ProAssurance Corporation
Q3 2013 Earnings Call Transcript

Published: 7 Nov 2013

[Operator:]

Please standby, we are about to begin. Good day, ladies and gentlemen. And welcome to the ProAssurance Investor Call to discuss the results of Third Quarter 2013. Today's call is being recorded. At this time, I would like to turn the conference over to Mr. Frank O'Neil. Please go ahead, sir.

[Frank O'Neil:]

Thank you, Rebecca. Good morning, everyone. Thanks for your interest and participation in our call to discuss the third quarter results of ProAssurance. On Wednesday, November 6, 2013, we issued a news release reporting our results for the quarter ended September 30, 2013, and subsequently filed our 10-Q and a current report on Form 8-K. These documents along with our other SEC filings will provide you with important information about our company and our industry, each discuss the significant risks and other factors that could effect future results and thus cause actual results to differ materially from current projections and expectations. Please read and understand these cautions and be aware of the statements we make today on this call dealing with projections estimates and expectations are explicitly identified as forward-looking statements subject to Safe Harbor protections reserved for these statements. Except as required by law or regulation, we will not undertake and we expressly disclaim any obligation to update or offer information disclosed as part of the forward-looking statements. If you happen to be reading a transcript of this call, please note that the content of the call is accurate only on Thursday, November 7, 2013, and it may contain a factual or transcription error that could materially alter the intent or meaning of our statements. We will be referencing non-GAAP items in our call today, so please refer to our recent filing on Form 10-Q and our recent news release for a reconciliation of those non-GAAP numbers to their GAAP counterpart. On the call with me today are our Chief Financial Officer, Ned Rand; Howard Friedman, our Chief Underwriting Officer and Actuary; and our Chairman and CEO, Stan Starnes who will start us off with some opening comments. Stan?

[Stan Starnes:]

Thanks Frank. Thanks to everyone for joining us this morning to discuss what we view as another successful quarter. Our premiums increased over the same period last year and earnings are higher as well. Book value per share our primary measurement of overall success is higher than year end by 4.4% and we believe we are on track to deliver increasing shareholder value and continued strengthening our balance sheet for the benefit of shareholders and policyholders alike. We’ll go first to Ned.

[Ned Rand:]

Thank you, Stan. Starting at the top, gross written premiums were $166 million, up 6% over last year’s third quarter and for the nine months ended September 30th gross written premiums increased 5%. In both instances, the primary driver was a new premium from acquisitions. In the third quarter, Medmarc produced almost $10 million of new premium from its medical technology and life sciences business, and $2.4 million of new legal professional liability premium. Year-to-date, those increases are $25 million and $8 million, respectively. We think these gains underscore our ability to add new profitable business through acquisition, while expanding our reach in key business lines. There are a number of moving parts within the medical professional liability components of gross written premiums. So I would like to get Howard to discuss those, as well as other market dynamics. Howard?

[Howard Friedman:]

Thanks, Ned. Gross written premiums in our Healthcare Professional Liability business were down $2.9 million, about 2% compared to third quarter 2012. But as Ned mentioned, you should understand the moving parts. To the downside, we did lose business due to the competitive nature of the market and as you will recall from last quarter’s call, about $3.3 million of third quarter gross written were shifted to second quarter this year to even out renewal workload. However on the upside, we wrote some $6 million of new Physician business, including the first premiums from our Cap Assurance joint venture in California and additional premiums from our Certitude program with Ascension. Our Nevada acquisition added $3.4 million to gross written in the quarter. The new Physician business number is strong and we are pleased with the performance of both the Cap Assurance program which brings our large group and facility expertise to California in partnership with CAP-MPT and also with the Ascension Certitude program which is near our initial goal of $20 million in annual gross written premiums. And we are on track to roll that program out in two new states in the first quarter, with a few more to come throughout 2014. There is really no change in the competitive landscape. We see heavy competition across the Board, which we think makes the 90% premium retention in our Physician business for the third quarter all the more remarkable. For the year, premium retention is 89%. We are convinced that our existing insureds and those buying our coverage for the first time understand the real differences in the product we offer them. Renewal pricing on our third quarter Physician business was 1% higher than the same quarter a year ago and is flat for the year. Our product is continuing benign loss trends and the competition. On the subject of loss trends, frequency is in the aggregate unchanged and overall severity continues to increase at a very manageable 2% to 3% per year. I think it probably makes sense to address reserve development at this point as well. We recognize $49.4 million in net favorable development, compared to $50 million in the third quarter of 2012. Favorable developments through the first nine months of 2013 is $141 million, compared to $157.5 million for the same period in 2012. The development is still primarily from the 2005 to 2011 accident years. The question will be, have the changes that ProAssurance saw last quarter abated or reversed? And the answer is that we address what we saw last quarter as we would with any changes in loss data through reserve adjustments and we do not believe further changes are required. We have also modified our underwriting and pricing where needed based on the loss experience that we observed. We continue to recognize current indications in each quarter as we discussed in last quarter’s call. It does not change the end result over time, but will likely change the quarterly amounts as we make those more current evaluations. Ned?

[Ned Rand:]

Thanks, Howard. Moving now to other line items in the income statement. Net investment income was essentially flat, fixed income investments were lower, as you would expect, but were offset by higher income from equities and distributions received from one of our limited partnerships. Our equity and earnings among consolidated subsidiaries decreased by $500,000, even though we did see increased income from one of our limited investment partnerships that was offset somewhat by our tax credit amortization. As you will recall, our tax credit limited partnerships are our primary component of unconsolidated subsidiaries. In third quarter 2012, the amortization was $200,000. This year the third quarter amortization was $1.9 million. The increase in tax credit partnership amortization during 2013 reflects an overall increase in our investment in these partnerships and reductions to amortization during the third quarter of 2012 that were attributable to the re-estimation of inception to date amortization of certain partnerships interests. Periodically we received revised operating data from the partnerships reflect this data in our amortization estimates as it is received. Operating expenses were flat in the quarter, but there were several factors involved. Compensation costs increased in 2013 and we incurred additional operating expenses related to our newly acquired entities. These increases were more than offset by an increase in the proportion of these expenses attributable to ULAE and lower professional fees in 2013. Operating expenses reflect an increase of 2.4% for the year, reflecting essentially the same factors as the quarter period, plus an increase attributable to transaction costs associated with our acquired entities. Cash flow was up 26.5% quarter-over-quarter. Net income was $63.4 million, an increase of 5.4% over third quarter 2012 and for the year-to-date net income is up 30%, mostly due to the $36 million non-taxable one-time gain associated with the Medmarc acquisition. Absent that gain, net income is still up about 9% for the year-to-date. Operating income was $54.8 million or $0.88 per diluted share in the quarter. Year-to-date, operating income is $160 million, essentially unchanged for the nine months in 2012. Operating income per share for the nine months was $2.57 per diluted share versus $2.60 a year ago. Return on equity was 10.7% in the quarter and year-to-date stands at 10.9%, both slightly higher than the respective year ago periods and the calculation excludes the one-time gain from the Medmarc acquisition. Book value per share is $38.48, up 4.4% since year end. Tangible book value per share which excludes intangible assets and goodwill is $35.1, up 5% since year end. As our share prices drop closer to book value per share in the quarter we repurchased approximately 175,000 shares of our stock at cost of about $8 million in the quarter. An average cost of $45.56 per share, we have $127 million remaining in our stock repurchase authorization and we will continue to evaluate the repurchase of shares as opportunities present themselves and we can evaluate the best use of capital at that point in time. To reiterate what we have said previously, we are aggressive buyers of our stock at or below book value per share and we’ll become less aggressive as a stock price moves above book value per share. Frank?

[Frank O’Neil:]

Thanks, Ned and Howard. I want to come back to you both for some comments on the transactions we announced in mid September. Howard, will you give us the news on our investment in Lloyd's Syndicate 1729.

[Howard Friedman:]

Sure, Frank., I think calling it an invest is exactly the right way to look at this. We’re committing capital to the Syndicate to be led by Duncan Dale, who is one of London’s preeminent underwriters. The Syndicate will leverage Duncan’s long standing ties in U.S. medical professional liability market but we will not be involved in underwriting decisions or data analysis on any business where we might be a competitor. We think the great benefit to us will be the value creation in the syndicate as it ramps up and we believe our Medmarc subsidiary will stand to benefit when it gains the ability to write medical device and clinical trials business that has been expanding internationally. The Lloyd's platform is an ideal vehicle to accomplish those risks. We expect there will be further insurance opportunities as well with the possibility of helping the Syndicate write international MPL business down the road. Much of the world is migrating toward more American style tort system and we see potential is that evolves. Within the next few weeks, we expect the Syndicate to receive formal approval from Lloyd's to begin writing business effective January 1, 2014. Frank?

[Frank O’Neil:]

Thanks Howard. Ned, can you give us an update on the planned acquisition of Eastern Holdings.

[Ned Rand:]

Happy to provide that Frank. We are still planning to close effective January 1, 2014 Eastern’s proxy has mailed to shareholders and the date for the special meeting is December 4th. Our format has been filed with the Pennsylvania Department of Insurance and we expect approval from them and time to close as planned. The transaction does not require formal approval by the Cayman Regulatory Authorities, but Eastern’s management has received the letter, saying they’re aware of the transaction and have no objections. We do not expect any anti-trust issues because of the separate lines of insurance written by both companies and our HSR filing has just been filed. Overall, everything is on track. Frank?

[Frank O’Neil:]

Thank you, Ned, Howard. Stan, any closing comments before we take questions.

[Stan Starnes:]

Frank, as I said at the outset, we think this is a quarter that underscores our ability to succeed in a challenging market. Our acquisition strategy continues to pay dividends by adding new well underwritten business that meets our profitability targets. We think our demonstrated ability to add new business sets a good tone when the market does begin to firm and greater financial strength will be an increasingly important factor in the insurance purchasing decision. Equally important in the future, will be our ability to meet the entire spectrum of healthcare providers at the point of liability meet need. We’re building a platform that will allow us to serve liability needs no matter how healthcare evolves. We will be positioned to cover the wide variety of risk from home healthcare, larger groups, hospitals and facilities to the smaller group or solo practitioner market, they will always exist and we’ll always have our undiminished commitment. And that’s a vital concept. The calls collectively we do not have the imagination to predict how healthcare will evolve over the next decade, but we are building the company that will be able to meet the liability insurance needs that evolve along side healthcare. The Eastern acquisition is a part of that. Workers’ comp is significant liability expenditure for our healthcare clients and we think being able to offer them this important coverage from a company and an agent they trust and with whom they already do business is a huge opportunity. As we continue to move ProAssurance forward, we will continue to build financial strength, to ensure that we were able to keep the insurance promise as we make. And in doing so we are cautious of the need to be good stewards of the capital and trusted to us. Our purchase of shares this quarter is a further demonstration of that commitment and of our dedication to creating long-term value for our shareholders. Frank, let’s take questions.

[Frank O’Neil:]

Thanks, Stan. Rebecca, that’s your queue to open the lines, if you will bring us some questions.

[Operator:]

Absolutely. (Operator Instructions) And your first question will come from Amit Kumar with Macquarie.

[Amit Kumar:]

Thanks and good morning, and cognates on a strong quarter. Maybe just two or three quick questions. The first question is on the discussion on cash and liquid investments in your 10-Q, if you added the number it’s roughly $480 million right now. Factoring in the Eastern acquisition, could you sort of refresh us on the conditions and thought process, which had led to a special dividend last December and how were conditions similar or dissimilar today based on where you stand?

[Stan Starnes:]

Amit, I’ll let Ned provide you with the details of information you seek. I would remind you and everyone on the call that our Board looks at capital very carefully at every meeting and we look at it from lots of different aspects and we have to, to measure our capital needs around what we see coming in the future. So it's not a situation in which we set up a capital protocol that will serve us years to come, but it will make a decision that has to be constantly reevaluated and remapped by the Board. So there is nothing that says that we have written a capital program and some sort of rigid script, which will guide us forever and ever. We look at it every quarter, we look at it at every Board Meeting and we look at it under the conditions that are prevailing at that point in time. Now, given that sort of overarching view of it, I will let Ned address the specifics of your question.

[Ned Rand:]

I don’t think really, Amit that I have a lot to add to what Stan said, what gave rise to the special dividend we paid last year, I think was a number of factors. I think lot of -- like a number of companies we were aware of the coming changes in tax policy that could have an impact on what a dividend means to investors and so that way and the decision to do something in 2012. At that time, our stock price was trading at a relatively high multiple of our book value and as we have said repeatedly, we are more aggressive and were closer to book value and buying back our stock. And then as we looked at our liquidity and our liquidity needs for the coming period, we were comfortable paying that special dividend. In addition to the Eastern transaction, I would also remind you that there are capital requirements for a Lloyd's Syndicate that we will use up some of that liquidity that we have with the holding company as well. But beyond that, the kind of the perimeters that and Stan said, I don’t have very much to add.

[Amit Kumar:]

I mean the Lloyd's -- it is spread over a few years, right. So the initial, how much of the per year outflow…

[Stan Starnes:]

Initial capital. Yeah, initial capital commitment is in the neighborhood of what, $60 million or $70 million for this first year.

[Amit Kumar:]

Got it. Because, what I was trying to understand is maybe you can help me on the relative attractiveness in terms of the attractiveness of the buyback based on where the stock is today versus where it was maybe a month ago. And if I’m understanding this correctly, what you are saying is that maybe there was a specific opportunity at that time when the stock had dipped a lot more versus where it is today? Is that fair?

[Ned Rand:]

Well, I think. Amit, a couple of things. So our stock, the significant fall in our stock occurred right before we got to quarter end. We have a self imposed blackout that we put up pretty early as we begin to close the quarter that took us out of the market, essentially from the end of September on from October 1 on.

[Amit Kumar:]

Got it. Okay. That’s actually helpful. And the only other question I have and I will stop here. Thanks for all the answers. Howard mentioned you modified underwriting and pricing which addressed, those I guess outliers in the allied heath sub-lines, could Howard expand on that a bit more.

[Howard Friedman:]

Sure. Whenever we see indications on the loss side, we try to take those into account as best we can in terms of the risks that we select and how we go about pricing those risks. So as we mentioned last quarter, we saw some client severity in one state. We saw some indications in one of our allied heath sub-lines of business that were loss indications that were higher than we expected. So, when we look at that particularly in the allied health area we can react to that. Looking at the risks that caused losses and how much we were charging for them, so we start to react in particular in those policies which are on an excess and surplus lines basis we can react very quickly, because they don’t involve rate filings or rate approval. So, just like any other indication that we would see, we try to take those under advisement and make sure that we are pricing appropriately. If there are particular areas of risks that have caused problems, we try to underwrite around them or away from them like any other insurance company would do.

[Amit Kumar:]

Was it more on the pricing front, or was it more on the underwriting side where the actions were taken in terms of the relative proportion of those two?

[Howard Friedman:]

Yes, I’d say at this point more on the underwriting side, risk selection side than on the pricing side. But we really didn’t see any kind of overall trends that would dramatically affect our pricing. It was more in terms of specific issues that we observed.

[Amit Kumar:]

Got it. Okay. This was very helpful. Thanks for all the answers.

[Howard Friedman:]

Welcome.

[Operator:]

And our next question will come from Doug Mewhirter with SunTrust Robinson Humphrey. Doug Mewhirter - SunTrust Robinson Humphrey Hi, this is Doug Mewhirter in for Mark Hughes. I just have two questions. First, about pricing, you had provided nice detailed commentary on the medical malpractice, pricing trends. What kind of pricing trends you are seeing in the Medmarc lines, particularly that medical technology, product liability?

[Stan Starnes:]

We are seeing that business hardened a little more than what we are seeing in the MPL line. But still single digit kind of increases, probably load of mid single digit increases but there is certainly more of a hardening trend in that line of business. Doug Mewhirter - SunTrust Robinson Humphrey Is that because loss cost are increasing at a proportionately higher rate or is it more of just a general industry reaction.

[Stan Starnes:]

I think it’s a general industry reaction. We have seen some capacity flowing out of the market place and in certain areas. I think that’s leading to it as well. Doug Mewhirter - SunTrust Robinson Humphrey Okay. Thanks for that. My second and final question, deals around your Lloyd's business. First, could you remind me what capacity, stamp capacity did you apply for the Syndicate?

[Stan Starnes:]

The Syndicate stamp capacity is 82 million pounds, approximately $130 million, current exchange rates. Yes. Correct. Doug Mewhirter - SunTrust Robinson Humphrey Okay. And that’s, obviously that’s a maximum not a budget of course. The -- related to the Lloyd’s Syndicate, you talked about how you could give that Medmarc more access to international products. Describe how the process would work, the underwriting process, so you have an underwriting team at the Lloyd's Syndicate and then you have Medmarc. Would the Lloyd's team take it through their brokers and use Medmarc as the actual underwriter or would the -- would Medmarc underwrite it and reinsure it to Lloyd's. How do you visualize those two entities working together?

[Stan Starnes:]

The current plan and what we’re gaining or looking to gain approval to do is for Medmarc through its agency, in-house agency to have a Lloyd's binding authority with the Syndicate. In other words, within certain parameters, the Medmarc team would have the authority to underwrite these foreign clinical trials and foreign products business. And then, if the particular risks were outside of agreed parameters, either size, geographical scope, loss experience or whatever, than those would be referred or underwriting to the Syndicate. Not so fairly common type approach in the U.S. There is Lloyd's binding authority businesses progressive throughout the marketplace. Doug Mewhirter - SunTrust Robinson Humphrey Okay. So Medmarc would be, I mean, hopefully I’m not -- Medmarc would really export more like MGA than actually a risk bearing underwriter and Lloyd's, the capital of Lloyd’s would actually bear the risk or most of the risk.

[Stan Starnes:]

That’s correct. The MGA term itself maybe a little bit further than is actually authorized but that’s the general concept, yes. Doug Mewhirter - SunTrust Robinson Humphrey Okay. Thanks. That’s all my questions.

[Operator:]

(Operator Instructions) From Janney Capital, we’ll go to Ryan Byrnes.

[Ryan Byrnes:]

Great. Thanks for taking my questions guys. I have a question about, I know it’s a little early but with kind of healthcare changes happening in 2014. I want to get your guys thoughts on how, I guess, how you guys are anticipating loss cost trends to settle out in 2014. I guess, both on the frequency and severity side, as more people obviously have insurance?

[Stan Starnes:]

Yes. It’s a great question and it's largely unknowable. What we would anticipate at this stage is that severity will continue to increase all be at the manageable rates mentioned earlier by Howard. We have no reason at this point to suggest we expect severity to go up. Now we monitored it all the time and it really doesn’t matter what we think, it’s going to do. What matters is what is does. But at this time, we see no signs that it’s going beyond what Howard has said. And we should know that severity almost always goes up. It hardly ever comes down. Our frequency is a bit of a different issue and there are lots of ways to look at it. We have been through a period where frequency has fallen. We don't think it's falling any longer but it is more or less leveled out. There is a lot of debate within the industry as to why our frequency fell. The true answer is nobody knows and there are very few common denominators from state to state. Frequency has fallen in states where there has been tort reform but it’s fallen in states where there has been no tort reform. My own view of the world is that frequency is a product of two things. First is patient frustration and second is unexpected outcome. From the standpoint of patient frustration, I think the expectation, at least my expectation is that patient frustration will increase as a result of the changes in healthcare. You can sort of feel that happening as we speak, but -- but even if the onset of the Affordable Care Act run perfectly, you’re still going to provide insurance coverage theoretically to 45 million people who did not previously had and we’re not adding any new physician under the Affordable Care Act. So there is an atmosphere that’s going to be created that will at least create the possibility of delays and patients being seen in physician’s offices and otherwise and in my view patient frustration is likely to escalate. And that will have again in my own personal an impact on frequency and I will expect it to go up. The other thing that in my view drives frequency or unexpected outcomes in healthcare, bear in mind, I didn’t say bad outcomes, I said unexpected outcomes. And there is nothing about the Affordable Care Act. It is going to diminish our patient expectations with respect to the outcomes of their healthcare. Our patient expectations always escalate. And so we -- I would think that’s a potential. Now all of this you didn’t go further and say what effect does this have on the liability insurance market as far as MPL is concern. And we’ll just have to see, it certainly could serve to harden the market in the fullness of time. But again we don’t make predictions, we go on the data but that’s sort of my view of world with respect to frequency and severity as we think ahead to the world is coming.

[Ryan Byrnes:]

And how do you guys try to I guess underwrite that -- in 2014, I guess, obviously you are underwriting, but how do you guys try to underwrite around those potential changes?

[Stan Starnes:]

Well, I don’t think there is any clear way at this point in time to underwrite around to any coming changes other than to look at what this particular on the physician side of the business -- what the physicians are doing, what kinds of ventures, if you will, where they are getting involved in, in order to physician himself for changes under reimbursement, changes under the Affordable Care Act itself, which has some affect some times on their corporate liability exposure. So the physician himself or herself taking more patients. It’s difficult to measure from our perspective, also depending on how they are using physician extenders, nurse practitioners, physician assistance, that type of thing. We certainly take that into account and if the scope of practice is changing as a result, they are using more extenders, well we rate for that, we underwrite for that. But I think the corporate liability issues are, are the ones that we really try to look at and make sure that what we’re covering on the business entity side isn’t expanding beyond what we have seen in the past. At this point, I think that’s about the extent of the -- what we can measure from underwriting and we’ll have to see how this all relationship evolves.

[Ryan Byrnes:]

Okay. Great. And this -- my last question is if I look at your numbers now versus five years ago in 2008. On an absolute basis, you guys have grown your net premium basis on absolute basis about 20%, 22%, 23% but your equity base has increased almost 80% over this past five years. Has anything happened in terms of opportunities or I guess the business model itself that requires I guess that growth of capital?

[Ned Rand:]

No, I don’t think anything that would say that you need that much additional capital to support the 20% additional business. I do think that the capital requirements in our line have increased overtime. And where people use the benchmark and say you could write at one to one premium at the surplus ratio. You now are probably at 1.2 or something. So I think there has been some modest changes part of this, just our capital base has grown. We continue to think that over the long term, there will be opportunities to deploy that capital.

[Ryan Byrnes:]

Okay. Great. Thanks guys.

[Stan Starnes:]

Thank you, Ryan.

[Operator:]

(Operator Instruction) And it appears there are no further questions.

[Stan Starnes:]

Very good. Thank you Rebecca and thanks everyone. We wish you a wonderful holiday season and we will speak with you when we next report fourth quarter.

[Operator:]

Ladies and gentlemen that does conclude today’s presentation. We do thank everyone for your participation.