Donegal Group Inc.
Q1 2008 Earnings Call Transcript

Published: 16 Apr 2008

[Operator:]

Welcome to the first quarter Donegal Group earningsconference call. (Operator Instructions) I would now like to turn the presentation over to your host for today’scall, Jeffrey Miller, Senior VP and CFO.

[Jeffrey D. Miller:]

Welcome to the Donegal Group earnings release conferencecall for the first quarter ended March 31, 2008. I am Jeff Miller, Senior Vice President and ChiefFinancial Officer and I will begin the conference call by highlighting ourquarterly financial results. I will then turn the call over to Don Nikolaus,President and Chief Executive Officer, for his comments on our results and adiscussion of the business trends we are experiencing. Certain statements made in our earnings release and in thisconference call are forward looking in nature and involve a number of risks anduncertainties. Please refer to our earnings release for more information aboutforward-looking statements. Further information on risk factors that could cause actualresults to differ materially from those projected in the forward-lookingstatements is available in the report on Form 10-K that we submitted to theSEC. You can find a copy of our Form 10-K on the Investors portion of ourwebsite under the SEC filings link. We are pleased to report a 6.9% increase in net premiumsearned during the first quarter of 2008 and a substantial increase in netincome over the prior year first quarter. However, our net earnings weresignificantly impacted by weather related claim activity in our operatingregions, as I will discuss in more detail in a few minutes. Our net income for the first quarter of 2008 was $6.7million or $0.27 per share of Class A common stock on a diluted basis comparedto $5.5 million or $0.22 per share of Class A common stock on a diluted basisfor the first quarter in 2007. Total revenues for the first quarter of 2008 were $89.8million, an increase of 7.3% over the total revenues of $83.7 million for thefirst quarter of 2007. Net premiums earned for the first quarter increased 6.9%to $82 million compared to $76.7 million for the prior year period. Our net premiums written for the first quarter of 2008increased significantly as a result of several contributing factors. As of March 1, 2008, Atlantic StatesInsurance Company received a non-recurring $13.6 million transfer of unearnedpremiums pursuant to the previously announced changein the pooling agreement between Atlantic States and Donegal Mutual. Since the pooling changewas effective for one month of the quarter, our allocation of net premiumswritten and earned from the pool increased by approximately $2.5 million. Wealso benefited from lower reinsurance rates in the first quarter of 2008,largely due to an increase in our per loss retention from $400,000 to $600,000.Adding all of these factors together, we reported a 24.7% increase in netwritten premiums, of which 17.1% was related to the non-recurring unearnedpremium transfer. Our investment income was $5.7 million for the first quarterof 2008, increasing 3.4% over the $5.5 million we reported in the first quarterof 2007. Net realized investment gains were $695,000 in the 2008 periodcompared to $105,000 ayear earlier. As we have stated previously, we have no subprime exposurein our investment portfolio. The aggregate market value of ouravailable-for-sale municipal bond portfolio declined in the current quarter. Onthe surface, this may seem inconsistent with the decrease in general marketrates during the quarter, but municipal bond yields moved in the oppositedirection of taxable bond yields in late March, resulting in overall marketvalue declines in our municipal bond holdings. We have very low credit default risk in our portfoliobecause our muni holdings carried high underlying ratings even without regardto insurance and we buy primarily unlimited general obligation bonds. Moving to the underwriting results, our first quarter 2008loss ratio was 65.3%, slightly less than the 66% reported for the first quarterof 2007. We experienced significant weather related claims activity fromwidespread winter weather events in the southern and mid-Atlantic regions. Comparing the weather patterns experienced in 2008 versusthe first quarter of 2007, we had many more property claims resulting from highwinds and hail throughout the quarter as compared to the first quarter of 2007when there were a few large snow and ice events. The hail losses were relatedto the storm system that produced a tornado in downtown Atlantain March. We also experienced increased severity in our workers’ compand private passenger auto liability lines. And while it is more difficult tolink casualty claims with weather events, we did have a number of localizedsnow and ice events in several of our regions that resulted in auto accidentsand an increased number of bodily injury claims reported. Our expense ratio was 31.9% for the first quarter of 2008compared to 32.1% reported for the first quarter of 2007, with both periodsreflecting reduced underwriting-based incentive compensation costs due to theelevated loss ratios. Our combined ratio for the first quarter of 2008 was 97.5%compared to 98.4% for the first quarter of 2007 with the difference primarilydue to the increase in earned premiums exceeding the increase in losses andexpenses. Our book value per share increased to $14.02 as of quarter end,representing an 8.4% increase over the $12.93 book value as of one year ago. In March of 2007, we initiated a share repurchase programauthorizing the repurchase of up to 500,000 shares of our Class A common stock.Pursuant to this plan, we repurchased approximately 88,000 shares during thefirst quarter of 2008, bringing the total number of shares repurchased to dateto 355,000 shares. At this point, I will turn the call over to our President,Don Nikolaus, for his comments on the quarterly results.

[Donald H. Nikolaus:]

You heard the financial results announced by Jeff andpossibly you also had a chance to read the press release. We’re pleased withthe results given the amount of weather activity that we experienced and thatis of course reflected in the numbers that Jeff has discussed. One of the topics that has always been of interest toparticipants in the calls over the last year and a half is what is thecompetitive environment and certainly there may be follow-up questions, but inanticipation of that, what I will do is cover our assessment of it. We are seeing early signs of rate increase activityselectively in certain states by a competitive company. And I know that youfolks have probably that follow insurance have read in various insurancejournals and other publications about the industry that there are early signsof that, including what has been embedded in some of the press releases of someother competitive companies. So we are beginning to see that. I’ll talk aboutour own activity in that regard in a moment. From the standpoint of personal lines, aside from what wesee with regard to some companies and their increases of personal lines rateswe do not at least at the present time, have not experienced any furtherdeterioration of the personal lines market from a competitive standpoint.Assessing it, one would have to conclude that it is fairly consistent in thefirst quarter with what we would have experienced in the third and fourth quarterof ‘07. On the commercial side, commercial business, of course, hasbeen significantly more competitive over the last year and a half in personallines, but our indications are that our renewals are flat, that we are issuingthem flat to down, low single-digits and low single-digits being defined assomewhere between 3% and 4%. Now, having said that, there will always be somerenewals where there are increases and there will be some renewals where thedecreases are more than the low single digits. It’s a sort of overallassessment. We have had reasonable success in attracting new businessfrom the standpoint of the commercial side. Although the marketplace iscompetitive from a pricing standpoint, what we have focused on in the firstquarter, as well as historically, is that it’s one thing to say that you’regoing to price a piece of business from a competitive standpoint from thepricing side. It’s a totally different perspective if you’re going to beinclined to write something that you previously wouldn’t, or to loosen yourguidelines. We remain committed to rate adequacy and also the quality ofthe book of business to us is paramount, and we’re continuing to endeavor to dothat. I made reference earlier that, with regard to personal linesrate increases, we ourselves have begun to participate in that process andduring the first quarter and into the very early parts of the second quarter,we have approved and have made rate filings in about five states for home andauto. Some states, we’d be filing auto increases, other states, it would behome. Some it would be both and the averages of those increases would be in the4% to 6% range. That gives you a little bit of the tone of it. Now we do business in 14 states, so it’s about a third ofthe states, but we will continue to do reviews in terms of assessing where wesee rate trends needing to be, and we will try to balance the need for rateadequacy against certainly having a focus on wanting to write additionalincreased business. And there is a balancing act there and we, I think, areprepared to do what is appropriate. If you have followed our companyhistorically, you will know that if we have to make a choice between writingincreased business or writing profitable business, we will always chooseprofitability. From the standpoint of some other continued goals that wehave been pursuing in the first quarter, we continue to work actively for theappointment of new agencies, which is part of the expansion of our distributionsystem. I am able to tell you that in the first quarter we appointed59 new agencies and that would be of course for the various regions of thecountry and the various subsidiaries and affiliates. It is somewhat higher thanwe would have appointed in the fourth quarter. I believe it’s fairly consistentwith what we would have done in the third quarter. On the technology side, as we have said previously, that weview competitiveness as being more than just the low price. We believe that thequality and comprehensiveness of a company’s technology is very important. We are working to roll out in the second quarter basicallywhat we call PXL, which is the personal excess policy, which some people callit umbrella policies, but we issue an excess policy.  And we will have that being part of theautomated features of WritePro, which is our platform for the automatic andreal-time quoting of business. We would also anticipate that, before the end of the secondquarter, we would have either gone live with or close to going live with ourBOP program, being as part of our WritePro and we have also added in at leastone state, we are rolling out additional pricing tiers, which does not mean wehave lowered the premium. What it means is we have provided additionalsegmentation to what we believe is already a robust program. WriteBiz, which is on the commercial side, we have gone livein three additional states with our WriteBiz program in the end of the firstquarter and the very early weeks of the second quarter and we are about to rollout the package, the [inaudible] package as distinguished from the BOP as partof our WriteBiz.  And when we accomplishthat, we will have all commercial lines of business being able to beelectronically quoted at our agents’ desks and interfaced into our systemshere. We continue to focus on managing expenses to reduce ourexpense ratio. I know that you probably took note that Jeff announced that wedid have a modest decrease in our GAAP expense ratio. We will continue to workactively in that regard. We are certainly focused on capital management and certainlythe activity that we took in terms of increasing the retention on reinsuranceis in our judgment part of the management of your capital because where youhave adequate capital to support increased retention, there is a balancebetween that and paying out reinsurance premiums, but it has to be based upon asound balance sheet. And speaking about balance sheets, as we all know, there arelots of issues in the financial services industry, primarily with banks andinvestment banking firms and the issues that they have had. Fortunately, ourconservative investment philosophy has shielded us from that and we think thatit’s very much a time to be focused on balance sheet strength. And we believe our balance sheet is quite strong and goingforward, we think that it will be helpful to us in a number of ways, includingbeing in a position to access the right opportunities in any acquisition thatwe might become involved with. Speaking of acquisitions, we continue to have a very activeprogram in terms of trying to identify potential acquisitions. Once again, wewill only do them if they make sense, if they fit our business strategy, ifthey are in the right geographic parts of the United States and if we can see that it helps to move theball forward. We are encouraged that with the competitiveness for premiumand combined ratios increasing for property and casualty insurance companies,we are beginning to see more opportunities to have discussion. And as you knowfrom the past, we have talked about having discussions with other companies. Many times those discussions do not lead anywhere or that weidentify that there probably may not be a transaction for us, but we areencouraged by the environment in which we find ourselves to be at the currenttime. At this point, we will be prepared to discuss questions.

[Operator:]

(Operator Instructions) Your first question comes from Michael Phillips - Stifel Nicolaus.

[Michael Phillips -Stifel Nicolaus:]

Jeff, you mentioned seeing the severity pick up in comp andauto. Could you speak to the magnitude of that?

[Jeffrey D. Miller:]

The magnitude is not a significant number it’s just anincrease. And specifically in our Southern [inaudible] subsidiary, we saw someincreases in the severity of particular cases and claims that were reported inlate 2007 of a severity that we would not have seen previously. So it’s nothing that we at this point can really draw anyconclusions or say that we are seeing any trends, but that did have an impactin the current quarter, to the tune of an additional $1 million or $2 million.

[Michael Phillips -Stifel Nicolaus:]

Reserve releases; is it just fair to say that it was aboutwhat it was in the past couple of quarters?

[Jeffrey D. Miller:]

The first quarter generally we don’t talk too much aboutreserve releases because there is so little time between the end of the yearand the end of the first quarter. We would not have seen as many favorablesettlements of open claims and that’s a function of our case reserves beingsettled quicker in 2007, but as far as our bulk reserves, there were noreleases of bulk reserves in the quarter.

[Michael Phillips -Stifel Nicolaus:]

How do you monitor changesin consumer shopping specifically for auto insurance? Typically folks like tothink that, if there’s a slight uptick in prices, maybe that means moreshopping, maybe more quote activity, whatever. How do you monitor that and whatare you seeing there?

[Donald H. Nikolaus:]

We have a very excellent WritePro auditor system and we areable to know on a daily, weekly, monthly, quarterly basis quote activity,whether it’s up or down, down to the agency level, territory marketing, statelevel, and also we can monitor hit ratio. So many times the quote activity willbe telling you one thing and hit ratios will be telling you another. So we try to monitor it very closely because it can be veryhelpful in a number of regards, including whether there is increased activityin the marketplace where people are looking around getting quotes. Also, if yousee that your hit ratios are too high, you probably want to take a look at yourrate structure on a competitive basis to see whether you’re too competitive. And certainly if it’s an area where you want to do businessand your hit ratios are quite low, you might want to take a look at those tosee, well, is there something that just isn’t right in the way you were pricingcertain types of risk. So, we have methodology for it and we use it veryactively.

[Michael Phillips -Stifel Nicolaus:]

Any comments on kind of trends there, what you’re seeing inthe past couple of quarters? Is it ticking up or ticking down in those?

[Donald Nikolaus:]

Our quote activity is about level with what we would haveseen in the fourth quarter. It has not gone up and it has not gone down. Hitratios are about the same, but as a general statement, that that varies bystate. We have seen some states where our hit ratios are better. We have seensome states where they may have contracted a bit. But on balance, we’re pleasedwith where our activity is. Needless to say, we’re always anxious to see increased quoteactivity. And what generally would happen if there are any companies in themarketplace that, for whatever reason, have to take somewhat more aggressiverate increase activity, that will be generally helpful to increased quoteactivity. Because in a down premium environment or a flat environmentconsumers are not nearly as inclined to be checking quotes because generallythat approach on consumer’s part is sometimes motivated when they get a premiumnotice in the mail that is higher than the last one.

[Michael Phillips -Stifel Nicolaus:]

Just clarification, you are defining the hit ratio, asactual sales over quotes, is that correct.

[Donald H. Nikolaus:]

That’s correct.

[Michael Phillips -Stifel Nicolaus:]

Could you give the premium growth split,personal/commercial? I don’t know if you can give that without the effects ofthe kind of nuances as of the March pooling arrangement.

[Jeffrey D. Miller:]

Personal lines would have been up for the quarter and if youpull out the pooling effect, it would have been around 2.8% and commerciallines are basically flat. They were up just slightly, so that would be on adirect basis prior to the pooling changeand the reinsurance savings. If you factor in the reinsurance savings and the pooling change,not including the portfolio transfer, personal lines would have been up 10.4%and commercial lines 3.7% increase. So, there is a lot of moving pieces thereto try to get your hands around, but we expect to see some nice premium growthover the remainder of the year because of the reinsurance savings, as well asthe pooling change.

[Donald H. Nikolaus:]

And from those statistics that Jeff quoted with regard tocommercial, we have seen an improvement in our ability to attract newcommercial business. Which would be reflected in the fact that in the fourthquarter and third quarter we would have actually had down direct premiumswritten in commercial, whereas it is up slightly in the first quarter, which wefelt was a positive.

[Operator:]

Your next question comes from Joseph DeMarino - PiperJaffray.

[Joseph DeMarino -Piper Jaffray:]

The higher severity claims in the southern states youmentioned for auto that was on the casualty lines.

[Jeffrey D. Miller:]

The casualty lines, as well as especially in the Georgiaregion, we had some hail losses. Those would have been auto physical damagelosses. So, we kind of look at the auto as one component, not just splittingout the casualty and the physical damage, but the severity comments that I madewere related to the casualty side of the business.

[Donald H. Nikolaus:]

As a follow-up on the severity issue, as Jeff mentionedearlier, we are reflecting it because it did occur. We don’t believe that it issignificant, but it did occur and it is certainly something that we need tomonitor. We are aware from what we see from reading press releases ofother companies, that companies basically have seen some activity on severity.So, we’re not necessarily surprised by it, but it’s like anything else, we needto monitor it.

[Joseph DeMarino -Piper Jaffray:]

Is the weather-related claims in the quarter, how did thosecompare to weather-related claims last quarter and in prior year’s quarter interms of dollars?

[Jeffrey D. Miller:]

The weather-related claims would have been comparable to thefirst quarter of 2007. We actually had a higher number of claims reported, butthey would have been smaller claims, a little bit different in character with alot more wind claims. We had a number of days where we received 50 to 100claims or in some days even over 200 and 300 claims just from winds that wereblowing. That was not the case in the first quarter of 2007, when wehad some bigger ice events that were prolonged over a number of days where wehad more weight of ice type of claims, freezing pipes and that type of thing.There were different levels, different types of claims, but quantitatively theywould have been fairly comparable in the $4 to $5 million range forweather-related property claims. It’s a little more difficult to say how many claims or whatmagnitude of the auto liability claims that we would have received or thegeneral liability claims, slip and fall types, or those are a little moredifficult to attribute to the weather. But compared to the fourth quarter, we had very mildweather. In the fourth quarter, very few weather losses would have been morenormalized and I don’t know that I have a number right in front of me. Butcertainly, the first quarter of each year would have had a much higher level ofweather-related losses than we normally would see.

[Joseph DeMarino -Piper Jaffray:]

Do you have any expectations as to what your tax rate willbe going forward, how long you can sustain the current tax rate?

[Jeffrey D. Miller:]

The current tax rate reflects a lower pre-tax income. So thecurrent quarter, I believe the effective tax rate is 23.2% where we were in the28% range at the later part of 2007. Certainly, we continue to invest in tax-exempt municipalbonds, so that’s going to help our tax rate, but we would expect the lossactivity return back to what we’ve historically seen and in that case, our netincome should return to the levels that we saw in 2007 and we would expect theeffective tax rate to be in that 28%, high 27%, low 28% range.

[Joseph DeMarino -Piper Jaffray:]

Can you quantify the impact on premiums from the reinsurancecosts? You touched on it a little bit earlier, but not in percent terms, but indollars.

[Jeffrey D. Miller:]

Dollar terms, it was in excess of $2 million.

[Operator:]

Your next question comes from Scott [Lawrence],a private investor.

[Scott [Lawrence]:]

We have $15 million in debt coming due in 25 days. Theinterest rate is 9% on that debt. Do you plan on paying it off?

[Jeffrey D. Miller:]

Well, the interest rate actually has come down. It is tiedto LIBOR, so it is actually down around 7%. We are looking at that and we havethe option of paying that down in any quarterly period between now and the next30 years actually, so we’re looking at it. It will probably be paid off withinthe year. Whether we pay it off in May, that decision has not yet been made.

[Scott [Lawrence]:]

Donegal has grown since 1986 by acquisitions. Theenvironment during the conference calls in the past year is ripe and ready.What is taking so long?

[Donald H. Nikolaus:]

Over the last several years, we have talked aboutacquisitions. Our mutual company is doing a modest sized one in the state of Wisconsin,which presumably at some point Donegal Group may very well be the owner of. We have continued a very proactive outreach through variousinvestment banking firms that deal with property and casualty insurancecompanies. We have had contacts that we have initiated on our own with bothmutual and stock companies. We have had various conversations with the variouscompanies and the only thing that I can say is that acquisition is a process.It’s not the same as being able to say, well, we are going to acquire a companyand you do it tomorrow. I can only say to everybody on the phone call it is verymuch a part of our business strategy and that we are going to clearly endeavorto do acquisitions.  They are going tohave to make sense. We are not going to want to overpay, but they have to makesense. I do agree that the environment that we are currently in isa better environment than we have seen in a while for those types oftransactions. We have the financial capital, we believe, to do appropriateacquisitions and we can’t give anyone any assurances that it is going tohappen. I can only tell you that we are going to work to see whether we canmake some good acquisitions happen.

[Scott [Lawrence]:]

Certainly, after a year and a half, are you getting close ona significant acquisition, Don?

[Donald H. Nikolaus:]

We do not answer those kind of questions Scott, becauseclose is a nebulous word. I am not going to say we are close. I am not going tosay we are far away. We just continue to have the process and you will knowwhen we announce it. That’s the only thing I can tell you. Whatever it mightbe, whenever it might be or it might not happen.

[Operator:]

Your next question comes from Dan Schlemmer - FPK.

[Dan Schlemmer:]

On the casualty severity trend, but is this some statisticalblip or if it is the start of a trend. Can you talk about where you’re seeingthe severity trend? In terms of layers, that if you see a handful of largeclaims that are higher severity then that’s more likely a statistical blip, afew $100,000 claims or whatever that are moving up versus if you have a wholebunch of your smaller claims that all just seem to be moving in that direction. Can you give us any background in terms of that? Is it asmall number of claims that is driving it or is it broader than that?

[Jeffrey D. Miller:]

We certainly would not want to make more of my commentsabout the severity than what they really should be. There were a small numberof claims that ended up being more severe than what we expected. So it is, asyou would have qualified, what we believe is a blip in the statistics. At this point, there is not enough data or enough of anincrease in severity to say that it’s a start of a trend or that we are seeinganything different globally in our book of business. It was just a handful ofclaims in those specific lines that were severe and the only reason I mentionedit is because it was part of the factor that drove the increase in claims forthe quarter. But it is not something that we would say at this point isan alarming trend or something that we are concerned about, other than that wewill be watching it to see how things develop in the coming quarters.

[Donald H. Nikolaus:]

But the answer just needs to be on what Jeff answered thatit was a few claims that developed larger needed reserves than we hadanticipated but as we have always tried to do, we have always tried to discloseboth positive things that happened and also something that may have a negativeelement to it. But we would not want anybody to over exaggerate what we haveannounced in that regard.

[Dan Schlemmer:]

Staying on the severity, I think I heard you say it’s mostly‘07 claims you are looking at. In other words, there is no chance that it wasthe increased retention on your reinsurance that’s making you see higherseverity. Is that accurate?

[Jeffrey D. Miller:]

That is accurate. The severity that we saw was in 2007claims. And it may not be that it is that unusual for the first quarter becausethe lifecycle of a claim and the increases in reserves would generally bewithin the first four to six months after a claim is reported and so this maynot be that unusual of a situation. It is just that, as it related to thosespecific lines of business in that specific subsidiary, it looked like ananomaly.

[Donald H. Nikolaus:]

As an example, you can have a BI automobile claim thatoccurs in November of a given year. And in the end of January or February youget medical information that makes it clear that that person is injured moreseverely than what would have originally been anticipated. It can be that simple, which would be not unusual and onceyou have those facts in front of you. So the first quarter you would expectthat you’re going to have a certain number of claims that were given averagereserves towards the end of the prior year where you learn more information inthe first quarter of the New Year and as a result, it causes the reserve to beappropriately increased. Our guess would be that it’s no more complicated thanthat.

[Dan Schlemmer:]

Also on the reinsurance, it is somewhat related to theseverity question, but not intended to be. Really on the reinsurance moving upfrom $400,000 to $600,000 and I guess I am assuming you are just talking aboutcasualty. You’re not changingthe property program or property coverages. But looking at that going forward, how does that impactmaybe the variability in the loss ratio that we are going to see going forwardand how many claims historically do you have in that layer? Is that somethingyou commonly see in the layers that you are writing?

[Donald H. Nikolaus:]

The increase in retention is multi-line. For years, ourretention has always referred to both casualty and property. So it is both.Needless to say, we would not have increased retention if we did not do ananalysis that would, in our opinion, represent a good business decision thatgiven our levels of capital and given the premiums that we may have been payingfor lower levels of retention. And it’s also a periodic exercise that you go through. Wewould have, if you go back five years or seven years, the retention would havebeen $300,000. You go back 10, 15 years, it would have been $250,000 or $200,000.So it’s a logical progression in terms of what you do with your retention. In terms of the number of claims that historically would goabove those levels, I don’t know that we have that information at hand here. Wecan only say to you that we have certainly analyzed it and that we believe thatit was a good business judgment that we will benefit financially from it if youlook at it not only in the short range, but over time.

[Jeffrey D. Miller:]

I would just say that I concur with that. We did anextensive analysis in determining whether or not to make that changeand the reinsurance rate environment was conducive to it. And we looked backover to the last five to 10 years and felt that, in that longer timeframe, itmade sense to do it and that it would be profitable going forward. So that all remains to be seen, and certainly in the firstquarter, we did not see any significant increase in losses as a result of theincrease in retention, but time will tell if that ends up being the case forthe rest of the year.

[Donald H. Nikolaus:]

And certainly in subsequent quarters where we have a littlebit more history, we would certainly be in a position to be more definitiveabout what early signs we may have as to how beneficial it actually is.

[Dan Schlemmer:]

Thinking about it just in terms of variable, you’re thinkingabout it as beneficial, and that’s the right way for you to think about it, ofcourse. I am thinking about in terms of whether it introduces highervariability in the results. Is that a fair way for me to be thinking about itor not?

[Jeffrey D. Miller:]

I would say no, because we’re only talking about adifference of $200,000 on any individual loss, and we do not have a significantnumber of losses that exceed $400,000 in a year. So we don’t expect it to add any significantlevel of variability to the loss ratio. At this point, it’s improving the topline. It’s improving the base of the earned premiums. And so if anything, weexpect it to reduce the loss ratio.

[Donald H. Nikolaus:]

As an example, to put a little bit of perspective on it foryou, a high percentage, and I don’t have the statistics in front of me. But Iwould say probably 80% of our personal auto book of business, the liabilitylimits would not be above $300,000, either $300 or $300 single limit unlessthere is some kind of stacked coverage on UM or UIM. But to put it in perspective, we would have a lot ofpolicies that by the terms of the policy that there would not be the potentialfor a loss above $400,000. It would generally be applicable to commerciallosses, generally. It could have some personal lines losses, and it couldrelate to larger properties where you have a coverage A above a certain dollaramount.

[Dan Schlemmer:]

On the interest expense, it dropped down quite a bit. I amassuming that is just a LIBOR reset. Can you confirm that, and how often doesthat reset or what’s the dynamic we can expect going forward on that?

[Jeffrey D. Miller:]

The LIBOR does reset on a quarterly basis. We have threeseparate trust preferred issues, and each one of those reset on a quarterlybasis, and they are a premium over LIBOR. So the interest rate, the interestexpense reduction in the current quarter is exclusively related to thereduction of those rates.

[Operator:]

Your next question comes from Gerry Heffernan - Lord Abbettand Co.

[Gerry Heffernan -Lord Abbett and Co.:]

In regards to the investment portfolio, were there anyimpaired assets or assets that are part of a market that is currently locked ornot trading auction rate securities, muni bonds, things of that sort?

[Donald H. Nikolaus:]

No, we have none of those.

[Gerry Heffernan -Lord Abbett and Co.:]

Could you just review the portfolio a little bit? I am justlooking at the seemingly significant changesin some of the numbers on the balance sheet as you provided where the held tomaturity balance dropped pretty significantly, whereas the available for salewas up and short term investments down. Just what is the mindset of the assetmanagement here?

[Jeffrey D. Miller:]

With the interest rates dropping, we have a significantnumber of calls in our held to maturity portfolio, and those are beingreinvested into the available for sale. For the last number of years, we haveclassified the majority if not all of our bonds as available for sale, just togive us further flexibility. So with the shift that you are seeing is basically a resultof maturities and calls of bonds that were held for a number of years and arebeing reinvested into agencies or municipal bonds in the available for saleportfolio.

[Gerry Heffernan -Lord Abbett and Co.:]

Have you been able to take advantage of the municipal bondmarket issues that have occurred in the last couple of months here? And if sois it, are you seeing any uptick in your overall portfolio yield?

[Jeffrey D. Miller:]

We are. We have seen that we are able to invest the proceedsof some of the bonds that are maturing and being called at higher interestrates than the bonds that are running off the portfolio. So we are seeing someincreases in yield on an after tax basis, and I would characterize those asmodest, but certainly over time we would expect to see increased benefit fromthat.

[Gerry Heffernan -Lord Abbett and Co:]

And you were commenting on an after-tax basis. So certainlythe two bonds at like rates if it’s moving into a muni that’s going to benefityou at the tax line.

[Jeffrey D. Miller:]

Correct.

[Gerry Heffernan -Lord Abbett and Co:]

Anything else that would be important to tell us about theinvestment portfolio?

[Jeffrey D. Miller:]

Only that we’ve put a lot of money to work in the firstquarter. We’ve reduced some of our cash positions and as we feel opportunity todo that, and as we saw rates starting to decrease, we locked in some of thosereturns. So we are carrying a lower level of cash, but we continue to have cashcoming in from calls and from maturities and investments. We continue to lookto ladder the portfolio to make sure that we have consistent cash flows andincome that’s adding to the bottom line.

[Donald H. Nikolaus:]

Over the years, we have probably been viewed as having avery vanilla, conservative investment portfolio, and of course now, we’re verypleased that that was in fact the case. These are interesting times as far asinvestments are concerned. So we are being opportunistic in terms of thetax-affected yield and the quality of what we’re able to buy.

[Gerry Heffernan -Lord Abbett and Co:]

A number of people have questioned about the comment thatyou made towards claims as far as frequency and severity and seeing a bump upin the quarter, and certainly when you’re comparing quarterly periods, there isa lot of stuff that can affect each one, and it’s somewhat hard to compare. I’dlike to ask the question on a prospective basis. If we are heading into a prolonged economic trough and I’mnot talking about depression. But just if we have a very tough economic periodhere coming up that extends for more than just two quarters, and my thought ofthe insurance industry in that claims, both frequency and severity, have atendency, while not perfectly correlated, to increase as economic situationsdecrease. Are you considering that in your underwriting right now?Have you been using the economic backdrop to question your current pick ratesand that you think that perhaps we should be increasing our pick rates givenwhere the economy might be going?

[Donald H. Nikolaus:]

I think that your observation is I think a reasonablyaccurate one. However, it certainly can vary depending upon what is the productmix of a particular company. For instance, if we were, which we are not, but ifwe were heavy in workers’ comp, one would have to be concerned about, in a downeconomy where unemployment is up, you’d have to be concerned about return towork trends. In our own case, we are seeing an actual decline ofindemnity workers’ comp losses over the last several quarters, which we wouldfind to be a positive trend from our standpoint. Following up on the point of increased loss activitypotentially in a down economy, anyone who knows about P&C companies, youknow that the moral hazard, the moral risk comes into play with propertyexposures where there sometimes can be an increased incidence of questionableclaims. We have reemphasized our SIU, our special investigative unit, processesto make sure that we are very alert to any claims that may have somequestionable issues as to their origins. We also inspect a high percentage of our business and wealso monitor the credit quality of all business, whether it be on the personalline side or the commercial side. So, I think that part of the issue that yourefer to depends a lot upon the quality of the book of business to start withand then secondly, how you manage through the process. So, hopefully that is helpful. We would not anticipate a lot of increased severity becauseof a recession, nor would we anticipate a lot of increased frequency because ofa recession. On the automobile side, if the price of gasoline continues to goup, what you will find is the miles driven will begin to decline. And most ofthe national statistics on frequency of automobile claims there is acorrelation between that and miles driven. – I don’t want to be perverse. But you could be a bit perverseto say that higher gasoline prices will actually help the property and casualtyside from the standpoint of automobile loss ratios. But all that will need timeto prove.

[Gerry Heffernan -Lord Abbett and Co:]

Going back to the comments you made on casualty about theinvestigation aspects of your claim processing and the underwriting, the creditchecks, all very smart, good business processes. Though I would say when business is good, those are thelittle things that seem to get lost and not remembered again until after themistakes show up in the adverse numbers. Can you just comment, to assure usthat none of these things have been reduced or if you are picking up the efforthere?

[Donald H. Nikolaus:]

It goes to the particular philosophy of a company. We never,ever back off of inspections of risk. For instance, every commercial risk,unless it’s something very tiny, we physically inspect. We have done that for25 years and certainly are not reducing it currently. So, no if anything youbecome more conservative as you see some cloudy skies. So, I can assure youthat that is reinforced on an ongoing basis. It’s audited. We have audits of what underwriters do to make sure that allthe requirements are being followed and if we see any aberration, it is dealtwith very promptly and in a very serious manner. Because at the end of the day,the quality of your book of business over time will determine whether you havegood combined ratios or you don’t. And there is really no other way of lookingat it.

[Operator:]

Your next question is a follow-up question from JosephDeMarino.

[Joseph DeMarino -Piper Jaffray:]

The $2.5 million in the quarter from the pooling allocationarrangement, is that a one-time thing or will that be built into premiumnumbers going forward? How do we understand that number?

[Jeffrey D. Miller:]

The pooling changefor the month of March added between somewhere around $2.5 million I think isthe number that I quoted to our net premiums written. In the second quarter, itwill be three times, that it will be $7.5 million. So if you recall the announcement we made related to thepooling change, itwas going to add $30 million on an annual basis to our premiums and so $7.5million per quarter is a pretty good estimate of the top-line growth related tothe pooling change.

[Operator:]

You have no further questions at this time.

[Jeffrey D. Miller:]

Thank you very much and we appreciate all the good questionsand the participation on the call. Have a nice day, everyone and thank you forparticipating in our conference call.