Old Republic International Corp (ORI) 2013 Q4 法說會逐字稿

Good day and welcome to the Old Republic International Fourth-Quarter 2013 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 would like to remind everyone that this conference is being recorded and I would now like to turn our 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 Fourth-Quarter and Full-Year 2013 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 January 23, 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.

Thank you, Scott, and good afternoon to everyone, on behalf of all of us at Old Republic.

In this conversation, we're going to follow the same approach as we have in recent quarters. There are, again, four of us who will participate in discussing the major factors that bear on the results for the final quarter and the full year 2013. Scott Rager will cover our General Insurance segment, Randy Yeager, our Title business, Karl Mueller will comment on significant financial matters, and I'll make a few remarks at the beginning and at the end of the call.

Let me start by addressing the overall picture and the run-off business in particular that had such a large impact on both the final quarter and full year results of 2013. The results for last year's final quarter, by the way, represented the third consecutive quarterly period of profitability since the onset of the Great Recession in 2007, mid-2007 for us. The big drivers, of course, of this renewed profitability are represented by the very dramatic turnaround in the mortgage guarantee run-off book of business and the very positive operating momentum that we have had for awhile now in our title business.

Since Rande Yeager will cover the Title segment in a few minutes and, of course, as I said, Scott will cover the General Insurance business before that, I'll just say a few words relative to the run-off book before turning the call over to my other associates.

With respect to the mortgage insurance line in particular, which is, as you know, as you can see in the news release, it's by far the largest element in the run-off book, we've been experiencing a very steady decline in loss provisions applicable to previously reported defaults since the last quarter of (technical difficulty). We're getting a buzz on our end here. I hope, Operator, that we're still connected.

Yes, you are, please go ahead.

Okay. I was talking about the decline in the loss provisions that apply to the previously reported defaults at year end 2012. In this regard, the much lower claim provisions are largely caused by the rate at which previously reported defaults are being cured or are otherwise being closed out without payment and thus eliminated from the inventory of open claims. As most everyone knows, publicly available data relating to housing and mortgage lending and employment trends, are all moving in a generally favorable direction and these are the major big picture factors that are driving the positive trends in the MI claim costs.

Nonetheless, we've continued to maintain a relatively high average claim reserve per loan in default and we're doing this in the face of a declining risk in force inventory, which, by the way, is down by almost 20% year over year, and a traditional primary default rate that's down by something like 11% year over year. You can see these statistics in the statistical exhibit that we've posted this morning on our website. But we mention these particular factors because they are most explanatory of the lower claim costs we've experienced in 2013.

In addition to the substantial reduction in these MI claim costs, we've continued to operate the run-off in MI at a very low expense ratio and we've done this in the context of a steadily declining earned premium base, and all that implies for the management of a business with a long term profitability as a fundamental objective. As we've said in the past, this achievement would not have been possible and we are most grateful for having retained a very good and fine group of professionals who are fully committed to manage the RMIC business for both its current run-off state, as well as for its planned, and, we believe, necessary, reactivation in a financially sound and very competitive and cost efficient manner.

With respect to the CCI run-off, which you see in one of the tables in the release, the operating statistics reflect a similarly substantial reduction of year-over-year claim costs. Together, there as well, with a very low expense ratio. The CCI coverage is obviously a much smaller portion of the RFIG run-off, but it is affected by the same positive housing and general economic factors that apply to the MI line. While the CCI claim costs as such are in a downtrend, the line, unfortunately, remains burdened by a relatively high level of litigation costs, which we currently believe will persist for a while longer. But leaving aside these ongoing litigation issues, we think that both MI and CCI claim costs should continue in a longer term downtrend and that the MI run-off line, in particular, should trend toward profitability for the foreseeable future.

Speaking of MI, in this morning's news release, we, once again, mentioned our objective of essentially selling that business by having it access the capital markets to, in effect, recapitalize itself. As we speak, the senior RMIC executives, together with the investment banking firm we've retained to do that, are making good progress toward that objective so that within the next several weeks, we should be in a position to report on this capital raise and on RMICC's ability to exit the ORI consolidation. By the way, as we've also indicated in the past, in a standalone RMICC Company, Old Republic would retain a small minority interest and, at some future date, our intent has been that would most likely sell or otherwise dispose of this interest in one fashion or another.

In all these regards, I should also reiterate a basic objective we've had since placing the MI business into run-off under the supervision of its main insurance regulator in the person and the institution of the North Carolina Department of Insurance. That objective, of course, has been to remain focused on the fundamental obligation of an insurance institution to first and foremost address the legitimate interests of its policyholders, of its main stakeholders. As an EMI business, those stakeholders, the more important ones, are obviously the regulator charged with overseeing insurance companies, as well as the lenders who have bought the MI subsidiary's policies, and expect to receive the benefits of those policies.

For some time, we have reported, in our footnotes and what have you, that the various modeling techniques we use to assess the ultimate financial outcome of the MI run-off, that those models point to a realistic, we think, possibility that all or substantially all of the MI claim obligations could be met by the end of a 10-year period that, in our case, would extend through 2022. Again, as is the case with all models, however, there are always uncertainties when one peers into such an extended period of time.

So our conclusion has been and it remains that we can achieve and provide greater certainty of outcome for MI policyholder interests by effectively shortening the run-off period and in so doing, accelerate the payment of the deferred claim payment obligations, or DPO, as we refer to them shorthand, that we've accumulated during the run-off period to date. As of year-end 2013, these DPO balances amount to approximately $550 million and they are held in the reserves of our MI insurance subsidiaries. And, with regulatory approval, we do have the funds in hand to pay off these obligations.

We come full circle to the idea of recapitalizing the MI subsidiaries and, in so doing, we can at once eliminate the supervisory burden carried by the insurance regulatory authority and also enable a new shareholder group to reactivate the business for the greater good of an important part of the insurance industry. That's how we come to the conclusion and the need of recapitalizing the MI business and, in so doing, exiting it insofar as Old Republic is concerned.

Having said all this, I will now ask you, Scott Rager, to provide some comments relative to our General Insurance business.

Good enough. Okay, thanks, Al.

For your information, I will be referencing numbers, excluding the effects of the CCI run-off in my following comments, so everybody can follow along if they wish. The General Insurance group's numbers are definitely moving in the right direction, as to both growth and composite underwriting ratios, with net premiums earned up 9.9% for the quarter and 8.1% for the year. Composite ratio was 96.7% for the quarter and 97.3% for the year and, being at that point, it was down about a 1.5 points from year end 2012.

The claim ratio ticked up a bit year over year, but was a little more stable in the fourth quarter and we believe the positive premium rate developments we've experienced over the last 24 months or so will continue into 2014. This should result in a return to historically lower claim ratios in the workers' compensation and general liability lines; in particular, on a going forward basis.

Still, the workers' compensation claim ratio continues to run up 2 points higher than we'd like, but we think we'll see a gradual improvement in the next several quarters as to that matter. We continue to experience moderate premium rate increases in the various books of our several operations and in the aggregate. And also, as a group, we've continued to manage our operations efficiently, as demonstrated by the rather stable expense ratio, even after considering the near 2% added variance we experienced in 2012 relative to that year's treatment of deferred acquisition costs.

In our view, the composite ratio of 97.3% is a good benchmark of how the business performed in 2013. We're still seeing opportunities for new business in almost all parts of the general insurance group of companies. Customer retention levels remain within or even exceed our expectations, and the economy, in general, is providing additional support for some organic growth within the book, as well. Our current expectation is that the growth patterns we've seen in 2012 and 2013 should likely continue into 2014.

In summary, we're about where we thought we'd be at this point, considering the general, economic and competitive influence in our various markets. And we firmly believe we're well positioned to meet the future underwriting performance and growth expectations in the five-year plan we posted on our website earlier in 2013.

Having highlighted the General Insurance operation, I'll now turn the phone over to Rande Yeager for his comments on our title business. Rande?

Great. Thanks, Scott. I appreciate it.

Title Group capped off the year with another good quarter. Each of the four quarters beat the previous year's results; something that we're very proud of here. In the most recent quarter, we reported pre-tax income of $25.7 million, compared to $20.2 million in 2012's fourth quarter. Pre-tax income for the year was $124.3 million compared to $73.8 million last year; great improvement. For the quarter, premium and fee revenues were up 2.5% over 2012 and, for the year, premiums were up 19%.

We're continuing to experience favorable claims development and, for the quarter, the claims ratio dropped from 7 in 2012 to 6.1 in 2013. The expense ratio, as well, dropped slightly to 89.7%. Our agency revenue made up a bigger percentage of our total premium, as sort of a factor in that. Interest rates ticked up over the past few months and that has slowed refinance activity a little bit. Purchase money transactions are helping mitigate the reduction in that refinance activity, so that's why our results are even better than they were last year.

Moreover, we continue to gain market share and, in the third quarter, which is the most recent information that we have, it indicates that we had 15.2% of the national market. I think, personally, there will be more challenges in 2014, but we're very optimistic about the title business' progress and opportunities. There's a lot of excitement amongst our people with regard to the near- and long-term prospects of our operations.

With that, I will turn the discussion over to Karl Mueller.

Okay, thanks, Rande.

This morning, we reported total assets of $16.5 billion, as of the end of December, and that's largely unchanged from both the September 30 balance and up just slightly from year end 2012. The makeup of the balance sheet is also substantially unchanged from earlier quarters in 2013, as well as year end 2012. The year-end 2013 cash and invested asset balance of $11.1 billion reflects modest growth resulting from the investment of positive operating cash flows. This growth was offset, to some degree, by reductions in the fair value of the bond portfolio in particular. This was due to the modest rise in interest rates that the US economy began to experience in 2013.

Also, as noted in the earnings release this morning, investment income has continued in a downward trend, as new investments are being made at market yields that are generally lower than those applicable to bonds that have either been sold or matured during the year.

Looking into the liability side of the balance sheet, the year-end 2012 consolidated loss reserves have developed favorably throughout 2013. Taking it by the pieces, the General Insurance reserves have trended slightly favorable. Title Insurance reserves, as Rande noted, have developed pretty much in line with original estimates. The RFIG run-off segment reserves developed most favorably in 2013 by comparison to deficiencies that were reported during 2012 and for several years prior to that. This morning's release does, in fact, quantify the effect of this favorable development on the 2013 mortgage insurance claim ratios.

We ended 2013 with a debt to equity ratio of 15.1%, and a debt to total capitalization ratio of 13.1%. These ratios have trended downward consistently during 2013 from the comparable ratios at year end 2012 of 15.9% and 13.7%, respectively.

Al commented earlier on the status of the recapitalization plan for the mortgage insurance companies. Upon the successful completion of the plan, Old Republic will no longer have a controlling interest in the mortgage operations, and will thus deconsolidate the mortgage insurance subsidiaries. At that point in time, the potential risk of an accelerated maturity of our convertible debt securities, attributable to our MI subsidiary, Republic Mortgage Insurance Company, will have been mitigated.

Shareholders' equity as of year end was just shy of $3.8 billion or $14.64 per share, which is an increase of $0.61 per share from the prior year end. Operating earnings per share, in excess of shareholder dividend, added $0.19 and $0.65 to book value for the quarter and for all of 2013, respectively. All other changes in book value for the year are included in the table on page 7 of this morning's release. From a parent company liquidity perspective, we ended the year with approximately $216 million of cash and highly liquid securities that are readily available to the ORI Holding Company.

This balance is, in fact, down from September, as we made additional investments in our general insurance group of companies during the fourth quarter to support their continued growth. We do remain confident that the sources of cash to the holding company are sufficient to meet our foreseeable operating needs.

There you have the financial highlights. And at saying that, I will now turn it back to Al Zucaro for closing remarks before we go to questions and answers.

Okay. Again, there you have it, insofar as our comments on highlights of what's happened in this latest quarter and for the whole year. The bottom line pressures and the potential threats to Company, to the parent Company liquidity, as Karl just mentioned, that were of some concern in recent years, we believe are now clearly behind us. Now we are, I must say, happily looking forward to growing Old Republic's business on a very solid ground in its core areas that would remain after the MI sale, so to speak. And, of course, those two core areas are the General Insurance business and its multiplicity of subsidiaries engaged in various niche markets, as well as our fast growing and leading Title Insurance business under Rande's leadership.

On this note, I suspect we will now proceed with the question and answer period that we've provided for in this discussion. Operator, if you can turn it on to whoever has questions, that would be great.

(Operator Instructions) Stephen Mead, Anchor Capital Advisors.

Can you talk a little bit more in terms of the insurance business and provide a little bit of color as it relates to the different lines of business and talk about it from the terms of volume and price?

You're talking about the General Insurance business in particular, right?

Yes.

Steve, you've seen the statistical exhibit, I take it, that we posted on the web this morning? As you look at that, you will see that we had some pressure from a loss cost standpoint in the workers' comp area and that's a continuation of pressures we've experienced since 2011, in effect. Those continued to about a similar extent in 2013 as they did in 2012. As I think Scott intimated before, we think that those should start to abate as 2014 moves along and as we get further help from the rate increases that are flowing through the system with respect to comp, as well as the general liability line in particular.

I think Scott also indicated that we think we've got very good growth opportunities in General Insurance, that the competition seems to be relatively reasonable and stable so we don't have any, to our way of thinking, particularly in the niche areas in which we play, we don't seem to have any crazies out there that are undermining the fundamental need for rate support that's necessary in a very volatile part of the business.

Things look good. I can't think of a single part of our business or a single industry that we serve that does not have good opportunities for growth and growth at a profit. If you look at the statistics, as I say in the exhibit, as well as in the brief table that's shown in the news release this morning, you will see that when you eliminate the CCI product from the General Insurance business, that the business is beginning to clock in with a 96% moving towards a 95% composite ratio.

We're going to get some help, I think, ultimately from the investment side of the business as rates start to increase and we've got a very liquid investment portfolio which can be easily repositioned to take advantage of rate improvements that may come down the pike. Things look good in the General Insurance business going forward.

Okay, thanks.

(Operator Instructions)

Christine Worley, JMP Securities.

I had a couple of numbers questions. For starters, on the general liability line, it looks like your loss ratio ticked up a bit in the quarter. I was just wondering what was driving that.

Of the two lines that have been challenging to us, Christine, comp is the biggest, of course, but the GL line, because it doesn't have the kind of volume and the number of accounts that we have in comp, tends to be very, very volatile. It is also the line that's got some remaining A&E types of claims in there and sometimes those claims can't be called correctly from a reserving standpoint. When we settle them, or pieces of them, sometimes we do get hit.

I would say the combination of the relatively small number of accounts, relatively small number of claim counts is what makes the line particularly volatile and that's why you're seeing what you see. I wouldn't be surprised if this year you experience a complete turnaround and we'll be at a loss to explain why all of a sudden it's gotten so much better.

Okay, so was there specifically an A&E sort of claim in the quarter then or you're just speaking a little bit more globally?

Scott?

It was more a combination of several claims throughout the system that just turned out, became a severity issue as to individual claims for the most part.

Okay. On the other side of the coin then, financial indemnity, on that line in the quarter, you had a negative loss ratio, so I was wondering what was driving that.

That came mostly or substantially, correct me if I'm wrong, Scott, from the surety operation where when we get a claim in surety, particularly if it applies to contractor business, which is one of the areas that we play in, that we do not necessarily recognize the salvage opportunities that may be there until we've got them well in hand.

I believe, again, correct me if I'm wrong, Scott, that in 4Q, we did recognize some of these recoveries that had not previously been booked, as I say, until we had greater confidence that they would be there. That's the main reason you see the negative. It's a take down of reserves by virtue of recoveries of salvage.

Okay, great. Thank you very much.

Thomas Kahn, Kahn Brothers.

I'm sitting here with two perplexed ORI shareholders, Bill Knox and Andrew Kahn, and we're trying to figure out how the disposition of the business that you're going to dispose of in the next few weeks benefits shareholders more than just keeping it. In other words, they're saying why not keep it and it'll create more shareholder value as it runs itself off as opposed to disposing of it, as you described in your comments. I was unable to help them with an intelligent answer, so I thought we'd lateral the ball back to you.

Okay. I think we tried to explain what is occurring and what has been occurring with that business in these terms. That business, as you know, the business operates by virtue of regulatory rules, and from a regulatory standpoint, the only reason why the Company is in existence is because of special regulatory considerations having to do with the treatment of the so-called DPO, deferred payment obligation claim reserves. Were it not for that treatment, the Company would be insolvent.

What has occurred by putting the Company in run-off has been that we have bought it time, together with the insurance regulators, we have bought time to, in fact, generate profits to offset the deficit that exists in its capital account. But there's never any assurance that a regulator would, in fact, give us the length of time, and I believe I mentioned this 10-year period extending to 2022, that would be extended for us, so we don't know that.

More importantly, however, again, as I tried to say, we have to be focused on the needs of policyholders. In our case, the policyholders for the mortgage guarantee business are basically the major lenders, the major banks that, in fact, made real estate loans to individuals or purchase loans, or what have you, and indirectly, Fannie Mae and Freddie Mac, which as you know, are the major purchasers and securitizers of mortgages in this country.

That's what I tried to say in my remarks and that is that we have to be focused on the basic obligations of an insurance institution to its policyholders as opposed to the shareholders.

Let's take two scenarios: one scenario, Al, is you effectuate the plan that you're talking about and that's plan 1. Plan 2 is just let the situation stay as it is and continue to improve. How do the policyholders and the stakeholders compare with those two scenarios?

Because the policyholders or beneficiaries of the policies heretofore, since we put the Company in run-off operating mode have taken a hit on their income statement, and balance sheet therefore, by virtue of not getting paid the so-called deferred payment obligation.

As you may know from what you've heard in the past or what you read in our footnotes, the run-off plan with the insurance department approval was put in place to allow the MI companies to pay 60% of all claims settled and retain the 40%. Those policyholders cannot recognize that 40% until they get it.

But are we saying in scenario one where we do nothing, they continue to get paid only a portion, but in scenario two, where two weeks from now you sell the Company, are they going to be in a position to get 100% of their claims paid?

Correct.

In other words, if the transaction or whatever you're contemplating takes place, these policyholders should say, this is great, because now we're going to get all of our claims paid to us because there's new capital in the Company and the Company is in a position to pay what they were deferring in the past?

Correct.

The policyholders are much better off doing the transaction?

Correct.

Now what about the shareholders?

The shareholders are in a no win, no loss position. It doesn't mean anything to the shareholders.

In other words, if the shareholders retain this business for 10 years and it works its way down versus doing the transaction that you're contemplating the next few weeks, it's indifferent in terms of shareholder value?

Yes. Because as I tried to say, Tom, before, in my comments, the profits that would inure so to speak to the shareholders would have to be plowed back into the Company in order to make it right, because the Company, without that DPO accounting treatment, is not solvent.

Okay, so what I can tell these two neophytes who are sitting here with me, that you folks have done a careful analysis of this, cognizant of your long time and friendly shareholders, and that this in no way disadvantages -- we're not giving away something that they may think we're giving away.

No, we're not giving anything away. We are focused on what we should be focused on primarily as an insurance organization and that is to focus on policyholder rights, first and foremost.

That I appreciate, but as money managers, these two gentlemen here are focused on--

I understand.

Their focus is somewhat different. They're tied into each other, you know?

I know, I know. But the point is that whether you invest in a bank or in an insurance company, both of which are institutions vested with the public interest, as a shareholder, you have to recognize that your interests are secondary to those of the depositors or the policyholders, as the case may be.

Okay. This has been very helpful and I'm sure we'll come back to you offline, because they still have a perplexed look on their faces. Thank you, Al.

Bill Laemmel, Divine Capital Markets.

Thank you, guys, for finally getting the stockholders' equity going. On the upside.

We're getting there, Bill.

It was a long-term downtrend and it looks like it's in the process of reversing.

We believe so.

Rande, you had incredible opportunities to pick up agencies in the title business. My goodness, I noticed that one opened up down the street here in New York. I just wondered, are those opportunities still like they were or do you think they'll diminish somewhat?

No, they still exist and there's a smaller pool of underwriters or companies with capital to make deals with those companies. As the market kind of shrinks for opportunities for agents who are looking for exit strategies, we're getting more and more contacts relative to agents that would like to make deals with us, so I honestly, Bill, see them picking up.

Okay and thank you very much and good luck with signing up the troops there.

It appears there are no further questions. At this time, I'd like to turn the call back to Management for any additional or closing remarks.

We've pretty much gone through our list here of points we wanted to make. We appreciate the few questions that were raised, very edifying. As always we appreciate everybody's interest in our Company and the long-term support that we have been truly blessed with by our shareholders. On that note, we'll bid you a good afternoon and look forward to our next visit sometime in April when we'll be discussing 1Q 2014 results. You all have a good afternoon.

Ladies and gentlemen, that does conclude today's conference and we thank you for your participation.