ProAssurance Corp (PRA) 2013 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the ProAssurance investor call to discuss the results of third-quarter 2013. 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, Rebecca. Good morning, everyone. Thanks for your interest and participation in our call to discuss the third-quarter results of ProAssurance.

On Wednesday, November 6, 2013, we issued a news release reporting our results for the quarter ended September 30, 2013, and subsequently filed our 10-Q and a current report on Form 8-K. These documents, along with our other SEC filings, will provide with you important information about our Company and our industry. Each discusses the significant risks and other factors that could affect future results and thus cause actual results to differ materially from current projections and expectations.

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

If you happen to be reading a transcript of this call, please know that the content of the call is accurate only on Thursday, November 7, 2013, and it may contain a factual or transcription error that could materially alter the intent or meaning of our statements.

We will be referencing non-GAAP items in our call today, so 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.

On the call with me today are Chief Financial Officer Ned Rand; Howard Friedman, our Chief Underwriting Officer and Actuary; and our Chairman and CEO, Stan Starnes, who will start us off with some opening comments. Stan?

Thanks, Frank. Thanks to everyone for joining us this morning to discuss what we view as another successful quarter.

Our premiums increased over the same period last year and earnings are higher as well. Book value per share, our primary measurement of overall success, is higher than year-end by 4.4% and we believe we are on track to deliver increasing shareholder value and continue strengthening our balance sheet for the benefit of shareholders and policyholders alike. We'll go first to Ned.

Thank you, Stan. Starting at the top, gross written premiums were $166 million, up 6% over last year's third quarter. For the nine months ended September 30, gross written premiums increased 5%. In both instances, the primary driver was a new premium from acquisitions.

In the third quarter, Medmarc produced almost $10 million of new premium from its medical technology and life sciences business and $2.4 million of new legal professional liability premium. Year-to-date, those increases are $25 million and $8 million, respectively.

We think these gains underscore our ability to add new profitable business through acquisitions while expanding our reach in key business lines. There are a number of moving parts within the medical professional liability components of gross written premium so I will look to Howard to discuss those as well as other market dynamics. Howard?

Thanks, Ned. Gross written premiums in our healthcare professional liability business were down $2.9 million, about 2% compared to third quarter 2012. But as Ned mentioned, you should understand the moving parts.

To the downside, we did lose business due to the competitive nature of the market, and as you will recall from last quarter's call, about $3.3 million of third-quarter gross written was shifted to second quarter this year to even out renewal workload. However, on the upside, we wrote some $6 million of new physician business, including the first premiums from our CAPAssurance joint venture in California, and additional premiums from our Certitude program with Ascension. Our Nevada acquisition added $3.4 million to gross written in the quarter.

The new physician business number is strong and we are pleased with the performance of both the CAPAssurance program, which brings our large group and facility expertise to California in partnership with CAP MPT, and also with the Ascension Certitude program, which is near our initial goal of $20 million in annual gross written premiums. We are on track to roll that program out in two new states in the first quarter, with a few more to come throughout 2014.

There's really no change in the competitive landscape. We see heavy competition across the board, which we think makes the 90% premium retention in our physician business for the third quarter, all the more remarkable. For the year, premium retention is 89%. We are convinced that our existing insureds and those buying our coverage for the first time understand the real differences in the product we offer them.

Renewal pricing on our third-quarter physician business was 1% higher than the same quarter a year ago and is flat for the year, a product that's continuing benign loss trends and the competition. On the subject of loss trends, frequency is in the aggregate unchanged, and overall severity continues to increase at a very manageable 2% to 3% per year.

It probably makes sense to address reserve development at this point, as well. We recognized $49.4 million in net favorable development compared to $50 million in the third quarter of 2012. Favorable development through the first nine months of 2013 is $141 million compared to $157.5 million for the same period in 2012. The development is still primarily from the 2005 to 2011 accident years.

The question will be, have the changes that ProAssurance saw last quarter abated or reversed? And the answer is that we addressed what we saw last quarter, as we would with any changes in loss data, through reserve adjustments, and we do not believe further changes are required.

We have also modified our underwriting and pricing where needed, based on the loss experience that we observed. We'll continue to recognize current indications in each quarter, as we discussed in last quarter's call. It does not change the end result over time, but will likely change the quarterly amounts, as we make those more current evaluations.

Ned?

Thanks, Howard. Moving now to other line items in the income statement.

Net investment income was essential flat. Fixed income investments were lower, as would expect, but were offset by higher income from equities and distributions received from one of our limited partnerships.

Our equity and earnings among consolidated subsidiaries decreased by $500,000, even though we did see increased income from one of our limited investment partnerships. That was offset somewhat by our tax credit amortization.

As will you recall, our tax credit limited partnerships are a primary component of our unconsolidated subsidiaries. In third quarter 2012, the amortization was $200,000. This year, the third-quarter amortization was $1.9 million.

The increase in tax credit partnership amortization during 2013 reflects an overall increase in our investment in these partnerships and reductions to amortization during the third quarter of 2012 that were attributable to the reestimation of inception-to-date amortization of certain partnership interests. Periodically, we receive revised operating data from the partnerships and reflect this data in our amortization estimates as it is received.

Our operating expenses were flat in the quarter, but there were several factors involved. Compensation costs increased in 2013, and we incurred additional operating expenses related to our newly acquired entities. These increases were more than offset by an increase in the proportion of these expenses attributable to ULAE and lower professional fees in 2013.

Operating expenses reflect an increase of 2.4% for the year, reflecting essentially the same factors as the quarter period, plus an increase attributable to transaction costs associated with our acquired entities.

Cash flow was up 26.5%, quarter-over-quarter. Net income was $63.4 million, an increase of 5.4% over third quarter 2012, and for the year-to-date, net income is up 30%, mostly due to the $36 million non-taxable, one-time gain associated with the Medmarc acquisition. Absent that gain, net income is still up about 9% for the year-to-date.

Operating income was $54.8 million, or $0.88 per diluted share in the quarter. Year-to-date operating income is $160 million, essentially unchanged from the nine months in 2012. Operating income per share for the nine months was $2.57 per diluted share versus $2.60 a year ago.

Return on equity was 10.7% in the quarter and year-to-date stands at 10.9%. Both slightly higher than their respective year-ago periods and the calculation excludes the one-time gain from the Medmarc acquisition.

Book value per share is $38.48, up 4.4% since year end. Tangible book value per share, which excludes intangible assets and goodwill, is $35.01, up 5% since year-end.

As our share prices dropped closer to book value per share in the quarter, we repurchased approximately 175,000 shares of our stock at a cost of about $8 million in the quarter, an average cost of $45.56 per share. We have $127 million remaining in our stock repurchase authorization, and we will continue to evaluate the repurchase of shares as opportunities present themselves and we can evaluate the best use of capital at that point in time. To reiterate what we have said previously, we are aggressive buyers of our stock at or below book value per share, and we become less aggressive as the stock price moves above book value per share.

Frank?

Thanks, Ned and Howard. I want to come back to you both for some comments on the transactions we announced in mid-September. Howard, will you give us the news on our investment in Lloyd's Syndicate 1729?

Sure, Frank. Calling it an investment is exactly the right way to look at this. We're committing capital to the Syndicate to be led by Duncan Dale, who is one of London's preeminent underwriters. The Syndicate will leverage Duncan's longstanding ties in the US medical professional liability market, but we will not be involved in underwriting decisions or data analysis on any business where we might be a competitor.

We think the great benefit to us will be the value creation in the syndicate as it ramps up. And we believe our Medmarc subsidiary will stand to benefit when it gains the ability to write medical device and clinical trials business that has been expanding internationally.

The Lloyd's platform is an ideal vehicle to accomplish those risks. We expect there will be further insurance opportunities, as well, with the possibility of helping the Syndicate write international MPL business down the road.

Much of the world is migrating toward a more American-style tort system and we see potential as that evolves. Within the next few weeks, we expect the Syndicate to receive formal approval from Lloyd's to begin writing business effective January 1, 2014.

Frank?

Thanks, Howard. Ned, can you give us an update on the planned acquisition of Eastern Holdings?

Happy to provide that, Frank. We are still planning to close effective January 1, 2014. Eastern's proxy has been mailed to shareholders and the date for the special meeting is December 4.

Our Form A has been filed with the Pennsylvania Department of Insurance and we expect approval from them in time to close as planned. The transaction does not require formal approval by the Cayman regulatory authorities, but Eastern's management has received a letter saying they're aware of the transaction and have no objections.

We do not expect any anti-trust issues because of the separate lines of insurance written by both Companies and our HSR filing has just been filed. Overall, everything is on track.

Frank?

Thank you, Ned, Howard. Stan, any closing comments before we take questions?

Frank, as I said at the outset, we think this is a quarter that underscores our ability to succeed in a challenging market. Our acquisition strategy continues to pay dividends by adding new, well underwritten business that meets our profitability targets. We think our demonstrated ability to add new business sets a good tone when the market does begin to firm and greater financial strength will be an increasingly important factor in the insurance purchasing decision.

Equally important in the future will be our ability to meet the entire spectrum of healthcare providers at the point of liability need. We are building a platform that will allow us to serve liability needs no matter how healthcare evolves. We will be positioned to cover the wide variety of risk from home healthcare, larger groups, hospitals and facilities, to the small group or solo practitioner market that will always exist and will always have our undiminished commitment.

That's a vital concept, because collectively we do not have the imagination to predict how healthcare will evolve over the next decade. But we are building the Company that will be able to meet the liability insurance needs that evolve alongside healthcare.

The Eastern acquisition is a part of that. Workers' comp is a significant liability expenditure for our healthcare clients and we think being able to offer them this important coverage from a Company and an agent they trust and with whom they already do business is a huge opportunity.

As we continue to move ProAssurance forward, we will continue to build financial strength to ensure that we were able to keep the insurance promises we make, and in doing so, we are conscious of the need to be good stewards of the capital entrusted to us. Our purchase of shares this quarter is a further demonstration of that commitment and of our dedication to creating long-term value for our shareholders.

Frank, let's take questions.

Thanks, Stan. Rebecca, that's your queue to open the lines, if you will bring us some questions.

(Operator Instructions)

And your first question will come from Amit Kumar with Macquarie.

Thanks and good morning. Congrats on a strong quarter. Maybe just two or three quick questions.

The first question is on the discussion on cash and liquid investments in your 10-Q. If you add up the number, it's roughly at $480 million right now. Factoring in the Eastern acquisition, could you refresh us on the conditions and thought process which had led to a special dividend last December, and how were conditions similar or dissimilar today based on where you stand?

Amit, I'll let Ned provide with you the details of the information you seek. I would remind you and everyone on the call that our Board looks at capital very carefully at every meeting. And we look at it from lots of different aspects, and we have to measure our capital needs around what we see coming in the future.

So it's not a situation in which we set up a capital protocol that will serve us in years to come, but it's a very dynamic decision that has to be constantly reevaluated and remapped by the Board. So there is nothing that says that we have written the capital program in some sort of rigid script which will guide us forever and ever. We look at it every quarter, we look at it at every Board meeting, and we look at it under the conditions that are prevailing at that point in time.

Now given that overarching view of it, I'll let Ned address the specifics of your question.

I don't know really, Amit, that I have a lot to add to what Stan said. What gave rise to the special dividend we paid last year was a number of factors.

Like a number of Companies, we were aware of the coming changes in tax policy that could have an impact on what a dividend means to investors, and so that weighed in the decision to do something in 2012. At that time, our stock price was trading at a relatively high multiple of our book value, and as we've said repeatedly, we're more aggressive when we're closer to back value in buying back our stock. And then as we looked at our liquidity and our liquidity needs for the coming period, we were comfortable paying that special dividend.

In addition to the Eastern transaction, I would also remind you that there are capital requirements for our Lloyd's Syndicate that will use up some of that liquidity that we have at the holding company as well. But beyond the parameters that Stan said, I don't know that there's much to add.

The Lloyd's -- it's spread over a few years, right? So the initial -- how much is the per year outflow?

Our initial capital commitment in the neighborhood of $60 million or $70 million.

A year.

For this first year.

Got it. Because what I was trying to understand is -- maybe you can help me -- is on the relative attractiveness, in terms of the attractiveness of the buyback based on where the stock is today versus where it was maybe a month ago, and if I am understanding this correctly, what you are saying is that maybe there was a specific opportunity at that time when the stock had dipped a lot more versus where it is today. Is that fair?

Well, Amit, a couple of things. Our stock, the significant fall on our stock occurred right before we got to quarter-end, and we have a self-imposed blackout that we put up pretty early as we began to close the quarter that took us out of the market essentially from the end of September on, from October 1 on.

Got it. Okay, that's actually helpful.

The only other question I have -- and I'll stop here, thanks for all the answers -- is Howard mentioned you modified underwriting and pricing, which addressed those outliers in the Allied Health sub-lines. Could Howard expand on that a bit more?

Sure, whenever we see indications on the loss side, we try to take those into account as best we can in terms of the risks that we select and how we go about pricing those risks. As we mentioned last quarter, we saw some claim severity in one state. We saw some indications in one of our Allied Health sub-lines of business that were loss indications that were higher than we expected.

So when we look at that, particularly in the Allied Health area, we can react to that, looking at the risks that cause the losses and how much we were charging for them. So we start to react.

In particular, in those policies, which are an excess and surplus lines basis, we can react very quickly because they don't involve rate filings or rate approval. Just like any other indication that we would see, we try to take those under advisement and make sure that we're pricing appropriately. If there are particular areas of risk that have caused problems, we try to underwrite around them or away from them, like any other insurance company would do.

Was it more on the pricing front, or was it more on the underwriting side where the actions were taken? In terms of the relative proportion of those two?

I would say at this point more on the underwriting side -- risk selection side -- than on the pricing side. But we really didn't see any overall trends that would dramatically affect our pricing. It was more in terms of specific issues that we observed.

Got it. Okay, this was very helpful. Thanks for all the answers.

And your next question will come from Doug Whitwider (sic -- see Industry Names, "Doug Mewhirter") with SunTrust Robinson Humphrey.

Hi this is Doug Mewhirter in for Mark Hughes. I just had two questions.

First, about pricing. You had provided nice detailed commentary on the medical malpractice pricing trends. What kind of pricing trends are you seeing in the Medmarc lines, particularly that medical technology product liability?

We're seeing that business harden a little more than what we're seeing in the MPL line. It's still single-digit increases, probably low to mid-single-digit increases, but there's certainly more of a hardening trend that in line of business.

Is that because loss costs are increasing at a proportionally higher rate, or is it more of just a general industry reaction?

It's a general industry reaction. We've seen some capacity pulling out of the marketplace in certain areas, that's leading to it as well.

Okay. Thanks for that.

My second and final question deals around your Lloyd's business. First, could you remind me, what stamp capacity did you apply for, for the Syndicate?

The Syndicate stamp capacity is GBP82 million, approximately $130 million at current exchange rates. And -- yes, correct.

And obviously that's a maximum, not a budget, of course.

Related to the Lloyd's syndicate, you talked about how could you give that Medmarc more access to international products. Describe how the process would work, though -- the underwriting process.

So you have an underwriting team at the Lloyd's Syndicate and then you have Medmarc. Would the Lloyd's team take it through their brokers and use Medmarc as the actual underwriters, or would they -- would Medmarc underwrite it and reinsure it through Lloyd's? How do you visualize those two entities work together?

The current plan, and what we're looking to gain approval to do is for Medmarc, through its in-house agency, to have a Lloyd's binding authority with the Syndicate. In other words, within certain parameters the Medmarc team would have the authority to underwrite these foreign clinical trials and foreign product business. And then if the particular risks were outside of agreed parameters, either size, geographical scope, loss experience, or whatever, then those would be referred for underwriting to the Syndicate.

That's a fairly common type approach in the US. There's -- Lloyd's binding authority business is pervasive throughout the marketplace.

Okay, so Medmarc would be -- and hopefully I'm not oversimplifying this -- Medmarc would really act more like an MGA than actually a risk bearings underwriter, and Lloyd's, the capital at Lloyd's would actually bear the risk, or most of the risk?

That's correct. The MGA term itself may be a little bit further than is actually authorized, but that's the general concept, yes.

Okay. Thanks. That's all my questions.

(Operator Instructions)

From Janney Capital we'll go to Ryan Byrnes.

Thanks for taking my questions, guys. I had a question about -- I know it's a little early, but with healthcare changes happening in 2014, I wanted to get you guys' thoughts on how -- or how you guys are anticipating loss cost trends to settle out in 2014, both on the frequency and severity side as more people obviously have insurance?

It's a great question and it's largely unknowable. What we would anticipate at this stage is that severity will continue to increase, albeit at the manageable rates mentioned earlier by Howard. We have no reason at this point to suggest that we expect severity to go up.

We monitor it all the time and it really doesn't matter what we think it is going to do. What matters is what it does. But at this time, we see no signs that it's going beyond what Howard has said, and we should note that severity almost always goes up, it hardly ever comes down.

Frequency is a bit of a different issue and there are lots of ways to look at it. We have been through a period where frequency has fallen. We don't think it's falling any longer, but it has more or less leveled out.

There's a lot of debate within the industry as to why frequency fell. The true answer is nobody knows.

And there are very few common denominators from state to state. Frequency has fallen in states where there's been tort reform but it's fallen in states where there's been no tort reform.

My own view of the world is that frequency is a product of two things. First is patient frustration and second is unexpected outcome.

From a standpoint of patient frustration, the expectation, at least my expectation is that patient frustration will increase as a result of the changes in healthcare. You can feel that happening as we speak.

But even if the onset of the Affordable Care Act had run perfectly, you are still going to provide insurance coverage theoretically to 45 million people who did not previously have it. We're not adding any new physicians under the Affordable Care Act, so there is an atmosphere that's going to be created that will at least create the possibility of delays in patients being seen in physicians' offices and otherwise, and in my view patient frustration is likely to escalate.

And that will have, again, in my own personal view, an impact on frequency. And I would expect it to go up.

The other thing that in my view drives frequency are unexpected outcomes in healthcare. Bear in mind, I didn't say bad outcomes, I said unexpected outcomes.

There is nothing about the Affordable Care Act that is going to diminish patient expectations with respect to the outcomes of their healthcare. A patient expectations always escalate. So I would think that that's a potential.

Now, all of this, you have to then go further and say what effect does this have on the liability insurance market, as far as MPL is concerned, and we'll just have to see. It certainly could serve to harden the market in the fullness of time.

But again, we don't make predictions. We go on the data. But that's my view of the world with respect to frequency and severity as we think ahead to the world that's coming.

And how do you guys try to underwrite that in 2014? Obviously, you're underwriting now, but how do you guys try to underwrite around those potential changes?

Well, I don't think there's any clear way at this point in time to underwrite around any coming changes other than to look at what the -- particularly on the physician side of the business -- what the physicians are doing, what kinds of ventures, if you will, that they are getting involved in, in order to position themselves for changes under reimbursement, changes under the Affordable Care Act itself, which has some effect sometimes on their corporate liability exposure. For the physician himself or herself, seeing more patients is difficult to measure from our perspective.

Also depending on how they're using physician's extenders -- nurse practitioners, physician's assistants, that type of thing. We certainly take that into account. If the scope of practice is changing as a result, they're using more extenders, we rate for that, we underwrite for that.

That but the corporate liability issues are the ones that we really try to look at and make sure that what we're covering on the business entity side isn't expanding beyond what we have seen in the past. At this point, that's about the extent of what we can measure from underwriting, and we'll have to see how this whole relationship evolves.

Okay, great. My last question is, if I look at your numbers now versus five years ago, in 2008, on an absolute basis, you guys have grown your net premium basis, on absolute basis, about 20%, 22%, 23%, but your equity base has increased almost 80% over those past five years. Has anything happened in terms of opportunities or the business model itself that requires that growth of capital?

No, I don't think anything that would say that you need that much additional capital to support the 20% additional business. I do think that the capital requirements in our line have increased over time, and where people used to benchmark and say could you write at a 1 to 1 premium to surplus ratio, you now are probably at a 1.2 or something. So there's been some modest changes.

Part of it is just our capital base has grown. We continue to think that over the long term, there will be opportunities to deploy that capital.

Okay. Great. Thanks for the answers, guys.

Thank you, Ryan.

(Operator Instructions)

And it appears there are no further questions.

Very good. Thank you, Rebecca, and thanks, everyone. We wish you a wonderful holiday season, and we will speak with you when we next report fourth quarter.

Ladies and gentlemen, that does conclude today's presentation. We do thank everyone for your participation.