ProAssurance Corp (PRA) 2014 Q4 法說會逐字稿

Good morning, everyone, and welcome to the ProAssurance conference call to discuss ProAssurance's results for year end and fourth quarter 2014. These results were reported in, a news release on February 24, 2015. That news release and the Company's other SEC filings, including its 10-K also filed on February 24, 2015, will provide you with important information about the significant risks and other factors that could effect ProAssurance's businesses and alter expected results.

Also Management expects to make statements on this call dealing with projections, estimates and expectations and explicitly identifies these as forward-looking statements subject to applicable Safe Harbor protections. The content of this call is accurate only on February 25, 2015, and except as required by law or regulation, ProAssurance will not undertake and expressly disclaims any obligation to update or alter information disclosed as part of these forward-looking statements.

Now I would like to turn the call over to Mr. Frank O'Neil.

Thanks, Jason. Please note today that we'll be referencing non-GAAP items during our call. Our news release provides a reconciliation of those non-GAAP numbers to their GAAP counterparts.

Participating in today's call are our Chairman and CEO, Stan Starnes; Howard Friedman, the President of our Healthcare Professional Liability Group; Chief Financial Officer and Executive Vice President, Ned Rand; and Mike Boguski, the President of our Workers Compensation Business Eastern Alliance Insurance Group. I'll ask Stan to offer some opening thoughts. Stan?

Thanks, Frank, and thanks to everyone who is taking the time to be with us this morning. Our call today wraps up a strong quarter and gives us the opportunity to both recap a successful 2014 and look ahead to a pivotal 2015.

Some of the highlights, the return of a record amount of our capital to our investors, a record level of premiums written, the successful integration of our Eastern acquisition, and an equally successful launch of Syndicate 1729 at Lloyd's in which we have a significant investment. We'll discuss the numbers behind those (inaudible) today. We'll also highlight some of the important initiatives that we think will play a substantial role in a successful 2015 and beyond. Frank?

Thank you, Stan. Howard Friedman, the President of our Healthcare Professional Liability Group, will cover both specialty P&C and Lloyd's. Howard?

Thanks, Frank. In Specialty P&C gross premiums written declined 11% in the quarter and were down about 6% for the year. The decline was entirely in healthcare professional liability. Both medical technology and life sciences and our legal professional liability lines ended the year with premium growth.

Physician consolidation, particularly into hospital-based entrance programs, remains the greatest single marketplace factor in the Healthcare Professional Liability portion of this segment. We also deal with ongoing competition among the traditional insurers due to the continued relatively benign loss environment and the amount of capital in the industry.

That said, we were able to maintain our retention for medical professional liability business. We were able to marginally increase pricing on renewing physician accounts. And we were able to win new business.

In 2014 we added $16 million of new physician professional liability business and another $7 million in other healthcare liability. Medical technology and life sciences and our legal professional line added another $10 million of new premium. We see all of that as a positive and endorsement of our strategy to build a platform that serves the liability needs of the broadest spectrum of healthcare delivery.

Specifically renewal pricing in the segment was favorable. With the largest component physician renewals up 1% in the quarter compared to a 1% decline in the fourth quarter 2013. For the year, physician renewal pricing was 1% higher as compared to flat for the full year 2013. Retention in the physician book was 90% in the quarter a 1 point increase over the year ago quarter. Retention for the full year was 89% in that book, unchanged from 2013.

Let me go back to premiums for a minute. Like gross premiums, net earned premium decreased quarter over quarter and year over year which somewhat counterintuitively reflects the progress we are making in our shared risk programs. For example, our Ascension program ended the year with $26 million in gross premium.

We are writing more business each quarter through CAP Assurance in which we partner with a California company to add new premium in California and adjacent states. Much of this new business is premium we would not otherwise be able to write, and even though we share risk in the C premium, we believe it is helping us build a stronger presence in parts of the market where we might not be as well known to buyers and to brokers.

We also think some of these shared risk programs may produce lower average loss cost in the long term, which is where we focus. In these programs, we and our partners, have skin in the game leading to a greater focus on reducing risk and enhancing patient care.

And on the subject of losses, I will say again this quarter we did not see a change in overall loss trends in the Specialty P&C segment. I know there's been some concern about larger or more frequent losses emerging as consolidation matures and the Affordable Care Act has more time to influence healthcare delivery. But we are just -- are not seeing any real change in the loss climate.

Frequency is essentially flat and severity continues to increase at about 2% to 3% a year which is very manageable. Net favorable reserve development in the Specialty P&C segment was $50 million in the quarter which brings the total net favorable development in this segment to $181 million for the full year, mostly from accident years 2007 through 2011. This fourth quarter development is a reflection of our efforts to recognize trends on a more contemporaneous basis throughout the year.

Two items related to reserves that deserve special attention. First, in addition to the favorable prior-year development in the fourth quarter, we also had an $18 million reduction in our reserve for the reporting endorsements we issue upon the death, disability, or with qualifications the retirement of an insured. The acronym is DDR. Of note the current gross DDR reserve balance is $82.6 million.

The change in DDR reserve is recorded as a reduction to current accident year incurred loss which was the main reason this segment's current accident year loss ratio was 74% in the fourth quarter, down 16 points from Q4 2013. The fourth-quarter DDR adjustment also help lower the year-over-year current accident year loss ratio to 83%, almost 2 points lower than 2013.

We look at DDR annually for trends in the retirement and lapse rates of our insurers. And this year the actuarial analysis indicated an adjustment that resulted in net favorable settlement.

The second point is forward-looking. We are maintaining our underwriting and pricing discipline despite the pressure of a soft market. It's no secret that premiums are down over the past five years. That means that even in a benign loss environment and even with no deviation from our prudent reserving policy, you should expect favorable development to slow in the years ahead.

Given the historical volatility of this line in general, and the well known difficulty in pricing the business accurately, we continue to establish initial loss reserves at a level that is 8 to 10 loss ratio points above our pricing targets. If everything works out exactly as anticipated in our pricing, that would be our long-term run rate for favorable reserve development. Of course in this line of business, experience has shown that even the most informed actuarial assessments can be proven wrong by a shift in the loss climate.

Our news release highlighted what we believe is real progress with two new initiatives I mentioned last quarter. ProAssurance risk solutions and ProAssurance Complex Medicine, or ProCxM. Recall that risk solutions focuses on structured financial transactions and risk financing opportunities. ProCxM is a program targeting large healthcare facilities or other entities that have a significant self-insured retention.

ProCxM wrote it first account effective January 1, and it's not the size of that account that's important, but the acceptance of the program that the program is seeing in the marketplace that is encouraging to us. The team at Pro-Praxis, our partner in ProCxM, is well known in the industry and has the backing of Cooper Gay Swett & Crawford, so we are confident this will open new doors in an evolving healthcare delivery landscape.

Risk solutions is also seeing a strong flow of submissions. But I want remind you again that these are likely to be sporadic transactions primarily in the medical liability and worker's compensation space and may involve runoff liabilities in M&A transactions or the assumption of existing liabilities in large organizations seeking to restructure capital. With that team's successful track record, we are confident in their ability to add long-term profitability to ProAssurance. Frank?

Thanks, Howard, I know that was a lot to cover but it might make some sense now to have you touch on the results from the Syndicate 1729. I'm going to let Howard catch his breath for a second and remind you that the participation in Syndicate 1729, which began operations January 1, 2014 is 58%. We are reporting on a one quarter lag with the exception of investment results associated with our funds on deposit with Lloyd's, which are held as an investment here and certain -- or investment in certain US-based administrative expenses. So Howard what else can you tell us?

Well we all know that the global reinsurance business is soft now, and while Duncan Dale and team are seeing a high level of summation activity, the underwriting discipline that is inherent under Duncan's leadership means that the business is growing a bit more slowly than initially projected although we are confident in the profitability of the business being written. The Syndicate is seeing a solid flow of submissions which we think is encouraging for a startup. And the level of expenses is consistent with our expectations. So we remain encouraged with our investment.

Our 58% share of Syndicate 1729's gross written premium for the quarter was $7 million. And was $34 million through December 31. The mix of business is approximately 64% casualty reinsurance, 18% property catastrophe reinsurance, 13% direct property coverage mostly in the US market, and the remainder is property reinsurance, again mostly in the US.

Looking ahead to 2015, Syndicate 1729 has been allocated a maximum capacity of approximately $117 million of which we have a commitment for up to approximately $67 million. Frank?

Thank you, Howard. Next comments we'll hear will be on Workers Compensation and those will come from Mike Boguski, the President of Eastern. Mike?

Thank you, Frank. This was another solid quarter and year for Eastern. The Workers Compensation segment benefited from improvements in the overall economy during 2014. We were pleased with the continued growth in payrolls, favorable production results across all operating territories and the consistent loss trends in the traditional book of business.

We were pleased with production results throughout 2014 which continued in the fourth quarter. Gross premiums written in Workers Compensation were $44 million and direct premiums written were $42 million for the three months ended December 31, 2014, which included premium renewal retention of 83.4% and new business writings of $7 million. Renewal rate pricing was relatively flat and auto premiums were $426,000 during the quarter.

Direct premium written were $218 million for all of 2014. The Workers Compensation calendar year net loss ratio was 68.2% in the fourth quarter. It's important to note the key difference between Eastern's traditional and alternative markets business which are -- which is our segregated portfolio self business housed within Eastern.

There were some medical severity related claim activity in a few of our segregated portfolios self programs during the quarter. However, this has a limited effect on our segment results because of the third-party ownership interest of the sell business.

In our traditional Workers Compensation business, the calendar year net loss ratio remained relatively flat at 66% reflecting favorable frequency and severity claim trends. The combined ratio for the year was 96% including 2 point -- 2.7 percentage points of intangible asset amortization and 1.4 points of nonrecurring expenses, primarily related to ProAssurance's acquisition of Eastern.

One of the sustainable competitive advantages of Eastern is our proactive approach to closing claims and 2014 was no exception. At year end, there were just 12 open claims in our traditional book of business net of reinsurance for accident years 2007 and prior. In addition, we were successful in closing 59.7% of 2013 in prior claims during 2014.

We were pleased with the progress on our 2014 strategic plan including continued focus on profitable organic growth, healthcare market segment expansion, geographic diversification, cross-selling initiatives and successful integration into the ProAssurance family of companies.

We are very proud of the consistent operational and financial track record as well as the reputation we have earned in the Workers Compensation Insurance business over the past 17 years. Frank?

Thank you, Mike. Now we'll turn to Ned Rand, our Chief Financial Officer, for a discussion of corporate and consolidated results. Ned?

Thanks, Frank. Let me quickly hit a few highlights from our Corporate segment. This segment brings together a number of unrelated activities and it is best look at them individually.

Starting with operating expenses, remember last year our fourth quarter had some significant costs associated with the start up of Syndicate 1729, and to a lesser degree, cost associated with what was then the upcoming purchase of Eastern. For the full year, operating expenses in this segment are down for similar reasons. Going forward you can expect to see some changes in this line item as we are reorganizing how we charge corporate expenses to our increased lines of business. And this will result in more expenses captured here and less allocated to our Specialty P&C segment in particular.

This segment also captures virtually all of our investment activity. And for the quarter, net investment income was up $2.6 million, and this is being driven by the performance in the quarter of several of our alternative investments. As we have discussed in the past, returns on these investments are more volatile than in our core fixed income portfolio.

On that portfolio, our income was down approximately $2 million, largely driven by lower portfolio balances. For the year, the income from the core portfolio is down $11 million and this is offset somewhat by a $6 million increase in our alternative investments and a $1 million increase in income from our equity investments.

The decline in the equity and earnings of unconsolidated subsidiaries is driven by results for the fourth quarter 2013 versus 2014. You may recall that we had an $11 million benefit in the fourth quarter last year related to change in accounting treatment of one of our investments.

Turning to consolidated results, the growth in gross written premium for the year came primarily from the addition of $225 million in Workers Compensation premium, and the $34 million of gross premium from our investment in Lloyd Syndicate 1729. Gross premiums written were up 28% over last year's fourth quarter to $148 million and are up 37% year over year to $780 million.

Total net favorable development was $49 million in the fourth quarter and $182 million for the full year, both lower than the prior-year periods but still strong. The decline is to be expected given the premium decline absent acquisitions over the past few years, and with lower premiums we have a lower base of reserves. I would echo Howard's comments here, we continue to approach reserves in our healthcare professional liability book in particular with recognition to the historical volatility that this line has exhibited.

While frequency has been flat over the last several years, the moderation in our pricing and the upward slope of the severity trend, even at a very low level, affects the actuarial assumptions we make in evaluating our reserves. The consolidated current accident year net loss ratio improved 19 points quarter over quarter to 71.1%. Most of this decrease is the result of the DDR adjustment Howard mentioned. But the lower loss ratio on Workers Compensation business and from Syndicate 1729 also played a role. The same factors were at work in decreasing the full year accident year net loss ratio by 7 points to 77.9%.

I also want to briefly refer back to Howard's comments on ProAssurance versus solutions. I'm not suggesting you incorporate any of this into a financial model because the timing is difficult to predict. But I want to highlight the fact that some of these transactions could be quite large, in some cases as much as $100 million of revenue over a finite lifespan.

Depending on how the transaction is structured, it could be recorded either as premium or under deposit accounting with fee income. It could make quarter-to-quarter comparisons quite difficult. There could also be a sizable impact on our expense ratio and loss ratio depending on how the business is structured. Frankly, most of these transactions won't reach the $100 million mark but I want everyone to be aware that these are the types of transactions on which this unit is focused.

Our expense ratio was 30% in the quarter, 2.5 points better than the year ago quarter. As I mentioned in discussing the corporate segment results, we had higher M&A and business expansion expenses in Q4 2013 than in this year's fourth quarter which accounts for the improvement. The expense ratio for the year was 30.2% which was up 2.2 points.

As we have added the business and premium of Eastern and the Syndicate, we have also added expenses. And that accounts for the majority of the increase in actual expense dollars. The increase in expense ratio is also driven somewhat by the year-over-year decline in Specialty P&C premiums.

Our underwriting results continue to be strong as well. The fourth-quarter combined ratio was 73.2%, and for the full year the combined ratio was 82.1%. All of this continues to drive profitability. Operating income in the quarter, which excludes realized investment gains, was $60 million, or $1.04 per diluted share. For the year, operating income was $186 million, or $3.13 per diluted share.

We continue to work in be effective capital managers as was demonstrated in the fourth quarter. In addition to declaring a special dividend to return $150 million to shareholders, we purchased a proximally 1.2 million shares at a total cost of $55 million. Since January 1 of this year, we have continued to purchase shares under the auspices of our 10b5-1 plan and our year-to-date repurchase through last Friday, February 20 has been 725,000 shares at a total cost of $33 million. That leaves $149 million in our current repurchase authorization.

In sum, we returned a total of $443 million to shareholders last year through buybacks and dividends declared. I want to stress that this doesn't mean we do not see opportunities to deploy our capital in our businesses. As a part of our capital management program we have retained capital we believe will be sufficient to allow us to pursue those opportunities that may arise.

At year end we had $403 million in cash and short-term investments held outside our insurance subsidiaries. One item of note, we have drawn down $100 million in secured borrowings under our revolving credit facility. We believe this is a positive arbitrage rather than selling securities to create liquidity. You may recall that we made the same decision when we bought Medmarc.

And one more item connected to the buyback. We are highly confident in the value represented by ProAssurance shares at the levels where we are buying today, and we believe our shares represent a sound investment in the future of ProAssurance for our shareholders.

But I want to stress that in the short run when we buy at these levels, our ability to grow book value per share is diminished. That activity and the $150 million special dividend are why book value per share declined year over year to $38.17. Tangible book value per share at year end was $32.66. Frank?

Thanks, Ned. Stan, some final thoughts from you?

Thanks, Frank. I mentioned at the outset that we regard this as a pivotal year for ProAssurance. We have put in place foundational strategies that have built a Company that is uniquely situated to provide the broadest array of Professional Liability and Workers Compensation insurance to the healthcare market on which we are focused. We are already seeing results from that strategy. I am confident that we have the right people and the right business plan to leverage our experience and expertise, our geographic reach, and especially our financial strength.

And on that subject, I'd like to leave you with a few facts about how our long-term strategy and focus comes to benefit our policyholders and shareholders alike. Since July of 2007, when this Senior Management team came together, shareholders equity has almost doubled to over $2 billion. And during that same time period we have returned over another $1 billion to shareholders through buybacks and dividends. And we have deployed more than $750 million additional to acquire businesses that have put us in this unique position to serve our customers.

I doubt there is another specialty insurance company of any size that can match that track record. It's a track record we are all proud of and one we are confident we can build on going forward. Frank, let's take questions

All right, Jason, if you'll open the line for questions we'd be happy to take them.

(Operator Instructions)

Amit Kumar, Macquarie.

Thanks and good morning, and congrats on another strong quarter. A few quick questions. Maybe I'll start with the discussion on capital repatriation, capital management, and obviously it was very strong in 2014. Based on the -- (inaudible) between the opportunities you laid out and the remaining buyback, how should investors think about that? Is it more opportunistic at this point or does it still remain strong for 2015?

Amit, we -- our Board looks at capital at every meeting. The primary advantage of our capital management strategy is that we are very flexible.

Ned can provide you some of the specifics with it, but we want to retain enough capital to conduct our business. We want to retain enough capital to grow our business. We want to retain enough capital to provide long-term financial strength to our policyholders. And we evaluate it periodically.

We also want to retain enough capital to take advantage of acquisition opportunities that come along. And we're confident that we're in a position to accomplish all that with a strategy that our Board has laid out.

As you know the transactional opportunities are quite episodic. One has to be in a position to act when they come along, you can't make them happen. We never go anywhere uninvited.

And we take all of that into account and our Board particularly looks at it very strongly at each meeting as we think about where we are from a capital standpoint. Ned, anything to add to that?

I think Stan that really sums it up well. To your question about the pace maybe of buybacks, we're very sensitive to the price of our stock as we've discussed before. We believe we have, as Stan mentioned, sufficient capital on the books today to take advantage of any opportunity we see and it's a fluid assessment. And we'll evaluate that every quarter in light of any profits that emerge out of the business.

Got it. And then segueing to discussion on consolidation and you're talking about consolidation and obviously you've played a phenomenal role in integrating some of the recent acquisitions, if you will. However I wanted to flip the discussion, there has been a broader trend towards industry consolidation recently. You've seen Bermuda space being quite active. Do you get the sense that broadly there would be any change I guess in the interest levels for evaluating specialty franchises such as ProAssurance at this point or has a broader discussion trend remained unchanged?

Amit, that's something that's probably way above my pay grade. A lot of people -- you hear all the chatter that you're talking about. Our Board and our Management team is very focused on executing the strategy we have in place. And I can tell you as a Member of our Board that we are very confident that the most compelling strategy available to us is represented by the course that we are on.

What happens outside the world of ProAssurance is not something we have any control over and frankly it's not something we pay a lot of attention to. We're very focused on executing the strategy we have in place and we're very confident in our ability to provide meaningful returns to our shareholders and extraordinary protection to our policyholders.

Got it. And finally, and thanks for the color on the loss cost trends in the MPL business, but broadly would it be fair that I guess the interplay of retentions, pricing and competition will remain stable for 2015? Or do you see any warning signs on the horizon?

It's, Howard. Really nothing imminent. We continue to see pretty much the same type of marketplace as we've seen for the past couple of years of which as you could see in the numbers for retention and pricing and lost cost trends have basically been pretty stable for the past couple of years as well. So right now nothing that indicates any significant change in that we look at all of our data quarterly and obviously we're monitoring the market as we see things happen almost on a daily basis but nothing on the horizon.

Got it. Thanks for all the answers and good luck for the future.

Paul Newsome, Sandler O'Neill.

Good morning and congratulations on the quarter and year. I had a couple of questions. One was I was a little bit confused, and I'm easily confused, about the comments about the decline in the Medical Liability business. And I think you said that there's been essentially stable retention but the business shrunk quite a bit. So does -- maybe this is a measurement issue. When you think about retention, are you excluding the impact of what happens when a client essentially disappears because of consolidation?

No. In fact we measure every which way somebody leaves us and it's all included in our retention numbers. But when we run roughly 90% retention and more or less flat rates, maybe up 1% in a quarter down 1% in a quarter, you're going to see that kind of compounded effect there of 88%, 89%, 90%, 91% of the expiring premium being renewed. And then of course that gets offset by new business. But new business is difficult to come by at least new business that meets our profitability requirements.

So you can run through the numbers and we do this to test our various reports to look at the effect of the combined retention pricing new business and how that translates into premium quarter over quarter or year over year. I guess you could say the factor that would determine the ultimate change is how much new business gets added because again if we're running 88% to 90% on expiring business, you have to offset that loss every quarter or every year.

So just so I understand the simple math here, essentially your losing about 10% of your customer base which is actually at a low level through --

Paul, one clarification. When we're talking about retention, we're basing it on premium because if you just do it on customer base, you might have an Allied Healthcare professional paying $1000 versus a neurosurgeon paying upwards of $40,000 or $100,000. So we measure it on premium because it's a better relationship.

And that makes perfect sense to me. But it looks like your premium in that business was down double digits. You lost -- if you didn't sell any policies than you could blame it all on retention and pricing would have had essentially a minimal impact either way.

But you did have some new business. And I guess that -- maybe I'm baiting the answer, is that a mix shift that's making the numbers -- that accounts for the difference between what you would have put on a new business and what you didn't get in premium?

There's always some mix involved but if you look at it for the year, we said that retention was 89% for the year. We said that the physician renewal pricing which is the vast majority of it was 1% higher. And for the year we were down 6%. So the difference there would be essentially the new business that we added. Otherwise it probably would have been down 10%.

Okay, that's very helpful. Like I said, I'm easily confused. My second question has to do with the Lloyd's business. Can you talk a little bit about, not next year but way out, when does that business in your opinion get to scale?

Well I think for one thing it depends on the marketplace. That's one of the biggest factors particularly with respect to the idea that it's a new operation and because of the underwriting discipline that Duncan Dale and the team of underwriters that he's recruited have among themselves.

The market at Lloyd's continues -- the overall Lloyd's market generally continues to expand as Lloyd's banks more of an effort in promoting itself internationally. And depending on the type of business Syndicate 1729 expects to take advantage of that in varying degrees.

It's not right now a matter of not seeing the submissions or not being fully staffed, both of those things are happening. It's really a reflection of what is out there that is worth writing and what the competition is.

Is the syndicate able to even -- when it quotes on certain accounts, get a share of the account that it wants because many of these programs are syndicated. So you might quote on something and authorize a 10% share and end up with of 3% share because of the amount of competition that is also quoting on it.

I would think that from a pure scale perspective, it will continue to grow and is expected to continue to grow. But I think a lot of it depends on what the marketplace does.

Obviously I think you're very smart in that I've never heard of a company going bankrupt because of too high expenses they always go bankrupt because of losses, right. But I guess does the premium need to be double, triple this size to get to a point where your expenses are in line with what you'd want from a profitability perspective? That's the question I was -- as opposed to the timing.

Yes, one thing to make sure you understand with the way that we've accounted for the Syndicate this year, we have not deferred any of the expenses given the startup nature. So we've expensing everything while we've been earning the premium over a 12 to 24 months period depending on the nature of the premium.

So you've got a bit of a mismatch in what's being reported on our results that makes the expenses look heavier than they are. So that's a piece of it I believe.

Our expectation is, so we're on a one quarter lag. So first quarter of 2015 will be fourth quarter for them. And our expectation is that we will begin to see those losses that we've seen in the Syndicate begin to moderate barring any unforeseen loss events as we begin to capitalize expenses in the Syndicate and amortize them over that 12 to 24 month period that the premiums earned.

Okay, terrific, that's great. Thank you very much.

Howard Flinker, Flinker & Company.

Ned you probably calculated the compounded return if you add back the $1 billion of payments to share holders and dividends and buybacks. What would that be?

We have, Howie, but I don't have it with me. We can get that for you, but we have calculated that, I just don't have it here with me.

I'm sure you did. Without it, it is 10%. Doubling in seven years is 10%.

One other comment, RLI has a similar record. They compounded 15% and they've done it for 30 years. So you better stick around for another 20 years, Stan.

I intend to, Howie.

Okay.

We'll have a great call in 2035.

All right, thanks.

(Operator Instructions)

At this time we have no further questions. So I'd like to turn the call back over to your speakers for any additional or closing remarks.

Well that's it, we will next speak with everybody in May. We have two investor presentations coming up, one next week on Monday and the other later in March. And we'll have an announcement about those coming up and we invite you to participate there. Thank you very much.

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