ProAssurance Corp (PRA) 2009 Q2 法說會逐字稿

Good day, everyone, and welcome to today's ProAssurance Second Quarter Earnings Conference Call. As a reminder, today's conference is being recorded. For opening remarks and introductions, I will now turn the call over to Mr. Frank O'Neil. Please go ahead, sir.

Thank you, Trinka, and thank you for joining us. The news release we issued yesterday afternoon and our SEC filings including this morning's 10Q filing include important detailed disclosures with respect to forward-looking statements. In that regard, please understand that many statements we make today will deal with projections, estimates, and expectations. We explicitly identify these as forward-looking statements subject to various risks. Our actual results could differ materially from current projections or expectations. 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 Tuesday, August 4, 2009, the date of first broadcast. If you are reading a transcript of this call, please note that we did not authorize it. We have not reviewed it for accuracy; thus it may contain errors that could alter the intent or meaning of our statements.

Participating 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. We're going to open our remarks today with Stan Starnes.

Thanks, Frank. Thanks to everyone on the call for taking time to join us. We're pleased about the results in the quarter. The top line results validate our strategies for bringing in new business where we think we see opportunities in our established markets and further underscore the value we add by executing carefully through our transactions.

Our bottom line success demonstrates the shareholder value we create by judiciously using our capital to grow our business profitably and repurchase shares when appropriate. Shareholder's equity is over $1.5 billion for the first time in our Company's history and the book value per share grew to $46.72, continuing the upward trend that we think is so important to maintain.

As I said, Frank, there's plenty for us to be pleased about and also much for us to be optimistic about.

Thanks, Stan. We're going to change things up just a little bit because there's a wealth of information in Howard's data. We're going to start with him this quarter.

Thanks, Frank. It's great to be able to talk about a higher top line for a change.

We saw gross premium growth of roughly $23.6 million this quarter. In a soft market, growth can be a red flag, but as we said in our news release, this growth is primarily from our recent acquisitions. The largest amount, about $13.8 million comes from the PICA group. This is the first quarter we've had those premiums in our results as the transaction closed on April 1. Let me remind you that the second quarter is the lightest quarter for PICA, somewhere between 10% and 15% of the premium is produced in Q2. Q3 is PICA's heaviest renewal period with about 50% of their renewals. The remaining 40% is split between the fourth and first quarters.

Mid-Continent accounted for $2.8 million of the new business and there was a small contribution from the legal book we acquired in the Georgia Lawyer's transaction. It's now fully integrated into our legal operations so we won't be breaking out specific Georgia Lawyers premiums going forward but for the quarter we wrote $2.7 million in total legal professional liability business, $5.3 million for the year to date.

In what we've called our historical medical professional liability business, the business in place before the PICA transaction, we saw a modest net gain after new business, renewal, retention, and rate change. Our renewal rates for the quarter was 89% and the rate change on renewing business this quarter was a negative 4%, both the same as in the first quarter.

We're writing this business in areas where we see real opportunity and at profitable rates given what we know about today's legal environment. We believe that the broad market is not undergoing further deterioration, but our rates remain under some pressure since there is no overall trend toward widespread hardening. Again, we're in no way saying that the soft market is over, but we'll repeat our statement from last quarter that the pricing environment may have reached a trough.

Growth trends are essentially where they were last quarter. Frequency no longer appears to be dropping but has stabilized. The increase in loss severity remains at a moderate level. That improvement in severity trends from our initial projections and initial reserving continues to be a positive for reserve development. In the second quarter we experienced $37 million of favorable net reserve development which brings us to $55.5 million for the year. The development like last quarter came primarily from accident years 2004 through 2006 with 2007 providing a small contribution. None of this quarter's development came from PICA.

We've explained the reserve evaluation process in great detail in the past, so I'll just remind you that we apply a rigorous process to our reserve evaluation that mirrors the conservatism we use when establishing our initial loss picks to set the reserves.

Frank?

Thanks, Howard. And now we'll look to Ned for details on how those results translate.

Thanks, Frank.

Starting at the end and working backwards, we had operating income of $1.52 per share for the quarter, bringing the year to $2.50. For the year, net income per share is $2.52.

Our results are being driven by several factors. Howard already discussed the increase in written premiums and the merger with PICA led to an increase in earned premiums which are up 10% over the second quarter of 2008. Net investment income, while improved from last quarter remained below the levels of the year-ago periods due to lower interest rates and lower average balances in our fixed income portfolio. PICA added $2.1 million to net investment income in the quarter.

Including PICA, we reported net realized investment gains of $5.1 million for the second quarter of 2009 as compared to net realized investment losses of $5.3 million during the second quarter of 2008. Our expenses, excluding the cost associated with the PICA transaction, were down slightly quarter over quarter although up slightly quarter over quarter with the PICA costs factored in.

Looking at the important ratios, we saw improvement in virtually every category in both periods. Our net loss ratio was down four points quarter over quarter as the current accident year loss ratio declined due to a change in the mix of business with PICA moving into our medical professional liability book. The net favorable reserve development reduced the current accident year loss ratio by 29 points in the quarter. The combined ratio improved by three points quarter over quarter and a bit less than that for the year over year period.

The improvements in our top and bottom line results combined with our share repurchase in the quarter helped to move our return on equity to 14.4% and that's also bringing the year to date ROE back in line with our long-term goals. In the quarter we purchased 397,000 shares of our common stock in the open market at a cost of $17.4 million. During the year we've repurchased 840,000 shares of our common stock at a total cost of $36.1 million. We have approximately $38.3 million left in the board authorization for share repurchase and debt reduction. Book value per share grew in the quarter attributable to the better results, unrealized investment gains, and to a smaller degree the share repurchase and now stands at $46.72, 9% higher than at year end.

We continue to be cautious about the allocation of our capital and right now we continue to search for ways to put our money to work under more favorable terms. At the same time, we are carefully deploying the cash we're investing mostly into corporate bonds with industrials being the largest component and high quality municipals. Our average duration remains at approximately four years and we continue to avoid the temptation to extend duration in search for a few extra basis points of yield. As always, our entire investment portfolio updated through quarter end is available on the Investor Relations of our website.

It's probably worth noting a few items from the PICA transaction. As a result of the transaction we recognized $10 million of amortizable intangible assets that will be amortized into earnings over the next 15 years. More details on these intangible assets are included in our 10Q. In addition we recognized $14 million of non-amortizable intangible assets and $29 million of goodwill.

As you know, under the purchase accounting rules, we value the assets and liabilities assumed in the transaction at fair value and there is one item in particular to which I want to draw your attention. In the transaction we acquired $7 million of notional value in surplus notes that had a fair value because of widening credit spreads of $4.2 million at the time of the acquisition. Under the accounting rules we are forced to bring this on our books at fair value.

We currently intend to redeem these notes at par in the third quarter. The result will be an after-tax book loss of $1.8 million in the third quarter. It's important that everyone understand that this is an accounting anomaly and is not reflective of the economics of the underlying transaction. The notes currently pay 4.1% over LIBOR and we believe redeeming these is a sound decision given our capital position.

Frank?

Thanks, Ned. Vic, we've heard a few references to the companies that have joined us in the recent acquisitions. Can you give us an update?

Sure, Frank.

Mid-Continent and Georgia Lawyers are performing well as we expected, making solid contributions to our Company and the most recent addition is PICA which closed on April 1. We said from the beginning that PICA will run as a standalone operation and that's the path we're following It has allowed PICA to fit into the organization quickly.

Our challenge now is to identify those opportunities that lie ahead to use PICA's knowledge and the knowledge base of Mid-Continent to insure more ancillary healthcare providers and expand our reach into the lower cost professional liability lines related to healthcare. It's a pretty powerful combination going forward. As you've seen this quarter, the results for Mid-Continent and PICA are already a nice addition for us.

Thanks, Vic. I know you also sit on the board of our industry organization and I know they're closely monitoring the healthcare reform debate for any possible effect on medical professional liability. Can you share something with us from that?

Sure. And it's interesting. Based on what we know of the Congressional debate so far, there are no game-changing developments in sight. Given the makeup of Congress and the President's remarks to the American Medical Association, no one is forecasting any comprehensive tort reforms as a part of a final bill. Compelling arguments are being advanced by our sector in the medical associations that a comprehensive tort reform package would help to reduce the overall cost of medical care but it doesn't seem likely that such reforms will be part of a final package.

It is worth noting that the administration has taken a position on lawsuits arising in related areas, that is medical devices and drug product liability cases that state law rather than federal law should govern tort claims. So, we do not expect to see a change in the dynamics of the state based tort system as it relates to medical malpractice claims as a result of the healthcare bills?

One other thing I found interesting in researching all this, the major changes in the healthcare system that are now being debated by Congress will not become effective until 2013 under the current (inaudible).

Thanks, Vic. Stan, some final remarks before we take questions?

Frank, I again want to say how pleased we are with our results this quarter and how pleased we are as we consider the opportunities looking forward. We're also seeking to improve through our continuing commitment to and implementation of Treated Fairly. We look forward to continued growth in our top line as we add business from PICA and Mid-Continent and as our legal professional liability business grows. We believe that this will be profitable growth based on past results and will be a real boost for us.

This is all supported by the disciplined execution of a plan that balances growth, capital use, and the creation of shareholder value with the strength and safety that is so important to our insured and our agents. You saw proof of our succession in this regard prior to our reporting our quarterly results. In June, AM Best upgraded ProAssurance Group to A. We were also named to the Ward's 50 for the third straight year, the only medical professional liability Company on that list to earn that award for three straight years. Ward starts with roughly 3,000 property and casualty insurers in the United States and identifies the 50 top performers that combine bottom line excellence with solid improvements in their balance sheet. In short, the Ward Group recognizes companies that protect their policy holders and build long-term value at the same time.

Frank?

Thank you, Stan. Trinka, we're ready to take questions.

(Operator Instructions) Our first question is from Mark Hughes with SunTrust.

Thank you very much. I missed the first couple minutes of the call. It sounds like pricing though relatively stable? Down about 4% in the quarter? But I think you did better in terms of volume. Where did that incremental success come from?

Are you talking about which states?

Either which states or which channels? Were there any unusual gains perhaps in terms of customer wins in the quarter?

Mark, I think we're probably not going to talk about individual states because there's no sense in telling our competitors where we've seen opportunities. Howard, is there anything you can talk about as far as channels?

Mark, I'm not sure all that you missed but I did talk about the premium that came from PICA and from Mid-Continent. PICA represented about -- almost $14 million of premium growth in the quarter, Mid-Continent a little under $3 million. So, that was a big part of what we saw.

Frank, was there more concentration of growth in one or two states that you care not to reveal? Was that the case?

I really think I'll just say we did have growth in the MPL line net of the business we re-underwrote, business maybe lost to competition.

It was also up about $3 million from Georgia Lawyers or from the lawyer business altogether. We did have in the state, just as an example and something we're disclosing in the Q, we have about $3 million of premium, $3.5 million of premium, additional premium in Alabama that was recorded as written premium because we're writing a small number of two year policies in Alabama.

Okay. Thank you.

Our next question is from Beth Malone with Wunderlich.

Good morning. Thank you. A couple of questions. On the A rating upgrade, does that change your strategy? Can you identify growth or opportunities specifically to that change?

Beth, it doesn't change our strategy. What it serves to do is confirm and affirm the financial strength of a Company. I think it serves to solidify our position so that physicians and hospitals and other healthcare providers can purchase our product with the assurance that we have the financial stability to be here five, six, seven years from now when the claims arise. So, I think it confirms the strategy that we've played out for the last several years now and it will continue to help us implement that strategy. But I don't foresee a change in strategy as a result of that.

Okay. And then on the frequency and severity trends, does the economy have any bearing do you think on those trends?

Beth, this is Howard. I guess we all think that it should or may but to be honest right now it's not clear at all. There's nothing that's really obvious. Frequency has been flat for a number of quarters now. Whether the fact that it's not declining anymore is a result of the economy or just that it has declined to a point that gets down to the root base claim frequency is really difficult to tell. I guess I'd say no apparent effect right now.

In terms of your reserve development, it's been very favorable, indicating the conservatism of your reserving in the past. With the -- one of the factors, I guess, that's driven that to some extent is the fact that frequency had been declining. Now that it's stabilized, are we to assume that reserve development may also slow down?

Not really as a result of frequency because the claims made book of business which is 95% plus of what we do, frequency is really determined at the end of the year. It's severity that is the major factor with respect to reserve development because once you establish your reserves and you base those on your expectations at the outset of the -- what you built into your pricing and also what you first see on the claims that are reported, it's a change in severity that's going to have an effect on reserve development if anything, not frequency.

Okay. And then on tort reform, is there any major changes in the markets, the states legislatures that you're focused on or either good or bad at this point?

We follow the popular news about what's being proposed or happening in different states, but there's nothing that is in any of our critical states that's passed in recent months and the real battle's being fought out in the Supreme Courts. We look for a decision in Illinois this year. We also are awaiting a decision when the case gets there for the Supreme Court of Florida regarding its tort reform. You've seen decisions in several states sort of whittling away at it and we just have to take it on state by state basis. To my knowledge, there's nothing in the verge of being enacted in any of the legislatures which would directly impact us.

As some of those tort reforms get modifying, I guess, or weakened compared to when they were first implemented, how does that -- is that a positive because you can raise prices, argue to raise prices? Or is it -- doesn't really change anything?

It's not a positive. It will have an adverse effect on our customers. But we don't take tort reform into account in a state until it has been validated by the court of last resort in that state. So, the fact that a piece of tort reform legislation is overturned by a state Supreme Court will not necessarily result in a change for us because we don't feel that it's prudent to recognize that tort reform in our operations until the court of last resort in the state has ruled on it because we've seen too many instances where people see a piece of legislation come through, the legislature get excited about it, and then it's overturned by the state Supreme Court. So, it just doesn't make sense to take it into account until we know it's there on a permanent basis.

Thank you.

(Operator Instructions) Our next question is from Mike Nannizzi with Oppenheimer.

Thank you. Frank, just a couple questions if I could. So, it looks like the accident year loss ratio was lowered than last year but you'd mentioned in the release that pricing is down. I'm just wondering what does that imply about how you're pricing the business? Maybe I'm missing an input there that I'm not including. Thanks.

Yes. Let me get Howard to take that.

Mike, I think it's a combination of a couple of two or three things. First, we have PICA and PICA's initial loss ratio historically has been established at a level that is lower than what we have done on our historical book of business. We're very comfortable with PICA's reserves and we evaluated those before the transaction and certainly have continued to be involved in the analysis. There's no question there in terms of our comfort level. But PICA has had historically lower volatility in claim severity in particular and therefore has booked the initial reserves closer to the expected value of loss cost. We will be working with PICA over the course, the remained of the year to determine just where the appropriate reserving approach or what the appropriate reserving approach is going forward but right now PICA's initial loss ration is approximately 75 compared to about an 83 on the historical ProAssurance book of business. So, you average that in there. We also have more Mid-Continent premium this quarter. Mid-Continent's expected loss ratio is lower because the expense ratio is higher. In that line of business you pay a good bit more commission. So, that gets factored in as well. Then there was a little bit of mix, just the mix of business that probably would pull the loss ratio down by a point if nothing else at all changed.

Okay. So, we went from an 83-7 to an 82-8 just on the pros legacy business. But that also I guess that includes the lawyers book as well? That's why I was thinking we've got a point lower accident year loss ratio but pricing is three to four points lower. So, some of that then is due to the mix change in that business, I guess?

The mix change and the pricing is lower but the pricing itself in my view, the change in the pricing wouldn't really change the loss ratio that we booked because if we're charging lower prices, it's because we think the losses in dollars are going to be less going forward, not so much the loss ratios going down.

I see. Okay. Okay. That makes sense. And if I could, Frank, just a quick follow-up. I know you'd mentioned new business a little bit. Can you talk about the - generally kind of the composition of that new book of business and just talk about how it relates to your legacy book just on forgetting PICA for a minute. Does it -- geographically does it look the same? From a practice size is it roughly the same? As you're bringing in that new business, is there something other than pricing that is attracting new physicians to ProAssurance?

Let me go from the back of the question first. I'm not sure that it's pricing because pricing is never the one thing that we sell. I think it's probably the strength of the balance sheet, the long-term commitment of the Company and sort of the intangibles that we bring to the table that are resonating with new insurers. I'm not sure that we can say that it's in a specific geographic area or that it's a new class of physicians so that it's -- I think the additional business is really spread across our entire book of business and would be viewed as just add-ons that we pick up a little bit at a time in various states. So, I wouldn't think that you would draw any conclusions about a change in our overall business based on the new business that we've added.

Okay. Great. Thanks.

Our next question is from Mike Grasher with Piper Jaffray.

Thank you very much. I also joined late. I don't know if you went over the details around the development in the quarter but was any of the - any of this include exposures outside of legacy ProAssurance?

No, it did not. It was strictly from the historical ProAssurance book. Nothing from PICA.

Okay. I appreciate that. And Frank, did you happen to mention when the Q would be out?

That was filed this morning. 5:30. It's out.

Thank you very much.

Sure.

Congratulations on the quarter.

Thank you.

And we do have a follow-up question from Mike Nannizzi with Oppenheimer.

It's me again. So, Ned, can you -- can I just ask a question about the portfolio? You recorded that gain in the quarter. What did you sell there? I'm just curious.

Mike, must of that gain came -- we hold the equities in the portfolio in a trading portfolio.

Yes.

Changes in values flow through it as realized gains and losses and we also picked up the PICA portfolio and we kind of -- we bought that on April 1. So, it kind of picked it up at the bottom of the market.

Right. Okay.

So, the trading portfolio gains for the quarter were about $4.3 million. We did have gross realized gains of $3.8 million and to be honest I don't think there's any one particular thing that we sold, just some movements in the portfolio. We had about $2.3 million other than temporary impairments.

Okay. And then what's the -- I don't know if Larry's there, but the TIPS income number? I know that there was a negative adjustment in the first quarter. I just wanted to know if you had that number handy?

Yes. I don't have the number handy. I know on a quarter over quarter comparison, Q2 to Q2 the TIPS performance was in line. It did turn back to a positive performance for the quarter in line with a similar performance in the second quarter of last year.

Got it. And then just last on the portfolio, are you other than the traditional tax advantage municipal bonds, are you -- you mentioned you're dedicating capital to corporates and particularly on the industrial side. Are you also looking at the taxable municipals as well or is that something that's just not --

We occasionally will buy a taxable muni but it's not a typical investment for us. Certainly not something we're targeting right. Now.

Great. Okay. Thank you again.

Alright. Thanks.

And Mr. O'Neil, there are no further questions by phone, sir.

Very good. Thanks, everyone, for participating. We look forward to speaking with you next quarter.

That concludes today's conference call. We thank you for your participation.