Employers Holdings Inc (EIG) 2012 Q1 法說會逐字稿

Good day, ladies and gentlemen. And, welcome to the first quarter 2012 Employers Holdings earnings conference call. My name is Amecia, and I will be your operator for today. At this time, all participants are in a listen-only mode. We will conduct a question-and-answer session toward the end of the conference.

(Operator Instructions).

I would now like to turn the call over to Ms. Vicki Erickson Mills, please proceed.

Thank you, Amecia, and welcome everyone to the first quarter of 2012 earnings call for Employers Holdings Inc. Yesterday, we announced our earnings results and after the call we will file our Form 10-Q with the Securities and Exchange Commission. Our press release and Form 10-Q may be accessed on the company's website at employers.com and are accessible through the investors link. Today's call is being recorded and webcast from the Investor Relations section of our website where a replay will be available following the call. With me today are Doug Dirks, our Chief Executive Officer, 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 events. 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. Additionally, the Financial Accounting Standards Board issued guidance that, beginning in 2012, change the definition of policy acquisition costs which may be capitalized.

During the first quarter of 2012 we recorded a $3 million increase to underwriting and other operating expense. As a result of our prospective adoption of the FASB change in accounting methods for deferred acquisition costs, or DAC. The change in DAC accounting impacts the year over year comparison of our results. Therefore, the earnings announcement released yesterday includes reconciliations of results for the first quarter of 2012 compared with the first quarter of 2011 which illustrate the impact of the change in DAC accounting. Please see the earnings announcement for these detailed calculations. 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 first quarter earnings call. Now, I will turn the call over to Doug.

Thank you, Vicki. Welcome, and thank you for joining us today. Yesterday, we reported adjusted first quarter net income, excluding the DAC accounting change and before the LPT, of $5.6 million or $0.17 per diluted share. An increase of $0.07 per share over the same period in 2011. Except for greater than expected growth in written premium, which is a reflection of a rapidly transitioning market, these earnings were fully in line with our expectations. Favorable and unfavorable variances in expected investment income and various expense components were de minimus.

GAAP net income was impacted by a $3 million accounting expense for deferred acquisition costs which dropped pretax earnings per share approximately $0.09. In terms of operating results, we reported an adjusted first quarter combined ratio, excluding the DAC accounting change and before the LPT, of 117.1% compared with 122.4% last year. An improvement of a 5.3 percentage points. While we are still near the peak of the workers compensation business cycle in terms of combined ratios, pricing and competition in our markets are beginning to improve. We reported strong revenue in the first quarter, up 26% as a result of the ongoing impact of the growth initiatives we implemented in mid-2010.

At the end of the first quarter, we added over 18,500 policies year over year increasing policy count 39% and in force premium 33%. Retention of existing policies was strong in the first quarter of this year. Overall retention of 87% improved 3 percentage points in the first quarter it year over year and was stable compared to the fourth quarter of 2011. Our strategic partner business, which represents approximately 25% of our book, demonstrated continued solid policy retention of 91% in the first quarter. The change in our net rate was a positive 0.6% year over year led by California with a positive net rate change of 13.6%. This is the first year over year increase in overall rate we have seen in several years. This is encouraging and, we believe, an indicator that pricing in the market is continuing to firm.

We will increase average rates in California an additional 6% as of June 15 of this year. Including this change, we have increased our filed pure premium California rates more than 40% since early 2009. In April of this year the WCIRB submitted its pure premium rate filing recommending an average rate level of 4.1% more than the industry average filed pure premium rate level as of January 1, 2012. This recommendation was based on experience as of December 31 that indicated increased loss development on the 2010 and 2011 accident years, increase loss adjustment expense, and lower forecast of wage growth in California for this year and next year. We will take this latest WCIRB filing and its underlying support data into account as we consider any additional rate action on our part.

In Illinois, we increased average rates 13.6% effective March 1, 2012. We also increased Florida rates 8.9% on January 1 of this year. In fact, as of May 1 of this year, in each of our top five states, we have filed for rate increases. These five states represented nearly 75% of our in force premium at March 31. We continue to actively and deliberately manage our capital. Our balance sheet remains strong evidenced by the repurchase of over 1.1 million shares in the quarter. In the first quarter, we returned $18.7 million to shareholders through share repurchases. At the same time, our book value per share including the LPT deferred gain grew 2% to $25.51 at March 31.

Approximately $74 million of the current repurchase authorization remained at the end of the first quarter. Since our initial public offering in early 2007 we have returned to shareholders nearly 120% of our net income before the LPT through share repurchases and dividends. At March 31, 2012 we had approximately $326 million in cash and securities at the holding company. We will continue to evaluate uses of capital relative to our organic growth, investment opportunities, capital retention needs, stock price, and other factors. We have in the past generally chosen to upstream dividends from the operating companies to the holding company. Going forward, we may use cash to support our growth strategy and maintain the financial strength ratings of our operating subsidiaries. Now, I'll turn the call over to Rick for a further discussion of our financial results.

Thank you, Doug. As Doug mentioned, in the first quarter we continued to report strong growth in premiums in revenue. Excluding the accounting change per deferred acquisition costs our combined ratio before the LPT was more than 117.1%. More than a 5% point improvement compared to last year's first quarter. The improvement was largely related to a decline in the underwriting and other operating expense ratio. The GAAP underwriting and other operating expense ratio improved 1.8 points year over year largely driven by the increase in net premiums earned and cost controls enacted by management. Excluding the change in DAC accounting methods expense ratio improved 4.5 points.

We indicated last quarter that we expected increases in 2012 underwriting and other operating expenses from the change in accounting method for deferred acquisition costs and from higher premium taxes. As previously disclosed, we expect that the increase in expenses related to DAC to be recorded largely in the first and second quarters of the year. With much smaller impacts in the third and fourth quarters. We still anticipate of the total $7 million in 2012 DAC expenses resulting from the accounting change the remainder will be recorded as follows; 31% in the second quarter, 16% in the third quarter, and 6% in the fourth quarter. For the rest of 2012 we will continue to report financial results and performance measures adjusted to exclude these DAC accounting changes.

The loss ratio before the LPT was down slightly year over year. Our provision rate for current accident year losses remains stable in the first quarter of this year at 76.9% compared to 76.6% in the first quarter of last year. The provision rate continued to be influenced by California operations. As in past quarters, we had slight unfavorable development which was entirely attributable to our assigned risk business. We evaluate prior accident years reserves collectively and these reserves continued to remain adequate at the end of the first quarter. We again saw some unfavorable development in more recent periods, 2007 and subsequent, offset by favorable development in accident years prior to 2007.

As we mentioned during the last call, in the fourth quarter of last year we began repositioning our investment portfolio to modestly decrease our exposure to tax-exempt municipals shortened duration, and increased high dividend equity securities. We completed that rebalancing strategy in the first quarter of this year. Our first quarter net investment income declined to $18.4 million from $20.5 million in the first quarter of 2011 due to the completion of the rebalancing of fixed maturity and equity securities in our investment portfolio in the first quarter this year and a slight decrease in yield. At March 31, our portfolio was primarily comprised of fixed income maturities which were rated, on average, AA or better. Equity securities represented approximately 6% of our total portfolio, up from 4.2% at the end of the first quarter of last year. The average tax equivalent yield of the portfolio was 4.9%, down from 5.3% at the end of last year's first quarter. The duration of the portfolio was relatively short at 4.3%. With that, I'll turn the call back to Doug.

Thanks, Rick. We reported strong revenue in the quarter with broad rate strengthening which points to a strengthening workers compensation market. Our operating performance improved relative to last year's first quarter even without the impact of the $3 million DAC accounting change that increased underwriting and other operating expense. The business is performing to our expectations at this point in the cycle. We remain committed to further improving our operating performance as market conditions improve and continuing our focus on growing the long-term shareholder value. Operator, now open up the lines and we will take questions, please.

Yes, sir. (Operator Instructions). Mark Hughes, SunTrust.

Thank you, very much. Good afternoon. What kind of rate increases do you think we need to start whittling away at that loss ratio?

If you look at the reported results at 117%, if the goal is to be at 100% combined or better, that defines the amount of rate increase that would be necessary. Now, some of that advantage would come through scale as we continue to grow the business. So, it doesn't all have to come from a rate that will drive a better loss ratio. But, if you think about in those terms, Mark, that gap between the reported results and 100% or better is what our objective is.

Would it be safe to assume that the rate increases that you are getting now, or will get in Q2, Q3, that those are going to be sufficient to start, as I say as, reducing that loss ratio? Not to get all the way to 100% combined but at least to start to see that loss ratio come down rather than holding steady like it did in Q1?

Yes, one of the things we will be looking for are what the changes might be in the loss trends. And, if you look at not only California but a number of other states there has been a moderation in loss trends. And so, we are getting to a point in the cycle now where our expectation is that rate increases are greater than the loss trend. And, consequently, that should start relieving some pressure and allowing the loss ratio to come down.

Okay great. Then the expenses, sequentially, certainly understand the $3 million from the DAC change. But, it looked like expenses were up even more than that. Again, on a sequential basis you looked quite good in Q4 and then seemed to lose some ground in Q1. Any more color on that?

There are a couple of things to focus on. Included in that number are some variables expenses. So, when you're looking at the absolute expense ratio you have to factor in the variable component associated with premium tax and bad debt. So, that will impact of some of that. It's not all fixed cost. And, that represents, generally, somewhere in the range between 5% and 6%. It's not steady. It's dependent upon the states where the growth is coming. But, you have to factor that piece in.

We would expect that as we go through the year we will continue to build scale. And so, we will see some increase is an absolute expenses over the previous periods and over the previous year. But, we expect to see a continuing decrease in the operating expense ratio.

Very helpful. Thank you.

(Operator Instructions) Amit Kumar, Macquarie.

Thanks, it's Amit Kumar from Macquarie. Just going back to your opening comments regarding the reserve development could you just expand on that? I think you said there was some reserve development from 2007 and later which was offset by prior period releases. Could you just expand and maybe share those numbers with us?

Sure, I will give us a broad ranges. When you look at -- let's look at 2007 through 2010. '11 is a very green period still so let's focus on '07 to '10. We did see some development there, but very modest. Consistent with what you might expect given our conservative approach to reserving. But, the numbers by year have been very modest offset by prior periods.

And so, we are not seeing anything in that development that suggests there is a trend that we need to be concerned about. In fact what's happened in California in particular has been a moderation. If you look at those years they range anywhere between $1 million to $2.5 million of adverse development on a total reserve in excess of $1.3 billion. So, we are talking about very modest changes in our estimate for those year's.

Got it. So, at net-net it's single-digit adverse offset by a single-digit releases?

Correct.

Got it. That's very helpful. Secondly, just the discussion on the business mix. I'm wondering if you could quantify what you think the new business margins are versus business which is being renewed?

Well new business typically has an average rate higher than renewed business. Theoretically, and, I think, factually there is some risk in writing new business. You know it less well than your renewal business. And, it's priced accordingly. And so, you would expect that the margins are adequate on that business. I think the most important thing when looking at our book is there has been the shift down to A and B hazard business which typically generates higher frequency but lower severity. And, our experience is consistent with that as well.

Okay. That's helpful. And, I guess related to that and maybe a follow-up to the last question. When you look at the mix of the book, when do you foresee returning to an underwriting profit? You are getting -- probably you'll soon start getting rate on rate. And, if you look at that rate on rate and the discussion on the increases which you expect to get going forward, is it fair to say that at least in your plan you think that maybe ended 2013 you could get there or is that too optimistic?

I'm not going to provide you a forecast there, Amit. But, certainly, when you look at the level of rate increase we are getting right now and the momentum of the market, if that were to continue we are optimistic that we're going to be able to drive better results from two areas. One will be decrease in loss ratio. The other will be the scale we are building in the business and an improved expense ratio. And, certainly everything is moving in the right direction. There are ways broad macro issues that you have to be concerned about. But, given the current trends, we're very encouraged with the speed with which we're able to push through rate increases. The competitive environment, though still something we have to contend with, is much better today than it was a year ago.

Okay. Last question and I will re-queue. Just based on, I guess, your -- the discussion on capital management. And, maybe I misunderstood this. Is it fair to say that based on your opening comments we should not factor in a buyback or I guess a meaningful buyback going forward? Is that fair or did I get that comment wrong?

That is -- I would not characterize that as a fair statement. As I indicated, we still have in our capital management plans and ability to consider share repurchases, down streaming capital to support the growth in the operating companies, and to pursue strategic M&A. And so, based on a number of factors as to the share repurchases, which may be market price and other considerations, share repurchases are still a part of our capital management strategy.

Got it. Okay. Thanks for your answers.

Mark Hughes, SunTrust.

Wonder if you could give us a little more detail on the new business? The extent to which it is coming through your new distribution initiatives. It tends to be -- I think there's a lot of technology involved in evaluating and underwriting those new risks. And then, geographically where is it coming from? I know, I think you discussed going into some new markets in the Northeast perhaps with some of your partners. Could you give just a little more clarity on what's driving the growth?

Sure. Let's start with the broad numbers. We have seen growth in most of our states since the beginning of the year. The states where we have not had growth the decline in premium has been very small. So, in fact we are -- and that may be related, in some cases, to an individual account. So, we are seeing growth across the country. We attribute that to a number of factors. Certainly, the deployment of our technology beginning in late 2010 has had an impact. Increasing the number of distribution points across the country has had a favorable impact on our growth.

Our strategic partner business is becoming a larger part of our book. As that has been expanding into some new states. Most recently expanding into New Jersey for us. We have additional technology initiatives that will be rolling out later this year that we expect will improve the ease of doing business and the customer experience for our agents and our insured's that will support growth going forward. We also expect that, that will deliver some better pricing tools for us to allow us to more aggressively respond to improving market conditions.

How do you think about, at this point in the cycle, the decision to be perhaps more selective or more aggressive with your pricing? Sacrificing a little bit of the top line versus -- I think you were taking a different tack which is to grow aggressively, still get pricing. But, it seems like there is a little more emphasis on the top line. How do you think about that?

Let's look at California. The WCIRB has just provided some insight into what happened in the California market over the last couple of years. We contracted and gave up share in the 2010. If what the rating bureau in California is seeing is correct, 2010 was a year that had made sense to contract and give up share because 2010 is developing unfavorably across the market. We grew share in 2011. And, we started growing share at a point when the pricing started to improve. And, as I indicated we are getting now in excess of 13% year-over-year rate. So, we think we took the opportunity to grow appropriately in California. And, I think we will see, overtime, that similarly the balance of the country is delivering the same result.

Right. And your reserves did look more conservative, let's say, this year in your STAT filings. Okay. Thank you.

(Operator Instructions)Ladies and gentlemen, this concludes the question-and-answer session for today's call. I would now like to hand the call over to Mr. Doug Dirks for closing remarks.

Thank you, very much, operator. Thank you, everyone, for joining our call today and for your participation. We look forward to speaking with you again next quarter.

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