Jul 31, 2009
Operator
Welcome to the Assurant Second Quarter 2009 Financial Results Conference Call. During the presentation, listeners are in a listen-only mode.
Instructions for posing questions will be given following the presentation. As a reminder today's conference is being recorded.
I would now like turn the call over to Ms. Melissa Kivett; Senior Vice President, Investor Relations.
Please go ahead Ms. Kivett.
Melissa Kivett
Thanks Lisa. Welcome to Assurant's 2009 Second Quarter Earnings Conference Call.
Joining me with prepared remarks are Rob Pollock, our President and Chief Executive Officer of Assurant; Mike Peninger, our Chief Financial Officer; Gene Mergelmeyer, our President and Chief Executive Officer of Assurant Specialty Property, and Chris Pagano, our Chief Investment Officer and Treasurer. Prepared remarks today will last about 25 minutes, and then we'll open the call to questions.
Yesterday, we issued a news release announcing our second quarter 2009 financial results. This news release as well as corresponding supplementary financial information is available on our website at assurant.com.
Some of the statements we make today may contain forward-looking information. And our actual results may differ materially from those projected in the forward-looking statements.
We caution you about relying on these forward-looking statements and direct you to consider the discussions of risks and uncertainties associated with our business and results of operations contained in our 2008 Form 10-K and subsequently filed Forms 10-Q and 8-K, all of which you can find on our website. The company undertakes no obligation to update or revise any forward-looking statements.
Additionally, the presentation will contain non-GAAP financial measures, which we believe are meaningful in evaluating the company's performance. For a more detailed disclosure on these non-GAAP measures, the most comparable GAAP measures and a reconciliation of the two, please refer to yesterday's earning release and the supplementary financial information that's on our website.
Now, I'll turn the call over to Rob.
Robert B. Pollock
Thanks Melissa and good morning, everyone. The second quarter of 2009 was difficult for us.
And we are especially disappointed by the operating results of Assurant Health. We understand the problems and are taking actions to return this segment to profitability as soon as possible.
In addition, we are implementing actions in all our businesses to improve performance while meeting the needs of our clients. We certainly understand concerns about the quarter's performance.
We share your concern. And in a moment, I'll address what happened?
But before I do, I want to mention that in evaluating the numbers, don't forget that our financial position is stronger, despite the unprecedented pressures in the economy and other negative factors. During the first six months, we've achieved annualized operating return on equity of 10.5%.
And our fully diluted book value per share has increased over 16% since year-end. Now, what's the underlying story behind the quarter.
Let me begin with Assurant Health. Higher utilization of medical services continued to negatively affect our results.
This was driven by three primary factors. First, people are visiting the doctor more often.
We believe this is likely related to a fear of losing health insurance. Second, doctors are increasing the number of tests for services performed when patients visits.
This maybe related to reductions in reimbursement for Medicare. Third, we experienced an increase in large dollar claims during the second quarter.
This maybe related to continued improvements in technology, as well as hospitals' need for revenue. While these factors are tied to the economy and consumer behavior in the marketplace, we should have recognized these trends sooner.
In our other businesses, the year-over-year changes reflect the decidedly different economic environment in 2009 than in 2008. In solutions, we're dealing with client bankruptcies, a dramatic slowdown in consumer spending and high unemployment in the United Kingdom.
In Benefits, small employers are struggling to stay in business, resulting in fewer additions to staff, reductions in employer paid benefits and higher utilization of benefits where employees fear losing their coverage. In Specialty Property, we've gone from an environment of bidding to acquire clients to dealing with servicers being consolidated and requiring more support from us.
With that as the backdrop, what are we doing and what is our view of the terrain ahead? Overall, we are implementing cost saving initiatives that will reduce future expenses by about $20 million pre-tax on an annualized basis.
The timing of these savings varies by business, but will begin in the second half of this year and be fully implemented in 2010. Now, let's talk in greater detail about each of the businesses.
I'll start with the Assurant Health. We have targeted some specific benefit plans for pricing and design changes.
Additionally, in response to the marketplace factors I mentioned earlier, our pricing will now reflect increased utilization of medical services. And we are negotiating provider arrangements to deliver more affordable services for our customers.
Assurant Health remains an active participant in the national debate over healthcare reform. CEO Don Hamm, continues to lead the AHIP task force on individual health insurance and has worked extensively with other key stakeholders inside and outside of Congress on the design and funding mechanisms for reform of the healthcare system.
Concerns about funding are causing policy makers to reassess the timing and direction of the reform, and we expect the extensive dialogue will continue throughout the remainder of this year. We are reviewing the impact of a number of possible scenarios for the final reform package and we'll adjust our business model to allow us to compete in the new environment.
We remain confident that individual medical insurance will play an important role in any new design. At Assurant Solutions, we remain optimistic about the growth opportunities in the wireless and the original equipment manufacture warranty markets.
We are seeing improvement in our domestic combined ratios. During the quarter, unemployment claims in the UK negatively affected our international combined ratio.
We believe this should begin to improve during the remainder of the year from actions we've put in place. At Assurant Employee Benefits, we saw improvement in disability experience during the quarter.
Our voluntary sales continued to gain traction, as they increased for the quarter and year-to-date. Gene Mergelmeyer is here today and will update you further on results in Specialty Property.
But I'll offer a few broad comments. We continue to support a stabilizing mortgage market.
The sheer number of changes underway in the market is a positive indicator. But the pace of decline in revenues from real estate owned properties has been faster than we expected.
Now, let me move to our investment portfolio and balance sheet, two areas of strength. This quarter's investment income is lower compared to 2008, in part because we continue to focus on shorter duration, more liquid investments.
We believe that this approach gives us the flexibility to earn better risk-adjusted returns going forward. With recovery in the credit markets this quarter, we were able to redeploy some of the portfolio's cash in the higher yielding assets.
Our capital position is solid. We began 2009 with about $230 million of capital at the holding company, and it has increased to $250 million at the end of the second quarter.
This excludes the proceeds we will receive from the legal settlement of 85 million. Dividends from our business units are weighted towards the second half of the year, allowing us to evaluate any changes to best capital model, portfolio results, storm activity and operating earnings.
At this point, we believe the best changes will be minimal, which should allow us to dividend the majority of Specialty Property's earnings this year. Our capital deployment priorities remain unchanged.
First, we want to use our capital to support organic growth. Second, we look for acquisitions to support our businesses and our third priority is to return capital to shareholders.
We increased our dividend during the quarter, but we did not buy back shares, even though we view as attractive at their current prices. Given the continued improvements in the credit markets since quarter end, we are very close to the level where we would buy back shares.
The amount of repurchase will be influenced as we enter storm season. In summary, despite the economic headwinds our focus is on adapting more quickly, improving operationally and taking actions to capitalize on opportunities when they are available.
With that mid-year overview in mind, let's now dive deeper into the results of each of our four businesses. I'll begin by turning it over to Gene Mergelmeyer to talk in greater detail about Assurant Specialty Property.
Gene?
Gene Mergelmeyer
Thanks Rob and good morning, everyone. At Assurant Specialty Property, we continue to have a strong business model that is producing very good returns.
We're focused on continuing to improve our efficiency and support our clients during this period of extraordinary change in the mortgage market. Our net operating income was $91.2 million for the quarter and 195.9 million for the first six months of 2009.
Both very good results, but admittedly not as spectacular as the first part of 2008. The decrease in our earnings is primarily, tied to slowing revenue.
So I'd like spend some time today and give you some insight into the trends of our top-line. Net earned premium decreased in the quarter and the first six months of 2009.
The loss of sub-prime clients that we previously announced, additional loan reductions and the decrease in real estate owned business, resulted in the decline of our premiums, despite an increase in some of the placement rates and the growth of our average insured values. We expect the premium levels to continue to moderate in the long run.
While loan consolidation has been slow in the first six months of 2009, we do believe that that trend will continue going forward. First and the biggest revenue driver was the number of loans tracked.
It continues to decline particularly in the sub-prime space. This reflects both loan losses that we previously disclosed on some of the high placement sub-prime loans, we lost to industry consolidation and a reduction in industry loan volumes resulting from virtually no new originations.
During the quarter, we did add 50,000 prime loans through consolidation that will slowly begin producing some premium in the third quarter. We look forward to producing premium from the previously announced 300 sub-prime loans that we want through an RFP process, with a small portion of the premium appearing in the third quarter and the full start of production in the fourth quarter.
Premium will be added on new, uninsured properties, and as enforced policies expire. Unfortunately, we were notified that our contract with the Merrill Lynch account will be cancelled effective December 31, 2009, as they consolidate the business within Bank of America.
This includes 230,000 sub-prime loans and premium on REO properties. We just received a notice and have no further details on the loss of the loan volume.
The second main driver in revenue is the number of real estate owned properties in both the market and our client inventory are shrinking. REO premium decreased from a high of 23% of gross earned premium in the third and fourth quarters of 2008 to 16% in the second quarter of 2009.
This is a function of real estate owned properties being sold and outpacing those moving out of foreclosure due in part the various state, federal and client initiatives. Actions have varied widely among clients.
Certain clients have done some bulk REO sales, while other clients continue under foreclosure moratorium during the entire quarter. REO has declined as a result of properties related to loan portfolios lost due to industry consolidation as well.
We believe we have likely seen the top of the REO premium. But production going forward could be somewhat variable as market factors affect foreclosures and property sales.
The third driver is catastrophic reinsurance premium that have been substantially higher in 2009, with $10.7 million of additional expense in the quarter and $23.6 million of additional expense for the first six months. These costs have increased due to three main factors.
We purchased additional coverage, commensurate with our exposure, we decided not to participate in the elective Florida Hurricane CAT Fund, and tickle fund, and we absorbed an overall increase in industry rates. All this was done to build a very comprehensive, catastrophic coverage.
As premiums continue to moderate to more normalized levels, we will look to be freeing capital supporting the business. In 2008, we're able to free about 70% of our net operating income.
This year, we're striving to increase that percentage. Current market conditions demand that we adjust our expenses to a more moderate premium level.
Our second quarter results include $3.8 million of pre-tax expenses related to the consolidation of several of our operations. This is expected to yield $5 million in annual expense savings starting in 2010.
We continue to work on additional technology and workflow initiatives, designed to continue to increase efficiency for the benefit of 2010 and beyond. During the second quarter of 2009, the loss ratio increased as a result of higher than normal frequency of smaller scale weather events, particularly wind and hail.
The ratio was also impacted by the increase in the catastrophe agreements. In summary, although our business has moderated, as we knew it ultimately would, we're focused on managing expenses, capital and continuing to produce strong results.
Our disciplined risk management and continued alignment with market leaders, positions us well to benefit as the mortgage market slowly returns to long-term health. Now I'd like to turn things over to Mike Peninger.
Mike?
Michael J. Peninger
Thanks Gene. Despite a fast changing environment, you and your team at Specialty Property continued to produce strong returns on equity and are taking the necessary steps to maintain your market leading position as the mortgage industry evolves and long portfolios are consolidated.
Now, let me turn to the results for the rest of the company beginning with Assurant Health. We are very disappointed to report a net operating loss for the quarter and minimal operating income for the first six months.
We noted in our first quarter earnings call that we based our March 31 reserves on the assumption that fourth quarter of 2008 claim cost increases were a temporary aberration and utilization rates would return to prior levels. Unfortunately, this has not proven to be the case.
The higher trends experienced in the fourth quarter continued into 2009 and have remained at levels which are significantly above historical norms. We now believe it is prudent to assume that these higher utilization patterns will persist and we have calculated our June 30 reserves based on that assumption.
In addition, we strengthened the reserves we are holding at June 30 for claims incurred prior to the second quarter by $9 million after-tax. With this strengthening, we believe that our June 30 reserves adequately provide for an incurred but unreported claims.
But changes in utilization patterns and costs have been significant. So we'll be closely analyzing third quarter development to ensure that this is the case.
In addition to adjusting reserves, we're taking targeted pricing actions across our book of business to properly reflect the increase claim costs we're seeing. We started implementing price increases in certain portions of the block late in 2008.
But it is clear with the benefit of hindsight that we underestimated the speed and magnitude of cost increases in a number of areas. In general, we have been hurt by richer benefit plans and by extended rate guarantees for certain plan designs.
So we're concentrating corrective action on those areas. We're also reflecting changes in medical practice patterns in our base pricing.
We're seeing more tests and procedures being performed for certain diagnosis and shift towards more extensive testing. We believe that these trends are likely to continue.
Given these steps we anticipate that Assurant Health will be modestly profitable in late 2009 or early 2010. However, the full extent of our actions will not be realized across our book of business until late in 2010.
We continue to monitor emerging experience and will make further pricing or plan design changes as appropriate. Net earned premiums at Assurant Health were down 4% for the quarter and the year.
The decreases were driven by higher lapses of both individual and small group policies, and lower average premiums for member, as consumers choose more affordable plans. Individual medical sales were versus the second quarter of 2008 as we continued to benefit from our broad distribution, expanded product portfolio and increasing numbers of employees leaving employer provided plans.
Future sales will be impacted by the economic environment, as well as our relative competitive position in the market. Despite a disappointing first half of 2009, Assurant Health remains focused on providing affordable healthcare options for consumers participating in the healthcare dialogue and taking the necessary steps to return to profitability.
Now let's move to Assurant Solutions. Net operating income at Solutions was down 14% for the quarter and 27% for the six months.
Part of the decrease for the quarter is due to higher than normal income tax expense driven by changes in the mix of domestic and international profits. Pre-tax results for the quarter were down 5% versus the second quarter of 2008.
The domestic combined ratio continues to improve reaching its lowest levels since the first quarter of 2008, driven primarily by the integration of our 2008 acquisitions of the GE Warranty Management Group and Signal Holdings. Both have helped to improve domestic loss experienced as we integrate our offerings to provide better service to our clients and customers.
The international combined ratio increased by 20 basis points for the quarter at 260 basis points for the six months, driven primarily by continuing the unfavorable loss experienced in unemployment coverage in the United Kingdom, due to the high unemployment rates and duration of unemployment there. Experience on a previously discussed unemployment products sold through a direct internet distribution channel continued to be poor.
However, we have exited this product and transferred all policies to another carrier effective June 1st of 2009. Our remaining risk on the product is combined claims for unemployment, which began prior to that date and we believe our reserves are adequate for those claims.
Like other Assurant businesses, Solutions have taken steps to reduce expense run rates. Second quarter results reflect $3.6 million of pre-tax restructuring charges in our domestic service contract operations.
We believe those actions will reduce our expense run rates by about $10 million per year. Turning next to revenue, net earned premiums decreased 5% for the quarter and six months.
The decreases are mostly attributable to the previously announced change in accounting for pre-need policies and unfavorable changes in foreign exchange rates. Absent these two items, net earned premiums increased 5% versus the second quarter of 2008.
Domestic service contract gross written premiums are down 38% for the quarter, reflecting the Circuit City bankruptcy and a slowdown in consumer spending, partially offset by growth in other clients. We continue to see positive sales trends in our pre-need business.
We recorded $29 million in gross written premiums from rating the forward payment protection forward advantage plan, which was launched and concluded during the second quarter. About $7 million of this premium was earned during the quarter and the remainder will be earned over the next three quarters.
International gross written premiums for the quarter were down 9% versus 2008, primarily due to the unfavorable impact of foreign exchange in the recessionary environment. We did see growth in gross written premiums in several countries and we're particularly pleased to begin to add premiums from our new credit insurance client, the Royal Bank of Canada.
Overall, Solutions continued to work creatively to maintain sales momentum in a challenging environment for consumer spending, while applying its risk management tools to improve experience in the UK as rapidly as possible. Now, let's move to Assurant Employee Benefits.
Net operating income was down 35% and 45% for the quarter and six month period respectively. The decline for the quarter was driven primarily by lower investment income and a $2.3 million pre-tax restructuring charge.
This restructuring will lead to about $5 million per year of ongoing expense savings beginning in 2010. Six months results were lower in the first half of 2009, due to lower investment income and higher disability loss ratios.
Disability incidence rates however have remained stable in 2009 and claim recovery rates approved during the second quarter. Net earned premiums were down 4% and 5% for the quarter and six months respectively.
Premiums are down in all product lines, reflecting shrinking payrolls and other economic pressures on the small employers. The employment picture will continue to pose challenge to the top-line growth in the Benefits business.
New hires and salary increases by our customers are important drivers of organic growth and net earned premiums. These trends have been hampered by the current economic environment as have overall new sales.
In this environment, we benefit from our voluntary product offerings. We've significantly increased our focus on voluntary products and are seeing increasing sales and substantial jumps in core activity.
Turning next to our corporate and other results. Corporate and other investment income declined $3.7 million for the quarter and $5.8 million for the six months due to lower short-term interest rates.
Net income for the quarter reflected an $85 million after-tax benefit from a previously announced settlement of litigation. Net income also includes a $13 million benefit for the quarter and an $8 million loss for the six months from changes in our tax valuation allowance.
This valuation allowance fluctuates for many reasons and changes from period to period can be expected going forward. Our investment portfolio benefited from improvements in the credit markets during the quarter.
Second quarter net realized losses were $4 million after-tax. The lowest quarterly total since 2007.
This included others and temporary impairments of $2.8 million after tax. Our portfolios net unrealized loss position improved by nearly $450 million pre-tax from December 31, 2008.
Our commercial mortgage portfolio continues to perform well, with no delinquencies through the second quarter. We continue to apply our disciplined approach to portfolio management and have been able to begin deploying our excess cash as credit markets improve.
Our balance sheet remains solid. Stockholders equity excluding and including AOCI increased to 4.68 and $4.36 billion respectively in the quarter.
We have no debt maturing until 2014, asset leverage of 2.9:1 and 17.3% debt-to-equity ratio. Book value per diluted share excluding AOCI increased to $39.38, up 6% from year-end.
In summary, our operating results for the second quarter were less than we had hoped for. Each of our businesses has already taken corrective measures and will continue to do so as appropriate.
Despite the challenges presented by the difficult economy, we believe that our specialty strategy remains sound and that we are well-positioned for long-term success. Now, I'll turn things back to Rob, to open the floor for questions.
Robert B. Pollock
Thanks Mike. Operator, we're ready for questions.
Operator
Thank you. The question-and-answer session will be conducted electronically.
(Operator Instructions). Over to John Nadel of Sterne Agee.
John Nadel
Hey, good morning, everybody.
Robert Pollock
Good morning, John.
John Nadel
Rob I guess the place that I'd like to start is the thoughts on sort of excess capital your progression that you've sort of historically talked about forever, supporting organic growth, accretive acquisitions, capital management. Is there anything right now on the M&A front that could possibly be better on a relative basis than buying back your stock?
Robert Pollock
It would have to be very compelling John. But, let's put that in a broader context of the strength of our capital position.
John Nadel
Yeah.
Robert Pollock
And then lets also have a few comments we can make really related to Chris and his team's view of the investment outlook, where we are today versus where we were a little time back. So clearly, we had indicated in the past that we wanted to see a credit market recovery before we made considerations for share repurchase, and we're seeing that recovery.
As I mentioned we've seen additional recovery subsequent to quarter end. So that's certainly one big consideration.
Another is just our ability to get dividends out and our other things, and I am going to have turn things over to Chris, for him to make a few comments.
John Nadel
Yes, if you could also touch on your comments A. M.
Best there, that'd be great.
Christopher Pagano
Sure, sure. Hi John.
John Nadel
Hi Chris.
Christopher Pagano
Just a couple of things. And again, we think about dividend, it starts with earnings obviously.
And clearly, there is some earnings pressure relative to 2008. But the next issue becomes how to get those earnings up in the form of dividends to the holding company.
Now, they are the two main drivers and we saw this pay out in 2008, where the growth charge related to Specialty Property and then of course, the portfolio results. And last year portfolio results in particular, were a significant drag, and a significant hindering factor with regard to our ability to get operating company earnings up to the holding company in the form of dividend.
Clearly, the recovery in the credit markets has mitigated that, removed that to some extent as an issue. The actions we took in the portfolio last year to reduce the risk going forward will certainly help us going forward.
And you're seeing our realized losses, drop off significantly and then also the unrealized loss position improved. So on top of that, as we mentioned, we're seeing the growth in property, relative to the industry is moderating.
Gene mentioned we got 70% of our net operating income up last year. We think having met with A.
M. Best a couple of weeks ago.
And although, the charges are not finalizing, still pretty comfortable that we'll be able to get even more, even greater percentage of the profits and property up to the holding company. So earnings are under pressure, ability to get out those earnings though, significantly improved versus last year.
So we feel pretty good about the ability to grow the holding company capital position through the end of 2009.
John Nadel
So then Rob, let me come back to you. And I know you guys have been talking about wanting to see credit markets get back to sort of the mid year 2008 level, sort of before the real devastation, I guess, we can call it, right?
Robert Pollock
Right.
John Nadel
But your investment portfolio is at least, in my opinion, far better positioned, relative to the broader credit market I think. And so, I wonder if that's -- is that the right -- not to necessarily question your judgment, but is that the right way you're thinking about it that credit markets have to get back to where you were then, I mean...
Robert Pollock
Well, I think a couple of things John. First, let's start with we've recognized the share price is attractive, okay.
And there is no doubt about it. On the other hand, what did we see happen over the course of a couple of quarters last year, alright?
Our total focus from thinking we have a lot of excess capital to a question of, did we have enough, alright? I think we're through those waters.
We want to be mindful however, that although there's been quite a recovery in the credit markets, as Chris tells me, perhaps things are a little ahead of themselves, perhaps they are not. We have been through the other way, it's possible.
Saying all that though, as I mentioned, we're about there, okay. And please be mindful of thing.
And we also are mindful that we're entering storm season. And...
John Nadel
And I definitely appreciate that. I mean, I don't think I'm trying to encourage you guys to spend a 100 million or 200 million on buybacks, right in front of the potential of something entering the Gulf.
So then to switch to health, just for a moment and then I'll get back into queue.
Robert Pollock
Sure.
John Nadel
You mentioned, sort of a return to modest profitability maybe later part of this year, early part of next year. And seeing the impact of pricing, work its way through the book, by the end of 2010.
Assuming you achieved the pricing implementation according to your plans currently, what is the -- what does the ROE return to, for this business when you get it fully through the book?
Robert Pollock
Yeah, we want to be in that 25 to 30% range, John.
John Nadel
Okay, alright. So, no real -- no change.
It's just a matter of getting this implemented and getting this worked through?
Robert Pollock
Yeah. Remember, we were putting lots of actions in place, alright.
We had to deal with things. We're committed to the healthcare business.
We think it is the specialty business that has performed very well for us over the long-term. And when I look at things, we picked up on these trends, quickly I think the magnitude of the changes were a little more than we thought.
John Nadel
Yeah. Okay, thank you.
Operator
We'll go to Adam Klauber of Fox-Pitt.
Robert Pollock
Good morning, Adam.
Adam Klauber
Good morning, everyone. A couple of questions.
On the Specialty Property, even if you expect some bad weather; it looks like your loss ratio was up by 300 basis points. What do you think is driving that?
Robert Pollock
Yeah. Well, I think there is a couple of different things, and I'll turn it over to Gene.
But one of things remember, when you calculate the ratio, is cap premiums are a bigger portion bringing down the net earned number, which is certainly a part of the impact item. And I'll let Gene give you a little more detail on some of the other things.
Gene Mergelmeyer
Sure Adam. Yeah.
That's I think the CAT premium's at about a percentage. We also again, it was an active weather period, even though they were smaller storms.
I can probable with last year, the ISO storms were about the same, but elevated from previous years we've seen. Or we actually really saw the increases and again, it was mostly wind and hail.
It was small storms. It actually tended to be more on voluntary products like mobile home and some of our voluntary homeowners from some of the wind and hail activity in the south.
Adam Klauber
How much to the total do you think this storms, weather added to the loss ratio this quarter?
Gene Mergelmeyer
Really when we looked at, it was almost the entire increase.
Adam Klauber
So you think it's really --
Robert Pollock
Yeah, I think, another one. Gene is also -- we talk and above creditor-placed.
But he's been working on other adjacencies in his business. And he has other things kind of legacy businesses, and they like the mobile home.
So as creditor-placed becomes a little bit smaller portion of the total, those other businesses don't operate with quite the same business model that we see in creditor-placed homeowners.
Adam Klauber
Okay. Is there an element as REO and sub-prime runs off, are higher profit, profit segments of the business.
Is that impacting the loss ratio?
Robert Pollock
No. That really hasn't had any real impact on the loss ratio.
We typically had comparable combined ratios across both the REO and the regular hazard place business. It can vary by individual clients.
And so, you can get some variability based on adding or losing portfolios.
Michael Peninger
You really do need, as Gene said, to look at the combined ratio to, because they do have different mix of claims and expenses.
Adam Klauber
Right, okay. On the health, I assume it takes roughly a year to put the rate increases.
And is there any seasonality where some parts of the book renew more heavily, so you can get them in earlier, or is it really more of a year to get that?
Michael Peninger
Individual it's pretty evenly distributed. In a group business, even though these are a small group, there would still be a bit of a skew in terms of first part of the year, because a lot of companies do think on a calendar year basis.
But individual, it's pretty evenly distributed.
Adam Klauber
Okay. And what do you think that's going to do to the growth rate?
Robert Pollock
Are you telling about the health business Adam?
Adam Klauber
Yes sorry.
Robert Pollock
No, that's right. I look at it and say, health is such a dynamic marketplace right now.
We've seen our sales pickup in really some of our offerings that consumers are targeting and what they can afford to pay? I don't know, but that's so.
That's going to be particularly impacted. On the other hand, there is other sales that can be and as we make changes, others make changes.
What we're very good at and have spent a lot of time on, is the consumer segmentation. And I think our insights there will put us in a position to continue to bring new products to market.
Christopher Pagano
Yeah, we've just to amplify on add a little bit. I mean, we have a line of different plan designs, ranging from very comprehensive and quite expensive plans to much more affordable plans.
So as I said earlier, we've seen some poor experience on the more comprehensive plans. So those price increases are likely to be more.
So we're going essentially the less expensive plans will be relatively more attractive price, although they are still going up to. So we've got a lot of ability to give a consumer a lot of different offerings so that they can pick where they want to be in the budget.
And we've been through these kind of things before, where we had to kind of more plan designs. And so, I think we have demonstrated over a period of time that we know how to make this kind of a shift.
Adam Klauber
Okay. Thanks a lot.
Christopher Pagano
Sure.
Operator
We'll go next to Ed Spehar of Merrill Lynch.
Robert Pollock
Good morning, Ed.
Edward Spehar
Good morning, everyone. Can you hear me, okay?
Robert Pollock
We can.
Edward Spehar
Okay. I have a few questions.
First of all, I was trying to get some clarification in response to John's question about share buyback. How did you say -- given where the stock is trading now, share buyback is a preference relative to an acquisition, unless there was something that was just beyond anything that we've seen before?
Robert Pollock
I guess that the way we think about it is we have a way to look at share buyback. And we have a way to evaluate acquisitions, okay.
At these levels, the share buyback is very compelling. And we, of course we compare the two.
And we also understand that the share buyback involves little risk. And so that is a consideration and if you were to do something different, you'd have to bring that into account.
Edward Spehar
Okay. I guess, it certainly does seem like it would be very hard to come up with something better than this right now.
I guess, the other question I had was on the health business. I think Mike when you had -- were characterizing the first quarter results, I think they were down.
I can't remember exactly, but maybe $20 million year-over-year, or 15, $20 million and you identified the incidents issue as the driver. And I guess, what I'm trying to understand is, you've always been conservative and reserving, and when you look at a reserve increase this quarter, obviously the health earnings were -- the health results were poor.
But a $9 million reserve increase, doesn't sound like a big number. And so, I was wondering how you can give us some comfort on that this is not just the first of a couple or more reserve increases in this business?
Michael Peninger
I guess what I think about Ed was -- I think about the reserves is, the bulk of your reserves are for the most recent quarter of imperials. So in this case the claims that were incurred for services in the second quarter.
And we've been moving in response to the experience. We've been moving our estimates of the most recent experience up.
So that when we talked about our strength, we are really kind of bulking up what I would say is the reserves for prior periods. So in this case for claims incurred in the first quarter is very small still left for 2008.
So we've been added into there. But we've also added, I just didn't characterize it as strengthening per se, but we have ratcheted up our estimates of the second quarters incur also.
So I think when we look at the overall level of reserves now, we feel that we're not going to continue to have unfavorable development that would flow through future quarters earnings.
Edward Spehar
Is it too much of an over simplification to say that, if you lost 10 million in health and you had been earning about 30 million, that $40 million is roughly the issue here, with 10 million in reserve strengthening and that 30 million being at current period, adverse claims?
Michael Peninger
It's something like that. I mean, yeah, I'd say that's -- if you look at our experience in the, like in the run-off that we published and exhibit in our 10-K.
We've had consistently very favorable development there. I think last year we were in the somewhere north of 50 million of favorable development, when I can see anyone near that this year.
Robert Pollock
We'd likely do not see any.
Edward Spehar
Okay. And then just real quickly, I know that it's been your policy not to give earnings guidance.
And I don't know that I am necessarily looking for earnings guidance in the sort of traditional sense. But I guess there are obviously a lot of things going on in the Specialty Property business.
And you have the ability, given the accounts you're loosing and accounts you are gaining, and how we might see the penetration rates migrate back to a normal level versus what we've seen historically? Is there any way to give us some sense of how low the earnings go?
Even if its not, this year or next year, the following year. But any sense based on what that might be helpful to help to try to quantify how far that the earnings go down before they start to go up again.
I understand it's a difficult question and I'm not really asking you to do my job, I guess, I am a little bit...
Robert Pollock
I think a good way to think about this Ed is that, if we start with the capital behind the business. Okay, the capital behind the business is going to go down as premium moderates as Gene said, okay.
So if you look at what our penetration rate is today and reduced that to levels we saw. And I think we published for earlier time periods an idea of what the revenues would be, you can get -- that will have then an idea of the capital that might be freed in the business.
And I think we feel very comfortable that we can produce excellent ROEs on equity that would remain in the business. Now I'd also point out, Gene is working on adjacencies to build out.
So we are not sitting still to the decline in revenue that might be attributed to creditor-placed homeowners. We're trying to find other specialty niches within his area.
Edward Spehar
Should we -- when we think about this, and we can obviously do that now. But I just like wonder, when we think about the return to normal penetration rates, should we model it along the lines of the same time period it took us to get to sort of very high penetration rates?
Gene Mergelmeyer
Well, as I look at it there is a number of factors that come into play. So this is not going to turnaround overnight.
So as we look at some of the historical growth drivers around things like loan, penetration and average insured value. You saw the Wall Street Journal headline yesterday that said, house prices rise across U.S.
That's not going to change delinquencies and foreclosure activities certainly in the short term. And we do see those continuing to rise.
The biggest decline has really been around just some of the portfolio movement. And then REO has been kind of the wild card.
We imagine that REO has hit top levels. But that's going to still be volatile as it move forward, just because of things, the foreclosure activity.
There is still the option on loans out there. So we still think there is quite a bit a considerable run in this.
As we highlighted on Investor Day, we had historically good results. And we believe strongly that we'll continue to deliver those.
Robert Pollock
I just think Ed that again, let's remember, when we went public, health was driving our earnings. Gene has been out in front with tremendous results.
We were expecting with the actions we have taken in some of the things we have going on that, we're going to see other businesses in a position to improve their earnings.
Edward Spehar
Okay. Thank you very much.
Operator
We'll go next to Mark Hughes of SunTrust.
Robert Pollock
Good morning, Mark.
Mark Hughes
Good morning. How are you?
Robert Pollock
Good.
Mark Hughes
In the consumer warranty business, just looking at the existing clients, what are you seeing with respect to buying pattern as we progress through the recession. Consumer spending has obviously been pretty choppy, how about warranty attachment rates, any observations there?
Robert Pollock
It varies on a client-by-client basis, Mark. I would say historically we have seen a pick up that would replace say 15 or 20% of the loss.
I think that maybe has not been quite as good in this turndown. On the other hand, we're seeing a number of clients that we're working with, who've been able to actually increase their sales with some of the things we've done around the performance management area on the sales side in Craig's area.
I think that's a testament to the value of the products we're providing. The wireless area, which we're very excited about is, actually continuing to see an increase in units sold there.
We're excited about the opportunities offered by that. And then the OEM side where we get a chance to actually to be in a position to sell a renewal, we're seeing some early positive signs in that area, as people are holding their products longer.
So tougher on the retail side, but some other things that we think where we're positioned ourselves to capitalize on that could really help us.
Mark Hughes
Could you elaborate on the wireless business? I think the market share opportunity was very attractive there.
Any insight you can give about how that's progressing?
Robert Pollock
Well, again there is a small number of large players, which really hits on one of the things we're good at, which is working with large partners and things. So we have put together our proposal and value proposition that's uniquely geared toward each of these people remembering that these things are quite often on large, long-term contracts.
So it's a timing issue, in terms of being prepared to capitalize when contracts expire.
Mark Hughes
Thank you.
Operator
We got to Rob Polley (ph) of Sandler Capital.
Robert Pollock
Good morning, Rob.
Unidentified Analyst
Good morning. How are you?
Robert Pollock
Good.
Unidentified Analyst
I just had another follow-up question on dividends from the sub, especially, in the Specialty Property and casualty business. And you alluded it to little bit when you're talking about penetration rates going back to maybe more normalized level, and what amount of capital is needed.
I guess, in your prepared remarks you talked about perhaps, getting closer to a 100% of the statutory earnings, up to the health goal. But what about the prospects of maybe a special dividend?
How do you just think about the capitalization of that business and will you ask, I you can't tell me if you are going to get, because you don't know if are going to get an extraordinary dividend. But will you at least ask for an extraordinary dividend and what amount could that be?
Robert Pollock
Yeah, there are a couple of things Rob. I mean first, there is the amounts that we list as ordinary dividend capacity.
Of course, though that's a nice guide mark for people. That's not really what we ever do.
We always go in and ask based on what we think is an appropriate capitalization level of each of the statutory entities. So, again and I'll let Chris maybe elaborate on this a little bit further.
But we have a best charge that was putting us in a position to not get any of the capital out. And we're getting some movement there, and Chris you want to just make a few comments?
Christopher Pagano
Again, just to back to a little bit of history, 2007 because of the growth in that business, we took none of earnings up in the form of dividends. Last year we had a dialogue with Best in the first half of '08.
We were able to discuss with them, how to measure growth in this business. And as a result, we were able to dividend up as Gene mentioned about 70, 60 or 70% of the earnings into, up to the holding company.
Now, some of that again, the portfolio comes into play there. And particularly on the unrealized loss side for the P&C.
So that was a bit of a drag last year. So now you fast forward to 2009, we've had our discussions with the A.
M. Best.
There've been a couple of changes to their formulas, but very minor. The big drivers are going to be growth again, the growth charge being essentially the same.
But overall, growth declining relative to the industry. So that's a positive for our ability to get out of the capital.
So again, we think, and again, this applies to a lot of -- all of the operating companies, we think absent portfolio impact, and then in particular for property. The slowdown in the growth allows us to get at more of the earnings in the form of dividends, and therefore capital of the holding company.
And again, our long-term goal, our capital management velocity is anything we can get up to the holding company, we try and get up to the holding company, because its there where we have maximum flexibility, in terms of redeploying the capital.
Unidentified Analyst
Right, but there is the earnings that you are generate in, say 2009, and then there is just the overall capitalization of the business. So as you look forward and try to think about how much premiums you are going to write in 2010 or 2011, how are you thinking about just how that business is capitalized today?
Is it overcapitalized? How much of it is capitalized, and how much do you think you can get out?
Robert Pollock
Well, it's a good question the way I think about Rob is that that Best is not going to allow us to take it out until the business moderates. Okay, as it does moderate, it will we will get some of the excess capital out with a lag.
We've used rules of thumb just throw one out 40 to 45% of net written premiums is kind of a governor on capital requirements within Best. There is lot of things that then adjust to that, okay, overtime.
So the difference between that ratio and I just don't have the numbers in front of me, but and the actual capital we have in the business is money we think we can ultimately get out.
Michael Peninger
And that's on the statutory basis. There are some GAAP adjustments involved in that.
Unidentified Analyst
What is that number? I think it was close to 400 million around there, is that sound like or is it lower higher?
Michael Peninger
Are you talking about the GAAP adjustment?
Unidentified Analyst
No, that's that number that 40, I think you said 40% of premiums is what you had...
Michael Peninger
40 to 45%, yeah. I get Rob, I just don't have it with me.
But why don't we get back to you on that?
Unidentified Analyst
Thanks.
Michael Peninger
Sure.
Operator
We'll go next to Terry Shu of Pioneer Investments.
Robert Pollock
Good morning, Terry.
Terry Shu
Good morning. I have two questions.
First on the health side, for your line, the deterioration has been really quite substantial. I used to follow the managed care company, but I don't anymore.
But I mean, I remember following the trend well. And they've seen some tick up in utilization as well, but not to the same extent as your individual or small group health line.
Can you maybe explain a little bit, why it's been so severe for your book?
Robert Pollock
Sure. I think that if you put the big managed healthcare companies on a spectrum, they start with being a 100% on the risk, and as you move into through a series of products, they maybe sharing risk.
Terry Shu
Right.
Robert Pollock
And they may be just administering products. So when they see -- they're just not having the same first dollar impact that a 100% fully insured plan where we're all on the risk, participates.
Terry Shu
Right.
Robert Pollock
I think that's the biggest contributor, Terry.
Terry Shu
Okay. Because, I just -- I've been sort of looking at their trends and their kind of -- they always talk about their medical loss trend and all are, just hadn't picked up as much.
And I just thought maybe its more -- maybe it's a small group of the individual book has seen the greater impact.
Robert Pollock
I don't think its anything. It's more of very different nature of the business.
Terry Shu
Okay. The other question is back on Specialty Property; you've mentioned a few times that you are kind of resizing the business or the expense base.
And the premiums are moderating. I guess, it's more like declining rather than moderating.
So I've been working hard trying to do a kind of a trajectory for the next couple of years, really plotting out a loan track prime and sub-prime and forecasting placement rates and such. Is that the right way to do it, that the sub-prime kind of loans track will keep on declining?
You gave some data points on RFP. You're with the 300,000 and then the loss, the Merrill Lynch loss, the 200,000 plus.
That's more because of this sort of consolidation or new business. But just generally speaking, looking at the number of sub-prime loans out there, is it the right assumption that that population is coming down.
I just don't know how to conceptualize it?
Robert Pollock
Okay. Terry, I think the big thing to think about first is, let's consider outstanding mortgage loans and inventory.
So if you think about as an inventory new originations increases the inventory.
Terry Shu
Right.
Robert Pollock
And foreclosures and pay-offs reduce the inventory. Okay, so we don't think there is a lot of new sub-prime originations going on.
Terry Shu
Is that a permanent thing I would think so?
Robert Pollock
Well, certainly, it's a near term issue, as banks have tightened their binding limits. And Gene, do you have a few comments?
Gene Mergelmeyer
Yeah, I really do think, you're thinking about it right. We've tried to be very diligent in providing with the loan portfolio changes that have had big impact.
But outside of those movements, it really is a declining book. In the near term, we continue to see that declining.
Some interesting phenomenon was going on. I mean, some of the loans that are sticking now to the extent they've been modified and to the extent that now they've had some principal reductions.
There is some likelihood that they may stay in place for a little bit longer. We're seeing some of that trend as we move forward.
But whether or not we can make any firm conclusions on it, we'll just going to see from that. I think you thinking it about right?
Terry Shu
After going through that exercise, the numbers that are kind of drop out for me is that for the home owners gross premiums written, just kind of declined through 2010 before stabilizing. Now, I don't know whether my numbers are even close, but that's about the only way to do it, right, to plot out the population and then I kind of held the penetration rates constant by segment.
So clearly, the pressures are going to be there, because you're the portfolio shift from more sub-prime to more prime where the penetration rate is, substantially lower. Is that right?
Gene Mergelmeyer
You're thinking about it the right way.
Terry Shu
But I gather, you don't have any forecast or you tried to model it.
Gene Mergelmeyer
No.
Terry Shu
Can you give us some guidance?
Gene Mergelmeyer
Well, yeah I mean, remember how our model works here, is we get notified in arrear that a policy is getting placed so. I know I think if you think about the economic factors that are going on here.
One is the inventory, second is the economy. And unemployment is something that certainly could drive placement.
Robert Pollock
I think one of the other things you may want to do is go back to the Investor Day presentation, where we really tried hard to look at the different factors that influence our business. And there were some things we highlighted that will affect our premium in the macroeconomic environment.
So that maybe helpful.
Terry Shu
Right.
Robert Pollock
In the near term, we're again focused on what we can control. So we've been preparing for the additional 300,000 loans.
We're excited about it. But frankly, we are focused on a flawless implementation of those.
And then, we still believe, we're positioned for the long run. And we got a good business model, still excited about it.
Terry Shu
Right. So sufficed to say that we can really only look out, near term and longer term.
You just have to kind of build a conceptual model.
Gene Mergelmeyer
I think that's right Terry.
Robert Pollock
Yeah.
Terry Shu
Alright, thanks so much.
Robert Pollock
Sure.
Operator
Our last question is coming from John Nadel of Sterne Agee.
Robert Pollock
Good morning, John.
John Nadel
Good morning. I have to refocus, sorry.
The follow-up that I sort of wanted to get at was a little bit along the lines of Rob Polley's a question Rob. I understand your guidance or your commentary around the 40 to 45%.
But you've had this sort of growth charge built in there for some period of time now. It appears at least, maybe this is a two part question.
Gene, you talked about some of the trends, I think in response to Ed, is this business permanently shrinking now? And if it's permanently shrinking now, we can certainly debate the pace.
If it's a permanently shrinking now, then doesn't it make all the sense in the world that you'd be able to go take that growth charge out?
Robert Pollock
Okay. So, let's just think about the process with that.
That will pull together calendar year information on the industry. And it will look at what happened to overall growth in the homeowners line.
And then they are going to compare how our growth was versus the industries, I don't think they'll do that until next year. Chris, am I thinking about that right?
Christopher Pagano
Yeah, I mean I think -- and again, keep in mind this is growth relative to the industry, one year and three year numbers, a little bit lagged effect coming in there. But, in general terms, I think conceptually just thinking about it right in that as growth moderates and/or declines again relative to the industry.
The availability, the ability for us to take our capital from property equal to and in potentially beyond the earnings on a given year. But that probability increases as we go forward.
So, its -- but the constraint again, goes back to pay invest and their models. And those changing from year-to-year.
For example, this year we -- Best elected not to give full credits for the Florida Hurricane CAT Fund reinsurance participations. We decided that somewhere less than I think 87.5% in the insurance just because of some of the issues that Florida is facing.
Those are things that changed from year-to-year. The main driver though is growth charge.
We've had the dialogue. We think we're in the right -- a good place with Best, in terms of understanding that.
And it will just be a function of growth in this business, relative to the industry going forward.
Robert Pollock
Yeah, and I go back, again. I think Chris said this very well.
We, our goal is aligned to release the capital and move it to the corporate line as quickly as we can for maximum flexibility. So we are definitely focused on doing that, and we'll continue to do that moving forward.
And the good news is, we think we'll get more of properties earning well this year than last. And we'll do our best to get what we can.
John Nadel
So then, let me ask you this, in follow-up. So I think it's crystallized, that there is a lag involved here.
And we can whatever that timeframe is, whether its three, six, nine months, whatever it might be, there is lag involved here as A. M.
Best gets the industry did and proves out, there'll be growth charge is no longer a necessity here?
Robert Pollock
Right. And just to point it John.
It is a function of two things. The one here which we obviously see that, but they also look at the three year.
John Nadel
Yeah. So let me ask you this Rob.
So if you guys have the data, you guys know your business. You guys know how the number of track loans is moving in the other key items.
And notwithstanding the fact that A. M.
Best is going to come back at some later point and affirm what you guys already know. Is there some way that you guys can accelerate whether it's through commercial paper or some other method, not necessarily to get all aggressive here?
But again, recognizing where your stock is relative to the book value, relative to the growth in that book value. By the time A.
M. Best gets around to proving what you guys already know, who knows where the stock is.
I mean, I suspect it will still end up being very attractive. But aren't you losing out on an opportunity as you wait for a third-party to affirm a trend that you already see happening.
And given your financial flexibility that the cap, and otherwise isn't there a way that the company can essentially accelerate that?
Robert Pollock
An eloquent argument on where we think we are John. And again, let's just put it in the context of...
John Nadel
The environment we just came out.
Robert Pollock
Yeah. We're just seeing lot of stuff that was quite different.
But, we are focused on getting the capital freed as quickly as we can. Again, we think we've got compelling, enduring long-term value at this company.
And we'd love to capitalize on that.
Robert Pollock
So our capital position much stronger than it was six months ago. Remember how quickly that moved last year.
We can take all that into account.
John Nadel
Okay. Understood, thank you.
Robert Pollock
Sure. In concluding the business environment is as challenging as any we have seen in years.
But our experience and expertise in specialty insurance businesses, where we've delivered strong operating -- to my confidence we can and will regain our stride. We look forward to updating everyone on our third quarter call.
Operator
And this does conclude Assurant's second quarter 2009 call. Please note that a replay will be available as of 12 PM Eastern Time.
You may now disconnect.