ProAssurance Corp (PRA) 2011 Q3 法說會逐字稿

Good day, everyone, and welcome to today's ProAssurance third-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.

Thanks, Nicole. Good morning, everyone. Thanks for joining us for our third-quarter 2011 results conference call. I need to take care of a bit of legal housekeeping first.

On Wednesday, November 2, we issued a news release and filed an 8-K reporting our results for the quarter and nine months ended September 30, 2011, along with our SEC filings, including the 10-Q we filed on Wednesday, November 2, 2011. These documents provide you with important detailed information about our company and our industry. These documents discuss in detail many important factors that could affect the outcome of future events and thus cause our actual results to differ materially from current projections and expectations.

Please read and understand these cautions, and 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 we expressly disclaim any obligation to alter or update information disclosed as part of these forward-looking statements.

The content of this call is accurate only on Thursday, November 3, 2011. If you happen to be reading a transcript of this call, please know that we did not authorize that transcript and we have not reviewed it for accuracy. Thus, it may contain factual or transcription errors that could materially alter the intent or meaning of our statements.

And one final reminder, we're going to reference 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 in today's call are our Chairman and CEO, Stan Starnes; our President, Vic Adamo; and our Chief Financial Officer, Ned Rand. Howard Friedman, our Chief Underwriting Officer and Actuary, is not on the call today because he is attending an industry conference. Stan, will you kick it off for us?

Thanks, Frank. Good morning to all. As we've been able to say for a number of quarters, our results reflect the product of the diligent execution of a well-conceived operational plan. By this, we focus our considerable energy on building an enterprise that can achieve long-term success in any financial or competitive environment. I want to briefly highlight a few things that I find encouraging and informative as we analyze our results.

First, we again grew the top line, primarily because of our acquisition with American Physicians a year ago, affirming our decision to acquire a quality business which is a good financial and strategic fit for our company.

Our long-term strategy also enabled us to increase operating income as well, validating our dedication to treat it fairly and all that it entails. With the relentless, enthusiastic pursuit of unparalleled customer service, we have built and maintained a loyal policyholder base. And we continue to attract new business from insureds who value the true difference of a ProAssurance policy.

Finally, a couple of items worth highlighting on the balance sheet. Book value per share rose to $66.23, up 10% this year. And for the first time in our history, shareholders' equity topped the $2 billion mark. Frank?

Thanks, Stan. Ned, can we get some further financial commentary from you?

Sure, Frank. I'll be focusing on the quarter's results in my remarks unless I specifically mention otherwise.

Our gross premium written was up 10% quarter over quarter to $175 million. For the second quarter in a row, new premium from our American Physicians acquisition, $17 million, was the primary driver.

In the quarter, pricing on renewing premium was up about 1%, driven by our podiatric business, the renewals of which are heavily weighted to the third quarter. For the year to date, our overall NPL business pricing is holding fairly steady, down just 1%. Our overall NPL retention was 89% in the quarter, and the same for the year to date.

While we are pleased with the top-line gain due to new premiums and steady retention, we have to acknowledge the challenge of the persistent low-interest-rate investment environment.

Our net investment result was $32 million, down $2.5 million compared to the third quarter of 2010. Our net investment result is the sum of our net investment income, plus any earnings or losses in our unconsolidated subsidiaries, excluding realized investment gains and losses. Net investment income in the quarter was $34 million, down $1.5 million compared to the year-ago quarter.

Also impacting the net investment result was the effect of our investment in federal tax credit limited partnerships. We continue to get questions about that. I'll explain that these tax credit investments reduce our investment result as we amortize the investment, but we generate tax credits that reduce our current tax liability. For example, this quarter the tax credits decreased our net investment result by $1.5 million on a pre-tax basis while reducing our overall tax liability by $1.2 million.

We present a table in our 10-Q that highlights the impact of our tax preference investments, and I would encourage everyone to take a look at it to help gain a better understanding of our portfolio.

On the expense side of the ledger, total expenses were down 12%, our third straight quarter of declining expenses, primarily due to the effect of net favorable reserve development. However, underwriting expenses were up about 9% quarter over quarter, almost entirely due to expenses related to APS. Those comparative amounts were not included in the prior year's third quarter.

In the third quarter, we recognized net favorable loss development of $52 million, related to losses previously established for prior accident years. In our non-APS business, that was primarily for accident years 2004 through 2009 and amounted to $47 million. The remaining $5 million was from our APS book.

Operating income for the quarter was $48 million, up 16% quarter over quarter. Net income for the quarter was $44 million, a 14% decrease quarter over quarter, largely driven by net pre-tax realized investment losses of $11.9 million, which reflect an $11.7 million mark-to-market adjustment for our trading securities portfolio.

On the diluted-per-share basis, that equates to operating income of $1.57 per share, up 21% over last year, and net income of $1.42, an 11% decrease compared to 2010's third quarter.

Return on equity, which we calculate using net income, on an annualized basis was 8.8% in the quarter, compared to 11.3% last year. Year-to-date return on equity was 10.1%, compared to 9.8% for the first nine months of 2010.

Stan mentioned book value per share reached $66.23, and I'm going to reiterate the 10% increase this year because we, and others, regard it as an important metric for measuring our performance as an organization. Tangible book value per share is $59.20, an 11% increase over year end.

I'll close by highlighting our ongoing commitment to capital management. We purchased 82,000 shares early in the quarter at a cost of $5.6 million, and we paid our first quarterly dividend three weeks ago. Frank?

Thanks, Ned. Vic, I know that you and Howard have discussed the overall loss climate. Can you address that topic for us?

Sure, Frank. Overall, frequency trends remained flat, basically unchanged since the end of 2008. We do continue to see stability in severity trend. It's still going up about 4% a year, a rate at which we've seen for some time and a rate which we believe is very manageable.

I also will briefly mention our reinsurance renewal. As you will recall, our treaty renewed on October 1. Our treaty was fully subscribed this year and renewed with no change in our retention or program structure, but some minor improvements in pricing. We remain with high-quality reinsurers who lead the program, and it's widely spread throughout Europe, London, United States, and Bermuda.

Thanks, Vic. Stan, can you wrap up with a couple of remarks on the Ascension program and give us your final thoughts before we take questions?

Absolutely. We continue to push forward with the Certitude program and Ascension Health. To date, the Certitude program is approaching 600 physicians and has generated roughly $7 million in first-year claims-made premium, primarily in Michigan. Much of the Michigan premium, arising from Ascension's preexisting physician program, is ceded back to Ascension's captive, as we explained last quarter.

We continue to generate new business as we move the Michigan program forward by concentrating on physicians affiliated with Ascension Health who are insured in the open market. The program will now move into several states in the next few months, as we and Ascension identify attractive markets within our common footprint. We can't forecast the premium from these markets yet, but we continue to be excited about the potential business there.

The Ascension program is generating quite a bit of interest in our ability to work with hospitals and large groups to deliver the kind of service and claims expertise that sets us apart. The insurance needs and expectations of physicians are far different from the needs of facilities, so we are viewed as an experienced, trusted partner that can deliver extraordinary service and protection to physicians, while allowing hospitals and their captives to focus on important strategic issues in healthcare.

At the same time, we see opportunities for growth in the traditional hospital market, where our expertise and financial strength makes us a natural partner. For example, I'm pleased to tell you that ProAssurance has won the professional liability endorsement of the Kentucky Hospital Association, after demonstrating our long-term commitment and our exceptional capabilities in that market.

As I've said at every opportunity, I think we offer a product that's unlike the offering of any other NPL carrier, and our insureds see the value in it. That allows us to keep our promise of insurance to them and live up to the promise of enhancing shareholder value, which puts us in a tremendous position to succeed in light of the evolving challenges facing healthcare and the NPL industry today. Frank?

Thanks, Stan. Before we ask Nicole to open the line for questions, I want to let everyone on the call know that Stan will be appearing on CNBC's Street Signs today at approximately 2.30 p.m. Eastern Time. And with that, Nicole, we are ready for questions.

Thank you. (Operator Instructions). And we have our first question from Amit Kumar from Macquarie.

Thanks, and congratulations on another strong quarter. Maybe we can start with a quick update -- and I know you mentioned Howard is not around -- on the tort reform climate. Has anything meaningfully changed in the past few months, or is it still business as usual?

Hello, Amit, this is Vic. Actually, there's quite a bit going on. Quite recently, Oklahoma and Tennessee both adopted tort reform packages that included caps on noneconomic damages -- $350,000 in Oklahoma and $750,000 in Tennessee.

Fairly recently, the California Supreme Court upheld another challenge -- they get challenged all the time -- to the noneconomic damage cap, and upheld it. And there are now cases pending before a number of state supreme courts on their caps -- Missouri, Florida, and Mississippi.

So we're seeing a lot going on. Some of those markets, definitely Florida and Missouri, are key markets for us. The rest we have only minor participation in. But there is quite a bit of activity going on and we'll keep you updated.

Want to mention federal tort reform at this point?

Well, as you know, the supercommittee is trying to figure out how to rein in our budget, and there have been proposals before to include tort reforms of some type to reduce the cost of the medical component of our deficit. But so far, as you know from general news, the supercommittee doesn't seem to be agreeing on anything. And we're doubtful that any tort reform's going to emerge from that, but it is constantly being placed before the Congress on a national level.

Got it. That's very helpful. The other question I have is on the capital management. I know previously you've talked about being aggressive buyers below book. And maybe, can you just sort of touch upon how you view that just based on the current multiple? And I guess just related to that, what about M&A opportunities related to capital?

Hi, Amit, it's Ned. Really, nothing's changed in our stance from a capital management standpoint. What we said in the past is that we'll be aggressive buyers of our stock below book value. And above book value we do buy stock, but a lot of different factors come into that evaluation -- alternative uses of capital, our expectation of future book value for the organization, things of that nature, our ability to replace capital in the markets if need be. So I would say nothing's really changed from a capital management standpoint. I'll let maybe Vic comment on the M&A environment. Or Stan.

Yes, the M&A environment remains as it has for the last several years. It's very episodic and you have to be very opportunistic. We think that in the coming months and several years out, there'll be plenty of opportunities for us to take a look at organizations as the healthcare environment becomes a little less murky, and we will do that as we always have.

Got it. And final question, just on -- this is quick one. On competition, has there been any change? I would assume that things only are getting better. Or has there been any change in any of the states from new competition?

It remains a very fragmented market, and as you know, the pricing cycle remains soft. We concentrate very much on what we at ProAssurance can offer physicians that others cannot, and it's through the differentiation of our products and what we do that we compete. And that's the case whether it's a soft market or a hard market or any other environment in which we're living.

So I would say, in terms of competition, you have to look at every state differently. Every state's a different business. But we feel like we're in the position we'd like to be in at this point in the cycle.

Got it. That's helpful. That's all. Thanks, and congrats once again.

Thank you.

And our next question comes to us from Jack Sherck from SunTrust.

Thank you very much. Just a question on the rate environment. You mentioned that rates, including the podiatric business, were up 1%. What would they have been exc. podiatric?

I don't know that we think of that.

Jack, I don't know that we have that on hand.

Okay.

I think it was down about 1%.

All right.

It's not meaningfully different from the podiatric business, but the podiatric business is up a couple percentage points.

Okay. And then just any early thoughts on pricing heading into next year?

No, we don't see any dramatic change coming forward in pricing. The market generally, over the last number of years, has been moving downward, though not irrationally so across the board. And we don't see anything that's going to flip the market from soft to hard, but we still don't see a widespread irrationality in the pricing.

Okay. And then just on the Kentucky Hospital Association certification there, could that be a game-changer for you, and do you have anything like that occurring in other states that would help your penetration rates in the hospitals?

We have insured hospitals for 25 years. The major part of our business, as you know, are physicians and dentists and individual healthcare providers, but then hospitals have been an important part of what we do. The Kentucky Hospital Association has recognized that by endorsing our program.

Will it be a game-changer? No, but as an organization, we're not real keen on game-changers. We like to do things on a rational, progressive sort of basis, and we look at things with a 20-year point of view and not a quarter-to-quarter thing. So while we think it's important to have the endorsements of organizations like the Kentucky Hospital Association, it's not going to make us a different company than we are today.

Great, thank you very much.

And we have a question from Mike Grasher from Piper Jaffray.

Thank you. Just a couple of topics here. First of all, congratulations on another stellar quarter. Great to see in this environment. Stan, I wanted to follow up just in terms of the market outlook. Just I guess perspective or a sense of these being highly fragmented, the smaller insurers. Any sense of maybe the pain that they might be feeling with investment yields where they are, or that combined with the pricing environment, having been so soft for so long?

No.

Sort of closer to a turn?

It's impossible for anybody, I think, to predict a turn, and we certainly don't anticipate being able to predict a turn. What we can say is this -- this low-interest-rate environment is persistent and it's having an impact on everybody in our space. Some people perhaps may choose to do things to seek to avoid it, such as going out in duration and that sort of thing, which we do not seek to do.

What the investment environment really means is that people have to be underwriters. There's no place to hide in terms of your investment return. And if you're a good, solid underwriter, it puts you in a much better position to weather the low-interest-rate environment. One would think that a low-interest-rate environment and the emphasis that it causes everyone to put on underwriting results -- or that it should, at least, cause everyone to put on underwriting results -- would depress the possibility of irrational pricing.

And I think beyond that, it's just speculation. But it is clear that the good performers going forward in this environment will be good underwriters, because you can only do the temporary things, like chasing duration and that sort of thing, for so long before it ricochets back to you.

Okay. And then just to flip over to the topic of the AMPH transaction in your Texas book, what are you learning about Texas overall? I guess more specifically, what is the retention on the book? As I look back, I think that maybe the net premium written had topped maybe -- or been right around the $20 million mark a year ago. This quarter they come in at around $17 million. So I guess what is the retention on the book, and what are you learning about that market?

Howard's not on the call. He's sort of the keeper of the specific retention figures. Ned will probably look that up. But the material we have in front of us, just on the market itself, I would say to you that we remain very positive about Texas. We think it's going to be a particularly good stake for us in the future. It has the constitutional tort reform. It's growing from a standpoint of the number of licensed doctors and that sort of thing. We've integrated our systems now with Texas, with our Austin office. That's been complete. And we've been pleased with the performance of the book we inherited in Texas. We're writing a bit of new business there, and we've been pleased with our retention. Ned may have the number for --

Yes. Mike, a couple things. One, just the pure retention numbers, that's 87% for the quarter, 89% year to date. But one thing to keep in mind, and this is really typical of any transaction that we've ever done, is we typically see a lower retention rate in that first year of renewal business just as we kind of overlay our underwriting standards on someone else's book of business. And so while competitive forces are certainly a significant contributor to that retention rate, some of our own underwriting standards also affect it, and I think you can see that really when you look at any transaction we've done.

Okay, so nothing to read into a dramatic change in the competitive landscape there, other than just your normal renewing -- rewriting of some of that book.

No, there's a -- I mean, yes, not to underplay the fact that it's a very competitive state given the attractive loss environment in Texas.

Okay. Thanks a lot.

And we have a question from Paul Newsome from Sandler O'Neill.

Good morning and thanks for the call. I was wondering if you could say if you a few words about the outlook for investment income. Is a good chunk of your book running off? What do you think about the reinvestment rates that you're getting today, and how should we think about reinvestment risk?

Yes. The portfolio has a duration around four years, maybe a little shorter than that. As Stan mentioned, one of the things we're kind of loathe to do is to chase yield by extending duration. So in our core fixed-income portfolio, what we have been seeing kind of on a quarter-over-quarter basis, looking back to the year-ago prior quarter, is investment income down $1 million to $1.5 million every quarter as we reinvest at lower rates. And I don't think we see anything right now that really stops that trend, unfortunately, going into 2012.

We are doing some things outside the core fixed portfolio to try and find some additional field for the overall portfolio. So we're adding dividend-paying equities to the portfolio. That is in large part what contributed to the significant realized loss in the quarter. We hold all of those dividend-paying equities in a trading portfolio, so we mark-to-market through the income statement.

And it's also the reason we're investing in things like federal tax credits. While they kind of obscure the result, because the benefit shows up in the tax line, we find very attractive yields, or have been finding very attractive yields there. And we'll continue to look at alternatives to the fixed portfolio to find some yield, not in a large way. We'll always be mainly fixed-income investors, but to find some incremental yield given the challenging environment that we're in.

Do you have some parameters by which you'll think about how much you would do in alternatives and other --?

Yes. Really, we want to limit our alternatives to about 10% of the portfolio. Right now it's around 5%. I don't know that we're in any hurry to take it up to 10%, but within our guidelines, that would be as high as we would take it.

Perfect, thank you.

And Matt Rohrmann from Keefe Bruyette Woods has a question.

Hey, guys, good morning. Just wanted to follow up on some of the state commentary that Vic had mentioned. Vic, first, it seems like there's been some more press out there as of late, having officials look at possibly revamping the system in New York. I know press doesn't mean anything; it's a long way from any real changes. But have you guys gotten any sense there that things might be moving in the right direction? Obviously not a key market for you, but could be down the road.

There's just a great deal of discussion in every state and as the legislatures change over and there's different dynamics. But in our key markets, the core markets, the larger markets we're in, there's not really a lot of activity going on now, which is fine from our point of view. Those are stable markets. We're not that familiar with New York. Our podiatric company does business there, but the main part of the organization does not do business in New York.

Okay, great. And then, obviously, Texas itself has been a great success for ProAssurance. As you guys get deeper in that market, has the TMLT or Advocate or any other competitors there changed sort of the way they're doing business as the market evolves?

I don't think that there's anything we could specifically point to that's a change attributable in the conduct of others that we have triggered in any way. It's a competitive state. They're good competitors in Texas, solid organizations, and they certainly affect the competitive landscape there.

But, again, what we need to concentrate on is what we do at ProAssurance and what we do to protect our physicians and the other healthcare providers we insure and what we offer that we genuinely think is a very, very unique product. And as we sort of escalate our efforts in Texas, we think physicians will see that, and it will enable us to enjoy the success there we've enjoyed in other states.

Okay, great. Thank you, gentlemen.

(Operator Instructions). And we have a question from Howard Flinker from Flinker & Company.

Morning, Howie.

Ned, I've got a question for you. How do you define operating income? I added back taxes and reversed capital gains and losses, and came up with completely different numbers, so I must have the wrong definition.

Yes, Howie, I'll give you kind of how we define it, but the easiest thing in both our press release and in our 10-Q is a reconciliation between net income and operating income. To get from net income to operating income, we exclude realized investment gains and losses. We exclude assessments from insurance departments, the state assessments, the funds. And in this quarter, we had a litigation settlement that increased net income, and we're taking that out to get the operating income.

Oh, I overlooked it. You have it on the second page.

Yes.

Okay, it's right there. All right, thanks.

Sure.

All right, take care, guys.

Thank you, Howie.

Thanks, Howie.

(Operator Instructions). And it appears we have no further questions.

Very good. Thank you, Nicole, and thanks, everyone. We will speak to you after the New Year with our year-end results. Thanks for joining us.

Once again, ladies and gentlemen, that concludes today's conference. We appreciate your participation today.