Transcript of EMC Insurance Group

Transcription

1 Transcript of EMC Insurance Group Participants Jason Bogart VP, Branch Operations Kevin Hovick EVP and Chief Operating Officer Bruce Kelley President and Chief Executive Officer Mick Lovell VP, Business Development Kelvin Sederburg VP and Appointed Actuary Lisa Simonetta SVP, Claims Lisa Stange VP, Chief Investment Officer and Treasurer Steve Walsh Director of Investor Relations Presentation Operator Good morning and welcome to the Third Quarter 2013 Earnings Conference call. At this time, all participants are in a listen-only mode. A brief question and answer session will follow the formal presentation. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Steve Walsh, Director of Investor Relations. Thank you Mr. Walsh, you now may begin. Steve Walsh Director of Investor Relations Good morning everyone, and welcome to EMC Insurance Group s 2013 Third Quarter Earnings call. A copy of the press release is available on the Investor Relations page of our website, which can be found at The webcast is also available on this site for replay purposes until February 7, The transcript of the webcast will be available for one year. This presentation includes some forward-looking statements about our expectations for our future performance. Actual results could differ materially from those suggested by our comments today. Additional information about factors that could affect future results is addressed in our SEC filings, including Forms S-1, 10-K, 10-Q, and 8-K. Any information provided today should be read in conjunction with the 2013 third quarter earnings release with accompanying financial tables issued earlier today. In addition, certain non-gaap terms may be used during today s discussions. Please refer to the Company s press release and/or SEC filings for a description and reconciliation of these terms. 1

2 Mr. Bruce Kelley, President and Chief Executive Officer, and Mr. Mark Reese, Senior Vice President and Chief Financial Officer, have prepared remarks this morning, and other executive officers are available to answer questions. At this time, it is my pleasure to introduce the Company s President and CEO, Bruce Kelley. Bruce Kelley President and Chief Executive Officer Thank you Steve, and welcome to those joining us this morning. Earlier today we reported operating income of $0.50 per share and net income of $0.55 per share for the third quarter of 2013, compared to operating income and net income of $0.65 per share in We also announced an increase in our 2013 operating income guidance from the previous range of $2.40 to $2.65 per share to a revised range of $2.60 to $2.85 a share due to strong operating results for the first nine months of this year. Pricing trends from the first half of the year continued through the third quarter, as premium rate level increases in our commercial lines of business remained in the upper-single-digits. Catastrophe and storm losses were within expectations and contributed fewer points to the combined ratio than our most recent ten-year average, but more than last year. Property and casualty insurance rate level increases continue to outpace both the industry average and the increase in loss costs. This outperformance can be attributed to the diligent efforts of our branch offices and the tools we have developed to support them, such as our Rate Compare system, which was discussed on the earnings call last quarter. We remain optimistic that the level of rate increases achieved through the first nine months of the year will continue through the remainder of the year and we expect rate level increases to continue into 2014, although at a somewhat lower level. Recent premium rate level changes in the reinsurance market will have little impact on fourth quarter results since the majority of the reinsurance segment s contracts renew in January and April. Looking ahead, current indications are that reinsurance premium rate levels will fall in 2014, especially for catastrophe excess of loss business; however catastrophe excess of loss business only accounts for approximately 15% of the reinsurance segment s total book of business. Premium income growth for the quarter was solid, up 9.9% in the property and casualty insurance segment and 5.9% in the reinsurance segment. In the property and casualty insurance segment, the vast majority of the growth was associated with rate increases on renewal business in our commercial lines, as well as some growth in insured exposures. Premium rate levels increased at all branch locations and across all major lines of business. Renewal rates across our commercial business increased approximately 7.4% during the first nine months of 2013, while premium rates across our personal lines of business increased approximately 8.1%; however, premium income from our personal lines of business was down slightly due to an intentional reduction in policy count to lessen exposure concentrations. Commercial lines policy count was up 2.2%, while personal lines policy count was down 10.7%. Net written premiums increased 4.7% in the third quarter. In the property and casualty insurance segment, net written premiums in commercial lines of business were up 11.5%, while personal lines of business were down 7.3%. In the reinsurance segment, net written premiums were down 8.6%, while premium income was up 5.9%. 2

3 Mark Reese will have more detail on the reinsurance segment s results during his remarks. As you may recall, last quarter we noted that we are seeing new opportunities to expand our program business, which largely consists of schools, municipalities, and other similar commercial accounts, to make them available on a broader basis. One recent example of this is the conversion of our EMC Choice Metal Goods Manufacturers program to the EMC Choice Light Manufacturers program. This conversion expanded program eligibility to include not only metal goods manufacturing accounts, but also wood products, furniture and fixtures, plastic or rubber goods, textiles, and electronic equipment and accessories, so that we could offer a more comprehensive manufacturing program. In addition, the conversion enhanced the industry-specific coverage extensions and introduced a new manufacturer s errors or omissions endorsement. Retention: Retention levels based on policy count remained strong and above industry averages, with commercial lines of business at 86.7%, personal lines of business at 83.9% and an overall retention level of 85.4%. Retention levels are down slightly from the prior year in both commercial and personal lines of business, with personal lines showing a slightly larger decline due to our intentional reduction in policy count. The relatively consistent overall retention level demonstrates continued support for ongoing premium rate level increases in our renewal book of business and indicates that we are not pricing ourselves out of the market as we work to increase margins. Retention levels in the mid-to-upper 80% range are well within our comfort level and expectations due to the large amount of commercial lines program business contained in our core book of business. This business tends to consistently renew due to marketing strategies designed to reward favorable loss experience. One item that we haven t really discussed on previous calls, which can have an indirect impact on retention levels is the ability to provide a broad choice of solutions that our independent insurance agents can offer to policyholders. In early 2012, we began offering data compromise coverage, making us one of the first companies to offer this type of insurance coverage. While we don t retain any of this business, we identified a need for this coverage and believed it was important to offer it to our insureds since the risk of a data breach has become an increasing concern. Balance Sheet: Book value of the Company s stock increased 0.9% during the quarter to $31.03 per share and was flat compared to year-end Excluding accumulated other comprehensive income from the calculation, book value increased 1.2% during the quarter to $28.83 per share and increased 5.3% from year-end The difference in the year-to-date growth rates of the two book value calculations is attributed to the decline in the fair value of the fixed maturity portfolio due to the recent increase in interest rates. With that, I ll turn the discussion over to Mark Reese, our CFO. Thank you Bruce, and good morning everyone. Earlier on the call, Bruce noted that premium income in the reinsurance segment was up 5.9%, while net written premiums were down 8.6%. As you may remember, we had some challenges in the first half of 2012 with the earnings stream of the new offshore energy and liability proportional account. Because this was a new account in 2012, the first report of written premiums was not actually received until the third quarter and included two quarters of written 3

4 premiums, so the comparison of written premium between the third quarters of 2013 and 2012 is distorted. The percentage increase in premiums earned reported in the third quarter of 2013 is affected by a large increase in premiums earned that occurred in the third quarter of 2012 due to an acceleration in the revenue stream of this account. Losses and Settlement Expenses: Losses and settlement expenses increased 11.2% in the third quarter, while the loss and settlement expense ratio increased to 66.7% from 65.3% for the same period in The increase in the loss and settlement expense ratio is attributed to the property and casualty insurance segment, which experienced an increase in catastrophe and storm losses. The primary catastrophe and storm loss events impacting the property and casualty insurance segment during the third quarter were a couple hailstorms in Kansas and Minnesota. Third quarter 2013 catastrophe and storm losses accounted for 11.4 percentage points of the combined ratio, which is below the Company s most recent 10-year average of 14.7 percentage points, but higher than the unusually low 8.9 percentage points experienced in the third quarter of It is important to note that the 10-year average includes the record third quarter catastrophe and storm losses in 2011 and If those record years are excluded from the calculations, the average would decline to 12.7 percentage points. There were no catastrophe and storm loss events during the quarter in the reinsurance segment that exceeded the $4 million retention level contained in the excess of loss agreement. Excluding the impact of catastrophe and storm losses, overall claims frequency was down approximately 0.4% and claims severity increased approximately 3.0%. Our rate level increases continue to exceed the increase in loss costs. We experienced favorable development on prior years reserves of $1.3 million in the third quarter, compared to $8.3 million in the prior year quarter. The decline in favorable development is primarily attributed to the reinsurance segment as described in this morning s release. Reported development amounts can vary significantly from quarter to quarter and year to year depending on a number of factors, including the number of claims settled and the settlement terms, and should therefore not be considered a reliable factor in assessing the adequacy of the Company s carried reserves. The most recent actuarial analysis of the Company s carried reserves indicates that carried reserves remain within the top quartile of the range of reasonable reserves, but at a slightly lower level within the quartile relative to previous evaluations. Investment Results: Turning to our investment results, investment income declined 3.9% and 3.7% for the third quarter and first nine months, primarily due to the prolonged low interest rate environment that has persisted for the past several years. Current interest rate levels remain below the average coupon rate of our fixed maturity portfolio and will result in continued reductions in future net investment income. The average coupon rate on our fixed maturity portfolio, excluding interest-only securities, was down slightly to 4.10% at September 30, 2013, compared to 4.23% at year-end The effective duration of the fixed maturity portfolio, excluding interest only securities, increased to 5.58 from 4.20 at the end of 2012, but remained consistent with the end of the second quarter. Duration extended as interest rates rose in the second quarter. Total return on the equity portfolio was 5.23% for the quarter and 19.09% year-todate, compared to 5.24% and 19.79% for the S&P

5 Capital Management: No shares have been repurchased under the Company s $15 million stock repurchase program that was put in place in November of Financial Accounting Standards Board s Recent Insurance Accounting Exposure Draft Before we turn the call over for questions, I would like to provide our take on the FASB s recent Insurance Contracts exposure draft issued in June. After a thorough review, we have concluded that the proposed guidance is far inferior to current U.S. GAAP for short-duration contracts. In fact, we believe the proposed guidance's requirement to discount estimated cash flows of portfolios of insurance contracts would turn property-casualty financial reporting into a complete black box. Nearly every aspect of the proposed guidance would render financial reports more opaque and void of decision-useful information. Adoption of the proposed standard would mean the loss of comparability not only between insurance entities, but to historical operating results. Such losses would likely decrease confidence in financial reporting and place the industry at risk for flight of capital. Further, the proposed guidance includes measures that would directly hinder company operations by appropriating management's ability to make prudent risk management decisions regarding company reserving practices, and is at odds with the conservatism explicitly favored by insurance regulators. Finally, the implementation of, and ongoing reporting under, the proposed standard would likely be a very expensive prospect. We have written comment letters expressing these concerns to the FASB and have applied to participate in upcoming FASB roundtable discussions. Company personnel are actively engaged, working with various industry and trade groups to persuade the FASB to retain current U.S. GAAP guidance for short-duration contracts. While we support the convergence of international accounting standards, the company asserts that there is already a quality accounting standard in use internationally for shortduration contracts, that being current U.S. GAAP. At this time, we are ready to open the call for questions. Operator Thank you. We ll now be conducting a question and answer session. (Operator Instructions.) Our first question comes from Neil Cybart from KBW. <Q> Thank you. Let me start with your guidance. It was a bit light versus what I was expecting especially since we only have one quarter here left in the year. Could I have the cat loss assumption that s included within guidance? Yes. Good morning, Neil, this is Scott Jean, the Chief Actuary. For the fourth quarter, we re looking at an overall cat ratio expectation of 5.4%, which by year end would result in 10.4% overall. So it would be 9.0% for the pool, 15.5% for EMC I m sorry, that was the original projection. The revised projection is 10.0% to the pool, 8.7% for EMC Re, and then 9.7% overall. 5

6 <Q> I see, and you said, for the quarter, you were including 5.4%? 5.4% for the fourth quarter, yes. <Q> Thank you. Staying on guidance, would you say it s fair to say that your revised guidance implies the P&C results continue to normalize in the fourth quarter, especially compared to the first half to us in 13? It looks like in the third quarter your current accident year results didn t really have too much improvement. Is it safe to say that the trend will continue? Hey, Neil, this is Scott Jean, again. The third quarter didn t, the results of the third quarter aren t necessarily representative of what we expect to happen the rest of the year. The attritional loss ratio, which we use excludes storms and large losses, is comparable to last year after adjusting for rate level increases, and that s really in line with expectations. The overall loss ratio for the quarter was higher than expected, primarily because of a handful of large losses that were reported in 2013, which had occurred in previous accident years. We also experienced a handful of large claims on our in-force book and we ve seen some additional reserve strengthening in a few of our branches. So at this point, we re not seeing a trend emerging, especially in light of year-to-date results as opposed to quarterly results, which tend to have increased variability. Overall, the year-to-date pure loss ratio is down about 5.1 points from 2012, that s excluding storms and development, so we re not really anticipating the fourth quarter to continue quite like the third quarter did. Does that answer your question? <Q> It does, Scott. Thanks. Moving over to the reserves, I ve become somewhat accustomed to look for your commentary on where carried reserves sit versus prior reviews, and this quarter you did disclose that it is now at a lower level. It s the first time in a long time I can recall seeing that type of commentary. How should we think about that going forward? Is it fair to say you still view your reserves as adequate, only the built in cushion, especially in reinsurance has been removed. Yes, this is Mark Reese. Our overall reserve levels are still very adequate in our estimations. The reason for the change in the phrasing of where we are is that we are definitely a little bit lower in the fourth quartile than we have been in previous evaluations, but that s not to say that our overall reserve level or adequacy has changed dramatically. We just wanted to make the point that given some changes that actually we ve made in our reserving methodology, we have intended to reduce our over-adequacy a little bit. I ll let Kelvin have some further comments on that. Kelvin Sederburg VP and Appointed Actuary Yes. Good morning, Mr. Cybart, this is Kelvin Sederburg, I m the Vice President Appointed Actuary, and if you bear with me for a minute I do have some extended comments to make regarding the reinsurance segments reserving. As disclosed in the press release, carried reserves remain within the top quartile of the range of reasonable reserves, but at a slightly lower lever within the quartile, relative to previous evaluations. As also disclosed, contract year 2012 and 13, expected loss ratios used to reserve several of the Home Office Reinsurance 6

7 Assumed Department s reinsurance lines of business are lower than those used in prior years, as a result of a thorough actuarial review conducted during This was a review of historic ultimate loss ratios of the more mature contract years with losses trended and premiums brought to current level. The 2012 review produced differing results from previous reviews, owing to a complete re-estimation of the rate change history associated with the Home Office Reinsurance Assumed Department contracts. Previous attempts to quantify the aggregate rate changes associated with this segment used a very limited number of renewal contracts for which retentions and limits had not changed. EMC Actuaries developed a technique to estimate the core rate level change for renewal contracts having limits and retention changes, and was therefore, able to estimate historic rate changes on a very much larger pool of contracts. The re-estimated rate change history had a significant impact on the current or on-level premiums then incorporated into the Expected Loss Ratio Study. It must be said that the impetus for the whole investigation into the rate change history was the result of the general feeling by actuaries and management that the expected loss ratios previously used were getting too far out of line with the subsequent development observed over the past few years for the more mature contract years. With this reset, and the continued monitoring and re-estimation of appropriate expected loss ratios using the updated rate change history and techniques, it is true that the company expects to observe lower favorable development going forward. The implication of the statement just made is that the company s reinsurance reserves were probably even more adequate than realized over the last few years, and the company continues to believe that its reinsurance reserves can still be characterized as strong to very strong. That s all I have to say. Forgive me for that long statement. <Q> Thank you for the answer. It is somewhat, a little bit more clear. Really, I only have one other question; quick numbers question. The other expense line item was 2 cents worse than I was expecting. Is that related to foreign exchange? Yes. My comment was just that the other expenses increase in the foreign exchange losses in our reinsurance business. <Q> Okay. Thank you. That s it for me. All right Operator Thank you. (Operator Instructions) We appear to have no further questions. I would like to turn the call back over to our speaker. Steve Walsh Director of Investor Relations Thank you ladies and gentlemen. This concludes today s conference call. I would like to remind you that a webcast of this call will be available on the Company s investor relations page of the Company s website at until February 7, 2014, and a transcript of this conference call will be available for one year, which can also be accessed from our Investor Relations page. We appreciate your interest in EMC Insurance Group. Have a great day. 7