Employers Holdings, Inc. (EIG) Q2 2013 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Second Quarter 2013 Employers Holdings, Inc. Earnings Conference Call. My name is Taheesha, and I will be your operator for today. [Operator Instructions] As a reminder, this conference is being recorded for replay purposes. I would now like to turn the conference over to your host for today, Ms. Vicki Ericsson Mills, Vice President, Investor Relations. Please proceed.

Thank you, Taheesha, and welcome, everyone, to the second quarter 2013 earnings call for Employers. Yesterday, we announced our earnings results, and today, we expect to file our Form 10-Q with the Securities and Exchange Commission. These materials may be accessed on the company's website at employers.com, and are accessible through the Investors link. Today's call is being recorded and webcast from the Investor Relations section of our website, where a replay will be available following the call. With me today on the call are Doug Dirks, our Chief Executive Officer; and Ric Yocke, our Chief Financial Officer. Statements made during this conference call that are not based on historical fact are considered forward-looking statements. These statements are made in reliance on the Safe Harbor provision of the Private Securities Litigation Reform Act of 1995. Although we believe the expectations expressed in our forward-looking statements are reasonable, risks and uncertainties could cause actual results to be materially different from our expectations, including the risks set forth in our filings with the Securities and Exchange Commission. All remarks made during the call are current at the time of the call and will not be updated to reflect subsequent developments. We use a non-GAAP metric that excludes the impact of the 1999 Loss Portfolio Transfer, or LPT. This metric is defined in our earnings press release available on our website. A list of our portfolio securities by CUSIP is available in the Investors section of our website under Calendar of Events, Second Quarter Earnings Conference Call. Now I will turn the call over to Doug.

Thank you, Vicki. Welcome, everyone, and thank you for joining us today. We're pleased to report that in the second quarter of this year, we continue to build scale in our business and further improved our operating margins. Net income before the LPT increased $0.29 per diluted share. Underwriting losses, adjusted for the LPT, declined $10 million relative to last year's second quarter, and the combined ratio before the LPT improved nearly 11 points year-over-year. Since March 31 of this year, we increased net income before the LPT by $6.4 million, or $0.20 per diluted share, and improved the combined ratio before the LPT by 3.5 points. The substantial improvement in our results is largely attributable to the growth, pricing and cost containment initiatives that we have implemented in recent years. Additionally, while incurred losses increased in the second quarter, in large part due to increases in premium, rate increases continue to outpace loss trends. As anticipated, for the second consecutive quarter, we reduced our provision rate for current accident year losses. Targeted growth continued in the second quarter, as net written premium was 24% higher than the same period last year. This increase was driven by a 15.1% increase in policy count, a net rate increase of 10.1% and a 7.5% increase in average policy size year-over-year. Our focus on pricing continues throughout all of our markets. Year-over-year, the change in net rate at the end of the second quarter was highest in Illinois at 17%, followed by California at 14%, and Nevada at 13%. Again, the year-over-year net rate change was 10.1% for the entire book of business. The pricing strategies we have implemented resulted in a modest decline in overall policy retention in the first quarter of this year. However, our second quarter policy retention of 83% was flat relative to the first quarter. Retention for our strategic partner business was 90% for the first quarter and 89% for the second quarter of this year. As we have indicated in the past, our policy retention for strategic partner business, which represents approximately 1/4 of our total in-force premium, has remained very stable. We also continue to actively manage our costs. Variable and fixed costs for the quarter and year-to-date were slightly better than our expectations. Our technology has enabled us to grow policies and premium without substantially increasing fixed costs. In fact, we just rolled out a new agency interface called EACCESS. This is a web-based system with a user-friendly portal and enhanced features to help agents better manage their accounts through a customized dashboard, and through self-service capabilities, reduce the number and length of customer interactions for our agents and for us. For example, agents now have easy access to customizable marketing materials and to key customer information, such as claims loss runs and policy documents. They also have access to our rapid quoting system. This new interface will greatly benefit our agents and allow us to continue to grow, while leveraging our fixed costs. Now, I'll turn the call over to Ric.

Thank you, Doug. As in the first quarter, our combined ratio before the LPT improved by more than 10 percentage points year-over-year in the second quarter. The additional scale we have achieved from the implementation of our growth and pricing strategies drove the significant improvement of 5.3 points in the underwriting expense ratio. In addition, our loss ratio before the LPT declined 4 points in the second quarter compared to the second quarter last year. We lowered our provision rate for current accident year losses to 73% compared with 77% in the second quarter of 2012. If rate increases continue to outpace loss costs, we expect that we will continue to incrementally reduce our loss provision rate throughout the end of the year. As in recent past quarters, our reserve analysis in June showed modest adverse development for recent accident years, offset by modest favorable development for older accident years. And while industry rating bureaus continue to report concern about Worker's Compensation reserve deficiencies, we believe our reserves are adequate. Net investment income in the second quarter declined to $17.6 million from $18.3 million at the end of the second quarter of 2012 due to a year-over-year decrease in yield. The average pre-tax book yield of the portfolio at the end of the second quarter was 3.4% compared with 3.7% for the same period last year. The tax equivalent yield was 4.2% at the end of the second quarter, compared with 5.2% at June 30 of 2012. The portfolio yield continues to decline as securities mature, and those securities are reinvested in lower-yield instruments. The estimated fair value of the portfolio increased 2.8% since December 31st of 2012. We employed an investment strategy that emphasizes asset quality and balances the consideration of duration, yield and credit risk. at June 30 of this year, we had a duration of 4.2. To minimize interest rate risk, our portfolio is weighted towards short-term and intermediate-term bonds. Equities continue to represent approximately 6.5% of our total portfolio at the end of the second quarter. New investment purchases in the second quarter were primarily in the taxable sector. About 70% of the fixed income purchases were corporate bonds, with the remainder being agency mortgage-backed securities, treasuries and tax-exempt municipal securities. Our purchase activity maintained the tax-exempt municipal exposure in the portfolio at approximately 34%, while increasing corporate exposure to approximately 34%. Our income tax expense was $1.2 million in the second quarter of this year, compared with a tax benefit of $2.3 million in the second quarter last year. The increased tax expense was primarily the result of a reduction in the tax-exempt income relative to the pre-tax net income and an increase in year-over-year projected annual net income before taxes. Our operating capital strategy has not changed. We have approximately $135 million in unencumbered cash and securities at the holding company at the end of the second quarter. We expect that we will continue to meet our liquidity needs over the next 24 months with cash generated from operations, investment income and maturing investments. The increase in our share count in the second quarter was largely due -- or largely the result of routine exercises of employee equity awards. Under the company's long-term incentive compensation plan, the first options granted are due to expire in 2014. The company expects officers to be exercising these options prior to their expiration in August of 2014. With that, I turn the call back to Doug.

Thanks, Ric. The year is unfolding as we expected. We are very pleased with our strong performance in the quarter. We have been successful in leveraging our operating strategies to substantially improve underwriting and financial results. We believe that our earnings will continue to benefit from a strengthening premium rate environment and rising yields, which will allow us to continue to grow our earnings per share. And with that, operator, we'll now take questions.

[Operator Instructions] Your first question comes from the line of Mark Hughes from SunTrust.

The submission trends, can you talk about just a little more detail on what you're seeing on new opportunities in terms of submissions? Also, any competitive dynamics, what you might be seeing with other underwriters, whether they're just stable, or getting in, getting out? How would you describe the market?

I would describe the submissions environment as continuing to be strong. Year-over-year, we have seen a decline in our submittals as we've been changing our pricing in our growth strategies, and that was not unexpected. But that being said, it's still a very strong environment. We rolled out new technology Monday this week. And so, it's a little early to give you a forecast, but at least what we've seen in the first several days is, our technology provides a very strong platform for submittals. From a competitive standpoint, I don't know that the competitive market is changing submittals consistently across the book, but we have observed that as we've moved up pricing, particularly on our minimum premium accounts, that we have seen a slowdown in submittal activity. But again, I would still characterize the overall environment as very strong.

Right. And the new technology, you say you like what you see so far. Is that to say more numbers, more submissions are coming in?

You know, it's -- we're in Day 4. So I don't know if we're seeing a trend or if we're just seeing a very rapid reaction to the technology. But clearly, we've had a lot of activity in the first several days.

Right. And then I'm sorry if you gave this, but the loss inflation that you're seeing, frequency, severity -- if you shared those numbers, I'm sorry, but could you give them again?

We didn't deal with those specifically. Again, let me answer that more generally. Consistent with what I think the rest of the market is experiencing, we're seeing increases in frequency and stable or declining severity. Some of that is related to changes in mix of business. But I was reviewing the materials put out by the WCIRB yesterday, and they're suggesting that across the entire market they're observing, that it may be -- obviously, that's not a business mix on an individual carrier, but it's probably a business mix within the economy in California, generally, less contracting activity and more service activity.

And then that's to say the declining severity piece of that?

Yes, I think that probably contributes to probably the increase in frequency and the decline in severity.

Right.

Your next question comes of the line of Amit Kumar from Macquarie Capital.

Just maybe following up on the previous discussion. Can you sort of talk about the pricing sustainability from here? You've had some strong rate increases in your key states. How do you think about that as you go forward? And maybe also, share with us your view on the WCIRB advisory rate number, that would be helpful.

Okay, let's start a little bit about the sustainability of the rate strengthening. I think there's a fundamental influence on pricing in the market and that is the sustained low yield on investment portfolios and the need to drive combined ratios lower to maintain adequate returns on equity. And I think that's the impetus for the industry to continue to push rate. That being said, the industry doesn't lack for capacity, capital or competition. And I have to assume that it becomes incrementally more difficult to get rate as you move forward, but we're seeing strong retention. That suggests an ability to continue to push forward on rate. We do see new business being a bit more competitive, but perhaps we've been more aggressive in pursuing rate than others.

Got it. And on the WCIRB, the rate number?

Yes. I wouldn't say there's anything in there that's surprising. What they're observing in terms of loss trends in California is consistent with what we've been seeing for the last several years. And that really is there was the increase in frequency somewhat because of the change in the employment in California -- the sectors. There was an increase in severity that was related to some of the cumulative trauma. That appears to be tapering. We're seeing similar trends in our book as well. In terms of what we're doing, we're in the process of standing up all 3 of our companies now in California. So in the first half of next year, we will have 3 different companies to write against and we'll be doing a rate filing, and will take that into consideration. So again, if you think about the bureau, it's an advisory rate. It's reflective of what the bureau is seeing in terms of loss trends and loss costs. And it's an important benchmark for us and it's where we start though, it's not necessarily where we finish.

Yes, absolutely, perfect. The only other, I guess, question I have is, I know that Ric was talking a bit about the capital position. How do you feel about your capital position, I guess, going forward, versus the top line expectations? And maybe, also remind us, has there been any change in terms of discussions with A.M. Best?

Okay. I'll take those in reverse order. We are on a routine schedule with A.M. Best. We are scheduled for a rating meeting early this fall. Our rating is typically reviewed in the fourth quarter, it's usually in November. So that's as usual. Nothing unusual in that, whatsoever. In -- I'm sorry, I forgot the first part of your question, Amit.

Oh, the capital position.

The capital. Yes, the holding company has adequate capital, we believe, to support a number of different alternatives. At this point, we're focused on potential uses of the capital invested in the business, because we're seeing very strong results, improving results quarter-over-quarter. And to the extent that it makes sense to use that capital to take advantage of strong market conditions, we are ready and able to do that. That being said, we also have a commitment to pursuing acquisition opportunities that further advance the interests of the company. And when either 1 or 2, being investing the money in the business or pursuing acquisitions doesn't make sense, that capital is available to be returned to shareholders.

I'm sorry, was that a change in the tone? I don't remember talking about acquisitions or acquisitions being mentioned in the last call? Or am I...

Yes. I don't view that any differently today than I ever have.

[Operator Instructions] Your next question comes of the line of Matt Carletti from Employers(sic)[JMP Securities].

I just had a couple of questions. First one, kind of following on the -- both Amit's question on the growth, is -- when looking at kind of the trend we've seen recently and kind of tying in with A.M. Best, do you think you can continue at the sort of growth rates you're seeing currently into the future that, from a leverage perspective, and granted you're still south of 1-to-1, and -- I just don't know what their view is, that you can continue to grow at that sort of pace? Or should -- there's been a little bit of a glide slope last year versus this year, which was to be expected in a downward direction. Should we expect to see that glide slope continue -- still nice growth, but maybe not mid-20s maybe coming off of there?

Yes. I would expect that the glide path continues, obviously always with an eye to what the rating agency views as required capital. But the plan to slow the growth was in place several years ago. We saw an opportunity to put business on the books. We believed that we would see an improving market condition, a better rate environment, hardening of the market, and what we expected to happen is exactly what we've seen over the last 18 months. So, we'll take advantage. We're really using this as an opportunity to reprice business in a better rate environment and to be more selective in the business we write. But we're also committed to sustaining growth, albeit at a lower rate than we've seen this year and last.

Okay, great. And then maybe one for Ric, just -- you mentioned on the development side, not much of a different story than prior quarters, a little bit of adverse in recent years and offset by some favorable in older years. Can you give us any color on the magnitude of those swings? Is it any different? Was it just a few million each way or was is it larger than that?

I hate to sound like myself from the prior quarter, Matt, but it really was very much a repeat of the first quarter. Single-digit, small numbers, '07 and before in general, showing some positive development, '08, '09, '10 showing a little bit of growth. But it was very insignificant, very much a reprise of the first quarter.

[Operator Instructions] All right, ladies and gentlemen, it looks like we have no more questions in the queue at this time. I would now like to turn the call back over to Doug Dirks for any closing remarks.

Thank you. Thank you, everyone, for joining us this morning. We appreciate your participation and we look forward to speaking to you again in November with our third quarter results. Good morning.

Ladies and gentlemen, that concludes today's conference. Thank you for your participation. You may now disconnect. Have a great day.