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Edited Transcript of PRA earnings conference call or presentation 8-Aug-18 2:00pm GMT

Q2 2018 ProAssurance Corp Earnings Call

Birmingham Sep 11, 2018 (Thomson StreetEvents) -- Edited Transcript of ProAssurance Corp earnings conference call or presentation Wednesday, August 8, 2018 at 2:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Edward Lewis Rand

ProAssurance Corporation - Executive VP, COO, CFO & CAO

* Frank B. O'Neil

ProAssurance Corporation - Senior VP of IR & Chief Communications Officer

* Howard Harley Friedman

ProAssurance Corporation - Chief Underwriting Officer, Chief Actuary & President of Healthcare Professional Liability Group

* Michael Leonard Boguski

ProAssurance Corporation - President of Eastern Insurance

* William Stancil Starnes

ProAssurance Corporation - Chairman, President & CEO

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Conference Call Participants

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* Amit Kumar

The Buckingham Research Group Incorporated - Analyst

* Arash Soleimani

Keefe, Bruyette, & Woods, Inc., Research Division - Assistant VP

* Charles Gregory Peters

Raymond James & Associates, Inc., Research Division - Equity Analyst

* Mark Douglas Hughes

SunTrust Robinson Humphrey, Inc., Research Division - MD

* Matthew John Carletti

JMP Securities LLC, Research Division - MD and Senior Analyst

* Robert Edward Farnam

Boenning and Scattergood, Inc., Research Division - Senior Research Analyst of Property and Casualty Insurance

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Presentation

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Operator [1]

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Good morning, everyone. Welcome to ProAssurance's conference call to discuss the company's second quarter 2018 results. These results were reported in a news release issued on August 7, 2018, and in the company's quarterly report on Form 10-Q, which was also filed on August 7.

These documents are intended to provide you with important information about the significant risks, uncertainties and other factors that are out of the company's control and could affect ProAssurance's business and alter expected results.

We also caution you that management expects to make statements on this call dealing with projections, estimates and expectations and explicitly identifies these as forward-looking statements within the meaning of the U.S. federal securities laws and subject to applicable safe harbor protections.

The content of this call is accurate only on August 8, 2018, as except -- and except as required by law or regulation, ProAssurance will not undertake and expressly disclaims any obligation to update or alter information disclosed as part of these forward-looking statements.

The management team of ProAssurance also expects to reference non-GAAP items during today's call. The company's recent news release provides a reconciliation of these non-GAAP numbers to their GAAP counterparts.

Now as I turn the call over to Mr. Frank O'Neil, I would like to remind you that the call is being recorded, and there will be a time for questions after the conclusion of prepared remarks.

Mr. O'Neil, please go ahead.

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Frank B. O'Neil, ProAssurance Corporation - Senior VP of IR & Chief Communications Officer [2]

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Thank you, Debby. On our call today are our Chairman and CEO, Stan Starnes; Chief Operating Officer and Chief Financial Officer, Ned Rand; and Howard Friedman and Mike Boguski, the Presidents of our Healthcare Professional Liability and Workers' Compensation Operations.

Stan, will you start us off, please?

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William Stancil Starnes, ProAssurance Corporation - Chairman, President & CEO [3]

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Thank you, Frank. This was a strong quarter for us and the results continue to underscore our optimism for the future and our continued confidence in the long-term strategy we've laid out. Trends in Healthcare Professional Liability continue to point to a business climate that will favor strong, experienced and disciplined companies such as ProAssurance.

Given the level of competition and the broad Worker's Compensation segment, we could not be more pleased with Eastern's ability to grow its business through focused operations and careful expansion. Our Lloyd's segment grew the top line modestly, and continues to build value as operations scale up.

I'd like to ask Ned to recap the consolidated financial results from this solid quarter. Ned?

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Edward Lewis Rand, ProAssurance Corporation - Executive VP, COO, CFO & CAO [4]

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Thank you, Stan. Top line growth was a highlight for us this quarter, up almost 18% over second quarter 2017 with increases in all operating segments. In Workers' Compensation, gross premiums written grew 19.2% year-over-year; and Specialty P&C increased 18.5%, driven by a loss portfolio transfer or LPT, which resulted in $26.6 million of premium written and fully earned in the quarter. We'll have much more to say about that shortly because it affects a number of different line items and ratios.

In our Lloyd's segment, premiums were up 3.8%. We continue to benefit from strong retention in our domestic insurance operations. Continuing trend has been evident from the past few quarters. In addition to achieving strong retention, we're seeing solid evidence of more rational pricing and underwriting in the medical professional market as evidenced by the renewal price increases Howard will discuss. We're also writing new business that we believe to be properly priced despite the competitive market. In the quarter, Specialty P&C and Workers' Compensation accounted for $21.4 million of new business, an increase of $2.5 million over last year.

Our coordinated sales and marketing strategy produced $4.8 million -- excuse me, $4.5 million of business, an increase of $3 million over Q2 of 2017. The consolidated current accident year net loss ratio for the quarter was 82.5%, an increase of 2.3 points over the year-ago quarter, although 1.9 points of that increase is due to the loss portfolio transfer. The remaining increase, as in the past 2 quarters, is reflective of our continued caution regarding long-term loss trends in healthcare professional liability. Howard will have more color on that, shortly.

Our net favorable loss development was $22.8 million with favorable development in both domestic operating segments, partially offset by unfavorable development in the Lloyd's segment.

Our expense ratio was 26.7%, a 5.4 point improvement over the year ago quarter. Net premiums earned increased in all segments, primarily driven by the LPT, which had low acquisition costs and accounted for 3.7 points of the expense ratio change. The remaining decrease was the result of reduction in overall operating expenses.

Turning to investments. Our net investment result was $27.8 million, a $2.6 million increase over Q2 2017 due to an increase in earnings from our unconsolidated subsidiaries. As you will recall, we adopted a new accounting standard in the first quarter that requires us to report results of certain LPs and LLCs at fair value with changes in fair value recognized through net income. Net investment income was essentially unchanged quarter-over-quarter at $22.4 million, and net realized investment gains were $2.8 million compared to a net realized loss of $2.2 million a year ago.

We had a tax benefit of approximately $311,000, giving us an effective tax rate of negative 1.1% in the quarter. And as of the end of the first half of the year, we are projecting an annual benefit of 3.2% for 2018, excluding the impact of discrete items such as realized gains and losses.

In summary, net income for the quarter was $28.4 million or $0.53 per diluted share, and operating income for the quarter was $26 million or $0.48 per diluted share. The LPT accounted for $1.2 million of pretax income. We achieved a return on equity of 7.2% in the quarter.

At June 30, book value per share was $29.37. And as of June 30, we held approximately $190 million in unpledged cash and liquid investments outside our insurance subsidiaries. We did not repurchase any shares in the quarter. And I know that is a subject of interest for some. Let me remind you that, in an effort to remove a motion about the stock price from our decision making, we target a payback period of 36 months or less when considering repurchases above book value. We do think that stock repurchase has a place in our capital management strategy, but we do not disclose the price-to-book ratio where we think we should be buying and that price may be flexible as we evaluate other uses for capital at any given point in time.

Frank?

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Frank B. O'Neil, ProAssurance Corporation - Senior VP of IR & Chief Communications Officer [5]

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Thank you, Ned. Now we'll pivot to Howard for comments on Specialty P&C. Howard?

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Howard Harley Friedman, ProAssurance Corporation - Chief Underwriting Officer, Chief Actuary & President of Healthcare Professional Liability Group [6]

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Thanks, Frank. This was certainly a strong quarter for Specialty P&C and the loss portfolio transfer was a contributing factor.

As previously mentioned, the LPT accounted for $26.6 million of written and fully earned premium in the quarter. This transaction was produced by ProAssurance Risk Solutions and addressed the pressing need for a large health care organization that was acquired by one of our insurers. Under the terms of the LPT, $18.7 million relates to retroactive coverage for a known quantity of existing clients and the remaining $7.9 million is for tail coverage. In addition, we recognized net losses and loss adjustment expenses of $25.4 million, including a deferred gain of approximately $600,000, which represents the excess of premiums received over losses assumed for the retroactive coverage.

This was a very competitive transaction and the risk was placed by one of the large national brokers, which allows me to highlight 2 important items. First, we are successfully competing in this market, which we think will grow in the future, although business will be sporadic. Second, I think, it's further evidence that of our broker outreach continues to succeed. Further to that point, I note that broker submissions at mid-year are up 25% over the same period of 2017.

We continue to see signs that the market is beginning to firm. New business was strong at $8 million, renewal pricing was up 3% for physician business and up 8% for health care facilities. Together, these are by far the majority of the Specialty P&C business.

Premium retention remain strong, 90% for both physicians and facilities, unchanged from the second quarter of 2017. All of this seems to emanate from greater discipline in the market, perhaps a recognition that the benign loss environment of the past 10 to 12 years is eroding. We are continuing to reflect that perception in our loss specs. Any change in severity is almost invariably followed by an upward change in frequency, as the plaintiff bar follows the money trail. Ultimately, and as we may be starting to see now, the market will enforce price and underwriting discipline, and companies such as ProAssurance should benefit as competitors feel the pinch.

Our current accident year net loss ratio for the quarter was 91.7%, up 2 points over the second quarter last year. The LPT is responsible for 1.1 points of that increase with the remainder stemming from our view of coming litigation trends due to a shift toward larger policies and more complex risks. Favorable reserve development was $20.1 million. Our underwriting expense ratio decreased 4.6 points. 4.2 points of the improvement was due to the LPT. And remember that 100% of that premium was earned in the quarter with minimal associated expense.

Frank?

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Frank B. O'Neil, ProAssurance Corporation - Senior VP of IR & Chief Communications Officer [7]

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Thank you, Howard. Now, let's turn to Mike Boguski for comments about the second quarter results in the Workers' Compensation segment. Mike?

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Michael Leonard Boguski, ProAssurance Corporation - President of Eastern Insurance [8]

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Thank you, Frank. The Workers' Compensation segment operating results increased 15.2% to $4.4 million for the 3 months ended June 30, 2018, compared to $3.8 million for the same period in 2017, driven by an increase in net premiums earned and a decrease in the underwriting expense ratio, partially offset by an increase in the loss ratio.

Gross premiums written increased 19.2% to $70.7 million for the 3 months ended June 30, 2018, compared to $59.3 million for the same period last year. This includes new business writings of $13.4 million during the quarter compared to $9.5 million in Q2 of 2017. Our second quarter 2018 production results includes $4.3 million of gross premiums written related to last year's Great Falls renewal rights transaction and consistent growth in each operating region.

The conversion of Great Falls operations into our New England platform is complete, and we continue to be pleased with the local team, agency partners and profitable production result. Renewal pricing increased 1.3% in this year's second quarter compared to renewal price decreases of 2.8% in 2017; and premium retention was 87.6%, both significant contributors to the continuing growth trend in the quarter.

Audit premium was $1.2 million in the quarter compared to $1 million in Q2 of 2017. We successfully renewed all 5 of the available alternative market programs in the quarter. Overall, alternative market program gross written premium increased 18.1% in the second quarter of 2018 compared to 2017, which reflected renewal price increases of 1.6%, premium retention of 94.6% and new business writings of $2.8 million.

The increase in the second quarter 2018 calendar year net loss ratio from 58.9% in 2017 to 60.1% in 2018 reflected an increase in the current accident year loss ratio, offset by favorable trends in prior year claim closing patterns, resulting in net favorable loss reserve development of $4 million in 2018 compared to $2.9 million in 2017. The net favorable loss reserve development for the second quarter of 2018 includes $1 million in our traditional book compared to $400,000 in 2017.

In alternative markets, net favorable development was $3 million in 2018 compared to $2.5 million in 2017. The 2018 net favorable loss reserve development reflected better-than-expected claim results, primarily related to accident years 2015 through 2017.

We successfully closed 36.4% of 2017 and prior traditional claims during 2018, including 14.6% in the second quarter. The increase in the current accident year loss ratio of 66.5% in the second quarter of 2018 compared to 64.1% in 2017 primarily reflected increased winter storm activity and economic growth trends. The decrease in the 2018 expense ratio is indicative of the increase in net premiums earned and effective management of operating expenses. The combined ratio of 89% in 2018 includes 1.4 percentage points of intangible asset amortization and 49 percentage points of a corporate management fee.

Frank?

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Frank B. O'Neil, ProAssurance Corporation - Senior VP of IR & Chief Communications Officer [9]

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Thank you, Mike. As we bring in Howard for an update on our Lloyd's syndicates segment, remember, this includes now the operating results from our participation in Syndicate 1729 and Syndicate 6131, the newly formed special purpose arrangement or SPA that is underwriting on a quota share basis with Syndicate 1729. As of January 1, we increased our participation in Syndicate 1729 to 62% and we began our participation in Syndicate 6131. And as a reminder, we report all of the Lloyd's syndicates' results on a 1 quarter lag.

Howard?

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Howard Harley Friedman, ProAssurance Corporation - Chief Underwriting Officer, Chief Actuary & President of Healthcare Professional Liability Group [10]

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Thanks, Frank. Gross premiums written increased approximately $1 million or 3.8% quarter-over-quarter to $24.2 million. The increase reflected our increased participation in the results of Syndicate 1729 and the initial inclusion of Syndicate 6131.

Net premiums earned were $17.5 million, an increase of $3 million quarter-over-quarter, primarily due to changes in the mix of business. A larger portion of premiums were written in the open market and those premiums are predominantly earned over 12 months. That shift in the mix of business was the primary factor driving a 7.2-point quarter-over-quarter decrease in the current accident year net loss ratio.

As we forecast in last quarter's call, there was unfavorable prior year loss development of $1.3 million in the quarter, driven by higher than expected losses and development on large complex claims resulting primarily from 2017's hurricane season, particularly Hurricane Irma, and to a lesser extent, the California wildfires of 2017.

We've stressed this last quarter, but it bears repeating, the syndicate makes every effort to evaluate and establish accurate initial reserves for each loss event. However, initial estimates are subject to sometimes significant change as additional information becomes available and underlying claims are resolved.

Underwriting policy acquisition and operating expenses were up approximately $1.3 million over the prior year quarter, as we absorbed the costs of additional staffing to address the anticipated growth in Syndicate 1729's operations.

Also, and to a lesser extent, there were new operational expenses connected to the startup of the SPA Syndicate 6131. Syndicate 1729 has made underwriting and pricing changes that we expect will improve profitability on non-catastrophe business. To that end, although the figures are not yet final, early indications are that we may realize a pretax profit in our Lloyd's syndicate segment of $1 million to $1.5 million for the third quarter based on what we know now, and barring the emergence of greater than expected losses.

Indications from Syndicate 1729 are that the majority of our Hawaii Volcano losses are known at this point and are included in the forecast profit for next quarter. As to this year's California wildfires, particularly the Carr fire, indications are that our exposure in the affected areas is minimal.

Frank?

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Frank B. O'Neil, ProAssurance Corporation - Senior VP of IR & Chief Communications Officer [11]

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Thanks, Howard. Great summary. Stan, some final comments?

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William Stancil Starnes, ProAssurance Corporation - Chairman, President & CEO [12]

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Frank, as I said last quarter, I'm optimistic about our domestic operating subsidiaries and confident in the ultimate success of our Lloyd's investment. Nothing in this quarter has changed my view on any part of our business. If anything, my conviction about our future is stronger than ever. We are seeing good opportunities in the healthcare liability market as that market continues to show signs of improving and we are able to leverage our expertise, geographic reach and financial strength to succeed in the market where marginal players cannot operate profitably.

Our Workers' Compensation business is a remarkable success story, having carved out a profitable niche by operating a truly differentiated product and superior service. We always have had a long-term vision of sustainable success and we are witnessing the next evolution of that vision.

In closing, I'd like to take just a minute for some people-related items. As I hope you saw a couple of weeks ago, we are promoting Dana Hendricks to our Chief Financial Officer, effective September 1. She has moved steadily up the management ranks within PICA, our podiatric subsidiary, and has a tremendous amount of experience in finance and accounting as well as operations. She will be a great asset for us.

I also want to tell you that Frank O'Neil will be retiring in the second quarter of 2019, likely sometime around the Annual Meeting of Shareholders. We are continuing to discuss some role for him after he steps away from his current responsibilities and will update you on that as our plans firm up.

Frank?

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Frank B. O'Neil, ProAssurance Corporation - Senior VP of IR & Chief Communications Officer [13]

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All right. Thank you. Stan. Debby, we're ready for questions. That concludes our prepared remarks.

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Questions and Answers

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Operator [1]

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(Operator Instructions)

Our first question comes from Matt Carletti with JMP Securities.

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Matthew John Carletti, JMP Securities LLC, Research Division - MD and Senior Analyst [2]

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Stan, I think, the first question I'll direct towards you and just kind of following on your comments there about kind of being more convinced than ever, and then kind of the future of the company and that certainly came across even before you said it.

My question relates to kind of what you've seen change kind of last update, last quarter versus now? I think my read on kind of your -- where you stood last quarter was that you had a good amount of near-term optimism on the facilities and hospital side of the business because they're more kind of commercial carriers, but thought that the turn could take a bit longer to materialize on the physician side just because of the nature of mutuals and smaller companies and being able to kind of wait it out.

What has changed there? I mean, obviously, we've gotten a little more rate on the physician side. I mean, 3% is a number we haven't seen in some time. Has there been -- have you seen any developments in the market incrementally versus say 3 months ago, that kind of gives you that little bit more confidence that things are indeed turning? Or is it just more kind of steady state and it will be a grind?

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William Stancil Starnes, ProAssurance Corporation - Chairman, President & CEO [3]

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I think, Matt, that 3 months is really an awfully short period of time to ascertain the extent of any lasting changes, if any. I think that we did not see anything during this last quarter that changes my optimistic view of the long-term opportunities for the organization. I think we will continue to take advantage of those opportunities as they are presented to us. I think that we are in for a longer period of rationalization of the individual physician business than the facilities business as you just alluded to; but I think it will happen.

You never know what triggers certain events. But as physicians on an individual level read the same sorts of articles and headlines you've been reading, they tend to gravitate toward companies that have a very stable existence and a very strong balance sheet. And I think over time, we will continue to see that.

I think for the near terms, one of our great strengths in health care is our ability to take advantage of the episodic opportunities that come along such as this quarter's loss prevention -- loss portfolio transfer. You can't predict those. You can't manufacture them. They happen as they happen. You have to be very analytical about them. But when the opportunities that are worthwhile come along, you have to be in a position to take advantage of that. And we did that this quarter and we will continue to do that as the opportunities permit themselves.

I think I would hearken back to something that we've said now for several years and we're seeing it come into fruition, and that is that as there is growing change in the health care environment and as there is increasing consolidation in that environment, there will be opportunities for one-off sorts of transactions like the loss portfolio transfer. You're going to see an increasing number of hospital captives come back into the market to take advantage of the market's ability to alleviate the stress on their captives because of a number of years or perhaps some of them were not taking adequate loss charges.

I mean, we're seeing it happen. I think we'll continue to see it happen. It won't be an avalanche. It will be more of a creek that turns into a river that someday will be an ocean. But we intend to take advantage of that and we think we will have significant opportunities to take advantage of that. I don't think you can see fundamental change in the course of 3 months. I think it will be more gradual than that, but everything we're seeing portends a future, which we feel will be very much to our advantage.

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Matthew John Carletti, JMP Securities LLC, Research Division - MD and Senior Analyst [4]

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That's really helpful. And then maybe just one other question on the Workers' Comp business. So I guess, this is for Mike. Can you talk a little bit about -- I mean, the Workers' Comp line broadly as an industry is facing some rate headwinds -- pricing headwinds, largely because the results have been so good and frequency and severity have been very good. You guys got a rate increase in the quarter compared to say a year ago, where there was a couple of points of decrease.

Can you talk a little bit about kind of how you're focusing your book? And what you're doing to kind of be able to maintain that rate versus a broader market that is experiencing little more headwind?

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Michael Leonard Boguski, ProAssurance Corporation - President of Eastern Insurance [5]

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Thank you, Matt, and good morning. The rate trend in the quarter was driven by rate increases in Pennsylvania. And as you look at Pennsylvania, it's 51% of our overall writings in the company. So it did -- it was very helpful to the overall rate trend for us. We did continue to see competitive pressures in all of our other operating regions. So that was one of the reasons that drove it.

We're also seeing signs of a little bit more market dislocation in our Mid-Atlantic region than we have in other regions, which helped us on the rate side as well. So we continue to be hopeful and optimistic that this trend will continue through the rest of the -- of 2018.

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Matthew John Carletti, JMP Securities LLC, Research Division - MD and Senior Analyst [6]

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Okay. Great. And Frank, congrats on the upcoming retirement and best of luck for everything in the future.

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Frank B. O'Neil, ProAssurance Corporation - Senior VP of IR & Chief Communications Officer [7]

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Plenty of time for us to talk about that.

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Operator [8]

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The next question comes from Greg Peters with Raymond James.

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Charles Gregory Peters, Raymond James & Associates, Inc., Research Division - Equity Analyst [9]

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I wanted to focus in on -- and I realize, Howard, you're not going to -- and Ned and Stan and Frank, you're not going to give us a lot of commentary around the expectation of future prior year development. But maybe we could turn it around a little bit. Maybe you could talk about the length of the liability tail of your Specialty business and how it's changed considering the LPT books that you've been successful with and the broker initiative versus the traditional more retail agency profile that you guys used to have.

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Howard Harley Friedman, ProAssurance Corporation - Chief Underwriting Officer, Chief Actuary & President of Healthcare Professional Liability Group [10]

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Sure, Greg, it's Howard. I guess, a couple of things. The LPT, in the overall scheme of things, probably doesn't change things very much. It is $26 million, $27 million of premium and almost that much in terms of book incurred loss. And it is broken down into a portion for the known claims, which obviously will have a shorter -- or should have a shorter tail since those claims are already in process in various ways and some may be fairly close to being resolved, others may take a little longer. And then there is the tail or the unreported portion, which will stretch out.

So I don't think that will change things significantly. And if we were to do a lot of them over a period of time, sure, that it might have some effect. But I don't think that's going to move the needle on the overall book of reserves.

Likewise, the production source itself doesn't change anything either. The reasons that we've done a broker outreach, and I think the reasons that we've been successful in that is, because number one, the change in health care and the consolidation within the health care providers, physicians, hospitals, and so forth into larger accounts, which make them more attractive to the brokers and that's why we've looked in that direction. But also the -- what we've been able to offer, what we do offer as an organization to these health care -- larger health care organizations in terms of the balance sheet, the spectrum of products that we have covering the -- really the entire liability spectrum for them and positioning ourselves over the past 10 years now to meet these needs.

All that said, the underlying resolution of claims and the type of claims that come in, really don't change as a result of the structure of the entities. Certainly, some larger entities will be retaining risk through self-insured retention, deductibles, captive-type programs. But to the extent that we are doing the claims handling or even participating in the claims handling in some of those on a shared basis, the resolution of the claims will be what they are and what they would have been. So I don't see that changing the tail overall, and I don't really see it changing the development patterns because we still establish reserves the way that we've always done it.

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Charles Gregory Peters, Raymond James & Associates, Inc., Research Division - Equity Analyst [11]

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That's great color. I -- on another sort of big picture question, given the lumpiness of your revenue opportunities, the expense ratio has gone down considerably both on a 3-month and a 6-month basis. And if we -- I'm curious and I noticed in your Corporate segment, you've commented on a decrease in professional fees and some other things.

So I was wondering maybe if you could step back and provide us some big picture ideas about how the expense ratio should look, as we think about not only the balance of 2018 but also think about -- starting to think about 2019?

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William Stancil Starnes, ProAssurance Corporation - Chairman, President & CEO [12]

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Greg, I'll let Ned to provide the detailed answer to that question, but my way of prep is, I would say that we look at expenses under the lens, the dual lens of effectiveness and efficiency. And you have to be effective and you have to be efficient. If you can get everything going in the same direction in terms of effectiveness and efficiency, that's good; but sometimes you can't and sometimes you should. Because we take such a long-term view of the world, we have to be very intentional about where we are at any given point in time.

The other caveat to keep in mind is that since a huge amount of our expense overhead is in personnel, we have to be very careful about that as well to make sure that we have the human resources to drive this organization for the long-term and not just for the quarter. So we pay a lot of attention to expenses and we pay a lot of attention to the consequence of our expenses in terms of efficiency and effectiveness.

And with that overview, I'll let Ned to give you some more detail.

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Edward Lewis Rand, ProAssurance Corporation - Executive VP, COO, CFO & CAO [13]

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Good morning, Greg. I'll add a couple of things. One, to go back to the lumpiness. I think, it's important when you look at something like the loss portfolio transfer transaction that was done this quarter that you really look at that on a kind of a combined ratio basis as opposed to expense ratio or loss ratio, because it has very little expense built into it. As a consequence to that it has a higher loss ratio because it's being essentially written on a net basis. And so you've really got to look at those together. Or I think maybe to your point, if you're going to try and look at run rate on expenses, you certainly need to back those sorts of things out. So that's one factor that's at play.

Stan mentioned personnel and I'll circle back to that in a second, and that is really the biggest kind of cost internally that we have, but about half of the expenses from our operations are commissions and premium taxes. And, unfortunately, there we face continual upward pressure, especially, on the commission side right now where our agents and brokers, I think, are feeling the squeeze of what's going on in the marketplace themselves and are pushing for higher and higher commissions. And we, obviously, resist that trend to the extent we can, but we also have to make sure that we remain competitive and relevant in the marketplace from a compensation standpoint for them in order to win their business. And so that had some upward pressure certainly on our operating expenses.

And then, as Stan mentioned, it's -- internally, it's really about leveraging the technologies we have in place, leveraging the people we have in place to make ourselves the most efficient and effective operation that we can.

And I think where we stand today is that we have significant capacity to grow our top line without having to add significantly to that operational structure. And that, as we sit today, is where the biggest benefit will come in for us as we look out into the next 6 to 18 months for the organization is that ability to grow without adding significantly to cost.

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Charles Gregory Peters, Raymond James & Associates, Inc., Research Division - Equity Analyst [14]

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Great. I appreciate your comment on the tax expectations for 2018. So I'm curious if you want to give us a preview or snapshot of how we might think about tax on a consolidated basis for 2019?

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Edward Lewis Rand, ProAssurance Corporation - Executive VP, COO, CFO & CAO [15]

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That's a good question, Greg. I don't think we're really in a position yet to talk about that. We'll be launching early in the next couple of weeks the kind of intensive process that we go through for planning out 2019. It may be that by the time we get to the end of the year, we'll have some idea on that.

What you're seeing right now is the fact that cash credits that we've invested in are kind of sufficient to offset the taxable income that we're generating. Those tax credits are something that we invested in around 2009, 2010 timeframe, when there was a dislocation in that market. So the returns were very, very high. We, obviously, bought those assuming a 35% tax rate. The 21% tax rate is causing us to not generate the taxable income that we thought, which is -- it's a good thing, obviously, but we're using -- those are becoming, I guess, more effective. That will extend the life of those tax credits, but those tax credits are winding down over the next several years.

And if you look in some of the investor materials we have on our website, you can see some projections of the expected benefits that we've got from those tax credits. We made those investments in 2009, '10, '11 time frame when that opportunity existed. We've not continued to add to those investments in recent years, so we do expect those to wind down. As those wind down over the next several years, you'll see our effective tax rate increase.

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Operator [16]

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The next question comes from Arash Soleimani with KBW.

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Arash Soleimani, Keefe, Bruyette, & Woods, Inc., Research Division - Assistant VP [17]

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So first question is just -- obviously, the 3% rate increase in physicians was very strong step in the right direction. Are you seeing continued momentum there in 3Q? Or does it seem pretty steady? Just wanted to see any thoughts you had there?

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Howard Harley Friedman, ProAssurance Corporation - Chief Underwriting Officer, Chief Actuary & President of Healthcare Professional Liability Group [18]

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It's Howard. The changes in rate vary from month to month, certainly, based on where the renewals are and size of account and all that. So I don't really have anything to comment on with respect to third quarter so far. I think what I will say is that we were very happy to see that the second quarter continued the pattern and increased it from where we were in the first.

We certainly are continuing our work with respect to both renewal and new business pricing. But in particular, we're measuring renewal pricing here to evaluate each of the accounts as they renew, look for opportunities to get rate where it's needed and where we can from a competitive standpoint, and I think you're starting to see those results. So I'm optimistic about the rest of the year, but in terms of any numbers right now, no, I don't have any.

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Arash Soleimani, Keefe, Bruyette, & Woods, Inc., Research Division - Assistant VP [19]

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Okay. And my other question is, I think this is the third quarter that you guys have talked about some of the higher loss severity trends in medical professional liability. But I think, in each of those 3 quarters, you've also said that you're not seeing it in your own paids yet. So one question is, why do you think a lot of your peers may be seeing it in their paids, but you're not? And then, do you think it could be a matter of even a couple of years until it shows up in your paids? Or is it a -- do you think you will see it sooner than that?

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Howard Harley Friedman, ProAssurance Corporation - Chief Underwriting Officer, Chief Actuary & President of Healthcare Professional Liability Group [20]

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I think with respect to peers, I think, what we've seen and heard at least is the -- some of the large verdicts and particularly for the larger health care systems. And I think you have to be cautious about looking at verdicts versus looking at payments to start with. You see the verdicts in the headlines and the payments come afterwards; and often times, there are subsequent appeals or settlements or whatever. And I think also we have a limited amount of information that we can get out of either the financial reports of some of the publicly-traded multiline competitors that might have health care liability and then the statutory statements that you can get from -- for all of the competitors, but certainly, have to do a lot of interpretation in those.

So in terms of what are the competitors seeing or what others in the industry are seeing, I believe that they are saying higher pays. And, again, we're certainly seeing the news of the verdicts. I think part of what we're saying is that in our numbers, we're being cautious about what we're establishing in terms of our anticipated reserves for known cases, the case reserves. We have not seen it in the page numbers yet and in terms of when we might, if we might, that's going to be over the next 6 months to a year, I think, before we can really tell whether some of these things are actually translating into paid losses or if we're just being cautious and conservative as we always have been.

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Arash Soleimani, Keefe, Bruyette, & Woods, Inc., Research Division - Assistant VP [21]

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Okay. And maybe just last question. I know you mentioned that you're being more conservative on the initial loss picks within medical professional liability. If we back up the loss portfolio transfer, the accident year loss ratio was up about 80 basis points. So is that the right way to think of the additional conservatism basically like an 80 basis point uptick year-over-year kind of as a run rate, so to speak? Or what's the right way to think about that?

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Howard Harley Friedman, ProAssurance Corporation - Chief Underwriting Officer, Chief Actuary & President of Healthcare Professional Liability Group [22]

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Yes, I think that -- I mean, that's something in the ballpark. You always have the mix of business that gets earned in the quarter and how that flows through. And if there is more or less than what we had last year in facilities versus physicians, and so forth. But -- I mean, I think that we're talking about something like that, 1 percentage point give or take, and until we start to see more activity one way or the other to confirm our expectations.

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Operator [23]

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The next question comes from Amit Kumar with Buckingham Research Group.

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Amit Kumar, The Buckingham Research Group Incorporated - Analyst [24]

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Two quick questions, follow-ups. The first is in the opening remarks, I think, Howard might have mentioned that the plaintiff bar is following the money trail. In the past, we have talked about the MPL verdict severity trends. And I was wondering if there was any change in that? Are you still seeing an uptake, aggressiveness, sort of flatlining? Maybe just expand on that comment a bit more?

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Howard Harley Friedman, ProAssurance Corporation - Chief Underwriting Officer, Chief Actuary & President of Healthcare Professional Liability Group [25]

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Yes. Maybe to clarify a bit. Frequency, we're not yet seeing any change. And while we logically may expect a frequency increase, we're not seeing frequency change at this point in time. And severity, as I mentioned earlier, as we talked about, we're seeing the establishment of higher case reserves by our claim staff and these are the same people that have been doing the same work in the same local jurisdictions for a long time.

So they believe in terms of how they've translated that into the case reserves that they are establishing the cost of damages, whether it's lost wages or medical expenses will be higher and/or the likelihood of noneconomic damages, the pain and suffering awards by juries will be higher. And that's based on their sense of the environment, their knowledge of what has happened in other cases that are not our cases but that are common knowledge.

So that's where we're seeing the potential severity increase. And we've talked in the past about 2% to 3% for a severity trend. I think 3% is probably a more solid number right now in terms of our expectation. But again, that is based on incurred, not paid.

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Amit Kumar, The Buckingham Research Group Incorporated - Analyst [26]

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Got it. That's helpful. The second question on, I guess, a broader discussion on LPTs and ProAssurance Risk Solutions, looking at these type of deals. Clearly, it seems that this was a very choppy sort of outsized deal and, I guess, anything going forward, which would probably be smaller in size? Or how should we think about the trajectory of these deals because they're like one-off in nature?

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William Stancil Starnes, ProAssurance Corporation - Chairman, President & CEO [27]

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Amit, it's Stan. You're not going to like this, but we can't tell you what size they're going to be. I mean they're going to be whatever they are. And I think you'll see a variety of sizes. I would say this one is on the larger end in terms of size. But by definition, these things are choppy because by definition, they're episodic. And we don't know which ones will come over the trends tomorrow, and so it's just impossible to say.

I mean, we have not seen any that give us the ability to segment them for you in terms of the potential different sizes that will come over. I mean, they're just all very, very different. Everyone has to be evaluated on its own footing and to see where they are. But I would say, this one is a -- on the larger end. It's not to say, it will be the largest one we'll ever do, but I don't know, it also could be. We can handle almost any size that's likely to come our way, but they're just so episodic that you can't really predict them.

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Amit Kumar, The Buckingham Research Group Incorporated - Analyst [28]

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I guess if I were to rephrase my question. What I was trying to ask is, are you seeing an uptick in LPT-type deals in the marketplace? That's what, I guess, I was trying to ask: has there there's been an uptick based on where the industry cycle is? Or if there was anything unusual, which will present more opportunities for LPT deals now versus the past. I guess that's what I was trying to ask.

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William Stancil Starnes, ProAssurance Corporation - Chairman, President & CEO [29]

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I think the answer to all of that is yes, but I'll let Howard expand on it.

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Howard Harley Friedman, ProAssurance Corporation - Chief Underwriting Officer, Chief Actuary & President of Healthcare Professional Liability Group [30]

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Yes. And I don't know that it's a cycle so much. It's possible that could drive it. But what is driving this, I think, and what we'll see more of is the consolidation on the health care -- in the health care industry, not the health care liability industry, but the health care industry, the hospital consolidations. Every one that we have done -- and this is the third one over the past 6 years -- have been driven by hospitals being acquired and the acquirer wanting to put finality to the previous liabilities.

So the more that we see, the more that's out there in terms of consolidation in the hospital space, the more opportunity I think there will be. And now I think there is also more visibility that we are in the market to do these. And we have great capability to do them not only from a financial and analytical side but from the claims handling side because that's what we do really well.

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Amit Kumar, The Buckingham Research Group Incorporated - Analyst [31]

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Got it; and that's what [I alluded], so that's helpful. I guess, the only other question I have, I think, Ned made some comments regarding uses of capital and sort of broadly touched upon buyback versus other uses of capital. I was curious, if you look at your stock price and how it has performed, it does seem to be sort of a compelling -- I guess, a compelling case could be made; and I know it's recovered a lot in July. I mean, maybe just -- Ned, just expand on that just based on where our stock is trading now versus the past and being one of the laggards for 2018 in the group.

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Edward Lewis Rand, ProAssurance Corporation - Executive VP, COO, CFO & CAO [32]

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Yes, absolutely. I don't know I have a lot more to expand on. As we said in our comments, we really try to take a motion out of the equation. And for the last 10 years, we've had a program in place where we look at how long it takes to recover the dilution in book value that is created by buying above book value, kind of the incremental improvement you get in your return on equity because you bought back that stock. And we look to be able to recoup that in 36 months, but that also gets tempered with kind of other corporate activities that may be going on and kind of our view of the need for capital going forward, so a lot of things that go into the process. As we said on our comments, it remains a tool that we think is important to managing capital and managing capital effectively, and we will deploy that when we think it's appropriate.

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Operator [33]

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The next question comes from Bob Farnam with Boenning and Scattergood.

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Robert Edward Farnam, Boenning and Scattergood, Inc., Research Division - Senior Research Analyst of Property and Casualty Insurance [34]

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You've covered most of my questions. I probably have a minor question on the Lloyd's segment written premium. So we had the net retention dropped considerably, and then you've reworked some quota share agreements. I'm just curious what we can expect in terms of premium retention going forward?

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Edward Lewis Rand, ProAssurance Corporation - Executive VP, COO, CFO & CAO [35]

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Bob, you're right. So I think when you kind of look at last year versus this year, one of the things you have to keep in mind is that we were previously seeding a portion of our podiatric business to Lloyd's and that business was not being then reinsured by the Syndicate. We no longer have that session in place. So you've got this chunk of premium that was going over to the syndicate without any reinsurance that's not there. That both kind of dampens the growth that you see in the Syndicate. So while we said we grew $1 million in premium, that $1 million of growth is having to catch up for the premium that we're no longer seeing out of our podiatric business.

At the same time, you've got more of the business now that has some sort of retrocessional reinsurance protection in place. I think where we are today is pretty representative of what we would expect for the segment, but we are also kind of constantly evaluating opportunities in the market to protect the balance sheet of the Syndicate. And so you should -- you could see some fluctuations there just depending on kind of what retropricing looks like.

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Operator [36]

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The next question comes from Mark Hughes with SunTrust.

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Mark Douglas Hughes, SunTrust Robinson Humphrey, Inc., Research Division - MD [37]

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Sorry if you touched on this earlier; I was on a little bit late. But the -- in terms of the paid losses, how much experience are you getting in a day-to-day in jury trials, either in the physician or the hospital area? When you see these potential for large verdicts, presumably you're exposed to that as we speak and so you're picking up your data points based on your own activity. Or are those -- those are just too infrequent where it actually gets to that point where there is a verdict, and so it's hard to draw conclusions from? I'm just sort of curious how much of your own experience either is consistent or not consistent with this idea of rising of jury verdicts?

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Howard Harley Friedman, ProAssurance Corporation - Chief Underwriting Officer, Chief Actuary & President of Healthcare Professional Liability Group [38]

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It's Howard, Mark. I think a couple of things. One is frequent or infrequent, I guess, relative term. We try a lot of cases. We're probably going to have something around 200 trials to jury verdict this year. So in that regard, we do have, I think, a pretty good base of experience to look at. That said, the vast majority of those are defense verdicts and continue to be. So that gets broken down into a relatively small number that end up with any type of a verdict that involves a judgment against our -- physician or a hospital.

So -- and then, further down that line of reasoning, the physician limits, policy limits have historically remained relatively constant. Certainly, larger groups take larger limits, but it's the hospital area that has gotten the most activity in the press when you look at some of the big verdicts; and those are some of the very large hospitals with large towers of coverage. So while we do have a lot of trial experience to draw on, we don't have a lot of data points relatively speaking in order to make very clear assumptions. And again, what we've seen in our resolved cases really have not pointed to that severity increase. But as I said earlier, what we see in the overall environment gives us some concern about it.

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Mark Douglas Hughes, SunTrust Robinson Humphrey, Inc., Research Division - MD [39]

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And then the 3% increase in physician pricing, how much of that was maybe just timing on certain renewals? Was there -- I'm sure you probably touched on this, what was the real shift in the market in terms of competitive environment? Just a couple of thoughts on that would be much appreciated.

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Howard Harley Friedman, ProAssurance Corporation - Chief Underwriting Officer, Chief Actuary & President of Healthcare Professional Liability Group [40]

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Sure. Well, I guess there is always some mix of renewals and it makes -- it differs by state and differs by size of accounts. So there's always going to be some fluctuation there. I think generally, certainly, what we've been trying to do is to get some incremental rate on our renewals. And, I think, we've been successful in doing that. Moving from 2% to 3% is great; if not, I wouldn't call it a major shift in the market, but it's certainly in the right direction and it's certainly up as compared to where we were a year ago or so, when at times, renewal pricing was flat or even down a bit.

So I think there is an incremental change in the market in terms of more discipline and a little less aggressiveness and that is translating through, but I'm certainly not calling it a major shift at this point.

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Mark Douglas Hughes, SunTrust Robinson Humphrey, Inc., Research Division - MD [41]

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Do you think you're on the front edge of that? You've got good long-term relationships with your policyholders, so they can probably tolerate a couple hundred basis points here and there. Is that your initiative? Or do you think it's broader?

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Howard Harley Friedman, ProAssurance Corporation - Chief Underwriting Officer, Chief Actuary & President of Healthcare Professional Liability Group [42]

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I think it's actually both. I think it's broader because I think other companies are feeling the pinch maybe even more, or concerned about it even more, as some may be feeling it directly and some may be more concerned about it given where their pricing and reserving has been. I think we do have a lot of franchise value with our policyholders. And if we're telling them after a long period of time that we think that the pricing needs to go up, I think we can draw on the goodwill that we've developed, the way that we've handled clients and service them to explain that and to get that. That counts for something; it doesn't support major increases unless the rest of the market is going in that direction too, but it certainly supports small incremental increases.

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Mark Douglas Hughes, SunTrust Robinson Humphrey, Inc., Research Division - MD [43]

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And then I did want to just express my regards for Frank. Congratulations and best wishes.

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Frank B. O'Neil, ProAssurance Corporation - Senior VP of IR & Chief Communications Officer [44]

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Thanks, Mark.

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Operator [45]

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Next, we have a follow-up question from Arash Soleimani with KBW.

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Arash Soleimani, Keefe, Bruyette, & Woods, Inc., Research Division - Assistant VP [46]

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I just wanted to ask -- I mean you guys have said in the past that each point of severity has a 3-point loss ratio impact. I just wanted to sort of clarify that. So are you saying each point of severity will have a 3-point impact on the accident year loss ratio? Or would that be on the calendar year loss ratio, including the impact on development?

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Howard Harley Friedman, ProAssurance Corporation - Chief Underwriting Officer, Chief Actuary & President of Healthcare Professional Liability Group [47]

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I think what we've tried to say is that because of the resolution period of claims, which is kind of a duration, if you will, of about 3 years, a 1 percentage point change in severity trends will translate through to a roughly 3x that in our ultimate loss ratio. So I would -- I mean, to answer your question specifically, I would say that, that is on an accident year basis.

Now of course, severity, if there is a change in severity, presumably, it's going to affect just -- not just the new claims, but everything that's being resolved. So you get a mix in terms of the older claims that are coming into a calendar year result. But I think, from a -- what we're trying to say in the theoretical sense is that the 1 point change in severity trend multiplies by -- I think, it's actually 3.2% is what we're saying in the expected loss ratio.

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Arash Soleimani, Keefe, Bruyette, & Woods, Inc., Research Division - Assistant VP [48]

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Okay. And is there a kind of a rule of thumb like that in terms of how to think about it for the prior year, the prior accident years?

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Howard Harley Friedman, ProAssurance Corporation - Chief Underwriting Officer, Chief Actuary & President of Healthcare Professional Liability Group [49]

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I suppose you could kind of construct a little bit of a model at the proportion of unreported by accident year. And if you assume that everything in each of those years was going to move up by 1 point, I mean, I think it's little tough to do this on the fly, but I think you could work out something there. On the surface, maybe it does translate exactly through; I just have to think about that a little bit more.

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Frank B. O'Neil, ProAssurance Corporation - Senior VP of IR & Chief Communications Officer [50]

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We're running real close to time here. So Debby, if we could take just 1 or 2 more questions, if there are any.

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Operator [51]

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Okay, there are no more in the queue.

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Frank B. O'Neil, ProAssurance Corporation - Senior VP of IR & Chief Communications Officer [52]

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All right. Thank you, everybody. We look forward to speaking with you in November when we report third quarter results.

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Operator [53]

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The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.