ProAssurance Corp (PRA) 2011 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, Karen. Good morning, everyone. Thanks for joining us. We'll begin our discussion of second quarter 2011 results after a couple of important notes.

On Wednesday August 3, 2011, we reported our results for second quarter and first six months of 2011 in a news release and an accompanying 8-K, along with our SEC filings, including the 10-Q filed this morning. These documents provide you important detailed information about our Company and our industry. These documents also discuss and detail many important factors that could affect the outcome of future events and thus cause our actual results to differ materially from current projections or expectations.

Please read and understand these cautions and please be aware that statements we make on this call dealing with projections, estimates and expectations are explicitly identified as forward-looking statements subject to these and other risks. Except as required by law or regulation we will not undertake and expressly disclaim any obligation to update or alter information disclosed as part of these forward-looking statements.

The content of this call is accurate only on Thursday, August 4, 2011. If you happen to be reading a transcript of this call, please note that we did not authorize it and we have not reviewed it for accuracy. Thus, the transcript you're reading may contain factual or transcription errors that could materially alter the intent or meaning of our statements.

A final reminder, we're going to be referencing non-GAAP items in our call today. Please refer to our recent filing on Form 10-Q and our recent news release for a reconciliation of these non-GAAP numbers to their GAAP counterparts.

Participating on today's call are our Chairman and CEO, Stan Starnes, our President, Vic Adamo, Chief Financial Officer, Ned Rand and Howard Friedman, our Chief Underwriting Officer and our Actuary. Stan, will you please start off for us?

Thank you, Frank, and good morning. This quarter's solid results underscore the benefit of adhering to a plan that focuses on building an enterprise for and over the long-term. The quarter's highlights include a number of items worthy of mention.

First, we experienced continued top line growth produced in part by a meaningful strategic acquisition. We also enjoyed bottom line growth resulting from many years of dedication to building and retaining a customer base that values the true difference of being insured by ProAssurance. Finally, we continued to grow book value per share, the measurement we believe best showcases our solid track record. All of this positions us financially to continue building value for our shareholders and operationally to respond to the rapidly changing world of healthcare.

Frank?

Thanks, Stan. Ned, would you review results from the quarter and the first half?

Happy to, Frank. Unless I specifically mention otherwise, I'm going to be addressing the quarter results. Gross premium written was $115 million, a 17% increase over the same period a year ago. In the quarter and year-to-date, we've added $10 million and $30 million respectively in premium from our acquisition of American Physician Services or APS, as part of our disciplined strategy to grow as markets and business allow.

We wrote about $8 million of new physician business in the quarter, which includes about $5 million of gross written premium in the Certitude program we launched with Ascension Health on April 1. And while it's not new business, I'll highlight the fact that we renewed a significant number of our two-year policies in the quarter. Net premiums earned were up 9% quarter-over-quarter to $137 million. We received a $1.6 million benefit to pre-tax income in the quarter as the result of the commutation of a reinsurance treaty with [Colechi Re], formerly AXA Re. The commutation increased net earned premium by $5.6 million and net losses by $4 million, which translates into a half point benefit to the net loss ratio.

The low interest rate environment continues to be a challenge and we continue to be faced with reinvesting at lower interest rates when compared to what is maturing in our portfolio resulting in a decline in our net investment income. Net investment income in the second quarter was $36 million, compared to $37 million a year ago. Our [CHIPs] allocation produced almost $2 million in investment income in the quarter compared to $900,000 in the second quarter of 2010. This increase somewhat muted the year-over-year decline in net investment income for the quarter. But for long-term analysis, I believe the 2010 number is closer to the typical run rate for our [CHIPs] investments.

Our net investment result, which is the sum of net investment income plus any earnings or losses in our unconsolidated subsidiaries, was down $4 million or 11% year-over-year. The key drivers here are the elimination of one investment during the latter part of 2010 that produced favorable results in Q2 2010 and the impact of our increased allocation to federal tax credit limited partnerships. As we discussed last quarter, while these tax credit investments actually have a negative impact on our investment results, decreasing the result by $1.3 million in the quarter, this is more than offset by a benefit in our tax liability, which was reduced by $1.8 million in the quarter.

Total expenses were down 3% for the quarter, the second quarter in a row and again this is primarily due to the effect of net favorable reserve development. In the second quarter, underwriting expenses including expenses at APS were up about 4% compared to last year and the expense ratio was down half a point compared to 2010. Net favorable loss development was $50 million in the quarter compared to $38 million last year. Howard will go into greater detail on reserves shortly.

Operating income for the quarter was $54 million, a 27% increase over last year. And net income was $55 million for the quarter, a 36% increase over 2010. On a diluted per share basis, that equates to operating income of $1.74 per share, up 35% over last year and net income of $1.79 per share, a 46% increase compared to 2010. Return on equity on an annualized basis was 11.4% in the quarter, an improvement of 2.3 points over last year's second quarter. And it was 10.8% for the year-to-date, an increase of 1.8 points over the year-ago period.

Book value per share is up 7% this year standing at $64.28 at the end of the first six months of 2011. Intangible book value per share is $57.17, a 7.6% increase over year-end. As Stan said, we believe the growth in book value per share is probably the best indicator of our overall success as an enterprise, both for shareholders and insured's. That's why we place so much emphasis on growing book value per share. While we did not purchase any of our shares in the quarter, I want to be clear that share repurchase remains an important part of our capital management strategy. That's evidenced by the $315 million we spent to repurchase shares in the last five years. As we've stressed there are a number of factors we evaluate when deciding about share repurchase, such as the amount of cash on hand and the appropriate amount of cash to hold, the cost of replacing capital and the effect of buying shares on book value per share and return on equity. Frank?

Thanks, Ned. Howard, would you give us some insights on reserve development and on the loss and rate climate in general?

Sure, Frank. The $50 million of net favorable reserve development in the quarter comes primarily from accident years 2004 to 2009 in our non-APS business, which amounted to $45 million. The remaining $5 million comes from favorable development in the APS book. As I mentioned last quarter the development at APS is principally for the 2010 accident year. We found that claims are resolved much sooner in Texas than other states and we are thus able to make a judgment about loss development more quickly for that book. Given that reality, our analysis shows Texas claim severity has declined below our December 31, 2010 estimates.

That said loss trends remain mostly unchanged this year. The overall frequency trend is flat, just as it's been since approximately the end of 2008. Severity trends are also stable and manageable rising at a level of approximately 4% per year. We have discussed our rate making philosophy in prior calls but I want to highlight again the approach of blending in loss history from a number of years, to ensure that we are pricing adequately for the risks we face. As loss trends have improved, we've reflected that in our rates but always with the idea that the rates we charge must meet our return hurdles to ensure financial stability and our ability to pay future claims.

For the year-to-date average pricing on renewing business, including PICA is down about 3% compared to a 1% overall decline in average pricing on renewals in the first six months of 2010. Retention for the six months ended June 30 was 90% as it was in the quarter. Both periods are a point better than last year. In all the market is still as competitive as ever but we do not see any one competitor that stands out in terms of overall pricing or concessions on coverage terms. There's always an isolated incident of very competitive behavior but that's generally on the better accounts where competition is most fierce. We don't think that signals a further downturn in market conditions.

Thanks, Howard. Before we let you go, will you update us on the Ascension Health program?

Sure. As you heard, we added about $5 million in gross premium due to the inception of that program in April. We've mentioned the Certitude program for a couple of quarters now but this might be a good time to recap how it works and will work going forward. The physicians targeted by the Certitude program in the April 1 Michigan rollout were all previously insured by an Ascension Health affiliate. Because of this, much of the premium from this block of business is seeded back to Ascension as part of our risk sharing arrangement. Going forward, business will largely come from the ranks of physicians now ensured in the open market and we will retain a greater part of the risk and the premium.

We're beginning to write some of those physicians in Michigan now and are encouraged by the initial results. As a result of the Certitude program success and acceptance to date, we expect to move it into at least three additional states by year-end.

Great. Thank you, Howard. Vic, can you touch on some of the accomplishments during the quarter?

Sure, Frank. I'm pleased to note a couple of external recognitions in the quarter. We were named to the Ward's 50 for the fifth straight year. Being named to this list in any one year is a great accomplishment but to do it five years in a row really emphasizes the long-term success engine of ProAssurance. Ward's starts with more than 3,000 property casualty writers in the United States and whittles that list down to the top 2% of all P&C carriers by applying a number of safety screens and financial measurements over a rolling five year period. We're quite proud of this achievement.

In addition, A.M. Best reiterated their A rating on the ProAssurance Group in the quarter, so we're pleased that their yearly check up on our financial health earned us an A again for this year. Stan?

Recognition such as this underscores the value of the long-term approach we've applied since we began operating as a public company 20 years ago in September of 1991. Since that time, we've grown book value per share at a compound annual growth rate of 16% and our share price has grown at a compound annual growth rate of 15%. These are notable gains that prove the value of our strategy in a very difficult business. Think back over that 20 years for a moment. During that time how many medical professional writers failed and how many saw their share price plummet due to reserve or pricing issues. Think about the companies that simply left our business, some after decades of market leadership. We should be reminded that despite the relatively benign loss climate of recent years, this is not an easy business and enduring success is an accomplishment of which we are all justifiably proud.

This kind of long-term disciplined approach to this business is what has given us the ability to grow ProAssurance by consolidating companies and books of business, more than 20 in all, and to expand into new states and new markets and to find new opportunities to address in the emerging challenges created in healthcare and healthcare liability. I'm tremendously excited about what lies ahead and I have every confidence that we've built a solid foundation, financially and operationally. All through our dedication to Treated Fairly. Frank?

Thanks, Stan. Thanks, everybody. We're going to ask Karen to open the line for questions.

Thank you. (Operator Instructions). We'll take our first question from Amit Kumar with Macquarie.

Good morning and congrats on another strong quarter. Just going back to your opening comments regarding Ascension, and expanding and retaining more, can you sort of maybe just expand a bit more in terms of how we should think about the level of premiums and the level of retention going forward?

We are expanding the program as we mentioned. We're not at this point going to specify which states we're expanding it into but we mentioned that we expect three more states this year and other states in 2012. In the initial Michigan rollout as I had mentioned earlier, the business that was written as of the April 1 common effective date was business that was insured with Ascension's affiliate previously so under the risk sharing as I mentioned a lot of that goes back to Ascension. Going forward we expect to see more of the risk retained by us and over a period of time there will be more of a balance in the sharing of risk. I think that's about all I can say right now. Does that answer your question?

Yes, and I think the other thing is because there is some variability in that risk sharing depending on the source of the business and a lot of these positions that we're now targeting are open market insured's, it's really hard for us to make any accurate predictions.

Correct.

I guess what I was trying to understand was that does that $5 million grow to something less than $50 million, just in terms of some type of broader range. That's what I was trying to understand. What's the sort of the uptick to the premium number?

Amit, it's Stan. We have not put a number on it internally. It's an opportunity about which we are excited but it's an opportunity that has to be executed. This is, to our knowledge, a unique program that carries unique attributes and so it would be folly to try to guess at what it may mean. I mean all we can do is tell you the results as they occur.

Okay. Moving on I guess related to that is the authorization, the discussion; you have $194 million remaining for buyback or repurchasing debt, can you just sort of expand how you think about capital levels currently and maybe refresh us on what your thoughts are on maybe a special dividend or a common stock dividend?

Hey, Amit. It's Ned. From a capital level standpoint, we certainly have adequate capital to run our operations and recognize that we have some level of excess capital. We do not put out a specific number as to what we think that excess capital amount might be. We continue to do share repurchases as a viable means of returning capital to the marketplace. Really haven't moved from our position that if we see our stock trading below stated book value we're going to be aggressive buyers of that stock. Above book value, we evaluate a number of factors including our perception of what it would cost to replace that capital. Competing capital needs. Competing investment opportunities.

As for a special dividend and a periodic dividend, we discuss with our Board on a quarterly basis capital management strategies. Nothing is ever off the table. But we have no current plans.

Okay. The only other question and I will read to you is, can you just quickly talk about that commutation and if there are other commutations in the pipeline? Thanks and good luck for the future.

Sure. The commutation as we said was with what used to be AXA Re. We will on a pretty continual basis evaluate our older reinsurance treaties. We will enter into discussions with reinsurers and if we can find terms that we think are economically fair, we'll look to commute those treaties. It's a two-party, at least a two-party agreement. Often times you have multiple reinsurers involved and it's really a matter of coming to terms that everybody can agree upon. But it's something we actively do with our older treaties but we'll only take action when as I said if we can come up with something that we think is fair economically.

Okay. Thanks. That's all I have.

Next, we'll go to Matt Rohrmann with KBW.

Gentlemen, good morning.

Morning. How are you doing, Matt?

All right. Just two questions, first I know we've talked a number of times before on doctors moving to hospitals for the lifestyle that provides stability there, I guess looking back over the first half of the year and things you've been seeing on a go-forward basis, have yourselves or anyone out in the marketplace seem to have changed their strategy in terms of targeting those larger institutions to try and attract more of that business?

Yes, Matt. This is Howard. I guess first I'd say that we don't see any change in that trend. It continues. We are targeting hospital business and we've written hospitals since the mid-1980s so it's not new to us. But we are making an extra effort to be in the hospital professional liability marketplace because one way of course to continue to insure physicians is now to insure the hospitals that are employing and acquiring the physician practices. So we have made an extra effort to be more competitive in the hospital marketplace on a reasonable basis particularly in areas where we have a concentration of the physician marketplace and can integrate the physician and hospital business together from a client's perspective.

Okay. Great. So really no notable changes in the competitive landscape overall.

No. The hospital market is quite competitive and maybe even more so than the physician professional liability market.

Okay. Great. And then it seems like every quarter we always have commentary covering different states such as some folks trying to get rates up in Maryland, some tort reform in North Carolina, Florida looking at their tort reform there post some M&A activity. Any of those or other states, anything that you'd be keeping a closer eye on that we've seen over the last few months?

You know, as we've said many times, we look at every state as a separate business. And so we analyze and evaluate every state individually. We obviously keep a close eye on what is going on in each state.

Okay. So none of those states in particular changes have attracted more interest from you than others?

No. No, we look at every state separately and every state independently and we are very driven by data and we're not particularly driven by headlines.

Okay. Great. Thanks very much, guys.

Next, we'll go to Mike Grasher with Piper Jaffray.

Thank you. Good morning, everyone. Congratulations on the quarter. Quick question just around the movement into the hospital marketplace relative to the regular flow, what is different about writing that policy from a terms and conditions standpoint as well as a rate?

Let me just start by saying that it's not a move into the hospital marketplace. We've been there. And --

Understood. Understood. Maybe more emphasis.

Just wanted to clarify that. It's a different -- certainly a different structure. You're ensuring a corporate entity that has in many cases wide ranging exposures both onsite and off-site where hospital zone outpatient facilities that may or may not be on the campus. They own physician practices that are potentially located where those physicians used to practice before the practice was acquired by the hospital. So the evaluation of the exposure and the loss prevention risk management activities have to be different. We have a group of risk management staff that is specialized in identifying hospital professional and general liability risks and customize what they are doing for the inpatient exposure, which is quite a bit different than evaluating and making recommendations on a physician practice.

From the structure of the policy, typically you're dealing with a single limit that encompasses all of the activities that arise out of one client, whereas with a physician policy you might probably have multiple physicians involved in the same claim, although those physicians have lower individual limits. The hospital tends to buy more of a tower type limit. So it's a different environment and a different -- and then finally I guess you could say a different claims environment as well because of the limits that are at stake in many cases.

Okay. And is there any sense of -- I mean is there a bit of cannibalization that potentially could arise from something like -- or from this?

In our own business?

Well, yes, exactly.

I guess I wouldn't look at it that way. I think it's more preservation in many instances again because the hospitals are becoming fairly aggressive in bringing physicians into their entity one way or the other either by direct employment or by acquiring their practice into a subsidiary. So I don't think -- it's not a matter of cannibalizing the business that we have, it's really a matter of holding onto some of the business that we might otherwise lose.

Okay. That makes sense. And, Vic, I wanted to ask just about the opportunities maybe that you're seeing out in the marketplace, has that changed any at all? Could you just provide some commentary around the M&A environment?

It's generally consistent. We look into the opportunities that are out there. They're somewhat episodic as we said in the past. It's more driven by the potential seller side. But we continue to explore every medical professional liability transaction that we're aware of, permitting it's suitable for us to pursue.

Okay. And then just final question around APS and that business, you mentioned I think a bit surprised in terms of the duration of the claim or coming to resolution. Any other surprises and how has that held up?

From an underwriting and book of business perspective, pleasantly surprised I guess maybe is the only surprise I would say. And the book of business is quite good and very pleased with the process that we're going through now to integrate computer systems and operations of the company. That's it.

Okay. Thanks very much.

(Operator Instructions). Next, we'll hear from Jack Sherck with SunTrust.

Thank you very much. A question on the faster resolutions in Texas, just for perspective, how much faster do those settle than the rest of your business in terms of other states?

You broke up a little bit there at the end of the question.

How much quicker is APS in others?

Well, every state varies and has its own payment pattern or claims resolution pattern, so as compared to our overall book of business, Texas is certainly faster. Maybe compared to some other individual states might not be as different. But we certainly see cases in Texas being resolved within 15 months of filing in many instances, which then gives us more comfort and certainty about what's happening in the more recently filed cases.

And then how would that 15 months stack up against the rest of your business?

Well, again, it varies a lot. But I mean some states, Indiana as the other extreme, the average claim resolution in Indiana can be as much as four years.

Right.

So it can be quite a bit different. And that's influenced by the court system. It's influenced by whether or not a state has mandatory arbitration panels or processes in place, the length of discovery and the whole process of discovery.

Okay. And then just moving on to rates, just in terms of the little down tick we've seen there, you mentioned it really wasn't -- you didn't think it was indicative of any real softer pricing environment. Is that just a mix going on there or a timing of renewals or just a little more color there would be great.

I think what we're trying to say there is that the average rate decline in the quarter is quite similar to what we had generally been seeing. In the first quarter of this year, it was a little higher and as we mentioned that was a result of concentration of business in Ohio where we had a rate decrease and the business was more concentrated in the first quarter. But I think overall this quarter was pretty similar to -- other than first quarter of 2011, pretty similar to the last four quarters in terms of the kind of rate change that we're seeing, which is a reflection of the loss costs that we've been seeing in the marketplace. And to some extent competition. And the competition is more or less similar now than -- as compared to what it's been over the past year.

Great. Thank you very much.

(Operator Instructions). Now we'll go to Seth Bienstock with TimesSquare Capital.

Hey, guys. Congrats on another strong quarter.

How are you, Seth?

Doing well, thanks. I was hoping you could please comment on the current loss severity trend and how this rate of change compares to recent prior years?

I think the severity trend is quite similar to what we've been seeing over the past year to 18 months. We're seeing trend at about 4% right now and that is again similar to what we saw in 2010. Somewhat lower than if you go back year by year, it's lower than what we saw three years ago when we were talking about 5% or 6%. And certainly lower than 10 years ago when we were in the high single-digits in some cases and to the low double-digits.

Okay. And then in terms of the favorable development, could you perhaps broadly delineate how much was [cases or takedown] versus release of IBNR?

Not immediately or not at my fingertips here. I think when we have the [statutories] filed you'll be able to see it in there. To be honest when we look at the reserving process what we're projecting is ultimate loss costs, subtracting paid, whatever case reserve change falls in. So we don't specifically project IBNR and that's why I don't have a readily available answer for you. It's more of a byproduct of the process.

Sure. That's helpful. And then maybe one final question just curious how much capital is currently sitting up at the holding company and if there's been any perhaps share repurchase subsequent to the end of Q2?

We've been in a blackout essentially since July 15 or so, Seth. So I can tell you there's been no share repurchase. I'm kind of tap dancing here while --

I think the number -- kind of available capital at the holding company is roughly $100 million - $97.5 million.

Okay. Great. Thanks a lot, guys.

(Operator Instructions). We'll now take a question from Howard Flinker with Flinker & Co.

Pretty nice results. Better than the results we get in DC I think. I've got a question about the activity of doctors, have you seen or been able to see any doctors retiring as a result of the insipient "Obama Care" in a year and a half?

No, I don't know that it would be fair to say if we've seen a lot of physicians retiring. I think it is fair to say is we see a lot of physicians very concerned over the increasing pressures they are under from a regulatory standpoint, a legal liability standpoint, a revenue standpoint that they're sort of at the pivot point for all these increasing pressures that society is imposing on them. We ask an awful lot of our physicians.

Yes, we do.

And now we're going to ask even more.

I wonder if -- go ahead.

And we here, recognize that and we try to be very responsive to the environment in which our physicians are expected to operate today and we want to be as helpful as possible in enabling them to navigate these challenges.

There are two reasons why I asked. One, one of my physicians who doesn't take any insurance or medical care and I want to see him anyhow. The guy used to be at Columbia, is now at Cornell. One day said, what do you do if I retire? And he only takes cash or checks. So he doesn't have many of the administrative problems others have but I'm sure there's only so much he can charge before all his patients go away. So I thought well he's not the only guy who's thinking about this. And two, --

I'm sure you're right.

I saw a graph the other day, a rather striking graph, which I've kept that said that when "Obama Care" was passed in April of 2010, there was a dramatic slowdown in the creation of new jobs nationwide from the already very slow rebound from the bottom. Exactly one month later, new jobs almost went to zero. It was rather striking and I thought you know what? If that's going through employers' minds or executives' minds, it's got to be going through more doctors' minds and I was wondering if you guys have seen that yet.

I know lots of physicians are very concerned.

Yes. They're talking about it but they haven't done anything yet, is that a fair description?

If your physician retires, Howie, you call us and we'll help you find somebody else.

All right. Thanks. I'll find others but I find ones that are typically more expensive than normal so they're going to stay on a little longer. But I saw what happened in Canada. Young people don't go to medical schools and doctors either leave or drop out -- leave if they can and go to another country. That's my question. Thanks, guys. And again, really good results.

Thank you.

(Operator Instructions). And we'll take a follow-up question from Amit Kumar of Macquarie.

Thanks. Just two quick follow-ups. In terms of pricing I know you briefly touched upon the states, but can you sort of separate out the pricing movement in your core book, the foot doctor book, as well as APS?

I think we'd say that APS is part of our core book as are the doctors of podiatric medicine. They're all physicians and so they're -- we really are hard pressed to break that out. We've got some break out in the Q that we filed this morning that may be helpful to you.

I did read that and that's why I was following up. It did talk about some moving parts in the Q but it did not expand.

In the past, Amit, we had mentioned that the podiatric business -- in the podiatric business we were seeing some rate increases because of increasing loss severity and recognizing that, but we had not quantified the percentages on that. Whereas in our physician, MD DO physician and hospital business, the market is more competitive and loss costs are generally stable or declining. So we've seen some rate decrease.

Okay. Thanks, Howard. And the only other question is on the tax credit investment, does that number continue to change or is that -- did you talk about it? Is it -- are you done with that allocation currently?

The allocation is roughly $100 million. We have committed somewhere between $85 million and $90 million of that $100 million. However, there is a ramp up time of actually investing the proceeds so we would expect over the next couple of quarters to continue to see the actual dollars invested in those tax credits to continue to increase.

Got it. Okay. Thanks for all the answers.

(Operator Instructions). And it does appear that there are no further questions at this time.

Thanks, everyone. We will speak to you when we report our third quarter results in November. Thanks for joining us this morning.

Once again, that does conclude our conference today. Thank you again for your participation.