Conifer Holdings, Inc.
Q4 2018 Earnings Call Transcript

Published: 2 Mar 2019

[Operator:]

Good morning, and welcome to the Conifer Holdings Fourth Quarter 2018 Investor Conference Call. [Operator Instructions] Please note this event is being recorded. I would now like turn the conference over to Adam Prior. Please go ahead.

[Adam Prior:]

Thank you, and good morning, everyone. Conifer issued its 2018 fourth quarter and year-end financial results after the close of market yesterday. On the company's website, ir.cnfrh.com, you can find the 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 product of the company and 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, in 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 the statutory accounting rules and is therefore not reconciled to GAAP. We will conduct a Q&A session after management's prepared remarks this morning. And with that I'd like to turn the call over to Mr. Jim Petcoff, Chairman and Chief Executive Officer. Please go ahead, Jim.

[James Petcoff:]

Thank you, Adam. Good morning, everyone. Joining us today from management is Brian Roney, Nick Petcoff, Harold Meloche and Andy Petcoff. Our strategy through 2018 has been to exit the volatile homeowners -- Florida homeowners market and shift their business mix away from wind-exposed premium in efforts to increase earnings visibility and reduce volatility. As significant shareholders ourselves, we aren't happy with the results and admit this business mix shift has taken some time to successfully implement. This happened because despite a three-year commitment to Florida assumption business, we are building a successful company for the long term, and as a result, we shifted our business logically and methodically to do so. With this positive business mix shift in place, our results of late have been impacted by select adverse development, and we've taken significant measures across the board to address. While we feel good about our premium mix going forward, we're very mindful and focused on mitigating pilots for future reserve development. In efforts to reduce claims cost and improve the economic outcomes, we focused on closing out as many 2016 and prior claims as practically reasonable in 2018, especially in the fourth quarter. Our thought process was to review each claim on its merits for the opportunity to successfully close today in efforts to reduce the ongoing claims costs and possible future litigation. By reducing the outstanding claims count so quickly, it has led us to utilize the full amount of the ADC in the fourth quarter. And this -- but then we still leave ourselves additional IBNR for future claims resolution. As we look back on the past year, we encountered several industry-wide challenges in select lines, mainly Florida homeowners, commercial auto to name 2. We've been making ongoing underwriting changes to exit the Florida homeowners and successfully re-underwrite and manage our commercial auto exposure. While these two lines generated sizable underwriting losses for us '18, which was more than 50% of our underwriting loss, we were pleased to see significant positive underwriting results in many other of our core commercial lines. Our strategy continues to be achieving a balance between growing our top line conservatively while simultaneously lessening our exposure to -- in unprofitable lines. At present, with moving away from the wind-exposed personal line, we continue to expand our core commercial lines business both geographically and by class. Have accomplished -- having accomplished business mix shift, we believe we can lessen earnings volatility and smooth the operating results going forward. The reduction in Florida premium has been offset by the increase in our core commercial business. Our book of business today is mostly comprised of our profitable commercial specialty niche products. We believe our loss ratios will continue to improve. Our total premiums are down. However, making a significant short-term reduction in our expense ratio is difficult. With the Florida and wind-exposed business already run off in 2018, we expect increased top line growth coupled with disciplined expense reduction, improved efficiencies and growth in our nonres grub. We are able to start making significant expense ratio reductions today. To say that Florida homeowners has had a significant impact on our financial results over the last several years is an understatement. With this behind us, we expect minimal development in the future. For 2019, with the planned changes in our premium mix currently in place, we believe that our business is now in much better position to achieve top line growth, greater scale and efficiency and most importantly, drive positive shareholder returns. With that let me turn this over to Nick and Harold, and then I'll return for a few closing remarks. Nick?

[Nicholas Petcoff:]

Thank you, Jim. Commercial lines grew as percentage of overall business in the fourth quarter rising to 95% of gross written premiums during the period. This is a direct result of our planned multiyear shift in business mix to focus even more on specialty commercial lines premium production. Throughout the year, Conifer's strategy has been to retain the business we want to keep at sustainable and profitable rate. For the full year 2018, we're pleased to achieve over 6% commercial lines growth during what has largely been a transitional year in terms of shifting our premium mix. In the fourth quarter, we grew commercial lines gross written premium slightly with solid growth coming from our small business and hospitality markets. While we continue to write commercial lines in all 50 states, we see strong potential for growth in the western states where we can leverage our access and surplus lines flexibility. We believe this will contribute to top line growth for 2019. As an example, we enjoyed significant growth in California during 2018. The breakout of our commercial lines production has remained consistent since our formation, with the specialty niche focus mainly on the hospitality sector. This includes the liquor liability and bundled packages for restaurants, bars and taverns. But as with exiting Florida homeowners, we have trimmed select states for certain liability lines as well in an effort to improve our underwriting results across the board. The key element is to focus on those accounts and agent relationships that are the most profitable. A primary goal of Conifer for the immediate future is to take advantage of the infrastructure we have. Our expense ratio has remained elevated, but with the return to anticipated growth in 2019, we expect improvement as we move to efficient operating scale. We're committed to lowering our expense ratio by first reducing our absolute cost in any way possible. This reduction of absolute costs will be coupled with select growth in our core commercial lines, which will grow our earned premium base over time. In addition, as our non-risk revenue grows, we can shift expense from our regulated companies to our non-regulated group. This shift will help lower our regulated operating companies expense structure over time. Overall, we see continued runway for new policy growth and select rate increases geographically on our existing and new commercial markets. Now I'll briefly touch on our personal lines. The personal lines business is now 5% of our overall gross written premium, which is down from 17% at year-end 2017. This is part of our expected business shift noted earlier as we have significantly de-emphasized our wind-exposed business over the last two years. The overarching goal is to reduce volatility in our operating results. Our combined ratio has remained elevated in personal lines largely due to many factors in these coastal markets, including greater-than-anticipated weather loss. In total, our wind-exposed business decreased by 86% in the quarter and will be a very small percentage of our business in 2019. Overall, personal lines premium was down 75% for the period. As for growth prospects, we continue to focus on developing our low-value dwelling products in the Midwest and Texas to complement our agency relationships in those states. Historically, this has helped us over several market cycles. As we continue this business mix transition and with clear focus on the bottom line, our goal is to write more of our especially commercial business and expand in our core select commercial lines. We believe that we can add value through solid underwriting coupled with strong active claims management to enhance our shareholder returns. For 2019, as we grow our business, this will help our company achieve scale, lower our expense ratio and ultimately lead to greater profitability and book value appreciation. I'll now hand the call over to Harold to provide a discussion of the financial.

[Harold Meloche:]

Thank you, Nick. As always, I encourage investors to review our filings for additional background including the 10-K when available. I'll provide a quick overview of the results, and then we'll open it up for any questions. In the fourth quarter, gross written premiums were $27.4 million, which was a decline from the prior year due to an 86% reduction in wind-exposed homeowners business. Compared to last quarter, however, premiums were up slightly. For the year, Conifer's combined ratio was 111% in 2018. The 2018 accident year combined ratio was 101%. Before deferring the gain on the ADC and before hurricane-related costs, the combined ratio was 103% in 2018 and 118% in 2017. The impact of prior year reserve development was significantly reduced by $4.6 million of ceded losses recognized under the adverse development cover. However, in 2018, we were not able to recognize an additional economic benefit of $5.7 million under the ADC. This benefit was deferred and will be recognized in future periods when we amortize it into income. As of December 31, 2018, the company had ceded the entire $17.6 million limit under the ADC, yet IBNR does remain to help cover additional claims. Before deferring the gain on the ADC and before hurricane-related costs, Conifer reported a loss ratio of 58% in 2018 and 75% in 2017. Again, before the deferred gain and hurricane-related costs, our expense ratio was 45% in 2018 compared to 43% in 2017. We expect to see this ratio decline as we continue to grow our commercial lines business and implement a number of cost reduction efforts. Net investment income for the quarter increased significantly by 27% to $911,000 compared to $720,000 in the prior year period. Our investments are conservatively managed with the majority in fixed income securities with an average credit quality of AA, an average duration of three years and a tax equivalent yield of just over 2.7%. For the fourth quarter, the company reported a net loss of $4.8 million or $0.56 per share. Both of our insurance company subsidiaries reported income, however, on a statutory basis, with a combined ratio -- combined statutory net income of $2 million and with a combined net premiums-to-surplus ratio of 1.4

[James Petcoff:]

Thank you, Harold. We realize the urgency of positive earnings and see a pathway to improved ROEs. Overcoming the decision to enter the Florida homeowners market has been a long painful process. We are confident in our current book and our position to grow conservatively while making progress on expense reduction -- expense ratio reduction. We are solely focused on profitably growing this company for the long-term benefit of shareholders. There's two important points. Development was from 2016 and prior, when we utilized the ADC with its unique accounting, not 2017 or 2018. Second, we continue to invest in Conifer personally and corporately, as we implemented and acted upon a share buyback program in late 2018. We believe that the initiatives we have put in place are the right ones, and our existing product mix -- premium mix and infrastructure will allow us to achieve solid profitable growth going forward. Now we are ready to take any questions.

[Operator:]

[Operator Instructions] Our first question comes from Paul Newsome with Sandler O'Neill. Please go ahead.

[Paul Newsome:]

Good morning. And thanks for the call. Could you talk a little bit more about the reserve development in the commercial lines business and where it's from, and frequency, severity what's sources it is? Obviously, we heard -- I heard you that it came from 2016 and actually years beyond, but just a little bit more detail, I think, would be helpful for all of us.

[James Petcoff:]

No problem, Paul. When we looked at the 2016 and prior loss situation, we looked at how many claims are outstanding, how much we're spending on carrying costs whether it was from litigation or just the expense of having the claims on. And a lot of them were Florida homeowners claims and then obviously, there were some GL and some auto and that kind of thing, but we made a significant push to get the numbers down to cut the future continuing costs of carrying these reserves. And our total number of claims outstanding went by -- down by around 2/3. So at the end of 2018, we have far less claims outstanding, and the outstanding property claims went down by 90%. So when you look at that, we did take some development, and there were some that we had to pay over the -- in amount, and I'm going to let Nick talk about the specifics, but I want to give you the overall strategy and why we did it. So Nick you want to go through.

[Nicholas Petcoff:]

Yes, on the commercial line side, the development really came from a couple different areas. Commercial auto continued to be a component of that, really on the 2016 and prior years, which we've spoken about in the past and we took pretty quick action in the end of 2015 and end -- into 2016 on an underwriting basis, so that was a component. And then we did have some development on the liquor liability line in Pennsylvania, where there were some law changes in 2015 that really made it difficult for us on that line in Pennsylvania, and we've since exited that line of business. We're in the process of exiting that line of business and then Montana liquor was another state that hurt us, where we stopped development. So really those three areas drove most of the development on the commercial line side.

[James Petcoff:]

And I want to -- Nick, I want to finish off with Nick, I mean when Pennsylvania, the law changed, we monitored it quite quickly, and we immediately reduced our policy limits in 2017 from $1 million to $300,000 to try and limit any -- and we were wondering if we could hold on at right $300,000, but it became clear in 2017 what's going on that it was better to just exit the liquor liability in Pennsylvania than try to deal with the change in the -- contributed toward negligence standard. So that's why you're not seeing the development in 2017 or 2018 on that line. The same thing is true of Montana. We got into Montana. The law on the books is pretty good, but they're on practicality is not when you get into the courtroom, so as soon as we saw that it was difficult to defend those cases, we exited the Montana liquor liability and that was in 2017, 2018. So we're not going to see the development for those years in those two lines. The commercial auto, Nick also pointed out that we started seeing development in 2015, made significant changes both in rate and policy form and the loss ratios have improved. So those three lines were the ones that hurt us 2016 and prior that were non-Florida homeowners.

[Paul Newsome:]

Great, that's great. It makes sense. I just want to make sure I've, sort of, the accounting straight on the ADC as we go perspectively in the future. It sounds like, just to make sure I've got it right, that we have, -- we've used up the limit, so prospectively, the only effect we'll see from the ADC is the amortization of the deferred component, is that correct?

[James Petcoff:]

Yes that's correct.

[Paul Newsome:]

Okay, so and then -- and that means any prospective reserve development will be fully reflected in the in 2019.

[James Petcoff:]

Correct. But I think it's just...go ahead.

[Paul Newsome:]

No, that's fine. Continue please.

[James Petcoff:]

One thing I was going to say with the ADC being utilized, on one hand you want to -- we went up, obviously, to the amount, the good side of it is that the recovery is here now, so I think from a GAAP basis, you'll see the kind of the reverse of the accounting, but statutorily as Harold mentioned, both of our operating subsidiaries statutorily made money as a result of the ADC in 2018.

[Paul Newsome:]

And that -- and actually, that was, sort of, my next question. Could you talk about the difference in the loss at the GAAP level versus the gain at the statutory level. What are the major components of why that is different.

[James Petcoff:]

Well, Harold is going to tell you the technical side, but from my perspective, it's this simple. You have to write off everything irrespective that you get no reinsurance credit on a GAAP basis when you put the reserves up into the ADC even though you are not going to pay them. They get deferred. And on a statutory basis, when you put up the reserves for the development in the ADC, you get immediate credit for the reinsurance, so it doesn't show as -- doesn't run through the income statement as a loss, but, Harold, that's is.

[Harold Meloche:]

Yes, that's essentially right. It just a matter of degrees. I mean we do get some of the benefit, but we don't get all of it. And that's why we have $5.7 million on a GAAP basis that we haven't been able to take credit for, but we had a $17.5 million layers, so that means there's obviously we've recognized $10 million of value so far over the existence of that. On the stat basis, Jim is exactly right, we get to get the full benefit for it, so to the extent that we recognize an actual loss, we get to recognize the ceded benefit as well, dollar to dollar.

[Paul Newsome:]

Would that follow that, prospectively, kind of the reverse will be true, because you'll have the deferred benefit in GAAP, but not in statutory.

[Harold Meloche:]

Yes. however, we still have IBNR that was up in that layer. So it's not like any development now is going to go directly to the stat line. We have IBNR as part of that layer that we're hoping is sufficient. Should it not be sufficient, and we go over, when that happens there would be some development, yes, that would come through on the stat basis.

[Paul Newsome:]

No, I'm just thinking. Let's assume in 2019, there's no development either way. You're going to have the deferral of benefit in GAAP but you will in stat. So if you have to make up numbers, sort 0 profits on a stat basis, you would have, some sort of positive number in GAAP because of the deferral.

[James Petcoff:]

Yes, absolutely true.

[Paul Newsome:]

Okay. Until the ADC is gone, the statutory should underperform the GAAP.

[James Petcoff:]

Yes. All else being equal.

[Harold Meloche:]

That does not mean we'll make money, but yes it should underperform.

[Operator:]

Our next question comes from Bob Farnam with Boenning and Scattergood. Please go ahead.

[Robert Farnam:]

Yes, thanks and good morning. I think I just want to continue the theme on the reserves. I think what we're going to try to figure out is so what's left for action years before 2016 and prior. Since you don't have any more protection from the ADC just, I don't know, is there any more details you can provide in terms of quantitatively, what's left there and how it could to theoretically develop?

[James Petcoff:]

The only thing, I'll tell -- I think I could tell you is, all of those claims that are left outstanding, which are not down 2/ 3 from what they were at the end of '17. All of those have significant reserves, I know, individually and we have IBNR allocated to that ADC. So I mean, it would be a normal reserve situation for '16 and prior where you have case reserves and IBNR.

[Robert Farnam:]

So in terms of the amount of the average claim size for what you've been booking thus far for 2016 and prior is that kind of comparable to what you have reserved for the remaining ones.

[James Petcoff:]

We do a lot of analysis and what the average pays are and what our average claims reserve is on a allocate -- I mean stated reserve for that claim. And we are always in excess, and it has been growing on how much we have up per claim versus what we have paid per claim. But that doesn't always mean -- you still could have development, I'm not saying that it's in and of itself, but yes from our perspective, we are accurately stating the claim on a per claim basis, and we have IBNR up. that does -- I mean that -- but you can't develop any other way. We could win a case, then put -- take it down or we could lose a case, and you have some additional. But we do have reinsurance on a specific basis, so when we put up a lot of these claims, we're hoping some of the ones that are more severe are we're up to the -- are net retention, so that if it does go up, it's not going to go through the ADC, it's going to go through the individual, the specific reinsurance claim. So when you're looking at adequacy, which I think is what we're all trying to get to, whether or not that's adequate, we feel comfortable with the case reserves. We know that they're not always going to be exactly accurate, and we have some IBNR.

[Robert Farnam:]

Okay, and it sounds like you made a pretty big push to close the property claims in the fourth quarter. So just how many, ballpark, how many claims still remain open -- property claims for actually maybe 2016 prior.

[James Petcoff:]

I don't know the total amount, but I do know the number for Florida. And that doesn't mean we won't get more in, because there's, I guess, a four-year statute. They could bring a water claim for years on the date they said it occurred, but we have 18 Florida water claims outstanding.

[Robert Farnam:]

18 Florida water claims, homeowners claims, okay. And that was down -

[James Petcoff:]

And to give you an idea, I think in the beginning of -- the beginning of 2018 or the end of 2017, we had 167.

[Robert Farnam:]

Okay that's good. That's kind of giving us some context of how many were closed this year. All right, so I guess one other non related question is the share repurchases. Are you -- What's your ability to continue to repurchase shares. Are you under any capital constraints from the rating agencies or whatnot in terms of your use of cash to be able to repurchase shares.

[James Petcoff:]

I would tell you that our interaction with the rating agencies has been disappointing as always. But they affirmed our rating, and we were hoping for something better than that. Because our statutory results are as we predicted, and but we are under no capital constraints. Our writings surplus are conservative service. All of our metrics with respect to rating analysis are well above where we think they need to be for the rating we have.

[Robert Farnam:]

Okay, so you can still be in the market looking to repurchase shares. You haven't really tapped that out.

[James Petcoff:]

No.

[Operator:]

Our next question comes from Scott Preston with Maven Fund. Please go ahead.

[Scott Preston:]

H, good morning, guys. Just -- first off, just I guess following up on the last question. You have the buyback in place and no capital constraints, adjusted book value of $7, we expect you to be a little bit more aggressive at current levels or is this something you kind of wait and see on the development of, kind of, commercial lines in the first half before you make a move there.

[James Petcoff:]

If you're asking about the buyback, I think that's for Brian.

[Brian Roney:]

Yes, no. Actually we would expect to be in the market when we can. Obviously, there's a 48-hour window, so we cannot do that and then there's, obviously, volume constraints as it relates to how much volume or how much share buy back we can make any given day, but we plan to be consistently in the market buying when we can for sure.

[Scott Preston:]

Okay and then a couple other, housekeeping, expenses I know, you expect the ratio to come down this year, but should absolute expenses be lower in 2019 versus 2018? And then how will your -- the ceded business and your reinsurance expenses change as you've, kind of, moved out of Florida and wind-exposed and into the commercial lines, how could that, maybe, benefit your costs and your top line growth and then finally on the ADC deferral, should we expect that kind of equally through 2019 or is it more back-end loaded, can you, kind of, talk about the cadence of how that might roll through.

[James Petcoff:]

Well, I think Andy should handle the reinsurance cost, and then Harold can handle the second part of that question.

[Andrew Petcoff:]

Our reinsurance from a cap perspective should come down significantly based on the sale of the Hawaii book of business and the exit of the Florida homeowners book of business. But I will also say that, that is renewing as of 6/1, so we're still under the current reinsurance structure until 6/1, and we will have the new one going forward at a reduced cost after 6/1.

[Harold Meloche:]

And from -- I heard originally that you were asking about absolute expenses and that we do expect absolute expenses to be a little bit lower this year. We have a handful of cost reduction efforts that are in play, and we're working on those right now.

[James Petcoff:]

And then how do you expect the ADC to, kind of, roll in through the year.

[Harold Meloche:]

So what we're going to see is $5.7 million, so we expect most of it actually come in pretty steadily through 2019 and a little bit into the earlier half of 2020 and then we should be done with it by then.

[Operator:]

Our next question comes from David [Idlemann with Idlemann Bran Capital]. Please go ahead.

[Unidentified Analyst:]

Yes, maybe if you could talk -- I view the stock more or less like a startup. You went public a number years ago and ran into the Florida homeowners. But kind of going forward, I wonder if you could talk about, how big a challenge is to get to a double-digit return on equity and what -- your expense ratio of 45% seems awfully high, I wonder if you have goal under normal circumstances, what in your opinion the expense ratio should be and how many years and how big a challenge is it? What would you have to do to get up to double-digit return on equity.

[James Petcoff:]

The expense ratio went up last year with a reduction of 10% essentially in premium volume and the earned premium additionally and -- that was gross written and the earned premium additionally hurt by reinstatement premiums from the Irma cat losses which were significant, which took the earned premium down and really impacted the expense ratio in a negative fashion. That we may have -- as Irma continues to be the gift that keeps on giving for the entire industry, as the Florida homeowners and AOB issues are out of control in Florida, we may see some bleed a little bit into the earned premium this year, but it's going to be way more significant as we are now in the upper layer, way less significant as we are into the upper layers. We don't see that as a problem, so we're not going to get hurt on just natural growth, naturally getting out, any expense reductions the expense ratio should be coming down. With our efforts on the expense ratio side, we hope to see significant improvement as measured by quarter-over-quarter, but I would say more than 10% reduction in the expense ratio. We could get it down to around 40 or 41 by the end of the year that would be a really significant move. And I mean double-digit ROE, if we continue to write the book -- mix of business we have today, which is in our core, hospitality, the security guards, et cetera, et cetera. Those loss ratios have been pretty good even considering the Pennsylvania liquor issue and Montana liquor issue. We've been clearing all those things up from a product mix standpoint and the book of business, that's on the books, we feel pretty confident. Do I think double-digit return this year? Maybe not. But certainly, somewhere in mid-single digit and hopefully 2020 is where we cross the double-digit. End of Q&A

[Operator:]

This concludes our question-and-answer session. I would like to turn the conference back over to Jim Petcoff for closing remarks.

[James Petcoff:]

Thank you so much. I want to thank everybody who's on board and for believing in us and staying with us. I really appreciate your support and your questions. We, as I said, are very optimistic and we're obviously unhappy with what happened, but having worked through it all and gone through the tough times, we think we're better off for it as far as the management team being able to deal with adversity, now we just got to deal with prosperity hopefully. But thank you so much, and we look forward to talking to you in the future.

[Operator:]

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