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Edited Transcript of AFSI earnings conference call or presentation 27-Feb-17 3:00pm GMT

Thomson Reuters StreetEvents

Q4 2016 AmTrust Financial Services Inc Earnings Call

NEW YORK Feb 27, 2017 (Thomson StreetEvents) -- Edited Transcript of AmTrust Financial Services Inc earnings conference call or presentation Monday, February 27, 2017 at 3:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Hilly Gross

AmTrust Financial Services, Inc. - VP IR

* Barry Zyskind

AmTrust Financial Services, Inc. - Chairman, CEO, President

* Ron Pipoly

AmTrust Financial Services, Inc. - EVP, CFO

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Conference Call Participants

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* Matt Carletti

JMP Securities - Analyst

* Mark Hughes

SunTrust Robinson Humphrey - Analyst

* Randy Binner

FBR & Co. - Analyst

* Adam Klauber

William Blair & Company - Analyst

* Meyer Shields

Keefe, Bruyette, and Woods, Inc. - Analyst

* Ken Billingsley

Compass Point Research & Trading - Analyst

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Presentation

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Operator [1]

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Good day, ladies and gentlemen, and welcome to the AmTrust Financial fourth-quarter 2016 earnings conference call. (Operator Instructions). As a reminder, this conference is being recorded.

At this time, I would like to introduce your host for today's conference, Vice President of Investor Relations Hilly Gross. You may begin.

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Hilly Gross, AmTrust Financial Services, Inc. - VP IR [2]

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Thank you. Good morning and thank you, everyone, for taking the time out to join us this morning for this AmTrust Financial Services fourth-quarter and fiscal-year 2016 earnings conference call.

With us this morning are Mr. Barry Zyskind, President and CEO of AmTrust, and Mr. Ron Pipoly, Chief Financial Officer of AmTrust, and, as always, it is a pleasure to acknowledge the presence of Chaya Cooperberg, Chief Communications Officer. Also, we are joined for the Q&A portion of this call this morning by Adam Karkowsky, Executive Vice President of Strategic Development and Merger and Acquisitions.

Before I call on Barry Zyskind and Ron Pipoly to give you their review and analysis of our financial and operational results, I would by your leave read into the record the obligatory paragraph on Safe Harbor, since comments on today's call may include certain forward-looking statements which can include plans and objectives with the management for future operations, including those relating to future growth of the Company's business activity or future availability of funds. Since these assumptions are based on current expectations and involve assumptions that are difficult, if not impossible, to predict since many of these assumptions are in fact beyond our control, so there can be no assurance that actual developments will be consistent with these assumptions. Actual results can differ materially from those expressed or implied in these statements as a result of significant risks and uncertainties, including those factors set forth in our filings with the Securities and Exchange Commission.

The projections and statements in this presentation speak only as of the date of this presentation. We undertake no obligation to revise any forward-looking statement, whether as a result of new information, future developments, or otherwise, except, of course, as may be required by law.

Finally, in the prepared remarks and responses to questions in today's presentation, our management may refer to financial measures that are not derived from generally accepted accounting principles, or as they are commonly referred to, GAAP. Reconciliations of these non-GAAP financial measures to those directly comparable GAAP measures are provided in the press release we issued earlier this morning, which is available on the Investor Relations section of our website, www.amtrustgroup.com. I repeat, www.amtrustgroup.com.

There. Having concluded the legal niceties, it is now my pleasure to turn the call over to Mr. Barry Zyskind, Chairman, President, and CEO of AmTrust. Barry.

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Barry Zyskind, AmTrust Financial Services, Inc. - Chairman, CEO, President [3]

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Thank you, Hilly. Welcome and thank you all for joining us this morning. I'll start with the highlights of our year-end financial results and then provide an update on our service and fee business, followed by an update on the timing of our annual financial statements.

2016 was another profitable year, with operating income of $461 million generating an operating return on common equity of 19.2%. During the year, we grew book value per share by nearly 13% to $15.15 and returned more than $262 million of capital to our shareholders. We achieved a record $7.95 billion in gross written premium, up 18% from 2015. Net earned premium reached approximately $4.7 billion, up 16%.

Several strategic acquisitions in our domestic and international markets drove much of our growth this past year. We completed and integrated 10 acquisitions, which broadened our diversified platform. Highlights included, one, Nationale Borg, which is a 120-year-old Amsterdam-based writer -- reinsurer of surety and trade credit insurance in over 70 countries.

We added Republic Companies, a Texas-based provider of P&C insurance for over 100 years, and in November we completed the acquisition of ANV Group, a specialty insurance company that underwrites a variety of commercial P&C insurance products to its Lloyds syndicates and an MGU. ANV, combined with our existing Lloyds syndicates, puts us close to the top 10 Lloyds underwriters.

These acquisitions are all performing well and integrations are running smoothly.

On our existing business performance, we are pleased with the expansion in our existing small commercial business in specialty risk and extended warranty segments. We are a leader in the commercial small business segment today. We focused on the small commercial customer long before it was popular and it means that now we have unrivaled expertise in this segment.

We intuitively understand and can react quickly to different market cycles. That's what we've always done, pulled back in soft markets and pushed harder when the market can support it. We have a technology platform tailored to small businesses, with product developers, agents, claim processors, and underwriters aligned with their needs.

We continue to invest in being the best partner for small businesses. We are developing tools and marketing and distribution systems to reach new audiences. We have a nice diversification of products for a wide variety of industries. In commercial auto, we have had unsatisfactory loss ratios, consistent with others in the industry, but we've made changes to pricing and to the underwriting. We increased our analytics and have made progress in this product line.

Turning to the specialty risk and extended warranty segment, our experience here dates back to our founding. Since 1998, we've expanded globally and developed a complete solution that includes fee service, claims, underwriting. We continue to bring aboard large new clients internationally and to expand our partnerships with blue-chip brand names. This is a short-tail non-cat business with lower risk exposures. We are growing organically and by acquisition.

Our specialty program segment had its lowest growth rate. It has been challenging to obtain adequate rate in some commercial auto and general liability programs. We are disappointed to have a prior-year loss and loss adjustment reserve charge of $65 million from this segment, which was the result of adverse development in some older lines of general liability. We identified the prior-period development through a deep analysis of our entire book of reserves. After all the work we've done for year-end, we're confident in the reserves in this segment, as well as our reserves on a consolidated basis.

We do expect better results from the program in the future. We have a new leadership for this segment.

Turning to our service and fee business, we enjoyed very healthy growth of more than 26% in 2016. As of Quarter 4, we are in a run rate to produce over $600 million in fee revenue.

This business is a combination of our administration business and our MGAs. On a standalone basis, if this business would be unconsolidated from AmTrust, the fee-based business would have gross revenue well in excess of $1 billion and is a high-margin source of income and cash flow.

When we look at recent valuations on similar businesses in the market, we believe we have a valuable asset that, based on our discussions with third parties, is comfortably worth in excess of $2 billion. We continually evaluate strategic options for this business to unlock shareholder value. For example, if you look at our market cap today, it is approximately $4 billion and the fee business could be worth in excess of $2 billion.

Turning to M&A, we continue to have a healthy pipeline of specialty insurance companies, as well as insurance-related fee businesses, that fit in our niches. We plan to continue to grow through targeted accretive acquisitions.

Now I'd like to address the timing of our filing and our annual financial statements. First, some background. We first announced our intention to change auditors in 2014. We engaged KPMG as our new auditor in 2016 after our audit committee initiated a competitive search process. We selected KPMG for their experience with property and casualty insurers, given their work with some of the largest companies in our sector, such as Travelers, Markel, RLI, AFLAC, Selective Insurance, and Navigators. Given AmTrust's significant growth since our founding and our expanding global reach, we felt that additional expertise and the scope of service with a Big Four was appropriate.

When we went public in 2006, AmTrust was writing about $500 million in gross premium with 325 employees in fewer than 15 offices. Today, celebrating our 10th year as a public company, we are generating about $8 billion in premium with 8,000 employees and more than 125 officer globally.

This is the first time that KPMG has assisted the Company with our year-end financial reporting. It is simply taking us more time to complete the work required for KPMG to complete its audit. We're very comfortable with where they are in their work. It is quite common for a company to have a filing extension following an auditor transition, though we expect to remain a timely filer by filing within 15-day extension period.

I'd like to take this opportunity to thank BDO, our former auditor, for their years of service to AmTrust. I will also thank the KPMG team for all their effort and for working so diligently. I believe we've been able to show that AmTrust is a great business with underwriting discipline, strong claims processing, and outstanding actuarial expertise.

In conclusion, we believe we are very well positioned for success in 2017. We have a strong business. We're optimistic about net earned premium growth and continued profitability. We expect to deliver strong returns with industry-leading ROEs, while returning excess capital to our shareholders. With that, I'll turn the call over to Ron.

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Ron Pipoly, AmTrust Financial Services, Inc. - EVP, CFO [4]

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Thank you. Good morning.

As Barry mentioned, we had a strong topline performance in the fourth quarter. Our combined ratio was 95.5%, above our historical range between 92% and 93%. This reflects both an unfavorable prior-period adjustment development that affected our loss ratio in the quarter, as well as a slightly elevated expense ratio. I'll discuss these shortly. Then I'll provide more color on the timing of our 10-K filing and the year-end auditing process.

I'll start with a review of our gross written premium, which totaled $1.9 billion in the fourth quarter, an increase of about 19% over the same quarter a year ago, bringing gross written premium for the year to just under $8 billion.

Our key strategic acquisition in 2016 were companies such as Barry mentioned, Republic, Nationale Borg, and ANV -- ANV, which closed in the fourth quarter this year, were the primary drivers of the increase this quarter. Acquisitions contributed $264 million of gross written premium to the quarter, representing 88% of the growth.

Our organic growth, also strong, was primarily in our small commercial business segment, as well as our specialty risk and extended warranty segments. Looking at small commercial business, gross written premium increased by $149.4 million or 20%. The increase in the premium in this segment was driven primarily by Republic, but also by continued expansion in our small business workers' compensation.

Workers' comp, which represents about 60% of the segment premium, saw continued growth in California, New York, and Florida. Overall, our workers' compensation policy count and retention rate has not deviated from our 81% to 82% retention rate.

We've continued to experience successful pricing on our -- increased pricing on our small commercial vehicle business, which represents about 19% of our small commercial business segment. We experienced growth both domestically in our European business and our specialty risk and extended warranty segment. The segment increased about 17.5% and contributed $110.4 million of gross written premium growth.

In Europe, our acquisition of Nationale Borg and ANV added about $115 million to gross written premium for the quarter, but the growth was also offset by the impact of the decline in the value of the pound relative to the US dollar and euro, which reduced reportable gross written premium by $46 million in this segment.

In our specialty program segment, as Barry mentioned earlier, we have intentionally reduced our exposure to certain commercial auto and general liability programs where we have determined the rate was not adequate. However, our gross premium in this segment increased by 40% -- $40 million, or 17%, which was driven by the Republic acquisition.

Our net written premium for the quarter rose 7.6% to $1.1 billion. Premiums ceded included 700 -- I'm sorry, $410 million to Maiden Holdings under our quota share agreement.

For the quarter, we retained 61% of our gross written premium. This compares to 62.7% in the fourth quarter of 2015. Net earned premium in the quarter was $1.2 billion, up 14.9% over the fourth quarter a year ago. Overall, small commercial business segment accounted for 50% of the net earned premium, specialty risk and extended warranty was 36%, and specialty program was 14%.

The loss ratio was 68.4% this quarter, compared to 68.1% for the same period last year. The loss ratio in the current period reflects a reserve charge of $65 million. The charge primarily relates to reserve strengthening in our loss reserves in our specialty program segment for accident-years 2015 and prior.

We've added to our actuarial and management resources in early 2015. They critically assessed our general liability line of business. We have identified a number of non-admitted programs as a significant driver of adverse experience and many of these programs are now terminated and are in runoff.

In 2016, we put a new management team in place in our program business. We've improved our internal capabilities through dedicated program management teams and have added to our internal actuarial and claims resources. We have targeted unprofitable programs for corrective action or termination. We have now instituted stricter underwriting policies.

As of December 31, 2016, IB&R reserves currently represent 52.5% of our gross reserves. This is consistent with the 53.3% at December 31, 2015.

Moving on to our expense ratio, it was 27.1% for the quarter, which compares to 23.8% for the fourth quarter of 2015. The elevated expense ratio was due largely to business mix in the quarter, as well as cost associated with increased year-end resources. As a result of these variances in our loss ratio and expense ratio this quarter, the combined ratio came in at 95.5%, which compared to 91.9% for the same quarter last year.

Other expenses in the fourth quarter was $152.8 million, an increase of 1%, reflecting higher administrative, consulting, and auditing costs associated with our auditor change.

Service and fee income, our service and fee income totaled $151 million in the quarter, an increase of 26% from $120 million in the fourth quarter of 2015. For the quarter, the largest sources of fee revenue were AMT Warranty with $26 million, Warranty Solutions with $18 million, Car Care Plan with $8 million, IT servicing fees of $18 million, AmTrust Specialty Equipment with $5 million, and workers' comp assigned risk fees of $7 million.

I will note disclosed in our press release this morning the amount of service and fee income in the prior period has been revised downward by approximately $50 million for the full-year 2015. This revision relates to how we are now recognizing a portion of our warranty contract revenue associated with administrative services. We had been applying one interpretation of the revenue recognition guidance in the accounting standards in recognizing some administrative service fee revenue upfront.

We have changed our interpretation of the guidance and now are deferring revenue associated with warranty contracts for which services are performed over the life of contract. The full table in the press release shows the impacts of these changes in revenue recognition to our consolidated statements of income for the fourth quarter and year ended December 31, 2015. We have determined that the area was not material to the consolidated financial statements taken as a whole.

Moving on to investment income, for the quarter we generated $48 million, which is an increase of nearly 7% when compared to the fourth quarter of 2015. We had net realized gains on investments of $5.2 million for the quarter. Investment income did decline on a sequential basis, related primarily to some additional bond amortization we had to take on a few of our European portfolios, but we expect investment income will return to its $60 million run rate next quarter.

Additionally, our investment in National General has generated equity income of $3 million for the quarter. Shareholders' equity is $3.5 billion, which includes $914 million related to preferred shares. Book value at December 31, 2015, is $15.15 per share. Book value has increased 17.4% since December 31, 2015. Total capitalization at December 31, 2016, was $4.7 billion, which is an increase in total capitalization of $960 million since December 31, 2015.

Total assets were approximately $22.3 billion. Total invested assets were $9.3 billion, up from $7.2 billion a year ago. The increase in our investment portfolio during the year was primarily attributable to acquisitions of ANV, ARI, Genworth, Nationale Borg, and Republic, as well as the utilization of cash from our debt and equity offerings in 2016.

Fixed maturities comprised 82.2% of the portfolio; cash and short-term investments, 15.2%; equities and securities, 2%; and other investments, 0.6%.

In the fourth quarter, our total revenue, including earned premium, service and fee income, and investment income, was $1.4 billion, an increase of 18.2% over the fourth quarter of 2015.

Our tax rate for the quarter was 22.4%, compared to 27.8% in the fourth quarter of 2015. For the quarter, we generated net income of $99 million, or $0.57 per diluted share, compared with net income of $59.7 million, or $0.35 per diluted share for the fourth quarter of 2015.

Operating earnings in the quarter was $66.3 million, or $0.38 per diluted share. This compares to $115.4 million, or $0.67 per diluted share for the same period last year. Net income attributable to common stockholders, as well as operating earnings, reflects the reserve charge of $65 million, or approximately $0.24 per diluted share. Return on equity for the quarter was 15.7% and operating return on equity was 10.5%.

As you know, we appointed KPMG as our new independent registered public accounting firm in 2016. Our Company has grown, both in product scope and geography, and we require a larger auditor with experience with P&C insurers of our size and scale. This is our first year under audit with KPMG.

Additional time is needed for us to complete our consolidated financial statements and assess internal controls over financial reporting for fiscal-year 2016, and as a consequence, for KPMG to complete its audit procedures in the audit of consolidated financial statements included in Form 10-K, we will need a little additional time. As such, we expect to file our 10-K on or before March 16, which we can still be considered a timely filer for SEC reporting purposes.

In addition, as part of our year-end close work, we've reviewed our internal controls over financial reporting, as required by Section 404 of the Sarbanes-Oxley Act of 2002, and identified material weaknesses in our internal control structure over financial reporting. These specifically relate to ineffective assessment of a risk associated with financial reporting and an insufficient complement of corporate accounting and corporate financial reporting resources within the organization. We expect to complete the remaining work quickly and file the 10-K within the allotted 15-day extension period.

We have started the process to improve our internal controls over financial reporting. We are expanding and enhancing our senior financial leadership team so we have the expertise and resources AmTrust needs. We have appointed a senior financial executive to the new position of Deputy Chief Financial Officer role. We've also created the roles of Chief Accounting Officer, head of Investment Accounting, CFO for AmTrust international operations, and CFO for AmTrust North American insurance operations. Over the past nine months, we have made several senior additions in our treasury group as well.

The expertise that we are adding in our finance group builds on the leadership that we've already built in our actuarial team. In 2015, we appointed a Global Chief Actuary and added new chief pricing and new chief reserving actuarial positions to complement our more than 50 actuarials globally, which are aligned by centers of excellence. The three individuals leading our actuarial teams have more than 80 years of combined experience. This gives us great confidence that our actuarial analysis process is best in class and that our reserves are adequate.

In addition to reviewing our team and adding resources where needed, we've also taken steps to ensure that the sophistication of our systems is matching the growth of our Company. For example, last year we engaged PWC to help identify and implement best practices and accounting policy and financial reporting and assist with our implementation of financial automation. We have an internal team dedicated to developing and implementing the associated financial automation project, which we expect will be completed sometime in 2018.

As we continue to grow, we remain committed to ensuring that our accounting and finance systems' expertise and skills are best in class, and in cases where improvement is needed, we will make those improvements.

Thank you, and with that, I'll turn it over to Barry.

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Barry Zyskind, AmTrust Financial Services, Inc. - Chairman, CEO, President [5]

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Thank you, Ron.

We are pleased with the underlying financial and operational performance we delivered in 2016 and are excited about 2017. AmTrust is well positioned to deliver sustainable profitable growth. We are committed to creating shareholder value through disciplined growth and steady returns.

Now, Operator, please open the call for Q&A.

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Questions and Answers

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Operator [1]

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(Operator Instructions). Matt Carletti, JMP Securities.

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Matt Carletti, JMP Securities - Analyst [2]

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Thanks, good morning. Just a few numbers questions to start, just to help us kind of put the $65 million in some perspective. Can you let us know either what -- in terms of the reserve base, how much of the AmTrust reserves are late to the programs business or even, what would be even better if you have it, is how much relates to these discontinued programs that the reserve charge relates to?

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Ron Pipoly, AmTrust Financial Services, Inc. - EVP, CFO [3]

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Hi, Matt, it's Ron. On a couple of those, our overall reserve base as we sit here at year-end on a gross basis is $10.14 billion, with net reserves being approximately $6.267 billion.

From a program perspective, I'll need to get back to you in terms of the specific breakouts by segment. But, again, this reserve charge, while we're disappointed in it really from an overall reserve perspective, is not that significant in terms of the percentage. But, again, in terms of the splits by program that we've discontinued, I'll need to get back to you on that.

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Matt Carletti, JMP Securities - Analyst [4]

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Okay. Great. Thank you. And then, another kind of separate question on the expense ratio. You talked a bit about how it was a little high in the quarter. Specifically, one of the reasons, aside from mix, was the increased year-end resources. Are you able to quantify that so we're kind of able to see go forward where it might be?

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Ron Pipoly, AmTrust Financial Services, Inc. - EVP, CFO [5]

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Matt, this is Ron again. In terms of the additional resources, in terms of PWC and some other firms that we've been using on a consulting basis to help us in this transition process, I think when you look at the expense ratio of 27:1 for the quarter, I think about 0.4% would relate to those kind of additional charges.

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Matt Carletti, JMP Securities - Analyst [6]

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That's helpful. Thank you.

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Ron Pipoly, AmTrust Financial Services, Inc. - EVP, CFO [7]

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And again (multiple speakers) we're going to transition and bring additional resources on board and continue to have a very good relationship with PWC and use them in a lot of different capacities, but we're going to be onboarding a lot of these resources.

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Matt Carletti, JMP Securities - Analyst [8]

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Okay. Great. And then one last question, I guess this one might be for Barry, but just wanted to focus on the fee income business a bit. Obviously, you focused on that in your opening comments. My question relates to, can you give us a little bit of color on how you view the underlying organic growth potential of that business? It has been obviously M&A that's helped that grow, but how should we think about, going forward, the organic growth potential of the collection of fee income businesses that you currently have under the AmTrust platform?

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Barry Zyskind, AmTrust Financial Services, Inc. - Chairman, CEO, President [9]

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I think through potential acquisitions that we see in the pipeline and organic growth I would feel comfortable for the next couple years that we would see at least a 15% growth in that line of business.

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Matt Carletti, JMP Securities - Analyst [10]

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Okay, great. Thank you. Great. Thank you for the answers and best of luck in 2017.

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Operator [11]

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Mark Hughes, SunTrust.

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Mark Hughes, SunTrust Robinson Humphrey - Analyst [12]

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Thank you. Good morning. The SOX-related issues, the internal controls, you had a slight delay in filing the 3Q 10-Q, what was the opportunity to handle that over the last three months rather than having another delay here? I'm just trying to understand why the extra 15 days was relevant when it seems like you've been working at this pretty steadily for quite some time now.

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Ron Pipoly, AmTrust Financial Services, Inc. - EVP, CFO [13]

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Mark, it's Ron. In terms of the transition, we've -- as I mentioned earlier, we added PWC. We brought them in to help us assess our control environment, add additional controls, help us implement those controls, test those controls, and as we pivoted off the third quarter, which was -- that delay [and fine] was related to one particular issue around OCI in the precision level of a control from an OCI perspective, we continue to push forward in terms of testing the controls.

And as a Company, right now we sit with 800 SOX controls, slightly above that, so it's a significant task to get everybody through all of those controls, to test them, to test them in the appropriate manner.

So as we move forward, we just need and KPMG needs additional time to complete the work around the control environment, as well as finalize their audit and review of the Form 10-K. So, again, as we move forward, I think we've gained a lot of experience as part of this transition and I think we know better in terms of how to plan and delegate resources between the SOX aspect of our operations, as well as the substantive side of the audit.

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Barry Zyskind, AmTrust Financial Services, Inc. - Chairman, CEO, President [14]

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And this is Barry, just to add. A quarter review is much different than a year-end audit. Obviously, it's a lot of work on the year-end audit than all the different operations and the foreign operations, so it takes a lot of work and a lot of controls.

We definitely have made a lot of progress, but I just want to say one comment is that when a company does transition from a non-Big Four, even though BDO is a very high-quality firm, to a Big Four firm, it is a very common thing for companies once they are reassessing their controls into the new environment, into Big Four environment, that there is things that maybe in previous years were not material weaknesses that do manifest itself into a material weakness, and you remedy it and you move on, so that's something that we're doing, but it's not uncommon.

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Mark Hughes, SunTrust Robinson Humphrey - Analyst [15]

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Has KPMG completed its work on your reserves?

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Barry Zyskind, AmTrust Financial Services, Inc. - Chairman, CEO, President [16]

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I believe the answer is yes.

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Mark Hughes, SunTrust Robinson Humphrey - Analyst [17]

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The Italian professional medical liability business, anything to say in terms of reserve adjustments there at year-end?

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Barry Zyskind, AmTrust Financial Services, Inc. - Chairman, CEO, President [18]

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I think if anything I think those reserves actually were positive, meaning we didn't have negative -- we had positive. Actually, we are doing very well there in Italy, and like I said many times on the call, it's a very stable book of business. We have our book. Most of our business today is renewal business. We know it very well. We have our own claims operation. Our actuaries are very much involved in the pricing, reserving, and we feel very good about that book the business, and I would here -- sitting today, it's probably one of the highest return businesses we have today.

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Mark Hughes, SunTrust Robinson Humphrey - Analyst [19]

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And then, the fee income business, is it -- from a practical standpoint, is that severable? Is that something that could be spun off or is it too integral for the rest of the business?

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Barry Zyskind, AmTrust Financial Services, Inc. - Chairman, CEO, President [20]

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I think there's a couple of ways. One of the things we've talked about over time, you could do potentially subsidiary IPO or you could do a spinoff or maybe sell a portion of it to a partner that has a different type of balance sheet and things where you would still have access to the business.

But over the last couple of years, we've definitely been building it out as a standalone company, so if we did decide to monetize it, in a way, it would be easy, and we're even working on creating its own separate audit opinion for those entities.

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Mark Hughes, SunTrust Robinson Humphrey - Analyst [21]

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Thank you.

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Operator [22]

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Randy Binner, FBR Capital Markets.

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Randy Binner, FBR & Co. - Analyst [23]

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Thanks, good morning. I have a few questions, but I just wanted to pick up on what Barry just said there. So if you really could monetize and separately audit the fee-for-service business, would you be able to do it in such a way that it would still be able to be a source of premium revenue for the rest of AmTrust?

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Barry Zyskind, AmTrust Financial Services, Inc. - Chairman, CEO, President [24]

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Yes, that's something that -- clearly, when we look at the different opportunities and different options, that's something that's important to us. And we think that -- when we talk about the valuations that I mentioned on the phone, when we look at -- that would assume that we were keeping the insurance business at the current returns we have on the underwriting.

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Randy Binner, FBR & Co. - Analyst [25]

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Okay. Great. And then, going to kind of the go-forward pieces of the model, so you mentioned that you've increased pricing pretty aggressively and changed structure, I think, on the commercial auto book and the small commercial lines area. Can you quantify the charges -- I'm sorry, quantify the price increases that you've put through in the commercial auto book and give a little more color on how you're reacting to the market challenges there?

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Barry Zyskind, AmTrust Financial Services, Inc. - Chairman, CEO, President [26]

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Definitely. I think if you think about it, before we bought the Tower book of business, we had really two books of commercial auto business. One was our commercial auto business that we did solely as a package, so what we call easy auto. And then when we acquired the Tower book of business, we got a lot of standalone commercial auto.

Now the auto business that we took over from Tower we knew was underpriced at the time, and at that time we aggressively started putting a lot of rates into the small commercial auto. And prior to that, we did have some monoline programs, but we saw poor results in auto and commercial auto years ago and we started exiting that way before the industry. We saw it on the program side.

So what we were left with is really the Tower business that we've integrated into our small commercial auto. I would say with the change, taking away certain carriers where we had preferreds and discounts, I would say all in with what the actuaries are doing we're probably seeing at least a 25% increase in rates overall by eliminating certain classes, re-underwriting. But it's something that we're watching very carefully.

And the interesting thing is with the rates that we put through we did not see a drop in renewal business -- not a significant drop in renewal business. We did not see a lot of new business, but we did not see a significant drop, so it's something that we want to continue building on and it's something that, being contrary, and I mentioned on the last call, we think there will be opportunities in pockets of commercial auto, but definitely more analytics.

And one of the things that we've noticed is the companies that have done the best have really been the personal lines auto writers that write commercial, like Nat Gen or Progressive, so there's something to where we think the industry was very heavily iso-based and the personal lines were very much looking at underwriters and drivers, so it's something we're doing a lot of work around and really trying to think about it like a personal lines writer.

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Randy Binner, FBR & Co. - Analyst [27]

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All right. That's helpful. And then, thinking about the underlying combined and loss ratio in the quarter, if I back out the reserve charge, it was in the program business, so the earned premium base that goes against is not very high, so it creates a very large loss ratio impact in that segment.

But basically I kind of end up with an underlying combined and program that is low for the fourth quarter, maybe like 76%, and then for the Company overall, and it's really more for the overall company, I'm getting an underlying that's just over 90%, 90.1%, so that would be a lower accident-year combined ratio than what we've seen so far this year. So, that kind of seemed to go against the trend of what we've seen in the industry and maybe relative to some of the soft market comments you made. So, was there something kind of disproportionate in the way the reserve charge came through and how it affects that view of the underlying combined, and maybe, more broadly, how are you thinking about your accident-year loss fixed going forward in a softer market?

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Ron Pipoly, AmTrust Financial Services, Inc. - EVP, CFO [28]

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Randy, it's Ron. In terms of the development charge, again we talked about program and we talked about some of the GL. I mean, some of this does relate to some commercial vehicle, which moves over into small commercial business segment, so it's not all related to specialty program.

So in terms of the performance for the quarter at a 95.5%, if we talk about the pricing environment that we're in on a go-forward basis, I think we're comfortable to say that from a loss ratio you're going to be somewhere around that 67.5% to 68% range and expense ratio that ranges kind of 25% to 26%, kind of depending on the business mix on a quarterly basis. And again, we think that that's still an outstanding combined ratio and is going to provide tremendous mid-teens ROEs as we move forward.

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Barry Zyskind, AmTrust Financial Services, Inc. - Chairman, CEO, President [29]

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One of the things, Randy, I think you should think about is historically we've been a very small property writer, and now when you start adding in the Tower book of business and some of the other property lines of business and especially the Lloyds, assuming a low cat year, you should see the 67%, 68% that Ron talks about, in a non-cat environment we should actually see a lower loss ratio as we start seeing a higher percentage of our business property compared to where historically where we had very low property and it was really a casualty-only company.

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Randy Binner, FBR & Co. - Analyst [30]

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Right. And you are going to take that cat. You're not going to reinsure it out, so you are going to accept that volatility, and then I guess that expense ratio (multiple speakers)

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Ron Pipoly, AmTrust Financial Services, Inc. - EVP, CFO [31]

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I just want to say one thing on that point. One of the things we're a little unique is for the size of our balance sheet, our cat tax is above $20 million for all business, including Lloyds, so we don't view it as a lot of volatility. We could get a $20 million hit, but that's very, very acceptable in the quarter.

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Randy Binner, FBR & Co. - Analyst [32]

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Okay. Understood. That's fair. So the expense ratio, I guess, does trend up going forward, based on those comments there, so what is that -- that's a function of business mix?

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Ron Pipoly, AmTrust Financial Services, Inc. - EVP, CFO [33]

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As Barry mentioned, you are bringing on an acquisition we are very happy to have concluded, ANV. Our Lloyds platform, we expect to write nearly $1 billion or maybe over $1 billion of premium this year through our Lloyds facilities. That's high acquisition cost business.

So, again, I think that the movement from an expense ratio standpoint is much more reflective of bringing things like ANV, bringing in things like Nationale Borg, which have higher direct acquisition costs, Republic as well. Republic was a significant contributor to growth this year, nearly $480 million of premiums.

So the expense ratio is really a combination of business mix.

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Barry Zyskind, AmTrust Financial Services, Inc. - Chairman, CEO, President [34]

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But I would add just one comment to what Ron is saying. Yes, you should see -- as a business mix, you should see the expense ratio higher just because of the package business and Lloyds business and the surety business, but hopefully over time we'll see that as that business higher expense ratio, but lower loss ratio, compared to where we were historically flowing through as well.

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Randy Binner, FBR & Co. - Analyst [35]

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And the last one is so, Barry, you mentioned in your opening comments that AmTrust has done a good job historically, and I agree with this, of reacting to market conditions and growing when it's good and shrinking when it is not so good. So it seems like we're kind of getting into a softer and softer market, and the topline production in small commercial business, so forgetting about any FX impacts on specialty risk, was lower than we would've thought. So should we start thinking that you might not be producing as much topline going forward organically because of the reaction to a soft market?

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Barry Zyskind, AmTrust Financial Services, Inc. - Chairman, CEO, President [36]

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I think you have to look at us over the time period. It depends where we are in the cycle. I think, like Ron mentioned, we do a great job on small commercial, on renewals. We have a high renewal ratio. We have a great distribution platform. We look at a lot of business, but at the end of the day we're disciplined underwriters, so it really depends where we are.

There's no question about it. Go back to 2013 and 2012 and 2011, those years, we were like the only guy driving on the roads in California and some other states and we were growing 50% in small commercial. Obviously, you are not going to see that at this point. We have to find new ways for distribution.

So, if something really depends on the cycle -- I will tell you we do believe where the market is priced today that we would take -- for the classes that we want, we would take all the business if it fits our underwriting, so we feel good where the pricing is. It's not increasing, but it is at a healthy margin for the business that we want.

So, we are doing all types of things to try to find new areas of business, and you hear people talking about direct and all these different things. We are clearly using our technology, looking at all different ways to find how we can get closer to that small business today, in the future, and how we can continue growing it.

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Ron Pipoly, AmTrust Financial Services, Inc. - EVP, CFO [37]

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And Randy, just to add a little more color on it from a workers' comp perspective in terms of our ability to see the opportunities to continue to grow there organically, California is a very good example. There's no doubt it's got more competitive in California. You've had promulgated rate decreases, but we were able, again, from utilizing all the companies that we have filed to write California comp, we were able to achieve a nearly 0.70% rate increase for 2016, and that 0.70% rate increase, while less than 1%, our loss trend is actually virtually zero in terms of projected loss costs for the year. So, again, we're encouraged from a small business workers' comp of our ability to continue to grow that book.

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Randy Binner, FBR & Co. - Analyst [38]

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All right. Thanks a lot for the answers.

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Operator [39]

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Adam Klauber, William Blair.

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Adam Klauber, William Blair & Company - Analyst [40]

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Good morning, everyone. On the changes to the financials, you lay out a table and I think you say it's mainly the warranty changing. It looks like for 2015, from service and fee income and other revenue, that's roughly $100 million less because of the accounting change. Is that around right?

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Barry Zyskind, AmTrust Financial Services, Inc. - Chairman, CEO, President [41]

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The service and fee income from the -- last year went from $478 million -- this is the topline service and fee revenue -- from $478 million down to $429 million.

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Adam Klauber, William Blair & Company - Analyst [42]

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Right. But then you also show other income -- other revenue coming down from $642 million to $594 million. I guess, what is that change coming from?

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Barry Zyskind, AmTrust Financial Services, Inc. - Chairman, CEO, President [43]

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That's like a cascading number, so the table is reflective of all the information. The $478 million, if you think about it as previously reported, is embedded in the $642 million.

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Adam Klauber, William Blair & Company - Analyst [44]

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Yes, that makes sense. And so, as far as the 2016 statements that we're seeing, does that already have that adjustment in the 2016?

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Barry Zyskind, AmTrust Financial Services, Inc. - Chairman, CEO, President [45]

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It does.

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Adam Klauber, William Blair & Company - Analyst [46]

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It does, okay. And how big is the revenue on the warranty administration that's being impacted by the financial with the overall size of that bucket?

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Ron Pipoly, AmTrust Financial Services, Inc. - EVP, CFO [47]

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To isolate this, this is related really to administrative fees as it relates to one particular company that we have, Warrantech, and it deals with their administrative fees, not anything to do with obligor fees or cost of insurance fees.

So Warrantech in terms of our fee business, this year it's about $540 million, Warrantech represents roughly 40% of that, and again that's all of their fees, so the administrative fees -- it probably represents maybe about 80% of their topline revenue.

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Adam Klauber, William Blair & Company - Analyst [48]

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Okay. That gives us an idea. And are there any adjustments to the expenses related to that?

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Ron Pipoly, AmTrust Financial Services, Inc. - EVP, CFO [49]

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There were slight adjustments related to the expense as well.

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Adam Klauber, William Blair & Company - Analyst [50]

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Okay. And then, you discussed that the auditor came in and he reviewed the financial. There is need to, it sounds like, bulk up the financial division. It sounds like that won't be done in the near term. Is that going to take throughout 2017? Will that take three months, six months? How long will that take to be put in place?

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Ron Pipoly, AmTrust Financial Services, Inc. - EVP, CFO [51]

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No, we're bulking up our resources as we've already done. We've added a Chief Financial Officer for our European and our international operations. We recently added a Chief Financial Officer for our North American insurance operations. We have added a Deputy CFO.

But I think what I mentioned in the call is that we are embarking on a financial automation process, and that's what I talked about having been completed on a global basis in 2018. So from a sufficiency of resources standpoint, we've already begun to add those bodies.

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Barry Zyskind, AmTrust Financial Services, Inc. - Chairman, CEO, President [52]

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So just to add a little bit, Adam, one of the things that we do very, very well is when it comes to IT systems in terms of the operating platforms, distribution, internal, so now we want to take that power that we have and really focus it towards financial automation, and it's something that we have not done historically, but now this is a big year. We want to put that in, and all the know-how and power and the teams we have for technology, we want to start using it to really streamline the financial reporting package and make us really strong.

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Adam Klauber, William Blair & Company - Analyst [53]

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Okay. So when KPMG signs the audit hopefully in 15 days, will there be any addendums, any weaknesses still? Would you expect that or do you expect it to be a normally signed audit at that point?

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Barry Zyskind, AmTrust Financial Services, Inc. - Chairman, CEO, President [54]

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I think at the end of the day we've disclosed that from an audit perspective, it's an integrated audit in which there is an audit of the financial statements conducted in accordance with generally accepted auditing standards and GAAP, and there's the second part of that, which is the 404 opinion, which deals with the internal controls. We've said that from an internal control perspective that we'll have a material weakness surrounding financial reporting, but other than that, we expect to move forward in audit of the financial statement.

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Ron Pipoly, AmTrust Financial Services, Inc. - EVP, CFO [55]

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So, Adam, to answer it another way, the audit -- we're assuming we're expecting a clean audit opinion, but when it comes to 404, there will be -- when it comes to Sarbanes-Oxley, there will be a material weakness in that, but that does not -- the audit is a clean audit. It means that the audit numbers are fine.

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Adam Klauber, William Blair & Company - Analyst [56]

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Right. And, again, to rectify that 404, will we have to wait until the end of 2017 or can that be rectified sometime in the next year?

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Ron Pipoly, AmTrust Financial Services, Inc. - EVP, CFO [57]

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I think technically how this works is that we're in the process of re-mediating these weaknesses and our remediation will be tested out throughout the year.

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Adam Klauber, William Blair & Company - Analyst [58]

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Okay. And again, with those weaknesses, are they -- any other parts of the business are they addressing, any other financial, any other segments, any other areas we should think about?

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Ron Pipoly, AmTrust Financial Services, Inc. - EVP, CFO [59]

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I think generally speaking when you talk about a weakness over financial reporting and it deals specifically with certain areas of financial reporting. FX translations, we have some fairly complicated international operations in which you have pound-denominated companies that are transacting business in euros and other currencies and then you're talking about remeasurements of all those currencies on a quarterly basis and on an annual basis, so we need to add more staff to do those types of calculations. You're talking about around very complicated statement of cash flows for very many of the same reasons in terms of the foreign operations.

So, again, it's really about bolstering the number of people we have and then making sure that there is sufficiency of staff to not only to execute on the substanive side, but also to then execute on the control side as well.

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Adam Klauber, William Blair & Company - Analyst [60]

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Okay. That's helpful. Then as far as the business, I think you addressed it, but -- so the specialty risk and extended warranty expense ratio was up materially for the quarter. Is that mainly the acquired businesses, ANV, and one or two of the other acquired businesses pushing that expense ratio up?

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Ron Pipoly, AmTrust Financial Services, Inc. - EVP, CFO [61]

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If you think about the quarter, Adam, we had growth in specialty risk and extended warranty. We went from about $631 million up to $741 million, so growth of $110 million. $85 million of that came from ANV, which is an additional Lloyds platform that we acquired during the year.

And as we've said before when we acquired AmTrust at Lloyds, it is very good business. We are very happy to have concluded on the ANV transaction. It's an accretive transaction, but it is going to change the dynamic from an expense ratio standpoint in the sense that it is a more expensive business to acquire.

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Adam Klauber, William Blair & Company - Analyst [62]

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Right, just double-checking that. That makes sense. Then as far as the comp, if you can X out the program, what was the accident year in 2016 versus 2015? Accident-year loss ratio?

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Ron Pipoly, AmTrust Financial Services, Inc. - EVP, CFO [63]

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I think for the current accident-year loss ratio from a workers' comp perspective we're hovering around 62%, which is not too dramatically different than 2015. Prices had begun to -- price increases had begun to kind of decelerate late 2014 and into 2015, so our accident-year view isn't materially different between 2016 and 2015.

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Adam Klauber, William Blair & Company - Analyst [64]

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And do you think that deteriorates moderately as the market is softening in 2017 or can you hold the line on that?

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Ron Pipoly, AmTrust Financial Services, Inc. - EVP, CFO [65]

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I think from a rate perspective we can continue. I used California as an example of achieving about a 0.70% rate increase for full-year 2016. With really if you think about loss trends being forecast to be essentially zero, I think that 2017 continues to be a year in which we can continue to grow comp and continue to grow at around the loss ratio we're projecting for 2015 and 2016.

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Barry Zyskind, AmTrust Financial Services, Inc. - Chairman, CEO, President [66]

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And just to give you a little perspective from my standpoint, obviously the renewal business always has a better loss ratio than new business, by the nature of it being renewal business and you have it for longer.

So, one of the offsetting things in small business is when you go into a softer cycle, you tend to write less new business and your renewal business is a higher percentage of your premium, so what you give back in some of the rates, you are getting back in by having a bigger percentage being renewal business.

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Adam Klauber, William Blair & Company - Analyst [67]

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Okay. And then, specialty program, can you give us an idea of what's the size of the books of business or how much premium are you non-renewing?

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Barry Zyskind, AmTrust Financial Services, Inc. - Chairman, CEO, President [68]

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Our growth for the year, Adam, we went from $2.15 billion -- I'm sorry, we went from $1.32 billion up to just a little over $4 billion, so we grew by about $80 million for the year, but all of that was attributable to Republic, so really from a size of the business that was nonrenewed it was about $100 million of business that we nonrenewed within program.

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Adam Klauber, William Blair & Company - Analyst [69]

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Okay. And is there more being nonrenewed in 2017 or are you pretty much take care of the bad programs?

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Barry Zyskind, AmTrust Financial Services, Inc. - Chairman, CEO, President [70]

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I think at this point over the years, just the nature of program business is you basically are underwrite them and you nonrenew them if they are no good, so we've done -- over the years, we've done a lot of cleaning out and I think what we have now, the core that we have now, we feel very good about.

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Adam Klauber, William Blair & Company - Analyst [71]

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Right.

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Barry Zyskind, AmTrust Financial Services, Inc. - Chairman, CEO, President [72]

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I'd just like to add one comment that over the years, one of the additional parts of the program is we've acquired four of our MGAs, and now they've turned into great fee businesses and we really tried to buy the ones that we're very comfortable with the underwriting.

So, sometimes where you look at the program business by itself and you see maybe the loss ratio or the margins are lower, but the other side of the house, as we start buying some of these MGAs over the years and we want to continue doing it -- we've bought some of our best ones, that turns into fee business and underwriting preference in other parts of the organization.

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Operator [73]

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(Operator Instructions). Meyer Shields, KBW.

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Meyer Shields, Keefe, Bruyette, and Woods, Inc. - Analyst [74]

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Thanks. So I guess the big-picture question is how concerned should we be about the material weaknesses implying a need for, I guess, further reserve strengthening?

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Barry Zyskind, AmTrust Financial Services, Inc. - Chairman, CEO, President [75]

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I don't think we expect any of the material weakness to be around reserves or reserve processing.

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Meyer Shields, Keefe, Bruyette, and Woods, Inc. - Analyst [76]

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Okay. Could you give a little more color on where the issues are, then?

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Ron Pipoly, AmTrust Financial Services, Inc. - EVP, CFO [77]

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The issues really, again, from a material weakness standpoint we talk about financial reporting in the sense of FX translations, statement of cash flows, goodwill, and the goodwill aspect is really a control SOX aspect. It's not about goodwill of the organization that we've acquired; it's about the process of testing the controls around the development of future forecasts and those types of things.

So as Barry said, the material weaknesses related to financial reporting is not about our actuarial process, which we've clearly built out and we believe to be a very robust and thorough process.

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Meyer Shields, Keefe, Bruyette, and Woods, Inc. - Analyst [78]

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Okay. That's very reassuring. You talked a little bit about the impact of the changing mix of business on loss ratios and expense ratios. If we have a normalized catastrophe year, whatever that means, would this new London business have similar commodity issues to the legacy casualty book?

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Ron Pipoly, AmTrust Financial Services, Inc. - EVP, CFO [79]

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I think so. I think it would be very close to that. I think it would be a low 90s. If we had a low cat year in Lloyds, you could get into the maybe mid to high 80s, but in a normal cat year, I think we would expect it to be in the low 90s.

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Meyer Shields, Keefe, Bruyette, and Woods, Inc. - Analyst [80]

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Okay. Perfect. Thanks so much.

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Operator [81]

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Ken Billingsley, Compass Point.

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Ken Billingsley, Compass Point Research & Trading - Analyst [82]

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Good morning. I wanted to follow up on a question from earlier regarding just the -- from an accident-year basis. When we look at the fourth quarter, accident-year loss ratio would come in around 63%, which we haven't seen since, call it, almost 2012. So just following up on some of your comments earlier, is this a new run rate that should be expected in general? Obviously, there's going to be, you're saying, an increase in the expense ratio, but are we talking that the run rate should be four to five points higher in expense ratio, but lower on the loss ratio side?

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Ron Pipoly, AmTrust Financial Services, Inc. - EVP, CFO [83]

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No, I think, Ken, and again we don't provide guidance, but what my earlier comments were is that kind of given our current business mix, and if you look at the full-year results for 2016 and where do we think we're trending, is that loss ratio is, kind of given the current business mix, somewhere around 67.5% to 68%, expense ratios being somewhere between 25% and 26%.

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Barry Zyskind, AmTrust Financial Services, Inc. - Chairman, CEO, President [84]

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And I think, Ken, you're looking at the accident year for a quarter, but I think Ron's point is you should look at it for the year, and it's not that dramatic on the year when you look at the full year.

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Ken Billingsley, Compass Point Research & Trading - Analyst [85]

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Okay. The next question, just on the reserve charge itself of $65 million, how much of this was related to business that Maiden just took a charge of -- I think theirs was $120 million, so how much of this is reflective in something that was something that they were looking at and how much of it is different, but business that you pass on to them?

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Ron Pipoly, AmTrust Financial Services, Inc. - EVP, CFO [86]

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I don't think we want to really comment on Maiden. They are going to have a call tomorrow and they will be able to talk about their business. I don't think it would be right for us to comment on that.

I will just remind that we do our own actuarial process and they do their own actuarial process. Not always if you look at their loss ratio and our loss ratio are they the same for accident year, but obviously this business would have been ceded to Maiden as part of our normal quota share.

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Ken Billingsley, Compass Point Research & Trading - Analyst [87]

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Okay. To clarify, because I know that they don't necessarily take everything in general, though, in the specialty programs businesses where the charges were, it is business that they do (multiple speakers)

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Barry Zyskind, AmTrust Financial Services, Inc. - Chairman, CEO, President [88]

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Some of it, yes, because they don't take the non-admitted from us, so they only take the admitted program business.

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Ken Billingsley, Compass Point Research & Trading - Analyst [89]

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And how much of the charge was from non-admitted for you?

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Barry Zyskind, AmTrust Financial Services, Inc. - Chairman, CEO, President [90]

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I don't have the exact breakout. It was between some general liability, two of them I know were not admitted. I don't have the breakout now.

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Ken Billingsley, Compass Point Research & Trading - Analyst [91]

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Okay. Thank you for taking my questions.

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Operator [92]

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Mark Hughes, SunTrust.

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Mark Hughes, SunTrust Robinson Humphrey - Analyst [93]

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Thank you. In the discussion about the restatement related to the differing accounting treatment for warranty, you also reference a bonus accrual, foreign-currency transactions as areas that, I guess, were restated or where there are weaknesses. Could you expand on that? Was that material? What were the differences there?

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Ron Pipoly, AmTrust Financial Services, Inc. - EVP, CFO [94]

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The difference is again going back to kind of a component of what would flow through your P&L as a foreign currency gain or loss as opposed to what would flow through as a component of your OCI. So, again, those two amounts were not significant, and as it related to 2015, one was actually -- it would've been a positive in 2015 of about $10 million, and from a bonus perspective there was about $3 million, so really neither one of those amounts are material.

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Mark Hughes, SunTrust Robinson Humphrey - Analyst [95]

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Right. So the key issue was the warranty revenue, and there it was you had an established practice that KPMG just disagreed on, but you had already disclosed it, et cetera, so that was just a straight disagreement?

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Ron Pipoly, AmTrust Financial Services, Inc. - EVP, CFO [96]

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Correct. We had a different interpretation of whether the administrative fees would qualify for multielement revenue recognition. That's the way we had previously handled it.

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Mark Hughes, SunTrust Robinson Humphrey - Analyst [97]

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Right. And then, the life settlement gains were a little higher this quarter. Is there any perspective you can provide on what we should think about on a go-forward basis?

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Barry Zyskind, AmTrust Financial Services, Inc. - Chairman, CEO, President [98]

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I think we had some mortality events in the quarter, and really it's one thing we really cannot project, life settlement, but I would tell you that it's living up to old expectations of the returns that we initially put in. It's something that we partnered with Nat Gen. We bought it very, very well early on.

We continue finding pockets of opportunities to buy policies here and there, not as we saw in the past when the returns were much higher. A lot of institutional money did come into the business now with a smaller return. You could see AIG sold part of its portfolio to an institutional buyer at returns that -- we don't like acquiring those returns. But we have a portfolio and we're basically sort of clipping coupons on the portfolio that we have.

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Operator [99]

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Thank you. At this time, we have reached the end of our allotted time for today's call. I would now like to turn the call back over to Hilly Gross for closing remarks.

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Hilly Gross, AmTrust Financial Services, Inc. - VP IR [100]

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Thank you. That concludes our AmTrust Financial Services 2016 first-quarter earnings conference call. We thank you all for taking the time out of your busy schedules to join us and we wish you all a very pleasant day.

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Operator [101]

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Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program. You may now all disconnect. Everyone, have a great day.