United Fire Group Inc (UFCS) 2013 Q4 法說會逐字稿

Good morning. My name is Danielle, and I will be your conference operator today. At this time I would like to welcome everyone to the United Fire Group fourth-quarter 2013 financial results conference call. At this time all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. (Operator Instructions) As a reminder, this conference is being recorded.

Thank you. I will now turn the conference over to Anita Novak, Director of Investor Relations.

Good morning, everyone, and thank you for joining this call. Earlier today we issued a news release on our results. To find a copy of this document, as well as a copy of this morning's slide deck that does not exist, please visit our website at www.unitedfiregroup.com. Press releases will be located under the Investor Relations tab.

Our speakers today are Randy Ramlo, President and Chief Executive Officer; Mike Wilkins, Executive Vice President; and Dianne Lyons, Vice President and Chief Financial Officer. Other members of our executive team will also be available for the question-and-answer session that will follow our prepared remarks.

Please note that our presentation today may include forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. The Company cautions investors that any forward-looking statements include risks and uncertainties and are not a guarantee of future performance. These forward-looking statements are based on management's current expectations, and we assume no obligation to update them. The actual results may differ materially due to a variety of factors which are described in our press release and subsequent SEC filings.

Please also note that in our discussion today, we may use some non-GAAP financial measures. Reconciliations of these measures to the most comparable GAAP measures are available in our press release and subsequent SEC filings.

At this time I am pleased to present Mr. Randy Ramlo, President and Chief Executive Officer of United Fire Group.

Thank you, Anita. Good morning, everyone, and welcome to United Fire's fourth-quarter conference call. As you may have noticed from our press release this morning, we are pleased with our fourth-quarter and year-end results.

Our operating income was $1.00 per diluted share. Net income was $1.04 per diluted share, and our combined ratio was 89% for the quarter. For the year, operating income per diluted share was $2.76 per share. Net income was $2.98 per diluted share, and our combined ratio was 94.8%. Our book value at December 31 was $30.87 per share, and our return on equity was 10.1%.

We did not see much change in the competitiveness of the market in the fourth quarter on renewals, but the competitiveness of the new business during the quarter was persistent. Nonetheless, we actually achieved more rate increases during the fourth quarter than we did in the third quarter of 2013.

Commercial lines renewal pricing increased in most regions, with average percentage increases in the upper-single digits and most small and mid-market accounts in double-digit increases on those policies with underperforming experience.

The fourth quarter was the ninth consecutive quarter of commercial lines pricing increases for us. 2013 was a less active catastrophe year, but given the potential for strong weather-related events in the US in recent years and the continuing low interest rate environment, we believe we will continue to see rate increases at least during the first half of 2014 and likely for most of the year.

Premium written from new business remained strong. It was down from the prior quarter but up from the same quarter a year ago. Our success ratio on quoted accounts increased slightly during the quarter and remained strong. New business pricing held steady.

Overall, personal lines pricing decelerated slightly due to a slight decline in the amount of increases in the homeowners line of business from high single-digit increases to mid-single-digit increases. Policy retention remained strong at 82%, but down slightly from the previous quarter.

The economy continues to grow, albeit at a slow rate, but enough that we continue to see positive trends in premium from endorsements and premium audits. Frequency continued to trend downward in the fourth quarter, and severity overall was flat.

Mike and Diane will give some additional color on our 2013 results in a moment or two, but I would like to spend some time this morning talking about some of the things we did in 2013 -- and will do in 2014 -- to build on what we believe was a pretty strong showing in 2013.

On February 1, 2014, we opened a new branch office in Los Angeles, California, to write excess and surplus lines business. The unit will be called the UFG Specialty. We hired a very experienced team to underwrite the line. The branch will write business in the states of California, Oregon, Nevada, and Arizona, and expand down the road into additional states.

The first policies will be effective in the first quarter of 2014. We have wanted to expand into this business for some time, and we are pleased that this opportunity has presented itself.

Over the last few years we have been working from our 2015 business plan. As we have reported to you from time to time, we are currently meeting or exceeding virtually all of our projected targets from that plan. As a result we have expanded our business initiatives, and in 2013 we created a new seven-year plan, which we affectionately call our 2020 Vision. The new business plan is a bit more aggressive than our 2015 five-year plan and has been expanded to include more internal metrics.

The key components of 20/20 Vision are people, service, profit, and growth. Key considerations are volatility in earnings and ROE growth, regardless of the current market conditions.

In 2012 we committed to a new claims system. We have been working diligently to implement the new system, since it will enhance our users' efficiencies, save time and resources, and enhance external reporting. I am happy to report that in 2014, the system will be fully implemented -- on time and on budget.

We believe additional benefits from the new system will include enhancement of our predictive analytics tools. Some of the immediate benefits of the product will be improving average paid losses, adjuster efficiency gains, and significant cycle time improvements.

Over several quarters we have discussed our ongoing success with predictive analytics. We have now accumulated enough data to correlate and substantiate additional uses of this underwriting tool. We will be expanding our use of this tool in 2014.

Effective January 1, 2014, we took advantage of more favorable reinsurance pricing and expanded our catastrophe reinsurance program. Essentially, we added $50 million of additional coverage, expanded the 72-hour coverage period for any one catastrophe to 96 hours, and eliminated the 5% co-participation on the program.

In our core program we increased our maximum any one life limit to $20 million, which will help mitigate our exposure to severity losses in our workers' compensation line, and negotiated more favorable reinstatement provisions.

With all the enhancements, we still saved money. On December 16, 2013, we bought the American building. This building is a 10-story unit adjacent to our other buildings in Cedar Rapids Campus. The building is currently occupied with non-UFG personnel, and our intent at the moment is to use the facility as a source of rental income. Improvements to the building are planned, so the future use by UFG employees may well be an option. We are currently studying any and all feasibilities for the property.

The last few years have been productive ones for United Fire. We have successfully integrated the Mercer Insurance acquisition and successfully created a plan to manage through the current insurance cycle. We continue to expand our agency force and our product offerings. We are not a company that toots our horn very loudly, but we feel we have some great things moving in the right direction, and I am happy to have an opportunity to share our enthusiasm.

With that, I would like to turn the discussion over to our Executive Vice President, Mike Wilkins.

Thanks, Randy. Our net written premiums in our commercial lines increased 9.5% during the fourth quarter and 11.2% year to date. The lines experiencing the greatest amount of rate increase were primarily commercial auto; workers' compensation; and fire and allied lines, which includes commercial, multi-peril, and inland marine.

Net written premiums in our personal lines increased 9.2% during the quarter and 4.6% year to date. We continue to see premium growth as we more appropriately price our book of business through the use of predictive analytic rate adjustments. Year-to-date fire and allied lines increased 4%, and personal auto lines increased 5.6%.

Written premiums in the assumed reinsurance line of business decreased 3.5% for the quarter due to the timing of premiums received. Year to date, written premiums in the assumed reinsurance line of business remain flat.

We believe rate increases continue to exceed loss cost trends, overall. Average loss cost trends for the industry are currently approximately 3.5%, according to a recent Towers Watson report. The organic growth recognized in the fourth quarter compared to the fourth quarter of 2012 was 9.4%. 6.2 percentage points are attributable to the renewal rate increases, 2.4 percentage points are attributed to new business, and 0.8 percentage points are attributed to net premium audits, endorsements, and the timing of renewals.

As we mentioned in our press release this morning, our rate increases and underwriting initiatives produced a nearly 1 point improvement in our net loss ratio, excluding catastrophes for 2013, despite slightly less benefit from our prior-year reserve development.

Frequency trended downward again in the fourth quarter compared to the fourth quarter of 2012, due to a lack of any major catastrophic events in the US. Frequency was also down for the year.

Last quarter we were seeing some increases in large claims as compared to one year ago. We indicated at that time that one quarter does not indicate a trend. We did not see a continuation of that claims pattern in the fourth quarter, and large losses for the year were consistent with previous claims history. Our underwriting expense ratio for the fourth quarter was 31.4 percentage points compared to 29.5 percentage points for the fourth quarter of 2012.

We like to see our underwriting expense ratio at 30 percentage points or less. It was a bit higher this quarter as a result of additional agent profit-sharing attributed to more profitable business in 2013.

Our annual underwriting expense ratio of 31.8 percentage points also reflects this same impact, as well as additional employee-defined pension benefit costs in 2013. We continue to believe that additional expense savings will occur in 2014 and 2015 as additional financial obligations associated with the Mercer Insurance acquisition are fulfilled and further integration efficiencies occur. As we move into 2014 we will be reviewing our profit-sharing and continued commission programs as well, to make sure they are consistent with industry standards.

Our life segment reported net income of $3.3 million or $0.13 per share for the quarter, and $8.7 million or $0.34 per share for the year. We continued to experience growth in the sales of our traditional life products, with the exception of the single-premium whole life product, and we continued to expand our geographic footprint.

We continued to focus on properly pricing our products in this low interest rate environment. We have had good success in the latter half of 2013 as we increased renewals of our annuity products. As a result, we have slowed the net cash outflow, improved margins, and increased net income.

Loss and loss settlement expenses declined during the fourth quarter but increased 4.3% for the year compared to 2012. Net withdrawals of our annuity products increased and sales of our single-premium whole life product decreased in 2013 compared to 2012, which resulted in a decline in the increase in liability for future policy benefits. However, deferred annuity deposits more than doubled in the fourth quarter due to a large number of annuitants renewing their old annuities into new contracts, which is a benefit to us, as most of their old contracts were at much higher credited rates.

With that, I will turn the financial discussion over to Dianne Lyons.

Thank you, Mike. Consolidated net income was $26.5 million for the fourth quarter and $76.1 million year to date compared to a net loss of $2.4 million and net income of $40.2 million for the same periods of 2012. The increases were driven primarily by growth in property and casualty premium earned, which increased 8.9% for the quarter and 10.3% year to date compared to the same periods of 2012.

Catastrophe losses for the quarter totaled $3 million in 2013 compared to $30.2 million in 2012. Normally third quarter of any given year will experience heavier losses associated to late summer storms and hurricanes, but 2013 proved to be a benign hurricane season for the United States. Year-to-date catastrophe losses contributed 4.4 percentage points to the combined ratio. Our annual catastrophe load is 6 percentage points, and that will not change for 2014.

During the fourth quarter of 2013 we experienced favorable reserve development of $8.9 million or $0.23 per share. Year to date we experienced favorable reserve development of $57.5 million or $1.46 per share.

I would like to remind investors that there is a great deal of volatility from quarter to quarter and year to year in the reported amount of prior-year reserve development due to the fact that reserve development occurs and is primarily affected by the timing associated with the settlement of claims. To that point I will remind our listeners that our average favorable development for the last four years, including 2013, has been $59.5 million and that our 2013 favorable development is consistent with that average. Consolidated losses and loss settlement expenses decreased $32 million or 22.5% compared to fourth quarter 2012.

Year to date, losses and loss settlement expenses were virtually flat compared to 2012. Consolidated investment income was $30 million for the quarter, which is an increase of 18.5% compared to $25.3 million a year ago. Year-to-date consolidated investment income was $112.8 million, which is an increase of 0.8% compared to 2012. The fourth-quarter improvement is attributable to limited liability partnerships whose increases in fair values were recognized in investment income.

As for 2014 we expect low interest rates to persist, at least for the first half of the year; perhaps for all of 2014. The weighted average effective duration of our fixed-maturity security portfolio at December 31 was 4.96 years compared to 4 years at December 31. Year to date, total return for the equity portfolio was 31.19% compared to 32.38% for the S&P 500.

Net realized investment gains for the fourth quarter totaled $1.4 million compared to $0.8 million in 2012. Year-to-date, net realized investment gains totaled $8.7 million compared to $5.5 million in 2012. Net unrealized investment gains net of tax totaled $116.6 million as of December 31, which is a decrease of $27.5 million net of tax. This is due to unrealized investment losses in the fixed-maturity investment portfolio as a result of rising interest rates, which were somewhat offset by market value increases in our equity investment portfolio.

Regarding capital management, during the fourth quarter of 2013 we declared and paid a dividend of $0.18 per share to shareholders of record on December 2, 2013. We believe that the consistent payment of dividends remains the most effective way of returning capital to our shareholders.

We have paid a dividend every quarter since March of 1968. During the fourth quarter we repurchased 56,026 shares of our common stock for $1.5 million at an average cost of $27.58 per share. The plan continues to have approximately 1.1 million shares available for repurchase until August 2014.

It is management's position, however, that our best use of capital at this time is to write new, profitable business. Our stockholders' equity increased 7.4% to $782.8 million at December 31 from $729.2 million at December 31. At December 31, 2013, book value was $30.87 and our average return on equity was 10.1%.

With that, I will open the lines for questions.

Thank you. We will now be conducting a question-and-answer session. (Operator Instructions) Paul Newsome, Sandler O'Neill.

I would like to get a little bit more detail on the new access and surplus lines business. And maybe talk a little bit about what makes you so confident in this team, and what's sort of the prospects -- I mean, is this going to be a small business for you in the short term? Or do you have great plans for it?

Paul, this is Randy -- and I will maybe let Mike Wilkins answer a little bit more in depth. We actually had a group of people approach us that had many years of experience doing this. As I mentioned in the transcript, it's something we've been looking to try to get into. We've looked at acquiring some E&S operations; just decided that that didn't work out very well. Maybe I will ask Mike to make a few more comments on what our expectations are for the future.

Good morning, Paul. As Randy mentioned, the group -- we hired a team of eight people. We had a previous knowledge of the head of the unit; we had met him before and knew him a little bit. We didn't know him real well, but it was somebody that we had known in the past and had been impressed with.

This was a segment of the business on our strategic plan that we wanted to get into. We were just trying to find the right way to do it. When this group approached us, we thought it made a lot of sense to move forward with it.

One of the things that we like about basically doing a lift-out and bringing in a team is they have some existing relationships with brokers, which we think will bring value. Unlike an acquisition, we don't have to worry about the liabilities and proper reserves on a book of business -- because we had looked at some acquisitions in the space, but that was always an area that concerned us.

Certainly it's going to start small, but we think we can expand it fairly rapidly into other parts of the country. We are pretty excited about what we might be able to do with this segment.

Can you talk about what they are actually going to write or think about writing, given excess and surplus lines could be all sorts of different things?

Yes. I would say typically what they write is fringe E&S business. So it's not -- they are not doing the super-hazardous energy, oil and gas. Not anything like that.

I would say a lot of the stuff that they write are similar classes to what we write, but maybe they don't have any prior experience, no years in business. They will write some property that we wouldn't write if the situation is correct. Does that help?

Yes. No bail bonds, or wind coverage in Florida?

No. No cat-exposed property. No -- obviously, California being a state, we are not doing any earthquake business. No cat-exposed business. That's really not going to be the target at all. You know, they do some liquor liability --.

Excess liability.

A lot of excess liability over classes that we maybe would write. The underlying -- they have a few special classes that they do. But I probably don't want to get into too many specifics there.

Great. I will requeue and let some other folks ask questions.

Vincent DeAugustino, KBW.

First, congrats on the nice quarter. It was very good to see to cap off 2013.

Just to follow up on some of Paul's questions, just with the E&S expansion. I am just curious if you would be able to share how much premium the team was handling, maybe this year in 2013; and then any detail you might have as far as their underwriting performance over the last couple of years?

This is Mike Wilkins, again. I don't think we want to share any of the premium information. I can say their underwriting performance has been excellent. I think we have pretty good documentation of that from public sources, so we felt pretty confident about that.

One other thing I probably should have mentioned when Paul asked the question: we also look at this unit as something we can leverage with our existing agency plan. So maybe some business that we would have rejected in the past, now we can channel it to this unit to take another look at it from our existing agency plan versus just a straight rejection.

One of your competitors kind of looks at their startup E&S operation kind of a similar way, and I know they do some surveys to gauge how big of a pipeline that might be. To your comment on E&S business that your current agency relationships are placing, would you happen to know how big that pipeline might be for United Fire, if you were able to shift some of that over?

I don't. No, not at this time.

All right, cool. So moving on to some of the points in the quarter, I am just curious if you might be able to provide the reserve release detail from fourth quarter 2012, just so we can kind of get to an apples-to-apples core loss ratio on 2013?

As far as the difference, Vincent, again, it's just a matter of timing. There was no change in reserve philosophy, no significant reserve strengthening. It was just timing of when the losses were settled.

Okay. So would I be able to roughly use statutory reserve releases from last year as a proxy?

Yes.

Okay. Perfect. And then just two other ones, real quick, if I could. On workers' comp and then personal auto loss ratios -- they were just a touch elevated sequentially, and I am just curious if there were any reserve movements that were impactful there in fourth quarter 2013?

We are kind of looking at each other and wondering who would be the best one to answer this question. This is Mike Wilkins.

I will comment on the lines individually. For work comp, that is a line that has ticked up a little bit on us. We had been writing a little bit more of that business. We are kind of reevaluating our underwriting guidelines there and doing a little re-underwriting of that business.

Our results haven't been horrible, but they have ticked up. That was really the only line this year that we saw an accident-year increase in loss ratio. So we are trying to address that and see if we can get that moving in the right direction again.

The personal auto actually looked good all year long and then sort of saw a little tick up in November and December. So we think that was just a little bit of a blip with a couple large losses, but we will continue to watch that really closely.

Diane, I don't know if you have any comments on the reserve strengthening in those lines? I don't know the detail by line of --.

You know, there wasn't a lot of reserve strengthening in either one of those lines. And in fact, as far as the commercial lines go, we have seen it actually come down over the last past couple of years as we have made changes in that line -- some re-underwriting and changing of underwriting guidelines, which we think will keep improving results in that line.

Okay. Great. And then just one last one. Just from some of the data that I look at, it looks like the weather was fairly good across a decent portion of your geographic footprint. The fire and allied lines kind of show that with a nice result there.

So I'm just curious if you could split out the benefit coming from a lot of the rate and underwriting actions that you have been putting through over the last bunch of quarters versus any sort of impact that we might be seeing from favorable non-cat weather? Thank you.

This is Mike again. We have estimated the -- I mentioned margin expansion was about 1 point in our loss ratio, and then the reserve differences -- the reserve redundancy differences between the two years contributed a couple more points. So we were anticipating we would get about 3 points of margin expansion with 6%, 7% rate increases that we have been reporting, and then the 3%, 3.5% loss cost inflation. So it appears to us that those numbers are about what we would have expected.

So I guess just to reconcile that, based off of using last year's fourth-quarter statutory reserve releases, that would basically show almost a 28-point year-over-year core loss ratio improvement. So I should roughly think about 3 to 4 points of that being, call it, core sustainable improvement; and then roughly, call it, 24 points of that being favorable weather?

That is probably right. I haven't done that math, and I was really talking more in terms of the year. But we did have Sandy in fourth quarter of 2012, so we had a significant number of additional points from Hurricane Sandy that apply to fourth quarter last year.

Okay. I am looking at the core, so I stripped that out. But thank you very much for the color, guys.

Paul Newsome, Sandler O'Neill.

Could you folks talk a little bit more about the cost reduction efforts, and what gives you confidence you can take that expense ratio down a little bit more? I know you have already said some things, but if you can give us some more specifics, that would be great.

Well, I think one sure way is our agent profit-sharing and commission schedule. We redid our profit-sharing plan a couple of years ago, and I think this was -- and 2013 ended up being somewhat of a perfect storm of a lot of agencies being extremely profitable and growing. We have a growth component in our profit-sharing plan that rewards profitable agents. They do have to be profitable, but if they also were profitable and grew, our plan is pretty lucrative.

And you might say, well, that is exactly who you would want to reward, which we do; but I think looking at our peers, we probably went a little bit too far on that. I think that's something I think we can reevaluate and correct pretty easily.

We have also -- kind of on the loss adjustment side, our construction defect book of business kind of continues to generate fairly hefty legal involvement, I will say. Our claims people and our attorneys have been working hard, and I think we can make some significant improvements in that area.

And then we still have some Mercer systems that we are continuing to have to pay for. That will slowly go away as time goes on. I think we have -- we subscribe to Wards financial, and we really went over all the areas that we have even slight increases over our peer group. And we will be focused focusing on all of those to try to get that expense ratio down a little bit.

Interestingly, this year we were extremely happy with our loss experience, which I think is kind of the hard one, but some of the expense areas I think we kind of need to work on a little bit going forward.

Paul, I might add, too, that our costs for pension plan benefits and other employee retirement benefits are heavily influenced by the interest rate and the discount rate that is used. The interest rates have been low for the last couple of years, which has driven that cost up. And we expect if and when interest rates start to go up, that cost will come down.

Does the new business plan change how the management team is compensated?

I doubt it. I guess our Board could always change our compensation method going forward, so I can't necessarily say that. But I would say that our new plan will hopefully take better advantage of our current compensation plan.

And then, lastly, I just wanted to touch on the buybacks. You bought a nice amount of shares in the fourth quarter. The stock was pretty cheap. How do you think about buybacks, especially at today's valuations?

This is Barrie Ernst, Chief Investment Officer. We bought back 56,000 shares in the fourth quarter. We thought it dropping below book value the way it did, that it was a good buy. We only had a few days to do that before the blackout, and so this was the amount of shares that we could accumulate in that period of time.

Going forward, if we see it below book value, we think that's a good place to enter in a transaction. And that's what we will be doing in the future.

Perfect. Thank you.

Craig Rothman, Millennium Partners.

I was also going to ask on expenses -- I guess you hit on that a bit. But is there an expense ratio target we should be thinking about over the next couple of years? Where do we stand as far as savings from the Mercer deal go?

Well, we traditionally have shot for an underwriting expense ratio of 30%. At 31.8%, we are a little over that. I don't necessarily think we want to go much below that -- as we get to be a larger company, maybe that's possible.

But there is a couple of reasons that we tend to think going lower would be counterproductive. We have a little bit larger surety operation than some of our competitors, which is a little bit higher expense operation, but it is one that we are big believers in. We use a lot more loss control than some of our competitors do. We think there is a benefit from that.

We are a little less on the personal lines side, which -- that is a little bit lower-cost segment, so that tends to move us upward a little bit. And then we mentioned earlier, we are believers in having a good profit-sharing plan for our agents, but maybe not quite as lucrative as it was in 2013.

So for those reasons we think we can justify being at 30% when maybe some of our competitors are in the upper 20s. But that is kind of where we would like to get back to.

Got you. Anything notable on the mix on small versus larger account size on premium growth this quarter?

I didn't see anything material. One of our growth initiatives is to be a better market for accounts over $100,000 for our agency force. We think that that value-added -- we can kind of leverage writing larger, more complicated accounts, and thus request some more middle-market and smaller accounts from our agency force.

So we are trying to focus a little bit more on larger accounts and have done pretty well with that in most of our branches. Other than that, I didn't see much difference in the mix.

So when you just talked about increased competitiveness on large commercial accounts, is that the over-$100,000 threshold you are talking about there?

Yes, I think -- you know, it seems like -- I don't know if I am necessarily predicting a softening of the market, but that is oftentimes where you see it first, on larger accounts.

Okay. And then your comments about getting rate increases the next two or three quarters -- there is obviously a lot of scrutiny from investors on the whole rate outlook in the market. Is there anything to read into on that as far as looking out past three quarters? You don't see the ability to get rate increases, or is that just more of a general comment?

For us, in general, I think we mentioned that this was -- the fourth quarter was the ninth straight quarter of getting rate increases. So if you go back to what we see, that meaning was that the policies of ours that renewed in the fourth quarter of 2013 -- that was their third consecutive quarter of rate increases. And they accepted that -- I mentioned that our retention held pretty well, assuming that.

So with the lower interest rates continuing into the foreseeable future, and the fact that we were successful getting rate increases a third consecutive time on our fourth-quarter policyholders, we are at least pretty optimistic about the first, second, and maybe even third quarters of 2014.

Also, I think we mentioned that we have had 9 straight quarters of rate increases. I think some of the larger national carriers were maybe boasting rate increases a quarter or two earlier than we were. I think we are in the same pool with a lot of our peers and competitors. I think we may be a little bit -- a quarter or two behind some of the national carriers. Hopefully we can still get a little momentum going forward into 2014.

Great. Thanks.

Thank you. I would now like to now turn the floor back over to Anita Novak.

Thanks, Danielle. This now concludes this conference call. As a reminder, a transcript of this call will be available on the Company website at www.unitedfiregroup.com. On behalf of the management of United Fire Group, I wish all of you a very pleasant day.

Thank you, ladies and gentlemen. This concludes today's program. You may disconnect your lines at this time. Thank you all for your participation.