ProAssurance Corp (PRA) 2015 Q1 法說會逐字稿

Good morning, everyone. Welcome to the conference call to discuss ProAssurance's results for the first quarter of 2015.

These results were reported in a news release on May 7, 2015. The release, along with the Company's other SEC filings, including the 10-Q filed on May 7, 2015, are intended to provide you with important information about the significant risks and other factors that could affect ProAssurance's business 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 May 8, 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.

Thank you, Lauren. Good morning, everyone.

Please note that we'll reference non-GAAP items in our call today. Our recent 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.

I'll ask Stan to offer some opening thoughts. Stan?

Thanks, Frank. My thanks to everyone on the call for taking the time to be with us this morning. We'll focus today on the solid quarter for ProAssurance, and we will be highlighting a $35 million operating profit, an increase in gross written premium, driven by our workers compensation segment, a significant amount of new business, as well as early success in our cross-selling initiatives.

I also want to underscore ProAssurance's continuing commitment to delivering value to our shareholders through dividends and a steady impactful stock repurchase program. Frank?

Thanks, Stan. We're going to begin today with our Chief Financial Officer, Ned Rand, for an overview of some consolidated results. Then we'll go into our each of our operating segments, but first, Ned?

Thanks, Frank. Starting at the top of the income statement, I'll highlight an increase in gross written premium in the quarter, again, driven by an increase in workers compensation, which was up 15% year-over-year, and a small contribution from our Lloyd's segment. Those gains were offset somewhat by a decline in top line in our specialty P&C segment.

We have said many times before that we see terrific opportunities in bringing together our MPL in workers comp products, and that over the course of last year we were laying the groundwork to enable this. We have begun to see early success in our efforts in cross-marketing with $735,000 in gross premiums written that is directly attributable to these efforts. We continue to be very encouraged by the potential to leverage these two lines of business that are so critical to those operating in the healthcare arena.

Net premiums written were $198 million, down a fraction of a point from last year's first quarter on 23% increase in ceded premiums which are higher because of our cession as per intercompany eliminations of $2 million to Lloyd's Syndicate 1729 from the podiatry business within our specialty P&C segment and increased ceded premiums from our workers compensation segment. Net premiums earned were $172 million in the quarter, essentially unchanged from Q1 of 2014. The decline in specialty P&C premiums earned of $11 million was offset by increases of almost $6 million each from our workers compensation and Lloyd's segments. The increase in Lloyd's is due to the one-quarter lag in reporting the results of the Syndicate, so there is no comparable premium in the first quarter of last year.

Total revenues were $208 million, virtually unchanged from a year ago. Our expense ratio was 29.9% in the quarter, compared to 30.6% in the year-ago quarter. Last year's Q1 expense ratio was increased by approximately 1.7 percentage points in transaction related and other one-time expenses, and this is offset somewhat by the addition of Syndicate 1729 in the first quarter of 2015.

Our current accident year net loss ratio for the quarter was 80.7% about a half a point higher than last year's first quarter. The current accident year loss ratio on our specialty book was up just under 2.5 points, driven largely by higher accruals for internal claims adjustment expenses on lower total premiums. Results from our workers compensation and Lloyd's segments together provided a benefit of about 7 points.

We recognize $33.5 million of favorable development in the quarter and continue to see claim trends holding relatively steady. As we previously have discussed, while we continue to take a prudent and conservative approach to reserving given the volatile nature of all the lines we underwrite, we would not expect favorable development if it occurs to occur at the same levels as in the past.

Premium volumes in our Healthcare Professional Liability line, which makes up the bulk of our favorable development have declined over the last several years. While pricing has remained relatively stable as has frequency, we continue to see an upward sloping severity trend. We remain very confident in the adequacy of our reserves and continue to approach the favorable trends we are seeing with a skeptical eye.

In all, we continue to write at an enviable combined ratio of 91.1%, and we are solidly profitable, earning operating income of $34.7 million or $0.61 per diluted share in the quarter. We remain committed to effective capital management, which along with our profitable operations, enhances the long-term value we create for our investors. In the first quarter, we spent $57 million to purchase 1.3 million shares of common stock, much of it under the terms of our 10b5-1 plan. As of April 30, our repurchase activity for 2015 total 1.7 million shares at a cost of $77 million.

Year-to-date, we have paid $35 million in regular cash dividends to shareholders, in addition to the $150 million special dividend paid in January. Our present intention is to return at least 100% of net income to shareholders this year. We expect to do this primarily through share repurchases and our ordinary dividends, but we are sensitive to the price at which we buy. We may consider other means of returning capital is needed.

Just a couple of final notes on the quarter, book value per share was $38.39, up from $38.17 at year-end. Our share buybacks during the quarter did dampen the growth in book value per share, but we view this as a short-term sacrifice to accomplish our goal of delivering superior long-term returns.

Tangible book value per share was $32.81, and at March 31, 2015, we held $137 million in cash and short-term investments outside our insurance subsidiaries and available for use by the holding company. We have just received regulatory approval to upstream $124 million in cash and securities from an operating subsidiary to the holding company. That will happen next week. Frank?

Thanks, Ned. We're going to check back with you (inaudible) to hear about the corporate segment. Right now, we're going to switch to Howard Friedman for comments on specialty P&C. Howard?

Thanks, Frank. In specialty P&C gross premiums written were $144 million in the quarter, down 6% year-over-year, which was almost entirely the result of a decline in physician professional liability premiums. Offsetting that decline, were gains in premium for healthcare facilities, up 11%, medical technology and life sciences up 3%, and legal professional liability up 8%. The drop in physician premium is due to consolidation of physician practices into hospital self-insurance arrangements and competitive market pressures.

There continue to be risks we simply won't write, due to our underwriting discipline and expectations for profitability. That doesn't mean we are unable to attract and write new business. Our ability to deliver superior service and security while responding creatively to emerging risk has allowed us to generate almost $13 million of new premium in specialty P&C in the first quarter, significantly more than in any quarter in recent memory.

A recent example of our ability to respond to unique liability needs came through our ProAssurance Complex Medicine initiative. We were able to use a combination of the proprietary Pro-Praxis underwriting methodology and the creativity of our underwriting department and Excess & Surplus Lines subsidiary to solve a reinsurance problem for a national not-for-profit healthcare organization that had been searching for such a solution for several years. That is just another illustration of the need to be broader in our approach to emerging risks, and we are confident our acquisitions and internal business development have put us on the right road for the future in this regard.

While we see opportunities such as these, we continue to see challenges as well. One of those challenges continues to be physician consolidation, which seems to be slowing in some areas, but remains very active in others. We lost three large physician groups in the quarter, two of which were brought into the self-insurance vehicles of the hospitals that acquired the groups. The loss of these accounts had an outsized effect on physician retention which was 85% in the quarter, down 2 points year-over-year. Renewal pricing on sufficient business was down 1% year-over-year.

Turning to losses, the loss environment remains benign. There was no change in overall loss trends in the specialty P&C segment. Within the largest portion of the segment, healthcare professional liability, frequency is essentially flat, and severity continues to increase at 2% to 3% a year which is manageable.

First quarter net favorable reserve development in the specialty P&C segment was $32 million as compared to $47 million in the year-ago order. This moved our net loss ratio up to 60.1%. Frank?

Thanks, Howard. Now might be a good time to ask you to handle the Lloyd's (inaudible) as well.

Sure. Remember that we are reporting on a one-quarter lag, with the exception of investment results associated with our funds at Lloyd's which are held as an investment and certain US-based administrative expenses. It will be next quarter before we begin to see year-over-year comparable financial results. Our 58% participation in the gross premiums written of the Syndicate was $4.7 million in its fourth quarter.

Underwriting expenses were $3.6 million in the quarter, primarily related to salaries and benefits, professional fees, and amortization of policy acquisition costs. I'll remind you we have viewed the internal costs of the Syndicate as start-up expenses, and we have elected not to defer them. We are confident the expense ratio will trend downward as the Syndicate writes additional business, and we can begin to match these costs against the associated premiums.

As we are reporting the results for 1729 on a one-quarter lag, this quarter represents the end of the first full year of the Syndicate's operations. For the year, the Syndicate wrote a broad book of property and liability business and our 58% participation in the year's gross premiums written totaled $38.4 million. A mix of business for calendar year 2014 was approximately 61% casualty reinsurance, the majority of it US-based,15% catastrophe reinsurance, 19% direct property coverage, mostly in the US market, and 5% property reinsurance, again primarily US-based.

The net loss ratio for the year was 68.3%, very much in line with our expectations for this start-up operation. The expense ratio for the year was 72%, and 66.4% if you excluded transaction related expenses which totaled approximately $1 million for the year.

Duncan Dale continues to report a strong flow of admissions which we expected given his standing and reputation in the London market, and we are confident in the future of the Syndicate and this segment. Frank?

Thanks, Howard. Next up, workers compensation and Mike Boguski, President of Eastern. Mike?

Thank you, Frank. During the first quarter our workers compensation segment benefited from favorable production results across all operating territories, prudent expense management, continued payroll growth, and consistent loss trends. Despite experiencing competitive pressures, gross premiums written increased to $76 million in the quarter compared to $66 million in the first quarter of 2014, an increase of 15%. This included new business writings of $12.4 million in the quarter.

Premium retention improved 5 points quarter-over-quarter to 87%, enhanced by the renewal of all 9 of the available alternative markets programs and premium retention of 95% in that sector of our business. Pricing on renewal business increased 1% during the quarter. Audit premium increase to $1.4 million in the quarter compared to $300,000 in the first quarter of 2014, as a result of improved economic conditions and strong financial underwriting.

The accident year net loss ratio was 65.9%, essentially unchanged from the first quarter of 2014. Both quarters included severity related claim activity from extreme winter weather conditions. We were successful in closing 19% of 2014 in prior claims in the first quarter of 2015 in our traditional book of business, which is the best first quarter closing rate in our history and represents a good start to the year in this important area.

Net favorable reserve development was $1.7 million in the quarter, primarily related to our alternative markets business. The favorable reserve development reduced the net loss ratio to 62.6%, which is essentially unchanged from the first quarter of 2014.

The combined ratio for the quarter was 92.6%, including 2.5 percentage points of intangible asset amortization, and 1.1 points from the initiation of a corporate management fee. The expense ratio reduction in the quarter was primarily driven by 4.3 points of transaction related and not occurring expenses incurred in the first quarter of 2014 that we did not experience in the first quarter of 2015. Frank?

Thanks, Mike. Let's go back to Ned now for a discussion of corporate segment results. Ned?

Thanks, Frank. Our corporate segment brings together a number of unrelated to activities, so as in past orders, I'll review each individually.

On the revenue side of the equation, we experienced a $2.6 million year-over-year decrease in investment income, and there are several reasons for this decline. The interest income from our fixed income portfolio declined because of a negative coupon on our [jets] portfolio, and the impact of lower average balances in the portfolio.

In addition, we continue to favor equities and alternative investments over fixed income investments in the current investment environment. And as a result, we have allocated a larger portion of the overall portfolio to these investments. Our expectation is that these investments will provide superior returns over the long term, and in the short term, they add quarter-to-quarter volatility to our investment results. At the same time we saw a $2.1 million increase in net realized investment gains despite a $1.8 million other than temporary impairment related to energy investments.

Starting in the first quarter of 2015, we are charging a management fee to each of our operating subsidiaries to cover costs of services provided by the corporate segment. This allows us to better track operating performance in each subsidiary while focusing on expense control throughout the organization. In the past the bulk of these expenses have been borne by the specialties P&C segment, and that is why operating expenses are down in that segment and up in the corporate segment. Taxes are down $7 million, and this is largely attributable to the decline in pretax income and the impact of both our tax credit investments and our allocation to other tax favored investments.

Thanks, Ned. Stan, some final thoughts for you before we take questions?

Frank, our focus continues to be on the long term and not any single quarter's results. We are transitioning ProAssurance from a best in class well-capitalized monoline carrier into an integrated family of healthcare-centric specialty Companies, with superior capitalization and unrivaled expertise, focused on the broad spectrum of risk faced by healers, innovators, employers, and professionals. This transition requires an enduring commitment to our insurers and agents and an equal commitment to our shareholders.

Like all others in our specialty line, we face the challenges posed by the combination of evolving changes in our healthcare system and a very soft pricing environment. Unlike others, we are uniquely positioned to convert these challenges to opportunities. To this point, we have successfully navigated the course that has taken us a long way toward becoming the organization we must become in order to take advantage of all that lies ahead of us. Given our discipline, and our long-term outlook, we believe we are assured of a very bright future.

Thank you, Stan. Lauren, that concludes our prepared remarks. We are ready for questions.

(Operator Instructions)

Amit Kumar, Macquarie.

Thanks and good morning. Just a few quick questions.

The first question is in regards to the positive movement and the discussion on cross-selling. Clearly, we are seeing some good results there. Is there any way to broadly talk about it? Does it get to a level where it offsets any pressures from competition, i.e., does it make up for the business which is being lost to competition?

Amit, it's Howard. I will start, and then others may want to join in.

I think it has a lot of potential. I think it does, and eventually will, make up a portion of the business that we lose to competition because it opens up new channels for us, new opportunities to approach existing insureds, say, on the worker's compensation side for their professional liability coverage. We might not be able to get that entree normally through our direct sales efforts or through our agents, depending on the state.

Over a period of time we do think it has potential. We have one program in place now that is really just beginning that would open up potentially for us a network of healthcare facilities in the Southeast. It has opportunities for us, and maybe Mike or Stan want to comment further.

Yes. I think just to add to Howard's comments, it's really four specific strategies that we can execute on. There's the cross-referral agents between ProAssurance and Eastern and all of our other operating entities which is attractive.

The cross-selling of additional customers, as Howard mentioned, both in our traditional business. But very uniquely in our ANOVA business, where we would be able to take the MPL and workers comp lines within our alternative market segment of our business, which we believe is going to be unique in both the short term and long term.

Then I think a fourth strategy for us both to consider, which we had one success for story this quarter, was to really look at the national broker relationships across all of our organization and the specific healthcare units within those national brokers and to bring our various product lines within to those shops. I think those are four areas that I think will be helpful in filling revenue down the road.

I think Mike and Howard have it exactly right, Amit.

These accounts come up for renewal only once the year, so we can't do anything overnight. There's an element of excitement among our agents or brokers over having a market in which they can easily place the two most difficult to place coverages that any healthcare organization encounters, the MPL and the worker's comp.

I think were seeing the first fruits. We're seeing early success. We remain very committed to the strategy, and we've see nothing that deters us from continuing down this path.

Got it. That's helpful.

The other question and maybe switching gears and going back to the core MPL book, and Howard I was comparing your commentary on (technical difficulties) physician consolidation and its impact. I got the sense that after many quarters, the language had changed. I think (technical difficulties) than others, and I think previously we were just talking about impact.

Can you expand on that comment? Have we crossed that hump, or how should we think about the impact?

I think what I was trying to point out was how large accounts and particularly as the physician consolidation continues among physician groups. And then in some instances large accounts or large physician groups are acquired by hospitals, how that can create volatility in our retention numbers. The departure from our normal 87%, 88% retention in the first quarter was really attributable to 3 accounts, 5 years or 10 years ago, we would not have seen that type of volatility as a result of just a few accounts moving.

That was the main point I was trying to make, not so much that we've crossed the threshold or over a hump or anything like that. It's really more how the larger accounts, when you acquire them, you can certainly have a big quarter for new business. When you retain them, they have a very stabilizing effect on retention. But if you lose a few, and particularly in a short period of time, it can create volatility almost like large claims do on the law side.

Got it. Just finally, on the final piece of the business.

On the Lloyd's piece on the last call we had spent some time discussing what the future might look like. At that time, your comments had indicated that things were ramping up. You are getting to the point where you'll have a clearer sense as to what the marketplace is telling you going forward.

Do we have that sense now as to how we should be thinking about it? Or is it still too early?

I think if you look at the numbers, it's still too early because 2014 obviously was not, even through it was a full year of operation for the Syndicate, it was not a full year for operations for the entire team, particularly the property team that didn't join until basically the third quarter.

Now that the full team is there, we need to go and look at the renewal cycle. The fourth quarter at Lloyd's in the property business is a very small, relatively speaking, portion of the business. Even on a casualty side, a lot of business is either January 1 or July 1.

I think we're very comfortable with the group we have. We're very comfortable with the submissions that are there, and as we go through this year I think it will be much more representative of a full year operation. No concern or complaints or anything on our part, but we really don't have base to compare to right now.

Okay. That's all I have. Thank you for the answers.

Mark Hughes, SunTrust.

Good morning. On the Lloyd's segment, since you're reporting it a quarter behind, can you give us some sense of what the ramp ought to like when you next report, just in terms of the premium trends from Q1 to Q2, again as reported?

While the first quarter will have, as it did last year, a significant amount of casualty business for the Syndicate as a whole, in part because of the business that our podiatry subsidiaries cedes to the Syndicate. That all gets recorded in the first quarter because of the January 1 effective date.

We will also see certainly more property business, we believe, in the first quarter because last year we didn't have it. I'm not really either ready or able to lay out what the year is going to look like, quarter-by-quarter, but I think the first and the second quarters are probably going to be heavier than the third and the fourth.

The tax rate, you described a number of puts and takes. How should we think about that on a go-forward basis being influenced by a level of profitability? Should we assume that back up to more normal historical level, or should we think it about as being a little bit lower?

I think short answer is think about it being a little lower, and for a couple of reasons. One, you just need to consider the proportion of tax-exempt income to the total taxable income, which is up.

Then you have to consider the impact of investments that we are making in tax credits, and we have tax credits and have had tax credits, and low income housing tax credits for a number of years. We are in the process of making an investment into some historic tax credits. The historic tax credits turn much faster than the low income housing tax credits. In the low income housing tax credits, we may see the benefit of that tax credit over, call it, a 5-year or 8-year time frame.

The historic tax credits are more like 12 months to 24 months, and we'll begin to see the impact of that more materially as the year progresses. That will be (multiple speakers).

Do you think you could throw out maybe a range perhaps, where you think it might end up for the next couple of quarters?

There's a lot of moving parts. I'm really hesitant to do that, Mark. I am sorry.

Okay. I think I heard correctly that you had suggested part of the reason the current accident year loss tick in the specialty P&C was up, perhaps it was related to [more] loss adjustment expense. Did I hear that correctly? Could you elaborate on that?

We had said that it was up because the internal costs used to be called unallocated loss adjustment expense [adjusting [and other] now on the statutory side are somewhat higher. Then the premium base certainly has, the earned premium, has moved downward. That was primarily the cause of the increase loss ratio in the quarter.

Of those two factors, is it 50-50? In terms of impact?

I don't have the numbers (inaudible).

Okay. Thank you very much.

Mark, it's Ned. Real quick, I think the majority of it is driven by the decline in net earned premium. I think the actual costs being allocated up as yearly costs are not up substantially. It's really being driven by the decline in net earned premium.

Right, so the underlying losses, that environment hasn't changed for the internal validation or leveraging issue?

Yes. We've got a fixed internal claim cost that we think it's important to maintain. The capabilities that we have there, so we're not looking to shrink that. That's going to cause a little bit of increase in the [UOE] ratio.

Understood. Thank you.

Ryan Byrnes, Janney Capital.

The first question, to follow up a little bit on the tax credit increase in the quarter, it moved to in the Q to $5.2 million from $4.4 million a year ago. It's been in that mid-$4 million range. I'm just trying to figure out what kind of impact the addition of these historic tax credits will be on, maybe on an absolute basis going forward.

A lot of it has to do with when the historic tax credits come online, and we don't really have complete control over that. It's the development of when they get whatever it is that's being renovated finally approved, so it's hard to say. It's probably $2 million this year.

We project out an effective tax rate for the organization, and so we give some credit to that even in the first quarter although we haven't seen the benefit of those yet. A lot of it will just depend on how quickly the tax credits come online.

Okay, and I just want to confirm that those historic ones did or did not impact the first quarter this year?

They do have an impact in the first quarter.

Okay. Great. Shifting to the investment income side, could you guys maybe talk about or break out the [tips] impact on the fixed maturity side?

Sure. Let me pull it up real quick. I believe it was about a negative $850,000. (inaudible) I just want to get to my sheet.

Yes, the swing in tips was about negative $850,000. We actually printed a negative $200,000 investment income from tips.

Actually, the swing for the quarter is bigger than that positive. It's about $1.3 million, compared to last year. We had a $1 million positive investment income in our tips, Q1 of 2014, and negative $200,000 in Q1 of this year.

Okay. Great, perfect. Thank you.

Then just my last one, I guess obviously it seems like the ROE profile, again, it seems like it's continuing to contract a little bit here. I just wanted to see, does that impact what you guys think about buybacks, especially buying back above book value, as the ROE gets into the mid-single digit range?

Our view on buybacks as we look at what we view as the recoupment period, of the dilution in book value. And as long as that's within a reasonable timeframe which we would say today is two to three years, we're comfortable buying at those levels.

Great. Thanks, guys.

Ron Bobman, Capital Returns.

I had a question for Michael. Michael, in your prepared remarks you mentioned additional audit premium collections, and you described it as a result of good financial underwriting. Is that candidly simply your insureds have had good payroll growth, and you go back and you audit the growth in payrolls, and your invoice them for additional premium?

That's spot-on correct, yes. We have a disciplined financial underwriting process, and typically those customers are the customers that continue to add employees and grow their businesses.

We've had a pretty good track record there, Ron, on the audit premium side. In 2014, we secured about additional $3 million in audit premium, 2013, $2.5 million, 2012, $4.3 million, and 2011, $2.5 million. We've had some pretty consistent trends on the audit premium side as we go back and look at our historical book of business.

Got you. I'm surprised there isn't a trend where 2014 is better than 2013, 2013 is better than 2012, and 2012 is better than 2011, given some underlying economic [withhold]. What am I missing that makes it erratic?

It's really the class of business and economic trends. That would be more in the profile of the book of business.

For example in 2011 going into 2012, we probably had more customers that were in the growth market than, say, the healthcare sector, education, and other areas. It really comes down to the profile of the book.

Okay.

To some degree, operating region. One of our strategies over time has always been to be diversified on the geographic side. You do see upticks and downticks in certain regions over a period of time, so that would also have some factor into it.

Okay. Then a simple buyback question. I'm assuming some portion of the buyback is systematized, whereby you've got in essence a 10b5-1, and there are certain parameters, and you buy at a certain pace depending upon the parameters being met. Also, do you have a variable component, Ned or Stan, whereby when an opportunity presents itself you can lean on the accelerator or pull back?

Ron, we do use a 10b5-1 plan. The way that the instructions are under that 10b5-1 plan are set up, it allows the individual who is administering that 10b5-1 plan to do exactly that.

Then from time to time, we will also see opportunities to buy blocks of business, our blocks of shares, and if those opportunities present themselves, we have the ability to take advantage of them. If and when we have a 10b5-1 plan in place, it is our view that we should not independently be in the market.

Okay, but you've incorporated variability in it, depending upon where stock price is?

Absolutely.

Okay. Thanks, gentlemen. Best of luck.

We're going to circle back. Ryan, we've got one thing just on your effective tips. We want to make one thing going forward.

Just one thing I should have mentioned when we were talking about investments, I mentioned that the impact of the tip portfolio, we actually have divested that portfolio. It's about $78 million, given the under-performance and volatility that it has provided and results. That's happened here early in the second quarter.

(Operator Instructions)

Paul Newsome, Sandler O'Neill.

Just a real quick question, when you are thinking about the increasing number of customers that you're selling multiple products, are you looking to price your products on a by-product basis, or are you doing in on an account basis.

By product.

Okay. That was my only question.

In other words, Paul, the comp coverage is separately underwritten and priced from the MPL coverage, which is separately underwritten and priced. It's very important to us to maintain the discipline of the pricing so that whatever the risk we are assuming are separately priced correctly.

Terrific. Thank you.

(Operator Instructions)

It appears we have no further phone questions. I'd like to turn the call back to our presenters for any additional or closing remarks.

Thank you, Lauren. We will speak to everybody next in August. Thanks for joining us this morning.

Thank you, and that does conclude today's conference. We thank you for your participation.