ProSight Global, Inc.
Q1 2020 Earnings Call Transcript

Published: 12 May 2020

[Operator:]

Ladies and gentlemen, thank you for standing by and welcome to the ProSight Specialty Insurance First Quarter Earnings Call and Webcast. At this time all participants are in a listen only mode. After the speaker's presentation there will be a question-and-answer session. [Operator Instructions] I'll now like to hand the conference over to your speaker today, Dean Evans. Thank you. Please go ahead.

[Dean Evans:]

Thank you. Welcome to the first quarter 2020 earnings conference call for ProSight Global, Inc. With me on the call today are, CEO and President; Larry Hannon; Chief Finance Officer; Buddy Piszel; Chief Underwriting and Risk Officer; Bob Bailey and Chief Investment Officer, Nico Santini. Following our prepared remarks, the call will be open for questions. Yesterday afternoon, we issued our first quarter 2020 earnings release, which is available on our website at investors.prosightspecialty.com. Let me remind everyone that during this call, management may make comments that reflect their intentions, beliefs, and expectations for the future. We caution that such forward-looking statements are not guarantees of future results and that actual results may differ materially from those forward-looking statements. For a discussion of some of the risks and important factors that could affect our future results and financial condition, please see the cautionary language regarding forward looking statements in yesterday's earnings release under risk factors sections of our reports and filings made with the SEC. Except as required by law, we undertake no obligation to publicly update any forward looking statements whether as a result of new information, future events or otherwise. Additionally, during today's call, we will discuss certain non-GAAP measures, which we believe are useful in evaluating our performance. A reconciliation of these non-GAAP measures to the most comparable GAAP measures can be found in our earnings release. With that, I'd like to turn the presentation over to our CEO and President, Larry Hannon.

[Larry Hannon:]

Thank you, Dean, and good morning, everyone. To start I'd like to take a moment to recognize the amazing efforts of the healthcare providers, first responders and all those who sacrifice for others every day in the fight against COVID-19. On behalf of everyone at ProSight I thank you and wish everyone good health and safety. With regard to our business, I would like to start by welcoming a new board nominee, and three recently hired members to our executive team. Anne Waleski, a 25 year veteran and the former CFO at Markel has been nominated for election to our board at our annual meeting of stockholders in June. Donna Biondich joined us at the end of 2019 as our Chief Claims Officer, bringing more than 30 years of claims experience to ProSight and having held senior leadership roles at Maxum Specialty, Colony Specialty and North American Risk Services. Nico Santini joins us as our Chief Investment Officer, having spent the last 20 plus years at New England Asset Management. And Jeff Arricale joins us as my Chief of Staff and Head of Capital Markets, having worked for nearly the last two decades at Lord Abbett and T. Rowe Price. I believe each of these individuals are tremendous additions to our already strong board and leadership teams and excited to have them as part of our company. As a reminder at ProSight, we are an agile, profit first, underwriting focused property and casualty insurer that specializes in specific industry niches. We offer innovative, differentiated products, services and third party solutions to our customers, often writing multiple coverage lines for a particular customer. We deliver our offerings through a select unlimited distribution network. And finally, we closely manage risks through our niche selection, strong execution and purposeful limits management. Given COVID-19 the economic hardship faced by millions of Americans, social inflation and an opportunistic claim this far, I think it's important to highlight our risk selection and remind our stakeholders where we do not have exposure. We do not write publicly traded DNO, medical malpractice, mortgage insurance, accident and health. We do not write event cancellation, opioid manufacturers or distributors, or hospitals and nursing homes. Further to that, our workers comp work has minimal exposure to hospitals and first responders. Our risk management approach also entails managing our gross and net limits, excluding our workers comp book which represents about 10% to 15% of our premium, approximately 85% of our policies have gross limits of $2 million or less. As I've shared in the past, our goals over the long-term are to generate a double digit ROE, along with double digit growth in groceries and premium and book value per share. We ended 2019 on a strong note, and that strength continued for the first few months of 2020 prior to the COVID-19 dislocations. Given the ongoing impact of COVID-19, we will not meet these goals in 2020. We remain very confident in our business and our ability to execute over the long-term given our risk selection niche approach, an opportunity to deploy capital at favorable terms. While we have no unique insight into what the future holds, we do take a very granular bottom up approach to our business and feel the circumstances warrant us sharing our latest forecasts for 2020, so that you can better evaluate our company during this unusual time. Gross written premium for customer segments could decline 10% to 20% from 2019, with the most significant COVID-19 impact expected in the second quarter. Our net loss ratio has the potential for a one to three point increase from COVID related claims and expenses in the current accident year. On the expense front, potentially higher costs from bad debt provisioning given state mandated deferrals of collections and the impact of lower written premiums could negatively impact the expense ratio. And finally, on net investment income, we expect our core fixed income portfolio excluding limited partnerships to yield approximately 3% for 2020. Net investment income volatility for the remainder of 2020 does remain possible from our limited partnership investments. That said, our longer term objectives have a 62% loss ratio and 200 basis point expense ratio reduction over the next three years remain appropriate based on what we know today. Our team continues to execute on all the activities that underpin these metrics evidenced by our Q1 operating results. We will revisit our objectives accordingly as we determine that COVID-19 is going to have a longer term impact on our top line. As I look forward, I believe our niche strategy, exclusive distribution arrangements and careful exposure management will leave us well positioned for profitable growth as we exit 2020 and execute against a favorable backdrop. I would now like to turn the call over to our Chief Underwriting and Risk Officer, Bob Bailey.

[Bob Bailey:]

Thanks Larry. Many of you have heard us talk about how ProSight with our niche orientation and limited distribution is different. We recognize that the impact from this approach is sour to see from the outside and can take some time to surface. Each of our niches is run like a single purpose underwriting organization working through a dedicated and limited distribution partnership such that we see market dynamics very clearly and very differently through that lens. This better enables us to do two really important things for an insurance company, maintain our underwriting discipline and streamline execution. We are able to anticipate change, respond directly to customer needs, and react just a little faster than others. We think there is a significant cumulative effect and advantage from this approach over time. Today, it feels like one of those times when our approach is demonstrating advantages in a very tangible way. I would like to highlight a few of these examples where maintaining our underwriting discipline and our capacity for streamlined execution are resulting in better outcomes. We are among the largest insurers of touring entertainers in the world, but we have not written event cancellation which is a significant product line for that niche. Our team has long felt 10 years or more, that the rate for this risk was significantly underpriced. So our focus and long standing discipline have helped us to avoid the current crisis, which as you know have affected that line severely. On the opposite end of the spectrum, we used to be one of the largest access workers comp writers in the United States. We expanded this business over a 10 year period, combining increasing rate and self-insured retention to deliver great underwriting result. Market conditions, however, started to shift in that niche a couple of years ago, pricing was not as strong and more importantly, exposure to potentially catastrophic claims were increasing. Many of our insurers were first responders and we were growing concerned about their safety, specifically, the anti-police sentiment. We exited this business in the first quarter of 2019. Obviously not expecting COVID to occur, but finding ourselves well positioned in light of it due to maintaining that underwriting discipline in our recent past. And here's an example of where execution streamlined. Taxi and bus operators were immediately and severely impacted by COVID-19 in the economic shutdown that surrounded. Within hours, literally focus of the bans on international flights, we're hearing directly from our taxi customers. As the first schools started to close, we were hearing from school and charter bus operators, long before regulators and I mean long before weeks and, in some cases, before regulators will order in premium and, and other regulatory actions. We were already working with these operators to adjust premiums to align with these new reduced exposures. We did not have to wade through tons of data to maybe be able to see these problems emerge. Did not have to contact and work through thousands of agents. We were immediately able to leverage our niche approach to respond to these customers when they were indeed in need of a very rapid response. Now, let's talk about business interruption. We have roughly 7,300 property policies, 100% of which require direct damage to trigger business interruption coverage. 99% of these have specific virus exclusions. The remaining 1% do not contain a virus exclusions specifically, but do have pollutant and contamination exclusions. This 1% or approximately 80 or so policies are entirely apartment buildings, which were not closed or shuttered by any civil authority. As far as rate and loss trends across our business, we execute rate at the next level. Our rate needs vary by niche, and we've talked about that in the past earnings calls. This quarter we were very satisfied with our rate execution and achieved an overall rate of 6.8% excluding workers comp, 6% including workers comp in the first quarter. This is an acceleration of more than 100 basis points versus the fourth quarter of 2019. We continue to see initial loss picks at 62, reflecting the seasoning of newer niches and as Larry pointed out may increase throughout the year based on the ongoing assessment of ultimate loss and claims handling expenses associated with COVID-19. I will now hand the call off to Buddy Piszel, who will discuss our financial results in greater detail.

[Buddy Piszel:]

Thank you, Bob. I will address underwriting and operating results during the quarter, our capital position, provide color on our expense ratio, and then hand the call off to Nico Santini, our Chief Investment Officer who will discuss the investment portfolio and its performance. Gross written premium for customer segments increased $15 million for the quarter, or 7.7% over the first quarter of 2019. Total gross written premium declined $42 million or 16.4% from the first quarter of 2019, due to our exit of excess workers compensation. As a reminder, our exit of excess comp results in approximately $60 million of non-recurring premium written from the first quarter of 2019. Gross written premium increased across all customer segments in the quarter except for transportation, where we executed a targeted reduction. Our underwriting results reflect a loss ratio in line with expectations of 62%, which was not impacted by cap losses or prior period development. It also reflects disciplined expense management. Our expense ratio was 35.8%, did include about a half a point benefit from non-recurring items. We do it Premium declines and potential bad debt expense from COVID-19 to challenge our progress on the expense ratio for the balance of the year. We had strong underwriting results in the first quarter with underwriting income of $4.5 million, and a combined ratio of 97.8%. That compares to underwriting income of $3.5 million and a combined ratio of 98.2% in the first quarter of 2019. Net investment income in the quarter was $8.8 million, negatively impacted by an $8.2 million mark-to-market adjustment on limited partnerships during the month of March. Excluding this unrealized loss on limited partnerships, net investment income was flat compared to last year. I want to note that we do not account for our limited partnerships on a leg and the effects of the investment portfolio of the economic downturn in March are fully reflected in our first quarter results. Our investment portfolio at the end of March stood at $2.2 billion, an increase of 1.7% from year end. The duration of the portfolio was 4.1 years, up from 3.4 years as of the end of the year. The tactical repositioning of the portfolio commenced early in the fourth quarter of last year, continued through the first quarter and resulted in modest realized gains. The portfolio was in a net unrealized loss position of $38 million at quarter end, a negative change of $79 million during the quarter. Our net income and adjusted operating income were adversely affected by the reduction in net income, which was attributed to the response of the credit markets to the emerging COVID-19 crisis. Our adjusted operating income of $8 million or $0.18 per diluted share, representing an adjusted operating ROE of 6.2%. This compares to adjusted operating income of $13.6 million or $0.34 per diluted share, representing adjusted operating ROE of 13.3% for the same quarter last year. Net income from continuing operations was $6.8 million, or $0.15 per diluted share, as compared to $13.7 million or $0.35 per diluted share for the same quarter last year. As a reminder, our adjusted operating income excludes certain non-recurring costs, specifically $1.4 million of IPO related stock compensation expense and the final $300,000 in transition costs for our former CEO and Executive Chairman. On a fully diluted book value per share at the end of the quarter was set $10.73, a decrease of 10.7% from year end. This decrease in diluted book value per share is largely driven by the net unrealized valuation change that occurred during the quarter at the end of March. Since the end of the first quarter, credit markets have improved, spreads have tightened, liquidity has increased and our pre-tax unrealized position recovered approximately $47 million. So as of April 30, we have an approximately 10 million realized gain in the portfolio. I'll close with commentary on overall liquidity and our debt re-fi. First, on liquidity, we've stressed our cash flow for lower premium and collection delays from state regulatory actions and feel well positioned for what lies ahead. We also have not drawn on our $50 million credit facility. We are actively engaged with the credit markets and have a number of options we are pursuing to refinance our debt prior to its maturity in November of this year. Expect updates on this topic by next quarter or sooner. I'll now hand off to our Chief Investment Officer, Nico Santini. As an aside, we are thrilled that Nico has chosen to join our management team earlier this year. We believe his experience and insights will serve ProSight well. And his timing is perfect, so Nico?

[Nico Santini:]

Thank you, Buddy. Probably in the fourth quarter, we began selling some of our Triple-B corporate credits and buying Double-A and Single-A rated taxable municipal bonds and some preferred securities. The net result of the program was an upgrade in credit quality as our Triple-B exposure decreased from 30% at the end of Q3 '19 to 26% at the end of Q1 '20. Our unrealized position was negative 38 million at the end of the quarter, and it has since recovered to approximately 10 million unrealized gain as of April 30. There was also 8 million of unrealized loss on fixed income limited partnerships. And this portion of unrealized gains and losses flow through our income statement. Of the 8 million unrealized loss that hit our income statement in Q1, approximately 3 million has been recovered through April. We have a total of 65 million in fixed income limited partnerships, and there could be some continued P&L volatility from these investments quarter-to-quarter. Please keep in mind that we do not currently hold any common stocks in our portfolio. We completed a comprehensive analysis of the portfolio in the quarter and I want to share some of the highlights with you. Within our Triple-B allocation, which represents 26% of the portfolio, we identified approximately 44 million of securities that may be exposed to rating downgrades. Boeing and Marriott represent 40% of these holdings. Within our below investment grade allocation, which represents 6% of the holdings, we identified approximately 3 million of securities for inclusion in our Q1 CECL analysis. This resulted in a $300,000 allowance for the quarter. Within our CLO allocation which represents 7% of the portfolio, we hold no securities rated below single-A and our average rating is Double-A. Within our CMBS allocation which represents 4% of the portfolio, we hold no securities rated below Single-A and our average rating is Double-A. As a result of the analysis we feel very comfortable with our portfolio positioning. Turning toward floating rate allocation, our floating rate securities were 16% of the portfolio at the end of Q1, down from 21% at the end of 2019. You may recall that our floating rate allocation was identified as 33% of the portfolio at year end. The difference results from a reclassification in securities by our new investment accounting provider, New England Asset Management and better represents the nature of the underlying securities. For example, some of the reclassified securities are fixed rate securities with a step up in coupon contingent upon call provisions. We are comfortable with our floating rate holdings and are allowing them to naturally mature or be called out of the portfolio. So this allocation will likely decline further as the year progresses. In conclusion, while we had an unrealized loss in the quarter, the portfolio relatively well positioned to handle the market dislocations and has returned to a modest unrealized gain. Overall, we feel comfortable with our interest rate, liquidity and credit positioning. Thanks and I will now turn it back to Larry.

[Larry Hannon:]

Thanks Nico. While we're all dealing with heightened levels of uncertainty and challenges, we did not expect to face, I am extremely proud of our ability to handle them thus far. Beyond the impact of COVID-19, our first quarter results reflect the strong fundamentals of our business and I believe we are well positioned to continue delivering value to our stakeholders going forward. With that, I'll turn it over the operator to open the lineup for questions.

[Operator:]

[Operator Instructions] Your first question comes from the line of Yaron Kinar of Goldman Sachs. Please go ahead. Your line is open.

[Yaron Kinar:]

Thank you and good morning, everybody. I thought maybe my first question was focused on the guidance for the loss ratio for the remainder of 2020. You kind of highlighted several of the lines where you do not have exposures. Maybe you can talk about why you would so potentially see a three point increase in the loss ratio.

[Larry Hannon:]

Sure. Good morning Yaron, its Larry, and I'll comment on that and then turn it over to Bob a little bit too. We didn't see anything from the first quarter where we actually would automatically assume that that we were going to have those losses. But there's a lot of uncertainty and we thought that it was prudent to kind of think about it in the context of being stable going forward and thinking about what that uncertainty could be. So for example, presumptive losses that are evolving on a daily basis in various states on the work comp side, we have to kind of watch that and monitor that and if you see activity in a kind of an increased basis with for presumptive loss extending to first responders extending to potentially beyond first responders, we think that that could obviously have a negative impact on loss ratio. We feel really good as Bob indicated on the business interruption side. And then the other parts of that become unknown where we just don't have an appreciation yet of what that might bleed into either on other lines or other niches and where that could be an impact. So it really was from our perspective a prudent kind of reservation of what we think could happen on the comp line if we were going to pinpoint it anywhere. Bob, would you add any other color to that?

[Bob Bailey:]

No, Larry. I think you said it well. The uncertainty is largely around what happens in the workers comp line and remains to be seen with a lot of moving pieces around regulation and legislation.

[Yaron Kinar:]

So maybe one follow-up on that. I just want to make sure I fully understand this. The three points already contemplates potential expansion of presumptive loss into all essential employees across various states. Is that correct?

[Larry Hannon:]

The all part is the only one Yaron that is my question mark, right, because we obviously don't have comp or significant writings in comp across a lot of states. So it would depend on the state. But when we're seeing the big states think about it, obviously, what just happened in California is the perfect example of that. We do have – as it relates to our overall comp book a significant portion of it in California, so we're watching that, that's our best estimate at this particular point as to what could evolve. Again, we haven't seen it evolve in the book. So that's why we didn't take that in the first quarter, but it's just our – when we're looking at the future and where we're seeing that potentially going and how that affects it, that's where we came up with that. And please recognize, I am saying it's kind of up to three points, right. It could not materialize. We don't know. But we just wanted to make sure that as we position that for you, is that if we're watching anyone in particular, it's on the comp line than where we're focused.

[Yaron Kinar:]

Understood, and any sense of what the percentage of the workers comp book that's exposed to essential employees?

[Larry Hannon:]

It all depends on how they define essential employees in every state, right, so that's where it comes into play. Our traditional piece is very small. So we write roughly, as I shared before, 10% to 15% of our premiums, so let's call it roughly $120 million of comp. When we think about what those numbers look like, we thought that less than 20 million of the written is in what would have been the kind of natural first responder bucket. So not significantly Yaron, but again, I had that conversation with you today. And by Friday, we might have a different definition. That's the concern that we have at this point. There's just so much uncertainty that we are trying to figure out as we go forward.

[Yaron Kinar:]

Okay, thank you. I appreciate the color on 2Q. Thanks.

[Larry Hannon:]

Sure.

[Operator:]

Your next question comes from the line of Mark Hughes of SunTrust. Please go ahead. Your line is open.

[Mark Hughes:]

Yeah, thank you. Good morning.

[Larry Hannon:]

Good morning.

[Mark Hughes:]

Talk about – in your guidance, your outlook for down 10 to 20 more impact in 2Q. How much of that is just lower exposures with existing customers versus challenges with the new business, just a little more on there?

[Larry Hannon:]

Sure, Mark. I'll start and then I'll hand it over to Bob. It comes in really three areas where you look at the miss and for us you're going to have the new business can be the biggest part, right. You guys are familiar with what we do and what our normal growth results are. So we think about every year about 25% of our business coming from New and there are certain niches that are obviously more severely impacted than others where you can't write that new. So that's a miss in the quarter. You'll have some businesses that don't make it, right from your renewal base. So you'll actually have some of that that impacts it as well. That's actually the smallest part for us. And then particularly in the second quarter, the biggest bucket comes from written premiums due to reduced exposure. So Bob, why don't you elaborate on those three buckets and start with the reduced exposure piece?

[Bob Bailey:]

Yeah, what we tried to do is bring as much of the delayed impact through this sort of bleeding off of month-over-month reduced exposures. We tried to bring as much of that forward as we can could. And just look at okay, what do you think the next quarter will be and try to deal with it before it's earned. So try to deal with right sizing those exposures while they're still in an unearned basis. And that's what – that was my commentary around particularly that transportation segment that was by far the hardest. For the niches that weren't as hard hit, there will be some shortfall as a renewal renews that used to be $100 it's about $80 or something like that that will linger as well. As we look ahead in the months, we sort of see the shortfall in new business as about equal to the shortfall in just smaller sort of renewal basis after we've sort of right sized. We took care of the bulk of the problem, brought it up recognized it early. However though, those other two factors, this is not something we could bring into April as quickly as we could. So those will linger over time.

[Larry Hannon:]

Mark, the other thing I would add, right, and this is the unknown that comes in through this place, right, is that the right sizing piece does come back, you just don't know when, right, but that's the element. So when we look at for example, I would think that somewhere around 35% or 40%, of whatever our second quarter miss will be, that could ultimately be something that we would recoup back. The question just when do those businesses get going again, ask for rates, and is that late 2020, is that 2021, we have to do it – we have to look at that. The new business opportunities eventually come back as an opportunity for us. So the most significant non-recurring element of coming out of the claiming long-term would be those companies that don't make it and obviously, that's an unknown at this particular point, and we'll be able to report more out on that is we get successive quarters in see how that evolves.

[Mark Hughes:]

Thank you for that. On the expense ratio, any sizing you can give us? You gave us up to three points on the loss ratio. How about the expense ratio?

[Larry Hannon:]

Yeah, we don't have that yet, Mark. So we're really going to watch that with the top line. I'll be happy to share that in future quarters. But right now, we don't have a great feel for that yet.

[Buddy Piszel:]

The only thing I would add – the only thing I would add Mark is that if the A P/E expense ratio is coming up, it's more than likely related to bad debt expense we have with these deferred premiums. We've been very diligent in managing all the levers with the disruption. Our headcount growth has been constrained. Our T&E is down. So there's a lot of things that we're saving and we're advancing. But we are exposed potentially to bad debt expense and if our expense ratio is going up that's primarily going to be the reason.

[Mark Hughes:]

The liquidity, you had mentioned you did a liquidity analysis or kind of a stress test and feel good about your liquidity. Could you maybe share some of the specifics on that?

[Buddy Piszel:]

I think we did a fairly draconian stress test where we took the New York regulations which basically postponed. You couldn't cancel for no pay. If there was nonpayment, you had to wait 60 days, then you could bill on an installment basis. And we assumed that a great proportion of the overall book follows that kind of a direction. Now, until we see second quarter play out, we really won't know what the take up rate was. But we assumed 70% of the premium started to defer payment where usually most of the book is annual pay. So it's fairly extreme. And even with that, we don't see a scenario where we're having to sell any of the investment portfolio to meet operating cash flow needs. So we stressed it seven ways to Sunday. We feel pretty good about it.

[Mark Hughes:]

Thank you.

[Operator:]

Your next question comes from the line of Meyer Shields of KBW. Please go ahead. Your line is open.

[Meyer Shields:]

Great, thank you. Good morning all.

[Larry Hannon:]

Good morning.

[Meyer Shields:]

A little fuzzy, was there a written premium in transportation in the quarter or without the actual drop off that you saw?

[Larry Hannon:]

There was not a return premium in the quarter that's going to affect the second quarter. The big issue that we had in the first quarter was a particular association that we non-renewed. Bob, do you want to give some of the details on that, so we chose to non-renew?

[Bob Bailey:]

Yeah, it was – we made the decision back in December, actually, maybe November, December timeframe last year sent notice. It was a subset kind of our intermodal book. I think of it is kind of like a master policy that was worth about $1 million of premium. And I believe the expiration date was March 1. So that's largely the impact you saw – we see there.

[Larry Hannon:]

There after the quarter with – obviously, we would have projected at the segment level, since we don't usually do things. Obviously, disclose them at the niche level, the segment level, we would have normalized that over the four quarters pre-COVID. But inside the quarter that was the real drop off,

[Meyer Shields:]

Got it, okay, that makes sense. It sounds – I don't want to misinterpret this, but it sounds like there aren't any aggressive short-term expense reduction plan because liquidity is okay, am I framing that properly?

[Larry Hannon:]

That's correct.

[Meyer Shields:]

Okay, and then finally, can you give us a sense as to how much rates would need to rise to become interested in a cancellation?

[Larry Hannon:]

I appreciate the laughter. That was good. I appreciate that very much. Bob, do you want to take that one. We thought it was underpriced multifold before this, so go ahead Bob.

[Bob Bailey:]

Yeah. I – honestly in – hand on heart, I would say that our touring entertainer guys would tell you that they were looking at as much as double, double and a half. I mean, it was massively underpriced in our opinion prior to this event. I don't know that COVID would necessarily specifically change sort of the underwriting paradigm. I mean, that's part of what you need to price for. And that's part of why we – well, not specifically allowing for COVID, but part of that price change we were looking for was for this amount of uncertainty and I would say at least double, if not more.

[Meyer Shields:]

Okay, that is very helpful. Thank you so much.

[Operator:]

[Operator Instructions] There are no further questions at this time. I turn the call back over to Larry Hannon for closing remarks.

[Larry Hannon:]

Thank you very much. Hopefully you're – you benefited from obviously both our press release and the expansion of what we've done there because we wanted to make sure that we could be as transparent as possible, and we appreciate the time and energy that you put into asking the quality of the questions and spending the time with us today. So thank you very much and everybody stay healthy and safe. Thank you.

[Operator:]

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.