Conifer Holdings, Inc.
Q3 2018 Earnings Call Transcript

Published: 11 Nov 2018

[Operator:]

Good day, and welcome to the Conifer Holdings Q3 2018 Investor Conference Call. [Operator Instructions] Please note this event is being recorded. I would like to turn the conference over to Adam Prior with the Equity Group. Please go ahead.

[Adam Prior:]

Thank you, and good morning, everyone. Conifer issued its 2018 third quarter financial results after the close of market yesterday. On the Company's website, ir.cnfrh.com, you can find copies of the earnings release as well as the slide presentation that accompanies management's discussion today. If you are looking at that presentation via webcast, you may find the slides are easier to read in the large slide view, which can be selected on the right-hand side of the webcast page. Before we get started, the Company has asked that I note that except with respect to historical information, statements made in this conference call may constitute forward-looking statements within the meaning of the Federal Securities Laws, including statements relating to trends, the Company's operations and financial results and the business and the products of the Company and its subsidiaries. Actual results from Conifer may differ materially from those results anticipated in these forward-looking statements as a result of risks and uncertainties, including those described from time-to-time at Conifer's filings with the SEC. Conifer specifically disclaims any obligation to update or revise any forward-looking statements, whether as a result of new information, future developments or otherwise. Also, a reconciliation of non-GAAP measures was provided with the news release. Statutory accounting data is prepared in accordance with statutory accounting rules and is therefore not reconciled to GAAP. We will conduct a Q&A session after management's prepared remarks this morning. With that, I'll turn the call over to Jim Petcoff, Chairman and Chief Executive Officer. Please go ahead, Jim.

[Jim Petcoff:]

Thank you, Adam. Morning, everyone. Joining us from the management team today is Nick Petcoff, Harold Meloche, Andy Petcoff and Brian Roney. Our third quarter financial results were very much the continuing reflection of our shift in business over the, business mix over the last year. We did this to reduce our volatility in earnings, while increasing our financial flexibility to pursue growth opportunities where we are performing above our industry peers. Over the last year, we accelerated the transition towards our more profitable, specialty commercial lines. We believe that shifting our business mix away from the wind-exposed premium and more heavily toward our core commercial and select personal lines businesses would better position Conifer for long-term profitability. Shortly, Nick will detail some of the specific elements within our underwriting lines, but I'd like to highlight our recent initiatives on a corporate level. First, in September, Conifer priced a public offering of $22 million aggregate principal amount of 6.75% senior unsecured notes. They mature in 5 years or 2023. We then exercised an over-allotment option for an additional $3.3 million. So in total, the Company received proceeds of roughly $24.3 million after deducting the underwriting discount. Our rationale for this offering was to lower our overall interest cost by partially repaying outstanding subordinated debt. This was very successful offering for the Company as we achieved our initial objectives of strengthening our balance sheet while providing greater holding company financial flexibility in a rising rate environment. With that, let me turn over to Nick and Harold, and then I'll return for a few closing remarks.

[Nick Petcoff:]

Thank you, Jim. In the third quarter, our shift toward our specialty commercial lines continued as planned. Commercial lines now represent over 93% of our gross written premium. Over the last 4 quarters, this percentage has been steadily rising as we focused on writing our best-performing business, whether commercial or personal. In the third quarter, we grew commercial lines gross written premium by approximately 5%, with noted growth coming from our specialty niche business and hospitality, particularly restaurants, bars, taverns, quick service restaurants and security guards. As we continue this transition and with a clear focus on the bottom line, our goal is to write more of our niche commercial business and expand in these core lines. This will help our company achieve scale, lower our expense ratio and ultimately lead to greater profitability and book value appreciation. The breakout of our performance within commercial lines has remained consistent since our formation, but the specialty niche focused mainly on the hospitality sector. This include liquor liability and bundled packages for restaurants, bars and taverns. We're the largest writer in our home state of Michigan in this line and are increasing market share as well as expanding our overall geographic footprint. Based upon the current market conditions, 1 of the areas where we see potential is in the western states, where the regulatory and pricing environment is favorable for these types of products we offer. Although we are able to write commercially in all 50 states, we want to remain flexible and price our products appropriately for underwriting profits. The overall pricing market continued to show moderate rate increases throughout many of our lines, with higher rates reflected in the commercial auto and commercial property sectors. The primary goal of Conifer for the immediate future is to take advantage of the infrastructure we now have in place. This includes pursuing potential renewal rights agreements in our specialty niche segments that are performing well. We recently executed 1 such deal in the security guards space. We've been underwriting these markets for years, and with our access and surplus lines flexibility, we believe we create a value proposition that is distinct from our peers. Overall, we are very pleased with the expansion of our commercial business and we see considerable runway for additional growth in our existing and new markets. Now, I'll briefly touch on our personal lines strategy and our continued goal of achieving [indiscernible] premiums written between commercial and personal lines. Over the past year, we have significantly de-emphasized our wind-exposed business. We've had our Florida and Hawaii homeowners book and non-renewals for much of the year and taken steps to reduce our exposure to successful Texas wind business as well. In total, our wind-exposed business decreased by 88% during the quarter and in 2019, will be a small percentage of our business. Overall, personal lines premium was down 70% for the period. As a result of this shift, gross written premium for all of our business is down for the quarter, but over time, we expect this will significantly improve our long-term profitability. An important component to our shift is that we reduced coastal exposure. As we reduce its coastal exposure, we expect to retain additional premium at a lower overall reinsurance costs. The reduction in personal lines exposure should help us reduce the wind risk for Conifer and help reduce our overall property cat spend going forward. Our combined ratio has remained elevated in personal lines, largely due to many factors in these coastal markets including greater-than-anticipated weather losses. We do remain committed to personal lines but focus mainly on low value dwelling opportunities in Texas and the Midwest. In our past experience, the balance of both commercial and personal lines premium has produced solid results for our shareholders across market cycles. And now, I'll hand the call over to Harold Meloche to provide a brief discussion of the financials.

[Harold Meloche:]

Thank you, Nick. In the third quarter, gross written premiums were $26.6 million. This was a decline from the prior year due to the 70% reduction in personal lines premium. However, as compared to last quarter, premiums remain flat. Net earned premiums were $23.5 million in the quarter, a $5.8 million increase from the prior year quarter as the $7.2 million ADC cost reduced net earned premiums last year. Conifer's combined ratio was 117% in the third quarter, compared to 207% for the same period in 2017. Before the deferred gain from the ADC and hurricane-related costs, our combined ratio was 104%. The impact of prior-year reserve development has been significantly reduced, due to the benefits of the adverse development cover. However, we were unable to recognize an economic benefit of $2.5 million in the quarter and $4.9 million year-to-date of ceded [ph] losses under the ADC, which was accounted for as a deferred gain. These ceded losses will be a benefit in future periods when we amortize the deferred gain into income. As of September 30, 2018, the Company has ceded $14.5 million under the ADC, leaving $3 million of cover in the event of future development. The Company's losses and loss adjustment expenses were $16.6 million in the quarter, compared to $26.5 million in the prior year period. Conifer reported a loss ratio of 69% this quarter, compared to a 146% in the prior year period. Last year's loss ratio was impacted by the reserve strengthening Jim noted earlier, as well as the cost of the ADC. Before the deferred gain on the ADC and hurricane-related costs, the loss ratio for this quarter was 58%. Our expense ratio was 47% in the third quarter of 2018, compared to 61% in the prior year period. We expect to see this number to decline over time as we continue to grow our commercial lines business and further implement cost reduction efforts. Net investment income remained largely flat at $786,000 during the quarter, compared to $768,000 in the prior year period. Our investments are conservatively managed, but the majority in fixed income securities with an average credit quality of AA and average duration of 3 years and a tax equivalent -- equivalent yield of just over 2.6%. For the third quarter, the Company reported a net loss of $3.6 million or $0.42 per share. Our adjusted operating loss for the period, which takes into account the deferred gain and losses ceded to the ADC, was $1.2 million for the quarter, compared to $19.1 million for the prior year period. Moving to the balance sheet, total assets were $233 million at quarter-end with cash and total investments of over $158 million and our book value was $5.41 per share. We had a $10.5 million valuation allowance against our company's deferred tax assets, or $1.21 per share and a deferred gain as a result of the ADC of $4.9 million or $0.57 per share. That represents approximately $1.78 per share that was not reflected in book value at quarter-end. And with that, I'd like to turn it back over to Jim for closing remarks.

[Jim Petcoff:]

Thanks, Harold and Nick. We are building the business with an eye towards accelerating growth on our topline in 2019. Our existing infrastructure is in place, our financing is completed and we are in a good competitive position to achieve solid profitable growth. We believe our -- our premium mix repositioning will help to maximize underwriting profits going forward and ultimately begin to achieve book value appreciation for shareholders. And now, we are ready to take any questions. Operator?

[Operator:]

We will now begin the question-and-answer session. [Operator Instructions] The first question comes from Greg Peters of Raymond James. Please go ahead.

[Greg Peters:]

I guess, as we look forward, 1 question that is worth asking is, there has been some hurricane activity in the fourth quarter and, and just if you, could you give us any impressions you have of what your potential exposure might be to that?

[Jim Petcoff:]

Andy?

[Andy Petcoff:]

Throughout the hurricanes, we've seen very, very little from a loss perspective, specifically on the personal line side. So far, since we've been getting out of that line of business in Florida, the numbers were extremely small. And I can let Nick talk to the commercial line side.

[Nick Petcoff:]

Yes, on the commercial line side, the losses we've seen to-date are small, typically food spoilage small business interruption type losses. Nothing that will be meaningful for us really moving forward.

[Jim Petcoff:]

In, in both hurricanes, to give you a little more color on it, I don't think we have 30 plans and as the 2, Nick and Andy pointed out, they're very small and they're more in food spoilage area. A lot of the quick service restaurants there we write are written excluding the wind. So, from a commercial line standpoint, we really didn't have a lot of [indiscernible].

[Greg Peters:]

Did you have a lot of TIV in that area or, I'm just trying to understand, because of the withdraw of large pieces of business, I'm just trying to understand where your exposures are, I guess.

[Jim Petcoff:]

Andy, why don't you talk about what we had in the panhandle and in the Carolinas?

[Andy Petcoff:]

Sure. Well, on the personal line side, it's really, there is a little bit in the panhandle, but with assumption book, lot of that business tend to be more stout Florida. So, we didn't see a large percentage of our portfolio initially in the panhandle to start. So, we had a very limited number of risks on a personal line side even in that area.

[Jim Petcoff:]

And those risks, the ones that we wrote, not assumption, but the ones we wrote…

[Andy Petcoff:]

[Indiscernible] voluntary basis.

[Jim Petcoff:]

On a voluntary basis, where usually newer buildings and they're better at construction, we just didn't see any plans or [indiscernible] any plans for that. We don't have a lot in the Carolinas either.

[Greg Peters:]

Okay. Just then the bigger question, it seems like some of the problems of the past are beginning to fade into the sunset thankfully, and I'm just curious about what your perspective is on sort of return of equity objectives as we think about 2019 for your company?

[Jim Petcoff:]

First, we expect them to be positive. Second, we expect as we continue to grow in our successful lines. The [indiscernible]. When you give up $20 million of homeowners business essentially over a 15-month period, it's kind of hard to manage that expense ratio much below. But when, if you think about us for '19, our cat buy is going to be way depressed. Therefore, the ceded premiums are going to be significantly lower. The business we're writing on a personal line basis has been performing well that we're writing going forward. And we have made significant underwriting changes specifically in a couple of areas that hurt us in '15, '16 on a liquor liability. We entered Montana, that was not very positive and in the Pennsylvania, there was kind of a change in the law with respect to,

[Nick Petcoff:]

The sanction.

[Jim Petcoff:]

No, the dram shop law with respect to, compared of negligence and went down to 1%. So, if the bar was 1% liable, that's only, it's part of the dram shop law. If the bar is 1% liable and they are 100% liable on a joint basis to pay the client. So, it became very difficult to defend any of those cases in Pennsylvania. So, we've made those adjustments. Both of those areas have been de-emphasized with Montana out. So, we look at our core book of business and where the loss ratios have been for the last 4 or 5 years. Now that we have history and the book of business and the earned premium and the unearned premium we have on the books should produce, will offset some of that we expected when we first entered this. So, we expect '19 to perform the way we expected we would perform from the beginning without the stumbles in Florida.

[Greg Peters:]

Great. Thank you for answers and good luck.

[Operator:]

[Operator Instructions] The next question comes from Paul Newsome from Sandler O'Neill. Please go ahead.

[Paul Newsome:]

Good morning. I was hoping you could talk a little bit of a follow-on with Greg's question but focused on the accident year combined ratio trend as we get into the fourth quarter and then into the third, I'm obviously not looking for estimates, those are kind of impossible. But if you could just talk, talk a little bit about what you think is the trend there? And, and I guess the follow-on is that, some of your peers have talked about increased general liability costs, particularly severity. That's kind of a change in the animal spirits of the legal system and I was wondering if you're seeing that as well.

[Jim Petcoff:]

If you think of it as the pendulum swinging from conservative to more liberal judgments, we're certainly on the liberal judgment side. It's, and you have to litigate these things further and it seems that litigation costs have gone up. So, all in all, we are seeing a trend in that, in that area. I talked about Montana and Pennsylvania and we're seeing the courts not being willing to give us, grant our motions for directed verdict, therefore, summary disposition just be, they just seem reluctant to do that. And as that goes, you end up with higher litigation costs and then you end up settling something or you take it to trial. We've had, I don't know, maybe 6 to 8 trials this year already and we've lost one and we've had success on the others. So, we are seeing definitely a change in the way the legal environment is. Having said that, it's extremely venue-specific. So, I talked about a couple of things with a couple of lines, specifically the liquor liability that are not -- have not been favorable to us as far as the development in the legal system. But when you look at the other states, we're still having success in Michigan, we're still having success in Colorado, we're still having success in Texas. And we're not seeing the same types of issues. So, we have become really sensitive to venues on all of our commercial lines of business and we're very targeted with where we're picking to deploy our capital and write our business. And sometimes you get smarter when you have a lot of hard knocks and we've taken some on the chin, but we've been able to work our way into a position where we're feeling way more comfortable with our loss ratios on the current accident year and for accident years to come, because of the change in the business mix. So that pretty much answers your question, Paul?

[Paul Newsome:]

It certainly does on the animal spirits thing, but what about the trends that we should think about for that -- actually your combined ratio? It's been bumping around sort of 99 to 102 in the last 4 quarters. And I was wondering, what do you think -- do you think you will get just below 100 soundly next year or should it be fairly flat, given the overall environment. Just your general thoughts on it.

[Jim Petcoff:]

Combined ratio?

[Paul Newsome:]

Yeah, the accident year; ex-reserve development.

[Jim Petcoff:]

Okay. Yes, we expect to be a 100 would be -- that's not our goal, that would be somewhat disappointing. We feel with the changes we've made in underwriting that we expect much better results on the loss side. And -- but for the getting off of all this business, the expense ratio would be much more acceptable and it is hurting us did not have an A- rating, because that seems -- that seems to be much more important after the 2008 financial or 2009 financial crisis. However, we mitigate that we get to write the business we want on a paper, but we have to pay a front-end fee for that. So, that front-end fee probably hurts us 2 to 3 points, maybe even 3.5 points a year on the expense ratio. So, as we go forward, our goal is to try to mitigate that expenses well. So, I would say on a combined basis, we expect to be sub-100 and sub-60 on the loss ratios.

[Paul Newsome:]

Great. Thanks. Appreciated.

[Operator:]

The next question comes from Scott Preston of Maven Group. Please go ahead.

[Scott Preston:]

Hi, good morning, gentlemen. Couple of quick questions. I'll just ask them all and then you guys can just answer them in order. Given the stocks trading roughly 25% below adjusted book value, would management consider a small buyback here, given your plans for '19 and beyond with growth picking up in book value accretion, it would seem like this would be good opportunity? The next 2 questions, when we expect to see the first flows reversing from the ADC development? And then finally, what would be a good assumption for growth rate next year, 2019, for commercial hospitality and then low value dwelling? Thank you.

[Jim Petcoff:]

Well, I'm going to take them in reverse order though. The growth rate for the commercial, I'll leave it to Nick if he thinks that it's going to pick up from where we are this year.

[Nick Petcoff:]

Yeah, I'd say next year on the commercial line side, we expect a high-single-digit growth on potentially -- on the 10% range. The hospitality side, that's probably about across the board. I don't think that between the small business and hospitality that you're going to see a big disparity between the growth, but on the overall basis, let's say, high-single-digits potentially up to 10%.

[Jim Petcoff:]

Andy?

[Andy Petcoff:]

On the personal line side, it's kind of difficult to say based on all the changes we've had over the last year and getting out of the few lines of business, but our goal is to be back up to the levels we were at in 2016 on the low value dwelling side in Texas and certainly grow the Midwest at single-digit rate over the next year.

[Jim Petcoff:]

Okay. And just --as we go backwards at least, you're asking about the ADC and when we expect to be realizing some of those -- that income. So, I think that's really a Harold question.

[Harold Meloche:]

Sure, absolutely. So, at the moment, we have about $4.9 million that we have not recognized that we will. Assuming everything stays the same, that'll -- that will amortize into income substantially over the next 2 to 3 years.

[Jim Petcoff:]

And now that I've gone backwards, I forgot your first question. Stock buyback?

[Scott Preston:]

Stock buyback.

[Jim Petcoff:]

I would tell you that everybody in this room would love to do a stock buyback. Okay? And the question is we have to model -- model out our cash flow and our expectations to make sure that we have adequate capital to sustain the growth because as I indicated on the expense ratio side, the A minus rate is hurting us, so we don't want to put ourselves in a more leverage position, because when you buy back the stock, your capitals are sound and so -- you actually get an accretion. I understand but the gross amount of capital goes down and we don't want to put our leverage ratios in a position where we are straining to try to keep our ratings, we rather try to grow our ratings. So, do we want to do a stock buyback? Yes. We think our stock is undervalued. And we think that we're in a good position. So yes, we would. Will we be able to? I can't answer that question and it's a -- it's a subject that comes up at the Board meetings on a regular basis.

[Scott Preston:]

Okay, thank you.

[Operator:]

[Operator Instructions] This concludes our question-answer session. I would like to turn the conference back over to management for any closing remarks.

[Jim Petcoff:]

Well, I want to thank the questions and I appreciate you guys listening in. I think we are in a good position and I hope you can see the progress we've been making and we expect the numbers to reflect that in the next -- in the near future, and appreciate you guys being on the call. So, thank you very much.

[Operator:]

Conference call is now concluded. Thank you for attending today's presentation. You may now disconnect.