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Executives

Ann Storberg - Vice President of Investor Relations

R. Kevin Clinton - President and Chief Executive Officer

Frank Freund – Executive Vice President and Chief Financial Officer

Analysts

Ron Bobman - Capital Returns

Amit Kumar - Fox-Pitt Kelton

Walter Schenker - Titan Capital

Beth Malone - Keybanc Capital Markets

American Physicians Capital, Inc (ACAP) Q3 2007 Earnings Call October 26, 2007 10:00 AM ET

Operator

Good day, ladies and gentlemen and welcome to the third quarter 2007 APCapital Inc. Earnings Conference Call. My name is Eric and I will be your coordinator for today. At this time, all participants are in a listen-only mode. We will facilitate a question-and-answer session toward the end of the conference (Operator Instructions). As a reminder, the conference is being recorded for replay purposes.

I would now like to turn your presentation over to your host for today's call, Ms. Ann Storberg, Vice President of Investor Relations.

Ann Storberg

Thank you, Eric. Good morning to everyone. Thank you for your interest in American Physicians Capital as we discuss our third quarter 2007 financial results. As always, this call is being webcast live on our corporate website at www.apcapital.com and you can listen to a webcast replay of this call later today, which will also be available on our website.

Our third quarter earnings release is posted on our website located in the For Investors section under press releases. Also for your convenience, a complete transcript of this call will be posted on our website in the For Investors section under webcast as soon as it is available.

As always, I need to remind our listeners that during today's discussion of our financial results, management may make certain forward-looking statements under the meaning of the Private Securities Litigation Reform Act of 1995. When we use words such as will, should, believe, expect, anticipates, estimates or similar expressions, we are making forward-looking statements.

While we believe any forward-looking statements made today are reasonable, they're subject to risks and uncertainties, which could cause our actual results to differ materially. For a complete discussion of these risks and uncertainties, please refer to today's press release or the company's latest Securities & Exchange Commission filings.

Participating in today's call is R. Kevin Clinton, our President and Chief Executive Officer, and Frank Freund, our Chief Financial Officer. Kevin and Frank will begin the call with their prepared remarks and then we are going to open it up to a Q&A session. Now I'm going to turn the call over to Kevin.

R. Kevin Clinton

Good morning everyone. Thank you for joining us. APCapital is pleased to announce our third quarter 2007 results. The third quarter was another excellent quarter for APCapital. Net income for the quarter was $13.3 million or $1.21 per diluted share, compared to net income of $11 million or $0.91 per share for the third quarter of 2006.

What I’d like to do is highlight and review some of the highlights of the quarter with you. First, this quarter highlighted our strong reserve position. During the quarter we observed that our prior projections of losses proved to be too high and we released $8 million of prior year professional liabilities reserves into income, and despite this favorable experience, we added $12.3 million to our total professional liability IBNR during the quarter.

During the quarter we also reduced the number of professional liability open claim count by 10% from 2,124 open claims at the end of the second quarter to 1,913 open claims at the end of the third quarter. So, in summary, if you look at our third quarter, we have less open claims, more IBNR and a favorable runoff of prior year reserves.

The second highlight is our reported claim count has decrease. We had just 191 professional liability claims reported this quarter. That is 36% less than the third quarter of 2006 and 29% less than just last quarter. I can't explain why the reported count was so low, but I'm pleased to report the results nonetheless.

The third highlight of the quarter is that we're retaining our insured doctors. Despite strong competition, our insured doctor count is down just 1.5% from year-end 2006. Our premium is down because our pricing is lower and we're comfortable with the rate decreases we've taken because that very same data that's indicating a release of prior year reserves is also indicating that we can reduce our pricing and still meet our profit objectives.

The fourth highlight during the quarter is our capital management. During the third quarter, while our stocks showed some signs of weakness, we were aggressive buyers, repurchasing about 500,000 shares of stock, which represented 4.5% of our company's total shares outstanding.

And as you see from the press release, we have $47 million of prior authorized buybacks remaining. We believe our stock buybacks have been a positive for our shareholders. While the rate decreases have resulted in a 6.2% reduction in total revenues from third quarter 2006, our stock repurchase program has resulted in a 2.8% increase in the total revenues per share over the same time period.

Once again, I’d like to thank you all for your continued interest and commitment to our company and I would like to turn it over to Frank.

Frank Freund

Thank you, Kevin. And good morning, everyone. As Kevin highlighted, APCapital had another very good quarter, generating income of $13.3 million in the third quarter of 2007, a 20.5% increase from the third quarter of 2006. This represents net income of $1.21 per share, which is up 31.9% from the third quarter '06.

Year-to-date, APCapital has generated net income of $40.1 million, up 31.1% from this time a year ago, and earnings per share of $3.54, which is up 43.3% over the first of nine months of 2006. Through September, the company has produced an annualized return on beginning equity of 19.9% and at September 30, 2007, our book value per share is $25.61, an increase of 10.1% since the start of the year.

Our operating results in the third quarter have followed recent trends. Although we have retained a relatively stable number of insured positions with a retention ratio of 86%, our directorate and premiums are down 12.7% in the quarter and 13% year-to-date. This is due to selective rate decreases and increased use of scheduled credits due to price competition.

This has been necessary to retain many of our insured accounts. However, we remain disciplined in our overall underwriting and pricing practices. Net written premiums are down only 9.7% for the quarter and 10% year-to-date due to our 2007 reinsurance program, which increased our retention but significantly lowered our ceded premium.

Investment income is down slightly from 2006 at $10.7 million for the quarter compared to $11.3 for the third quarter of 2006. Year-to-date investment income is $33.1 million compared to $34 million at this time last year.

Our pretax average return on investment is 5.05% in 2007 compared to 5.33% last year. This decline in yield is a result of corporate bond maturities and our reallocation of the portfolio into tax-exempt securities. We have incurred no losses or impairments due to subprime mortgage exposure.

As Kevin mentioned, while premiums are down in 2007, our careful management of capital through share repurchases has resulted in an increase of total revenue per weighted average share from $12.02 at this point in '06 to $12.25 per share so far in 2007. Moving from revenues on to losses and expenses, we continue to see very favorable trends in loss and loss adjustment expense.

In 2007, the year-to-date accident year loss ratio remains very good at 74.5%, which is down slightly from the 75.8% ratio for 2006. Due to declines in frequency and stable loss severity, we've been able to recognize $25.1 million of positive prior development this year, including another $8 million this quarter. This compares to $8.1 million for the entire first nine months of 2006.

This large positive development was a result of several factors. As I noted and Kevin mentioned, our claim frequency continues to decline. Reported claims in the third quarter are down 36% from the third quarter of 2006. Year-to-date, we've had 707 new claims reported in 2007 as compared to 901 at this time in 2006, a 21.5% decrease.

Severity remains very stable and we continue to settle claims for significantly less than recorded case reserves. Our reported professional liability losses, which equals paid losses plus changes in case reserves, was only 13.7% of net earned premiums this quarter and is only 22.5% of net earned premiums year-to-date.

Despite these reserve releases, we continue to be cautious with our overall reserve position. We added another $12.3 million to medical professional liability IBNR reserves this quarter. That brings the year-to-date IBNR increase to $27.9 million. Our relationship of IBNR reserves to case reserves has gone from 77.5% at the start of the year to now 97.5% at September 30, 2007.

Year-to-date underwriting expenses are up as a percentage of net earned premium from 20.2% in 2006 to 21.1% in 2007. As a result of the lower premium, our fixed costs are increasing as a percentage of our premium, hence the increase in our underwriting ratio. However, our other expense categories have remained relatively stable. Our effective tax rate is 32.2%, reflecting our movement into tax-exempt securities.

From a balance sheet perspective, we continue to maintain a conservative, but effective investment portfolio. Our average rating is AA+ with only 4.3% of our bonds rated BBB. We keep 64.1% of our bonds in the held to maturity category and we have no sub-prime exposure. We have 31.5% of our cash in investments in tax-exempt securities and we have $81.5 million of cash in the system, which is approximately 9.4% of our portfolio.

Capital management and shareholder value continue to be key focii for the company. We paid our first shareholder dividend this quarter and yesterday the Board approved a $0.10 per share fourth quarter dividend. During the third quarter, we’ve repurchased 506,400 shares at an average cost of $37.12 per share. Year-to-date, we have repurchased 995,600 shares at an average cost of $37.48. We have $25.5 million remaining from the discretionary Board authorizations and another $21.4 million in our 10b5-1 plan.

At September 30, 2007, we have $61.2 million of cash and short-term securities at the holding company to fund our capital initiatives, yet we’ve remain flexible with our capital as our current writings represent only 0.66 of our 206 million statutory surplus.

That concludes my remarks on the quarter. Kevin, back to you.

Kevin Clinton

I'll open it up for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Ron Bobman with Capital Returns.

Ron Bobman - Capital Returns

I know you sort of begged off in the commentary as to why the number is down, but what are at least the better reasons you've heard people comment as to why claim counts are down at ACap and industry wide or at least in the states you are operating in?

Kevin Clinton

Well, I can tell you my theory. I can't explain why they were down so much this quarter. I mean that's a significant drop from last quarter and from a year ago. So, I guess the magnitude I can't explain.

I think one of the reasons, you take our state of Michigan, we’ve had the same tort environment, the same tort law since 1994. So, nothing has changed as far as that goes. But if you look at the gatekeepers, the plaintiff attorneys, they determine what claims go into the system and what claims don't. So, I don't think they're making any money at this.

It’s getting more and more costly for them to bring a case to trial. They have to spend a lot of money on expert witnesses, pay them a huge hourly rate. They have to depose our expert witnesses. This is all coming out of the attorney's pocket, if they don't lose.

And we have taken a much stronger stance in all of our states in taking things to trial. We're not settling cases easy anymore. At the end of the trial when they just want to settle it for their costs, we aren't doing it. So, I think that it is the attorneys who are weeding this out of the system. I think a lot of it has to do with we're getting a lot more tough on what we take to trial.

We're not taking bad claims to trial. As you can see, we've won about 88% of our cases we take. We're not taking bad ones but the nuisance ones and the ones that we should win, we're taking them right to the mat.

Ron Bobman - Capital Returns

Okay. Thanks. And then I had an investments question. Other invested assets - what's that include?

Frank Freund

We have one strategic equity investment. We have a little bit of development land that we've had for several years that we just sell off over time. And then there is a note receivable related to when we exited the Florida market.

We helped the group who used to work with us start their own company. And they've been paying on that regularly and that's been performing well for us.

Ron Bobman - Capital Returns

And what's the note in the land carrying amounts?

Frank Freund

The note is, I believe, about $2.5 million and the land is about $3.5 million.

Ron Bobman - Capital Returns

Okay. And so, at the beginning of the year, at 12/31/06, the $6.5 was largely the note and the land, I assume?

Frank Freund

Yes.

Ron Bobman - Capital Returns

Those numbers, I guess, don't change that much.

Frank Freund

Right. And then the strategic equity investment has developed over the year.

Operator

Your next question comes from the line of Amit Kumar with Fox-Pitt Kelton.

Amit Kumar - Fox-Pitt Kelton

Just starting with market conditions, could you perhaps go through all of your core states and talk about what you're seeing in those states?

Kevin Clinton

I think competition, in my opinion, has leveled off. I think we're in a nice, competitive environment. Probably wasn't what it was about three or four years ago. Obviously, in Michigan, we've been the number one writer of physicians for many, many years, same as New Mexico. And we're doing very solid growing in those states.

I think we're the market force to be dealt with in those two states. Ohio, I think we're holding our own. We've come through with some strategic rate decreases there and we're hoping to grow the business this year.

Illinois has been probably the toughest state where we've gotten the most competition. We've taken rate decreases because I think their tort law has been very positive, although, unfortunately, I don't think we expect that to continue. But I think we're having a more difficult time growing in Illinois because of the competition but we tend to hold our own in our renewals.

Amit Kumar - Fox-Pitt Kelton

Yes. I guess that leads to the next question in terms of acquisitions. Do you see any new opportunities for you in some new states or maybe on the coast?

Kevin Clinton

The company is interested in expanding our lines into other states. We're keeping track of the competition there and we're always interested in looking at acquisitions. I'm not sure you're going to see real huge acquisition activity, maybe over the next year, but I think it will heat up.

Companies are doing well right now. And a lot of the boards sit back and say ‘well, why do I need anything? Why do I need the change?’ But we're developing our relationships and I'm very encouraged that we can do something in the future.

Amit Kumar - Fox-Pitt Kelton

Is that a change in tone when you say you are encouraged that you'll do something in the future?

Kevin Clinton

No, I don't think it is a change in tone of anything we've said over the past several months, or several years.

Amit Kumar - Fox-Pitt Kelton

In terms of just moving on to the Standstill Agreement, can you just give some more color as to the termination of the Standstill Agreement with Joe [Stilwell]?

Kevin Clinton

Sure. The Standstill Agreement was due to expire next month. And if we did nothing, there was a provision in the agreement that if we did nothing, if we didn't terminate it the way we did, the board could have called for the resignations of Mr. Stilwell and Mr. Schneider.

So, I think what you're seeing there in the termination is a strong statement from our board, acknowledging the contributions of Mr. Stilwell and Mr. Schneider to the overall success of this company. They want to retain them on the board and they see no need to have any type of Standstill Agreement in place.

Amit Kumar - Fox-Pitt Kelton

And final question just in terms of the cycle. Do you have any thoughts as to when do you see the cycles reversing over the next several years?

Kevin Clinton

Yes. I haven't seen things get significantly worse, I'm encouraged by that. And I think things will start to turn around. We've gotten opportunities to bid on several accounts. I won't mention because some of them are in progress right now.

But we've had the opportunity to bid on several large accounts, hospital programs that are coming back from being employed physicians to employed physicians at the hospital into our marketplace. We've had recently an offshore company that decides they don't want to be offshore company anymore and their doctors are coming back into the market place.

Actually, we did grab a few of those doctors. It was about a 60-person group and we think we grabbed 15 to 20 of the doctors. And we're actually bidding on a loss portfolio transfer. It is not going to be an enormous thing on the loss portfolio transfer but I just bring that up because the opportunities have presented themselves in recent months.

Operator

Your next question comes from the line of Walter Schenker with Titan Capital.

Walter Schenker - Titan Capital

Just to make sure I understand what you said, as we saw on the way up, rate pricing takes a while to flow through the actual reported results. I believe there was a 6% figure. That is the effect on the quarter and therefore the question is on an apples-to-apples basis, what sort of rate changes have you seen?

Kevin Clinton

I'm trying to understand the 6%. I'm not sure I understood.

Walter Schenker - Titan Capital

I may have misunderstood the presentation. Let me ask the question directly instead of anything else. When fully implemented, current rates across the portfolio are how much lower than they were a year ago?

Kevin Clinton

I'm going to estimate. It’s probably in the area of about let's say 8% or something like that. And it will vary by market. That's just an estimate. I don't have anything directly in front of me.

We've taken rate decreases in most of our major states. We took a 14% rate decrease in Illinois effective March of this year. We took a 5% decrease in January of 2006 in Michigan. We took a 7% decrease this year in Ohio.

And what we're finding is that the trends have not followed past practices. The trends in frequency, in particular, are much lower than they have been in the past. And that justifies the rate decrease. But it doesn't mean that we can't meet our profit projections, because the claims are coming down, as you saw from this quarter.

Walter Schenker - Titan Capital

Okay. And obviously looking at your retention, one might conclude that the rate decreases have been sufficient to maintain your position in the market place.

Kevin Clinton

Yes. When you take a rate decrease, you certainly take the desire for the doctor necessarily to go shop that insurance. They're kind of pleased they got a rate decrease and they don't shop as much.

So, we're pleased with our retention and I think it is the same for all companies. Retention is up and it makes it a little bit more difficult for them to take our business and for us to take their business.

What we've been doing on that is getting a lot more aggressive in assigning people on the street, assigning new agents and to shake the bushes and knock on doors and show them that even though they may have gotten a rate decrease from one of their carriers, our rates may even be better.

Operator

(Operator Instructions) Your next question comes from the line of Beth Malone with Keybanc Capital Markets.

Beth Malone - Keybanc Capital Markets

I had a question about the experience you're seeing in your books of business. Can you really figure out whether that’s due to the fact that you have really pulled back from the more challenging or less attractive markets and that some of this trend is due to the fact that you're more concentrated in fewer markets?

Kevin Clinton

I will attribute it to maybe three things. One is the environment. You see a lot of companies having to decrease [inaudible]. I think ours has been substantially better than most companies and I would attribute our own internal decrease to our underwriting, which has been a lot more strict, let's say, in the past four or five years and it is going through.

I think we have an excellent underwriting department. They're doing a very good job. We got out of the high-risk specialties and the high-risk areas, which were producing significant losses for us in the past. Those were not producing a profit.

The other things we've done, as I said, we've been a lot more aggressive on the claims end of it. I think that's helping to reduce our claim frequency. If they realize that they are going to be in a big fight on kind of a nuisance claim, I don't think the attorneys are going to bring those.

Beth Malone - Keybanc

Do you think that that new strategy, is that somewhat supported by the fact that you're a little bit better capitalized now and you have a little more confidence that you can spend the money up-front to make sure these claims don't end up costing you real development?

Kevin Clinton

Yes, we have a new person in charge of claims, who took over two to three years ago. We've been instituting this new strategy in most of our states. And it takes some time. But I tell you what, because of the decrease in the number of claims, we have a lot of defense attorneys knocking on the door looking for business now because the business for them has kind of dried up.

So, what we've done internally is we've picked out the very, very best attorneys. We have a great stable of attorneys and we're not afraid to go to court with some of these attorneys. They're great defense attorneys.

We're giving our doctors a wonderful service, something they're paying us for and we would rather pay the attorney $50,000, the defense attorney, than the plaintiff's attorney $50,000.

Beth Malone - Keybanc

Yes. Okay. And can you just talk about what do you think of the SCPIE acquisition and the price and were you involved and if so - I mean maybe it is still in play, I don't know.

Kevin Clinton

I don’t think I'll comment on that one. I think if you want information on the SCPIE bid, you'll just have to read it in their proxy statement when it comes out.

Beth Malone - Keybanc

Okay. It sounds like acquisitions are always going to be challenging. It is a difficult market even in this environment. Do you see organic growth given the success you've had in these markets as being a viable thing? Can you now look at some of the states that you find more attractive and apply some of these strategies to those states?

Kevin Clinton

Yes. I do. I don't know if you want any more comment.

Beth Malone - Keybanc

I would like to know what states?

Kevin Clinton

We can grow internally.

Beth Malone - Keybanc

Do you want to comment on what states you think are more attractive than others or not?

Kevin Clinton

I don't know if we filed for rates in Michigan, but when we took a rate decrease in Michigan two years ago, we found we got, I think it was $8 million of new business coming in.

We have concentrated in Michigan because we know it. We're the market leader here. We're reviewing our rates for January of '08 and I think, we're going to take some strategic rate decreases and we're going to work with our agents to hit the areas where we see some real good opportunities. So, we're look forward to it.

Operator

It appears we have no more questions in queue. I would like to turn the call over to Kevin Clinton for closing remarks.

Kevin Clinton

I don't have any more closing remarks, but I wanted to thank everybody for joining us on the conference call. And we will talk to you next quarter.

Operator

Thank you for your participation in today's conference. This concludes our presentation.

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