State Auto Financial Corporation
Q2 2010 Earnings Call Transcript

Published: 31 Jul 2010

[Operator:]

Welcome to the State Auto Financial second quarter 2010 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. Mr. English, you may proceed.

[Steve English:]

Thank you Courtney, good morning and welcome to our second quarter 2010 earnings conference call. Today I’m joined by several members of STFC’s senior management team. Our Chairman, President and CEO, Bob Restrepo, Chief Operating Officer Mark Blackburn, Chief Investment Officer Jim Duemey, Chief Actuary Officer Matt Mrozek and our Chief Accounting Officer and Treasurer Cindy Powell. Today's call will include prepared remarks by our CEO Bob Restrepo and me, after which 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 Steve, good morning everyone. After a solid first quarter, we experienced a difficult second quarter despite improving non cash fee results in our first to launch business. As been a widely reported catastrophe have plagued industry results this quarter, this quarter has always been a difficult one for State Auto, the spring is when we see the largest share of our catastrophe losses driven by wind and hail. In addition, we had a rash of flood related claims which affected our automobile physical damage results in both personal and commercial automobiles. Virtually all of this resulted from the unprecedented rain and subsequent flooding in the national area in May. STFC’s combined ratio for the quarter was 115.2%. Catastrophe loss was accounted for 18.6 points or $57.5 million compared to 12.6 points and $36.9 million respectively for the same period 2009. Book value for share declined $1.28. Obviously our underwriting results are a major contributor. In addition, changes to our pension plan and investment evaluations also contributed to the book value per share decline. Steve English will address this in greater detail following my opening comments. Unusually high catastrophe losses masked improvements in our personalized ex-catastrophe loss ratio. Personal auto results continue to improve as we earn out the price increases we’ve been taken for over a year. Over 50% of our premium growth in personal auto is now driven by price. Virtually all the remaining growth is coming from the expansion state of Arizona, Colorado, Connecticut and Texas. All in all, the impact on our written premium and price changes is now a 5% increase. Loss trends have increased a bit in the quarter but these move around from quarter to quarter and we think the trends are anticipated well by our rate actions. New business is down compared to last year or remain steady. Profit, pricing and production trends look good for our core personal auto book. Homeowner results continue to be adversely affected by the weather, both catastrophe and non catastrophe. Our non cash, non weather results have actually improved quite a bit, driven by lower large losses and price increases. In the second quarter, prices increased 10%. We’ll continue to see the positive impact of our pricing actions as the year progresses and these price increases are announced. In addition to addressing the impacts of catastrophes and weather on our Homeowner results, we’ve also been evaluating the impact of the economy. Last year we saw an increase of large fire losses in state with above average for closure rates. We’ve instituted a new physical inspection program for our home owners who were more than a 150 days behind on their mortgage payments to ensure that the home was built properly and maintained and occupied. If not, we’re taking the appropriate underwriting action. Although this represents a very small part of our overall book, we obviously want to make sure that we’re doing everything possible to ensure the individual risk quality of our homeowner business, while we’re addressing the portfolio and management issues related to weather and then the need for more price. In addition of pricing and underwriting actions, we continue pursuing insurance to value, implementing wind and hail deductibles in 15 states, which accounts for almost two-thirds of our average wind and hail losses and rolling out our new biperil homeowner product which will be in 11 states by the end of this year. Business insurance results were a mixed bag in the quarter. General liability results deteriorated primarily due to reserve increases on five individual cases from prior accident years. Commercial auto liability results remain quite good. Physical damage results that were hurt by large losses and claims related to the national flooding. Commercial property results improved and as we return to more normal levels of large loss activity. Pricing in this business, the insurance segment remains flattish. We continue to use predictive modeling on our property and liability lines and plan to extend this for the remaining business insurance lines to enhance pricing discipline and precision. We continue to push for increases in commercial lines wherever we can but it’s a tough slot given the market environment and the economic climate. New business has decreased but retention is holding up better than we expected. Policy accounts declined, but modestly. Overall production in business insurances is increasing with the addition of our new alterative risk transfer business, which we call RED or Risk, Evaluation and Design. RED is the managing general underwriter and an affiliate of State Auto Mutual. 80% of the business that we write through this new facility is included in the results of STFC. Business insurance production was up over 16% but virtually all of this resulted from RED. Excluding RED business and insurance premiums increased just 0.1%. We’re seeing opportunity in the commercial multi peril line resulting from the roll out of our new BOP Choice Program. This product has been very well received by our agents. Its easy to use, its easy to sell and to be quoted by a nation on a real time basis. We get better pricing precisions to the use of predictive modeling and the ability to attract more casualty oriented business to give us better spread of risk. We expect this new BOP Choice Program will also create more total accounts business opportunities. Our expense ratio is essentially flat quarter-over-quarter and year over year. We continue to target and expense ratio on the low 30s and we’ve made good progress particularly in reducing commission expense and expenses related to underwriting reports. Though some of this is masked by the expenses incurred to build out our new RED program. With that, I’ll turn you over to Steve English

[Steve English:]

Thank you Bob. For the quarter, our book value per share declined $1.28. First and foremost, the net loss of $0.66 per share accounts for about one half of this decline and Bob has already commented on the operating trends. For the six months ended June 30, 2010, we recorded a tax benefit and an annual estimated effect of tax rates. This is being offset by the $4.5 million of deferred tax expense we recorded in the first quarter of this year relating to the impact of the treatment of the Medicare Part D subsidy under the Patient Protection and Affordable Care Act of 2010. The overall effect of tax rate is based on an estimate of our annual effective rate before the impact of the Medicare adjustment. This resulted in an overall effective rate of approximately 12.6% in the quarter. I would anticipate that improved operating performance in the second half of this year would result in tax expense being provided at similar effective rates without regards to Medicare adjustment. In addition to our quarterly dividend of $0.15 per share, changes in investment evaluations decreased in book value per share by $0.14, primarily related to equity securities. The SMP, Russell 2000 and international indices were all down in the quarter. Our sixth income portfolio was up over March as interest rates moved down. The duration of the fixed income portfolio is 4.5, down from last quarter’s 4.8. Finally the remaining material changed to our book value per share, was a result of a pension re-measurement done effective at the end of May 2010. Beginning this year, new employees are no longer eligible for our defined benefit pension plan. Existing employees were given until May 31 to make a decision to remain in the pension plan or to begin to participate in an enhanced for our 401K plan. Approximately 20% of the eligible employees elected the enhanced 401K resulting in a curtailment and it required remeasurement of attention. As a reminder, we typically only remeasure the pension plan annually in the fourth quarter. The decline in interest rates used to discount the liability as well as change in pension asset values resulted in an increase to the net pension liability and an after tax reduction of equity recorded to accumulated other comprehensive income. In total, AOCI was reduced 13.3 million in the quarter for benefit plan obligations, which translates into $0.33 per share. A couple of final notes, first, we successfully renewed all of our reinsurance treaties on July 1, 2010 with no material changes in terms or conditions. Our reinsurance cost are not expected to materially change. And finally, the statutory surplus of STFC’s insurance subsidiaries stands at $725 million, which reflects the $40 million dividend State Auto National, our non standard auto carrier, paid STFC less than approximately $20 million, contributed by STFC to State Auto property in casualty. And with that, we would like to open the line for any questions that you may have.

[Operator:]

(Operator Instructions) Our first question comes from Paul Newsome from Sandler O’Neill, your line is open.

[Paul Newsome:]

Good morning. I was hoping you could just address the, I guess two things, one is the CAT losses which, I understand what business you’re in and you know your always going to have them but they do seem to be growing and I think the last time I checked in with you folks here, your view was that it was just another round of bad luck as opposed to something that’s more consistent and I was wondering if your views have changed on that and if you intend to try to reflect that in pricing and underwriting as well.

[Bob Restrepo:]

The bad weather continues Paul. When we looked at where all these events happened, we had a heat map showing where the storms happen in the second quarter and they were all over the territory and on the year-to-date basis, they were even more scattered. We, like a lot of other eastern carriers that had issues in the first quarter was snow but as you remember in the first quarter, our CAT loss ratio was slightly lower than our five year rolling average. We usually run 12 to 14 points in the second quarter, obviously 18.6 is higher than our normal run of catastrophe results in the second quarter. Year-to-date, we’re about 11%, we expect it to be in the 8% range. So if we are higher, but certainly not what we’ve seen in the prior two years and but definitely a bit higher. In the upper mid west, we haven’t really seen any catastrophe this year in the South East or anything significant in Texas and what we’re doing is really focusing in on the states that have produced a disproportionate amount of our wind and hail losses going back ten years but particularly in the last three years by rolling out wind and hail deductibles and we’re kind of leading the pack. We’re going into states including Indiana and Ohio and Kentucky, that’s our three biggest states representing 40% of our total premium volume. We’re definitely ahead of the market and requiring mandatory win and hail deductibles and we’ll have those in places I mentioned, 11 states that account for disproportion amount of our wind and hail losses. We’ll also be rolling out our biperil product and we have very, very good success already in Missouri, where we introduced last December. We’re getting as much as 30% price increases in the south west part of Missouri and retention is holding up but what it’s also allowing us to do is to balance our portfolio in Missouri by writing more business in the St. Louis suburban area where the risk of wind and hail is substantially lower. It gives us an opportunity to get more adequate prices and to get a more precise for specific perils and we’re going to have that in place and virtually all of our big states as I said by the end of this year. We also continue to look on a county by county basis to look where the frequency of wind and hail is out of proportion with the rest of our business, both in that state or across the territory and we’ve taken actions in both the Minneapolis, St. Paul area and the Louisville area where we thought we were over concentrated relative to our writings in the rest of the state, in the rest of the mid west and we terminated and the aggregate between those two territories, several hundred agencies. So between wind and hail deductibles between our biperil, getting more adequate prices and when we talk about our prices of 10% in the quarter, that doesn’t include more aggressive insurance to value and also more aggressive upgrading of existing values across the whole book. Our current run-rate, when you add those two together as another three to five points depending upon the state we’re in. So we’ve got a run-rate from a pricing standpoint close to 15% and the increases will continue for at least another year or two. So it’s the balance of price adequacy, it’s a balance of wind and hail deductibles, rolling out our new homeowners custom fit product, risk modeling by county, taking agency actions where we’re over concentrated and of course, we continue to have our aggregate catastrophe reinsurance treaty in place. We renewed that the first of the year to really buy us the time to address these issues. The weather is clearly changed. Our footprint really hasn’t changed. The one thing that has changed is we’ve added states with lower wind and hail exposure. But clearly over the past three years, the weather has changed and because of our concentration in the mid west, we’ve been unusually vulnerable. I think we’re taking aggressive actions to address it.

[Paul Newsome:]

I wanted to continue the conversation here, that as long as I've been covering State Auto, the company has had problems with weather catastrophe losses. And it would appear, and I haven't done a formal survey or anything like that, but it always seems to me and it seems to be getting worse that catastrophe losses as a percentage of your premium are larger for you than for any other company that I am aware of. And that, I don't mean that just in this quarter, I mean over time. And that includes some companies that are in the same footprint from a geographic perspective. So what is it about State Auto that makes them, makes it uniquely susceptible to weather losses?

[Bob Restrepo:]

Well I think for the publicly health companies, we have traditionally had a higher percentage of our business in the homeowner line, accounts for 20% of our business. Knowing who you cover, they end to be more 80% commercial line, homeowners represents a much smaller part of their overall business and clearly it’s the homeowner line that’s been most effective. When I talked to Mutual Insurance companies and when we compare our results for the industry, actually our homeowner results, are comparable to the industry and actually better than the industry for our mid western footprints but when we - so - if the homeowner line is just a much larger percentage. Personal lines in general, we’re still 60% personalized and 20% in the homeowners line. So we have a higher richer mix of personal lines business. Its one of the reasons given the market place, given the economy, we can’t balance it with growth and the standard commercial lines. What we’re looking to do is balance it by integrating our Rock Hill’s so that our overall portfolios business is less dependant upon the weather and less dependent upon homeowner profitability.

[Paul Newsome:]

Thanks. I'll let some other folks ask questions, but appreciate the answers.

[Bob Restrepo:]

Thanks Paul

[Operator:]

Your next question comes from Caroline Steers from Macquarie. Your line is open.

[Caroline Steers:]

Hi, everyone. I was actually just sort of focusing on commercial lines now. I was just hoping you could talk a little bit about the RED business, just in terms of the business they write, and whether that's -- what's driving the growth in commercial, auto, and CMP, and whether you expect that to continue to help growth a little bit in future quarters?

[Bob Restrepo:]

I’ll ask Steve to kind of give you an estimate of the potential volume, but in the short answer Caroline is yes. Virtually all the growth we’re seeing in commercial multi peril is coming from RED and all of the growth we’re seeing in commercial Auto is coming from RED. If you exclude RED, we have a little bit of an increase in commercial multi peril primarily resulting from the roll out of our new BOP Choice Program but the lion share that is coming from RED. A large restaurant program which is primarily casualty in the commercial multi peril line and as I indicated in the last quarter’s call, we also have the transportation related risks that’s contributing to the increase in commercial automobile. Steve?

[Steve English:]

Yes hi Caroline. On the commercial auto line, I’ll just give you some numbers here that will you sort some of that out. In the quarter, RED contributed $10.8 million to the commercial auto line and on the commercial multi peril line the restaurant program in the first quarter, it was 5.7 million, second quarter it was 7.9 million. So collectively within the program, we’ve written over $24 million of premium this year and I would expect those programs by the end of the year to generate as much as $70 million of written premium. So in that, of course since the program was not in place in 2009, will all be growth.

[Caroline Steers:]

Ok thank you, that’s really helpful and then just really quickly on auto and homeowners rates, how much were each of those up in the quarter?

[Bob Restrepo:]

In the quarter first along the bill rates were up 5%, homeowner rates are up 10% but that’s strictly rate action that doesn’t include upgrading and doesn’t include our insurance value program.

[Caroline Steers:]

And the 5% of that all standard Auto?

[Bob Restrepo:]

Yes.

[Caroline Steers:]

Ok, alright, thank you.

[Operator:]

(Operator Instructions) Our next question comes from Larry Greenberg from Lange and McCleany, your line is open.

[Larry Greenberg:]

Good morning. Can you elaborate a little bit on the five cases in GL you referenced where there was prior year reserve strengthening and possibly can you quantify that and did that take the entire book business into a reserve deficiency standpoint for the quarter?

[Bob Restrepo:]

The five cases that accounted for virtually all of the quarter-over-quarter increase and all of them were prior accident years, ’07 through ’09 and they were all results of new information that we received. In one case, the business was in bankruptcy and we just couldn’t get information on it and then the course release information that we could use to better assess what the ultimate value of the case was going to be. So it was just an unusual rash of case development. This is all case development on those five cases and they were all collectively very significant.

[Larry Greenberg:]

So can you quantify them?

[Bob Restrepo:]

That’s about over 25 points.

[Matt Mrozek:]

Yes

[Bob Restrepo:]

Yes, Matt Mrozek is here. It was over 25 points.

[Larry Greenberg:]

25 points for GL?

[Bob Restrepo:]

That’s correct

[Larry Greenberg:]

Okay, so they weren’t of similar nature.

[Bob Restrepo:]

They were all different, all new, based on new information.

[Larry Greenberg:]

Ok and then on the wind and hail deductibles, can you just give us some idea of what the level of the deductibles might be and maybe some sensitivity analysis when they’re in place, what it might - how it might change your performance and fairly active wind and hail quarter?

[Bob Restrepo:]

Once they are fully in place, number one, the deductibles are $1,000 and in many of these states are typical deductible for all perils this 500. So it’s a $1,000 deductible. We’ve monitored Alabama, it was the first state that we implemented at the end of 2008 and we monitored it, does it stick and it does stick and it does reduce severity of the claim settlement by 8 to 10% I think and Matt’s shaking his head, yes, 8 to 10%. We’ve also evaluated it in Minnesota, which is one of our biggest trouble spots, again to determine if it sticks and are we reducing severity and it does reduce severity by 8 to 10%. And of itself, it’s not the answer but it does reduce overall severity and reduce the figure in overall net loss.

[Larry Greenberg:]

And is there something magical about a $1,000. Is it just a level that you think the market could tolerate or?

[Bob Restrepo:]

It’s the level and we’ll see it. As I said, we’re ahead of the market but for deductibles that had been in place for wind and hail, if you got a $1,000 deductible and at some stage as the percentage deductible. In Texas, we have 1 to 2% of deductibles and in Oklahoma as well, but in the mid west to get it started, we saw both from a regulatory perspective as well as from a market perspective a $1,000 is a place to start.

[Larry Greenberg:]

Okay and I know Board actions are sensitive but you did have a director who resigned earlier July and it was unusual and that in his letter that was made public it, you know, was clear that he was dissatisfied I guess with the aggressiveness of your rate actions and perhaps your policy pruning. Is there anything more you could say on that situation and whether it's representative of the Board in general or it's just really a one-off individual?

[Bob Restrepo:]

I really can't add anything to our disclosure. Our disclosure did say that the board, the very supportive of the direction. We’re all disappointed with the results we’ve had which is obviously weather related. We can't control the weather but we need to control our actions against the weather better. The only thing I’d add Larry is that the Board was surprised and disappointed with fixed decision and so is management. We were surprised we didn’t see this coming and obviously, we’re required to disclose any communications that we received from board members.

[Larry Greenberg:]

Thank you, appreciate that.

[Operator:]

We have no further questions at this time. (Operator Instructions)

[Bob Restrepo:]

Well, thank you Courtney. We want to thank all of you for participating in our conference call and for your continued interest in and support of State Auto Financial Corporation. We look forward to speaking with you again on our third quarter earnings call, which is currently scheduled for November 2, 2010. Thank you and have a good day.

[Operator:]

Thank you. This concludes today’s conference. You may disconnect at this time.