Employers Holdings Inc (EIG) 2010 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the first quarter 2010 Employers Holdings, Inc. earnings conference call.

(Operator Instructions)

As a reminder, this conference is being recorded for replay purposes. I will now hand the call over to your host for today, Vicki Erickson, Vice President of Investor Relations. Please proceed.

Thank you, [Selea], and welcome, everyone, to the first quarter 2010 earnings call for Employers Holdings.

Yesterday, we announced our earnings results, and today we will file off 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 Marti 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 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 website. Now, I will turn the call over to Doug.

Thank you, Vicki.

Welcome, everyone, and thank you for joining us as we review our first quarter results. Our results in the first quarter reflected, in part, national trends. Today, the NCCI reported that workers' compensation total premium fell in excess of 13% in 2009. For the same period, our in-force premium declined by 17%. Additionally, the rating bureau in California, the WCIRB, has reported that California has experienced a decline in workers' compensation premiums of approximately 17% in 2009 compared to 2008. For the same period, our in-force premium in California declined by 11%. The NCCI also reported that the estimated deficiency in total workers' compensation loss reserves increased from $6 billion in 2008 to $9 billion in 2009, a 50% increase, year-over-year.

Taking a closer look at our results, we have grown book value by $0.24 per share since December 31, 2009, to $20.91 at March 31, 2010. Net income in the first quarter was $0.38 per share, and $0.27 per share before the LPT. We, again, benefited from favorable prior accident year reserve development of $11.1 million in the first quarter.

On a GAAP basis, we had an underwriting loss of $4.6 million, with a combined ratio of 105.9. Excluding the impact of the LPT, we generated an underwriting loss of $9 million, with a combined ratio of 111.3. Our loss, commission expense, and dividend expense ratios remained stable or improved. The underwriting loss was caused by declining premium, which, in relation to fixed costs, increased the underwriting expense ratio, despite our nearly 12% decrease in underwriting and other operating expenses, year-over-year. Declines in net premium earned continued in the first quarter, stemming primarily from trends in employment and payrolls, rate decreases in some states, competition, and our continued underwriting discipline, with a focus on the loss ratio.

Our in-force premium declined 21%, year-over-year, with Florida, Wisconsin, Nevada, and California representing approximately two-thirds of the total decline in in-force premium. Our in-force premium was approximately $25 million lower than we expected it to be at March 31, 2010 with 40% of the miss occurring in the Midwest, and Marti will discuss that a bit later.

We are disclosing two new measures this quarter. Insured payroll, which is an indicator of exposure, and net rate, which is defined as total premium in-force divided by total insured payroll. Our nationwide payroll exposure declined 17% since March 31, 2009, and 7% since December 31, 2009. Our net rate declined 5% since March 31, 2009, and less than 1% since December 31, 2009. So while payroll declined, our positive net rate in California improved our net rate results for the three-month reporting period.

It appears to us that the national declines in total employment and payroll may have leveled off, but we do not know when new business formations will increase, or how soon our small business customers will add jobs and increase payrolls. In 2010, we expect our top line and expense ratios to continue to be pressured, mitigated in part by positive net rate in California, which represents half of our book of business at the end of the first quarter. Our trailing 12-month return on average equity, including the deferred gain, was 6.9% at the end of the first quarter.

As you know, the Board of Directors has authorized up to $50 million in share repurchases during 2010. In the first quarter of 2010, we repurchased 319,719 shares of common stock and an average price of $13.70 per share, for a total of $4.4 million. Our share repurchase authorization and our capital management plan contemplate a $50 million return of capital in 2010 through share repurchases. The rate at which we execute share repurchases throughout the period of the authorization is influenced by available cash, the market price of our stock, and contemporaneous alternative strategic uses for cash and capital.

Yesterday, our Board of Directors declared a quarterly dividend of $0.06 per share, with a record date of May 19 and payable on June 2. We are pleased to continue our demonstrated record of returning capital to our shareholders. Now, I'll turn the call over to Ric for a further discussion of our financial results. Ric?

Thank you, Doug.

First, I'll discuss our underwriting performance, then I'll move on to investments. Our operations generated a first quarter GAAP combined ratio of 105.9% and 111.3% before the LPT, compared with 99.8% and 103.6% before the LPT in the first quarter of 2009. The 6.1 percentage point increase was largely the result of lower premium volume, which, in turn, increased our expense ratio. Restructuring charges of approximately $945,000 increased the expense ratio by approximately one point, while restructuring and integration charges in the first quarter of last year added approximately 3.4 percentage points to the combined ratio.

Our acquisition savings and ongoing cost control efforts successfully helped reduce underwriting and other operating expenses by $4.2 million or 11.6% in the first quarter. Excluding the one-time charges, underwriting and other operating expenses declined 4% relative to last year's first quarter. Our loss rate ratio in the quarter continued to be better than historical industry averages, and our loss ratio before the LPT was stable relative to last year's first quarter. Losses in LAE expense before the LPT declined $18.9 million compared to the prior year's quarter. Prior year accident year development was favorable, and we released $11.1 million in reserves, $2.4 million lower than the prior year's quarter.

Our effective tax rate in the first quarter was a negative 3.4%, due largely to the impact on the calculation methodology of lower pre-tax income, tax exempt investment income, non-taxable amortization of the LPT, and non-taxable prior accident year reserve releases. Our pre-tax investment income was $21.3 million in the first quarter of 2010, compared with $23.3 million in the prior year's quarter; a slight decline, related to 2% decrease in invested assets from debt reduction and our return of capital to shareholders through dividends and share repurchases since the end of last year's first quarter. We have realized gains on investments of $0.5 million in the first quarter of 2010, compared with realized losses of $2.1 million in the first quarter of 2009. Net unrealized gains of $135 million at March 31, 2010 increased $4 million relative to December 31, 2009. Market factors contributing to changes in investment returns, year-over-year,were the narrowing of credit spreads, which more than offset the higher Treasury yields, and the rally in domestic equities.

The fair market value of our portfolio at March 31, 2010 was $2 billion, and was comprised largely of fixed income maturities, which were rated on average AA+. The average yield on our portfolio was 4.3% pre-tax, and 5.5% after tax, with a duration of 5. A list of our portfolio securities by CUSIP is again available in the Investors section of our website under Calendar of Events, first quarter earnings call.

In the first quarter, we received dividend payments of approximately $110 million from our operating subsidiaries. The fair market value of cash and securities at the holding company was approximately $300 million at March 31, 2010, with almost half of that amount held as collateral for the credit facility.

With that, I'll turn the call over to Marti.

Thank you, Ric.

As Doug mentioned, approximately one-half of our business is generated in California, where we have seen increased net rate for 12 consecutive months. This net rate increase is helping to offset, though not yet completely overcome, the effects of lower payrolls on our California premium revenues. We continue to see a steady level of new business submittals there, and our policy count in California remains relatively stable.

Across the country, net rate declined 5%, year-over-year, and less than 1% in the quarter. The modest declines were in large part driven by a positive shift in business mix to business classes with lower risk profiles in our acquired states, and consequently lower pricing per unit of exposure that is more consistent with our strategy of writing lower-risk business.

These are challenging times for a disciplined underwriting company. As Doug mentioned earlier, nationally workers' compensation premium declined 13% in 2009 compared to 2008. In California, total industry premium declined 17%. At the end of the first quarter, we were $25 million below our planned estimated in-force premium. Nearly 60% of this miss can be attributed to economic conditions and competition in many of our states. Nationally, we saw reduced premiums on our renewal policies which is evidenced by the 16.5% decline in our average policy size to $8,256 in the first quarter of this year, compared to the prior year's first quarter.

So why was our drop in premium so much greater this quarter? The remaining 40% of our premium miss occurred in the Midwest. In addition to challenging economic conditions in our Midwestern states, we took the following underwriting actions. We non-renewed some of our larger accounts in the Midwest during the first quarter, due to poor loss experience. We also repriced some of the Midwestern book of business, and as a result, lost accounts to competitors. We took these actions because they were appropriate, and while exacerbating our top line premium challenge, we believe they position us for strong operating results in the future.

Further impacting our premium shortfall in the Midwest has been a decrease in new business submittals. This drop in new business activity is in contrast to a year ago, when our newly available A-rated paper drove higher submission levels than had been experienced in that region in the past. This decrease in new business activity, compared to last year, has occurred in the Southeast as well. Our expectation of continued additional revenue generation through the availability of A-rated paper in our acquired operations seems to have been offset in the first quarter of 2010 by economic and competitive pressures.

In all of our markets, we are battling less than prudent pricing from both multiline and monoline carriers. Nevertheless, we continue to price our book to a level that we believe to be appropriate. However, it is clear to us that not all of our competitors are exercising the same level of discipline. As I have stated in previous quarters, and will restate here, while some companies may choose to pursue soft market strategies that chase top line premium, we continue to selectively underwrite and appropriately price our business. We believe that the pain from a declining top line premium in the near term from such discipline is clearly preferable to the greater pain from deteriorating loss experience that would come in the future as a result of compromising this discipline.

Our 12-month decrease in policy count was a modest 2,602 policies, or 5.7% with 43,100 total policies in force at March 31, 2010. This reduction in policy count was driven by large reductions in two of our most economically-challenged states, Nevada and Florida. Policy counts in California remained relatively stable in the quarter.

Our strategic partnerships and alliances generated $72.3 million, or 20.4% of our in-force premiums, as of March 31, 2010, as compared to $77.7 million, or 17.2% of in-force premiums, as of March 31, 2009. The percentage increase was primarily due to the higher retention rates during the preceding 12-month period for this business than for our independent agent produced business. Our retention in our partnership business was above 90% for the first quarter, while our overall company retention was approximately 75%.

New business activity, company-wide, is lower compared to the prior year's quarter. Our partnership submissions are somewhat lower, driven largely by ADP, whose growth in small business payroll customers has been challenged. We continue to drive increased new business submissions, quotes and written policies in California, year-over-year, while our average policy size there has decreased.

In summary, while we are certainly not pleased with our declining revenues, we believe they are an appropriate reflection of our market environment and our underwriting discipline.

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

Thanks, Marti.

Operator, we'll now open up the call to questions.

Thank you.

(Operator Instructions)

Your first question comes from the line of Amit Kumar with Macquarie. Please proceed.

Thanks. Good afternoon. Maybe just staying on the topic of the economic recovery, I'm wondering what sort of lag exists between an economic recovery and when it shows up in the smaller account base? Maybe can you just talk about the past business cycles, compare that to the current scenario, and overlay that with your different classes?

If you look at this economic recession, it's definitely been characterized by a more dramatic drop in employment than we've seen in some other downturns. The other I think unique characteristic at this time is the amount of underemployment, which is reflected in the number of people who are working fewer hours than they would like to. And although we have seen at least maybe a hint that the job recovery is beginning, there really hasn't been a turn in that underemployment number, and that's the one that we focus on most, because ultimately as underemployment improves, payrolls will increase, and that will drive additional revenues for us.

It remains to be seen how this recession plays out, but I think the most common view is going to be that it is going to be a slow recovery in jobs, potentially a slow recovery in hours worked, and until that improves it's difficult to see how premium in the workers comp line will improve. So I think you have to look at every recession individually.

The other thing that I think that is unique about workers' compensation is some of the premium is based on estimates of what the payroll will be for the coming 12 months, and to the extent that individual employers who report payroll to us that way fail to fully anticipate the recovery, our premium will lag, and we'll eventually catch it up at the time we do a final audit. Those are the primary drivers that impact the top line in comp.

Okay. That's helpful. In terms of - you mentioned competition and sort of re-underwriting the book in pretty much all of your states; what exactly is going on in terms of the competition being so aggressive at this stage of the cycle? Is it just rates? Is it terms and conditions? What is their view in terms of trying to garner a lot of new business at this stage?

This is Marty. We see it as rate competition. There really isn't a lot of difference in terms and conditions. Rate competition in a couple of our states like Wisconsin and Florida comes in the term of dividend plans, but for the most part it is just the rate on the policy, and insurance carriers apparently disagreeing in their view of what is an appropriate price for that exposure.

Okay. Then final question. Can you just talk about how we should think about, I guess, the tax rate and the expense ratio going forward?

Well -- this is Ric. With respect to the tax rate, as I mentioned, we have a GAAP methodology that gives an uneven performance over the year, but if I were to normalize it, in 2009 we had an effective tax rate of 10%. That was reflective of, for example, reserve releases of $51 million. If we look at the current year, if -- and I stress the word if -- if you have somewhere in the neighborhood of $40 million or $50 million of reserve releases again, again our effective tax rate for a full 12 months would be in the 10%, 11% range. However, the way the methodology works, it's a combination of actual to date, and budgeted for the remainder of the year, and that combination, especially when you are in the early quarters, can give you an indication as you see in our first quarter, with a negative effective rate of 3%.

As to the expense ratio, the way to think about that for the balance of the year, we continue to be focusing on expenses and, as you can see, we had a 12% drop in the actual amount of the expense. But because of the declining top line, we have an increase in the expense ratio, and that's simply going to be a function of when the market turns and when the top line starts to grow again. It doesn't mean that from an expense management standpoint, we sit around and wait for that to happen. We clearly haven't done that. But it is going to take some lift in that top line before we can begin to see some improvement in the ratio.

Got it. That's all I have. Thanks so much.

Your next question comes from the line of Michael Nannizzi with Oppenheimer & Co. Please proceed.

Thank you. Just one question. You had mentioned the $25 million less in premiums than you had expected; when was the budget or when had you set that expectation? Was it a year ago or was it at the end of last year?

It would have been at the end of the third quarter and beginning of fourth quarter of last year.

Okay. So that $25 million less, was it -- I am thinking in percentage rate, so 40% of that difference was due to the activities in the Midwest and then 60% was due to -- was it California? I'm sorry, I don't remember the other 60%.

It's really a combination of economic conditions and rate levels, and competition everywhere else.

Okay. So the 40% was in -- and that would be the former AmCOMP book, the business in the Midwest?

Correct.

Okay. And so is the other -- this business, is it different than other AmCOMP legacy business? What made this particular business unique?

Well, I don't know that it was unique, Michael. I think the AmCOMP book we inherited had a broader spectrum in its book than our did in terms of appetite, class and the probably average severity of the classes that were underwritten. So while a good portion of the AmCOMP book, probably the lion's share, actually, was pretty close to looking like the former Employers book of business, there were aspects of the AmCOMP that were in tougher classes and had perhaps not the price it should have, or had other experience issues that we knew we were going to have to deal with as we went through that whole book of business the first year or so after our close.

I see. Okay. And then in terms of -- are you conducting that same level of review on any other patches of that book of business now, that led you to that conclusion in the first quarter?

I wouldn't refer them as patches of our business. We do underwriting audits in all of our locations, and manage the quality of the files that we have, and effectively when we got into some of the offices in the acquired operations, there was a little more work to do there.

If you think about the book of business that we have in California, a much more mature market and had it for a long time, we still do underwriting quality reviews there as well, but for the most part the book of business is a book that we are comfortable with, we recognize and have accepted for some time.

Thank you. Just a question about the industry. I think, Doug, you mentioned in your comments that national premiums fell 13% in 2009. So this is not EIG, but just overall workers comp premiums, and this may be a silly question, but total employment didn't decrease 13% year-over-year. So is that part of what you were alluding to as far as people working, less utilization, so temporary workers, underemployed people? Can you help me understand how to reconcile those sorts of trends?

There's a combination of things that will drive that number. One is rate level, and if you think nationally, we are seeing some large rate decreases move through Florida, which is a large part of the national market. Some of it is competition, so you have competitors providing schedule credits that ultimately influence the total amount of the premium; and then some of it is payroll, where you have people that might still be employed but working 30 hours a week instead of 40. All of those forces together resulted in a decline nationally of 13% in the total premium.

Got it. Great, thanks. One question for Ric. You had mentioned that tax rate; can you explain the concept of taxation and reserve releases? Because I'm not sure I heard that right. I just want to make sure, is the tax treatment of prior year reserve releases different than the tax treatment of current accident year losses?

Well, two things. To the extent that the reserve releases relate to our pre-privatization periods, pre-2000, those releases are tax exempt.

Oh, I see, okay.

The other aspect that I am referring to is the methodology of computing what your annual tax rate will be, and in that situation you take your -- in this case, first quarter actual results, but then you are including your budgeted results or your planned results for the remaining nine months, and we never anticipate reserve releases; that constitutes additional income to us, and that's how potential future reserve releases can impact the quarterly tax rate calculation.

I see. Do you disclose how much of your reserve releases relate to post or pre-LPT?

It's about $5 million.

Okay. Thank you very much for answering all my questions.

Your next question comes from the line of Mark Hughes with SunTrust Bank. Please proceed.

Thank you very much. Just a question about California pricing, the WCIRB. I think as you alluded to, one of the things they reference in their recent report was that still there were pretty good redundancies and reserves in that state. So even though the current policy seemed to be going at a loss, the reserves were redundant. Do the carriers have to eat through those reserves before the pricing will firm up? What is the dynamic there that will finally allow a little more reasonable results in the state?

I think we've already started to see the firming of prices in California. A number of carriers have filed for rate increases over the last roughly year and-a-quarter or so. We filed for three different ones that pushed our filed rates up to something almost 25%. So I think we are starting to see some of that.

I suspect within the industry, there's always some concern around potential impact, as judicial decisions that could impact previous years, and I think that just argues for a bit more conservatism in the rate at which companies may be reducing redundancies.

Can you say -- your effective rates in California, seem like at least statewide they haven't been much movement, at least through 2009 in effective rates, even though I think a lot of folks have filed for increases?

If you look at the bureau's latest report, they are saying that the net rate 2009 over 2008 was flat.

Right.

We are saying that ours has increased for the last 12 consecutive months. We don't disclose how much that's moving, but it would suggest that if the total market has been flat, we are in fact getting more rate relative to the market.

Right. Okay, thank you.

Your next question comes from the line of Robert Roell with Columbia Management. Please proceed.

Hi there. I was curious on the scheduled credits, and there's been some discussion on gross rate filed versus net rate, effective rate. I'm curious if you can comment on the schedule credits that are happening, that you are giving out and your competitors are giving out, I am wondering what the nature of that activity is? And also, can you comment on credits outside of California as well? Thanks.

If you look at our numbers in totality, if we filed for a 25% increase over the period of the last 15 months, the market isn't giving all of that, clearly. And so what that means is scheduled credits have to be increasing to react to the competitive pressures in the market. We don't disclose what our average scheduled credit is; we consider that to be proprietary. But there's no question that there is a gap between filed rates and the net rate out the door.

What about outside California?

Outside California, scheduled credits are -- it does vary greatly by state, and it's somewhat a function of what the market's perception is of rate adequacy, filed rate adequacy. So I can't tell you that there's a single thought that you should have as to what scheduled credits do; it really varies around individual state rate filings and rate adequacy at a point in time. But it is the mechanism by which the market typically competes, and in our case, that would exclude Florida and Wisconsin, which are administered pricing states, where the scheduled credit mechanism takes the form of a dividend plan.

Okay, thank you.

(Operator Instructions)

Your next question comes from the line of Bob Farnam with KBW. Please proceed.

Hi there. It looks like your current accident year loss ratio is about the same as it was for the full year 2009 accident year loss ratio. Can we infer from that that you think that your rates are pretty much offsetting now lost costs?

That would be correct, Bob.

Okay. So no change in frequency, I assume, that you've come across yet?

We see frequency continuing to go down. It's prehaps not as steep, Bob, but our frequency of claims indexed continues to be lower quarter-over-quarter.

Okay.

And I think, to add to that, Bob, there's really a couple of things that are happening. This isn't just us, but it is what the market is seeing. Not only is there a declining frequency or a stable frequency, but because of the decline in exposure the total number of claims is falling. And although that's not a measure of frequency, it is kind of an interesting phenomenon to see, and you can see what the impact has been of declining payrolls on the industry. Just the total number of claims is having a fairly large drop.

Right, okay. And in terms of reserve development, it sounds -- just to go back to that, $5 million was from the LPT years? Do I have that right?

No -- well, LPT years are 1995 and prior. In this case, we're just saying it's 2000 and prior, and I don't think anything impacted 1995 or prior.

Okay. So was there any movement in the reserves in the recent accident years, like 2007, 2009?

Nothing material.

Okay. And the -- how was the performance of the business from the strategic partnerships relative to your regular agency book? I'm just curious whether or not the trends in the two different books are similar?

Are you talking about loss ratio, Bob?

Yes, right.

We don't report out segments, but we believe our loss experience in our partnership book is as good or better than the overall book.

Okay, very good. Thank you.

Your final question comes from the line of Matt Carletti with JMP Securities. Please proceed.

Doug, just had a quick question on the share buyback activity in the quarter. Could you just give a little more color on maybe some of the reasons why specifically this quarter it was pretty light? And if you do plan on, throughout the remainder of the year, making use of the $50 million.

Yes, as to what is happening individually on the authorization, Matt, I really can't provide much more color around there. As we've always said, there are three uses of capital for us; one is to invest in the business, one is to do strategic acquisitions, and the third is to return it through share repurchases and dividends. And at various points in time, even though the authorization is outstanding, we may be thinking about potential uses of capital within that context differently. But we do have an authorization that calls for $50 million during the year, and that remains unchanged.

Okay, thank you.

This concludes the question-and-answer session. I will now hand the call over to Douglas Dirks.

Thank you very much, Operator. Thank you, everyone, for joining us today. We look forward to talking to you again next quarter.

Ladies and gentlemen, that concludes today's conference. Thank you for your participation. You may now disconnect, and have a great day.