Employers Holdings Inc (EIG) 2011 Q2 法說會逐字稿

Good day ladies and gentlemen. Welcome to the second quarter 2011 Employers Holdings earnings conference call. My name is Keisha, and I will be your Operator for today. At this time, all participates are in listen-only mode. We will conduct a question-and-answer session toward the end of this conference. (Operator Instructions) As a reminder, this conference is being recorded for replay purposes. I would like to hand the conference over to Vicki Erickson, Vice President of Investor Relations. Please proceed.

Thank you. Welcome everyone to the second quarter 2011 earnings call for Employers Holdings Inc. Yesterday we announced our earnings results and today we will file the 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 these materials are accessible through the investor's 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; and Ric Yocke, our Chief Financial Officer.

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 the non-GAAP metrics that excludes the impact of the deferred gain from the 1999 lock portfolio transfer, or LPT. This metric is defined in our earnings press release, available on our website. As has been our practice, a list of our portfolio securities by QSIP is available in the Investors Section of our website under calendar of events, second quarter earnings call. Now I will turn it over to Doug.

Thank you Vicki. Welcome, thank you for joining us as we review our second quarter results. Let's start with some highlights. Year-over-year gross written premium increased 41%. Net earned premium increased nearly 13%. Policy count increased 20%. These results are explained by several factors. First, the growth initiatives that we put in place a year ago are yielding the results we expected. Second, final audits increased our net earned premium by $4.5 million in the second quarter, accounting for approximately 6 points of the increase in earned premium. Third, total payroll exposure increased 5.6% year-over-year, and 9.3% in the first 6 months of this year. Finally, while net rate declined 4% year-over-year, it declined by just over 1% in the first 6 months of 2011 and increased by more than 10% year-over-year in California, our largest market.

Now let's look at some of the details. As we expected, loss cost trends were stable, relative to the first quarter. In terms of our loss provision rate, whereas in the first quarter our provision rate increased because of changing loss trends in California, the increase in the second quarter is due to 2 factors -- and I want to make this very clear. Half of the change is related to our assigned risk business. The remaining half is due to a change in the allocation of premium by state. None of the increase reflects any change in our view of loss cost trends. The lack of favorable prime-period development in this years second quarter decreased net income by $0.13 per diluted share, relative to last year's second quarter; and represented most of the $0.18 per share decline in net income.

Our policy count at June 30, 2011 grew by approximately 8,700 policies, since June 30th of 2010. This increased our total in-force policies to over 52,000 at June 30, 2011. In the past year our average policy size has declined 16% to approximately $6,700 at quarter end. We have added over 700 producer appointments over the last 12 months. As we add new policies and agencies, our underwriting remains selective; focused on small businesses and those hazard groups and classes that have historically produced favorable loss ratios.

During the second quarter, we grew in-force premium 1.4% year-over-year and 8.1% since the beginning of this year. Our strategic partners generated 23% of our in-force premiums as of June 30, 2011 compared to 21% at the end of last year's second quarter. Retention of strategic partner policies in the second quarter was 89% compared to overall retention of 87%. Overall retention rates improved 3 percentage points quarter-over-quarter and 10 percentage points year-over-year.

In California, which represented approximately 55% of our in-force premium at the end of the second quarter. Payroll dropped over 1% in the past 12 months, but grew just over 5% year-to-date. Illinois continues to be our second largest state in terms of both payroll and premium. Payroll increased in Georgia over 30% year-over-year and year-to-date, making it one of our top 5 states in terms of payroll, as well as in-force premium. In July, we filed for an average pure premium rate increase of 3.9% in California, and that filing was recently approved. The new rates will be effective September 15. In Illinois, NCCI expects that the reforms enacted under House Bill 1698 will lower system costs by 8.8%. As to our book of business, we disagree and believe that the reforms will have no meaningful impact on our loss cost. And we will file not to adopt the rate decrease that was recommended by NCCI. Given this changed environment, we will exercise caution related to growth in Illinois.

Book value grew 3% since December 31 of last year. During the quarter, we repurchased 763,300 shares of common stock, at an average price of $16.34, for a total of $12.5 million, with approximately $65 million of the authorized share repurchase remaining through June of 2012. Going forward, this program will be executed based on a number of factors, including; stock price, corporate and regulatory requirements, and other market and economic conditions. Now I'll turn the call over to Ric for a further discussion of our financial results.

Thank you, Doug. Underwriting margin in the second quarter continued to be pressured by current accident year loss trends and the lack of favorable reserve development for prior periods. We recorded a non-adjusted underwriting loss of $14.3 million in the second quarter with a combined ratio of 116.2. Excluding the impact of the LPT, our underwriting loss was $18.5 million with a combined ratio of 121. Our second quarter loss ratio increased 15.1 points year-over-year, largely due to the difference in prior period reserve development and second quarter provision rate for current accident year losses.

We had $5.5 million of prior period reserve releases in the second quarter of 2010 and none related to voluntary business in the second quarter of 2011; this difference contributed 6 of the 15 point increase in the second quarter loss ratio. The remainder was attributable to the provision rate for current year losses, resulting from increasing medical and indemnity cost trends, particularly in California. We believe our reserves for prior accident years will remain adequate.

As we have noted before, while we evaluate prior accident year reserves collectively, we have seen some deficiencies in more recent periods, 2007 through 2009 offset by redundancies in earlier accident years, roughly 2003 through 2006. These accident years carried deficiencies and redundancies have remained largely unchanged since our last review. In fact, the 2010 accident year for our California operating company actually improved by $2.5 million. A recent rate increases in California are intended to respond to the increasing loss costs that we have observed, and they will improve rate adequacy as they become effective in September and roll through our book of business. Our intent is to keep pace with the development we are observing, and we will continue to adjust rate levels inline with those observations, in order to provide for ultimate claim costs. The increase in our loss ratio was partially offset by a 2.3 point improvement in our underwriting and other operating expense ratio year-over-year, driven largely by the 13% increase in net premiums earned.

Underwriting and other operating expenses increased approximately $1 million in this year's second quarter, compared to the same period last year. This increase was driven primarily by a $2.6 million increase in premium taxes and assessments. In the first 6 months of this year, underwriting and other operating expense decreased $5.5 million, or 9.6% compared to the first 6 months of 2010. Throughout the year, we expect quarterly operating expenses, other than commissions and premium taxes, to be relatively flat compared to those recorded in the first and second quarters. However, as we grow the top line, the expense ratios should continue to fall. Second quarter pre-tax net investment income declined to $20.3 million from $20.6 million in the second quarter of 2010, due to a slight decrease in yield. A tax benefit recognized in the second quarter was primarily attributable to the carry-forward of tax exempt investment income and tax impacts related to the LPT agreement.

Our $2 billion portfolio remains largely unchanged in the second quarter. The portfolio is comprised primarily of fixed-income maturities which are rated on average AA or better. Our portfolio is weighted towards short-term and intermediate-term bonds. At June 30, 2011 equity securities represented 4.2% of our total portfolio. The average yield of our portfolio was 5.2% on a tax equivalent basis, with a duration of 4.85%. We project our balance sheet with a comprehensive reinsurance program that was renewed on July 1, and we retained our coverage at previous levels. June 30, 2011 we had approximately $425 million in cash and securities at the Holding Company. Our uses of capital remain the same. First, we invest in the organic growth of our operations. Second, we look for opportunistic strategic acquisitions. And third, we return capital to shareholders through stock repurchases and dividends. With that, I'll turn the call back to Doug.

Thanks, Ric. Our initiatives to grow our business through the addition of agents and policies resulted in increases in written and earned premium in the second quarter. As I've said in past quarters, our current market is characterized by a unique set of challenges -- a slow economy, historically low yields on invested assets, and continuing price competition. Given these operating conditions, we have successfully reduced underwriting and other operating costs. We have improved and expanded service delivery through technology, increased our number of agents, and expanded unique strategic alliances and programs. We have responded to increasing lost cause trends in California nationally by providing for current accident year losses at rates higher than historic norms. Our growth initiatives are yielding the relates we anticipated. Looking forward, we see opportunities to continue to expand our presence in the 30 states in which we operate. With that Operator, we'll now take questions.

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

Yes, thank you. Good morning, or good afternoon. The loss ratio, with the prices in California, you describe up 10%, you filed for another 4% -- is that going to be enough that we should start to see the loss ratio in California start to come down?

Mark, I think it's a combination of factors. If you recall how we approach rate levels in California, the base rate, or the filed rate is one component, the scheduled credit is another component. And then the individual account loss modifier is applied, and it's a combination of those three things that ultimately drive the net rate. But I think the largest factor is going to be what happens on a competitive front. To the extent that the market starts to harden, we've got available both the rate filing and the scheduled credits to try to achieve more rate going forward. But I think the rate filing itself has less to do with it and the competitive market pressures will have more to do with it.

With the competitive situation you're in today, is the pricing that you're seeing -- effective pricing -- is it adequate to start to bring the losses down?

We are providing in rates that we believe are adequate to cover the loss cause trends in California. But if you think about where we are and where the market is, relative to what the bureau is suggesting, the bureau indicated that about a 40% rate increase was required. Our cumulative rate increase is now at about 30%. We have always indicated that in the competitive market, we're not getting all of that. So we expect that as the market hardens, we will have an ability to get more rate through a combinations of the filed pure premium as well as the scheduled credit.

Is it fair to say that the market is hardening with your prices rising as fast as they are?

Yes, I think if you look at the market, the fact that we're getting more rate would suggest that maybe the market has made that turn. But it continues to be a very competitive marketplace.

How about the new business that you are bringing on. Obviously, you're getting tremendous growth in written premium. What kind of loss ratio are you bringing to that business as more of that is earned through? Should that help drop the loss ratio?

Typically you will see a higher net rate on new business than you do on renewal business. The reasoning for that is, that on the renewal business, you have more experience on the risk; and also if it's been a good risk, it's eligible for some renewable credits. So we do see more rate on the newer business, which if it performs the same as the -- or the new business gets more rate. If it performs the same as renewal business, yes, you would have a wider margin.

Do you have enough experience with the policies you've signed up post this growth initiative to say how they are doing in terms of loss performance? Obviously this is a very good growth. Do you feel like your pricing it appropriately?

It's early, so the data we have is green. That being said, what we are observing is that the new business is performing consistent with the existing business.

Great, thank you.

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

Thanks and good afternoon. Just going back to the discussion on your top-line growth and new agents, several other Workers Comp companies are in fact shrinking their books right now and they're not growing in many states. Why do you think that other companies are somewhat unable to replicate your strategy of just hiring new agents and growing? And I guess related to that, why do you think the strategy is right in these times and in these markets, as opposed to shrinking the core book?

I'll cite some data that you may want to follow-up on. If you look at the AM Best data for 2010 -- in fact, in 2010 we gave up market share relative to 2009. That can't be said for a majority of the top 50 writers of Workers Compensation. So if companies say they're shrinking -- of course they are shrinking, exposures were down nationwide. It's more important to go and look at what companies are doing in terms of their share in individual states. I think that would give you a different story. As to why we are looking to grow and how we are doing it -- go back to the core of our business. It's a very focused underwriting strategy, it' in a niche that's well-defined and we have a great deal of experience. We've been able to bring to the marketplace technology that has been adopted very quickly -- and surprisingly on our part, very quickly by a lot of agents -- they like what they see. They like the quality of our brand, they like the quality of our operations and they're bringing us business.

Okay. Just related to that, in terms of this new business coming in, what specific changes have you incorporated in writing this new business, which was based on lessons learned from the uptick, and extending the loss payment in your core book?

I'm sorry, Amit, I'm not sure I understand your question.

I guess what I'm saying is, how do you change the current business? The way you write the current business, based on the loss picks ticking up in your previous business?

Well the new business, as well as the renewal is reflecting the rates as we see them being required for the current period. In terms of the underwriting, we've not changed our underwriting approach. The pricing approach changes based on market conditions.

So you are still applying the same underwriting standards to the new business and new agents?

Yes. What we have done is automated a lot of the process. But the underwriting strategy, the underwriting discipline remains unchanged.

Okay. Just one other question and I might re-queue. On capital management, you talked about the buy-back. Obviously, you mentioned $425 million number at the hold call. That is a meaningful number. What are your go forward plans with the capital in the current times?

They remain unchanged from what we have been saying in the past, which is first objective is to invest in the operation. Second, is to pursue strategic opportunities. And the third is to return capital through, share repurchases and dividends. And it has always been a combination of the three and continues to be.

Okay, that is helpful. I will re-queue, thanks.

(Operator Instructions)Your next question comes from the line of Matt Carletti with JMP Securities. Please proceed.

Thank you. I had a few questions. First one, you mentioned the renewal of your reinsurance treaty and that the coverage was unchanged. Can you tell us what happened with the pricing?

Matt, prices were flat. There was a slight decimal point down tick. But for all intents and purposes, the pricing was flat.

Then, Doug, could you comment on -- you mentioned Georgia is in the top 5 and you saw pretty good growth there. Can you comment, just give us a little color on the dynamics of that state and what makes it attractive to the employers?

What we're finding in Georgia, is that ADP, one of our key strategic partners is driving a lot of that growth. And we are able to put on the type of business and the classes that we like and we've had a great deal of success. So that's the primary driver in Georgia.

Okay, and then last question is -- I saw earlier this week that there is some index of small business borrowing that got to a high not seen since 2008 and that the delinquencies among small businesses are at a low. Can we interpret anything from that? Do you view that as a positive foreshadowing for your core small business activity? Or historically, have you not seen that correlation?

If that were a trend, I think it would be beneficial going forward. We're seeing a number of different reports that are suggestive of things starting to improve and even amongst small businesses. Just to look at some of our data, two of the states where we were hit the hardest and where the recession was the deepest were Nevada and Florida. And we saw a leveling, or stabilizing, of the loss of business near the end of the second quarter. So, I believe we're getting to the bottom of that. And those states are probably pretty good barometers for what is happening in small business environments.

Are you seeing any changes in the mix of kind of the change in payroll coming from, say, new businesses opening doors versus existing customers in your book adding employees? Or has that kind of remained stable?

I can't point to specific data there, Matt. The payrolls are going up. We're seeing a decline in average policy size. I think part of that is as we've increased our growth rate, we've been producing a larger number of smaller accounts. But they are all mostly in hazard group A to D, they're within the 85 classes of business that we've rolled out our technology to. So I think that is an indication of some turn in the small business market, but I think it's a little too early yet from our data to call that.

Okay. Great. Thanks a lot.

Your next question is a follow-up from the line of Mark Hughes with SunTrust. Please proceed.

Thank you. Doug, you suggested that of the change in losses in 2Q, half of that was from the assigned risk business, another half was a change in the premium mix by state. Were you referring to the sequential change there?

What that means is that the provision rate is a composite. So we establish an expected or provided rate in all of the states where we do business. To the extent that premium grows in one state that might have a higher provision rate, and it shrinks in a state with a lower provision rate -- that would have the effect of increasing the composite rate or the provision rate that we carry it at. And that's really what was happening. There is enough precision to the number that a movement in the allocation of premium by state can have an impact on it.

In those terms, you're talking about the Q2 compared to Q1? Is that right?

Yes.

So no real deterioration? Steady, you'd say?

Correct.

And then you talked about Illinois, that you disagree with the NCCI. Is that because your class codes are different than whatever aggregate they're calculating? Or you just don't think whatever changes are really going to make a difference overall?

Let me pull out one specifically. The 8.8% decrease provided by NCCI took into account expected loss cost savings from the use of Medical Provider Networks. We already use Medical Provider Networks in Illinois. So, if you don't use them, you might get some benefit. If you are already using them, it has no impact on you whatsoever. So that's would be an example why we view it differently as to our book of business than does NCCI to the total market.

Right. So it wasn't that you questioned their methodology, it's just applicability to you?

Yes.

That it's not applicable. Okay. Thank you.

There are no further questions in queue at this time. I would now like to hand the conference back over to management for any closing remarks.

Thank you very much. Thank you for everyone for joining us today. We look forward to speaking with you again on our third quarter earnings call in November. Thank you.

Thank you for your participation in today's. This concludes the presentation. You may now disconnect your lines. Have a good day.