ProAssurance Corporation (NYSE:PRA)
Q4 2012 Earnings Call
February 20, 2013 10:00 am ET
Frank O’Neil – SVP-Communications, Investor Relations
Stan Starnes – Chairman, President, CEO
Ned Rand – SVP, Chief Financial Officer
Howard Friedman – Chief Underwriting Officer
Darryl Thomas – Chief Claims Officer
Vic Adamo – Vice Chairman
Mark Hughes – SunTrust
Chris Maimone – Macquarie
Paul Newsome – Sandler O’Neill
Good day, and welcome to the ProAssurance Fourth Quarter Earnings Conference Call. Today’s conference is being recorded. At this time, I’d like to turn the conference over to Mr. Frank O’Neil. Please go ahead, sir
Thanks, Shelly. Good morning, everyone. And thank you for your interest and participation in our call to discuss ProAssurance’s fourth quarter and year-end 2012 results. I need to handle few legal points before we begin.
On Tuesday, February 19, 2013, we issued a news release reporting our results for the quarter and year ended December 31, 2012. Subsequently, we filed our 8-K and our 2012 10-K with the SEC. These documents and our other SEC filings provide important information about our company and our industry. Each discusses many important factors that could affect our future, and thus, cause our actual results to differ materially from current projections or expectations.
Please read and understand these cautions, and be aware that statements we make on this call, dealing with projections, estimates, and expectations are explicitly identified as forward-looking statements subject to the risks and other factors covered in those documents. Except as required by law or regulation, we will not undertake and expressly disclaim any obligation to update or alter information disclosed as part of those forward-looking statements.
The content of this call is accurate only on Wednesday, February 20, 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 be referencing non-GAAP items in our call today. Please refer to our recent filing on Form 10-K and our recent news release for a reconciliation of these non-GAAP numbers to their GAAP counterparts. In this final note, all share and per share numbers in this call will reflect the two-for-one stock split that was effective December 27, 2012.
Participating on the call today 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; and Darryl Thomas, our Chief Claims Officer.
Stan, your opening thoughts, please?
Thanks, Frank. I want to preface our discussion this morning by noting some of the remarkable successes from 2012. We received a remarkable return on equity of 12.4%. We continued our unblemished record of increasing Book Value per share in every year since we became a public company in 1991, over 20 years ago.
We did so while returning a little more than 6% of our capital to investors in a special dividend and while increasing the yield on our stock to approximately 2% by effectively doubling our dividend when we split our stock and maintained the per share payout amount. In terms of net income and operating income, this was a stellar year indeed the second best in ProAssurance’s history.
We strengthened the balance sheet that secures the future of our insureds. We completed two acquisitions that hold the promise of profitable top-line growth at a time when companies in our niche of insurance were struggling to add premium, and we did so at a reasonable price. All of this helped to drive a total return of 13.5% for our shareholders.
Finally, I want to underscore once again, the discipline and rigor, which we operate our business, and note the positive results we have achieved by executing our long-term strategy.
And with that, Frank?
Thanks, Stan. We’re going to ask Ned Rand and Howard Friedman to present an overview of our results. We’ll start with Ned.
Thank you, Frank. Let me provide a brief summary of fourth quarter results before Howard discusses the current state of the market. Gross Premiums Written were $107 million in the fourth quarter, a decline of about $8 million over last year’s fourth quarter. Market forces accounted for almost all of that change.
Net Premiums Earned were $156 million versus $162 million in the fourth quarter of 2011. The difference there is 4% and we continue to believe that net earned may be a better measure of our premium trend given the effect of the two-year policies on Written Premiums. Howard, it might be helpful for you to comment on competition, pricing and retention.
Sure, Ned. I’ll characterize the market as quite competitive, but essentially unchanged in that regard over the course of the year. In medical professional liability, the level and intensity of the competition varies from state to state, but seems more rational than what we have witnessed in previous cycles.
There are various theories for that such as better information or more experienced management teams, or fewer new market entrants. The bottom line is that for the year our retention was higher, our pricing was up and new business was down. All of this reflects our consistent approach to the market, writing business that meets our underwriting standards and our pricing requirements.
As to specifics, average renewal pricing in our physician book was higher for the year, an increase of 1% for 2012 compared with a decline of 1% for 2011. In the fourth quarter, average renewal pricing was unchanged. Our podiatric rates continued to firm and were primarily responsible for the improvement in the average renewal pricing for the year.
Retention in our physician book was 90%, a point higher than in 2011, and was 89% in the fourth quarter compared to 87% in the fourth quarter of 2011. For the record, we did write $9 million of new physician business in 2012. Our Medmarc executives report that rates in medical devices and life sciences continue to firm modestly, although that premium is not yet reflected in our results.
Changing topics. Let me also address reserve development. Net favorable loss reserve development was $115 million in the quarter compared to $184 million in the fourth quarter 2011. That brings net favorable development for the year to $272 million compared to $326 million in 2011. While this year’s reserve development is not as large as last year’s in absolute terms, it compares favorably with development trends in the past five years. In relative terms as a percentage of total reserves, 2012 is two percentage points below the level of release from 2011.
Favorable development continues to be driven by stable loss severity levels that are proving to be better than our expectations. Severity is increasing 2% to 3% per year, and the overall frequency trend is flat, although we are seeing more variation this year and we are watching that closely. But in the aggregate we see nothing to drive a significant change from current loss trends.
While I’m on a subject of reserves, let me mention the change in the current accident year net loss ratio in the fourth quarter. In 2011, that ratio was 91.5%. And it was 76.8% in this year’s fourth quarter. A large portion of the difference is related to the reserves established for death, disability and retirement or DDR. Last year, the DDR reserve adjustment added 13 points to the current accident year loss ratio in the quarter. In contrast, the DDR adjustment provided a decrease of just over a point in the fourth quarter of 2012.
The DDR reserve estimate can vary from year-to-year and often introduces some volatility in the fourth quarter, which is when we record DDR adjustments. Both years also contains some other true up adjustments during the fourth quarter as well as the effect of retrospective reinsurance premium adjustments on a premium base. None of these items indicates exchange in our basic loss reserving philosophy. Ned?
Thanks, Howard. Now let’s turn from underwriting results to our investment results. In the fourth quarter, our net investment result was unchanged compared to the prior year. For the year, the net investment result was down 2% due to both lower balances and lower yields in our fixed income investments. Bright spots have been better results in our unconsolidated subsidiaries and higher income from our equity portfolio, where we added high-quality dividend paying equities.
On the expense side of the ledger, underwriting, policy acquisition and operating expenses for both the quarter and the year were essentially flat. Cash flow from operations was $30 million, down from $53 million in the last – in last year’s fourth quarter. This was primarily due to the timing of payments related to the swing provisions of our reinsurance treaties and there were tax refunds in 2011, mostly related to American physicians that provided a one-time increase to cash flow in the fourth quarter, 2011.
All in, net income was $101 million or $1.64 per diluted share in the quarter and was $275 million for the year or $4.46 per diluted share. Operating income for the fourth quarter was $97 million or $1.56 per diluted share, and $257 million for the year or $4.16 per diluted share.
I’ll touch on two ratios we think are important as a measure of what we accomplished this year by executing our long-term strategy. Return on equity for the year was 12.4%, within our range of a long-term target. Our combined ratio was 57.1% for the year.
We’re especially pleased to have continued our unbroken string of increased Book Value per share in every year we’ve been a public company. This year we grew Book Value per share by 4% to $36.85, split our stock two-for-one on December 27, and we paid $2.50 per share special dividend following that split.
One final note, we mentioned in the news release that we accessed our existing credit facility in the quarter, borrowing $125 million to fund the Medmarc transaction and to use for other corporate purposes. We initially intended to liquidate investments for that purpose. But our analysis showed it to be more advantageous to retain the investments which yield a higher return than the cost of borrowing. As the investments securing the loan mature, we will use those proceeds to pay down the credit facility. Frank?
Thanks, Ned. Howard, any other developments in the year that you’d like to highlight?
Yes, Frank. I’d like to mention our progress in the Certitude program with Ascension Health, which are now working in five states, Michigan, Florida, Illinois, Indiana and Texas. And we’re particularly enthused about the response from our rollout in Illinois. In total, we now have more than $15 million of in-force premium in the program. We’re pleased with the level of retention and are appreciative for the level of support we’re receiving from Ascension Health, our partner in Certitude.
We expect to expand in our existing states and open additional states in 2013. But we will not identify those states for competitive reasons.
Thanks, Ned and Howard. The loss trends that Howard mentioned are most readily evident in claims. Darryl Thomas, our Chief Claims Officer is here to give us a recap of important claims statistics from 2012. Darryl?
Thank you, Frank. The number of new claims opened up slightly over 2011. But to put that in perspective, the number of new claims opened last year was the second lowest in the last 10 years. We saw corresponding increase in the number of closed claims in 2012 as compared to 2011.
So our ending inventory of open claims was essentially unchanged year-to-year, which reinforces the data regarding the continuation of the benign claims environment. We continue to be aggressive in our some non-meritorious claims. We tried 319 individual claims to a verdict, a 17% increase over 2011.
Importantly, we’re still trying the same percentage of open claims to a verdict as we have historically. This is all reflective of the significant decline in claims filed in the past five years. The benefit for us is that this allows our claims staff to devote more time to each claim. Also our claims staff makes a real difference in our group sales effort because they can convey the absolute advantage of our claims philosophy during meetings with our – with renewal accounts and prospective customers.
Our trial win ratio was 75% this year, essentially unchanged year-over-year. Given the significant number of claims we take to trial each year, including tough claims that our competitors generally settle, we believe that is a terrific result to one that benefits our insureds, as well as our shareholders. Frank?
Thanks, Darryl. We closed two transactions since our last call in November. Vic, you were closely with Independent Nevada Physicians. Can you give us an update?
Sure, Frank. The Nevada transaction with IND closed as expected at the end of November, but none of the IND premium appears in our 2012 results. On a statutory basis, IND had Gross Written Premiums of $11.5 million in 2012. The combination of IND, the largest writer in Nevada, with the national balance sheet and expertise of ProAssurance is opening up new opportunities for our Nevada agents.
They now have a company with the products, financial size and ratings that allow them to approach a broader range of risks, including the large integrated healthcare risks that are emerging in Nevada. We are also expanding the ProAssurance claims staff in Nevada, which is demonstrating our long-term commitment to the state. So Frank, we are confident in our ability to grow our market presence in Nevada.
Thanks, Vic. Ned, you’ve been the point person on Medmarc. Will you update us there?
Sure, Frank. For the record, Medmarc had $41.6 million in gross premiums on a statutory basis in 2012, $32.1 million in life sciences and medical technology and $9.5 million in lawyers professional. We closed the transaction with Medmarc effective January 1 and the combined organization has hit the ground running. Recall that Medmarc will continue to operate as it has, but now with the greater financial strength and operational flexibility of ProAssurance behind it.
Anecdotally, we hear that being a part of ProAssurance with our balance sheet strength and strong ratings has already enabled Medmarc to reopen some doors that have been closed to them over the past few years. We also see a great deal of excitement in our existing agent and broker network as they learn more about Medmarc’s broad reach and unchallenged expertise in life sciences and medical devices.
We’ve also seen a number of examples of cross-selling opportunities that have become apparent as our sales and marketing staffs have had a chance to work together.
Thanks gentlemen. Stan, any final comments before we take questions?
Thanks, Frank. From these reports, you see the picture of a company that enjoyed an extremely successful year. We strengthened our balance sheet, lived up to the insurance promises we made to our insureds, group Book Value per share and rewarded our shareholders with a meaningful increase in share value and a solid total return.
We demonstrated that our vision of a company with a long-term focus can succeed in a challenging environment, especially when that plan is executed through the promise of treating fairly by dedicated employees and local agents, loyal agents, who bring enthusiasm and intensity to their jobs every day.
As I look ahead to this coming year, I’m excited for a number of reasons. First, we will see additional growth in premium as a result of bringing IND and Medmarc into the ProAssurance family. Both are off to a great start as part of our larger organization.
We have traction in our Certitude program with Ascension Health and I am confident that it will continue to grow. Remember, as I have said many times, it is something that will start small, but eventually will become something much greater as we bring new states and new ministries into this program. And we are seeing growth in our hospital programs and with national accounts.
Our deep experience in writing hospitals and large healthcare systems, our broad geographic reach and our substantial balance sheet coupled with our significant experience in ensuring both physicians and hospitals, help make us the company best positioned to meet the needs of these systems today and to take advantage of the coming opportunities.
I think the true picture of our success in this segment of our market will emerge over the next four to five years. But I am confident we are building a strong bridge to that success with every passing day. The M&A market show signs of greater activity as you have seen in the past month or so, that plays to our strength as well.
So I think our future is as bright as our past. And I am more excited now about the prospects for our future than anytime since I became the CEO in 2007.
Frank, we’ll now take questions.
All right. Shelly, that concludes our prepared remarks. Will you open the line for questions?
Thank you. (Operator Instructions) And our first question is from Mark Hughes with SunTrust.
Mark Hughes – SunTrust
Yeah. Thank you.
Good morning, Mark.
Mark Hughes – SunTrust
Good morning. Howard what should we think about for the current accident year lost pick for this year? Obviously, fourth quarter was down. Should we think about extending the average or should it look more like the fourth quarter?
Yeah, yeah. I would say Mark that extending the average is much more representative. The fourth quarter as I mentioned during the prepared remarks, always has some noise in it from a variety of sources.
But fundamentally, if you look at where we started the fourth quarter before we made the various adjustments, it was a continuation of what we had seen throughout the year, just with the normal variation for mix of business by state or layer of coverage. And I would not really anticipate anything changing going forward. We’re still underwriting in pricing as we had previously and therefore the loss estimates should be more or less in line with the longer-term average.
Mark Hughes – SunTrust
Okay. Any observations on the pricing in the fourth quarter, had moved up a little bit last quarter, kind of went back to flat, I know these are small variations but anything you noticed in the fourth quarter with respect to the competition?
No, on that I wouldn’t say anything significant. The competition remains quite intense as we pointed out earlier. But no real change in the environment that I could point to. We always have the variation by quarter, and again that goes back very much to the pattern of renewals if you look at the distribution of renewals by state, for example, it varies from quarter-to-quarter, so if we have some states where we may have a filed rate change up or down, that could affect a given quarter whereas it wouldn’t affect in other quarter. So, no particular changes there.
Mark Hughes – SunTrust
Okay. And then on the M&A front, showing signs of more activity, is that just a recognition of the two deals you’ve closed here lately or is there more potential deal flow, and if so anything behind that we should know about?
You know, Mark, I think it’s a reflection of the fact that we were able to announce and close two deals in the fourth quarter and early in the month of January of 2013. I think it’s also reflection of the fact that what you’ve seen in the public market announcements over the last month. Be mindful that the transactions are quite episodic. You cannot make them happen. You can be available when there is interest. We never go anywhere uninvited. And we take a very long-term view of sort of the transactional agenda.
We think as this economy perhaps begins to improve, there will be opportunities. We think there will even be more opportunities in the years ahead because of the changes that are coming in healthcare. Those changes are going to produce an environment in which there is a much greater benefit from having a wide geographic reach such as we have at ProAssurance and there is great benefit from having a very strong balance sheet which we have as ProAssurance.
And that’s – we have these calls quarter-to-quarter, but one thing we look at is the long-term. And in the long-term there’s nothing more important than capital to take advantage of the opportunities that are coming to you. So our view of transactions is a long-term view. And my guess is that we’ll see more transactions in the years ahead and my guess is that, and it’s just a guess, that the opportunities for transactions will accelerate in pace in the coming years.
Mark Hughes – SunTrust
(Operator Instructions) And we’ll go to Ray Iardella with Macquarie.
Chris Maimone – Macquarie
Hi. Good morning. This is actually Chris Maimone calling for Ray. Thanks for taking the call. I was hoping maybe to expand a little bit on the previous question. I know the pricing environment is a little flat, and given the competition, maybe you could just talk about what the sort of top line outlook for the year is, excluding the impact of the two recent acquisitions and along those lines where retentions are expected to fluctuate around roughly?
Chris, I’ll let Howard respond to the specifics. But first, it might be helpful just to recall our overarching view with respect to top line. This is an industry in which you can have all the market share you want. Remember, we have to put a price on our product years before we know what it’s going to cost. So it’s very easy to delude yourself into approaching pricing in a way that results in an adequate pricing, but won’t be reflected in your results for several years.
So one of our hallmarks is that we buy – we sell risk. In other words, we take the risk from the policyholder and we do it at a price. It is essential that we obtain what we feel is an adequate price for the risk or we won’t take the risk.
So we are not a top line organization. We recognize that there are some organizations that are top line. And unfortunately, the landscape of the past 30 years is littered with the corpses of companies that decided to be top line.
Because we’re not a quarter-to-quarter company and indeed even a year-to-year company, we try to be very disciplined in our pricing, because that’s the only way that we can provide the financial strength that our shareholders insist on and that our policyholders are entitled to.
So as we have opportunities for top line growth at adequate pricing, we will aggressively pursue them. But in the absence of those opportunities we are content to see our top line shrink until there are opportunities to grow with adequate pricing. In my view, that’s how you get to have an organization that has $2.3 billion of equity. Howard?
Yeah. And just talking a little bit about the numbers, if you look back by the quarters, but certainly, if you look back over the last few years, our retention has moved more or less between 88% and 91% and varying from quarter-to-quarter and year-to-year. And the renewal pricing has basically been from minus 2% to plus 2%, again, with a lot of variation, but within that range.
And that’s where we intend to try to keep it. We look at that pretty carefully on a monthly basis, adjust where we can and you always have variations when you write a renewal or don’t write it, and what effect that has on the retention ratio. But those are the general targets that we’re trying to achieve.
Chris Maimone – Macquarie
Sure. No, that’s helpful. And I can appreciate all the comments within those responses. I guess may be what might be helpful, building off of – building off that and I know M&A was just mentioned in the previous question and I understand the episodic nature of M&A transactions. But perhaps maybe if there is anything to comment on, you could talk about the pipeline and or the appetite, especially in light of a potentially contracting top line environment, the appetite and availability of maybe ancillary businesses outside of the core medical professional liability space in the near to intermediate term.
Yeah. I wouldn’t say there is a pipeline; I would say there is an appetite. And as healthcare changes, we think it’s going to be important for us to be in a position to respond to the needs of the healthcare industry. That’s what prompted our acquisition of Medmarc for example, because that extends our product line into an area of healthcare, which – into which we previously had not ventured. That’s what prompted our transaction a few years ago with Mid-Continent in order to enable us to aggregate and underwrite home healthcare providers as healthcare is pushed down to lower and lower provider levels and to the provision of healthcare off-site in people’s homes.
So as time evolves, we expect to offer products along the entire spectrum of healthcare, and we think these opportunities present themselves that are the Medmarc type opportunity, that is to extend our product line beyond sort of the traditional medical products liability, we want to be in a position to take advantage of those opportunities. And we think there will be many of those in the future.
Now, you can’t put a timeline on them. You can’t predict them. You can’t make them happen. But our view is that in the coming years we will have those opportunities and we are willing to do them at a prudent price. And that will provide meaningful and appropriate top line growth for us, as opposed to facing top line growth by extending business at an adequate pricing which is just a recipe for major problem down the road.
Chris Maimone – Macquarie
Okay. Thanks very much for your answers.
And our next question is from Paul Newsome with Sandler O’Neill.
Paul Newsome – Sandler O’Neill
Good morning, everyone. Thanks for the call. I’ve got two questions. One is a real simple one and one is a little bit more complicated. The simple one is just if you could give us kind of an update on the broad legal environment from a tort reform, et cetera, perspective, if there’s been any other change?
My second question is a little bit more complicated in that – bear with me, I’m not sure I can say it exactly the way I want to. But what I’m curious about is if there is a change in the advantage or disadvantage of having more of a national or multistate footprint, given that we’ve seen this really amazing consolidation in the provider networks, I’m guessing and maybe I don’t – I just don’t know the answer to this, that we are going to see more multistate groups that would require multistate approaches to the business. And is that eroding a business that historically has been very, very much state-by-state?
Paul, with respect to tort reform, it continues as it always has to be a state-by-state issue. And it’s difficult to talk about it in any monolithic sense. Perhaps the day will come, and we hope it will, where you will have some meaningful Federal tort reform to apply throughout the system. But that appears doubtful for us, at least in the foreseeable future. That means that tort reform will be played out on a state-by-state basis across the United States. And it’s an effort that will never be over.
The plaintiffs bar will never cease their efforts to have that tort reform that has been passed declared unconstitutional, and presumably and hopefully organized medicine will never cease in its efforts to have the tort system refined in a way that will make it more fair to physicians and more predictable to healthcare providers.
So I think you just have to talk about tort reform on a state-by-state basis. We saw some movement last year in Georgia and Missouri, the Florida bill is before the Florida Supreme Court now, and we are awaiting some decision there. And you just have to talk about it state by state. It is important in my view for this country if we’re to have meaningful access to care, for us to have a tort system that treats the healthcare provider with fairness and with predictability.
Moving on to your other questions, the environment of healthcare is changing. It is changing rapidly. It is changing at a pace that is accelerating. Those of us in this room and on this call do not have the collective imaginations to know what healthcare will look like in five years or so.
As you say integration is continuing. It is crossing state lines, it is crossing specialty lines, and we think that is going to continue apace and we think that provides ProAssurance with really very unique advantages in the years to come.
As you know historically this has been on a state-by-state business. Most of the companies in this space were started as mutual companies 20 years and 30 years ago, and they remained that. Many of them remained one in two state organizations. And they do a great job of what they’re doing for their physician customers. And they have played a very, very important role over the last 20 years to 30 years.
Those companies are waking up every day to seeing groups that are crossing state lines, in which they do not operate. They are waking up to seeing multispecialty groups, they are waking up to see a lot of their physician base going into hospitals, and we’re the same way. I mean, it’s affecting all companies that way.
And we think to be a significant provider of this type of coverage in the future, you’re going to have to have a wide geographic footprint and you’re going to have to have a strong balance sheet. And by strong balance sheet, I don’t mean top-line, I mean capital.
And that will present us with lots of opportunities in the future. And I think it will present us with lots of opportunities to partner with some of these one-in-two state companies, which as I say do a great job and they will be able to even do a better job when they’re part of a larger organization. So we look forward to that as it develops.
Paul Newsome – Sandler O’Neill
Does that imply that at some point a national 50-state license platform is in the future?
We already are. And between our various statutory companies we enjoy licenses in every state, and we like products of one sort or another in virtually every state. So, we have the platform in place that we need to do that.
What you see most – and of course, none of us can predict the future, but what you see most of the debate about today is not whether integration is going to occur, but whether what is going to be the form of integration. But it’s – it already is multistate and multispecialty and we think that will continue.
Paul Newsome – Sandler O’Neill
And there are no further questions at this time.
All right. Well, we thank you all for your interest, and we will speak with you again in May.
And this concludes today’s presentation. We thank you for your participation.
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