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Infinity Property and Casualty Corporation (NASDAQ:IPCC)

Q2 2008 Earnings Call Transcript

July 24, 2008 8:45 am ET

Executives

James Gober – Chairman, President & CEO

Roger Smith – EVP and CFO

Analysts

Michael Grasher – Piper Jaffray

John Gwynn – Morgan Keegan

Doug Mewhirter – RBC Capital Markets

Alison Jacobowitz – Merrill Lynch

Operator

Good day, ladies and gentlemen, and welcome to the second quarter 2008 Infinity Property and Casualty Corporation earnings conference call. My name is George, and I will be your co-coordinator for today. At this time, all participants in listen only mode. We will be facilitating a question and answer session towards the end of this conference. If at any time during the call you require assistance, please press star followed by zero and a coordinator will be happy to assist you. As a reminder, this conference is being recorded for replay purposes. I would now like to turn the presentation over to your host for today’s call, Ms. Amy Jordan, AVP of Investor Relations. Please proceed.

Amy Jordan

Good morning and thank you for joining us for Infinity’s second quarter earnings conference call. The live event link on our web site does contain a slide presentation for this morning's call, if you would like to follow along. We also have an excel spreadsheet on our web site under the Quarterly Reports tab that provides more detailed quarterly financial data, and page 10 of the report does contain the definition and reconciliation of any non-GAAP items that we discuss this morning.

Certain statements made during this call may be deemed to be forward-looking statements that anticipate results based on estimates, assumptions and plans that are subject to uncertainty. These statements are made subject to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. All statements in this call not dealing with historical results or current facts are forward looking and are based on estimates, assumptions and projections. Statements that include the words believe, seeks, expects, may, should, intend, likely, target, plans, anticipates, estimates or the negative version of those words and similar statements of a future or forward-looking nature identify forward-looking statements. Examples of such forward-looking statements include statements relating to expectations concerning market conditions, premiums, growth, earnings, investment performance, expected losses, rate changes and loss experience.

Actual results could differ materially from those expected by Infinity, depending on changes in economic conditions in financial markets including interest rates; the adequacy or accuracy of Infinity's pricing methodologies; actions of competitors; the approval of requested form and rate changes; judicial and regulatory developments affecting the automobile insurance industry; the outcome of pending litigation against Infinity; weather conditions including the severity and frequency of storms, hurricanes, snowfalls, hail and winter conditions and changes in driving patterns and loss trends. Infinity undertakes no obligation to publicly update or revise any of the forward-looking statements. For a more detailed discussion of some of the foregoing risks and uncertainties which could cause actual results to differ from those contained in the forward-looking statements, please see Infinity's filings with the SEC.

And with that I will turn it over to Jim Gober, our Chairman, President and CEO.

James Gober

Good morning, everyone, and welcome to our conference call and webcast for the second quarter of 2008. Roger Smith, our CFO is also with us this morning. And as usual, we will open the lines for questions after our comments.

Let’s begin with the highlights on slide 3. Overall premiums were down 11% in the second quarter and down 14.2% versus the first half of 2007. Of course, our six months last year benefited from the big run up of our premiums from the continued roll out of electronic enforcement of the auto insurance laws in California. Recall, that during last quarter’s earnings call, we said that we expected premiums in the second quarter of this year will be down low to mid single digits, so the decline in premiums we experienced in this quarter wasn’t a surprise. It was just more than we expected. Of course, few of us anticipated the turmoil in the general economy we’ve seen in the last three months. Rising unemployment, high gasoline and food prices, and even greater levels of consumer uncertainty combined to dampen insurance buying behavior. I will give you some more details on our thoughts regarding the premium trends a little later.

For the second quarter, premiums in our focus states fell 10.8% as compared with a strong second quarter in ’07. Within these states, business in our target urban zones fell 8.5% for the quarter, again down more than we had expected. Nevertheless, even in these tough economic times, during the second quarter, eight of our 22 targeted urban zones grew as did our commercial vehicle and classic auto programs. As a matter of fact, 7 of our 22 urban zones are running ahead of our premium plan for the second quarter this year.

As for the bottom line, operating income for the quarter was 14.2 million, down from a strong second quarter of last year. On another note, economic conditions in all of our focus states other than Texas turned noticeably worse in the second quarter. Unemployment is up over 1 point in each of our focus states except for Pennsylvania. Most of you have read about the dramatic fall off in auto sales which negatively impacts our business as well.

In other news, we surveyed several of our larger agents and brokers who told us that their overall business was down anywhere from 10 to 50% with many attributing the fall off from consumers who are economically strained from high gas prices, in some places over $4.50 per gallon, along with high food prices and worsening labor conditions. Agents say and they did confirm that many consumers were choosing not to purchase or let the coverage lapse on a new role. Others are opting for liability only coverage by dropping the physical damage coverages on their policies. As a result, our overall premiums in new application counts have declined.

A slower economy and higher gasoline prices does yield some positive benefits to auto insurance, namely people are driving owners. In California, our largest market, for example, consumers have purchased 4% fewer gallons of gasoline according to a recent report. Although not significant enough to lower our reported accident year loss ratios, there are early signs that claim counts are dropping as consumers may be filing fewer claims again as they drive fewer miles.

Regarding overall market conditions, the market remains very competitive with many of our competitors continuing to raise commissions, enhance agency incentives and adjust rates in order to maintain their growth premiums levels. However, in many of focus states, we are beginning to see a noticeable bifurcation in the markets with larger more disciplined competitors raising rates and tightening underwriting standards. One large national competitor has actually stopped writing single car policies in its attempts to improve its overall underwriting results.

However, many smaller undisciplined competitors have not taken rate actions to address their poor underwriting results. One bright spot is that a few of these smaller companies are beginning to take action to reverse what has been years of aggressive marketing and pricing. Another good sign is that industry rate increases are positive according to both the consumer price index and insurance.com in their latest car insurance reports. However, these modest overall rate increases still fail to cover rising loss cost trends.

When you look at the rolling four quarters data from (inaudible) the first quarter of this year, this is the data on all coverages excluding cars I am talking about, we see positive claim frequencies and positive average severities in the first quarter of ’08 versus the period a year ago. Those combined trends give you lost cost trending upward at a rate of about 2%. So, given the positive loss cost trends, profit margins for insurance companies continue to get squeezed, and many are now taking rate increases to remedy the issue.

On slide 4, operating EPS for the quarter were $0.87, the same as that reported in the second quarter of ’07. Reserve releases in the second quarter of ’08 were 6.3 million pretax or about $0.25 per share. We had about 6.1 million of favorable development in the second quarter of ’07 or about $0.20 per share.

Net EPS for the quarter was $0.74 compared to $0.73 in the second quarter of last year. Losses from impairments and investments of 3.5 million and 1.2 million pretax in the second quarters of ’08 and ’07 respectively detracted from operating income per share to yield a lower EPS.

Next bullet point on slide 4 is our GAAP combined ratio for the quarter of 94.5%. Excluding the effect of redundancy releases for the year, our business is currently running at a 2008 accident year to date combined ratio of about 97.5. This is about a 2.1 point increase over our 2007 accident year combined ratio as reported for the full year. This is also about 50 basis points higher than that reported in our first quarter earnings call. This 50 basis point increase is attributable to an uptick in our expense ratio quarter over quarter as our earned premium has declined without a corresponding decline in our fixed underwriting expenses. Roger will give you more color on that a little bit later.

Regarding capital management actions, the accelerated share repurchase programs we announced last October was completed on June 16. So, we recommenced share repurchases under the 2006 10b5-1 program. To date through yesterday, we have repurchased 676,500 shares for $29.1 million. That leads to approximately 26 million of repurchase authority before today’s announced Board action.

Consistent with Infinity’s objective to return excess capital to the shareholders, we announced earlier today that the Board of Directors has approved an increase in the repurchase authority under the share repurchase program to $100 million and has extended by one year the date to execute the program.

On slide 5, I will begin with an update on our personal auto business. Overall, personal auto premiums were down 12.2% for the quarter. As I mentioned earlier, a slowdown in premiums in the quarter was expected but not quite at this level. However, during the quarter, we did see positive growth in our focus states, such as Texas, Nevada and Illinois. Maintenance states ranked 29% in the quarter, as we concentrated on growing our focus states while reducing under performing business in these maintenance only areas. As we mentioned in the last several quarters, we expect this culling process will continue throughout 2008.

Premiums in non-focused states for the quarter fell about $1.3 million to 640,000. Today, these states represent only about 0.3% of our private passenger auto book. We will continue to reduce our writings in these difficult and unprofitable states throughout this year as well.

As for the detail on our top markets, let’s start with California. In this state, gross written premiums were down 13% for the quarter and down 16.1% year to date. As I mentioned earlier, the comparison with the second quarter of ’07 is very difficult given the dramatic increase we experienced back then from electronic enforcement. Overall, the state’s business is about 7% behind plan year to date.

The economic slowdown in California is part of the reason for this drop in premium. California’s overall economy is in recession. Certain sectors such as construction have been hit especially hard. Construction employment has fallen almost 10% in the last 12 months which has impacted our Hispanic customers since many work in this industry. As you know, many of our customers are working class or lower middle class and are being hit hard disproportionately hard by the economic slowdown along with the significant increases in the cost of food and fuel.

From a competitive standpoint most companies continue to aggressively seek business. However, we are beginning to see larger, more responsible competitors file for rate increases. Nevertheless, many of the smaller competitors continue to relax underwriting standards and/or reduce rates to levels below cost. These type actions will continue to put downward pressure on our premium growth.

Industry loss cost trends are modestly positive year over year with small negative paid claim frequency trends and offsetting low single digit increases in average paid claim severities. Average earned premiums per car year are down modestly for the industry. Our own calendar year data reflects modest increases in year-over-year loss cost trends with single digit increases in frequency but negative trends in average severities. Since the first quarter of this year, our paid loss costs are flat. We continue to see modest declines in our average earned premium per car year on a year over year basis as we reposition our book to a better risk profile.

As compared with the first quarter, average earned premiums are flat. On an ultimate accident year basis, our California combined ratio is down a couple of points from the first quarter. In Florida, gross written premiums were down 16.1% for the quarter and 17.3% year to date. Premiums versus plan were down 14% for the quarter and 8% year to date.

Some of this decrease is by design. For example, in order to improve the profitability of this state, we’ve implement five rate increases in 2007 totaling 13.5% and rate increases on two programs in January of ’08 and smaller rate increases on two programs in April of this year. We’ve also taken actions to slow the business volume in Miami where business was operating at an unacceptable combined ratio. Not surprisingly, our actions along with a faltering economy are crating somewhat of a drag on top line growth. Some customers are dropping beyond our coverage and opting only for the statutorily required TEPD [ph] coverages.

We suspect many other drivers are simply letting their coverage lapse and not renewing their policies and are going uninsured. As for the bottom line, we are confident that our actions are having a favorable impact on underwriting ratios. Since the first quarter, our combined ratio in Florida has fallen 1 point. As for trends, loss cost for the industry are fairly moderate with increases in severity somewhat offset by a decline in frequency, overall though still positive. And a result of these positive trends, more responsible competitors for the most part are beginning to tighten up on rates and/or underwriting. Other competitors are terminating relationships by purging under performing agents.

Onto Georgia, where our gross written premiums were down 18.7% for the quarter and 22.4% year to date, premiums in this state versus plan are down 26% for the quarter and 20% year to date. The accident year to date 2008 combined ratio for Georgia continues to sit stubbornly above our plan, and as we’ve discussed in earlier calls, the book of business in Georgia has changed fairly dramatically over the past 18 months from one that was primarily outside Atlanta to business more heavily focused or concentrated in the Atlanta urban zone. However, in Atlanta we are not happy with our business profile and are taking steps to sharpen our focus on the Hispanics and underserved communities. For example, there are plans underway to reposition the book focused on Hispanic customers in Dalton, Gainesville and Northeast Atlanta.

Loss cost trends for the industry in Georgia are down slightly with small single digit decreases in claim frequencies offsetting single digit increases in average claim severities. Average earned premiums per car year are also down slightly, so the industry loss ratio is flat. Our own data show increases in both average earned premium and loss cost as the book has become more urban focused. Consequently accident year combined ratios are up slightly compared with both last year and the first quarter.

Competitively one of the larger, more disciplined carriers have made modest rate changes, less disciplined smaller players are reducing down payment requirements and raising agency incentives. We don’t believe that these less disciplined players are sustainable in the long term. In the short term, they disrupt the market and make it more difficult for us to gain traction and grow our business.

In Pennsylvania, gross written premiums were down 6.3% for the quarter but up 1.8% for the year to date period. Premiums versus plan were down 12% for the quarter and down about 1% year to date. Allentown our new targeted urban zone grew 4.3% for the quarter as a result of strong agency relationships along with new contingent commission arrangements and a marketing campaign. However, business in Philadelphia was down 10.8% as a result of weaker economic conditions.

From a profitability standpoint, business in this state continues to perform very well. The accident year combined ratio was currently one of the best in the country although it is showing a slight deterioration from that in the first quarter as claim frequency and average severity have picked up slightly.

Industry loss cost trends have been positive now for the past three quarters with increases in both frequency and severity. Following a year where we estimate the industry generated a combined ratio for personal auto of 98.5%, we suspect that the industry is now above the 100 combined ratio for personal auto in 2008. As a result, several larger more established competitors have recently taken low to mid digit single digit rate increases in the state and we expect smaller competitors to follow suit. As a matter of fact, we have filed for modest rate increases in two of our own programs.

In Texas, our gross written premiums were up 36.7% for the quarter, and 27.7% year to date. Premiums are running ahead of our plan of about 20% quarter to date and 21% year to date. Texas for the quarter is now our third largest state in terms of premium volume behind California and Florida. New agency appointment in advertising in Dallas, Houston, and El Paso have fueled a lot of the new business growth, and we do expect growth to continue for the remainder of the year, although at a slower rate as these efforts continue.

Also we are positioned very well to execute a marketing strategy later this year to take advantage of the electronic enforcement of the mandatory auto insurance laws. This state has been testing the Texas electronic enforcement program in Austin and is expected to roll it down state wide in the latter part of the third quarter. We are also planning to offer a monthly policy with a limited number of agents as a test to determine the market appetite for this option.

As for trends, industry loss cost is positive with increases in frequency and severity, compounding this upward pressure on the industry loss ratio is the continued decline in the average earned premiums per car year. We estimate that the industry’s combined ratio for this state for personal auto in 2007 was close to 100. So, these trends in ‘08 have probably pushed the industry into an underwriting loss position. Our own business in Texas continues to run at a combined ratio above our targets with up ticks in ultimate claims frequency and severity and a slight drop in our average earned premiums per car year in the second quarter versus the first quarter of this year.

So, we have still more to do in this state to improve underwriting profitability. This includes taking rate increases in May and August to help improve that situation. As for competition, it has also been relatively well behaved. In the first quarter of this year, there was a lot of rate activity among companies who offered statutory minimum limits policies as the state increased the limits from 20-40-15 to 25-50-25 effective April 1. And we understand that some smaller competitors are planning rate increases later this year, since they didn’t file new rates when the limits were increased.

For Arizona, our gross written premiums were down 13.4% for the quarter and 10.8% year to date. Premiums as compared to plan were down 2% for the quarter but up 10% versus plan year to date. The drop in premium is the result of a weakening economy, a continued crackdown on the legal immigration by the state and local authorities and aggressive actions by our competitors.

First of all, economic conditions including higher food and fuel costs as well as a decline in construction employment have dampened the growth in the Hispanic population. Surveys of our agents in target Hispanic neighborhoods continue to report a fall off in overall business ranging anywhere from 20 to 50%.

Secondly, we continue to see a fall off in Hispanic business in the state due in part to a exodus of Mexican immigrants as a result of legislation enacted earlier this year that permits law enforcement agencies to suspend business licenses to anyone found employing illegal immigrants. And lastly while competitors have slowed their aggressive pricing in this state, several are now lowering down payment requirements and fees in order to attract new business. In addition, we have seen some competitors offering commissions as high as 20% new and 20% renewal.

As for trends, industry loss costs are up slightly and average earned premiums are down slightly. Even though some of the major players have combined ratios well above 100, the overall industry combined ratio for personal auto in 2007 in Arizona was around 96. So, we suspect aggressive marketing actions by many of the competitors will continue here for some time. Our own ultimate claim frequencies and severities have dropped modestly from those in the first quarter of this year along with average earned premiums per car year. This combination has yielded an accident year combined ratio that is down 2 points from the first quarter.

Our business in Phoenix is very profitable but we have work to do in Tucson. There the combined ratio was unacceptable, so we are taking actions to improve profitability including suspending under performing agencies and filing for rate increases.

Onto Nevada, which is a relatively new state for us, we’ve been there only two years now, and so far this year we have written 11.3 million in the state, up from about 8.5 million last year to June. The state shows a lot of promise with its proximity to California. I said that because many people who live in Las Vegas emigrated from California where they were familiar with the Infinity brand, and it goes without saying that there is a sizable Hispanic population in Vegas which is one of our target customer segments. We will keep you informed of our progress in Nevada throughout the year.

In Connecticut, our gross written premiums were down 44.6% for the quarter and 53.3% year to date and are down 35 and 27% from the quartet and year to date plan respectively. This state has performed poorly from an underwriting standpoint with combined ratios well above 100, so our product manger continues to take aggressive actions to improve profitability.

Illinois, a new state for us is next. We began writing business there in the first quarter of this year. Year to date though June we’ve written $957,000 of premium. Initial marketing efforts are through independent agents with support from three company owned stores. And as part of our direct writing experiments, on June 16, we began to offer business on a direct basis over the web. Though July 18, we have written 30 new policies in Chicago through this channel.

And finally when we take a look at our commercial vehicle and classic auto businesses, both show solid growth in the second quarter. For commercial vehicle, premiums rose 7.8% overall and 14.8% in our focused states with the second quarter as compared with the second quarter of ‘07. As for classic auto, we enjoyed 5.9% premium growth in the second quarter, certainly a good start for 2008.

Now let’s talk just a minute about our outlook for the remainder of this year. Overall, as we’ve experienced over the past four years, we expect the overall personal auto insurance market to remain very competitive as many companies continue to aggressively pursue growth with increased agency incentives and advertising, along with liberal underwriting standards and select rate reductions. However, we do expect to see aggressive actions by competitors to slow as we’ve seen in several of our key states.

We expect to continue to see more competitors file for modest rate increases as combined ratios exceed targeted thresholds. However, we do not expect a significant hardening of the market. Even if some companies take increases, those increases will not be sufficient offset rising loss costs. Consequently, we expect the industry loss ratio will continue to worsen throughout 2008. We really don’t expect this to reverse until sometime in 2009.

In addition, we expect consumers will continue to be under financial pressure throughout this year with increasing inflation and weakening if not negative real growth in job creation and GDP. Consumers in the working and lower middle classes which are a significant portion of our customer base are likely to feel a disproportionate level of strain as this strata of the customer typically suffers more in times of economic downturns.

Yet in spite of this difficult environment, we still think there are many opportunities to maintain or even grow premium levels, particularly in our urban zones. For example, in California, our recently approved second program which we began writing in May appears to be well positioned to grow our business in our targeted urban zones. Of course, as we mentioned last quarter, we are checking growth of our business in California this year, the wildcard will be the impact of rate actions by our competitors. Many have rating class 10 [ph] filings still pending with the DOI with many more filings to come. Roughly 200 companies had to file programs by the July 14 2008 deadline.

The DOI must now review all of these filings. And as we’ve seen in the past, rates filed oftentimes are higher than those ultimately approved by the department. So, given the level of uncertainty in California with these pending filings, we expect our 2008 premium volume to be down about 5% from that in 07, with a wide confidence around that number.

In Florida and Georgia, with the actions we’ve taken to improve underwriting results, we expect premiums to be down about 8 to 12% for this year. In Pennsylvania, with relatively low market shares in our targeted urban zones and with competitors taking rates up, we expect mid single digit growth for the year. In Texas, we are building momentum with our programs and brand, and with a strong second quarter along with extra boost from electronic enforcement beginning in late summer, we look auto grow as much as 15 to 20% for the year. While growth in Arizona premiums is difficult to predict given the illegal immigration concerns and the competitor actions taking place there, at this point we expect to be down 5 to 10% for the year.

Nevada as a new market is expected to grow double digits this year, and Connecticut as mentioned will be down in ‘08 as we continue to address poorly performing business with upward rate adjustments. For all four urban zones, we are expecting premiums to be down 5% to flat for 2008. Personal auto premiums in non urban zones and focus states are expected to decline in 08 although we are taking tangible actions to retain profitable business in these areas.

In addition, as mentioned earlier, we expect a continued decline in our maintenance state premium volume this year as we seek to retain only profitable pockets of business in these areas. We expect commercial vehicle and classic auto to continue to grow, so for the year we anticipate overall growth of 2.5 to 5% for CV and 0 to plus 4% for classic auto. In total, we are expecting premium growth to be down 2.5 to 10% for the year. This projection is down substantially from that a quarter ago. I am simply much less optimistic about our overall growth prospects in the second half of this year, given the increasing weakness in the economy across most of our markets.

From an underwriting standpoint, we expect our overall accident year combined ratio to be 97.5 to 98.5. Other key assumptions include a 4.7% book return on investments, an effective tax rate of 32% and about 250,000 of remaining charges for the completion of our call center consolidation. All of this should generate an operating EPS of $2.85 to $3.15 for 2008.

With that I will turn the presentation over to Roger.

Roger Smith

Thanks, Jim, and good morning. I am going to discuss the financial results for the second quarter of 2008.

Slide 6 summarizes Infinity’s financial performance for the quarter. My discussion of the results is summarized on slide 7 and 8. So, let’s first turn to slide 7.

Infinity’s quarterly revenues were down 11.6% primarily as a result of a 11.9% decline in earned premiums. Earned premiums were down as a result of the decreases in written premiums in the second half of 2007 and the first half of 2008. As Jim has discussed, gross written premiums were down for the quarter falling 11%. Investment income for the quarter was down 2.3 million over that of the second quarter of 2007 or about 13.5%. The average investment balances have decreased $147 million or about 9.9% as a result of a $100 million ASR that we announced last October and a decline in the business.

Book yield in the fixed income portfolio were down about 29 basis points as compared to those of the second quarter of 2007, as a result of the general decline in market interest rates for high quality bonds. At June 30th, 2008, book and market yields on the fixed income portfolio were 4.82% and 4.87% respectively. The duration of the fixed income portfolio is 3.5 years, slightly higher than that of 3.8 years at the end of the second quarter of 2007.

Regarding the investment portfolio, our subprimes and Alt-A exposure remains modest. Our investment portfolio contains 13 securities or about $22.2 million of subprime and Alt-A securities. Of these securities, all but two are AAA rated. We have one rated AA, and one rated BBB. These are the same 13 securities we held last quarter. Market value on these 13 securities fell about $1.9 million since March 31. These 13 securities represent only 1.8% of our total fixed income portfolio, so our exposure is very small.

In general, our fixed income portfolio is a high quality portfolio with an average credit quality of AA+. As we did last quarter when we file our 10-Q, we will post to our IR website a list by CUSIP of our entire consolidated portfolio.

Regarding holdings in Fannie Mae and Freddie Mac, we currently hold $48.7 million of market value of direct fixed income obligations from Fannie Mae and Freddie Mac and another $214 million of mortgage backed securities that carry these organizations’ guarantees. We have no common stock in either entity. All told, we have about $263 million of total direct and indirect exposure to these organizations. This represents about 22% of Infinity’s total fixed income portfolio. These institutions carry AAA ratings and it appears that though equity offerings or the federal government backing, these institutions will continue to provide needed liquidity to the United States housing market.

By the way, the market seems to agree with me as at June 30 these bonds were trading at only a slight unrealized loss to us about $1.9 million or seven-tenths of a percent. Since then the bonds have traded at slightly narrower spreads to treasuries.

If we step back and compare Infinity’s total overall exposure to federal agency and mortgage backed securities with that of the overall fixed income universe, you would find that we are underweight relative to the marketplace. Approximately 5.6% of Infinity’s exposure is the federation securities that compare to 11.0% for the Lehman Aggregate Index, a generally accepted proxy for the bond universe and for mortgage backed securities, 25.2% of Infinity’s portfolio are made up of these type securities, as compared to 38.7% of the Lehman Aggregate Index.

Turning to slide 8, in regards profitability, as Jim has discussed, operating profits were solid in the second quarter. Operating income was $0.87 per share for the quarter. This compares to the same number, $0.87 per share for the second quarter of last year. Underwriting income for the quarter fell $1.7 million as a result of decline in earned premiums and a very slight increase in the calendar year quarter combined ratio.

As Jim mentioned, we are currently booking the accident year to date combined ratio at about 97.5%. Offsetting the accident year results was a $6.3 million release of redundant reserves, mostly on unallocated loss adjustment expenses as compared with the $6.1 million released in the second quarter of 2007.

The accident year combined ratio through June is up about 2.1 points from the 2007 accident year combined ratio developed through the year end 2007 of 95.4%. Pass though losses for the second quarter of 2008 were $257,000 as compared to $251,000 in the second quarter of 2007, so again very small exposure to catastrophe losses this quarter as is typical for our group of business. We incurred less than $100,000 of pretax charges for our services center consolidation efforts that we began late last year as we talked bout in the past. We would expect another $250,000 of pretax charges in late 2008 or early 2009 for the completion of this.

These future charges for the most part represent sub lease losses we are expecting to incur when the remaining excess space is freed up in Alpharetta, Georgia. When these charges will occur will depending on when we can free that excess space up for sublet scheduled for the end of this year.

The overall effective tax rate for the quarter was about 35. 9%. This is up compared to the prior period as a result of the $1.8 million capital losses for which we set up 100% valuation allowance with a tax benefit on those losses. On an operating income basis, excluding capital gains and losses, the effective operating tax rate for the quarter was about 31.4%. I would expect the effective tax rate on operating income for the entire year of 2008 to be around 31.5 to 32.5%. This rate is down from the 33.3% in 2007 since a greater portion of our investments are now invested in tax exempt municipal bonds and in turn a greater portion of our operating income will be sheltered from federal income taxes.

Lastly, as Jim mentioned, we completed our ASR that was announced last October, and we completed that on June 16. The closing adjustment for shares repurchased was $768,000 or about $0.30 per share more than we initially paid for last year at the initiation of the ASR. So, under the ASR, the 2.55 million shares were purchased at an average price of $39.44. The initial purchase price as you recall we initially settled for last October was $39.14. So, the total cost of the ASR to Infinity was $1,768,000.

Once the ASR was completed, Infinity repurchased 144,800 for an average price of $42.54 by June 30 and another 531,700 shares for an average price of $43.01 through yesterday in the third quarter. Through yesterday, there remains $26 million of repurchase capacity on the 2006 share repurchase program. And as Jim mentioned, this morning we announced the Board has approved an additional $74 million to be added to the current remaining share repurchase authority and the date to complete the repurchases was extended to December 31, 2009. This increases management’s share repurchase authority to a total of $100 million.

We continue to have adequate capital to support either future growth in the business or fund additional share repurchases. Our current debt to capital ratio is 24.8% below the 30% required by rating agencies to maintain our current debt ratings. Our adjusted debt to capital ratio which includes an adjustment for operating lease payments is 30% or below the 30 to 35% required by rating agencies to maintain our current ratings. With our current statutory capital levels, our insurance companies are currently writing business at a 2.1 to 1 premium to surplus ratio year to date, below the 2.25 to 2.5 times surplus needed to maintain our current A.M. Best ratings. And the holding company has sufficient liquidity, $188.6 million of cash and investment which is available to either infuse into the insurance company should they need additional capital or for the share repurchases.

By the way, we did pay a dividend up from the insurance companies on June 24 of $17.5 million into the holding company. Our total ordinary dividend capacity for the year is $79 million. So, we still have about $35 million of capacity remaining in the insurance companies. In short, we are well positioned with current capital to support future growth of the business and certainly the share repurchases that we described.

This concludes our formal presentation. So, at this time, we would like to open it up for questions.

Question-and-Answer Session

Operator

(Operator instructions) Your first question comes from the line of Mike Grasher from Piper Jaffray. Please proceed

Michael Grasher – Piper Jaffray

Good morning, everyone.

James Gober

Good morning.

Roger Smith

Good morning

Michael Grasher – Piper Jaffray

Few questions. I guess first off Roger, do you want to give us any sort of scenario or some sort of guidance around the pace of this share repurchase?

Roger Smith

Anticipated to come up?

Michael Grasher – Piper Jaffray

Yes.

Roger Smith

I mean it will be opportunistic over the next 18 months, so depending on the price and the opportunity.

Michael Grasher – Piper Jaffray

Okay.

Roger Smith

As we demonstrated in the past, this is no promise for the $100 million of capacity we have currently, but we have been pretty faithful in executing on share repurchases announced.

Michael Grasher – Piper Jaffray

Okay. And then, you mentioned the tax rate, what is the actual tax rate on the investment portfolio right now?

Roger Smith

About 21% municipals, so it is going to be about 28, 29%.

Michael Grasher – Piper Jaffray

Okay, thanks for that. And then Jim, I wanted to follow up with you just in terms of the guidance that you’ve given us, I mean it sounds like you’ve got rate increases coming through, there is lower frequency of claim, is it simply that – I mean two factors, the claim cost accelerating and then the general economic environment where we have less coverage and your policies, is that in terms of being much more guarded in your outlook?

James Gober

Well, I think, Mike, the rate increases are really state specific. The states that have given us problems regarding profitably are the ones that we are taking some pretty aggressive actions and those being states like Connecticut. Certainly Florida is another good example. You know states like Texas, we are growing there, but there is opportunity just given the growth that we’re experiencing to date, you know take some action on some specific coverages, and especially trying to get the rates in line in Texas before the electronic enforcement goes into effect.

So, it is those type of targeted rate actions that we are talking about. We saw and I reference in my prepared comments, we saw some improvement in frequencies in May and June. Although we are just not ready to maybe join the bandwagon with the other companies that have talked about frequencies dropping regarding gasoline prices, again the trend looks favorable. We may have a little more data by the end of the third quarter to comment a little bit more intelligently on that. So, we just have to wait an see what happens there.

Michael Grasher – Piper Jaffray

Okay. Final question, just you referenced it in your remarks that what has been or do you a feel for what the total impact of the crackdown on immigration has been, or illegal immigration, I am sorry?

James Gober

It’s been again a sort of state specific issue. What we have seen is that there our business in Phoenix has been impacted the enforcement. Yet when you take a look at Texas, it’s a state where the economic conditions haven’t been quite as dire. Our business has picked up. So, we think a number of the illegals may be moving to Texas, certainly areas like Vegas, although construction is down in Vegas, but we still see those individuals either move to another location within the US, or sometimes they return back to Mexico. So, it is not as though when there is a crackdown, that we lose all of that business. It is just sort of reallocated to other areas. So, that’s pretty much what we’ve seen so far.

Michael Grasher – Piper Jaffray

And do you see any difference between urban zones and non urban zones?

James Gober

Yeah, well again, the Hispanic population, more construction driven. We typically see more Hispanics in the urban zones and as such we take a look at areas like Houston and San Antonio and Austin and Dallas, we see up ticks there versus non urban areas. Although Georgia is a little bit of a different scenario from us, I know them in our prepared comments I mentioned that Atlanta is our targeted urban zone, although when you take a look at Atlanta, we are seeing somewhat of a migration of Hispanics from that Atlanta area even up to Dalton which is more a carpet industry type driven economy there. So, we are sort of taking the position that we are flexible on. I mean if Hispanics move to other areas in order to gain jobs, to get employment, we are willing to adjust and certainly move in those directions as well. So, we are just trying to be flexible I guess in terms of what’s happening out there right now.

Michael Grasher – Piper Jaffray

Okay. Thanks very much.

Operator

Your next question comes from the line of John Gwynn from Morgan Keegan. Please proceed.

John Gwynn – Morgan Keegan

Thank you. Roger, the release this quarter which you mentioned was mostly ULA [ph], I assume that’s mostly been from your non-standard book?

Roger Smith

Yes.

John Gwynn – Morgan Keegan

Okay. And Roger, the guidance for the year, the operating earnings per share guidance incorporates your accident year combined ratio, i.e. it excludes any development positive or negative?

Roger Smith

That’s right.

John Gwynn – Morgan Keegan

All right. And Jim, when states propose and enact increased minimum limits, it’s usually opposed by industry associations. I assume that’s because of the migration to uninsured medres [ph] and is that something that gets aggravated in an economic environment such as we are in today?

James Gober

Yeah, you are exactly right, John. It does compound a problem that already exists. Alabama which is not a target focus state for us, they just increased the minimum limits here and Alabama hasn’t been immune to some of the economic downturns, so you wonder what they are thinking. I think a lot of it is pushed by some of the standard preferred companies quite frankly, because from a political standpoint, it makes no sense to me to increase limits from 20-40 to 25-50 be it Texas, Louisiana, Alabama or any other state. I think it compounds the problem. And certainly when you look at economic conditions today, it makes it even worse, because again as we pointed out, those are the type individuals that typically have to make decisions regarding insurance or food and clothing. So, it does make it more difficult.

John, I will mention once thing about accident year combined ratio. It moved up half a point quarter over quarter because of the expenses, not necessarily because of the loss ratio. So, we alluded to it in some of our prepared remarks, but we’ve got some work to do on our expenses. We are not ready today to talk about any initiatives that will be underway. Hopefully, by the end of the third quarter, we will have some information to share, but we’ve got to tighten up on the expense side as well.

John Gwynn – Morgan Keegan

All right. And Jim when your Board considers its alternatives when it comes to capital management, obviously I think you’ve done a great job in terms of your share repurchase programs and a very laudable job on the increase in the regular cash dividend, has the Board also reviewed any potential extra cash dividend?

James Gober

No. The Board – I will tell you, John, the Board considers everything. All the opinions are on the table, the pros and cons are discussed. We have had feedback from investors that is discussed openly at the Board meetings as well. So, it’s a process where all options are on the table and are discussed completely in order to come up with a recommendation that makes the most sense for the shareholders of the company. So, yeah, it is all considered, nothing is off limit.

John Gwynn – Morgan Keegan

Okay, thanks a lot.

James Gober

Sure.

Operator

Your next question comes from the line of Doug Mewhirter from RBC Capital Markets. Please proceed.

Doug Mewhirter – RBC Capital Markets

Hi, good morning. One of my questions was answered. The other question I had was dealing with you kind of hint it, down payment terms and credit policy, I noticed that your – I was actually wondering if your defaults or your credit losses have picked up because of economic related factors and have you done anything to change your credit policy either way even in the light of competitors maybe getting more liberal?

James Gober

No, Doug. In terms of actually on the bad debt charge offs, we’ve actually improved a little bit. We made some changes in some things that we were doing regarding down payments. It’s a tough thing, it’s a balancing act because if you increase your down payment, you are going to reducing the charge offs that you will incur typically despite the virtue of getting more money upfront. But at the same time, it puts you in a competitive disadvantage when there are companies out there that are willing to pay much less down, but we’ve pretty loyal in terms of looking at bad debt. We looked at it throughout 2007 and we came to the conclusion that that was an area that we could improve on. So, we’ve actually been a little bit more conservative I guess you could say. We’ve actually taken down payments up in a number of areas in order to address that issue. Beyond that, we really haven’t seen – I don’t know, Roger, if you’ve seen anything, any difference in the numbers, I certainly haven’t.

Roger Smith

No. I mean Jim is right. In a couple of state, we have actually tightened up a little bit. This is well in advance of the economic problems we’ve had. We did see pick up in charge offs last year in terms of actions, it looks like it is paying some dividend this quarter.

Doug Mewhirter – RBC Capital Markets

And Roger, just as a reminder, the charge offs are consolidated within loss in LAE line, is that correct?

Roger Smith

They are consolidated in expenses.

Doug Mewhirter – RBC Capital Markets

Oh, in the expenses. Okay. Thanks, that’s all my questions.

James Gober

Okay. Thanks, Doug.

Operator

Your next question comes from the line of Alison Jacobowitz from Merrill Lynch. Please proceed.

Alison Jacobowitz – Merrill Lynch

Hi, thanks. Two question, one just a clarification on your own estimate, you re including the reserve changes year to date, right? You are just assuming nothing further going forward? Correct?

Roger Smith

Yes, correct.

Alison Jacobowitz – Merrill Lynch

And then the second question was the issues you mentioned or Miami and Atlanta, we were just wondering if you could give a little color, more color as to what’s going on that’s pressuring those two regions?

James Gober

Well, regarding, Miami, Alison, I will start with that first. Miami was a relatively new urban zone for us, and I think I may have made some comments about Miami last quarter, but we in some respect sort of put the cart before the horse. Typically when we go into a new urban areas, we will try to have in the field company appraisers, adjusters there before we write the first policy. In Miami, we sort of experimented with a different approach. We thought we would try to build a book of business first, hand off those claims from a centralized unit here in Birmingham and once we had built a credible book of business, we would put people in the field in order to address the issues that are typically associated with these urban zones, and quite frankly it was a bad decision on my part. We shouldn’t have done that.

So what we done since then is that we’ve adjusted our rates, we’ve tried to tweak the rates, we have also added staff by way of our own appraisers, our own SIU fraud investigators. We now have a very capable claims manager running the operation. We’ve got an outstanding in house attorney that just joined us, not too long ago. So, we are getting the right pieces in place in order to address the Miami issues and we terminated quite a few agencies as well. We found that fraud is prevalent there and the agencies have their toes in the water in a big way, many of them do. So we’ve been able to identify those agencies and we’ve terminated those relationships. So, our Miami book has improved quite dramatically over the past six months, I would say, and anticipate even more improvement throughout the remainder of this year. So, we are still optimistic about Miami, very high average premium type policies. It really fits well with our urban strategy.

As far as Atlanta is concerned, we really made some mistakes in pricing in that particular urban area. Again, our strategy has been to go after the Hispanics in these urban zones, first and foremost, and again we made some pricing decision and structured our rates such that we were riding in some areas of Atlanta that typically weren’t heavily populated by Hispanics. And what we did was we made some changes and we are again more focusing on really the northeast area of Atlanta on up through Gainesville and then again if you take I-75 on up to Dalton as I mentioned earlier trying to target those areas more in terms of our rate structure. But again some pricing mistakes in Atlanta whereas Miami was more an issue of just having some infrastructure in place from the get go. That’s something we should have done.

Alison Jacobowitz – Merrill Lynch

Thank you.

James Gober

You are welcome.

Operator

(Operator instructions) Our next question is a follow from Michael Grasher from Piper Jaffray. Please proceed.

Michael Grasher – Piper Jaffray

Thanks. Just wanted to follow up on a question John has asked earlier just around the loss and adjustment expenses, Roger. Would or should we expect these to be lower in terms of thinking about a run rate going forward than they have historically?

Roger Smith

Probably not given the overhead component. Again, we will have more comments to make next quarter. So, we are expecting no market improvement at least anytime soon.

Michael Grasher – Piper Jaffray

Okay. And you are talking about the LAE portion, right?

Roger Smith

Yes.

Michael Grasher – Piper Jaffray

Okay, thank you.

Operator

Sir, you have no questions at this time, I would now like to turn the call over to management. Jim Gober?

James Gober

Well, thanks to everyone for participating in the call and listening in and we certainly look forward to the third quarter conference call. Thank you all again.

Operator

Ladies and gentlemen, thank you for your participation in today’s conference. This now concludes the presentation. You may now disconnect. Good day.

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Source: Infinity Property and Casualty Corporation Q2 2008 Earnings Call Transcript
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