Selective Insurance Group Inc (SIGIP) 2002 Q4 法說會逐字稿

Please stand by.

We are about to begin.

Good day everyone and welcome to the Selective Insurance Group fourth quarter earnings release conference call.

At this time for openings remarks and instruction I would like to turn the call over to VP and corporate secretary, Ms. Michele Schumacher.

Please go ahead, ma'am.

Thank you.

Good morning.

Before I turn the call over to Dale Thatcher, Chief Financial Officer of Selective Insurance Group and Greg Murphy, our chairman, president and CEO, I want to remind you that some of the statements made during this call are not historical facts and are forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995.

Such statements are subject to certain risks and uncertainties.

The factors which could cause actual results to differ materially from those suggested by any such statements include but are not limited to those discussed or identified from time to time in the filings we make with the Securities and Exchange Commission including our annual report on form 10(K) and our quarterly report on form 10(K).

We do not promise to update such forward-looking statements to reflect actual results or changes in assumptions or other factors that could affect these statements.

Management will make every effort to disclose all material information and prepared remarks which are supplemented by materials available on our Web site at www.selective.com.

After the prepared remarks we'll have a question and answer period.

The following corporate executives are on this call along with our speakers.

Richard Bernstein, executive VP and general counsel, Jim Ochiltree, executive VP, insurance operations, Jim Coleman, executive VP, diversified insurance services, Kerry Guthrie, senior VP and chief investment officer, Ron Zaleski executive VP and chief actuary, Sharon Cooper, senior VP and director of communications and John Marchioni, VP of government affairs.

As a reminder this call is being simulcast over the Internet at WWW.selective.com.

A replay will be available at the same site through March 7, 2003.

With that I will turn the call over to Mr. Thatcher.

Thank you, Michele.

Good morning and welcome to our conference call.

Today we will discuss fourth quarter and yearend results as well as the ongoing execution of our long-term strategy.

We will focus on our core commercial lines operation, personal lines, reinsurance, our diversified insurance services, and investments.

I will begin with our financial results.

This morning we released our fourth quarter 2002 results.

Net income was $12.3 million for the quarter, or 46 cents per diluted share, compared with $6.4 million or 25 cents per diluted share for this period last year.

For the year net income was $42 million, or $1.56 per diluted share, compared with $25.7 million, or 98 cents per diluted share in 2001.

Driven by strong results from our core commercial lines operation, operating income from continuing operations increased 91% to $11 million, or 41 cents per diluted share for the quarter, up from $5.8 million or 22 cents per diluted share in the fourth quarter of 2001.

For the full year operating income from continuing operations was $40 million, or $1.49 per diluted share, compared with $21.9 million, or 83 cents per diluted share in 2001.

For the quarter net premiums written increased 11% to $236 million, including $48.5 million in new business.

For 2002 net premiums written climbed 14% to $1.1 billion, including $224 million of new business.

Our overall as a statutory combined ratio dropped five points to 103.4% for the quarter.

For the full year we recorded a three and a half point drop in our overall statutory combined ratio to 103.2%.

This year end result is almost a full point ahead of our full year 2002 estimate of up to 104[inaudible].

On a more current note we started 2003 with one of the coldest Januarys in recent memory with winter storms all along the East Coast including Cat 81.

As a result we incurred property catastrophe loss of approximately $6 million pretax which will impact the first quarter.

Although unwelcome these weather-related losses are not dissimilar magnitude to the April 2002 storms which spawned the[LaPlata] Maryland tornado.

Despite that catastrophe we ended 2002 with pretax catastrophe losses of $11.4 million, or 27 cents per diluted share.

Commercial lines net premiums written which represent over 80% of our business were up 13% for the quarter and 17% for the year.

We wrote $41 million of new commercial business in the fourth quarter and $197 million for the full year, driven by our field strategy which puts underwriting and claims specialists in direct contact with our agencies.

This new business growth also reflects continued agency integration of our small business and technology initiatives through systems such as One and Done.

In 2002 our agents processed $19 million of small commercial business through One and Done, accounting for more than 30% of our new commercial policies.

Higher premiums were driven by 11 consecutive quarters of double-digit commercial renewal price increases which averaged 18% in the fourth quarter and 19% for the full year.

These results are in line with our three-year improvement plan of commercial renewal price increases of 13% in 2000, 16% in 2001 and exceeded the 18% we had budgeted for 2002.

When compounded over the three-year period this pricing initiative yielded premium increases of 55%.

Retention at point of renewal was 83% for the full year versus 81% in 2001.

Continued strong price increases combined with stable retention ratios were good indicators of further pricing opportunities in this market.

Quarter yielded solid improvements in underwriting results across most commercial line segments.

The statutory combined ratio for commercial properties dropped more than 12 points to 85.6% compared with 97.9% in the fourth quarter of 2001.

The commercial automobile statutory combined ratio improved 14-points to 98.1% for the quarter, compared with 112.1% in the fourth quarter of 2001.

While the general liability ratio improved six-points to 103.8% over fourth quarter 2001.

Improvements in these lines reflect higher pricing as well as continued underwriting improvement in heightened loss control efforts, all of which lead to a better overall mix of business.

Our Workers' Compensation line requires further improvement, however.

As we entered the year about 4.3 points over 2001 to 110.9%.

In a line where it's difficult to increase prices because of extensive regulatory involvement we have initiated action plans to address an up tick in severity.

These include underwriting improvements and our diversification strategy that will make this line a small portion of our overall commercial book.

When attainable we are also seeking aggressive pricing which includes an 11.5% increased effective January 1, 2003, in New Jersey, one of the our larger Workers' Compensation markets.

Also important to keep in mind is our use of account based underwriting.

In New Jersey, for example, our Workers' Compensation statutory combined ratio was 120.7% for the year.

However, the state's overall commercial line statutory combined ratio came in at 93.7% for the year, demonstrating our ability to manage the Workers' Compensation product as just one component of the overall commercial account.

Significantly, the company's commercial line statutory combined ratio narrowed to 103.1% for the quarter, down from 106.4% at this time last year.

We finished the year at 102.2% compared with 104.5% in 2001.

Commercial lines earned premium increases outpaced logs trends by about eight points for the year although some of our competitors announced increased reserve for asbestos-related claims in 2002 we maintain a strong reserve position with a 15-year survival ratio and a three-year average paid claims.

Turning to personal lines, although our primary focus continues to be core commercial lines operation, our goal for personal lines is to maintain a smaller but profitable segment.

For the quarter personal lines net premiums increased 2% up 1% for the year.

The overall personal lines statutory combined ratio dropped more than ten-points for the quarter to 105% from 115.3% for the same period last year.

This gain reflects solid improvements in our New Jersey homeowner' line with a statutory combined ratio of 47.2% for the quarter, compared with 92.2% in the fourth quarter of 2001.

Those still unprofitable, the New Jersey personal automobile line had a statutory combined ratio of 106.1% for the quarter, down ten-points over fourth quarter 2001.

With two years of pricing and tier changes impacting this book, we saw the average premium per vehicle increase 9.3% for 2002.

Commission savings for the year of $3.5 million, a decline in the number of insured vehicles to 111,009 at yearend from 121,000 at year end 2001 and as a result of our continued diversification efforts, New Jersey auto now represents less than 12% of company-wide premium volume, down from 23% in 1994.

For the year, the New Jersey personal auto statutory combined ratio was 107.5%, below our projection of 108%.

As we continue to earn higher premiums from price and tier changes we expect ongoing improvements and results.

In addition, we are recently grants add 2.8% increase effective in March, 2003, that will continue the upward trends of higher premiums per vehicle.

In our nine other personal line states net premiums written were up 10% for the quarter to $16.1 million reflecting the ongoing implementation of price increases, tier changes and other underwriting actions to improve results.

We also continued efforts to control our exposure in New York due to the high cost of required participation in the involuntary automobile insurance market.

In 2002 we decreased the number of vehicles written in New York by more than 17% to under 11,000.

For the quarter the personal line statutory combined ratio for these nine states was 120.3%, down from 124.6% for this period last year.

For the full year the personal line statutory combined ratio was 120.5%, compared with 115.4% last year, reflecting the negative impact that charges relating to the New York assigned risk automobile business.

Excluding New York, the full year ratio was 116.1%, in line with our full year 2002 revised estimate of 118%.

Obviously, these results are not acceptable and we have extensive plans by state to establish an appropriate level of profitability.

Price in tier changes for these nine states totaling more than 22% for automobile and about 12% for homeowners over the last two years continue to favorably impact net premiums earned.

We are aggressively pursuing additional double-digit rate increases and tier changes in 2003 as personal lines prices continue to push upward industry wide.

We recently completed a favorable rounds of reinsurance renewals with both cost and coverage levels coming in better than anticipated.

As with our July renewals, the nature of our business as a regional carrier with smaller risks in middle market communities had a positive impact on renewals.

Our New Jersey homeowners 75% quota share treaty renewed at the expiring $75 million per occurrence limit with form following coverage.

The cost of this treaty remained flat.

Our property catastrophe excess of loss treaty renewed at existing limits of $150 million and retention of $15 million.

Terrorism coverage is excluded as per definition of the Federal Terrorism Risk Insurance Act.

The overall program costs for this treaty increased about 4%.

We also achieved a favorable renewal of bond treaty which included a slight increase in retention and a small co-participation feature but no increase in rates.

We are pursuing options for terrorism coverage as our industry works through the complexity of the new terrorism act and its ultimate implication of our industry and policyholders.

At this time or strategy is to have a combination of other treaties and facultative placements for losses not covered by the Terrorism Act.

In our diversified insurance services businesses quarterly revenue from continuing operations was $20 million, up 16% over fourth quarter 2001.

For the year revenue from continuing operation for these businesses was $81 million, an increase of 16% over full year 2001.

Return on revenue from continuing operations increased to 3.9% for the fourth quarter, compared with .2% for the same period one year ago.

Full year return on revenue for these businesses was 5%, below our 2002 estimates of 6%.

For the year the diversified insurance services operation contributed $4.1 million in income from continuing operations.

The businesses generated operating cash or free cash flow of $16 million.

EBITDA from continuing operations was $7.4 million for the year.

In February, 2003, these businesses will provide a $5.9 million cash dividend that will continue to support our strategic growth initiatives.

During the quarter, revenue at our flood operations rose 16% to $4.30 million.

Net income was $.5 million, up from $.3 million for the same period last year.

In early January, Congress reauthorized the National Flood Insurance Program after failing to reenact the program at yearend.

With the January 1 retroactive date we anticipate no impact on our flood business.

We currently service more than 135,000 flood insurance policies representing about $53 million in premium, a 26% increase over this time last year.

In our managed care businesses, revenue increased 12% to $5.3 million for the quarter.

Net income was $.4 million, consistent with the fourth quarter 2001.

Revenue for Selective H. R. Solutions, our provider of human resources benefits and administration services, was $9.9 million for the quarter, compared with $8.3 million for the fourth quarter 2001.

The operation recorded a modest net loss for the period.

Selective H. R. ended the year with about 22,000 work site employees, up 7% over year end 2001 despite average fourth quarter price increases of 8.1% for Workers' Compensation and 9.3% for client administration fees.

January work site lives were about 19,000 which we expected given our aggressive pricing and underwriting strategy and the planned loss of a large client.

We will continue to push price and fee increases in 2003, along with Selective's more stringent underwriting guidelines.

With these measures in place and our ability to take advantage of changes in the human resources benefits and services industry, we expect this business to be profitable for 2003.

Although lower interest rates have put pressure on investment returns we still generated an increase in after tax investment income to $22.9 million for the quarter compared with $19.3 million for the fourth quarter of 2001.

After tax net investment income rose 3% to $76.2 million at yearend 2002, reflecting strong cash flow during the year.

The after tax portfolio yield was 4%.

The company generated cash flow, operating cash flow of $180.1 million in 2002, compared to $52.7 million last year.

When coupled with the proceeds from the September convertible bonds offering, the overall investment portfolio reached $2.1 billion at yearend.

We continue to maintain a conservative, diversified investment portfolio.

With our bond holdings representing 88% of invested assets, 59% of our debt securities portfolio is rated triple A. Our portfolio has an average rating of double A. with only 1% rated below investment grade.

Now I will turn the call over to Greg Murphy

Thank you, Dale, and good morning.

This was a strong quarter for our company and capped off a solid year for us, one in which we did what we said we were going to do, achieved the financial and strategic goals we set for 2002.

The results for our insurance operation for the year met or exceeded our projections in almost every area.

Overall net premiums written grew 14%, well above the ten to 12% we projected at the start of the year.

Commercial lines renewal price increases averaging 19% were better than we expected.

Our commercial line statutory combined ratio improved to 102.2.

Our New Jersey personal automobile business continues to improve, rate and tier changes pushed average premium per vehicle up 14% over 2000, and our statutory combined ratio of 107.5 was just ahead of our projections.

More importantly, our overall statutory combined ratio dropped to 103.2 as we outperformed the AM Best industry estimate continuing our ten-year trend.

Our insurance and technology results clearly reflect the high tech, high touch approach that makes it easy and cost-effective for our agents to do business with us.

Our premiums per agency reached 1.3 million for the year, up 21% over 2001, and Selective now ranks as one of the top five carriers based on premium volume in 80% of our agencies.

We continue to deliver value- added programs such as our new claim service center.

In just less than six months we successfully implemented this program company-wide.

The service center is currently resolving many small claims which enables our field staff to focus on larger losses where their hands-on experience is critical to the agent and the customer.

The claims service center not only improves our competitive positioning by offering professional 24-hour service but it also standardizes procedures and lowers the cost per physical damage claim.

Initiatives such as this fuel our small business strategy which includes a successful deployment of our One and Done straight-through business processing system and our underwriting service center.

In just two years, the underwriting service center is servicing more than $25 million of premiums.

Agents are quickly realizing that it's not efficient to handle small business.

For a 2% reduction in commissions, our service center is a much better option.

Couple that with higher retention of service center business and it becomes a powerful tool for us to increase market share.

Our strategy is to eliminate redundancies in the independent agency description model by delivering easy and efficient systems which provide agents additional time to profitably grow their business with Selective.

For the year our One-and-Done system alone generated 30% of new commercial policies at a marginal expense ratio of about 23.

At the same time, our Web-based commercial line system delivers real-time rating to our agencies while enabling them to seamlessly exchange information with Selective.

In 2003, we will expand these capabilities to include renewal and endorsement processing that will make it even easier to do business with us while at the same time driving our productivity higher.

Overall Selective agencies utilize these systems to enter more than 65% of commercial policies directly from their offices.

Selective's 2002 agency survey reinforces the direction and execution of our initiatives with an overall satisfaction score of 8.4 on a ten-point scale.

This survey is one more agent touchpoint that helps us continually improve and aggressively promote successful strategies.

Our diversified insurance service operation posted strong revenue growth of 16% for the year, exceeding our expectations and, more importantly generated free cash flow of $16 million to support our strategic growth initiatives.

Return on revenue came in at 5%.

Although slightly below our projected level the productivity gains at each of these companies have positioned them for continued growth and improved earnings.

Our overall investment portfolio reached $2.1 billion in 2002, fueled by operating cash flow of 180 million, about three and a half times greater than 2001, as well as our successful convertible debenture offering.

Operating earnings per share were $1.49 for the year Selective's total return to stockholders was 18.7; a performance that surpassed the S&P 500 the S&P property and casualty indices and we were proud to have Selective named to the Forbes Magazine Platinum 400 list of companies with the best balance of long and short term financial performance.

In closing, this year was characterized by serious challenges to our industry and the U.S. economy.

However, Selective's competitive positioning and growth strategies enabled us to reach the goals with set for 2002 and reinforced our capacity for continued improvement.

As Dale said earlier, 11 consecutive quarters of double-digit commercial renewal price increases have had a significant impact on our results.

With January renewal price increases ahead of expectation at 16%, we expect ongoing pricing power in our core commercial lines throughout 2003.

Renewal price increases for an entire book of business, not just one line, are the leading indicator of future performance for this industry and they should be closely monitored.

In addition to these increases we expect productivity gains driven by our technology programs that will push our net premiums written per employee higher.

Together these initiatives should generate continued earnings momentum into 2003 and 2004.

Barring excessive catastrophies for the remainder of 2003 we anticipate a New Jersey personal automobile statutory combined ratio of about 103 and overall statutory combined ratio of up to 101, including about 1.6 points of catastrophe losses, for our diversified insurance services revenue growth of 12% and a return on revenue of 6% and operating earnings per share between 215 and 235.

Now I will turn the call back to the operator for your questions.

Thank you, sir.

Today's question and answer session will be conducted electronically.

If you would like to ask a question please press the star key followed by the digit one on your telephone.

Press star one for questions.

We will pause for a moment to assemble our roster.

Again it is star one and please be sure that your mute function is disengaged so your signal will reach our equipment.

We will take our first question from Beth Malone with Advest.

Thank you, good morning.

Good morning, Beth.

Good quarter.

I just have a general question on, as we hear from some of your competitors or other property casualty companies there has been an increased concern about areas like asbestosis, worker's comp, worker's comp liability, surety, can you speak to what your exposure is or are there areas where you're concerned about going into 2003 that we might focus on, or how are you managing all that?

I guess the best way for me to frame my response to that question is to understand the 788 agents that we distribute our product through, I mean, they are principally in rural and semi-rural areas.

Our appetite for business, we are not writing high hazard, high liability exposed kind of accounts.

I think that's why when you look at the company over the years we have not had a big asbestos situation.

So I think that's something that, we didn't write a manufacturer or anything like that.

In terms of comp, on the Workers' Compensation, yeah, and I think Dale tried to address that in his comments.

When we are writing an account we are writing an entire account that means we are writing the automobile, the property, the umbrella as well as Workers' Comp. when we write the comp on the account.

And when we look at that we look at the overall profitability.

I think in our other conference calls we've indicated that's best the most difficult price higher in, although you can see that, and we were very pleased with the fact that New Jersey, we just got an 111/2% increase and that's a tremendous book of Workers' Comp. business.

As we continue to work through them we've tightened down dividends and we've done a number of things in underwriting that Jim Ochiltree might want to comment on as well, we've done a number of things in underwriting on the comp side, we don't write smaller construction accounts with one, two, three-type person accounts and Jim, I don't know what you might want to add in terms of other underwriting that we've done there but we really tightened that area down a lot.

I guess the only thing I would add to that is when we look at an account if we really do feel that the Workers' Compensation on the account can be, would render the entire account unprofitable we typically stay away from the comp and we will write the rest of the account.

Okay.

Second question, on New Jersey, I know that you all have made a lot of progress with that market, and you've reduced your exposure to that market.

Is it possible that some time in the near future if progress continues that that could actually prove to be a good market to be in?

Well.

I have to tell you, in my 20, 23 or whatever it is years experience with the company I've been through several cycles in the New Jersey market, some profitable but most not.

Our overall history in New Jersey is I think in the last 15, 20 years we've generated about 109 combined ratio on that book.

So we are due a few profitable years.

But I think it's something that we closely monitor as we move forward.

One thing I always like to point out, too, Beth is whenever we talk about New Jersey auto is I like to make sure that we remind everyone that New Jersey as a whole is our most profitable region.

And for the quarter it turn in a 98.1 combined ratio and for the full year it turned in a 97.1 combined ratio.

So we do generate a lot of profits out of the New Jersey territory.

Okay.

Last question on pricing, both in the commercial and the personal line, you said that you were still getting double-digit rates even in January.

Looking out, do you see any reason to anticipate that we would see, is there competition coming back in the marketplace or what the longevity of the pricing cycle for your particular market could be?

I will just answer that question in a sense that we've set a plan internally and where we need to be price-wise.

I will say that the 16% is above our expectation, just to kind of give you that indication.

The marketplace, you always see individual competitors out there doing certain things.

The best thing that you guys need to do is just closely monitor how pricing levels are going forward and let your view of that stand on a company basis.

We don't sit here and prognosticate increases on a specific line ore a specific product.

Our price increases are all in commercial lines, same store sale kind of increases, and I think that we spend a lot of time measuring and monitoring that and that's the only thing I can comment on.

Thank you.

Again, star one for questions we go next to Nick Pirsos with Sandler O'Neill and Partners.

A couple of questions.

I'm sure the cap losses for the quarter were light but do you have that for the quarter?

I think it was about .4.

For the quarter it was .4 points on the combined ratio Nick, and it was $980,000.

Great.

Also the effective tax rate for the quarter had jumped up.

Can you just walk through that, maybe what the outlook for that is going forward.

We are now at about 75% taxable bonds versus tax exempt and that was as we've discussed over the course of the quarters this past year in an effort to maximize our after tax yield in terms of the AMT position that we were in.

Effective in late January we began as a buyer once again of municipal bonds because of the improving underwriting results will pull us out of the AMT position.

So we believe that you will see that tax rate creep down over the course of the year from the current 27% tax rate on investments probably down to 26, high 25 kind of range over the course of the year.

Okay.

And also maybe you can just talk a little bit about if you are doing anything within -- bear with me a minute -- the commercial auto, the trend in the rate of increase quarter over quarter and premiums written has consistently declined from 21% down to 11% over the course of this year.

Is there anything specific, is it a line that you are not just interested any more or can you shed some light there?

Commercial auto, no, not really, no, nothing unusual there.

I mean obviously commercial auto, if you look at our lead commercial lines, it's commercial auto, GL.

Workers' Comp. and we've seen a lot of, just a lot of good price increases in that kind of insurance.

Nick, just to round out one other thing on tax retail resale, we talked a little bit about migration of the tax rate.

I still think though in the end of the year when that whole thing settles out because of the heavy migration into the continued buying of taxable bonds throughout the year, that rate still could be in the 26 to 27 range, more like 27 taxable rate for 2003.

Okay.

Great.

Thank you.

We'll take our next question from Greg Peters with Raymond James.

Good morning, everyone.

Good morning, Greg.

Based on -- this is a big picture question for you, but based on your earnings guidance of, I think it was 215 to 235 for 2003, by my pen, at least on an operating basis, that comes out to a return on equity between, let's say, eight and 10% being liberal.

And I was hoping you might provide us some color there because some of your other peers, large and of equivalent size, are looking for double-digit returns for 2003, some of them in excess of 15%, and I thought maybe you could just given us a sense of where you are and elevating your return on equity to a higher level.

Okay.

Yeah, I would say that you are right, it's about in that 9% range, somewhere in that neighborhood return on equity.

And I think what you're looking at is the improvement in the company's performance, all the uplift has been driven in the commercial lines arena.

And for several years now the commercial lines which does represent slightly in excess of 80% of our business.

It's been doing most of the heavy lifting.

I think where we start to get ongoing improvement is when we start to hit the '04 year in terms of earnings.

But more so when we start to address some of the issues in a in the person lines area, particularly in New Jersey where we do have that new rating and tiering plan that will continue to drive higher prices for the next, say, three-year period.

That's expected to generate a lot of return.

As well as the stance that we've taken in our non-New Jersey states plus New York in terms of personal lines.

I think that's where we need to get a little bit more improvement and then start to push the returns higher.

So I think we've set an expectation for '03 that we feel comfortable with.

Can we look at the rate increases and the actions that you're taking in '03 as being directly correlated with your ability to achieve say a 12% or higher return on equity in 2004.

I would say yes.

Thank you.

Again it is star one for questions.

At this time there appear to be no further questions.

I'd like to turn the call back over to management for any additional or closing comments.

Thank you very much.

If you have any follow up items please contact Dale.

Thank you very much.

That does conclude today's teleconference.

Again, thank you for your participation.

You may disconnect at this time.