Baldwin and Lyons, Incorporated Q3 2008 (Qtr End 09/30/08) Earnings Call Transcript

Nov. 3.08 | About: Baldwin & (BWINB)

Baldwin and Lyons, Incorporated (NASDAQ:BWINB)

Q3 2008 Earnings Call

November 3, 2008 11:00 am ET

Executives

Leslie Loyet - Vice President, Financial Relations Board

Gary W. Miller - Chairman and Chief Executive Officer

Joseph J. DeVito – President and Chief Operating Officer

G. Patrick Corydon – Executive Vice President and Chief Financial Officer

Analysts

Chris [Gaffen] – Equity Portfolio Unlimited Partnerships

Operator

Good day, everyone, and welcome to today’s Baldwin and Lyons Incorporated third quarter earnings 2008 conference call. Today’s call is being recorded. At this time for opening remarks and introductions, I would like to turn the call over to Leslie Loyet of the Financial Relations Board. Please go ahead.

Leslie Loyet

Thank you and thank you all for joining us this morning for the Baldwin and Lyons third quarter 2008 conference call. If you did not receive a copy of the press release, you may access it online at the company’s website which is www.baldwinandlyons.com. I would like to remind everyone that we are hosting a live webcast of the call which may be accessed again on the company’s website as well.

At this time, management would like me to inform you that certain statements made during this conference call and in the press release which are not historical may be forward looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Although Baldwin and Lyons believes the expectations reflected in any forward looking statements are based on reasonable assumptions it can give no assurance that its expectations will be obtained.

Factors and risks that could cause the actual results to differ materially from expectations are detailed in the press release and from time to time with the company’s filings with the SEC. And now, I would like to introduce Gary Miller, Chairman and Chief Executive Officer of Baldwin and Lyons and turn the call over to him. Please go ahead.

Gary W. Miller

Thank you. Good morning to all of you joining us for the Baldwin and Lyons conference call reporting 3rd quarter 2008 results. We are happy you joined us this morning and pleased that you have an interest in our company. My name is Gary Miller. I am the CEO of the company. Joining me on the call this morning are Joe DeVito and Pat Corydon. Joe is President and Chief Operating Officer of the company. Pat is Executive Vice President and Chief Financial Officer of the company.

Continuing the changed format first used last quarter for this call, I will give some highlights and a broad view of the just completed quarter results. Joe will then expand, giving more details on the operations and products that make our business. Pat will go into more detail regarding investment results by presenting some of the numbers and the ratios you have come to expect. As always, we all stand ready to answer any questions you might have at the end of our presentations.

The just completed quarter was challenging. On the operations side, we continued to operate in a very soft insurance market which presents volume and margin challenges. Then we had a major hurricane, causing significant catastrophe losses. On the investment side, the quarter saw the financial equivalent of a hurricane, as financial disruptions were revealed almost daily and equity markets plunged.

With our strong capital structure, while not unaffected by the unfolding events, your company remains strong and solid, with value per share at September 30th, 2008 stands at $22.99, representing a surplus number of $333.9 million. That is down from the beginning of the year by about $37 million reflecting losses, both realized and unrealized, in our investments that were not completely offset by our operating income. Also included in the $37 million in surplus decline were $11.4 million of dividend payments this year, and $6 million for the repurchase of the company’s stock.

Since the first of the year, we have made open market purchases of 287,000 shares of the company’s stock, about 2% of outstanding, at an average below book value price of $21.03. A total of 89,000 shares were re-purchased in the 3rd quarter. Authorization for repurchase of 2.7 million shares remains. Operating income for the quarter was $0.21 per share. We have previously announced $4.4 million pre-tax in hurricane losses for the third quarter.

That is a net loss estimate after [retrosations] in which by the way, that is still a good estimate at this date. Our growth loss is more. When we had projected results by the purchase of the previously mentioned [retrosational] coverage. As a result, Hurricane Ike reduced our quarterly operating results by about $.19 per share.

Joe will have more comments on our other products’ results. In general, all had satisfactory quarters with profitable operations. However, net operating income was not up to the prior year’s or the prior quarter. There were few reserve releases in the quarter and continuing rate softness is having an impact.

There is no need to give a macro view on investment results for the quarter. We have all felt the pain. As you may recall, the company has allocated a portion of its investment portfolio to the limited partnerships. When those partnership participations have a reduction in value due to investment losses, realized or unrealized, we, due to accounting rules, must take that decline as a realized loss through our income statement. That plus losses on our direct security trading accounted for the income statements after tax investment loss of $10.4 million for the quarter and $21.1 million for the year-to-date.

Operating income could not fully offset those investment losses and we therefore reported net losses for the quarter at $7.3 million or $0.48 per share and for the nine months of $5.6 million or $0.37 per share.

Pat will go into more detail regarding investments and how they affected results for the quarter. I do, however, wish to point out that our exposure to the unprecedented financial turmoil seen throughout the world is fully reflected in our income statement and balance sheets. All of our investments are fairly valued. We have no exposure to the various toxic [derivities] or other turbulent investments that remain most difficult for many others to value in their financial statements.

As we have often discussed, partially because of our capital to premium writing ratio, and therefore the lower underwriting risk that produces, we believe more investment risk was prudent and had long significantly invested in equities. That philosophy has served us well in the past although not so well in the just-completed quarter or generally in 2008.

There is no wholesale change planned in this philosophy due to recent investment results. But we do continue to monitor our overall investment approach and our individual investments, positioning ourselves where we believe the best opportunities for increasing value exist. Today that approach is certainly influenced by an overall faith in the ultimate strength of the country’s economy.

I will also report that the previously discussed company’s acquisition of transport insurance agency in Toledo, Ohio was completed last week. Transport insurance agency writes about $20 million in premiums, almost all of which is in transportation insurance and the type of products offered by our subsidiaries, Protective and Sagamore Insurance Companies.

We welcome Rick [Galagos], CEO of Transport, and his staff to the Baldwin family. Our search for other acquisitions, expansion into new products, and alignment with other opportunities continues as Joe will more fully explain.

Now I’ll ask Joe DeVito to further discuss the company’s operations.

Joseph J. DeVito

Last quarter I provided the details of our management realignment which has and will enable us to operate more efficiently and grow more significantly. I also mentioned that as a result of this restructuring, it would be necessary to modify the format by which we report our operational results.

Therefore, today’s presentation represents the company’s new operating structure and reflects the first steps toward the goal of a more efficient and effective usage of all of our resources. Any or all of us would be happy to answer any questions regarding the format at the conclusion of our presentation.

Regarding our property casualty insurance operation which includes all commercial auto products, personal auto, and the independent contractor business, direct written premium was up 3% from the third quarter of 2007 and $7.3 million or 6% year-to-date. Earned premiums were down 4% from the same period last year reflecting decreases in fleet trucking and personal auto.

For the year-to-date, earned premiums were down less than 1% due to 24% growth in the independent contractor segment. Loss ratios were good t 61% for the quarter and 64% year-to-date. They are, however, higher than the excellent 54% and 58% for comparable periods last year.

The differences are almost entirely attributable to decreases in prior year reserve savings for both the quarter and year-to-date. The combined ratio for the quarter was 98% compared to 89% in ’07 and 98.5% for the year compared to 90% for 2007. As expense ratios remained virtually flat, up 1% for the quarter and 2% for the year, the differences were attributable to the previously mentioned reductions in prior year loss reserve savings.

The trucking industry in general remains vulnerable to the weak macro economic conditions but our customers, among the best and most financially sound in the industry, certainly appear to be holding their own as total revenues reported are down only slightly from the second quarter just 2% and actually up 3% year-over-year. As I noted last quarter, there is a variance based upon size, sector, and regional focus. Insurance rates remain very soft and while the number of our accounts enforced has remained relatively stable, it has been necessary to apply selective rate reductions to maintain the business.

I will note, however, that in virtually every case, the loss experienced justifies the rate level activities. As always, while market conditions may certainly influence our pricing and margins may be compressed, all accounts are and will continue to be priced to make a profit. Our independent contractor product continues its steady growth with written premium up 20% from the third quarter of last year and 33% year-to-date.

This growth is attributable to a number of factors including the addition of some new accounts via our new IP2 technology platform and the expansion of our distribution system, allowing for growth from both our direct sales force and carefully selected new broker and agency relationships.

Our personal auto segment’s year-to-date results continue the most recent patterns with declining volume but stable loss ratio. Direct written premium is down 22% year-to-date with the loss ratio improving slightly from 65.4% to 64.6%. However, we see or first glimmer of hope in quite some time. Written premium actually increased almost 8% over the 2nd quarter of ’08. Our scorecard rating, marketing focus, and commitment to service may be paying off.

While much too early to light any candles, we will continue to price appropriately, improve our relationships with our best agents, invest in our technological platform, which by the way, is scalable and transferable to most of our current and planned products and expand geographically. Our new operating structure is working, leveraging all of our internal resources across all product lines thereby reducing immediate volume pressure. However, all segments of this business remain under considerable competitive pressure.

It is too early to determine the impact of recent developments related to the deterioration of many insurance companies’ balance sheets. Our opinion is that the property reinsurance segment of our industry will be impacted first. Hopefully, we will see some pricing stabilization in other lines during 2009. Speaking of the property reinsurance business, our reinsurance assumed products which report directly through Executive Vice President and CFO, Pat Corydon, continue to grow. Direct written premiums were up 5% over the 3rd quarter of 2007 and 23% year to date. Premiums earned increased 4% and 14% for the same period.

Unfortunately, we were not spared the industry-wide hurricane losses and the combined ratio for the quarter was an unprofitable 123%. The loss ratio was 107%. For the year the numbers are 83% combined, including a 64% loss ratio. This compares to 76% and 55% for the comparable period in 2007. As Gary has pointed out many times, quarter-by-quarter results in this segment are somewhat dependent upon a higher power than those of us on this call today.

However, in light of the unusual 3rd quarter activity, the year to date numbers still allow for a nice profit. We anticipate and expect the calendar year to be consistent with that goal. At the end of our presentation, Pat will be happy to answer any more specific questions regarding results in the reinsurance assumed area.

Looking to the future, overall we continue to find the reinsurance assumed segment attractive. As I stated earlier, our opinion is that pricing may be increasing, and we continue to explore our potential for expansion. We are currently and actively engaged in a comprehensive review of all opportunities, and our expectations are that we will carefully and judiciously expand our writings in this space.

On a consolidated basis, direct and assumed premiums written by the companies’ insurance subsidiaries for the current quarter and 9 months increased by 3% and 8% respectively. Overall for the 3 month, our combined ratio was 103%, the results being adversely impacted by the already noted 3rd quarter catastrophe events.

For the year, despite the unusual activity, the combined ratio was a still solid 95.6%. Fee income would reduce fees to 101% and 94% respectively. In the way of comparative information, the non-capped numbers would be 91% for the quarter and 91% for the year. The same periods for 2007 were 89% for the quarter and 88% year to date.

Despite negative global economic conditions which impact our investment operations, overall we remain positive regarding our strategic planning and operation execution. As stated, we plan to continue the implementation of our plan for expansion into additional lines of insurance. Our goal is to expand and widen the scope of our product offering, allowing each premium pool to go as deep as market conditions and our execution response will allow.

As this expansion of products continues, careful analysis will be conducted related to correlation and aggregation of risk, distribution, and selection of business partners. Our current experience, in a wide range of products, illustrates the scope of our talent and ability to handle this plan’s diversifications. Last quarter, I mentioned some exciting new developments. Public transportation continues to grow and thrive. In force premium is now approximately $3 million. New partners are calling to establish relationships and current producers are looking to expand.

It is early, but underwriting results to date have been very good. We are engaged in meaningful discussions with a number of potential significant partners related to our new access and surplus lines company, Protective Specialty, with a target date for implementation being the first quarter of 2009. Information will be provided as appropriate related to developments as they occur. Baldwin and Lyons brokerage is growing, providing enterprise risk management services to fleet transportation customers, and developing relationships with additional risk taking partners.

As Gary mentioned, we have completed our acquisition of Transport Insurance Agency, and look forward to enhancing it and our revenues and profits. We plan to continue to explore distribution and acquisition opportunity with a particular emphasis on agents and brokers, evaluating all options, including business partnerships, investments, and ownership.

At this time, I will turn things over to Pat Corydon, our Executive Vice President and CFO, who will report on investments, investment related activities, and some additional details of my overview of our insurance operations.

G. Patrick Corydon

Thanks Joe. Pre-tax investment income increased 4% from the 2nd quarter to just under $4.4 million. The individual components of investment income changed slightly as short-term interest rates again declined; however, redeployment of assets generated higher income that more than offset the lower short-term rates.

After-tax investment income was 2% than the 2nd quarter. Comparing to the prior year, pre-tax investment income is down between 13% and 14% for both the 3rd quarter and the nine-month periods. As we noted last quarter, the primary components of this decrease are the significant declines in short term interest rates and redeployment of assets in the tax exempt bonds and new investment vehicles including Maratan which generate less current income with the expectation of long term gains. After-tax investment income decreased only 9.5% for the quarter and 8.4% year to date on essentially level average invested assets reflecting the impact of municipal bonds.

There were no significant changes to the average duration or contractual life of our bond portfolio since year-end. Yields on our bond portfolio through September 30th, 2008 have declined much more modestly than short-term rates, however bonds purchased this quarter produced over 100 basis points lower after tax yield than those maturing or sold during the quarter, accelerating the trend experienced over the past several quarters.

The second component of our investment operations includes gains and losses generated by direct equity security trading and investments in limited partnerships. Our direct equity investments are managed for overall appreciation, and in general subscribe to a buy and hold philosophy. As such, directly managed equity trading games are generally not a large component of this income statement category.

This quarter, losses of $1.4 million were realized, bringing the year-to-date loss to just under $1 million compared to $1.9 million in gains last year. The larger component of investment gains and losses relates to our participation in several limited partnerships which for the most part invest in public and private debt and equity securities on a worldwide basis.

In fact, most of the assets allocated to limited partnerships is invested outside of the United States with a heavy concentration in India. Limited partnerships along with our Maratan trading account, generated total losses, both realized and unrealized this quarter, of $14.6 million compared to $6.4 million in gains during the same period last year.

For the nine months, limited partnership losses of $31.5 million compared to $13.2 million in gains in 2007. As the decline in domestic and foreign stock markets continue during the third quarter, the operations of the partnerships with few exceptions worsened. Our investment in the Indian stock market has been the most volatile this year, declining in value by 47% in line with the major Indian indices after increasing 63% during 2007.

While our exception to date average annual yield for this investment is still above 12%, we expect continue quarter to quarter volatility for the Indian limited partnership in the near term. In total, investment losses for the quarter were $10.4 million after tax or $0.69 per share, compared to gains of $4.2 million or $0.27 per share last year.

Year-to-date 2008 losses of $1.40 per share compared to gains of $0.67 per share last year. The final component of investment operations is the change in fair value for non-limited partnership investments owned. As we did not liquidate our portfolio into the dropping market, the equity security portfolio experienced after tax holding losses of approximately $5 million this quarter.

Our bond portfolio also experienced a modest unrealized loss of $0.4 million. At quarter end the market value of the company’s equity security portfolio remains almost $25 million above cost. The value of the bond portfolio is essentially equal to cost. The company’s pretax return on direct equity security trading for the quarter was a negative 8.3% on level with the S&P 500’s negative 8.4%. Year-to-date our equity trading has produced a total return loss of 14.6% compared to the S&P loss of 19.3%.

Cash flow from operations this quarter was $9.5 million as loss payments declined significantly from the first two quarters. Last year’s third quarter produced $4.1 million in positive cash flow. The difference is primarily attributable to higher premium collections during the current quarter.

Year-to-date cash flow from operations was approximately breakeven reflecting the settlement of several large losses during the first half of the year. Last year operations produced $21.6 million of positive cash flow through nine months. In addition to the higher loss settlements, the majority of this difference relates to lower investment income, higher commissions paid to non-affiliated producers, and the increased utilization of reinsurance.

Reinsurance recoverable on unpaid losses increased from $132 million at December 31, 2007 to $158 million this quarter reflecting changes in reinsurance treaties over the last two years. Less than 50% of this total represents actual case basis reserves with the majority being composed of incurred but not reported in loss expense reserves.

Reinsurance recoverable on paid losses totals $3.8 million at quarter end, all of which is current. The consolidated prior year reserve savings on direct business for the quarter was $4.8 million bringing the year-to-date savings to $6.9 million or about 4% of beginning reserves, while reinsurance assumed developed a deficiency of $1.1 million for the nine months.

I’ll remind listeners that we posted our quarterly financial statements on our website at www.baldwinandlyons.com. Click on our Investor Relations page and select Presentations from the drop down menu. From this page, select the latest financial supplement which can be downloaded using Adobe Acrobat or printed for your use.

This concludes our formal presentation. At this time we would be happy to answer any questions listeners may have.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Chris Gaffen – Equity Portfolio Unlimited Partnerships.

Chris [Gaffen] – Equity Portfolio Unlimited Partnerships

If we were to do a rough ballpark about the impact on our book value through this month of October, do you have kind of a rough idea of how much we’ve taken as a further hit?

Gary W. Miller

It depends on what day you measure it.

Chris [Gaffen] – Equity Portfolio Unlimited Partnerships

Let’s take today then.

Gary W. Miller

It moves around quite a bit. The impact obviously has been pretty much in line with the way the S&P goes. We don’t... Even though our portfolio isn’t necessarily aligned with the S&P, we move in pretty much the same direction obviously and with about the same magnitude and as far as the limited partnerships, if you watch [SinTechs] you can get a pretty good track of where we are there too, so it’s obviously been down. I don’t have a measurement as of today but if you use those two broad guidelines you get pretty close.

Chris [Gaffen] – Equity Portfolio Unlimited Partnerships

Okay, so in other words if I took the equity value on the balance sheet as of 9/30 and the limited partnerships, and then took the decline in the S&P 500 times those two values, I’d have a rough idea?

Gary W. Miller

We’ve actually one a little better than that. Our Maratan investment has significantly outperformed the S&P during the month of October, so that’s a piece of it, but that would get you a ballpark number, anyway.

Chris [Gaffen] – Equity Portfolio Unlimited Partnerships

If we were to take the limited partnerships, for example, now most of this is invested in India?

Gary W. Miller

About half of it is in the Indian market, it would be a little more than half.

Chris [Gaffen] – Equity Portfolio Unlimited Partnerships

What’s the rationale behind doing something like that?

Gary W. Miller

It was believed... We’ve been in this space now since November of ’03 I believe. As I said, even with the decline that we’ve experienced this year, our average annualized return is over 12%.

Chris [Gaffen] – Equity Portfolio Unlimited Partnerships

I understand that, I’m just wondering what the rationale... Is it someone within Baldwin and Lyons that decides that something in India makes sense, or is this an outside investment advisor that comes in and discusses this with you? What’s the... How do you guys determine that a sink position in India is worthwhile?

Gary W. Miller

The initial position was $15 million which we don’t consider to be a huge position. That was a program that was brought to our investment committee. It was evaluated and decided that the space looked attractive at the time.

Chris [Gaffen] – Equity Portfolio Unlimited Partnerships

Who brings that to you?

Gary W. Miller

We have programs brought to us by a number of different people. This particular one came through New Vernon Capital Management.

Chris [Gaffen] – Equity Portfolio Unlimited Partnerships

Do you employee still a number of different outside investment people that bring this stuff to your attention or?

Gary W. Miller

Yes, on our equity side we have five different managers that each manage a different piece of the portfolio and we have over a dozen limited partnerships, each of which comes from different sources.

Operator

There are no more questions at this time.

Gary W. Miller

We appreciate you joining us this morning and look forward to visiting with you again in three months. Thank you very much.

Operator

This does conclude today's conference.

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