United Fire Group Inc (UFCS) 2020 Q4 法說會逐字稿

Good morning. My name is Chuck, and I'll be your conference operator today. At this time, I would like to welcome everyone to the UFG Insurance Fourth Quarter and Year-end 2020 Financial Results Conference Call. (Operator Instructions). Please note this event is being recorded.

I would now like to turn the call over to Randy Patten, Assistant Vice President and Controller. Please go ahead, sir.

Good morning, everyone, and thank you for joining this call. Earlier today, we issued news release on our results. To find a copy of this document, please visit our website at ufginsurance.com. Press releases and slides are located under the Investor Relations tab.

Our speakers today are Chief Executive Officer, Randy Ramlo; Mike Wilkins, Chief Operating Officer; and Dawn Jaffray, Chief Financial Officer.

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. The actual results may differ materially due to a variety of factors, which are described in our press release and 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 also available in our press release and SEC filings.

At this time, I'm pleased to present Mr. Randy Ramlo, CEO of UFG Insurance.

Thanks, Randy. Good morning, everyone, and welcome to our fourth quarter and year-end 2020 conference call. As we mentioned in our press release on February 11, 2021, our fourth quarter results were negatively impacted by social inflation, resulting in an increase in severity of current accident year losses and in prior accident year reserve strengthening.

Social inflation continues to impact the entire industry. Unfortunately, our 2 largest states, Texas and California are amongst the highest trending social inflation states, meaning the impact to UFG is magnified. In recognition of social inflation trends during 2020 and particularly in the fourth quarter, new commercial auto and general liability claims were reserved with more pessimism. Additionally, progress has been made to shorten the claims cycle with reserves being established earlier in the process than in past years with new analytic insights driving these outcomes. Also, during the fourth quarter, we reviewed the reserve adequacy of our open prior year accident year case reserves in consideration of our more pessimistic view.

The full year of 2020 results were also negatively impacted by a historical level of catastrophe losses. Catastrophe losses added 13.5 points to the combined ratio in 2020, which is the highest in the last 5 years and significantly higher than our 5-year historical average of 5.6 points prior to 2020. During the year, we experienced catastrophe losses of $231 million before reinsurance, $142 million net of reinsurance. The majority of these losses came from 3 significant events that occurred in some of our largest geographically exposed areas. 2 of these events impacted Cedar Rapids, Iowa, the location of our corporate headquarters. These events were the August Midwest derecho with peak winds of 145 miles per hour and a hailstorm in April, impacting the greater Cedar Rapids, Iowa area. The third event was Hurricane Laura, which impacted another heavy exposure area for UFG in Southern Louisiana, the location of our 2019 agent of the year.

Though we are very disappointed with our results in 2020, we remain optimistic about our future. Throughout 2020, we focused on building the foundation of our new strategic plan to improve profitability. Our strategic plan, which we call "One UFG boldly forward," contains a number of initiatives aimed at long-term profitability, portfolio diversification, sustainable growth and continuous innovation. As a result of our efforts, we are able to point to some early underlying improvements, including our fifth consecutive quarter with a decrease in the frequency of commercial auto losses and commercial auto exposure units. We also saw improvement in our core loss ratio despite reserves being established earlier in the claims cycle and with more pessimism.

Our core loss ratio improved 0.6 and 0.4 percentage points, respectively, in the fourth quarter and full year of 2020 compared to the same periods in 2019. Mike and Dawn will go into more depth in a few minutes of discussing additional positive outcomes from our strategic plan in 2020.

Although the level and speed of improvement this year was unacceptable, we firmly believe that we are on the right path forward, and we'll remain focused on improving profitability as a part of our strategic plan.

In regard to the ongoing pandemic, as a reminder, nearly all of the policies we've issued contained contract language that specifically excludes business interruption coverage for losses attributable to viruses, such as COVID-19 pandemic. At this time, we expect the effect of COVID-19 on claims currently under our coverages to be manageable. However, the pandemic continues to evolve, and we cannot predict how future legislation, regulation or court actions will impact us.

Before turning the call over to Mike, I want to mention that UFG reached an important milestone on January 2, 2021, our 75th anniversary. But much has changed in our 75-year existence; we remain committed to our humble roots and founding belief that the insurance business is a people business. It was our founder, Scott McIntyre Sr., who instilled in the company the principle of doing business the right way and treating people the right way. A legacy I'm proud to say that is carried out daily by UFG employees across the country.

I will now turn the call over to Mike Wilkins.

Thanks, Randy, and good morning, everyone. My portion of the call, I will discuss the progress of our strategic plan focusing on the positive outcomes of the past year while addressing our 2020 results and our plans for improvement.

First, as mentioned throughout 2020, our focus has been on reducing the size of our commercial auto portfolio by nonrenewing underperforming accounts and reducing the number of exposure units. During 2020, we successfully decreased our commercial auto book, which now makes up 28.7% of our portfolio compared to 31.2% at the end of 2019.

Looking at only new premiums on Slide 6 in our slide deck. Commercial auto accounts for 24% of the new premiums added in 2020 versus 32% in 2019. Our goal is to have a commercial auto represent closer to 24% of our portfolio mix, which we are achieving.

Part of the strategy in balancing our book of business is also to improve our risk selection. In 2020, we established a centralized approach to underwriting establishing consistency across our geographic regions using a broad brush in selecting risks in our strategic plan to balance our book of business. In 2021, we intend to be more targeted on where and what we write based on state and geographic region, especially focusing on the states that have the highest trends of social inflation, Texas, California and Florida.

With the sale of our personal lines renewal rights nationwide effective September 1, 2020, we believe we have reduced our exposure to the type of catastrophe events we experienced in 2020, especially near our headquarters. We remain disciplined on our pricing strategy, specifically on our commercial auto, property and umbrella books of business.

The commercial auto average renewal rate increase remained in the double digits at 10.5% in the fourth quarter of 2020. The commercial auto average 12-month rate increases have been in the low double digits since the beginning of the year. We continue to get the most rate in our bottom 30% of our retained commercial auto book. As a reminder, we are nonrenewing a large percentage of our underperforming commercial auto business in the bottom 30% of our book.

Commercial property improved in the fourth quarter with the average renewal rate increases now at 7.4%, up from 5.8% at third quarter. As we stated last quarter, we believe there is an opportunity with our commercial property book to be more aggressive with rate increases and reducing undesirable exposures as we see signs of the market hardening.

From a claims perspective, our strategic plan focuses on shortening the claim cycle time, reducing legal expenses and the impact of litigation. As Randy mentioned, the impact from social inflation for UFG is more significant than other carriers, given the concentration of our book for business in Texas and California. Part of our strategy to address this is improving our legal and claims process. In the fourth quarter, we started to see the impact from the strategy of shortening claim cycles and setting case reserves earlier in the claims process and with more pessimism.

Additionally, we recognize that increased specialization by our claims adjusters will allow us to deploy enhanced expertise on our most complex and severe claims. In the fourth quarter, as a precursor to specialization, we deployed a team of experts to review reserves on open claims leading to prior accident year reserve strengthening. We also deployed an analytics model for claims severity in the fourth quarter. This model assists our adjusters by identifying early and regular indicators of the severity of the loss. We expect to release a case reserving model for commercial auto by the third quarter of 2021 and continued support of our reserving accuracy. Additionally, we are pursuing opportunities for early but equitable settlements, reducing the tenure of our open claims.

I will wrap up my portion of the call today discussing some of our growth strategies. Our strategic plan is to grow and expand our profitable lines. Our most profitable lines in 2020 and the lines we believe present us with the greatest opportunities are surety and E&S. Both our surety and E&S lines exceeded the profitability and written premium goals in 2020. Our plans are to continue to grow these lines in 2021. For E&S, this includes state and product expansion. And for surety, this includes additional surety producers in the Northeast U.S.

Another historically profitable line that we intend to grow is assumed reinsurance. Growth in this line will allow diversification of our current portfolio mix. We had several new assumed reinsurance programs in place in 2021 that will diversify our overall book of business.

Lastly, in mid-2021, we are excited to begin the initial rollout of a new online quoting experience for our agents, allowing us to increase our straight-through processing of policies and grow our profitable BOP line of business in the future.

With that, I'll turn over the discussion to Dawn Jaffray. Dawn?

Thanks, Mike, and good morning, everyone. In the fourth quarter, we reported a consolidated net loss of $8.9 million compared to a net loss of $23.2 million in the same period of 2019. For the full year of 2020, we reported a consolidated net loss of $112.7 million compared with net income of $14.8 million for the full year of 2019. As Randy and Mike mentioned, quarterly results were impacted by severity of losses from what we believe to be the influence of social inflation and prior accident year reserve development.

During the fourth quarter, we recognized unfavorable prior accident year reserve development of $12.4 million, primarily driven by our commercial liability and auto liability lines of business. For the full year of 2020, we had favorable development of $17.7 million compared to favorable development of $5.3 million for the full year of 2019. As a reminder, we've had continued favorable prior accident year reserve development every year since 2009.

Catastrophes were significant and impactful on results during 2020 with the results of $142 million compared to $64.4 million for the full year of 2019. Also contributing to the fourth quarter net loss was the continued impact in severity of losses.

Moving on to investments. We reported an improvement in the fourth quarter for both realized investment gains and net investment income. This is primarily due to an increase in the fair value of our investment portfolio, recovering a portion of the realized losses and decline in investment income from the first 3 quarters of 2020. In the fourth quarter of 2020, the fair value of our investments in equity or what I refer to as phantom gains increased $32 million pretax compared to $4.4 million increase in the fourth quarter of 2019. And net investment income increased $0.9 million in the fourth quarter compared to the fourth quarter of 2019, primarily due to an increase in fair value of our limited liability partnerships or our bank funds. Our bond portfolio also increased in 2020 with an after-tax unrealized gain of $36 million during the year.

Despite these improvements in the fourth quarter, we reported net realized investment losses of $32.4 million and a decline in net investment income of 34% for the full year of 2020 compared to the full year of 2019. We have reduced some of the volatility in the investment portfolio with the sale of equities we undertook this year.

As for our operating metrics for the quarter, we reported a combined ratio of 123.1% compared to 117.9% in the same period of 2019. For the full year, we reported a combined ratio of 115.9% compared to 109% for the full year of 2019.

We did see a decrease in the expense ratio in the fourth quarter of 2020 to 30.8% from 32.2% reported in the fourth quarter of 2019. The decrease is primarily the result of a decrease in commissions. For the full year of 2020, the expense ratio was 33.5% as compared to 32.6% for the full year of 2019. The increase of less than 1 point was primarily due to our continued investment in technology initiatives. We have several expense initiatives as part of our strategic plan, including a change in our agent commission structure, the establishment of a vendor management office and a shift in the design of our pension and retiree medical benefit plans.

In the second half of 2020, we began to see some impact from changes to our commission structure. These changes included an adjusted agency commission schedule, aligning with the profitability of our lines of business and an adjusted agency profit sharing plan, emphasizing profit over volume. These changes will have a greater impact in 2021.

We also established a centralized vendor management office in 2020 to better track and manage our vendor contracts. We believe this approach will provide opportunities for further negotiation of contracts and ultimately, additional cost savings going forward.

For the pension plan, we made the decision at the end of 2020 to transition from a traditional defined benefit pension plan to a cash balance pension plan, which significantly reduced our long-term liability and our volatility in the potential benefit obligation. This had a positive impact on equity in 2020 and will have a positive effect on our expense ratio beginning in 2021.

In addition, we just announced the difficult but necessary decision to change our retiree medical plan to a voluntary plan funded exclusively by participants commencing at the start of 2023. We are currently working through the financial reporting and accounting implications of this decision. Our expectations are that this decision to end the employer-provided funding for the retiree medical plan will have a short-term benefit to the expense ratio in '21 and '22, with the greatest proportion of the impact to 2021. Longer term, we expect this action will provide some additional savings to the ongoing escalating cost of benefit expenses for UFG.

For reference, the retiree medical plan liability at December 31, 2020, was about $32 million. This existing obligation will be recaptured, along with releasing prior credits into the income statement over the next 2 years. Although dependent on premium levels, with these expense management actions, our expectation is that our expense ratio will be lower in 2021, with a conservative estimate for the ratio to decrease by approximately 2 points for our 2021 performance year. We will provide a more definitive number during our first quarter 2021 conference call following the completion of the required accounting and actuarial valuations of this change in the retiree medical plan.

Moving on, I will end my portion of the call by discussing capital matters. As of December 31, 2020, I am pleased to report that we continue to maintain a strong balance sheet to support our business, and our One UFG strategic plan initiative. At the end of 2020, we made the decision to leverage our balance sheet by adding $50 million of long-term debt with the addition of 2 surplus notes from a privately negotiated transaction. The new instruments result in a small impact to our capital structure, with UFG now holding 6% in terms of a debt to equity ratio. This decision to add additional debt capital will support the profitable growth initiatives Mike discussed as part of our One UFG strategic plan.

Also, during the fourth quarter, we declared and paid a $0.15 per share cash dividend to shareholders of record as of December 4, 2020, marking our 211th consecutive quarter of consistently paying dividends dating back to March of 1968.

Lastly, during the quarter, we did not repurchase any UFCS shares. We made the decision in mid-March to suspend share repurchases. We remain authorized by our Board of Directors to purchase an additional 1.8 million shares of common stock under our share repurchase program, which will expire at the end of August 2022.

And with the closing of our prepared remarks, I will now open the line for questions. Operator?

(Operator Instructions) And the first question will come from Paul Newsome with Piper Sandler.

I was hoping you could give us a little bit more details on what you call social inflation. Is it very much specific to commercial auto? And is there any sort of additional details to the kinds of lawsuit severity that you are seeing that would give us a sense of what might be going on?

So Paul, I'll start with this one and then maybe Corey Ruehle will chime in a little bit from the claims side. I think we've kind of mentioned that a couple of the states that show up in the press as being the more difficult ones and Texas and California are, unfortunately, our 2 biggest states. So we have a bit of a problem right there.

Yes, commercial auto has been a huge target kind of by the plaintiffs' bar. Kind of workers' compensation maybe was at one time, but a lot of the kind of scheduled limits on compensation has made that less attractive, but commercial auto and especially lines covered with an umbrella have been real targets.

And it's not just necessarily jury or judgment awards. But 2 things we see -- that we used to see in claims that were somewhat unique, which is traumatic brain injuries and then post-traumatic stress syndrome. And it is amazing on what percentage of really even low-impact claims that we see both of those. We've kind of talked a little bit about our analytics tools, and those tools pick out characteristics of claims that translate into a high likelihood that: a, there will be litigation; and b, adverse litigation. And those are 2 terms that really stick out.

So where that's coming from, if it's -- physicians are more likely to diagnose those 2 conditions, but both of them kind of translate into possible bigger payouts. So a lot of it is juries and judges ignoring negligence, but also, it's kind of the propensity of these kind of injuries.

So UFG, yes, auto is a big target, auto with umbrellas. Unfortunately, we have a large percentage of our book in auto and considerably above a lot of our peers. And as I think Mike mentioned, we're working on getting that more in line. And then we're also in kind of some of the worst states. So those 2 both have been very averse to UFG.

So maybe I'll ask Corey if he wants to chime in here a little bit with some more information on just claims specifically.

Paul, this is Corey Ruehle. If you look at our social inflation on an overall basis, it's running right in line with what the industry is seeing as well. If you break out commercial auto for California and Texas, it's about double that year-over-year over the last 5 years. We are seeing some positive results, though. Our new suit counts starting in January of 2019 until now have been dropping steadily. But if you look at those new suits, California and Texas run almost half of the total for overall new suits.

Our closing cycle time on those suits has continued to be very steady. And so what we've created is a nice gap between the number of new suits coming in and the number of closed suits that we're still maintaining.

Our payment cycle time has also improved over the last few years, which to me is a good leading indicator that we're actually getting out ahead of these claims. We've also been tracking for new commercial auto BI claims that come in, in a given quarter, what level of reserving that we're establishing on those claims. And I can tell you that we've almost doubled where we were at traditionally, starting in the third quarter of 2019 and all of 2020. So we're making really good progress there.

As Randy had mentioned, we also instituted the severity model in the fourth quarter of last year. And that severity model has allowed us to be able to triage these claims to the right adjusters right off the bat, so that we're getting out ahead of these claims and seeing improved settlements.

If you look at social inflation on claims that are opened longer than 2 years versus those claims that we're able to close in less than a year, the gap is continuing to widen there, too. So the longer claim is open, especially if it's in litigation, we're seeing quite a bit more inflation there.

So my second question, in regards to the math of the fund raising, those $50 million of surplus is debt. Could you kind of put together the pieces of why $50 million would be needed to fund growth when it looks like the book is actually going to shrink at least on a revenue basis because of your underwriting initiatives?

So maybe we'll let Dawn tell you a little bit about -- she was most heavily involved in the surplus notes. So I'd let her kind of give a little background.

Sure. I'll make a couple of comments here, Paul, and then I'll ask Mike to weigh in as well. Clearly, our growth opportunities looking forward made sense for us to add some additional what's treated for insurance purposes as capital, as you know, in the form of a surplus note, yet on a GAAP basis, it's treated as debt. And we thought it was an opportunistic time to add a very small amount that was -- to support our various One UFG plan initiatives.

Yes, Paul, this is Mike -- sorry, Paul. You're accurate that we expect to see premium shrink going forward. However, we do have scenarios that we plan to try to grow fairly aggressively, areas that have been extremely profitable for us in the past, and we think represent good opportunities going into the future. And the main areas there would be our surety operation, excess surplus lines and assumed reinsurance. We've set out fairly aggressive growth goals in those areas and felt this was a good move to make sure we have that adequately supported.

So is this a desire to end up putting cash in the right spot for that particular segment in growth? Or is it just -- I guess I'm still not -- if the business is shrinking, why do you need more surplus capital? Maybe we can take it off-line. But wondering how the math looks going on.

Thank you, Paul. I think that the main point is just continuing our historical approach to retaining a strong balance sheet and being prepared for the future. As you're aware, this is a very small amount relative to our overall capital structure. And we've had no debt type instruments and the uniqueness of this opportunity being a surplus note was also part of the draw for us.

The next question will come from Marla Backer with Sidoti.

I have a couple of questions. In part, a follow-up to what the discussion just talked around. First, during 2020, we obviously saw a lot of delays, if not outright closures in the courts. Do you think there's any impact of that in terms of what you're saying that makes you more pessimistic now in the social inflation?

So again, maybe -- this is Randy. Maybe I'll make a quick comment and then ask Corey, if he has any thoughts. Kind of early on, I think we did. We saw some willingness to settle claims early on in the pandemic. I'm not sure that has necessarily lasted on. But kind of from everything we're seeing, most people are predicting this kind of not to be a short-term fad, but it's kind of just baked in another factor, income inequality. That's one of the big drivers in states that have the largest income gaps, are also where a lot of the big judgments are coming out of, some calling them nuclear judgments.

We haven't necessarily had that much problem with that. Ours is more -- a percentage is kind of being added on to what a normal judgment would have been 4, 5 years ago. So I think some of the courts are getting ready to start to open up. But I don't know if the pandemic has had much overall effect on social inflation itself. I think it's just more of kind of a changing attitude of society. Corey, do you have any comment?

Marla, when we look at some of the leading indicators that have kind of driven where we're at with social inflation, a lot of those were -- we were seeing good signs prior to the pandemic even starting. And I had mentioned our new suits dropping...

That's what I thought.

So I'd mentioned our new suits dropping. And even with the pandemic, the rate of drop on a year-over-year basis has continued to be pretty steady. So it wasn't a sharp drop off when the pandemic started there. It will be interesting to see though as courts open up what happens there to see if there are changes in the way people approach things. But we're still taking a very fair but very aggressive approach to getting claims settled as early as possible.

Okay. And then in terms of higher reserving and earlier reserving, does that mean that we should expect to see that trend continue at least until we sort of anniversary this slight shift in your strategy vis-à-vis reserve?

We're going to continue to review claims on a regular basis. One thing about social inflation is it is a moving target and that claims are changing on a daily basis. And so it's important for us to do -- continue to do a constant review, and there could be some continued development into 2021, but there'll be more to come there.

Okay. And then...

And Marla, this is -- go ahead. This is Randy. One kind of further comment I would make is, usually when you hear of reserve strengthening, you look to -- that the reserve was maybe put up incorrectly. And I think what we're more seeing is just that the game has kind of changed. The reserves we may have put up a year or 2 ago were kind of adequate for the times. But as we have kind of seen things settle and develop, as we've mentioned, we've just become a bit more pessimistic on what it's going to cost to settle some of these claims.

Okay. My last question, I'm actually switching topics. Now you talked before in your prepared remarks about introducing an online platform for your agents sometime in mid-2021. Can you expand a little bit on the platform? And also talk about the potential perhaps at some point down the road to expand its functionality a bit to possibly offer some direct-to-consumer offerings?

So Marla, this is Randy. We probably will respectfully not touch the going direct-to-consumer question right now, because we could make some enemy with that. But I think I'll let Mike tell you a little bit about our platform. He has a good handle on kind of what some of the things we will offer.

Marla, Mike Wilkins here. So yes, a little bit more information about the initiative. We are going to release that as a pilot in April. So not that far away, but expect a broader release to 7 states midyear. It's a product that is aimed at the small business segment. So the -- often referred to as the BOP segment in insurance, the business owners policies.

We will expand to additional states about every 3 or 4 months after that initial midyear release. The user interface is very intuitive. It's been built to be very flexible. It's -- we market 100% through independent agents. And the tool is built in collaboration with our agents to support them issuing that business.

Now what is common in the business owners segment is a lot of that business is handled in our service centers. So we have a service center that provides a lot of the servicing for the agents, and we've also designed the system to make servicing that business easy and also allow the insurance to do some of the self-servicing of that business as we go forward.

So it's very flexible. It will allow us a lot of opportunities to change the way we do business with the insurers and with the agents over time. And we're pretty excited about it.

(Operator Instructions) This concludes our question-and-answer session. I would like to turn the conference back over to Randy Patten for any closing remarks. Please go ahead, sir.

This now concludes our conference call. Thank you for joining us, and have a great day.

Ladies and gentlemen, this concludes today's program. Thank you for joining us, and have a great day. You may disconnect your lines.