State Auto Financial Corporation
Q4 2007 Earnings Call Transcript

Published: 19 Feb 2008

[Operator:]

Welcome to the State Auto Financial Fourth Quarter Earnings Call. (Operator Instructions) Today's conference is being recorded. If you have any objections, you may disconnect at this time. Now, I will turn the call over to Mr. Terry Bowshier, Director of Investor Relations of State Auto Financial Corporation. Sir, you may begin.

[Terry Bowshier:]

Thank you, Catherine. Good morning to you all welcome to State Auto Financial Corporation's fourth quarter 2007 earnings conference call. Today, I am joined by several members of STFC's senior management team, our Chairman, President and CEO, Bob Restrepo; Chief Financial Officer, Steve English; Chief Investment Officer, Jim Duemey; Corporate Actuary, Matt Mrozek; and our Chief Accounting Officer and Treasurer, Cindy Powell. Today's call will include prepared remarks by our CEO, Bob Restrepo, after which we will open the lines for questions. Please note our comments today may include forward-looking statements, which by their nature involve a number of risk factors and uncertainties, which may affect future financial performance. Such risk factors may cause actual results to differ materially from those contained in our projections or forward-looking statements. These types of factors are discussed at the end of our press release, as well as in our annual and quarterly filings with the Securities and Exchange Commission, to which I refer you. A financial packet containing reconciliations of certain non-GAAP measures, along with supplemental financial information was distributed to registered participants prior to this call and made available to all interested parties on our website www.stateauto.com, under the investor section as an attachment to the press release. Now, I'll turn the call over to STFC's Chairman, President and CEO, Bob Restrepo.

[Bob Restrepo:]

Thank you, Terry, and good morning, everyone. We are very pleased with our fourth quarter results, although we have the twin benefits of favorable weather and positive reserve releases, our underwriting results also were held up very well and we have reported solid results across all lines. For the year our combined ratio of 92.8% and our net income from operations of a $111 million exceeded our expectations. We are particularly pleased with the increased in book value per share that we produced in 2007. As reported earlier today, book value increased 13.7% to $23.10 a share. The excellent result is a testimony to our strong underwriting performance, conservative investment philosophy, and prudent risk management practices. We continue to manage our investment to an attractive after-tax return and have no material exposure to the sub-prime and municipal bond insurance problem that are plaguing many other companies. Our investments in new products and new technology are paying off in the marketplace. After several years of flat or negative growth, we have positive growth in the fourth quarter in both our personal and business insurance segments. All in all, an excellent quarter and a very good year. Personal auto remains our largest and most important line, frequency and severity were up modestly, but pure premium trends remain quite manageable. During 2007, personal auto rates were flat, but we planned modest price increases for 2008. We produced an underwriting profit in homeowners, but a good part of this resulted from favorable weather and relatively low catastrophe experience. Our non-catastrophe loss ratio was 46%; we need to get it well under 40% and has several initiatives underway to improve results. Commercial automobile and commercial multi-peril were not as strong in 2006, but are still quite good and remain good profitable. And workers' compensation results have improved substantially, since the second quarter. Our premium volume was up 1.5% for the quarter and flat for the year. Personal insurance premiums increased 2% and business insurance premiums were up just under 1%. We continue to see substantial increases in new business particularly in the personal automobile and business owner or BOP line. The investments we have made a new products and new technology are paying off and substantially higher levels of submission and quote activity. Clyde Fitch, our new head of sales says, we're getting a lot more back. The key for us is becoming top of mind with our agency plan and getting more opportunity to quote and write profitable new business. In 2007, 96% of new personal insurance was submitted to us electronically and 82% of all policy changes. In the BOP line new business increased over 40% last year following the countrywide rollout of our new bizXpress capability. Commercial automobile will follow with bizXpress in the second quarter of this year. Our productions run rates for all key lines of insurance have good momentum as we began a new year in 2008. The production momentum we have established with their standard lines will be augmented by the pooling changes we announced late last year. In 2008, we will add new premium to STFC's results coming from the Beacon Insurance Group in Texas, the Patron's Insurance Group located in southern New England and our middle market business, which we call SAMMI. At the end of 2007, these three businesses accounted for over a $130 million in direct written premium, 80% of this business will be reported with the results of STFC in 2008. For the quarter and for the year expense ratio suffered somewhat from weak premium production and higher fourth quarter accruals for agent and employee related compensation expenses. Separately today, we announced preliminary catastrophe loss estimates for a series of unusual first quarter storms. So, far this year we have had three separate catastrophes that we estimate will produce $30 million to $33 million and pretax catastrophe losses for STFC. Over the past five years, our average first quarter loss from catastrophes was less than $7million. At this point, we expect to have an unusually poor first quarter catastrophe wise. Not withstanding the bad weather experience, we have had at the beginning of the year, we remain confident that the investments we are making in profitable organic growth and the new acquisitions will incorporate into STFC's result will continue to build book value and strong returns for our shareholders. Before we open it up to questions or before I turn it back to Terry, I'd like to have Matt Mrozek to give you a little bit more color on our reserve releases that were included in our 2007 results. Matt?

[Matt Mrozek:]

Thank you, Bob. As Bob mentioned 2007 did see some favorable reserve development on prior accident years. For the entire year 2007, the total favorable development amounted to $54.7 million. Specifically within that catastrophe is accounted for about $4.6 million. The balance is made of largely of four components each contributing about the same; the first is ceded reinsurance, the second is loss adjustment expense reserve development and the last two are on the law side on both the private passenger auto liability segment and the other liability segment. To add a little bit more color within those two lines of business for private passenger auto the primary contributors are the latest two accident years -- the accident years '06 and '05 and primarily a change in the loss severity although there has been some improvement also in the frequency for private passenger auto liability and for other liability the emergence coming predominantly from the last three accident years and being driven by improved severity. We had in total $54.7 million and rough numbers that compares to $72 million for year ago 2006.

[Bob Restrepo:]

Thank you, Matt. I'm sure we'll have some follow-up questions on that and Terry we'll turn it back to you and open it up for questions.

[Terry Bowshier:]

Okay. Thank you Bob, Matt. At this point, Catherine would you please open the lines for questions.

[Operator:]

Thank you (Operator Instructions) Our first question comes from Beth Malone at KeyBanc. Your line is open you may ask your question.

[Beth Malone:]

Good morning and congratulations on the fourth quarter.

[Steve English:]

Good morning

[Bob Restrepo:]

Thank you, Beth.

[Beth Malone:]

My first question is just to unclear on the loss the reserve releases what was it in the fourth quarter for reserve release. I know it appeared in the press release I just want to make sure I heard the right number?

[Bob Restrepo:]

That's I'll ask Matt to respond.

[Matt Mrozek:]

For the fourth quarter, we've and catastrophes broken out specifically for catastrophes in the fourth quarter the number was about $6.1 million.

[Beth Malone:]

That was when you say catastrophe that wasn't reserve releases from previous catastrophes reserves or was that actual catastrophes you experienced in the quarter?

[Matt Mrozek:]

The $6.1 million is the favorable reserve development in the fourth quarter on prior period catastrophes.

[Beth Malone:]

Okay. And then was that the only reserve release or was there more?

[Bob Restrepo:]

As far as the non-cap we don't break that out as far as quantifying the impact in the fourth quarter specifically versus other quarters just at the full year numbers that I mentioned earlier.

[Beth Malone:]

Okay. And for the whole year the favorable was down compared to the year ago?

[Bob Restrepo:]

That's correct.

[Beth Malone:]

Okay, all right. I just also wanted to ask a question about the premium growth or the flat premiums just so I get the picture you all were able to generate as much written premium this year as you did last year, and you said prices were flat. In the market, which I think where some of your competitors are, we've pretty consistently been told that's rates in 2007 were down anywhere from 5% to 10% to as much as 20%, if you're talking about trying to get new business. So, your book you saw rates flat in the same markets that these other companies are saying that they saw them decline that much?

[Bob Restrepo:]

My comment that's in terms of flat pricing related to personal automobile and if I give you a general feel by line in business insurance, personal automobile rates were flat. We took some rate discounts custom rates in 2006 on our legacy book to maintain retention and our policyholder retention has held up very, very well for both the personal insurance as well as the business insurance. In homeowners we had some price increases, but pretty modest and commercial insurance -- in the business insurance areas our prices per exposure were down, somewhat fourth quarter was pretty consistent with what we seeing throughout last year in the mid single-digit area. Conversely, in addition to strong retention as I mentioned, our new business was up substantially and business insurance particularly in the BOP line that contributed to a slightly positive increase in our policy count. So, our exposures were up somewhat prices net-net, when you roll in business insurance were down somewhat. That's what adequate contributed to a flat year, but our run rates in the fourth quarter, particularly from a new business standpoint were substantially higher in the prior three quarters and that's contributed to the modest premium increase.

[Beth Malone:]

Yeah. You mentioned that BOP was up substantially, is that I think you said 40%. Is that because -- is that a new product line for you?

[Bob Restrepo:]

We have the BOP product out there for sometime. We had fall behind many of our competitors in terms of our ease doing business particularly from a technology standpoint. The big stimulus to our production increase was implementing the new technology, which we call netXpress, which allows quote and issue policies real time in their office. So that was the biggest significant change, we've also made several enhancement to the product itself broadening eligibility, enhancing coverages to make it easier to sale the products. But the biggest thing will contributor to the increase in business within a system we put in place early in the fourth quarter.

[Beth Malone:]

Okay. And then just one last question, that on the catastrophe did you release this morning for the first quarter with $33 million. So that was the tornados that made the press and you happen to have some pretty meaningful exposures in those markets, where those tornadoes occurred?

[Bob Restrepo:]

Yes. We have three separate catastrophes. One, the first week in January, the second the fourth week in January and the third and the most significant one was last week and that significantly affected areas of Kentucky and Western Tennessee, where we've substantial property business.

[Beth Malone:]

Okay. Thank you.

[Operator:]

Our next question comes from Joseph DiMarino from Piper Jaffray. Your line is open.

[Joseph DiMarino:]

Good morning.

[Bob Restrepo:]

Good morning.

[Joseph DiMarino:]

Just one quick question what would be your proportions of casualty risk versus property risk the ratio, if you have one? How does your business break out in terms of casualty risk, exposure versus property risk exposure?

[Bob Restrepo:]

We don't have that right in front of me and our 50% of our business is automobile business either personal or commercial obviously that's both a liability and a property risk. The property damage and the physical damage coverages are property oriented either our own clients or somebody else's, but we also pay a lot of bodily injury and medical claims as well. Though it's a reasonable mix, generally speaking we've more property exposure than liability or casualty exposures.

[Joseph DiMarino:]

Okay, thanks.

[Operator:]

Our next question comes from Chuck Hamilton from Ftn Midwest. Your line is open.

[Chuck Hamilton:]

Hi, good morning. Thank you and congratulations on a very good quarter.

[Bob Restrepo:]

Thank you.

[Chuck Hamilton:]

Say just the quick answer to the previous caller. I think roughly your split is about 72/28 property casualty, if you roll in your homeowners and fire and allied lines, maybe half of your commercial multi-perils. So, I think that's broadly about what the split is at this point for '07.

[Bob Restrepo:]

Thanks, I'll invite you in here for the next call.

[Chuck Hamilton:]

Okay. Actually I do have one question for Matt and Matt sorry, but I'm going to need little bit more information on the cat loss ratio and the loss development just for clarity purposes because I have to confess on I'm confused at this point. I think which you had indicated is for the '07 full year, you got 54.7 combined loss development in cats, which I think you identified $4.6 million in cats. So, really $50.1 million net all the catastrophes for the full year, is that correct?

[Matt Mrozek:]

Yes. Correct.

[Chuck Hamilton:]

Okay. And in '06 you identified $72 million total what was the cat portion of them?

[Matt Mrozek:]

800,000.

[Chuck Hamilton:]

Okay, as you reported, yeah.

[Matt Mrozek:]

Very well contribution.

[Chuck Hamilton:]

Okay. And I think and I'm trying to understand I guess looking at the fourth quarter in particular and when I look at last year I think that's big start on fourth quarter '06 call. You identified that net cats and loss development you had a hit of $1.5 million or 0.6% loss ratio of impact, further follow-up indicated cats were about $7.9 offset impart by loss development of 6.4. You had indicated today $6.1 million is favorable impact from combination in the quarter. How would you break that down Matt between the cats and loss development?

[Matt Mrozek:]

The $6.1 is the loss development of prior period catastrophes.

[Chuck Hamilton:]

Okay.

[Matt Mrozek:]

That combines with a very small few $100,000 fourth quarter catastrophes, though in total for the quarter the catastrophe amounted $5.9 million.

[Chuck Hamilton:]

Okay. $5.9 so it's got 0.2.

[Matt Mrozek:]

Favorable, okay. Then I've to say the most of the difficulties analyst are having is the fact we can't get at the loss development from prior periods. And again you got still significant cash lines here and it's difficult for us to be able to access the impact in this quarter from favorable loss development unless we actually have it split out from cat so, just a comment going forward. That's it for questions. Thanks very much.

[Bob Restrepo:]

Thank you.

[Operator:]

Our next question comes from Larry Greenberg from Langen McAlenney.

[Larry Greenberg:]

Thank you and good morning.

[Bob Restrepo:]

Good morning, Larry.

[Larry Greenberg:]

I was wondering is it fair to say that you got some favorable developments this quarter from prior 2007 quarters?

[Steve English:]

Yes it is, Matt.

[Matt Mrozek:]

[Both the] catastrophe, yes of the $6.1 million that I've noted $5.4 million came from prior years with the balance coming from prior '07 quarters, the catastrophes.

[Larry Greenberg:]

Okay. But beyond the catastrophe was there non-cat favorable development from the prior quarters?

[Matt Mrozek:]

Well, the cats are the only piece that we breakout on a quarterly basis but we can't speak to the impact of prior quarters development in the fourth quarter are non-cats.

[Larry Greenberg:]

Okay, that's fair. What were the total cat losses for the year?

[Steve English:]

Its $37.1 million, Larry in total for the year.

[Larry Greenberg:]

Okay. And you and your disclosure on the first quarter cat Steve "normal" first quarter the average over the last five years. Do you have that information broken out for each of the four quarters?

[Steve English:]

Yes, we do.

[Bob Restrepo:]

Well, I don't have with me. We don't have it in front of us, Larry.

[Steve English:]

We can provide that.

[Larry Greenberg:]

Okay. Just in general, what are you using for your overall cat flows on an annual basis now?

[Steve English:]

We've been averaging over the last five years or so 6% to 7% of our premium paid out cat. Obviously it moves around quite a bit quarter-to-quarter, definitely year-to-year. It tends to be concentrated in the second and third quarters.

[Larry Greenberg:]

Okay.

[Steve English:]

First and fourth quarters are generally like catastrophe quarters for us. This was very unusual year and a lot of mild weather that we had in the south really produced a lot wind and tornadic events event that we don't ordinarily see in January and February.

[Larry Greenberg:]

Okay. Okay great that's very helpful. I appreciate it.

[Steve English:]

Thanks Larry.

[Operator:]

Our next question from Beth Malone with KeyBanc . Your line is open.

[Beth Malone:]

Thank you. I just wanted to ask a follow-up. I was just interested in understand why this morning did you put out your earning's release and then followed up with the press release about the cat losses. Why not put them into one release. I just wondered was there a purpose for that?

[Bob Restrepo:]

There was nothing material.

[Beth Malone:]

Okay.

[Bob Restrepo:]

And there are two separate stories and

[Beth Malone:]

Okay.

[Bob Restrepo:]

One having to do with last year, which we were very pleased with the result and we had a material event. We could have waited another week or two until we had a better handle. But we felt we had a reasonable handle on those three periods or on those three catastrophes. I mean rather than wait later on the quarter and then preannounce that before we announced our first quarter results. We saw that the appropriate in the interest of transparency to make it as early as possible.

[Beth Malone:]

Okay that's fine and I understand that. And did these I mean it's little early to tell, but does the tactic you had this significant loss from tornados had caused you to think about your exposures or where you are writing business or anything?

[Bob Restrepo:]

Not really, Beth. But this is any company no matter how big they are its going to have property concentrations usually in their backyard. Right been in the past in New England and happened to be New England and New York because the business within the backyard to a bad winter there. Of course here our backyard is in Ohio and Kentucky and Indiana, Tennessee those are bigger states. We're obviously working overtime to achieve better spread of risk, which is a key to our M&A strategy. But where we're right now Louisville in particular Kentucky and most particularly is the area where we've our large concentration of property risks and bad weather in Kentucky, such as we've seen particularly over the past week or so unduly hurts us.

[Beth Malone:]

Okay, all right. Thank you.

[Bob Restrepo:]

It could happen in Connecticut tomorrow who knows.

[Beth Malone:]

I don't think if tornado could happen in Connecticut tomorrow but…

[Bob Restrepo:]

I went through one, when I lived in Connecticut, but it's a rare event, I agree.

[Beth Malone:]

Okay, thanks.

[Operator:]

Our next question from [Matt Wellman] from KBW. Your line is open.

[Matt Wellman:]

Gentlemen good morning.

[Bob Restrepo:]

Good morning, Matt.

[Steve English:]

Good morning.

[Matt Wellman:]

Just one quick numbers question what was the cost of the shares repurchased in the first quarter?

[Steve English:]

It was 22.1 million for the full year, Matt. I'd like to quick calculate it, most of that with in the fourth quarter.

[Bob Restrepo:]

I'm sorry Jim what was…

[Jim Duemey:]

$27.50 was the average price.

[Matt Wellman:]

$27.50 that is?

[Jim Duemey:]

That was the average price.

[Matt Wellman:]

Yeah. Okay, great. Thanks so much.

[Operator:]

Our next question from Chuck Hamilton, Ftn Midwest, your line is open.

[Chuck Hamilton:]

Great, thank you. Bob couple of quick questions, in terms of looking at the great growth in the private passenger auto 2.3% for the quarter. Can you provide some additional colors, some additional details maybe give a sense of what kinds of an impact CustomFit is having and maybe some the metrics you follow to determine your success in that product whether it's market penetration or states or those kinds of things?

[Bob Restrepo:]

One of the things that we look at, we look at several things. One is activity. As I mentioned how many at bats are we getting and last year we saw significant increases in the number of times our agents quoted us. The other thing we monitor both from an efficiency standpoint, but also making sure that we are not getting selected against or that we are not overly competitive is what our quote to write ratio is and we write about one out of every three quotes that we do. And that to me at least in my experience is the good balance. That means we're near neither too hot nor too cold from a pricing standpoint. But the key is just to really get more opportunities and make sure that we are increasing the dominator I think quote to write ratio. We also look at the profitability. We have extremely profitable legacy book. We are not converting the legacy book two CustomFit. We monitor where -- we monitor how often agents rates actually convert existing business to our CustomFit products and about 20% of our new business can be accounted for us, as resulted conversions from our legacy book to our current book. We also monitor the loss ratio the profitability of the new CustomFit business relative to the legacy business and it's comparable. Our loss ratios are comparable, particularly as we build out the book and I'm looking the math right now, I think custom should accounts for about 30% of our or little less than that.

[Steve English:]

20% of our…

[Bob Restrepo:]

20% of our total business now is in CustomFit.

[Chuck Hamilton:]

Is it do you mean personal auto business, Bob.

[Bob Restrepo:]

I know it's in the single-digits.

[Chuck Hamilton:]

Maybe the 20% of the personal auto book?

[Bob Restrepo:]

Yes.

[Chuck Hamilton:]

Okay. And I guess in the follow-up looking at the tremendous growth in workers compensation this quarter you had 11.8% growth in comp over the fourth quarter. What can you attribute that growth in the quarter of two?

[Bob Restrepo:]

First of all a very low premium base, so it doesn't take a whole lot of growth to increase relative to where we are, but one of the things that we've been really focusing in on over the last year or so is rounding out accounts. We've had very profitable results for small workers compensation policies by small I mean low premium. Also guaranteed cost most of our growth is virtually all of our growth is coming from guaranteed cost. But not a player [Wall Street response] programs in our standard lines. So, it's really rounding out account in low hazard. We're not writing workers compensation much for construction or for any high hazard classes most of our BOP business in particular tends to be focused on low hazard classes and our efforts and interest to round out those accounts.

[Chuck Hamilton:]

Okay. Again and I think the third question I'll let somebody else takeover. I guess on the back of the first quarter catastrophe losses of $30 million to $33 million, given further thought to put in place an aggregate treaty. I think, when it renews in July?

[Matt Mrozek:]

That's something that we've looked at in the past over the past 18 months or so. The market wasn't receptive to an aggregate treaty, but that's definitely something that we'll continue to look at. My guess is given the softening in the property cat markets there might be a greater receptivity to an aggregate treaty. But when we looked at in the past it was really dollar trading and didn't make economic sense for us. But we'll continue to check.

[Chuck Hamilton:]

Great, thank you very much.

[Operator:]

Our next question from Larry Greenberg with Langen McAlenney. Your line is open.

[Larry Greenberg:]

Thank you. Just curious with a pretty clean investment portfolio and strong capital position given some of the dislocations in the markets there. Are you inclined at all to maybe diversify a little bit into some opportunistic areas?

[Bob Restrepo:]

What are you referring to specific Larry? I think I know, where you're going but…

[Larry Greenberg:]

It's could be more into equity, it could be more into certain of the fixed income segments that have gotten whacked pretty good?

[Matt Mrozek:]

We've taken a look at our -- just our risk reward tolerance for our investments that we've done a lot of work with that the investment committees of our two boards. We've also examined, do we've the appropriate asset allocation and I'll ask Steve and Jim to make kind of respondent. Our conclusion is that we've made some modest changes but not significant ones.

[Steve English:]

Yeah, Larry this is Steve English. We've made some changes. We typically on the equity portfolio had restricted that to just large cap US dividend paying stocks. So, we now are moving dollars out of that bucket and into US Small Cap stocks and some international stocks and had accomplished some of that by the end of the year. In fact, if you look at the balance sheet you will see an increase in our other invested assets year-over-year and what's driving that is because of the accounting nuances. That's where our international money went. But in terms of shifting say the mix between fixed income and equities at the moment we've no plans to be that. Jim, do you've anything to add to that?

[Jim Duemey:]

No I don't it's exactly what we've done for the last year.

[Bob Restrepo:]

There is nothing new, Larry.

[Larry Greenberg:]

Yeah, okay. thanks.

[Operator:]

At this time, I'm showing no other questions.

[Bob Restrepo:]

Terry?

[Terry Bowshier:]

Thank you. We would like to thank all of you for participating in our conference call and for your continued interest and support of State Auto Financial Corp. We look forward to speaking with you again on our first quarter earnings call scheduled for April 24, 2008 if not before. Thank you. And have a great day by remembering our loved one on this Valentine's Day. Thank you.

[Operator:]

Today's call is concluded. All parties may disconnect.