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ProAssurance Corp. (NYSE:PRA)

Q4 2007 Earnings Call

February 26, 2008 10:00 am ET

Executives

Stan Starnes - Chief Executive Officer

Vic Adamo - President

Ned Rand - Chief Financial Officer

Howard Friedman - Chief Underwriting Officer

Darryl Thomas - Chief Claims Officer

Frank O’Neill - SVP, Corporate Communications and IR

Analysts

David Lewis – Raymond James

Ron Bobman – Capital Returns

Elizabeth Malone - Keybanc Capital Mkts

Mark Hughes - StarTrust

John Gwynn – Morgan Keegan

Michael Whitney - Taylor Investment Company

Amit Kumar - Fox-Pitt, Kelton

Michael Paisan - Steifel-Nicolaus

Presentation

Operator

Good day, everyone, and welcome to today's ProAssurance Fourth Quarter and Year End for 2007 Earnings Release Conference Call. As a reminder, today's conference is being recorded. For opening remarks and introductions, I would like to turn the call over to you, Mr. Frank O'Neil. Please go ahead sir.

Frank O’Neill

I would like to welcome everybody and thank you for joining us We will discuss our results and outlook after I remind you that one of the reasons you have joined us is to hear forward-looking statements and projections. And we do expect to make some of those during this call. These statements and projections will be based on our estimate and anticipation of future results and events. Please review the caution regarding forward-looking statements in the news release we issued Today, Tuesday, February 26, 2008. You should also consult the detailed discussion of risk factors and uncertainties about our business in our Forms 10-K and 10-Q. Both will help you better understand today’s remarks in our business.

We will not undertake and expressly disclaim any obligation to update or alter forward-looking statements where there is a result of new information or future events, except as required by law or regulation. The content of the call is accurate only on Tuesday, February 26, 2008, the day of the first broadcast and it is the property of ProAssurance.

It you are reading a transcript of this call, especially through one of the realtime transcription services, place no transcripts are subject to error and we have neither reviewed nor approved the transcript.

On the call today is our Chief Executive Officer, Stan Starnes; our President Vic Adamo, Chief Financial Officer, Ned Rand; Chief Underwriting Officer, Howard Friedman, and Chief Claims Officer, Darryl Thomas.

Ned will review will review a few of the key numbers and help provide some background for our brief remarks. So Ned lead us off.

Ned Rand

I am going to let most of the numbers speak for themselves but there are a few key items on which I want to focus your attention. Long-time investors are aware of our dedication to a strong balance sheet and solid bottom line results. We continued to maintain both in 2007 aided by a solid fourth quarter.

We grew a book value per share by 15% during 2007. It is now $38.69. Our ROE for the year was 14.2 %, which squarely hits the upper range of our long-term target.

For the quarter, ROE was 16.7%. Both the year and the quarter were boosted by fair overall net reserve development. Net income from continuing operations was up 43.5% in the quarter to $51.4 million and up 32.4% for the year to $168.2 million.

Earnings per diluted share from continuing operations rose from $1.01 in the fourth quarter of 2006 to a$1.47, an increase of 45.5%. Year-over year, net income for diluted share was up 28.5% to $4.78, making this one of the most successful years in our history in terms of earnings per diluted share and by virtually every other measure. Favorable net reserve development was a major driver of results in the quarter, so I am going to Howard, if we will talk more about the actual numbers in the process for reaching the ultimate conclusions.

Howard Friedman

I think I mentioned some of this last quarter but it varies repeating. With every quarter, we have new lost data with which to evaluate our current reserves. Thus, we obtained a new insight as prior accident years mature quarter by quarter and our evaluation could move up or down.

Remember that we set initial reserves at levels which we believe to be adequate. Should results be no better than previous experience as indicated? That prevents us from a major financial stumble of things deteriorate. If on the other hand the losses mature better than we expect. We benefit. That is why necessity color is not only our current thinking but ripples back through reserves still on the books. After all those cases have yet to be resolved and their outcomes will be determined in the current or future loss climate.

For now we are seeing today’s favorable loss trends principally affect accident years 2003 through 2005. Because this is an alternative process involving a number of variables each quarter we will not try to tell you today what lies ahead in 2008. I can re-emphasize that we look at this every quarter in a systematic manner.

The regular valuation of our reserves and our commitment to maintain our historical level of reserving go hand in hand to ensure that we are able to meet our policy obligations.

Ned Rand

The primary driver of the increase in the expense ratio for the year is the reduction and earned premiums. Expenses for the year were also affected somewhat by stock base compensation cost.

There has been a lot in the media recently regarding the credit markets. As you heard us state before, we maintained a very conservative investment portfolio. I will refer you to an 8-K we filed on February 11 providing details of the compensation of our portfolio as of the end of the year.

Finally, an update on capital management, in December of 2007, we redeemed $15.5 million of trust preferred debt that came to us in the nick of our transaction. We also continued to be active but prudent in share repurchases. As of January 31, 2008, we have repurchased approximately 1.2 million shares of our stock at the total cost, the $67.1 million. After the debt redemption and share repurchases, we had $67.4 million remaining in our authorization the repurchase share and redeem that securities.

Our convertible debt becomes callable this summer and today, it is likely that we will call their securities. There are a lot of moving parts. Not the least of what (inaudible) the interest rate environment and the state of the capital markets.

Frank O’Neill

Howard, you briefly mentioned the fact that premiums were down in the quarter into the year. Will you touch on that for us?

Howard Friedman

Sure, we will continue to see the effects of both software market and the decline and loss costs. In the fourth quarter our gross rate and premiums were $109 million down 14% compared to last year.

Year to date, gross written premiums were down a little bit more than 5%. The new business brought on to our books in the first seven months of the year by the PIC Wisconsin transaction, did cushion the year-over-year number as we expected.

I want to emphasize here that while everyone acknowledges that we are in a soft market, it is not only competition that has resulted in premium declines.

I will comment more specifically on frequency and severity in a moment, but overall our loss projections are down and we are reflecting that with lower rates, obviously leading to lower written premiums. On the whole we are not seeing the irrational Kamikaze – pricing that we saw during the soft market of the late 1990’s. My guess is that the hard market did not erase all the pain from the last stock market and that is a good thing for industry and our insurance.

While we tend to ease into a soft market, the hard market often arrives abruptly. We have tried to maintain our pricing discipline and we hope to avoid the rapid severe price escalations that mark the early part of this decade. That market place discipline means that we are prepared to see our top line fall but we will maintain our margins and protect our balance sheet at all costs.

We had a retention rate of 86.5% in the fourth quarter and policy is renewed at premium rates that were down 7.5% from a year ago. For the full year, policy is renewed at premium rates that were within 2.3% of expiring. Loss trends have improved and we do expect that to continue. We see frequency moderating generally across the board although there are variations from state to state. Those who were able to maintain our margin expectations and that rate that we are filing. Even though most of those are likely to indicate a decrease in 2008 but I want to emphasize what I mentioned last quarter, if we were not seeing this almost universal trend toward lower frequency.

Rates would likely be increasing due to severity, which is continuing to rise at expected and manageable levels.

Frank O’Neill

That is a little underscore expected in manageable levels.

Howard Friedman

Certainly.

Frank O’Neill

Darryl Thomas, will you comment for us on 2007, claim date and the current claims environment?

Darryl Thomas

Sure Frank. Just as Howard and Ned have reported, little change in their areas, I can say the same holds through for claims. Within the working layers, relative stability Howard mentioned is very evident. Although we continued to experience sporadic large verdicts, in 2007 obtained favorable outcomes and 90% of the claims closed in our historical book of business and an 89.4% of the claims closed when we include PIC Wisconsin; that means we made not indemnity payments on behalf of our insured in those cases. We tried 733 claims to a jury verdict last year in 528 separate trials and the current claims environment leads me to the conclusion that will likely try significantly fewer claims in 2008, due to the decline in our claims inventory, which is a direct result of fewer file claims over the past few years. I does not signal a change in our claims philosophy, it is just a reflection of the current claims trend and our lower inventory of claims.

As I mentioned, we do see large verdicts from time to time, they are facts of life in medical liability. We have always had them and they are absolutely changing the laws but they will always be with us, but it is just that do occur seem to be larger, which puts the premium on having the balance sheet to cope with them which we do and now the need for experience or localized claims management, which is one of your many strengths.

Given the current claims trend, we have heard of some companies that have been reducing claims staff, we have been able to use out proprietary data system to shift some processing around to balance workload among offices and we have been able to reposition some claims staff into other role. This preserves our expertise and capabilities for when feel a return to what we believe are more normalized claim level.

Frank O’Neill

Vic, this is not the first cycle you have been through. Any thoughts on how this one compares?

Vic Adamo

Yes Frank, I agree with Howard’s comments but we do not see the degree of irrational pricing that existed in prior cycles although we do see examples of pricing that raises our eyebrows but theses practices are not as broadly based as in prior years and as Howard also noted, the general drop in frequency does give some level of rational underpinning great decreases.

Tort reform often has a role in market pricing but the TWIs are difficult to read at this moment. The Bush administration is once again sending the total reform proposal. The congress this time is part of an effort to control Medicare cost and while we applaud this effort, it is unrealistic to think that any tort reform will emerge from this congress.

At state level, the plane ASPire just yesterday began their first real challenge of Texas in these tort reforms. They are trying to convince the Federal Courts to declare the Texas reforms unconstitutional. And while it is hard to imagine that succeeding, if it does, that could be a significant consequence to companies in Texas given the size of a rate decrease that they have given based on tort reform.

There was also a recent ruling in CookCounty declaring the Illinois tort reform unconstitutional. That now sets up appeal and ruling in the future by the Illinois Supreme Court. On the other hand, in Ohio, the Supreme Court rules in favor of non-medical tort reforms and court watcher say there could be a clue as to how they will handle the almost identical medical malpractice tort reform laws when a case comes before the Ohio Supreme Court. So in some, there is not much guidance, individual companies can elect how much weight they want to give to tort reform. We elect to be cautious until there is a final ruling in the law that emerges.

Changing subjects, Frank, if I may to our internal operations. I am pleased to report that ProAssurance is doing well at the operational level and that PIC Wisconsin is now fully merged into our day-to-day activities.

Frank O’Neill

Stan, any comments from you?

Stan Starnes

Frank, I think we have established that we are in a soft market. So the real question is how long will it last? It’s one of those things that’s really hard to predict, but given the lack of cut-throat price competition, so far, this maybe a fairly benign manifestation of the cycle. That does not mean that we will see top-line growth. In fact, we can expect our top-line to diminish further in the coming year. And no, I cannot predict by how much because I do not know what our competitors might do in the market. But I do know that the one sure path to insurance disaster during the soft market absent some direction of driving force is an increasing top line.

But I think there is a potential difficulty confronting the industry. In reviewing the data and comparing this cycle to others, we see that our industry as a whole has never been this optimistic in the low level of initial reserving. We will show you a chart in our next presentation that bears this out but given the softness in pricing and level of profit, companies are recognizing today, there could be a number of M&A or expansion opportunities ahead if or should I say when the market returns to more normal trends.

That is why we are continuing to be dedicated to the diversity of our business and the discipline of our operating model. We are not held hostage to the vagaries of any one state and as we said in this morning’s news release, we are also being careful to maintaining our historical level of reserving and we are building in the same expectations for margin. It is this discipline that we think sets apart from the competition. It allows us to sell a product that no one else offers.

An insurance policy is just a piece of paper until you are assigned a lawyer to defend you or until you are told to pay a verdict against you. That is when you want the best attorney with the chance for an unfettered defense of your non-meritorious claim. If you did commit malpractice, you want a company with the resources to make a fare settlement as quickly as possible.

We offer that balance sheet strength and willingness to let our insurers go the distance to defend their names. You hear Darryl Thomas tell you that we have tried 733 planes last year. Other companies probably would not tell you how many they tried. They may tell you how many claims they paid no indemnity on but that is a fairly meaning this number if you only try several cases filed against your insurance. This more becomes more important, is the world of transparency comes to others and across the country as it already has in places such as Florida and Massachusetts. With the public enjoying access, the malpractice litigation results on the internet.

In short, we will think twice about settling claims because no matter what, a patient or potential patient will think you must have done something wrong if you settled it. In fact, just last Tuesday, I saw a news release from a company that promises to send watchdog alerts via the e-mail, if a doctor you want to monitor has had a malpractice judgment or a disciplinary action against he or she.

The world is changing and we are going to be ready for it. And that means we will do everything in our power to protect our balance sheet but also the strength of our organization. We are committed to maintain our infrastructure during the softer portion of the market cycle in order to be able to capitalize on the opportunities when the market turns and we are confident that it will.

Frank O’Neill

We will open the line for questions right now.

Question and Answer Session

Operator

(Operator Instructions)

We will take our first question from David Lewis with Raymond James.

David Lewis – Raymond James

Goof morning, thank you. A couple of questions, first on the gross rate and premium declines down 14% in the fourth quarter, kind of accelerating on the downward side after being down 9% in the third quarter and that was difficult to predict and there are a lot of moving factors and you are a national player but let us kind of step back a minute and look at if you can, what you think maybe if you can input it on your book of business what average rate decreases, just give us a range or a high level of number I you could.

Two, do you feel that some of the startups that went back five plus years ago, we are starting to feel any pain or is the favorable claim trends allowing them to continue to stay afloat. And then three, do you feel like there is any increased M&A activities that might help you out or do we need to start to feel more pain on the claims side before people get realistic on pricing.

Howard Friedman

I will start with the first question on the average rate decreases. I think if you looked at an overall average we are probably talking bout mid-single digits. Although we have seen some rate decreases that are in the 13-14-15% range, we had one that was 11%. We have had other situations where we have looked at the rates and not made any changes at all or actually had some small increases but I would say probably, I guess, 5% on average. I really have not tried to look at it specifically that way.

David Lewis – Raymond James

Howard, are you talking on about on 2007 or what do you anticipate in 2008.

Howard Friedman

What we have filed in 2008 so far and what would be effective in the first half of 2008 at this point?

David Lewis – Raymond James

An how would that compare to the ’07 roughly?

Howard Friedman

2007, I think we will probably would have been closer to a zero. I think the increases and decreases balanced out at least on a file basis.

Stan Starnes

David, in terms of the question regarding whether the market has created paying for some of question regarding whether the market has created hanging for some of the startups; that is highly variable, this would be a very difficult market for them to be feeling no pain in the end so we will just have to wait and see. With respect to M&A and Gs we think there will be opportunities and in that regard we intend to be opportunistic. The market has a way of sort of moving those activities forward as people encounter the difficulties and we have a strong enough balance sheet that we think we will be in a position to take advantage of that.

David Lewis – Raymond James

Stan, at least all the public companies that we see reporting have pretty significant favorable development, you know, I would guess that the other private and smaller independent companies are feeling the same type of benefit so, does it take a year or two to kind of play off before the M&A activity starts really feed up or you know, start to build or are you starting to see a little increased activity now?

Ned Rand

It could take sometime before you see it reach its peak. I expect we will see some activities or opportunities to evaluate during the first six months of 2008. Now, whether any of that will come to provision, it will just depend upon the conditions as they exist. As I commented in my remarks, we have seen something that we have not previously seen and that is the industry, the whole is being very optimistic at the low level of initial reserving. We are maintaining our historical levels for reserving on new business, and we think that is a prudent, cautious and long term approach to the position in which we find ourselves.

David Lewis – Raymond James

And just lastly our comeback with some other questions, PIC Wisconsin – premiums if you still can still can break them out? What where they in the fourth quarter and full year of 2007, please?

Ned Rand

David, we will come back to that, I must pull that information out.

David Lewis – Raymond James

Alright, thank you Ned.

Operator

We will now go to our next question with Ron Baobad from Capital Returns.

Ron Bobman – Capital Returns

I just have a couple of questions, what is your PIF number approximately?

Stan Starnes

I would think we probably say it is going to be roughly 30,000.

Ron Bobman – Capital Returns

Okay, and if that is approximately the number of policies that you are buying to each year, you mentioned, I think Howard mentioned the 86, well maybe with fourth quarter number, but the 86.5% retention rate. The portion of the business that you do not renew, whether it be in the fourth quarter, 13.5% or a number that ballpark for the whole calendar year, are substantially all of those loss that counts that presumably someone else has written, lost because you are under quoted on rate. Was there a meaningful number on those that you choose not to quote, or you are quoting at much higher rates, or whatever? I am just getting us with a distribution of business not renewed.

Stan Starnes

Well the first thing I would say is that we use the most conservative method of calculating retention. It is not one that if we do not think that we have a choice to renew it, we do not count it, that we include people, for example, who are retiring or become disabled. Disability would be a very small amount that the number who retired. There is some percentage that we would re-under write and not renew ourselves, and then some lost to competitors, and I am to look at Howard now.

Howard Friedman

And then you have the other situations where physicians die, they retire, they become disabled, they moved to other state. They have all variety of reasons, but there is underlying…

Ron Bobman – Capital Returns

Right, but I am sure this is 80-plus percent of the lost business really tied to someone under quoting you on a piece of business that you would normally like to renew?

Stan Starnes

I would say that this is really rough, but I would say about 2/3 of what we loose is probably due to price competition and the other third is due to either the actions of an insured that takes them out of the market or our own action, in terms of not wanting to renew.

Ron Bobman – Capital Returns

Stan, you mentioned in your prepared remarks, I do not know if some kind of renewed M&A, the business turns the normal trend and I was trying to understand what you meant by normal trends?

Stan Starnes

Well normal claim trends.

Ron Bobman – Capital Returns

Normal claim trends.

Stan Starnes

The people that are pricing their business today and reserving their current business, as if this frequency is a permanent thing and that the claims environment in the United States is undergoing some drastic change, it is going to last forever. Only time will tell what the fact is, or we think that is being unrealistic, and that will create M&A opportunities.

Ron Bobman – Capital Returns

I have two more questions. The loss ratio PIC that you are using right now in early 2008, I am curious whether you choose to give us the number or not, it is not critical to me, but pretty curious, how about loss ratio PIC is varying from the number you started in early 2007, and if it is varying, sort of, what is driving the variants beyond prizing? Thanks, and what order of magnitude might you be talking about?

Howard Friedman

Well, I guess it is different ways of looking at that, if you look at the loss ratio that we booked without favorable development, it is in the roughly 85% range, which is relatively similar to where we were a year ago. I do not have the exact number with me from a year ago.

Ron Bobman – Capital Returns

Are you talking about Q4, Howard, or are you talking about early 2008, 85%?

Howard Friedman

No, Q4. Yes, I am only talking about what is already done.

So I think that is pretty similar to where we were a year ago. I do not have that at my finger tips, but I would say it is pretty close.

We booked in Q4, if you look at the current accident year we booked at 85.9% loss ratio. Not maybe actually be quite higher than where we were, say in Q1, but it is similar.

Ron Bobman – Capital Returns

And would you talk a little bit about going forward, do you thing that you made any changes to the loss ration PIC in Q1 2008, compared to this, you know, nearly 86 number. Is the change going to sort of solely be driven by rate action you are taking, or are you incorporating any factors associated with improving margins on this 2003, 2005 book of business. Maybe some indications of 2006 and 2007, looking better, was it going to be all price driven changes there?

Howard Friedman

It is always I think the combination of what we have seen and what we have recognized in the past, because that all feeds into not only the pricing but our reserved assumption. So it is a combination of both and we do take a look at the level of pricing that we are achieving into the, as we mentioned earlier, the rates that we are filing have the same level of expected margin built into them. So that in itself would not change our view. However, if we are being more or less aggressive in certain areas of the market in terms of price deviations, then we have to take that into account in a loss ratio. But I think on the whole, if my sense is that what we are doing right now is consistent with similar to what we have been doing in the past.

Ron Bobman – Capital Returns

Okay, my last question, thanks a lot for your patience, is you defined that 733 planes retried in 2007, just so we are clear. What do you mean by claim stride? How are you defining claim stride.

Howard Friedman

Yes, when a case goes to trial, there maybe multiple defendants in it there are insured. Some maybe couple of doctors and a codefendant corporation. So we count that those are three in that example, those are three trials against our insured, but only one case tried. So that is the distinction that we are making for the first time here.

Stan Starnes

This is Stan. We tried 733 claims in 2007, and some instance, one claim was tried and one case and that was all there was tried. In other cases, there may have been 2 or 3 claims tried in one case.

Howard Friedman

Does that does clear that up?

Ron Bobman – Capital Returns

Yes, but I sort of focusing on the threshold as far as being tried. Does that mean that litigation has been filed against the company, and is actually, the parties have shown up in court one day, and not settled prior there to?

Stan Starnes

No, it means, that we had cases tried to a jury in which our insured were defendants.

In 733 of our insureds, were subjected to jury trials in 2007.

Ron Bobman – Capital Returns

Got you, and you went to distances as far as the jury delivering a verdict?

Howard Friedman

Yes.

Operator

We will now take our next question from Beth Malone with Key Bank.

Elizabeth Malone - Keybanc Capital Mkts

Okay, thank you. I just have a want a couple of questions. Could you give us an update on the Florida market and what you are seeing there? Is it getting any better or, what is the situation?

Stan Starnes

We do not see any change in it Beth.

Elizabeth Malone - Keybanc Capital Mkts

Are you still concerned about it, or do you feel like you can manage the environment that is there?

Stan Starnes

We can manage the environment that is there, if I were at position in Florida, I would be very concerned about it. But we can manage is an insurance company, the environment that exists. Of course, one thing, we do not have a definitive ruling from the Florida Appellate Courts about tort reform, and that is going to have a very significant effect, and that room with this issue from the…

Elizabeth Malone - Keybanc Capital Mkts

Do you have any sets of timing, as they would -- rule on that?

Stan Starnes

None.

Elizabeth Malone - Keybanc Capital Mkts

Okay, when we backed out the reserve releases from the year end, the combined ratio is above a hundred. So I am just wondering, are you all comfortable with that level that you can meet your ROE goals and everything, was it that high?

Ned Rand

Hey, Beth this is Ned. A couple of things, one as you know we are sitting on Connecticut capital and that probably more than anything makes achieving our ROE goals a challenge. But at the levels that we are currently riding business, we are comfortable that we will meet our ROE objectives.

Elizabeth Malone - Keybanc Capital Mkts

Okay, and then finally, had there been any change or trend in the market itself? Are there more or less physicians out there? Is that growing and what factors drive that, or is it something you even worry about?

Victor Adamo

Hey Beth, Vic Adamo, you know there is plenty of physicians out there for a company like ours selling insurance to positions, on a day to day basis, it is not dramatically changing. Over long terms, obviously, there is some changes as practices get larger, they become part of the hospital affiliated group, it might be self inured and out of the market. Out of, you know, day to day, year to year basis, there is not dramatic changes, but there maybe long term changes.

Elizabeth Malone - Keybanc Capital Mkts

Okay, so as more doctors choose to be part of a hospital program or a larger physician group, will you continue to be pretty exclusively an individual doctor, or are you looking at extending your product line?

Victor Adamo

We insure larger groups now. I mean our sweet spot are the smaller groups, and individual physicians. We do it all up the line, but larger groups have more interest in alternative mechanisms, so that is definitely an area on our development. We plan it now, but not maybe as much as down the road.

Howard Freidman

You know, while we insure a significant number of physicians who are in small groups less than 5, the fact is, eventually practice arrangement, most positions in United States have, so that is why a majority bank insurancing group, is because the majority of physicians around the country are in those groups. But we do insure larger groups. We insure groups that are affiliated with hospitals. So those changes when they occur, I think they will over the long term, I do not feel any dramatic change in the next few years, but those changes as they occur, will be met by us with products which will be of benefit to those situations.

Elizabeth Malone - Keybanc Capital Mkts

Okay, thank you.

Operator

And we would now take our next question from Mark Hughes with SunTrust.

Mark Hughes - StarTrust

In cases for top-line decline, should we look for that continued inch up a bit, or can you hold that steady?

Stan Starnes

Mark, I have to tell you that we did not get about the last few words of your first sentence. Could you repeat that for us?

Mark Hughes - StarTrust

Yes, what trend do you think an underwriting expense as given that you have an outlook for declines and premiums over 2008? Should we look for that to inch up, relative to revenue or can you hold the line there?

Ned Rand

A couple of things, obviously there is a component of the under running expense that is variable. Commissions and premium taxes in particular. On the operating expenses, our objectives, as we go into 2008, it is to work to hold operating expenses on par on nominal or dollar value basis with 2007.

Mark Hughes - Star Trust

On a dollar basis?

Ned Rand

Yes.

Mark Hughes - StarTrust

Right and then, how big the decline in open cases at year end?

Stan Starnes

There has been a considerable decline in open cases year end. I am not going to give year-old specific numbers, but year over year, due to the drop in frequency, obviously that affects inventory.

Mark Hughes - StarTrust

Right, and is that the magnitude of the drop greater than what you have seen, you know, relative of the volume of business you have been writing compared to prior years?

Stan Starnes

Yes, I think that is sort to say.

Mark Hughes - StarTrust

And then just one more point on that, your outlook for trying fewer cases in 2008, I guess I assume that is already captured in loss reserves, but does that point to the potential for, you know even more favorable development in the future?

Stan Starnes

Not well even though development is primarily a result of where we start reserving and what happens to the cases as they are resolved. The frequency issue really, only comes into play on the reporting endorsement or tell business and on the small amount of the current business that we have. So I do not know that you can draw the direct correlation there. I think the overall claims environment that we are seeing is one of moderating or decreasing frequency and gradually increasing severity, both of which are better than we anticipated when we established the reserves for the prior years, and that is why we are seeing development in a favorable manner.

Frank O'neil

Let us pause for a second, Ned has got an answer to David Lewis’s earlier question, and then we will get back to questions.

Ned Rand

David, you asked about premiums coming from PIC Wisconsin, and the fourth quarter, we had gross written premiums on PIC Wisconsin of $12.1 million for the year. That would be $74.4 million on a net basis. $11.7 million and $66.8 million, and on a net earned basis, $18.6 million and $73.9 million, thanks Frank.

Frank O'neil

Okay.

Stan Starnes

And I think, here to say that given the way we are integrating PIC Wisconsin in the rationalization of distribution, it is going to be really hard for us to do that next year.

Okay Jennifer, we will resume questions.

Operator

(Operator Instructions)

We do have a follow up question from David Lewis.

David Lewis - Raymond James Lewis

Thank you Ned for that, you would not have by chance what the gross rate was in the fourth quarter of 2006, would you? Just to throw another kink in your thought process there.

Ned Rand

I actually do have that you call it $15 million in the fourth quarter of 2006.

David Lewis - Raymond James Lewis

Oh I understand, okay $15 million perfect. Stan, just clarifying on Beth Malone’s question, you said that there are no decisions out on ****, and Florida. To my understanding, there is not a case that is actually pending out there to go to the State’s Supreme Court, is that accurate?

Stan Starnes

I do not know if that is accurate? I have been told, and this is hearsay, I have been told that there is at least one and perhaps as many as two cases making their way up the system in Florida on that. But now that is adding dawdle up. Just bear in mind, they are not our cases, so I can not tell you what the sureness if they are. Bear in mind that in the Florida State System, of an appeal of right, lies from the Circuit Court in Florida to an intermediate Appellate Court, which you are geographically spread among the state according to districts. Thereafter, any further appellant activity would take place in the Supreme Court of Florida and typically that is by permission, there is no right of appeal, and actually right of appeal in this kind of case to this Supreme Court of Florida, according to my understanding. So to get a definitive ruling, you would have to first have ruling in a Circuit Court. You then have to have a ruling in an intermediate Appellate Court, and you would then have to have the Supreme Court of Florida agree to accept the case, and issue its own ruling.

David Lewis - Raymond James

That is awful. Stan I know you still have not been there that long as CEO, but when I met with you the day after you accepted the position, you indicated that, you thought it would be helpful to kind of have everybody, including yourself, kind of review each of the operations to see they are greater efficiencies or better operating methodology to kind of move forward, and you know, in your short 10 year there, have you found any? I know, you are pushing everybody to look for best practices, even further than what they have historically. Is there anything meaningful that you can tell us?

Stan Starnes

You know, we said back in July and I say again today, everything is on the table. We wan to take a fresh look at everything to see that we are doing things in a way that best accommodates the needs of our share holders and our policy holders and our employees. We have made some changes, I do not know that I care to announce under the world and then need to tell you, but we are moving forward as we think things are appropriate and I would say that the changes, or changes in new launch, and not drastic changes in direction. We are just twicking it. You know, everything can be made better. There is nothing that is perfect and we are doing our best everyday to make things a little bit better here, and I have to tell you, one of the great strengths of this organization is our cadre of employees who are simply magnificent. I can not take credit for that, but I can tell you that observing it closely and first hand, I would not trade them for anybody in the world.

David Lewis - Raymond James

That is thoughtful, and Howard, I know you said most of the prior development came out of 2003 and 2005 years, can you give us a magnitude, is it a greater percentage from the 2003 or 2004, or how do you see that if you can? Just from a high level?

Stan Starnes

Yes, it is more from 2004 and 2005 as I recall, but we will be able to get you more or we will have the statutory statements out there, within a week you will be able to actually see it by accident year.

David Lewis - Raymond James

I guess I am trying to also kind of back into what the excess capital levels might be at the organization today so do you know what capital and surplus was at your end?

Stan Starnes

Statutory capital and surplus? We have that, we are going to have to get our hands on it. I would speculate it is roughly $900 million, in that neighborhood.

David Lewis - Raymond James

So with the repurchases and the redemption of the preferred, are we still running close?

Stan Starnes

Actually, it is right at a billion dollars. That is statutory capital.

David Lewis - Raymond James

So with the repurchases and the redemption of the preferred, are we still looking at potentially excess capital today in the $250 million range, would you guess?

Stan Starnes

I think everybody kind of comes up with their own number. Obviously, the rating agencies have one perspective on it and we at the company may have another, so I am kind of hesitant to throw in numbers out there, but we are in a position of having excess capital.

David Lewis - Raymond James

And I do not know what the exact numbers are right now, so you are clearly riding at a much lower premiums to statutory capital and surplus that you might prefer, so what do you think you could write up without the rating agencies getting too excited. Is that 1.2 to 1.3, a reasonable number, is it now 1.1 or 1.2? What do you guess?

Stan Starnes

The rating agencies seem to rate for our line of business 1 to 1. You can push them a little bit and maybe go a little higher, but they seem to like 1 to 1.

David Lewis - Raymond James

And that is really a change over the last couple of years, is it not? It seems to me it is.

Stan Starnes

A dramatic change, I think there have been times when we may have been willing to go up t 1.2, but I have not seen them go above that.

David Lewis - Raymond James

And just lastly, Ned, do you know what the stock based option costs were in 2007 versus 2006.

Ned Rand

We have that. It will just take me a second. Stock-based compensation costs 2007, $8.3 million and 2006 $4.7 million; I would remind you that in 2007, we had about $1.8 million of options related to Stan coming on board.

Operator

We will now take our next question from John Glen with Morgan Keegan.

John Gwynn – Morgan Keegan

Howard, a year or so ago, one of your competitors in at least one venue reintroduced the occurrence form, is there any broadening of that trend in the business?

Howard Friedman

No, John. We really have not. That was announced, it made a little bit of a splash at the time. We really have not seen any of our insured leave us to take advantage of moving back to our occurrence, at least not that we are aware of. I think it is probably more about talking points, sales at the time of sales than it is for actual selling any, but we have not.

John Gwynn – Morgan Keegan

And Howard, your buddy, Thomas McCarthy down in Florida recently mandated a return of premium I guess is what I will call it or excess profits and Work Comp, it seemed to be specific to Work Comp, but is there a similar legislation on meds now in Florida?

Howard Friedman

No, there is not. Florida has a fairly well prescribed medical malpractice rating process and a very formula driven approach to rate approval, rate making, but no excess profit provisions have been put into place at this point that we are aware of and nothing that has had any effect. We just went through a rate approval process in Florida within the last month.

John Gwynn – Morgan Keegan

Okay, was that a public hearing?

Howard Friedman

No, it did not require a hearing. We had a rate decrease and went through the process within the LIRD office, the office on insurance regulation and resulted in approval.

John Gwynn – Morgan Keegan

Ned, what is the cash at the holding company?

Ned Rand

Just one second, with cash and short term, we are sitting on about $80 million and we have got about almost $70 million and six maturities.

John Gwynn – Morgan Keegan

Oh so it is 80 plus 70?

Ned Rand

Yes.

John Gwynn – Morgan Keegan

And do you have an idea of what your dividend capacity is this year from the subs?

Ned Rand

Some of it, $162 million without prior approval.

John Gwynn – Morgan Keegan

And Ned, do you spearhead the relationship with AMBest.

Ned Rand

Actually Frank does.

John Gwynn – Morgan Keegan

So, Frank, this is all your fault?

Frank O’Neill

No, somebody here has to take the blame for it, might as well be me.

John Gwynn – Morgan Keegan

Your A-minus rating is sort of out of kilter from my perspective, I know I am just preaching to the choir, but—

Frank O’Neill

Do I get your phone number to call?

John Gwynn – Morgan Keegan

I mean, if they give A-minus ratings to almost anything that walks around these days, I am just curious, I mean with the operating in financial lack of leverage that you have in the operations today, what is the hang up?

Ned Rand

Obviously, BEST looks at the world the way they do as we look at what they do, ourselves and competitors. I mean, clearly they do not, from our point of view look at it holistically, and we would say, you look at us as an organization, not by individual pieces. In addition to that, I guess part of the reason that we do not make it a major issue which is not a factor in the marketplace and so there is no, I mean, A-minus, you are on everybody’s good list from the agency point of view and there is really not much premium above that, so I guess it is one of the issues that we will work on and desire to continue to maintain. It is not a high priority item in an organization.

We certainly have conversations with them and talk to them about their view of our company, but I guess the bottom line is we just do not get the credit for cash at the holding company that we might get with another agency.

Operator

We will now take our next question from Michael Whitney with Taylor Investment Company.

Michael Whitney - Taylor Investment Company

My questions have been answered. Thank you.

Operator

We will go to the next question from Amit Kumar with Fox-Pitt, Kelton.

Amit Kumar - Fox-Pitt, Kelton

I guess just going back to maybe Beth or Ron’s question on top line. Do you see any organic growth opportunities in new states or perhaps in allied lines?

Howard Friedman

I think the first answer is, probably yes, we might see a little bit, but if we knew where they were, we probably would not tell our competitors. I mean, we typically do not get into state by state discussions. We have a couple of states where we have grown and we have at least one state that we are looking at right now in terms of a market entry. We have some related lines of business that we already are in. You know that we are in the large professional area. We are looking and doing more in smaller hospitals and allied health; allied health meaning, non-physician medical liability. So there is a variety of things underway, at the same time, most of these are relatively small average premium lines so, it does not have quite the same impact as writing physicians or hospitals, but nevertheless, we think it will add to the business going forward.

Amit Kumar - Fox-Pitt, Kelton

That is helpful, and I guess just moving on to the investment portfolio just based on what the markets have done recently, has your approach or thought process changed in terms of how your portfolio is structured?

Ned Rand

Not in particular, especially if you look at our core fixed income portfolio, there has really been no change there. What we are seeing is perhaps some better opportunities in some of the areas that we have alternative exposures to, so for instance, sub prime, there seems to be opportunities and leverage loans, there seem to be opportunities and so we are certainly looking at expanding our allocations to those areas but we are talking very, very small components to the portfolio. I think alternative investments for us equities and equity substitute is around 3% of the portfolio and I do not see it much going above 5% in the near term.

Amit Kumar - Fox-Pitt, Kelton

And then maybe, this is the final question, I think in the Q3 call, you had mentioned a shock loss and I was wondering if A) there was any update to that and B) have you seen any other shock losses recently. That is my final question. Thanks.

Ned Rand

I think Darryl mentioned that we see them from time to time in our book of business and that as I go back to that I do not think there is a trend that you would say that we are seeing some rapid acceleration in that?

Darryl Thomas

No, certainly no rapid acceleration and I think you are referring to the Florida case, as you know that amount was confidential and the minute it was resolved with all claims taken cared of, resolved amicably among the parties.

Howard Friedman

I think he was referring to the last quarter when we mentioned the case in Iowa.

Darryl Thomas

And again, Amit, we mentioned that not to call specific attention to that one case as being something out of the ordinary or an outlier, but to simply use it as an illustrative example. I am afraid, it got blown way out of proportion that somebody read into that that this was a major big deal while we take them all seriously. We were really just using that as an example and I did not want you to reach too much into that.

Amit Kumar - Fox-Pitt, Kelton

No, I was just wondering for an update because obviously, $15 million to $20 million on I guess a $2 billion-plus reserve base pretty much is not meaningful.

Darryl Thomas

Again because it was an example, we would not be giving an update on it. It is obviously in the numbers we reported.

Operator

(Operator Instructions)

And we will now take our next question from Michael Paisan with Steifel-Nicolaus.

Michael Paisan - Steifel-Nicolaus

A couple of questions actually just a broader base. I am trying to sort of rectify this whole shock loss issue relative to what others are saying and others are not saying the same thing, and is it because ProAssurance basically try so many more cases than their competitors and therefore the probability that you are going to have a shock loss is greater because you take so many more to jury, is that simply the reason why or am I looking at it in too general of a term?

Darryl Thomas

I do not know that we have any more or less shock losses than anybody else. We happen to mention one loss in one call and all of a sudden it is being set out that we have this huge number of shock losses. That is just not the case.

Michael Paisan - Steifel-Nicolaus

Well, just to relative to everybody, nobody else seems to be seeing the same shock losses, so I just did not know, there is obviously something in the way that you guys defend or do you your claims versus others.

Darryl Thomas

Let me look back, but I think we mentioned one shock loss that we had in the last quarter and we mentioned about five or six others that we saw in unnamed other companies. So we said last time for example, we said there was an $8 million verdict in Maine. We are not in business there, $26.5 million verdict in Massachusetts, we are not there. It was $23 million in Wisconsin which was not ours, verdicts in Connecticut where we were not and there was a $35 million verdict in Michigan where we were not.

So we mentioned one verdict of ours and a handful of verdicts from other folks, and again, people blew that out of proportion. We were using it certainly as an example just to say, there are shock losses in the world and Darryl said earlier today, these shock losses have occurred since we got in, since the business started. They are going to continue changing the laws and they are a fact of life and you better have a strong balance sheet and good claims management to deal with them and we are probably at the top of the heap in both of those.

Michael Paisan - Steifel-Nicolaus

In terms of trying to rectify the lower frequency and how that may play out, is it fair to assume that their lower frequency is due to the lack of or the significant decline in frivolous lawsuits that have been filed, so in other words, let us say the percentage of meritorious cases would really not be changing that much, it is mostly the frivolous lawsuits or the non-meritorious claims that are no longer being filed?

Darryl Thomas

That certainly is the theory and at this point, I guess, we are seeing mixed conclusions or mixed results from the theory if you go back a few years. When you look at the years where we actually can see what has happened and in some instances, we have seen no real change in the number or in the ratio of claims both with payment as compared to those without payment and in some states, we have seen some difference and there are a lot of things that have to be taken into account to kind give you our controls number in terms of what may have caused the frequency change, was it the reform that was implemented in a given state, was it a state without reform. It is not completely clear yet. I am not sure that it ever will be. It was not in the late 80’s when the same phenomenon existed and then frequency jumped back up again by about 1990 or 1991, so that is certainly the logical explanation for it, but we are not completely able to tell and practice whether that is the case.

Michael Paisan - Steifel-Nicolaus

So it is more theoretical right now?

Darryl Thomas

Yes.

Operator

And as we have no further questions, I will turn the conference back over to Mr. O’Neill.

Frank O’Neill

Thank you everybody for joining us. We will join you again when we report first quarter earnings. Thanks again.

Operator

This concludes today’s conference. Thank you for participating and have a great day.

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Source: PRA ProAssurance Corp. Q4 2007 Earnings Call Transcript
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