Employers Holdings Inc (EIG) 2014 Q1 法說會逐字稿

Good day, ladies and gentlemen and welcome to the quarter-one 2014 Employers Holdings Incorporated earnings conference call. My name is Patrick and I will be your moderator for today.

At this time all participants are in listen-only mode. Later we will conduct a question-and-answer session. (Operator Instructions).

As a reminder this conference is being recorded for replay purposes. I would now like to turn the call over to Ms. Vicki Mills, Vice President Investor Relations. Please proceed.

Thank you, Patrick, and welcome everyone to the first-quarter 2014 earnings call for Employers. Yesterday we announced our earnings results and today we expect to file our Form 10-Q with the Securities and Exchange Commission. These materials may be accessed from 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 replay will be available following the call. With me today on the call 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 a non-GAAP metric that excludes the impact of 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 and thank you for joining us today.

Our results in the first quarter of this year were strong. Before the LPT we recorded a year-over-year increase of $0.09 per diluted share in earnings and a 2 percentage point improvement in the combined ratio. Our book value per share adjusted for the LPT increased 1.6% in the first three months of this year.

In the first quarter our net premiums earned were 13% higher than the same period last year, as we increased pricing and grew both the number and size of our in-force policies. Policy count growth of 4.8% was more modest than in recent periods while the average policy size increased 7.3% relative to last year's first quarter. We are seeing benefits from our continuing increases in pricing as our aggregate net rate increased 6.5% over last year's first quarter.

In California, which represents 60% of our in-force premium, we slowed policy count growth to 3% while policy size grew 10.7% and our year-over-year pricing increased 9.8%, 6.7 percentage points higher than all of our combined states excluding California. Our underwriting results improved in the first quarter of this year relative to last year's first quarter primarily due to increases in premium and our ability to continue to contain the underwriting costs that don't vary with premium. Our losses and loss expenses as a percent of net earned premiums were flat year-over-year.

You will recall that in the fourth quarter of last year we experienced a significant increase in a litigated claims concentrated in Southern California. From January 1 through September 30 of 2013, our open litigated indemnity claims as a percent of total indemnity claims in Southern California increased 6 percentage points, or an average of 2 points per quarter. From September 30 to December 31, the increase was 8 points.

We are pleased to report that in the first quarter of this year the number of open litigated indemnity claims as a percent of total indemnity claims in Southern California grew less than 1 percentage point since December 31 of last year. Our actuarial analysis of ultimate losses indicated a decrease in the frequency of indemnity claims in the first quarter year-over-year while our loss experience indicated upward trends in medical and indemnity costs per claim that are reflected in our current accident year loss estimate. Adjustments made in the fourth quarter of 2013 resulted in an annual loss provision rate of 77%.

In the first quarter of this year we reduced our loss provision rate to 74.7%. The decrease in our current accident year loss estimate was primarily the result of net rate increases which more than offset anticipated increases in loss costs.

As I indicated during the last earnings call we don't see anything on the immediate horizon that suggests a reversal of general loss trends in California. We believe the factors reported by the WCIRB, which we have previously discussed, including increased benefits associated with the passage of Senate Bill 863, continued to impact loss cause.

We have stated in the past that we have not factored any savings related to SB 863 into our California rate. That continues to be the case. And in fact, with pending challenges to medical lien reform and judicial decisions related to independent medical review boards we do not anticipate any cost savings associated with this legislative reform.

According to California Worker's Compensation Institute data, our average cost per paid claim has been significantly lower than the California market. We have been implementing and will continue to implement the following underwriting and pricing strategies which will reduce our exposure to adverse claims in California and offset the expected loss of premium from non-renewed business.

First, we are currently quoting policies effective June 1 utilizing three operating companies with new rates and territorial multipliers; second, we are non-renewing poor performers which represent a small percentage of our California policies; third, we are increasing prices for chronically underperforming class codes; and forth, we are targeting attractive classes of business both within and outside of California. In the third quarter of last year we announced an operational restructuring. We are currently staffing a more centralized operational structure and will continue to announce key appointments as they are made.

Throughout the remainder of 2014 we will continue our focus on pricing, cost containment and service improvement. With that now I will turn the call over to Ric for more details about the quarter.

Thank you, Doug. Good morning.

Our first-quarter 2014 net income before the LPT nearly doubled at $0.20 per diluted share compared with $0.11 per diluted share in 2013. The increase in our invested assets led to a 3.5% year-over-year increase in net investment income during the first quarter. Average book yields continued to decline slightly as investments matured.

The first-quarter average pretax book yield on invested assets was 3.3% and 4% on a tax equivalent basis. Net realized gains on investments were $3.3 million in the first quarter. Investment income remained pressured for both the industry and for us in light of continuing historically low yields.

Our revenues grew 13% in the first quarter of this year compared to the same period in 2013. Our expenses excluding the LPT increased 11% primarily attributable to a nearly 13% increase in loss and loss adjustment expense driven largely by premium growth.

Our recognition of prior-rate increases in combination with the year-over-year decline in indemnity claim frequency allowed us to reduce our current-year provision rate to 74.7%, a 2.3 percentage point reduction from our effective provision rate of 77% and yearend 2013. This is a 40 basis point lower than the rate in the first quarter of last year.

We believe our current-year accident year loss estimate is adequate. The minor prior accident year loss development reflected in the combined ratio table in our earnings release is related to assigned risk business. As we have indicated in the past, due to the late reporting by the states the adverse loss development related to assigned risk pools will generally be for prior periods.

Our first-quarter loss ratio was one-tenth of 1 percentage point lower than the same quarter last year while our combined ratio before the LPT improved 2 percentage points largely due to improvements in our underwriting expense ratio. We have limited increases in underwriting and other operating expenses to 5.6% with cost increases consisting largely of premium taxes and assessments related to premium growth and nonrecurring IT expenses of $700,000.

Our underwriting expense ratio declined 130 basis points in the quarter and our commission expense ratio declined 40 basis points. Our income tax expense was $1.3 million in the first quarter compared with a tax benefit of $200,000 in the first quarter last year. The increase tax expense was primarily the result of the reduction in tax exempt income relative to pretax net income and an increase in year-over-year projected annual net income before taxes.

Please see Note 4 in the Form 10-Q which will be filed after the call. This note provides reconciliations from the corporate tax rate of 35% to our effective tax rates of 10.9% and negative 3.1% for the first quarters of 2014 and 2013 respectively. We know that modeling our tax rates is not easy and we hope the tax note is helpful.

The estimated fair value of our portfolio was $2.4 billion at March 31, an increase of 1.3% since December 31 of 2013. Approximately 93% was fixed maturity securities with a duration of 4.2. Equities represented 7% of our total portfolio at the end of the first quarter with a continued focus on dividend yielding equities.

At March 31 we had approximately $170 million in cash and securities at the holding company based on market value. Approximately $85 million of the securities were restricted. The principle uses of capital in recent years have been investments, supported the growth and financial ratings of our operating subsidiaries and the payment of dividends to shareholders.

We continue to evaluate and consider other uses of capital as well including acquisitions and share repurchases although at this time we have no plans or authorizations for these other options. In conclusion, we are confident in our underwriting actions, our reserving practices and in the availability of capital for operations. With that I will turn it back to Doug.

Thanks, Ric. We reported a strong start to this year. Worker's Compensation insurance is a volatile business but as a monoline specialist company we have the ability to recognize issues quickly and deal with him. We are monitoring and handling the issues related to loss trends in California.

Our first-quarter results reflect our significant progress in strengthening our financial and operating performance. And with that, operator, we are ready to take questions.

(Operator Instructions). Mark Hughes, SunTrust.

Thank you very much. I'm sorry I missed the first few minutes of the call, but could you talk about your thoughts about topline strategy going forward? I know around 4Q you were talking about being very careful and more selective in your underwriting.

That was translated into a little slower topline this quarter. How are you feeling about the opportunity versus the risks going forward?

Let's start with opportunity and risk. We have identified, again both within and outside of California, classes of business that we believe present very good opportunities. That will offset some if not all of the business that we expect to lose principally in Southern California as a result of our nonrenewal activities.

Also as we implement the tiered strategy in California with the territorial modifiers, that will likely have an impact on our new business production in Southern California. But again we are seeing rate strengthening particularly in California but in other parts of the country as well. The market continues to be competitive.

We see particularly in new business production challenges because of the pricing levels in the market. And we are prepared to miss on the business if we can't get the price we have set.

So when you put all of that together, how do you think that it shakes out over the next couple of quarters? Is it more balanced in favor of a little more topline growth, or is this what we ought to expect a little more modest topline expansion?

Yes, relative to prior periods the topline growth will be slower because the ability to get rate is more a challenge now than it was a year and two years ago. The unknown is what the impact our pricing activity will have in Southern California.

There is certainly business in Southern California that we are prepared to write but only if we can get our price. If we are unable to get our price and if the renewal activity falls off, the topline could go down. That is not our expectation as we sit here today but it is certainly a possibility.

And you may have done some of this at the start of the call, but could you reflect on what you saw in the fourth quarter? In your experience have you seen spikes like this, short periods where you get a sharp acceleration and then it flattens out? How does this episode as it is playing out compare to your experience?

I have seen these periods before where you might have a single quarter that is outside of expectations. When I look at the fourth quarter of last year what occurred was not expected. I look at the first quarter of this year the results were in line with our expectations.

It's a little early yet to say that things will return to normal in Southern California for the market as a whole. Those litigation rates may just stay at those levels for a while.

The underwriting actions we are taking, we expect will bring that down. If you look at what was driving the litigation rates, the things that those claims had in common is that they were cumulative trauma claims, in a lot of cases they were late reported, and they seem to be concentrated in a handful of classes of business. The plan we put in place deals with all of those.

And so we would expect that our litigation rates could fall. Whether or not they ever go back to historical levels I don't know. At this point we are not even certain what caused that spike in the fourth quarter.

We will have more industry data probably in the next six to eight weeks that might give us a little bit more insight as to whether or not what we experienced was reflective of the entire market. It's a little too early to know yet.

Thank you.

Amit Kumar, Macquarie.

Thank you and good morning. Just a few follow-ups on the opening comments.

First, first of all, just going back to the discussion on the increase in litigating claims. You mentioned it's gone down to less than 1%. Was there sort of a monthly trendline which you could share with us in terms of how Jan, Feb and March look and I don't know if you have an early view for April on that trendline?

I don't have an early view on April yet given where we are on May 1. So if I had it I would certainly be happy to share it with you, I simply don't.

In terms of where that sell -- I'm just looking to see if in my notes I have it by month. Let's see, I've got this in front of me.

The movements are very slight. They are one-tenth of 1 point up-and-down, so there's really no trend there.

Okay. The other question I had was, just a discussion on bank expense initiatives.

I recall on the last call you had talked about reductions in the expense ratio. I was wondering if you could expand a bit further on that discussion from last call?

Yes, as I indicated earlier, we are embarking on a restructuring of our organization. Some of the staffing of which has already occurred, some of which is yet to come. I guess the best way to describe it is we have reached a point where we believe the Company will benefit from centralizing a lot of what had previously been regional operations.

And we think by doing that we will be able to drive much greater efficiencies as well as consistency, much greater efficiency as well as consistency in the operation. And I expect you will see more of that as we go through the year. Again it is still in the process of being staffed and there are many decisions yet to be made in terms of how we will ultimately structure the operation but the key idea is to drive centralization and greater efficiency and consistency.

Okay. The last question, and then we got a lot of questions on the loss pick discussion. You pointed out in your opening comments what you thought about the loss provision.

I guess going forward could there be a possibility that you could have overshot in Q4? And hence over time there could in fact be a possibility that we could see some reserve takedowns? Or how do you think about 2013?

Well, I would say that we believe there's an equal opportunity for it to go up or down. We have picked our best estimate for that quarter.

So we, when we picked the number it wasn't well let's take a high one and maybe it will come down. I think the best way to think about the fourth quarter is what was driving that was an uptick in the number of litigated claims and once those claims go into litigation they are not going away.

And if they cost 7 times more than the average indemnity claim it seems unlikely to me that that is going to do suddenly improve. There is something structural about those claims and that's why we reacted the way we did in the fourth quarter. We just don't see them going away.

And consequently we had to provide for them accordingly. Now is there a possibility that we went too far and things will be better than we expect?

Well, I would certainly hope that's the case, but I can't tell you that we expect that. If we expected that we would be booking another number.

Got it. And finally, is there any update on the three companies discussion we had last quarter? I know it starts from June 1, I think it was in the press that those people have already received notices.

Can you just give us a quick update on where we stand on that process? Thanks.

Yes, we are quoting June 1 business with the three company strategy, with the territorial multipliers. Given the way business comes on the books and the fact that a lot of it comes near the end of the quarter, particularly June 30 in our case, which is a large renewal date, it is too early for us to tell you what the implications of that might be.

We will probably have a better feel for that in maybe six weeks and certainly the two weeks following the middle of June we will have a pretty good idea what the impact is going to be. The notices have gone out, people have an understanding of what's coming, but it's too early yet for June 1 business.

Got it. Okay, that's all I have. Thanks and good luck for the future.

Matt Carletti, JMP Securities.

Thanks, good morning. First question probably for Ric, just a numbers question.

Apologies if I missed it in the prepared remarks. Can you give us the moving pieces behind the very minimal amount of adverse development net in the quarter, which accident years generally went plus or minus?

The entirety of that number is assigned risk pools and as we've mentioned before, those just by their very nature are reported late to us. They are reporting on the historical developments of the pools and they hit our statements as prior-period development. We have no other prior-period development other than the assigned risk.

Great. And then second question might be for Doug just on the improvement in the accident near. It's nice to see and I thought it would be coming, maybe a little earlier than what I thought given your comments on the last call in response to somebody's question about if the litigated claims slow down maybe in a quarter or two we could bring down the loss ratio a few points and I think you essentially said it is a possibility but we are going to be a lot slower in taking it down than we were the last time around. Can you just maybe give a little color on what you saw that led you to believe that do that now instead of maybe wait a quarter or two?

Sure. If you look at where we are providing for right now it is essentially at the same level we are providing for a year ago. And so if you would have taken where we were last year and factored through loss trends and rate expectations I think you would have expected to see our loss ratio a bit lower right now than where it is.

So we are pretty much flat to last year. Again, I am looking at the fourth quarter now more as it may have been an anomaly.

It is real. We have responded to it. I think where the loss provision right now is appropriate to what we were seeing in the first quarter.

Again, there was a slight decline in frequency, fairly modest increases in the medical and indemnity trends. So it has a sense of being back on track to where we thought things were.

Doesn't mean that we can't have some other unexpected event but you can always have an unexpected event. Things are kind of right as we anticipated they would be as we put together our plan for 2014.

Great. Thank you for the answers and best of luck.

(Operator Instructions). Heather Takahashi, Three Bridges Capital.

I just had some questions on the claims trends. You mentioned that you saw decreasing frequency but increasing severity and I am wondering if you had any sense of what was driving the changes in each? And also, I am wondering if you think there isn't any seasonality involved in what you saw in the fourth quarter?

Let's start with the second part of that. In terms of seasonality I don't expect so. That's something we look for.

I just look at data historically. For some reason September tends to be a quiet month, something about back-to-school I suspect. But I didn't see any seasonality in the fourth quarter.

Now if you look at some of our first-quarter results at a claim level and these aren't significant but if you look at the largest claims in the quarter, I think 4 of the top 10 were weather-related, they were in the East, they were slip and falls. So you can once in a while, it's not predictable, but once in a while you can see some seasonality related to the way claims come in. Again, that was not significant at all to the quarter but responsive to your question.

In terms of causes of changes in frequency in the loss trend on medical indemnity, frequency I don't know, I can't attribute a particular cause to the change in frequency. It was modest. In terms of the medical and indemnity trends nothing out of the ordinary there, just normal kind of inflationary impacts. Certainly in California we have seen increasing medical severity related to increased medical utilization.

And I think a lot of that has to do with the impact of the SB 863 reforms. And again that is not changing, it's just kind of a continuation of what we've seen.

And I'm just wondering about the change in the loss picks on the fourth quarter to the first quarter. How much was driven by what you have actually seen in terms of reported claims versus what you, or I guess the anticipated benefits from the remedial actions that you have taken already?

We're not building in expected benefit from actions that we are taking. It's responsive of what we are seeing in real time in terms of paid and incurred data.

Okay. And then the change in, I guess it's not a change really, it's more a stabilization of the legal representation in the claims, or the proportion of represented claims, do you have any sense of what drove that spike in the fourth quarter last year? Have you had any more insights on what drove that, or why it would reverse going forward?

We have segmented this a number of different ways and tried to develop a better understanding of what is driving it. And every time we take a different approach in terms of the segmentation we come back with the same answer, which is it seems to be principally cumulative trauma claims and they have the commonality of higher litigation rates and higher costs.

And in our case it was principally related to particular geography and more common in a number of classes. And again we have taken a number of stabs at this trying to see if there isn't some other explanation for it and every time we look at it we come up with that same commonality.

Where that may have come from is just the increase in permanent disability awards coming out of 863, and frankly the amount of the awards going up makes it more attractive to litigate and more attractive to be an applicant's attorney. And it may be nothing more than that.

But that's just our view of what we are seeing. It's going to take some time to really understand if there is some other alternative explanation. That is our best guess at this point.

And so just to clarify then, so what you have said in the press release with the 1%, that is just a lower delta versus the prior quarter versus an absolute reduction of proportion of litigated claims. So the proportion of litigated claims continued to increase but just at a lower rate, that's correct?

Yes, a lower rate than we had seen in any of the previous four quarters. And again in response to Amit's question it was moving around slightly up and down tenths of a point.

So to the extent that three months means anything, and certainly we felt it did last quarter, this quarter it appears to be relatively stable. Although again mathematically it is up but it doesn't seem to have a trend whereas the previous 12 months there was a trend.

So I was wondering about then, so if the proportion of litigated claims actually continue to rise and litigated claims tend to be more expensive, why would your loss pick have come down so much? I just was wondering about that.

So we are seeing a declining frequency and we saw the medical and indemnity loss trends in line with expectations.

And we are seeing the continuing earning in, if you will, of previously charged rates that we spoke about in 2013. So as those rates realize themselves as earned premium and they are effectively higher rate on the policies they express themselves as a lower loss ratio.

Okay, so you are saying then it is the earn in of the higher rates and the lower general frequency offsets the impact of the increased represented claims, is that -- ?

Correct.

Okay. Thank you.

Robert Paun, Sidoti & Company.

Doug, I believe you said the average policy size was up about 11%. Was this mostly due to the rates or was there any movement in the buckets of hazard groups and classes of business that might've moved that policy size higher?

Yes, it's mostly rate. There's very little movement in terms of the book from has a group or class.

It's been relatively stable. There's not a lot of business mix moving through the book.

Okay and --

Robert, let me just expand on that a little bit. As we move production more outside of California, you are going to see some impacts there as well.

So it is very difficult to define that at a very precise level. There isn't business mix in terms of hazard groups but as you start moving it around the states you can have an impact.

Right. And just a follow-up on the new operating companies in California. Are there any material expenses associated with creating the additional companies that we might see in the second quarter?

No.

Okay. Thank you, that's all I had.

There are no additional questions at this time. I would now like to turn the call back over to Doug Dirks for any closing remarks.

Thank you, everyone, for joining us today. We appreciate your questions.

And we look forward to speaking with you again with our second-quarter results. Thank you.

Ladies and gentlemen, that concludes today's conference. Thank you for your participation.

You may now disconnect. Have a great day.