ProAssurance Corporation (PRA) Q1 2013 Earnings Report, Transcript and Summary

Good day everyone, and welcome to the ProAssurance Call to discuss 2013 First Quarter Earnings Results. Today’s call is being recorded. And at this time, I’d like to turn the call over to Mr. Frank O’Neil. Please go ahead, sir Frank O’Neil: Thank you, Jenny. Good morning, everyone. And thanks for your interest and participation in our call to discuss ProAssurance’s first quarter 2013 results. Before we get started, I have a few legal matters to take care of. On Monday May 6, 2013, we issued a news release reporting our results for the quarter ended March 31, 2013. We subsequently filed our 10-Q and a current report on Form 8-K with the SEC. These documents and our other SEC filings provide you with important information about our company and our industry. And each discusses the important factors that could affect future results which could cause our results – our actual results to differ materially from current projections and 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 risks and other factors covered in those documents. Except as required by law or regulation, we will not undertake and we 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 Tuesday, May 7, 2013. We neither authorize nor review any transcripts you may obtain, so please know that a transcript may contain a factual or transcription error that could materially alter the intent or meaning of our statements. We will reference non-GAAP items in our call today. Please refer to our recent filing on Form 10-Q and our recent news release for a reconciliation of those non-GAAP numbers to their GAAP counterparts. Participating in today’s call are our Chairman and CEO, Stan Starnes; Vic Adamo, our Vice Chairman; Chief Financial Officer, Ned Rand; Howard Friedman, our Chief Underwriting Officer and Actuary. Stan your opening thoughts.

Thanks Frank and good morning to those on the call. Before I get to the quarter’s results, I want to acknowledge the debt of gratitude we all owe Vic Adamo, who is retiring towards the end of this quarter. This will be Vic’s last conference call and this is my last chance to publicly say thank you for dedication he has shown and what will be 13 years of service to ProAssurance and previously 16 years at Professionals Group. Over that 3 decade span, Vic’s vision has helped ProAssurance to achieve its position of leadership in our industry and he has served our insureds and investors with distinction. Vic also has been a tireless advocate for our industry through his service on the Board of the Physician Insurers Association. Vic, we are truly grateful for all that you have done. We wish you well and want you to know you will be missed. Now to our results. Our successful quarter highlights a number of important (tenants) of our long-term strategy. First is, I have often said, our long-term focus is on the bottom-line and what it means to our policyholders and investors. Today again, this was another profitable quarter in which we achieved our goals of increasing financial strength and building shareholder value. Our M&A strategy again proved fruitful in the quarter. Independent Nevada Physicians, IND and Medmarc combined to add $12 million of premium that we expect to be profitable at a time when achieving growth is extremely difficult. Our Medmarc acquisition proved especially beneficial for us as we broadened our reach in a medically related line of business and (posted our lawyers’) liability line plus our purchase of Medmarc resulted in a $35.5 million gain. That gain is just one of the mini-items that Ned Rand, our CFO will be addressing as he discusses the several moving parts from the first quarter. Ned?

Thanks Stan. I can provide that explanation right off the bath. We acquired Medmarc for less then a fair value of its net assets from the closing date January 1, 2013. Because the fair value of the net assets we acquired exceeded our purchase price, we recorded a gain in the income statement as required by applicable accounting guidance. That gain is reflected in net income but not in our calculation of operating earnings or return on equity. Now to the details of the income statement. Gross premiums return were $163 million down 4% from $170 million in the first quarter of 2012. As Stan mentioned our acquisitions brought $12 million of new premium into the company in the quarter and we wrote $5 million of new business in our existing physician book. However, that was offset by the impact of an increasingly competitive market. Also recall that in the first quarter of 2012, we wrote a single reporting endorsement with a premium of $6 million. That one time policy distorts comparisons to some degree in which at the time that opportunities to write such policies would be sporadic. Net premiums earned also declined quarter-over-quarter from $137 million a year ago to $135 million in the first quarter of 2013. This 2% decline is a direct result of competitive market forces. The continued consolidation of medical providers and that $6 million tail policy I just mentioned. It was 100% earned in last year’s first quarter so again its skewing the comparisons. Somewhat offsetting the decline in net premiums earned was $10 million of additional premium from acquisitions. Further, ceded earned premiums was reduced by $4.8 million due to the emergence of favorable loss experience in our ceded loss reserves resulting in a reduction in the variable components of our reinsurance treaties. This quarter, as a result of our reserve analysis, we recognized favorable development in both our retained losses as well as our ceded losses. Historically, we have seen development in our ceded losses only during our more in-depth annual fourth quarter reserve review process because ceded losses have been more volatile than retained losses. However, as we have gained confidence in the trends in our ceded losses, we are now more comfortable in evaluating these trends in a more frequent basis because the premiums ceded under certain of our reinsurance agreements are variable (with the term) swing-rated treaties. This evaluation also impacts ceded premiums related to prior years. The adjustment resulted in a $4.8 million increase in net earned premiums, which in turn reduced the current accident year net loss ratio by approximately 3.4 points. If you exclude that adjustment, and the impact of scaled premiums, our current year loss ratio would be level with last year. Howard on the hilt of that premium discussion, it might be a good time to discuss pricing and retention and the effect of competition.

Thanks Ned. Competition in the healthcare professional liability line is certainly not slacking off. Every renewal is aggressively contested and new business is difficult to obtain. Large account physician business is particularly competitive right now and we certainly see some pricing that we view as a rational. But, there are bright spots. You mentioned that we wrote $5 million of new physician business in our exciting NPL book. About half of that was from the inception of the Illinois portion of our Certitude Program with Ascension Health. Traditionally, IND brought in $3.5 million of physician premium when we added them to our group. Geographically, there isn’t one stage or region, I would consider to be more or less competitive and the key competitors vary from state to state as well. Even the degree of competition, retaining business at a profitable rate level is challenging. In our NPL line premium retention was 87%, down 5 points compared to the year-ago quarter but closer to the average, we’ve seen over the last four quarters which has been 88%. We’ve certainly seen individual quarters that resulted in a lower retention in this quarter. As (surpassed) notably last year has proven, the first quarter of the year is not always the predictor of the remaining three quarters. Average renewal pricing in our physician book was down 1% year-over-year, given that competitive nature of the market, I think this shows a meaningful level of satisfaction from the vast majority of our customers who value our service and security even one other coverage is available at lower prices. A couple of another bright spot, premium in our lawyers’ professional line was up $2 million year-over-year due to the addition of premium from the Medmarc Lawyer’s book. A Medmarc also contributed $5.9 million of premium in the medical technology and life sciences line. I can also talk about loss reserves for a moment. Favorable reserve development continues to be driven by loss severity levels that are proving to be better than our expectations when losses were last evaluated. As Ned mentioned, we made a $7 million adjustment to our ceded loss reserves, the breakdown is $60 million of growth favorable loss development and $53 million of net favorable development. Right now the rate of severity increase remains at about 2% to 3% per year. And the overall frequency trend remains flat. Although we continue to monitor these trends very closely given the amount of variation, we’ve seen in the past. In our last call, I said we see nothing in the aggregate to drive a significant change in our loss assumption and that remains the case.

Thanks Howard. I hope those explanations are clear that we can revisit then in our Q&A if anything needs clarification. Let me spend a bit of time on operating cash flow which was down year-over-year. On the positive side, we saw an $18 million reduction in payments related to net loss and loss adjustment expenses but that was offset primarily by lower premiums, an increase in tax payments and an increase in cash out flows associated with operations within our recent acquisitions. On investments, our net investment result was essentially unchanged year-over-year. Like almost every other fixed income investor, we are experiencing lower yields as we reinvest cash flows in the portfolio. This was offset by higher income from our investments and dividend paying equities, higher earnings from our investment limited partnerships and the addition of assets from the Medmarc portfolio. Underwriting policy acquisition and operating expenses were up almost $3 million year-over-year, primarily reflecting payments made in connection with our acquisitions and the addition of expenses associated with the operating cost of the acquired companies that were not present in last year’s first quarter. Net income was $113 million, a $57 million increase from last year. Keep in mind that $35 million of that $57 million was that one-time gain associated with the Medmarc acquisition. (We therefore made comparisons) next year difficult and we’ll give the headline writers who don't look beyond the numbers something to write about. We also have $27 million in realized investment gains, principally as a result of mark-to-market gains in our equity trading portfolio, operating income excluding these gains were $60 million or $0.97 per diluted share, return on equity was 13.4% in the quarter excluding the gain from the Medmarc acquisition. Book value per share increased 4% in the quarter, to stand at $38.19 intangible; book value per share is $34.69. Frank? Frank O’Neil: Thanks. Ned loves to follow there. Thanks for laying it out for us. Vic, would you give us a quick update on the integration of our recent transaction?

Sure Frank. You’ve heard that as expected both Medmarc and IND contributed meaningful premium to our first quarter. Medmarc serves distinct clientele; medical product manufactures and drugs companies rather than physicians and other medical providers. Accordingly, Medmarc will operate as a specialized division focused on their unique client base. Mary Todd Peterson, Medmarc’s President has joined our senior management team. The primary points of integration mainly financial reporting and investment management have meshed well. We are also pleased to note that our respected sales teams are seeing cross over opportunities on the marketing side especially at the national accounts level. And mid-market is about to undergo some rebranding to bring it into closer alignment with ProAssurance. On IND, as I reported last quarter integration is proceeding equally well under the leadership of Jim Hooban. We have our claims department in place and we are adding two new claims employees to serve our Nevada insureds. IND is benefiting from the greater resources available as a result of the merger into ProAssurance. So we are extremely pleased with our progress. Stan any closing comments before we take questions?

Just a couple Frank. From my perspective there is a great deal of encouraging news in this quarter’s results as a company with a long-term focus on excelling in an often volatile business, we understand that our top-line will not grow every quarter, in fact, if you see a healthcare liability company growing to top-line in this market ask why because absence something unusual that company could be writing the prescription for future difficulties or something even worse. Instead our focus is on the bottom-line and increasing book value, the things that make us stronger and better prepared to respond to the needs of an increasingly complex healthcare delivery system. These things make us a more desirable insurer for an increasingly sophisticated buyer and a more desirable M&A or business partner. You saw an example of our ability to be an important business partner in March when we announced our CAPAssurance Program with CAP, MPT to write hospitals and facilities in California. CAP is a physician focused organization, with a long history of success in California and our CAPAssurance program will leverage their local knowledge and expertise and our long experience driving hospitals and providing risk management services. Our financial strength is what made us a desirable partner for Medmarc and we are pleased to see that being part of an organization of greater financial strength has allowed Medmarc to gain the attention of clients who value that financial strength in an insured. We have already seen an increase in premiums written by Medmarc in the first quarter as a result. Both IND and Medmarc are making meaningful contributions to our organization both in terms of business and in terms of leadership. And as you have heard Howard mention, we continue to break new ground with our Certitude Program and Ascension Health. Fitch recently affirmed our financial strength rating at A, while noting that our performance is supportive of an even higher rating. And Moody’s upgraded our prospective debt ratings in the quarter, which we view as a positive independent verification of our dedication to financial strength. So I continue to be as optimistic as I have been in the past. Frank let’s take questions. Frank O’Neil: Thank you, Stan. Jenny, we are done with our prepared remarks and ready for questions from our callers.

Thank you. (Operator Instructions) And we’ll go first to Ray Iardella with Macquarie.

Thanks Stan and good morning.

Good morning, Ray.

Maybe just talking a little bit more I think Stand your comments about the CAPAssurance program kind of how should we think about that, and do you guys I guess see anything, similar deals or strategic alliance if I guess, I should call it like that in the future?

Ray as the world of healthcare continues to change the needs of our, traditional customers are going to change. There is a significant amount of integration as you know taking place throughout the United States with respect to the delivery of healthcare. You have physicians increasingly joining other physicians and joining healthcare systems. And as you have this aggregation of providers in terms of both hospitals and physicians, their need for insurance product is going to grow more sophisticated and going to require more expertise. So we think that CAPAssurance program which I mentioned earlier is an example, of two things that are very important. The first is, as many of you have heard me say repeatedly, this is a local business, and if you do business in 50 states in this field, you are engaged in 50 different businesses. Thus, it’s important to have local knowledge and local expertise and CAP NPT brings that to the table in the CAPAssurance program. It’s also necessary to have financial strength and experience in writing hospitals. And ProAssurance brings that to the table. So the CAPAssurance program is an example of what I think would be an increasing number of opportunities to join local expertise and knowledge with financial strength and underwriting experiences, all of which puts us in a unique position to take advantage of the changes that are offered in healthcare.

Think that’s helpful. I mean how should we think about that relative to sort of your appetite for just sort of pure M&A transactions and I guess specifically maybe talk about your appetite maybe for lawyers professional liability as well?

Yeah, ProAssurance today is a creature of over 20 M&A type transactions. And our appetite for appropriate and profitable M&A remained as strong as ever. As you know, we have to be prudent with respect to the acquisitions we make, they are episodic, you cannot make them happen, you cannot predict that they will happen. And we think that we will be as active in the future as we have been in the past with respect to transactions. The lawyer liability space is a space that we have been in for many years. It’s a space, I think we write about today somewhere around $26 to $27 million of premium in that space which puts us in about 4th position in the country in terms of that premium. We saw a significant increase in that premium as a result of our combination with Medmarc, and we think that’s a book of business that we will go in the future. Again, the growth needs to be a prudent and it needs to be profitable, and we think we will have ample opportunities in that respect in the years ahead.

Okay. Well, thank you. I’ll requeue for a few other questions, but just wanted to pass along my congrats on a good career.

Thanks Ray.

Thank you.

And we will hear next from Mark Hughes with SunTrust.

Thank you very much. Good morning.

Good morning, Mark.

You have mentioned that consolidation of providers as one issue that affected premium in the quarter, can we just talk about the pace of that as the healthcare reform is developing here. Then also in time statute you have mentioned opportunities for gain perhaps related to that consolidation, could you give us your updated thoughts on that?

Sure. Probably you have seen it there is a study that’s been published by Century in recent months, which projects that by the end of this year only 36% of the physicians in the United States will be what they label independent practitioners. I think about what that represents in terms of the cede change over the last 30 to 40 years. I expect that when I started practicing law in 1972, fewer than 10% of the physicians in United States were affiliated with hospitals or these very, very large aggregations of healthcare providers. So, we have seen a remarkable acceleration in aggregation and it seems to be picking up almost every year now. Now, it won’t be entirely linear, it will accelerate at times and then slowdown at times and it won’t be without a step backward on the part of some physicians along the way who join the group and then decide they want to do something differently. We at ProAssurance think of it in this way. Our historical customer has been the solo practitioner of the small group physician that’s why we were founded and that’s why we issued our first policy in 1977 to attract and to ensure that type of physician. As time went on, we began to insure hospitals, and as time went on through our mergers and acquisitions, we acquired organizations that are insured much larger groups. We now have the geographic reach and the financial ability to ensure these very large sophisticated healthcare organizations. And that’s going to create opportunities for us in several respects. First, if you’re a large group of physicians or if you’re a large hospital group, you’re not likely going to be comfortable purchasing your insurance from an insurance company that writes only in one or two states…

And how is your experience been recently on those sorts of opportunities?

We see them, you don't catch everything. We have a lot of books in the water and we think that they will pay off appropriately. From our standpoint, we want to make sure that when we write these risks that a) we write them in an appropriate price. We’re not interested in being a loss leader. And secondly, we want to make sure that as we write these risks, there is a common understanding of the benefits and advantages we bring to the table and an appreciation on the part of our customer of those advantages. We don't write everything that we quote but we like our position and we like the results thus far and often times in this business what starts off as a small creek increases in size as time goes along and we expect that to be the case here.

The favorable development the ceded losses, a way to think that you wouldn’t see as much volatility or as much a backend loaded development going forward, if you started to recognize that on a quarterly basis, does that mean 4Q is left like (inaudible) it has been like for a couple of years?

Mark, this is Howard. Presumably, yes, if as we evaluate each quarter and to the extent that we think that a change in the ceded portion of the loss reserves indicated than that would alleviate some of the larger changes that we’ve had in the past in the fourth quarter. It really gets more to a matter of sort of comfort or confidence in what we’re seeing in excess loss area broader experience, a little bit more stability than maybe we’ve had in the past. So, we felt that it was an appropriate change to make.

Thank you.

And we will here next from Ryan Byrnes with Langen McAlenney.

Hi, good morning everybody and…

Hi, Ryan.

Congrats Vic for a very long successful career. But just quickly just on the last point to follow-up on Mark there. Do you guys have the magnitude of, I guess in the fourth quarter reserve release, I guess from the ceded the reinsurance adjustment, just want to see the magnitude of that, if you had the available?

Not off the top what we’re looking here, if you have another question, go on.

Okay, sure, yeah, yeah. Yeah, so the other thing else have noticed, I guess the expense ratio had uptick obviously I’m sure its partially from kind of bringing the new deals on, but just want to see what a clean run rate is, maybe if you can give some of those figures as to what its kind of non recurring there?

Non-recurring expenses for the quarter?

Yeah.

Mainly they are around the close of the transaction, if you give just a second we will…

Sure.

I want to say they are in the neighborhood of a million of the three but want to confirm now.

Sure. Okay. Sorry for –

That’s all right.

Maybe quickly just may be an update on kind of claim frequency for the core physicians’ book; is that still on flattish area?

Frequency, we are still looking for the other number for you.

Thank you, guys.

Frequency as I mentioned in the prepared remarks pretty flat, we always see some variation when we look at it by state, nothing that we see that is out of the ordinary we will see a state maybe move up in one quarter, and move down in the next and it has more to do with this sort of the timing of lawsuit filings and anything else right now.

And Ryan, let me go back, so on the expense, there is about $2.9 million kind of non-recurring expenses in the first quarter, $1.8 million of that relates to the transaction -- closing of the transactions. And $1.1 million just relates to when cost get incurred particularly with the new acquisitions. They have some front loaded costs that was occurring in the first quarter. So they are non-recurring for the rest of the year but on an annual basis they are ordinary expenses and that’s about $1.1 million of cost.

Got you. Great, thank you.

Ryan, this is Howard. Back on your first question the adjustment in the fourth quarter of 2012 to ceded reserves related to prior year was $49.4 million.

Great. I appreciate the (inaudible). Thanks again. Sorry for the tough question.

And we will hear next from Howard Flinker with Flinker & Company. Howard Flinker - Flinker & Company: Good morning.

Good morning, Howie. Howard Flinker with Flinker & Company: Ned, do I deduce correctly that the $35 million mark up for Medmarc is the same both pre tax and post tax in the income statements?

Yeah, it’s how you are doing? A non-taxable gain. Howard Flinker with Flinker & Company: Right, okay. Thank you

Sure.

(Operator Instructions). And we do have couple of follow up questions, if we have time to take those.

Absolutely.

We will go to a follow up from Ray Iardella with Macquarie.

Thanks for taking the follow up. Ned, maybe I know one of your favorite topics as excess capital and sort of the impact on ROE. But and I guess everyone definition of excess capital is a little bit different. But I mean, how should we think about an ROE drag additional capital, I guess you guys are holding in excess of what you need to operate the business?

That’s a tough question Ray. I think everything does have their opinion. From a pricing standpoint, we are pricing to a 13% percent or 14% ROE target and that is assumes a one-to-one premium in the surplus ratio. So that’s how we approach the business from a pricing standpoint. However, I don’t think that we could operate on a one-to-one basis. And maintain our A rating and we probably could operate on a 1.3, 1.4 something like that surplus to premium. And so I guess if you want to get very technical about it, you could look at it in that regard. We think it’s important to maintain capital to take advantage of opportunities in the marketplace and M&A opportunities. And so we would factor that into the capital that out that we need to hold. But everyone is going to have their take on it. And the other thing to keep in mind from – I guess from a rating agencies standpoint is, any drastic change in anything kind of troubles to rating agencies and would be impactful to our ratings. So we want to be conscious of that well.

Okay. And then maybe thinking about the tax credits in the quarter, I’m not sure, if I can tell look into the Q, if you guys increase the allocation to that, maybe can you talk about sort of the expectation of that line item going forward?

Absolutely, we did increase the allocation of the tax credit and particularly we did one kind of private deal that’s got a financial guarantee wrapped to it that increased our allocation. The other thing that’s happening with the tax credit is, my guess they are seasoning, but as you get into out years in the tax credit, the amount of available credits increases and so you are seeing that in the quarter as well. And so we would expect to see the tax credit increase for about $7 million in income. So that is, that’s kind of where we would see the tax. There is suppose an increase in the absolute amount of tax credits, but also the tax credits that we have been holding are (inaudible).

Okay, that’s helpful. Thanks again for taking the follow-up.

Sure.

And we will go to a follow up question from Mark Hughes with SunTrust.

Yeah, thank you. Just maybe a little bit more on the competitive environment things like the pricing trend if we look over the last 3 quarters. Q3 with up a little bit, Q4 is flat, Q1 down a point, there is some new players and new behavior out there?

This is Howard. No really not in the sense of any new players, in terms of the behavior, I think, as you get further along in this cycle, I think with premiums coming down for many companies particularly some of the smaller companies become more aggressive and trying to hang on to business. We also see a lot more competition as I mentioned earlier on the large account physician business. I think it maybe a reflection of reaction to the consolidation of providers as they move into larger groups, they have more bargaining power. And also they become more attractive targets for companies that are trying to either maintain or possibly even grow their premium volume. If you go back, I was just looking at the notes from the Q4 call a couple of months ago and I had laid out some targets in the sense, we have said we are trying to achieve 88% to 91% retention in general and -2 to +2 on rate. And in very general terms, and we can’t control that from quarter-to-quarter. And I think that’s what you are saying here. So, this quarter maybe a little low on the retention side but within the range on rates, and if you look back over the average of the past 4 quarters it’s been within those parameters.

Howard, anyway to characterize, you talk about typical impact smaller players wanting to hold on to their policyholders, more competition larger account physician business visits, is this is bad as a guess or does it gets a little bit more (inaudible), what’s your say?

Oh, it’s hard to say. I mean each cycle is different. I think we have certainly seen worse 12, 14 years ago, and that late 90s range, where not only was the pricing coming down but there was pretty significant erosion on terms, multi-year rate guarantees, and multi-year policies and things like that. I don’t think we are seeing that (network). Certainly we are not seeing any significant amount of that right now. But I don’t know that we are going to get there either. I think it really just depends on the mix of players and it’s different this time, and you have many of the commercial carriers that are not actively in the physician marketplace even though they are very active in the hospital market and that’s a different from prior cycles.

I think you add – also like to add my congratulation to Vic, good luck.

Thank you.

(Operator Instructions). And it appears that there are no further phone questions at this point in time. Frank O’Neil: All right. Vic, I will put on the spot any retiring words.

Thank you, Frank. Certainly, we are going to have a little gathering here at the company and I’m going to say all my internal words, but I do appreciate the opportunity to work with the market over the years, the analyst, the investors, its been a wonderful learning and very great experience for me and I appreciate all the following that the market has given to ProAssurance. Frank O’Neil: And with that Jenny we will disconnect and invite everybody back to speak with us in August when we discuss second quarter results.

Again, that concludes the call. We’ll like to thank everyone for their participation today.