Employers Holdings Inc (EIG) 2008 Q3 法說會逐字稿

Good day ladies and gentlemen and welcome to the Employers Holdings third quarter 2008 earnings conference call. My name is Michele and I will be your coordinator for today. At this time all participants are in a listen-only mode. We will be facilitating a question and answer session towards the end of today's conference. (OPERATOR INSTRUCTIONS)

I would now like to turn the presentation over to your host for today's conference, Ms. Vicki Erickson, Vice President of Investor Relations. Please proceed.

Thank you, Michele. And welcome everyone to the third quarter 2008 earnings call for Employers Holdings, Inc.

Yesterday we announced our third quarter 2008 earnings results and today we will file our form 10-Q with the Securities and Exchange Commission. These materials may be accessed on the company's Web site at Employers.com and are accessible through the investors link. Today's call is being recorded and webcast from the Investor Relations section of our Web site where a replay will be available following the call. Representing the company on the call today are Doug Dirks, our Chief Executive Officer, Ric Yocke, our Chief Financial Officer, and Marty Welch, the President and Chief Operating Officer of our insurance subsidiaries.

Before I turn the call over to Doug I would like to remind everyone that statements made during this conference call that are not based on historical fact are considered forward-looking statements. These statements are made in reliance on the Safe Harbor provision of the Private Securities Litigation Reform Act of 1995. Although we believe the expectations expressed in our forward-looking statements are reasonable, risks and uncertainties could cause actual results to be materially different from our expectations including the risks set forth in our filings with the Securities and Exchange Commission.

All remarks made during the call are current at the time of the call and will not be updated to reflect subsequent material developments. I'd again like to remind you that we use the nonGAAP metrics that excludes the impact of the 1999 loss portfolio transfer, or LPT. This metric is defined in our earnings press release available on our Web site.

Now I will turn the call over to Doug.

Thank you, Vicki. Hello everyone and thank you for joining us today.

We are very pleased to report that our acquisition of AmComp Incorporated announced in January was completed last week. The close of the transaction was five months later than originally planned due to issues between AmComp and the Florida office of insurance regulation that have since been resolved and resulted in a reduction in the purchase price. Despite epic dislocations in the credit capital and insurance markets since the deal was originally announced, we continue to believe that this is a compelling transaction because of its excellent strategic fit, acceleration of our growth and expansion strategy, complimentary geographic fit, increase in scale and meaningful synergy opportunities. We are implementing our integration plan and are aggressively working to ensure the efficient integration of systems, operations and financial reporting.

Due to the timing of the close of the transaction we have just received unaudited third quarter stand alone financial results for AmComp. We will not be filing a third quarter 10-Q for AmComp. We will file pro forma financial statements for the consolidated entity with estimated impacts of purchase accounting for the nine months ended September 30, 2008. This filing will be made before year end.

In addition to our discussion today of Employers third quarter and nine months results, Ric will also provide a high level overview of AmComp's third quarter top line and Marty will discuss integration activities. We are somewhat limited in our ability to respond completely to questions concerning AmComp's third quarter given that the acquisition only closed on Friday. But we will do our best to answer those questions we can. So with that let's turn to Employers Holdings' third quarter and nine-month results.

Let me begin by restating the obvious. Over the past several months we have seen unprecedented volatility and turmoil in the credit, capital and insurance markets. Although we have been impacted by the disorder in each of these areas, we are pleased with our performance for the quarter and through the year, particularly given the number of challenges facing the financial Services industry.

In terms of the credit markets, we have previously announced that we have drawn under a credit facility provided by Wells Fargo to complete the acquisition of AmComp. Although this was not originally our intended method of financing the transaction, we were able to obtain the necessary financing on terms that we believe are attractive.

In terms of capital markets, our portfolio, conservative and diversified by design, has performed as expected given market conditions. We remain committed to our investment philosophy which is geared toward providing maximum returns over time within the constraints of a prudent portfolio risk. Because only 6% of our portfolio at cost was allocated to equities, the impact on our total portfolio from the decline in equity values has been somewhat muted. Our portfolio including equities and fixed maturities has minimal exposure to recently troubled sectors and our realized losses in the portfolio have been minimal.

In terms of the insurance market, we have not to date observed any impacts from financial difficulties being experienced by some of our competitors. However, we continue to monitor our markets for potential negative impacts and favorable opportunities that might arise.

The third quarter was marked by continuing favorable prior accident year reserve development. Also having a significant impact on the quarter was a decrease in income taxes resulting from the final reversal of liabilities for previously unrecognized tax benefits. Our third quarter results reflect reduced premium revenue, stable book value and an improved calendar year combined ratio. With a nine-month net income of $72 million and a book value of $16.50 per share at September 30, 2008, we continue to be a strong, resilient and well capitalized company.

At the end of the third quarter, California represented 74% of our total stand alone book of business. While this percentage will drop with our acquisition, going forward California will still represent a meaningful portion of our business. The California Workers' Compensation insurance rating bureau recommended a 16% rate increase effective for new and renewal policies as of January 1st, 2009. The WCIRB recommendation is largely tied to medical inflation and to a lesser extent increasing loss adjustment expenses. California commissioner Poizner issued an advisory ruling providing for an overall increase of 5% to be effective the first of the year.

Separately, changes to the Permanent Disability Rating Schedule may be adopted in California and would likely impact benefit levels and loss costs for injuries occurring on or after January 1st, 2009. Based on our analyses of rate adequacy, last week we filed for an average rate increase of 10% in California for new and renewal policies to be effective February 1st, 2009. If the proposed Permanent Disability Rating Schedule changes are adopted, we may file for an additional increase. While our net premiums written in California have continued to decline, our total policy count has increased over 9% since September 30th of last year.

In terms of capital management, yesterday our Board of Directors declared a dividend of $0.06 per share with a record date of November 20th and payable on December 4th. In the third quarter we repurchased approximately $7 million of our common stock, and as of September 30, 2008, we have repurchased nearly 790,000 shares at a cost of $14.2 million. We closely monitor the capital and credit markets and are being appropriately prudent in evaluating all sources and uses of capital. As such, we suspended our share repurchase program in September. While repurchasing common shares below book value is normally attractive, we will likely continue to conserve cash through the remainder of this year and into next year.

And now I'll turn the call over to Ric for a discussion of our financial results. Ric?

Thank you, Doug, and good day to everyone on the call.

Despite volatile and uncertain markets we continue to be pleased with the performance of our $1.7 billion portfolio. At the end of the third quarter, over 86% of the carrying value of our investment portfolio was rated double A or better. We experienced minimal other than temporary impairments or OTTI, of $5.5 million for the first nine months of the year. Our commercial backed mortgages holdings represented 2.4% of the total portfolio and were all AAA rated issues. Sub-prime was less than 200th of 1% of the total portfolio.

Our exposure to Fannie Mae and Freddie Mac totaled $234.1 million including $98.4 million of senior debentures, $135.7 million of mortgage backed securities, and CMOs and just $11,600 in Fannie Mae equity. We hold no subordinated debt or preferred stock in Fannie Mae or Freddie Mac. The duration on the portfolio was 5.44, indicating a higher level of short term investments.

In the third quarter of this year, our combined ratio was 78.8% on a GAAP basis, and 85% before the LPT. Year to date our combined ratio was 79.6% on a GAAP basis, and 85.9% before the LPT. Our combined ratios improved in the third quarter of this year and the nine months year to date relative to comparable periods last year largely because development related to prior accident years was more favorable than last year. Losses and LAE ratios before the LPT improved in the third quarter and the first nine months of this year. Reductions in losses and LAE were partially offset by an increase in the current accident year loss estimate from 61.7% for the first six months ended June 30, 2008 to 66.2% for the nine months ended September 30, 2008. Adjustments to loss estimates were driven by the same observations about premium adequacy which drove our rate filing that Doug mentioned earlier.

Our commission expense ratio was nearly flat for the quarter and the first nine months of the year.

Our third quarter underwriting and other operating expense ratio was driven higher in the quarter and the first nine months of 2008 by lower net earned premiums. Underlying expenses were generally flat in the quarter and in the first nine months were 1.7% lower than in the first nine months of last year, evidencing our efforts to contain costs while writing more policies.

Our shift to cash and short term investments impacted net investment income and average pretax book yield. Investment income decreased $700,000 in the third quarter of 2008, and $3.5 million in the first nine months of this year. And our nine-month pre-tax book yield dropped ten basis points to 4.04% from 4.14% at September 30, 2007. Recall that last year we had $1.8 million in extraordinary interest income from invested proceeds related to our conversion from a mutual holding company to a public stock company.

Income taxes in the third quarter and the first nine months of 2008 decreased compared to the corresponding periods in 2007, primarily due to a change of $4.8 million in the final reversal of the liability for previously unrecognized tax benefits including interest. The effective tax rate for the first nine months of 2008 was 13.4% compared with 19.3% for the same period in 2007. A decrease in the effective tax rate was primarily due to the reversal of the liability I just mentioned.

At September 30, 2008, we had cash, short term investments and maturing fixed securities of $615.9 million. In September, we drew down the Wells Fargo $150 million amended secured credit facility. The facility which expires on March 27th of 2011 had an effective interest rate of 5.25% at September 30, 2008. The first $50 million principal payment is due on December 31, 2009. $100 million of the amount was hedged with an interest rate swap agreement providing that the amount will bear interest at a fixed interest rate of 4.84% through September 30, 2010 with the remainding $50 million bearing interest at LIBOR plus 125 basis points.

We paid $188.4 million in cash and proceeds from the credit facility for the acquisition of AmComp. We will be allocating the total purchase price to tangible and identifiable intangible assets acquired and liabilities assumed based on their estimated fair values. Any excess of purchase price over the aggregate fair values will be recorded as goodwill. AmComp results for October 31 through December 31, 2008, will be included in our annual report on Form 10-K along with the allocation of the purchase price. And as Doug mentioned, by the end of December we will file pro forma financial statements for our combined companies through September 30, 2008.

Now I'd like to provide you with some key third quarter financial data for AmComp. This information, provided to us by AmComp, is unaudited and subject to change. The carrying value of AmComp's portfolio, including cash and cash equivalents, was approximately $442 million at September 30, 2008 compared with $450 million at June 30, 2008. Realized losses were approximately $200,000 for the third quarter ended September 30, 2008. AmComp reported to us third quarter 2008 net earned premiums of approximately $48 million, compared with $48 million for the second quarter, and $52 million for the first quarter of 2008.

With that I'm going to turn the discussion over to Marty.

Thank you, Ric. Employers net premiums written for the third quarter were $72.3 million compared with $70.4 million in the second quarter, and $79.1 million in the first quarter. Top line premium continues to be a challenge due to competitive rate pressures and a now struggling economy. The state of Nevada and, among our new markets, Florida, are hardest hit economically. We have not seen significant payroll reductions yet in California. Our average policy size is approximately $8,000, down from about $10,300 at September 30 of last year and unit count is strong as we achieved a 9.3% increase in total policy count since September 30, 2007.

New business activity remains strong. Through September, submissions, quotes and written policies are up year over year. Policy retention is down slightly, but remains in the mid eighties percent with our strategic markets business seeing consistently higher retention rates than overall. New reported claim counts are down both for medical only and for indemnity claims.

We are very pleased with the completion of our acquisition last week. Although we did substantial planning early on, the real integration started with the close of the acquisition. We have employee teams in place targeting processes, resources and savings for the combined companies in every functional area. We expect to realize a minimum of $10 million in annual pretax savings by 2010. This figure only contemplates the elimination of certain public company expenses, some overlap in IT systems and infrastructure, and reductions in the cost of reinsurance for the combined companies.

While this is only the first week of the new organization, we are working to solidify and strengthen agent and producer relationships in all territories. I have just returned from meetings with key agents in each of our acquired operating regions. We are focused on introducing them to the Employers brand and on generating new business and renewal success specifically targeting January business. There is excitement within our new regional operations and among their agents about what we can do together to build business success, particularly given A.M. Bests recent affirmation of our A minus rating post acquisition. We are awaiting regulatory approval of our pooling agreement and once that approval is received the introduction of A minus rated paper should help us reach more customers in our new states.

I will now turn the call back over to Doug.

Thanks, Marty. That concludes our prepared remarks. Thank you for joining us this morning. And, Michele, I will now open up the call to questions.

(OPERATOR INSTRUCTIONS) Your first question comes from the line of Mark Hughes, SunTrust. Please proceed

Thank you very much. Do you have the gross premiums written for AmComp for the third quarter?

I mean at this point since we've only received the information very recently, we are only providing the earned premium today.

Okay.

And we will be able to provide more information as we file that pro forma financial statement prior to the end of the year.

Understand. The increase in current year accident ratio in the quarter between Q2 and Q3, what were the key drivers in that?

Well, as we've noted numerous times as we've spoken to you, our process of monitoring our loss experience in our premium adequacy is ongoing. We've been looking at some information that was indicating that during the first nine months of '08 we had seen some erosion of premium adequacy in California and we are reacting to that.

So the adjustment that you see, and this is what you should expect from us. This is the process that we believe is important for us, any insurers, to be looking at the information currently and reacting to do two things; one, to adjust the reserves appropriately and; also to react by looking at rates and adjusting those appropriately. And we've done both of those based on the information that we are seeing. So what you are seeing in the third quarter is a cumulative adjustment for the first nine months of the year. Does that answer your question?

It does. Is that to say that the fourth quarter that the rate might, that the ratio might come down a little bit as you are not catching up for the first nine months?

Well, certainly we would not have a catch up if you will since we've, we believe that we've appropriately adjusted as of September 30, '08.

Right.

Again, every period that we are looking at the entire matter again and I guess it would be inappropriate to say that I think reserves will go up or down. But given, if everything were to remain constant, the provision rate that we expect in the fourth quarter would be similar to the nine-month provision experienced so far.

Got you. You talked about the potential for the changes to the Permanent Disability Rating Schedule. Have you made an early judgment as to what that might mean in terms of your filed rates, if you are up 10% without that, how much might it be with it?

I've seen some of the information coming out of the Bureau. I don't think the number would, if adopted as proposed, would be as large as you've described. We would have to do the analysis through our own book of business.

Right. So I guess off of that 10% base that you're already, you've already filed for, would it be a couple points, more than that?

What we are looking at, you were referring to the rate increase which we've announced or referred to, which was 10%.

Right, that's right.

And so your question is would you expect that this additional adjustment might exceed that and there's no indication that it would be anything other than single digits as we see it at this point.

Right, that alright. Thank you. And then one more question, the tax rate going forward, on a normalized basis, say for Q4 for next year?

It would be more normalized, more in the 20% range.

Okay. Thank you very much. Nice quarter.

Thank you.

Thank you.

(OPERATOR INSTRUCTIONS) Your next question comes from the line of Michael Nannizzi of Oppenheimer. Please proceed.

Hi, thanks. Just a couple of questions. One, on the AmComp transaction. Have you look into the synergies that might develop from extending the ADP platform into that business? And I just have one follow up. Thanks.

We are aware that ADP does business in many of the states that AmComp does business in. And part of our state expansion going back began a couple of years ago was trying to expand into states that ADP was doing business in, and Florida, Texas and Illinois were three examples of those.

And that was a large part of the reason why we chose those three states when we did our expansion. So I think the answer to your question is, yes, that we do think there will be opportunity within that ADP strategic partnership across the additional states that are now part of our company.

Okay. Just a question on expenses. You mentioned cost containment, Ric, before, can you talk about where you are kind of seeing that cost containment? Is it on the underwriting side? Is it in just kind of general operating expenses or kind of where specifically are you seeing that? Thanks.

Well, the cost containment is throughout the organization. Certainly like many organizations our largest expense is payroll. We have maintained a virtually flat staffing for over a year now. And we are focused on, as we go into the integration how we can maintain that efficiency. So most of has been focused on human resources if you will, and it's been across the organization. It hasn't been focus on any one area to date.

Okay. Great. Thanks.

Your next question comes from the line of Matt Carletti of Fox-Pitt Kelton. You may proceed.

Good afternoon. Just a couple of questions, the first one is, Doug, maybe you could elaborate on your comments regarding suspending the share repurchase. Curious on your thoughts on capital here. Maybe I'm looking at it the wrong way but it seems that still pretty low premium surplus leverage even including AmComp and given the stock price. Could you just elaborate a little on your thoughts?

Sure, I'd be happy to. If you look across our capital management strategy, it's involved the three aspects that we've discussed all along which is being able to grow the business, being in a position to take advantage of opportunistic acquisitions, and then finally managing the capital through dividends and share repurchases.

And as I indicated in my prepared remarks, although it is attractive to repurchase shares at something below book value, given the volatility of the capital markets as we see them right now, we are being certain that we will be able to honor the commitments we've made without having to attempt to find capital in a market that might not be able to provide it. And I think that's just a testament to the degree of caution that we exercise as we run this business.

Is that, am I reading into that correctly that you're referencing maybe the line of credit and if you do get the chance to make a longer term financing solution that then your views might change?

That would be one instance under which our view could change.

Okay. And then maybe just a follow-up question, maybe this is best for Marty, given that you've spent some time visiting with AmComp agents. Have you given any thought to what sort of impact bringing the A minus rate together AmComp might have if that's going to be a big deal or is it just too early to assess that?

I think it's probably a little early to assess that, Matt. It was clear that with all of them regardless of what territory I was in that it was important that they have A paper for their clients rather than non-rated paper.

And I think it's been clear, too, that as they've gone through the year with the economy the way it is, particularly with some of the pressures on construction, that that lack of a rating has been more significant as the year has gone on than maybe it was at the beginning of the year or in past years.

So I still expect that we will get some kind of lift from the activity level out of those agents when they have access to A paper. I don't have any way of saying to what degree that would be, but it does give me confidence for our ability to continue to grow profitably in those new territories.

That's very helpful. Thanks a lot.

(OPERATOR INSTRUCTIONS). You appear to have no further questions at this time.

Very good. Thank you, operator, thank you, everyone, for joining us today. We look forward to speaking with you again following the completion of our year. Thank you.

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Have a great day