Transcript of Second Quarter 2013 Earnings Conference Call Q&A Participants Jason Bogart VP, Branch Operations Ron Hallenbeck VP, EMC Re President and COO Kevin Hovick EVP and Chief Operating Officer Ron Jean EVP for Corporate Development Mick Lovell VP, Business Development Mark Reese SVP and CFO Kelvin Sederburg VP and Appointed Actuary Lisa Simonetta SVP, Claims Lisa Stange VP, Chief Investment Officer and Treasurer Steve Walsh Director, Investor Relations Analysts Neil Cybart - KBW Presentation Operator Good morning and welcome to the Second 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. Steve Walsh Director, Investor Relations Good morning everyone, and welcome to s 2013 Second Quarter Earnings call. A copy of the press release is available on the investor relations page of our website, which can be found at http://www.emcins.com/ir. The webcast for replay purposes is also available at this site until November 8, 2013. 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 second quarter earnings release with accompanying financial tables issued earlier today. In 1
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. Mr. Kevin Hovick, Executive Vice President and Chief Operating 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 Executive Vice President & COO, Kevin Hovick. Kevin Hovick Executive Vice President and Chief Operating Officer Thank you Steve, and welcome to those joining us this morning. Before I comment on our second quarter results, we have some unfortunate news to report. One of our former board members, George Carpenter III, passed away on August 2 nd. George was a director since 1981, and most recently served as Chairman of the Board for five-and-a-half years until his resignation in May. We benefitted greatly from his management experience and supervisory abilities. We will remember the expertise and guidance that he generously gave the Company. Our thoughts and prayers are with his family at this time. We will miss George, his insight and his leadership, and we thank him for his contributions. Turning to our results, earlier today we reported operating income of $0.47 per share and net income of $0.48 per share for the second quarter of 2013, compared to an operating loss of $0.14 per share and a net loss of $0.20 per share in 2012. For the most part, trends from the first quarter continued through the second quarter as premium rate level increases in our commercial lines of business remained in the upper-single-digits and catastrophe and storm losses were within expectations and consistent with our most recent ten-year average. Our core book of business is performing well and consolidated results are in line with the projections laid out at the beginning of the year; however, there have been some variations by segment. Rate level increases continue to outpace the industry average. We attribute this outperformance to the diligent efforts of our branch offices and the tools we have developed to support their efforts, such as our Rate Compare system. This proprietary system is a unique and powerful online system that rates exposures of commercial renewal policies at both current and prior period rates. It provides a very accurate measure of the actual rate increase obtained by policy, underwriter, line of business or branch, and gives us the ability to drill down on aggregate results to whatever level of detail we want in nearly real time. This allows us to better match the actual rate level change with the rate level needed on each policy based on past loss experience, current risk exposure and future profit potential. The recent rise in interest rates has not changed our strategy to seek more adequate rate levels. We remain optimistic that the pace of rate level increases achieved in the first half of the year will continue for the remainder of the year, and will continue to stress improvement in our underwriting margins. Premium rates in the reinsurance market declined somewhat during the second quarter of 2013; however, it is too early 2
to predict what premium rate levels will be in January, 2014, when the majority of the reinsurance segment s contracts renew. Premium income was up 11 percent in the property and casualty insurance segment, with the vast majority of the growth associated with renewal business in our commercial lines. We are also seeing new opportunities to expand our program business, which largely consists of schools, municipalities, and other similar commercial accounts, to make it available on a broader basis. Premium rate levels increased at all branch locations and across all major lines of business. The growth in our six major lines of commercial business reflects a combination of rate level increases, growth in insured exposures on existing accounts and an increase in retained policies. Premium rates across our commercial business increased approximately 7.5 percent in the second quarter. Premium rates across our personal lines of business increased approximately 8.8 percent; however, premium income was relatively flat due to an intentional reduction in policy count to lessen exposure concentrations. Commercial lines policy count was up 1.1 percent, while personal lines policy count was down 9.2 percent. Premium income was up 30.9 percent in the reinsurance segment. Mark Reese will have more detail on this during his remarks. Net written premiums increased 15 percent in the second quarter of 2013. In the property and casualty insurance segment, net written premiums in the commercial lines of business were up 11.4 percent, while the personal lines of business were down 4.5 percent. Net written premiums were up 41.5 percent in the reinsurance segment in the second quarter. Retention: Retention levels based on policy count remained strong and above industry average with an overall retention level of 86 percent compared to 88 percent in the prior year. Retention levels were down slightly in both the commercial and personal lines of business, with personal lines showing a slightly larger decline due to our intentional reduction in policy count to lessen exposure concentrations. 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 stated last quarter, these are targeted rate level increases rather than across the board mandates for every policy. Retention levels in the mid-to-upper 80 percent 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. Balance Sheet: Book value of the Company s stock decreased 1.1 percent to $30.75 per share from $31.08 at December 31, 2012, reflecting a decline in the fair value of the fixed maturity portfolio due to the recent increase in interest rates. Excluding 3
accumulated other comprehensive income from the calculation, book value increased 4.1 percent to $28.50 per share from $27.38 per share at year-end 2012. While the recent rise in interest rates resulted in a significant reduction in net unrealized investment gains on our fixed maturity portfolio, it will have a positive impact on future investment income. However, I would point out that the current interest rate level, while up somewhat, is still below the average coupon rate of our fixed maturity portfolio and will result in continued reductions in future net investment income. Agent Satisfaction: Before I turn the discussion over to Mark Reese, I would like to mention a recent agent survey we had a third-party vendor conduct on our behalf. We have received wonderful feedback from our agents about our strengths, what is important to them and where we have opportunities to improve. We currently have initiatives underway that should allow us to capitalize on these opportunities and continue to improve the ease of placing business with EMC. With that, I ll turn the discussion over to Mark Reese, our Chief Financial Officer. Mark Reese Senior Vice President and Chief Financial Officer Thank you Kevin, and good morning everyone. Net income, including net realized investment gains and losses, totaled $20.5 million, or $1.58 per share, for the six months ended June 30, 2013, compared to $16.6 million, or $1.29 per share, in the prior year period. The increase in net income is primarily attributed to improved underwriting results in both of the Company s operating segments as ongoing rate increases, coupled with careful risk selections, have produced a strong core book of business. Earlier on the call, Kevin noted that premium income was up 30.9 percent in the reinsurance segment in the second quarter. This increase reflects a significant increase in premiums earned on policies written in the prior contract year, moderate rate level increases and the addition of some new business. This increase also reflects a negative $2.7 million earned but not reported,(also known as EBNR) premium adjustment recorded during the second quarter of 2012 in connection with a new offshore energy and liability proportional account that Employers Mutual began participating in effective January 1, 2012. Corresponding decreases in incurred but not reported loss reserves and commission expense reserves were also recorded, resulting in an after-tax impact of less than $100,000. If the EBNR premium estimate resulting from the more refined actuarial analysis had been utilized at March 31, 2012, premiums earned during the three months ended June 30, 2012 would have been approximately $3.1 million higher, and the percentage increase reported for the three months ended June 30, 2013 would have been approximately 16.1 percentage points lower. The reported increase in premiums earned for the six months ended June 30, 2013, was not impacted by the negative EBNR premium adjustment recorded during the second quarter of 2012. 4
Losses and Settlement Expenses: Losses and settlement expenses increased 0.6 percent in the second quarter, while the loss and settlement expense ratio decreased to 70.0 percent from 80.2 percent for the same period in 2012. The improvement in the loss and settlement expense ratio reflects improved rate adequacy, a moderately lower impact from catastrophe and storm losses and better than expected second quarter results in the reinsurance segment. In the release this morning we stated there had been some variations by segment, which are most evident in the reported amounts of catastrophe and storm losses and reserve development. Events impacting the second quarter included a windstorm in Omaha and tornados in St. Louis, Kansas, and Moore, Oklahoma. Second quarter 2013 catastrophe and storm losses accounted for 16.8 percentage points of the combined ratio, which is consistent with the Company s most recent 10-year average of 16.9 percentage points and well below the 22.5 percentage points experienced in the second quarter of 2012. It is important to note that the 10-year average includes the record second quarter catastrophe and storm losses of 2011 and 2008. The portion of the combined ratio attributed to catastrophe and storm losses declined by about three and a half percentage points in the property and casualty insurance segment and by approximately 13 percentage points in the reinsurance segment. There were no catastrophe and storm loss events during the second quarter in the reinsurance segment that exceeded the $4 million retention level under the terms of the excess of loss agreement. As a reminder, under the 2013 terms of the excess of loss agreement, we retain the first $4 million of losses per event, and also retain 20 percent of any losses between $4 million and $10 million and 10 percent of any losses between $10 million and $50 million, at a cost of 9 percent of total assumed reinsurance premiums written. Excluding the impact of catastrophe and storm losses, overall claims frequency increased approximately 0.1 percent and claims severity increased approximately 1.6 percent. Our rate level increases once again greatly exceeded our loss cost trend, allowing more premium income to flow through to the bottom line. Large losses, which we define as losses greater than $500,000 for the EMC Insurance Companies pool, excluding catastrophe and storm losses, increased slightly to $6.5 million, or $0.33 per share after tax, in the second quarter of 2013, from $6.1 million, or $0.31 per share after tax, in the prior year quarter. We experienced favorable development on prior years reserves of $2.1 million in the second quarter, compared to $1.4 million in the prior year quarter. In the property and casualty insurance segment, development on prior years reserves declined sharply in the second quarter due to a large adverse jury decision, as well as the reallocation of bulk reserves by accident year that occurred at year-end 2012. The reinsurance segment experienced favorable development on prior years reserves of $2.8 million in the current quarter compared to adverse development of $3.1 million in the prior year period. The adverse development experienced during the second quarter of 2012 was primarily associated with the 2011 accident year in the HORAD book of business. 5
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 therefore should not be considered a reliable factor in assessing the adequacy of the Company s carried reserves. The most recent actuarial analysis of our carried reserves indicates a level of adequacy that is consistent with other recent evaluations. From management s perspective, this measure is more relevant to an understanding of the Company s results of operations than the composition of the underwriting results between the current and prior accident years. Investment Results: Turning to our investment results, investment income declined 1.0 percent in the second quarter, primarily due to the prolonged low interest rate environment. It should be noted that this decline in investment income reflects a $170,000 increase in the amount of funds received from the settlement of securities litigation. Excluding this amount, the decline in investment income would have been 2.5 percent. The average coupon rate on our fixed maturity portfolio remained relatively flat at 4.26 percent at June 30, 2013 compared to 4.23 percent at year-end 2012. The effective duration of the fixed maturity portfolio increased to 5.55 from 4.20 at the end of 2012. The recent rise in interest rates lengthened the duration of the portfolio by approximately 0.5 due to the expected impact on callable bonds, while the remaining 0.9 increase was due to the investment of cash, primarily into municipal securities. We don t want our duration to get much longer, so I expect it to remain fairly steady or possibly come down a little in future quarters. Total return on the equity portfolio was 1.68 percent for the quarter and 13.17 percent year-to-date, compared to 2.91 percent and 13.82 percent for the S&P 500. Capital Management: No shares have been repurchased under the Company s $15 million stock repurchase program that was put in place in November of 2011. 2013 Operating Income Guidance: Based on results for the first six months of 2013 and management s expectations for the remainder of the year, management is reaffirming its 2013 operating income guidance of $2.40 to $2.65 per share. This guidance is based on a projected GAAP combined ratio of 99.2 percent and a projected mid-single-digit decline in investment income for the year. At this time, we are ready to open the call for questions. Operator Our first question comes from the line of Neil Cybart from KBW. <Q>: My first question is on your guidance range. I assume you are waiting to see third quarter storms, but is there anything else underlying guidance, say maybe assumptions for more normalized reinsurance results in the second half of 2013? 6
Mark Reese Senior Vice President and Chief Financial Officer Well, our current internal calculation on guidance is well within the range that we have published right now. We recognize that third quarter can be a pretty volatile quarter, so depending what happens during that time period we ll re-evaluate our guidance and possibly refine it if necessary. But at this point all or our indications are that our current guidance is appropriate. <Q>: Could you remind me the process of revising your guidance? I recall you mentioned if it s over a certain percent you would announce at a certain time. Mark Reese Senior Vice President and Chief Financial Officer Sure. If we choose to refine guidance and the refined guidance is more or less than 10 percent of our current guidance range we would do a pre-announcement, anything less than that we would do the announcement during our third quarter earnings call. <Q>: Moving on, thank you for the rate commentary, is there any way to break that in to what you re seeing with property rates versus casualty rates? Kevin Hovick Executive Vice President and Chief Operating Officer Neil, we ve got a couple of folks in here; Mick Lovell, do you have something on that or Scott Jean? I d say we re probably getting a little bit more on property rates than we re getting on casualty rates; it s not significantly more but we are getting a little bit more on the property side. <Q>: Have you see any change in terms of more normalized cats and maybe larger players becoming a little bit more interested in cat property? I guess from my perspective so far this year we haven t necessarily seen that. I think a lot of it may depend upon or it s possible it may depend upon what happens in the third quarter with hurricane activity and other storms. <Q>: Is there any way to break your P&C growth up in to mix of rate insured exposure and retention, how much each made up? Yes I can provide that for you. Most of it is coming from rates; although, we have seen a pretty good increase in our insured exposure as well. <Q>: So probably more maybe 75/25 something like that? Yes. Looking at the total, of our increase, about 25 percent of it is coming from the assumed reinsurance side, the growth there, but then the majority of the rest of it is coming from increases in rate levels on the pool side on the P&C side, and then the 7
increased exposures. Of the total premium change five and a half to six of those points are coming directly from rate levels, another 1.5 points or around there is coming from changes in exposure. <Q>: My final question, I guess taking a step back where are you seeing opportunities today? You mentioned the program business. Maybe any additional information on that, and maybe have you changed focus in recent months given the change in landscape maybe due to competitors or really anything you can give I would appreciate? Jason Bogart VP, Branch Operations We really are feeling like, continuing to execute like we have in our Branch operations is the key to the future, focusing on our agency relationships and providing them great service and underwriting expertise. We re not really looking to significantly change the territories we operate in, significantly change the types of business that we re going to seek. We think that we just need to keep focus on what we ve been focusing on and that s working for us. Mick Lovell VP, Business Development I ll add just a little bit more to that too. Through the early part of 2013 we ve seen a little bit of uptick in the manufacturing and retail segments. Our new business is slightly outpacing our renewal book in those two segments. We ve got about eight or nine states that are poised to add pretty significant new business this year in the $8 million to $10 million range. We ve got five of those that are seeing good growth in new business currently, Minnesota, Michigan, North Carolina, Illinois and Nebraska are some that come to mind, and the nice part about it is those are fueled by across the board, across industry increases. It s not a single line of business or a single industry that s fueling that growth. We re seeing good broad-based growth in many territories. Operator Mr. Walsh, there are no further questions at this time. I d like to turn the floor back over to you for closing comments. Steve Walsh Director, 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 http://www.emcins.com/ir until November 8, 2013, 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. Have a great day. Operator This concludes today s teleconference. You may disconnect your lines at this time. Thank you for your participation. 8