ProAssurance Corporation (PRA) Q4 2011 Earnings Report, Transcript and Summary

Good day everyone and welcome to today's ProAssurance fourth quarter 2011 earnings conference call. As a reminder, today’s call is being recorded. For opening remarks and introductions, I now turn the call over to Mr. Frank O'Neil. Please go ahead, sir.

Good morning, everyone. Thanks for joining us to discuss our fourth quarter and full year 2011 results. Please bear with me for a minute while I handle some important legal matters. On Wednesday, February 22, 2012, we issued a news release and filed an 8-K reporting our results for the year and quarter ended December 31, 2011, along with our SEC filings, including the 10-K we filed Wednesday afternoon. These documents provide you with important detailed information about our company and our industry. These documents also discuss in detail many of the important factors that could affect the outcome of future events and thus cause our actual results to differ materially from current projections or expectations. Please read and understand these cautions and be aware that statements we make on this call dealing with projections, estimates and expectations are explicitly identified as forward-looking statements subject to these and other risks. Except as required by law or regulation, we will not undertake and expressly disclaim any obligation to update or alter information disclosed as part of these forward-looking statements. The content of this call is accurate only on Thursday, February 23, 2012. We do not authorize or review transcripts you may obtain, so please know that transcripts may contain factual or transcription errors that could materially alter the meaning or intent of our statements. As a final reminder, we're going to reference non-GAAP items in our call today. Please refer to our recent filings on form 10-K and our recent news release for a reconciliation of these non-GAAP numbers to their GAAP counterparts. Participating in today's call are our Chairman and CEO, Stan Starnes; our President, Victor Adamo; and Chief Financial Officer, Ned Rand; and Howard Friedman, our Chief Underwriting Officer and Actuary. Stan some remarks from you please.

Thanks, Frank. To sum it up, we had a terrific year. We maintained our unparalleled record of protection of and advocacy for our policyholders. We delivered impressive gains in shareholder value and we continued to build financial strength. We are also pleased to note that we added our 20-year string in which we have increased book value per share. The 2011 book value per share increased 17% over yearend 2010. Our success in 2011 builds on the solid foundation we have laid in prior years, but I'm most excited about what this means for our future. We have hundreds of dedicated effective employees and a senior management team, who each understand that we learn from the past so we can excel going forward. For example, the favorable development we have seen is a result of not just the effect of an improvement in industry-loss trends. It is meaningfully affected by the rigorous way in which we manage claims today. We reserve our current business at prudent levels. We underwrite our business with the knowledge that it may be many years before associated claims or result. And we manage our claims process with an eye, not just on today's claims, but on the claims to come. We also manage our investments cautiously and prudently, to ensure our ability to meet our commitments, both today and in the future. To that end, we remain focused on doing those things necessary for continuing success in the future. Confident that such foresight leads to year to year to year success as well.

Drawing on Stan's statements, let me address our significant net favorable reserve development in the fourth quarter, which amounted $184 million, bringing in net favorable reserve development for the year to $326 million. The bulk of the development is from accident years 2004 through 2008, with smaller amounts in 2009. In short this is a result of the prudent nature of our reserving overtime, given the extreme volatility and medical professional liability during the 35 years that MPL has been broken out from other liability. It was not that long ago, when our industry saw loss ratios above 100%. And while we do not believe we are headed to that level of losses anytime soon, this knowledge certainly informs our actions. Volatility exists in both directions however. During this phase of the cycle, loss severity continues to develop at levels below those we considered when we established our initial reserves. Further, the decline in claim frequency experienced through the middle of the last decade has only resulted in marginally higher average loss payments, despite expectations of more significant increases. During the 2004 through 2008 timeframe, we established reserves reflecting the then current loss environment. Both assumptions is based on knowledge that the industry had seen periods of rapidly escalating loss trends like those we observed in the late 1990s and early 2000s. Trends evolved differently than expected, but we are being just as careful to consider the evolving loss environment that exist today and we expect to apply that same careful analysis as trends evolve in the future. Given the size of the reserve development in this quarter, I want to remind you about our reserve evaluation process, which will help explain why fourth quarter can vary so much from the preceding quarters in a given year. As we've always said this is a long-tail business and is only so much that can be discerned on a quarter-to-quarter basis. We use the perspective of the full year to form our conclusions at yearend. Our independent consulting actuaries conduct two major studies each year. And those complement the work that our in-house actuaries have been doing throughout the year. As we get more data with each passing quarter, we get a better picture of what another full year of loss data looks like. For the past four years that analysis has led to significant development in the fourth quarter. But remember, it could just as easily go the other way if loss trends change. Also remember that the analysis we perform each year is consistent with prior year's analysis, but with an expanding pool of data. Just a couple of other comments on trends. The overall frequency trend is generally flat just as it has been for the past three years or so. And the rise in severity is about 3% to 4% per year, which is slightly less than we've seen for the past several years. And that means we expect flat rates this year, unless loss trends change or investment yields decline further. Average renewal pricing was down 1% comparing 2011 to 2010. However, average renewal pricing was up 2% year-over-year in the fourth quarter. Retention was 89% for the year in our physician business compared to 90% in 2010, so no significant change there. Business acquired from APS is included in both years.

For the year gross written premium was $566 million, a 6% increase over 2010. This was driven principally by premium from our acquisition of American Physicians. Our gross written premium of $115 million in the fourth quarter was down 3% from the fourth quarter last year, reflecting current market conditions. We are pleased with the increase in our topline for the year. It demonstrates what we think growing by disciplined M&A is often the best route in a market such as we are experiencing right now. You will notice that net earned premium is up for the quarter. This increase is not only the result of the inclusion of American Physicians, but is also affected by favorable development and our ceded losses. This reduces the premium expected to be seated under certain of our reinsurance treaties. I should also take a minute to discuss our net investment result. We continue to acknowledge the painful reality of the persistent low interest environment in which we find ourselves. Again, this quarter it is resulted in a decline in our net investment income, which was $34 million in the fourth quarter, down $2 million compared to the year ago quarter. For the full year 2011, net investment income was $141 million compared to $146 million in 2010. As you will recall, net investment income is just one component of our net investment result and primarily includes interest on our fixed income securities and dividends on our equity investments. The other component is our earnings or losses from unconsolidated subsidiaries. We experienced a loss of $3 million in the fourth quarter and $9 million for the year on our unconsolidated subsidiaries, due in large part of the expected amortization of tax credit limited partnerships. With those declines, our net investment result was $31 million in the fourth quarter, a decline of $3 million from 2010's fourth quarter and for full year 2011 our net investment result was $132 million versus $148 million for the prior year. On the expense side, underwriting expenses were down 18% quarter-over-quarter mostly due to one-time charges in Q4 2010. Remember, in the fourth quarter of last year, we recognized significant cost attributable to the American Physicians transaction as well as one-time costs associated with the termination of a captive reinsurance arrangement. For the full year, underwriting expenses were up 1%, driven principally by the inclusion of API's expenses for the full year. Operating income for the year was $279 million or $9.03 per diluted share, a 32% increase over operating income per diluted share in 2010. In the fourth quarter, operating income was $132 million equal to $4.27 per diluted share, a 38% increase over operating income per diluted share in the fourth quarter of 2010. For the year, net income was $287 million or $9.31 per diluted share. And for the fourth quarter, net income was $141 million or $4.56 per diluted share. Return on equity, which we calculate by dividing net income for the year by the average of beginning and ending shareholders' equity was 14.3% in 2011 compared to 13% for 2010. Book value per share is now over $70 for the first time in our history, reaching $70.84 at yearend, a 17% increase for the year, 1 point above our historical compound annual growth rate at book value per share. If there is a silver lining to be found in the declining interest rate environment, it's found in the entries in the value of our fixed income investments, which helped boost book value per share. Tangible book value per share is $63.86, a 20% increase during 2011. While we did not repurchase any shares during the quarter, we are very pleased to pay our first shareholder dividends. Frank?

Thanks, Ned, good summary. Darryl Thomas can't be with us today. Can you update us on yearly claim stats and fill us in on industry and regulatory matters of interest.

Yes, Frank, thank you. We know that nothing significant in the way of new claim trends during 2011. For the year, our claims inventory and the number of claims opened and claims closed were all essentially unchanged over 2010. Trial numbers which are like claims numbers also continue to reflect the trends Howard cited. In 2011, we tried 293 individual claims, and Darryl wanted me to stress that we continue to try the same percentage of claims as in recent years. Now, with fewer claims in our inventory, we are able to bring more intensity to our handling of each claim. Our trial win ratio this year was up about 4 points to 78%. Given the significant number of claims we take to trial, including the tough claims that other companies typically settle. This is a great result from one that benefits our insurers as well as our shareholders. On the tort reform front, Florida is the center of attention right now. The Florida Supreme Court would argument on the validity of that state's tort reform about 10 days ago. So a ruling should come down sometime later this year. At the same time, the Florida Legislatures considering further restrictions on medical professional liability losses, although these are aimed at procedural changes rather than damage limits. And still no word from the Supreme Courts in Missouri and Mississippi, which heard arguments on their tort reforms in late October of 2011. So we'll get a ruling hopefully sometime this year, I guess.

Thanks. Stan, can we get something to close from you?

Thanks, Frank. We have said repeatedly that we are not a quarter-to-quarter company. We remain very focused on the long-term, on providing disciplined underwriting, on providing an unparalleled claim experience for our policy holders, providing a great environment for our employees in which to carry out the mission we receive from our shareholders. We remained focused on the long-term. It's that long-term vision that sets us apart I think from others in this space. We are pleased to have been able to deliver for our shareholders in 2011 and we have the very same determination and momentum to succeed in the future. Thanks Frank.

Thanks to all. And we're ready for questions, if you'll queue them up for us.

[Operator Instructions] Our first question comes from Matt Rohrmann with KBW.

Obviously, quarter was phenomenal, just a couple of questions. First, Stan, I just want to get your thoughts as we're on the 2012 now, and how the Certitude program is rolling out?

Matt, we continue to be excited about Certitude. We introduced it as we said in Michigan, we're working with Ascension to deepen the Certitude engagement in Michigan and we are moving it into other states within the Ascension's footprint. We'll make public announcements of that as we actually move the product out. We are very excited about our relationship with Ascension, as you know that they're largest catholic healthcare provider in the United States, the largest non-profit provider of healthcare in the United States. And they clearly are going to be a very major participant in the changes that are going to come to healthcare in this country over the coming years. So Certitude represents one a sort of response to what we anticipate will be the changes in the healthcare system. It's not the only response, but it's an important response and we look forward to working with Ascension to continue to implement it.

Stan, is it possible that given the changes that are occurring in medical mal that programs like Certitude would become the primary growth driver as opposed to M&A as it has been in the past?

We think it's important to respond with nimbleness to whatever the environment presents. There are occasions in the cycle where you have to rely on M&A. There are other occasions in the cycle where you have to rely on organic growth. Frankly, I think that the Certitude program is a program that will overtime flourish in any cycle, because it's not a response to the insurance cycle, it's a response to the various fundamental changes that occur in healthcare in this country. So I think it does present a great opportunity for us for organic growth. But I think it presents that very same opportunity, whether it's a hard market or a soft market, because of the changes that are coming in healthcare are not depended on the insurance cycle. They're going to overtake the insurance cycle.

And then just last question for all the press and moves that you guys mentioned earlier on Florida, is that really anything that we haven't seen before to one degree or another from other states?

Tort reform remains essentially a state-by-state battle and you'll see a lot of publicity surrounding it. The important thing is to step back and wait and see what actually is passed. As an organization we very much support those legislative enhancements that improve access to care and it protects physicians and other healthcare providers from frivolous claims against them. But you have to step back and see what legislation actually passes as oppose to what is merely publicized. And then you have to see what the State Supreme Court in that particular state does with it. It's not like turning a light switch. It requires a lot of time and attention before it all finally sorts itself out.

Our next question comes from Mark Hughes with SunTrust.

The pricing in the quarter, up 2% a little bit better than the full year, but then your outlook for a steady pricing was there. Any particular reason why this better trend wouldn't be sustained into 2012?

It's partially a function of the mix of business in a given quarter depending on the state or states that heavier renewals in any quarter versus other states. And what we're doing either with rates or what the competitive environment is in those states and even in that mix of physician hospital by specialty. So I think on a whole point or two variations from quarter-to-quarter is not unexpected from our perspective. And we're still looking at it as the year that we expect to be relatively flat. If we have the opportunities to do more that we will. But right now we're not projecting any continuation necessarily of a 2%-plus or anything else like that.

How about retention in the fourth quarter how was it? While you're looking, I'll ask another question, which was the APS acquisition. How much did it contribute in terms of gross premium this quarter? And then I know it contributed for the month of December last year. How did those numbers compare this year versus last year?

I will answer the retention question while we're working on that one. Retention for the quarter was 87%.

How is that compared to fourth quarter last year?

Fourth quarter last year was a touch higher. I have that here actually. Actually for the last year we were flat. Let's see retention was 90% in the fourth quarter of 2010, I believe.

The API premium number in the fourth quarter of 2010 was $5 million and in the fourth quarter of 2011 just under $3 million.

Is that a gross premium?

That's gross.

Our next question comes from Ray Iardella with Macquarie.

Just sort of a couple of quick ones from me, I guess the first one maybe could you touch on the reaction from maybe some of your employees to the centralization of the claims and underwriting process, and then the other think I just wanted to, wondered if you could comment on the employee count as of last year was 739 and I guess at the end of 2011 was 652. Just is that the naturally progression of the AMPH transaction or could you comment on that further?

The API transaction is largely responsible for those different numbers that you see there and that was what was anticipated from the point in time we started negotiating the transaction, as we implemented and integrated the two organizations. In terms of the employee reaction to the consolidated customer service centers that will be opened over the next 18 months. We've had a very positive growth. Response from our employees, we are all very committed to making that successful and to bringing to that effort, the necessary expertise and professionalism and enthusiasm that we think will enhance even further what we regard as the gold standard customer service in this phase. So we're excited about that. Change always brings its challenges but you can't leave change to chance and we're not leaving that chance. And our employees, all of us working together will make certain that it works and works in a very effective and efficient way.

I agree 100% with that thought process. Then I guess for, Ned, how do you guys think about cash and investments at the holding company, now that you guys have a dividend in place, I know its roughly probably $30 million a year but does that change how you think about how much capital you have at the hold co?

Not significantly, Ray. I think where the biggest challenge that we face right now with the cash we hold at the holding company, we like that to be fairly liquid. And it's just a challenge to find any short term investments that provide any yield at all. And so that's part of the greatest challenge we find with the capital that we hold at the holding company. But the $30 million of anticipated dividends does not really change our approach at all.

And then I guess, last sort of longer-term going back to the growth question. I mean do you guys still consider the medical professional liability line of business a long-term growth business? I know you've been through the Certitude program and I think moving a little bit more towards the hospital risk. I mean longer-term do you see that as a good growth business overtime?

The healthcare system in this country accounts presently for about 17% of the gross domestic product of the United States. Unfortunately that's growing and our space within that we think will continue to be a place where folks who know what they're doing and who bring disciplined underwriting and disciplined claims resolution will be able to grow their business. So we like the space, we liked our position in this space and we anticipate that we will continue to be a very professional liability centric organization.

Our next question comes from Seth Bienstock with TimesSquare Capital.

Just had one quick question, I appreciate at the color that you shared on the favorable development earlier. But I was curious if you could share perhaps were the developed accident year loss ratios for '04 and '05 now sit versus where the initial picks were?

I'm not sure if I have the loss ratios in front of me right now. I don't think I do. We have the amounts of development by year as you saw on the case. But I think we have to come back to you with that. And then we'll have those posted on our website, Seth, certainly after they're filed.

Our next question comes from Meyer Shields with Stifel, Nicolaus.

Two quick questions on the expense ratio. One, was there any impact from the favorable development with a strong operating income on the expenses incurred in the quarter?

Not on expenses, but what you will see is an impact on premium.

No incentive comp or anything they get?

No. So we had no impact on expenses themselves but it does impact the earned premium component of the ratio.

Second, on a related issue we saw the expense ratio obviously declined not year-over-year but sequentially. So should we expect that sort of seasonality going forward as well?

I don’t know if I'd refer to it as seasonality, it is more event-driven. And so this quarter we had both when you kind of looking at, I guess, sequentially it's the earned premium impact is the most significant but we have just event-driven items like we did in the fourth quarter of last year that impact the expense ratio. But I wouldn't call it seasonal.

And our next question comes from Ron Bobman with Cap Returns.

I had a couple of questions, Ned. You characterized t favorable development largely concentrated. I think '04 through '09, if I remember your prepared remarks correctly, generally speaking roughly the current rate levels that you're charging for early 2012 business or 2011 business. How would you compare those, how different are they than the rate levels in '04 and '05, let’s say. Could you sort of give us a ball park of the delta?

We actually look at that. We have some charts on that which are not in front of us right now but I would say that at this point probably down about 15% to 20%, remember when we had a number about a year ago it was down 14% over that rough period of time, maybe from 2004 to peak of the pricing cycle and it may have moved down a little bit since then. So it might be 15%, 16% at this point decreased.

I don't believe I heard any comments about the reinsurance program but I guess sort of a naïve listener could -- which I consider myself but hopefully not foolish. But a naïve listener would sort of look at this outstanding results and possibly suggest to conclude that you missed a fair bit of opportunity in the '04 through '09 timeframe because of a degree of conservatism. And I recognize there will be a lot of peril to sort of at some point in time last year or next year to say. But here we can be more aggressive and take on some more risk that we might have otherwise passed on under the existing sort of underwriting regime. But I am wondering if reinsurance and modifying the reinsurance program, even modestly provide you way to sort of adjust that dial a bit or is that also sort of in some respect sort of deemed of foolish endeavor from where you sit?

Yes. We do look at the reinsurance structure annually. And we had made some modifications in the sense of obtaining better pricing in certain areas, certain states, certain lines of business as well as making slight modifications that we've mentioned over the past couple of years in some of the turns. For example, we no longer look to our reinsures for recovery of proportional defense cost, which is typical in most reinsurance agreements. We've decided that we don't need to reinsure that exposure. We do quite well on our own managing defense and we don't need to trade dollars with reinsurers on that. At different points and we have several years, we've retained a portion of the risk that we would otherwise cede on a percentage basis. So in other words, we participated if you will on our own reinsurance, depending on what our perception was of the reinsurance pricing. So without making a wholesale change in the structure we have modified it and enhanced it over a period of time. We look to the reinsurance structure that we have to protect us from the volatile unexpected losses. So anytime that we consider increasing our retention, in other words using less reinsurance, we have to consider the volatility effect that it would have on us. And we think we have a pretty good structure now, but we're going to look at it again this year.

[Operator Instructions] Our next question comes from Howard Finkler with Finkler & Company.

Rick Scott in Florida is surely changing the market for insurance down there. He's making it more commercially friendly. Have you seen any effect yet in medical malpractice or its initial focus on potentially massive hurricane losses?

The answer is we've seen no effect in medical malpractice. I've read about what governor Scott is doing and obviously he's got a significant task in front of him with respect to Florida personal lines, markets, and both homeowners and otherwise. But we have not seen any effect on the medical malpractice down there. We like our book in Florida very much. It's a small book. It's deliberately small. But it's a core group for physicians that we're very, very pleased with. But the answer to your question, Howard, is no. We hadn't seen any impact on the governor's activities yet in our space.

Before he was elected, did the previous insurance commissioner have a say in your rates or was it the file and use?

Florida has been essentially file and used for quite a while, over a decade. But with our fairly active review process by the Office of Insurance Regulation there, we and most other companies generally treated as prior approval. We can file and use the rates, but at our own risk of insurance office coming back and making us change.

So risk cost policy spreads, it may affect you positively?

Yes, depending on what it ultimately turns out to be. Yes.

And we have a follow-up question Mark Hughes with SunTrust.

A bottomline impact of that favorable development in the ceded losses still had a current year loss of 90% or better. I wondered is that due to the bottomline?

I’m sorry, I don’t know that I followed your question. The question was you got the bump in earned premium, because of that favorable development in the ceded losses. How much of that actually flow through to the bottomline?

I believe that the impact and I don't have it right in front of me. Let's say it was in the $10 million range, a pretax which would put us at $6.5 million after-tax impact. I think that I need to verify that it may be slightly higher than that.

Yes. And if I've my numbers right, I was just pointing out that the current accident year losses were still 90% of earned premium, which included that extra amount. Again, assuming I'm looking at this correctly. I was wondering whether it really had much of a bottomline impact at all?

Current accident year loss ratio was somewhat higher than normal, because we've made adjustments to the death, disability, retirement reserve to reflect the ever aging physician population in the longer horizon, I guess, and I could say that the physicians are retiring later than they use to.

And I would add to that, the impact on the ceded earned did not having impact on our valuation of current year losses. That earned premium from our associated loss would be pushed back into prior period, so that pertains to.

So the loss associated with that would be negligible.

But the loss it's associated, so that ceded earned premium factor is associated prior accident years. It would not incur any loss in the current period on that earned premium.

Right. So then your losses in the current accident year on premium aside from that favorable development ceded losses was fairly healthy, fairly high?

And that is because principally as the DDR adjustment that we made in the fourth quarter, which is outcome of our actuarial review process. And you'll see a similar trend in Q4 last year.

And we have a follow-up question from Ray Iardella with Macquarie.

Just on the ceded premium, can you guys maybe comment on how we should think about that line item going forward, I guess, here in 2012, just been a lot of volatility or moving pieces in that line item that would be helpful?

Yes, and I think it is a challenge, Ray, this year more than in prior years we saw a reduction in our ceded losses, when we did our actuarial review. A lot of the actuarial review that we've done and the results of actuarial review in the past years has been within our net retained layer. And this is the first time we've had a significant decline in ceded losses during the period. It’s a little difficult to predict going forward how that's going to be impacted. So I don't know that I have a good answer. I think on a normalized basis that ceded expense is around 8% of premium. So we ceded about 8% of our premium. But it is going to vary based on ultimately what losses get ceded under the treaties. Our primary reinsurance arrangement has a swing provision in it, where the premiums that we pay under the treaty are determined in part by the losses incurred on the treaty. And to the extent that we see less losses to the treaty, we see less premium. But it's kind of hard to predict.

Ray, I'll add to that. We go back and we talk about being an environmental line of business and then when we look at the excess layer you’re adding another level of volatility on top of that, so that the variability there is even tougher for us to make any projections about.

It appears there are no further questions at this time Mr. O'Neil. I'd like to turn the conference back to you for any additional or closing remarks.

Thank you everyone on the call. We appreciate your attention and we will join you next in May. Thank you.

This concludes today's conference. Thank you for your participation.