Good morning, everyone, and welcome to ProAssurance's Conference Call to discuss the Company's Fourth Quarter and Full Year 2019 Results. These results were reported in a news release issued on February 20th of 2020 and in the company’s annual report on Form 10-k, which was also filed on February 20th of 2020.

Included in these documents are cautionary statements 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. Please review those statements.

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 protection.

The content of this call is accurate only on February 21st of 2020, 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, I'd like to turn the call over to Mr.

Ken McEwen, I would like to remind you that this call is being recorded and there will be a time for questions after the conclusion of prepared remarks. Mr. McEwan. Please go ahead..

Thank you, Chuck. On our call today are President and CEO, Ned Rand; Dana Hendricks, our Chief Financial Officer; Mike Boguski, President of our Specialty P&C lines; and Kevin Shook, President of our Workers' Compensation Insurance Operations. Ned, floor is yours..

Thank you, Ken. I hope everyone has had a chance to review our news releases and 10-K because this call is going to be a little different. In the history of the company, I don't think we've ever had so much to talk about on an earnings call.

So we're going to avoid repeating too much of what's been reported in yesterday's announcement to leave as much time at the end as possible for questions. Before I turn it over to Dana for a look at our consolidated results, just a couple of comments.

For over 40 years, ProAssurance and its predecessors have navigated the peaks and valleys of a long cycle characteristics of our businesses. The two announcements we made yesterday, our fourth quarter and full year 2019 results and the NORCAL transaction, serve as an example of what we have always believed.

It is during the most challenging stages of the long cycle that the greatest opportunities arise. With that, we'll jump right in.

Dana?.

Thanks Ned. As we preannounced on January 22nd, we had adverse development that came out of our regular year-end review of updated loss data with internal and external actuaries.

This adverse development was largely attributable to increased reserve estimates for a large national health care account and to a lesser extent in our broader excess and surplus book of business.

Given this reserve strengthening, we reported a net loss of $59.4 million for the quarter or a loss of $1.10 per share and net income of $1 million for the year or net income of $0.02 per share. Our consolidated operating loss was $68.3 million for the quarter or a loss of $1.27 per share.

For the year, we reported a consolidated operating loss of $43.8 million or a loss of $0.81 per share. For the quarter, our consolidated current accident year, net loss ratio increased by 20.4 percentage points to 109% and the full year ratio was 90.3%, an increase of 6.6 percentage points.

Excluding the reserve adjustments related to the large national health care account, these ratios were 93.5% and 86.4%, respectively. We experienced unfavorable development in our prior accident year reserves of $30.4 million for the quarter, which drove the calendar year net loss ratio to 123.2%.

However, for the full year, we've recorded favorable development of $11.8 million. And our calendar year net loss ratio was 89%. Our underwriting expense ratio was 31.5% for the fourth quarter and 29.9% for the year. This brings us to a combined ratio of 154.7% for the quarter and 118.9% for the year.

In our Corporate segment, we reported net investment income of $21.6 million in the quarter and $87.1 million for the full year.

Due to the reserve adjustments recorded in the fourth quarter, we recognized a consolidated pre-tax loss for the year, which resulted in the recognition of a $21.9 million tax benefit from tax credits, which was the primary driver of the total tax benefit of $29.8 million for both the full year as well as the current quarter.

For more details on the results from our Specialty P&C segment, I'll turn it over to Mike.

Mike?.

Thank you, Dana. The Specialty P&C segment recorded a year-end 2019 operating loss of $147.9 million. This result was driven by our reserve strengthening in the fourth quarter of 2019 as referenced by Dana in her comments related to the large national account and excess and surplus lines business.

I want to be clear that the Specialty P&C segment had favorable loss reserve development of $45.8 million, exclusive of the large national account during 2019. In 2019, the new leadership team executed a comprehensive business strategy in response to emerging loss trends and changing conditions in healthcare professional liability.

This includes organizational structure enhancements, consolidation of operations, recruitment of additional talent and health care professional liability specialty underwriting, tightening of underwriting criteria terms and conditions as well, as price strengthening.

In early 2020, we introduced the field organization of the future for our healthcare professional liability business. We established four operating regions with regional hubs and reduce the number of offices from 20 to 10 across our operating territories.

We believe the strategic business decisions that have been made to date will improve the operating efficiency, pro forma expense structure and value-added service to distribution partners and customers. We expect to see the benefits of these actions in late 2020 and beyond.

We are encouraged by our early progress and we'll continue to execute this strategy throughout 2020 to position us well for the future. I will now update you on year-end 2019 results starting with the top-line trends. Gross premiums written were essentially unchanged as compared to 2018 finishing 2019 at $577.7 million.

The increase to gross premiums written in our physicians business is driven by solid production results and renewal rate increases. This is offset to some degree by the re-underwriting efforts in our health care facilities and certain sectors of the Excess and Surplus Lines business.

Gross premiums written for the other Lines in Specialty P&C were relatively flat year-over-year. Overall, we observed firming of the market in healthcare professional liability. However, this was offset by the excess capital in the space and pockets of intense competition, particularly in the physicians business.

Premium retention for this segment was 86% for the year, three percentage points lower than the prior year, reflecting our focus on underwriting discipline and our willingness to walk away from business that does not fit our risk appetite or longer-term profit objectives.

We were aggressive in re-underwriting our Healthcare facilities and excess and surplus lines business. As a result, the premium retention in our Healthcare facilities business was 62% for the year and 47% for the quarter.

Exclusive of the facilities business, premium retention was 88% in each of our physicians, medical technology and legal liability businesses for the year, a strong result in a market that remains competitive. We were also encouraged by renewal rate increases of 14% in our health care facilities and 6% in physicians our largest portfolio of business.

In our large account business, we achieved significant improvement in terms, conditions and product structure improving overall rate adequacy in that segment. We wrote $42.6 million of new business in 2019 compared to $47.9 million in 2018 reflecting our disciplined underwriting evaluation of the business presented to us.

Our physician new business was a driver at $25.1 million of writings during 2019. The increase in the current accident year loss ratio to 105.5% was due to the previously mentioned underwriting loss for a large national account and to a lesser degree adverse loss trends in our Excess and Surplus Lines business.

For 2019, the prior year adverse loss development related to the large national account was $51.5 million, which was entirely responsible for the $5.7 million of adverse development, recorded in the segment for 2019.

As previously stated in my opening comments, excluding the impact of a large national account, loss reserves developed favorably by $45.8 million. On a very bright note, we are extremely pleased with the exceptional underwriting results in our life sciences business during 2019.

We are excited to announce the NORCAL Group acquisition and look forward to the combination of the companies.

This is a transformative strategic transaction for both organizations and provides us with geographic diversification, a true national platform, significant penetration in the physician market, best-in-class talent, and high-quality distribution partners.

We look forward to working with the exceptional employees, distribution, and strategic business partners of both companies to create a premier organization to serve the health care market, ultimately creating long-term value for our shareholders.

Please keep in mind, the transaction is subject to regulatory approvals and other required closing conditions.

Ken?.

Thanks, Mike.

Kevin will you please lead us through the results of our Workers' Compensation Insurance and segregated portfolio cell reinsurance segments?.

I will Ken. The Workers' Compensation Insurance segment produced operating income of $12.5 million and a combined ratio of 94.7% for the 2019 year in a highly competitive marketplace.

During 2019, gross premiums written which includes traditional and alternative market business ceded to the SPC Reinsurance segment decreased 5% to $278.4 million compared to $293.2 million for 2018.

A consistent application of our individual account underwriting strategy which carefully assesses the underlying risks of each policy resulted in this production decrease in 2019. Correspondingly, new business writings for 2019 were $30.8 million compared to $51.5 million in 2018.

However, it's important to note that 2018 includes $11.7 million of new business related to the Great Falls renewal rights transaction. Audit premium was $5.7 million in 2019 compared to $5.9 million in 2018. Renewal price decreases were 4% and premium renewal retention was 83% for the 2019 year.

We continue to monitor closely historical loss ratio results on the business we renewed versus loss or non-renewed to determine we are retaining profitable accounts that value the Eastern service model. The increase in the calendar year loss ratio reflected an increase in the current accident year loss ratio from 68% in 2018 to 68.4% in 2019.

Net favorable reserve development was $7.8 million for the year. The 2019 net favorable loss reserve development reflected better-than-expected claim results primarily related to accident years 2015 and 2016.

The claims operation closed 65.7% of 2018 and prior claims during 2019, the best planned closing result in Eastern's history and indicative of the short-tailed strategy embedded in our Workers' Compensation business model.

The increase in the current accident year loss ratio reflects the impact of renewal rate decreases and the effect of updated contract terms to our reinsurance treaty renewed in the second quarter of 2019, which included the addition of an annual aggregate deductible substantially offset by the previously mentioned favorable claim trends in 2019.

The full year 2019 underwriting expense ratio increased to 30.4% compared to 29.9% in 2018; primarily due to an increase in policy acquisition and employee benefit related costs.

The Segregated Portfolio Cell Reinsurance segment operating result was $3.5 million for the 2019 year which represents our share of the net operating profit of the Segregated Portfolio Cell Captive programs in which we participate to varying degrees.

Gross written premium in the SPC Reinsurance segment increased to $87.1 million for 2019 from $85.1 million in 2018. This includes premium renewal retention in 2019 of 91%, new business writings of $3.8 million and audit premium of $2 million offset slightly by renewal rate decreases of 5%.

The 2019 calendar and accident year loss ratios were impacted by a $10 million reserve recorded in the second quarter of 2019 for an errors and omissions liability policy assumed by one of Eastern re-segregated portfolio cells.

As a reminder, the recording of this reserve increased net loss and loss adjustment expenses but had no effect on our operating results as we have no participation, or ownership interest in this particular Cell.

Year-over-year, the SPC reinsurance 2019 calendar year loss ratio increased to 54.4%, excluding the impact of the $10 million E&O reserve, driven by an increase in the current accident year loss ratio, partially offset by net favorable loss reserve development of $10.1 million in 2019 compared to $9 million in 2018.

The favorable development reflects better-than-expected claim results, primarily related to accident years 2015 through 2018. The increase in the current accident year loss ratio in 2019 is due to an increase in severity related claim activity.

Underwriting expenses and the SPC reinsurance segment represent the ceding commission paid to the Workers' Compensation insurance and Specialty P&C segments for the services they provide to the Segregated Portfolio Cells.

Ken?.

Thanks, Kevin.

Ned, would you please give us a quick update on Lloyd's before we get to NORCAL transaction?.

Sure, Ken. As you know for the past year, we've been looking at ways to reduce our exposure at Lloyd's. And as a result, we have decreased our participation in Syndicate 1729's operating results for the 2020 underwriting year from 61% to 29%.

During the one quarter lag, we'll begin to see the effect of this change comes through during our second quarter 2020 results. Duncan Dale and his team have built an excellent operation at Lloyd's as evidenced by the fact that he was able to secure additional capital providers for the Syndicate at a time when others struggled to do so.

We look forward to continuing our relationship with Dale underwriting partners under the new arrangement, which we believe is more in line with our operating goals for the 2020 year. In return, I'll talk a little bit about the NORCAL transaction. But before I do I'm going to get Dana to give us a little additional financial information.

Dana?.

Sure. Although, NORCAL will not file its year-end 2019 annual statutory statements for its group of company with the California Department of Insurance until March 1st it may be helpful for you to know that when they do, we expect it will show consolidated statutory surplus of approximately $575 million as of December 31, 2019.

That will reflect reserve strengthening for both current and prior accident years. Back to you, Ned..

Thanks, Dana. We've always been selective in our approach to M&A activity growing where and more importantly when it makes sense to do so.

The increasing complexity of modern medicine, the shifting health care professional liability loss environment and the growing competitive importance of scope and scale in our industry make it an ideal time for two companies with decades of specialized experience to align their futures.

We expect this transaction to deliver multiple strategic and financial benefits, including enhancements to our scale and capabilities, expanded access to the high-quality California physician market and an expected $18 million in pre-tax synergies.

These synergies will consist of corporate and back office expenses, staffing and other cost areas such as technology and real estate along with consolidation of reinsurance and investments.

We anticipate the transaction will be accretive to earnings in the second year of ownership and over the long term generate highly attractive returns for shareholders. As Mike said, bringing the NORCAL Group into the ProAssurance's family of companies represents a transformational strategic opportunity.

I'd like to thank Scott Diener, President and CEO of NORCAL and his team for all their efforts to bring us to this point. Since, we first began discussing the possibility in the spring of 2018. I'd also like to thank Mike Boguski and his team as well. I know there's more to do, but the work that's been done to get us to this point is truly outstanding.

With this transaction ProAssurance gains a truly national platform and healthcare professional liabilities with operations in all 50 states.

It doubles the size of our physician book of business opening the door to the California market and simultaneously makes ProAssurance the third largest writer of healthcare professional liability insurance in the country.

As always, our due-diligence process on NORCAL's loss reserves in particular has been very thorough with both internal and external experts contributing to the project for well over a year. We believe the transaction valuation at this level is attractive. We expect the transaction to close by the end of 2020.

But we have a lot of work ahead of us to ensure a smooth transition. It was during the last true hardening of the market under conditions similar to those we proceed today that the merger between ProNational and Medical Assurance, created ProAssurance. I said before that this cycle feels different.

And we should not expect the markets to harden as quickly nor perhaps as dramatically as in the early 2000s. Regardless of how the next phase of the cycle manifests, ProAssurance will be prepared thanks to our commitment to early and decisive action.

While, we continue to navigate the challenges of an evolving market, we are confident that our strategy is the right one and we're excited for the next stage of ProAssurance's journey.

Ken?.

Thanks Ned. That concludes our prepared remarks. We are ready for questions.

Chuck you there?.

Yes sir. [Operator Instructions] And our first question will come from Amit Kumar of Buckingham Research. Please go ahead..

Thanks and good morning.

Can you guys hear me?.

Yes Amit. Thanks. .

Okay perfect. So let's start with -- I have some questions about the NORCAL reserves, loss ratio as well as the surplus.

So did Dana give the number of $575 million? Was that the surplus number you mentioned?.

Yes. Yes that's legitimate..

If I'm looking at this correctly, was the surplus for NORCAL at nine months $740 million?.

Yes. Yes that's about right..

So that's a $200 million shift which obviously seems like a material shift.

Can you just discuss a bit more was that based on your input or was that a number your team looked at the results of the deep dive and hence that was a pre-close adjustment?.

Amit, no. Absolutely not. The adjustments that they are taking in the fourth quarter are certainly adjustments that their management team views as prudent for them to do that is no way reflective of any input from ProAssurance..

Okay. The reason why I'm asking is, when you look at that level of adjustment. And even if you go back and look at the nine month development that in line adverse development, it was spread in 2018, 2017, 2016 and higher. So it seems there's something going on across the book in terms of loss tick.

And I'm just curious as to the level of comfort you have merging with a company which is -- which was running at historically the combined ratio of 100. And now recently is witnessing massive amounts of adverse development across multiple periods.

What gives you comfort that there wouldn't be additional issues as you merge and as you sort of kick the tires over the next several months and maybe uncover additional reserving strengthening?.

Amit. It’s Ned. It's a good question. One is, we've been kicking the tires for quite a while. So as far as the due-diligence process, it's been extremely thorough. NORCAL has been very forthcoming and open about the information that it has provided to us. And so that gives us a great deal of comfort.

If you look at the way that the transaction is structured, there's an initial base consideration of $450 million and then contingent consideration of up to $150 million that is subject to the development of reserves from the date of acquisition over a three year period.

And so to answer your very specific question of how do we gain comfort? One, it is through our due diligence process and understanding of how reserves are being held today but it's also through the structure of this transaction that we think gives us protection as well..

And so just maybe staying on that topic. As we go forward, do you expect – how do you expect to I guess look at reserving or claims, how the claims are being done differently? I would imagine you're contemplating meaningful changes or actions down the road for the NORCAL book..

Yes. So obviously, the transaction is subject to regulatory approval and a vote by the NORCAL policyholders and they will continue to run as a stand-alone company with no influence from us over that time period.

Once the transaction is closed we – I think under Mike's leadership, as Mike mentioned, some of the changes that we've made apart from the NORCAL transaction and reorganizing, restructuring the Healthcare professional liability business for ProAssurance.

And NORCAL will slot well into that new structure that we have becoming a West Coast region for us. But under the leadership in particular on the claims side of Darryl Thomas who has led claims for ProAssurance for – we were talking about this earlier 25 years..

Two more follow-up questions and I'll re-queue. The first question is NORCAL is California-specific. If you look at the market share and then you look at ProAssurance's market share, it's de minimis in California. NORCAL I think is 14%, 15% of that market in med mal.

When you think about the entire topic of social inflation, the changes et cetera, attorney involvement all the pressures you've been talking about, I would imagine their book would feel continued pressure on that front.

And I was curious if you had a view on social inflation as it relates to their States versus your States?.

One of the things that I think has been interesting about this kind of most recent round of social inflation is that it doesn't feel geographically specific. We have seen in our own book and the marketplace more broadly, large verdicts in places, where I would say large verdicts are not expected.

And so while it is true that kind of certain hot beds continue to be hot. The concept of social inflation is much more broad than that. Speaking about California in particular, California has some of the longest-standing tort reforms in the country as regards to medical professional liability. It was established in the '70s.

I believe has been challenged all the way up to the U.S. Supreme Court. And so it has a good environment for the physicians in that state to operate in, because of that tort reform and we're very comfortable with the marketplace..

Last question and I'll re-queue. In your opening remarks and in the slide show, you talk about accretion to EPS, et cetera.

Is there any way you can talk about what you would view this NORCAL book running at post-everything? And I'm just curious, do you think it turns in underwriting profit down the road, or is more of an investment income play? Thanks..

No, we absolutely think that over the long term, the performance of that book of business will line up with the performance of the existing ProAssurance book of business. And the objective across that entire book is to return an underwriting profit and get to that 10%, 700 basis points above a 10-year treasury.

I guess that's a little less than 10% right now. Returns for our shareholders and we're very confident in our ability to do that..

Okay. I will stop here and re-queue. Thanks for all the answers..

Thanks, Amit.

Our next question will come from Matt Carletti of JMP. Please go ahead..

Thanks. Good morning..

Good morning..

Just a couple of questions. One, I just wanted to go to the results in the quarter and just see if what additional color you could give us around that large national health care account that drove the adverse development. And even if not specific to that account, just help us understand kind of what is driving a loss of that magnitude.

I think we have a good feel for kind of the limits profiles and reinsurance profiles and your physicians' book.

But can you walk us through kind of what you're seeing whether in this case or broadly in the health care side? And then how we might think about reinsurance structures on that side of the business?.

Matt, it's Mike. Just talking about the Specialty business in general, there's no question as the physician's market has consolidated and there's been more capital and competition in that large account space that the loss volatility in general has been more volatile than the physicians' book.

And that's true with respect to severity and it's true with respect to just overall loss ratio results. With respect to the national account, it was -- at the end of the day on the reinsurance side, it was not a vertical severity insurance exposure, it was a unique structure that was more on an aggregate basis.

I will say this with respect to that structure, we have no others in our book of business. And it was a miss on the loss projections and attachment points. The pricing there was a unique structure and there were severity over that period that was maybe not as contemplated as well as we needed to.

And that really at the end of the day is the rationale for that result. We're encouraged that we've identified it we're certainly -- have looked at our overall specialty book of business to make sure we don't have any similar structures and we don't and we just have to take it from here..

Okay. And so in regard to that is there -- I guess that particular structure.

Is there any kind of -- are we close to any sort of limits on the account or reinsurance kind of capping it, or is it more of -- you guys have just put a good scrub on it put a lot of conservatism on it and you're at a higher confidence point in the reserving?.

It's the higher confidence point in reserving..

Okay. Great. And then just one more if I could, I guess, probably for Ned just shifting back to NORCAL. I'm curious if you could just update us on kind of your view of where the cycle is. I mean to me this is a very strong signal that you see light at the end of the tunnel, that you see things changing.

And I think in your words and I would agree it will take time. But maybe just kind of -- if you could frame kind of your decision to enter into a transaction like this alongside kind of your updated view on where the cycle is headed..

Matt, it's a hard question to answer just, because I think there are just so many unknowns but maybe talk about a couple of things.

On kind of the causation side of the market what people are labeling social inflation, we're encouraged that the broader P&C market is recognizing these trends, we began recognizing reflecting in our results and our pricing these trends back in 2018. And it's good that the rest of the industry is beginning to do so as well.

And so I think that will help certainly from the pricing environment. On the actual social inflation side to go to the jury behavior component where we are in the pendulum swinging up or back down is much harder to know. We've been through these cycles before.

And I'm my guidance thing says the pendulum's probably swinging up still with kind of where we are from a jury and trial standpoint. But that we are getting the traction and pricing that is needed to keep up with that shift. When it reaches its peak and if and when jury behavior changes or moderates that's a little harder to know.

But we feel like we're in a good position in reacting effectively to what is going on..

Okay. Well thank you for the answers and congrats for the deal and best of luck fitting at quiet integrated..

Thanks Matt..

And our next question will come from Greg Peters of Raymond James. Please go ahead..

Good morning.

A couple of questions; first of all on NORCAL, can you step back and provide us a sense of business mix? I mean what I'm thinking about is small group physicians individual practices versus mid and large-sized groups?.

Greg, it's Mike. We think one of the strategic advantages and benefits of this transaction for both organizations. It is the fact that NORCAL is primarily a physicians' market and has a much higher profile in the book of business on that side of it.

So when we look at it, we kind of believe that market -- the physician markets when we combine those -- that business has a lot less of a runway to go on price adequacy and the competitive issues out there than say some of the things that we're seeing in the -- especially in large account area.

And we think that's a good thing for us long-term because we would expect less volatility in that combined book of physicians business than we would in the large account sector. And roughly in rough terms, we're roughly 65%. If you look at ProAssurance, we're 2/3 Physicians and 1/3 Specialty.

Then when you kind of -- if you were to look back at the 2018 results and put the companies together would be more like 75% Physicians and 20% Specialty. So we think that's a good product mix going forward..

Thanks for that color.

One just follow-on on that point, we know that the physicians market has been a shrinking market most everywhere in the country, would you characterize the trends that have affected your business the physicians' business and most of the country also being relevant in California?.

Yes I think they are Greg. California is a little different. And that one of the things California does not allow is for hospitals to directly hire physicians.

So you do not see that phenomenon, but they are kind of workarounds that have been created where trust and other organizations are created that are affiliated with hospitals that will then employ physicians. But the physician market is a little bit different in that regard.

But yes, the same consolidation trends that are occurring elsewhere in the country are certainly occurring in California..

And just one other minor point, I should assume that most of the NORCAL book is claims made except perhaps a nose-coverage or a tail-coverage type of exposure?.

Yes. And then well there -- as Dana said they'll have their statutory statements filed on March 1 and obviously you can get a lot more detail about their book of business. I want to say statements as well..

So just a final NORCAL question for me and that would be considering the substantial reserve change that they're going to post at year-end 2019, that would suggest that their business has been underpriced and I'm not sure about medical malpractice in the state of California, but we know other lines of insurance in the state of California very hard to get rate increases approved by the Department of Insurance who is almost an adversary to the insurance industry.

I'm curious one about your perspective on whether the business adequately priced today.

They have enough rate in the pipeline, or two, how you view the negotiations and discussions going with the California Department of getting additional rate?.

Yes. So I think California is a reasonable and rational department and we'll look at the loss trends that underpin the results at NORCAL and allow NORCAL to take any actions that are appropriate. NORCAL's book of business is greater than just California. And I think that's important to recognize.

And if you have access to our press release on the transaction there's a small slide deck that's included with that. And you can see that in reality only 31% of NORCAL's business is California based business. So the other states are equally important.

And NORCAL as much an industry as rates have come down rather than filing reduced rates is used credit mechanisms within the discretion of the rate filings they have in place to lower that pricing, which is a lot of latitude and the ability to raise pricing. And that's similar to what we have done.

So we're confident that NORCAL will be able to take any steps that they believe are necessary. I don't want to get into the details of kind of their claims business, but we do have confidence that some of the things that have led to the results that they are posting are a little bit anomalous.

And they have the ability both through how they manage and handle claims and pricing to respond quickly to it..

And you didn't include an ADC cover in the purchase did you?.

We did not. Mike, yes, go on..

one, which we have less penetration in Texas that are attractive markets and we have limited penetration in Pennsylvania and NORCAL has a strong position there. So I think when you just kind of look at the overall geographic diversification kind of spread of risk on the book that will be helpful as well..

Great. Thank you for those answers. I'm just going to -- the last question sort of dovetails with some of the previous answers you provided about where we are in the cycle, and say, we don't know where we are. But you pointed out Ned that the company began to change its posture on the market back in 2018.

So we're now entering the third year of your -- if you will change posture more conservative or cautious as it relates to trends you were seeing in the industry regarding big settlements.

And for the most part as you -- as this process was evolving you were pointing out to investors that for the most part you weren't seeing those trends in your book, but you're seeing them in the industry. And so therefore you're exercising caution. Now that we've got 2019 in the books.

Can you say that you're still seeing the industry trends that are negative? And I think that's an affirmative, but you're not seeing that same trend show up in your book..

So I just want to be clear -- what we have said previously is that, we were seeing it in our incurred losses the loss reserves being established by our clients professionals, but had not materialize itself in a material way in our paid claims..

Okay. Sorry about that….

Yeah, no. Yeah and I would say that we are beginning to see severity tick up in our paid clients as well. So we -- the caution and the prudence that we have been taking, I think is proving to be justified. And so as we got into that year-end analysis, we did begin to see some of that.

And that really as Mike alluded to we had about $15 million of adverse development in our E&S book. And that's a contributor to that. We remain very, very comfortable with where our reserves are established. And as I said earlier that we're making the ground necessary and the price increases that we're seeing..

Great. Thanks for your answers..

Sure. Thank you..

And our next question will come from Mark Hughes of SunTrust. Please go ahead..

Thank you. Good morning..

Good morning, Mark..

Good morning, Mark..

Reflecting on that you're starting to see the severity in your paids.

Is 6% rate enough to cover what's going on here?.

Mark, it's Mike. When you kind of look at the severity trends, it is really unique by the sector of the business and the state. So we have seen lower severity trends in some states higher severity trends for example in the Specialty and Excess and Surplus Lines business. Overall, it's been ranging in that kind of 2% to 5% range.

And when we look at that we got 6% to 14%, 6% in position, 14% on the Specialty this past year. And I would say, we had a very strong January on the rate side as well that is above the severity trend. And the good news there as well is the frequency trend has been very flat or slightly down.

So we are from an underwriting perspective, clearly given up retention for the rate side -- for the rate adequacy going forward..

The other thing that I think is important I know that Mike highlighted is on the Specialty book in particular. It's not just the rate increases. It's the underlying structure of the policies with higher deductibles higher is that are the factor rate increases that don't get reflected in that rate increase number and I think that is important.

So when you combine the business that we're moving away from and the lessons that we're learning and making sure we don't repeat the same mistakes. The price increases and the structural changes that we're able to make on that E&S book, we feel like we're making out of it ground up..

How should we think about the -- go ahead..

I was just going to add we're -- from that perspective; we're about 70% through that book with our new leadership team in specialty. And we got a couple more quarters and I think we're making excellent progress on what -- both the premium rate increases and the structure changes..

And that 70% includes the facility book.

I think your retention was it 47% for the quarter? Do we see that for a couple of more quarters and then you're through it?.

That's correct..

How about the loss pick when we think about the 2020 in the Specialty P&C, a lot of moving parts clearly.

Can you give us some rough guidance on where that ought to be?.

I think as we kind of historically have done, part of it will be dependent upon the evaluation of the impact of the pricing we had over this past year and then the pricing gains we made in the first quarter. But I'd say, look at the accident year loss ratios for the business as a good starting point..

Last year's accident year loss ratios?.

Yeah. For the 2019 year..

And is that to include the -- what is it -- is 93.5%. Is that the right number I'm thinking about or….

I would strip out the large national account we gave you the details. Now, I don't have the numbers directly in front of me. I apologize..

Okay. I think I understand. Okay. I think that’s it. Appreciate it..

Sure Mark..

Thank you, Mark..

[Operator Instructions] Our next question is a follow-up question from Amit Kumar of Buckingham Research. Please go ahead..

Hi. It's Amit Kumar. A few questions. Just going back and better trying to understand the rationale and the timing of this deal. Was this -- you mentioned that you were kicking the tires for some time.

Was this in the pipeline for quite some time, or is this more Ned's vision of PRA 2.0?.

Good question there. So our discussions actually go back into 2018. And the process that NORCAL ran began in 2018. So it has been ongoing. As far as my vision, I will say that I'm extremely excited about bringing NORCAL end to the ProAssurance group. And I think together, we'll be a better stronger organization that can really be impactful..

That's helpful. The second question I have is -- and I might have missed it if you mentioned this in the opening remarks, they have 300 employees.

Maybe talk about what's the -- and again, I understand the sensitivities, what do you think about that? And also maybe talk about is there a one-way or a two-way breakup fee? And what's that number?.

Yeah. There is a breakup fee. It is I think $15 million. The employees -- so through the diligence process, one of the things you don't get to do is really know the bulk of the employees of an organization. And so we've had -- not had that opportunity. We've gotten to know the management team well. And the Board well, but really not the employees.

And so we're excited about the opportunity to begin to meet the employees. And Mike and I and Bob Francis will be making a trip early next week to hit the largest offices of NORCAL, so we have exactly that opportunity. I made a reference in my prepared remarks to kind of – bringing together the two companies that formed ProAssurance.

And in a lot of ways there are similarities here. And so we're going to find great talent across both organizations and we're excited to do so. But we do that with our eyes wide open and knowing that in order to extract the full benefit of this combination that we do have to find efficiencies.

And as we mentioned in our prepared remarks, we've got an $18 million bogey for synergies and the synergies will come from a number of places. But unfortunately one of those places will be staffing as we look at kind of the best-of-breed across both organizations..

And -- I'm sorry was that a two-way break-up fee, or is that a one-way break-up fee?.

Jeff?.

ProAssurance will be paid $15 million, if the NORCAL board accepts a competing offer. It's a one-way break-up fee..

It’s a one way break-up fee. Okay. And then last question I have is that I think, again I want to go back and talk about the legacy piece. I think all of us have looked at the reserves for quite some time. We understand the issues with asymmetric information. Why not consider like an ADC or an LTT or something which would give comfort to investors.

Generally, if you look at the deals historically there have been multiple instances where the reserves have gone sideways after a period of time and especially for a company which is just this level of reserve strengthening at year-end.

Why not consider a part of that, or why not even look at renewal rights kind of deals? Maybe just talk about the sort of the bigger rationale here on that front?.

You take it Mike. I'll....

Yeah, I think if you take a step back I mean I think all those – all those opportunities have been looked at. And I think that no final conclusions on that. So that – I think it's a really good point Amit.

But at the end of the day what Ned said earlier, I think is the most important piece, which is a very strong due diligence, a very good review of the company on the reserve side. And we feel comfortable with where we're at..

And again, ADCs and other things can make sense, but they have to make economic sense. And so you know, as compared to somebody that might have the opportunity to put on ADC I think the level of diligence that we have been able to do across the entire company is far greater..

Was there some urgency to the deal in terms of there being competing bidders et cetera? Was it an open bidding process which is coming to conclusion? I'm just trying to understand and I think Greg was the one asking about the loss environment and you're talking about the paids now reflecting some of the pressures.

I'm just curious, why not wait for the cycle turn? And again, I have to use that word carefully to get better data where you can say that okay we're getting closer to the trough now is when we benefit on the uptick in pricing and market conditions et cetera.

I mean, why not wait for that confirmation than do a deal at this point of time we are still trying to play catch-up with the loss trends?.

I guess part of the answer to that question really needs to be addressed to NORCAL in this instance, it's the seller. And answer to the first part of your question about urgency. Again, I'll go back to the conversations with NORCAL started in the spring of 2018, and culminated in the announcement that we made yesterday.

So I don't think anybody that sits around the table with our executive leadership team tell a sense of urgency I think what we felt was that we had a very good period of time over which to negotiate an appropriate transaction and do appropriate due diligence that gave us considerable comfort and executing the transaction that we have with the protections in it with the way that the consideration is put forth that gives us great comfort..

That’s all I have for now. I'll stop here. Thanks so much for the answers..

Thanks, Amit..

Our next question will come from Bob Farnam of Boenning & Scattergood. Please go ahead..

Yes. Hi, there. Yet another question on NORCAL. So it looks like in 2018, the direct written premium was $342 million or so and then growing in 2019 up to maybe $370 million. Given the reserve charge that they are expected to take and the market conditions. Any idea of what that would look like through 2020.

And if we assume that you close this deal at the end of 2020, how much of that book do you think will -- you'll be able to renew it or keep starting in 2021?.

Yes. Bob, its Mike. Talking on 2020, that's obviously going to be determined by the NORCAL team and what their underwriting strategy is throughout 2020. As we get to 2021, if we're successful in the close, we're going to certainly implement our combined underwriting strategy within our underwriting structure.

And, obviously, we'll evaluate that very closely at that time. And I think, clearly, in this marketplace, the way we've assessed it today is, there is emerging severity. There is social inflation. There is a prolonged soft market here.

So I think the strategy would be, obviously, to move rates up and underwrite the book to our long-term profit objectives..

So, do you know -- can you tell us about the growth at NORCAL in 2019? Like how -- obviously, it's been a very tough market conditions. So they have pretty decent growth for the year.

Do you have an idea of what was driving that?.

Bob, the two numbers that stand out is that the new business was consistent with other years. It was a very strong retention result. And there is some rate coming through the books and it's primarily in the core physician market..

Okay.

And you said, ProAssurance is getting 6% rate there? Do you just expect that NORCAL is getting something similar?.

I suspect that that's a reasonable range of targets that they're considering on their book as they go forward..

Okay. That’s it for me. Thanks. .

Thank you, Bob..

And our next question will come from Ron Bobman of Capital Returns. Please go ahead..

Hi. Thanks. Well, the pricing and structure in loan due diligence process and the engagement of third-parties, all sound good to me. I had a question about --.

Thanks, Ron..

Yes, yes. I had a question about the earn-out, so to speak. If in fact that reserves prove out in favor of NORCAL, in essence the reserve estimates that NORCAL has positioned.

Will that be additional purchase price, the payment of some or all of the earn out?.

Yes, I just believe that will be additional purchase price contingent consideration. Again, its three years later, after the deal closes, paid six months thereafter. And, yes, it would be contingent consideration or additional purchase price..

Could you explain just -- thanks a lot -- could you explain in a little bit more detail the conditions upon which it gets paid, meaning it's the reserve as of closing proving to be adequate. Could you talk about sort of the sensitivity? Is it a sliding scale, et cetera, et cetera? Thanks..

All right. One second, Ron. Look, I'm just trying to get the timing of some things figured out real quick. So there will be a lot more details eventually in Q1. I think, at the end of Q1 we'll file the agreement. The way that it has worked, because there is obviously a lot of unknowns in the business that will be produced between now and closing.

There's a point in time of estimated reserves based on our view of reserves as of the end of 2019.

And then, their provisions in the agreement that are basically kind of projected loss ratios based on earned premium up through -- well actually that's a 2018-point estimate, 2019 loss ratio based, 2020 loss ratio based against earned premium that establishes kind of the baseline for reserves and then based on an actuarial assessment that is done three years post-closing relative to that number will be the determiner for that.

It would be easier to assume when you I think you see it in writing in our agreement..

Okay. And then -- and let's just say reserves are close, but are a little bit deficient, is there sort of a -- you end up paying 90% of the earn out? Is it -- it's not all or nothing I take it..

No, it's dollar-for-dollar. So, if from that kind of point estimate that I just described if reserves are on an after-tax basis, $10 million better than they'll receive $10 million. So, it's just dollar-for-dollar up through that corridor..

Okay.

So, I'm sorry, so it's the magnitude of favorable development off of that base level?.

Yes. So, for every dollar -- so, we've got a point estimate of what we think reserves are. For every dollar, the reserves that I would say we think is conservative. And for every dollar that reserves develop favorably. They get that.

So, it kind of locks in a pretty close-to-book value transaction at the end of the day I think when you consider the contingent consideration..

Okay.

And the last question is because of the reserve addition there, are -- I assume it will be stretched out, but are there some tax benefits -- that NOL type tax benefits that PRO or at least this book will enjoy going forward even if they are stretched out?.

Yes. So, you're right Ron, a lot of times in transactions they do get stretched out, but they'll have some -- they'll bring forward some tax benefits..

Okay. Thanks a lot and good luck. Sounds good..

Yes, thanks Ron..

Our next question will come from Amit Kumar of Buckingham Research. Please go ahead..

Thanks. These are my final questions I promise. Two quick follow-ups.

One is, is the management teams sticking around? And I apologize if you mentioned this in the opening remarks there's a lot to digest, are they sticking around for how much time or what's happening on that front once the deal closes?.

Yes, we've not made any disclosures or comments on specific personnel items..

Okay. That's number one. Number two just going back to the discussion regarding comfort on the book. NORCAL is to buy reinsurance historically if I look at 2014, 2015 and then they started retaining it all in 2016, 2017, 2018, and now.

Have you thought about reinsurance differently for that book or for the combined company? Any thoughts on that process or will the entire book be retained for NORCAL? Thanks..

Amit, its Mike. If we get to -- we're very hopeful to get to a year-end 2020 close. We will be going through our reinsurance process is kind of early into the fourth quarter of 2020. We're kind of locked up until then.

And then I think there will be a tremendous opportunity to evaluate both sides of both reinsurance contracts and decide what makes sense going forward for the combined organization..

And then would you consider buying more reinsurance at that time, or -- I know it's too early I'm just trying to like figure out how we should think about the premiums being retained over the two, three, five-year period of time..

Yes. I mean, there's – I just think it's too early to comment on that Amit. We have a full year ahead of us before the close and we'll evaluate the data and the frequency and severity trends in our capital position all the things that you evaluate in a reinsurance discussion. Then make the decisions then..

Got it. And then finally Amherst. Have you on – I think you realized your ratings to – or maybe the outlook one of those things to negative. I'm curious have you already had discussions on this deal with them? And again, I don't want to get ahead of the discussion and what comes out.

But has there been some preliminary discussion and have okayed the deal right now?.

So a couple of things there. Yes, we learned that a long time ago, the rating agencies don't like surprises. So yes, we've had conversations with the rating agencies. Okaying the deal or not really that's not their prerogative. They can take action, if they so choose but we don't go to them in those discussions for them to okay the deal.

They've had no comment, material comments so far. And we'll just – we'll wait to see what they do. We think again the terms of the deal are very, very reasonable. We're very, very comfortable with our capital position. We recognize that our earnings miss in the fourth quarter and for the year, we'll have some impact on their view.

But we've had discussions around all that with them and so we'll just have to wait and see what they choose to do..

Got it. And then just one finally.

On the reserves, was an outside actuarial review included in this process, or that's going to happen down the road?.

Yes, I'd refer you back to some of our comments around due diligence. We had I think on both sides of the table, internal and external experts and actuaries. And they obviously have an actual – an external actuary who signs an actuarial opinion for them..

Got it. Okay. That’s all I have. Thanks so much for answering all my questions..

Yes, no worries, Amit. Thanks..

This concludes our question-and-answer session. I would like to turn the conference back over to Ken McEwen for any closing remarks. Please go ahead, sir..

That's all we have. Thank you very much for joining us and we're very excited for the future..

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