Meadowbrook Insurance Group Q4 2007 Earnings Call Transcript

Feb.13.08 | About: Meadowbrook Insurance (MIG)

Meadowbrook Insurance Group Inc. (NYSE:MIG)

Q4 2007 Earnings Call

February 13, 2008 9:00 am ET

Executives

Karen Spaun - CFO

Bob Cubbin - CEO

Analysts

Bijan Moazami - Friedman Billings Ramsey

Beth Malone - Keybanc Capital Markets

Robert Paun - Sidoti & Co.

Scott Heleniak - Ferris, Baker Watts

Tom Spiro - Spiro Capital Management

Operator

Greetings, ladies and gentlemen, and welcome to the Meadowbrook Insurance Group Incorporated Fourth Quarter 2007 Earnings Release Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. (Operator Instructions) As a reminder this conference is being recorded. It is now my pleasure to introduce your host, Ms. Karen Spaun, Chief Financial Officer for Meadowbrook Insurance Group Incorporated. Thank you, Ms. Spaun. You may begin.

Karen Spaun

Thank you, and welcome to Meadowbrook's fourth quarter 2007 Earnings Call. I will lead off today's call with a review of our fourth quarter financial results. Bob Cubbin, our CEO, will then follow with a review of our financial outlook and current market conditions. The call will then be completed with a question-and-answer session.

During this call, we may make certain statements related to future results and expectations. These statements constitute forward-looking statements as defined under the Private Securities Litigation Reform Act of 1995. We therefore must state actual results may differ materially from those projected and may involve risks and uncertainties that are outlined in our Form 10-K and 10-Q that are filed with the SEC.

Please note Meadowbrook undertakes no obligation to update or revise any forward-looking statements. If you have not received a copy of our earnings release it is currently available on our website Meadowbrook.com or you can give me a call and I will be happy to fax a copy to you.

Now, for our results. Net income for the full year was up 27% to $28 million, or $0.85 per share, compared to net income of $22 million or $0.75 per share in 2006.

Net operating income, excluding amortization, increased 32.1% to $29.8 million, or $0.90 per share, compared to $22.6 million or $0.76 per share in 2006.

In the fourth quarter, our net income increased 23.3% to $7.3 million, or $0.20 per share. Our year-over-year improvement reflects growth in underwriting process, and increase in net investment income as well as growth in our key business.

Net investment income increased primarily from positive operating cash flows. Improvements in underwriting results, reflects an accident year loss and loss adjustment exempt ratio of 63.8%, and continued favorable development on prior year losses, and a slight reduction in expense ratio.

These increases were partially offset by amortization of intangibles, and interest expense associated with the acquisition of the USSU business. Our commitment to strong underwriting discipline, and our controls over price adequacy resulted in an annual underwriting profit of $12.6 million and a combined ratio of 95.4%.

Net revenues for the year increased $22.5 million or 7.1% to $340.7 million. Net revenues in the quarter increased $7 million or 8.9% to $86.1 million. Despite softer market conditions for the year net earned premiums increased $13.3 million to $268.2 million.

This increase is the result of selective growth consistent with our corporate underwriting guidelines, and our controlled over price adequacies. Partially offset in this increase, was a $2.7 million reduction in residual market premiums that are assigned to us as a result of a decrease in the estimate of the overall size of the residual market, as well as mandatory rate decreases.

For the quarter, net earned premiums increased $4.9 million. Year-to-date, net commissions and fees increased $4.8 million or 11.7% to $46.0 million. For the quarter, net commissions and fees increased $802,000 or 8.4%. This increase is the result of the acquisition of the USSU business offset by a slight decrease in freight fees related to our North East operations.

In addition, net commissions and fees reflect lower commissions due to rate reductions on policy renewal in our retail agency division. Year-to-date net investment income increased $4.3 million or 19.6% to $26.4 million.

For the quarter, net investment income was up 23%. This reflects a $79 million increase in average invested assets, primarily as a result of an increase in cash earnings on our fee-for-service revenue, and continued favorable underwriting results as well as cash flows from our equity offering in July of 2007.

The average investment yield was 4.6%. The current pre-tax book yield was 4.5%. The current after-tax book yield was 3.4%, compared to 3.3% for the comparable period in 2006.

The duration of our investment portfolio is 4.3 years. Our investment portfolio remains 99.8% in investment-grade securities, and we continue to invest in securities with minimum credit risk. While our investment portfolio includes investments in mortgage-backed and agency-backed securities, we do not have any direct exposure to subprime risk.

Our asset-backed securities sector comprises only 4.2%, or $26.6 million of our investment portfolio. Within this sector, only $2.8 million relates to home equity loans, of which $1.2 million is insured. All of these assets-backed securities are adequately collateralized AAA rated investment quality, and are expected to continue to perform.

Our GAAP combined ratio for the year was 95.4% compared to 96.8% in 2006. Our GAAP combined ratio for the fourth quarter was 94% compared to 96.6% in 2006. The loss and loss adjustment expense ratio for 2007 improved to 61.2% compared to 62.3% in 2006.

The loss and loss adjustment ratio for the quarter was 59.5%. Improvement primarily reflects favorable claim settlements in the professional liability and workers compensation lines of business offset by unfavorable development primarily within the general liability line of business.

We have seen positive trends in both paid and incurred losses, and a reduction in the frequency of losses.

For the year, we had favorable development on loss reserves from prior accident years of $7.1 million, or 2.3% of reserves at December 31, 2006. For the fourth quarter, we had favorable development of $2.7 million.

On a year-to-date basis, our GAAP expense ratio was 34.2% compared to 34.5% in 2006. The GAAP expense ratio for the quarter was 34.5% compared to 35.1% in 2006. Our adjusted net expense ratio and non-GAAP measure, which gives credit for the margin in our fee-for-service business, was 30.1% in 2007 compared to 30.3% in 2006.

On the expense side, salaries and employee benefits for the year were $56.4 million, compared to $54.6 million in 2006. With the fourth quarter, salaries and employee benefits were $14.3 million, compared to $13.2 million in the fourth quarter of 2006. This increase is primarily due to merit increases or acquisition of USSU business and variable compensation.

With flat headcount, we continue to grow our revenue base without adding to our overall staffing levels. Administrative expenses for the year were $32.3 million, compared to $28.8 million in 2006. For the fourth quarter other administrative expenses were $8.1 million compared to $7.1 million in the fourth quarter of 2006.

This increase is the result of our acquisition of the USSU business, primarily due to the management fee component associated with the acquisition.

In addition, this increase was partially offset or partially the results of information technology initiative. Amortization expense increased $1.3 million to $1.9 million in 2007, compared to $590,000 in 2006.

Amortization expenses for the fourth quarter increased $480,000 to $621,000, compared to a $141,000 in 2006. Amortization expense primarily relates to intangibles from the customer relationship acquired with the acquisition of a Florida-based operation in 2005, and our acquisition of the USSU business.

Interest expense remained flat at $6 million for the year. Interest expense for the fourth quarter was $1.4 million, compared to $1.5 million in 2006. Interest expense includes interest related to the temporary increase in our line of credit associated with the borrowings to fund the USSU business acquisition.

With the proceeds from the equity offering, we reduced the outstanding balance to zero. We effective federal tax rate for the year was 28.1%, compared to 29.3% in 2006. This reflects a shift towards a higher level of tax exempt securities in our investment portfolio.

Shareholders equity increased to $301.9 million at December 31, 2007, compared to $201.7 million at December 31, 2006. Book value per share was $8.16, an increase of $1.23 compared to year end 2006. This increase primarily reflects year-to-date earnings, and the $58.6 million of proceeds from the July equity offering, where we issued 6.4 million shares at $9.65 per share.

In addition to this increase, we had an increase in our unrealized gains, net of deferred taxes of $4.3 million. For the year, statutory surplus in our insurance company subsidiary increased to $188.4 million, this increase in primarily attributable to statutory net income.

With that, I will turn the call over to Bob Cubbin, our Chief Executive Officer. Bob?

Bob Cubbin

Thanks, Karen, good morning, everybody. 2007 was another record year of earnings for us. Despite a softer market, we are pleased with the incremental growth we experienced in '07.

Due to our A.M. Best upgrade, and the success of our stock offering in July, we are confident that with already identified new programs, we can achieve substantial profitable growth as we continue to implement our strategic plans.

Probably, I'd expected a somewhat quicker implementation pattern following these achievements; we are on track for significant continued growth in our business over the next 12 to 24 months.

We continue to explore new acquisition opportunities that are complimentary, accretive and that will generate immediate cash returns, while we remain committed to our underwriting discipline and controls over price adequacy.

We have already overcome the diluted impact to EPS from the most recent equity offering, and are positioned to achieve improved ROE results, as we invest in the growth of our business.

In our most recent meeting, out Board declared a quarterly dividend of $0.02 per share, this is the first dividend since the third quarter of 2001. The dividend is based upon the consistent earnings pattern we've experienced over the past several years, and is an important component of our overall capital strategy, and our goal to build long-term shareholder value.

Gross written premium increased 4.7% for the year. This is partially the result of a $3.2 million reduction on residual market premiums, due to the smaller overall size of those residual markets. That amount going down as favorable since it is in essence a tax.

We also had mandatory rate decreases in the Nevada, Florida, and Massachusetts for comp market, which impacted growth and net premium volume. However, underwriting results remained favorable.

Our overall year-to-date rate change is only down 1.7% compared to industry recorded average price decreases of 15%. We continue to be selective our new program implementation by focusing on programs that meet our new business guidelines, and have a proven track record of profitability.

We exceeded the top end of our 2007 full year EPS guidance by ending the year earnings per share of $0.85. Our full year guidance per earnings in 2008 remains unchanged at $0.83 to $0.89 per share that includes $0.08 of amortization.

This outlook also includes the revised gross premium target of $385 million to $395 million based upon premiums volume growth from the new programs implemented in 2007, as well as from the extension of existing program. This growth only reflects new business that is in some phase of implementation.

We are also expecting substantial growth on the fee side of the business to be between $105 million and $110 million in growth commissions and fees. Although, growth in revenue is a factor in achieving our long-term goal, we continue to remain committed to improve productivity and efficiency. We continue to obtain processed improvements through technology and training.

Our goal is to make it easier for our clients to do business with us. We believe this higher level of customer service in satisfaction creates loyalty and higher retention rate. As we previously announced, we have exercised our option to purchase the second half of the economic related to our acquisition of USSU business.

We did this by eliminating the management agreement associated with the original acquisition. We retained the options to terminate the management agreement at our discussion, based on a multiple of the management team calculated for the trailing 12 months.

The USSU acquisition is going extremely well, which led us to the decision to exercise our option to a part of the second half of the deal. Our employee management team at USSU has performed very well, and will continue in their current staffing in managing the business as they have for many years.

This provides us a full benefit of the business model, and substantially increases our non-regulated key business EBITDA in 2008. We remained committed to our long-term ROE goal of 14% to 16%.

Year-to-date, our return on beginning the equity was 13.9%, up from 12.4% in 2006. While the equity offering in 2007 created a temporary diluted impact on ROE, we expected to deploy the remaining capital and reach our targeted return on equity of 15% by the end of 2009 and beginning of 2010.

We have already overcome the impact that EPS from the dilution of the offering. Our targeted ROE focuses on growing net commissions and fees, and growing net investment leverage, and income while maintaining underwriting profitability.

With long-term relationships and high service standards, we've been able to maintain high client retention ratio. This helped us to grow by not replacing lost business. We will maintain our balance business model focused on stable and profitable results, with a reduced exposure to volatility usually associated with the market underwriting cycle.

We thank you for your continued interest in Meadowbrook. At this time, I'll turn the call over to the operator for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from the line of Bijan Moazami with Friedman, Billings, and Ramsey. Please proceed with your question.

Bijan Moazami - Friedman Billings Ramsey

Good Morning everyone. The premium volume suggestions you have for 2008, indicates 11% to 14% growth rate, which is a very good growth rate, but somewhat lower than what you guys were talking about in the third quarter. Could you explain why you have decreased those numbers, I know, you have alluded to the market conditions and there is a pricing decline, but has it really anything changed over the past three months that it is leading you to decrease those estimates going forward?

Bob Cubbin

Yes, good Morning, Bijan. Yeah, the growth rate for '08 is really based upon what we have seen in the last 90 days or so, because that is slightly slower implementation rate on the new business than we had previously anticipated. But we do expect to see that increase as we get into 2008.

If market conditions do sort of flatten out, as opposed to continue to deteriorate from a pricing standpoint, then we may see appropriate growth rate. But based upon all the times that we have seen in the last 90 and 120 days, we think it is more prudent to target those lower growth premium targets, even though we do expect to see earnings at the same range as what we previously announced.

Bijan Moazami - Friedman Billings Ramsey

So, it is safe to assume that you also believing that the loss ratio in this book of business is somewhat better than what it has been producing historically, Right?

Bob Cubbin

Yes, we have seen the decrease in frequency. And both on our claims and incurred basis, we have been experiencing better than anticipated results, which is then reflected in the reduction in prior accident year reserve alternates. So, yes, we do see the loss adjustment expense ratio performing better than expected. And we also, as you'll recall, we eliminated the fronting fee in the latter half of last year. So, we'll start to get the full benefit of that in '08. So that does improve the overall combined ratio as well.

Bijan Moazami - Friedman Billings Ramsey

Thank you.

Bob Cubbin

Thank you.

Operator

Our next question comes from the line of Beth Malone with Keybanc Capital Markets. Please proceed with your question.

Beth Malone - Keybanc Capital Markets

Good morning and congratulations on the quarter. When you talked about soft pricing, in the last couple of quarters when you've talked about the markets, it seems like you've been somewhat insulated from the more severe pricing environment that we've heard from a lot of your competitors. In general, we are hearing 5% to 10% and there is some surprising reductions of as much as 20% and -- so, what exactly are you seeing?

Bob Cubbin

Okay. For the full year '07, our overall rate decreases were at 1.7%, and we are expecting that to be slightly higher in '08. There are some things, though, that in pocket of competition that we are seeing greater reductions. In that, largely though that's in Nevada, Florida and Massachusetts workers comp where there have been mandated rate changes of low double-digit decreases that have been mandated by the state.

In other places we are seeing pockets of competition, for example, in our transportation business in Southern California, there has been some competitors who've come in briefly and under-priced certain accounts at fairly significant amounts. But those are really sort of one-off situations. We are not seeing an overall competitive market like that. So, we are continuing to see some competition out there but through our underwriting guidelines and our pricing discipline, we are remaining. So, we are willing to walk away from some business if it becomes under-priced based upon our standard.

So, this depends on what date and what line assets there are. There is nothing that we see on a very consistent kind of the cost support basis.

Beth Malone - Keybanc Capital Markets

So, the implementation that you are talking about of the -- is it for the USSU business or is that your other business that was slower than you had anticipated? And what is the part, what are the market conditions that are causing it to be a slower implementation than you would have expected?

Bob Cubbin

Yeah, USSU is hitting this target, so that has gone as expected. But we are not writing a lot of that business on our own paper. We use another market, so primarily USSU is a fee-driven business for us, and we will start to write some of that business on our own paper, but a small percentage.

So then as going as expected. The business that has been slightly slower to implement had primarily been program that we expected to see the premium volume of those programs willing on to the book more quickly than expected some of that was related to rate and form fillings that didn't -- that were not approved as quickly as we would have like. So, there were a number of different factors that led to that somewhat slower implementation schedule.

Market condition, I would say contributed somewhat through that so it's really a number of issue that led to that those are really all under control and its not anything that we are concerned about just maybe takes a little longer to roll some of that business not into our books then we have previously anticipated.

Beth Malone - Keybanc Capital Markets

Okay. So, I guess you are suggesting that 2008 some of the revenue that you anticipating beginning in 2007 rolling in 2008 or now you expecting 2008 to roll into 2009?

Bob Cubbin

Well, you have seen somewhat look into those quarterly impact of somewhat of the growth in '08 we'll see go into '09 but most of the growth that we anticipated in '07 should be coming online in the first six months. So, during the first six months of the year, we'll be able to get a handle on what the full volume for '08 will be. We've seen these things accelerate, and if the market does perform a little more in line with a flat versus a continued down market, we might be able to achieve a faster growth than we had. But we just don't want to promise that later, in what we've seen over the last 90 or 120 days.

Beth Malone - Keybanc Capital Markets

Okay. Also on the commissions and fees line, it was up 11.7% for the year. How much of that is coming from USSU?

Bob Cubbin

That's a good question, hold on a second.

Karen Spaun

$5.5 million.

Beth Malone - Keybanc Capital Markets

That wasn't there in 2006, I guess…

Bob Cubbin

That's correct.

Beth Malone - Keybanc Capital Markets

And that was in the second half.

Bob Cubbin

That's right.

Beth Malone - Keybanc Capital Markets

…of the year. Yeah, alright.

Bob Cubbin

So, with the second half with the full year on USSU, could also the second half of the economic picking up, we should see commissions and fees, actually the commissions and fees are in growth basis, and won't go up that much because of most of the difference in what the economics were. We're paying management feedback so that are really reduced our expenses. So, it increases the margin and the fee business. It won't dramatically increase the top line other than the fact that we've full year of it, as opposed to a half year. So, we won't see kind of three times the amount of fees from that in '08, but we'll see an expansion and the margin on that business.

Beth Malone - Keybanc Capital Markets

Okay, and all right. That is fine. Thank you.

Operator

Our next question comes from the line of Robert Paun with Sidoti & Co. Please proceed with your question.

Robert Paun - Sidoti & Co.

Good Morning.

Bob Cubbin

Good Morning Robert.

Robert Paun - Sidoti & Co.

Net premiums increased nearly 8% in the quarter. How much of that was new business, and what was the retention ratio on renewals?

Unidentified Company Representative

Yeah. The retention ratio of our business really varies by program. We didn't see any loss programs in the fourth quarter. The retention rate within individual programs varies anywhere from 80 to 98%. So, in general, we are in the high 80s and low 90s in terms of retention and individual programs. The new business piece to that, and programs that were implemented in '07… hold on here, one second really, look that up?

Bob Cubbin

Robert, I don't have it at the top of my head, but I can give that to you.

Robert Paun - Sidoti & Co.

Okay. Great, and then, can you talk a little bit more about the competitive environment and what you are seeing now compared to what you were seeing a year ago?

Bob Cubbin

Yes, absolutely. In the third and fourth quarter of '07, there definitely was a greater level of competition than in '06. And that is reflective of a little lower growth rates than we would have anticipated in '07. But we did maintain our underwriting and rate standard. So, only going down by 1.7% on rates, and increasing in the fourth quarter by 8%, really reflects continued and very solid underwriting results that we would expect in the future. So, presently I think there is slightly greater competition in the third and fourth quarter, and probably even into the beginning of this year.

Although, January seems to -- have been slightly less competitive in some areas, but a lot of the rate changes, as we have mentioned, particularly in our workers comp business, came from the three states that really have mandatory rate decreases. So, you can't really consider competition. The pricing there is still very solid. The underwriting results are expected to be very solid because benefit changes have primarily kept up with those rate decreases. So, a lot of what we are seeing is in our smaller segment of the business. It's slightly more competitive but not irrationally so.

Robert Paun - Sidoti & Co.

Okay. And one last question. Can you quantify where the favorable reserve adjustments were coming from. What accident years they were from?

Bob Cubbin

Yes, pretty much all accident years '06 and prior. I'd say for the most part you are seeing 2005 and prior on workers comp and professional liability, they had the most significant favorable developments, and so we do still expect to see. '07, we didn't see very much in the way of favorable developments, because it's still pretty green. So, '07 and '06, you know we still rely more on our initial expectations there. And then, adjust those based upon any specific pattern of paid and incurred losses. So, as we get into '08 and '09, we'll take a closer look at '06 and '07 based on more information and more reliable statistical analysis.

Robert Paun - Sidoti & Co.

Okay. Sounds good, thank you.

Karen Spaun

Robert? This is Karen. For the net earned premium, for the quarter, programs that were implemented in 2006 and programs that were implemented in 2007, together that was about $4.5 million for our net earned premium for the quarter.

Bob Cubbin

And on a written basis.

Karen Spaun

And on our gross return phases that would have been $7.3 million.

Robert Paun - Sidoti & Co.

Thanks Karen.

Operator

Our next question comes from the line of Scott Heleniak with Ferris, Baker Watts. Please proceed with your questions.

Scott Heleniak - Ferris, Baker Watts

Hi, good morning.

Bob Cubbin

Good morning.

Scott Heleniak - Ferris, Baker Watts

Just a couple quick things here, I wonder if you could touch on some of the acquisitions target you are looking for. Do you think there is another USSU, would you be going down that road or something on the insurance side? And sort of what size? And this pricing come down enough to make -- have that size of acquisition at this point?

Bob Cubbin

Yes, Scott our acquisition strategy would be primarily looking for fee businesses that are specialists in program type businesses, or in insurance companies that have the same sort of appetite the risk that we do smaller average premium size, things that are going to be complementary from a geographic or product line standpoint.

The size of the acquisition really is depending on what is available and what is priced properly, and what is going to fit our strategic plan. So, the USSU acquisition was a fairly large acquisition in total, including the exercise management agreement of around $44 million or $45 million. So that time acquisition is doable for us. We can make larger acquisitions with that. We really want to focus more on the fundamentals of the business talent management team, complimentary product lines, complimentary geographic distribution systems, and that sort of thing.

So, we are not really only targeting data $10 million or $12 million of acquisition, but we are looking at really what's going to help propel us to the next level in terms of trading shareholder value. So, really nothing would be off the table for us in terms of size.

Scott Heleniak - Ferris, Baker Watts

Okay and are there any changes in your reinsurance traces here. Do you expect your retentions to feel higher this year?

Bob Cubbin

No. We have a long history of very favorable relationships with our reinsurance, and so we do anticipate continuing with the same sort of retentions that we have now. In the past few years, we have increased our retentions as our capital-base has expanded. But right now, I think, we're in a pretty good position, relative to the great point, and what the reinsurance offer as a value proposition in terms of where your attachment points are and look pricing as our of the products. So I think we would anticipate a pretty steady state in terms of the reinsurance purchase and pricing.

Scott Heleniak - Ferris, Baker Watts

Alright, yeah, it certainly becomes favorable. There's no question about that. Okay, thanks.

Bob Cubbin

Thank you.

Operator

Our next question comes from the line of Tom Spiro with Spiro Capital Management. Please proceed with your question.

Tom Spiro - Spiro Capital Management

And Tom Spiro, Spiro Capital, Good morning.

Bob Cubbin

Good morning Tom.

Tom Spiro - Spiro Capital Management

I wonder if you could turn our attention for a moment to the investment portfolio. There is a little commentary in the press release regarding the subprime and asset-based securities. I wonder if you can offer us your thoughts on the tax-exempt securities within our portfolio. In particular, are there any issues regarding the model line insurance? What percentage of our portfolio is insured? What would the credit quality be without the insurance, and that sort of thing?

Bob Cubbin

Yeah, just in, maybe I will take those kind of in some reversed order. We really look at, we have an investment advisor planning asset managers and they watch that very carefully. We have weekly conversations with them relative to better quality, and any new purchases that are occurring. And then in the [Munis] in particular, we're not going to be impacted by the monoline insurers. The underlying credit quality remains investment grade, and so and I think that the difference between the enhanced and non-enhanced is something like 60-40 of our business. And I think 40% being enhanced, 60% being non-insured.

So, it is a very high quality, low credit risk portfolio. And both are advisors in our internal treasury staff, and monitor it very carefully. So, we don't anticipate any changes there, in fact, our investment portfolio has performed very, very well. And so being conservative, slightly lower yield and some in the insurance industry, but with no volatility and no credit risk, so we are willing to trade that off for predictability.

Tom Spiro - Spiro Capital Management

What are your funds managers doing with the new inflows of cash, how do they invest them?

Bob Cubbin

Well, that is a good question. Presently our main focal point has been to increase the duration slightly on our investment portfolio. We have been relatively shortage you know, the duration of our reserves has lengthened. So, we do have room as the yield curve has steepened slightly, to go out a little farther and it take or stretching the durations a little bit farther out. So primarily, we have been focused on that, and again staying away from anything that will have a potential for credit issues and maintaining a very risk diverse profile.

Tom Spiro - Spiro Capital Management

Could Bob or Karen, could you remind us what are the goals, the company's goals for the premium to surplus ratios, and where do you stand as of the end of the year?

Bob Cubbin

Well, the goals for the premium-to-surplus are to approach 3-to-1 on growth and 2.25-to-1 on a net basis. Presently, we are substantially under that as a result of the capital rates.

If you look at gross written premium to debt equity, presently we're at 1.15 and on a net basis under 1. So, we're definitely under-levered right now, as a result of the equity rates that we achieved in July of last year. And it's our goal and our plan to deploy that capital through growth of gross premium, but also to target some very specific acquisitions that will be immediate cash return that will be accretive and that will allow us to continue to deploy that capital.

So that's our major challenge right now, Tom, is to profitably and appropriately deploy that capital over the next 24 months. On a statutory surplus basis we're slightly higher than I said. On equity, we're at 1.8 to 1. Gross written premiums on statutory surplus and net written premiums are 1.5 to 1. Those leverage ratios are slightly higher because we have not contributed all of the equity that we raised through the insurance companies. We kept some of that at the holding company for acquisition purposes.

Tom Spiro - Spiro Capital Management

Thanks and lastly, I noticed that the pre-tax margin on the fee-for-service income in Q4 dipped to 5%, a bit lower than it has been recently. I was curious why it dropped?

Bob Cubbin

Well, one of the reasons is the cyclicality, particularly in the USSU business. So, the third quarter has a higher level of fees and commission. So, you are going to see some cyclicality in those margins, as you see some quarters have higher key volume than others. So that's probably just reflecting on the third quarter to the fourth quarter. So then, as we move into '08, we will expect to see some increase in those margins as we go forward.

Tom Spiro - Spiro Capital Management

Thank you.

Bob Cubbin

Thank you, Tom.

Operator

We have a follow-up question from Beth Malone with Keybanc Capital Markets. Please proceed with your question.

Beth Malone - Keybanc Capital Markets

Okay, thank you. Are there any new programs that you are introducing in 2008, or is the growth coming from existing programs?

Bob Cubbin

We have new programs that are in some stage of implementation that we signed up in '07 that are starting to come on line in '08. So, the answer to your question is, yes. There are some new programs that we've already signed up, which are in our plans for '08. And there are also new programs that are in some stage of research, development or implementation that we expect to have come online in '08.

So, the answer to your question is, yes, there is always a pipeline of new programs that are coming on line, and it just depends on how quickly we are up and running, and then once through up and running how quickly do they ramp up. So, as we don't generally see kind of a cancel and rewrite, or moving a whole account for the business thing all on one particular renewal basis. It's really spread out over the entire year. So, it's a gradual implementation that you see.

Beth Malone - Keybanc Capital Markets

So the competition or the softening market hasn't prohibited you from entering into new programs?

Bob Cubbin

No, it has not, it's really has not -- it does sometimes reduce the number of new programs that we are willing to look at if they don't need our underwriting standard. So, if somebody has under-priced the program, and they are looking to move it, we are certainly not going to accept under-priced business. So that has influenced the number of programs that actually get through our underwriting screens.

Beth Malone - Keybanc Capital Markets

Okay. And then just one last question on the guidance, as you mentioned, you lowered your range of growth on written premiums for 2008 modestly. But it looks like growth commissions and fees are about the same, and the combined ratio is about the same. And the operating earnings guidance is about the same. So, is it the fact that growth written premiums are going to be lighter than expected, and that you are anticipating that business will maintain the profitability that you've achieved in the past?

Bob Cubbin

Yes.

Beth Malone - Keybanc Capital Markets

I am just trying to figure it out. Does that mean in 2009, when we start to recognize the earned premiums from that growth, we are going to see a decline in operating profit?

Bob Cubbin

We don't expect to see a decline in operating profits in '09, but note that the new business that we add in '08 still has to meet our underwriting criteria. And as we have said, we've seen small deterioration with rates of 1.7%, and we are maintaining our position on underwriting profitability and accessibility at a rate level.

We also expect to continue to see improvements in our margins because we are not adding people to add this new business. So, we control expenses and we get the benefit of some efficiencies and technology enhancements, but we do expect to see continued improvement and expansion of bottom line profits. Every year we are targeting to increase our bottom line profit by 15% or greater, and we'll continue to do that in our planning and in our budgeting process.

Beth Malone - Keybanc Capital Markets

Okay. And then just one last thing on the guidance, you talked about growth in pre-tax income from agency management fees of 60%. Is that growth as a result of the USSU acquisition?

Bob Cubbin

Primarily that is where it is emanating from, but it's from other sources as well.

Beth Malone - Keybanc Capital Markets

It sounds like a pretty big number.

Bob Cubbin

It is

Beth Malone - Keybanc Capital Markets

80%.

Bob Cubbin

And that is the EBITDA. And as I mentioned, we had half of the growth commissions and fees, if you will, in '07. We'll have a full year of growth commission and fees in '08. As the margins will improve since we eliminated the management fees, which provided us with the second half of the economics. So, yeah, the margins on that will expand greater than the growth in the top line of business.

Beth Malone - Keybanc Capital Markets

And how much of the management fees are you eliminating?

Bob Cubbin

It was approximately…

Karen Spaun

It was approximately $2.5 million in '07.

Beth Malone - Keybanc Capital Markets

So, should we assume that $2.5 million is added to '08, because you don't have that fee anymore?

Karen Spaun

Right. And that is in the guidance already.

Beth Malone - Keybanc Capital Markets

Okay, just so I am clear. Alright. Thank you.

Operator

There are no questions in queue at this time. (Operator Instructions) I would like to turn the floor back over to management for closing comments.

Bob Cubbin

Thank you, Anthony. Karen and I will be available today, if there are additional follow-up questions, if we had not answered them fully, we would be happy to do so. Well, thank you again, and we will talk to you soon.

Operator

Ladies and gentlemen, this does conclude today's teleconference. You may disconnect the lines at this time. Thank you for your participation.

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