Employers Holdings Inc (EIG) 2014 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the fourth-quarter 2014 Employers Holdings, Inc., earnings conference call. (Operator Instructions)

As a reminder, this conference is being recorded for replay purposes. I would now like to turn the conference over to your host for today, Ms. Vicki Mills. Please proceed.

Thank you, Chantalay. Good morning and welcome, everyone, to the fourth-quarter and full-year 2014 earnings call for Employers. Yesterday we announced our earnings results, and today we expect to file our Form 10-K with the Securities and Exchange Commission. These materials 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 on the call are Doug Dirks, our Chief Executive Officer; Steve Festa, our Chief Operating Officer; and joining us today is our new Chief Financial Officer, Terry Eleftheriou.

Statements made during this conference call that are not based on historical facts 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 non-GAAP metrics that exclude the impact of the 1999 Loss Portfolio Transfer or LPT. These metrics are defined in our earnings press release available on our website. Now I will turn the call over to Doug.

Thank you, Vicki, and thank you all for joining us on our call today. 2014 was a solid year for Employers. We are pleased with our strong fourth-quarter and full-year results, evidenced by higher earnings, improved combined ratios, and a higher book value per common share than in 2013. These solid results demonstrate the benefits of the operating initiatives we implemented in 2014.

We centralized management of our underwriting and sales operation. We slowed policy count growth in California. We adjusted pricing in California based upon rates and territorial multipliers. We increased prices statewide in California for underperforming class codes. And we targeted attractive classes of business inside and outside of California.

We placed additional focus in the past 18 months on actions to improve our underwriting margins and to mitigate adverse loss experience in Southern California. A December 2014 report by the Workers Compensation Insurance Rating Bureau of California confirms what we have observed in our book of business over the past two years. That is: in 2012 indemnity claim frequency declined nationally but increased in California, in part as a result of higher levels of cumulative trauma injuries and late-emerging indemnity claims.

The increase in indemnity claims described by the WCIRB was particularly focused in the Los Angeles area. At the end of the fourth quarter in 2014 the Los Angeles Basin represented one-quarter of our total premium, and California was 59% of our total premium. We have successfully decreased our policy count in California while increasing average policy size compared with the prior year.

Our underwriting actions focused on Southern California have primarily impacted our accounts over $25,000, which in part drove a modest decline in fourth-quarter net written premium year over year. We reduced our California payroll exposure by 9.3% and our overall exposure by 2.1% in 2014 while continuing to renew and write new policies at higher rates.

Our net rate increased 11.2% in California and 3.9% overall year over year. In 2014 we significantly lowered our loss provision rate for the fourth quarter and the full year, consistent with comprehensive year and actuarial analyses which showed, among other things, that our positive trends in rate have outpaced increases in loss costs.

Our improved current accident year losses contributed to a combined ratio before the LPT that decreased 16 points in the quarter and 4.8 points for the full year. At 102.2% we are close to breakeven underwriting in the fourth quarter of 2014. Our focus on underwriting and pricing will continue in 2015. We increased our book value per share 8.6% since December 31 of 2013.

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

Thank you, Doug. Good morning, everyone. It's a pleasure to be with you today.

Our pricing and underwriting initiatives over the past year have led to improved underwriting results, particularly in California. Improvement in our current accident year loss provision rate drove an increase in net income before the LPT, which was $0.47 per diluted share higher than in last year's fourth quarter and $0.61 per diluted share higher in the full-year 2014 compared to 2013.

Our fourth-quarter combined ratio before the LPT improved 16 percentage points year over year, and our full-year combined ratio before the LPT improved 4.8 percentage points. We lowered our provision rate for losses by 14.3 points in the quarter and 3.4 points in the full year, as rate increases continued to outpace increases in loss costs.

The slight adverse development in the accident year loss ratio was related to assigned risk. While our indemnity claim frequency decreased year over year, our loss experience indicates a slight upward trend in medical and indemnity costs per claim in 2014, which is partially due to year-over-year increases in cumulative trauma claims, particularly in California.

While net rate continues to increase, loss trends have not changed materially in 2014. These trends are reflected in the current accident year loss estimates that I just described. Comparisons of our year-over-year GAAP loss ratios are not meaningful, because adjustments related to LPT reserves flow-through losses. Excluding impacts related to the LPT, our loss ratio declined 17 percentage points in the quarter and 3.8 points in the full year, largely due to the low provision rates for losses compared with the same period in 2013.

The sharp increase in open litigated indemnity claims that we experienced in the fourth quarter of 2013 in Southern California did not continue throughout 2014. While the rate of attorney involvement in our Southern California claims remains high, we excel in managing litigated claims. Our average paid litigated claim was 40% lower than the statewide average at year-end 2013, according to the California Workers' Compensation Institute.

Average paid claim in California at the end of 2013 was 22% below industry average as reported by CWCI. We continue to prudently manage expenses. Our underwriting expense ratio ticked up slightly in the quarter but improved slightly in the full year compared with the same period in 2013, as we contained costs and increased net earned premium.

Underwriting expense increased in the quarter and the full year, primarily due to slight increases in premium tax, professional fees, and policyholder dividends. Net investment income in the fourth quarter was flat relative to the fourth quarter of 2013, and it was $1.6 million higher in the full year. The increase in realized gains in the full year was primarily related to a rebalancing of our equity investment portfolio.

We continue to actively manage our capital, and our balance sheet remains strong. There were no increases to overall reserve this quarter for our voluntary business.

The market value of our investment portfolio was $2.4 billion at the end of the quarter, an increase of 4.4% since December 31 of 2013, with only a slight drop in yield. During the quarter purchase activity was concentrated in the municipal and structured sectors, while portfolio exposure to municipals held steady at approximately 30% due to a high level of municipal maturities.

We shortened portfolio duration slightly to 4.0 years. At the holding Company, we have $82 million in cash and securities net of restricted cash and securities. Cash in our insurance subsidiaries increased $64 million at December 31, 2014, compared to year-end 2013.

We held a high level of cash and cash equivalents in our operating subsidiaries at year-end in anticipation of implementing an amendment to our intercompany pooling agreement, which required settlement of intercompany balances.

And now I'll turn the call over to Steve Festa, our Chief Operating Officer.

Thank you, Terry, and good morning. Our results in the fourth quarter reflect the intentional actions we have been taking since June of 2014, particularly in California. As we have discussed previously, we have identified and targeted classes of business that have underperformed relative to our expectations. We have raised rates in these classes and demonstrated a willingness to walk away if the appropriate price was not accepted.

We have purposefully reduced our exposure in these underperforming classes, predominantly in Southern California. Since June of 2014, we have nonrenewed 13.3% of our premium available to renew in this market because of poor individual risk characteristics. This has been offset by growth in other parts of the state as well as outside of California. We are committed to the California market, but our commitment extends only to those individual risks in classes of business that meet our profit expectations.

We have also identified and targeted other classes of business within California with historically low ultimate loss ratios. Within these classes of business we have seen growth in new business of 29.9% in the second half of 2014 compared to the same period in 2013. As a result of these actions as well as others, we have reduced our in-force payroll in California year over year by 9.3% while increasing our net rate over the same period by 11.2%. Over the same period of time, we have reduced our in-force policies in California by 2%; and since June of 2014, the reduction has been 3.9%.

We believe the long-term benefits of these actions will be improved profitability. As we have stated previously, the trade-off in California in the near term is decreasing premium and policy count -- specifically in Southern California, offset by growth outside of California.

In states outside of California, our emphasis has been and will continue to be on profitable growth. Although relatively early in the process, we are already seeing the impact of several initiatives that have been launched to drive this growth. Since June of 2014 in our states outside of California, we have increased in-force policies by 3.3% and increased premium by 1.9%, with the fourth quarter showing acceleration of these emerging trends compared to the third quarter.

Given current conditions, we expect these trends to continue in 2015 and have already seen evidence of this in January's results. And now I will turn to call back to Vicki.

Thank you, Steve. And with that, Chantalay, we will now take questions.

(Operator Instructions) Amit Kumar, Macquarie.

Thanks and congrats on a very strong quarter. Just a few quick questions. The first question is: I know we spent a lot of time talking about the shift in the loss cost trends in Southern California and non-Southern California markets. Can you just maybe talk a bit more about the loss cost trends in non-California markets? Is it business as usual? Or is anything else going on in any state which might be giving you some concern?

I'll take that question, Amit. If you look at the trends generally around the country, we've seen favorable frequency trends, fairly benign loss trends. And if you think about what's happened in most states for 2015, there's been filed rate reductions -- and that's being allowed because of the improving loss environment.

So the one part of the country that continues to stand out is Southern California where the market sees the increase increasing frequency and some of the issues that Steve touched on around cumulative trauma -- and litigation involvement, obviously, related to that. That's not worsening, but it's unchanged, whereas the rest of the country is in a fairly benign loss environment.

That's helpful. The other question I had -- and we talked about this a bit last quarter -- it seems that we are finally turning sort of around the corner here. We talked about the ROE expectations. But your combined ratio is trending down and looking within shot of 100. What would be helpful for investors is if you could sort of broadly talk about your ROE expectations. Let's say, in the next three to five years, what sort of milestones has the management team set for themselves to achieve for the ROE?

We've historically said that in normal times, this is a business that generates ROEs in the 12% to 13% range. What those are in the near term are going to be a function of what happens particularly with the risk-free rate of return. With the Treasury at 2 or below, I think it's unrealistic to expect that type of historical returns for the industry will be achieved in the short run -- because at that point you are talking about combined ratios in the mid-80s, and that is somewhat unprecedented.

We do expect, however, that ROEs could improve, given the current trends in the loss environment. Certainly we all wait to see what might be happening in terms of risk-free rate of return.

And in then any sort of range? Just based on where you are -- I mean, internally, when you're pricing, what sort of numbers are you picking where you are saying that we can achieve these many basis points above the RF right now?

You know what, I'm not going to give you the guidance on that. As I have indicated, it's a function of the combined ratio obviously needing to be under 100 to improve the ROEs.

I want to be clear that there is some structural challenge built into the industry's portfolio, and ours as well, which is: there will be maturing portfolios that will be reinvested at rates below what they are maturing at. I think that's the headwind on the ROE. I also tend to view that somewhat optimistically -- that that provides some pricing support to get the combined ratio lower.

Final question: there has been, obviously, a lot of discussion regarding consolidation in the industry. And it doesn't relate to Workers' Comp per se, but you've seen a lot of Bermuda guys looking at specialty; specialty looking at Bermuda. A lot of franchises are being snapped up.

Do you -- where do you see yourself in those discussions? Buyer, seller, on the sidelines? More work needs to be done before you are a viable candidate to be acquired? Maybe just refresh us on how you feel about the changing marketplace?

Let me put a longer-term view on that. Our objective is to build a franchise that is valuable to its shareholders and potentially is valuable to others. And if we enter a market where we've created an asset that is particularly attractive at a premium price to a buyer, that would be an ideal situation.

That's a long-term view. I'm not suggesting that's something that we are attempting to do in the short range. We are looking to build long-term shareholder value, and what happens in terms of acquisition activity is a function of many other probably macro issues.

Got it. And I'll stop here. Good answer. And congrats on the numbers and good luck for the future.

(Operator Instructions) Mark Hughes, SunTrust.

I wonder if you could give us some sense where the strategy is going to take you in the near term -- the next quarter or two? The fourth quarter represented an acceleration in the rate increase in California, and that has an impact on gross written premium, albeit just sort of flat to down slightly.

How do you see that playing out? Are you going to continue to push aggressively on rates here, and let that still put some pressure on the top line? Or have you made about as much progress as you want to make? What should we think about that?

Mark, this is Steve. I'll answer your question. We continue to get rate in California today, and I don't expect that ability to subside over the next several months. A don't see it accelerating, back to your question about acceleration. We are getting rate today; I expect that to continue, at least in the short-term.

I don't want to make any commitment beyond the short-term at this point. We don't control all of that, obviously. We are clearly, though, seeing some softening nationwide outside of California. And I expect that trend to continue. If you look at the states that we are in, and particularly the NCCI states, we are seeing rate decreases. And our objective in those states is to increase our market share going forward with some of the initiatives we have talked about previously.

Do you think the net of that will be reasonably stable gross premiums written in the near term here?

I expect some growth, obviously, in our gross written premium. I'm not going to get into specifics in terms of how much, but the expectation we have is to grow in 2015.

Mark, I'll jump in there. There are several components to touch on. We talked about -- almost, what, 7 months ago now -- the initiatives to non-renew underperforming business in LA. We are not even through the first year of that. So we will continue to aggressively pursue the nonrenewal of that business through June of this year. And that will just be the first year through the book.

So that will be a bit of a headwind. Given our pricing discipline in Southern California -- and Steve's numbers supported this -- we clearly are willing to walk away from business that is not achieving our pricing parameters. Offsetting those two elements will be the ability to grow and diversify the book outside of California. And all of those activities will continue through 2015.

You've spoken about your claims performance in California, how it's superior to the industry as a whole. I think you've made the point in the past that you have not yet given that full credibility in setting your loss numbers and your reserves.

Where does that stand today? Because that's an attractive point for the Company, but does that imply that there is some improvement in losses that's sort of sitting there, waiting for the passage of time; and in your day, they are going to get more credibility, and so therefore it will have a favorable of impact on losses? Is there some quantity that's built in already -- again, assuming the time passes and you get more credibility -- is there a specific number or range of numbers that are relevant here?

Maybe I'll go back to a comment I likely made a year ago, which is: when we see something that concerns us -- the spike in litigation and cumulative trauma last year -- we are going to be quick to take it up and much slower to bring it back down. And certainly, that's the experience we are having, which is the litigation rate stabilized. The loss trends - although they are slightly unfavorable, we are not seeing the type of spike we saw a year ago.

So you would expect that over time, to the extent that the current environment is better than the prior, that favorable results emerge. But they do emerge over time. If in fact we are correct, that means there is the potential for those to be building up in the book. And I'm not telling you that's what's happening, but that's what the potential is.

Right. If we follow the logic of what you are saying, there should be improvement coming, other things staying the same. So if in California your rates are low double digits -- I think you had suggested there's a slight upward trend in severity, but it sounds like you still have a pretty wide gap there. The California book -- if we think about how that should progress, the potential is for that to improve pretty meaningfully, is that not right?

When we initiated the activities in the middle of 2014 -- and, again, it was very specific as to what our plans were, even down to the account level in Southern California, our expectation was that that would drive a much better result. And as I indicated just a few moments ago, we are now not quite eight months through that process. So we expect to continue to get lift from those underwriting activities.

Right. Okay. How about your operating expenses -- underwriting and other operating expenses? They've declined sequentially in the last few quarters from Q1 down to Q4. I don't know whether there's some seasonality in that, but this sort of $31 million or so in expenses -- depending on the level of business, of course, should we continue to see progress on that front from a ratio standpoint?

This is Terry. I think the comments I would make on that is we would expect the recent trend in the ratio to continue. I think the level that has been established -- we would expect that to continue into 2015.

The movement down has been in recent years largely attributable to an uplift in earned premium, but I think we've got to the point now where underwriting and operating expense ratio is broadly in line with where we expect it to be. We continue to manage expenses very carefully. We are very focused on the controllable elements of our expense structure. So I think that's where we are.

Okay. And then final question: uses of capital -- kind of where do you stand in terms of your view of underwriting leverage, where you are comfortable. Is there capital that would be available, potentially, for share buybacks with the stock at attractive levels?

We expect that with improving results, there is an internal generation of capital. As you know from the last few years, we have been rebuilding the capital base to support future growth.

Our expectation is, given what's happening with rate levels around the country, that that's manageable for us. So, yes, we could be in a situation where we could be building capital. I wouldn't say that means specifically we would utilize it in terms of share repurchases. It opens up a variety of other options for us in terms of capital management. Obviously, share repurchases would be one of those.

Okay. Thank you.

Ron Bobman, Capital Returns.

I just had a couple of questions. One, Doug, could you talk about what's going on with the California State Fund? And really, in particular, I guess if there's been sort of a change in their reserving practices? Could you sort of expand on that -- if my understanding is right, and if it's having any impact yet as far as their pricing and market behavior?

I'll turn over part of that question to Steve, so he can talk a little bit about what we are seeing in terms of pricing behavior in California. I'm sure you are aware that they've announced that they are doing an increase in rates, particularly in Southern California. So some of the things that we've observed in the last several years, they seem to be reacting to.

So I suspect that that helps create some type of a pricing floor, since they are the residual market mechanism in California. But maybe -- specifically as to their reserving activities I don't have any insight there. I'll let Steve talk a little bit about what we are seeing in the marketplace.

Right. Thanks, Doug. Ron, specifically, what we hear with some consistency from the agents that we do business with in California -- throughout the entire state -- is that the State Fund has become more competitive over the past year or so. And we see that in some of the results, and we are hearing that loud and clear from some of the agents.

As Doug alluded to, they made an announcement -- the State Fund made an announcement that effective April 1 of this year, that they are going to be raising rates; and in some cases those rates will be pretty substantial for certain insureds. So time will tell what -- the impact that will have on the market itself.

Clearly, the State Fund is a competitor that we bump up against. And as of the end of 2013, at least, they were number one in terms of California market share. So we are taking a wait-and-see attitude with respect to what impact this has on the market -- their price changes effective April 1.

So if I hear you correctly, it sounds like it's conceivable we could be at an inflection point as far as their market behavior -- as you said, time will tell. Am I hearing you right?

Yes, I would say that it feels that way to us as well, which is they've maybe been hopefully the last to recognize what's happened. And then again, as a residual market mechanism, they have the ability to lift the floor for pricing.

What remains to be seen is whether or not that creates any opportunity for us. To the extent that they are being more aggressive in their pricing in Southern California, that's a market that we've been aggressive in now for a while; the business is falling off, as we intended it to.

If it supports their pricing, it doesn't necessarily create an opportunity for us to step back into LA. So I don't think you should interpret it that way at all. But we'll monitor what it does to pricing overall.

Okay. I had two more questions, one related to this topic. Do their rates -- the State Fund's rates have to get approved prior to implementation?

California is a file-and-use state, so they have to file their rates with the Commissioner.

Okay. And then, unrelated -- and I'm not familiar with who made the comment, but it was not you, Doug -- but someone referenced the expectation that, at least for the short term, rates in California should continue increasing. I was wondering how that person defined short-term?

That was Steve. Steve said that. And now Steve wants your question, Ron. (laughter)

Okay. Steve.

In the short-term -- I don't want to extend the definition of short-term any longer than the current and the next quarter. I mean, the market is so dynamic, I wouldn't be comfortable at all putting anything beyond that.

Okay. So up to a six-month horizon.

Yes.

Okay. Thanks a lot, gentlemen, and best of luck. Hope it continues.

At this time there are no additional questions in the audio queue, and I would like to turn to call back over to Mr. Doug Dirks for closing remarks. Please proceed, sir.

Thank you very much. Thank you, everyone, for joining us today. Again, it was a very strong quarter, a very strong year. We look forward to talking to you again with our first-quarter 2015 results. Thank you all and have a very good day.

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