Employers Holdings Inc (EIG) 2009 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the quarter three 2009 Employers Holdings earnings Conference Call. My name is Veronica and I will be your Operator for today. At this time, all participants are in a listen only mode. We will conduct a question and answer session toward the end of this conference. (Operator Instructions). As a reminder, this call is being recorded for replay purposes.

I would now like to turn the call over to your host for today, Ms. Vicki Erickson, Vice President Investor Relations. Please proceed.

Thank you, Veronica, and welcome to the Third Quarter and year-to-date 2009 earnings call for Employers Holdings Inc.

Yesterday we announced our earnings results, and today we will file our Form 10-Q with the Securities and Exchange Commission. Our Press Release and Form 10-Q may be accessed on the Company's website 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 website, where a replay will be available following the call.

With me 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.

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 fourth 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.

We use the non-GAAP metric that excludes the impact of the deferred gain from the 1999 loss portfolio transfer or LTT. This metric is defined in our earnings Press Release available on our website.

Now, I will turn the call over to Doug.

Thanks, Vicki. Welcome, and thank you for joining us as we review our Third Quarter 2009 results. To begin our discussion of the Third Quarter, I will quickly walk through at a high level the one-time items included in this quarter's GAAP financial statements. As we indicated in our earnings Press Release yesterday, we have two non-recurring items in the quarter. The contingent profit commission on the LPT and integration of restructuring charges related to our acquisition of AmCOMP Incorporated.

Our GAAP combined ratio before the impact of the LPT deferred gain for the third quarter was 93.7%. In the quarter, we recognized $14.1 million in contingent profit commission related to the LPT. Rick will discuss in more detail the LPT contingent profit commission in a few minutes. The impact of the profit commission reduced the combined ratio for the quarter by 14.4 percentage points.

Also in the third quarter we incurred $600,000 in one-time integration and restructuring charges, increasing the combined ratio for the quarter by six tenths of 1%. Adjusted for these two items, the GAAP combined ratio before the impact of the LPT deferred gain for the quarter would have been 107.5%. Our GAAP combined ratio before the impact of the LPT for the first nine months of 2009 was 99.8%. With the impact of the contingent profit commission, and one-time integration and restructuring charges of $4.9 million through the first nine months, the combined ratio would have been 102.7% or 2.9 percentage points greater.

In the third quarter we earned before the LPT deferred gain $0.57 per share compared with $0.58 per share in last year's Third Quarter. $0.31 per share of our current quarter results is attributable to the LPT contingent profit commission.

Turning to operations, we increased net premiums earned 34% in the third quarter of this year, compared to the same period last year. Excluding acquired operations, net premiums earned declined 20% as the result of prior rate decreases, economic contraction, pricing competition and our continued underwriting discipline.

Business activity was challenged in three of our largest markets, California, Florida, and Nevada. Overall, we have been successful in offsetting a portion of our premium decline with solid retention, increasing rate on renewals in California, and new business and policy count growth in some states, particularly in the Midwest since our acquisition. We benefited from favorable prior accident year reserve development of $10.4 million in the third quarter.

Our operating and other expenses, excluding non-recurring integration and restructuring charges, were flat in the third quarter with a nine month decrease of $4 million compared to the same period last year.

Results this quarter once again demonstrated the Company's significant Balance Sheet strength. Our portfolio produced consistent returns with a tax equivalent yield of 5.6%, and unrealized gains of over $100 million since December 31, 2008.

We repurchased over 1.5 million common shares during the quarter. We grew shareholder's equity, including the deferred reinsurance gain, 5.6% since June 30, 2009, and returned during the quarter $25 million to our shareholders through a combination of common share dividends and stock repurchases. As of September 30, 2009, the Company repurchased a total of 9.3 million shares of Common Stock at an average price of $15.41 per share, representing over 17% of the shares issued in our initial public offering nearly three years ago, with over $143 million returned to shareholders.

Our book value per share grew over 9% in the quarter, and 19% in the first nine months of this year, to $20.74 per share at September 30, 2009.

Yesterday, our Board of Directors again declared a quarterly dividend of $0.06 per share with a record date of November 18, and payable on December 2. Also yesterday our Board established a $50 million share repurchase authorization to be effective January 1 for calendar year 2010. We anticipate that share repurchases under this program will be done in an opportunistic and disciplined manner.

Our actions and these results demonstrate our strong capital position and our ability to invest in our operations and return capital to shareholders while growing shareholder value. We continue to be impacted by a challenging economic environment that appears to be taking a toll on our small business customers.

In these conditions, we believe maintaining underwriting discipline is paramount. That same discipline puts pressure on our expense ratio, as we increasingly have less premium to cover fixed costs. We continue to manage our expenses, and anticipate some relief in 2010 from the integration of our acquired operations. However, we expect pressure on the expense ratio to continue until payrolls and employment trends improve.

Now I'll turn the call over to Rick for a discussion of our financial results. Rick?

Thanks, Doug. Our operations generated a Third Quarter GAAP combined ratio of 88.9%, and 93.7% before the LPT gain, compared with 78.8% and 85% before the LPT gain in 2008.

The 10.1 percentage point increase represents a combination of factors. First, acquired operations contributed 16.6 percentage points of the increase in our Third Quarter GAAP combined ratio. With this increase primarily driven by conservative reserving related to uncertainties surrounding regulatory reform, declining rates, and challenging economic conditions in Florida. 1.6 percentage points of the increase from acquired operations was related to policy holder dividends.

Second, lower favorable reserve development increased the combined ratio 14.8 percentage points compared to last year's Third Quarter. These increases were partially offset by a negative commission expense ratio of 1.3%, primarily due to the increase of $14.1 million in the contingent profit commission calculation under the LPT agreement. Excluding the LPT contingent profit commission, our commission expense ratio would have been 13% in the quarter.

Consistent with the past six years, we had favorable prior accident year development of $10.4 million in this year's Third Quarter compared with $25 million in the third quarter of 2008. The impact of favorable development on the third quarter combined ratio was 10.6 percentage points compared with 34.2 in the third quarter of 2008.

You may have questions on the LPT profit or contingent profit commission, so I'll explain that in more detail now. Under the LPT agreement, we are eligible to receive a contingent profit commission from the participating reinsurers based on the paid loss experience of the seeded business. The calculation of actual losses paid versus contractually expected loss payments per the agreement, is determined every five years beginning June 30, 2004, through 2024, and is the basis for determining the amount of the contingent profit commission.

We review the accrual of the estimated ultimate contingent profit commission to be received on a quarterly basis, and adjust the estimated profit-sharing periodically based on comparisons of the emerging claims payment and contractually expected payment patterns.

In the initial years of the contract, we conservatively weighted estimates towards the expected patterns until sufficient data, actual data was available to support a more comprehensive adjustment of the full paid development pattern. Based on this approach, we recorded earned contingent commission as follows in millions of dollars. 2002, 9.8, 2003, a negative 3.8, 2004, again a negative 1.5, 2005, 3.8, 2006, a negative 198,000, 2007, 2.5, and lastly 2008, no adjustment.

In 2004, we received our first cash payment of $14.3 million under the agreement. Based on the earned calculations I just reviewed, we had reserved for potential return commissions as follows, again in millions of dollars. 2004, 9.8, 2005, 6.1, 2006, 6.3, 2007, 3.8, and 2008 remained unchanged at 3.8.

We have received a second LPT contingent profit commission payment of $10.3 million due to the continued favorable emergence of payments. Based on the observed paid development patterns through the second measurement date at June 30, 2009, we have placed increased weight on the actual emerging paid data in projecting prospective payments.

Based on these projections, we believe that we have earned all amounts received through the second measurement date. Consequently, we recorded an adjustment to recognize an additional earned contingent commission of $14.1 million, which is the total amount received less amounts previously recognized as earned.

Further, the projection has indicated that while we may receive modest additional payments in the third and fourth measurement periods, these amounts are expected to be repaid in the fifth and final measurement period. So in summary, no additional net contingent commission is expected.

Based on our analysis, we have also concluded that the ultimate liabilities under the LPT are materially unchanged from previous projections. The impact of payments in excess of initial expectations in years beyond 2019, is expected to offset the impact of the positive payment experience prior to 2019. Consequently, we do not believe that any material adjustment of the carried LPT reserves or the related deferred LPT gain is required.

Moving on to total Company expenses, excluding acquired operations, losses and LAE declined 1.9% in the third quarter relative to last year's Third Quarter, but increased on a consolidated basis by $27.8 million. Our current accident quarter loss ratio estimate was 69.7% compared with 75.4% in the third quarter of 2008. Some uncertainty continues in California, tied to the status of certain court cases that have reversed portions of the previously enacted Workers' Compensation reforms.

Cost controls and integration efforts related to last year's acquisition continue to favorably impact ongoing expenses. Excluding acquired operating expenses of $11.2 million, and one-time restructuring and integration charges of $600,000, underwriting and other operating expenses were flat in the quarter. Last year's Third Quarter included a $1.6 million decrease in the allowance for bad debts, with no such adjustment in the third quarter of this year.

Our long term fixed income portfolio continued to produce consistent returns. Third Quarter net investment income increased $3.9 million or 20.9% over last year's Third Quarter, due primarily to increases in invested assets.

Our effective tax rate in the third quarter was 13.1%.

In the first nine months of 2009, our GAAP combined ratio was 95.6%, and 99.8% before the LPT gain compared with 79.6%, and 85.9% before the LPT gain in 2008. Acquired operations excluding integration and restructuring costs contributed 12.8 percentage points of the GAAP increase, with the remainder attributable to lower favorable reserve development, along with lower premiums earned due to the competitive pressures and overall economic conditions.

In addition, year-to-date at September 30, 2009, integration and restructuring expenses added 1.6 percentage points to the combined ratio. These factors were partially offset by the increase in the LPT contingent profit commission. Combined statutory surplus at September 30, 2009, was approximately $613 million.

At September 30, 2009 we had approximately $100 million in cash at the Holding Company. We are building cash balances at the Holding Company, as our first payment of $50 million associated with the Wells Fargo Credit Facility is due at the end of the year.

The fair market value of securities at the Holding Company, collateralizing our Wells Fargo Credit Facility, was approximately $210 million at September 30, 2009.

Our capital is backed by our invested assets, which are very high quality. The fair market value of our invested assets at September 30, 2009, was $2.1 billion with a net unrealized nine month gain of $101 million. Fixed income maturities were rated on average AA plus, and 77% of the carrying value of our portfolio was rated AA or better. The duration of the portfolio was 5.08. Tax equivalent yield was 5.6%, and the book yield was 4.6% for the nine month period at September 30, 2009. A list of our portfolio securities by CUSIP is again available in the investor section of our website under calendar of events, Third Quarter earnings call.

In closing I would mention that we are finalizing our updated rating with AM Best, and we expect a BCAR of something north of 225 and that compares with 195 for the prior period.

With that, I will turn the call over to Marty.

Thank you, Rick. First I would like to report that the integration of our acquired operations continues to be on track. We are currently focused on planning for and executing the integrations of our underwriting and claims systems, which are expected to take place in the First Quarter of next year. These are key initiatives to improving our precision, consistency, and agility, and in creating a single aligned insurance operation going forward.

On to our operating results, since September 30, 2008, in force policies are up 24.2%, primarily the result of acquired operations. Policy count in the first nine months of this year has actually declined 1.6%, driven by unit decreases of 921 in Nevada and 363 in Florida, two significantly economically challenged states. These policy count decreases were partially offset by policy count increases in our other states, particularly Illinois and Georgia.

We continue to see the impact of the economic contraction on our new business opportunities, though that impact varies across our book of business. As we have reported in the first two quarters of this year, we continued to see increased opportunities in the Midwest in the third quarter of 2009, with submissions up significantly in that region compared to the Third Quarter of 2008. Our Nashville office has also experienced a significant increase in activity, and business activity in Texas remained strong as well.

Rate and competitive conditions in California continue to make new business success difficult, but increased sales activities have led to good quality submissions, which are higher relative to the Third Quarter of last year. Business activity continued to be challenged in Nevada and Florida, however, across the Company, submissions and quotes are up relative to the Third Quarter of last year.

Our renewal rate change increased slightly again in the third quarter. You will recall that the Second Quarter was the first time since 2004 that we have obtained additional rate on our renewal book. This increased renewal rate was driven by our filed rate increases in California. We anticipate filing another rate increase in California effective mid February 2010.

Our Third Quarter retention declined slightly relative to the Second Quarter of this year, as a result of pricing discipline in California. We believe that a modest increase in rate, coupled with a slight reduction in retention, produces a better result. Consistent with past quarters, strategic partnerships continued to produce retention results higher than our agent produced business.

Continuing impacts of the economic contraction have not adversely impacted our claim results. In the third quarter, reported claim counts continued their downward trend. Overall, reported losses were lower through the first nine months of 2009 compared to the first nine months of 2008. However, we also continued to see a slight increase in average claim severity, driven by the increase in cost of medical treatment in California.

In summary, we continue to operate in a very difficult environment, but with our continued efforts to improve renewal rates, combined with stable unit count, we believe we will be well positioned as economic conditions improve.

I will now turn the call back over to Doug.

Thanks, Marty. That concludes our prepared remarks. Operator, we'll now take questions, please.

(Operator Instructions). Your first question comes from the line of Mark Hughes from SunTrust. Please proceed.

Thank you very much. Can you give some indication of what the effective price increase was in California, I think you filed rates but then I'm curious when you take into account credit and other things, how it's shaking out?

Yes, that's not a number that we release. We believe it's a very competitive piece of information. We did file for a 10% rate increase last February and another 10.5% last August. It was not our expectation that we would necessarily get all of that in the competitive environment, but as Marty has indicated we are starting to see the impact of those filed rate increases on our net rate out the door.

And you say that with those increases overall, I guess your effective pricing was up nationally?

Yes, very slightly, as it was last quarter.

How much did the court cases, I don't know if you can break this out but the current accident year loss ratio, how much did those court cases add to that because of the uncertainty?

They haven't as of yet added, it's mostly a forward-looking, anticipation of what these costs can amount to if it's not, if the court cases aren't reversed.

But we've not specifically reserved for them.

Gotcha. Thank you very much.

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

Good afternoon.

Hi, Matt.

A question on, I think Rick, you talked about the BCAR and how it was 195 and you're expecting something I guess 225 or maybe a little north.

Yes.

What does that imply? Do you expect any change in the outlook from AM Best whether it be a positive outlook or potentially maybe what's the threshold to, I know it's a vague number to kind of get to an A. And lastly, is that something you'd even want or that would even really have a material benefit to running your business?

Well as you know, we work carefully to ensure that we retain our A minus rating. I think we've spoken to the issue in the past that for our operating model, that we don't believe that an A rating is required, so while we are pleased that the BCAR is likely to come in where it's at, that we believe that ensures are continued A minus rating, but I don't envision that AM Best will change the current evaluation of the staple at this point in time.

Great, thanks, congrats on a nice quarter.

Thanks.

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

Thank you. I didn't hear a beep, so I might have hit star 1 a couple times, so in advance sorry about that. But just first question, on the combined ratio on an accident year basis, can you just tell us, where is that when you backed out LPT and all of the other adjustments, where do you want to see that number. What's a good run rate for that number just for your model? And I just have a couple of follow-ups, thanks.

Well if you make all of the adjustments for one-time events during the quarter, and the restructuring charges, reserve releases, the contingent profit commission, you're looking at an accident quarter combined of around 118. Our pricing model aims for a combined ratio of 100, and if you look at what's happening in this part of the market cycle, our losses are coming in pretty close to where we would expect them to be. Where we're getting squeezed is on the expense ratio, and that's really a function of declining premium levels against fixed costs, and it really is, the challenge is to manage that to get us back to a target of 100.

I see, so the overhead is kind of built for more premium dollars but right now, just because of conditions, you're writing less so that quotient is getting bigger?

Correct. And that's despite the fact that expenses aren't rising. In fact, they're falling.

Right, okay. And then when you look at your book of business, I imagine that the reserve releases are coming from not everywhere, some places they're coming from other places they are not, and I'm just curious, in the places where the accident year combined ratio is highest, are those the same places where you have the most reserve releases coming through or is it more haphazard?

Would you restate the last part of your question there? Is it where the reserve releases are coming from?

I guess the question is like, for example, if you're writing business in California and it's the accident year combined ratio is 120, but you're getting 20 points of favorable development, then net-net that would seem to be meeting your criteria just on a calendar year combined basis. But if you're writing 120 combined in one area but your reserve releases are coming from somewhere else, then I guess the question is, is there a mismatch between the releases and where the accident year ratio is the highest.

No, I don't see that mix. It is true that the reserve releases generally are coming from California operations in prior years.

Right.

So not the current years. It's, I think it's more level in the current years across-the-board, although we, because of the rate filings we have made recently in California, we expect California on a relative basis to be more adequate than some of the other states, but we don't have that same flexibility on the rate.

Okay, and then just if I could a couple questions about Holding Company capital. What is the total remaining repurchase authorizations when you don't consider the 2010 one you just announced, so how much do you have available on current authorizations?

The original authorization was $100 million.

And that was, all purchased during the current year would fall against that number?

Yes.

I'll do the math. That's fair.

Let me see if I can pick this out here.

Thanks, Rick.

Forgive me while I read the schedule here. The amount remaining in the program as of September 30, was about $31 million.

Okay, so 31 plus the other 50, okay, and you mentioned the $100 million that you have in cash and then you have $50 million that you need to pay back at year-end, so when you think about the next year, is it the operating cash flow that will help to kind of create more capital to execute share repurchases next year? Is that kind of how you think about it?

That's right. Beginning January 1 of 2010, we will again be in a situation where we will have available to us ordinary dividends from all of our operating companies. Through 2009, our western companies are coming up through Ikon, we're limited to extraordinary dividends, which would have required prior approval from the commissioner by waiting, having kind of a cleansing period of 12 months, we're now back to having ordinary dividends that do not require prior approval, and that will be true of all of our operating companies.

Perfect, great, thank you. One last one if I could. The contingent commission situation, so the first time you did that you weren't a public Company. This time obviously you are, and then you think that the next three will basically net each other out?

That's correct.

Okay, so if the book somehow changes or is better than you think or not as good as you think, is there a possibility that some of that will get reversed, or regardless of outcome it looks like the next three wash each other out?

It is possible but our analysis of this would indicate given the patterns we're seeing that everything we have received we will retain.

Okay, and it's an every five year, effectively it will come in in the second or Third Quarter, but no other time, it's not like it could just pop in somewhere in between?

The payments are five year intervals.

Great. Okay, thank you very much. Sorry for all of the questions.

We have no further questions on the line.

Very good. Thank you, everyone, for joining us this quarter. We'll speak with you again following our year-end 2009 results. Thanks.

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