Employers Holdings, Inc.
Q3 2013 Earnings Call Transcript

Published: 7 Nov 2013

[Operator:]

Good day, ladies and gentlemen, and welcome to the Third Quarter Employers Holdings Conference Call. My name is Britney, and I'll be the operator for today. [Operator Instructions] As a reminder, this conference is being recorded for replay purposes. I would now like to turn the presentation over to your host for today, Ms. Vicki Ericsson Mills. Please proceed, ma'am.

[Vicki Erickson Mills:]

Thank you, Britney, and welcome, everyone, to the third quarter 2013 earnings call for Employers. Yesterday, we announced our earnings results, and today we expect to file our Form 10-Q with the Securities and Exchange Commission. These materials may be accessed on the company's website at employers.com and are accessible through the Investors link. Today's call is being recorded and webcast from the Investor Relations section of our website, where a replay will be available following the call. With me today on the call are Doug Dirks, our Chief Executive Officer; and Ric Yocke, our Chief Financial Officer. Statements made during this conference call that are not based on historical fact are considered forward-looking statements. These statements are made in reliance on the Safe Harbor provision of the Private Securities Litigation Reform Act of 1995. Although we believe the expectations expressed in our forward-looking statements are reasonable, risks and uncertainties could cause actual results to be materially different from our expectations, including the risks set forth in our filings with the Securities and Exchange Commission. All remarks made during the call are current at the time of the call and will not be updated to reflect subsequent developments. We use a non-GAAP metric that excludes the impact of the 1999 Loss Portfolio Transfer or LPT. This metric is defined in our earnings press release available on our website. A list of our portfolio securities by CUSIP is available in the Investors section of our website under Calendar of Events, Third Quarter Earnings Call. Now, I will turn the call over to Doug.

[Douglas D. Dirks:]

Thank you, Vicki. Welcome, and thank you for joining us today. We are pleased to report that in the third quarter, we continued to build upon the strong financial and operating results reported in the first 2 quarters of this year. Third quarter net income before the LPT increased $0.33 per diluted share year-over-year. Net premiums earned increased 25%. Our GAAP combined ratio was below 100 at 96.2, and underwriting losses adjusted for the LPT declined $9 million relative to last year's third quarter and $2 million relative to the second quarter of this year. The combined ratio before the LPT improved more than 8 points year-over-year. Year-to-date, compared to the same period last year, we increased net income before the LPT by $21.8 million or $0.69 per diluted share and improved the combined ratio before the LPT by 9.7 points. We recorded 2 items in the third quarter that impacted our financial results. First, we recognized favorable development of $14.5 million to reserve ceded under the LPT agreement. Favorable development in our ceded reserves resulted in a cumulative adjustment to the deferred gain, so that the deferred gain reflects the balance that would have existed had the revised reserves been recognized at the inception of the LPT agreement. The amortization was also recalculated and a portion of the reduction in LPT reserves is yet to be amortized. The adjustment reduced losses and LAE and increased net income by $10.1 million or $0.32 per diluted share in the quarter and year-to-date. Second, in the third quarter, we reallocated $24.3 million of reserves from nontaxable to taxable accident years. The reallocation reduced our income taxes and increased net income by $5 million or $0.16 per diluted share in the quarter and year-to-date. The reallocation of reserves was based upon trends and ultimate losses that we have observed over the past 2 years. The reallocation does not reflect the change in loss trends in the third quarter, and we have not changed our overall level of reserves. In fact, we lowered our loss provision rate again in the third quarter. We continue to build scale in the third quarter. Consistent with our plan, we now have approximately 84,000 policies. The average policy size was approximately $7,200. This represents a policy cap growth of more than 10% in the last 12 months and an increase in average policy size of 8%. The change in our total net rate was 9.3%, with the largest year-over-year increases in Illinois, California and Nevada. Our focus on pricing, combined with other factors, resulted in a 15% increase in third quarter net written premium compared to the same period last year. California continues to represent approximately 60% of our book of business. In October, the WCIRB, the California rating bureau, voted to amend its initial advisory rate filing for January 1, 2014 rates, which had recommended a 6.9% increase in pure premium rates. The amended filing added 1.8% for increased costs related to the physician fee schedule recently adopted by the California Division of Workers' Compensation and required under Senate Bill 863. The California Insurance Commission held a hearing on October 28, and a decision is expected within 30 days of the hearing. We find the actions of the WCIRB governing committee to amend its pure premium rate filing encouraging, in that incremental costs of implementing SB 863 are being recognized. We have yet to see the benefits from the legislation reflected in our actual experience. We set our own pure premium rates in California based upon actuarial analyses of current and anticipated loss trends, with the goal of maintaining underwriting profitability. We have increased our rates in California by a cumulative 41% since early 2009. We said that as we implemented our pricing strategies, we would closely monitor retention. As we have reported, the pricing strategies we implemented over the past year resulted in a modest decline in overall policy retention in the first quarter of this year. However, our second quarter policy retention of 83% was flat relative to the first quarter, and our third quarter policy retention of 84% was up slightly relative to the second quarter. Retention for our strategic partner business was 90% for the first quarter, and 89% for the second and third quarters of this year. Our strategic partner business continues to represent approximately 1 quarter of our total in-force premium, and policy retention in that portion of our book is stable. So while building the business scale that has enabled us to lower our expense ratio, we have also been able to increase our net rate while retaining policies within our underwriting appetite. We saw a continuing improvement in our loss ratio since June 30 of this year as rate increases continue to outpace increases in loss cost. Therefore, in the third quarter, we modestly lowered our loss provision rate. We continue to focus on the cost side of the income statement by actively managing our expenses. We have recently begun the first phase of a new strategic initiative, which will be led by our newly appointed Chief Operating Officer, Steve Festa. We will focus on customer service and process improvement, with the goal of further reducing our expense ratio while bettering customer satisfaction. A part of this initiative includes a restructuring and centralization of our insurance operations, which was recently announced. We will be discussing this initiative more with you as it unfolds. We believe that the ongoing slow economic growth, combined with continuing low yields on investments, will drive the need for greater efficiencies in the industry. In line with our plans for future growth and in order to maintain the financial strength rating of our insurance operations, we made a $40 million capital contribution to our insurance subsidiaries in September. That resulted in statutory surplus of approximately $580 million, with approximately $180 million in cash and securities at the holding company. Now, I'll turn the call over to Ric.

[William E. Yocke:]

Thank you, Doug. In the third quarter, we continued to improve our underwriting performance, which is a key driver of profitability. Our combined ratio before the LPT improved by more than 8 percentage points year-over-year. Our underwriting expense ratio improved 3.1 points in the quarter as the increase in net premiums earned outpaced increases in our expenses. The largest contributors to higher costs were premium taxes and assessments, which are directly tied to our growth in premium. Our loss ratio before the LPT declined 4.4 points in the third quarter compared to the third quarter of last year. We lowered our provision rate for the current accident year losses to 72.8% compared to 77.2% in the third quarter of 2012. We continue to see sequential quarterly improvement in our loss ratio this year. The rate of improvement in the third quarter was lower than in the first and second quarters. The incremental reduction in the loss provision rate of 0.2 points since June 30 reflects the third quarter moderation in loss ratio improvement. As in recent past quarters, our reserve analysis in September showed continuing adverse development for recent accident years, offset by continuing favorable development for older accident years. As Doug mentioned, in the third quarter we recognized the tax impacts associated with reassigning reserves in nontaxable years to taxable years. Ordinarily, changes in reserves by accident year would not constitute a change in estimate. However, the movement of reserves from nontaxable to taxable accident years resulted in adjustments to our income taxes and deferred taxes. Majority of the adverse development was in accident years 2007 and forward, but primarily in 2010. And the majority of the offsets were in years prior to 2000. Again, the reallocation does not reflect a change in loss trends, and we have not changed our overall level of net carried reserves. Our income tax benefit was $3.3 million in the third quarter of this year compared with a benefit of $1.2 million in the third quarter last year. Net investment income increased by $293,000 or 1.7% compared to the third quarter of last year, largely due to an increase in invested assets. The average pretax book yield of the portfolio at September 30 of this year declined slightly to 3.4% compared with 3.6% for the same period last year. The tax equivalent yield was 4.2% at the end of the third quarter compared with 4.7% at September 30 of 2012. The estimated fair value of the portfolio has increased 4.6% since December 31 of 2012. We employed investment strategy that emphasizes asset quality and balances the consideration of duration, yield and credit risk. At the end of this year's third quarter, we had a duration of 4.2. To minimize interest rate risk, our portfolio is weighted towards short-term and intermediate-term bonds. Equities represented 6.6% of our total portfolio at the end of the third quarter. New investment purchases in the third quarter were primarily in the taxable sector. Equity purchase and sales activity was driven by the rebalancing of the high dividend equity portfolio, which generated gains. Net realized gains on investments were $1.1 million in the third quarter. In the third quarter, additions to the portfolio other than cash yielded 2.2% and 2.47% on a tax equivalent basis. In conclusion, we're pleased with our results in the first 9 months of 2013, which saw an increase in earned premiums of 31%, growth in shareholders' equity of 3% and a 37% improvement in cash flow from operations, which represents both growth in scale and effective expense management. With that, I'd turn it back to Doug.

[Douglas D. Dirks:]

Thanks, Ric. We delivered another strong quarter. We continue to achieve solid targeted organic growth and to retain customers within our appetite, while increasing net rate and improving underwriting margins. Most importantly, our reserve position remains stable. Additionally, our portfolio continues to demonstrate consistently good results with very high asset quality. We believe that our financial results will continue to benefit from a strengthening premium rate environment and rising yields, which will allow us to continue to grow our earnings per share. With that, operator, we're now ready to take questions.

[Operator:]

[Operator Instructions] And your first question comes from the line of Amit Kumar, representing Macquarie.

[Amit Kumar:]

Just, I guess, 2 or 3 quick questions. First of all, in your opening remarks, you talked about, I guess, the new strategic initiative to reduce expense ratio. What would be helpful is if you could talk about if there are any sort of specific quantifiable goals.

[Douglas D. Dirks:]

Amit, thank you for that question. At this time, I'm not prepared to publish what those goals are. Certainly, we believe that as we've built this business out, it lends itself to much greater scale and much greater efficiency. So what we're looking to do through centralization of our operations is develop very consistent business rules and processes to drive the expense ratio down. When I think generally about targets, and I'll talk not only about expenses but losses as well, to generate the type of ROEs that are necessary, given what we expect the investment environment to look like in the coming years, the combined ratios have to be below 100. And they -- to deliver double-digit returns, they have to be in the low 90s. So if you think about loss as being somewhere between 60 and 65, that means you've got to have expenses at 30. And those are kind of broad targets, but that's -- those are the types of things we're thinking about as we're looking at initiatives to decrease our expense ratio.

[Amit Kumar:]

That actual is very helpful. The other question I had is, your comment on SB 863, and you mentioned WCIRB, but if you look at the report which came out a few days ago, which looked at the initial, I guess, evaluation, the report pointed out that they were in fact seeing a jump in the claim frequency. And again, the report said it is not clear if it's all because of 863, but the initial trends they had seen indicated that the claim frequency had, in fact, jumped for the recent accident years. I don't know. Do you have any thoughts on that, that perhaps the benefits accrue over a much longer period, but initially could there be a case where loss cost trends do uptick?

[Douglas D. Dirks:]

Amit, I would be speculating on the frequency. I don't -- I'm not convinced anybody is certain what that is. Let's talk a little bit about 863, however. Consistent with what we've thought all along, there were some early benefits coming out of 863. We expect that the reforms to liens will have a positive impact. It's so early we're not really seeing it in our data, but we do know anecdotally that there are benefits coming from the reform of liens. We again don't see it in our data yet, but we expect that the independent medical reviews will have a favorable impact on loss costs. So those 2 areas all along we thought would be beneficial. If you look on the other side of it, there's no question that permanent disability awards are going to go up. And everything else is kind of in the middle as to whether or not it's going to have any favorable impact or not. And it's just too early to tell.

[Amit Kumar:]

Okay. No, that's good to have an early read. The final question I have is for Ric. Just looking at the discussion on the reallocation of loss reserves, could you very quickly help us reconcile how did you get from the $24.3 million number mentioned in the reallocated reserves to, I guess, the third bullet in the press release, which talks about the $5 million impact on net income?

[William E. Yocke:]

It's -- you step through it, the reserves are taxable at a discounted amount, Amit. And then -- at a 35% statutory rate. I can step through that with you mathematically, if you want.

[Amit Kumar:]

Yes, we can do it. We can do it offline, if that's okay.

[William E. Yocke:]

Right. I think that we can provide you with an outline of that.

[Operator:]

[Operator Instructions] And your last question comes from the line of Doug Mewhirter, representing SunTrust Robinson Humphrey.

[Douglas Mewhirter:]

This is Doug in for Mark Hughes. Just had 2 quick questions. The Loss Portfolio Transfer favorable development, I know it's some pretty old business, but what -- was there any specific accident years where you made that adjustment?

[William E. Yocke:]

Yes, the LPT applies to the first half of '95 and prior accident years, and excludes DCC and AO -- certain DCC and AO costs. Does that speak to your question?

[Douglas Mewhirter:]

I just didn't know if there was -- if it was sort of spread out across that period or if there was one particular time period.

[William E. Yocke:]

The actuarial analysis that supports the adjustment is looking at all of those accident years going back, but individual accident years don't constitute material pieces of it. It's spread rather evenly over those accident -- prior accident years.

[Douglas D. Dirks:]

And it's decades worth of claims.

[Douglas Mewhirter:]

Yes, understood. Yes, that makes a lot more sense. My second and final question, did you have any benefit or drag from auto premiums this quarter?

[William E. Yocke:]

No. Our auto premiums continue to maintain at a high level, as they have in the past several years. Third quarter saw an increase in that experience, and it really reflects some of the additional payrolls in our insureds.

[Douglas Mewhirter:]

Okay. So it sounds like the -- I guess that's encouraging that the underlying economics of your insureds are good in this slow economy. I guess that...

[William E. Yocke:]

It continues to be positive, yes.

[Operator:]

And your next question comes from the line of Matt Carletti, representing JMP Securities.

[Matthew J. Carletti:]

Doug, I just wanted to point to a part of your comment in the press release and see if you could just provide a little more color, the part that talks about you're still seeing accident year loss ratio improvement, but the rate of improvement was slower than in the first and second quarters of the year. You had, last year, about a 77 kind of adjusted for some movement. You went to 75 then brought the year to 74 round numbers in Q2. And it brought down a little from there for the 9 months, but essentially is still about 74. Is that more related to the rate that even though you're getting good rate increases, still, they are slowing a bit? Are you seeing something on the other side of that, whether it be loss cost related, that maybe the spread between rate and loss cost is narrowing? Or is there something else that's maybe causing you to exercise just a tad more caution as you go forward?

[Douglas D. Dirks:]

When you look at what's happening on the rate side, in some parts -- some of our markets, some parts of the country, we've been getting rate increases for a longer period of time, and maybe they are starting to get a little long in the tooth some places. So we are exercising a little bit more caution there. We are sensing that in some markets, we might be hitting a bit of a ceiling. Now that may be temporary, and the market might just be pausing and there might be another leg up. So this is going to be a little bit bumpy, I expect. But overall, the rate trend continues to be favorable. It just isn't a straight line. And the market adjusts quarter-by-quarter, and when we take a look at it, we adjust our thinking accordingly.

[Operator:]

We have a follow-up question from the line of Amit Kumar.

[Amit Kumar:]

Just one, I guess, quick follow-up on the last question. Can you sort of share with us what you might be filing for 1/1/2014?

[Douglas D. Dirks:]

Anywhere specific or generally or...

[Amit Kumar:]

Yes, generally. I mean if you can expand on a state-by-state basis, obviously excluding Florida. Maybe you can just start with California and just go through some of the states.

[Douglas D. Dirks:]

Yes, let's start with California because there's quite a bit going on there for us. Strategically, our objective is to stand up 3 companies in California. Since we started doing business in California in 2002, we've only had one licensed company and one rate filing. We now have 3 companies licensed in California. And next year, all 3 will be stood up with 3 rate filings. And our rate filings will be changing, our rating algorithm will be changing. The objective there is to allow us to use multiple rate filings, make sure that we're able to get the most rate where we can everywhere in market -- in the market and attract the best business. And that's the objective. There'll be a number of steps as we get there. We'll be making some adjustments in things like loss cost multipliers. We can -- California is very different from other markets. It's not just a question of LCMs. You also have to look at schedule credits. And again, with multiple papers, we will be able to more finely tune our approach to the market. So we'll be doing things around adjustments, loss cost multipliers, and then be doing a filing for all 3 companies. So as you see this kind of rolling out over the next several months, it might appear a little bit confusing. But just remember, the long-term objective is to have 3 rate filings in California. And the effect of that is outside of any of the rate trends, we would think it would be more or less rate neutral. But it's not going to be rate neutral because obviously, the Bureau is indicating a rate increase and all of our actions are going to be designed to get that rate. So that's what's happening in California. There's several steps involved in it. In terms of the rest of the country, I think you should expect that our filings will be in line with whatever the various bureaus or the NCCI is recommending. There tends to be much less variability to our filings around the rest of the country.

[Operator:]

There are no further questions at this time. I would now like to turn the call back over to Mr. Doug Dirks for closing remarks.

[Douglas D. Dirks:]

Very good. Thank you, everyone, for joining us today. Thank you for your questions. We look forward to speaking with you again early next year to report our 2013 results. Thanks, and have a great day.

[Operator:]

Ladies and gentlemen, that concludes the presentation for today's conference. You may now all disconnect, and have a wonderful day.