ProAssurance Corp (PRA) 2013 Q1 法說會逐字稿

Good day, everyone, and welcome to the ProAssurance call to discuss 2013 first-quarter earnings results. Today's call is being recorded. At this time, I would like to turn the call over to Mr. Frank O'Neil. Please go ahead, sir.

Thank you, Jenny. Good morning, everyone, and thank you for your interest and participation in our call to discuss ProAssurance's first-quarter 2013 results. Before we get started, I have a few legal matters to take care.

On Monday, May 6, 2013, we issued a news release reporting our results for the quarter ended March 31, 2013. We subsequently filed our 10-Q and a current report on Form 8-K with the SEC. These documents and our other SEC filings provide you with important information about our Company and our industry. And each discusses the important factors that could affect future results, which could cause our results -- 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, subjects to risks and other factors covered in those documents.

Except as required by law or regulation, we will not undertake, and we 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, May 7, 2013. We neither authorize nor review any transcripts you may obtain, so please know that a transcript may contain factual or transcription errors that could materially alter the intent or meaning of our statements.

We will 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 those non-GAAP numbers to their GAAP counterparts. Participating in today's call are our Chairman and CEO, Stan Starnes; Vic Adamo, our Vice Chairman; Chief Financial Officer, Ned Rand; and Howard Friedman, our Chief Underwriting Officer and Actuary. Stan, your opening thoughts?

Thank you, Frank, and good morning to those on the call. Before I get to the quarter's results, I want to acknowledge the debt of gratitude we all owe Vic Adamo, who is retiring toward the end of this quarter. This will be Vic's last conference call, and this is my last chance to publicly say thank you. The dedication he has shown in what will be 13 years of service to ProAssurance and previously 16 years at Professionals Group. Over that three-decade span, Vic's vision has helped ProAssurance achieve its position of leadership in our industry, and he has served our insureds and investors with distinction. Vic also has been a tireless advocate for our industry, through his service on the Board of the Physician Insurers Association. Vic, we are truly grateful for all that you have done. We wish you well, and want you do know you will be missed.

Now, to our results. Our successful quarter highlights a number of important tenets of our long-term strategy. First, as I have often said, our long-term focus is on the bottom line and what it means to our policyholders and investors. To that end, this was another profitable quarter in which we achieved our goals of increasing financial strength and building shareholder value. Our M&A strategy again proved fruitful in the quarter. Independent Nevada Physicians, IND, and Medmarc, combined to add $12 million of premium that we expect to be profitable at a time when achieving growth is extremely difficult. Our Medmarc acquisition proved especially beneficial for us as we broadened our reach in a medically related line of business and bolstered our lawyers' liability line. Plus our purchase of Medmarc resulted in a $35.5 million gain. That gain is just one of the many items that Ned Rand, our CFO, will be addressing as he discusses the several moving parts from the first quarter. Ned?

Thank you, Stan. I can provide that explanation right off the bat. We acquired Medmarc for less than the fair value of its net assets on the closing date, January 1, 2013. Because the fair value of the net assets we required exceeded our purchase price, we recorded a gain in the income statement as required by applicable accounting guidance. Net gain is reflected in net income, but not in our calculation of operating earnings or return on equity. Now to the details of the income statement.

Gross premiums written were $163 million, down 4% from $170 million in the first quarter of 2012. As Stan mentioned, our acquisitions brought $12 million of new premium into the Company in the quarter, and we wrote $5 million of new business in our existing physician book. However, that was offset by the impact of an increasingly competitive market. Also recall that in the first quarter of 2012, we wrote a single-reporting endorsement with a premium of $6 million. That one-time policy distorts comparisons to some degree, and we said at the time that opportunities to write such policies would be sporadic. Net premiums earned also declined quarter over quarter from $137 million a year ago to $135 million in the first quarter of 2013. This 2% decline is a direct result of competitive market forces that continued consolidation of medical providers and that $6 million tail policy I just mentioned. It was 100% earned in last year's first quarter, so again, it is skewing the comparisons.

Somewhat offsetting the decline in net premiums earned was $10 million of additional premium from acquisitions. Further, seated earned premiums was reduced by $4.8 million due to the emergence of favorable loss experience in our seated loss reserves, resulting in a reduction in the variable components of our reinsurance treaties. This quarter, as a result of our reserve analysis, we recognized favorable development in both our retained losses, as well as our seated losses.

Historically, we have seen development in our seated losses only during our more in-depth annual fourth-quarter reserve review process, because seated losses have more volatile than retained losses. However, as we have gained confidence in the trends in our seated losses, we are now more comfortable in evaluating these trends on a more frequent basis. Because the premium seated under certain of our reinsurance agreements are variable, what are termed swing-rated treaties, this evaluation also impacts seated premiums related to prior years. The adjustment resulted in a $4.8 million increase in net earned premiums, which in turn, reduced the current accident-year net-loss ratio by approximately 3.4 points. If you exclude that adjustment and the impact of tail premiums, our current year-loss ratio would be level with last year. Howard, on the heels of that premium discussion, it might be a good time to discuss pricing and retention and the effects of competition.

Thank you, Ned. Competition in the healthcare professional liability line is certainly not slacking off. Every renewal is aggressively contested and new business is difficult to obtain. Large account physician business is particularly competitive right now, and we certainly see some pricing that we view as irrational. But there are bright spots. You mentioned that we wrote $5 million of new physician business in our existing NPL book. About half of that was from the inception of the Illinois portion of our Certitude program with Ascension Health. Additionally, IND brought in $3.5 million of physician premium when we added them to our group.

Geographically, there isn't one state or region I would consider to be more or less competitive, and the key competitors vary from state to state as well. Given the degree of competition, retaining business at a profitable rate level is challenging. In our NPL line, premium retention was 87%, down five points compared to the year-ago quarter, but closer to the average we have seen over the last four quarters, which has been 88%. We have certainly seen individual quarters that resulted in a lower retention than this quarter.

As the past, notably last year has proven, the first quarter of the year is not always a predictor of the remaining three quarters. Average renewal pricing in our physician book was down 1% year over year. Given the competitive nature of the market, I think this shows a meaningful level of satisfaction from the vast majority of our customers who value our service and security, even when other coverage is available at lower prices. A couple of other bright spots, premium in our lawyers' professional line was up $2 million year over year, due to the addition of premium from the Medmarc lawyers book. And Medmarc also contributed $5.9 million of premium in the medical technology and life-sciences line.

I can also talk about loss reserves for a moment. Favorable reserve development continues to be driven by loss-severity levels that are proving to be better than our expectation when losses were last evaluated. As Ned mentioned, we made a $7 million adjustment to our seated loss reserves. The breakdown is $60 million of gross favorable loss development and $53 million of net favorable development. Right now, the rate of severity increase remains at about 2% to 3% per year, and the overall frequency trend remains flat, although we continue to monitor these trends very closely given the amount of variation we've seen in the past. In our last call, I said we see nothing in the aggregate to drive a significant change in our loss assumptions, and that remains the case.

Thank you, Howard. I hope those explanations are clear, but we can revisit them in our Q&A if anything needs clarification. Let me spend a bit of time on operating cash flow, which was down year over year. On the positive side, we saw an $18 million reduction in payments related to net loss and loss adjustment expenses. That was offset primarily by lower premiums, an increase in tax payments, and an increase in cash outflows associated with operations within our recent acquisitions.

On investments, our net investment result was essentially unchanged year over year. Like almost every other fixed-income investor, we are experiencing lower yields as we reinvest cash flows in the portfolio. This was offset by higher income from our investments in dividend-paying equities, higher earnings from our investment limited partnerships, and the addition of assets from the Medmarc portfolio. Underwriting, policy acquisition, and operating expenses were up almost $3 million year over year, primarily reflecting payments made in connection with our acquisitions and the addition of expenses associated with the operating costs of the acquired companies that were not present in last year's first quarter.

Net income was $113 million, a $57-million increase from last year. Keep in mind that $35 million of that $57 million was the one-time gain associated with the Medmarc acquisition, which will make comparisons next year difficult, and will give the headline writers who don't look beyond the numbers something to write about. We also have $27 million in realized investment gains, principally as a result of mark-to-market gains in our equity trading portfolio. Operating income, excluding these gains was $60 million, or $0.97 per diluted share. Return on equity was 13.4% in the quarter, excluding the gain from the Medmarc acquisition. Book value per share increased 4% in the quarter to stand at $38.19. Intangible book value per share is $34.69. Frank?

Thank you, Ned. Lots to follow there. Thank you for laying it out for us. Vic, will you give us a quick update on the integration of our recent transaction?

Sure, Frank. You've heard that as expected, both Medmarc and IND contributed meaningful premium to our first quarter. Medmarc serves a distinct clientele, medical product manufacturers and drug companies, rather than physicians and other medical providers. Accordingly, Medmarc will operate as a specialized division focused on their unique client base. Mary Todd Peterson, Medmarc's President, has joined our senior management team. The primary points of integration, mainly financial reporting and investment management, have a meshed well. We are also pleased to note that our respective sales teams are seeing crossover opportunities on the marketing side, especially at the national accounts level. And Medmarc is about to undergo some rebranding to bring it into closer alignment with ProAssurance.

On IND, as I reported last quarter, integration is proceeding equally well under the leadership of Jim Hooven. We have our claims department in place, and we are adding two new claims employees to serve our Nevada insureds. IND is benefiting from the greater resources available as a result of the merger in to ProAssurance, so we are extremely pleased with our progress.

Stan, any closing comments before we take questions?

Just a couple, Frank. From my perspective, there is a great deal of encouraging news in this quarter's results. As a Company with a long-term focus on excelling in an often volatile business, we understand that our top line will not grow every quarter. In fact, if you see a healthcare-liability company growing the top line in this market, ask why. Because absent something unusual, that company could be writing a prescription for future difficulties or something even worse. Instead, our focus is on the bottom line and increasing book value, the things that make us stronger and better prepared to respond to the needs of an increasingly complex healthcare delivery system. These things make us a more desirable insurer for an increasingly sophisticated buyer and a more desirable M&A or business partner.

You saw an example of our ability to be an important business partner in March when we announced our CAPAssurance program with CAP MPT to write hospitals and facilities in California. CAP is a physician-focused organization with a long history of success in California. And our CAPAssurance program will leverage their local knowledge and expertise and our long experience writing hospitals and providing risk-management services.

Our financial strength is what made us a desirable partner for Medmarc, and we are pleased to see that being part of an organization of greater financial strength has allowed Medmarc to gain the attention of clients who value that financial strength in an insurer. We have already seen an increase in premiums written by Medmarc in the first quarter as a result. Both IND and Medmarc are making meaningful contributions to our organization, both in terms of business and in terms of leadership. And as you heard Howard mention, we continue to break new ground with our Certitude program and Ascension Health.

Fitch recently affirmed our financial-strength rating at A, while noting that our performance is supportive of an even higher rating. And Moody's upgraded our prospective debt ratings in the quarter, which we view as a positive independent verification of our dedication to financial strength. So I continue to be as optimistic as I've been in the past. Frank, let's take questions.

Thank you Stan. Jenny, we are done with our prepared remarks and ready for questions from our callers.

Thank you.

(Operator Instructions)

We will go first to Ray [Aradello] with Macquarie.

Talking a little bit more, I think Stan, your comments about the CAPAssurance program, how should we think about that? And do you guys see anything similar deals or strategic alliance, I guess I should call it, like that in the future?

Ray, as the world of healthcare continues to change, the needs of our traditional customers are going to change. There is a significant amount of integration, as you know, taking place throughout the United States with respect to the delivery of healthcare. You have physicians increasingly joining other physicians and joining healthcare systems. And you have this aggregation of providers, in terms of both hospitals and physicians. Their need for insurance products is going to grow more sophisticated and going to require more expertise.

So we think the CAPAssurance program, which I mentioned earlier, is an example of two things that are very important. The first, as many of you have heard me say repeatedly, this is a local business. If you do business in 50 states in this field, you are engaged in 50 different businesses. Thus, it's important to have local knowledge and local expertise, and CAP MPT brings that to the table in the CAPAssurance program. It's also necessary to have financial strength and experience in writing hospitals, and ProAssurance brings that to the table. So the CAPAssurance program is an example of what I think will be an increasing number of opportunities to join local expertise and knowledge with financial strength and underwriting experience, all of which puts us in a unique position to take advantage of the changes that are afoot in healthcare.

Thank, that's helpful. How should we think about that relative to your appetite for pure M&A transactions? And specifically talk about your appetite for lawyers' professional liability as well.

ProAssurance today is a creature of over 20 M&A-type transactions. Our appetite for appropriate and profitable M&A remains as strong as ever. As you know, we have to be prudent with respect to the acquisitions we make. They are episodic; you cannot make them happen. You cannot predict if they will happen. And we think that we will be as active in the future as we have been in the past, with respect to transactions.

The lawyer liability space is a space that we've been in for many years. It's a space I think we write about today somewhere around $26 million to $27 million of premium in that space, which puts us in about fourth position in the country in terms of that premium. We saw a significant increase in that premium as a result of our combination with Medmarc, and we think that's a book of business that we will grow in the future. Again, the growth needs to be prudent, and it needs to be profitable. And we think we will have ample opportunities in that respect in the years ahead.

Okay, well thank you. I will requeue for a few other questions, but just wanted to pass along my congratulations to Vic on a good career.

Thank you, Ray.

We will hear next from Mark Hughes with SunTrust

You had mentioned the consolidation of providers as one issue that affected premium in the quarter. Could you talk about the pace of that as healthcare reform is developing here? And also in times past, you've mentioned opportunities for gain, perhaps, related to that consolidation. Could you give us your updated thoughts on that?

Sure. There's probably you've seen it, there's a study that's been published by [Senture] in recent months which projects that by the end of this year, only 36% of the physicians in the United States will be what they label independent practitioners. Now think about what that represents in terms of a seat change over the last 30 to 40 years. I expected when I started practicing law in 1972, fewer than 10% of physicians in the United States were affiliated with hospitals or these very, very large aggregations of healthcare providers. So we have seen a remarkable acceleration in aggregation, and it seems to be picking up almost every year. Now it won't be entirely linear; it will accelerate at times and then slow down at times. And it won't be without a step backward on the part of some physicians along the way who join a group and then decide they want to do something differently.

We at ProAssurance think of it in this way. Our historical customer has been the solo practitioner of the small group physician. That's why we were founded, and that's why we issued our first policy in 1977 to attract and to ensure that type of physician. As time went on, we began to insure hospitals, and as time went on through our mergers and acquisitions, we acquired organizations that insured much larger groups. We now have the geographic reach and the financial ability to insure these very large, sophisticated healthcare organizations.

That's going to create opportunities for us in several respects. First, if you're a large group of physicians or if you're a large hospital group, you're not likely going to be comfortable purchasing your insurance from an insurance company that writes only in one or two states or that is perhaps smaller than the hospital system itself. So we think it takes financial depth to actually participate in that market. And if relatively few competitors in a position to write the policies and insure the risks, we are in a position to insure in that respect.

Second, this aggregation of healthcare providers that has been taking place over the last number of years often results in the physicians being moved from an organization like ProAssurance into a healthcare or hospital captive. It's my own view that these captives have ingested more physicians than they have the infrastructure to digest. And I think that's going to create opportunities to us to work in partnership with these captives, perhaps to provide the claims infrastructure they need, to provide reinsurance support that they need, to share with them or co-insure these risks. I think that you're going to see lots of opportunities in the future in that regard, particularly as the big hospitals decide that they don't want to keep the capital required of these captives locked up in the captives. So as we say, we don't think we have or anybody else has the imagination to fully understand what healthcare is going to look like in the coming years, but I like our position in being able to take advantage of it and being able to continue to protect the physicians and healthcare providers in the same way in which we've done so on a historical basis.

Stan, how has your experience been recently on those sorts of opportunities?

We see them. You don't catch everything. We have lots of hooks in the water, and we think that they will pay off appropriately. From our standpoint, we want to make sure that when we write these risks that A, we write them in an appropriate price. We are not interested in being a loss leader. And secondly, we want to make sure that as we write these risks, there is a common understanding of the benefits and advantages we bring to the table and an appreciation on the part of our customer of those advantages. We don't write everything that we quote. But we like our position and we like the results thus far. And oftentimes in this business, what starts off as a small creek increases in size as time goes along, and we expect that to be the case here.

In the favorable development and the seated losses, are we to think that you won't see as much volatility or as much backend-loaded development going forward if you're starting to recognize that on a quarterly basis? Does that mean 4Q is less likely to be as big as it has been the last couple of years?

Mark, this is Howard. Presumably yes. As we evaluate each quarter, and to the extent that we think that a change in the seated portion of the loss reserves has indicated, then that would alleviate some of the larger changes that we've had in the past in the fourth quarter. It really gets more to a matter of comfort or confidence in what we are seeing in the excess loss area, broader experience, a little bit more stability than maybe we've had in the past. So we felt that it was an appropriate change to make.

We will hear next from Ryan Byrnes with Langen McAlenney.

Congratulations to Vic for a long, successful career. But quickly on the last point, to follow up on Mark there, do you guys have the magnitude of the fourth-quarter reserve release from the seated reinsurance adjustment? Just want to see the magnitude of that, if you had that available.

Not off the top. We're looking here. If you have another question go on.

So the other thing I also noticed the expense ratio had an uptick. Obviously I'm sure it's partially from bringing the new deals on, but just wanted to see what a clean run rate is. Maybe if you can give some of those figures as to what is non-occurring there.

Nonrecurring expenses for the quarter.

Mainly they were around the close of the transaction, and if you give us just a second we will pull those out. I want to say they're in the neighborhood of $1 million of that $ 3 million.

Sorry for getting a tough one. Maybe quickly an update on claims frequency for the core physicians book, is that still in the flattish area?

Frequency -- we're still looking for the other number for you. Frequency, as I mentioned in the prepared remarks, pretty flat. We always see some variation when you look at it by state, nothing that we see that is out of the ordinary. We will see a state maybe move up in one quarter and move down in the next, and it has more to do with just the timing of lawsuit filings than anything else right now.

And Ryan, let me go back. On expenses, there's about $2.9 million of nonrecurring expenses in the first quarter. $1.8 million of that relates to the transactions, the closing of the transactions. And then $1.1 million relates to when costs get incurred, particularly with the new acquisitions. They have some front-loaded cost that will occur in the first quarter, so they are nonrecurring for the rest of the year, but on an annual basis, they are ordinary expenses. And that's about $1.1 million of costs.

Got you, great, thank you.

Ryan, this is Howard, back on your first question. The adjustment in the fourth quarter of 2012 to seated reserves related to prior years was $49.4 million.

Great. I appreciate the answers. Thank you again. Sorry for such tough questions.

And we will hear next from Howard Flinker with Flinker & Company.

Ned, do I deduce correctly that the $35 million markup from mid-market is the same both pretax and post-tax in the income statement?

Yes, Howard, you do; it is a non-taxable gain.

(Operator Instructions)

And we do have a couple of follow-up questions, if we have time to take those.

Absolutely.

We will go to a follow-up from Ray Aradello with Macquarie.

Ned, I know one of your favorite topics is excess capital and the impact on ROE. But and I guess everyone's definition of excess capital is a little bit different. But how should we think about an ROE drag for additional you guys are holding, in excess of what you need to operate the business?

That is a tough question, Ray, because I think everyone does have (inaudible). From a pricing standpoint, we're pricing to a 13%, close to 14% ROE target, and that assumes a one-to-one premium-to-surplus ratio. That's how we approach the business from a pricing standpoint; however, I don't think that we could operate on a one-to-one basis and maintain our A-rating. We probably could operate on a 1.3, 1.4, something like that, surplus to premium. And so if you want to get very technical about it, you could look at it in that regard. We think it's important to maintain capital to take advantage of opportunities in the marketplace and M&A opportunities. So we would factor that in to the capital that we need to hold. Everyone's going to have their own take on it. And the other thing to keep in mind from a rating-agency standpoint is any drastic change in anything troubles the rating agencies and would be impactful to our ratings. So we want to be cautious of that as well.

Okay, and then thinking about the tax credits in the quarter, I'm not sure if I could tell looking to the Q if you guys increased the allocation to that. And can you talk about the expectation of that line item going forward?

Absolutely, we did increase the allocation to tax credits. In particular, we did one private deal that's got a financial guarantee wrapped to it that increased our allocations. The other thing that is happening with those tax credits is they are seasoning, but as you get into out years in these credits, the amount of available credits increases. And so you're seeing that in the quarter as well. So we would expect to see the tax credits increase. We have about $7 million in income. That is where we would see the tax rate. There is both an increase in the absolute amount of tax credits, but also the tax credits that we've been holding are pushing through more benefits.

And we will go to a follow-up question from Mark Hughes with SunTrust

A little bit more on the competitive environment, it seems like the pricing trends, if we look over the last three quarters, Q3 was up a little bit. Q4 was flat. Q1 down a point. Are there some new players, some new behavior out there?

This is Howard. No, really not in the sense of any new players. In terms of behavior, I think as you get further along in the cycle, I think with premiums coming down for many companies, particularly some of the smaller companies become more aggressive in trying to hang on to business. We also see a lot more competition, as I mentioned earlier, on the large account physician business. I think it may be a reflection of or reaction to the consolidation of providers. As they move into larger groups they have more bargaining power, and also they become more attractive targets for companies that are trying to either maintain or possibly even grow their premium volume.

If you go back, I was just looking at the notes from the Q4 call a couple of months ago. And I had laid out some targets in the sense we said we were trying to achieve 88% to 91% retention in general and -2 to +2 on rate, in very general terms. And we can't control that from quarter to quarter. And I think that's what you are seeing here. So this quarter may be a little low on the retention side, but within the range on rates. And if you look back over the average of the past four quarters, it's been certainly within those parameters.

Howard, any way to characterize -- you talk about the typical impact, the smaller players wanting to hold on to their policyholders, more competition, large account physician business. Is this as bad as it gets, or does it get a little bit more challenging from here? What is your sense?

It's hard to say; each cycle is different. I think we have certainly seen worse, 12, 14 years ago in the late 90s range, where not only was the pricing coming down, but there was pretty significant erosion on terms, multi-year rate guarantees and multi-year policies and things like that. I don't think we are seeing that, or certainly we are not seeing any significant amount of that right now. But I don't know that we are going to get there either. I think it really just depends on the mix of players, and it is different this time. You have many of the commercial carriers that are not actively in the physician marketplace, even though they are very active in the hospital market, and that's a difference from prior cycles.

Thank you. I'd also like to add my congratulations to Vic. Good luck.

Thank you.

(Operator Instructions) It appears that there are no further phone questions at this point in time.

All right. Vic I will put you on the spot. Any retiring words?

Thank you Frank. Certainly we are going to have a little gathering here at the Company, and I'll to say all my [internal] words. But I do appreciate the opportunity to work with the market over the years, the analyst, the investors. It's been a wonderful learning and very great experience for me, and I appreciate all the following that the market has given to ProAssurance.

With that, Jenny, we will disconnect and invite everybody back to speak with us in August we discuss second-quarter results.

Again, that does conclude the call. We'd like to thank everyone for their participation today.