Tower Group Inc., Q4 2007 Earnings Call Transcript

Mar. 6.08 | About: Tower Group, (TWGP)

Tower Group Inc. (NASDAQ:TWGP)

Q4 2007 Earnings Call

March 6, 2008 10:00 am ET

Executives

Michael Lee – President & CEO

Frank Colalucci – Sr. VP & CFO

Thomas Song – Managing VP

Analysts

Michael Grasher – Piper Jaffray

Bijan Moazami - Friedman, Billings, Ramsey

Elizabeth Malone - Keybanc Capital Markets

[Analyst] - Sidoti & Company

Operator

Good day ladies and gentlemen, at this time I’d like to welcome everyone to Tower Group’s fourth quarter earnings conference call. (Operator Instructions) It is now my pleasure to turn the floor over to your host, Managing Vice President Mr. Thomas Song, please go ahead sir.

Thomas Song

Good morning, before I turn the call over to Tower Group President and CEO Michael Lee and the company’s Senior Vice President and CFO Frank Colalucci, I want to remind you that some of the statements that will be made during this call will be forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Actual results could differ materially from those projected in these forward-looking statements. For more information on the risks and other factors that may affect future performance, investors should review periodic reports that are filed by the company with the SEC from time to time. Also I want to remind everyone that a replay of this call will be available in the Investor Relations section at Tower’s website. Now I’d like to turn the call over to Michael.

Michael Lee

Thank you Tom and good morning everyone. I’d like to thank all of you for joining us on this conference call to discuss our fourth quarter and full year 2007 operating results. As described in this morning’s press release I’m pleased to report that Tower Group has once again produced strong operating results for the quarter and the full year. Excluding realized investment gains or losses our fourth quarter diluted earnings per share increased by 69.6% to $0.78 per share as compared to $0.46 per share for the same period last year.

For the full year our diluted earnings per share excluding realized investment gains or losses increased by 33.5% to $2.43 as compared to $1.82 in the same period last year. Our return on equity increased to 23.8% for the quarter compared to 20.7% for the same period last year and 22.6% for the full year compared to 22.2% last year again when excluding net realized losses. We experienced significant top line growth during the quarter and for the year. We achieved 62.6% growth in total of gross premiums written and produced during the past quarter and 44.4% for the full year over the same periods last year. Despite the robust premium growth rate we continue to maintain our underwriting and expense discipline as reflected by our 80.9% net combined ratio during the fourth quarter and 83.7% for the full year.

As we have noted during our past two earnings calls significant events in the real estate and fixed income markets have affected some of our investments. Much of the decline in value in 2007 was caused by the continuing lack of liquidity and volatility in the credit markets. In response to this challenging investment environment we took affirmative steps to maintain the quality of our investment portfolio by selling investments to reduce our exposures. We also wrote down investments that had unrealized losses. In doing so we shifted a significant portion of our unrealized investment losses that already ran through our balance sheet in the third quarter and realized these losses through our income statement in the fourth quarter.

Our sales significantly reduced our exposure to sub-prime mortgages and strengthened our investment portfolio. Despite the unfavorable investment environment in 2007 our book value grew by 44.5% for the full year. So we believe we have been very proactive in responding to the challenges in the investment environment that have or may continue to adversely impact the financial sector.

As a result we believe our investment portfolio is well positioned to support our growth in 2008. Later on this call, Frank will go over in detail our investments as well as the favorable operating loss ratio and expense ratio trends that we continue to experience during the past quarter and in 2007.

Overall the fourth quarter and 2007 as a whole, were very successful in that we continue to profitably grow our business despite the challenging market conditions. We successfully executed our business plan in 2007 on several fronts. First we successfully integrated the acquisition of Preserver within a nine month period of time and substantially reduced the expense ratio in each quarter since the closing of the transaction of the beginning of the second quarter. We were able to generate $63.6 million in gross premiums written since closing on this transaction on April 10, 2007. In addition we lowered Preserver’s gross expense ratio from approximately 42% that Preserver recorded in 2006 to 31% for the fourth quarter of 2007. Consistent with our plan we anticipate Preserver to be fully integrated into our company by the end of the first quarter with an expense ratio similar to Tower’s expense ratio for 2008.

Second we were able to grow organically through various strategic growth initiatives particularly in the second half of 2007. The most important initiative for us in 2007 was to expand territorially through our wholesale distribution system. We were able to write $29.4 million by appointing additional wholesalers or taking over a book of business from existing wholesalers throughout the country by distributing our products that we have designed for our wholesalers in the north east. Much of the additional premium volume came from our expansion into Florida. We have begun our expansion into Texas and California beginning in 2008. Given that most of the premium from this initiative in Florida took place in the latter half of 2007 and began our expansion into Texas and California in 2008, we believe this wholesale expansion initiative will be a significant source of growth for us in 2008.

With respect to our recent expansion, I would like to point out that we have an 18 year track record of successfully expanding into new products and territories and our recent expansion into different parts of the country is consistent with the approach that we have taken in the past. As we have done with our expansion in the north east during the last several years, we have properly addressed the risks associated with expanding into states outside of the north east by using the same underwriting processes and controls that have worked well for us in New York City where we commenced business in 1990.

We also realized success especially in the fourth quarter in placing business with CastlePoint Insurance Company through our risk sharing arrangement with CastlePoint. Through this arrangement we were able to generate significant amount of commission and fee income by placing over 84 million of premiums with CastlePoint Insurance Company in 2007. This increase in commission and fee income allowed us to significantly increase our return on equity to 23.8% in the fourth quarter excluding realized investment losses from 17.2% in the second quarter of 2007 when we did not have access to CastlePoint Insurance Company. We anticipate that we will be able to continue to generate additional commission and fee income throughout 2008 as a result of this risk sharing arrangement with CastlePoint Insurance Company.

Despite challenging market conditions we continue to maintain high retention on our business as reflected by the 85% and 79% retention rates for personal lines and commercial lines respectively in 2007. This again demonstrates our ability to successfully allocate capital using our broad product line platform to profitable lines of business and select market segments in those lines of business.

Finally now that we have successfully integrated Preserver we are actively seeking new acquisitions to expand our product offerings and to expand into new territories. We are seeing meaningful opportunities in this area and look forward to working with CastlePoint to take advantage of these opportunities. As we have done with Preserver, we believe we have the ability to make acquisitions accretive for our shareholders by applying our business model and business strategies. With that overview I would like to now turn the call over to Frank to discuss the details of the financial results, Frank?

Frank Colalucci

Thank you Michael and good morning everyone. As Michael mentioned we saw a strong operating performance during the quarter and the year. I’ll cover some of the financial highlights and provide an outlook for 2008.

Our net income growth excluding net realized investment losses in both the quarter and for the full year was again the result of strong contributions from all sources of revenue, excluding realized investment losses net premiums earned, commission fee income and investment income. For the quarter our net premiums earned represented approximately 61% of total revenues excluding realized investment losses. Net investment income represented 7% and commission and fee income represented 32% of total revenue excluding realized investment losses. For the quarter our gross premiums written increased by 12.9% to $136.6 million from last year’s fourth quarter and our net premiums written increased 14.8% to $74.4 million. We ceded 40% of our premiums to CastlePoint under our quota share arrangements during the quarter.

For the year gross premiums written increased by 21.1% or $524 million. Net premiums increased by 5.8% to $259.2 million over the prior year period. The smaller increase in net premiums written resulted from the increase in quota share premiums ceded to CastlePoint in 2007 over 2006.

In the fourth quarter of 2007 our total commission and fee income revenue increased significantly by 168% to $41.8 million in the fourth quarter of ’07 as compared to $15.6 million in the same period last year primarily as a result of the risk sharing arrangement with CastlePoint through TRM. For the year, our total commission fee income revenue also increased significantly by 104% to $106.3 million compared to $52.2 million in 2006. The gross loss ratio decreased to 49.1% in the fourth quarter of ’07 as compared to 49.5% in the fourth quarter of ’06. And for the year, the gross and net loss ratios were 50.7% and 55.2% respectively as compared to 55% and 60.3% respectively in 2006.

The decrease in the gross and net loss ratios for 2007 compared to 2006 excluding the affect of the PX3 commutation in 2006 was primarily due to lower than expected loss emersions for Workers’ Compensation, commercial auto liability and our property lines of business plus we’ve had increased pricing in our property lines. The prior year’s net loss reserves developed favorably to the extent of $1.6 million. While there was some continued affect of cat reinsurance premiums on our net loss ratio it was not significant as of 2006 as our overall earned premiums have grown.

The year 2007 now marks the fifth consecutive year in which we’ve had no adverse reserve development on the prior year end net loss reserves. While we continue to see the benefits of greater scale our 2007 gross expense ratio of 29.2% was slightly higher than at 28.7% we saw in 2006. As Michael mentioned we have been reducing Preserver’s expense ratio throughout the year. Our progress can be seen in our overall fourth quarter gross expense ratio which was 28% as compared to 29.8% in the fourth quarter of 2006. And on a net basis, our expense ratio was substantially improved at 25.7% for the quarter versus 30.6% last year. This not only reflects the progress we’ve made on Preserver’s operations during the year but also the increased affects of ceding commission revenue that lowers our net expense ratio.

That combined ratio decreased to 80.9% in the fourth quarter of ’07 from 85.2% in the year ago period. And for the year we saw a decrease to 83.7% from 87.6%. As you can see from these ratios our underwriting results contributed very strongly to our overall earnings and return on equity.

As Michael mentioned earlier during this call we face challenges in the investment environment due to the dramatic credit spread widening that occurred in the fourth quarter in real estate related bond markets. As we reported at the end of the third quarter of ’07 we already experienced unrealized losses of $20.6 million primarily in our mortgage backed investments including sub-prime assets and equity REITs. Ordinarily unrealized losses would not pose problems for us in that most of our investments are comprised of conservative, highly rated or fixed income investments that we purchase and hold in order to match up with the maturity of our insurance liabilities. For the most part, fluctuations in the price of bonds do not impact the surface of our insurance companies on a statutory accounting basis. But as you know on a GAAP basis if we sell these investments we convert our unrealized losses to realized losses. Therefore it is a matter of shifting unrealized losses reflected on our GAAP balance sheet and recognizing losses in our income statement however to the extent of these losses that already in the unrealized position, the sales of these investments has no impact on our GAAP book value.

During the fourth quarter we performed a comprehensive review of our investments with the help of our outside advisors and decided to take affirmative steps to respond to the challenges in the investment environment. Based upon that review we decided to strengthen our balance sheet by identifying investments that we want to sell or write down in order to position them for a sale. At the end of the third quarter we had $29.1 million of sub-prime exposure at fair value at which 97% was investment grade. Also at that time as reflected in credit spreads the market appeared to have stabilized. However during the second half of the fourth quarter the market for these types of investments deteriorated significantly more and as a result we decided to reduce our exposures by selling a significant portion of our sub-prime investments which represented a realized loss of $11.3 million on a pre tax basis.

In addition primarily as a result of our change and in intent to hold other real estate related investments we took other than impairments on our REIT stock investments for a pre tax loss of $5.2 million and certain directly held bonds which were primarily the remaining sub-prime positions for a pre tax realized loss of $4.9 million. Overall we recognized $17.5 million of net realized investment losses and impairments or $11.4 million net of tax. However for those investments on which we recognized losses in the fourth quarter, $13.2 million of these losses were already unrealized at the end of the third quarter. Recognizing losses on these investments as realized in the fourth quarter contributed significantly to the reduction in our unrealized losses of $20.6 million at the end of the third quarter to $12.1 million at the end of the fourth quarter.

I would also like to point out that it was our lack of intent to hold to maturity or cost recovery that drove the vast majority of our impairment decisions, not non performance or ratings down grades which we have not experienced to a significant degree. Just to add some additional facts about our portfolio, the overall quality is a AA and with cash and short terms positions plus treasuries added in, nearly 57% of the fixed income portfolio is in the AAA category. The average life of the positions in our fixed income category is about five years and the duration is about four years.

Due to our strong operating performance our invested assets including cash and cash equivalents increased 23% to $697 million. For the year our net investment income increased by nearly 59.4% to $36.7 million compared to $23 million in 2006. Net cash flow of $74 million provided by our profitable operations was an important contributor to the increase in invested assets. Also as part of our overall investment diversification strategy we have added [Standish Melon] as an additional investment manager during the fourth quarter.

On a tax equivalent basis our book yield was slightly lower at year end 2007 at 5.6% compared to 5.7% in 2006 and currently our new money rate on taxable bonds is about 5%. For the full year of 2007 our interest expense was $9.3 million compared to $6.9 million last year. The increase resulted primarily from an increased expense on the subordinate debentures underlying our trust deferred securities of which $20 million were issued in January of 2007 and the assumption of Preserver debt in the amount of $12 million.

We carry our investment in CastlePoint under the equity method of accounting, our ownership percentage is about 6.7% excluding the warrants and for the year this represented a $2.4 million of pre tax income.

Now I’ll discuss our earnings outlook for 2008. For the first quarter of 2008 we project net income to be in the range between $13.5 million and $14.5 million. We project diluted earnings per share in the first quarter to be in the range between $0.58 and $0.62 per diluted share. For the full year we anticipate net income to increase to a range between $67.5 million and $70 million and diluted earnings per share to be in the range between $2.90 and $3.00 per diluted share. These projections do not include any amounts for realized investment gains or losses.

We will now turn the call over to the operator to open the floor for questions.

Question-and-Answer Session

Operator

Your first question comes from Michael Grasher - Piper Jaffray

Michael Grasher – Piper Jaffray

Good morning gentlemen congratulations on a great year. I wanted to ask you about your geographic expansion and how you spoke to Florida being important in ’07, Texas and California here in ’08, where are the most significant growth areas that you’re seeing where you’re already up and running?

Michael Lee

Good morning Mike, we’re seeing very good growth in Florida. We started in Florida I guess early part of 2007 and really ramped up in the second half of the year and a lot of our wholesaler and annuities also have presence in Florida so that made it easier so we plugged into Florida with the same products that we distribute in the north east and had very, very positive results very early on. And I think that’s due to our experience in dealing with wholesale distribution systems so a lot of our products really are geared towards meeting the needs of the wholesale distribution system. We have a lot of products that we write on on admitted basis whereas a lot of their markets provide products on a non admitted basis so although we write on an ENS basis in Florida a lot of our products have similar features of an admitted product that we distribute in the north east. So that has resonated well with the wholesale distribution system in Florida. We’re also expanding into Texas. We did a lot of work in Texas in the third and fourth quarter of last year and now we’re up and running and we’re also up and running in California. So we think that we have a very good potential to grow our business significantly in 2008 as result of these initiatives that we started in 2007.

Michael Grasher – Piper Jaffray

And then by going into Florida as well as Texas has your exposure on a cat basis changed?

Michael Lee

No we don’t write homeowners, we don’t write a lot of property lines of business. Most of our products are really geared towards the small commercial package types of business and also we emphasize writing mono line general liability products so we’re not at all exposed to any type of cat type of catastrophic events that frequently occur in Florida as well as some of the other areas that we’re going into. So our approach is to really only distribute products that will give us consistency in terms of being able to generate underwriting profit on a consistent basis rather than going into these areas and writing a risk that are cat prone.

Michael Grasher – Piper Jaffray

Can you give us some numbers in terms of where you are right now in terms of production within the state of Florida?

Michael Lee

Well I think I mentioned that we wrote through our wholesale appointments that the appointments that we made in 2007 I believe I mentioned approximately about $30 million, $25 million to $30 million were generate through that initiative.

Michael Grasher – Piper Jaffray

And that was just Florida?

Michael Lee

No that was some in the north east and some in Florida, I would say Florida was probably a little shy of $20 million so within a very short period of time we were able to significantly expand our writing. Overall we think that we will be able to generate at least $50 million in 2008 just from these wholesale initiatives. I just want to point out that I mentioned $20 million, I’m sorry that’s on an annualized basis for the full year since we started out in second half of the year, we started ramping up our writings so our total writings in Florida was around $10 million for 2007. That’s obviously on an annualized basis, so that’s about $20 million.

Michael Grasher – Piper Jaffray

Okay and then one final question I think you spoke to pricing for the year, can you give us some idea about what maybe it’ll look like in the quarter, how much it changed in the quarter?

Michael Lee

I think we’re now about flat, we’re not seeing too much rate increases except for these increases that we get on renewals due to changes in exposure units and maybe the increase in values as a result of these endorsements that adjust the exposure based on inflation or some other factors so we’re very happy with our pricing right now and what we’re trying to do is use our broad product line platform to go into lines of business or market segments within those lines of business where there’s pricing integrity. So overall our pricing is very stable because of the selections that we made with respect to the markets that we go into and we’re also seeing some intense competition in markets that we have withdrawn from or we have reduced our writings. So we are impacted but our business strategy allows us to go in and out of different markets and allocate our capital to market segment where there is pricing integrity and I think a lot of investors often ask us how we’re able to maintain that pricing integrity and its really because we’re able to generate significant premium volume opportunities in many different areas that allows us to exit or reduce our writings in areas that we’re seeing intense level of competition.

For example in the middle market commercial area we started reducing our writings two years ago and we’re not competing in that market segment but we also have developed new products and have gone into new territories that have allowed us to make up for that. We also acquired Preserver so for us it’s not the market cycle, we’re not as affected by the market cycle because of our business strategy that we use and because we’re able to develop business plan each and every year where we’ve changed the business mix, where we expanded the different territories, we introduced new products and overall based on those initiatives we’re able to maintain our pricing integrity and you can see that because our loss ratio has actually declined since we went public in 2004 and we’re seeing some really very favorable loss trends despite what is going on in the marketplace.

Michael Grasher – Piper Jaffray

Any particular region that you are walking away from right now?

Michael Lee

I think in the north east and certain areas, commercial, middle market, we’re letting our volume drop down and we’re substituting the volume by looking at other parts of the country in running these small package policies, small mono line general liability policies, where we’re seeing integrity, pricing integrity and in order to maintain that pricing integrity we really have to work hard and find these market segments where we don’t see that type of intense competition that we find in certain market segments like commercial middle market segments.

Michael Grasher – Piper Jaffray

Okay, thank you.

Operator

Your next question comes from Bijan Moazami - Friedman, Billings, Ramsey

Bijan Moazami - Friedman, Billings, Ramsey

Michael it’s been awhile since you made an acquisition, what do you see out there in terms of opportunities and when should we be expecting that there’s going to be additional premium volume generated from an acquisition?

Michael Lee

We’re seeing a lot of great opportunities. In many ways we benefit from the soft market. I know that’s unusual statement to make as an insurance company but we are seeing opportunities mainly by ceding our premium volume and generating fee income as we have done in the fourth quarter as a result of the fact that there’s softening in the reinsurance sector. So we were able to generate significant amount of premium volume and then be able to place that business with reinsurers that are looking to expand their writings because they’re finding it difficult to increase their top line growth. So we see an opportunity in a soft market for us to expand our premium writing and be able to shift our premium volume to reinsurers and to other companies that want to pay us fee income for managing that premium volume.

We also are seeing in the soft market where the competitive landscape is having adverse impact on our competitors especially ones that have very limited opportunity for growth and those that have very high expense ratio. So I think Preserver was an example where we took a company that really wasn’t seeing top line growth, where their expense ratio was very high and we were able to make it very accretive in less than a year by reducing the expense ratio and by consolidating that operation into our operation. So we are seeing a lot of opportunities, more than we have in the past so I think you can anticipate that we will supplement our organic growth with acquisitions and if that happens given our track record I think it will have a beneficial impact in 2008 and our earnings guidance that we provided which contemplates significant growth in our earnings per share excludes those acquisitions so I think if we do, we’re successful in making an acquisition I think it really will have a very positive impact above and beyond what we have stated as our earnings guidance for 2008.

Bijan Moazami - Friedman, Billings, Ramsey

Wonderful. My next question is for Frank, there is an undue level of concern in the market about the fixed income market and the mortgage backed market especially today with Carlisle Group, Frank could you share with us some of the due diligence that you’ve made on your investment portfolio given that you do not manage the investment portfolio internally to give us confidence about the fixed income portion of the investment portfolio that you have.

Frank Colalucci

Well we can’t predict what will happen but we certainly can take a close look at what we hold and I mentioned on the call we tend to hold pretty highly rated securities with significant amount of subordination in the mortgage back areas. We did indeed undertake a very comprehensive review of our portfolio at the end of the year and we continue to do this periodically because not only do we have to make sure we conform to the accounting rules with respect to impairments but we also want to make sure that we maintain a high quality portfolio. We subjected all of our fixed income positions that had an asset back associated with it to cash flow testing meaning that we measured the expected cash flows from each position and matched that up against the expected cash flows we had on those positions on the day we bought that. Any cash flows that were less than what we anticipated when we bought that security, would suggest that there is an impairment associated with those securities and they were indeed reflected as impaired losses in the fourth quarter. So we look at every position to make sure that we are going to realize the value of that security as we contemplate it on the day we bought that because when we buy these securities as I mentioned they’re bought with the intention of holding those in order to match up with our insurance liabilities.

Bijan Moazami - Friedman, Billings, Ramsey

Thank you.

Michael Lee

Just adding Bijan, just adding to what Frank said, I think during the call we mentioned that we did a comprehensive review of our investment portfolio and we selected investments that we felt may cause us some problems in the future so we took an affirmative step and I think we looked at everything that may present problems for us and took the hit this quarter. Of course a lot of these securities, a lot of these investments as Frank mentioned were already in an unrealized loss position but we decided that we wanted to realize these losses to position well for 2008 and I think based on that decision our investment portfolio is in a much better position than it was before and then the rest of the investments that we hold are the types of investments that we feel very confident about and we believe that our investment portfolio now is very conservative and it should give us the ability to support our growth in 2008.

Operator

Your next question comes from Elizabeth Malone - Keybanc Capital Markets

Elizabeth Malone - Keybanc Capital Markets

Just a couple of questions, when we look at the guidance that you’re providing for 2008, I think Frank you said it was $0.58 to $0.62 for the first quarter of 2008 and then its $2.90 to $3.00 for the full year, is that accurate?

Frank Colalucci

That’s what I said, yes.

Elizabeth Malone - Keybanc Capital Markets

Okay so that would suggest that there’s a pretty significant ramp up during the year on operating results, am I getting that right?

Frank Colalucci

Yes it has a lot to do with the timing of the premium that we write under our risk sharing arrangement with CastlePoint. As you recall, as Michael discussed and I think I might have mentioned as well that that really began in earnest in the middle of 2007 so the renewal process will have a big beneficial affect on those policies in the third and fourth quarter of 2008.

Elizabeth Malone - Keybanc Capital Markets

Okay so it’s heavily weighted towards the second half of the year.

Frank Colalucci

Right.

Elizabeth Malone - Keybanc Capital Markets

Okay and as Michael you mentioned that you anticipate that you will be relying more on reinsurance or reinsurance will continue to be an important part of how you’re growing the business and so should we assume them that the insurance services segment which had a big jump in revenues in the quarter compared to a year ago, will that continue?

Michael Lee

Yes Beth, we were confident and we faced this issue last year if you recall, our return on equity for the second quarter after our funnel on offering was 17% and we ramped it up to around 24% so I think there was some doubt as to whether we could have achieved that type of ramp up but we knew that we could accomplish that substantial increase because we started using CastlePoint Insurance Company in the second half of the year and we wrote most of our volume in the fourth quarter. When that happens we’re able to generate commission and fee income so what is happening throughout the year is, what happened in 2007 was we were in the first two quarters we were utilizing our own capital and we were leveraging our own capital that we received through the funnel on offering once that was done we were utilizing reinsurance. Once we exhausted that capacity we used other insurance companies for capacity then as you do that you start increasing the return on equity because you’re generating significantly more commission and fee income as you exhaust your own capital base and start generating commission fee income with the additional premium volume that you’re generating. So that is what happened in the fourth quarter and because we’ll have full use of CastlePoint Insurance Company for the entire 2008 we should be able to do much better in terms of the ROE and the track record that we’ve built in fourth quarter will continue into 2008.

Elizabeth Malone - Keybanc Capital Markets

Okay now what do you anticipate from the reinsurance costs, are you expecting that they go up or go down or stay the same?

Michael Lee

I think the commission should go up, our expense ratios should go down because of the scale that we’re creating and that override that we get from the commission that receive above and beyond our expense ratio is what gives us the commission and fee income that lowers our expense ratio on a net basis and augments our return on equity so we’re seeing very favorable trends and when we go out to the marketplace we’re getting better terms than we did two or three years ago. So that will help us and that’s the differentiator, that’s what make us unique with our business model and that will enable us to counter balance the disadvantage in a soft market cycle for those companies that utilize their own capital and as a result we think we’re well positioned.

Elizabeth Malone - Keybanc Capital Markets

Okay and is that true on the catastrophic reinsurance agreements too, are you anticipating seeing a reduction in those, in the cost of those?

Michael Lee

Yes, we had managed our cat exposure very well so what we’re doing is trying to decrease our cat exposure by using our cat management technique and we have done that successfully and we have not increased our cat exposure despite the growth in homeowners’ business as well as property lines of business in the north east. And in addition to that we’re seeing cat costs decrease. So we’re able to write more property business in the north east but our cat load or our cat costs relative to the total premium volume is going down significantly and as a result of that we are seeing some favorable trends for homeowners and property lines of business because when the cat cost goes down relative to the total premium volume the impact of that is in lower net loss ratio for our homeowners and property lines of business and that’s what you’re seeing and the higher weighting of those lines of business is what’s driving our total net loss ratio down and you’re seeing that positive trend occurring in 2007 and we anticipate that to continue in 2008.

Elizabeth Malone - Keybanc Capital Markets

And then one final question on the acquisition strategy, as you said there’s lots of opportunities out there. Do you think it’s more difficult for you to get the right valuation on an acquisition with your stock trading at a much lower valuation than it was six months ago? Does that have an impact on how you look at pricing, potential acquisitions?

Michael Lee

No we have not used stock as a currency for acquisitions. Perhaps we will do that but we take a company like Preserver and the advantage that we have is making that company better, more profitable. Not too many acquirers can do that. We’re able to do that because of our expense discipline, our business model and the efficient business processes that we utilize to make other companies, make these acquisitions accretive and profitable for our shareholders. So when we find these acquisitions we tend to look at, we don’t pay a price for these acquisitions that’s too out of line because the value that we’re able to achieve comes from our effort after the acquisition and as a result of that we’re able to buy these acquisitions at a reasonable price and add greater value by applying our business practices and therefore we think that we’re in a good position despite the fact that our stock price has declined during the last couple of months. In addition to that our valuation is still very good relative to other companies that we’re trying to acquire you know because of our fee base income and our business model we’re able to enjoy a higher book value multiple relative to other traditional insurance companies that are trading fairly low relative to book values. So I think on relative terms we still have that advantage and even if we were to use stock as currency we think that we’re in a very good position relative to other insurance companies to make these acquisitions.

Elizabeth Malone - Keybanc Capital Markets

Okay, thank you.

Operator

Your next question comes from [Analyst] - Sidoti & Company

[Analyst] - Sidoti & Company

Could you provide a bit more color regarding the launch of the commercial package policies on the web?

Michael Lee

Could you repeat that, I’m sorry I didn’t catch that. You asked about our commercial policies on the web?

[Analyst] - Sidoti & Company

Yes the package policies that you had the initiative for the launch on the web that you were talking about in the third quarter conference call.

Michael Lee

Yes, that is, I’m glad you asked that because that’s an important initiative. As you may know we have all of our products on the web and CPP or Commercial Package Policy is the last line of business that we’re trying to put in place on the web and it’s been a very long effort for us and we’re in a testing mode right now and we have it with eight of our largest agents and they’re testing our CPP, what’s called CPP light web platform and we think that would be in a position to probably start expanding that capability, offering that capability to other agents throughout 2008. So we think we’ll be up and running probably in the first half of the year. That means that we’ll have all of our products on the web and that should further decrease our expense ratio.

[Analyst] - Sidoti & Company

Okay and what kind of retention ratio assumption for commercial and personal lines does the ’08 EPS guidance reflect?

Michael Lee

It reflects pretty much the same type of retention that we have experienced in 2007. I believe I provided that figure. Frank do you have that figure as far as our retention rate for personal and commercial lines?

Frank Colalucci

Yes.

[Analyst] - Sidoti & Company

I got those, 79 for commercial and 85 personal, right so it’s pretty much the same for ’08?

Frank Colalucci

Yes, pretty much the same.

[Analyst] - Sidoti & Company

Okay and also the premiums produced by TRM on behalf of CPIC was $85 million in ’07, do you have a goal for ’08?

Michael Lee

Yes, we do. We’re looking at probably in excess of about $120 million to $130 million. We haven’t finalized our projections with respect to how much we anticipate putting into CastlePoint Insurance Company but that’s what we’re looking at right now based on the projections that we have currently.

[Analyst] - Sidoti & Company

Okay and finally that $11.5 million current sub-prime exposure, is this directly held or part of the closed end fund?

Frank Colalucci

That is directly held. The closed end fund was part of the sale that we executed in 2007.

[Analyst] - Sidoti & Company

Okay, thank you very much.

Operator

Your next question is a follow up from Michael Grasher - Piper Jaffray

Michael Grasher – Piper Jaffray

A couple of follow-ups here, Frank just wanted to know where exactly you are putting new money to work right now?

Frank Colalucci

Right now we’re putting money to work in taxes and securities. We see good value there and as we discussed today Tower’s profitability makes us a very significant tax payer and this is an opportunity for us to add value to shareholders’ equity by that strategy.

Michael Grasher – Piper Jaffray

And is it significant enough to where we might see the tax rate change 50, 100 basis points or anything in that range?

Frank Colalucci

Well it will have an affect on the tax rate but it may not be quite as visible because we do have to recognize that as we write more business to a TRM there is a slight impact resulting from a local income tax impact that does not exist in the insurance companies. But it will have a beneficial affect on the tax rate.

Michael Grasher – Piper Jaffray

Okay and then Michael just if you could summarize maybe in terms of your property versus your casualty exposures, what’s the mix right now?

Michael Lee

I don’t have the figure but it is typically with the homeowners business it’s probably around 55% to 60% is probably property driven. Is that correct Frank?

Frank Colalucci

That’s about right, yes.

Michael Lee

Yes, 55% to 60% and rest of the business mix is comprised of short tail liability, Workers’ Comp, commercial, auto policies so there’s very little tail on those types of lines of business so overall we think that we have very low hazard, very innocuous risk profile that will hold up very well in the soft market.

Michael Grasher – Piper Jaffray

Okay and then any concerns or positive, potentially positive developments from a regulatory perspective whether it be in existing states or where you maybe see opportunity or diminished opportunity in states that you’re looking to move into such as Texas, California?

Michael Lee

No, not really. We’re not motivated by those factors. I mean we’re pretty much motivated by what we’re seeing in terms of the market opportunities for our product and that’s the main reason for expanding into those states.

Michael Grasher – Piper Jaffray

Okay, thank you.

Operator

It appears we have no further questions at this time; I’d like to turn the call back to Mr. Michael Lee for any closing or additional remarks.

Michael Lee

The year 2000 was a year in which we demonstrated that we can continue to profitably grow our business despite challenging market environments. Based upon the growth initiatives that we have developed in 2007 the strength of our business model and business strategies we believe we’re one of the few companies that can commit to continue to grow our business profitably in 2008 as reflected by our strong earnings guidance. We appreciate everyone participating on this earnings call and look forward to speaking with you again next quarter. Thank you.

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