income for those two items, it's $57 million in 2006.
We had, this year, $94.4 million, with $25.7 million of reserve releases, normalized $68.7 million of operating income, so $57 million last year versus $68.7 million this year, a 20.5% increase in our operating income quarter-over-quarter. And I think that's what we need to focus on here as the organic engine continues to generate profitable growth to the tune of 20.5% for this quarter.
So clearly an excellent result. This is a real tribute to our differentiated approach to bringing business in. We've talked about this a number of times. The fact that we drive the pipeline, we drive the submission flow, and we're seeing net growth come through to the bottomline in the way of solid operating earnings.
That also translates into a 20.8% increase quarter-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 a 20.8% increase in our operating earnings per share quarter-over-quarter. And you 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 grew our shareholder's equity from the end of last year by 24%. Total shareholder's equity is just shy of $1.5 billion. The book value per share is now $20.23, a 22% increase from the end of last year. And I should point out our quarter-over-quarter increase of 32%.
This time last year, our book value was $15.24. $So we've increased our book value significantly quarter-over-quarter, a 32% increase.
Shares outstanding have remained relatively constant from the end of last year, and we had a solid return on equity of 24.9%, which includes the reserve releases. Excluding reserve releases, we were roughly 22%.
So clearly, we're making very good use of our capital, and we're going to continue to need our capital as we see opportunities in the market and as we see the need for the A-plus rating for our insurance companies.
Page seven, the third quarter events, which reconciles our operating income, a very simple slide this year -- or this quarter, $25.7 million of favorable prior-year reserve development, which was $0.35 in the quarter.
And moving to page eight, it details exactly where those reserve releases came from, primarily in professional liability for 2006, '05 and '04, and then to a lesser extent, including general liability, for 2004 and 2003.
So we've seen very good trends in our professional liability book. The prior-year accident loss ratio picks that we had made were very conservative, and we've seen positive trends. As a result, we've been able to take 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 has become a very competitive marketplace, especially for larger accounts in excess of $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. So we're primarily below that level. So the competition for the larger accounts is a smaller part of what we do. Net investment income, 30.6% growth over the nine-month period last year and 19% growth in our net income. And then you can see the combined ratio year-to-date, 73.3% versus 68.3%.
We've had an increase in our property losses for the year and that's attributed to a little bit higher loss ratio for this year versus last year. We don't see any trends there. We see that really is related to weather-related incidents throughout the year.
Page ten, reconciling our year-to-date highlights for an operating income, $235.4 million of operating income versus $221.5 million. When you remove the reserve releases and the adjustments for the accident year loss ratios, we have roughly a 17% increase in our operating income for the nine-month period year-over-year.
And that goes as well for the earnings per share. So we continue to see very good growth in operating income. Again the organic engine continues to fuel our growth, and the new products are beginning to take hold and contribute to that topline growth.
Page 11, year-to-date events reconciling our operating income from a year-to-date perspective. The reserve releases totaling $47.6 million equates to $0.64 for the nine-month period. And then we had realized investment gains, primarily last quarter, as a result of moving to a new equity manager, $14.4 million, which is $0.19 for the nine-month period.
Page 12, the reserve releases for the year basically are coming from professional liability, property, general liability and auto, so primarily across all lines of business for prior accident years. We're seeing favorable claims development as a result of negotiating very big claim settlements by our claims department professionals and just better experience overall in our book of business.
Page 13, gross written premiums by segment. These are three reportable segments. Our commercial lines segment grew by 15.6% quarter-over-quarter to $425.1 million. The specialty lines segment grew by 9.4% to $68.5 million, and we continue to dehydrate our personal lines operation, 58% negative growth down to $11 million, most of which is flood premium, where we administer the flood insurance on behalf of the National Flood 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 very good growth.
Page 14, on a nine-month basis, on a year-to-date basis, the commercial lines segment has grown by nearly 21% over the same period last year. Our specialty lines business grew at 18.1%, and we de-emphasized the personal lines business. 34.2% year-over-year growth for that particular segment. Looking at just the commercial and specialty again, 19% growth for those two segments year-to-date, year-over-year.
Page 15, our commercial lines segment, which is most of what we do, 84% of our third quarter gross written premium. We've had a compound annual growth rate in this product from 2001 to the present of roughly 30%. So this has been a significant area of growth for our company.
15.6% growth quarter-over-quarter, as we've gotten to be a larger company, 20.9% year-over-year growth for the nine-month period. We've seen growth in a lot of areas with the commercial lines segment.
The condominium associations, we saw a roughly 93% growth quarter-over-quarter to $36 million. Our homeowner's association product grew by 75% to $9 million, and we've seen some growth in our health club package business, 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 that contributed 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 a dead start contributed $9.1 million in the quarter, and entertainment package was 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. The total new products, as I mentioned earlier in the call, $25 million versus roughly $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 have commercial buildings in Southern California.
So far we have one claim that's been reported to us as a result of the fires in Southern California. I think it's too early, really, to tell what our ultimate exposure is going to be there. We've monitored the location of our accounts. But I think over the next few days, we're going to get a better sense of what our actual losses will be.
Moving to page 16, our specialty lines segment, professional liability is roughly 14% of our third quarter gross written premium. We've had a compound annual growth rate of 24% roughly in this segment over the last five years, 9% growth quarter-over-quarter, 8% year-over-year.
Non-profit D&O seems to be a real good grower in this particular area, 16% growth quarter-over-quarter to $24 million. Our private company 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 good growth out of our professional liability products.
This is smaller, transactional business, where it's a lot more difficult to move the topline, but I have to give due credit to our specialty lines department who has done a great job, turning the quotes around, being very responsive to our producers and growing significantly from a submission 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's business. 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 this season.
We've had no hurricane activity. The weather activity has been very cooperative. But it still continues to be very challenging regulatory environment down there. So we continue to de-emphasize this particular segment of the company.
Moving to page 18, our investment portfolio continues to be very 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 an average quality of triple A. That's been consistent quarter-over-quarter. Our portfolio duration is just under five years at 4.9, and we've got a taxable equivalent yield on the fixed income portfolio of 5.5%.
Our stock portfolio, which is roughly 12% of the total investments, our quality long-term gross stocks, we have four managers, a growth manager of value, a small cap and an international manager. So we continue to look for opportunities within the common stock area to help build our book value for the company.
Page 19 drills a little deeper into the phenomenon of the sub-prime issue, and the sub-prime issue is not an issue for Philly Consolidated. As you can see in the middle of the page, we have $9 million of sub-prime loans. They are triple A-rated primary cash flow tranches. They have a 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 part of our portfolio will continue to perform without any kind of hiccups and any kind of problems.
Page 20, the investment income. We had good growth, 27% quarter-over-quarter, contributing to our earnings in the quarter. That came as a result, as I mentioned, of good operating cash flow, $141 million of operating cash flow in the third quarter compared to $88 million in the second quarter of '07. That's a 60% increase from the prior quarter. And we put most of 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 retention continues to be very good. It's a competitive market. We have a number of companies that have identified Philly as a target, but we continue to renew our business. We have good loyalty from our producers and our policyholders.
We have an excellent service model that provides the policies on a CD, where we can e-mail the policies as PDFs, and I think the overall offering by Philadelphia Consolidated of better service, a better product and our high-quality securities helped us hold on to our business.
The rate changes, obviously, are coming down, 3.8% decrease quarter-over-quarter, a 1.8% decrease for the professional liability products. As I mentioned, we're seeing more competition on larger accounts. The new business 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 smaller policies contributed significantly to that policy growth, and then to a lesser extent, our non-profit directors' and officers' liabilities saw good policy growth in the quarter.
Page 22, some more operating statistics. Our preferred agents now number 204. That's up roughly 19% from this time last year when we had 172 preferred agents. These are our key partners that have our interests in mind. We've sold out $49 million of gross written premium growth in the quarter from this group, which is a 33% increase quarter-over-quarter.
Renewal retention was at about 95%, which is consistent with our overall book, and then we saw 41% increase in new business from this group to $13.4 million. As of the end of the third quarter, we're just over 1,300 employees coast to coast versus roughly 1,200 this time last year.
So we've increased our employee count by roughly 12% from this time last year, but we've remained efficient. The measure of efficiency is our gross written premium per employee. That's remained at $1.2 million. That's where it was this time last year.
So again, I have to give credit to our employees, who are doing a super job at making it happen, executing everyday and delivering these kinds of results that I can report to Wall Street on the earnings call. Our turnover 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 our national presence in our mixed marketing, our proactive approach to controlling the distribution, controlling the growth, and that's going to become a real differentiator as we move into a competitive market, being able to control our distribution and then also having the benefit of prescreening the business, so that we have hit ratios in the commercial lines area of 50%-plus and in our professional liability area of 30%-plus.
So it becomes a more efficient model by incorporating the distribution 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 existing products, at least in the short-term. We have a number of new products that we'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 consolidation in the industry with ample capital with good, combined ratios from other companies. We think there is going to be consolidation, and we'll be the beneficiary of that consolidation to the extent there are lines of business or products that the consolidated entity wants to get out of, we'll be there to pick that up as it presents an opportunity.
We have our experienced management team. Obviously, we're very disciplined from an underwriting and pricing perspective. We continue to invest in our technology platform because we think that that's a differentiator for the company, being entirely web-based company, which helps improve from a speed of service standpoint will translate into higher retention ratios for our renewal business and better new product opportunities for new business.
We're going to maintain our A-plus rating from AM Best because we believe that, as the market consolidates and as our regulatory actions, having the strong rating will make us the clear choice for producers to place their business with. And then our goal for our preferred agents is to grow the premiums 15% quarter-over-quarter, which we've done.
Page 24, expectations for 2007. Our operating earnings per share 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 the higher property loss ratio for the year, which I've mentioned. It also assumes one catastrophe loss for each of our two cat towers, $10 million for our commercial lines, $3.5 million for our personal lines business.
We anticipate organic growth approximating 15% for the balance of the year. We're looking at a combined ratio approximating 80%. We think our renewal retention levels will remain above 90%. The investment environment is clearly in transition, especially with what's happened in today's market. And we anticipate increased competition, mostly on the larger accounts to a lesser excellent in the lines of business that we do.
That concludes my presentation. At this point, myself, and my team would be willing to take your questions.
Question-and-Answer Session
Operator
(Operator Instructions) We'll go first to Mike Grasher with Piper Jaffray.
Mike Grasher - Piper Jaffray
Good morning. Congratulations on the quarter. Good afternoon. 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 you actually 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 would have 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 are you looking to do when you get a new line established in, I guess, the first year?
And then how do you think about the, I guess, the growth rates after the first year? So by year two, you would like to see it growing X amount, 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 and aquariums, if that might be what you're referencing. We'd like to see a product aggregate about a $5 million range within the first 12 to 18 months and then grow at about 15% a year thereafter with the caveat that it has to be profitable 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 a base?
Jamie Maguire
I think it's a good base to go with. I mean we're hoping that we're going to see some efficiencies from some of our technology that we're going to implement over the next year or two. So I think in the short term, 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 Philly as 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 radar screen. 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 good market to go after. I don't think it's not singling us out, per se. We're just seeing 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'm just thinking that at this stage of cycle, I wonder if those accounts are looking for customization or if they're more price sensitive? If you are growing at this stage of the cycle, who would be losing those type of accounts?
Jamie Maguire
For example, in the religious organizations, there were programs that were put together on a national basis, and they had been hurt with the Katrina-type losses. So we would be taking them away from specialty programs where maybe an Arthur Gallagher had a program with a particular insurance company.
You may have a niche underwriter like a GuideOne, who we might have some opportunities with. Brotherhood Mutual, Church Mutual are religious organization competitors, so we might be taking business away from them.
On the smaller accounts, taking business away from our competitors -- there is value add in our "ten reasons why" in the coverages that we're offering. So there is a reason why they might move, and that's kind of what we're focusing on. A lot of our competitors are managing general agents that might have depend from markets. So I think with our financial result and the "ten reason why", that is a reason for them to consider us.
Amit Kumar - Fox-Pitt Kelton
Okay. Got it. In terms of the loss on large accounts, can you 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 large schedule of property, office parks, office buildings, hotels. And typically, you're looking at a real estate schedule in excess of $20 million. And that's usually 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 I look at the quarterly trend, it seemed to be in like a $15 million, $20 million range in the past, I think, three quarters. I'm just wondering, what changed from Q2 to Q3, which resulted in such a large reserve release?
Craig Keller
Amit, this is Craig speaking. You know, we do what actuarial department does full quarterly reviews each quarter, and a lot of the releases in this quarter were expected case development and professional liability lines that had been expected and they just weren't coming.
And it gets to the point that during these actuarial reviews and where they are in their trending, if their trends aren't correct, they need to be adjusted. And I think that's what happened, at least in the special liability lines this quarter.
Jamie Maguire
I mean the experience is just coming in much better than what we expected, and at some point, you have to bring those reserves into income 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've expected, which is a good thing.
Amit Kumar - Fox-Pitt Kelton
So the Q4 -- would the Q4 reserve review be similar to the Q3 reserve review? Or would that be more comprehensive in nature?
Craig Keller
No, they're not comprehensive. We do a full reserve review each 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 Jacobowitz with 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 earnings outlook you gave, your own earnings outlook for '07 and you talked about the cat load, doesn't that sort of imply maybe a decent amount of cats or a lot of cats for the fourth quarter? I mean what exactly are you building in the fourth quarter?
I don't know if you're counting the -- you're probably not counting that property, the weather-related property losses from the first quarter in the cat load. So it seems like you're building in a decent amount for cats for the fourth quarter.
And then the second question is, the accident year loss ratio combined ratio was, I think, around 79%. Given the way everything has worked 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, will you be making any changes in how you book your -- other than that, the current year accident year combined ratio because of the great results this year?
Jamie Maguire
Taking the second question first, I think it's too early right now. I think what we think is that the property loss ratio ticked up as a result of some weather events. So we're going to watch that through the fourth quarter. 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 clearly listed on the page here. We're still -- we haven't -- we're still in cat season. We're in cat season through November. So we have a $10 million pre-tax net for our commercial tower and a $3.5 million pre-tax net for our personal tower. 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 expense exhibit in the supplemental information, in your prepared remarks, you went through it maybe a little bit too quick for me to follow, but if you can just walk me through a couple of these numbers, specifically the commercial lines and the specialty lines numbers on the incurred loss for the three months. I'm assuming a big portion of the reserve release came out of the professional liability lines in the specialty segment, but if you could just help me sink the 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 have mentioned came in professional lines came from specialty, and that's why there's a negative incurred number. And in your prepared --
Craig Keller
Mark, this is Craig. That's correct. There was a large reserve release in the specialty Lines. I think approximately -- I don't remember exactly, approximately maybe $27 million. On page eight of the presentation is the reserve release, not only by accident year, but it does highlight which lines also.
Mark Serafin - Citadel
I'm afraid I'm running blind without the PowerPoint presentation. The commercial lines you mentioned in your prepared remarks, last year, the incurred ratio benefited from a prior quarter release. If you could run 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. And then at 2004, it's from both the professional liability lines and the commercial lines, primarily general liability. We had $9.2 million of pre-tax decrease in our reserves for 2004, which came from the professional liability lines 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 general liability products. So, it's really '04 and '03 where the commercial products came into play, and it was '05 and '06 that they were exclusively professional liability.
Craig Keller
Mark, is your question also -- were you referring to the 2006 year third quarter?
Mark Serafin - Citadel
When I look at the 146 next to the 54, I believe you said the reason that the 54 is so low is that also included a prior quarter release in the calendar year in '06?
Craig Keller
Yes. What occurred in '06 was in the third quarter, we had such good results in prior years that caused the actuarial department to relook at the '06 year. And in the third quarter, we actually adjusted the '06 ultimate loss ratio for the entire year with some benefit in doing that that really was attributed to the first and second quarter results of '06 because we had reported a higher loss ratio initially for those first two quarters, and that 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 the quarter, I know you had mentioned earlier. Can you articulate what the top 2 drivers are of the expense improvements?
Jamie Maguire
I think first is the cat reinsurance. We negotiated significantly lower cat reinsurance in our June renewal. So that means that we've got more net earned premium coming through as a result of lower cat costs. And then to a lesser extent, there was some guarantee fund assessments last year, which didn't appear this year, which was a benefit and helped lower the expense ratio.
Mark Serafin - Citadel
Thank you very much.
Operator
We'll take our next question from Scott Horsburgh with Seger-Elvekrog.
Scott Horsburgh - Seger-Elvekrog
Congratulations on another terrific quarter. The question I had related to pricing by segment.
Jamie Maguire
Okay. I think we have a slide on that, if you go back to slide -- page 21 of the presentation. It looks at the rate changes for each of the two segments.
Scott Horsburgh - Seger-Elvekrog
Got it. Thank you very much.
Jamie Maguire
Okay.
Operator
(Operator Instructions) And it appears there are no further questions at this time. Mr. Maguire, I would like to turn the call back over to you for any additional or closing remarks.
Jamie Maguire
Great. Thank you. I just want to thank our employees again for a great quarter. It's obviously getting more difficult out there from a competition standpoint, and I appreciate and really thank you for challenging yourselves to do better and help us post such great results. I want to thank our producers and our agents for their profitable business, and our shareholders and analysts for your support and confidence, and we will talk to you next quarter. Thanks.
Operator
Thank you, ladies and gentlemen, for your participation on today's conference call. You may disconnect at any time.
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