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Edited Transcript of AFH earnings conference call or presentation 14-Mar-17 12:30pm GMT

Thomson Reuters StreetEvents

Q4 2016 Atlas Financial Holdings Inc Earnings Call

TORONTO Mar 14, 2017 (Thomson StreetEvents) -- Edited Transcript of Atlas Financial Holdings Inc earnings conference call or presentation Tuesday, March 14, 2017 at 12:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Scott Wollney

Atlas Financial Holdings, Inc. - President & CEO

* Paul Romano

Atlas Financial Holdings, Inc. - VP & CFO

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Conference Call Participants

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* Bill Dezellem

Tieton Capital Management - Analyst

* Samir Khare

Capital Returns Management - Analyst

* Wally Walker

Hana Road Capital - Analyst

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Presentation

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Operator [1]

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Greetings and welcome to the Atlas Financial Holdings 2016 fourth-quarter earnings results. (Operator Instructions). As a reminder, this conference is being recorded. I would now like to turn the conference over to your host Scott Wollney, Chief Executive Officer of Atlas Financial. Please go ahead, Mr. Wollney.

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Scott Wollney, Atlas Financial Holdings, Inc. - President & CEO [2]

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Thank you very much, Rob, and good morning, everyone. With me today is Paul Romano, our Vice President and CFO. This morning we will discuss Atlas' results, trends and changes within the evolving niche light commercial auto market where we operate and share our expectations in terms of goals and general visibility regarding the future.

I will now turn it over to Paul to provide details about our quarterly materials and review our policy regarding forward-looking statements.

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Paul Romano, Atlas Financial Holdings, Inc. - VP & CFO [3]

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Thank you, Scott, and good morning, everyone. Yesterday after market close Atlas issued its 2016 fourth-quarter financial results. Copies of this press release are available at the Investor Relations section at the Company's website at www.atlas-fin.com.

On this call Atlas may make forward-looking statements regarding the Company, its subsidiaries and businesses. Such statements are based on the current expectations of the management of each entity. The words anticipate, expect, believe, may, should, estimate, project, outlook, forecast or similar words are used to identify such forward-looking information.

The forward-looking events and circumstances discussed on this call may not occur and could differ materially as a result of known or unknown risk factors and uncertainties affecting the Company, including risks regarding the insurance industry, economic factors and the equity markets generally, and the risk factors discussed in the Risk Factors section of its Form 10-K for the year ended December 31, 2016. No forward-looking statement can be guaranteed.

Except as required by applicable securities laws, forward-looking statements speak only as of the date on which they are made and the Company and its subsidiaries undertake no obligation to publicly update or revise any forward-looking statement, whether as a result of new information, future events or otherwise.

When discussing our business operations we may use certain terms of (inaudible) which are not defined under US GAAP. In the event of any unintentional difference between the presentation materials and our GAAP results, investors should rely on the financial information in our public filings. All amounts discussed on this call are in US dollars unless otherwise indicated.

We will be utilizing a slideshow presentation in conjunction with this call. Though we may address a few slides specifically, in general we will use this as a Company event. Feel free to follow along as we will follow the basic structure of this document. This presentation is available on our website Investor Relations section and then under the Earnings Release Info selection.

For those of you following along with our presentation we will begin on slide 3. With that I would now like to turn the call back over to Scott.

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Scott Wollney, Atlas Financial Holdings, Inc. - President & CEO [4]

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Thanks, Paul. Throughout 2016 Atlas remained focused on strengthening its market-leading position in the specialty light commercial auto sector. There were certainly some challenges in the year. We encountered shifting market dynamics impacting our tax year related insurance policies and also strengthened reserves in certain isolated areas of our business primarily related to older accident years.

Once recognized we addressed these issues in a proactive manner that we feel exemplifies Atlas' transparent approach. We also believe our ability to identify and isolate these issues in a timely way demonstrates our core strength as a hyper focused underwriter in specific niche markets.

Some key underlying factors related to the previously announced reserve strengthening which Paul and I will touch on are highlighted on slide 3. To be clear, we take responsibility for this issue and the unfortunate impact it had in the short run. But hope it serves as a positive example of how our team addresses adversity, learns from it and will ensure that it does not dilute the extraordinary value of our overall business.

That said, we can also confidently say that there were more examples of wins than losses in the year operationally. The experienced and dedicated team at Atlas achieved a number of milestones that we believe position us well for strong underwriting performance above our peers in the years to come.

Commercial auto insurance overall has been cited as challenging for most large generalists recently. This type of environment creates incremental opportunity for Atlas as a specialist. The foundation we built coupled with our increasing reach and analytics capabilities position us well to generate outsized returns on deployed capital especially in the context of current market conditions.

Throughout 2016 we've been taking advantage of favorable pricing trends in virtually all of our markets. We have a high level of visibility to implement rate changes where appropriate and have been doing so. Leveraging the investment we have made in machine learning based predictive analytics also allows us to better segment relative risk and should maximize the ultimate benefit of rate changes.

The Company continues to target a better than 60% loss ratio in all areas with a run rate expense ratio, excluding amortization of expense related to stock-based incentives, within the 24.5% to 26.5% range that we have communicated in the past. While I will go into further detail later in the call on our premium makeup and growth expectations, we do feel that it is notable that on a full-year basis, [although] Atlas increased its premiums in the face of a market that has seen considerable shifts unlike any other commercial lines of business in the P&C industry.

The increased impact of transportation network companies and their significant effect on our markets did reduce taxi premiums during the year. However, as we have mentioned on past calls, we believe this reduction to be short-term. At the same time the longer-term trend is very positive. Overall the market for light commercial auto and drivers carrying people and things for money increasingly dubbed first and last mile transportation is expanding and ultimately that is good for Atlas.

We are focused on deploying our unique business model in three ways. First, continuing to grow to a proportionate 20% market share in our traditional niche market based on our strong value proposition while pricing conditions remain favorable. Second, thoughtfully pursuing opportunities to distribute our traditional specialty insurance products in the growing transportation network company base segment. And third, exploring entirely new ways to evolve our product offerings informed by the experience and expertise derived over decades in our traditional business to ensure that Atlas can maximize its opportunity set in this changing environment.

We believe that our Company is better positioned than any other commercial auto writer to accomplish these three objectives. For the next few minutes I'll briefly address the recent reserve strengthening that we pre-announced last month and about which I have spoken with many of you subsequent to that release.

We feel very strongly that we've isolated the issue and that we were open with investors as to both the cause and the short-term impact it had on our operating results. As a result of the proactive measures we took and are taking, we believe that Atlas is well-positioned going forward. I certainly encourage everyone to review the materials we made available on our website in advance of the AIFA conference last week and the press release we issued last month.

For the 2016 fourth quarter and year end Atlas performed a comprehensive review of its reserves. As a result of changing loss payment trends identified through yearend actuarial work we ultimately decided that it was appropriate to strengthen reserves at this time. The impact on net income after tax and preferred share adjustments related to acquisitions was approximately $17 million.

The primary cause of the reserve strengthening was related to increased severity in light commercial auto within the Michigan market for business written in prior accident years. Certain unrelated pre-acquisition claims at Global Liberty were also identified as requiring reserve strengthening.

The bulk of the net impact on our balance sheet related to Michigan so I will provide more detail in that regard. On slide 3 we outline a few of the causal elements at the heart of the issue.

On slide 4 we further explain the analysis around our book, the origination of the challenge, how we proactively addressed the issue and ultimately how Atlas is positioned going forward. As we referenced before Michigan had been underperforming for a number of years relative to the rest of our book. As a result our exposure to the Michigan market was reduced significantly through a combination of rate increases, reduced policy count and most recently by refocusing claim efforts based on developments in the past year in particular.

While some of the macro level causal issues, such as high unemployment in Detroit back in 2012 and 2013, have improved, we do not believe these changes are sufficient to achieve our underwriting profit expectations based on market rates in the state at this time. As illustrated in great detail in the materials we presented at the AIFA conference, litigation percentages and paid severities in Michigan essentially doubled in 2016 as compared to the prior year.

While the relative underperformance was not a surprise, as evidenced by our significant actuarially supported rate increases in the past three years, the dramatic increase in paid severity in one year was the reason we felt it was important to strengthen reserves based on our 2016 yearend actuarial work.

By the end of 2017 we expect Michigan to be less than 1% of our overall book of business. This doesn't necessarily mean that we are exiting the state to never return. We just understand that as a nimble operator we must focus on properly deploying our capital in states where we can achieve our underwriting goals.

There are a number of states where we currently don't write due to environments that we believe will not support underwriting profit at this time for various reasons. There are also other states that were historically challenged but have improved. In both cases our expertise, coupled with an ability and willingness to adjust our exposure based on these changes, is something that distinguishes us from a larger generalist.

There are no other states or segments in our book of business that show the kind of rate need or severity challenges I just described. And the predictive analytics we have implemented in the claims area last year will help ensure that any such trends can be identified even earlier in the future.

Moving forward, we are pleased to have directly addressed this issue, do not see any long-term impact on our business as a whole and remain very positive with respect to moving forward in achieving our objectives of exceeding industry return on equity by 500 to 1,000 basis points.

Despite the reserve strengthening taken at the end of 2016, we did improve book value modestly year over year and have maintained a strong rate of book value appreciation with a compound annual growth rate of approximately 12% since the creation of Atlas several years ago.

I will now move into a discussion on premiums and the current state of our markets. We continue to take advantage of favorable pricing trends in many of our markets, which have begun to decidedly retrench as evidenced by industry data such as the information prepared by Barclays Research and the CIAB shown on slide 5.

As you can see, the vast majority of commercial auto business is experiencing accelerating rate increases in recent quarters and commercial auto is the only large segment within P&C insurance that is not softening. To date we are not seeing any indicators of the softening insurance market in our niche either.

Also the fact that broader commercial auto writers are facing challenges suggest that the timeframe during which potential price aggressive new entrants, such as managing general agents, will be unable to find support will be extended. We are continuing to achieve sequential rate increases and are targeting better than average accounts through the increasingly sophisticated use of our predictive analytics tools.

On our last call, based on feedback from our distribution channel in insureds, we noted that we expected the reduction in available taxis to flatten in a matter of quarters not years. Already we have seen signs that the decline was beginning to moderate towards the end of the year and are now seeing taxi volume flatten within an improved retention of vehicles in force as we move into 2017.

Throughout the change in market makeup driven by the rise of transportation network companies we have not compromised our underwriting criteria or return on deployed capital expectations. Many companies might have been willing to lower price in exchange for increased top-line premiums, but we have consistently maintained that underwriting profit will always take precedent and we remain firm in this belief.

Our research also suggests that people who elect to drive for categories of P&C businesses that do not require commercial auto insurance tend to do so for less than six months. Those who are or elect to become professional drivers generally transition to a category of service requiring commercial auto insurance or return to the taxi space within 12 months. We remained patient throughout 2016 and have been pursuing areas where we can benefit from these changes.

While there has been a shift in terms of the sub segments within our addressable market, we believe that the niche in which Atlas focuses still represents approximately $2.25 billion of the broader $31.3 billion in annual commercial auto premium. To be clear, this figure includes only full-time professional taxi, limo, livery and paratransit drivers. Part-time drivers who are not commercially licensed are incremental.

Based on consumer demand and demographic preference we anticipate the overall market size will continue to grow in terms of total vehicles in operation. As regulations continue to evolve across the country and as commercial realities become more clear to both drivers and passengers, the size of the market for our products will likely expand further.

We are seeing a number of indicators that the headwinds we saw in the taxi space are beginning to settle and growth in the livery and paratransit segments continues. As shown on slide 6, on a full-year basis comparing 2016 to the prior year premiums from taxis shrunk 29% while limo and livery grew 39% and paratransit grew 30%. The result is a more diversified pool of potential insureds in a larger overall market in light commercial auto.

Our geographic diversification also continues as illustrated on slide 7. These are good trends for our business and we continue to see pricing gains throughout our book. As of December 31, 2016, 28% of our book of business was taxi, 36% was limo and livery and 36% was paratransit. As compared to only a few years ago our book of business is now much more diversified both geographically as well as by business sub segment.

Underlying trends and expectation in this regard are also summarized on slide 8. We have a high level of visibility to implement rate changes where appropriate and have been doing so. For a number of periods now the Company has targeted a better than 60% loss ratio in all areas with rate increases exceeding loss trend. Our expectation is that the 2017 loss in LAE ratio should reflect these positive impacts and be at the low end or even below the range of 59% to 61% provided in our pre-announcement.

As I mentioned earlier, our annual expense ratio targeted, excluding amortized expenses related to share-based incentive compensation, continues to be in the 24.5% to 26.5% range. As we have communicated in the past, we anticipate being on the high end of that range as we grow and should be able to move lower when markets eventually soften and/or when we achieve incremental scale efficiency in the future.

2016 was an unusual year and it was challenging to manage expenses in the face of the changing dynamics of our niche. But we feel our team struck the right balance of expense control and investment in the future.

While the cyclical nature of our business has an impact on this dynamic, we will always look for ways to become more operationally efficient while still delivering the strong value proposition that differentiates our business competitively and should allow us to support higher than average price levels at any point in the market cycle. And, as referenced previously, we will never take a price aggressive approach just to move the top line.

As the leader in this niche Atlas continues to take a long-term broader view to identify means of taking advantage of market dynamics. We have implemented and continue to evaluate analytics and technology to ensure that we can both service and price effectively ahead of market conditions. We are also actively developing products that cater to the evolving needs of new and existing customers in our niche.

Atlas should be well-positioned to deliver stronger margins with the goal of always exceeding the industry ROE due to this hyper focus. I will talk more about this after Paul reviews our financial results.

At December 31, 2016 our operating leverage, as measured by net written premium to surplus, was roughly 1.5 to 1 as seen on slide 9. Managing this ratio is important from a regulatory and rating agency perspective. As I indicated earlier, we intend to ensure that this ratio is consistently evaluated to maximize ROE over time.

We are confident that there will be opportunities to benefit from the dry powder we've currently got in our capital structure in terms of both organic and M&A growth opportunities and we feel comfortable with our current capital position. With that I will once again turn the call over to Paul for a more detailed review of our financial results and then I will return for concluding remarks.

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Paul Romano, Atlas Financial Holdings, Inc. - VP & CFO [5]

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Thanks, Scott. I will keep the quarterly financial overview relatively brief and, as always, encourage each of you reach out to review our filings, our slide presentation and to reach out to Scott or myself with any questions. I will also highlight a number of full-year figures, which are good indicators of our relative performance.

Because there are certain seasonal and one-time impacts that flow through our quarterly results, as a rule we encourage users of our financial information to focus on the trailing 12-month comparison which remains a better overall representation of our results.

As indicated on slide 11, gross premium written was $52 million in the fourth quarter 2016 representing a decrease of 0.8% for the quarter when compared to 2015. This decrease is primarily due to the reduction of the Company's traditional taxi business offset by increases in our paratransit, limo and livery businesses. Premium in force as of December 31, 2016 was $224.6 million representing a 6.6% increase over the premiums in force at December 31, 2015.

As mentioned last quarter, we have the flexibility to deploy financial tools such as debt or quota share reinsurance to adjust our operating leverage in order to maximize ROE. We remain in a growth mode based on current market conditions and are committed to finance our Company's expansion in a way that optimizes the return on deployed capital.

Our quota share reinsurance agreements allow Atlas the flexibility to make changes to [session] rates on a quarterly basis between a minimum of 5% and a maximum of 50% of subject written premiums as we deem necessary. As of July 1, 2016 we lowered the session rate from 15% to 5% of subject written premiums for American Country, American Service and Gateway Insurance companies. The session rate for Global Liberty remains unchanged at 25% of subject written premium.

We have renewed these agreements for additional two-year period and as a result these agreements will continue to provide the flexibility to adjust the session rates depending on our premium growth.

Net premium earned increased 5.5% in the fourth quarter 2016 to $44.3 million as compared to $41.9 million reported in the fourth quarter of 2015. On a full-year basis net premium earned increased by 12.5%, the increase in net premium earned was primarily the result of the timing of the Global Liberty acquisition in 2015, which was effective March 11, 2015, coupled with the increase in net premiums earned from the ASI pool companies.

Our previously announced reduction in the quota share reinsurance sessions for the ASI pool in mid-2016 also had a positive impact in the quarter and should continue to have a positive impact on net earned premium into 2017.

On slides 13 and 14 we layout the components and comparisons of Atlas' combined ratio for the three months and 12 months ended December 31, 2016 and 2015. Included in the impact of the prior year reserve strengthening, the loss ratio was 135.7% in the fourth quarter 2016 compared to 60.9% reported in the prior year period. Without the reserve strengthening adjustments on a full-year basis the Company's 2016 loss ratio was 59.7%.

On a full-year basis our expense ratio, excluding the impact of share-based compensation expenses and the adjustments related to stock purchase agreements, Atlas reported a 26.9% underwriting expense ratio for the 12 months ended December 31, 2016, which is slightly above the high end of our target underwriting expense ratio of 26.5%.

Included in the impact of prior period reserve strengthening Atlas' total combined ratio for the fourth quarter 2016 was 156.5% compared to 88.2% for the fourth quarter of 2015. Excluding the impact of reserve strengthening and stock purchase agreement-related adjustments, our full-year reported combined ratio of 102.9% would have been approximately 85%, which is a better representation of our run rate expectations for operating results.

Atlas generated net investment income of $1.7 million and $1.1 million for the quarters ended December 31, 2016 and 2015, as well as $206,000 and $183,000 of realized gains respectively. This resulted in an overall annualized investment yield of 2.2% for the quarter ended December 31, 2016.

Atlas reported a net loss after tax of $13.6 million during the three-month period ended December 31, 2016 compared to net income after tax of 4.3% -- $4.3 million during the prior year period. Atlas generated a loss of $1.13 per common share diluted for the three-month period ended December 31, 2016 as compared to $0.34 of common share diluted as reported for the three-month period ended December 31, 2015.

For reference purposes on a full-year basis, excluding the impact of the four quarter reserve strengthening adjustments, net earnings per share would have been $1.60. We increased book value by $0.36 to $10.54 at December 31, 2016 from $10.15 at December 31, 2015. Details regarding changes in book value in the quarter is shown on slide 15.

On slide 16 we have modeled the compound annual growth rate in our book value from yearend 2011. We have made pro forma adjustments to allocate the reserve strengthening back to the relevant accident years which, based on these pro forma adjustments, our compound annual growth rate would have been 12.2%.

As indicated earlier, in force premium continued to grow to $224.6 million on a year-over-year basis as shown on slide 17. Unearned premium balances, which represent premiums corresponding to the time periods remaining on the underlying in force policies, were $113.2 million compared to $108.2 million at December 31, 2015.

Moving to the investment portfolio, we continue to place a priority on the preservation of capital to support future premium growth. The high-quality of our investment portfolio is detailed on slides 18 and 19. Our cash and invested assets at December 31, 2016 was $224.8 million compared to $233.3 million at December 31, 2015.

Our investment duration is 3.4 years and it remains consistent with our anticipated liquidity needs and claim payout patterns and the majority of our holdings are in fixed income securities rated AA or better by S&P. Because we intend to hold securities to maturity, while any increases in interest rates could create an unrealized loss in the short-term, we would not anticipate such losses to be realized.

Working with our outside investment advisors, we monitor the positions in our portfolio closely. As indicated on page 64 of our Form 10-K, a 100 basis point move in interest rates would result in a $5.6 million change in accumulated other comprehensive income. With that let me turn the call back to Scott for his concluding remarks.

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Scott Wollney, Atlas Financial Holdings, Inc. - President & CEO [6]

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Thanks, Paul. We have a positive long-term view of Atlas' position within the overall commercial auto market and specifically our underwriting performance when compared to that of the market as a whole. As I mentioned previously, as a hyper focused specialist we anticipate benefiting from the increasing challenges facing the broader industry. We are seeing rate increases retrenching as a result of reserve strengthening throughout the industry with commercial auto rates trending up.

Throughout 2016 we worked through a considerable shift in our specific market with livery policies, including those written for professional drivers under dispatch by transportation network companies, representing an increasing percentage of active public auto vehicles. We are navigating this shift and are well-positioned to potentially see growth increase while still achieving rate levels necessary to ensure our target underwriting profit.

Information shared by our distribution partners as well as other commercial auto carriers continues to suggest that the market will follow our price leadership and that there is room for incremental rate change. It seems unlikely that generalist insurers will choose to enter our space through price aggressive channels so long as opportunities for improvement exist in the larger commercial auto segments on which they focus directly.

Slide 21 illustrates the incrementally positive sequential pricing actions we've taken on a quarterly basis since our US IPO in contrast to those recommended by ISO. As you can see, while we did moderate the strong rate increases taken in the early part of 2016, we are still pursuing incremental positive rate changes.

We have grown our business while still maintaining our focus on improving profitability over the long-term and have worked diligently in recent years to implement sophisticated processes and predictive analytics to identify both favorable and problematic conditions in our markets faster and more efficiently.

Furthermore, we believe that the investment we've made in predictive analytics and point of sale distribution coupled with our commitment to partner with telematics providers will compound the underwriting benefit that can be achieved based on the competitive environment this year. We are confident that our business will continue to grow profitably in 2017, as indicated on our third-quarter call. Until we see a clear pattern of marginally [lesser] reductions in the taxi space, we do not plan on providing specific expectations regarding future premium levels.

We regard being a good steward of capital as a critical core competency and, as we did in 2016, we will manage the financial tools we control to maximize return on deployed capital at any level.

I want to take a few moments to address the use of analytical tools and their impact on Atlas and the insurance industry. I recently attended an insurance conference and the buzzword was certainly telematics and analytics. A few years ago the buzzword was big data.

We feel that the impact of analytics for a Company like Atlas are even more pronounced than those of the broader industry, largely due to the highly specialized nature of the Company's operations, the relatively high frequency of claims experience by our insureds and the significant repository of segmented data we have been able to accumulate as a result.

For Atlas the use of data, analytics and telematics is not a new trend. Access to decades of data was a key element underlying our acquisition strategy from the beginning. Our commitment to analytics has always been strong and in the past couple years we embraced a machine learning approach which has already begun to prove its power and efficiency.

For years we have also been focused on identifying, evaluating and partnering with in-vehicle technology firms to ensure we understand how their tools can measure and impact risk. This focus of our business strategy was featured at our Investor Day last May and will be something we expand on further at this year's meeting.

Given Atlas' highly specialized market niche coupled with a large repository of niche specific data across each of our subsidiaries, we can deploy these analytics tools in a way that cannot be accomplished by generalists, while having a significant pricing advantage over smaller, less sophisticated and lesser capitalized competitors. We began to leverage this advantage in renewals throughout 2016 and are beginning to see the benefit which we anticipate may continue to improve underwriting performance throughout the coming year and beyond.

Slide 22 demonstrates the bias towards better than average loss ratio accounts within a normal distribution of premium, which is ultimately the desired objective of predictive analytics and underwriting.

Slide 23 provides examples of the positive impacts we are already seeing in terms of claims handling, which includes faster closure rates, reduced open inventory with high risk attributes and lower allocated loss adjustment expense as a percentage of indemnity payments. Also, despite our growth over the past few years, our overall claim inventory was actually lower at the end of 2016 as compared to 2015 as a result of these initiatives.

While there were challenges over the past year Atlas remains committed to the Company's previously stated goal of exceeding P&C industry return on equity by 500 to 1,000 basis points going forward based on more recent accident years. As summarized on slide 24, we have a very favorable outlook, will remain proactive regarding market changes and expect to leverage our resources to maximize return on deployed capital.

I want to specifically thank all of our exceptional employees and partners for navigating the past year in such a manner that leaves the Company in a strong position to continue its growth as a specialty niche writer of light commercial auto. With that let's turn it over for any questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions). Bill Dezellem, Tieton Capital.

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Bill Dezellem, Tieton Capital Management - Analyst [2]

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A couple of questions. First of all on the big picture front, would you pontificate on how rising interest rates might affect the industry behavior relative to pricing?

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Scott Wollney, Atlas Financial Holdings, Inc. - President & CEO [3]

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Sure, Bill, it varies a lot by line of business, in particular the duration of claim payout patterns. So in terms of the industry, underwriting behavior is more likely to be impacted for longer tail lines of business where they are holding surplus in the investment portfolio for a longer period of time. In our case our duration is about 3.5 years.

And so, while we will have some benefit from a rising interest rate environment in terms of investment income going forward where we are investing new premium dollars as they come in, as Paul mentioned, there will also be a near-term mark-to-market impact in terms of unrealized loss if interest rates go up as well.

So I think in shorter tail lines of business like commercial auto you probably won't see a significant change in underwriting behavior as a result of increasing interest rates. It is possible that you might see that in terms of longer tail lines of business. And in fact that may be part of what is causing many other segments in Property Casualty -- or a contributing factor.

I don't think it is the driving factor but it could be a contributing factor in terms of the softening that you see outside of commercial auto, particularly in some of the other long tail lines of business. I think the availability of relatively inexpensive reinsurance and general overcapacity in the industry are probably more significant issues in terms of underwriting behavior, but all of those things play a factor.

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Bill Dezellem, Tieton Capital Management - Analyst [4]

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Thank you. And then two additional questions. The new systems and analytics that you are referencing, had you had these two years ago how would it have led to either a different outcome or a different behavior on Atlas' part in Michigan specifically? And then the second question is, if you would discuss the Mobileye relationship in New York, please.

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Scott Wollney, Atlas Financial Holdings, Inc. - President & CEO [5]

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Sure, I would be happy to. So in terms of the analytics specifically focusing on claims, one of the key initiatives with our claims-related predictive analytics is to early identify potentially severe claims and be as proactive as possible in bringing them to a favorable resolution.

We have always taken the view that our industry requires us to quickly vet a legitimate meritorious claim from a fraudulent inflated or non-meritorious claim. And then based on which path the claim is on, either bring it to quick and fair resolution if it is legitimate and/or make our insurers a hard target if it is an inflated or illegitimate claim. And so, the predictive analytics tools help us to sort of amplify or accelerate how quickly we can do that.

So if we look at the settlement time for claims over $50,000 for example, which is a relatively small percentage of our total claims paid, it is about 1.5% -- 1.5% 1.6% of total claims paid in general, not just in Michigan. We were able to reduce the days to settle those claims in 2016 by about 20%. And we have always from a best practice standpoint focused on doing that, but the analytics tools give us the ability to do it more quickly.

And so, if you apply that to the issue we saw in Michigan, as we have talked about and I touched on on the call, Michigan had been underperforming, we were doing state specific actuarial pricing work for the past five years. Over the last three years that pricing work indicated we should be increasing rates fairly significantly. We did increase those rates taking the full actuarial indication.

However, it was really that significant increase in paid severity that we saw in 2016 that caused us to feel it was appropriate to increase reserve. And so, those increased severities might have been seen earlier if we had had accelerated the time to close, especially for the cohort of large claims earlier in the process.

So it is hard to tell for sure whether or not settlements in 2015 might have shown an earlier indication had we had the analytics tools in place. But it certainly couldn't have hurt. And again, it is one of the key benefits of focusing on analytics in early -- either, again, early adjudication or identification of fraud is that it does give us the ability to collect paid data points as early as possible and then use that information to inform both our pricing and our reserving work from an actuarial perspective.

The only other caveat I would throw into it, there were definitely some macroeconomic issues that drove the exposure in Michigan, in particular high unemployment and some other factors that we have talked in detail about and highlight in the deduct for AIFA. So I won't go into them here in the Q&A, but some of those macro level factors ultimately I think were on a track to simply emerge in terms of loss payment in 2016.

So I definitely think it would have helped, it probably wouldn't have materially changed how quickly we were able to reduce exposure in Michigan. But I think it would have allowed us to do some of the things we are doing now in terms of reacting to those changes even more quickly.

And so, it is one of the reasons why we believe that predictive analytics tools are increasing our confidence going forward that something like that wouldn't happen again and certainly wouldn't have the significant impact that it did in terms of our overall reserves and/or book value.

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Bill Dezellem, Tieton Capital Management - Analyst [6]

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Great, thank you. Mobileye?

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Scott Wollney, Atlas Financial Holdings, Inc. - President & CEO [7]

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So in terms of Mobileye, Mobileye is an example of a technology provider that we have been working with for a number of years to make sure that we understood how their technology can be used to measure and improve risk related to the types of operators we ensure.

And as was cited in a press release they issued a couple weeks ago, we successfully partnered with them to secure a large provider of vehicles to transportation network drivers in New York recently, and are continuing to work closely to see how we can together improve the quality of fleets we are insuring. And then obviously the impact of that is both better safety and risk management, but also reduced cost of exposure which ultimately is good both from our loss ratio standpoint and also from the operator's cost of insurance standpoint.

So Mobileye is not the only in-vehicle technology firm that we've been focusing on, we actually featured a number of them at our Investor Day last year. In fact, had some folks from some of those firms there talking about the types of things we were working on together.

But it is a great example of our making sure that we can leverage every resource and in particular new information that we can combine with the historic loss and severity information that we have from the decades of operations that our insurance companies have had in this space to really come up with the most sophisticated solution, the most confidence in terms of expected cost of loss and really be a market leader in a niche that tends to be underserved.

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Bill Dezellem, Tieton Capital Management - Analyst [8]

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Thank you.

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Operator [9]

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(Operator Instructions). Samir Khare, Capital Returns.

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Samir Khare, Capital Returns Management - Analyst [10]

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I just have a few questions first on the reinsurance. On the renewal of the reinsurance arrangements, any of the terms and conditions change or [are broadly] in line with expiring?

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Scott Wollney, Atlas Financial Holdings, Inc. - President & CEO [11]

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No, it was renewed and -- well, both the quota share and the [excessive] loss were renewed in line with expiring in terms of terms and conditions and the cost basis on the quota share was unchanged. And we actually are expecting a slight reduction in cost on the excessive loss treaty.

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Samir Khare, Capital Returns Management - Analyst [12]

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Okay. And then you guys showed that exhibit on maximum net -- or sorry, the net and gross premium to surplus that you guys run your subsidiary at. What is the maximum that we should think that you guys should operate under?

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Scott Wollney, Atlas Financial Holdings, Inc. - President & CEO [13]

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Two times is sort of the upward bound that we have always felt was important to keep in mind from a net written premium to surplus standpoint for statutory because of really it's that statutory operating leverage that regulators and rating agencies look at. And so, with the effect of the reserve strengthening we are at about 1.5 to 1, so still have sufficient room. And that is using the minimum 5% quota share session in the ASI pool companies and 25% at Global Liberty.

So in that exhibit in the DAC we show the gross and the net. So even on a gross basis if we weren't using any quota share we would be right below the 2 to 1. And obviously if we saw more significant growth this year that we did last year, for example, that would be something.

If it took that surplus -- net written premium to surplus ratio up closer to 2, we would have the ability to use the quota share as a way to moderate that. So it is an important tool and we were glad that Swiss Re confirmed to renew that for another two years in the first quarter of this year.

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Samir Khare, Capital Returns Management - Analyst [14]

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Okay, and for the foreseeable future it sounds like 5% quota share, you guys will keep it at that level?

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Scott Wollney, Atlas Financial Holdings, Inc. - President & CEO [15]

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Yes, and we expect to continue the same protocol that we've used before. If we anticipate a change to the quota share sessions we would articulate that on the earnings call in -- sort of before the quarter that we would make the change. But at this point we are anticipating keeping it as is.

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Samir Khare, Capital Returns Management - Analyst [16]

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Okay. And just on Michigan, of the $24 million of adverse development, how much would you say came from the indemnity side versus defense cost and containment?

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Scott Wollney, Atlas Financial Holdings, Inc. - President & CEO [17]

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So the vast majority of it was related to indemnity. Obviously we did see a big percentage increase in Michigan claims that were attorney represented, which does or did increase the [allay] as a percentage of indemnity there. But the biggest impact was really the indemnity itself.

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Samir Khare, Capital Returns Management - Analyst [18]

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Okay. And is there any evidence of the incidence rate of litigated claims is changing there and have you guys -- how are you guys changing your strategic tact and how you guys are combating issues there?

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Scott Wollney, Atlas Financial Holdings, Inc. - President & CEO [19]

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Sure, so in 2016 the number of lawsuits we received were equal to 64% of all Michigan claims and that figure was up about 39% or up from about 39% in 2015 and 35% in 2014. So the attorney represented claims as a percentage literally doubled in a year. And the percentage of open features we have in Michigan is -- when we look at that -- compare that to the national average, 64% in Michigan were litigated, the nationwide average we have is less than 20%.

So that was a significant shift and it is the only jurisdiction where we see that extraordinarily high percentage of attorney representation on incoming claims. And in addition to the much higher percentage of the Michigan claims being attorney represented, the settlement amounts for those claims also increased about 42% in 2016 as compared to 2015. The demand amounts or the amounts claimed in 2016 for attorney represented claims increased about 75% year over year.

So, with all these things in mind, we definitely have been adjusting our approach to claims handling. We do have Michigan specific adjusters, some of whom work remote in that state. And the goal is always to achieve the best possible outcome.

So, I think there are two things that we observed in 2016 that are impacting operational behavior. The first is, as we have always said, if we believe a claim is inflated we are going to use our experience and technology to defend against that claim inflation. And unfortunately in 2016 in that state we really saw that the indemnity amounts were simply not benefiting from that additional defense and expertise.

And so, we are now focusing more on early settlement, again leveraging the analytics tools we have, and learning from what we observed during the year in 2016 so that we are not effectively throwing good money after bad. So that is one piece.

And then the second is as newer claims come in the door, making sure that they are being triaged with the more recent outcomes in mind to ensure that a claim is either on the right path and/or that it is being reserved in a way that we are comfortable represents kind of the new normal. But all of these things were factored into the actuarial analysis that was done at yearend 2016.

And so, we do believe that the reserve strengthening is appropriately conservative, reflecting both the disproportionate amount of reserves that claims in Michigan used up through the end of 2016 as well as the expected future payment for the runoff of remaining claims. Again with the expectation that what we saw in 2016 would not improve from a reserve standpoint but operationally we are doing everything we can do to achieve the best possible outcome. So we are optimistic that those things will have a positive impact and that would ultimately be a good fact of course.

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Samir Khare, Capital Returns Management - Analyst [20]

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Okay. Then just on the average claim cost in Michigan for all your Michigan claims in 2016 and then I guess all your litigated claims in Michigan in 2016.

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Scott Wollney, Atlas Financial Holdings, Inc. - President & CEO [21]

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Yes, so, to give you some context, I mean we -- in 2016 all coverages combined in Michigan had an average severity paid of about [$]12,700 for PIP, which is about half the claims we paid, it was about [$]24,000. And again that was up from about [$]12,315, so a significant increase there.

So, in terms of the current inventory, at the end of 2016 we had approximately 665 Michigan claims pending, about 59% of which were PIP. The average reserves per claim were at about [$]11,000 for PIP, so more consistent with 2015. And again, those were reserves to a great extent that had been set in 2014 and 2015 and then about 6,200 for non-PIP. So that was before the reserve strengthening.

And then as a result of the 2016 reserve analysis we did increase IBNR but not individual case reserves. And the rationale for that is to ensure that our actuaries can best track the run off of that cohort of claims relative to expectations. But if you divide the gross reserve strengthening by the current open inventory it would be something like $38,000 per claim. Obviously that simple comparison doesn't factor in additional new claims which will come in during the duration of the runoff.

But as we show on I think it is page 6 of the deck we published for the AIFA conference, the claim inventory in Michigan is declining, both the open Michigan inventory as well as the new claims presented. So we are confident that the approach we took, as I said, is appropriately conservative with the total impact of the runoff in mind. And it does some clear from the data that the high water mark for both open inventory and new claims presented was 2015.

We saw settlements accelerating in 2016 and the average days to close is starting to, again, come down consistent with what we have been able to achieve across our overall book of business. So average days to close in Michigan claims in 2016 was about 554; the average age of open claims is about 412.

Keep in mind for Michigan in particular these are driven by third-party liability claims most of which are attorney represented. But to give you some context, the average days to settle non-Michigan claims in 2016 were 224 days and that number is about 30% better than just a few years earlier.

So, you can see there is a real difference between what we are seeing in the rest of the country and what we have seen in Michigan. And we are definitely learning from what we have seen and making sure that we can do everything possible to not only isolate that exposure and quantify it, but ultimately deliver the best possible outcome in the face of some of these challenges.

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Samir Khare, Capital Returns Management - Analyst [22]

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[All right, good news]. I will re-queue for the majority of the questions. Thanks.

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Operator [23]

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(Operator Instructions). Wally Walker, Hana Road Capital.

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Wally Walker, Hana Road Capital - Analyst [24]

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Just a point of clarification. Did I hear Paul say that normalized earnings, for lack of a better term, at least without the reserve strength they would have been $1.60 in 2016?

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Paul Romano, Atlas Financial Holdings, Inc. - VP & CFO [25]

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Correct.

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Wally Walker, Hana Road Capital - Analyst [26]

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And as you say, quote, you remain in growth mode, I know you are not giving guidance, nor am I asking, but just -- is that a baseline for growth then just as you think about it?

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Scott Wollney, Atlas Financial Holdings, Inc. - President & CEO [27]

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I think so. I mean we believe that operating expenses as a ratio will be pretty constant, again, within the high end of that 24.5% to 26.5% range. We do expect loss ratio, excluding the effect of reserves strengthening in 2016, to be fairly consistent or slightly better than 2017 as a result of the rate activity.

So -- and there really were not any significant sort of nonrecurring benefits or expenses that didn't sort of generally wash out on a full-year basis. So yes, I think it is a reasonable baseline to assume that the growth we are anticipating would build on that level.

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Wally Walker, Hana Road Capital - Analyst [28]

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Okay, very helpful. Thank you. Good luck.

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Operator [29]

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Samir Khare, Capital Returns.

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Samir Khare, Capital Returns Management - Analyst [30]

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Just on the accident year 2016 loss ratio there was -- it seemed like there was a true up in Q4. What was that attributable to?

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Scott Wollney, Atlas Financial Holdings, Inc. - President & CEO [31]

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So, we did strengthen 2016 accident year by about $1.8 million in total, which was about 1.1% on the loss ratio. I think part of that was our wanting to just apply some [conservatism] given that we have strengthened the older accident years. So it wasn't a specific isolated issue, but, again, it does give us confidence that the reserves we are carrying going forward are robust.

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Samir Khare, Capital Returns Management - Analyst [32]

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I think you said in your earlier comments that you would expect the business you are running now to slow, but ultimately between (technical difficulty) loss ratio or even that range. Do you think that is what you will book accident year 2017 at or what are you guys thinking there?

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Scott Wollney, Atlas Financial Holdings, Inc. - President & CEO [33]

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Well, we will see how the losses come in. As always, we want to allow loss development, especially early frequency, to inform our decisions about how quickly to take the benefit of any rate changes. So we are very confident in the pricing work that has been done and the positive impact of the predictive analytics.

But in particular when we think about the potential incremental margin from the use of the predictive analytics and our ability to better select more favorable risks, because it is a relatively new initiative over the last couple of years, I think we want to be clearly measured in terms of how quickly we take that benefit. So those will be the two things I think that we are going to look most closely at in terms of how quickly we start reflecting our target underwriting levels in our actual financial results.

We have commented before as a rule of thumb probably 18 months from the time we take a rate initiative to the time it shows up in our financial statements is reasonable. So that lag is not set in stone, but that is a pretty reasonable window to give us the opportunity to see claims come in.

98%-99% of all of our claims in terms of count are presented within 12 months following the end of a given accident year. So we get a really clear idea of the total inventory. And then obviously we want to understand expected severity and then ultimately determine whether or not we can take the benefit of pricing action that went into the business written in those accident years.

So I know I am not giving you a precise answer, but again, we are comfortable. When we did the pre-release we were comfortable with that range of 59% to 61%. Again, the full-year non-accident year 2016 loss ratio was strengthened a little bit. And we obviously want to see the positive benefit of the things that we did in 2015 and 2016 come through and that will ultimately determine what we book in 2017.

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Samir Khare, Capital Returns Management - Analyst [34]

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Okay. And the [biz] that remains in Michigan, is that -- what loss ratio are you guys booking that at? Is that business that you guys ultimately want to keep?

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Scott Wollney, Atlas Financial Holdings, Inc. - President & CEO [35]

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So the dynamic there -- the rating paradigm in Michigan requires actuarial support when we submit rate changes, which we can do annually. And last year our rate increase there was about 60% and that was supported by the yearend 2015 actuarial work. Now we obviously have new actuarial support and we're in the process of again submitting a rate increase.

Our rates last year were already above the state pool rates, in fact in the AIFA presentation on slide 6 we show the consistent decline in both vehicles and policies in-force throughout 2016, which I think really was a result of the fact that our price level had gotten at or above the state fund rate. And I think we have made that comment even on calls at certain points last year.

With an incremental rate increase I don't think from a practical standpoint we are going to see much retained business. If we do retain it it should ultimately deliver a more acceptable loss ratio. But again, our goal is not going to be to retain business, it is focusing on putting a price in the market that would achieve an appropriate return on that deployed capital. And again, just being realistic, we don't expect that we are going to see any meaningful amount of renewals or new business being written.

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Samir Khare, Capital Returns Management - Analyst [36]

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Okay. And then just on the Mobileye technology press release. What kind of near-term top-line opportunity do you think that will provide for?

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Scott Wollney, Atlas Financial Holdings, Inc. - President & CEO [37]

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It is hard to put a number on that specifically. But we have been over the last year in particular talking with a lot of operators, especially those who are supplying vehicles to drivers -- full-time professional drivers in the transportation network space. And that is a real opportunity for us to leverage what we have learned about that technology as well as other in-vehicle technologies.

And it is not limited just to the transportation network space either, I think the first significant deployment of the Mobileye technology that we supported was actually in Las Vegas where we had an account that had a significant incidence of rear end collisions on the strip. And by instituting the Mobileye technology we were able to see a very meaningful reduction in rear end collisions, which generally result in at fault claims against our drivers.

And so, there was a pretty broad potential application of that. And so, while I don't think we can put a specific number on it, it was a great example of how our commitment to the concept of telematics has really been one that has been ongoing and it is now we have sort of planted the seeds over the last few years, made sure that we understood which technologies work, which technologies don't, what the relative benefits are. And we can articulate that to our insureds and contemplate it in terms of how we structure their insurance programs.

So, it's a real-world application of sort of the buzzword that today everybody is talking about. But I think it is really a great example of Atlas as a relatively small Company being innovative and nimble and doing things that ultimately now the whole industry is saying, gee, I think we need to do this. So we definitely want to continue to be in the front end of that curve and we will continue to look for opportunities where we can cultivate incremental profitable business as a result.

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Samir Khare, Capital Returns Management - Analyst [38]

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Okay, the press release I specifically saw cited a fleet of 4,500 (technical difficulty) cars. And it seemed to read that you guys had some kind of exclusive deal with them or maybe just a research project; I couldn't figure out which one. Is that a program that you guys are looking at? Is it just in the research stage?

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Scott Wollney, Atlas Financial Holdings, Inc. - President & CEO [39]

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What was referenced in the press release, and I don't want to get into the specific details for competitive reasons, but the scope of what was described in the press release is describing an account that we were able to successfully secure working together in 2017.

So it is not something that was reflected in our gross written premium in 2016, but, again, obviously when we announce our first quarter we could probably get into some additional detail in terms of the revenue impact it had. But again, obviously we don't want to get into a whole lot of detail for competitive reasons. But it is something that is generating or will generate revenue for us in 2017.

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Samir Khare, Capital Returns Management - Analyst [40]

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Great, thank you.

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Operator [41]

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Thank you. At this time I will turn the floor back to management for closing remarks.

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Scott Wollney, Atlas Financial Holdings, Inc. - President & CEO [42]

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Great, thanks again. As I mentioned earlier, we are again this year going to hold an Investor Day following our annual general meeting. It will be scheduled on the morning of May 16 in the Chicagoland area. More details will be forthcoming as we get closer, but hope many if not all of you can attend. And thanks to everyone for joining us on today's call and we look forward to speaking with you again soon.

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Operator [43]

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Thank you. This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.