Selective Insurance Group Inc (SIGIP) 2004 Q1 法說會逐字稿

Good day, and welcome to the Selective Insurance Group’s first quarter earnings release conference call.

At this time, for opening remarks and introductions, I would like to turn the call over to the VP and Corporate Secretary, Ms. Michelle Schumacher.

Please go ahead.

Thank you, and good morning.

Before I turn the call over to Dale Thatcher, EVP and CFO at 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-Q.

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 in prepared remarks, which are supplemented by the investor package and other information on the investor page of our public 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: Jim Ochiltree, SEVP, insurance operations;

Kerry Guthrie, SVP and Chief Investment Officer;

Ron Zaleski, EVP and Chief Actuary;

Sharon Cooper, SVP, Director of Communications; and John Marchioni, VP of Government Affairs.

This call is being simulcast over the Internet at www.selective.com.

A replay will be available at the same site through May 27th, 2004.

With that, I will turn the call over to Dale.

Thanks, Michelle.

Good morning, and welcome to Selective’s first quarter call.

We continue to drive performance improvements, and this quarter demonstrates another step in that direction.

Net income was $27.5m, or 88 cents per diluted share, up from $8m or 29 cents per diluted share from the first quarter of 2003.

Operating income increased 341 percent to $24.1m, or 77 cents per diluted share for the quarter, up from $5.5m, or 20 cents per diluted share for the same period last year.

For the second consecutive quarter, we earned 11.9 percent operating return on equity, substantially exceeding our cost of capital of 7.3 percent.

Net premiums written increased 16 percent to $375.3m for the quarter, including $75.5m in new business.

Our overall GAAP combined ratio dropped almost 9 points to 97.9 percent for the first quarter, down from 106.7 percent for the same period last year.

The overall statutory combined ratio fell to 95.7 percent, compared with 104.4 percent for the first quarter of 2003.

Weather-related catastrophe losses were in line with our budget for the quarter, accounting for 1.5 points of the statutory combined ratio, or $3m after-tax.

That, compared with 4.4 points, or $7.7m after-tax for the first quarter of 2003.

Favorable first quarter results were driven by ongoing improvements in almost every segment of our commercial lines operation.

Commercial lines net premiums written, which represent 83 percent of our business, were up a strong 19 percent for the quarter, while earned premium increases outpaced loss trends by 4 points.

Commercial lines growth was driven by new business of $68.3m, and a 3 point increase in retention to 83 percent, which pushed policy count up 12 percent over the first quarter of 2003.

Renewal price increases held steady, up 10.3 percent for the quarter.

Four plus years of double digit commercial renewal price increases have generated a compounded price increase of 92 percent.

Our three key liability lines have registered significant improvements for the quarter.

The commercial automobile statutory combined ratio dropped about 5 points to 84.9 percent, compared with first quarter 2003.

For the same period, the general liability statutory combined ratio fell 4.5 points to 90.2 percent.

In addition, our worker’s compensation segment showed marked improvement during the period, with the statutory combined ratio down more than 5 points to 101.6 percent, compared with 106.7 percent for the same period last year.

Our solid performance in these lines reflects our long-term improvement strategy which incorporates higher pricing, continued underwriting enhancements and heightened loss control efforts, all of which lead to a better overall mix of business.

Worker’s compensation represents about 26 percent of total commercial lines premiums, and less than 5 percent of the business is unsupported by another commercial line.

Since 2000 we have increased worker’s compensation pricing by 40 percent through a combination of rate increases, credit reductions, cutbacks in dividend plans, and shifting business to higher priced tiers.

Our underwriting and pricing actions are ongoing, including a focus on lower to medium hazard business, and a targeted 6 percent overall price increase in 2004.

A 6.2 percent price increase in New Jersey, which represents 24 percent of our worker’s compensation premium, was effective January 1st.

Generally favorable weather contributed to a 60 point drop in the property statutory combined ratio to 101.8 percent for the first quarter, compared with a 162% for the first quarter of 2003.

The business owner’s policy, or BOP line of business, made significant progress during the quarter as the statutory combined ratio dropped more than 30 points to 109.2 percent compared with first quarter 2003.

We are aggressively pursuing profitability for this business by focusing growth efforts on the more profitable office segment which is running a five-year, on level accident year combined ratio of 95.3 percent.

This segment now represents more than 52 percent of total BOP locations.

In addition, we continue to implement ongoing pricing and underwriting actions to improve results, including the elimination of classes such as furniture stores, which have been consistently unprofitable.

Results in our bond operation were impacted by a $2m reduction of a salvage and subrogation recoverable related to prior accident years.

The one-time charge added more than 64 points to the first quarter bond statutory combined ratio of 165.6 percent, compared with 118.3 percent for the same period last year.

Although the bond operation represents only 1 percent of our commercial lines business, we continue to improve this segment, given its value to our agents in rounding out the commercial account for their clients.

For the quarter, our overall commercial lines statutory combined ratio dropped nearly 11 points to 93.4 percent, down from 104.2 percent for the same period last year.

In our personal lines operation, net premiums written increased 3 percent for the quarter.

The personal lines statutory combined ratio, which includes the flood operation, was 106.1 percent, compared with 105.3 percent for the same period last year.

The increase was due to a large number of extraordinary fire losses in our homeowner’s line, that added 38 points to the homeowner’s statutory combined ratio of 133.2 percent for the period, compared with 122.6 percent for the first quarter of 2003.

While the unusual fire losses have driven up severity, our underlying homeowner’s book of business reflects ongoing improvement.

During the quarter, claims frequency continued its downward trend.

Pricing continued to rise, and we implemented enhancements to the improvement plan initiated three years ago, including double-digit rate increases in six states; expanding the use of client credit history to apply discounts and surcharges for new and renewal business; continuing the rollout of higher wind and hail deductibles in coastal and certain inland territory; and expanding our account credit where appropriate, which encourages agents to write both auto and home policies with Selective.

The personal automobile line achieved profitability during the quarter, led by ongoing improvements in New Jersey.

The overall personal automobile statutory combined ratio came in at a 98.9 percent, compared with 104.2 percent for the first quarter of 2003.

The New Jersey personal automobile statutory combined ratio improved to 94.7 percent, compared with 101.9 percent for the same period last year.

Ongoing initiatives to improve our New Jersey business are a strong indication of Selective’s ability to achieve profitability in even the most challenging lines.

While we are pleased with our progress, efforts to achieve stability in this often volatile book of business continue.

Building upon a 5 percent rate increase effective in March, 2004, our action plans include further tier revisions expected to lower rates for our best customers; raise prices for higher-risk drivers, and improve our competitive position in this changing marketplace.

Throughout our personal line operating regions, we are implementing the rate increases and tier changes.

Where allowed, we are utilizing credit scoring to improve our rating structure.

These initiatives, combined with the new web-based personal lines system are expected to continue our underwriting improvements and support growth, leading to a more profitable personal lines segment.

At the end of the first quarter, overall net premium written per insurance employee was up 22 percent to $739,000, compared with the same period last year.

Technology enhancements that enable agents to initiative and self-service their Selective business are driving this progress.

During the quarter, agents processed over 6,300 endorsements through our commercial lines system, while underwriting templates automatically renewed over 28 percent of commercial policies.

Agents are on pace to process 40 percent of certain commercial lines transactions by year end.

Our 2006 goal is $1m per premium written per employee that will produce a 28 percent expense ratio.

In our diversified insurance services operation, quarterly revenue was $24.2m, up 14 percent over first quarter 2003.

Return on revenue remained consistent at 6.1 percent.

During the quarter, revenue at our flight operation increased 24 percent to $5.7m, driven by strong premium growth of almost 19 percent.

Net income was $0.9m, up from $0.5m for the same period last year.

In our managed care businesses, revenue was $4.9m for the quarter, compared with $5.6m for the first quarter of 2003.

The reduction reflects a loss of business that occurred primarily as a result of industry consolidation, the elimination of unprofitable accounts and the loss of one large client due to competition.

Net income was $0.3m, compared with $0.6m for the first quarter of 2003.

Revenue for Selective HR Solutions, our provider of human resources benefits and administration services, was $13m for the quarter, compared with $10.7m for the first quarter of 2003.

Net income was $0.1m.

With expense reduction and re-underwriting initiatives firmly in place, we are focusing our efforts on growing this business.

We find increasing support among our agency force for the value-added benefit Selective HR brings to their clients, as well as a high level of activity agents are facing from non-traditional competitors.

At the end of the first quarter, Selective HR manages about 20,500 work site lives, up 10 percent compared with this period last year.

In addition, we anticipate ongoing worker’s compensation pricing and administration fee increases in 2004 to drive additional improvements.

We generated a 10 percent increase in after-tax investment income for the quarter to $21.8m, up from $19.8m for the first quarter of 2003.

Investment income was aided by a $1.2m after-tax increase in the limited partnership income for the quarter, as well as continued strong operating cash flow of $55.2m, up 35 percent for the period.

The after-tax portfolio yield was 3.5 percent.

Our investment portfolio reached $2.5b at the end of the first quarter, compared with $2.2b one year ago.

Higher interest rates, although having an immediate impact on the market value of our debt securities and stockholder’s equity will increase return on invested assets over the long term, and our return on equity.

We continue to construct our investment portfolio with the long-term objective of maximizing after-tax results.

Bond holdings represent 84 percent of invested assets, with 63 percent of the portfolio rated AAA.

The bond portfolio has an average rating of AA, with only 1 percent rated below investment grade.

As previously announced, commencing April 1st, 2004 our senior convertible notes due 2032 are now convertible on the company’s common stock.

The conversion condition was met when our common stock traded above the conversion trigger price of $35.15 for more than 20 of the last 30 trading days in the first quarter.

As a result of this event, approximately 3.9m shares are included in the diluted EPS calculation for the quarter, as well as an add-back of $800.000 after-tax interest expense per quarter.

This calculation will hold for as long as conditions for conversion are met.

At the end of the quarter, stockholders equity was up 22 percent to $800m, compared with March 31st 2003.

For the same period, book value per share increased 18 percent to $28.88.

Clearly our ability to generate consistent, favorable financial results is indicative of the well-defined strategies that differentiate Selective and drive profitable growth.

Now I will turn the call over to Greg Murphy.

Thank you, Dale, and good morning.

Our strong results for the quarter reflect excellent performance in our commercial lines operations.

Commercial premiums grew 19 percent, driven by a 20 percent increase in new business; renewal price increases of 10.3 percent; and a 3 point increase in retention.

These improvements and lower weather-related catastrophe losses led to a further drop in our commercial lines statutory combined ratio, which neared 93 percent.

We are pleased with the progress in our New Jersey automobile business, which generated a 94.7 statutory combined ratio for the quarter.

Ongoing improvements reflect significant actions we’ve taken over the last four years, including aggressive pricing, a redesign of our rating tiers, reduced agency commissions, and improving political and regulatory climate.

Yesterday, AM Best reaffirmed Selective’s A plus superior rating for the 43rd consecutive year, citing the company’s “strong balance sheet and benefits gained from its field office structure, technology and continued leveraging of agency relationships.

In addition, the rating recognizes Selective’s disciplined underwriting culture, conservative investment philosophy and prudent capital management which have contributed to the group’s consistent operating profitability.”

Independent agents control 80 percent of the commercial lines marketplace, as they continue to expand their share of regional carriers, Selective’s competitive advantages place us at the forefront of an industry where only 6 percent of commercial lines carriers achieve an A plus or better rating, and provide us with significant opportunities to grow our commercial lines business.

We recently completed a 12-day road trip where senior management met with over 650 agencies.

Almost without exception, agencies tell us we’re at the top of their list for market stability, superior people, technology and quality products.

They recognize Selective as one of the few carriers with a clearly defined strategy that produces results.

In our 2003 agency surveys, agents ranked us a 9 out of 10 for overall satisfaction with the company, our highest score ever.

They say they choose to grow with Selective because we are one of the easiest companies to do business with, national or regionally, and our business model delivers real time solutions.

Our strategies continue to produce long-term growth opportunities.

For the quarter, commercial lines new business was up 20 percent to $68m.

Small business from our [One and Done] system increased 57 percent to more than $135,000 a day.

We are on track to reach $200,000 a day by year end.

At that run rate, we would generate $50m of new business annually at a 23 percent marginal expense ratio.

Volume at our underwriting service center reached $48m, including $1m in rollover business from competitors this quarter.

Currently, more than 200 agencies place their small commercial lines accounts with a service center, and account retention exceeds 95 percent.

Middle market new business, driven by our field underwriters, grew 12 percent for the quarter to $50m.

In our large account operation, Selective Risk Managers, added $11m in new business, up 44 percent.

To generate business growth that meets our profitability measures, we closely monitor the pricing and quality of new accounts.

New business pricing and the use of schedule credits were in line with our budget, while Selective’s aggressive loss control efforts led to a 60 percent increase in service calls.

In addition, we now have the capability to perform infrared tests which detect potential electrical problems that could cause fires in commercial buildings.

All but one of Selective’s regional offices is now generating a commercial lines underwriting profit.

As commercial lines pricings continue to moderate, the question is, at what point will they cross with loss trends?

In 2004 we anticipate earned premiums, excluding exposure to increase 7.5 percent and significantly outpace loss trends, which are projected to rise by 4 percent.

Our loss trend is based on an expected 2 percent increase in the consumer price index, including medical cost increase of 5 to 7 percent.

In 2005, we believe the margin between earned premiums and loss control should still be positive.

In addition, the effect of inflation is already projected in our loss reserves based on inflation trends over the last 15 years, and the duration of our reserves is relatively short at 2.5 years.

Because our initiatives are firmly established, we have been able to focus on profitable growth at any abrupt pricing cycle and aggressively leverage our value-added products and services to drive yet another wedge between Selective and the competition.

These include loss control services, human resource benefit outsourcing, flood insurance policy services and a broad commercial lines appetite that makes us a top contender for more of the best business from our agency force.

Our consistent profitable growth advanced Selective’s position on the Fortune 1000 list of the largest companies in the United States.

Based on 2003 revenues, we now rank 917, up from 967 based on 2002 revenue.

More importantly, we outperformed many larger Fortune peer companies in both earnings growth and total return to shareholders.

For the second year, Selective’s been named to the Forbes Platinum 400 list of best-managed companies in America.

Few regional carriers receive national recognition.

For 2004, our projections are based in part on the following key assumptions: Increasing after-tax investment income by 3.5 percent; overall premium growth between 14 and 16 percent; commercial lines renewal price increases of 8 percent; a New Jersey personal automobile statutory combined ratio below 100; catastrophe losses of 1.6 points; and diversified insurance services revenue growth of 13 percent and return on revenue of 6.5 percent.

With the exception of the convertible bond offering that reduced EPS, we are on track with the key assumptions at the end of the first quarter.

Barring excessive catastrophe losses for the remainder of 2004, we anticipate an overall statutory combined ratio under 97; a GAAP combined ratio below 98.5 and operating earnings between $3 and $3.25.

Thank you, and now I will turn the call back to the operator for your questions.

Thank you. (Operator instructions) We will take our first question from Mike Dion with Sandler O’Neill.

Good morning, everybody.

A couple questions.

One, just in terms of the overall market opportunity on the commercial lines space, you talked a lot about the new business growth in the quarter.

Are you seeing any new business from what is going on with the merger of St. Paul and Travelers?

Has that created some opportunities for you, and if not, will it going forward?

And second question on the personal lines side is, with one of your competitors in New Jersey using credit scoring, do you foresee any change in the environment there that will allow you to be able to do the same?

Sure Mike.

With respects to the opportunities in the marketplace, I think anytime you see changes I think that that creates opportunities for Selective, and I think what we’ve focused on is our positioning in the marketplace, offering our agents the real things they need to do to get business done, and that’s the field underwriting, having their own field claim person, the loss control services that we do.

I think the value that we bring to agents is clear.

Our opportunity to grow our business model continues every day, I think anytime there is any kind of dislocation in the marketplace, whether it be a ratings downgrade, a merger or anything I just think that creates opportunities for us.

With respect to your second question on the credit scoring, we do have a filing now with the department that we are looking at credit scoring opportunities, and I will turn it over to John Marchioni to comment on that.

Actually, to add to what Greg said, earlier this week the Department did issue their guidance, letting it be known and it was publicized in the print media here yesterday, that the rest of the market was now permitted to make filings for the use of credit in rating.

Selective has been in discussions with the Department.

It was reported again today that we are well-positioned in that regard, so we think that in the next 50 days or so the rest of the market should be on equal footing with that one competitor who has been using credit scoring since last fall.

Great, thank you.

Thanks, Mike.

Now we will move on to Beth Malone with Advest.

Thank you, good morning and congratulations on the quarter.

A couple questions.

Can you review again your guidance with – you bring it down from $3 to $3.30 to $3 to $3.25, or did I mishear that?

I’m sorry, Beth, we’re having trouble hearing you.

Can you pick up your handset possibly.

Okay, how’s that?

Much better, Beth.

Yes we did bring it to $3 to $3.25 from $3 to $3.30 is what we previously had as guidance, and that is strictly as a result of the convertible bond being able to convert for more periods than initially expected in our initial guidance.

And Beth, let me just add a little more color to that.

And I have got to tell you, the accounting firms are not firmly on the same camp on this in terms of the treatment of how the conversion feature works.

Right now we have been under the understanding that we have to include the conversion in the quarter that the conversion is met, as well as the next quarter, so even though if we were not to meet the conversion in the second quarter, this is going to be included in our diluted calculation in the second quarter.

So even though -- this is the confusion, and I don’t mean – this is an area where there seems to be a lot of moving parts, but right now it is our understanding that since we met the conversion in the first quarter, that it would be included in our as-if converted shares in the first quarter as well as in the second quarter.

So even though we might not meet that conversion for another quarter or two, it is automatically going to be included in the first two quarters of the year.

Solely as a result of that, which cost us approximately 8 cents a quarter, we reduced our upper end guidance from $3.30 to $3.25.

Okay, thanks.

Another question is, on the – this is not a big part of your business, but the managed care operation.

I mean, you talked about the fact that there is consolidation going on in the industry, you seed out on a large product.

I’m just wondering, what do you see as the long-term opportunity for value for this managed care?

I understand the outsource, human resource outsource seems to be a benefit, but what about that business.

I guess if you honestly look at this business, because we use the managed care services on a day-to-day basis to manage our medical claims activity that we have both on the worker’s comp side as well as from a personal/commercial automobile side, and that’s really why we got that, so that was part of the theoretical vertical integration, and not so much a complementary vertical integration that you were referring to before as the [SHRS] situation provides.

Right now in the marketplace, what we’ve found is that sales and the assimilation process has been a little bit slower in the marketplace.

We have some new accounts that have come online that will manifest themselves in future quarters with additional revenue and we just closely monitor that situation.

The other thing I’ll add, Beth, a little more color on the consolidation, is that was actually consolidation among clients, so we had a number of clients who were bought by other enterprises who weren’t clients and we lost that business, so that was the consolidation that led us to lose some of the revenue that we had.

The other thing is we’ve closely worked with our expenses in that operation to make sure that we manage that as closely as possible so we can achieve the right kind of net income, and we did have an announced layoff of 30 individuals in that operation to try to match the employees with the amount of revenue that’s coming in, so we managed that very well, I think.

Okay, and on your investment portfolio, your duration.

Is that pretty much matched with liabilities, and do you anticipate with interest rates serving to edge up you wouldlengthen the duration, do you think you could pick up some more interest rate profit on that?

Beth, this is Kerry Guthrie.

As interest rates rise, we really do not anticipate lengthening the duration.

We feel that the duration of the bond portfolio is where we want it relative to the liability duration.

It is mismatched, it is a little bit longer on the asset side than the liability side, but that is something we are monitoring very closely.

We also take not only the overall level of interest rates into consideration, but the shape and yield curve which is still fairly steep right now.

And one last question on pricing.

It seems like a pleasant surprise that you continue to be able to get rate increases still in the double-digit range.

What is the outlook for that?

Is the market still not competitive enough, the demand that prices come down much more?

I can tell you, we did our 12-stop road show, and we heard, the message was definitely choppy throughout those 12 stops, but I will tell, what I’m reading a lot about in the press today about universal price reductions, because what we heard is just as long as the price increases are reasonable and they are done on a client by client basis and they are not these wholesale price increases that you have the ability, just as long as you are adept enough in the marketplace to get increases.

So we’ve been able to do that, as we’ve indicated that for the full year we believe we will be at 8 percent, so we are going to see some deceleration in that as we move throughout the rest of the quarters.

Okay, well thank you.

(Operator instructions) Now we will hear from John Keefe with Farris, Baker, Watts.

Good morning, guys.

A couple of numbers went by me.

Early on, Dale, did you mention the customer retention rate?

Commercial lines was 83 percent?

That’s correct.

And that was up about 3 points?

3 points.

And Greg, did you say that you expected earned premium for ’04 to be up 7.5 percent?

I just want to make sure that’s clear.

Because we are comparing that to loss trends, John, we’re excluding exposure on that.

So that is just a pure price-earned premium trends are 7.5 percent versus the loss trend.

So you’ve got other – there’s a lot of confusion in the modeling, because in your modeling you’ve got exposure increases and other things in there.

So what we are talking about is pure price trends versus pure loss cost trends, and that’s how you really have to compare those two numbers.

I see, so there is about a 350 point spread?

Probably close to that, yes.

Beth asked the question about duration of assets, did you give a number as to the duration of the fixed portfolio?

That’s 4.4 years, and the liabilities is about 2.5 years.

Very good, thank you.

Thank you.

(Operator instructions) It appears there are no further questions at this time.

Mr. Murphy, I’ll turn the conference back over to you for any closing or additional remarks.

Thank you very much, operator.

If anyone has any follow up questions, please contact Dale.

Thank you very much.

That concludes today’s conference.

Thank you for your participation.