ProAssurance Corporation
Q2 2013 Earnings Call Transcript

Published: 6 Aug 2013

[Stan Starnes:]

Thanks Frank. Thanks to everyone for joining us this morning. We remain quite focused on our long term efforts to build our financial strength to provide ongoing profitability for our shareholders and to establish the platform which will serve the needs of policyholders and shareholders in the years and decades ahead. Even though the operated earnings for the quarter are less than those projected by some, we are pleased with our overall results and our continued progress. We regard quarters, not so much is an isolated period to be viewed in a vacuum but as a point along a continuum at which we may report to you the progress we are making toward our long term goals. To those with whom we have worked for many years or even decades in some cases, it will be no surprise that we manage the company with a long term view, unencumbered by a dangerous allegiance to producing particular quarterly results. However, we recognize that it is important for our various constituencies to understand the moving parts in each quarter's reported results even though as is the case today the quarterly results pertain no change in our long term performance. For an explanation of these moving parts, will turn to Ned and Howard, starting with Ned.

[Ned Rand:]

Thanks, Stan. There are number of items that make up the 20% increase in gross premiums written. The total increase was $20.6 million and of which Medmarc contributed $9.4 million in medical technology and life sciences product liability premium and $2.7 million in new legal professional liability premium, underscoring the importance of that acquisition. We also add $1.7 million of new premium from our Nevada acquisition and $3 million of new premium in our legacy physician business is somewhat offset loss premium. Additionally, there was an increase in written premium resulting from a shift of renewal dates in selected policies and from the net effect of two year policies. Neither of those changes will have an effect on net earned because this simply shifts the timing of premium collection. Net premiums earned were essentially flat in the quarter, down $914,000. One note for the year-to-date net earned number. Please remember that comparisons to the prior year are skewed by the large reporting endorsement policy written in the first quarter of 2012. We discussed that last quarter but we will be happy to go over in Q&A if you need a refresher. Ceded premiums increased approximately $3.5 million quarter-over-quarter, due primarily to sessions within our Certitude Program with Ascension in the effect of acquisitions. Those increases were offset by continued favorable loss experienced in our ceded loss reserves related to variable components in our reinsurance treaties. Before we move away from premiums, I would like to get Howard to comment on the market in general, specifically on pricing and retention. Howard?

[Howard Friedman:]

Thanks, Ned. There has been no letup in competition in any of our lines and that may make our accomplishments with regard to pricing and retention and our core healthcare professional liability business all the more remarkable. Premium retention in the physician line was 91% second quarter, three points higher than the year ago quarter and an improvement on the 87% retention last quarter. Year-to-date premium retention was 89% compared to 90% in 2012. Pricing was also encouraging. Despite heavy competition renewal pricing was 1% higher in the second quarter of 2013, than in 2012 and is unchanged year-over-year. We continue to see that as an endorsement of the value we bring to policyholders. It’s also a testament to our agents as they continue to communicate the value proposition of ProAssurance. It makes sense for me to address loss trends and reserves here as well. I will give you the raw numbers first and then get into the moving parts. In the quarter, we recognized $38.5 million in net favorable development, compared to 60.1 million in the same quarter a year ago. For the year our net favorable development has been $91.6 million, compared to $107.5 million for the same period in 2012. For the second quarter, development came primarily from the 2006 through 2011 accident years. Let me underscore that we continue to recognize a significant amount of favorable loss reserve development and the six month total for 2013 is actually slightly more than the $90.2 million for the same period in 2011. However, second quarter development is less than the first quarter. So let me try to provide some background that I hope will be helpful. As we’ve explained in prior calls, we do an internal analysis of loss reserves every quarter and engage our outside actuaries twice a year for a more in-depth study. Our analysis as of the end of first quarter indicated a continuation of the trend that were evident in our year-end review and accordingly we recognized $53 million of favorable development in Q1. Fast forward to the end of Q2 where we have the perspective of six whole months of additional data and an updated study from our independent actuaries, that data showed among other things a minor deviation from the still favorable trends in one state, a small amount of adverse development in one of our allied heath sub-lines and a couple of other minor changes. I want to emphasize that these are very small changes and isolated changes by themselves and it is too early to say if any or new long term trends but they became evident as we analyzed data for this quarter and we believe a cautious approach to such information as appropriate. The changes that resulted from this recognition of updated data were incremental and did not move the needle to any significant extent on total reserves, but because of the size of reserves those minor changes in aggregate had a significant effect on the favorable development that you see in the quarter. Now back to the recognition of the trend, we are endeavoring to become more sensitive to current indications each quarter, which is something we’ve talked about for two quarters now. As we report results using that approach, there were likely be greater volatility in our reserve estimates both up and down and thus we are likely to see greater volatility in our quarterly results. Moving to a more current recognition framework would introduce volatility in any P&C line but that is especially true in long tailed line such medical professionals. We also understand that these adjustments will be harder to predict and clearly harder to model because as you see this quarter small changes in reserve assumptions can have a big effect on quarterly results. While we recognized the potential for added volatility in our results over short terms time horizons, this has no impact on the long term which is our focus. And as to overall trends a repeat Stan's lead in. We do not see any changes to the macro-picture. Overall severity is still increasing at 2% to 3% a year and frequency is in the aggregate unchanged. Ned?

[Ned Rand:]

Thanks Howard. Continuing to move down the income statement, net investment income was down 3.6% in the quarter compared to last year. Even with the late quarter movement in interest rates, we’re investing new money at rates lower than those of maturing bonds and that’s limiting growth in investment income, the same issues facing every other insurer and like many other insurers we did see a mark-to-market decrease in net unrealized investment gains in the quarter. Operating expenses were down slightly in the quarter but again with several moving parts. Compensation costs increased $1.2 million but that increase was more than offset by an increase in the proportion of these expenses attributable to ULAE and policy acquisition cost decreased due to lower earned premium. This year we have expenses from nearly acquired entities that we didn’t have in 2012, but we also do not have the severance expenses we had in 2012 when we took a charge related to the enhancement of our customer service capabilities. Cash flow returned to positive in the quarter although for the year we are still negative, largely due to the tax payment of almost $21 million we mentioned last quarter and the amount and timing of expenses related to our acquisitions. Net income was $50 million, down 14% as compared to last year’s second quarter, again primarily due to the lower favorable reserve number compared to last year. Year-to-date net income was $163 million, up 43% compared to 2012, with much of that increase being the results of the $35 million onetime gain associated with the Medmarc acquisition. Operating income was $45 million or $0.72 per diluted share in the quarter. Year-to-date operating income was $105 million, a 2.5% decrease compared to 2012. Return on equity was 8.6% in the quarter and year-to-date stands at 11.1%. And remember our calculation excludes that onetime gain from the Medmarc acquisition. Book value per share is $37.79, up 2.6% since year-end but lower than last quarter, making this the first quarter I can remember where we didn’t have sequential growth in book value per share. ProAssurance like every other insurer saw a decline in the value of our bond portfolio right at quarter-end with the spike in interest rates. Tangible book value per share is $34.31. Frank?

[Frank O’Neil:]

Thanks, Ned and Howard. Stan, any closing comments from you before we take questions?

[Stan Starnes:]

Frank I want to stress again that on the whole we don’t see any significant change in the long-term macro view of ProAssurance or in the market in which we are operating. Howard is right however when he points out that volatility will likely occur in our quarterly results and recognize that the volatility by definition will be difficult to model in the short-term but it will not affect the long-term result. Most importantly, this volatility will not diminish our commitment to managed ProAssurance for the long-term. Now in addition to the solid profitability of our second quarter I want to highlight a couple of other bright spots. Our acquisitions are performing well. Our performance is being recognized by policyholders who vote with their check book and by others such as the Ward Group which for the seventh year in a row named us one of the 50 top performing P&C companies out of the more than 3,000 in the United States. A. M. Best upgraded the ProAssurance Group to A plus and several subsidiaries were upgraded as well and Standard & Poor's upgraded our shelf offering one notch to BBB Plus just two weeks ago. All-in-all the fundamentals are strong. We operate in a historically volatile line of business, which today is wrapped in the uncertainty of a rapidly changing healthcare system. Are there challenges because of that? You bet, there always are. Are we up to those challenges? I am confident that we are and as I have, I wouldn’t trade places with anyone. Frank, let’s take questions.

[Frank O’Neil:]

All right Stan, thank you. Aaron, we are ready to open the line for questions.

[Operator:]

(Operator Instructions) And we’ll take our first question from Mark Hughes with SunTrust.

[Mark Hughes:]

You described a stable environment but that’s a fairly meaningful change in pricing from down one to up one on the quarter and then retention obviously improved very nicely on a sequential basis. That seems to point to a more favorable environment. Is there possibly some underlying reason for that improvement?

[Stan Starnes:]

Howard?

[Howard Friedman:]

Yes Mark, the pricing is affected very much by the mix of business by state and even to some extent by line that renews in a given quarter. And I think we kind of see the minus one to plus one range as being pretty normal from quarter to quarter. It’s a reflection of maybe an adjustment in rates in a given state based on the renewal pattern of the business or particular accounts larger or smaller that renew. So I think I have said in the past that anywhere in that minus one to plus one range and anywhere in that 87, 88 to 90, 91 range on retention quarter-to-quarter is probably within what I would consider a normal variation.

[Mark Hughes:]

And you are talking about a deviation in one state that influenced the losses in the quarter? Was that a regulatory development, a legal development or something else?

[Howard Friedman:]

No it was just something that we have observed in this quarter in terms of claim severity, increase in average settlements and payments that just became more clear as we looked at the quarter but also looking at the six months in particular. You have a certain number of claims that close in any given period. Sometimes it takes maybe more than a quarter to really recognize what is going on, particularly when you are looking at claims closed with indemnity because that is a small proportion of the overall claims as it is. So it’s not anything that’s attributable to tort reform or legal changes. It’s really something that we are just looking at right now and seeing whether it’s an aberration or a pattern.

[Mark Hughes:]

And then a final question. Just any updated thoughts on consolidation of small physician practices. Healthcare reform is obviously moving ahead in its own way. Do you see anything new on that front?

[Stan Starnes:]

Mark its Stan. I think what we see is sort of a continuation of what we have been seeing for the last several years. It is not a linear phenomenon and it sort of migrates around the different parts of the United States. I think the most important thing we see is continued uncertainty; uncertainty among physicians, uncertainty among hospitals, and uncertainty among integrated healthcare systems. As to what the world is going to look like, both in the short term and the long term; the acquisition of physicians by hospitals is a finite development, simply because hospitals can't afford to buy them all. But I think you are continuing to see it, I think you are also beginning to see even more sort of imaginative affiliation arrangements between hospitals and physicians where perhaps the physicians is not employed by the hospitals but they have closer relationships. Perhaps the medical record systems, perhaps otherwise. So there is no lessening of the uncertainty that characterizes the healthcare system today, and certainly the acquisition of physician practices by hospitals is not over.

[Mark Hughes:]

A follow up on that. Any opportunity, you have talked in the past about perhaps being able to pick up some of those larger pieces of business once the consolidated entities. Are you making any progress on that front?

[Stan Starnes:]

Howard I will let you response specifically but I would say we're seeing more opportunities along that line than we've ever seen before. Howard?

[Howard Friedman:]

Yes, I think the opportunities on the market are there, particularly as the healthcare entities become larger, physician groups become larger, hospitals are acquiring other small hospitals, are becoming larger through their own consolidation with other small hospitals. So they are looking for carriers that have larger balance sheets and more expertise.

[Operator:]

We'll take our next question from Ryan Burns (ph) with Janney Capital Markets.

[Ryan Burns:]

Just wanted to see if I could zero in and figure out I guess which state saw the increase and severity and maybe also if you guys could maybe quantify that as well?

[Stan Starnes:]

Howard?

[Howard Friedman:]

Well in terms of which state, we've historically have not provided state by state information mainly from competitive considerations. So I think we will continue that pattern here. It's really as I mentioned earlier in the script and also in response to the earlier question, a result of looking at closed claim severity. It's not something that I would consider to be major. It's something that was a change in the pattern. We've historically in this particular state seen a pretty good predictable pattern and generally where we have had some degree of case reserve redundancy, which is offset by our IBNR projections and as we look at the data for the quarter and for the first six months, we just didn't see that this time. So we are reacting to it. In terms of whether it's a trend, as I said earlier we're not calling that at this point. We're just reacting to it in terms of adjusting our projections for this particular segment or portion of our book of business.

[Ryan Burns:]

And would it be I guess a top 10 revenue state for you guys? I am just trying to figure out what kind of magnitude it would be?

[Howard Friedman:]

It's a state that's big enough where we have data that we think is credible to look at. If it was a state where we had one closed claim in the quarter, it obviously wouldn't be something where we could discern a pattern.

[Ryan Burns:]

And my last one, could you talk about I guess the new quota share arrangement you guys talked about in your 10-Q about I guess with a captive insurer, Just want to see what kind of arrangement that is and what that could be?

[Howard Friedman:]

Sure it's Howard again. One of our larger agents has expressed interest over the years in sharing in the risk on the book of business, which we think is a great thing. And the agency holding company has formed a captive insurer in order to be able to take a quota share reinsurance participation on the risk in the business that agency produces. So again we think it's good that an agent is interested in the risk side of the business. We think that in a long run will help to solidify the results on what's already a good book of business that that agency produces.

[Operator:]

We'll take our next question from Matt Carletti with JMP Securities.

[Matt Carletti:]

Just a couple of questions. First one on the development and more so just the recognition pattern. Could you maybe provide a little color, and I know it's not new this quarter, that it's kind of been a change in view in recent quarters but I think it showed up a little more noticeable in the results this quarter, as to kind of what’s driven your change and look at how you kind of interpret the data and then kind of secondly on that if, if I am interpreting it correctly that the historical pattern of maybe strong Q4 releases wouldn’t be the norm anymore on that; it will be more spread out over the year and potentially you could have a big release, kind of any quarter and likewise volatility the other way.

[Howard Friedman:]

Yes, I will start, and if Stan or Ned want to jump in, we have been asked by various audiences, regulators, rating agencies, even some of you who are regularly on the call to be more responsive in recognizing trends in the data rather than necessarily waiting until we were absolutely certain about things, to try to recognize indications sooner; and we attempted to do that. And as we've mentioned in the last couple of calls, we mentioned it. We actually even mentioned it over a year ago in the February 2012 call for year-end 2011 that we were going to give more recognition at that time to what we saw as more benign loss severity trends. So once we begin to do that obviously and we continue to do it; it will create a little bit more volatility but at the same time as you said, it would presumably get us to be more responsive to individual quarter's results and it may, I can't tell you for sure, but it may result in a different pattern than we have seen in past years in terms of their fourth quarter adjustment. But that’s still to be seen. We don’t know what the third or fourth quarter of this year would look like.

[Matt Carletti:]

And maybe one for Stan. It’s a very nice growth in the quarter and nice to see the recent acquisitions contributing. What’s your outlook? Any change in your outlook, I guess for M&A and I know there is a lot of small companies continuing to be out there. Could you continue to see attractive acquisition opportunities?

[Stan Starnes:]

Yes, Matt, we continue to look at a lot. Our entire senior management team is involved in that, particularly when it comes to evaluating whether this is something that we are interested in. As I mentioned in the first part of my remarks, one of our long term objectives is to develop the platform which will serve the policy holders and the shareholders well over the coming years and decades. And the key part of the development of that platform lies through acquisitions. We look at a lot more than we are interested in. It’s a time consuming process, but the one that we think is worthwhile and we anticipate that we will continue to be active in the acquisition process and in looking at different opportunities as they come along. As you know they are very episodic. You can't make them happen, and shouldn’t make them happen. It has to be something that fits into the long term platform development. But I will be very surprised if this time for example, a year from now, we have not at least announced a new acquisition. That doesn’t mean it’s going to happen, but I think, in my view, we will have those opportunities and we will take advantage of the ones we deem appropriate.

[Matt Carletti:]

And then just one last one, if I can, just on capital management; kind of tying on. We have seen nice growth, but your leverage remains quite conservative. Can you kind of walk us through your thoughts as we near year-end on capital management and should there be any sort of expectation for a special dividend? Again as that in the discussions, kind of now on an annual basis or do you think the growth is absorbing a bit of the capital and probably not likely to see that?

[Stan Starnes:]

Well I will let Ned respond specifically, but I would just repeat as I have said in the past; that at every board meeting, our board takes a very detailed look in capital management. Ned?

[Ned Rand:]

Yes, Matt. I think that the capital management has a lot of different components to it. We continue to favor putting capital to work in the business and in M&A. That will certainly have an impact on any capital management decisions that we make. When our stock was trading closer to the book value, we favored share buybacks. With where it’s trading today, we have favored dividends. All those things will go into consideration to any decision that we make regarding dividends and buybacks as year-end approaches.

[Operator:]

(Operator Instructions). We will go next to Paul Newsome with Sandler O'Neill

[Paul Newsome:]

Just a quick follow-on to the reserve thing, which obviously is the main issue. Should we be thinking, is there any sort of or can we quantify if there is any sort of true-up nature of the reserve in the quarter. We’re always trying to look for sort of run rates. To what extent was the trend change that you put in with something you have to sort of make up for because it is a semi-annual reserve analysis. I guess this an elongated way of saying we should we be looking at more sort of first quarter in total as opposed just looking at it, or the first half in total as opposed to just looking at the second quarter?

[Stan Starnes:]

Every time that we review reserves, it’s always a cumulative review. Because what we’re doing, we’re not trying to determine what our reserve development is in the quarter. What we’re doing is always trying to project for each accident year and each component of the business, what the ultimate losses will be and once we make those projections and subtract out paid losses to date, then that equals the reserves and then the change in that for any prior periods becomes the development. So the development is an end result, not an objective. So to go your question what we did now is the same as always, re-estimated the ultimate reserves and then calculated the development for the quarter. So, in terms of it being a true-up, I guess it’s always in that regard always a true-up. In terms of how to look at it; I would look at it more over an extended period of time, either look at the two quarters for the year or look at a rolling average four quarters much more so than looking at any individual quarter in itself.

[Ned Rand:]

Paul, I’ll point out from our last couple of presentations, we’ve put up a chart that showed reserve development. We've begun to break that down by quarter, which should help you out in that regard.

[Paul Newsome:]

And could we talk a little bit about the accident year and how these trends could or could not impact your view of the accident year results over time, the current accident year I should say?

[Howard Friedman:]

We did not make changes to the current accident year reserves or loss ratios that we are booking for 2013. So I think that may answer it in itself. The changes that drove the change in ultimates which then resulted in the development for this quarter were really very minor and has it magnified effect when you look at it over a number of prior accident years. But in terms of what we’re seeing for the current year, we didn’t make any change in the quarter.

[Paul Newsome:]

Is there, my understanding, the way the actuaries work is sort of one quarter is blip, three years is a trend. I don’t know if you have those kind of rules of thumb and if they apply to some of the trends that you’re seeing in these issues?

[Howard Friedman:]

One quarter may well be a blip but I wouldn’t wait for three years to call something a trend. So we’ll be and we do continue to look at this regularly. But it would certainly be much less than three years before we reacted to any changes that we saw. Whether that’s three quarters, four quarters; something in that range is probably much more likely than multiple years. And, it’s always a rolling four quarter kind of process as I mentioned earlier that when we look at things and maybe a good way for you to look at them as well.

[Operator:]

It appears we have no further questions. At this time, I’d like to turn the call back to management for any closing remarks.

[Stan Starnes:]

Thank you, Aaron. We appreciate your attention today and we appreciate the participation on the call from our investors and we will look forward to speaking with you in early November when we discuss third quarter results.

[Operator:]

This does conclude today’s conference. We thank you for your participation.