Old Republic International Earnings Call INSIGHTS: CCI Product, Future Risk

On Thursday, Old Republic International (NYSE:ORI) reported its second quarter earnings and discussed the following topics in its earnings conference call. Take a look.

CCI Product

Jim Ryan – Morningstar: First question is on the CCI, first of all let me also mention that the new format is very helpful and hope you continue that. Regarding the CCI I see that the claims are up quite significantly over the cost. When you were doing the spin-off there was conversation or statements made that Old Republic still stood behind certain parts of CCI. Is there a point at which the CCI expense or claims is then transferred back to Old Republic Corp?

Christopher S. Nard – President and COO, Chairman, President and CEO – Republic Mortgage, Insurance Companies: Well, if you look at the SEC filing that we had for in anticipation of the spin-off, Jim, you will see that we disclosed the fact that we had moved the CCI business from a reinsurance standpoint from our General Insurance Group to the RFIG segment. However, in doing that we willfully limited the exposure of the RFIG CCI assumed reinsurance subsidiary to as I recall an 85% loss ratio, such that if the loss ratio were to exceed 85% cumulatively over a period of time, the General Insurance Group subsidiaries that were in fact involved with the CCI product would bear that cost as long as it exceeded the 85%. So, that has not changed. What we have done here in the tables that you see is that we’ve taken that entire CCI product experience and we have shown it as part. We’ve taken it out of the General Insurance business and we have put it into the RFIG business and that in effect is to adhere to or is required in segment reporting. So that’s what we think adds clarity to the various parts of our business and what is in run-off versus what remains in an active operating book. Karl, do you want to add anything to that?

Karl W. Mueller – SVP and CFO: Jim, the only thing I might add is that if you look to the footnote in the news release, it does in fact quantify the amount of pre-tax operating losses that remain with general insurance companies from a legal perspective.

Jim Ryan – Morningstar: Secondly, could you give us a annual run rate on the holding company expenses because it’s now — for the dividend, the debt, the holding company expense?

Aldo C. Zucaro – Chairman and CEO: Basically what you have Jim is we’ve got $550 million, maybe $560 million total debt structure, most of which namely $550 million is in that convertible debt issue that we put out in early 2011 and that’s got about a 4% all-in cost attached to it, so that’s $22 million and then you’ve got maybe $5 million or $6 million of internal costs for legal expense, accounting fees, some very little management expense since we don’t have a super structure sitting on top of the holding company here, so maybe you are looking at $30 million or so. Now, that’s offset to some degree by interest we get, we received at the holding company level from various insurance subsidiaries that are capitalized with the various debt instruments. And I don’t remember what that number is. But if you use $6 million, $7 million if you promise not to hold it against me that’s about what you are looking at. So, we are probably looking at $20 million, $21 million of net expense at the holding company year in and year out now that we’ve paid-off that $316 million of debt which was costing us close to 900 basis points.

Jim Ryan – Morningstar: It is 21 million plus the dividend cost?

Aldo C. Zucaro – Chairman and CEO: Correct.

Jim Ryan – Morningstar: And finally just as a update any thoughts on – any changes to the existing debt is there any thought about modifications or new debt or anything along those lines to alleviate the one issue there is with the mortgage insurance possibility being declared (solvent)?

Karl W. Mueller – SVP and CFO: We’ve looked at a number of options and have held some discussions, but at this point given our current liquidity position and we believe that we can adequately manage our way through for the foreseeable future without making any modifications.

Risk

Christo Fifer – Kingsdon Capital: I have two questions; the first one is for Chris Nard probably and relates to the CCI business line. The first is, the $1.2 billion that’s listed as risk in-force on your first quarter 10-K or 10-Q rather, I’m just trying to understand to make sure that the book of business that associates with Table B in your press release here. And then secondly, if you could comment at all on the tail of that business or at what time period we are likely to see that CCI portfolio run off?

Christopher S. Nard – President and COO, Chairman, President and CEO – Republic Mortgage, Insurance Companies: Let me do the last one first. The tail on that business – that business is written, traditionally is what I would call a full insurance policy that has a fixed stop loss associated with each one of the customers book of business. So that has unlike the regular traditional primary on the mortgage guarantee side of the business, that serves the function of truncating the tail as the business starts to burn out. So as we’ve reported in the last few quarters we have begun to see a steady consistent decline in the paid claims trends in that business and that’s driven largely by we think as we mentioned earlier on the burnout of the books of business that are still within those stop losses and then obviously accounts where they might have burned through the stop loss in its entirety that business is truncated but contractually essentially because of the stop losses on it. So that’s the thinking on the tail section of that business. I look to Karl to see on – I am not sure I followed the first part of your question trying to match the risk in-force with Footnote B, any restatement.

Christo Fifer – Kingsdon Capital: I guess just to clarify, I’m just trying to get a better sense of how the book will run down over time, obviously as you mentioned one way to look at that is just how your benefit and claims cost have all (indiscernible). I was curious, another way to look at it is how your risk in force evolves and the risk in force has been down significantly over the last couple of years. I was wondering if that’s a good way to track how the portfolio is shrinking over time.

Aldo C. Zucaro – Chairman and CEO: I think what you are seeing, this is Al. I think what you are seeing there (Cristo) in terms of the loss ratio, particularly in the second quarter of this year for the CCI. As Chris mentioned in his comments that was really driven by somewhat unusual amounts, certainly a much greater amount of provision for litigation expenses, which we have to defend against a couple of – at least a couple of lawsuits we have which we typically disclosed in the 10-K as well as the 10-Q; the biggest one of which as we disclosed is with the Countrywide Group of companies. What we have done there this quarter – what we did there this quarter was to in fact assume that the cost of that litigation namely the legal fees attached to that litigation would continue for a more extended period of time. The other thing we did has to do with the nature of the product in addition to the features that Chris mentioned before. There are two distinctive features to the CCI product in addition to as I say what Chris mentioned before. One, is the fact that anywhere depending on activity on individual accounts, but anywhere between 40% and 45% of the book is subject to some sort of retrospective premium adjustment which has driven by the level of claims activity and those premiums get adjusted on account by account basis, right. Each account moves and that’s what Chris was talking about when he says basically it’s pool insurance on account by account basis. The other distinctive feature of the business is that unlike mortgage guarantee when we paid a claim we’ve done with it. In the CCI product when we pay a claim, we acquire ownership to the note and that note gets put into salvage inventory and then we proceed to collect on that note. Now we don’t always collect, some time we don’t collect. If we do collect, we don’t collect the full amount of the note, but there is a relatively long tail aspect to that collection what we refer to as salvage and what we did this quarter as part of and which is one of the reason you see the loss ratio popping up to the degree that you see i.e., the expenses, the legal expenses on one hand, but the other thing was that we reduced the amount of expected salvage recoveries in the future and the reason we did that was because we feel increasingly vulnerable from the standpoint of the employment picture in this country et cetera et cetera and of course as you know whenever people don’t have a job, their ability to meet their continuing obligation has reduced and therefore we said to ourselves listen, we better lower our sights as to how much salvage and subrogation we may have on this. Just one final comment to put it in perspective for you, we are (indiscernible) in that business. We are down to maybe 5 – is that around 5 or 6 comp salvage recovery expectation?

Karl W. Mueller – SVP and CFO: Yes, correct.

Aldo C. Zucaro – Chairman and CEO: Whereas in good years pre-2006 and so forth it was not unusual over a 15 or 20 year period after the payment of the claim that we would collect ultimately on any one years of salvage 20% or 25%. It is very slow track type of thing, but it is an asset of some value to the business. So, it is those two elements…

Christo Fifer – Kingsdon Capital: And the increased salvage loss you booked is that – am I correct in understanding that that’s associated with an entire pool of claims as opposed to a particular loss incident?

Aldo C. Zucaro – Chairman and CEO: Yeah, it is associated with all the claims that we have already paid and all the claims that are in reserve.

Christo Fifer – Kingsdon Capital: Then maybe just one other short question as it relates to your general business and the incremental reserves you took this quarter there. You mentioned that some of them had to do with your legacy business?

Aldo C. Zucaro – Chairman and CEO: We did not say that. We didn’t say anything about legacy business or the general insurance business.

Christo Fifer – Kingsdon Capital: Prior year business? You mentioned that some of the reserves had to do with the current loss year and there are incremental reserves related to prior loss years?

Aldo C. Zucaro – Chairman and CEO: Okay, so what we mean there is the reserves at the end of 2011 not developing as redundant as they had in the past. The level of redundancy is lower. And what we also said is that with respect to the current year that we were a little more, as I put it as I recall, a little more heavy-handed in terms of our expectations as to how much more reserves we needed for pharmaceutical and healthcare types of costs that are associated with workers’ comp business.

Christo Fifer – Kingsdon Capital: Are any of your incremental reserves associated with legacy (aspects of) environmental issues?

Aldo C. Zucaro – Chairman and CEO: No, we historically have not had a great book of A&E reserves at Old Republic.