ProAssurance Corp (PRA) 2012 Q2 法說會逐字稿

Good day, everyone, and welcome to the ProAssurance Second-Quarter 2012 Earnings Call. 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.

Good morning, everyone. Thank you for being part of our call to discuss our second-quarter 2012 results. Please bear with me while I handle some important legal statements. On Monday, August 6, 2012, we issued a news release reporting our results for the quarter ended June 30, 2012. Subsequently, we filed an 8-K in our second-quarter 2012 10-Q with the SEC.

These documents and our other SEC filings provide important information about our Company and our industry, as they discuss in detail many important factors that could affect the outcome of future events, and thus cause actual results to differ materially from current projections or 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 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 Tuesday, August 7, 2012. We do not authorize, nor review, any transcripts you may obtain, so please know the transcript may contain factual or transcription errors that could materially alter the intent or meaning of our statements.

And the final item, we are 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, who has joined in remotely; Chief Financial Officer Ned Rand; Howard Friedman, our Chief Underwriting Officer and Actuary; and Vic Adamo, our Vice Chairman. Stan, your opening thoughts, please?

Thanks, Frank. Second-quarter results were again solid, as we continue to prove the benefits of a disciplined approach to a business that demands both vigilant attention to current operational details, and a long-term philosophy that rewards our consistent dedication to profitability and book-value growth. That's a proven combination that allows us to reward our shareholders, and protect our policyholders.

This was also a significant quarter in that we announced two transactions. The first, Medmarc, broadens our ability to ensure the wider scope of healthcare delivery, while adding to our growing legal professional liability business. The second, Independent Nevada Physicians Insurance Exchange, or IND, deepens our share in our traditional medical professional liability business. We have much to talk about, so let's get started.

Okay, we'll do that. Thanks, Stan. Let's focus first on second-quarter results, and then we'll update planned acquisitions. So, we'll go first to Ned.

Thank you, Frank. Gross premiums written were $102 million, a decline of $13 million over last year's second quarter. Approximately $6 million of the decline is due to the effects of our two-year policies written last year, and earned pro-rata for 24 months, and we continue to see the impact of a competitive market on our retention of business.

Howard, will you characterize the state of the market right now?

Yes. The market is quite competitive right now, and some areas a bit more competitive than at the start of the year, but still not at levels we have seen in previous soft markets. In fact, we see some slightly encouraging signs in some states. For example, we now know that one of the primary lower-priced competitors in the podiatric market is raising filed rates by 20% in select states. Rates for lawyers' professional liability are increasing across the industry. Taken as a whole, we continue to believe that the core physician and hospital markets will remain competitive, given the favorable loss environment.

Underwriting and pricing discipline has been a hallmark of ProAssurance in both hard and soft markets. As you can tell from this quarter's top line, we remain committed to writing only the business that supports our profitability target, and to walking away from business that does not meet our targets.

I will also touch on reserve development. Net favorable loss reserve development was $60 million in the quarter, $10 million higher than last year's second quarter, and primarily from accident years 2004 through 2009. In the current loss environment, our favorable development is being driven by the continuation of loss severity levels that have proved to be different from our expectations. In this case, the development is favorable because losses were lower than expected.

While we are pleased with the current outcome, the statistics from the early 2000s remind us that loss costs can change rapidly, and can result in industry-wide loss ratios well above 100%. We continue to exercise caution when considering today's evolving loss environment, as we set 2012 accident-year loss [space].

Ned?

Thanks, Howard. I want to mention a couple of other items. Net investment income is the primary component of our net investment results, and those are down approximately 5% quarter-over-quarter. This is primarily reflective of the low interest rate environment that all insurance companies are dealing with right now.

Also involved is the effect of the earnings or losses from unconsolidated subsidiaries, primarily the result of the amortization of tax credit limited partnerships, which are an important part of our investment strategy. The comparative effect of those tax credits is now becoming less noticeable because the credits were in place by second-quarter 2011. And for those of you for whom this may be a new concept, these losses are expected, and are more than offset by a reduction in our federal tax liability.

We saw an uptick in underwriting, policy acquisition and operating expenses quarter-over-quarter, primarily reflecting higher employee and benefit costs in the second quarter, driven by an increase in stock-based compensation and other incentive compensation. Also at work was a change in timing of recognition of policy acquisition expenses resulting from new FASB guidance.

The bottom line was net income of $58 million, or $1.89 per diluted share, and operating income of $59 million, or $1.92 per diluted share. Return on equity, which we calculate by dividing annualized net income by the average of beginning and ending shareholders' equity, was 10.4%, down 1 point from the second quarter of last year. Our focus on the bottom line is mirrored by our dedication to building book value. We are please to report that book value per share stands at $74.30. Tangible book value is $67.42 per share.

That is our review of the second quarter, but I want to mention some capital management decisions that will affect the third quarter and beyond. We intend to repay $35 million in outstanding long-term debt, which consists of $23 million in trust preferred securities issued in 2004, to provide additional premium capacity, and $12 million of surplus notes we assumed when we acquired (inaudible). Repayment will occur in August, and we will be using funds from the authorization granted by our Board for the repurchase of shares and retirement of debt.

In July, we paid off a $17 million note, and terminated an associated interest rate swap. Because we carried the note on our books at fair value, and we retired it at par, we will recognize a book loss of $2.5 million in the third quarter. Our decision to repay the debt was driven by the economics of the transactions. The end result is that we will have no long-term debt by the end of August, which will eliminate related interest expense that was $2.7 million in 2011, and $1.3 million through June 30, 2012. When the payments are complete, we expect to have $136 million remaining in the Board's authorization to repurchase stock.

Frank?

Thanks, Ned. Howard, anything you can add about loss and actuarial trends?

Sure, Frank. Frequency remains flat, as it has been for some time. Severity continues to be below our prior expectations, currently estimated to be increasing at about 3% to 4% annually. Average renewal pricing in our physician book was up 2% quarter-over-quarter. Primarily at work here is the automatic step increase in the claims-made policies that incepted in the Ascension health certitude program during the second quarter of last year. Absent those increases, renewal pricing essentially would have been unchanged. Premium retention in the second quarter was 88% in our Physician Book of Business, down 2 points quarter-over-quarter, consistent with our approach to the competitive nature of the market.

Frank?

Thanks, Howard. Now, let's swing over to Vic for an update on the status of Medmarc and IND.

Happy to give you an update, Frank. Both transactions are on track. Our legal counsel is reviewing the transactions with regulators in Vermont, where Medmarc is domiciled, and in Nevada, where Independent Nevada Physicians Insurance Exchange is located. The regulators have been very responsive as we work with them to complete the required documentation and prepare the material that will lead to a vote of the policyholders of each company.

We continue to believe that both transactions will close by January 1, 2013. Until closing, we are limited to the extent that we can work on transition and integration, but as we said in our conference call in June, we do not expect significant issues in that regard. Medmarc will function as a distinct business unit, given its distinct line of business. In the case of IND, they have a more robust operation in Nevada than ProAssurance, and we plan to move into the IND offices in Las Vegas, and serve the doctors of Nevada from that location.

Frank?

Thanks, Vic. One general development I want to mention is the Missouri Supreme Court's ruling on that state's tort reform laws. Last Tuesday, the Missouri High Court struck down the $350,000 limit on non-economic damages. Howard, could you walk through how that might affect the Missouri market?

Sure, Frank. It means that losses are likely to increase with the removal of the cap. We will be watching that, and also looking for signs that frequency may rise in that state, now that it may become more attractive to file lawsuits. We have not historically factored the caps into our Missouri rate-making and reserving, but have been guided by actual loss data.

However, the Missouri market has been dominated by a number of smaller companies formed under a state law that allows Missouri-domiciled insurers to get started with a relatively small amount of capital. Most of these companies have operated primarily in the post-tort-reform era, and have grown rapidly by selling lower priced assessable policies, which allow those insurance companies to force current or former policyholders to pay additional premiums if the company's reserves prove inadequate.

So, the ruling could have a significant effect on these smaller insurers and their policyholders, and could create some market opportunity for larger companies such as ProAssurance. Certainly this will have an unsettling effect on healthcare providers and patients in Missouri who have benefited from a stable medical legal climate since 2005.

Thanks, Howard. Stan, your background might give you some additional insight. Will you comment on the effect this will have on healthcare, and the effect it could have on other state courts considering tort reforms right now?

Frank, it would be unsettling to everyone and every institution delivering health care in Missouri because it removes the certainty and predictability of fair treatment in the courtrooms of Missouri, and that's unfortunate. It's too early to know the effects, but I assure you, we will be extra vigilant in Missouri.

As for the effect on other state courts, my experience tells me that it will be determined on a state-by-state basis. The general argument used by the plaintiffs is well-known and understood, and has been rejected in some states, and accepted in others. But it is certainly unfortunate because of what it could mean for the future of healthcare cost and availability in Missouri.

Switching topics, although we covered the importance of our two announced transactions in a call on June 27, I want to reemphasize how important both will be to us. Medmarc offers us a singular opportunity in the medical technology and life sciences realm of healthcare, which we think will continue to be significant as multi-faceted healthcare systems grow in importance and complexity in the next decade. We have to be able to serve that market to offer a complete healthcare liability solution, and we are excited to have an innovator such as Medmarc become part of ProAssurance.

While we know the traditional physician market has been shrinking, it is clear that there will always be a need for a medical liability insurance company that is dedicated to serving the needs of those physicians who choose not to join larger groups or become hospital employees. The addition of IND will make us the market leader in Nevada, and set the stage for us to respond to some growing opportunities there as healthcare evolves. Gaining a larger share of that market, and expanding to get a solid base of operations in the West, is a major step forward for us.

Finally, I want to highlight the fact that ProAssurance was named to the prestigious Ward's 50 for the sixth year in a row. This is significant recognition of the overall financial and insurance performance that sets ProAssurance apart from our competitors. I wish to salute the senior management team at ProAssurance for their vision and dedication, and I am especially proud of the enthusiasm and commitment of our employees who are the backbone of our success. My thanks and congratulations to each one.

Frank, all in all, it's an exciting time for ProAssurance, and we look forward to the future.

Thank you, Stan. Amy, I think that concludes our prepared remarks. We'll open it up for questions.

(Operator Instructions)

Mark Hughes, SunTrust.

Could you remind me how much Missouri is of your total premium? And have you had more favorable development there? I know you're not pricing for -- assuming the caps -- but losses come in better than expected, so you benefited from them?

Hey, Mark, Missouri is not even a top five state for us.

Okay.

Don't have the exact figure here, but, yes, $10 million to $15 million front-line premium. Howard?

Yes. In terms of the loss environment, it's hard to say -- the cap has been applied by some judges in some cases over the time that it has been in effect. So there has been benefit on those cases that have gone to trial, resulted in a jury verdict that included non-economic damages, and where those damages were limited and the case was resolved and not appealed.

So there has been some benefit, and therefore that would be factored into the loss experience. There are other cases where the cap was not applied, or certainly settlements where it was not specifically considered -- so it's not entirely clear, the beneficial effect that it's had or the effect that now it is gone. But we do think that it will have the effect of increasing fine frequency over a period of time, just because cases that have historically involved strictly or mostly non-economic damages, it might not have been as attractive, will now be more attractive to bring to a trial.

Missouri is that state that we talked about, the companies that have come into being under that law called the 383 Company. Those companies really have come to dominate the Missouri market and those are the companies you mentioned during your prepared remarks.

Right.

But still a relatively small part of the book, it sounds like, in any case.

Right.

Howard, was your language perhaps more upbeat in the press release on the reserve picture?

Well, I think what we're trying to explain in the news earnings release is that -- and what we have been saying over the past several quarters or years -- that the severity has been less than expected, and that as time goes on and it gets factored more and more into the data, that we are able to make judgments and our decisions about loss reserves with that in mind.

The expectation that we all had, that the lower frequency would result in higher average claim severity, has proven to be true to some extent but not to the extent that we thought, and we're just trying to be a little bit more explicit in some of our comments about that.

Last question -- the higher operating expenses this quarter -- would you expect that those should be sustained at this level? Or do some of those expenses drop off or drop down going forward?

Yes. Mark, they're -- it makes it hard, because there are lot of moving parts on expenses. Part of what, on the employee cost, a part of what was driving it was stock-based compensation expenses. And as our stock price has increased, the value of the stock-based compensation has gone up and that runs through the P&L. That is the going-forward and unfortunately, I don't have in front of me a breakdown of the pieces.

The other impact to incentive comp through the quarter was more of a one-off adjustment, so I would not expect it to continue. The other component is the new DAC guidance that was put out by FASB, and it will take a full year before that gets settled out, but the effect it's having right now is, it's increasing operating expenses. We saw this in the first quarter as well. Once we get through a full year of the adoption of that we will see those costs normalize. It doesn't impact the actual expenses. It's just the timing of the recognition of those expenses.

Right. Thank you.

Matt Rohrmann, KBW.

Howard, I know going back four or five years, talking to you about those 383 Companies that you mentioned -- is the ruling based on how aggressive they have been pricing? We have kind of viewed them as, at least in my words, more of a nuisance in that market over time with the aggressive pricing. Is this ruling a killer for those type of companies given how aggressive they've been?

I think -- this is Howard.

I think certainly the issue is going to be how they reserve, and to what extent those cases that they have open in particular -- how those cases are reserved, and that's hard for us to tell. We do think it will have a -- it should certainly have an effect, a company that is entirely in a market and where that market is, experience the change. If you look back ten years ago, something similar happened in Oregon, and it had a pretty significant effect on the company that was a dominant writer in that market. If you collectively look at these companies being Missouri only, and with the elimination of the cap, you would expect some significant reserve increases. But I don't know, ultimately, what effect it will have on those companies.

Again, as I mentioned in my comments, at least some of these companies are assessable, meaning that the policyholders can be required to pay additional premiums for prior years of coverage.

Got you; great. And then just a quick question -- Ned, I believe the European debt exposure for you guys is pretty much minimal, but I just wanted to verify that with you.

Yes, it is. I've got some detail here -- just one second and I'll pull it up. If you take a look at our Q, we've got some information in there. June 30, we held debt securities totaling $127 million that were with European exposure. $37.2 million of that is industrial and utilities in Europe. $44.2 million is energy and about $46 million is financial.

Okay, great. Thanks. Great quarter, guys; appreciate it.

(Operator Instructions)

Ray Iardella, Macquarie.

Maybe starting out with Howard, if I could -- could you talk about the decline in the current action in your loss [ratio]? Was that more mix-driven, or is there something else going on, or did you guys re-estimate the loss takedown for the current accident-year?

I guess let me start by saying, no, we didn't re-estimate down, and when you see the Q, there's a fair amount of disclosure in the Q about that. There's a number of things going on in the quarter. We had a little bit of a change in tail premium. We also had a change or a benefit from the re-estimation of [TDIT] premium from some old reinsurance years that resulted in a higher net earned premium than we would have otherwise had. It was a little under $3 million of additional net premium. That had the effect of pulling the loss ratio down a little bit.

And like I said, there's a table with some disclosure that will help guide you through that process in the comparison to the prior quarter. Year-to-date, I think it's fair to say that we're booking basically the same net loss ratio that we have done and that is roughly in the 84% range. It's a lot of noise but no change in approach.

Okay. Fair enough.

And then maybe for Ned -- just on the operating cash flow, it looked like a little bit low in the quarter. Anything going on there? I'm sure there's a lot of moving pieces, but I know paid losses might have picked up a little bit? Can you talk about that?

Yes, and it's exactly that. A lot has to do with timing. We did see a pick-up in paid losses in the quarter, in particular a couple of large losses that were settled -- older cases, where they were ultimately resolved during the quarter. We do expect significant reinsurance recoveries on those losses, because they do hit the excess layers that go to our reinsurer. We would expect some recovery to come forward in the next couple of quarters on them, but a lot of it is timing related.

Okay, that's helpful.

And maybe last strategy question for Stan or Vic -- just thinking about the Medmarc transaction, certainly a little bit of a new business line for you guys but close to where you have been operating in the healthcare stage. Should we look for other acquisitions from ProAssurance in these tertiary, or lines that are similar to this? Or are you guys going to be more focused on the core physician book going forward?

We're not going to change our commitment to insuring physicians in private practice. That remains steady. But in order to keep that commitment to those physicians, we think we have to offer products throughout the spectrum of healthcare. The healthcare system of the United States is changing dramatically over the next number of years, and in order to be a significant participant in our niche in that system, we think you are going to have to offer products across the spectrum of the system.

That was what was compelling to us about Medmarc. As you see physicians moving into larger and larger organizations, you are going to have to be an enterprise that has the geographic scope and the financial reach to provide products for the entirety of the organizations. That's sort of our strategic index, if you will, is what will enable us to participate fully in the healthcare system in the United States, which will evolve in the coming years. And as acquisitions come along that enable us to do that in an efficient and effective manner, a manner which benefits the policyholders, a manner which benefits the shareholders, then we will look carefully at every one of those.

My view of the world is that every company in the United States that offers professional liability to physicians is at a fork in the road. And they either are going to have to shrink as their universe of traditional policyholders shrinks, or they're going to have to expand to accommodate the world that is coming. And we think that will offer us opportunities.

I appreciate that answer.

Is there any other products that you think are attractive right now that aren't in your product suite? And thanks again for all the answers.

You are more than welcome.

We are in the process of reviewing that now, and I'm not going to telegraph our exact strategy, other than to say that we think it's going to be important for an organization like ours to offer a total package of insurance products to the healthcare system that's evolving in the United States.

Ray, before we move on, just let me follow up. The table that might be helpful to you on the accident-year loss picks is at the top of page 55 in the 10-Q.

Great. Thanks, Frank.

Matt Carletti, JMP Securities.

Just had a quick question on capital -- clearly, more than plenty by any leverage ratio that we might look at. With the recent performance of the stock, buybacks are at least less financially attractive. How should we think about your capital? Is there potential for an increased regular dividend? Would you consider a special dividend at some point? Or on the flip side, do you think you have enough growth opportunities to put the book of that to work, and you'd rather hold onto it?

Matt, it's Ned.

It's easiest to say we have all options on the table. We're not necessarily going to telegraph what our intentions are, but we do have all options on the table. We recognize that the excess capital that we hold is a drain on our ROE, and that can be impactful to the book value multiple that we trade at. Our desire, certainly, is to take that excess capital and put it to work in the insurance space, and we are continually looking for opportunities to do just that. But we are leaving all options on the table.

Okay; thanks.

Mark Hughes, SunTrust.

Yes. Howard, the 3% to 4% increase in severity -- was that a little lower than you talked about before? I've seen you using language of about 4%. Am I over-reading that, or is that something of a change?

I think we changed that last quarter. I think in 2011 we were talking about 4% to 5%. So, yes, I think you could say this year, again, with the additional data and looking at it, the current estimate is 3% to 4%. We will find out if that's right a few year from now.

Okay, thank you.

(Operator Instructions)

Ray Iardella, Macquarie.

Thanks for taking the follow-up.

Just quick numbers question, maybe for Ned -- in fourth quarter, assuming the deals close, anything in terms of additional expenses we should be looking for? Any guidance you can give us, numbers-wise?

Yes, Ray, probably not at this point. We hope to have these deals closed either by December 31 or January 1. And so some of those expenses may go into 2013. You know, we have been incurring expenses all along, legal expenses and the like, where we will have expenses around fairness opinions and fixed trustees with investment bankers and things like that. That will be larger. What is being paid on both sides of the transactions is market norm.

Okay, thanks again.

(Operator Instructions)

And, gentlemen, at this time there are no further question in the queue.

Thank you very much, Amy. Thank you, everyone, for participating in the call. We look forward to speaking with you again in November.

Thank you. That does conclude today's presentation. Thank you for your participation.