State Auto Financial Corporation
Q3 2008 Earnings Call Transcript

Published: 4 Nov 2008

[Operator:]

Welcome to State Auto Financial third quarter earnings conference call. (Operator Instructions) At this point I would like to turn the call over to Mr. Steve English, State Auto’s Chief Financial Officer.

[Steven English:]

Thank you, Kelly. Good morning, and welcome to our third quarter 2008 earnings conference call. Today I’m joined by several members of STFC’s senior management team. Our Chairman, President and CEO, Bob Restrepo; 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.

[Robert Restrepo:]

Thank you, Steve and good morning, everyone. For those of us at State Auto, 2008 is turning out to be an unfortunate and unfunny version of Groundhog Day, and it’s dominated by similar, recurring themes

[Steven English:]

Thank you, Bob. At this point, Kelly, would you please open the lines for questions.

[Operator:]

(Operator Instructions) Our first question comes from Michael Phillips - Stifel Nicolaus.

[Michael Phillips:]

Bob, a couple things. You mentioned the homeowners doing well ex cat. You mentioned auto was somehow affected by weather and cat. Any way you can help us quantify that auto piece on the cat piece? Because we look at the loss ratio you give and see it spike up quite a bit, and some of that’s weather related, but I just wonder how much?

[Robert Restrepo.:]

Two points in the loss ratio.

[Michael Phillips:]

Okay. Thanks. And a numbers question here. You might have said this. If you did, I apologize, I didn’t hear it. Organic growth in commercial lines, 0.5%?

[Robert Restrepo:]

0.7.

[Michael Phillips:]

Okay, and then the first question on auto. The loss ratio ex cat, obviously impacted by more weather claims that just didn’t make the cat threshold; any way you could help us quantify that please?

[Robert Restrepo:]

The big change that we saw this quarter relative to what we see is higher incidents of large losses that affected our [personal] on the field line. Just to give you an example we had 13 losses over $250,000, which is higher than usual, both the size and the frequency, and 12 of those were 2007 or prior losses. We also had a higher incidence of large losses in our commercial automobile general liability business, and as I mentioned in my opening comments, we increased customer reserves on prior accident years for worker’s compensation almost exclusively related to increases in medical costs.

[Michael Phillips:]

Trying to understand what’s happened there. Is that the adjuster was looking at that and maybe, I’m picking a number, $5,000 per claim and then they say ‘oh gee it’s no longer $5,000 it’s $250,000.’ Is it a big jump or was it $100,000 and then $250,000, and some of these got over $250,000 over time? Or was it more of a big jump?

[Robert Restrepo:]

It’s a timing issue. These things work out over time it’s just we had an unusual concentration of them and, in the third quarter we regularly review all of our outstanding claims. But often times we’re at the mercy of a doctor sending us bills and we had a uptick in several cases where we reassessed what we thought the ultimate liability would be for medical costs for several people that were seriously injured in automobile loses. But it’s a timing issue; we didn’t see anything that we thought was untoward; we just had a spike this quarter.

[Michael Phillips:]

Okay, great. Thanks Bob.

[Operator:]

Our next question comes from Edin Imsirovic - Keybanc Capital Markets. Edin Imsirovic - Keybanc Capital Markets I was wondering if you could give us an update on your efforts to obtain how you get reinsurance coverage for the wind and hail events? And I believe on the last conference call you mentioned that it may be in effect on January 1, 2009 and I was wondering if that’s still the case?

[Robert Restrepo:]

We are hopeful but, two things. We are continuing discussions, ongoing discussions with several reinsurers regarding aggregate reinsurance cover as we’ve discussed in the past and I was frankly more optimistic six months ago than I am right now given the weather that we’ve seen in the Midwest and also given what we believe is going to happen in the property reinsurance markets. As you’ve seen with reinsurers as well as primary companies reporting financial results in the third quarter, not a good year for any of us relating to weather. That, my guess, is going to make us much more difficult to get the kind of solution we want, if nothing else just from a cost benefit standpoint going forward. Matt Mrozek is here with us and he’s on point with this and I’ll ask Matt, if you can add any color to that.

[Matthew Mrozek:]

Just that we’ve looked at aggregate cover for a couple of years now. Historically it’s not been a cost effective purchase. This year we are more hopeful with the changes in the reassurance market we’ve come to some coverage that made sense from a cost standpoint, again is bottled into the changing reinsurance market right now may or may not make that a possibility. That’s something we continue to assess. Edin Imsirovic - Keybanc Capital Markets Okay, thank you. And just one last question. Just given how the investment markets have behaved lately, are you making any significant changes to your portfolio? Do you see any opportunities in terms of new investments?

[Robert Restrepo:]

We’ve not changed our asset allocations which has emphasized municipal bonds and within our STFC portfolio just fixed income in general. I’ll ask Jim Duemey to comment on any significant changes he sees going forward, particularly the equity.

[James Duemey:]

I’d to like to think that are opportunities to, at some point, increase our equity portfolio but the primary emphasis will be on the income side primarily with municipal bonds. So really not much change going forward. Edin Imsirovic - Keybanc Capital Markets Okay, thank you.

[Operator:]

Our next question from Elizabeth Malone - Keybanc.

[Elizabeth Malone:]

Just a couple of questions; on the pricing in the auto market, that looks like it has improved. Can you identify why pricing is a little bit better than we’re seeing in the general property casualty environment right now; is it typically a leader?

[Robert Restrepo:]

I think it’s a just inherently a more disciplined market; there were fewer big players; they are more disciplined. Large well known companies particularly the stock companies have analytics; we all have the analytics now. We have much better handle on our business than let’s say we had back in the 90s, predictive modeling allows us to refund much more quickly with price increases even in the absence of rate increases. The market has been changing in personal automobile because of deteriorating accident year trends for the past year or so. We’ve lagged a bit behind because our accident year trends have remained terrific, very good. But we are seeing a pure premium trends that are on the positive side so it’s time for us to join the pack and get the kind of rate increases we need to preserve our margins.

[Elizabeth Malone:]

Okay, and then another question on M&A opportunities; you’ve spoken quite a bit about your interest in expanding through mergers and acquisitions in past conference calls and I wondered given market conditions and what’s happened with some investments, does that provide more opportunities and would you need to raise capital or debt in order to make an acquisition?

[Robert Restrepo:]

Of course it depends. I’ll answer the second question first; our financing needs would obviously be depended upon the size of the opportunity. Until we actually disclose that we’ve completed the transaction, it’s kind of hard for me to respond to that. On your first question, yes, we continue to see opportunities regardless of what’s happened in the market. We’ve have ongoing discussions with a couple of prospective partners and we’re optimistic that over the next couple of quarters one of them will actually wind up being a successful new partner to State Auto.

[Elizabeth Malone:]

In terms of what you’re looking for, is it really more a product expansion or geographic expansion?

[Robert Restrepo:]

It’s primarily right now product expansion. We’d really like to diversify our product portfolio particularly in the commercial specialty area.

[Elizabeth Malone:]

Okay. Thank you.

[Operator:]

Our next question comes from Joseph Demarino - Piper Jaffray.

[Joseph Demarino:]

What primarily drove the increase in both personal and business segment in net premiums written? What do you attribute the growth to?

[Robert Restrepo:]

Let me talk about personal lines first. Number one, most importantly, it’s very stable retention. We’ve always had good retention. We’ve been primarily a total account writer and that contributes to excellent retention ratios over the years. Those have continued. The second issue is we have a lot more pricing flexibility now with our custom set. We’re introducing the second version of it and that’s allowed us not only to broaden our underwriting appetite, but to preserve the margins by getting the pricing precision we need. And the third thing and probably the most important change over the past two years is the point of sale technology that we’ve introduced. We’ve talked in the past about our net express technology which allows our agents to rate, quote and issue policies in their office. But we’ve augmented that with new bridging technology, and new bridging solutions that make it even easier for agents to deal with us from their agency management systems. So we’ve seen our quotation activity triple over the past two years. What hasn’t changed is the percentage of quotes that we actually write, which is good for us because that means we’re not being overly aggressive in the market place. Our hit ratio is about one out of four. It was one out of four two years ago and it’s still one out of four. What’s changed is our ability to generate more activity. As our head of sales says ‘the more at bats you have, the more hits you have.’ We’ve have lots more at bats over the last two years, and we continue to roll out new bridging solutions and we like our run rate. Let me just respond quickly to business insurance. Early in the third quarter we rolled out what we call BizExpress, which is our point of sale technology for commercial automobile. As we saw with our BOP line when we rolled this capability out last year, we again had a significant uptick in activity. And the more activity you get the more opportunities you have to quote new business, the more opportunities you have to write business. We have really not a pricing issue as much as an ease of doing business issue. We have our business owner product and our commercial auto product supported by that technology and workers compensation will come early next year.

[Joseph Demarino:]

Great, thanks. Did you say pricing in the personal side was up 2 to 5%?

[Robert Restrepo:]

Prospectively. It’s been flat retrospectively, but we have filed rates and implemented rates and on a prospective basis, it should earn out in the 2 to 5% range depending upon lines [inaudible].

[Joseph Demarino:]

Okay, got it. First of all do you have much overlapping business with AIG and if so can you quantify or tell me about some impact you’ve seen from that?

[Robert Restrepo:]

The short answer is no. We really don’t have any direct competition with AIG. I’ll start with our biggest line, personal automobile; most of AIG’s personal automobile business is the oldest on the market right now is direct response business, and we are obviously 100% independent agencies. They have a small independent agency business that we don’t really compete with or in a very small way. They have some non-standard automobile products that represent a competitor in our non-standard auto line. We may get some business from there. Commercial lines, if we had a specialty business we would be benefiting it, but in our standard lines we really don’t run up against AIG much.

[Joseph Demarino:]

Okay, thanks. And then one last question, what stocks in particular caused the OTCI impairments?

[Robert Restrepo:]

It’s kind of across the board in terms of industries.

[James Duemey:]

They were primarily in our consumer discretionary, industrial, and one [inaudible]. Pretty much across the board, just like the market.

[Joseph Demarino:]

Individual stocks though, not ETFs? Do you have ETFs?

[James Duemey:]

No. We have no ETFs. They’re all individual stocks.

[Joseph Demarino:]

Okay. Thanks.

[Operator:]

Our next question comes from Caroline Steers - FPK.

[Caroline Steers:]

I just have two quick questions. One is if you could comment on the buy back and when you expect that to start up again? And then, you noted a bottoming out on [inaudible] and commercial pricing, and I’m wondering if there are any lines in particular that you would expect to be hardening first?

[Robert Restrepo:]

Regarding the stock repurchase plan. It’s still open and we have always said that the highest priority use of our capital is for M&A. That remains our highest priority. We are also looking for opportunities to buy back our stock, but given all the volatility in the financial markets, as I said given the opportunities we’ve seen in the M&A market, we thought the most prudent use of our capital was to keep it and not buy back the stock. We’ll be evaluating that on an ongoing basis. What makes the most sense going forward. But certainly during the third quarter for those two reasons

[Caroline Steers:]

Okay. Great. Thanks.

[Operator:]

There are no further questions at this time.

[Steven English:]

Thank you, Kelly. We want to thank all of you for participating in our conference call, and for your continued interest and support of State Auto Financial Corporation. We look forward to speaking with you again on our year-end earnings call, which is currently scheduled for February 17, 2009. Thank you, and have a nice day.

[Operator:]

Thank you for participating in today’s conference call. You may disconnect at this time.