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Executives

Kevin Clinton - President and Chief Executive Officer

Frank Freund - Chief Financial Officer

Ann Storberg - Vice President of Investor Relations

Analysts

David Lewis - Raymond James

Amit Kumar - Fox-Pitt Kelton

American Physicians Capital Inc. (ACAP) Q4 2007 Earnings Call February 8, 2008 10:00 AM ET

Operator

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

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

Ann Storberg - Vice President of Investor Relations

Thank you Loraine and good morning everyone. Thanks for your interest today in American Physicians Capital as we discuss our fourth quarter and year end 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 be also available on our website.

Our 2007 earnings release is posted on our website located in the for investor section under press releases. Also for your convenience, a complete transcript of this call will be posted on our website in the forum investor section under webcast as soon as it is made 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're 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 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 the call for questions and I'm going to turn the call over to Kevin.

Kevin Clinton - President and Chief Executive Officer

Thank you Ann and hello everyone. We are pleased to announce our fourth quarter 2007 results. The fourth quarter was another excellent quarter for APCapital. Net income for the quarter was $12.7 million or a $1.19 per diluted share compared with net income of $11.4 million or $1.06 per share for the fourth quarter of 2006.

In addition to our earnings I would like to review some of the highlights of our professional liability line of insurance for the year with you. First of all is our strong reserve position. Since December 31st, 2006 our open claim count has decreased by 23% from 2,256 open claims to 1,741 open claims. Yet our total reserves decreased by just 3.5% from $552 million to $533 million. Our IBNR reserves during this time period increased by $38 million.

The second highlight is our reported claim count has decreased. In 2007 we had just 952 claims reported compared with 1,168 claims reported during 2006, an 18.5% decrease for the year. Our rates in our premium did not decrease by 18.5% in 2007 and therefore we collected more premium dollars per reported claim in 2007 than we did in 2006.

The third highlight is that we are retaining our insured positions despite strong competition our insured doctor count is just down just 2.5% from year end 2006. Our premium in down because our pricing is lower, and we are comfortable with the rate decrease because the very same data that is indicating reserve releases at year end is also indicating we can reduce our pricing and still meet our profit objectives.

The fourth highlight is our capital management. During 2007 we were able to repurchase approximately 1.472 million shares of stock which represented about 12.7% of our company’s total shares outstanding as of 12/31/06. We believe our stock buybacks has had a significant positive impact to our earnings per share for our share holders.

The final highlight is our investments. With all the difficulty in the subprime market we incurred no subprime losses in 2007. We have an effective yet conservative investment policy.

And finally, I want to reiterate that our company is focused on maximizing our bottom line not our top line. For people who are looking for significant top line growth in this market keep this in mind. There are several medical malpractice companies who in the past were focused on top-line growth. PIC out of Pennsylvania, PHICO which is a Pennsylvania Hospital Insurance Company, [MIX] out of New Jersey and the Virginia Reciprocal.

Problem is none of those companies exist anymore. They are all insolvent. We are focused on maximizing our return on equity which includes growth, but growth at the right time.

Once again, I want to thank you all for your continued interest in our company and your commitment to us. And I'll turn it over to Frank.

Frank Freund - Chief Financial Officer

Alright thanks Kevin and good morning everyone. As Kevin highlighted, APCapital completed a very successful 2007 generating net income of $12.7 million or $1.19 per diluted share in the fourth quarter. This brings our total net income for 2007 to $52.8 million or $4.73 per diluted share. This represents a return on beginning GAAP equity of 19.6%, net income is up 22.2% and earnings per share are up 34.4% over 2006 results. Our book value per share is up 11.9% in 2007 and we paid our first shareholder dividend in the third quarter.

The most significant component of our 2007 results was the performance of our medical professional liability book of business, both current year results and development of prior year reserves. Through years of careful pricing underwriting and risk management our medical professional liability book has become very stable and profitable generating an accident year loss ratio of 74.6% in 2007 and 75.7% in 2006.

Due to the somewhat soft market conditions in 2007, our focus was on policyholder retention and limited growth in selected markets. Through small rate reductions and careful use of credits, we were successful in retaining 85% of our accounts in 2007, while only reducing our effective rates by 7.8%.

We were able to add over $8.50 million of new premium focusing on lower risk specialties in lower cost jurisdictions. The combination of the lower rates, the net 2.5% decline in insured physicians and fewer higher risk specialties resulted in a 13.7% decline in direct written premiums. At December 31 2007, we insured just over 9,200 physicians.

The development of reserves established on prior year claims was very good in 2007. We continue to experience a significant decline in claim frequency. We had 952 new claims reported in 2007 down 18.5% from 2006 and down 37.1% from 2005. In addition, claim severity has remained fairly flat.

We believe the decline in claim frequency is attributable to three factors, one our high quality book of business, two, greater social awareness concerning medial malpractice cost, and three, our aggressive but intelligent claims management strategy, which we believe has significantly reduce non-notorious claim actions against our insured's.

As a result of declining claim frequency and flat severity, reserving assumptions made on past accident years have proven to be very conservative. Accordingly as actual development emerges we've had to adjust our original reserve estimates downward.

During 2007, we reduced prior reserve estimates by $34.2 million or 6.2% at the beginning year end net reserves. This favorable development emerged in all of our professional liability markets. Included in this positive reserve development was an increase of $4.2 million on a runoff workers compensation reserves.

Despite these reserves take downs in 2007, our overall reserve position is still very strong. Our open claim count at December 31 2007 stands at 1,741 and as Kevin highlighted that's down 23% from a year ago. Our average case reserves continue to increase and is currently at $144,800 per claim compared to an average paid claim in 2007 of $67,500.

We also continue to add to our IBNR reserves, which were up $38 million or 18.9% this year. Our workers compensation open claims now total only 271 claims, down 24.1% from the end of last year. Our independent actuary again has our recorded reserves above their best estimates.

Another key component to our 2007 results was the performance of our investment portfolio, again as Kevin highlighted we incurred no subprime related losses in 2007 and our portfolio generated solid 5% return.

All of our mortgage backed securities were issued by government sponsored agencies and all our insured tax exempt securities have an underlying rating of A or better and are essential purpose funds. We currently have 31.3% of our portfolio in tax exempt securities. Our 5% return in 2007 is down from the 5.3% generated last year; we would expect a similar decline next year as interest rates continue to come down.

Our seeded premiums in 2007 were down 54% from 2006 and totaled $4.6 million. This is only 3.4% of direct written premiums as compared to a seeded percentage of 6.4 in 2006. This decrease was a result of changing our reinsurance structure while we moved our effective retention from $750,000 to $1 million per claim. However, we were able to add a clash or per event coverage. We've renewed a similar program for 2008.

We continue to focus on controlling expenses. However our underwriting expense ratio increased from 20.4% in 2006 to 21.7% in 2007. This is primarily the result of our lower premiums rates and volume. Our other expense category remained relatively flat despite an increase in interest expense.

Our effective tax rate increased to 32.5% in 2007 primarily which resulted the higher pretax income. During the year we utilized the remaining unrestricted net operating loss and AMT credit carryforwards. As a result our actual taxes paid in 2007 increased by $9 million causing the decline in our cash flow from operations.

During 2007, we repurchased approximately 1,473,000 million shares for $57.7 million an average of $39.23 per share. Our shareholders equity is $263.6 million or $26.02 per share an increase of 11.9% from the end of 2006.

We have $221.6 million of statutory surplus at our insurance companies plus another $10.5 million of available surplus at our holding company. Our 2007 net written premiums to surplus ratio was down to 0.59 to 1.

We continue to be careful and flexible managers of capital, profitable growth or M&A opportunities are not available. We will continue our share repurchase and dividend strategy. We have $46.4 million of buyback authorizations at December 31, 2007 and yesterday our Board approved an additional $25 million of discretionary authorization as well as the first quarter 2008 dividend.

We also have the opportunity to pay down our trust deferred debt in the second half of 2008, although recent declines in 30 day LIBOR has reduced the carrying cost of this debt. We have $41.4 million of cash at the holding company at December 31, 2007 to fund these initiatives.

We remain flexible and proactive with our capital management. The company begins 2008 in good financial condition with a solid book of business and a strong balance sheet.

That concludes my comments on the quarter. Kevin?

Kevin Clinton - President and Chief Executive Officer

I will ask you to open it up for questions.

Ann Storberg - Vice President of Investor Relations

Loraine, we open up the call for questions?

Question-and-Answer Session

Operator

(Operator Instructions) And your first question comes from the line of David Lewis with Raymond James.

David Lewis

Thank you. Good morning, congratulations on a solid quarter.

Kevin Clinton

Thank you

Frank Freund

Thank you

David Lewis

Claims frequency was down 18.5% in '07. Kevin, I know this is a gut feel question, but what's your thoughts obviously you can't keep going at that rate we'll go to zero. But no way do you think some of the trends that you benefited from over the last couple of years will continue and is it kind of mid single-digit upper single, just what's your best guess at this point?

Kevin Clinton

Well, I think our claim frequencies have been roughly cut in half over the past three or four years. I certainly expect that the level up. But one of the phenomena going on right now in the market is its very expensive for plaintiff attorneys to bring lawsuits. I mean, the witnesses that they have to hire costs a lot of money. We're going to make it very difficult on them and make them spend money. And so I think that is part of the reason that the claim frequency is down, which is a good thing for us.

Is it going to continue at this rate? Absolutely not, I mean it would be zero in a few years. So it's going to level off. Will it go down a little bit further? Potentially, but our anticipation that we've actually had in our rating assumptions is that maybe where its hit right now is maybe even a little bit too low. What I am anticipating, that it's going to necessarily remain at the lowest point. Does that help?

David Lewis

That does help, and just couple of other questions. First, any guidance on net premium written declines in 2008 and what kind of overall rate reductions you would anticipate?

Kevin Clinton

We haven't projected that yet. What we do is we look at various states throughout the year we try to spread our workload out. So, we will look at states throughout the year and we rate them based on their own individual data. So, I don't anticipate major changes. I mean, that's just of the top of my head. Major changes in rates, you might see some slight decreases, because as we said this claim frequency is going down but [quite better] have that then and have our costs going up by 15% and our premiums are only going up by 5%.

David Lewis

But a lot of your competitors have said that rates are probably coming down somewhere, and you know may be 5% to 10% range. Would you think that is reasonable for your book as well?

Kevin Clinton

Potentially, but I will say we'll break each individuals data on its own.

David Lewis

I understand. Thanks so much.

Kevin Clinton

Okay.

Operator

(Operator Instructions) And your next question comes from the line Amit Kumar with Fox-Pitt Kelton.

Amit Kumar

Good Morning, congrats on the results.

Kevin Clinton

Thank you

Amit Kumar

Just starting with the guidance of $4.25, I don't know if you can, but can you just go through the components, how did you get to that number?

Kevin Clinton

Well, let me start off by saying may be the purpose for the guidance. We earn $4.73 this year, the consensus estimate was buck lower, and we looked at that, so we probably have a lot of confused investors out there. Either the sky is falling in for our company or something's wrong. We want to give some guidance that basically said; we expect that this company is going to do very well and earn at least $4.25 a share next year, and have even a better year the following year. So we want to give some guidance and we felt that we owed a duty to our shareholders. We have not gone through and tried to individualize and break up the components of that, we have not given any guidance on that.

Amit Kumar

And I guess it would be fair to say that the reserve release component is higher than '07, right?

Kevin Clinton

No, we haven't given any guidance on it. I mean, you could look at it in a number of ways if you want to. As we reported our outstanding claim count decreased pretty significantly about 23%, we went from 2,256 claims to 1,741. We added $38 million to IBNR this year. If we didn't add $38 million of IBNR this year, our earnings would have been up, roughly $2.5 a share. So I think; we have very strong reserves, going into 2008.

Amit Kumar

Okay, maybe we can talk about this offline. Secondly; I think you mentioned that 85% of the accounts were retained. Can you just talk about what happened to the other accounts, what was it, like terms and conditions or was that competition coming in, and taking those accounts?

Kevin Clinton

Yes. We probably account our retention differently than other companies, because if a doctor retires, moves out of state, joins another group, a lot of companies say well that's an account we never had a chance at, so they don't count it under renewal we do. So its a combination, its price competition, I don’t think generally its terms and conditions, it would probably be that the doctor moved out of state, retired, died, whatever, became disabled or went to another company.

Amit Kumar

Got it, okay. And just moving on in terms of the share buyback, obviously I saw the press release, which came out this morning. Is that, first of all, what could be the timing, and secondly is that a thing that signals that there isn't something interesting on the M&A front and perhaps you can also talk about, I think now its in the public domain, regarding Skippy and does that market still interest you?

Kevin Clinton

You asked a bunch of questions there. First of all, on the buyback, this is a discretionary buyback. So we will evaluate the price of our stock in buyback, on discretion. So we don’t have necessarily a set plan on that, we do have the 10b5 out there which is a formalized plan that we buy, but we don’t on the discretionary. So we are going to evaluate our stock price and buy on an opportunistic basis I think. So there is no necessarily set plan there. And when you say there might be something on the horizon, if we knew of something on the horizon, we would not be able to utilize that discretionary plan. That would be insider trading, so we wouldn’t be able to use that. We just have this right now on our back pocket that we’ve been use it at our discretion. And what was your third question?

Amit Kumar

Regarding Skippy, and I think obviously you've seen those proxy filings and it talks about your bid and your interest. So, is that something which still interests you or have you sort of moved on?

Kevin Clinton

Yeah. We were named in there, I think probably with a little bit of research you can figure out roughly what our bid is based upon what's [the key], put in there and you can probably determine what the exchange ratio was based upon Skippy's filings. But other than that, we are still under a confidentiality agreement on that. So, I guess I can’t speak about anything else more than, I think what they put in their filing.

Amit Kumar

Okay, and then I guess final question. I'll re-queue. If I look at the list of equities you own, you have ownership of American physicians AMPH. Is that more of a passive interest or is that a pointer of things to come?

Kevin Clinton

Well, they came out with the secondary offering, we like to price on it. I think, we bought 4.5% of it and we made some money on it, and we’re just going to hold it for now.

Amit Kumar

Okay and I guess a final question. Previously I think you’ve gone through the states and talked very briefly about that the trends in each and every state. Can you update us on that?

Kevin Clinton

Yeah. We are kind of the hometown people in both Michigan and in New Mexico, because it is our home state here and actually we purchased the or we merged it with the New Mexico Medical Company, were sponsored by the medical societies in both states and those states have always been very favorable to us, and we expect will continue to be.

Ohio, it just seems that everybody is staying with the company they have. Our policy holders are other people are staying with them. But Ohio has been a wonderful state for us. Their tort reform really has taken effect it has produced wonderful results for us and for the doctors in that state. Kentucky just we're just kind of waiting until I think maybe something happens there. They put some type of tort reform in or something because it's a very difficult state to do business in.

And Illinois remains competitive we've added some new captive agents. They have overturned tort reform at least in Cook County. They have over during tort reform has very, very little affect on us. We never anticipated it was going to hold anyhow. We didn't anticipate it any extent in our rates or our reserves and really the claim success we've had in court are claims that are five years old and really the tort reform has not taken hole on those claims. It was not effective until after the effective date of the act.

So the success we've had there in court has not really been due to tort reform. So I think Illinois is going to continue to be a question mark. I doubt very seriously that maybe some of our competitors that gave the full effect of tort reform I think they maybe scrambling a little a bit now, which could be helpful to us.

Amit Kumar

Okay. This is very helpful. Thanks, and congrats once again.

Kevin Clinton

Okay. Thank you.

Operator

And your next question is a follow-up from the line of David Lewis with Raymond James.

David Lewis

Thanks, just couple of questions. Frank, I think you mentioned something about your outlook for investment income, it was down 4% in '07. I didn't catch what you said if you did refer to that, but would you expect something similar in '08?

Frank Freund

Yeah that's what I said. Just, especially where short term rates are going…

Kevin Clinton

And with the buy back.

David Lewis

Okay and what's the outlook for tax rate, you think somewhere in the 32% range depending on underwriting profitability?

Frank Freund

Yeah and we haven't like in terms that we didn't get the whole details but again looking at our investments and tax exempt securities, that's probably where we'll end up.

David Lewis

Okay and was there any comment that you can provide us on reinsurance renewal rates as related to '07? Are you getting savings there, I don't know what's happened in the medical malpractice market in particular but most reinsurance rates are down in '08 versus '07.

Frank Freund

Yes, we don’t have a lot of cost in the reinsurance area any more.

David Lewis

Yeah I know it.

Frank Freund

It's not all that significant. So I think we're probably going to be roughly the same as we were last year.

David Lewis

Okay.

Kevin Clinton

Yeah, the seeded premiums were only $4.6 million, so.

David Lewis

Alright, thanks very much

Operator

And there are no further questions. I'll now turn the call back over to Mr. Clinton for closing remarks.

Kevin Clinton

Yeah, I was just going to make one comment on the reinsurance. Frank mentioned that we have a higher retention per claim and we do. On each claim we have now up to $1 million dollars where we've been scaling it up over time from $0.5 million to about $750,000. What we retained, we've actually seeded more on a an event that may incur and that would involve two or three doctors.

So it may have been in the past if you aggregated all those claims we're taking more on the small claims and less retention on the large claims, we're actually seeding more reinsurance on the large claims than we did in the past. So that’s really the type of reinsurance we wanted, we had it priced out last year we were very pleased with it. We are again, but thank you for joining us and have a great day. Thank you.

Operator

And thank you for your participation in today's conference. This concludes the presentation and you may now disconnect. Good day.

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Source: American Physicians Capital Inc. Q4 2007 Earnings Call Transcript
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