Old Republic International Corp (ORI) 2014 Q2 法說會逐字稿

Good day, and welcome to the Old Republic International second-quarter 2014 earnings conference call. Today's conference is being recorded.

At this time, all participants are in a listen-only mode. Following the presentation, we will conduct a question and answer session. Instructions will be provided at that time for you to queue up for questions.

I'd like to remind everyone that this conference is being recorded. I'd now like to turn the conference over to Scott Eckstein with MWW Group. Please go ahead.

Thank you, Operator. Good afternoon, and thank you for joining us today for Old Republic's conference call to discuss second-quarter 2014 results.

This morning, we distributed a copy of the press release. If there is anyone online who did not receive a copy, you can access it at Old Republic's website, which is www.oldrepublic.com.

Please be advised that this call may involve forward-looking statements as discussed in the press release dated July 24, 2014. Risks associated with these statements can be found in the Company's latest SEC filings.

Participating in today's call we have Al Zucaro, Chairman and Chief Executive Officer; Scott Rager, President and Chief Operating Officer; Karl Mueller, Senior Vice President and Chief Financial Officer; and Rande Yeager, Chairman and Chief Executive Officer of Old Republic Title Insurance Companies.

At this time, I'd like to turn the call over to Al Zucaro for his opening remarks. Please go ahead, sir.

Okay. Thank you, Scott, and this is Al Zucaro, and on behalf of all of us here, I bid you a good afternoon.

We're going to follow the same approach we've taken in the past, and that means that we'll have several of our senior officers that Scott has just identified to participate in this discussion today. Therefore, Scott Rager will address happenings in our general insurance business. Rande Yeager will pick up the microphone for and discuss our title business. Karl Mueller will talk about the significant financial aspects of our consolidated operations. And I'll say a few words initially and then at the end of the discussion, at which point we'll, as we've indicated, open it up to questions.

So, let me begin by first addressing the RFIG runoff business, which has continued obviously to surprise both positively and negatively in this particular quarter, as a matter of fact. As we reported this morning, if you do the calculations, a little more than 80% of the approximate $110 million reduction in the latest quarter's consolidated earnings for Old Republic came from the RFIG runoff.

And this overall RFIG operation obviously ended up in deep red territory on the heels and following, I should say, four consecutive quarters of positive performance which began in the second quarter of 2013 and which was driven principally by the mortgage guarantee insurance operation, which was during those quarters and has remained in this latest quarter favorably appreciative -- appreciating to the bottom line.

Now, as we show in the release, this sudden turn into red obviously stemmed from the consumer credit indemnity, or the CCI portion as we refer to it in the business, of the runoff book of business. And as we also said in the release, there are two basic reasons for this turn of events. First, we experienced in July a final settlement of a suit for an amount that exceeded the most recent expectations we had. And secondly, we made a management judgment to make some -- to effect some further increases in reserves for ongoing litigation that also relates to the separate CCI disputes, one in particular of some consequence.

This particular larger dispute is with one of the nation's largest banks, and it has been disclosed for a number of years in our regular reports and filings with the SEC. And this dispute stems from our findings of what we consider to be systemic misrepresentations and fraud committed by the institution to secure CCI coverage from Old Republic in prior years, mostly, of course, the years which preceded the Great Recession.

Now, as in all litigation, there is never any certainty of outcome, but we believe that in this particular instance there can be some great confidence that, litigation expenses aside, that our position should be sustained.

Turning to the mortgage guarantee portion of the RFIG runoff, the news here continues to be uniformly good. First and most importantly we think, as we reported on July 1, as I recall, we have stabilized the financial condition of our flagship mortgage insurance subsidiary, and we've done that by injecting a necessary amount, specifically $125 million of cash and securities that were available within our holding company system.

Concurrently, we also had applied and then received regulatory approval to at once discontinue the deferral of a portion, namely, 40%, of all claims that had been finally settled in the past couple of years or so and then to also liquidate all the accumulated and previously deferred payment balances.

As I say, this was all accomplished during this month of July following the regulatory approval that came from the main insurance regulator for our mortgage guarantee company, which is the State of North Carolina.

So from this point forward, we expect some reasonably clear sailing as we work steadfastly to achieve an orderly and we believe very economical runoff of the mortgage guarantee book of business. As we've said on many occasions, we count our blessings in having a very dedicated, highly qualified, and resourceful group of associates in our mortgage guarantee business that are helping us to achieve all the worthwhile objectives we have.

As indicated in both the tables on pages 3 and 4 of this morning's release, the MI business posted an operating profit for the fifth consecutive quarter. Again, as indicated, the key factors leading to this positive performance are the same as we've outlined in past releases, as well as this one, and as is further evidenced among the mortgage guarantee statistics and the trends that are shown in the financial supplement, which we've posted on our website as we do each quarter.

As always, there is no guarantee that this MI runoff will continue to perform as positively as it has in the recent past, but housing trends are all favorable, as you know. They bounce up and down, but the longer-term trend does seem to be very forward-looking for anything having to do with housing for the foreseeable future, and all of this is a good omen for the mortgage guarantee runoff.

So, let's -- before -- let me just add a couple of points, before turning the call over to Scott Rager, about the future affects that the mortgage guarantee runoff has on Old Republic's overall business franchise. First of all, we are achieving a runoff by fully meeting all of our legitimate claim obligations and thus serving the direct interests of all MI policyholders, claimants, and other stakeholders.

Secondly, and just as importantly, by stabilizing the MI insurance subsidiaries from a financial point of view as we have, we are eliminating any perceptions or concerns that their operational difficulties of the past could have posed and served to expose the overall Old Republic business to certain dire happenings such as liquidity or debt acceleration issues, or even, I might say, possibly consequential risks to our reputation and good name.

We think that all of these perceptions and related concerns can now be safely put to rest and that Old Republic can move forward on with the rest of its business and remain in very good shape for the future.

So, on that note, I will turn the meeting now, as I said, to Scott Rager and my other associates who will address the other important factors of our business. So, Scott, you want to take over?

Thanks, Al. Okay, we'll now address the general insurance group results exclusive of the CCI product impact on those numbers. Net premiums earned were up nicely for the quarter and year-to-date at 9.4%, and we believe that trend will continue for the remainder of the year as we're seeing new business opportunities in many segments of our operations. And that coupled with increasing payrolls associated with the slowly recovering economy, as well as moderate rate increases, would indicate that this increase is sustainable for at least the remainder of the year.

Premium growth is really taking place across all underwriting units, but it is particularly accentuated in our risk management, motor carrier transportation, and construction operations. Growth in the latter is much more driven by increased rate levels and organic growth of existing accounts.

On the claims side of the ledger, as our release indicates, we are still experiencing increased loss costs particularly in workers' compensation and general liability. These trends are more pronounced in the middle markets and construction segments of our business and much less pronounced in the loss sensitive products.

In the latter, [insureds] have skin in the game, so to speak, through higher retention levels or other experience-sharing mechanisms. And thus, that's our strategy to move our underwriting focus away from largely Main Street, rate-sensitive writings to more loss-sensitive products and programs.

As for the construction results, we believe the implications of the recession and the slower recovery in the commercial construction arena have definitely impacted claim costs to a greater degree than in other markets in which we participate.

Pressures on opportunities for light-duty and return-to-work status continue to impact the long-term costs of claims. Loss cost [does mount] and more adequate rate levels are necessary to address this phenomenon. We have implemented such strategies and are seeing gradual progress.

All in all, workers' compensation and general liability aren't where we want them and they won't remain there. Results can vary quarter to quarter but our emphasis is on building quality books of business that deliver over time. That's our strategy and we are actively managing to that end.

The loss ratio in workers' compensation year to date of 82.9% should moderate to 2013 year-end levels as the year progresses and as increased rate levels are realized [to] the earnings stream. General liability results should ultimately perform likewise with the caveat, though, that general liability is a much more volatile line and can be more impacted by the severity of occurrences in that [interim.]

In a nutshell, as we've said before, the expected loss ratios in 2014 should track similar to year-end 2013 with workers' compensation and general liability moderating thereafter to what we have demonstrated as more historic levels. Our expectations have not changed in these regards.

The expense ratio at 23% for the quarter and 23.2% year to date is the result of increased writings and of our deep-seated culture to efficiently manage the business.

So in summary, we expect good, steady growth for the remainder of the year with operating ratios moderating toward those, as indicated, of 2013.

Those are my remarks, so now I'll turn the phone over to Rande Yeager. Rande?

Great. Thanks, Scott.

As we reported, the title company experienced a nice profit rebound in the second quarter. As we reported this morning, the earnings were positive at $26 million. Industry-wide real estate activity remained sluggish.

This year, refinances are running about 65% below last year and purchase money, resale, new building money transactions are running about 10% below 2013 levels. But in this context, our commercial business has continued to grow and our market share ticked up to 15.5% in the latest ALTA report.

At this juncture, we don't see signs of a rapidly improving real estate market. Refinances are not going to improve to 2013 levels, and sales of new and existing homes are not going to improve quickly enough to compensate for the currently smaller refinance segment of the market. We're going to see a gradually improving purchase money market, but it probably will take a two- or three-quarter look-back at our business to say that things aren't as slow as they were, at least what they seem they are.

Industry-wide, the first quarter was an aberration. Interest rates, regulatory influences, as well as the weather contributed to the falloff in the business, and I think in the second quarter results represent some of the makeup for the difficulties we encountered in the first quarter.

As you see in the release, premiums and fees were down about 18% for the quarter and 16.5% year over year. We've always concentrated on the long-term value of our business and we'll continue to do so. Our emphasis on the agency side of the industry helps us to keep our variable costs more in line with market downturns. Agency growth has certainly benefitted our rapidly increasing national market share and does not appear to be stalling out. We're confident that this strategy will continue to benefit our bottom line.

We remain highly committed to the success of our company, and its long-term growth and profitability. We are continuing to search and have been succeeding in identifying additional sources of profitable revenue. We believe they're out there and we really believe that we'll continue to enhance our performance and industry presence.

With that, I will turn it over to my associate, Karl Mueller.

Okay. As we've done with previous quarterly calls, I'll comment briefly on Old Republic's financial condition as of June 30 before we then open up this call for your questions.

This morning we reported that Old Republic ended the quarter with consolidated assets growing to nearly $17.2 billion, and that's up about 4% from year-end 2013. The cash and invested asset balance of $11.4 billion is up slightly from the first quarter as the portfolio continues to benefit from the investment of positive operating cash flows and higher market valuations on those securities.

The fair value of the bond portfolio increased slightly from 103.6% of book value at the end of March to 104.6% at June 30. The credit quality of the portfolio remains at an overall A- rating, which is unchanged from the prior year end.

As noted in this morning's release, we continue to place greater emphasis on common equity investments, which now make up approximately 13% of the total portfolio. And that's up from around 9% at year-end 2013.

Investment income increased $85.4 million in the second quarter as new investments in fixed income securities are benefitting from slightly higher market yields. In addition, investment income benefitted from the shift to higher-yielding common stocks and equity funds, which I just noted.

On a year-to-date basis, these factors have resulted in net investment income increasing to $168 million, which is up from $158 million during the same period a year ago.

Claim costs on a year-to-date basis have developed essentially even with the prior year-end consolidated loss reserve balances, and that's in contrast to a modest favorable development for the same period in 2013. This year's reserve development was most significantly impacted by the CCI claim settlement that was noted earlier in this call and in this morning's release and the continued development of prior year's workers' compensation and general liability claims.

The June 30 benefit and claim reserves balance also includes nearly $657 million of mortgage insurance deferred payment obligations, or DPOs, as we often refer to them. As discussed earlier, the North Carolina Department of Insurance recently approved the payment of these accumulated DPO balances, and we've now processed payment of these reserves and have used the short-term investment balances that had been accumulated over time in our mortgage insurance subsidiaries for this purpose.

So the impact of this payment will be to decrease reserves and the related balance sheet net reserve leverage by roughly 10%. In addition, it will reduce the size and financial significance of our flagship Republic Mortgage Insurance Company subsidiary in relationship to Old Republic's consolidated totals.

We should also point out that investment income should not be negatively impacted in future periods since the short-term investment balances used to fund the DPO payments have been earning a yield of basically next to nothing.

As of June 30, the debt to equity ratio stood at 14.3% and the debt to total capitalization ratio was right at 12.5%. Both ratios largely unchanged from the prior year end.

While we have no imminent plans to raise debt capital for general corporate purposes, these leverage ratios clearly support our ability to do so.

Shareholders' equity at the end of June was $3.95 billion, or $15.29 per share, which was an increase of $0.32 per share from the end of the first quarter of this year. Page 5 of this morning's release provides a reconciliation of the key elements effecting this change for both the quarter and the year-to-date periods.

And then finally, from a parent company liquidity perspective, as was mentioned earlier, we did complete the $125 million capital contribution to the mortgage segment during the second quarter, as we disclosed several weeks ago. And despite this contribution, we continue to maintain sufficient liquidity at the ORI parent company and our affiliated noninsurance underwriting subsidiaries to meet our foreseeable obligations.

So there you have the highlights of our current financial situation. And I'll turn the call back to Al for a few closing remarks.

Okay, Karl. So, looking ahead to the next few quarters, we think that the RFIG runoff ex any litigation surprises should proceed on a fairly even keel. And general insurance, as Scott intimated, we should experience a very gradual lessening of the upward pressure on workers' compensation and general liability claim costs in particular as the benefits of rate changes that have been instituted steadily in the past 30 months or so continue to kick into the premium income stream.

And moreover, as Rande Yeager has indicated, our title business is in good shape to also gradually provide upside potential over time to the Old Republic bottom line.

So, now having said all of this, as we promised and as was indicated, we'll now entertain the questions that any call participants may have. You can all direct your questions to me and we'll in turn direct them to each of our associates here as necessary.

So let's move on.

(Operator Instructions) Vincent DeAugustino, KBW.

Just to start off with Al or Scott, to the points that you made about expecting workers' comp and GL margins to moderate towards 2013 levels, I guess from one angle it would seem that the market really isn't going to tolerate a rapid acceleration in rate increases. And so to your point on the loss cost side, I'm just curious what it is exactly about the loss cost environment that you expect to become more favorable, or if it's just really to clarify that you would expect some of the reserve pressure on workers' comp and GL to sort of taper off.

Well, I think first to answer your question, I think we're implementing, obviously, some loss cost mitigation factors in terms of the -- on the medical side. I think we're seeing a little lesser degree of medical inflation than we've seen in the past, particularly the past five years.

The other option is I still that in the areas in which we seem to be having our issues with respect to workers' compensation, we are still able to achieve what we think are fair but adequate rate increases in those areas. Our business is spread over such a large spectrum of the industry, different industries actually, that some are, shall we say, low risk. Some are high risk classifications. And where we're having the most issues we are still capable at this point in time of getting moderate -- by moderate, I mean anywhere from mid-single-digit percentage to high-single-digit percentage increases on those books of business.

Also, with respect to -- as I indicated earlier, it depends on where the book is on the accounts, the individual accounts and how -- whether we move those again to more risk-sharing opportunities and programs versus middle market, guaranteed-cost type products. And I think as we move the book -- and we've been successful in that endeavor over the last couple of years, gradually shifting that book more toward a loss-sharing book versus a rate driven book, I think the results will be forthcoming. Does that answer your question?

It most certainly does. And then, Al, just completely understanding that your first priority is to responsibly run off the MI unit, if we go back to last quarter, I think one of the thoughts that was still kind of around was that at some point -- again, some point down the road when the time was right that there was maybe going to be an opportunity for you to part ways with RMIC. And I'm just curious if, with some of the new GSE capital rules coming out, if you would think that some of those capital requirements being a little bit more onerous would make it just a little bit more difficult to really recapitalize RMIC and turn the lights back on, if you will.

Well, I think it's all going to be dependent on what appetite there is in the marketplace to have one or two or three additional players in the business. It remains to be seen what is done with the GSEs, specifically the extent to which they are pulled back from the major activity that they had at one time. And if that happens, obviously there's going to be greater room for the private sector to step in. And if it can be shown that the results can be there, the private sector usually fills the vacuum.

As to your point about the greater capital requirements, I mean, those capital requirements are going to be uniformly greater for everyone. So whether you have an active company or a new company, it all comes down to -- listen, can you make money in this business? Can you get a decent return? And if the answer to that is yes, the money will be there. That's our feeling right now.

As to when this might be an active prospect for us, time will tell. I mean, we're just overcoming a bunch of activity, namely, the payment of the DPO, the recapitalization to stabilize the companies, et cetera. So now we're going to sit back and relax for a while before we attend to any other approach with respect to that business.

Okay. And you may or may not want to comment on this, but if we look at AIG's favorable settlement with Bank of America over their MI claims, is that something we can maybe look at as a good indication of how your own litigation with Bank of America might turn out?

I think the issues tend to be similar. And I think that's why you had not just Bank of America but other banks, Chase, Citi, you name them, all coming to the trough and settling. And I think our time is going to come and I think our feeling is that the settlement with anybody that we are having difficulty with will be fine. It will work out fine because, as I say, the issues are similar and they all deal with misrepresentations of one sort or another and sometimes systemic fraud.

And if I can sneak one last one in and then I'll let somebody else have a turn. On the title side, just with the environment from a volume standpoint being a little bit more challenged. Has the pricing environment on the agency indirect side, is that changed at all or have things either have been stable or more competitive? Just looking for some dynamics on what the environment might be like.

If you want, Al, I can certainly address that.

Yes, please.

It's stable. We haven't seen any nods to higher or lower pricing. Agency splits have remained the same. And as far as the different regulatory schemes that we have around the country, we're not seeing much difference at this particular point.

Okay. Great. That's all very helpful. Thanks, guys.

Christine Worley, JMP Securities.

Hi. I actually just wanted to dig in a little bit on the reserve development in the general liability and workers' comp lines. Would it be possible to quantify that?

Well, as Karl indicated and as we have indicated I think every quarter for many years, Christine, we always point out first of all that one quarter, or half a year in this case, does not make a whole year. That's point number one.

And point number two, we have indicated for at least the last couple of years I would say that the level of reserve redundancy that we had been experiencing steadily at Old Republic for a good decade and more had been decreasing. And that is really reflective of the pricing issues that we have been dealing with, particularly in the last four or five years before we started to, as Scott mentioned before, to rectify our pricing both as a Company as well as an industry.

So, it bears repeating that the studies we make of publicly held companies reserve developments as those are set forth in the triangles which appear in the forepart of the 10-K still show Old Republic as one of the relatively few companies that produce reasonably steady favorable developments of reserves. So what we're talking about and what I believe Karl indicated a few minutes ago is that we are still in a positive manner overall.

Again, as Karl I think mentioned, the main issues relate to the RFIG business, specifically, the CCI having gone into the red for a longstanding claim which got settled which therefore by definition ends up reflected as a negative or unfavorable development of prior-year reserves. And you see those numbers there. That's been offset by the MI business, and we've indicated what the effect is there.

And so what remains is the general insurance business and that's become much more of a touch and go. Typically, we've had 2% to 3% reserve -- favorable reserve developments in general insurance over many years. And now, as I say, it's touch and go. It's pretty much [on the button.] That's the best we can say to you or tell you about the dynamics of this reserve development.

No, that is helpful. Thank you. I'm just trying to, I guess, get to the core of sort of where the accident year is running for this year and if there were any movements in that in the quarter (multiple speakers) --

Well, as say in our footnote disclosures regularly, we do use loss [pick] technology for current years, long tail business. And as you know, what that reflects is our best assessment of what's happened to pricing and the implication that has on prior years' actual [developed plan costs].

So for the last three years in particular, we feel comfortable that the loss assumptions we're making should prove reasonable. So the lion's share of what we're experiencing, which is throwing a bit of a monkey wrench into the thing, relates to years 2010 to -- what would you say, Karl, 2004 or 2005? That's where the lion's share of any adverse development is occurring and it's occurring in these lingering cases. As you know, the easy cases are settled first and the bad ones remain in the pipeline and that's what we're trying to resolve right now. We're trying to get some of these old ones paid off and settled as quickly as we can. But whenever we do that, that's where we've been experiencing some case reserve deficiencies.

Okay. Did you experience, I guess, any of these hiccups in the first quarter? Or are those sort of better run rate numbers for our modeling for the -- for where the current accident year is running?

Karl, help me on that, but I think the -- this has been developing steadily the last two years, right?

That's right. I would say the second quarter was perhaps a little more exacerbated than the first, but the conditions that Al described were present in the first quarter as well.

Okay. Thank you. That's helpful. And then in the general -- in these lines that you say you want to keep getting rate, is there a way to sort of quantify the gap between the rate that you're getting and where loss cost is currently trending?

Well, as Scott mentioned, we're still experiencing, not across the board, some rate increases in GL, general liability, and comp. But I think the biggest benefit for us, again as Scott has mentioned already, is going to come from the fact that we are moving -- keep moving a greater portion of our business to what's referred to as loss-sensitive approaches to underwriting where the customer has got some skin in the game, as Scott put it before, and also the utilization of alternative market mechanisms such as retros and captives and what have you. That's where I think our biggest benefit is going to come from going forward rather than straightforward rate increases.

Okay. Great. Thank you for the answers.

Okay.

And it appears there are no further questions at this time. I'll turn it back to our presenters for any closing remarks.

Okay. Well, as always, we appreciate your interest and look forward to our next visit. Hopefully, we will not have some of the adverse developments that we've had to report rather unpleasantly this quarter.

So we'll look forward to visiting with you next time. You all have a good day.

And that concludes today's conference call. We appreciate your participation.