Protective Insurance Corporation
Q4 2018 Earnings Call Transcript

Published: 27 Feb 2019

[Operator:]

Greetings and welcome to the Protective Insurance Corporation’s Fourth Quarter 2018 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Han Huie of MWW. Thank you, Han Huie, please go ahead.

[Han Huie:]

Thank you. Thank you all for joining us this morning for the Protective Insurance Corporation fourth quarter 2018 conference call. If you did not receive a copy of the press release, you may access it online at the company’s website, along with an investor presentation to accompany today’s call and earnings release, which is available at www.protectiveinsurance.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 made during this conference call and in the press release, which are not historical maybe deemed forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Although Protective Insurance Corporation believes the expectations reflected in any forward-looking statements are based on reasonable assumptions, it can give no assurances that its expectations will be obtained. Factors and risks that could cause actual results to differ materially from expectations are detailed in the press release and are included from time-to-time with the company’s filings with the SEC. Now, I would like to introduce Jay Nichols, Interim CEO of Protective Insurance Corporation and turn the call over to him. Please go ahead.

[Jay Nichols:]

Thank you, Han and good morning everyone and thank you for joining our call. I just want to start by stating that I'm very proud of the contributions of our team embracing a path to profitability, serving our customers, and remaining focused. We have completed much of the diagnostic work in our portfolio and we are well on our way to implementing solutions in the segments and operations that need work. While there is much to do, we have accomplished much in a very short period of time. During this call, I will focus on four items. I will provide an overview of our earnings. I will report on our progress on operating initiatives specifically the initiatives to get rate, and to manage volatility in our portfolio. I will review the decision to reduce our dividend and I will comment on our strategic review. During the quarter, our book value declined by $2.01 from $25.96 to $22.95. This decline was attributed to the following; we had underwriting losses of $0.75 primarily due to increased severity in our commercial auto line of business, investment losses of $0.82 related to the December decline in investment markets. The write-off of goodwill of $0.16 and a dividend payout of $0.28. On the brighter side of things, subsequent to the end of the quarter, our investment portfolio rebounded by approximately $0.60 a share, due to the appreciation in the market value of our portfolio. The underwriting results for the quarter were impacted by severity in our commercial auto book related to large liability claims. Historically, severity has been very unpredictable on a quarterly basis, although the experience this quarter was at the high end of the range. Full year 2018 severity was more in line with our growth in premium. This severity is almost entirely related to the 2013 accident year, with prior year development only impacting the loss ratio by 1.8 points in the quarter. Our workers compensation results continued to perform at/or in many cases better than expectations. Additionally, during the year, and continuing through redemptions at January 1st, we took action to reduce the level of risk assets in our investment portfolio. This actually reduces the volatility of our investment portfolio and our investment results increases the capital available to support our insurance business and to support our clients. And our initiatives we're making considerable progress on our primary initiative to get rate or more broadly improving our pricing methodology across the business. Unfortunately, there is much farther to go as the need for improvement was significant in a few segments. While we relate to the rate parade, there has been a significant shift in the mindset here at Protective in the last few months. We are approaching rate in a very thoughtful, analytical and targeted way, but with a commitment to speed. The increasing trend of lost cost inflation is an accepted fact in the commercial auto line of business. Last quarter, we identified 14 of our 59 segments that needed rate in excess of 10%. During the last few months, we continued to analyze the drivers of results in these identified segments. This exercise has been a very encouraging exercise as we are analyzing it -- analyzing in excess of 25 factors that contribute to the outcomes we are experiencing. We have identified where we need to shift our rates and we are taking action on these signals to increase rate or not renew business where appropriate. We believe that specialty focus provides us with better information, better capabilities, and a strong customer base from which we can create value. While the need for rate creates uncertainty, we are supported by the fact that I so rate need across the commercial auto insurance line for 2019 is in excess of 15%. Our second initiative reducing volatility is also moving along well. We have found faculty of reinsurance partners and we are placing the higher layers of our agency excess commercial auto lines business into the facultative market. This is giving us the dual benefit of reducing our exposure to severity and also providing insightful pricing information on these layers. We will continue to work towards a more integrated process to bring significant capacity to our customers and distributions where possible. We are also making progress on the establishment of digital partnerships to better provide value to our customers, streamline our processes and enhance our data and analytics capabilities. Strengthening our infrastructure for the 21st century and creating a more value driven digital platform is essential to our success. As we announced yesterday afternoon, the Board of Directors declared a dividend of $0.10 per share this quarter, which is reduced from our previously previous quarterly dividend of $0.28 per share. This action was made to bring our dividend in line with that of our peer group, preserve capital as we are committed to maintaining our rating and provides increased resources and optionality to repurchase shares when appropriate. We view share repurchases as a valuable and effective capital management tool. Our strategic review committee of the Board of Directors continues to explore opportunities to maximize long term shareholder value. Unfortunately, I will not be expanding on our activities in this area, nor can I comment on the numerous articles regarding this activity. The board remains committed to the maximization of long term shareholder value. I will now turn the call over to our CFO, William Vance.

[William Vens:]

Thank you, Jay. As discussed in our press release, our fourth quarter net loss was $24.6 million or $1.65 per share which compares to net income of $16.5 million or $1.10 per share for the prior year’s fourth quarter. For the full year of 2018, net loss totaled $34.1 million or $2.28 per share which compares to net income of $18.3 million or $1.21 per share for the prior year period. Gross premiums written for the current quarter increased 5.9% to $152.7 million compared to $144.2 million written during the fourth quarter of 2017. Gross premiums written for the full year of 2018 increased 15.4% to $582.5 million compared to $504.7 million written during 2017. The increase was driven by continued growth in the company's commercial, auto and workers compensation products in both our retail and program distribution channels. Our operations produced an underwriting loss of $14.5 million resulting in a combined ratio for the fourth quarter of 112.2%. This compares to a combined ratio of 99.3% for the fourth quarter of 2017. For the full year of 2018, the combined ratio was 108.6% which compares to a combined ratio of 108.4% for 2017. The increase in the combined ratio during the fourth quarter of 2018 reflects an increase in the current accident year loss ratio related to severe commercial auto losses. The elevated combined ratio for the four year 2018 reflects unfavorable, prior accident year loss development of $16.8 million related to commercial auto coverages, ceding an additional $17.3 million in premium, related to variable premium adjustment provisions in our historical reinsurance treaties, and an increase in current accident year loss estimates as discussed earlier. During last year’s -- during last quarter's earnings call, Jay discussed how this unfavorable prior accident year loss development is the result of increased claims severity due to more challenging litigation environment as well as an increase in the time to settle claims. Fourth quarter net investment income increased 6.7% compared to the fourth quarter of 2017. The increase in net investment income reflects an increase in average funds invested resulting from positive cash flow as well as higher interest rates, leading to higher reinvestment yields for a short duration fixed income portfolio. For the full year of 2018, net investment income increased 21.8% compared to 2017. We expect future increases in net investment income to be more modest. However, we continue to expect further increases due to higher invested assets resulting from expected future positive cash flows. Over the past year, our fixed income portfolio duration including cash, has remained relatively level, at an effective duration of approximately 2.3. Our high quality fixed income portfolio has a weighted average rating including cash, of AA minus. During the fourth quarter of 2018, we reallocated approximately 24 million of equity investments into short duration fixed income securities. This is consistent with our actions in the first three quarters of 2018. Throughout 2018, we reallocated approximately 122 million of equity investments into short duration, fixed income securities. These equity sales and predominantly low tax basis stocks were opportunistic as the company benefited from the new lower corporate tax rate of 21%. Proceeds from these sales were reinvested into high quality, short duration fixed income securities. Further, shifting our investment portfolio to a still more conservative posture. In addition, these sales were accretive to income, given the increase in yields at the shorter end of the yield curve. Premium growth is continuing to have a favorable impact on our expense ratio, consistent with our stated strategy to exercise expense discipline. Favorable prior accident year loss development from our workers compensation products also favorably impacted the expense ratio, due to increased seeding commission income from prior year contingent reinsurance contracts, which has the effect of reducing expenses. Moving to our financial position at December 31, 2018 operating cash flow was once again positive during the fourth quarter, resulting in 107 million of positive operating cash flow for the year ended December 31, 2018. Book value per share on December 31, 2018 was $23.95, a decrease of $3.88 per share during 2018 after the payment of cash dividends to shareholders totaling $1.12 per share. It is not lost upon us that 2017 and 2018 were consecutive challenging years for Protective. Reviewing book value over that two-year period, the change in book value per share plus dividends paid was a decrease of $0.66 per share. Jay mentioned earlier that the investment portfolio has increased approximately $0.60 per share this year due to appreciation in the market value of our portfolio. We believe we're beginning 2019 with a strong balance sheet which is well supported by our reinsurance treaties. And Jay has us focused on our operating initiatives to deliver better results to our fellow shareholders and the future. As a reminder, we've posted our press release, quarterly financial statements and a brief presentation reviewing our fourth quarter results on our website at protectiveinsurance.com. This concludes our formal commentary. At this time, we'd be happy to take questions.

[Operator:]

Thank you. We will now begin the question and answer session. [Operator Instructions]. Thank you. Our first question comes from Brett Reiss from Janney Montgomery Scott. Please go ahead.

[Brett Reiss:]

Good morning gentlemen. How much is left under your share buyback authorization?

[William Vens:]

Brett Reiss, we have a pretty robust authorization. I think it's perhaps on the order of like 2 million shares. So frankly it's more than we would go after in any quarterly period. And so there's plenty of room under the authorization. There's no need for the board to pass another resolution to re-up it.

[Brett Reiss:]

Okay. And are there any parameters on where you'd be looking to buy back stock. I mean like Buffett with Berkshire, we’ll buy stock if it dips to 120% of book. Your stock is like about 85% to 90% of book. Would that entice you to be a buyer? Or does it have to trade it at a bigger discount to book? Any color on that would be appreciated?

[Jay Nichols:]

As far as the discount to book we think that the return at those levels to our shareholders is a creative and we would -- we are at discount to book of those numbers. We would, at the appropriate time and we would be in the market.

[Brett Reiss:]

And would you be looking to buy both the B and A shares or just the B shares?

[Jay Nichols:]

I think more that depends on the volume and availability then [Indiscernible] or the other.

[Brett Reiss:]

Okay. Is there a kind of internal targeted combined ratio you'd like to exit 2019 at?

[William Vens:]

Reiss, we haven't historically given guidance and so we're not breaking from that on this call with any forward looking statements.

[Brett Reiss:]

Okay. And just one last question. The combined ratio has been negatively impacted by the increased severity due to more challenging litigation and the increased time to settle claims. That seems to be a kind of new normal going forward. Are you comfortable that the amount of rate increases that you're going to be able to institute will more than compensate for this new normal going forward?

[Jay Nichols:]

It's a very good point that -- and you've caught on to it. That is a new normal in the industry. And we're doing a few things. On the claims adjustment side we're trying to address some of the elements that are driving those larger limit or larger judgments, but we also are setting our rates considering that new normal and we're also trying to find reinsurance or facultative reinsurance on the excess layers in recognition of that new normal to reduce our volatility to larger judgments. So the answer your question on the rate side is yes we are considering the new normal of trend in severity and incorporating that rates.

[Brett Reiss:]

Right, right. Could you just go into a little bit more in terms of being more into what is in your control to reduce litigation costs and to maybe decrease the amount of time to settlement? I mean, are these just things that happen and you just have to grin and bear it? Or do you -- you're suggesting there are things you can proactively do to reduce your exposure there? Can you give me some examples?

[Jay Nichols:]

Well, there are absolutely things we can do on the claims adjusting side too. And I wouldn't say to reduce our exposures just to get better outcomes on that which is we're under the cases much quicker. We are engaged much more deeply and we're making decisions much more quickly about our course of action on a case to one, reduce our expenses and two, reduce the [Indiscernible] by trying to settle sooner.

[Brett Reiss:]

Right.

[Jay Nichols:]

We are also taking some other actions to try to identify where there's – where -- if and where there's any litigation financing engaged in the loss. And so we're doing -- our claims folks are, I think they're the best in the industry and I think they're doing a fantastic job on getting good outcomes on these cases. But they are keyed into the new normal which it does take years to sort of settle into a new normal and they're keyed into the new normal of slightly different process is necessary to get a good outcome on these cases.

[Brett Reiss:]

Right. If there is litigation financing is there anything you can do to stop that or is that a permitted practice these days?

[Jay Nichols:]

There's nothing we can do to stop it per say, but we can take some actions to just to figure that out and to -- and there's some actions that the industry is taking as well which is very encouraging around a process that is very helpful as well. And I -- we are supporters of that.

[Brett Reiss:]

Right. Thank you for answering my many questions.

[Operator:]

Our next question comes from Steve Spence with RBC Wealth Management. Please go ahead.

[Steve Spence:]

Good morning gentlemen. I wonder if you can give us a little light with respect to management succession and if there has been an interim announcement in the last few months that I missed it, I apologize. But I would like to know at this time, has the board taken a position?

[Jay Nichols:]

On management succession you're more referring to me.

[Steve Spence:]

Yes.

[Jay Nichols:]

So I'm the interim CEO.

[Steve Spence:]

Trying to find – apply appropriate, politically correct way to ask the question. Apologize, it was sloppy.

[Jay Nichols:]

Not necessary with me. So, I was on the board from something in April of 2017. I was appointed Interim CEO as well as Chairman on October 19th, and I've been here ever since [Indiscernible] of my life. And the board has engaged a search for a permanent CEO and that is in process. And there is a very thoughtful process going on as to both looking for a permanent CEO which is a great opportunity, and for transition with me. So if you look to my – whether it’s my contractor or my – or disclosures we've made around my tenure is that I will remain as Chairman for a long period of time. And not as Executive Chairman, just as a partner to the new CEO for a longer period time and my compensation goes over that longer period of time. So I'm not compensated for my time as interim. I'm compensated for my time as interim and through transition to maintain consistency of our mission and our approach to our people and our customers for that long period of time. I think it's a very thoughtful process and I'm very confident it will work out well.

[Steve Spence:]

Thank you. I appreciate that. In that role and let's say you're having joined the board there seems to be a pattern here, a serial pattern here of combined ratio problems and mispricing of coverage. And I recognize that that they're statistically there are periods of time where you can price your product correctly, it doesn't mean you don't have adverse client ratios. But there's a pattern here going on many quarters of having to go back and restate. Can you give us a little color on that as to defining that problem? And I think that there would be if you can shed any light on it for us as to how you address that?

[Jay Nichols:]

Sure. Sure. So just to be clear, this quarter we didn't actually have to go back and restate and the prior year development for this quarter made up only one point eight points on a loss ratio and we're much more confident in our reserve levels now and relative to adverse development because of both the reserve levels and because of the reinsurance program which we've spoken of on these calls and which is posted on our website. As far as actions to -- so you're right, there's been rate issues and there was a -- and so we are addressing rate and volatility actively across the entire commercial auto portfolio and other workers comp portfolio is performing well or better than expectations across the whole portfolio. But the commercial auto portfolio where there's been significant trend in losses both on the liability side and on the physical damage side. We were -- I would say late to the rate parade as I said in my prepared comments. And we are now committed to moving on that. So we've done a lot of work drilling down and continue to drill down and not just using a broad brush approach to rate across the portfolio but on a very granular basis with tens of thousands of possible sales to try to figure out exactly where we need to apply rate to the lines of business where we are seeing -- where it's appearing that where rate inadequate and we are making significant moves on rate and on retentions and on limits. So I think that we are -- like I said before through the diagnostics that we've identified where the issues are and we’ve identified the sort of causes of those issues or the factors that are contributing to that. And we are and I'm really happy with the way we're moving to take action on those accounts. And in January our rate moves for much more significant than there were in the prior periods.

[Steve Spence:]

Thank you. And one last question. Can you comment in general on the growth in volume, that is the addressable market. Part of our investment thesis has been that the – to the extent that people aren't walking into department stores to buy product and carrying it out, it has to be transported which in theory I'm assuming would relate to more miles driven with various types of vehicles. Is that a flawed scenario? How do you folks see in terms of the growth of the addressable market?

[Jay Nichols:]

Absolutely, I agree with you. When I came in I stated that the winners in the Amazon economy are cardboard and trucks -- are truckers and many more miles driven. And there's -- not only are there more miles driven and the winners are the -- is the trucking industry of well-organized and so we're as an insurance company enabling commerce in that space and we look to play a role in that. We have a small market share. So our opportunity is significant. I do believe that the trucking market is undergoing significant disruption as well. In terms of what's going on with digital dispatch as well as a whole host of other sort of digital endeavors in the market and the mandated data on ELDs for interstate commerce as well as the just new technology in trucks. It's a very dynamic market and we share your excitement that there's an opportunity in this space. And as an enabler of commerce in this space we think there's a significant opportunity for us. So thesis is correct.

[Steve Spence:]

Is there a metric out there that's available to you folks with respect to accidents per miles driven in the industry with combined data? Or is it a little bit more like clicking your finger and put it up in the wind?

[Jay Nichols:]

No, no. There's so much data there's so much data. The trend on deaths per hundred million miles, the trend on accidents per mile, there's -- it's mandated data. So you -- and it's in reasonably good form. The question is there's so many dimensions to it. They're trying to use it, to convert it to pricing has historically been a challenge in the industry, but I think we're moving more towards what I refer to as probabilistic pricing and away from factor based pricing because you can layer over a whole host of factors, and then the probability is that those of occurrences and we're not -- we're no longer sticking our finger in the wind. There's a lot of data and to analyze in the quest, the real challenge you get signals out of that data and that's what we're spending our time doing.

[Steve Spence:]

Right. Well thank you very much. I appreciate you taking my questions.

[Jay Nichols:]

Thank you.

[Operator:]

There are no further questions at this time. I would like to turn the floor back over to Jay Nichols for closing comments.

[Jay Nichols:]

Okay. I want to thank everyone for their time on the call today. Our singular focus is to set the company on a path to improvement. We're committed to that endeavor and we're making tangible progress. I want to extend our appreciation to our people here for their tenacity and commitment to improving our operations and profitability. I would also like to thank our customers and producers for their continued partnership. And in closing, I want to recognize and remember Norton Shapiro, a shareholder, a member of the board more than three decades who passed away on February 2nd. He was a very special man and will be dearly missed by all of us. Thank you for your time.

[Operator:]

This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.