State Auto Financial Corporation
Q1 2013 Earnings Call Transcript

Published: 30 Apr 2013

[Operator:]

Welcome and thank you for standing by. At this time, all participants are in a listen-only mode until the question-and-answer session. (Operator Instructions) This call is being recorded. If you have any objections, you may disconnect at this time. Now, I’ll turn the call over to Steve English, Chief Financial Officer. Sir, you may begin.

[Steve English:]

Thank you, Timothy, and good morning. And welcome to our First Quarter 2013 Earnings Conference Call. Today, I'm joined by our Chairman, President and CEO, Bob Restrepo; Joel Brown, Vice President of Standard Lines, Jessica Buss, Vice President of Specialty; Chief Investment Officer, Scott Jones; and our Chief Actuarial Officer, Matt Mrozek. Today's call will include prepared remarks, 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 Investors 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, and good morning, everyone. State Auto Financial Corporation began 2013 with a strong quarter. Loss ratio spend for normal catastrophe experience, the negative impact to the formal RED unit is diminishing as the largest program completed its runoff this past quarter. And we continue to get price increases in all segments and in all lines. Today, I’ll provide an overview of corporate results, following my introductory comments Joel Brown will provide more detail for the Personal and Business Insurance segments. Following that Jessica Buss will provide an overview of the Specialty Insurance segment, which includes our Excess and Surplus businesses, Program unit and Worker's Compensation line, and Steve English will conclude our opening commentary with an overview of investment result and balance sheet performance. For the quarter, we reported earnings per share of $0.49 and earnings per share from operations of $0.38. Our combined ratio was 100.2%. RED added approximately 2 percentage points to the combined ratio. The impact of RED will diminish as the year progresses, since the earn primer is front loaded and will decline going forward. In addition, the homeowner’s quota share treaty impacted our combined ratio by 4.2 percentage points. Our exceptional homeowner results in the quarter produced a relatively higher impact on our combined ratio because of the business ceded to third-party reinsures. Netting after RED and homeowner quota share effect the underlying combined ratio was 94%, a profitable quarter coming on the heels of the strong fourth quarter of 2012, when viewed on a comparable basis. State Auto Financial Corporation book value at the end of the quarter was $18.96, a solid 4 percentage point improvement over the year end result. Our current book value includes a reduction of $2.24 a share for the deferred tax asset valuation allowance that we established at the end of the second quarter 2011. The trailing four quarter return on equity improved to 4.3%. And with that, I'll turn you over to Joel Brown.

[Joel Brown:]

Thank you, Bob. Results in Standard lines improved compared to the first quarter of 2012 due to overall reduced catastrophe experience, especially in our business segment. Personal auto loss ratios were essentially unchanged from the same period in 2012. Our largest line continues to remain profitable and benefited this quarter from a more normal first quarter catastrophe results. Bodily injury severity continues to be an area of focus although improved compared to previous quarters. Personal injury protection is showing a heightened loss ratio, primarily due to prior accident years affecting Michigan. We are also seeing results deteriorate in Minnesota and Pennsylvania, and we are addressing this coverage aggressively with rate increases. Personal auto premium for the quarter was flat with higher prices, a slight decrease in new business and a small reduction in policies in force. Agency terminations and our aggressive actions with homeowners are impacting auto premiums and retention. During the first quarter, we increased price on personal auto by 6.9% and our rate plan for 2013 is in excess of pure premium trends. Our homeowners remediation plan continues to produces our results. This line was profitable in the quarter and showed significant improvement over the same period in 2012. Looking at the results prior to the quota share impact we saw an approximate 9-point improvement in the non-cat loss ratio and our cat loss ratio improved by over 25 points. Homeowners rates increased by 14% for the quarter and we expect the comparable rate increase for the year. As with personal auto, our rate plan is in excess of the pure premium trend. We continue to be active increasing both all-peril and mandatory wind/hail deductibles, and are now beginning to use our second generation bi-peril rating model, which provides greater price granularity. As we are reshaping our homeowners book, we continue to see growth in desirable less cat prone states and are reducing policies in those states which have higher than average cat activity. Homeowners premiums grew 10.2% for the quarter and this growth is based solely on price increase. New businesses up slightly due to our efforts to target growth in desirable states, however, our overall policies in force declined in the quarter due primarily to agency terminations in cat prone states. Moving to Standard business, our Standard business results improved by over 10 points compared to the first quarter of 2012. This result was driven by substantial improvements in the cat loss ratio. The non-cat loss ratio increased 3 points compared to the same quarter in 2012. The increase in the non-cat loss ratio was driven by two factors. A large loss explains 1.7 points of this difference. This loss is being recorded under the other commercial line. The remaining difference in loss ratio comes from our CMP business, where we are comparing a good first quarter in 2013 to an extremely profitable quarter for the previous period in 2012. Our underwriting and our book profile remain strong and we are pursuing aggressive rate changes to improve non-cat loss results. For the first quarter we increased price per exposure on our standard commercial lines business by 7.1%. We expect to see continuing increases in commercial lines rates in excess of the first quarter results for the remainder of 2013. Similar to personal insurance, our business insurance pricing is in excess of loss trends. I'll now turn it over to Jessica Buss.

[Jessica Buss:]

Thanks Joel. My comments today will follow our new Specialty statement reporting which is now broken into E&S Property, E&S Casualty, Programs and Workers Compensation. Our Specialty Insurance segment overall excluding RED perform better than expected. The E&S Property and Casualty units continue to produce exceptionally strong profit and production growth. Premiums for the quarter increased 30% compared to the first quarter of last year. E&S Property reported a 17.5% loss in ALAE ratio for the quarter. Our E&S Property business primarily dominated by Florida hurricane insurance continues to see strong rate increases at 13.5% for the quarter. Our property rates have not yet been affected but what the general market believes will be decrease in rate on catastrophe reinsurance which is driven by new capacity entering the market and the anticipated release of RMS Version 13, which is predicted to reduce probable maximum loss curve. We do expect that both of these will result in downward rate pressure for the second half of 2013 in the property catastrophe market. However, given that 34% of our wind business renewed before June 1st, we feel we are well-positioned in the property and property from reinsurance perspective. E&S Casualty also performed well with 54.2% loss in ALAE ratio and rate increases in the low single digits. Our Program unit excluding RED performed as expected with premium growth coming from programs added last year after the RED reorganization. In the first quarter of 2013 this book produced a loss in ALAE of 65.9%. We are pushing rates in this sector as well with our largest program achieving an 8.6% rate increase. We continue to build our Specialty program unit focusing on small to medium-sized programs with MGUs having proven track records in terms of profitability and distribution. Programs overall were adversely affected by RED results in the first quarter as mentioned by Bob. However, those will have less of an influence throughout the year. We are very pleased with the results of the first quarter of Workers' Compensation book, which finished the quarter with a 61.6% loss in ALAE ratio which was better than expected and a 21.4 points improvement for the last year. Results were also aided by affirming price environment. Our first quarter rate increase was 9.2% on our entire Workers' Compensation book. Growth for the first quarter of 3.3% was focused on our targeted states and classes. We anticipate continued solid underwriting profits from our targeted Workers' Compensation strategy, which focuses on accounts under $10,000 and our traditionally profitable debit MOD business written by RTW. And with that, I'll turn you over to Steve English.

[Steve English:]

Thanks, Jessica. Focusing on investment results, first in the quarter, our net investment income declined year-over-year by $600,000, and sequentially from the fourth quarter of 2012 by $3.3 million. As we've highlighted in past calls, this is almost entirely due to our TIPS portfolio and the impact of changes in the CPI index. As of March 31, 2013, STFC's investment portfolio contained $229 million of TIPS at market value. We continue to believe the securities provide uncorrelated returns versus equity securities despite the income statement volatility. Having said that, we are at our target allocation for these investments and do not anticipate adding more TIPS to the portfolio at the present time. For the quarter ended, equity returns were strong, contributing to our book value per share increase, while interest rates -- interest rate changes resulted in unrealized losses in the quarter on our fixed income portfolio. Earlier this year I commented on our plan to refinance STFC's $100 million senior unsecured notes which mature this coming November. As I previously mentioned, State Auto Property and Casualty, STFC's largest insurance subsidiary, is now a member of the Federal Home Loan Bank. We anticipate in the next few months beginning the process of redeeming the senior notes to our refinancing and borrowing from the Federal Home Loan Bank of Cincinnati. We have obtained regulatory approvals and are in the process of making final plans, which include considering tenders up to 20 years as compared to the 10-year term of the expiring notes. This can be done at very cost-effective rates and structured such that there is no prepayment penalty, if some time in the future STFC wanted to retire or refinance prior to maturity. As Bob mentioned, we continue to hold a valuation allowance against certain differed tax assets of STFC, you will notice a small tax provision in the income statement. STFC generated both book and taxable income this quarter. On the tax side, while 100% of our regular taxable income was offset by NOLs, the tax law only allows us to offset up to 90% of AMT taxable income, and allowance was booked against the corresponding differed benefit established, resulting in the recognition of a small amount of tax expense this quarter. As our results are improving, we continue to assess the need for the allowance but expected to remain in place at least until 2014. And with that, we would like to open the line for any questions you may have.

[Operator:]

Okay. (Operator Instructions) Our first question comes from Mr. Paul Newsome of Sandler O'Neill. Sir, your line is now open. Paul Newsome - Sandler O'Neill Thank you and good morning.

[Bob Restrepo:]

Good morning. Paul Newsome - Sandler O'Neill Could you just remind me, I just don't remember how the TIPS work and why the decline sequentially I just a quick…

[Steve English:]

Sure. With the TIPS each quarter there is a CPI adjustment made that adjusts the par value of the bonds that we have and that for GAAP purposes runs through the income statement. So each time that adjustment is a preferred adjustment. We book income and if the following quarter the CPI declines, we reduce the value which is a reduction of income. Paul Newsome - Sandler O'Neill So what -- how can we think if it’s run rate per industrial income with their stable CPI?

[Bob Restrepo:]

Well, in terms of the overall book yield, we’ve gone back and we’ve looked at it on an annual basis, Paul. And it adds -- Scott, that chart we prepared, about how many basis points a percentage?

[Scott Jones:]

Anywhere -- we were getting book yield anywhere from 3% to little over 5%.

[Bob Restrepo:]

Yeah. So, I guess, Paul, my advice to you would be to somewhat think of it on an annual basis knowing that the amount we have build into your expectation, a rate in that state, 3.5%, 4% range. But from quarter-to-quarter, it’s always going to move with that CPI index change. Paul Newsome - Sandler O'Neill So how -- is there anyway to identify, how much investment came as following or not following doable interest rate environment in your portfolio?

[Bob Restrepo:]

Well, I guess, we could consider, we don't presently have it out there in the investor packet. But we could consider isolating the TIP impact each quarter so that you can see that, I suppose. Paul Newsome - Sandler O'Neill Yeah.

[Bob Restrepo:]

So that’s the way to get to answer to your question, I believe. Paul Newsome - Sandler O'Neill Thank you. Appreciate it.

[Operator:]

Thank you. The next question comes from Larry Greenberg [Langen McAlenney]. Sir, your line is now open.

[Larry Greenberg:]

Thank you related to RED, so the underwriting associated with that in the quarter, was that just what you would, kind of, characterize as your loss picks for that earned premium or was there any reserve movement on that stuff?

[Bob Restrepo:]

There was some modest reserve movement, Larry. We put up $1.4 million associated with prior years.

[Larry Greenberg:]

Okay. And then can you -- thanks for the increased disclosure by the way, specialty. That's helpful. Can you tell us how much more earned premium is to go from RED?

[Bob Restrepo:]

Yeah. This quarter, Larry, it was about $11 million or so. And I would say that that's probably going to drop into the 7 -- let see here -- into the -- may be the $9 million range, a $6 million range and a $3 million range.

[Larry Greenberg:]

Great. Thank you. And then on personal auto, are the reported loss ratios seem to bow level with a year ago. The ex-cat was, I think, 2.5 points higher. And I know, you guys talked about PIP in Michigan. Was that Michigan adverse development? Can you give us some idea of, kind of, what were the factors in that 2.5 deterioration?

[Joel Brown:]

Larry, this is Joel Brown. It was due mostly to prior accident year development on that book of business.

[Larry Greenberg:]

And was that mostly Michigan?

[Joel Brown:]

It was mostly Michigan. I did mention we’re seeing PIP increase in some of our other states but Michigan is the driver of the overall result?

[Larry Greenberg:]

Okay. And your confidence level that you've got your hands around the prior development?

[Bob Restrepo:]

Yeah. I’ll take that one, Larry. I would say, as we’ve talked about other times when we had reserve adjustments such as RED, we always -- in setting reserves, attempted to do the best job possible. I would say that I don't expect any true significant further adjustments as a result of this though.

[Larry Greenberg:]

Okay. If you adjust for the prior period, how would that ex-cat loss ratio compare with a year ago?

[Matt Mrozek:]

This is Matt Mrozek. The prior-year PIP development makes up pretty much the entire Delta between a year-ago Q1 and this year. So it will be flat on the non-cat.

[Larry Greenberg:]

Okay. Thanks.

[Operator:]

(Operator Instructions) The next question comes from Brett Shirreffs [Keefe, Bruyette & Woods]. Sir, your line is now open.

[Brett Shirreffs:]

Hey. Good morning, guys.

[Bob Restrepo:]

Good morning, Brett.

[Scott Jones:]

Good morning.

[Brett Shirreffs:]

I was wondering if you just update us on the remaining quantity of RED reserves.

[Scott Jones:]

Sure. The balance of the RED reserves sitting on STFC’s balance sheet at March is approximately $127 million.

[Brett Shirreffs:]

Okay. Great. And then just a couple others here. You mentioned the policy count decline in homeowners. I was wondering if you could quantify that for personal auto as well.

[Bob Restrepo:]

Brett, this is Bob Restrepo. The big change for both auto and homeowners is in our retention. Ex the agency termination, our retention is holding up nicely for both auto and homeowners and the net impact on the retention and Joel is looking at the numbers. It’s about two points.

[Brett Shirreffs:]

Okay. So it’s primarily the agency terminations.

[Scott Jones:]

It is on a PIP basis. In the first quarter, it was a modest 0.8% reduction for auto.

[Brett Shirreffs:]

Okay. Great. And then another nice quarter of growth for the business segment. Just wondering if you could update us on kind of the growth outlook there.

[Bob Restrepo:]

It’s the combination of three things, which really is consistent with our commentary on the growth patterns in the last quarter. One, we are getting price increases and as those earn out, we expect margin improvement. But obviously they're affecting our written premium results. We are seeing a modest improvement in the economy for several years then we had net return on our audit premiums. We are seeing a net positive growth from audit premiums and at renewal higher premium basis for sales and payrolls and property values. And the third thing, which is really part of our strategy, is we’ve been a very small account producer traditionally in our commercial insurance book. We are looking to write larger accounts, which are more typical of the quality regional companies like State Auto. So we are writing more accounts in the above $10,000 range for new business. Traditionally, 85% of our business was under 10 -- most of it under $5000 in premium. So we are seeing good growth in targeted classes. It really hasn’t changed our risk profile. It’s just somewhat larger accounts, which we think long-term is going to have a beneficial impact on our expense ratio as well.

[Brett Shirreffs:]

Okay. Great. And lastly on the homeowner’s line, can you just maybe clarify the seasonality there of the ex-cat loss ratio and I know that went up know from third quarter and fourth-quarter 2012 but it was down year-over-year. Is that just based on seasonality of the results there?

[Bob Restrepo:]

Yeah. Our ex-cat losses tend to run a little higher earlier in the year. We have more fires and chimney fires and the like, particularly in the Midwest and it settles down in the third and fourth quarter. That’s been pretty consistent over the years.

[Brett Shirreffs:]

Okay. Great. Thanks so much for the answers.

[Bob Restrepo:]

All right.

[Operator:]

Thank you. (Operator Instructions) At this time, we have no further questions.

[Bob Restrepo:]

Okay. Well, thank you, Timothy and we want to thank all of you for participating in our conference call and for your continued interest in support of State Auto Financial Corporation. We look forward to speaking with you again on our second quarter call, which is currently scheduled for August 1, 2013. Thank you and everyone have a great day.

[Operator:]

Thank you. And that concludes today's call. Thank you for participating. You may now disconnect.