ProAssurance Corp (PRA) 2013 Q2 法說會逐字稿

Good day and welcome to the ProAssurance Corporation's second quarter earnings call. Today's conference is being recorded. At this time, I would like to turn the conference over to Mr. Frank O'Neil. Please go ahead, sir.

Good morning, everyone. Thanks for your interest and participation in our call to discuss ProAssurance's second quarter 2013 results. First, we've got a few legal matters. On August 5, 2013, we issued a news release reporting our results for the quarter ended June 30, 2013. We subsequently filed our Form 10-Q and a current report on Form 8-K. These documents and our other SEC filings provide you with important information about our Company and our industry, and each discusses important factors that could affect future results which could cause our 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 the risks and other factors covered in those documents. Except 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. This caution is for those reading a transcript of the call. The content of this call is accurate only on Tuesday, August 6, 2013, and the transcript you're reading may contain a factual or transcription error that could materially alter the intent or meaning of our statement.

We will be referencing non-GAAP items in our call today. Please refer to our recent filing on form 10Q and our recent news release for a reconciliation of these non-GAAP numbers to their GAAP counterparts. Participating in today's call are Chief Financial Officer Ned Rand, Howard Friedman, our Chief Underwriting Officer and Actuary, and our Chairman and CEO Stan Starnes, who joins us by phone while traveling out-of-state. Stan, we're going to come to you for our opening thoughts, please.

Thanks, Frank. Thanks to everyone for joining us this morning. We remain quite focused on our long-term efforts to build our financial strength, to provide ongoing profitability for our shareholders, and to establish the platform which will serve the needs of policyholders and shareholders in the years and decades ahead. Even though the operating earnings for the quarter are less than those projected by some, we are pleased with our overall results and our continued progress. We regard quarters not so much as an isolated period to be viewed in a vacuum, but as a point along a continuum at which we may report to you the progress we are making toward our long-term goals.

To those with whom we have worked for many years, or even decades in some cases, it would be no surprise that we manage the Company with a long-term view, unencumbered by a dangerous allegiance to producing particular quarterly results. However, we recognize that it is important for our various constituencies to understand the moving parts in each quarter's reported results, even though as is the case today, the quarterly results portend no change in our long-term performance. For an explanation of these moving parts, we'll turn to Ned and Howard, starting with Ned.

Thanks, Stan. There are a number of items that make up the 20% increase in gross premiums written. The total increase was $20.6 million, of which Medmarc contributed $9.4 million in new medical technology and life sciences product liability premium, and $2.7 million in new legal professional liability premium, underscoring the importance of that acquisition. We also had $1.7 million of new premium from our Nevada acquisition and $3 million of new premium in our legacy physician business that somewhat offset lost premium. Additionally, there was an increase in written premium resulting from a shift of renewal dates in selected policies and from the net effect of two-year policies. Neither of those changes will have an effect on net earned because this simply shifts the timing of premium collection.

Net premiums earned were essentially flat in the quarter, down $914,000. One note for the year-to-date net earned number; please remember that comparisons to the prior year are skewed by the large reporting endorsement policy written in the first quarter of 2012. We discussed that last quarter, but we'll be happy to go over it in Q&A if you need a refresher.

Stated premiums increased approximately $3.5 million quarter-over-quarter, due primarily to sessions within our Certitude program with Ascension and the effect of acquisitions. Those increases were offset by continued favorable loss experienced in our ceded loss reserves, related to variable components in our re-insurance treaties. Before we of move away from premiums, I'd like to get Howard to comment on the market in general, specifically on pricing and retention. Howard?

Thanks, Ned. There's been no let-up in competition in any of our lines. That may make our accomplishments with regard to pricing and retention in our core healthcare professional liability business all the more remarkable. Premium retention in the physician line was 91% in the second quarter, three points higher than the year-ago quarter, and an improvement on the 87% retention last quarter. Year-to-date, premium retention was 89% compared to 90% in 2012.

Pricing was also encouraging. Despite heavy competition, renewal pricing was 1% higher in the second quarter of 2013 than in 2012 and is unchanged year-over-year. We continue to see that as an endorsement of the value we bring to policyholders. It's also a testament to our agents as they continue to communicate the value proposition of ProAssurance.

It makes sense for me to address loss trends and reserves here as well. I'll give you the raw numbers first and then get into the moving parts. In the quarter, we recognized $38.5 million in net favorable development, compared to $60.1 million in the same quarter a year ago. For the year, our net favorable development has been $91.6 million, compared to $107.5 million for the same period in 2012. For the second quarter, development came primarily from the 2006 through 2011 accident years.

Let me underscore that we continue to recognize a significant amount of favorable loss reserve development. The six-month total for 2013 is actually slightly more than the $90.2 million for the same period in 2011. However, second quarter development is less than the first quarter, so let me try to provide some background that I hope will be helpful. As we've explained in prior calls, we do an internal analysis of loss reserves every quarter and engage our outside actuaries twice a year for a more in-depth study. Our analysis as of the end of the first quarter indicated a continuation of the trends that were evident in our year-end review, and accordingly, we recognized $53 million of favorable development in Q1.

Fast forward to the end of Q2, where we have the perspective of six full months of additional data and an updated study from our independent actuaries. That data showed among other things a minor deviation from the still favorable trends in one state, a small amount of adverse development in one of our allied health sub-lines, and a couple of other minor changes. I want to emphasize that these are very small changes and isolated changes by themselves, and it is too early to say if any are new long-term trends. They became evident as we analyzed data for this quarter, and we believe a cautious approach to such information is appropriate. The changes that resulted from this recognition of updated data were incremental and did not move the needle to any significant extent on total reserves. But because of the size of our reserves, those minor changes in aggregate had a significant effect on the favorable development that you see in the quarter.

Now back to the recognition of the trend. We are endeavoring to become more sensitive to current indications each quarter which is something we've talked about for two quarters now. As we report results using that approach, there will likely be greater volatility in our reserve estimates, both up and down, and thus we are likely to see greater volatility in our quarterly results. Moving to a more current recognition framework would introduce volatility in any P&C line, but that is especially true in long tail lines such as medical professional. We also understand that these adjustments will be harder to predict and clearly harder to model because as you see this quarter, small changes in reserve assumptions can have a big effect on quarterly results. While we recognize the potential for added volatility in our results over short-term time horizons, this has no impact on the long-term which is our focus.

As to overall trends, I'll repeat Stan's lead-in. We do not see any changes to the macro picture. Overall severity is still increasing at 2% to 3% a year, and frequency is in the aggregate unchanged. Ned?

Thanks, Howard. Continuing to move down the income statement, net investment income was down 3.6% in the quarter, compared to last year. Even with the late quarter movement in interest rates, we're investing new money at rates lower than those of maturing bonds, and that's limiting growth in investment income, the same issue facing every other insurer. And like many other insurers, we did see a mark-to-market decrease in net realized investment gains in the quarter.

Operating expenses were down slightly in the quarter, but again, with several moving parts. Compensation costs increased $1.2 million, but that increase was more than offset by an increase in the proportion of these expenses attributable to ULAE, and policy acquisition costs decreased due to lower earned premium. This year, we have expenses from newly acquired entities that we didn't have in 2012. But we also do not have the severance expenses we had in 2012 when we took a charge related to the enhancement of our customer service capabilities. Cash flow returned to positive in the quarter although for the year we are still negative, largely due to the tax payment of almost $21 million we mentioned last quarter and the amount and timing of expenses related to our acquisitions. Net income was $50 million, down 14% as compared to last year's second quarter, again, primarily due to the lower favorable reserve number compared to last year. Year-to-date, net income was $163 million, up 43% compared to 2012, with much of that increase being the result of the $35 million one-time gain associated with the Medmarc acquisition.

Operating income was $45 million, or $0.72 per diluted share in the quarter. Year-to-date, operating income was $105 million, a 2.5% decrease compared to 2012. Return on equity was 8.6% in the quarter and year-to-date stands at 11.1%. Remember, our calculation excludes that one-time gain from the Medmarc acquisition. Book value per share is $37.79, up 2.6% since year-end, but lower than last quarter, making this the first quarter I can remember where we didn't have sequential growth in book value per share. ProAssurance like every other insurer saw a decline in the value of our bond portfolio right at quarter-end with the spike in interest rates. Tangible book value per share is $34.31. Frank?

Thanks, Ned and Howard. Stan, any closing comments from you before we take questions?

Frank, I want to stress again that on the whole, we don't see any significant change in the long-term macro view of ProAssurance or in the market in which we are operating. Howard is right, however, when he points out that volatility will likely occur in our quarterly results and we recognize that the volatility by definition will be difficult to model in the short term, but it will not affect the long-term result. Most importantly, this volatility will not diminish our commitment to manage ProAssurance for the long term.

In addition to the solid profitability of our second quarter, I want to highlight a couple of other bright spots. Our acquisitions are performing well. Our performance is being recognized by policyholders who vote with their checkbook, and by others such as the Ward Group which for the seventh year in a row named us one of the 50 top performing P&C companies out of the more than 3,000 in the United States. AM Best upgraded the ProAssurance Group to A plus, and several subsidiaries were upgraded as well. Standard and Poor's upgraded our shelf offering one notch to BBB-Plus just two weeks ago.

All in all, the fundamentals are strong. We operate in a historically volatile line of business which today is wrapped in the uncertainty of a rapidly changing healthcare system. Are there challenges because of that? You bet. There always are. Are we up to those challenges? I am confident that we are, and as I've said, I wouldn't trade places with anyone. Frank, let's take questions.

All right. Stan, thank you. Aaron, we're ready to open the line for questions.

(Operator Instructions)

Mark Hughes with SunTrust.

Thank you very much. Good morning.

Good morning, Mark.

You describe a stable environment, but it's a fairly meaningful change in pricing from down one to up one on the quarter. Then retention, obviously, improved very nicely on a sequential basis. That seemed to point to a more favorable environment. Is there possibly some underlying reason for that improvement?

The pricing is affected very much by the mix of business by state, and even to some extent by line, that renews in a given quarter. I think we see the minus one to plus one range as being pretty normal from quarter to quarter. It's a reflection of maybe an adjustment in rates in a given state, based on the renewal pattern of the business or particular accounts, larger or smaller, that renew. I think I've said in the past, anywhere in that minus one to plus one range, and anywhere in that 87%, 88% to 90%, 91% range on retention quarter-to-quarter is probably within what I would consider a normal variation.

You talked about a deviation in one state that influenced the losses in the quarter. Was that a regulatory development? A legal development? Or something else?

No, it was just something that we've observed in this quarter in terms of claim severity, increase in average settlements and payments that just became more clear as we looked at the quarter, but also looking at the six months in particular. You have a certain number of claims that close in any given period. Sometimes it takes maybe more than a quarter to really recognize what's going on, particularly when you're looking at claims closed with indemnity, because that's a small proportion of the overall claims as it is. It's not anything that's attributable to tort reform or legal changes. It's really something that we're just looking at right now and seeing whether it's an aberration or a pattern.

Then, a final question, just any updated thoughts on consolidation of small physician practices? Healthcare reform is obviously moving ahead in its own way. Do you see anything new on that front?

Mark, it's Stan. I think what we see is a continuation of what we've been seeing for the last several years. It is not a linear phenomenon, and it migrates around the different parts of the United States. I think the most important thing we see is continued uncertainty, uncertainty among physicians, uncertainty among hospitals, uncertainty among integrated healthcare systems, as to what the world is going to look like, both in the short term and the long term.

The acquisitions of physicians by hospitals is a finite development simply because hospitals can't afford to buy them all. But I think you're continuing to see it. I think you're also beginning to see even more imaginative affiliation arrangements between hospitals and physicians, where perhaps the physician is not employed by the hospitals but they have closer relationships, perhaps through medical records systems, perhaps otherwise. There is no lessening of the uncertainty that characterizes the healthcare system today, and certainly the acquisition of physician practices by hospitals is not over.

I'll follow up on that. You've talked in the past about perhaps being able to pick up some of those larger pieces of business once the consolidated entities, are you making any progress on that front?

Howard, I'll let you respond specifically, but I would say we're seeing more opportunities along that line than we've ever seen before. Howard?

Yes, I think the opportunities in the market are there, particularly as these entities, the healthcare entities, become larger. Physician groups become larger. Hospitals are acquiring others. Small hospitals are becoming larger through their own consolidation with other small hospitals. So, they're looking for carriers that have larger balance sheets and more expertise.

Thank you.

Ryan Byrnes with Janney Capital Markets.

Good morning, everybody. Just wanted to see if I could zero in and figure out which state saw the increase in severity, and maybe also if you guys could quantify that as well.

Howard?

Well, in terms of which states, we've historically have not provided state-by-state information, mainly from competitive considerations. I think I'll continue that pattern here. It's really, as I mentioned earlier in the script and also in response to the earlier question, a result of looking at closed claim severity. It's not something that I would consider to be major. It's something that was a change in the pattern. We've historically, in this particular state, seen a pretty good predictable pattern, generally where we have had some degree of case reserve redundancy, which is offset by our IBNR projections.

As we looked at the data for the quarter and for the first six months, we just didn't see that this time, so we are reacting to it. In terms of whether it's a trend, as I said earlier, we're not calling that at this point. We're just reacting to it in terms of adjusting our projections for this particular segment or portion of our book of business.

Would it be a top 10 revenue state for you guys? I'm just trying to figure out what magnitude it would be.

It's a state that's big enough where we have data that we think is credible to look at. If it was a state where we had one closed claim in the quarter, it obviously wouldn't be something where we could discern a pattern.

Okay. Great. My last one. Could you talk about the new quota share arrangement? You guys talked about in your 10-Q with a captive insurer, just want to see what arrangement that is and what that could be.

Sure. It's Howard again. One of our larger agents has expressed interest over the years in sharing in the risk on the book of business, which we think is a great thing. The agency, the holding company, has formed a captive insurer in order to be able to take a quota share re-insurance participation on the risk in the business that that agency produces. Again, we think it's good that an agent is interested in the risk side of the business. We think that, in the long run, will help to solidify the results on what's already a good book of business that that agency produces.

Okay. Great. Thanks for the answers, guys.

Matt Carletti with JMP Securities.

Good morning. A couple questions. First one is on the development and more so, just the recognition pattern. Could you maybe provide a little color? I know it's not new this quarter, that's it's been a change in view in recent quarters, but I think it showed up a little more noticeable in the results this quarter, as to what's driven your change in look at how you interpret the data? Then secondly on that, if I'm interpreting it correctly, is it correct that the historical pattern of strong Q4 releases wouldn't be the norm anymore, and that it would be more spread out over the year, and potentially you could have a big release quarter any quarter, and likewise volatility another way?

I'll start, and if Stan or Ned wants to jump in. We've been asked by various audiences, regulators, rating agencies, even some of you who are regularly on the call to be more responsive in recognizing trends in the data, rather than necessarily waiting until we were absolutely certain about things to try to recognize indications sooner. We've attempted to do that. As we've mentioned in the last couple of calls, we mentioned to do it. We actually even mentioned it over a year ago in the February 2012 call for year-end 2011 that we were going to give more recognition at that time to what we saw as the more benign loss severity trends.

Once we begin to do that, obviously, and we continue to do it, it will create a little bit more volatility. But at the same time as you said, it would presumably get us to be more responsive to individual quarters results and it may, I can't tell you for sure, but it may result in a different pattern than we've seen in past years, in terms of the fourth quarter adjustment. But that's still to be seen. We don't know what the third or fourth quarter of this year will look like yet.

Thanks. One for Stan. Very nice growth in the quarter, and nice to see the recent acquisitions contributing. Any change in your outlook for M&A? I know there's a lot of small companies continuing to be out there. Do you continue to see attractive acquisition opportunities?

Yes. Matt, we continue to look at a lot. Our entire senior management team is involved in that, particularly when it comes to evaluating whether this is something that we are interested in. As I mentioned in the first part of my remarks, one of our long-term objectives is to develop the platform which will serve the policyholders and the shareholders well over the coming years and decades. And a key part of the development of that platform lies through acquisitions.

We look at a lot more than we are interested in. It's a time-consuming process but one that we think is worthwhile. We anticipate that we will continue to be active in the acquisition process and in looking at different opportunities as they come along. As you know, they're very episodic. You can't make them happen and shouldn't make them happen.

It has to be something that fits into the long-term platform development. But I will be very surprised if this time, for example, a year from now we have not at least announced a new acquisition. That doesn't mean it's going to happen, but I think in my view, we'll have those opportunities and we'll take advantage of the ones we deem appropriate.

Okay. Thanks. Then just one last one, if I can, just on capital management, tying on. We've seen nice growth but your leverage remains quite conservative. Can you walk us through your thoughts as we near year-end on capital management? And should there be any sort of expectation for a special dividend again? Is that in the discussions now on an annual basis? Or do you think the growth is absorbing a bit of the capital and probably not likely to see that?

I'll let Ned respond specifically, but I would just repeat as I've said in the past, that at every Board meeting our Board takes a very detailed look at capital management. Ned?

Thanks, Stan. Yes, Matt, I think that the capital management has a lot of different components to it. We continue to favor putting capital to work in the business and in M&A, and that will certainly have an impact on any capital management decisions that we make. When our stock was trading closer to book value, we favored share buybacks. With where it's trading today, we favor dividends. All of those things will go into consideration in any decision that we make regarding dividends and buybacks as year-end approaches.

Great. Thanks very much for all the answers.

Thank you, Matt.

(Operator Instructions)

Paul Newsome with Sandler O'Neill.

Good morning. Thank you for the call. Just a quick follow-on to the reserve, which obviously is the main issue. Can you quantify if there is any true-up nature of the reserve in the quarter? We're always trying to look for run rates.

To what extent was the trend change that you put in with -- something you had to make up for because it is a semiannual reserve analysis? I guess this is a long way of saying, should we be looking at this more as the first half in total, as opposed to just looking at the second quarter?

Every time that we review reserves, it's always a cumulative review. Because what we're doing, we're not trying to determine what our reserve development is in the quarter. What we're doing is always trying to project for each accident year and each component of the business what the ultimate losses will be. Once we make those projections and subtract out paid losses to date, then that equals the reserves and then the change in that for any prior periods becomes the development. The development is an end result, not an objective.

To go to your question, what we did now is the same as always, re-estimated the ultimate reserves and then calculated the development for the quarter. In terms of it being a true-up, I guess it's always -- in that regard, always a true-up. In terms of how to look at it, I would look at is more over an extended period of time, either look at the two quarters for the year or look at an average, rolling average four quarters, much more so than looking at any individual quarter in itself.

Paul, I will point out from our last couple of presentations, as we've put up a chart that showed reserve development, we've begun to break that down by quarter, which should help you out in that regard.

Terrific. Could we talk a little bit about the accident years, and how these trends could or could not impact your view of the accident year results over time? Or the current accident year, I should say.

We did not make changes to the current accident year reserves or loss ratios that we are booking for 2013. I think that may answer it in itself. The changes that drove the change in ultimates, which then resulted in the development for this quarter were really very minor. It has a magnified effect when you look at it over a number of prior accident years, but in terms of what we're seeing for the current year, we didn't make any change in the quarter.

My understanding, the way the actuaries work is one quarter is a blip, three years is a trend. I don't know if you have those rules of thumb, and if they apply to some of the trends that you're seeing in these issues.

The one quarter may well be a blip, but I wouldn't wait for three years to call something a trend, I guess. We are, and we do continue to look at this regularly. But it would certainly be much less than three years before we reacted to any changes that we saw, whether that's three quarters, four quarters, something in that range is probably much more likely than multiple years.

Okay. Thank you very much.

It's always a rolling four-quarter process as I mentioned earlier, when we look at things and maybe a good way for you to look at them as well.

It appears we have no further questions. At this time, I'd like to turn the call back to management for any closing remarks.

Thank you, Aaron. We appreciate your attention today and we appreciate the participation on the call from our investors. We will look forward to speaking with you in early November when we discuss third quarter results.

This does conclude today's conference. We thank you for your participation.