Transcript of Participants Bruce Kelley President and Chief Executive Officer Larry Hamling Vice President, Financial Reporting Presentation Operator Good afternoon and welcome to s 2014 Third Quarter 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. Good afternoon everyone, and welcome to s 2014 Third Quarter Earnings call. A copy of the press release is available on the Investor Relations page of our website, which can be found at www.emcins.com/ir. The webcast is also available on this site for replay purposes until February 7, 2015. 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 2014 third quarter earnings release with accompanying financial tables issued earlier today. In addition, certain non-gaap terms may be used during today s discussions. Please refer to the Company s press release and/or SEC filings for a description and reconciliation of these terms. Mr. Bruce Kelley, President and Chief Executive Officer, and Mr. Larry Hamling, Vice President of Financial Reporting, have prepared remarks this afternoon, and other executive officers are available to answer questions. At this time, it is my pleasure to introduce the Company s President and CEO, Bruce Kelley. Bruce Kelley President and Chief Executive Officer Thank you Steve, and welcome to those joining us this afternoon. Due to scheduling conflicts, we were unable to have this call at our regular time in the morning, so we appreciate you joining us this afternoon. One other housekeeping item: Mark Reese, our Senior Vice President and Chief Financial Officer, who typically has prepared remarks on earnings calls, is out today with the flu, so Larry Hamling will be filling in. Earlier today we reported operating income of $0.18 per share and net income of $0.16 per share for the third quarter, compared to operating income of $0.50 per share and net income of $0.55 per share in 2013. In an announcement on October 24 th, we estimated operating income would be in the range of $0.11 to $0.15 per
share, but subsequently had a small revision to the financial statements that increased operating results outside the previously announced range. Operating results for the third quarter were below expectations considering the relatively benign quarter for industry-wide catastrophe and storm losses, as carryover losses from weather events that occurred late in the second quarter were higher than expected. This was a contributing factor in the operating results of our reinsurance segment, which produced a combined ratio of 117.7 percent for the quarter, compared to 91.2 percent in the prior year quarter, and was responsible for much of the increase in the GAAP combined ratio from 100.8 percent in 2013 to 107.1 percent in 2014. In addition, large losses, which we define as losses greater than $500,000 for EMC Insurance Companies pool, excluding catastrophe and storm losses, were elevated in the quarter and year to date, due to an increase in the number of severe fire-related losses and commercial auto losses. Improved premium rate adequacy achieved over the past several years in the property and casualty insurance segment reduced the impact these losses otherwise would have had on our results. Net written premium growth for the quarter remained in the mid-single digits in the property and casualty insurance segment, growing 7.2 percent. Net written premiums in commercial lines of business were up 8.8 percent, while personal lines of business were down 6.8 percent due to an intentional reduction in policy count to lessen exposure concentrations. Commercial lines policy count for the first nine months was up 2 percent, while personal lines policy count was down 9.9 percent. Renewal rates across our commercial lines of business increased approximately 4.7 percent and personal lines of business increased approximately 3.4 percent during the first nine months of 2014, as premium rate levels increased at all branch locations and across all major lines of business. Renewal rate increases have slowed across most lines of business as the year has progressed; however, certain lines of business, like businessowners, commercial auto and commercial property are receiving larger increases of between 6 percent and 7 percent, while renewal rates in workers compensation, which has performed well for us this year, are up 1.9 percent. We anticipate that we will continue to implement rate level increases in the property and casualty insurance segment during the fourth quarter, and into 2015. Premium income was up 4.5 percent for the quarter. In the property and casualty insurance segment, premiums earned increased 7.9 percent, with the vast majority of the growth attributable to rate level increases on renewal business and, to a lesser extent, growth in insured exposures. Commercial new business policy counts are up a modest 1 percent, as new accounts are carefully selected. As previously noted, we continue to grow new business in the Northwest, Southwest and Southeast parts of the United States at a slightly faster clip than other regions, and generally expect this trend to continue. This growth helps diversify the Company s book of business geographically, while staying consistent with the industry and line of business mix of the existing book of business. In the reinsurance segment, net written premiums were down 8.7 percent and premiums earned were down 5.9 percent due to a change in the premium recognition period of two large facility contracts, which Larry Hamling will discuss in more detail during his remarks. While the reinsurance marketplace remains challenging, we are cautiously optimistic that overall 2015 premiums will exceed those of 2014. Retention: Retention levels based on policy count remained strong and above industry averages, with commercial lines of business at 86.7 percent, personal lines of business at 84.4 percent and an overall retention level of 85.7 percent, which approximates the retention level at the end of 2013. 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 group business contained in our core book of business. This business tends to consistently renew because of marketing strategies designed to reward favorable loss experience. Page 2
We are pleased that we have been able to continue to obtain rate level increases while maintaining our consistent, high retention level. The balance between rate and retention over the past few years would not have been possible without our strong, stable partnerships with our independent agents, the tireless efforts of our branch offices, and our sophisticated underwriting and pricing tools. Balance Sheet: Book value of the Company s stock increased 4.9 percent to $35.89 per share, from $34.21 per share at year-end 2013. Excluding accumulated other comprehensive income from the calculation, book value increased slightly to $30.11 per share from $29.78 per share at year-end 2013. Other Items: Before I turn the call over to Larry, I would like to take a minute to discuss the recent recognition we received from an insurance agency group. We are continuously trying to improve the agent experience and promote our ease of doing business with agencies. With that in mind, we are proud of the award EMC recently received - The Best Practices Award for Excellence from the Independent Insurance Agents & Brokers of America, also known as the Big I. EMC Insurance was one of three recipients of this award out of 30 carrier members represented on the Big I Best Practices Council. The award recognizes those companies that have made outstanding and unique contributions advocating Best Practices philosophies, which enhance the independent agency system and improve agency performance. In addition to improving the agent s experience, we always strive to improve the policyholder experience. While outstanding service has been part of our culture since our founding more than 103 years ago, we are constantly working to improve that service, including the rollout of commercial policyholder access next week, which will allow commercial insurance policyholders to more effectively manage their business with EMC, by being able to do such things as view their policy, review billing and claims information, access loss control resources, and manage notifications. In addition, personal lines customers can now report auto claims quickly and easily from their mobile devices. It is my bittersweet pleasure to thank Ron Jean, Executive Vice President for Corporate Development, who as previously announced, is retiring on January 2 nd after nearly 36 years with EMC. After a nationwide search, Ron was hired to start our actuarial department in 1979. The capabilities and responsibilities of this department have expanded greatly beyond pricing and reserving to include sophisticated modeling and analytics. Ron also started our Corporate Communications, Employee Development and Program Management Office departments as his responsibilities have grown during his tenure. Ron will be missed and we wish him well in retirement. Fortunately, Ron will continue to serve on the Board of Directors for s parent company, Employers Mutual Casualty Company, so we will continue to benefit from his profound expertise, vast experience, and excellent judgment. As previously announced, upon Ron s retirement, the executive management responsibilities will be restructured. In connection with this restructuring, Scott Jean, Senior Vice President and Chief Actuary, will assume the newly created position of Executive Vice President for Finance & Analytics. Scott has been employed by Employers Mutual since 1993 and was Vice President-Chief Actuary from 2009 until October 31 st of this year. In addition, Mick Lovell, Senior Vice President of Business Development, will assume the position of Executive Vice President for Corporate Development. Mick has been employed by Employers Mutual since 2003 and was Vice President from 2009 until October 31 st of this year. We look forward to the continued, valuable contributions from Scott and Mick to our success in their new and expanded executive management roles. With that, I ll turn the discussion over to Larry Hamling, Vice President of Financial Reporting. Larry Hamling Vice President, Financial Reporting Page 3
Thank you Bruce, and good afternoon everyone. As Bruce mentioned earlier on the call, premiums earned and written in the reinsurance segment were both down due to a change in the premium recognition period of two large facility contracts. Upon completion of the 2014 renewal of these facility contracts, a detailed analysis of the underlying contracts in these facilities was completed, and it was determined that the vast majority of them do not attach until January 1, 2015, or later. Therefore, most of the premium income associated with the 2014 facility contracts will not be recognized until calendar year 2015. In 2013, twelve months of premiums were appropriately earned on these facility contracts, with four months of premium income stemming from the 2012 facility contracts and eight months of premium income stemming from the 2013 facility contracts. This change in premium recognition did not have a material impact on the third quarter results because corresponding adjustments were made to incurred but not reported (IBNR) loss reserves, commission expense reserves and the cost of the excess of loss reinsurance protection. A detailed review of the premium recognition period of all remaining pro rata contracts will be completed before year-end. Any adjustments to earned premiums that become necessary as a result of this review will be recorded in the fourth quarter, along with corresponding adjustments to IBNR loss reserves, commission expense reserves and the cost of the excess of loss reinsurance protection. As a result, the after-tax impact of any fourth quarter adjustments is not expected to be material. Losses and Settlement Expenses: The loss and settlement expense ratio increased to 77.1 percent in the third quarter, from 66.7 percent in the prior year, as both segments experienced increases. The increase in the reinsurance segment was caused by an increase in catastrophe and storm losses, and an increase in loss severity attributed to a number of fire losses and some crop hail losses. The decline in premiums earned also contributed to the increase in the loss and settlement expense ratio. In the property and casualty insurance segment, the increase in the loss and settlement expense ratio was primarily due to an increase in large losses and under-performance of the underlying book of business. Third quarter catastrophe and storm losses accounted for 12.6 percentage points of the combined ratio, which is below the Company s most recent 10-year average of 14.5 percentage points, but above the 11.4 percentage points experienced in the third quarter of 2013. The reinsurance segment had a significant amount of additional losses reported in the third quarter that occurred during the second quarter. One of these losses marginally exceeded the $4 million retention level contained in the excess of loss agreement. We experienced favorable development on prior years reserves of $1.7 million in the third quarter, compared to $1.3 million in the prior year quarter. The most recent actuarial analysis of the Company s carried reserves indicates that carried reserves remain within the top quartile of the range of reasonable reserves. Over the past several years, the property and casualty insurance segment has consistently reported favorable development on prior years reserves. During this same time, our commercial auto line of business has seen an increase in adverse development. After analyzing the current year commercial auto losses, and their associated reserves, there is evidence to suggest that the case reserves are now being set at more adequate levels in the current accident year. To establish adequate reserves in a timely manner, commercial auto losses are being reviewed early in their life cycle. Large losses increased to $9.7 million or $0.47 per share after tax, in the third quarter of 2014, from $5.8 million, or $0.29 per share after tax, in the third quarter of 2013. Fire-related losses and commercial auto losses have been elevated throughout the first nine months of 2014. We have had an increase in the frequency of large homeowners and commercial property losses as a result of fires, which affects severity. The fire losses are not showing any patterns or trends across our 16 branch offices, the states we serve, or by industry. As for commercial auto, we have seen, as have other commercial insurance carriers, an increase in large losses in the commercial auto line of business due primarily to an increase in severity. We are carefully analyzing our commercial auto accounts and taking steps to identify and mitigate the Page 4
causes of these losses. In addition, as commercial auto policies renew, we continue to evaluate the underlying exposures to ensure we are getting an adequate price for the risks we are insuring. Claims frequency and severity were both higher than expected through the first nine months of the year due to losses stemming from the severe winter weather during the first quarter, convective storms during the second quarter, and increased frequency and severity of fire related losses and commercial auto losses. Renewal rate increases continue to exceed our estimated long-term loss cost trend. Employee Retirement Plans: Results for the third quarter of 2014 reflect a significant reduction in the amount of pension and postretirement benefit costs allocated to the Company. Pension benefit cost declined to $170,000 in the third quarter of 2014 from $753,000 in the same period in 2013. This decline reflects an increase in the expected return on plan assets, due to an increase in plan assets, and a decline in the amount of net actuarial loss amortized into expense. Postretirement benefit cost changed significantly as a result of the plan amendment that was announced in the fourth quarter of 2013. The Company recognized postretirement benefit income of $770,000 in the third quarter of 2014, compared to postretirement benefit expense of $728,000 in the same period in 2013. The plan amendment created a large prior service credit that is being amortized into expense over 10 years. In addition, the service cost and interest cost components of the revised plan s benefit cost are significantly lower than those of the prior plan. Investment Results: Turning to our investment results, net investment income increased 9.1 percent for the quarter and 7.5 percent for the first nine months of the year. These increases primarily reflect a higher average invested balance in fixed maturity securities and an increase in dividend income. The average coupon rate on our fixed maturity portfolio, excluding interest-only securities, declined slightly to 3.8 percent at September 30, 2014 from 4 percent at year-end 2013. The effective duration of the fixed maturity portfolio, excluding interest only securities, decreased to 4.9 from 5.7 at year-end 2013. Duration contracted as interest rates declined. Total return on the equity portfolio was 1.1 percent for the quarter and 9.3 percent year-to-date, compared to 1.1 percent and 8.3 percent for the S&P 500. During the first quarter of 2014, we invested in a limited partnership that is designed to help protect the Company from a sudden and significant decline in the value of its equity portfolio. The carrying value of this limited partnership declined approximately $0.6 million and $1.4 million after tax during the third quarter and first nine months of 2014. These declines are reported as realized investment losses for those periods. Capital Management: No shares have been repurchased under the Company s $15 million stock repurchase program that was authorized in November of 2011. At this time, we are ready to open the call for questions. Operator (Instructions given) 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 www.emcins.com/ir until February 7, 2015, and a transcript of this conference call will be available for one year, which can also be accessed from our Investor Relations page. We appreciate your interest in EMC Insurance Group. Have a great day. Page 5