ProAssurance Corp (PRA) 2006 Q2 法說會逐字稿

Good day, everyone, and welcome to today's ProAssurance second-quarter earnings release conference call. As a reminder, today's conference is being recorded. Now for opening remarks and introductions, I would like to turn the call over to you, Mr. Frank O'Neil. Please go ahead.

Thanks, everyone, for your time and interest this morning. We expect to discuss historical information and make forward-looking statements and projections on this call that will be based on our estimates in anticipation of future results and events. This is especially true for any discussion of our acquisition of PIC Wisconsin.

We will not undertake and expressly disclaim any obligation to update or alter forward-looking statements, answer cell phone calls, or any other activities, whether as a result of new information, future events or otherwise except as required by law. We expect our statements today to be reasonable, but you should review the contents of this call in conjunction with the caution regarding forward-looking statements in the news release that we issued on Tuesday, October 8, 2006. Further discussion of risk factors and uncertainties about our business are contained in our Form 10-K for the year ended December 31, 2005 and in the Form 10-Q we expect to file for the current quarter as well as a registration statement we filed on February 15, 2006 and updated on June 2, 2006.

We are webcasting this call, and we will make it available for replay as described in our news release and 8-K. Today's content is time sensitive and accurate only on August 8, 2006, the date of first broadcast. The call is the property of ProAssurance, and you may not disseminate its contents without our expressed written consent. If you're reading a transcript of this call, you should know that we have neither reviewed it nor have we approved it.

Our executive team is assembled for the call today -- our Chairman, Dr. Derrill Crowe; our President, Mr. Vic Adamo; our Chief Financial Officer, Mr. Ned Rand; Chief Accounting Officer, Mr. Jim Morello; Chief Underwriter and Co-President of the Professional Liability Group, Mr. Howard Friedman; and our Chief Claims Officer and Co-President of Professional Liability Group, Mr. Darryl Thomas. Ned Rand will start with a review of the financial information.

The detail is in our release, so let me touch on a couple of things I believe are worth noting or need additional emphasis. First, at a time when premium growth is challenging in our line of business, our acquisition of NCRIC last year continues to drive higher premiums. Gross premiums written grew by 3%, almost $3 million in the quarter, to $107 million. And year-to-date, we are showing a healthy increase of 8%. The good news is that our recently-closed transaction with PIC Wisconsin should allow us to continue showing premium growth barring unforeseen events. For example, had PIC Wisconsin been a part of our organization since January 1st, we estimate our premiums would've been somewhere in the neighborhood of $40 million to $50 million higher on a GAAP basis.

Our growth in premium warrants a little further discussion. Physician premium for the quarter is actually up $9 million. However, this is largely offset by a decline of $6 million in our hospital book. We have seen our hospital business become more and more competitive and during the quarter saw two accounts that priced at levels we found unacceptable. As a reminder, hospital business makes up only 8% of our business. However, the accounts tend to have a large premium associated with them. So a loss of a single account can stand out.

But long-time ProAssurance investors know that we focus on the bottom line. And we're pleased to note that our net income from our continuing operations professional liability saw a quarter-over-quarter increase of almost 64% and an increase of 76% comparing this year-to-date with last year. We did have $8 million of favorable net reserve development in the quarter, a small percentage of our overall reserves. Howard will address this more in a second.

We spoke last quarter about our expected 123R expense for stock compensation. These expenses were $956,000 for the quarter, which is the approximate level where we think they will settle for the remainder of the year. For the first six months of the year, 123R expenses are about $3 million. Book value grew by $0.57 per share even in a quarter with rising interest rates, reflecting our higher profitability. Higher interest rates can hinder growth in book value. But the other side of the coin is the help we get with a net investment income. For the quarter, net investment income is up 53% and for the year, 52%.

This leads me to cash flow. You'll see that we focus special attention on cash flow in this quarter's release. During the quarter, we established a new trading portfolio of fixed-income securities, and accounting rules require that trading portfolio activity be included as a component of operating cash flow. This treatment distorts the cash flow generated by our insurance operations. Excluding these investments, we generated $31 million in operating cash flow in the quarter and have generated $147 million for the first six months of the year. That said, I want to acknowledge that this quarter's operating cash flow is down a bit from the same period last year. The decrease comes principally from the timing of claim payments and associated reinsurance recoveries and an increase in estimated tax payment given our increased profitability. Frank?

Now, I'm going to ask Darryl Thomas if he can give us a little bit more insight into those claims-related issues that Ned mentioned to talk about claims environment in general. Darryl?

I believe we need to stress how random the timing of loss payments can be, especially when viewed over a short period of time, such as a single quarter. Since almost all of our claims are in the litigation process, we do not control the timing of trials in the fields and we have only limited ability to control the timing of settlements. We track payments as well as many other claim measures on a monthly and quarterly basis, and we remain confident in the direction of our claims philosophy and operation. We continue to be as successful as ever in winning cases we take to trial. We expect to take a record number of cases to trial this year. We may even exceed 600 cases. Now, bear in mind that represents an expected extra caseload with the addition of NCRIC. However, I haven't factored in the additional cases we will try with PIC Wisconsin, so 600 may even be light.

In gross numbers, this would be a record year. But in terms of lawsuits per 100 insureds, remember we've been adding risk. However, also realize our claims inventory is down somewhat. But I will say that shock verdicts are an unfortunate fact of life for our business. We've seen several verdicts above $20 million across the country in the quarter and a couple above $10 million. That's why I believe our aggressive defense of non-meritorious claims is so important. With severity seemingly being pointed higher, we benefit from winning more cases for our insureds. I guess the bottom line is that now, more than ever, effective claims management requires venue-by-venue expertise, and premiums and underwriting have to reflect what's going on in those individual venues. I believe our track record shows that we've been leaders in this area. Howard should probably weigh in here on these issues as well. Howard?

I have to agree that there is no substitute for local knowledge in our line of business. As many of our investors know, we continually review loss trends in our states and are very proactive in ensuring that our rates are at adequate levels to achieve the margins we require on our business. This year, we've seen rate filings as high as 16% in one state, a few states have had no rate movement and in a few states we've had small rate decreases. Generally speaking, most filings are in the low single digits. But remember that it takes discipline to stick to filed rates.

Across all our states, overall average rates on renewing policies are up 5% in the quarter and 4% year-to-date. Those are encouraging numbers for us at a time in which we've seen some real softening in the pricing environment. Perhaps even more encouraging is the fact that our retention rate remains relatively constant. We were at 88% in the second quarter after being at 87% in the first quarter. I think that's showing that our value proposition of excellent service and strong defense of non-meritorious claims has a definite and ongoing appeal in the medical community.

I think we are also passed the peak with the effect of startups in our business. A recent report showed that startups were down in 2005. And frankly as prices have leveled off, fewer physicians seem ready to gamble on those untested malpractice insurers.

Before I turn the call over to Vic, I want to mention the $8 million of favorable net loss reserve development in the quarter. This continues to come out of prior accident years, especially 2003 and 2004. It's still a small portion of our overall reserves, which are more than $2.3 billion. And although I know it's something many analysts focus on, I would rather highlight our ability to make our margins through capital underwriting and real attention to adequacy in the rate-setting department on the front end and excellent claims management on the back end. Favorable development is really a byproduct of doing well in the basics of our line of business. That gets us back to the focus on global knowledge, which leads us to our expansion of global knowledge and expertise through the merger of PIC Wisconsin into ProAssurance, which is Vic's main topic. Vic?

The transaction with PIC Wisconsin closed a week ago. We're very pleased to have PIC Wisconsin as a part of ProAssurance and to add the Upper Midwest to our footprint. PIC Wisconsin has a 20-year history of successful operations in that region. There is a strong loyalty to PIC Wisconsin among its policyholders of skilled staff and generally all of the ingredients that should lead us to the further successful expansion of ProAssurance. We are well underway in our integration activities, and we expect to parallel the timetable that was used at NCRIC. That is, by this time next year, PIC Wisconsin should be close to fully integrated into ProAssurance's accounting and data processing format, while continuing to serve the underwriting, claims, risk management and sales needs of its customers from what is now the Madison, Wisconsin office of ProAssurance.

The recap is that PIC Wisconsin is in many markets ProAssurance had targeted for growth, not the least of which is PIC's home state of Wisconsin, which was a natural expansion target for us. Besides having the number one market position in Wisconsin, PIC Wisconsin also had a strong and has a strong market share in Iowa and will add to our already existing market positions in Illinois and Kansas. PIC Wisconsin also gives us entry into the states of Minnesota, Nebraska and South Dakota and the opportunity to go a bit further west to Nevada. Nevada was not on our radar screen pre-transaction, but it's been a good market for PIC Wisconsin. And we will continue to watch that and see how we might leverage that position in the future. I want to turn it back to Ned for a moment for the financial highlights of the PIC Wisconsin transaction.

As you will recall, we valued PIC Wisconsin at $5000 per share or roughly $98 million. In consummating the transaction, we will issue just under 2 million shares of ProAssurance stock and a modest amount of cash to the current PIC Wisconsin shareholders in exchange for their shares. There is no lockup period or restriction on the ProAssurance shares received by the PIC holders. However, we do not expect a great deal of volatility or price pressure associated with the issuance of these shares because the exchange process is such that our shares will be issued as the PIC Wisconsin shares come in for exchange rather than all at once.

From a financial perspective, it is a bit too soon to provide much detail. PIC Wisconsin is still in the process of closing their second quarter. And as they have not historically produced GAAP financial statements, we will have to wait a bit longer to have specific details. One thing that we do know is that the transaction will be accretive to book value per share immediately. You will see that effect when we report third-quarter numbers. Frank?

As always, before we go to questions, I want to give Dr. Crowe the last word.

This continues to be a very good year for us, but we still see some mixed signals. We had really good results from operations this quarter, but the cash flow was less. Although, I think the reasons are isolated and understandable. Many competitors continue to talk about improving claims trends. Yet, between ProAssurance and our competitors, we have seen more verdicts above $20 million than I can ever remember. So rampant optimism may be misplaced.

That said, I still feel good about ProAssurance and our position in the marketplace. We're on track to meet the one goal we've given out publicly and that's a bettering of last year's combined ratio. We continue to see growth in our top line as a result of our successful M&A strategy. I know someone will ask about the M&A pipeline. I can assure you that we remain a player in that landscape. But if we had something to announce, we would have opened the show with that announcement. So, we can't tell you if we're talking to another company other than to say we are always interested in M&A growth, and so maybe that will answer some questions before we open up to (multiple speakers).

With that, I'm going to ask Michael if he will prepare the lines for questions and open it up for us.

(Operator Instructions). John Gwynn, Morgan Keegan.

Ned, the elevated expense ratio, is that largely because of the stock compensation?

Yes, there are really three components to the expense ratio being up. One of them is indeed the stock compensation. The other piece is the guaranty fund assessment that we incurred in the second quarter. The state of Florida had an assessment for companies that got in trouble from the hurricanes but for the non-property lines, and so they assessed most of the non-property writers in the state a 2% premium fund assessment.

We do have the ability over the next 12 to 18 months to look to recoup that through a premium surcharge to our policyholders in Florida and we're looking at that. However though the way the accounting rules work, you do have to book that expense. You can't book the recovery. And so, we do have that and that's about $1 million in the quarter. Then in addition to that, the one other thing if you're looking back at historic information just to recall is that we have reclassified the way we're handling our real estate and that has also increased the expense for the year by about $900,000 of it.

I thought that Bell companies were exempt in Florida. Is that not--?

No. This is covering all of the non-property lines. I think there was a large property assessment in the fall of last year that hit all the property carriers in Florida, also 2% of Florida premium. This went out -- the only significant line that I'm aware of that was not part of this assessment was workers' comp.

Again, Ned, do you have -- maybe you can't answer this -- but how much goodwill is coming on the balance sheet with PIC?

We don't have a good answer for that yet because they've not historically produced GAAP financials. That's one reason. The other is -- at 7/31, we'll obviously want to do a very thorough reserve review. So kind of pending the outcome of those two things will ultimately determine.

Right. So you just recently added 12 million in there, right?

We did not. They increased their reserves at year end.

Ned, one other quick question -- mechanically, how does that Wisconsin patients' fund work? Do you all collect the premium and forward it to the fund?

I'm probably not the best person to answer that. I'll let Vic or Howard take that one.

We are neophytes in learning. But unlike some of the other states, Wisconsin collects the money directly. So it's very good from the insurance point of view because we do not serve as a collection agency.

Are the carriers in Wisconsin viewed as a back stop to the solvency of that fund?

No. No.

Adam Klauber, CCW.

A couple of questions. You mentioned that pricing in a couple of hospitals got a little too aggressive. What region were those in?

They were in the Southeast.

In the Southeast, okay. Switching topics, if I look at your accident year loss ratio for the quarter, it looked like it came down from where it had been in the first quarter. Any reason that that jumped down for the quarter?

I think it's primarily mix of business to be honest. We made some minor adjustments in the loss ratios as we fine-tuned. Because what we do when we go through the quarter is we're looking at the achieved rate increase that we have and the portion of that that is earned in the current quarter or year. But I think it's primarily a mix of business difference there.

Do you think the -- on a go-forward basis, is the second-quarter accident year loss ratio a better barometer than the first quarter?

Yes, I would say so.

As you look at the PIC Wisconsin book of business, can you give us any sense of as you work through that, how much of that book you will retain and how much may not be up to your standards?

From what we know about it, I will just say that we think that the PIC Wisconsin book of business is probably going to be business that we retain more than some of the other companies that we've bought. When we buy a company like this, we're not surprised to see 30 or 40% of the book of business go, but this one is a little bit different. Vic, do you agree with that?

Yes. I think PIC Wisconsin has got good market position in the markets it is in. It's been a good underwriter. And we would expect to retain with the help of everybody in the Madison office the bulk of the business.

That's good news. And also, as far as these large shock awards, do you have a sense that severity is moving up or do you still think they are more of a one-off situation?

I think severity is moving up, and I think it's a one-off proposition as well. I think we're going to continue to see high verdicts in certain jurisdictions, and it's just something that's going to continue in our environment.

I think you need to be aware of the fact that we do expect sometimes the appellate courts to help us with these runaway shock verdicts. But having said that, when you get one of these verdicts even if you get it remitted or new trial, etc., it's still a settlement cost. And in spite of the fact that we try a heck of a lot of cases, we settle a lot of cases. Most insurance companies settle a lot of cases. So, when you have these shock verdicts, it has a psychological effect that increases the settlement value. It increases the next jury verdict and is just an upward trend that it's -- you know everybody is having trouble controlling.

So couldn't you give us an idea what the rate of growth of severity is right now?

I think overall, if we're looking at the severity within the range where we feel it's most credible to make the estimate and that's up to $1 million policy limit, we're thinking that it's more in the 4 to 5% range now, which is a little lower than what we had set a year or two ago. When you start to look at overall or unlimited severity when you are taking into account all policy limits and some of these larger awards, it gets a lot more difficult to make that projection. So we really haven't tried to put a number on that. I think we're saying that 4 to 5% at the $1 million limit is a good run rate for us.

Right. So there's probably difference between the net and the gross severity.

Sure.

Given that, can you remind us of the -- what are the upper limits in the aggregate on your reinsurance that you start? The attachment is at 1 million, but could you give us the other characteristics?

The reinsurance program that we have talked about in the past, which is the same, is we have coverage for $15 million excess of $1 million and that's divided into two layers.

But that's not aggregate (multiple speakers).

No. On an aggregate basis -- the reinsurance program is primarily a per claim reinsurance program.

(Operator Instructions). David Lewis, SunTrust Robinson Humphrey.

A couple of questions. Can you talk about who some of the competitors are on the hospital side putting pressure? I mean is it the big multi-line companies starting to come back for those premiums or is it just sporadic competition coming in?

I think the main competitors that we are seeing on the hospital business now are Zurich, CNA, Hudson, AIG. Those are the most frequent competitors we're running up against for the larger risks.

That's helpful. Just while we are on the hospital, any new development from the large hospital claim against NCRIC Columbia still?

No. There's no development.

No changes since last quarter?

No. Well, no changes. Briefs have been filed, and we hope to get something maybe as early as late fall. And we're just on a wait-and-see basis at this point.

There will be arguments. The case will be orally argued to the Appellate Court in Washington in September.

I know you don't normally break this out, but can you give us a sense of what the real organic gross written premiums were in the second quarter if we could strip out NCRIC?

Yes, we'll have a 10-Q hopefully filed a little later today to give a little more detail. But NCRIC -- actually, the second and fourth quarter for NCRIC are kind of low premium quarters. The bulk of their business renews in the first and third quarters. So we saw the bigger impact in the first quarter. I believe for the second quarter, NCRIC was about $10 million of premium. And we're to a point now with NCRIC because it has been so integrated into our operation, it's hard to specifically isolate exactly what that premium is. But we estimate it to be around $10 million.

Howard, you might talk about business renewal strategy for risks that were with NCRIC.

Yes, I think we may have mentioned it earlier. But what we've done and what we're still in the process of doing is to try to deleverage NCRIC a little bit to better match the premium volumes to NCRIC surplus. So NCRIC is continuing to renew and write new business in the District of Columbia. But in the other states where NCRIC had previously been operating -- Virginia, Delaware, West Virginia and Maryland -- we moved that business on renewal to one or the other of the ProAssurance companies that had also a presence in those states respectively. And new business and renewal business is being written by either the medical assurance company, Woodbrook or ProNational. So that's why it gets a little bit more difficult to track all this because you get into the issue of what is NCRIC renewal business, what's new business and so forth?

I understand. And excess capital today at the holding company or within the insurance subsidiaries, where does that stand -- somewhere in the 200 million range?

Yes. We've got at our -- at the holding company level a little north of $250 million. We talked on the last call about the fact that we were looking for regulatory approval to move up about $200 million from ProNational from the MEEMIC sale, and that has been accomplished. But I would not necessarily tend that $250 million as being all excess capital.

The rating agencies certainly recognize the fact that we've got capacity and capital sitting at the holding company, and they take that into consideration when they look at our overall ratings. So it's an ongoing discussion and analysis as to what adequate capital is. But we certainly think we do have some excess capacity. But I would not pin it on being what's necessarily sitting at the holding company.

But it's probably in excess of $200 million or in that range I would guess. Don't you think?

No. It's difficult to say.

As far as the reserve development in the second quarter, typically you do the studies if I recall in the second and fourth quarters. And if all trends remained the same or improved, could we assume -- again everything being equal and just an assumption -- that you might have similar reserve development in the third and fourth quarters?

Nothing is ever equal, and it's difficult to make any kind of assumption. Therefore, it's difficult to respond to something like that. You know we've seen now a favorable reserve development for the past several quarters. We believe that the trends that we are predicting at this point in time are reasonable. And if all else was equal, which again is very difficult to say, but if all else remained constant, we could see favorable reserve development going forward. As far as how much and in which quarters, you know we're not making that prediction right now.

I understand. The typical rule of thumb is if you are more than 10% above the midpoint of the actuarial range, you must start to release those redundancies. Is that fair to say that you are in excess of that 10% and that's why you are continuing to have the redundant reserve releases?

I don't -- I guess I disagree with the proposition to start with because the ranges that people talk about vary from company to company based on the size of the company, their position, their surplus and all. So I wouldn't -- I would start out by saying that I don't think there is a clear line in the sand at any percentage level that can be applied to all companies. We make the decision on reserve development based on what we're seeing and where we think the losses for the given years are going to come out. And when we see developments either direction, we take it. So I don't think it's based on a particular level relative to a range.

That's fair and helpful. And last question -- Howard, you talked about severity. How about frequency? Would you expect that to be down in the low single digits?

Yes. Frequency is -- we keep going back over the past several years; frequency never really was the issue. And it's played its cycle if you want to call it that. It was severity, and frequency is still behaving very nicely, down in some places, flat in others. So I think from the frequency perspective, we're very happy with what we see.

Quickly, Ned, do you have the pre-FASB 115 book value?

I do not. We can get that for you.

(Operator Instructions). John Gwynn, Morgan Keegan.

Ned, on the Florida guaranty fund assessment, was that based on the prior year's net written, net earned?

It was based on net written -- excuse me I believe direct written actually.

Direct written. That means your Florida book is down to about 50 million?

We wouldn't comment on anything specific.

Well, Frank, 2% equals 1 million.

But that's why you are an analyst.

Okay.

No, that would be good use of math.

Thank you very much, Ned.

You passed.

One other quick one. Ned, you mentioned that PIC had been part of the company for the first six months of '06 that your gross written would've been higher by 40 million to 50 million. PIC has a pretty heavy first-quarter renewal. Is that not correct?

I'm not that familiar with their quarter-to-quarter pattern.

Yes, I believe that they do have a proportionally larger first quarter than certainly the rest of the year.

Right. But I guess what I'm getting at is that 80 to 100, there is not an annual run rate there?

No, I'd caution you against using that as an annual run rate.

I just wanted to clarify that. I'll go back to my arithmetic. I'll get back to you all later.

There are no further questions at this time. Gentlemen, I will turn the call back over to you for any additional or closing remarks.

I guess one follow-up, looking at the pre-FAS 115 book value -- I guess we would caution first that this is a non-GAAP metric before I put it out -- but we calculate that to be $30.37 per share.

David, does that answer your question? I guess you are gone. Okay, with that, Michael, we will end the call and thank everyone for their attention.

Once again, thank you all for joining us today. That does conclude today's presentation. Have a great day.