Selective Insurance Group Inc (SIGIP) 2006 Q1 法說會逐字稿

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

At this time for opening remarks and introductions I would like to turn the call over to the Vice President, Assistant Treasurer, Ms. Jennifer DiBerardino.

Please go ahead, ma’am.

Thank you, Lisa.

Good morning, and again, welcome to Selective Insurance Group’s first quarter 2006 conference call.

This call is being webcast on our website and the replay will be available through May 26, 2006.

A supplemental investor packet, which includes GAAP reconciliations of non-GAAP financial measures referred to on this call, is available on the Investors’ page of our website at www.selective.com.

Selective uses operating income, a non-GAAP measure, analyze trends and operations.

Operating income is net income excluding the after-tax impact of net realized investment gains and losses and discontinued operations and the cumulative effect of change in accounting principle.

We believe that in only providing a GAAP presentation of financial information for Selective would make it more difficult for investors to evaluate the success or failure in our insurance business.

As a reminder, some of the statements and projections that will be made during this call are forward-looking statements as defined by the Private Securities Litigation Reform Act of 1995.

Forward-looking statements are not guarantees of future performance and are subject to risks and uncertainties.

We refer you to Selective’s Annual Report on Form 10-K filed with the U.S.

Securities and Exchange Commission for a detailed discussion of these risks and uncertainties.

Please note that Selective undertakes no obligation to update or revise any forward-looking statement.

With us today are several members of Selective’s Senior Management team -- Greg Murphy, our CEO;

Kerry Guthrie, Chief Investment Officer;

Ron Zaleski, Chief Actuary;

Jim Ochiltree, our Head of Insurance Operations; and members of his Senior Leadership Team consisting of Ed Pulkstenis, Chuck Musilli, and John Marcioni.

At this time I’d like to turn the call over to Dale Thatcher, our CFO, to review first quarter results.

Thanks, Jennifer.

Good morning.

We’re off to an excellent start for 2006 with all areas of the Company performing well in the first quarter.

Compared to the first quarter of 2005 net income increased 11% to $40 million, or $1.28 per share.

Operating income increased 10% to $35 million, or $1.13 per share.

Net premiums written were up 9% to $432 million.

The statutory combined ratio improved .5 points to 93%.

After-tax investment income increased 14% to $28 million.

And revenue for our Diversified Insurance Services grew 16% to $27 million and return on revenue was 8.6%.

The increase in net premiums written includes a return of $11.3 million in ceded premium related to the elimination of our New Jersey Homeowners quota share reinsurance treaty.

Excluding the returned premium, net premiums written increased 6% for the quarter.

As you may recall from the yearend discussion, effective January 1, 2006 we eliminated the Homeowners Treaty and increased limits on our Property Catastrophe Treaty to more broadly cover growth and diversification in our 20-State footprint.

We’re seeing the benefit of ongoing underwriting and pricing initiatives as evidenced by the overall 93% combined ratio with Commercial lines at a 91.9%.

Weather-related catastrophe losses for the quarter were better than anticipated at $3.2 million pre-tax.

That’s 0.8 points higher than first quarter of 2005 when catastrophe losses were unseasonably low at only $0.4 million pre-tax.

Additionally, we had a small amount of favorable development of $600,000 in the quarter.

Commercial lines, which make up 86% of total premium, grew 6% in the first quarter to $372 million.

Commercial lines renewal price increases were 3.4% for the quarter, although that includes exposure growth of about 5%, so pure price was down slightly.

An average Commercial lines account size for Selective is about $8,000, which is a sector of the market that has traditionally not shown as much price volatility.

Our Commercial lines loss ratio improved 1.1 points in the quarter to 62% based on ongoing underwriting improvements.

Commercial lines loss costs increased modestly by 1.6% for the quarter, with frequency down 0.8% and severity up 2.5%.

This quarter, with the exception of Workers’ Compensation, every Commercial line of business was profitable as combined ratios ranged from the mid-70s to the mid-90s.

Workers’ Compensation came in at 110.3% for the quarter.

Given our account-based underwriting approach the inclusion of Workers Compensation coverage is often necessary to write an overall profitable account.

However, we don’t view this line as a loss leader.

We are aggressively working on making improvements to the profitability of this line, although we recognize that it will take some time.

For that reason, our Knowledge Management and Predictive Modeling efforts were initially focused on Workers’ Compensation.

We adopted a new IMPROVEMENT plan in 2005, which includes six key initiatives, including predictive modeling, loss control, and maximizing our quality agency relationships.

Independent of other factors we believe our multifaceted strategy will produce a 7-point improvement in the Workers’ Compensation combined ratio over the next two years.

A good example of our underwriting success is our Business-owners’ policy, or BOP business.

In the first quarter of 2004 we told you about our plan to reduce the combined ratio by 6 points and we achieved that milestone.

Just this quarter the combined ratio improved 22.5 points to 83% from this time last year.

With the interim BOP correction plan behind us and our BOP rewrite in place in all states of operation, we’re beginning to see an increase in new business, which was up 21% in the first quarter compared to the first quarter of 2005.

Excluding the flood business, our Personal lines operation had a statutory combined ratio of 103.5% for the quarter.

Excluding the one-time impact of the $11.3 million reinsurance returned premium discussed earlier, net premiums written increased 3%, so we’re beginning to see some signs of improvement.

The loss ratio for the quarter improved by 0.7 points as loss costs for the quarter were up 1.1%.

Frequency was down 1.1%, but severity was up 2.2%.

And net premiums earned per policy were down 1%.

Competition in New Jersey Private Passenger Auto continues to affect Personal lines growth.

The number of cars insured in New Jersey declined to 86,100 from 87,600 at yearend.

However, we saw an increase in new business of 23% for the first quarter.

Retention also improved nearly 7 points since 2005.

We anticipate retention and new business to continue to improve as we roll out our new pricing structure in the third quarter, beginning with New Jersey.

We’re committed to writing Personal lines because it tends to soften the cyclicality of the Commercial lines business.

More importantly, independent agents continue to grow their market share in Personal lines and they want to grow with Selective.

We see Personal lines as another facet of our diversification strategy, particularly as we add scale and lower the expense ratio.

To improve our competitive position for Personal lines we have several initiatives underway.

A pricing redesign for Auto will roll out in all of Selective’s Personal lines states in 2006, beginning with New Jersey.

And we will implement a new pricing structure for Homeowners in mid to late 2007.

In 2005, we launched SelectPlus, our automated Personal lines system. 83% of our agents are inputting data directly into the system for new business and 48% are initiating endorsements.

xSELerate, our agency integration system originally developed for Commercial lines, will be introduced for Personal lines beginning in July.

We expect to drive usage of SelectPlus to 90% when xSELerate is fully implemented.

Our Personal lines Service Center will open next month with a pilot group of New Jersey agents.

Agents with about $80 million in Selective Personal lines premium volume have requested Service Center capability, so we believe this initiative will provide new business opportunities for us.

The strong performance of our Diversified Insurance Services was driven by a 29% increase in flood revenue for the quarter, reflecting 25% growth in flood direct premiums written to $25 million.

We continue to monitor developments for the National Flood Insurance Program regarding its ability to pay claims in the event of another large-scale event.

Congress controls the Federal Agency’s BORROWING authority, which topped out after hurricane Katrina and is again nearing maximum capacity.

At this point it is uncertain what impact, if any, this will have on our flood business.

Selective HR Solutions added about 1,000 new work site lives during the quarter and revenue was up 10% to $17.2 million.

We saw increases in active quotes and the close ratio this quarter, compared to first quarter of 2005.

In addition, the new Employer Protection Program, or EPP, was launched at sales meetings this quarter.

The program was designed to protect business owners from employee-related liabilities.

It has generated great excitement with our agents and initial feedback has been positive.

After-tax investment income increased 14% to $28.2 million for the quarter, led by a 10% increase in bond income, an 8% increase in dividend income, and a tripling of short-term interest income.

Our overall annualized after-tax portfolio yield was 3.5% and investment assets increased 14% from the first quarter of 2005 to $3.3 billion.

The growth is a result of our strong operating cash flow in 2005 at $407 million, the proceeds from November 2005 $100 million bond offering and first quarter cash flow of nearly $80 million, partially offset by the $52 million in share repurchases.

As a result of higher interest rates since yearend, our fixed income portfolio had a $3.2 million after-tax net unrealized loss at March 31, 2006, reducing its value in the short term.

The 10-year Treasury rate has increased 46 basis points and the 2-year Treasury is up 42 basis points in the first quarter.

However, at these new rate levels our overall portfolio yield is rising slightly as bonds mature and are replaced with higher yielding ones.

Now, I’d like to turn the call over to our CEO, Greg Murphy.

Thanks Dale, and good morning.

I’d like to begin by pointing out that last week A.M.

Best reaffirmed our A+ financial strength rating for the 45th consecutive year.

In support of the rating, A.M.

Best cites Selective’s solid capitalization, historically favorable operating performance and strong regional presence within the Small Commercial lines market segment.

Financial strength, coupled with our high-touch, high-tech way of doing business, is why agents make Selective their market of choice.

In fact, at yearend almost 70% of our agents with more than a 5-year history with Selective ranked us as a top-3 carrier in their office.

Less than 9% of Personal and Commercial lines carriers are rated A+ or better.

Our first quarter performance reflects the value of our excellent agency relationships in a more competitive marketplace.

We achieved Commercial lines growth of 6%, more than twice the A.M.

Best estimated industry growth rate for 2006.

Our agents are committed to long-term profitable growth with Selective and a key indicator is Commercial lines new business, which grew 17% to $72 million.

New business was generated by the following sources -- middle market or AMS business, $52 million, up 29%;

One and Done Automated Small Business, $11 million, up 14%;

Large account business, Selective Risk Managers, $7 million, down 33%.

The unique ‘high-touch’ role of our AMS, or Agency Management Specialist, drives more business to Selective.

AMS are in our agents’ office at least weekly with the technology to quickly and efficiently quote and issue business.

They have the underwriting authority to make decisions on the spot and as a result, they’re able to write more business.

We added new 5 new AMSs in the quarter, bringing the total to 82.

Based upon annualized first-quarter numbers, each AMS will generate about $2.7 million in new business.

Our Automated One and Done Small Business system produced new business of $167,000 per work day, moving steadily towards our growth goal of $200,000 a day.

Today nearly 95% of our agents are using the system and we have experienced broadbased growth in many segments.

Currently there are 330 eligible classes of business in the One and Done and we expect to increase that to 375 by yearend.

This business typically results in a 2-point better average loss ratio and is written at a 23% marginal expense ratio.

We’re experiencing the most competition with accounts over $250,000 in premium.

This business, which is large for us, tends to be middle-market business for many larger carriers and it’s more susceptible to competition.

Growth was off in this segment from our expectations, but retention remains strong at 90% and the combined ratio for the quarter was 84.8% as we maintain our underwriting discipline.

Our success with renewals speaks to the high-touch level of customer service that we provide, particularly loss control and claims service.

For example, we lost an account recently that returned within six months due to poor claims handling service of one of our competitors.

We are driving growth through our market planning initiative, which identifies Selective’s market share premium growth, current year combined ratio, and last 3-year combined ratio by 80 Commercial lines business segments.

We plan with the highest impact agents at this level.

We are also identifying underserved territories to appoint new agents, particularly at our growing mid-America operation where approximately 100 prospects are in various stages of appointment.

Our expectation is to appoint 150 agencies Company-wide over the next two-year period.

Agents want to grow with Selective due to our high-touch, high-tech way of doing business, which creates products and technology based on agents’ business concerns and needs.

We also have one of the most visible management teams in the industry to reinforce the Selective franchise value proposition.

During the quarter, the Senior Management Team spent several weeks on the road attending sales meetings and targeting growth areas in the Midwest, New Jersey, Maryland, and Virginia.

We hosted more than 100 President Club agents at a two-way Executive session in March.

And we continue to harvest new business opportunities in one-on-one meetings with our agents and their top producers.

Selective is a pioneer in creating a solution to an often-expressed agent frustration of not being able to recruit and develop producers.

Through a third-party vendor Selective is now helping agents hire, develop and retain producers.

The program was rolled out in 2005 with [30] President Club agents.

It will be expanded to another 50 agents in 2006.

We expect each new producer to generate a Selective book of business of nearly $900,000 in premium over a five-year period.

To address an agent’s need for the ability to move data between their agency management systems and our systems we were first in the market with the launch of xSELerate.

With xSELerate an agent can reduce the resource cost to remarket a piece of business to Selective.

We wrote $3.5 million in new business through xSELerate year to date through April 21st.

The 8.94 rating out of a 10-point scale, 10 being the highest, that Selective received on its 2006 Agent Satisfaction Survey is a strong indicator of the true value of the high-touch.

Once again, we ranked #1 Company for the quality of service in the Goldman Sachs Semi-annual Nationwide Survey.

These results verify the strong franchise value that we have with agents and affirm our high-touch, high-tech strategies.

The ability to improve profitability without the benefit of a hard market is what drives companies’ initiatives.

Through Knowledge Management we’ve added Decision Support Screens to our Commercial lines system, enabling us to deliver the collective knowledge of the organization to every underwriter’s desktop.

This information allows the underwriters to target the most profitable business, down to the individual policy level and underwrite it and price it more precisely.

The next phase of Knowledge Management is Predictive Modeling, which has yielded great insight into our business.

Predictive Modeling has enabled us to more precisely identify highly profitable business to target and it’s just as importantly identifying un-profitable segments that should be addressed.

As Dale indicated, Predictive Modeling, coupled with the expertise we now have in Workers’ Compensation, should improve our Workers’ Compensation combined ratio by 7 points over the next two years.

Our key Commercial lines models should be completed by yearend.

At Selective we look at many drivers of profitability, then monitor and measure them to maximize our results.

Not only do we manage the traditional industry benchmarks, like line of business, regions, but we analyze results by strategic business unit -- agent, AMS, class of business, new versus renewal, and by standard industry code level.

Selective’s data warehouse provides for a very detailed capability to drill down into our results. 77% of our 750 agents and 90% of our 80 business segments were profitable at the end of the first quarter.

The focal point of our capital management is to maximize shareholders’ returns.

Our statutory surplus has increased at a compounded annual growth rate of 14% over the past 5 years.

To more effectively manage our cost to capital we utilize debt issuance, share repurchases, and dividends.

Since April of 2005 we’ve repurchased 1.3 million shares at an average price of $53.00 under the currently authorized 5-million share repurchase program.

We have raised the dividend three times in the past three years with a 16% increase in 2005.

At March 31, 2006 our weighted average cost of capital was 9.5.

For 2006 we are revising the operating earnings per share guidance upward to a range of $4.30 to $4.50.

This increase reflects the 950,000 shares repurchased in the first quarter and related decrease in the estimated diluted weighted average shares from 32.2 million to 31.5 million.

Other key assumptions include the following -- a normal level of catastrophe losses, $13.8 million after tax, or $0.44 per share for the year; a combined ratio target of 96.5% on a GAAP basis and 96% on a statutory basis; after-tax investment income growth of 13%; and Diversified Insurance Services revenue growth of 12%; and return on revenue of 8%.

Now, I’d like to turn the call back to the operator for your questions.

[OPERATOR INSTRUCTIONS]

Mike Grasher with Piper Jaffray.

A couple of questions.

It’s on Workers’ Comp and talking about the 7-point improvement over the next two years.

What should we use as sort of a benchmark or the bogie and what’s our starting point?

What’s our starting--?

We’re running right now at about -- right about 110 and I think that’s probably a good benchmark.

And the other factors that obviously affect that performance in terms of what happens to our [inaudible], what other premium increases we’re able to get in the marketplace, but I’d say we’ve laid out a very strong -- about a 7-point improvement plan that has a number of facets that contribute to that.

In addition, there are other things that we’re looking at to drive even more improvement.

So I would say you would like at -- it’s going to come in two facets.

You’re going to see our premium per exposure go higher.

You’re going to see improvement in our loss costs.

And then you will see just a general improvement in the type of business that we’re writing.

On the Insurance Services segment it looks like revenues were fairly strong in the quarter, I would say, and also the margins [inaudible] revenues [inaudible] come and go. [Inaudible].

I know you mentioned a return on revenue of about 8%.

It seems like margins were a little bit stronger than that in the quarter.

Is that just a scale issue there?

Yes, there are a number of things that push those margins around.

The two business segments you have in there are the flood and our Selective HR Solutions.

Selective HR Solutions margins have a tendency to be more level through the course of the year and they run in the 3-4 range and that’s pretty consistent.

The business that has a little more lumpiness is our flood business and the margins have a tendency to be higher in the latter part of the year where we have a tendency to see more flooding in the marketplace.

Mainly associated with hurricanes.

So, yes, we get a big claims service revenue so that margin gets pushed around.

In the first quarter of this year what we had recorded was a growth bonus that we got based on our performance for last year that got recorded in the first quarter.

So, those are the things that kind of push it around.

We’re still comfortable with our 8% overall return on revenue for that business though for the year.

Okay.

And then one final question on capital management.

Pretty strong quarter [inaudible] share repurchaser, I guess actively in the market [inaudible].

Do you expect the same sort of repurchase on a quarterly basis throughout the rest of the year?

The only thing I would tell you is that we have a program and we opportunistically buy stock in the marketplace and that’s all we really can say on that.

Mike Dion with Sandler O’Neill.

Two questions.

The first question concerns the strong growth in new business during the quarter.

If you could maybe expand on where you’re getting that new business from.

Is that coming from national carriers, other regional carriers, some mutual companies, and I think, kind of in terms of whether it’s small mid-market or I think the large account you mentioned that it was a little more competitive?

Maybe just a little bit more on that.

And then the second question concerns any changes that you might be doing to your CAT treaty given some changes in regulatory bodies in terms of what you’re defining as your PMLs.

Given your territories in the northeast are you looking at perhaps purchasing any additional CAT reinsurance for this year?

Why don’t I start with the reinsurance and then the new business I’ll move over to Jim and Chuck.

On terms of that we did modify our CAT treaty based on some of the changes that came out of the RMS model this past year.

We know other changes will be forthcoming and that’s why we reconfigured our program into a 220X20 capacity program.

We got out of the New Jersey Homeowners quota share because of the broaderbase protection that that provided us nationwide.

And so, we continue to look at our exposures and will modify our purchasing habits in the marketplace, but we are close to a 1 in 250-year event that we cover in our estimates.

So we expect that obviously to change when the new RMS models come out, but we buy to a much more conservative level than many of our competitors in the marketplace.

For the new business I’ll turn it over to Jim and Chuck to comment on that.

Yes, hi, this is Jim Ochiltree.

I’d say that the Commercial new business is strong pretty much throughout our territories.

It’s pretty uniform.

And it’s in that segment of business that our AMS has produced, which is above the One and Done and below what we call the Selective Risk Managers or the large account area.

The large accounts are under a lot of pressure and we just have not --.

We’ve seen a lot more people working on those and we’ve seen a willingness to come down below where we’re comfortable in writing some of that stuff, although we have been able to maintain our renewals in that segment on a pretty reasonable basis.

But again, that business from I’ll say $8,000 to $10,000 in premium, up to that level, our AMS has built pretty strong relationships with our agents over the last several years and it’s just allowed us to continue to see a number of very good opportunities.

Chuck, do you have anything to add to that?

The only thing I would add is where we’re getting the business.

I think it’s pretty much across the board and depending on the territory we are successful in taking business from all of our competitors -- Mutuals, Regionals, Nationals.

A lot of it depends on how strong the relationships are between our AMSs and the agencies and how often they’re in there and how successful we can be at taking it from the competitors.

And Mike, I would say that with all the time that we’ve been in the market we’ve obviously created some new beachheads out in mid-America, up in Connecticut, Rhode Island, and I think you’re starting to see the benefits of a much stronger brand value universally through the 20 states that we operate in.

We’re not necessarily the new kid on the block anymore in any of these territories, and like Chuck mentioned, we have a very high-powered group of agents and that has been supplemented with a very strong group of AMSs.

And as I mentioned earlier, we’re now up to 82 AMSs.

We have an apprentice program where we have 14 AMSs in various stages of readiness to come into the marketplace.

So, we’ve created a lot of very strong bench strength throughout the organization and I think that will yield better results moving forward.

Alison Jacobowitz with Merrill Lynch.

Just one question.

I think I heard comments on it and if I’m seeing this right, your other lines and other after tax was an expense of $5.4 million almost.

That’s a high number for you I think, more than a run rate.

Was there something unusual there?

Did something change?

How should we be looking at that number going forward?

This is Dale Thatcher, Alison.

Including the Other line you’ve got the bond issuance that we had in November, or actually the end of October last year, so you’ve got a full dose of the interest expense on that now, so that factors into that at this point in time.

So, going forward then it should be similar?

Yes.

Lara Devieux of Wachovia Securities.

Can you give more color on the Commercial lines market conditions by geographic region?

I think we’ve heard from some companies that the market has become increasingly competitive in the Midwest states.

So, are you seeing this?

And then, does this change your strategy in trying to grow in the mid-America region?

Yes, I’ll start with that and then if Chuck or Jim want to add anything.

It’s funny, when you look at the broadbased nature of our renewal price increases, which were 3.4% for the quarter, almost every region was at about that level or close to that level, maybe with the exception of mid-America, which was still up over 1%.

So, that is an area where that is our best performing region last year.

In other words, of all the 6 regions that we track, that combined ratio was the best.

And it’s also in the best in class through the first quarter of this year.

So, of all the markets that maybe can affordable of an enhanced pricing or more pricing flexibility you’re going to see that in the market.

That depends on the competitor and what state we’re in and who it is, what’s the product that we want to write, who’s on, who are we competing against or who is competing against us in the marketplace.

So, that’s choppy, I mean, overall.

But I would say the Midwest has seen a little more enhanced competition, but it’s also a very profitable region.

You’re not seeing any broadbased competition from any one player though in any of your markets?

I’d say it varies, depending on the producer, depending on what the line of it is, the appetite of the company, their desire to grow.

I think that’s why sometimes you see a little more aggressiveness on the higher-end accounts because it’s easier for some of them to make their premium quota by going after a few larger accounts than it is by slugging it out in the smaller accounts.

So, there’s no universal --.

I don’t think any universal company that you can identify, maybe with the exception of one or two out there.

On the New Jersey market, did the recent Legislative developments have a positive impact in the environment there?

And then also, do you have any initial thoughts or impressions on the new Insurance Commissioner?

John, do you want to take these?

John Marchioni – SIGI – Senior Leadership Team: With regard to the new Commissioner, nothing specific there.

Because it’s their home state I’ve always maintained a good relationship with that regulatory body and certainly expect that to continue going forward.

On the Legislative side, are you referring to the reforms of ’02 that are starting to take hold now?

Specifically the bill that would bar the Insurance [inaudible] occupation and education, do you think that’s going to be passed?

John Marchioni – SIGI – Senior Leadership Team: That’s obviously out there.

This will be the first real test of whether or not the Legislature is going to continue their hands-off approach.

There’s been a clear benefit on the political side for the reforms of’02 and as a result of that, consumers have been relatively pleased with the options in the marketplace.

So, yes, I think that works in favor of not seeing action on that, but at the same time there has been some talk about it.

So, it’s speculation at this point as to whether it gets done, but I think generally speaking that the Insurance Department has been satisfied that those rating variables have been justified and have taken the approach that they should be allowed to continue to use those sorts of variables.

So, that could change, but I think generally speaking, so far their reaction on a broad level has been relatively positive.

Alison, a little bit more color on your question on the Other expenses.

The impact of the interest expense increase is about $700,000, $800,000 after tax per quarter.

But then, you also have, because of the Rule of FASB on stock compensation and the way we do our stock grants in -- our [inaudible] stock grants in February timeframe you also have an extra layer of expense in the first quarter that you wouldn’t otherwise have and that relates to a couple million dollars related to that also, so that also impacts the number.

[OPERATOR INSTRUCTIONS].

And there are no more questions.

Thank you.

If you have more questions please contact Dale or Jennifer.

Thank you very much.

Thank you for your participation in today’s conference.

Have a nice day!