ProAssurance Corp (PRA) 2017 Q3 法說會逐字稿

Good morning, everyone. Welcome to the conference call to discuss ProAssurance's results for the third quarter of 2017. These results were reported in a news release issued on November 6, 2017, and in the company's quarterly report on Form 10-Q, which was also filed on November 6.

These documents are intended to provide you with important information about the significant risks, uncertainties and other factors that are out of the company's control and could affect ProAssurance's business and alter expected results.

We also caution you that the management expects to make statements on this call dealing with projections, estimates and expectations and explicitly identifies these as forward-looking statements within the meaning of the U.S. federal securities laws and subject to applicable safe harbor protections. The content of this call is accurate only on November 6, 2017. 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.

The management team of ProAssurance also expects to reference non-GAAP items during today's call. The company's recent news release provides a reconciliation of these non-GAAP numbers to their GAAP counterparts.

Now as I turn the call over to Mr. Frank O'Neil, I'd like to remind you that this call is being recorded and there will be a time for questions after the conclusion of prepared remarks.

Thank you, Brendan. On our call today are Chairman and CEO, Stan Starnes; Howard Freidman, the President of our Healthcare Professional Liability Group; Chief Financial Officer and Executive Vice President, Ned Rand; and Mike Boguski, the President of Eastern, our Worker's Compensation subsidiary. Stan, will you start us off please?

Thank you, Frank. We have a great deal of positive news to discuss in today's call. So as I turn the call over to Ned Rand, I will simply say that we're pleased with the overall results and a very solid quarter. Ned?

Thank you, Stan. We did see an increase in gross premiums written in the quarter in our Specialty P&C and Lloyd's segments. But I want to caution against reading too much into the increase in Specialty P&C for reasons Howard will discuss shortly.

Gross premiums in our Workmen's Compensation segment were down only slightly, which in that competitive line represents a real accomplishment. Retention across all of our lines of business remained strong, which we believe shows that our insureds see value in the suite of coverages and the services we are providing. And that carries over to the success in our coordinated sales and marketing efforts, which produced approximately $3 million of new business in the quarter, topping $12 million for the year. All 3 of our segments saw quarter-over-quarter growth in new business as well.

Our consolidated current accident year net loss ratio was 84.1%, an increase of 4.7 points over third quarter 2016. And our calendar year net loss ratio was 3.6 points higher than last year's third quarter, both of those increases being driven by strong related losses in the Lloyd's segment. We did recognize $32.3 million of net favorable development, and you'll hear more about that in our segment discussions.

The story in our investment-related results continues to be much the same as in prior quarters. The quarter's net investment result was up about 27% over the last year to $27.9 million. That is primarily due to increases in the earnings from our unconsolidated subsidiaries, which were up substantially, $4.2 million in this year's third quarter versus a loss of $3.3 million last year. Partially offsetting those earnings was a 6% or $1.5 million decline in net investment income due to lower interest rates and the smaller size of our portfolio due to our capital management activities.

Summing all this up, net income for the quarter was $29 million, $0.54 per diluted share. Operating income for the quarter was $24.3 million or $0.45 per diluted share.

At September 30, our book value was $34.65 per share, up $0.24 since the end of the second quarter of this year and up $0.87 per share or approximately 2.5% since year end.

Finally, at the end of the quarter, we held approximately $264 million in unpledged cash and liquid investments outside our insurance subsidiaries. Frank?

Thanks, Ned. We'll turn next to Howard Freidman for more detail on our Specialty P&C segment. Howard?

Thanks, Frank. Starting at the top, I'll note, gross premiums written increased quarter-over-quarter, but the vast majority of the increase had to do with the timing of renewals, both last year and this year.

As we have said, as ProAssurance writes larger policies, we expect the overall trajectory of premiums to be positive, but there will be some variability along the way. That was the case this quarter where some policies that were processed in the fourth quarter last year renewed and were processed this year in the third quarter. It makes the comparisons a bit difficult, and I want to caution against reading too much into that as a trend.

We called out another example in the news release. We had a onetime bump in premiums from tail premiums that were paid because a group of policyholders transitioned their coverage in a shared risk arrangement, in essence terminating one ProAssurance policy and beginning another one with us.

We did write $11.4 million of new business in the Specialty P&C segment, up from $10.1 million last year. There was some growth in every line in this segment. And importantly, $1.9 million came from our health care facility line, underscoring the effectiveness of our broker outreach and our increasing success in that important growth area of our business.

Premium retention for physicians was again 90% in the quarter, level with last year and up 1 point from third quarter 2016. Year-to-date, retention is also at 90%, also up 1 point from the first 9 months of 2016. Pricing on renewing physician business, something we believe is a key benchmark for us and a key indicator of market strength, was 2% higher for the quarter and for the year-to-date.

Our loss ratios, both current year and net, were essentially unchanged quarter-over-quarter. Favorable net loss reserve development in the segment was $30.1 million, basically unchanged compared to last year. The expense ratio at 22.8% and the combined ratio at 85.2% were also essentially level with the prior year quarter. All of this underscores the relative stability of the overall loss trends that we're seeing for this segment. Frank?

Thank you, Howard. And we'll turn next to Mike Boguski for comments about the Workers' Compensation segment. Mike?

Thank you, Frank. The Workers' Compensation segment operating results were $2.6 million for the 3 months ended September 30, 2017, a $2.2 million increase from $332,000 in the third quarter of 2016. The increase was driven by higher net earned premium, a decrease in the net loss ratio and underwriting expense ratio and an increase in the operating results of our segregated portfolio cell business.

Gross premiums written decreased slightly, down less than 0.5% to $59.7 million for the 3 months ended September 30, 2017, compared to $59.9 million for the same period in 2016. However, gross premiums written have increased 4.5% year-to-date in 2017.

New business writings were $9.2 million during the quarter compared to $6.8 million in 2016, and audit premium was approximately $700,000 in the third quarter of 2017 compared to $1.5 million in 2016. Renewal pricing decreased 5% in the quarter, reflecting continued price competition and loss cost reductions in some of our core operating states. Premium retention was 87% for the third quarter, driven by improved retention results across all Workers' Comp product lines.

Premium retention was especially strong in alternative markets at 92% in the third quarter of 2017 compared to 88% for the same period in 2016. We were pleased to renew the available alternative market program and wrote one new program in the third quarter of 2017.

The decrease in the third quarter 2017 accident year loss ratio reflects overall favorable trends in claim closing results. Through September 30, 2017, we successfully closed 50.5% of 2016 and prior claims, reflective of the short-tailed nature of our Workers' Compensation business model.

Favorable reserve development was $2.3 million in the quarter compared to $1.8 million in the third quarter of 2016, primarily related to alternative market business, but also includes approximately $400,000 in both periods related to the amortization of purchase accounting fair value adjustments.

The decrease in the 2017 underwriting expense ratio primarily reflects the increase in net earned premium, a 1.1 point reduction in intangible asset amortization and the continued impact of our focus on effectively managing operating expenses, partially offset by an increase in underwriting acquisition expenses.

The 2017 combined ratio of 92.8% includes 1.3 percentage points of intangible asset amortization and 0.8 percentage points of a corporate management fee.

From a strategic perspective, we were extremely pleased to close the renewal rights transaction with Great Falls Insurance Company during the quarter. This transaction provides us with further geographic diversification, the foundation for New England expansion, increased scale in our small business book and the ability to expand our broad Workers' Compensation product line to this market. We are also extremely pleased to welcome the talented Great Falls employees and their valued agency partners to the ProAssurance family of companies. The New England Region will continue to operate from its current location in Auburn, Maine.

Thanks, Mike. Let's go back to Howard for an update on the Lloyd's segment. And as we do that, I want to remind you that the results reflect our 58% participation in Syndicate 1729. We normally report those results on a one quarter lag, except as is the case this quarter, when there is an event which we believe will have a material impact to the segment and should be disclosed to investors for the sake of transparency. So Howard?

Thank you, Frank. That material event is, of course, the preliminary loss estimates from the 3 hurricanes that hit Texas, the Southeast U.S. and much of the Caribbean.

As we disclosed in the news release in October, we estimate our 58% share of the Syndicate's net pretax losses to be $7.5 million. That number is net of reinstatement premiums which are written and earned during the period, and it is also net of reinsurance. The estimated storm-related losses were the primary driver of a 66.5 point increase in the current accident year loss ratio. Those losses also drove the net loss ratio increase, which was 47.8 points higher than a year ago.

Excluding the storm-related effects on the segment, we continue to believe that normalized loss trends will continue as the Syndicate writes new business and the existing book matures. That is the loss side of the equation.

On the premium side, gross premiums written increased by $2 million quarter-over-quarter. There is a component of new business in that increase and also some benefit from $1.4 million of reinstatement premiums, which represents additional premium payable to the Syndicate to restore coverage limits that were exhausted as a result of reinsured storm-related losses.

Underwriting and operating expense were up by approximately $500,000 in the quarter, but the rate of increase is slowing as operations mature. With the moderation in expense growth and the increase in earned premiums over last year's third quarter, the expense ratio declined 1.7 points. All in all, we see the Syndicate's continued underwriting discipline as the best course of action in this competitive market. We often say that you can sometimes make the most money by not writing a piece of bad business. Duncan Dale and his team are continuing to underwrite carefully, selecting those risks that they believe will prove to be profitable in the long term.

That marries well with our underwriting philosophy and is within our expectations. We're confident that we are creating long-term value with permanent capital at Lloyd's. In addition, the dedication to profitable underwriting is increasing the value of Dale Underwriting Partners, which is a key part of the Syndicate's business. And our minority ownership in that back-office service is yet another vehicle for value creation. Frank?

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

Thanks, Frank. Our vision for the future remains intact and encouraging. We're positioned to not only grow our business, but retain those risks we write with the dedication of our employees and distribution partners. We hear quite often that their commitment to excellence is why so many of our insureds forgo the tempting lure of the lowest price and choose the ProAssurance promise of real, long-lasting value. We've built a strong foundation, and we are now expanding on it, growing an enterprise that continues to give me great confidence in our future. Frank?

Thank you, Stan. Brendan, that concludes our prepared remarks. And so we're ready to take questions, please.

(Operator Instructions) Our first question comes from Greg Peters with Raymond James.

So a couple of questions for you with your results. And I certainly appreciate Howard's comments around the Specialty PC segment and some unusual anomalies that affected the top line in the third quarter. Perhaps we could step back and you could provide us perspective of when you take through the anomalies that happen in any given year, what you think the underlying growth rate of that business looks like on an annual basis perhaps.

Howard?

Sure. The marketplace right now, as we've talked about and as you know, is still quite competitive. And what we've really been looking at and if you look at it over probably the course of the last couple of years is more or less offsetting our losses due to retention with new business production. And that is generally, I think, where we see things right now. Quarter-by-quarter, it varies. But over the course of the year or so, that's about what we're -- what we believe that we're able to do. And we have a great emphasis on developing opportunities for good new business. But at the same time, a competitive market does take business away from us. And we've been able to get our retention ratio up a little bit this year as you've noted. But at the same time -- and we've also been able to do better on -- in terms of the rate change being in the low positive territory. But the -- even 10% loss and 90% retention ratio still creates a big challenge to replace that with new business. So I'd say long answer, but basically flat is kind of what I see right now.

And should I infer that because there was some, I don't want to call it pull forward, but some fourth quarter business that ramped to the third quarter that we should see, everything else equal, the fourth quarter possibly being down? Is that the right way to look at it?

I think other than new business that may offset it, and again, constantly trying to generate that, yes, basically there was a shift of some policies that -- new business policies that were effective in the third quarter of 2016. But due to the complexity of the policies and issuance and everything else, they got issued and processed in November of last year. So they got into the fourth quarter and now they renewed on a timely basis. So yes, I think that shift is likely unless offset by new businesses this quarter.

Yes, perfect. I understand completely. I wanted to shift gears and also have you talk about the Lloyd's business. And I'm just curious -- and maybe, Stan, this would be appropriate for you to comment on as well. What did you learn about the performance of the Lloyd's business in the third quarter this year that -- and specifically around the catastrophe exposure that might have surprised you are or maybe was favorable to your expectations? And then this is an additional question around the Lloyd's business. As we think about this and the specialty nature of Dale's operation, should we view this as somewhat of a sidecar type of business where you might put extra capital in that might be allocated to more property-related type of exposures if cap pricing affects the U.S. property insurance market?

Greg, it's Stan. I'll let Howard comment. But I will say this, I was -- clearly, when you start a new Syndicate, you have to play by Lloyd's rules, and Lloyd's -- particularly a Syndicate such as ours, which is a new underwriting Syndicate and not a corporate Syndicate. Lloyd's expects you to write and approves a diversified book of business, including cat exposure. Obviously, nobody wanted the wind to blow like it did. And obviously, there was a great human catastrophe and loss involved in that, and we are mindful of that and respectful of that. Having said that, I was pleased, but not surprised at Duncan's ability to write that cat coverage in a disciplined way with the appropriate backstops in place so that regardless of what happened, the Syndicate's loss exposure was mediated by the backstops. And you never know for sure that, that's going to be the case until you're confronted with one of these catastrophes. And so from that standpoint, we were quite pleased, though again, I want to emphasize, not surprised by Duncan's expertise both personally and that of his staff and by their very disciplined approach to this. It's that discipline that makes the Lloyd's underwriting effort at Syndicate 1729 a science and not simply a bet. With respect to your question regarding the allocation of capital, both at the parent ProAssurance level and the Syndicate 1729 level, we constantly evaluate what our capital requirements are and what our capital opportunities are. As you know, we've announced and made a long-term commitment to Syndicate 1729 for capital. And if opportunities came along that we thought were noteworthy, we could invest more capital in 1729. But that will be made on a current basis based on opportunities as we see them at the time. As you know and they've commented on, we're blessed with an abundance of capital at the moment. And as we've said many times, rule #1 is not to do anything stupid with it, but we do not think placing capital with Duncan Dale is anything other than sound advice based on circumstances as we see it at the time. Howard and Ned may want to add something to that. Howard?

Yes, I would just second Stan's comments. Certainly, there -- we expect that there will be opportunities in the property reinsurance market in particular that Duncan and his team will be able to take advantage of in the way of rising rates, and we stand behind that. But it's not a clinical kind of view of it. As Stan said, this is a long-term view. It's not just a matter of moving capital from one bucket to other. It has to make sense business-wise, and we're very confident that Duncan and the team there will be evaluating all of that very carefully.

Ned?

I don't have anything to add to that, Stan.

Our next question comes from Mark Hughes with SunTrust.

On the Lloyd's business, are you seeing any kind of movement in pricing? I assume the cat-exposed property would be up. Are you seeing anything on the casualty side? How do you feel about that?

If you read [Best] this week, you saw a variety of opinions ranging from the expected pricing on property renewals to go up without hesitation. You have others saying that they're not certain what will happen to it. And within the organization, we have a plethora of opinions about what will happen. We'll wait until the January 1 renewals and see. But we're not in a position to tell you of what's going to happen. There are a variety of opinions around about it, Mark, as I'm sure you've seen even more than even I have about it. I'll say this personally -- and I'm often wrong, but never in doubt. Personally, I'll be surprised if prices soften any. And that's a change from last long-term period.

Right. The underlying losses in the Lloyd's, if you take out the $7.5 million, still seems like they are in the upper 70s. Anything there we should be concerned about? It seems like it's going in the wrong direction lately. Understanding that it's still early days and the book is still pretty green, et cetera, but still seems to be moving up.

Howard?

Sure. Mark, no, I don't think there's anything to be read into that other than reserving it as the business seems to deem and really looking at -- as we have said it number of times, looking at the Lloyd's historical averages to be conservative until the Syndicate has developed its own experience. And the mix of business shifts from quarter-to-quarter, and that drives the loss ratio more than anything else.

Howard, I'm sorry if I didn't catch any commentary on pricing. I think position pricing up 2%. That's about as strong as we've seen in some time. Last quarter, you had referred maybe possibly some lessening in the competitive environment. How do you see that today?

Still see things, I guess, the same way that I did last quarter. I'm very pleased to see the overall plus 2% and holding at that level for us at least. Certainly can be influenced by the effect of large account renewals or other factors like that. But generally in the marketplace, still seeing some level of stability, no less competition, but a little bit more stability in pricing than seen over the past 2 years. And that's about as optimistic as I want to get about it, but it is somewhat more optimistic than maybe what I saw a year or 2 ago.

Ned, refresh me on what drives that equity in unconsolidated subs. It was a nice contributor this quarter. What drives that?

Mark, there are really 2 things that fall into that. The tax credits that we invest in flow through that line item. And those are an expense as we amortize those off and the benefits from those tax credits are seen in the tax line. Other than that, it is a variety of the investments that we have made in limited partnerships and other funds that by nature of the structure of those funds and our ownership of those funds, we carry as investments in unconsolidated subsidiaries. And by the nature of those, there's just a lot of volatility there.

And it was interest rates, equity market, gas prices, oil prices, anything that...

It's really returns on our private equity investments.

Okay. And are those mostly equity linked?

Yes.

Okay. In the Workers' Comp business, the Great Falls renewal rates, what's the potential premium impact on that, say, over the next few quarters?

Mike?

If you look at the premium writings at the end of 2016, they were about $13.6 million. We did write some premiums at the end of the third quarter as a result of the transaction closing on 9/18. And for the most part, because it's a small business book, that those premium writings kind of relatively equal as you look out over the 4 quarters. So we expect a really good reception from the Great Falls employees and agency partners to the transaction, and we expect that to proceed forward with good solid renewal retentions.

And Mike, as I recall, you've told me there's not much seasonality in that book.

Yes, I had indicated earlier. It books pretty consistently on a quarterly basis.

The prior 3 quarters, you had had some pretty good growth, mid-, upper single digits, double-digit growth. This quarter, premium audits, renewal pricing down. Is this just kind of a blip? Do you think you'll get back into positive growth territory? Or is this kind of the -- a reflection of current market conditions?

The market conditions were challenging in the quarter, obviously, if the rate's being down 5%. Just to comment on that, I mean, we've really looked at that closely. We've had really positive rate over the last 5 years of about 7.2%, and our frequency continues to go down. So we are seeing the broader industry trends with respect to rate adequacy as a result of frequency reductions. So we still think we're pretty well positioned there. We like the quality of our book of business and the rate adequacy. I think what we have built, though, strategically will help us as we go out into the future. We've built the Eastern Specialty Risk high hazard business. We added the Maine transaction. And keep in mind, Pennsylvania is our only mature state of our 19 core operating states. So we still think we have some runway to grow in each of our other regions. So I think it was more of an anomaly. We're actually pretty pleased with the new business in the quarter.

(Operator Instructions) Our next question comes from Arash Soleimani with KBW.

One question I have with Lloyd's. I think you're still talking about Lloyd's as an investment today. How should we think about -- at what point do you foresee it becoming more of a, I guess, core part of the business rather than simply an investment? Is that something we're still talking more 3 to 5 years kind of in terms of the time frame?

It's Ned. Yes, I think it's probably the outer end of that realistically. The focus today is on establishing all the infrastructure that's needed to run the Syndicate. You may recall that we partnered with a third-party service provider called Asta that provides a lot of the back-office operations. Over time, we take in those operations. And I think it will be after -- sometime after we stand up the Syndicate fully on its own that we really began to see it more as a core to the organization. And that's probably the tail end of that 3- to 5-year time horizon is what we're talking about.

And in the MPL space, are you seeing any changes in the competitive environment, or are you seeing any of your competitors, I guess, struggle more than they have been in the past? Or is it really just pretty steady all around?

Howard?

Yes, sure. This is Howard. I think with the exception of some very small players in the market, I think the competition is pretty stable, I'd say. We have some of the larger national or regional competitors still, obviously, like us trying to modify what we're doing in the way that health care continues to evolve and doing more with larger groups and doing more with facilities and so forth as compared to the past. We see some of the smaller competitors really, I think, trying to struggle to remain relevant, fighting very high expense ratios and the continued reduction in the number of physicians who are in private practice and making their own insurance decisions. And then we've seen a few very small players start to run into some financial difficulty. But these are very isolated cases and don't seem to be a trend right now. There just seems to be 2 or 3 of them going on at the same point in time for totally unrelated reasons.

Well, we have Amit Kumar with Buckingham for our next question.

Just a few follow-up questions. Number one, going back to the catastrophe loss estimate, I guess, I would imagine, based on the discussion on reinstatement premium, was the loss in the property reinsurance subsegment of 1729? And how should we think about if the overall losses drift upwards?

It's Ned. The losses were kind of spread between the property and the property reinsurance/cat book of business at the Syndicate, and we have booked our best estimate for that. And I would say that, that best estimate is like at a 70% to 80% confidence level. And we will just have to watch. But certainly depending upon how losses emerge, and as you know, it can take a long time in these situations for losses to emerge, and we'll see what happens. But we're very confident, very comfortable with the estimate that we've put out.

Got it. The second question I had was on capital management. And almost I missed the discussion there wasn't any stock bought in the quarter. Was that more a function of, I guess, opportunities in the marketplace in maybe Lloyd's going forward? Or how should we think about -- or is it more a function of the stock multiple at this stage?

Yes, I think what we've talked about in the past is that rather than take a view on the value of our stock, we have a very objective way that we evaluate stock buybacks. And we look at how long it takes to recoup any dilution in book value that's caused by buying our stock above book value. And we've got a return period of about 3 years that establishes that price. And so we did not hit that price during the quarter.

Got it, that makes sense. And I don't think you're hitting it anytime sooner based on today's price. The last question I had was on the reserve release piece. Was this, I guess, strength as usual or was there anything unusual in the reserve release this quarter versus the prior quarters?

Howard?

It's Howard. No, really nothing that I would consider unusual there. We just try to evaluate each quarter the way that we see it and -- based on what we have in the data, and in terms of -- as we've you said over the past couple of years, trying to be a little bit more responsive on a quarterly basis as opposed to waiting until the end of the year to do a more thorough evaluation. So nothing that I would say is out of the ordinary this quarter.

And one thing when you look at it on the consolidated basis, you may recall that in the third quarter of last year, we had just under $3 million of adverse development at Lloyd's, and from a comparative standpoint, that was essentially just flat -- 0 this year, I think $100,000. So that's also impacting at a consolidated level.

This concludes the question-and-answer session. I would like to turn the conference back over to Frank O'Neil for any closing remarks.

Thank you, Brendan, and thanks to everyone who participated on the call today. I think we will speak with you next in February when we announce results for the fourth quarter. Thank you, and goodbye.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.