National Interstate Corp. Q4 2008 Earnings Call Transcript

National Interstate Corp. (NATL)

Q4 2008 Earnings Call

February 19, 2009; 10:00 am ET

Executives

David Michelson - President & Chief Executive Officer

Julie McGraw - Chief Financial Officer, Vice President & Treasurer

Gary Monda - Vice President & Chief Investment Officer

Analysts

Eli Fleminger - Stifel Nicolaus

Presentation

Operator

Good day, ladies and gentlemen. Welcome to National Interstate Corporation’s 2008 fourth quarter conference call. My name is Francine and I’ll be your coordinator for today. (Operator Instructions)

Your hosts for today’s call are Mr. David Michelson, President and Chief Executive Officer; Ms. Julie McGraw, Vice President and Chief Financial Officer and Mr. Gary Monda, Vice President and Chief Investment Officer.

I’d now like to turn the call over to Ms. McGraw to begin the presentation.

Julie McGraw

Thanks you, Francine. Certain statements made during this call are not historical facts and may be considered forward-looking statements and are based on estimates, assumptions and projections, which management believes are reasonable, but by their nature subject to risks and uncertainties. The Private Securities Litigation Reform Act of 1995 provides a Safe Harbor for forward-looking statements.

The factors which could cause actual results to differ materially from those suggested by our forward-looking statements include, but are not limited to, those discussed or identified from time-to-time in National Interstate’s filings with the Securities and Exchange Commission including the annual report on Form 10-K and quarterly reports on Form 10-Q. The Company does not promise to update such forward-looking statements to reflect actual results or changes in assumptions or other factors that could affect these statements.

David Michelson

Thank you, Julie. Thank you for joining our 2008 fourth quarter earnings conference call. From an operation’s perspective we finished the year strong. Specifically, net income per share from operations for the 2008 full year was $1.69, of which $0.66 per share was earned in the fourth quarter. The 2008 fourth quarter combined ratio was 80.9%, which contributed to a very solid 89.4% combined ratio for the 2008 full year.

Gross premiums written for 2008 were $380.3 million, which represented a 10% increase over last year. Offsetting the income from operations were further write-downs in our investment portfolio related to the continuing credit crisis. For the year we had net realized losses from investments of $1.14 per share. In 2008 we experienced net realized losses from investments of $22.4 million and as of December 31, 2008 we had an additional $16.2 million of pretax unrealized investment losses.

To complicate matters, we were unable to recognize a tax benefit in the current year related to the realized investment losses. Three areas of the investment portfolio comprised approximately 70% of the realized and unrealized investment declines. $7 million relates to Fannie Mae, Freddie Mac and Lehman write-offs. $11.2 million relates to our securities lending program and $8.7 million is attributable to our other than temporary impairments on exchange traded funds.

We continue to hold the Fannie, Freddie and Lehman investments, but do not expect any significant recovery from them. The $11.2 million in securities lending included an impairment charge of $1.2 million and the remaining $10 million of unrealized losses represents fixed-income investments that we believe will return full value at maturity. Finally, the exchange traded funds were written down in accordance with the other than temporary accounting guidelines and have potential to recover in future periods.

We have historically maintained conservative investment practices. At December 31, 2008 our investment and securities lending portfolios totaling nearly $650 million are comprised of 95.2% investment grade holdings, including approximately $77 million of available cash and cash equivalents.

As I noted earlier, our favorable 2008 fourth quarter results from operations, which includes underwriting and recurring investment income, contributed to a solid year. Our gross premiums written of $380.3 million were 10% above last year. Growth in Alternative Risk Transfer and Specialty Personal Lines components were offset by lower premiums in the Transportation and Hawaii and Alaska components.

Competitive and often rational pricing in the commercial insurance markets has been the story all year for the Transportation and Hawaii and Alaska components. Combined premium for these two components declined 5.5% in 2008 compared to 2007, which we find acceptable considering the alternative of writing business that is under priced.

Our recreational vehicle product, which is the largest product in our Specialty Personal Lines component, has felt the negative effect of lower sales of new RVs, reflecting the difficult economic conditions. The Specialty Personal Lines component did grow in 2008, as a result of our commercial vehicle product that was introduced in 2007.

This product, which provides vehicle insurance to small business operators, is currently offered in three states, Ohio, Texas, and California. Although still a modest percentage of the company’s overall premium, we continue to grow this product by increasing distribution sources and we expect to offer the product in more states in 2009.

Alternative Risk Transfer was again our growth engine, with a 23% increase in gross premiums and now we have representing over 50% of the top-line. During the 2008 fourth quarter growth in several of our truck captive programs was offset by the non-renewal of two of our smaller captive programs. This component is subject to some quarter to quarter variability due to the size and common renewal dates for the programs. We continue to experience very high customer retention in this component and continually have new prospects in the pipeline.

During the first three quarters of 2008, we experienced an unusual number of large claims. In the 2008 fourth quarter, the number and financial impact from the large claims returned to normal levels, contributing to 80.9% combined ratio for the quarter. We completed 2008 with a satisfactory 89.4% combined ratio, comprised of a 64.7% loss and loss adjustment expense ratio and a 24.7% underwriting expense ratio.

The 2008 full year underwriting expense ratio was 1.8 percentage points higher than 2007 reflecting a greater mix of higher commission business. Consistent with our historic business practices, we continue to manage our fixed expenses closely.

The 2008 full year loss ratio was 6.7 percentage points higher than 2007 reflecting the elevated number of large claims in the first three quarters, as well as the cumulative effect of lower rates charged for our traditional commercial products. Over the past several years we have experienced annual single digit rate decreases in our Transportation and Hawaii and Alaska components.

In regard to the large claims, bad luck and bad timing are always a factor because of the higher limit policies that we write. However, we did not take for granted that all of the large losses were attributable to these factors. In the third and fourth quarters, we reviewed our underwriting practices and audited our entire in-force book of charter bus business. This process led us to make several process improvements, particularly related to our smaller charter fleet risks and we added new analytical tools.

In 2008 we again experienced favorable development from prior year reserves, which lowered the loss and loss adjustment expense ratio by a modest amount. We remain confident in our reserving practices that consistently produce adequate reserves. 2008 presented us with several obstacles including turmoil in the financial markets, continued soft commercial insurance pricing and a concentration of large claims in the first three quarters of the year.

Nevertheless we had several positive outcomes in this very challenging environment. Specifically we grew the business 10%; we achieved an overall return on equity of 5% and return on equity from operations of 15.3% and our book value increased slightly to $11.20 per share. 2009 promises more of the same market challenges that we faced in 2008. We are continually cultivating new business opportunities and remain optimistic that we can continue to grow our business in 2009.

We are also confident that our business and disciplines will continue to produce excellent underwriting results and we remained committed to our objective of achieving a return to our shareholders or 15% plus inflation. Julie, Gary and I are available to answer your questions and comment further on our results.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Eli Fleminger - Stifel Nicolaus.

Eli Fleminger - Stifel Nicolaus

Can you discuss the big drop-off in the expense ratio in the quarter? I know last quarter you attributed part of the increase, the expense ratio last quarter to growth in several of your higher commission product. Did that slow in the fourth quarter?

David Michelson

This is David Michelson. I can comment generally speaking and Julie might have something to add, but on a quarterly basis our commission expense is even more exposed to business mix than on an annual basis.

I do know that in the fourth quarter, we had some successes on some larger captive accounts, which does have lower agency compensation on it. So, I believe that was at least in part attributable, but just off the comp that’s probably all I could contribute at this point.

Julie McGraw

I would concur to what Dave just explained to you. There was nothing else significant within our expense ratio that changed besides the commission.

Eli Fleminger - Stifel Nicolaus

Also can discuss a little bit what are the reasons for the non-renewal, the two smaller truck group captive programs? Is it more rates is, did they go out of business just what happened there?

David Michelson

We’ve got a product management structure here and we have got over 30 products and every product is owned by a product manager, which keeps us pretty close to the results and we had a couple of small programs that as we entered in the fourth quarter, we weren’t as satisfied with the results in those programs as others and as a result we had a rate level mean that we simply had to get on those products for the renewal and due to market factors or just overall buying perspective on the customer, really the decision was made by them to walk away.

Again from our standpoint we wanted to renew them, but we’re not just about growth here, we’re about growing earnings and we had a price we needed and they found the price lower than where we were willing to go and so they decided to move elsewhere.

Eli Fleminger - Stifel Nicolaus

Just lastly, I’m assuming you could discuss a little about Lincoln General’s problems and their plan to shrink their premiums by about to $150 million. That looks like an opportunity to win or perhaps buy a bigger share of U.S. truck insurance market?

David Michelson

Lincoln General has clearly been playing in our space and in the passenger transportation and the truck transportation for a number of years. There are a lot of competitors in both the passenger and the truck world. Lincoln did write a good share of business over the last number of years and we do cross pass with them from time to time, but I would also say that there are a number of other competitors that we compete against more consistently.

Is it foreseeable that what actions Lincoln decides to take, could open some doors for us? I’d say the answer to that is, yes, but in terms of my ability to quantify the impact of that on our business I think at this point that would be highly speculative.

Operator

(Operator Instructions) I’m not showing we have any further questions in the queue. I would like to turn the call other to Mr. David Michelson.

David Michelson

Thank you for participating in our conference call. 2008 was a rather difficult year and National Interstate performed well in many respects. We can’t predict the economic conditions for 2009, but we are confident that we will continue our enviable track record of growth and profitability. Your interest in National Interstate is valued and appreciated and we look forward to our next conference call with you. Thank you.

Operator

Thank you for your participation in today’s conference. This concludes our presentation. You may now disconnect. Have a good day.

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