Employers Holdings Inc (EIG) 2011 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the fourth-quarter 2011 Employers Holdings earning conference call. My name is Jennifer, and I will be your coordinator for today. At this time, all participants are in listen-only mode. Later we will conduct a question-and-answer session towards the end of the conference. (Operator Instructions) As a reminder card, this call is being recorded for replay purposes. I would now like to turn the call over to today's host, Ms. Vicki Erickson-Mills, Vice President of Investor Relations. Please proceed.

Thank you, Jennifer. And welcome, everyone, to the fourth-quarter and full- year 2011 earnings call for Employers Holdings Inc. This morning, we announced our updated earnings results, and after the call, we will file a our Form 10-K with the Securities and Exchange Commission. Our updated press release and Form 10-K 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, and Rick 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 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. As has been our practice, a list of our portfolio securities by CUSIP is available in the investor section of our website, under Calendar of Events, Fourth-quarter Earnings Call.

As you know, this morning we reported updated financial results. Our financial statements were updated to adjust for an accrual associated with incentive bonus programs. This adjustment has been recorded in the fourth quarter of 2011 and has not had a negative impact on the Company's current or historical financial statement. Please refer to our updated earnings press release for changes in results related to this adjustment. Now, I will turn the call over to Doug.

Thank you, Vicki, Welcome, everyone, and thanks for joining us today. I would like to once again to extend the Company's apologies for any inconvenience we may have caused as a result of the rescheduling of this call. The workers' compensation market experienced another difficult year in 2011. While final underwriting results have not yet been published for 2011, AM Best reported a calendar-year statutory combined ratio of 118% for the workers' compensation industry in 2010, the highest level since 2000, and industry observers expect an even higher combined ratio for 2011. Workers' compensation premium dropped from $48 billion in 2005 $34 billion in 2010, largely because of rate decreases, competition, and job losses. Also, investment yields remain at historically low levels. So, reflecting on this past year, we are pleased with what we have achieved, particularly in terms of growing premium and reducing our non-loss operating expenses.

We have now reported fourth-quarter net income before the LPT of $16 million, or $0.46 per diluted share, an increase of $0.07 per share over the same period in 2010. The increase in earnings per share benefited from our repurchase of over 6 million common shares during 2011. In the fourth quarter, we repositioned our investment portfolio to achieve the following strategic objectives, to reduce tax-exempt municipal exposure, to shorten duration, and to increase high dividend yielding equities. Realized gains of $18 million were from the sale of the municipals and longer-term Treasury agency and corporate bonds. While our unrealized gains at the end of 2011 are still substantial at approximately $180 million, we chose to take some profits off the table in the fourth quarter and modestly lower overall exposure to tax-exempt municipals.

Throughout the year, we continued to build scale in our business. As a result of the growth initiatives we implemented in mid-2010, we added over 16,000 policies during 2011, increasing policy count to over 36% by year-end. We increased net premiums written by 31%. We added over 1,100 agencies to our distribution pipeline. Much of our growth in policy count in premium was from a higher rate of electronic submittals and our rapid quote system used by agents and strategic partners.

Additionally, our underwriting remained selective, as by year-end we succeeded in shifting a larger percentage of our in-force premium to the least hazardous groups, A and B. As a percent of in-force premium year-over-year, hazard group A increased 4 points, and hazard group B increased 1 point. Hazard groups A and B represented just over 42% of our total in-force premium at the end of 2011. Our strategic partner business represented 24% of our in-force premiums as of December 31, 2011, compared to 22% at the end of the fourth quarter in 2010. Retention of strategic partner policies in the fourth quarter was 90%, compared to overall retention of 87%. Overall retention improved 7 percentage points in the fourth quarter year-over-year, and was stable compared to the third quarter of 2011. ¶ Year-over-year, we saw an increase of 24% in our total payroll exposure, with substantial upticks in virtually all of our states. At the same time, our underwriting remained selective, as demonstrated by the shift in business to the lowest hazard groups A and B.

Our markets are influenced by state-directed, legislative, and rate actions. We did not see significant workers' compensation reform in any of our states in 2011. In terms of rates, several states implemented rate changes, most notably Florida, with a rate increase of 8.9% on January 1, 2012. In California, what we have raised our filed pure-premium rates more than 33% since early 2009. Bureau recommendations for rate increases in our markets nearly equaled declines in 2011. In the fourth quarter of 2011, relative to the third quarter, and for the first time in recent years, the change in our net rate was a positive 1%. We believe the improvement in net rate is primarily attributable to pricing increases and is influenced by changing mix in business. Year-end net rate has changed a negative 1.4% in 2011, compared with a negative 5.1% in 2010. The substantial improvement in year-over-year net rate was once again led die California.

California is the nation's largest workers' compensation market, and it represents over half of our business. Throughout the year, the Rating Bureau released data which indicated continued stress in the California workers' compensation market. On a positive note, written premium in all of California increased 12%, $8.3 billion in the first nine months of 2011, compared to the same period in 2010. However, industry results in California demonstrated continuing deterioration for accident year 2010. Aggregate industry data at September the 30, 2011 indicated that the 2010 accident-year combined ratio was 130% in California, with a pure-loss ratio of 84%. Indemnity claim frequency was stable for accident year 2011, compared to 2010, but was up significantly for accident year 2010 as compared to 2009. Indemnity claims severity was down slightly for accident year 2010, compared with 2009.

Employers continues to build scale going into 2012, and our change in net rate was positive in the fourth quarter of 2011, relative to the third quarter of 2011. While economic recovery coming out of the 2008, 2009 recession continues to be a lengthy process, we are hearing some anecdotal evidence that our markets are beginning to firm. We have solid January renewal results across the Company. We continue to actively and deliberately manage our capital. Our balance sheet remains strong, evidenced by the repurchase of over 3 million shares in the quarter and 6 million common shares in 2011. In the past year, we returned nearly $93 million to shareholders through share repurchases, which contributed significantly to our 14% increase in book value since December 31 of last year. Approximately $93 million of the current repurchase authorization remained at December 31, 2011. Now I will turn the call over to Rick for a further discussion of our financial results.

Thank you, Doug. As in the third quarter, our underwriting margin in the fourth quarter was pressured by premium growth and current accident-year loss trends in California. Excluding the impact of the LPT, our underwriting loss was $14.8 million, with a combined ratio of 114.9%. Our fourth-quarter loss ratio, before the LPT, increased 4.1 points year-over-year, while underlying losses in LAE increased $16 million, or 27%, year-over-year, with approximately 73% of that change related to premium growth. Much of the remaining change in losses in LAE was related to the increase in the provision rate for the current accident year losses resulting from lost cost trends, particularly in California. Our provision rate for current accident year losses remains stable at approximately 77% in each quarter throughout 2011. We had a $0.5 million unfavorable development in the fourth quarter, which was attributable to our assigned risk business. We believe our reserves for prior accident years continue to remain adequate. As we've noted before, while we evaluate prior accident years' reserves collectively, we have seen some unfavorable development in more recent periods, 2007 and subsequent, offset by favorable development in earlier accident years prior to 2007. However, our overall prior-year -- prior-period reserves remained largely unchanged.

The increase in our fourth-quarter loss ratio was partially offset by improvement in our underwriting and other operating expense ratio, year-over-year. The fourth- quarter improvement was largely driven by an increase in net premiums earned of approximately 20%. In terms of underwriting expenses, our cost-control measures resulted in declines in salary, benefit, and facilities expenses of $2.2 million for the fourth quarter of 2011, compared to the fourth quarter of 2010. However, growth raised premium taxes and assessments by $1.9 million, and the allowance for bad debt increased $0.7 million. In total, although underwriting and other operating expenses increased slightly, by approximately $600,000 in the fourth quarter, our expense ratio declined 4 points, attributable, in large part, to our premium growth. At the end of the year, our annual expense ratio was the lowest it has been since 2008.

With respect to investments, fourth-quarter net investment income declined slightly to $19.7 million, from $20.4 million in the fourth quarter of 2010, due to a slight decrease in invested assets and yield. As Doug mentioned earlier, we re-balanced our investment portfolio in the fourth quarter to modestly decrease our exposure to tax-exempt municipals, shortened duration, and increased high dividend equity securities. Sales of securities were across the municipal, Treasury, corporate, and agency sectors. The resulting cash was used to repurchase or was reinvested. Our portfolio is still comprised primarily of fixed-income maturities, which are rated, on average, AA or better. The average yield on our portfolio was 5% on a tax-equivalent basis with a duration of 4.2%. At year-end 2011, equity securities represented approximately 5% of our total portfolio, as compared to 3.9% at the end of 2010. At December 31, 2011, we had approximately $353 million in cash and securities at the Holding Company. In terms of our expectations for 2012, we will continue to closely examine our reserves, and trends for our losses and loss adjustment expenses will be reviewed quarterly. However, at this point in time, we see nothing that would indicate that we will need to further increase our estimated provision rate for the current accident year losses.

Cost controls remain in place, and we continue to implement process improvements to drive efficiencies. Our actions have been effective in lowering our operating expenses. However, we expect increases in underwriting and other operating expenses in 2012 for two reasons. First, continued growth will result in increases in premium taxes and assessments. Second, the Financial Accounting Standards Board refined the definition of acquisition costs, which can be capitalized and deferred, beginning January 1, 2012. Acquisition costs are the costs associated with acquiring and renewing insurance policies. Companies can choose to adopt this accounting change prospectively or retrospectively. We have chosen to adopt guidance on a prospective basis. We anticipate this accounting change will increase our operating costs and decrease total assets in 2012 by approximately $7 million, compared with 2011. Based on 2011 deferred acquisition costs, we expect these expenses to be recorded during 2012 as follows, 47% in the first quarter, 31% in the second quarter, 16% in the third quarter, and 6% in the fourth quarter. These percentages may be different than what we were anticipating based on actual.

Throughout 2012, we will report underwriting and other operating expenses net of the DAC accounting change, as well as the GAAP amounts. Excluding the account change and costs related to premium growth, we expect underwriting and other operating expenses in 2012 to increase in the low single digits, as a percent of 2011 underwriting and other operating expense. With that, I'll turn the call back to Doug.

Thanks, Rick. Our focus in 2011 was to continue to control operating expenses, to build scale by growing in markets which have historically produced losses that are lower than industry averages, to closely monitor and react to loss trends, to prudently price our products, and to actively and judiciously manage our capital. We achieved virtually all of our objectives in 2011 with the exception of our premium growth target. While premium growth has been substantial, our average policy size continued to decline throughout the year. However, in January of this year, we saw a slight uptick in the average policy size. We believe that the declining trend will reverse. In terms of underwriting performance, increases and losses in LAE related to premium growth, and recent loss trends have temporarily out-paced cost reductions and rate increases. However, our total net rate is flattening, and in fact, the net rate turned positive in the fourth quarter, compared to the third quarter of 2011. The key question in 2012 for us and for the workers' compensation industry as a whole, is whether increases in pricing will be adequate to overcome increased losses. Additionally, we expect historically low investment yields will continue throughout the year. While overall profitability will remain a challenge, increasing rates, and a sluggish but recovering job market may help to provide some lift in the workers' compensation market this year.

While the difficult market for workers' compensation 2011 is likely to extend into 2012, there are some bright notes. According to AM Best, industry net written premium in the first nine months of last year increased, compared to the same period in 2010. As I mentioned earlier, industry premium increase in 2011 in our largest market California. In 2011, the NCCI, an independent Rating Bureau, filed rate increases in 19 jurisdictions nationally, and we write business in 13 of them. We believe we will continue to produce additional revenue in 2012 as a result of our growth initiatives with a larger policy size than in recent past. With that, operator, we will now take questions.

( Operator Instructions)

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

Amit Kumar from Macquarie Capital. Good afternoon.

Going back to the discussion on growth initiatives -- obviously you've had substantial growth in 2011. Can you talk about how should we think about your premium to surplus going into 2012? How far can you go on a premium-to-surplus basis?

Well, let me answer that question slightly differently. It does relate to the premium-to-surplus ratio, but first and foremost, we do manage our capital relative to what the requirements of the rating agencies are; in particular, A.M. Best. As we've indicated previously, we believe an A-minus rating is necessary to support the business we write, not more than that and not less than that. Consequently, as we think about how much capital is required, and how we model potential capital use going forward, and what the impact of growth might be on it, we are keeping a very close eye on the A.M. Best BCAR calculation.

I'm sorry, my question was, what ratio do you have in mind for your go-forward premium to surplus?

The ratio will be influenced by ultimately what our capital requirements are from the rating agency.

Kumar, we're not targeting any ratio, such as 1.5 to 1, or something of that order, if that answers your question.

It does answer my question; I am somewhat -- moving on, and I'll ask this question in a different way. What is the state regulators' view on the growth as you have seen coming from you?

This state regulators express less of an opinion than the rating agencies do. We are subject to risk-based capital requirements from the various states, and that is something that we have to monitor and manage. But in terms of growth -- as you are well aware, as A.M. Best thinks about growth -- they are measuring both in terms of premium growth and policy-count growth. That's in light of the quality of the capital; so that's really looking at the balance sheet, the allocation of assets on the balance sheet and loss. So it's not as simple for us as to just pick a target in terms of leverage of premium to surplus. It's really much more important to think about it in terms of what the capital is required to support the rating.

I guess that's where my follow up question comes. If you look at the maximum dividend capacity at year-end 2010, that was roughly $115 million. Out of that $115 million, roughly $68 million was dividended by the subs to the Holding Company as of Q3. I'm just wondering, based on your growth, is it fair to say that one should not expect buybacks going forward, based on your current capital position?

A fair question, Amit.

As we move into a harder market, one of the things we will be considering is the best use of capital. And, as I have repeated many times, we really think about capital in three ways. One is to continue to invest in the business; one is to use it for opportunistic acquisitions; and the third is to return it to shareholders. As we see a hardening of the market, the opportunity may be better going forward, to reinvest that capital back into the business. I can't tell you we have definitive plans on that, because it is something we are evaluating constantly as we try to judge where we are in terms of the market cycle and where capital will be best deployed.

But even if you look at the current capital scenario, it does seem, as of today, you would be limited in buying back stock, irrespective of the market turns going forward or not. Or are you saying that, as of today you are fine, but if the market turns, then it would be a different story? I'm just trying to reconcile the Holding Company numbers, the dividend capacity. And if you do the math, it seems that should the flexibility and buying back would be fairly limited going forward, irrespective of the market turn.

Well, Amit, first, the dividend capacity that you are looking at coming from the operating companies is somewhat separate, in the sense that our share repurchases are, in fact, coming out of the Holding Company. That capital is separate. We evaluate that, as Doug has just said, as to whether it's going to be returned to shareholders, whether we're going to hold it for some period of time, or whether it's needed to be infused back down into operations. The dividending up is something that we evaluate separately from what we are doing with the Holding Company capital. There is not necessarily a direct link there. They are related.

But the capital has to move from one place to other. It can either sustain the growth or you can buy back. The same capital cannot do both at the same time. That is my question.

I guess that's my point, Amit; which is, we have that choice to make. We may choose to reinvest more capital back in the business because we believe that in a firming market, that the returns are more attractive there. We may choose to do an acquisition and use the capital in that fashion. And finally, we could choose to return it to shareholders through repurchases and dividends. Those are choices that we make, and it can come either through organic growth within the operating companies to support growth, or it can come in the form of capital contributions up or down from the Holding Company.

Okay. That helps.

Last question -- and thanks so much for answering these questions. Based on your debt to capital, if the market does turn, do you anticipate tapping the credit markets at that time to sustain your growth?

Again, we would view that as an option available to us. We carry very little debt on our balance sheet today, and so we certainly would have capacity to do that if we saw a need for it and we found terms that were favorable.

Your next question comes from the line of Jack Sherck. Please proceed.

A question for you on the commission expense line, moving up as a percent, there. Is that just the going after the smaller accounts? Is that a function that is going to continue, or is it more one-time in nature?

A combination of forces there that are impacting that number. First, as we grow the percentage of business that we write to our strategic partners, that carries a slightly higher commission load than we do with our independent agent business; because of the services they provide in addition to producing the business. We are seeing in some of our markets continuing pressure on commission levels, although recently we've begun to see a change in that trend. Finally, the last thing, as you point out there, is that number is influenced by the amount of contingent profit commission that's related to the LPT. So, year-over-year, or period-over-period, that can influence that number.

Okay. And then on the underwriting and other operating expenses -- Rick, you mentioned that, that was mostly operating leverage; but at the same time, in your earlier prepared comments, you mention that much of your policy growth you're seeing is coming electronically. I think on some previous calls you had mentioned technologies and so forth helping out there. Can we look for some upside there, based on other factors other than operating leverage?

Well, as we mentioned before, we continue to strive for improved efficiencies. We do see some increases in cost as merit raises, et cetera, that have a upward influence. We continue to look at it. We are not forecasting that right at this moment for 2012. It certainly is something that we're working towards.

Okay. Just my final question -- on any return-to-work initiatives, or what you're seeing from claimants in terms of their activity? If that's changed at all recently.

It hasn't changed enough yet for us to declare a trend. Something we've observed, and I think others in the industry have, is that duration of claims was lengthening because of the challenges of return-to-work. We believe that our business model has been particularly challenged there, because we focus on small employers. And they tend to have more limited return-to-work opportunities. In some cases, maybe even appetite. But as the employment market improves, we would expect that, that number will start to come back down to more historic norms. We are just not quite ready to say we are seeing that yet.

( Operator Instructions)

Your next question comes from the line of Matt Carletti. Please proceed.

I just had a few questions. The first one is, following on the growth comments, or questions that Amit had; maybe going about it a different way is -- I know that growth has been, in percentage terms, quite large relative to employers. If I recall the whole -- what got you moving in this direction was following the AmCOMP acquisition, very undersized market share in the ex-AmCOMP states, as compared to what you viewed as more mature markets, legacy EIG states. Can you give us some idea of how you think you've moved on a market-share basis, since this initiative started, on average, in those states? And how that compares to where you stand in legacy EIG states?

That's a difficult question to answer, Matt, because the data lags so much. We won't have good data for 2011 until late summer of 2012. So that market-share data is very challenging to get to on a real-time basis. We have -- if I think about how are getting growth across the country, California has been a combination of both rate and policy count. We are starting to experience the same thing in the rest of the country -- or most of the rest of the country -- as well. Whereas the beginning of last year we were getting much more growth in terms of policy count, as we move to the end of the year, we start to see more of the growth coming in terms of premium. And in fact, if we look at January -- January was the first time we've seen policy count growing at a slower rate than premium growth. That's been a trend that's been in place going back many years. We've seen that turn now, where we're starting to see lots of the growth in policy and more into premium. I think that's going to be fairly consistent across the country now.

Okay. And then moving to the uses of capital question again -- can you help us think through, particularly given where your stock is trading on a book basis -- so, roughly call it 70% of book, currently. How you view the return metric on clearly a near-term basis on buying back shares, versus ROE hurdles or combined ratio hurdles or however you might think about it you view on new business needing to have, in order to make that decision or that option to reinvest in the business versus buying back your shares?

We think about it less on a short-term and more on a longer-term basis. With the share price where it is today, no question that repurchases are extremely accretive to book value, as we saw in the last quarter; and really over the last year, with nearly 14% growth in book value. Over the longer term, when you think about the best use of capital, it really requires us to model where we believe the market is going; because as we move into a hard market, despite our best hopes, it's not going to be overnight. It is going to take some time. That's why we think about that on a longer-term basis as we are evaluating alternative uses of capital. So, the share repurchases might look very attractive in the immediate timeframe, but if we believe the market is hardening over a longer period of time, that may be the better use of capital.

Is there a general rule of thumb as how many years you might look out? Is it three years, five years, or no set rule?

We model out beyond three, but it's hard to put a lot of credibility out beyond three years.

Fair enough.

And then just one quick last numbers question, probably for Rick. I know you mentioned from recalling an aggregate, the moving adverse and favorable pieces within accident years for the year was more or less a wash, at least aside from the assigned risk pool. How much -- can you tell us how much, either in dollars or loss ratio points, 2009 and 2010 accident years developed adversely in 2011?

Generally speaking, that moved around 1 point or less.

There are no further questions at this time. I will not turn the call over to Mr. Doug Dirks for closing remarks.

Thank you very much, Operator. Thank you everyone for joining us today. Again, our apologies for having to move the call to today. We thank you for joining us, and we look forward to speaking with you again next quarter.

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