#### Description

I think IPCC, a non-standard auto insurer trading at $30, is worth at least $48 in one year (and $60 in two), with 10% max downside. (This downside calc is explained in Note #7, but essentially my downside conclusion is based on tangible book being $23.70 per share by FY04 end and IPCC guidance of earning at least $2.90 in GAAP EPS on such per share book value). IPCC was spun-off from AFG about 1.5 years ago.

The reasons for my price-targets are:

1. Cash EPS of $3.40-$3.60 is about 15% greater than midpoint of FY04 GAAP EPS guidance of $2.90-$3.10. There is significant excess D&A due to one-time capital investments relating to software installment and other smaller items. Therefore, take q1fy04 D&A of $4.2m, run-rate is $16.8m, and subtract annual capex going forward of $1-2m. The result is about $15m, at 33% tax rate and using 20m shares, or $0.50 in EPS. If IPCC can make $3.50 in cash EPS, that’s a 16% ROE on tangible book of $20.70 per share.

2. Guidance is conservative given q4fy03 run-rate of $0.81. Given that the winter quarter should have the worst loss ratio because most accidents tend to happen in the winter and given that there is no seasonality in writing new business, IPCC should earn more than the q4fy03 run-rate of $0.81 in FY04. If one assumes $.85 per quarter, one gets $3.40 in reported GAAP EPS. Cash EPS would be $3.90.

3. IPCC has an excellent underwriting record over the last 10 years, on average being 2% redundant, ie over-reserving for losses by 2%, and the greatest deficiency in any one year being 3%. IPCC’s consistent over-reserving leads me to believe that the actual/economic combined ratio is really 2% points below the reported combined. (I explain the EPS impact of a reduction of 1% of combined ratio in middle of note #4 below.)

4. IPCC is still streamlining its business. It inherited a book of premium called the Assumed Agency Business from AFG, which amounts to 7% of premium earned. This Asssumed book has a combined ratio close to 100% while the remaining 93% of IPCC’s business is in the low 90s combined. If IPCC can lower the Assumed book’s combined to low 90s, the current combined ratio should decline by 1%.

IPCC is also still integrating the back office functions of several of its subsidiaries, which the company has indicated could lower the combined ratio by 1-2% from fy03 level of 93%. (One should use fy03’s combined because the combined ratio is seasonal, with the winter months yielding the worst because of the more difficult driving conditions.)

Therefore, given fy03’s GAAP combined of 93%, the reported combined should fall to at least 91% by fy04 end and annualize in fy05 (which should be realized by market when mgt gives fy05 guidance at fy04 end).

The actual/economic combined should then be 89% at most (I explain above that over the last 10 years, the combined has been 2% points lower than the reported combined). A 2% point improvement in the combined ratio from fy03’s 93% would yield an extra $0.65 in EPS (I take $246 in Net Written Premium, multiply by 2% and assume a 33% tax rate and 20m shares). From a tax perspective, being more conservative on the combined is beneficial.

5. Longer term option value of rising interest rates via the large investment portfolio of $1.45bn (includes $130m in cash) on 20m shares. A 1% increase in interest rates would yield an extra $0.48 in EPS (take $1.45bn in investment portfolio and multiply by .01, assume a 33% tax rate and 20m shares). Given that interest rates could probably rise 2% over the next 2 years, cash EPS would approach $5.00 if one assumes 5% growth over current run-rate in 2005. The company is guiding towards 5% growth in gross written premium in 2004 over 2003.

6a. Longer term option value of IPCC lowering its combined ratio to around 86% by writing more business in its Franchise states, which are the states in which IPCC focuses its growth and is writing most of its business now. The other categories are Resource States, Rate Maintenance States and Non-Focus states. These other categories are not growth categories. In q1fy04, Franchise states were $196m of $232m total written premium in the quarter.

Written/Earned Premium Loss/Combined Ratio

Franchise $196m/$180m 53%/86%

Resource $22.4m/$24m 50%/95%

Rate Maintenance $11.3m/$15.1m 81%/136%

Non-Focus $2.5m/$4.5m 72%/168%

Total/Weighted Avg $232m 55%/92%

Clearly, if IPCC can get its combined to 86% (remember that’s reported, actual would probably be 84%), which is 6% lower than q1fy04 combined of 92%, earnings would be 3 times $0.65 (mentioned in Note #4 above), or $1.95 on top of today’s fy04 cash earnings power of around $3.80-$4.00, ie $5.75-6.00 per share!!!!!!!! Assuming interest rates rise 2-3% points over the next 2-3 years, IPCC could be earning $1.00-$1.50 on top of that, ie $6.75-$7.50 in EPS, which I think happens in fy05 or fy06!!!!!!!!!

Therefore, I expect earnings in FY06 to be more than double today’s earnings.

6b. Given Jim Gober’s (current CEO who took helm in Jan 2003) excellent 10 year record running one of Infinity’s subsidiaries and the reported combined of PGR, MCY, DRCT, and BRW, which range from 75% to 85%, such results are not unattainable.

The combined ratio per year of Jim Gober’s subsidiary is as follows:

2002: 75.6%

2001: 93.7%

2000: 102.9%

1999: 86.3%

1998: 81.8%

1997: 90.1%

1996: 96.9%

1995: 103.3%

1994: 100.7%

1993: 95.9%

10 year average: 92.8%

7. Tangible book value should be $23.7 at FY04end and close to $28 by FY05 end, limiting downside to 10%. As of q1fy04 end, tangible book was $20.70. Given that IPCC will earn $3.00 in cash EPS over remainder of 2004, tangible book should increase to $23.70. Given IPCC’s guidance of at least $2.90 in GAAP EPS, which is a 16% ROE on avg tangible book value of $22 per share in FY04, I do not see IPCC trading below $27, which would be slightly below 2005 end tangible book of $28 per share.

8. Favorable Frequency trends are being perpetuated by higher oil prices, which cause people to drive less.

9. We’ve done a thorough analysis of reserves, with help from the company, and concluded that reserves are solid and could prove redundant by 1-5%.

Essentially, IPCC is a 5-10% net income grower in a very steady business, even through soft and hard markets, and on a run-rate to earn $3.90-$4.00 in cash EPS in FY04 and probably $5.00 or a bit higher in FY05. I think such a business deserves a p/e of 12x, resulting in my $48 target in 2004 and $60 in 2005. IPCC will probably grow closer to 5% per year over the next several years because of the current soft pricing environment, which is more than reflected in current price. (IPCC’s anemic growth, partially due to exiting unattractive states such as NY, which was a large source of adverse development, is the other reason for cheap stock price.)

The risk in IPCC is that irrational pricers enter the market, causing IPCC to lose market share and/or pricing power. I think such risk is low because the current non-standard auto pricing environment is already soft, leaving little incentive for new players to enter. If one wanted to hedge this risk, one could short Progressive, PGR, the leader and largest player in the non-standard insurer space.

If one looks at comparables, most trade north of 2x book and at p/e’s of 12-13x. Such comps include:

Price P/B FY04E P/E

ALL $43 1.4 8x

BRW $18 3.3 10x

DRCT $35 4.3 13x

ERIE $44 2.7 15x

MCY $49 2.2 15x

SAFC $42 1.1 11x

STFC $30 2.0 13x

PGR $80 3.2 12x

IPCC $30 1.45 7.56x (Using my FY04E $3.90 in cash EPS)

8. The after-tax marginal return on every dollar in premium earned in this business is 10-20%, depending on the interest rate environment and the combined ratio. For instance, if one assumes IPCC, on average, can earn 7% on its investments (which I think IPCC can earn if rates rise by 2% points and which I think represents a normal interest rate environment) and a 88% (actual) combined, the after-tax return on every premium dollar earned is just above 13%. The calculation is as follows. Each dollar that comes in has to pay out about $.20 in expenses immediately. The remaining $0.80 lasts about 2.25 years on the investment portfolio. Assuming a 7% yield, one multiplies 2.25 by 7% and then by $0.80, to get 12.6%. Add to that the 12% underwriting profit and take off 2% for charge offs and bad faith claims, ie net 10% in underwriting profit. Therefore total profit margin is 22.6% pre-tax, or just above 15% after-tax on every dollar earned, assuming a 33% tax rate.

#### Catalyst

FY05 guidance at end of fy04; rising interest rates

stock buyback; which the board is contemplating