Protective Insurance Corporation
Q4 2014 Earnings Call Transcript

Published: 29 Jan 2015

[Operator:]

Welcome to the Baldwin & Lyons Incorporated Fourth Quarter 2014 Earnings Conference Call. [Operator Instructions]. At this time I would like to turn the conference over to Ms. Han Huie of MWW Group. You may begin.

[Han Huie:]

Thank you. And thank you all for joining us this morning for the Baldwin & Lyons fourth quarter and year-end 2014 conference call. If you did not receive a copy of the press release, you may access it online at the company's website which is www.baldwinandlyons.com. I would like to remind everyone that we are hosting a live webcast for the call which may be accessed at the company's website as well. At this time, management would like me to inform you that certain statements during this conference call and in the press release which are not historical may be deemed forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Although Baldwin & Lyons believes the expectations reflected in any forward-looking statements are based on reasonable assumptions, it can give no assurance that expectations will be attained. Factors and risks that can cause the actual results to differ materially from expectations are detailed in the press release and from time-to-time with the company's filings with the SEC. And now, I would like to introduce Gary Miller, Executive Chairman of Baldwin & Lyons and turn the call over to him. Please go ahead.

[Gary Miller:]

Thank you, Han. Good morning and welcome to all joining us this morning for the Baldwin & Lyons and conference call reporting the company's results for the fourth quarter of 2014 and for the year of 2014. We welcome your participation this morning and we appreciate your interest in the company. As usual, joining me this morning on the call is Joe DeVito, President of the Company. He will expand on my brief remarks by providing more detail and flavor on how the company is doing and what might be expected in 2015 and beyond. Following Joe's remarks, Pat Corydon, the Chief Financial Officer and Executive Vice President of the Company will provide a more detailed look at the company's results for the quarter and the year with further comment on areas of importance in the financial report. Following Pat's representation we will be happy to entertain any questions our listeners may have. For the fourth quarter of 2014 the company earned $0.46 per share and operating income exclusive of realized gains on investments. This favorably compares to the year earlier fourth quarter earnings also before investment gains and $0.30 and to the $0.36 per share for 2014 third quarter. For the year 2014 operating income was a $1.34 per share just slightly off 2013's a $1.43 per share. Joe will go into more detail as to where the good earnings came from within our operations. We point out that the favorable earnings were mainly a result of premiums exceeding claims and expenses in the company's [inaudible] insurance. Investment income accounted for only 25% of pretax operating income. Those of you that have been following the insurance industry for some time realize how things have changed. Remember when cash flow underwriting was involved, get the premium in, even if claims and expenses ultimately exceed a 100% of the premium and make up the short fall, plus some more from investment income. Not today. If you can't underwrite your business profitability, investment income will not bail you out and your future is dispel. Baldwin & Lyons has always subscribed to the principle that underwriting income is paramount and following that principle in practice has achieved underwriting profits nearly all years. Principle and practice that is even more important today. Speaking of investment income, some changes throughout the year as to our types of investments have increased our interest and dividend income so that in the fourth quarter of 2014 we actually increased pretax investment income by 19% over the same quarter in 2013 and by 25% over the third quarter of 2014. Still with yields remaining low and even falling recently by historical standards, investment incomes remains anemic. Pat will expand more on this topic. Net gain from our investment trading was $0.09 for the quarter, that did not compare well to the same quarter of last year, which produced $0.30 in net gains. Main difference being, the aforementioned favorable gains both realized and unrealized in our limited partnership last year that were not matched this year. For the year net gains from our investment trading was $0.64 versus last year's $1 or $2 which was primarily the same explanation of the difference as given for the quarter. The value of securities retained by the company at quarter's end declined by 4.5 million during the quarter. The main reason for the decline in value was a decrease in value of the company's bond portfolio caused by a price decline in issues that had oil and gas exposure and also a decline in the valuation of some foreign exposure credits. After tax effect, the decline in unrealized gain was 2.9 million or about $0.19 per share for the quarter. For the year net unrealized gains increased by 2.7 million. For the quarter book value increased by $0.09 per share and in the year at 26.67, for the year book value increased by a $1.10 per share, that increase plus the payment of dividends to shareholders of a $1 per share provided a total shareholder return for the year of 8.2%. And now I will turn the call over to Joe DeVito, our CEO and President for his comments. Joe?

[Joe DeVito:]

Thanks, Gary. Our company closed the year with a very good quarter from insurance operations especially considering the overall market conditions. Our consolidated combined ratio for the quarter including fee income was an excellent 90%, for the year the combined ratio including fees was 92.4% producing $20 million in pre-tax underwriting income. Property casualty segments combined ratio for the quarter was 92% with fees continuing the string of good results over the most recent quarters. For the full year, our P&C products produced a very good combined ratio of 92.1%. Our fleet transportation products again did very well with a loss in LAE ratio of 57.7% for the quarter and 58.8% for the year, a 4 plus point improvement over the good 63% generated in the full year of 2013. Personal auto had another difficult quarter with the fourth quarter being negatively impacted by much higher frequency, we believe as a result of a dramatic surge in miles driven primarily as a result of lower gas prices and an improving economy. There is a bit of difficult in states accepting projected versus actual loss ratios and therefore despite some severity issues in the third quarter we had difficult achieving timely rate increases. However, due to two consecutive quarters of higher than acceptable loss ratios, those increases now should be approved and our issues will be resolved. Terminated programs and primary professional liability continue to be the gift that keeps on giving or I should say keeps taking. In any event we made the decision to reserve those programs even more conservatively essentially to worse case rather than expected ultimate and are hopeful that by so doing we can begin the new year with a clean slate having a smaller yet profitable book of miscellaneous professional liability products which have historically and currently provide a nice margin of underwriting profit. After encountering some significant losses in the last two quarters details of which were provided in our previous calls, our property reinsurance business generated virtually no loss activity with a loss in LAE ratio just under 4% for the quarter bringing the full year's loss in LAE ratio in it's 68.6%. Our casualty reinsurance business had another good quarter producing a loss in LAE ratio of 48.8% with the year at an excellent 46% and almost 15 point drop and 24% improvement when compared to the prior year. Despite our previously stated muted optimism related to premium growth reflecting our decisions to withdraw from certain markets and cut back in others, we again set records for both return and earned premium this time for both the quarter and the year. The driving force continues to be our fleet transportation products in which premium written increased over $10 million just over 13% quarter-over-quarter, and up almost $32 million, 11.2% year-over-year. Related to overall market conditions I will essentially restate what you’ve heard from many others, namely that in my experience our business has changed more in the last five years than it did during the previous 37, than I’ve been around. There are however something's that never change, more on that later. There is too much capital searching for home, there is no equilibrium between supply and demand, riding the surplus the historical measurement of capital advocacy and leverage is at an all-time low. Despite the fact that fixed rates of return are also at historically low levels, this excess supply is continuing to put downward pressure on rates. ROE is therefore in general decline with most estimates ranging from 5% to 7%. Underwriting results across the broad market will most likely deteriorate. Some companies that have tried to squeeze margins by aggressively reserving are beginning to show restraint. It is the game that continues to be played. As I’ve said something's never change. Regarding specific products as always, I will begin with the caveat that there are differences some significant by line, company strategy etcetera. In workers' compensation, compensation is still a factor and is creating some headwinds due to a continuing rate strengthening environment. In transportation classes during 2014 we were able to generate overall increases of around 10%, however we’re definitely beginning to see that some of that rate is backing down. As soon as there were initial reports that in the aggregate insurers riding this line returning the corner toward profitability, rating bureaus including NCCI have jumped in with recommendations to lower rates. Sticking to the theme that something's never change, these same bodies were very slow to increase rates when the industry was bleeding money but rush-in quickly to decrease rates at the first sign of a turn in particular in this highly regulated politically charged line. In this long tail business which is very sensitive to both inflation and economic conditions, we believe it to be improving to begin to lower rate so soon after just a year or two of improved results. In addition the combination of increased exposure in large part due to increased economic activity and declining rates is a slippery slope we wish to avoid. Commercial transportation auto market also after a brief period of low single digit rate increases appears to be entering a new phase as well. There is robust competition for good accounts, again at a time during which there are increasing exposures due to better economic conditions. Here the combination of more miles and new and experienced drivers continues to be a concern. As always this is not a market for the timid or naïve. High premiums are certainly attractive from the outside, however with those come high limits, volatility, target defendants and a landscape of mine fields for those who are unaware of the signs or the location. Regarding trucking specifically the need for underwriting and claims expertise has never been greater. One of the biggest keys is selection, the ability to segment and differentiate risk. Improved technology continues to have a positive impact here and we have been engaged for years with a number of strategic partners to ensure that our customers are receiving optimum benefit thereby lowering frequency. We continue to be at the forefront of utilization telematics to not only reduce losses but also to refine and evolve our already robust databases, thereby becoming much more granular and precise in the constant development of our rating algorithms. I’ve already addressed some of the underwriting challenges we encountered during the second half of 2014 related to our personal auto program. During calls over the last several years, we have touched upon the challenges with this product related to the advertising arms race, our limited scale and continuously increasing competition. Given the nature of our customer base, essentially what was previously known as the non-standard market the incessant ads have created a price is king mentality resulting in continuing, highly commoditized and competitive environment. Turning to reinsurance, the only good thing I can say about the property market is that we’re out of it with our final policy set to expire on June 30, '15. As I’ve previously stated our causality reinsurance products continue to perform as expected. However there has been a significant impact of the highly competitive property market on our relationships and programs in this space. As the revolution and reinsurance continues to evolve, the disruption is forced historical property specialist to look elsewhere for premium. Those who already had a presence are demanding larger lines, some are opening trading program share for a willingness to accept hard to place risks. The conditions that create an opening for us to enter this space several years ago have changed, and we have let deals go when the margin erodes to the extent the risk reward proposition is no longer attractive. So in these difficult conditions what can our stakeholders expect? For one we have been through times like this before. One thing that we have and will continue to do is be extremely disciplined underwriters, we plan to continue our relentless focus on producing an overall underwriting profit. We will always be proactive related to market conditions and we have certainly done so, significantly reducing our volatility via product eliminations, recalibration of pricing models and efficiency use of reinsurance. Our talent pool is deep, the Baldwin brand and infrastructure of stronger than ever and we’re exploring multiple ways to leverage both. That should allow us to continue to pay a handsome dividend to provide attractive total value returns to our shareholders and maintain a strong balance sheet with minimal surprises. And now I will turn the call over to our Executive Vice President and CFO, Pat Corydon who will provide detailed information related to our investments and related activity, Pat?

[Pat Corydon:]

In last quarter's call we noted that after seven years of consistent declines we believe that we finally bottomed out with respect to average bond yields for our portfolio. While one quarter does not confirm a trend, fourth quarter bond income displayed a directional results we anticipated, both dollars of interest earned and average yields on our bond portfolio were up over the fourth quarter of 2013 as well as the immediately prior quarter. Equally encouraging average after-tax yields on bonds purchased during the quarter increased by more than 70 basis points from that of the maturing securities which will result in further increases in 2015. Combined with higher dividends received on equity holdings, total pretax and after-tax investment income were each up 19% this quarter compared to last year's fourth quarter. It's noteworthy that this was accomplished without meaningfully extending the duration or average contractual maturity of the fixed income portfolio. For the full year while bond interest was slightly lower than in 2013, higher dividend income produced an overall 3% increase in pretax and a 5% increase in after tax investment income during 2014. Considerable speculation continues with respect to anticipated changes in the Feds interest rate policy in both the near and long terms. Regardless of the timing of any such changes our portfolio is structured to take quick advantage of upward movements in interest rates. In the fourth quarter the company reported pretax realized gains of 2.1 million all of which came from direct trading activity as our limited partnerships investments produced roughly breakeven results during the quarter. For the year direct trading gains totaled $7.9 million which is above average but well off of the $13.6 million realized in 2013 when a larger than normal number of equity securities were liquidated as part of a redistribution of our investment portfolio. Limited partnerships produce $7.1 million of gains for the year nearly a 10% return on funds invested. In total pretax realized gains of $14.9 million while below the excellent $23.5 million reported in 2013 was well above average and added $0.64 to the current year's earnings per share. Unrealized gains declined by $4.6 million during the quarter as Gary noted. Due to debt holdings in the energy sector, as well as the impact of the strengthening dollar on valuations on non-domestic debt. We believe that this is a temporary decline as actual credit risk in these issues is not considered significant. Total investment activity for the year including changes in unrealized gains produced a $28.2 million gain before tax which equates to a 4.2% return. Operating cash flow during the fourth quarter was negative by $1 million bringing year-to-date positive cash flow to $30.2 million which compares with last year's 35.9 million. The lower cash flow for the year was result of claims settlements relating to catastrophe losses occurring in the second quarter of this year. Prior year loss developments remain favorable and consistent, claims settlements during 2016 produced a consolidated prior year reserve savings of approximately $10.3 million. This overall development is equal to 4% of year-end 2013 net loss reserves and had the effect of reducing the 2014 calendar year loss ratio by 4 points. This result compares to a 2% reserve savings reported in 2013 which reduced that calendar year-to-date loss ratio by about 2 points. A consolidated savings is composed of a savings of $6.6 million from our property and casualty insurance segment and an additional $3.7 million of savings from the reinsurance segment. The 2014 property and casualty segment savings equates to about 3% of that segments year-end 2013 reserves which is fairly typical of our historical development patterns. In terms of impact on loss ratios, the current year-to-date property and casualty segment savings reduced this segment's loss ratio by little over 3 points, compared to a 1 point reduction from reserve savings recorded in 2013. The development savings for the reinsurance segment for 2014 was equal to about 6% of year-end 2013 reserves and lowered the calendar year-to-date loss ratio for this segment by 10 points compared to a 6 point savings impact on the reinsurance loss ratio during 2013. I will remind listeners that we posted our press release and quarterly financial statements on our website at baldwinandlyons.com. Click on the investor relations page and select news from the news and market data dropdown menu. The press release and the financial statements can be printed or downloaded using Adobe Acrobat. All other quarterly financial data available at our investor relations website has also been updated. This concludes our formal presentation. At this time we will be happy to answer any questions listeners may have.

[Gary Miller:]

Thank you for joining us this morning and look forward to meeting with you again following completion of the first quarter 2015. Thank you.

[Operator:]

This concludes today's conference. Thank you for your participation.