ProAssurance Corp (PRA) 2008 Q4 法說會逐字稿

Good day, everyone. Welcome to the ProAssurance 2008 year-end Conference Call. As a reminder, this call is being recorded. Now I'd like to turn the conference over to Mr. Frank O'Neil. Please go ahead.

Thank you, Jennifer, and thanks, everyone, for joining us. The news release we issued yesterday afternoon and our SEC filings including this mornings 10-K filing, include disclosures with respect to forward-looking statements. In that regard, please understand that many of the statements we make today will deal with projections, estimates, expectations, and are thus explicitly identified as forward-looking statements subject to various risks.

Our actual results could differ materially from current projections or expectations. Our SEC filings have a full listing of risks you should understand about ProAssurance. We will not undertake and we expressly disclaim any obligation to update or alter forward-looking statements whether as a result of new information or future events except as required by law or regulation. The content of this call is accurate only on Wednesday, February 25, 2009, the date of first broadcast. If you happen to be reading a transcript of this call, please note that we did not authorize it nor have we reviewed it for accuracy, thus it may contain errors that could alter the intent or meaning of our statements. On the call today is our Chairman and CEO, Stan Starnes, our President, Vic Adamo, Chief Financial Officer Ned Rand, Chief Underwriting Officer Howard Friedman, and our Chief Claims Officer Darryl Thomas will all have a part today but Stan will open our remarks.

Thanks, Frank. Welcome, everyone, and thanks for your interest. I wanted to open the call because I want to highlight our very strong results in a very difficult market. By many measurements, 2008 was the strongest year we've ever had. In a year where losses reduced the stockholders equity of many companies by double digit amounts, we grew stockholders equity by 13% and increased book value by 10%. In a year where companies investment portfolio suffered significant losses, our prudent investment management limited the damage to our investments. The number of cases against our insured declined as loss trends remain moderate and those moderate loss trends were a factor in modest premium declines during the year. We maintained our historic level of reserving because nothing, not even the current malpractice climate, lasts forever and we want to be ready.

Importantly, we introduced Treated Fairly in the fourth quarter as the standard by which everything we do will be guided, and I am confident that the applications of the principals embodied by Treated Fairly will result in a continued strengthening of our performance as an organization. I am emphasizing Treated Fairly because I want everyone our organization touches and everyone within our organization to understand how committed we are to the notion that everyone we encounter will be treated with fairness and respect. Treated Fairly is becoming a way of life at ProAssurance and is gaining traction with our insureds and with our agents. Physicians tell us they are frustrated with being treated as pawns in today's medical/legal system and really welcome our committment to giving them an explicit voice in the decisions that have such a direct effect on their future.

In 2008, we applied the same sound insurance management that has characterized our operations since our founding. Those principles are the heart of our operations today and set the foundation for success in the years to come. I've said before and I say again, as excited as I am about our business today, I'm even more excited about the future, given our operational discipline and the M&A success we had in 2008. Frank?

Thank you, Stan. Ned, will you walk us through the financial results?

Happy to, Frank, thanks. Stan highlighted our operational success and I'll start there before recapping our investment results. Because the operational trends for the fourth quarter of 2008 largely mirror those for the year, my comments will focus on the quarter in comparison to the same period last year. I'll touch on a few year-to-date comparisons but for the most part I'll refer you to this mornings 10-K filing for the majority of our yearly numbers.

As with last quarter, we are reporting our results on an operating income and net income basis. We believe operating income results, which exclude the effects of realized gains and losses and the gain from the retirement of our debt, provide a clearer picture of what our core operational strategy accomplishes. On an operating basis, our bottom line was up 47% and operating earnings per diluted share of $2.36 was up 53% over last year, a direct result of our operational success and a challenging insurance market and difficult financial environment. The top line was down 11% in the quarter, due to the expected decline in premiums. The insurance market continues to be challenging which Howard will address next.

Our net loss ratio was a negative 1% in the quarter. Let me briefly explain why. We recognized net favorable reserve development of $104 million in the quarter. Howard will go into more detail but in general, this development simply reflects our improving loss experience and the effect that has on our expectations for future payouts. As in previous quarters this year, our variable expenses, such as commissions and premium taxes, decreased in line with the premium decline, while our fixed costs remain relatively flat. Decline in premium resulted in an increase in the expense ratio up 1.4 points over last years fourth quarter. The combined ratio and operating ratio both benefit from the net favorable reserve development and we believe both reflect the strength of our overall operations.

A few other successes I want to highlight. First, we grew book value per share 10% in 2008 and stockholders equity grew 13% in the year. In spite of remaining under leverage from an operational perspective, we earned a return on equity of 13% based on net income which is in line with our long term goals. We're proud of these accomplishments, especially in a difficult year. We feel our results demonstrate our committment to building shareholder value and financial stability, insuring we are a long term source of insurance for our customers. The financial markets did affect our investment portfolio in the quarter, but our net realized investment losses were lower than in the prior quarter.

Here, I'll mention the losses in the year and the quarter. In the fourth quarter, investment losses were $10 million and for the year, $51 million. While a $51 million loss is certainly not desirable, these realized losses represent less than 2% of our portfolio and we view it as manageable given the size and quality of our portfolio. Included in our $10 million of realized losses in the quarter were $10.9 million in other than temporary impairments, the largest being a $2.9 million impairment as a non-agency mortgage backed security and a $1.8 million impairment for our distressed debt portfolio, for the year, other than temporary impairments, were $47 million.

We also had a loss of $3.5 million on our trading securities in the quarter and all of these losses were offset by $4.5 million in gains from our available for-sale securities. Let me remind you, that the majority of our equity portfolio is classified as trading, with fluctuations in fair value recognized as gains in losses from period to period. We continue to be conservative in the deployment of cash and in new investments, accumulating more cash and short-term investments than we have historically held. We are being very cautious about any money we put to work long term. For those of you who may not know, our entire investment portfolio, updated through year-end and enhanced to include additional descriptions and categorizations, is available in the Investor Relations section of our website. The vast majority of our holdings continue to be in government and agency securities and the overall rating remains AA.

Turning to capital management, in the fourth quarter we acquired $23 million of our trust preferred debt. We paid $18.4 million for those securities and thus realized a pre-tax gain of approximately $4.6 million. We did buy back shares in the quarter, acquiring 164, 544 shares of our Common Stock at a cost of approximately $7.2 million. For the year, we repurchased 1.8 million shares at a total cost of $87.6 million using funds from our August 2008 and April 2007 authorizations. Right now, we have approximately $74 million remaining in our authorization to repurchase shares indebt. Frank?

Thanks, Ned. Howard, can you give us a review of reserves and talk to us about overall trends at year-end and maybe then follow-up with some insight into 2009?

Sure, Frank. As Ned said, there was $104 million of net favorable reserve development in the quarter, which makes net favorable development for the year, $185 million. This was primarily from accident years 2004, 2005 & 2006. Let's be clear that this net favorable reserve development results from a consistently applied evaluation process and represents the result of disciplined pricing and operations at a time when the loss cost indications were dramatically different than today. While the improved loss climate is reflected in our current pricing, we have not changed our historical reserving discipline. We are not deviating from what's worked in the past. We understand that volatility, in some cases extreme volatility, will always be a part of medical professional liability and we are doing what it takes to insure that ProAssurance is prepared for it.

Our policyholders and shareholders both benefit from our long-term view and success. You can see that long term conservative view in our 2008 loss pick of 86.4% and the current accident year loss ratio of 94% in the fourth quarter. The increase in a loss ratio to 94% in the fourth quarter is primarily the result of $10 million of additional expected loss costs, $5.8 million is attributable to an increase in the reserve for the death, disability and retirement benefits under our claims made coverage, based on a periodic reevaluation of the expected cost of those benefits. $4.2 million is attributable to an increase in the reserve for internal claims handling expenses, or ULAE as it's known, which is also reevaluated on a periodic basis.

Neither of these items is attributable to a change in the current claims environment. Let me say that again for clarity. Neither of these items is attributable to a change in the current claims environment. Without these two adjustments the loss ratio for the quarter would have been 84.9%, quite comparable to the 83.9% book for the third quarter of the year, and the 84% loss pick for the first three quarters of 2008. Although it's been nine years, we still remember the painful lessons that 1999 and 2000 taught our industry and its investors. Rate levels have come down primarily in response to reduced claim frequency; however, we're determined not to repeat those hard lessons based on our belief that today's lower loss environment will ultimately revert to historic levels so we are being as conservative today as we were in the years past.

Now, turning to the state of the insurance market, we're encouraged by our ability to retain 88% of our business in 2008. Our overall premium level on renewing policies was down just 6%. That decline is based on our actuarially-driven pricing models, which insure that we charge an adequate rate for each risk that we write. That helps us maintain the margins needed to help us emerge from a soft market in a strong financial position. Along those lines, they can report the claim frequency per unit of exposure was essentially flat for the year. The quarters bounced around a bit, up one, down the next, but overall, it looks like frequency is no longer dropping. Severity continues to move upward as well, but in a manageable and expected rate and is lower than the historical levels upon which we based our projections when initially setting reserves.

As for the marketplace overall, it's still very competitive but we're holding our own and we have been seeing more opportunities to write new business at rates we believe will meet our profitability objectives. In summary, we have taken a careful approach to underwriting and pricing for the past few years, as the market softened, and we're seeing the benefits of that strategy. We might have been able to write more premium volume but we don't think that we would have produced results that are better than this. Growth in the top line by writing more policies at lower rates would have done nothing to enhance our profitability. It would have only increased our risk profile without increasing the long term financial strength that is vital for our policyholders.

Thanks, Howard. Now let's turn to Darryl Thomas to get a comment on claims.

Thanks, Frank. I believe it goes without saying, that lower frequency means lower law costs for us to manage. Quoted claims are down and they have been declining for a few years. In today's environment, there are just not as many cases to try due to lower claims inventory, but we're just as diligent as ever preparing for trial, with the number of reported claims down, we have the ability to bring significant resources to bear on each case and we continue to have success in the courtroom.

In 2008, the open claims declined significantly from 2007. The number of claims tried to a jury verdict went from 723 in 2007 to 481 in 2008. This continues to be especially meaningful in our key states, where the number of claims we tried to a jury verdict again exceeded our competition and again demonstrates our desire to stand by our insureds. Frankly, our number of trials each year may mean little or nothing to you because no competitor, that we know of, is willing to share their trial numbers with you. I am confident that they be much lower than ours. You are aware that our defense posture is a key point of differentiation for us and it's in keeping with our Treated Fairly philosophy. However, our relationship with our insureds is more than the number of trials each year, although that's a good barometer of our willingness to go the distance with them in those venues, where circumstances permit. It says that we are willing to listen to our insureds, most of whom want and expect a strong defense of their claims. It also says we are ready to use our balance sheet wisely to stand with them even when the stakes are high. Frank?

Good stuff, guys. And Vic, we'll ask you now for an operational update, especially if you could touch on PICA, Mid-Continent and Georgia Lawyers.

Let me start with PICA, since it's still in progress. PICA, or more formally, Podiatry Insurance Company of America, was the nation's leading writer of professional liability insurance for podiatric physicians, and the second largest writer for chiropractors. In 2008, PICA had a strong year with almost $96 million direct written premium in policyholder retention in the mid 90's. As we announced in January, all the regulatory approvals have been granted in connection with our sponsor demutualization of PICA. PICA has mailed the required documents to its policyholders and a special meeting to record the final vote will be held on March 31. We anticipate closing early in the second quarter.

Mid-Continent is a general agency that focuses on professional liability insurance for ancillary healthcare professionals and facilities. It also provides some other miscellaneous liability coverages. Mid-Continent will continue to operate from its home office in Houston and work with its existing marketing channels. Mid-Continent produced about $26 million in total premium in 2008, about $20 million of that was in the healthcare arena. Although we did write some of that existing business, we only wrote $2.5 million of that premium. We are looking for good premium growth during 2009 as the majority of Mid-Continent's healthcare business will be written by ProAssurance. There are some parts of the Mid-Continent business that aren't healthcare-related and will not be written on ProAssurance paper. Mid-Continent will continue to place this business with other Markets and earn Commission and fee based income for ProAssurance.

When PICA and Mid-Continent are viewed together, they represent a major expansion in the scope of our underwriting and marketing effort to a broader healthcare clientele. We're quite excited about this expansion which positions ProAssurance very well for the future.

We also have been working to grow our lawyers professional liability book. In early February, Georgia Lawyers Insurance Company became a part of ProAssurance. Key personnel remain in place in Atlanta to serve Georgia customers and solicit new business. Early reports indicate good acceptance of ProAssurance among the small to medium-sized law firms in Georgia that are our target market. We're also seeing premiums begin to flow from the two underwriting agencies we signed to bring us legal professional liability business from the Mid-Atlantic and the far West. It's too early to know how much premium they will generate, but we're confident they will also contribute to a solid book of profitable lawyers professional liability business.

One final operational note. Last fall, we announced that we would be renaming our insurance subsidiaries to reinforce the ProAssurance brand. As you saw on the final pages of our Earnings Release, all of our major subsidiaries now proudly bear the name ProAssurance. We believe that operating under one brand will enhance ProAssurance's recognition in the marketplace. Frank?

Thank you, Vic. Stan, we'll come back to you for a wrap up. I know you wanted to mention Treated Fairly one more time.

Thanks, Frank. We talked earlier about Treated Fairly and our insureds, but Treated Fairly is also about what our investors should expect. We think it's fair to align our incentives with shareholders to insure that we have a significant financial stake with you, and we do. We think it's fair to insure that we manage the business to produce a profitable return this year and into the future. We think it's fair that you know exactly what's in our investment portfolio so as to remove any doubt in your mind about the stability and conservative nature of the portfolio, so we post it on our website. I want to emphasize again the pride we take in our Company and its results. Everyone in this room is well-invested in ProAssurance and brings to the table everyday a dedication to insure that we will not be out-worked by anyone in any facet of our business. If you can think of something we should be doing better or different, please share it with me or one of our Senior Management Team. Frank?

Thank you, Stan. Jennifer, I think we're ready for questions if you'll open the line and tell everybody how to ask that question.

Certainly. (Operator Instructions). We'll hear first from Mark Hughes of SunTrust Bank.

Thank you very much. Could you talk about the sequential pricing trends you talked about down 6% year-over-year? What are you seeing more recently?

Mark, this is Howard. Yes, in the fourth quarter that we did have about a 6% reduction in price on renewing business. I would expect that, and this is my personal opinion, I would expect that we would see somewhat of a moderation of that as we go into 2009, just the sense of the market, the feel of the market right now, is a little less price-focused and I think policyholders are a little bit more concerned about the company that they are insured with, not as inclined to look around in the marketplace. So my sense is that 2009, as we move through the year, we'll see a lower rate of decrease. I think pricing will still be down for the year on renewing versus expiring policies, but my sense is that it will be less than the 6%. I don't want to put a number on that right now.

Right. And in the uptick in the current year loss as you described the $10 million, is that a little bit higher level of spending or losses expect to be sustained, should we think about the 86.4% or I think you described maybe an 84.9% loss without the 10 million. What should we think going forward?

Oh, I'd say what I tried to describe there in the presentation was that the $10 million addition really does not relate to the current loss environment. It relates to two things that are categorized as losses, certainly, but not related to the frequency or severity that we're experiencing in the environment. The death, disability and retirement reserves relates more to the age distribution of our insureds and the interest rates that are expected to be earned in the future for that particular policy benefit and the unallocated loss adjustment expense adjustment really relates to the relative cost of running off the claims. It's a reserve that all Companies are required to carry and it's a reserve that looks at the internal operating cost related to claims run-off if the Company was decided to stop writing business, so again, they're more expense, it's more of an expense oriented reserve, not a cost environment reserve so I would say that the number excluding that $10 million is much more like the run rate that we're looking at.

Thank you very much.

We'll move to our next question from Mike Grasher of Piper Jaffray.

Good morning, gentlemen and congratulations on a great year. Wanted to follow-up on Mark's question just in terms of the states that you're seeing more firming than others, if you could comment on that?

You know, we have historically treated our book of business as a unified book and have really not mapped out a road map for our competitors by singling out any one state, so if you'll accept our willingness to say no comment, but just this is our general business, we like to give you that answer.

Okay, fair enough, and then if you could, Ned, I think you mentioned some write-down on the distressed debt in the portfolio. Does that take into account the high yield? Is that the same category or are we talking about the same investments?

No. We have two alternative investments on the debt side. We've got a high yield debt portfolio and then we have a distressed debt portfolio that's a limited partnership in which we're invested in.

Okay and then on the high yield, any concerns there? Just looking through the K, seeing unrealized position in that, any comments on that?

Well, the high yield debt portfolio we carry as an investment in a sub, basically, and so it's mark-to-market through the Income Statement every quarter.

Okay, fair enough and then just a question for Vic. You brought up the cross-sell opportunities. What are you doing in advance in terms of prior to the close, or not close, but hitting the ground running here on the deal with regard to your field in terms of trying to bring in the podiatry for the full organization?

Well, PICA will continue to run as it has. It has the lion's share of the podiatric business and will continue to operate out of Nashville doing that. The other parts of PICA that work with other healthcare providers, they do some miscellaneous C&O is very complimentary to what Mid-Continent does although Mid-Continent writes on an excess and surplus line basis and as an example, just this afternoon, we're having a meeting that includes Mid-Continent, PICA, core ProAssurance to sit down and talk about how we can expand some of these opportunities, look at ways to work together so we're very conscience of it and working on it. Obviously, PICA hasn't closed yet, but we look at the combination of Mid-Continent and PICA as a great opportunity for ProAssurance to expand further into liability areas that traditionally it has not written.

And you're saying second quarter is the close?

Early in the second quarter PICA will close, yes.

Mike, just to supplement, and emphasize one thing for our future podiatric physicians. After the close, the core insurance activities relating to our podiatric insureds, that is risk management claims, underwriting, all the things that touch podiatrists, will continue to be handled by PICA out of Nashville.

Okay. Thank you very much.

We'll hear next from David Lewis of Raymond James.

Good morning, thank you. Ned, got on a little bit late but can you go through kind of what your current portfolio yield is, what your new investments are? I guess what I'm trying to get to, is there anything unusual other than short-term rates that have continued to put pressure on the net investment income line?

Sure. It's two different questions. One, where are we putting money? We are holding more cash and more in short-term investments than we have historically held so as money is rolling up the portfolio, we're pretty slow to reinvest it, and so that's one thing that's bringing down investment income.

It's just that we don't have as much invested in longer term investments, and that gets compounded by the 300 basis point decline in short-term rates. We are putting money to work very cautiously. We've purchased some FDIC insured paper. We've bought some pre-refunded municipal bonds very selectively. We are buying corporate notes but we're very cautious in what we're doing, given the current environment. One of the other items that drove a decline in investment income in the quarter is we have an allocation to tips and they actually produced given the deflation concerns, actually produced a negative return for the quarter, and brought investment income down by about $1 million.

And if we look at the tips going in the first quarter, then that should be kind of leveled out because the impact already occurred in the fourth quarter. Is that correct?

I believe that should be our expectation, yes.

So if we take something in the $36 million to $37 million range going forward and assuming nothing changes in short-term rates, that's maybe a good starting point?

That's what you guys get paid the big money for, David.

Your allocation is probably not going to change materially?

We don't expect asset allocation to change. Just be mindful of the fact that we're holding a lot in cash and short-term and the return on that cash and short-term is very small, if anything.

Okay, and do you have a sense of the alternative investment values so far in the first two months and I think you actually report that on a month lag, so maybe actually over the past three months?

Sure. There's only one investment that we report on a one month lag and it doesn't really represent a material portion of that alternative portfolio. Everything else is reported on a current basis and I don't know that we've gotten any strong indications one way or the other for the first quarter.

And then since you retired some debt, what's probably a good quarterly interest expense run rate here?

Give us a second, we'll come up with it. Basically, what remains of the debt, about half of it is fixed and half of it flowed to 385 over LIBOR. There's more detail--easiest way to get that is in our K, which we filed last night, should have posted this morning has a break down of the debt.

That will be helpful. I can do that. And Stan do you want to just comment on any changes in M&A activity that you see out there in the marketplace and I don't know if all of the mutual companies have reported but I'm wondering whether there have been any significant deterioration in capital levels that might create opportunities.

They haven't reported yet, so we're not able to answer that question with any specificity. Given the levels of equity investments in some companies, one would expect that to be a possibility. Overall, I would say that the M&A chatter, as we call it, is probably not quite as crisp as it was a year ago and I think that's principally a result of the uncertainty that's in the world right now and the dislocations that have occurred in the credit markets. One thing that I do think is capital is king today and there's nothing more important for a company to have going forward than capital, and that puts us in a position to take advantage of these opportunities as they occur.

That's helpful. Congratulations on a solid 2008.

Thank you.

(Operator Instructions) We'll move next to Michael Nannizzi of Oppenheimer.

Hi. Just a quick question, Howard, on PICA if I might. Given ProAssurance's reserve approach, have you looked at how when you bring the PICA book in and pull it together with Pro's book, was their reserving philosophy similar to ProAssurance in terms of its conservatism? Is there going to be a period of adjustment or how do you see that working out? Thanks.

Sure. We looked very carefully at PICA's reserving, as we would in any acquisition, and we were very comfortable with what we saw. PICA has historically utilized Tillinghast as their independent actuarial consultant, just as we do. They also have an actuary on staff, so I would not foresee any significant adjustments once PICA becomes part of ProAssurance.

Okay, and then in terms of the reserving as you go forward, I know that Pro is typically reserved a little bit more to account for the uncertainty--I think it was 8 points roughly on an accident year basis. Is that the same approach going to follow with business book down the PICA platform?

I would say yes, in general. The one thing I would say about PICA, when you look at the profile of the book of business that PICA has, it's a generally much more predictable, less volatile book of business in terms of claims severity, so I would say yes, PICA is going to be part of ProAssurance and we have one overall reserving philosophy but in terms of the, if you will, the risk margin that might be attributable to PICA's reserves, I'd say that might be less than the physician and hospital lines of business that predominate in the existing ProAssurance reserves.

That's perfect. Thank you, very much, Howard.

(Operator Instructions). We'll now take a follow-up from Mark Hughes.

Thank you. The premiums seated were a little higher in the quarter. Should we expect that to continue?

There really have been no significant changes in the reinsurance program. I think that, probably, the seated premium change is more due to mix of business than anything else. There's always going to be some adjustments, particularly at year-end when we look at the retrospective rating, retrospectively rated reinsurance contracts that have to be trued up with respect to loss experience but I don't, I wouldn't attribute that to anything unusual.

Okay. And then can you share your success rate when you took cases to trial this year versus last year?

Yes, we did better this year or we did better in 2008 than we did in 2007. However, we didn't try as many cases, as I indicated, simply because we don't have the inventory that we've had in previous years due to lower claims frequency.

Mark, this is Stan. I would also add to that that a so-called success rate is utterly meaningless, unless you know how many cases a company tried. So it would be possible to have a success rate of 100%, if you picked out one case during the year to try, so I think we need to be very careful when we talk about success rates. A far more significant figure in my view and one that's a far better barometer of a companies committment to its insureds, are the number of cases it's willing to take to trial, and nobody else in the country, so far as I know, is willing to give you that number.

Right, understood. The 2008 open claims count, you suggested was down. Are there any specific numbers you can share?

We're not going to share specific claims numbers on our claims counts.

Mark, we'll file our statutory statements end of this week, early next week, and you can dig in the schedule and get that information there.

Right, exactly. Thank you.

There are no other questions in the queue at this point. (Operator Instructions). Mr. O'Neill, it appears we have no further questions.

Very good. We will speak to everyone when we discuss our first quarter 2009 results, if not sooner. Thank you.

That does conclude our conference for today. Thank you, all, for your participation and have a great day.