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Delphi Financial Group Inc.(NYSE:DFG)

Q4 2007 Earnings Call

February 13, 2008 11:00 am ET

Executives

Robert Rosenkranz - Chairman

Don Sherman - President and Chief Operating Offer

Bob Smith - Executive Vice President

Bernie Kilkelly - Vice President of Investor Relations

Duane Hercules - Executive Vice President and Treasurer

Larry Daurelle - President and CEO of RSL

Mark Wilhelm - Executive Vice President

Thomas Burghart - Vice President and Treasurer

Analysts

Mike Grasher - Piper Jaffray

Beth Malone - KeyBanc

Jukka Lipponen - KBW

Mark Finkelstein - FPK

Richard Sbaschnig - Oppenheimer

Eric Berg - Lehman Brothers

Randy Binner - FBR

Jerry Kahn - William Harris

Operator

Good morning, ladies and gentlemen. Thank you for standing by. Welcome to the Delphi Financial Group Fourth Quarter Earnings Call. (Operator Instruction).

I would now like to turn the conference over to our host and Chairman, Mr. Robert Rosenkranz. Please, go ahead.

Robert Rosenkranz

Thank you and welcome to Delphi Financial's fourth quarter 2007 conference call. Our earnings release was distributed last evening and posted on the company's website, along with our fourth quarter financial supplement. This call is also being broadcast live on our website www.DelphiFin.com.

Participating in the call with me this morning me are Don Sherman, our President and Chief Operating Offer; Bob Smith, Executive Vice President; Anita Savage, Vice President of Finance; Bernie Kilkelly, Vice President of Investor Relations, and our colleagues at Reliance Standard Life, Safety National and Matrix.

Bernie's would you please now read the Safe Harbor Statement.

Bernie Kilkelly

Sure. Thanks Bob, and good morning, everyone. For those listening to a replay of this call, it is being held on February 13, 2008. That means for those of you listening live you still have one more day shop for Valentine presents. Our call this morning contains time-sensitive information that is currently as of this date. This call is the property of Delphi and any redistribution, re-transmission or re-broadcast of this call without the express written consent of Delphi is prohibited.

Statements made in this call relating to the future operations, performance, goals and expectations of the company, as opposed to historical facts, are forward-looking statements under the Federal securities laws. These statements are based on assumptions and estimates by the company that are subject to various uncertainties and contingencies.

Discussions of these risk factors can be found in our fourth quarter earnings release yesterday, our third quarter Form 10-Q and our 2006 Form 10-K. These factors could cause the company's actual results to differ materially from those expressed in any forward-looking statements made during this call and should be considered carefully.

In addition, certain non-GAAP financial measures will be discussed on this call. The comparable GAAP financial measures, along with reconciliations to such measures, are contained in our fourth quarter earnings release and financial supplement accessible on the company's website.

Now, I'll turn the call back to Bob.

Robert Rosenkranz

Thank you, Bernie that was very romantic indeed. Delphi had solid earnings growth in the fourth quarter to finish off a very strong year. Operating earnings per share were 6% to $0.82. For the year operating EPS grew 13% to $3.24, which was at the upper end of our guidance range. Our earnings growth was driven by the strong performance of our insurance businesses and the leadership positions we've achieved on a niche markets.

We benefited from the underwriting and pricing discipline of Reliance Standard Life in the small case group employee benefits market and the growth we've achieved from such new initiatives is integrated employee benefits, voluntary products and turnkey disability. Safety National continues to be a leader in the niche market for excess worker's compensation insurance which after seven years of a hard market is flattening out, but remains very attractive.

Delphi's balance sheet and capital position are extremely strong, which should enable us to support our growing insurance businesses and take advantage of additional growth opportunities.

This morning, in our remarks, we're going to cover four main topics. First, I'm going to ask Don Sherman to review our fourth quarter results. Second, I'll discuss some of the reasons why we believe our insurance businesses are well positioned to achieve continued earnings growth even in a recessionary environment. Third, I'll talk about our strong balance sheet and capital position, which is another important reason we feel Delphi is well positioned for the future. And finally, we'll be discussing our outlook and earnings guidance for 2008.

Afterwards, of course, we would be glad to answer your questions. Now, I'll turn it over to Don.

Don Sherman

Thanks, Bob and good morning, everyone. Our insurance business has capped off an excellent performance in 2007 with a strong growth quarter for the fourth quarter. Core group employee benefit premiums rose 10% to $312 million. Our core premiums at RSL rose 14%, which was driven by a 15% growth in group life and a 13% growth in disability premiums. While RSL's core production declined in the fourth quarter, we don't think this is an indicative of a trend. We did maintain our strong pricing and underwriting discipline, out performing our pricing targets in the fourth quarter quite handily.

We think the comparison to an unusually, exceptionally strong ending 2006 may be misleading, we think the production trend at RSL is better reflected in the numbers for the full year in which core production rose 15%, driven by a 15% increase in our core product group disability production.

Looking at the full year 2007, core premiums at RSL rose 16%, production rose 15% as I said. Our growth was boosted by strong contributions from our focus on two areas, which we believe offer us competitive advantages, voluntary products and integrated employee benefits. Voluntary products represented 17% of RSL's core production in 2007. That's up from 12% in the prior year.

In addition to strong sales of voluntary group disability and group life, we also ended with $18 million of production in our limited benefit health insurance product RSL BasicCare. We are expanding the separate sales force that markets this product to brokers and expect continued growth as we gain increased traction in that marketplace.

RSL also had a strong contribution in 2007 from our integrated employee benefits or IEB program for larger companies. That's the program where we bundle our insurance coverages with Absence Management Services from Matrix. New sales of insurance products to IEB clients were 22% of RSL's production in 2007, that's up from 14% in 2006.

We are pleased with the continued growth and the strong profitability in this area, which allows us to differentiate our insurance products and maintain attractive margins.

Premiums from RSL's turnkey disability division, custom disability solutions, or CDS or $11.8 million in the fourth quarter that compares to $13.3 million in the quarter a year ago. The $50 million of premiums for the full year 2007 for CDS were essentially flat with 2006. This comparisons are driven by several factors. 2006 premiums were boosted by some one-time items related to our purchase of the assets to form CDS. And 2007 premiums were impacted by some customer losses that resulted from our initial purchase of those assets.

The nature of these customer relationships are somewhat long-term taking several quarters to perhaps more than a year to show both the departure of exiting customers and the arrival of new.

We have added some major new turnkey partners in 2007. We are working to add additional and we think the benefits of those outcomes will show over the future quarters.

We continue to be excited about the long-term growth opportunity at CDS which provides us with significant alternative distribution to the small case market.

Turning to Safety National. Our excess workers compensation premiums declined slightly in the fourth quarter to $67 million down from $69 million a year ago. For the year premiums grew 6% to $276 million.

The premium declined in the fourth quarter reflects our disciplined response to the flattening out of the market, which we expected would occur after a seven-year hard market in which rates and attachment points both rose at accumulative 60% level.

The market for excess workers comp remains very favorable as shown by the trends in the recent January renewal period in which Safety typically renews 25% to 30% of the business.

In that renewal period rates declined in the low single-digits and we continued to achieve low single-digit increases in the average self insured retention. As you know, the self insured retention is the point at which the risk shifts from the employer to us.

We have been able to raise that average attachment point to $500,000 up from an average of $300,000 in 2001. We feel very good about the business we have written in this positive market cycle given the attachment point in the premium changes.

Another positive trend was the near record percentage of cases that renewed which we believe demonstrates the strength of Safety's market position.

Safety National's fourth quarter production decreased from the last year's fourth quarter, as we maintained our pricing and underwriting discipline in the face of the flattening market.

Looking at our combined ratio, our group employee benefit combined ratio in the fourth quarter was 92.3%, down from 93.6% in last year's fourth quarter.

For the full year 2007 that ratio improved to 92.4% compared to 93.2% last year. We are continuing to achieve better loss ratios from our disciplined pricing and underwriting and lower expense ratios, as we realize economies of scale.

Let me turn to the asset accumulation segment if I may. Operating profits in the fourth quarter were $7.4 million compared to $8.8 million in the fourth quarter of last year. This decrease was due to a decline in the investment income from assets allocated to this segment, which were impacted by the low interest rate environment.

For the full year, operating profits in the asset accumulation segment increased 4% to $31.5 million. Funds under management in this segment were basically flat at just under $1.1 billion which includes $100 million from the institutional funding agreements we issued in 2006.

New sales of fixed annuities increased to $23 million from $20 million in last year's quarter. We had a positive response from our wholesalers to the new indexed annuity product we introduced in the fourth quarter called Keystone.

Sales of indexed annuity represent about 60% of the total market for fixed annuities compared to about 20% or the sales of the traditional fixed annuities with no equity index component. So from the total market perspective, we are entering a very large segment of the market and we are expecting a strong contribution to our annuity sales from the Keystone product later in 2008, as we get it established in the market.

Looking now at our investment results, investment income in the fourth quarter was constrained by the low interest rate environment and somewhat slower growth in invested assets is our premium growth moderated.

Our tax equivalent yield was 5.9% in the quarter, compared to an above average 6.6% in last year's fourth quarter. Results from our trading account securities were modestly positive in the fourth quarter and the size of our trading account portfolio at the end of the year was about $145 million.

Invested assets increased 11% year-over-year reaching $5 billion at the end of December. Our fixed income yield continue to be constrained by the high level of short-term investments, which rose to $286 million at year end from $261 million at the end of September.

The credit quality of our investment portfolio remained high, with 8.1% of our fixed maturity portfolio in the low investment grade securities at the end of December.

We continue to have a very modest exposure to subprime and Alt A in our portfolio, as you can see from the additional data we included in our fourth quarter financial supplement.

Subprime exposure was about $39 million and Alt A exposure was $58 million combining to $97 million. About $30 million of that total was purchased in the fourth quarter at deep discounts, as we are taking advantage of opportunities in that market. In our supplement, we have also included data on our municipal bond portfolio which has been a very strong contributor to our investment performance over the years.

We continue to have a very strong balance sheet and capital position which Bob Rosenkranz will talk about in more detail in a few minuets. We have excellent financial flexibility to support the growth of our businesses and at the same time take advantage of opportunities to repurchase shares.

We've bought back over 1.6 million shares in the fourth quarter at an average price of $37.47. So, I feel very good about our ability to return value to shareholders and support the continued growth of our insurance businesses.

Now turning the call back to Bob.

Robert Rosenkranz

Well, thanks Don. For a second topic today, I want to talk briefly about why we believe Delphi insurance businesses are well positioned to achieve continued solid results, and earnings growth even in our recessionary environment.

We've done a quite a bit of analysis on this start for go for the past few years, as part of our overall enterprise risk management work. The analysis was shown that there is really no significant correlation between changes in gross domestic product and our earn premiums or a loss ratios.

There is couple of reasons for this, first, our product lines are well diversified with no one product making up disproportion of percentage of our premium. The three main product lines disability, group life, and access works comp, have different market cycles in different competitive environments.

Our customer basis also well diversified by industry and the significant percentage of our customers on industries that are less economically sensitive, for example, almost two thirds of Safety National's customer basis and government entities, healthcare, and education, which are clearly not economically sensitive parts of the economy.

Our sale has a broadly diversified customer base with significant percentages in healthcare and education. Finally, our focus on smaller companies, which is, where the vast majority of job growth is better in the past decade and which is expected to perform better in a recession.

Almost half of our sales premiums come from customers with less than 500 employees. On a case count basis 90% of the cases have less than 500 employees. So we feel very good about our ability to continue to grow premiums and earnings in a recessionary environment. Another kind of counter cyclical example is our accidental debt and dismemberment benefit, which is about half the losses in that are arise from business travel and automobiles and the recessionary environment. The company cut down on business travel so (inaudible) to conference calls and the like, and the loss ratio in that business tend to be quite counter cyclical. But third topic I want to review our strong balance sheet. Delphi’s capital position is very strong; debt-to-capital ratio at year end was only 14%. In Novembers we increased our bank line from $250 million to $250 million.

And at the end of December we had unused borrowing capacity on this line of $276 million. We also have a $116 million in financial assets at the holding company. We’re going to have additional opportunities to strengthen our capital structure later this year as about a $150 million of 8% retail notes issued in 2003 become callable.

As Don mentioned we have excellent financial flexibility and taking advantage of the weakness in the equity market to buyback or stock. We repurchased over 1.6 million shares in 2007 with a majority of those shares purchased in the fourth quarter. We clearly have the financial capacity to make significant purchases in 2008, the equity markets remain weak.

From a strategic standpoint I also feel we have the financial strength to take advantage of M&A or other opportunities coming out of the current market turbulence, which has created stress for some financial services companies. So I feel very good about our ability to both return value of our shareholders and at the same time look at other growth opportunities that may come up.

Next to the final topic, I want to discuss outlook and guidance for next year or 2008, this year I guess. Over the past five years Delphi is being consistently able to meet or exceed our long-term growth target of 10% to 12%. Our growth is being better than expected for three main reasons. First; we benefited from the hard market for Safety National’s excess workers compensation insurance that began in 2001. Second. Safety had very strong premium growth from the employers’ re-renewals rights purchased. And third we benefited from the very strong premium growth we’ve achieved ourselves from newest initiative such as integrated employee benefits, voluntary products and turn key disability.

As we announced on our earnings release yesterday, we currently expect operating earnings in 2008 to be in a range of 345 to 360. The midpoint of this range represents 12% growth over the midpoint of the initial 2007 range of guidance we provided a year ago, which was range of 310 to 320. Our results in 2007 exceeded our initial expectations coming in at 324. We’re being cautious in our guidance for 2008 to reflect the flattened market and excess worker comp at Safety National and the turbulent investment in economic climates we’re facing.

We’ve also - always followed a philosophy of trying to promise results that we believe are achievable. What we try to deliver results that exceed our expectations, we’re being especially cautious this year due to the reasons I’ve talked about. We remain confident in our ability to build shareholder value, by capitalizing on the leadership positions in our insurance businesses in their attractive niche markets. We’ll also use our strong balance sheet to return value to shareholders to share repurchases when attractive opportunities are available.

So in closing, strong earnings growth in 2007 and continued optimism about our growth prospects in the future. And at this point I'd be happy to take any questions. Operator.

Question-and-Answer Session

Operator

Thank you. (Operator Instruction) And the first question is from the line of Mike Grasher, with Piper Jaffray. Please go ahead.

Mike Grasher - Piper Jaffray

Good morning everyone and congratulations on a great 2007. I had a couple of questions on Safety National first of all, obviously new annualized premium sales were down significantly in '07 over '06. Do you expect that to be a bottom in here, would you expect it to be flat for '08? Can you give us any indication given what you have seen out of renewals as well as your thoughts around the economy? I know you just commented to some degree, but if you could elaborate on that?

Robert Rosenkranz

Why don't we ask the Safety folks in St. Louis to respond?

Mark Wilhelm

Hi, Mike, this is Mark Wilhelm at Safety National.

Mike Grasher - Piper Jaffray

Hi Mark.

Mark Wilhelm

Good morning and thanks for listening. Our expectation is still optimistic for '08. We have a number of initiatives that we're pursuing that we hope will make up for the flattening of the market and the lower amounts of new business we’ve seen in the fourth quarter especially. So, we are pursuing things with a lot of urgency here and we hope that we can make up for some of the shortcomings that we witnessed in the fourth quarter.

Duane Hercules

Mike, this is Dwayne. I'd also like to point out in '06 we had almost $26 million of production from the ERC renewal rights transaction. So actually if you take that out and look at it on an apples-to-apples basis it was down, but it was 15% year-over-year.

Mike Grasher - Piper Jaffray

Understood, and the renewals, are we going to see retention that are in line with '06 or I guess around 87% level is where they were?

Duane Hercules

Well.

Mike Grasher - Piper Jaffray

I said '06, I meant '07.

Mark Wilhelm

This is Mark Wilhelm again. We greatly exceeded that in January so we do have some optimism that we'll continue to have a strong renewal retention for the balance of '08.

Mike Grasher - Piper Jaffray

Okay. And then on the reserve aspect, was there any positive reserve development at Safety in the quarter?

Duane Hercules

No, overall Mike for the year, the net development was adverse but significantly less than the prior years. We had positive development in the more recent years, we had some adverse development in the 2000 and 2001, kind of at the end of the soft market years. But it was significantly less than 2006.

Mike Grasher - Piper Jaffray

So net overall though it was adverse.

Duane Hercules

Yes.

Mike Grasher - Piper Jaffray

For '07.

Duane Hercules

Yes. For calendar year '07.

Mike Grasher - Piper Jaffray

Understood, okay and then just a capital position question Bob. What is actually left on the authorization?

Robert Rosenkranz

At the moment it's about 530,000 shares, but we are considering increasing that authorization.

Mike Grasher - Piper Jaffray

Okay. I have other questions, but I'll get in the queue. Thank you.

Operator

And the next question is from the line of Beth Malone with KeyBanc. Please go ahead.

Beth Malone - KeyBanc

Hi, good morning. I just wanted to get a little bit more color on your individual health business, are you anticipating that this becomes a much larger like a third part of the two -- an additional business to the other two you already have. What do you think the prospects are for that particular business?

Robert Rosenkranz

Larry may be you could respond to that Beth's question.

Larry Daurelle

Sure, good morning. Beth, this is Larry Duarelle.

Beth Malone - KeyBanc

Hi, Larry.

Larry Daurelle

You're talking about the basic care, I presume?

Beth Malone - KeyBanc

Right.

Larry Daurelle

I mean, just you said individual, this is a group product and this is sold traditionally to those employers that have seasonal and part time employees. And so in the last two and half years, we ramped this up to $80 million in force and I think, we're going to continue to have modest growth, if certainly not today looking to be a major replacement for disability or life but we believe that since its sold in the market with our current brokers and its sold to smaller employers, more regional employers, we are providing' that product where its not being provided due to force. So, its similar distribution to our core products and we'll continue to see some modest growth and it has some decent profitability.

Beth Malone - KeyBanc

Okay. So, it is sold by the same brokers that are currently selling your other small group product?

Larry Daurelle

Yes, that's the key. We have a separate sales force that goes…

Beth Malone - KeyBanc

I see.

Larry Daurelle

…distributes to the brokers that we're selling the core, life and disability group.

Beth Malone - KeyBanc

Okay, thank you.

Larry Daurelle

Sure.

Operator

And the next question comes from the line of Jukka Lipponen with KBW. Please go ahead.

Jukka Lipponen - KBW

Good morning, I guess, first on the buyback and the share count didn't seem to go down much. So was that the buyback basically offset by option investing at one of your companies?

Robert Rosenkranz

Jukka, yes, and if you are looking at the average share count, of course, the timing within the quarter is to when it happens also has some impact on that number.

Jukka Lipponen - KBW

Okay. And in terms of the subprime, can you give us some color in terms of what is the ratings distribution for the things that you bought in the fourth quarter?

Robert Rosenkranz

Jukka its Bob, certain highly rated securities that we bought in the fourth quarter you can see that page 9 of our supplement there is a distribution by rating category of subprime in all day. So, I would say we continue to be purchasing in the high rate of tranches to these securities.

Jukka Lipponen - KBW

Higher meaning AA, AAA or…?

Robert Rosenkranz

Yes.

Jukka Lipponen - KBW

Okay. And then, for the guys of the Safety National Mark you refer to some of initiatives that you are pursuing, can you give us a little more color what kind of initiatives are we talking about?

Mark Wilhelm

Jukka, this is Mark, I'd rather not elude our competition to what we're up to but they are mostly within our co-reliance and just represent product line extensions.

Jukka Lipponen - KBW

Okay. And lastly, I missed your comment regarding the January renewals did you say that they were the retention was much better than the '07 retention?

Mark Wilhelm

I wanted to clarify that better in terms of policy comp retention, is the number I was referring to, and that's December 2007 in terms of premium retention.

Jukka Lipponen - KBW

Okay, great. Thank you.

Operator

And the next question comes from the line of Mark Finkelstein with FPK. Please go ahead.

Mark Finkelstein - FPK

Hi, good morning. I guess first question I believe the Safety -- can you guys hear me okay?

Robert Rosenkranz

Yeah.

Don Sherman

Yes.

Mark Finkelstein - FPK

Okay. I believe the Safety management incentive plan I believe it ended kind of end of '07. Can you just tell me whether that has been re-upped and kind of what the terms around that look like in terms of kind of the incentive plans?

Robert Rosenkranz

Mark, you are right that the prior arrangement ended with the end of '07 and we are in discussions on renewing that, until that is all settled it wouldn't be appropriate to talk about that at this time. But we will have that available in the near future I think.

Mark Finkelstein - FPK

Okay. I guess just to get a feel for kind of margins at Safety right now. I mean I know you had some developments kind of in '07 on prior accident years. You know rates are kind of flat or slightly down, retention slightly up. So, in that it sounds like margins are holding relatively stable. What do you estimate the current accident year ROEs are based on kind of new business being written right now?

Robert Rosenkranz

Duane, you want to take a shot at that one?

Duane Hercules

Sure, I think we are kind of projecting similar combined ratios and return on equity that we have had. So, we have actually seen an improvement in the expense ratio would not really reflected any improvement in the loss ratio, but I will say the years, accident years 2003 through 2006 the initial indications are positive.

Mark Finkelstein - FPK

Okay. But I mean I guess just to follow-up on that. I mean are we looking at mid to high teen ROEs on kind of new accident on your Safety business right now or is that a little bit aggressive in terms of where you think accidents years are being priced at currently?

Don Sherman

Mark, this is Don. Obviously, the long tail nature of this business mean anything that we say about brand new production we have to prove over a long period of time. Having said that, we are comfortable with ROEs that we're writing right now on the new business, because we think we are still benefiting from very attractive market conditions that are out there and in the mid-teens ROEs, we think is something that would be easily resulting out of the development of the book.

Mark Finkelstein - FPK

Okay, all right. That gets me. I guess…

Robert Rosenkranz

I just would like to add just one which is in a sense we are not exactly constrained by the equity in Safety. I mean we have the capacity quite a bit of additional business with the existing amount of capital, so it's the real constraint is finding opportunities to grow the book of business at prices that we think are provide attractive margins on premium levels. It's not as if capital is the scarce resource that constraining the growth of the business.

Mark Finkelstein - FPK

Okay. Just real quick on -- at RSL: what is the sales rep growth target for 2008?

Robert Rosenkranz

Larry, you want to take that one?

Larry Daurelle

Sure. Hi, Mark. About 5% growth in the sale staff for 2008 right now.

Mark Finkelstein - FPK

Okay, great. And then just Bob Smith, one quick question. I mean, just thinking about your commentary in terms of the buyback. 14% that the cap, $116 million kind of sitting at the holding company. I guess Safety, not kind of growing in the current market. When you talk about a meaningful buyback, I mean, could this include significantly above where we are at or I mean, how should we think about that for 2008, if valuations are current, at current levels?

Bob Smith

Well, I thought we had a pretty meaningful buyback in the fourth quarter. And that was 1.6 million shares. So I don’t want to have you infer from that that could be of that magnitude. But we think about this topic a lot, and we have financial resources to make whatever we do there meaningful and we will continue to focus on that so.

Mark Finkelstein - FPK

Okay. Great. Thanks.

Operator

And the next question is from the line of Richard Sbaschnig with Oppenheimer. Please go ahead.

Richard Sbaschnig - Oppenheimer

Hi, good morning. Just a question, in terms of on the Group Disability business, now that interest rates are starting to come down, mechanically, theoretically, the prices should start going up in the market. Of course you have seen anything like that or do you anticipate that potentially some peers might start raising their prices?

Robert Rosenkranz

Larry, you want to comment on the competitive environment on group disability?

Larry Daurelle

Sure. We hadn’t seen a lot of price movement. This is continues to be a competitive market place, where we do well, obviously in the under 500 lives. But not any movement and the whole market seems to move together. So if anything moves we tend to see the overall move with all the [gush], all the competition.

Richard Sbaschnig - Oppenheimer

Sure. And in terms, and also at Safety National, what did you assume in the guidance with regard to reserve releases or maybe possibly adverse development at safety?

Larry Daurelle

Well I think in terms of looking at overall guidance Richard, what our perspective has been is, if you list Duane's comment earlier on where we've been. Let me start there, we've had some adverse development which has trended toward if you look at in the 10-K trended toward the level of the discount, this should be consider "normal development" in there. And in terms of the guidance we are looking at a comparable pattern going forward, that the adverse development in excess of the discount would evaporate over a relative period of time, we are not counting on huge positive developments in the guidance.

Richard Sbaschnig - Oppenheimer

Got it. Also at Safety I am just curious with things beginning I guess to kind of slow down. Clearly its not slowing down that dramatically, but just kind of longer term in the future (inaudible).

Robert Rosenkranz

Wait a second, Richard. Operator

Larry Daurelle

Richard. Operator?

Operator

Yes hold-on

Robert Rosenkranz

We have lost the question.

Operator

Evidentially he disconnected, he did disconnect.

Bernie Kilkelly

Okay, can we go to the next in the queue.

Operator

Then next question is from the line Eric Berg with Lehman Brothers. Please go ahead.

Eric Berg - Lehman Brothers

Thanks very much good morning. I didn't quite, I am sorry could you just give the answer to the question about the share accounts, why it held fairly stable throughout the year despite the share repurchase, what was the answer that question, I am sorry I didn’t get it.

Larry Daurelle

Eric it's done. I think there are two things going on there in addition of the share repurchase one is there are some impact on auction grants and the other one is the if you are looking at the average share account the timing within any timing period when the transaction happens so the share account would react to the average, and not just the absolute, if you're looking at average share count.

Eric Berg - Lehman Brothers

Okay. I will revisit Bernie on that one. I have a couple of questions regarding Safety. First question is are you actually experiencing lower case count in terms of new [case count] met in the year earlier? Or what’s happening with just new case count relative to where it happened, ignoring price, self-insured retention, just looking at numbers of customers?

Robert Rosenkranz

Well I think from the Safety perspective, the new case count is lower taking into account both comparisons that Duane talked about earlier, which is -- some of the ’06 comparisons would include ERC.

Eric Berg - Lehman Brothers

Right.

Robert Rosenkranz

But the new case count is lower, just as Mark said, the retained case count is higher and we think there maybe some connection there in terms of us and our competitors attempting to renew cases more quickly. So, I don’t know Mark if you want or Duane you want to add any color to that on case count?

Duane Hercules

Eric, this is Duane. New case production in 2006 was about 156 new accounts and for 2007 it was 136. So, down, but the other thing we should point is actually which we don't count as new business, our association -- the number of members in our associations group, which is the easiest area for a self-insured to join an association and existing association. And our membership there grew, I think, double-digit for the year. So the case count actually has been fairly good on the new business, though it is slowing down.

Eric Berg - Lehman Brothers

Are you saying that the case count is not necessarily representative because you could have membership growing within a particular association?

Duane Hercules

Exactly.

Robert Rosenkranz

Exactly and that’s why you’re seeing the total premium numbers at pretty satisfactory levels.

Eric Berg - Lehman Brothers

Right. My final question regarding Safety is this, in (inaudible) it is really, really difficult to know from the disclosure as well as the comments made today whether we’re entering the period of, sort of, flat sales or a multi-year period decline. It is very difficult to tell, while I appreciate your desire not to tip off your competition -- if I were in your shoes, I would be doing the same thing. For this analysis, there is absolutely no basis at all to assess whether your initiatives to grow the business from here are going to work. To hear about production expansions, is helpful, but it's really a beginning.

And I would ask if you would be willing -- I want to ask the question again, would you be willing to provide additional detail on what you are doing to keep Safety growing because otherwise I don’t know what to think?

Robert Rosenkranz

This is Bob Rosenkranz. I think one important thing that one has to keep in mind here is the basic business model of Safety does not really rely and that important to weigh on top-line growth. We can have a very satisfactory bottom-line growth even with the flat top-line for a couple of years, coming really from two things. One, the years in which development was negative or adverse or kind of small premium years and that sort of winding down, the big premium years, the last six or seven years when development is looking much more positive will start to be reflected in reported earnings. So, we can see improvements in underwriting margins that are kind of cooked into the business right away.

The second thing is, with the $500,000 attachment point, if there's an accident or an injury our first dollar out the door is typically going to be about 14 years away. So, the business as its constructed will generate large amounts of invest able assets on which we earn a float of an invest able income.

So the point, I'm making really is that this can be a very satisfactory growth company within the Delphi portfolio, even in an environment where premiums are flat and I'll remind you when we bought safety we bought it going into a very soft market and much softer market than we have today as it was a much more competitive marketplace. The reinsurers were much sillier and what they were doing and in that marketplace Safety had the discipline to cut premiums quite a lot.

I'm remembering that day one from then the level of maybe 70 million down to something in low-to-mid-50's and yet that was a period where the Safety management team had to produce 20% compound earnings growth to achieve [learn out] that was the part of the original purchase price and they achieved it.

So, we were able to get 20% bottom line growth from a company whose top line was actually shrinking considerably and that's really built into this business model. I think we have the luxury of being quite discipline about pricing. We don't have to grow the top line of this company to show very good bottom line growth. Now that being said of course we want to grow the top line and we've brought in a new head of sales, we have the group, series of initiatives to target specific marketplaces that we think are unreserved or specific markets that we think represent a good opportunities. But the main point, I want review was this is simply that don't equate a flattening top line with the flattening bottom lines.

Eric Berg - Lehman Brothers

That's helpful, supplemental information, thank you.

Operator

And your next question is from the line of Randy Binner with FBR. Please, go ahead.

Randy Binner - FBR

Hi everyone three questions. The first is on the benefit ratio in the group benefit segment. It was favorable again this quarter earning given that there was a small adverse development Safety, I mean, referring that RSL provided most of that benefit. Can you give any color on what improve there, if it was related to disability to life and perhaps what time period that was associated with?

Don Sherman

Randy, this is Don. I will take an overview and then we can go to another level if you'd like, Safety's negative development has been decreasing, so to the extent you are comparing history. There is some contribution from Safety in that and RSL I think is achieving or recognizing the benefits of the continued discipline we've been applying to the niche markets and the imports they are hitting our pricing targets. So, I think that we believe that while the number may move around a little bit and within a range we believe that's a good indicator of the success of our underwriting and then it give us confidence about the future in terms of development.

Randy Binner - FBR

Okay, so it's more flat or a sale in moderately improving safety?

Larry Daurelle

Yeah, either some modest improvement at RSL as well, but they both made contribution I think.

Randy Binner - FBR

And then kind of coming off that, is there any way for the folks of Safety to quantify a little bit more; what's the average development was for full year '07, relative to those prior years, you had indicated there was much less than before, like can we get kind of a calendar quantification of that?

Robert Rosenkranz

Duane you want to take a shot at that?

Duane Hercules

Sure, and I'll do this on a GAAP basis on the guide sixth disclosure that would be on the 10-K. It was about 11.6 million compared -- that's net of the discount accretion that Don mentioned before, compared with $36 million in the prior year.

Randy Binner - FBR

Okay, that is helpful.

Duane Hercules

Randy did that answer your question?

Randy Binner - FBR

Yeah, absolutely, that's perfect. Because we are in this time period where we are a little bit out of the [KMS]. The last question was on the allocation of municipals in the invested assets portfolio. The tax rates, I guess rate, kept down for the year to roughly 29% and running around 30% before. I don't really see there might be other issues, in that Muni allocation it appears to be still around 18% in the invested asset portfolio.

Is there any change in the Muni allocation as it relates to taxes and if not, can give more color on why we saw at 29% instead of the historical 30%?

Duane Hercules

I think, actually, there has been more than of a allocation.

Randy Binner - FBR

Okay

Duane Hercules

That's in the Muni portfolio, because of the higher percentage of Munis there than the prior year the tax rate ticked down to somewhere in the mid-29 call it and we feel that’s about the right one-way to think about it because we feel that no way the allocation will be pretty comparable.

Robert Rosenkranz

Muni spreads are I think particularly attractive right here and we are allocating a fair amount of new money in that direction because, when you have Munis at higher nominal yields in treasuries right now which is a pretty unusual phenomena.

Randy Binner - FBR

Okay. That's perfect and actually just one other question, you'll mention that you bought - you said about 30 million of all [pay] or sub prime in the quarter.

Robert Rosenkranz

All day.

Randy Binner - FBR

So, if I am looking at what vintage was that?

Robert Rosenkranz

These are some of the newer vintages '06 some '07, but most in more AAA so --

Randy Binner - FBR

Okay, so that's helpful. So if I look at your disclose on page 9 of the [sub] basically that AAA '06 - '07 vintage for all day that's a lot of new stuff that bought it at discount.

Robert Rosenkranz

Exactly.

Randy Binner - FBR

Is that correct?

Robert Rosenkranz

Sorry, yes. Exactly.

Randy Binner - FBR

Okay. And so any color on how much of discount you bought over there?

Robert Rosenkranz

Sufficient.

Randy Binner - FBR

Sufficient, okay, fair enough thank you.

Operator

Our next question is from the line of Mike Grasher with Piper Jaffray. Please go ahead.

Mike Grasher - Piper Jaffray

Thanks, just a couple of additional questions, wanted to go over RSL. Larry if you could just update us on the small case with businesses that have 2 to 19 lives and how that's progressing?

Larry Daurelle

Mike that continues to grow well. We recognize this kind of large segment, but at the same time just get some feedback on that.

Robert Rosenkranz

It's continuing to grow we are trying to reach out to more MGAs remember that product is sold through MGA versus the Employee Benefit brokers. And it grew 20 some percent in the past year.

Mike Grasher - Piper Jaffray

Okay. And then also the Equity Indexed Annuity Business?

Larry Daurelle

The Indexed Annuity we kicked it off in October, and what happens is that has to filter in through the distribution system. Remember we are selling through the wholesalers and they have to get in to their system. They have to get it approved by their broker dealers and the advertising process. So it started to kick in, and we started to see sales in January or February and as Don mentioned we expect that to grow nicely over the year.

Mike Grasher - Piper Jaffray

Okay. And then final question. I think that you had implemented a national services organization. Can you quantify the impact that has had on the expense ratio or even productivity?

Larry Daurelle

We are getting there. We are getting there to do a more complete analysis, but it has helped modestly in terms of the expense ratio. As you recall, that was done to help normalize the jobs in the field and the cut down on the turnover, and then of course when you implement anything you are going to have turnover anyway just in the case of implementing that which we saw but it is working well. And it is working well in terms of getting the sales reps out in to the field, doing what they should be doing and selling. And then the processing is all done internally in the offices and quite. And we did see some impact in the fourth quarter where there is a lot of quote activity with the offices sharing it. One office had some capacity they would jump in and do some quoting for the -- for another office that was at total capacity. So we will see more of that and see some more impact in '08 and '09.

Mike Grasher - Piper Jaffray

So positive development for this move?

Larry Daurelle

Yes, we are very happy with it.

Robert Rosenkranz

Yeah. This is -- I would say a very good production year at RSL and does reflect substantial improvements in productivity as a result of this revamping of the sale support structure.

Mike Grasher - Piper Jaffray

Thank you.

Operator

And we have a follow up question from the line of Jukka Lipponen with KBW. Please go ahead.

Jukka Lipponen - KBW

Yes. Discount rate on the new long-term disability business, can you give us some color what you are doing there going into '08 versus '07?

Robert Rosenkranz

Tom Burghart, do you want to take that one?

Tom Burghart

We are looking at keeping on discount rate about the same -- at about 5.5% for '08 at this point in time.

Jukka Lipponen - KBW

Okay. Thank you.

Operator

And we have a question from the line of Jerry Kahn with William Harris. Please go ahead.

Jerry Kahn - William Harris

Hello, everybody. Congratulations on continued good results.

Robert Rosenkranz

Thanks Jerry.

Jerry Kahn - William Harris

With regard to your investment portfolio, the way you do things except for the trading account, do you plan to buy and hold so, put everything on there to essentially to your cost or amortize cost, but for example since you just bought some all phase at substantial discount or whatever. Obviously, within the portfolio there is some probably significant negative marks to market because we were doing it that.

Larry Daurelle

You might be misunderstanding this, we are not reporting on the balance sheet on a health to maturity basis.

Jerry Kahn - William Harris

Carrying value?

Larry Daurelle

No the balance sheet shows the marks-to-market and we have the overwhelming bulk of our assets for readily marked securities. So, there is no mystery about the market value of the portfolio.

Jerry Kahn - William Harris

I misunderstood that. I am glad to hear that, thank you. I will take another look at it. And I guess in this environment we should expect the yield on the portfolio to continue to decline?

Robert Rosenkranz

Well, I mean just, I think that’s a reasonable expectation, although with spreads boiling out --

Jerry Kahn - William Harris

You plan what you are buying, obviously.

Robert Rosenkranz

We maybe able to maintain yields. You have these two things going in different directions, obviously with basic short term rates going down at the same time credit spreads are getting wider. So, its not so crystal clear what the net effect of those changes is going to be.

Jerry Kahn - William Harris

So far, you had lower yields.

Robert Rosenkranz

Yeah. And I think that’s probably a reasonable where to bet. But, as I say, I don’t think its crystal clear.

Jerry Kahn - William Harris

Well it can change, obviously.

Robert Rosenkranz

I don’t think it is crystal clear that is going to be the result.

Jerry Kahn - William Harris

Okay. Not much is crystal clear, I guess.

Robert Rosenkranz

I mean we have seen, for example in the senior bank debt market, as rates, we don’t have much exposure to this. But it is an asset class that we're taking a look at. And as interest rates have come down, the prices of this paper have come down to maintain the same yields. So, it’s a complicated sort of relationships.

Jerry Kahn - William Harris

All right. Thank you.

Operator

And you have a follow-up question from the line of Eric Berg with Lehman Brothers. Please go ahead.

Eric Berg - Lehman Brothers

Could you build upon your answer to the question about the disability business at Reliance. In particular could you expand upon why you don't believe the decline in sales in the December quarter is -- you said you talked about the overall decline at Safety, primarily at Reliance. But if we home in on the disability business, why do you believe presuming that's the case that the decline in sales in disability new business production is not sort of reflective of the trend and that leaders of your financial statements are better served looking at the full year numbers.

Don Sherman

Eric, this is Don I will start and then let Larry fill in our correct for me. '06 was a year that had a very strong close to it. I remember --

Eric Berg - Lehman Brothers

Okay.

Don Sherman

Wanting to see the production reports on a monthly basis because we felt like we should be on target for a bigger number than what we saw through the third quarter and I think the episodic reasons are not necessarily trend reasons. '06 ended very strong in that fourth quarter and '07 has been more of a steady environment for us. There is still some seasonality of course to the business when renewals come up and new accounts are available. But we feel very good about the production trend that we have going at RSL and feel that the year comparison is more indicative. Larry you want to add to that.

Larry Daurelle

I think I agree entirely.

Don Sherman

That helps?

Larry Daurelle

And if you look at the disability production in this quarter, last year was 52 million and a full year total of 114. So it was just kind of a really strong quarter in '06.

Robert Rosenkranz

And based on what we're seeing in terms of opportunities and run rate in terms of quotes and close rates, we think where we ended for the year looking at the entire year is more indicative of the momentum that we've and have continued to have.

Eric Berg - Lehman Brothers

Okay. And looking at quotes and close rates towards the end of the year is more indicative of what '08 will bring than the full quarter's number is that kind of point frontline?

Don Sherman

Well, this is Don offering that and yeah Eric we think the quote activity and the ultimate close rates have been more consistent than the quarterly pattern would have suggested and we think it suggest the continued momentum.

Eric Berg - Lehman Brothers

Thank you, Don.

Operator

And we have a follow-up question from the line of Mark Finkelstein with FPK. Please go ahead.

Mark Finkelstein - FPK

Hi, real quick one follow-up on the investment portfolio. Part is you've already addressed this, just looking at the CMBS portfolio, you are pretty active in that on 01, 02 vintages kind a took a step way but then you got this big increase in '07 on the BBB about 5.9 million little bit of As in there. And I am just curious Bob Smith, I guess, what was the strategy on that how do you feel about those securities and did you buy them as a kind of added discount some of that had you thought about the Alt As or one were those acquired?

Bob Smith

The books you refer a little while and obviously not that long because they are '07 vintages but yeah, I mean, we feel pretty good about CMBS it hasn't seen a deterioration that you've seen in subprime Alt A and this were attractive from a yield on a risk adjusted basis. So, we feel pretty good about it, I mean, there's not a lot of portfolio in these particular categories.

Mark Finkelstein - FPK

Okay. I don't think, if you going to dispose this or not, but was mark on the securities meaningful at yearend?

Robert Rosenkranz

On which?

Mark Finkelstein - FPK

On the BBB CMBS?

Robert Rosenkranz

Oh, it was a meaningful.

Mark Finkelstein - FPK

Okay, all right. Thank you.

Operator

Mr. Rosenkranz, there are no additional questions at this time. Please continue.

Robert Rosenkranz

In that case, I just simply thank everybody for participating in the call.

Don Sherman

Thank you.

Operator

Ladies and gentlemen that does conclude our conference for today. Thank you for your participation and for using AT&T executive teleconference service. You may now disconnect.

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Source: Delphi Financial Group Inc. Q4 2007 Earnings Call Transcript
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