Employers Holdings Inc (EIG) 2009 Q4 法說會逐字稿

Good day, ladies and gentlemen and welcome to the fourth quarter 2009 Employers Holdings incorporated earnings conference call. I will be your coordinator for today. At this time, all participants are in listen-only mode. We will be facilitating a question-and-answer session towards the end of this conference. (Operator Instructions). As a reminder, this conference is being recorded for replay purposes.

I would now like to turn the presentation over to your host for today's call, Ms. Vicki Ericsson, Vice President, Investor Relations.

Thank you, Chanel.

Could we just do a quick sound check because you sound to us like you are breaking up a little bit and I was just checking how we sound to you.

You guys sound great.

Okay. Great.

Thank you, Chanel and welcome, everyone, to the fourth quarter and full year 2009 earnings call for Employers Holdings Inc. Yesterday, we announced our earnings results and today we will file our Form 10-K with the Securities and Exchange Commission. Our press release and Form 10-K 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. With me today are Doug Dirks, our Chief Executive Officer, Ric Yocke, our Chief Financial Officer, and Marty Welch, the President and the Chief Operating Officer of our insurance subsidiaries.

Statements made during this conference call that are not based on historical factor 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 developments.

We use a non-GAAP metric that excludes the impact of the deferred gain from the 1999 loss portfolio transfer or LPT. This metric is defined in our earnings press release available on our web site. Comparisons of fourth quarter and full year financials for the year 2008 include two months, November and December, of reported data for acquired operations since the acquisition of AmCOMP incorporated closed on October 31, 2008. The Company has provided in past reports for periods in 2008 and 2009, a breakdown of stand-alone financial results. Beginning in the fourth quarter of 2009, the Company will no longer provide such stand-alone data. Reference can be made to our past SEC filings for the fourth quarter and full year of 2008 and the first three quarters of 2009, which collectively provide 11 months of stand-alone financial results for our acquired operations.

Now, I will turn the call over to Doug.

Thank you, Vicki.

Welcome and thank you for joining us, as we review our fourth quarter and full year 2009 results. Reflecting on this past year, we are pleased that we have benefited from our acquired operations, in terms of geographically diversified premium, synergy savings, increased scale, and increased human capital. Our AmCOMP acquisition has served to greatly diversify our book of business. Our California concentration in terms of in-force premium has gone from just over 70% preacquisition, to approximately 47% as of December 31, 2009. However, benefits from the acquisition and our expense control initiatives could not completely offset the consequences of the recession that have led to historic declines in employment and payrolls.

On a GAAP basis, we had an underwriting gain of $8 million, with a combined ratio of 98%. Excluding the impact of the LPT, we generated an underwriting loss of $10 million, with a combined ratio of 102.5%. The underwriting loss was caused by a declining premium base against which to offset fixed expenses, which resulted in an increase in the underwriting expense ratio. Despite our growth in premium from the acquisition, policy count and premium volume in some of our states, particularly in Nevada and Florida, declined. Our Form 10-K contains a new table of in-force premium by state. This table reflects an in-force premium decline of 17% year-over-year. Growth in the top line was constrained in 2009, as a result of high unemployment and negative payroll trends, competitive pricing environments, rate reductions in some states, and our continued adherence to an underwriting strategy that places a higher value on acceptable loss ratios over premium growth.

I cannot recall a period where economic conditions characterized by high unemployment and low interest rates have been more challenging for the workers' compensation industry. We are not discouraged by these challenges, but also recognize that our performance is short of our expectations for this business. We are actively managing our operations to improve these results. We continue to achieve efficiencies in our organization by making staffing level adjustments to reflect business activity in our premium production offices and by consolidating corporate activities. We also completed the integration of all core operating systems in our acquired operations in January. Now, all of our premium production and claims offices are using the same underwriting and claims platforms. We believe this will lead to increased cost effectiveness and operational efficiency in managing our underwriting and claims functions. We still expect to achieve in 2010 savings of $20 million to $22 million from our acquisition of AmCOMP.

Turning to our earnings, pre-tax income in the fourth quarter increased 8.4% to $13.8 million, or $0.32 per share, compared to pre-tax income of $12.8 million or $0.26 per share in the prior year's fourth quarter. Net income before the LPT in the fourth quarter of 2009 was $6.6 million, or $0.15 per share, $4.7million lower than last year, largely due to a tax benefit of $3.1 million in the fourth quarter of 2008. During the fourth quarter of 2009, there were nonrecurring integration costs of approximately $800,000, or $0.02 per share pre-tax. In the full year 2009, gross premiums written were $380 million, an increase of 19% from the prior year, due to our acquisition. Acquired operations provided helpful diversity in our earnings stream throughout the year. Unemployment in three of our largest markets, California, Florida, and Nevada, exceeded the national average in December.

On the other hand, we were successful in offsetting a portion of that premium decline with solid retention and new business and policy count growth in some states, particularly in the Midwest. Also, previously approved rate increases have resulted in an increase in net rate on renewal business in California, in each of the last ten months. California represented nearly half of our business at year-end 2009. The California Insurance Commissioner approved our additional average rate increase of 3%, effective March 15th of this year. We benefited from favorable prior accident year reserve development of $11.8 million in the fourth quarter, and $51.4 million in 2009. Since our initial public offering in early 2007, our favorable reserve development for prior accident years has resulted in reserve releases of approximately $183 million.

Our capital and strategic goals are long term and we are focused on maximizing shareholder value over time. Our return on average equity, including deferred gain, was 7.5% in 2009. While a number of companies suspended share repurchases during 2009, we repurchased over 1.3 million shares at a cost of over $20 million in the fourth quarter alone. In the full year, we returned over $85 million to shareholders and share repurchases and dividends while growing GAAP shareholders equity 12%, and shareholders' adjusted equity 4.2% since December 31, 2008. This return represents approximately 130% of earnings before the LPT in 2009. Since our initial public offering in early 2007, we have returned to shareholders nearly $200 million through a combination of share repurchases and dividends, representing approximately 80% of earnings before the LPT, while growing GAAP shareholder equity over 60% and successfully completing an acquisition. We have grown book value per share over 18% since December 31, 2008, to $20.67 at December 31, 2009. Our total share repurchases since 2007 have been accretive to book value at an average price of $15.37. Yesterday, our Board of Directors declared a quarterly dividend of $0.06 per share, with a record date of March 10 and payable on March 24.

Our actions and these results demonstrates 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 is taking a toll on our small business customers. Given these economic 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 this year from the integration of our acquired operations; however, we expect pressure on the expense ratio to continue until payrolls increase and employment trends improve.

Now, I will turn the call over to Ric for a discussion of our financial results. Rick?

Thank you, Doug.

First, I will discuss the fourth quarter with a focus on underwriting performance, and then I will move on to our full year results. Our operations generated a fourth quarter GAAP combined ratio of 106.5%, and 111.7% before the LPT, compared with 99.1% and 103.4% before the LPT in the fourth quarter of 2008. The 7.4 percentage point increase was largely the result of lower premium volume, which, in turn, increased our expense ratio. Restructuring and integration charges of $800,000 increased the expense ratio by approximately one point. Excluding the one-time charges, underwriting and other operating expenses were generally flat, relative to the prior year's quarter, while premium declined 15.2%. An LPT profit commission of $900,000 in the fourth quarter lowered the commission expense ratio by about a point.

You may recall from last quarter, that under the LPT agreement, the ultimate contingent profit commission is estimated each quarter through June 30, 2024, and changes are included in commission expense in the period that the estimate is revised. Our loss ratio in the quarter continued to be better than historical industry averages and was flat relative to our loss ratio in the fourth quarter of 2008. Losses in LAE expense declined 14.9%, compared to the prior year's quarter. Prior accident year development was, once again, favorable, and we released $11.8 million in reserves, $6.6 million lower than the prior year's quarter. Our effective tax rate in the fourth quarter was 18.6%.

Now, turning to our annual results, combined statutory surplus at December 31, 2009 was approximately $661.3 million. Net premiums to statutory surplus was 0.6 to one at year-end 2009, compared with 0.8 to one at year-end 2008. On a GAAP basis, our 2009 annual revenues increased 25% to $496 million from $397 million in the prior year due to our acquisition. Our total pre-tax investment return was $167.1 million in 2009, compared with $49.7 million in 2008. Net investment income was $90.5 million, compared with $78 million in 2008, an increase of 15.9% due to the increased invested assets from our acquisition.

We had realized gains on investments of $791,000 in 2009, compared with realized losses of $11.5 million in 2008. Our pre-tax investment return also includes an increase in net unrealized gains of $75.8 million during 2009, compared with a decrease of $16.8 million during 2008. Market factors contributing to changes in investment returns year-over-year with a narrowing of credit spreads, even though treasury yields rose and a rally in domestic equities. Our invested assets are very high quality. The fair market value of our portfolio at December 31, 2009 was $2 billion. Fixed income maturities comprised most of our portfolio and were rated on average double A plus. The average yield on our portfolio was 4.5% pre-tax, and 5.6% after tax with a duration of 5.02., with all of these measures stable throughout the year. A list of our portfolio securities by CUSIP is again available in the investor sections of our web site under calendar of events, fourth quarter earnings call.

For the year 2009, our GAAP combined ratio was 98%, and 102.5% before the ELPT, compared with 85.9% and 91.5% before the LPT in 2008. Given the declining in-force premium base, more than half the 12.1 percentage point increase was from lower favorable prior year accident -- or accident year loss development year over year, one-time integration and restructuring expenses of $5.7 million in 2009, and higher policyholder dividends. These factors were partially offset by increases in the LPT contingent profit commission. Losses in LAE expense increases in 2009, largely as a result of our acquisition, although $20 million lower than in 2008, prior period accident year reserve releases in 2009 were $51.4 million, continuing our history of favorable development. Current accident year loss and loss adjustment expenses were 70.2% at year-end 2009, and 68.9% at year-end 2008.

Underwriting and other operating expenses increased due to our acquired operations and one-time restructuring and integration charges. Our effective tax rate for the year was 10.1%. At year-end 2009, our debt ratio declined to 15%, as we paid down $50 million of our credit facility with Wells Fargo. Our debt also includes $32 million of acquired surplus notes. The fair market value of cash and securities at the holding company was approximately $197 million at December 31, 2009, with about two-thirds of that amount held as collateral for the credit facility.

We intend to continue to keep the level of capital in our operating companies sufficient to maintain an A minus stable rating from AM Best. Our uses of capital remain the same, and we are focused on building long-term value. First, we invest in our business. Second, we look for opportunistic acquisitions, and third, we return capital to the shareholders.

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

Thank you, Ric.

As Doug mentioned earlier last month, we completed the integration of our core systems for all of our combined operations. We established an extremely aggressive integration timeline that was less than 15 months from the closing date of our acquisition. We are pleased that we were able to integrate our core underwriting and claims platforms this expeditiously. Our common platforms make us more productive and efficient. We are now even better positioned to face the challenges of the market place as a combined and more diversified organization.

Our new business activity remained consistent relative to the prior year's fourth quarter and year-over-year. That is, we continued to receive and quote a high volume of submissions, though competitive pressures are resulting in a lower hit ratio than we would like. At December 31, 2009, in-force policies remained relatively stable, showing a slight decline of 3.2% since December 31, 2008. This slight reduction in overall policy count was driven by significant reductions in two of our most economically challenged states, Nevada and Florida, where unit counts dropped by 1,102 and 485 policies, respectively.

Despite a similarly difficult state economy in California, Despite a similarly difficult state economy in California, policy count there stayed relatively even. Policy counts increased in many of our states, including Wisconsin, Illinois, Georgia, and Virginia. Though policy counts increased in Wisconsin, year-over-year, we experienced the loss of some larger accounts due to underwriting decisions, economic conditions, and competitive pressures. In Illinois, we saw a continued steady growth which contributed to Illinois becoming our fifth largest state at year-end 2009, based on in-force premiums. While some companies pursue soft market strategies that chase top line premium, we continue to selectively underwrite and adequately price our business.

Our lower hazard account focus has produced loss ratios which continue to be better than the industry's. While we actively manage our expenses, when the top line is under market pressure, as it is today, our focus on losses and loss ratios cannot be sacrificed in order to relieve the short term pressure on fixed costs. As I have communicated in previous calls, our average rate on renewed policies in California began increasing in the second quarter of 2009. As Doug noted, this important trend has continued through year-end. Over the past year, we have received approval for three rate increases, 10% effective February 1, 2009; 10.5% effective August 15, 2009; and our most recent 3% increase to be effective March 15, 2010. More importantly, we are realizing these rate increases in our renewal book, which is an optimistic sign.

Our fourth quarter retention declined slightly relative to the fourth quarter of 2008, impacted somewhat by our pricing discipline in California. The combined result of this lower retention and higher rate is still positive for us. Consistent with past quarters, strategic partnerships continue to produce retention results higher than our agent-produced business. In terms of claims results, in the fourth quarter and for the full year 2009, reported claim counts for indemnity and medical, decreased compared to 2008. We also continued to see a slight increase in average claims severity, driven by the increasing cost of medical treatment in California. Overall, incurred losses were lower in 2009, compared to 2008.

In our acquired operations, we re-negotiated rates and service agreements with claims-related vendors and strengthened investigation protocols, which resulted in a 7% savings in loss adjustment expense costs per claim. In 2009, our claims settlement recoveries were nearly $6 million. These include fraud program savings, subsequent injury account recoveries, and subrogation recoveries. In summary, our integration of acquired operations is complete, including claims and underwriting systems. We are seeing savings from our acquisition, and we are realizing a higher average rate on renewed policies in the California market, which represents half of our book of business.

With that, I will turn the call back over to Doug.

Thanks, Marty.

It appears that recovery by small businesses from the recession may be a long process. So, what is our strategy to respond to a soft insurance market in a bad economy? Well, first and foremost, we remain focused on loss ratio management through disciplined underwriting. Second, we continually evaluate the efficiency of our processes and make changes to properly align expenses with revenues. Third, we are pursuing growth opportunities that best leverage our strengths; and fourth, we manage our capital consistent with our current and future needs.

With that, operator, we will now open up the line for questions.

(Operator instructions). We will pause for a moment. Your first question comes from the line of Mark Hughes of SunTrust. Please proceed.

Thank you very much. In California, how much are rates up on an effective basis when you take into account scheduled credits?

That's not a number that -- that we provide because we consider that to be a very competitive number. What I can tell you is Marty has taken you through what our filed rate increases have been. The market doesn't give all of that because of competitive pressures, because of scheduled credits, and because of individual account modification factors. We think it's important because the trend has been consistent, that month-over-month, we are getting more rate in the market.

When you look at the expense structure, as a percentage of premium, it's obviously up substantially. Do you look at it in terms of claims volume or an activity measure or something that -- that it wouldn't -- that your growth and expenses would be more consistent with that underlying operational metric, and so therefore it would -- the expenses aren't up so much relative to the underlying business activity? I'm not sure if that's clear, but just trying to understand why we couldn't see a little more -- a little more opportunity to cut costs in the underwriting and other expenses.

This is Ric.

Let me respond by saying that across the organization, certain of the operations are more directly responsive to changes in volume, for example, if -- if there's fewer policies and consequently fewer claims, you can see a more -- I'm not saying a direct -- but a more direct correlation of the same, perhaps, on the premium audit side.

On the other hand, if you look at things like the finance department, we are still turning out the same number of annual reports, and SEC reports, so it's a less direct connection to expenses. That's -- I know you are trying to get a little bit more quantification around it than that, but we do pay attention to that.

Doug, do you want to add to this?

Yes, let me throw in a couple of things. When you look at the change in policy counts, versus the change in premium, and you will see those tables now in our 10-K. You can see what our estimated annual premium is, the in-force, versus the policy count and although the premium is down, the policy count isn't down by much, and so a lot of the activity levels right now are not significantly different from what they've previously been.

The other thing I want to touch on is I referenced the fact that we are continually making changes and adjustments. We've just recently done another one of those that we expect will result in approximately $1 million charge in first quarter, but ultimately will generate about $2.5 million of savings through the year, and we're estimating approximately $4 million on a run rate after 2010. So, we are doing those things, but sometimes the activity level and the -- the premium amount are not as directly linked as -- as you might think.

Just one follow-up on that. The $20 million to $22 million in expense savings, how much of that is incremental in 2010?

Well, that was -- we have -- we have completed our integration activities, so our expectation is that that is the run rate of savings from 2010 and beyond.

Okay. Thank you.

Your next question comes from the line of Michael Nannizzi of Oppenheimer.

Thank you. Just on a couple of those expense items, if I could. When you look at the business, today, relative to where it was last year or the year before, do you think about expenses, like an optimal expense ratio? Do you think about revenue relative to marginal costs, so losses and variable loss and LAE and other expenses? Can you just talk a little bit about your overhead, infrastructure, and how it sits with premium levels at -- or exposures at today's levels and just a follow-up? Thanks.

Well, all the things you mentioned are items we consider. When we talk about a normal market that would generate a combined ratio of -- of 100, you are really talking about an all-in expense ratio of somewhere between 30 and 35 and you're talking about loss ratios somewhere between 65 and 70. I think historically, that's how the industry gets to a combined ratio of 100.

Our issue right now is, obviously some of our costs are clearly variable. Commissions are variable. Premium taxes are variable, but as you build an infrastructure and then have the type of decline we've had, and, again, it's not a decline in activity. It's a decline in average policy size, it puts a tremendous amount of pressure on the expense ratio. And so we're constantly looking for ways to reduce the fixed component of the expense because the variable component takes care of itself.

All right. Right. Okay. And then I don't know if you have disclosed it before, but do you -- what percentage of your policies generate zero claims? I mean, just -- there's small premium dollar policies. Have you talked about what percentage of those result in no claims at all.

We have looked at that in the past, Mike. This is Marty.

Clearly more than half of those small policies we have in-force have no claims associated with them. And, that's part of the challenge here too is driving large numbers of those small policies in and collecting an average rate from the great majority of them who are not going to have any claims in order to maintain the loss ratios that we have, but it is significantly fewer than half of those policies that actually experience a claim.

Okay. Great. Thank you. And then just, if I could, a couple more. So if you look at this kind of variable cost versus variable -- or versus earned premiums, are there areas where you are generating marginal profit on that basis, or is all of your business "profitable" just on a marginal basis?

Well, I will go back to the way we segment our business. At various parts of the cycle, there are some segments of the business that do better than others. You look at large account business where you say, well, there's definitely more room to cover fixed expenses, but they also tend to be more competitive and drive thinner margins. So it -- you have to look at -- you have to segment the business, and it's not consistent through the cycle.

Got it. Got it. Okay.

And then just one question for Ric, if I could. Thank you very much for that. On the portfolio. So the duration is 502 --

Right.

-- can you -- does that include cash?

No.

Okay. So that's pure. And what is -- what is the duration of the liabilities or do you have an estimate of that at year-end as well?

Mike, that's typically run north of seven.

North of seven. Okay. So your portfolio -- (Overlapping speakers). Inside of your --

That's right. That's historically the case.

Okay. So that's without. So if you included cash, the portfolio duration would be under five and the gap would be a little bit wider.

Yes.

Okay. Great. Thank you very much.

Your next question comes from the line of [Bruce Pavel].

Thanks for taking my question. I have one question on the capital structure. How much capital -- how much excess capital is in the business today and what is your strategy and timeline for getting the appropriate level of premium to equity?

Well, let's look at it from a couple of levels. If you look down through the operating subsidiaries, as Ric referenced in his comments, we are writing at 0.6 to one, and that is not maximizing the leverage that the insurance companies could have. Again, a lot of that has been a function of that declining top line.

In terms of timing of the capital structure, again, the same three things that we consistently point to are, number one, we want to invest in the business so that we can grow it, because we think in the long term, that's how we create value. Number two, we look for opportunistic acquisitions, because they can grow long term value. And the third one is dividends and share repurchases. And so the combination of those three are how we consider capital management. And, again, if you refer back to my comments, we've relied most heavily on a third of those, which has been share repurchases and dividends.

And that 0.6 to 1, what is the normal alignment -- (Inaudible).

You are breaking up a little bit. Could you please repeat your question?

The 0.6 to 1, the premium to equity equation, where could that go in a normalized environment? Where would you like to see that in a normalized environment?

In a normalized environment, one to one would not be considered heavily leveraged or over leveraged in any sense. When you think about where you start going above that, when you are selling into a strong market, you absolutely want to take on more leverage, and when you are selling in a soft market, you pare it back.

Certainly one to one would not be over leveraged in any sense. In fact, if if you look at the broader P&C industry, it has dropped below one to one, which is one of the lowest leverage ratios the industry has had in decades.

Thank you.

(Operator instructions). Your next question comes from the line of Bob Farnam of KBW.

Hi there. I just have a question on the loss ratio and the trends. I'm just curious -- you have give spend idea of what rates are doing in California.

When you look at your overall book in terms of premium, is that still going down? And is it enough to offset the loss (inaudible) trends? It seems like with the frequency down and the severity minimal, the loss trend is probably pretty flat. I'm just curious where your loss ratio going forward will be still ticking up or will it start ticking down?

Well, this is Ric. I will ask Marty to come in after I make an initial comment here. While we have seen rates other than California continue to go down, it's that rate decrease is moderating over time, some of these decreases are not significant.

At the same time, we continually are examining our underwriting looking at where we are focused, where we want to focus. Those are having -- those are both having impact on the forecasted loss ratio. The target, obviously is to bring it down.

Marty, do you want to add color to our underwriting, I guess, is what I was leading to?

Well, I guess, as I said in my remarks, our claim frequency continues to go down, but we're also -- we also experienced lower incurred loss dollars in 2009 than we did in 2008, and that was in my remarks earlier. And I think it's probably what you implied earlier in your question, Bob, that our -- our loss ratio is -- is hanging in a narrow range. It's not -- it's not falling because it's -- it's hard when our denominator is falling, but, it's not getting materially worse either, because we are able to get some rate in California, and we're maintaining, the discipline from an underwriting standpoint and the loss adjustment expense gains that we made from a claims handling standpoint.

All right. As -- we may be getting ahead of ourselves here. As the economy improves and we start getting to recovery, are you expecting to see frequency increase at that point? Do you have any thoughts on what you expect as the economy improves?

There's been a lot of work done on that and there's a lot of ideas about what will happen. Our thought is that generally frequency declines are supported right now by the presence of more experienced workers in the work force.

But, the decline in frequency has been occurring for a very long time, as the economy has shifted from manufacturing to service, and there's been a greater attention to safety, and that -- as you know, that else a fairly long trend now. So I don't know that I would say, well, with an economic uptick, we would expect frequency to change, because there's so many other things that could impact that number.

Okay. Great. Thank you.

Your next question comes from the line of Robert Paun of Sidoti & Company.

Hi. Can you just talk about the payroll trends that you are seeing? Clearly they have been pressured, but are you seeing the rate of decline to be slowing similar to what you are seeing in the rates?

Well, unquestionably payrolls are declining. I don't know that I can give you a real precise number there. We are looking at the trending more generally and what we see is the trend is down in terms of -- of the payrolls. Beyond that, I don't have a -- a good number to give you.

Okay. But how does it compare from the fourth quarter relative to what you saw three or four quarters ago?

It's still trending down in the fourth quarter.

Okay. Thanks. That's all I have.

There are no further questions. I would now like to turn the call back over.

Very good. Thank you, everyone, for joining us today. We look forward to speaking with all of you with our results for the first quarter. Thank you all very much.

Ladies and gentlemen, that concludes the presentation. Thank you for your participation. You may now disconnect. Have a great day.