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Executives

Ann Storberg – VP of IR

Kevin Clinton – President and CEO

Frank Freund – EVP, Treasurer and CFO

Analysts

David Lewis – Raymond James

Amit Kumar – Fox-Pitt Kelton

Mark Iden [ph] – KeyBanc

Walter Shankar [ph] – Scion [ph] Capital

APCapital, Inc. (ACAP) Q1 2008 Earnings Call Transcript May 2, 2008 10:00 AM ET

Operator

Welcome to the first quarter 2008 APCapital Inc. conference call. (Operator instructions) I'd now like to turn the presentation over to your host for today's call, Ms. Ann Storberg, Vice President of Investor Relations. Please proceed.

Ann Storberg

Thank you, Karma, and welcome, everyone. Thank you for joining us today as we discuss our first quarter 2008 financial results for American Physicians Capital. As always, this call is being webcast live on our corporate web site at www.apcapital.com and you can listen to a webcast replay of this call later today which will also be available on our web site. Our first quarter earnings release is posted on our web site located in the For Investors section under press releases. Also for your convenience, a complete transcript of our call is posted on our web site in the For Investors section under webcast as soon as it is made available.

As always, I need to remind our listeners that during today's discussion, management may make certain forward-looking statements under the meaning of the Private Securities Litigation Reform Act of 1995. When we discuss our plans or expectations or use words such as will, should, believes, expects, anticipates, estimates, or similar expressions, we're making forward-looking statements. We do not undertake any obligation to update these statements except as required by law. While we believe any forward-looking statements made today are reasonable, they are subject to risk and uncertainties which could cause our actual results to differ materially. For a discussion of these risks and uncertainties, please refer to today's press release and the company's latest Securities and Exchange Commission periodic report.

Participating in today's call is Mr. Kevin Clinton, our President and Chief Executive Officer, and Mr. Frank Freund, our Chief Financial Officer. Kevin and Frank will begin the call with their prepared remarks and then, as always, we’re going to open up the call for questions. I'm going to turn the call over to Kevin.

Kevin Clinton

Good morning, everyone. APCapital is pleased to announce our first quarter 2008 results. The first quarter was a steady and solid quarter for APCapital. Net income for the quarter was $11.4 million, or $1.13 per diluted share, compared to net income of $10.5 million, or $0.90 per share for the first quarter of 2007, an increase of 26% in earnings per share. Our reported claim count continues to decline. We had just 937 claims reported for the year ending March 31, 2008, compared to 1107 claims reported for the year ending March 31, 2007, a 15.4% decrease for the year. Our reserve position remains strong. Since March 31, 2007, our professional liability open claim count has decreased by 24% from 2200 open claims to 1672 open claims. Yet our total net reserves decreased by just 3.4% from $553 million to $534 million.

Our IBNR reserves during the same time period increased by $38 million. We're retaining our insured doctors. Despite strong competition, our retention percentage has increased and our insured doctor count is down just 0.3% from year end 2007. Our premium is down because our pricing is lower and we're comfortable with the rate decrease because the data that is indicating that we can release prior year reserves is also indicating we can reduce our pricing and still meet our profit objectives.

During the first quarter of 2008, we returned excess capital to our shareholders through our stock repurchase program. We were able to purchase 404,000 shares of our stock at an average price of $42.93. The 404,000 shares of stock represented approximately 4% of our company's total outstanding shares as of 12-31-07. We believe our stock buyback had a significant positive effect on our earnings per share for our shareholders. We're also pleased to report that A.M. Best has increased our financial rating from B++ to A- and we're hopeful that the increased rating will lead to additional growth and expand our business and I’ll turn it over to Frank.

Frank Freund

Great, thank you very much, Kevin. As Kevin highlighted, APCapital had a very positive start to 2008, generating net income of $11.4 million, or $1.13 per fully diluted share in the first quarter. This represents a 26% increase over the $0.90 per share in the first quarter of 2007. The $11.4 million net income represents an annualized return on beginning GAAP equity of 17.3%. Operating income, which excludes realized losses net of tax, was $1.18 per share. For the quarter, APCapital generated $12.8 million of positive operating cash flow and its book value per share increased to $26.53. Our direct written premiums were down $2.6 million, or 7.2%. The decrease was principally in Illinois and Ohio where price competition remains strong and, as Kevin mentioned, is primarily tied to rates. We did generate a premium increase in our home state of Michigan. During this softer market, we continue to focus on retaining our existing accounts, maintaining a retention ratio of 88%. We remain committed to careful underwriting and adequate pricing.

Investment income was down $1.2 million. Our average yield decreased from 5.12% in the first quarter of 2007 to 4.71% this quarter. Reduction in short-term rates and a greater allocation of our portfolio to tax exempt securities were the causes of the decline in gross yield. We also monitor the quality of our portfolio very carefully and given the turbulent financial markets, we will make quick decisions to head off or mitigate losses. In recent quarters we've sold Tribune, Temple-Inland and Sally Mae bonds ahead of major price decline. Subsequent to March 31, 2008, we sold our HSBC and CIT bonds, again due to concerns over the long-term value and volatility of these securities. We've incurred an after-tax loss of $558,000 on the sale of CIT, which was recorded as of March 31, 2008. Loss and loss adjustment expense incurred trends remain at historically low levels.

Our accident year loss ratio was 77.8% in the first quarter of 2008 compared to 76% for the first quarter of 2007. The slight increase reflects the pricing reductions we've taken over the last year. We also experienced an 8.4 million of positive reserve development in the quarter, which reduced our calendar year loss ratio to 51.2%. We continue to see a decline in claim frequency and have been able to settle claims for less than expected amounts. On a quarter-over-quarter basis, reported claims were down 6.1% from the first quarter of 2007. We added $3.9 million to our medical professional liability IBNR reserves and our average case reserve per claim increased to $148,600. Underwriting expenses were down $345,000, or 4.7%, as a percentage of net earned premium the underwriting expense increased to [ph], from 21% in the first quarter of 2007 to 22.2% in the first quarter of 2008. This increase in the expense ratio as a result of our lower premium rates and volume. Our effective tax rate is currently 31.4%. We've allocated 38.5% of our total cash and investment portfolio to tax exempt securities.

From a balance sheet perspective, APCapital remains in very good condition. Cash and investments total $850.3 million and the average rating of our investments is AA+. We maintained a 12.1% allocation of our portfolio to cash and short-term investments to maintain flexibility. As Kevin highlighted, our loss and LAE reserve picture also remains solid. Our medical professional liability outstanding claims inventory is 1672 claims, down 24% from a year ago. Our average case reserve, as I mentioned, is up 7% over last year to 148,600. With the increases we made to our IBNR reserves, the average total reserve for open claim and IBNR claim is up 12% to 170,800. Our shareholder's equity is $258.2 million or $26.53 per share outstanding. Our statutory surplus is $231.8 million, up $10.2 million since the start of the year. Our net written premium to surplus ratio is 0.55 to 1 based on the last 12 months of premium volume so we retain adequate capacity for additional writings.

We continue to carefully manage our capital. We renewed our re-insurance treaty, maintaining essentially the same terms as 2007 whereby we retain the first million dollar per claim. However, we continue to have the important event and excess policy limit terms to better protect the company against larger losses. We believe this is a prudent use of our excess capital. It allows to us retain more of our premium and based upon our current book of business performance, more of our profits.

As Kevin highlighted, we've been active with our share repurchase program. In the first quarter we repurchased 404,000 shares at an average cost of $42.93. On March 7, 2008, we announced the completion of the $20 million 2007 discretionary repurchase authorization and we commenced utilizing a new $25 million discretionary program. In the first quarter, the Board of Directors declared a first quarter cash dividend of $0.10 per common share which was paid to shareholders on March 31, 2008. Yesterday, APCapital's Board declared a second quarter cash dividend of $0.10 per common share, payable on June 30 to shareholders as of record as of June 13. We continue to view share repurchases and dividends as the most efficient means to return excess capital to our shareholders. As always, management is mindful of new business opportunities which could also enhance shareholder values. Overall, APCapital is in good financial condition and producing solid results. As Kevin highlighted, we've returned to an A minus to A invest level and we will continue to carefully manage our capital and remain flexibility for growth opportunities. That concludes my remarks on the quarter. Kevin.

Kevin Clinton

We can open it up for questions.

Question-and-Answer Session

Operator

(Operator instructions) And the first question comes from the line of David Lewis from Raymond James. Please proceed.

David Lewis – Raymond James

Thank you, and good morning.

Kevin Clinton

Good morning.

David Lewis – Raymond James

Kevin, I'm sure you have heard the FPIC conference call yesterday, and Bob White [ph] talked about the fact that AIG's been a little more aggressive in the large group marketplace. Why don't you talk a little bit about competitive pressures out there, what you're seeing, what the commercial carriers are thinking about, and then, and/or Frank, talk about, a little bit about the M&A activity discussions that might be occurring out this in the marketplace. Thank you.

Kevin Clinton

As far as AIG specifically, AIG is rarely in our markets. They may be in different states or they tend to go for the real large accounts. They don't hit the, the accounts that we're in, which are the – our bread and butter's probably 25 and under and they don't tend to be in that market, so we don't get direct competition from AIG. Occasionally we do, but not very often. The market has really, I think in many of our states, kind of stabilized. As you saw our retention went up, I think a lot of companies' retentions went up. I think we're all finding it's difficult to steal somebody else's business right now, but you're retaining your own and keeping your policy holders. So, I think the market is kind of stabilized in many of our states. As far as M&A, I don't know what's going on with other people and we can't disclose anything necessarily that we're doing here either. I guess if I, if I knew something with somebody else, I guess probably you would know about it already.

David Lewis – Raymond James

Kevin, I was just asking. Is there more activity, more discussions going on, now there's a PIAA meeting coming up, I think it's in July? Kind of what's the activity and discussion levels?

Kevin Clinton

You know what, ask me that next quarter because I'm going to the one in May and I'll check whose talking to who if I can. I think there is a lot of activity. I think there is a lot of discussion out there. I'd have to guess. I'm not sure it's the right time for it with many of the companies, but as soon as somebody stubs their toe, I think you may see quite a bit of activity.

David Lewis – Raymond James

Kevin, you mean by that, not the right timing, because everybody's coming off of record profitability?

Kevin Clinton

Yes. I think there's a lot of capital out there.

David Lewis – Raymond James

Right.

Kevin Clinton

So nobody's being forced to do anything. In companies that should be looking at it really are saying, oh, we're doing great on our own. I don't think those companies can necessarily do great on their own long-term. But short-term, they are doing great on their own and so they think, well, why do we need a partner right now. But, I think we're actively looking for opportunities. I know other companies are out there actively looking for opportunities. So I don't have any doubt that you are going to see some M&A activity.

David Lewis – Raymond James

Frank, can you maybe talk about some of the pricing reductions in the major markets?

Frank Freund

Sure, David. As Kevin mentioned, we're utilizing the same data that's been indicating the reserve releases and so where necessary we've been taking kind of what I'd call strategic rate adjustments and they have tended to be in the single-digit range and, again, we've been focusing more on utilizing those to retain our existing accounts. Really the only market where we've seen significant growth has been in Michigan, where we again saw some increases as far as new business quarter over quarter.

David Lewis – Raymond James

Can you give us a little more specific detail?

Frank Freund

Sure, as far as like in Michigan at the start of the year our rates went down 6.5%. Again, that's kind of typical, similar, we're still looking at Ohio and Illinois we were more in like the 10, 11% range but, again, these are street rates. You have to apply all the discounts and credits and those get adjusted on a case-by-case basis. Like I say, we're still looking at Ohio.

David Lewis – Raymond James

What do you expect out of Ohio, something in the upper single digits?

Kevin Clinton

To tell you the truth, I don't expect a whole lot out of Ohio. I think we're going to – we're discussing this still internally. Adjust some territorial relativities, adjust some specialty classes, but I don't think you're going to see a huge overall change there. I think more fine tuning of our rates.

David Lewis – Raymond James

Great. Thanks very much.

Kevin Clinton

You're welcome.

Operator

The next question comes from the line of Amit Kumar from Fox-Pitt Kelton. Please proceed.

Amit Kumar – Fox-Pitt Kelton

Thanks. I guess just starting with the buyback; you have bought back shares at an average price to book of 1.6 times. I'm just wondering at this stage what is the goal of your capital management? Are you trying to sort of boost EPS or is it more so trying to increase book value per share over time?

Frank Freund

I think our goal is to look at what our capital needs are, and if we have excess capital, return that to the shareholders. We've been doing it through dividend programs. We've been doing it through buy backs. But interestingly enough, we've gotten that same question when our stock was 25, when it was 30, when it was 35. Why are you buying it back at these levels? We bought it back I think at about a little over $42 a share and I think as we stand now, that looks to be a good buy for us.

Amit Kumar – Fox-Pitt Kelton

Okay. I guess just moving on to the loss ratio trends and I have been switching between calls. I don't know if you talked about it or not, but I think if you strip out the reserve for leases there was an uptick in the loss ratio. Could you just talk about that?

Frank Freund

Yes, as Kevin mentioned, I mentioned too, we have, as Kevin said, fine tuned rates a bit. They have come down in single digits, and so we kind of expect the accident year to tick up just a little bit. I think it was up like, less than 2 percentage points quarter over quarter. So it's kind of consistent with the rate changes we're taking.

Kevin Clinton

Keep in mind the difference in that loss ratio, even as you're looking at it, even at 2 points, that's one claim. I think the actuaries do as good a job as they can in estimating it, but I don't think it's a significant change over last quarter to tell you the truth. It was just, as Frank said, less than 2 points, which on $33 million is certainly less than $1 million claim that we're doing.

Amit Kumar – Fox-Pitt Kelton

Okay. I guess final question, and then I might come back, in terms of the insurance cycle, and you might have talked about this in the opening, Collins, which is I guess a reinsurance broker they came out with their survey where they polled all the insurance and reinsurance executives and 40% of those guys said that the soft market would, I guess, end in 2011. What are your thoughts on the soft market?

Kevin Clinton

That's a good question. I think we even participated in that. However, I haven't seen the results of it. I was stuck on a plane all day yesterday. I probably would be in that particular group, to tell you the truth. I think we were. That would say probably 2011 would changing the cycle and turning upward. Or at least the bottom of the cycle would be in 2011. So I don't – however, I think it's kind of leveling off right now. We may reach the bottom of the cycle in 2011, but it slowly goes there. It doesn't all of a sudden drop for the next couple of years and hit a low in 2011 and then bounce back up. So we're competitive out there right now and I think the companies that I know of, including our own, are handling it pretty well. There's a few of them out there that have very little experience and fortunately, very little capital that don't know how to handle it. They have never been through a soft cycle before and they aren't going to come out of this very well.

Amit Kumar – Fox-Pitt Kelton

Got it, and I guess just a follow-up to that is clearly, and I think we've all talked about the start-ups and new companies trying to enter in sort of failing in that process. Any change on the competitive front from new companies or from existing commercial lines players who aren't writing med/mal at this time or is it still pretty much the same?

Kevin Clinton

I don't think in our markets. Now, there's a potential new one coming in in Illinois, but in discussing this with some of our Illinois agents they just said, there's enough players in the market there that have been there a long time, have name recognition in the Illinois market, and they don't think, even our agents and some of them who represent this company, don't think that they are going to have much of an impact at all on the competition in the state or the rates in the state. They just think it's the wrong time for them to enter, to tell you the truth. So there really isn't much change in this company than have a lot of capital behind it. We don't see a lot of change in our marketplaces and that's why I think you see our retention so high. It's increased and I think right now the policy holders are tending to stay with the company they are with. They have enjoyed the rate decreases over the past couple of years and I think you'll see our retention stay up there.

Amit Kumar – Fox-Pitt Kelton

Okay, and just to – I guess join to that, some of your peers talk about shock losses in the quarter. Did have you any shock losses or any outside losses in the quarter?

Kevin Clinton

No. To tell you the truth, I'll knock on wood, but we haven't had a shock loss in five years.

Amit Kumar – Fox-Pitt Kelton

Okay, that's helpful. Okay. Thanks so much.

Kevin Clinton

You're welcome.

Operator

The next question comes from the line of Mark Iden [ph] from KeyBanc. Please proceed.

Mark Iden – KeyBanc

Good morning. I'm calling in for Beth Malone as well. Just two quick questions. We've been seeing frequency has been coming down. Do you think it will continue going into the future?

Kevin Clinton

It really can't. If you graphed our frequency curve in a few quarters, it would probably be at zero. I think it has to level off. I'm hoping it's going to level off a little pit lower than what it is right now. That would be very nice, but it is at a nice low figure. We're pleased with the frequency. The severity has leveled off as well. We expect that to go up. I mean just based on our reserve position, we expect it to go up. But, no, we're pleased with the frequency and I think what our company has done, as I look at other companies, I think we've actually outpaced it and I think some of what we're doing in the underwriting department, what we're doing in the claims department has really helped drive the frequency down for our company.

Mark Iden – KeyBanc

The other question I have was just there's been a couple announcements of severe claims in the market recently. You think it's cause for concern or signifies any type of trend?

Kevin Clinton

In large claims?

Mark Iden – KeyBanc

Yes.

Kevin Clinton

Certainly every time you read about one of those in the paper, it is a cause for concern for you. Nobody wants to get hit with one of those. We're taking them to court. We're getting a lot more aggressive and I'm not saying we won't get hit with one of those one day. We've not. I think we internally do a very, very good job of managing and deciding which claims to take to court and which claims not to take to court. In fact, I think our win ratio is, over the past four or five years, about 88% even the 12% that we lose, a lot of those I consider wins because we're not fighting about liability, we're fighting about damages. So we go in, we lose, but we were unwilling to pay $1 million and we may come out of it at 250,000. So in my book, that's a win and not a loss. So we're very, very successful in court nowadays and I think that's helping keep our frequency down.

Mark Iden – KeyBanc

Okay. Thank you very much.

Operator

(Operator instructions) And the next question comes from the line of Walter Shankar [ph] from Scion [ph] Capital. Please proceed.

Walter Shankar – Scion Capital

Thank you. Hello.

Kevin Clinton

Hello.

Walter Shankar – Scion Capital

Question, when you talk about and make an indication on both this year and next year from an earnings standpoint, I realize you're not going to give us anything specific, but both numbers are predicated on some level of continued, as has been the case for sometime, releases of past reserves?

Kevin Clinton

As you can read – I think you're reading it correctly. It's just as if the current trends in frequency, severity in pricing continue then we expect that to happen. So I think if the current trends do continue that we're going to continue to have reserve releases.

Walter Shankar – Scion Capital

Realizing that this is the insurance business, so there is art as much as science, as one goes quarter to quarter and releases have become a very significant component of performance because of all the actions you've taken in the past, can you give us just some sense as to how or who decided, obviously some actuaries decided, that the number for this quarter should be $8 million, $8-odd million. I'm not asking versus by hundreds of thousands of dollars, but when I look at the claims and the claims reserves, it seems to me it possibly could have been larger. Could you just explain how we decide quarter to quarter what that number should be?

Kevin Clinton

I'll just give you internally we do have several actuaries, myself being one. I do not do the reserve analysis at the end of every quarter. We've another actuary who does that and I review it along with Frank, with him. I think, I'll tell you his general sense at the end of the first quarter, he does a big full blown analysis at the end of the year and it's very, very detailed. When he gets to the first quarter, I think he's a little bit reluctant to move off of those year-end numbers significantly. So if you're saying it could have been more, it possibly could have been more. This is, as you said, not an exact science. You have reserve ranges and I think our actuary is a little bit reluctant. First quarter right after he did the big reserve analysis, to come off that number significantly. What he does is he goes through and he selects an ultimate loss for every particular accident year and every particular coverage and then he subtracts of our case reserves and backs into the IBNR that way. So his projection is really on the total loss and he looks at what we've in case reserves and, therefore, he says the difference has to be made up in IBNR and that's where if you compare it to last year, we can get reserve releases flowing from that analysis. Did that help?

Walter Shankar – Scion Capital

Yes. Just one other question, the retention numbers were excellent. From a seasonal standpoint, roughly what percentage of your policies renew in the first quarter?

Kevin Clinton

I'm trying to think. Our big quarters, our first quarter and third quarter, because they are January 1 and July 1. And I'd have to say January 1 is one of our biggest ones. It's probably maybe 40% of our total.

Walter Shankar – Scion Capital

Okay, thanks a lot.

Kevin Clinton

That's a guess. I don't have the numbers right in front of me. A lot of people like to be on calendar year basis. So January 1 is a big quarter for us.

Walter Shankar – Scion Capital

Good, thanks a lot.

Kevin Clinton

Okay. Thank you.

Operator

(Operator instructions) And the next question comes from the line of David Lewis from Raymond James. Please proceed.

Ann Storberg

Hello? Hello. Operator, do you want to just re queue one more time, or re ask?

Operator

(Operator instructions)

Ann Storberg

Nobody's there?

Operator

There's no further questions. I'd now like to turn the call back over to Mr. Kevin Clinton. Please proceed.

Kevin Clinton

Great, thank you very much, everyone. Thank you for joining us, and we will see you again next quarter.

Operator

This concludes the presentation for today. Ladies and gentlemen, you may now disconnect. Have a wonderful weekend.

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