EMC Insurance Group Inc. Q4 2008 Earnings Call Transcript

Feb.27.09 | About: EMC Insurance (EMCI)

EMC Insurance Group Inc. (NASDAQ:EMCI)

Q4 2008 Earnings Call

February 27, 2008; 11:00 am ET

Executives

Bruce Kelly - President & Chief Executive Officer

Mark Reese - Senior Vice President & Chief Financial Officer

Ron Jean - Executive Vice President of Corporate Development

William Murray - Executive Vice President & Chief Operating Officer

Steven Peck - Senior Vice President, Actuary

Ray Davis - Senior Vice President, Investments and Treasurer

Kevin Hovick - Senior Vice President, Business Development

Anita Novak - Director, Investor Relations

Analysts

Paul Newsome - Sandler O’Neill & Partners

Bob Barnum - Keefe Bruyette & Woods

Operator

Greetings and welcome to the EMC Insurance Group Inc. Fourth Quarter 2008 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. (Operator Instructions) As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host Anita Novak, Director, Investor Relations for EMC Insurance Group Inc. Thank you. Ms. Novak, you may begin.

Anita Novak

Thank you, Sherry. Good morning, everyone and welcome to EMC Insurance Group’s 2008 fourth quarter earnings call. A supplemental investor packet is available on the Investor Relations page of our web site, which can be found at www.emcinsurance.com. The webcast for replay purposes is also available at this site until February 26, 2010. 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 2008 fourth quarter earnings release with accompanying financial tables issued earlier today.

With us today are several members of EMC Insurance Group’s executive management team. They are Mr. Bruce Kelley, President and Chief Financial Officer; Mr. Ron Jean, Executive Vice President for Corporate Development; Mr. Steven Peck, Senior Vice President, Actuary; Mr. Ray Davis, Senior Vice President, Investments and Treasurer; Mr. Kevin Hovick, Senior Vice President, Business Development and Mr. Mark Reese, Senior Vice President and Chief Financial Officer.

At this time, it is my pleasure to introduce EMC’s Chief Executive Officer, Bruce Kelley.

Bruce Kelley

Thank you, Anita. I am pleased to report that even though last year presented furious challenges on several fronts, we remained financially strong and secured. It is doubtful that anyone could have completely prepared for the events of 2008, but we believe our strong financial position in our overall strategic approach helped us weather a very difficult year.

My intent today, is to describe how we addressed the challenges of 2008 and our expectations for 2009 and beyond. The entered 2008 certainly had a significant impact on EMC Insurance Group Inc. We experienced our largest amount of catastrophe and storm losses ever, recognized a record amount of investment in payment losses in our equity portfolio, had a significant decline in the amount of unrealized gains in our investment portfolio and we are confirmed with a generally competitive environment from marketing property and causality insurance.

Catastrophe and storm losses; the company has a brand structure and a risk management approach that foremost diversifying our exposures. However, even as diversified as we are catastrophe and storm losses were a major issue in 2008. Storms were unusually large and numerous in 2008, often spreading across much of the United States. Major events in 2008 include hurricane Gustav and hurricane Ike and the EF5 tornado that hit Parkersburg, Iowa.

Catastrophe and storm losses added 13 percentage points to our combined ratio in 2008, compared to an average over the last decade of 5.4 percentage points. Factoring in a normal amount Catastrophe and storm losses, our under writing results would have been in line with management’s expectation. Excess Catastrophe and storm losses alone accounted for a decline of $19.2 million in stockholders equity in 2008.

Wide spread storms generating large numbers of claims in numerous territories created serious challenges for claims adjusters. The company was able to meet those challenges by utilizing our automotive claims management system and distributing the claims processing throughout the branch offices in order to more timely and effectively facilitate the increased volume of claims, thereby expediting the final payment of claims.

The system allows the various branch offers to easily share data and check the status of all claims. We significantly decreased the burden of claims processing for any one geographic location. This was an important factor, especially with hurricane Ike claims since both our Birmingham branch and our Cincinnati branch were physically affected by the storm. 100% of all catastrophe and storm losses claims have been adjusted and nearly all have been paid.

Record impairment losses. As you know from this morning’s earnings release, the company reported a net loss for the year of $0.13 per share. The net loss was directly related to net realized investment losses, as was the case with nearly all our competitors we have felt the effects of the global recession and severely depressed equity markets.

Realized investment losses for the year totaled $24.5 million or $1.17 per share after taxes and reflect $30.9 million or $1.49 per share after taxes of other than temporary investment impairment losses. The $14.9 million of those impairment losses are attributed to perpetual preferred stocks issued by Freddy Mac and Fannie Mae.

It should be noted however that $31 million of impairments is less than 3% of our 2007 invested assets, relatively small fraction of our investment portfolio. We have a well diversified investment portfolio that does not have any larger concentrations in any one asset class or single investment. Additionally, our investment policy does not permit investments within our own industry. These limitations had created a well diversified investment portfolio that has produced negative annual returns only twice in the company’s history.

Investment portfolio and benefit plans; due to adverse economic conditions, the company’s investment portfolio experienced approximately $36 million in unrealized investment losses. The average economic conditions also had a negative impact on the funded status of our employee benefit plans which generated a $16.7 million decline in equity.

Competitive market; soft pricing conditions prevailed during 2008, but rate stabilized some what for the end of the year. On an overall basis, premium rate levels declined approximately 4.8% in 2008. We attribute our ability to effectively price and retain good business to our brand structure and independent agency relationships.

Our brand structure puts us in close proximity physically to our agent’s offices and allows us to focus our efforts in those areas where we believe good business can be written. To our branch offices, we provide local service for underwriting, risk improvement, marketing and client’s management.

In some respect, 2008 could be viewed as a perfect storm as we were confined with record amounts of both catastrophe and storm losses and investment losses. Although some what damaged, we survived that storm and are well prepared for the challenges of a new year. As we began 2009, we expect marketed conditions to remain competitive with premium rate stabilizing at current levels. Premium rates could begin to improve during the second half of the year with any improvements likely to occur first in personal lines and reinsurance followed by commercial lines.

As regard to economy, we don’t expect much improvement before the latter half of the year. Based on those expectations, our operating income guidance for 2009 is a range of $1.45 to $1.70 per share. This range is based on achieving a GAAP combined ratio of 105.5, which reflects the lighting effects of previous rate level reductions and assumes to more normal catastrophe and storm loss year.

With that I will call on Mark Reese, Senior Vice President and Chief Financial Officer to discuss the financial statements. We would be happy to answer any question after his presentation.

Mark Reese

Thank you, Bruce. Operating income for the fourth quarter was $5.6 million, which was up slightly from $5.4 million reported in the fourth quarter of 2007. For the year, operating income was $14.2 million, which is down significantly from $40.1 million reported in 2007. Operating income for calendar year 2008 was negatively impacted by a record $50.8 million of catastrophe and storm losses, compared to $21.5 million in 2007.

In addition to the record amount of catastrophe and storm losses, operating income for 2008 reflects a slight decrease in the amount of favorable developments experienced on prior year’s reserves and a moderate, but steady decline in overall premium rate levels.

Net income for the fourth quarter was $474,000, compared to net income of $7.1 million for the same period in 2007. For the year the company reported a net loss of $1.7 million compared to net income of $42.5 million in 2007. Results for the fourth quarter and year ended December 31, 2008 were negatively impacted by record other than temporary investment impairment losses of $9.2 million and $30.9 million respectively, resulting from the severe and prolonged turmoil in the financial markets.

For comparative purposes, other than temporary investment impairment losses totaled $1.3 million in calendar year 2007. Net written premiums decreased 5.8% to $85.4 million in the fourth quarter and 2.2% to $386.6 million for the year. In the Property and Casualty Insurance segment, net written premiums declined 3.3% in the commercial lines of business and 4.8% in the personal lines of business.

In the reinsurance segment, net written premiums increased 3.7% primarily as a result of an increase in earned, but reported premiums associated with property pro-rata business and accrued reinstatement premiums. Under the terms of the quota share agreement the reinsurance segment received reinstatement of premium income that is collected by Employers Mutual from the ceding companies when coverage is reinstated after a loss event.

However, the cap and loss is assumed for event under the quota share agreement is automatically reinstated without cost to the reinsurance subsidiary. For calendar year 2008, new business premium was down 8.9% in the commercial lines of business reflecting decline in premium rates and reduced exposures.

Personal lines new business premium was up 9.9%, with much of that increase coming in selected territories which management believed to offer greater profit potential. In total, new business premium was down 7.6%.

Investment income decreased 3% to $12.2 million for the fourth quarter and 0.2% to $48.4 million for the year. These declines are primarily attributed to the elimination of the dividends on the Freddie Mac and Fenny Mae preferred stocks as well as a decrease in the yield on cash and short term investments. The total rate of return on our equity portfolio for 2008 was negative 37.4%, which is consistent with a negative 37% total return on the S&P 500.

During the fourth quarter, our equity portfolio returned negative 23% compared to a negative 21.9% for the S&P 500. The current annualized yield on our bond portfolio is 5.53% and effective duration is 5.6 years, which is up from 3.75 years at year-end 2007.

Net book value of the company’s stock at December, 31 was $21.32 per share, a decrease of 18.5% from $26.15 per share at year-end 2007. Consolidated assets totaled $1.1 billion, including $965.2 million in the investment portfolio and stockholder’s equity was $282.9 million.

In 2008, the company’s Board of Directors authorized a stock repurchase plan totaling $25 million. The program does not have an expiration date and a timing in terms of the purchases is determined by management, based on market conditions and the applicable rules of the SEC. As of February 23, 2009, 590,515 shares have been repurchased. And $10.2 million remains available for the purchase of additional shares.

At this time, I would like to open the phone for questions.

Question–and–Answer Session

Operator

(Operator Instructions) Our first question comes from Paul Newsome - Sandler O’Neill & Partners.

Paul Newsome - Sandler O’Neill & Partners

I was hoping you could walk through the combined ratio assumptions that you have for next year and might back in the envelope, I think calling on the third quarter, but is you really may be [Inaudible] 102, but you’ve had price increases or decreases that are probably mid-single-digits and I assume that there is some loss cost inflation its out there. So, I’m having trouble getting to 102, as low as 105 and just if you guys could help my thinking in that regard that would be much appreciate it.

Bruce Kelly

Thanks Paul for your question, this is Bruce Kelly. First, Mark Reese will give an overview of the combined ration and then Steve Peck will add some details to that.

Mark Reese

Yes, the assumption is 105.5 for the year and that does reflect the lag in effect rate decreases that were implemented in prior years and also, I think I think a more normal cash storm loss here than what we experienced in 2008. With those comments, I’ll turn it over to Steve and I can get into a little more on the detail.

Steve Peck

I would assume largely because of economic conditions and even policy account reduction of 2.5% is fairly in frequency a little difficult right now, but my assumption is an increase in seniority of 7% and reduction in frequency of 4.2%. I’m assuming that the impact of 2008 our rate changes on 2009 premium will be about 1.6% reduction on a return basis and somewhere in the neighborhood of 3% on year-end basis.

In addition to that, I’m assuming no change in 2009 in manual rates. That is rates that would be implementing on the manual side would not change the overall rate level in 2009 and I’m also assuming no change in the average underwriting credit on commercial policies. The cat load that is included, I should also say that those statistics are for the accrual which is the driver combined.

The overall cat load including EMC Re that I have assumed is 7.6% and that breaks down to 5.9% on the accrual and 15.1% on EMC Re. Finally, the one area of reserve development that can affect the combined ratio, case reserve development. I am assuming no case reserve development in 2009, either up or down.

Bruce Kelly

Did that help you Paul?

Paul Newsome - Sandler O’Neill & Partners

Yes, it does. Two clarifications, it sounds like you are assuming essentially flat pricing at least from your perspective next year?

Bruce Kelly

On going basis. Yes.

Paul Newsome - Sandler O’Neill & Partners

Then from a reserve release perspective, are we assuming essentially a similar amount this year than last year, I mean, I know your reserved systems are little bit different than others, but just to be clear. You had to have some reserve releases in there, I would imagine given that they are near by half year earnings right now?

Bruce Kelly

Well, we have to distinguish between reserve releases. We have to identify reserve releases that actually impacts combined ratio. A lot of our development is caused by reallocation of the bulk reserves from the prior action years to the current action year, as we move through the year. It doesn’t mean that those reserves are going to change at all, but they can show off as developments, downward developments as they take down in the reserve for prior years exceeds the recorded loss for prior years during that calendar year.

The only area where developments would directly impact the combined ratio would be case reserve developments. In 2008, we assumed a case reserve development on accrual of minus 2%. It actually came in a little higher than that, it was about I believe about minus2.7. This year, compared with the minus 2, the assumption is zero and the reason for that is a decline in the estimated adequacy of the case reserves.

Mike mentioned that the downward development of the case reserves last year, which was partially due to a reduction in adequacy, was more than offset. I don’t know if the development was more than offset, but at least partially offset by the increase in the bulk case reserve to offset the decline in the individual case reserve adequacy. So it is a long answer to your question, the short answer the assumption this year is zero compared to minus 2, a year ago.

Paul Newsome – Sandler O’Neill & Partners

Great thank you, very much.

Mark Reese

Remember Paul, last year, Steve predicted the 101 and if we had a normal storm here, he would have been spot on, on his predictions. So, we are pleased with this predictability.

Bruce Kelly

Ron has a comment.

Ron Jean

Yes, Paul this is Ron Jean and I’ve description on that to add to as Steve said. What happens is since we had a very conservative reserving position, even though we see some favorable develop years we are pulling out very conservative reserves on a New Year as well. So, we are maintaining a fairly consistent level of reserve adequacies. So, whatever release we see from old years, is some what offset by new reserve that has been put out on a calendar year basis.

Operator

(Operator Instruction) Your final call is from Bob Barnum - Keefe Bruyette & Woods.

Bob Barnum – Keefe Bruyette & Woods

Two questions, one was the return premium growth in the property causality segments was lot lower, I think it was down 10% for the quarter and I just wanted to know if there was any thing particular in that net quarter that drove that number down so much, relative to the earlier quarters during the year.

Bruce Kelly

I will let Mark talk about that and I then I think Kevin has some comments also.

Mark Reese

Bob, as fare as the quarterly fluctuations, we feel a lot of fluctuation by quarter in the PMC segment, but I wouldn’t read too much into that change for the quarter. I think more important to look at the year-to-date results when that was about 3.7 declines for the year and that’s consistent with our expectation were. On a quarter-to-quarter basis there is going to be fluctuation as to what power series are actually built and when, it’s going to have a little bit up before the quarter.

Kevin Hovick

Yes, this is Kevin Hovick. We don’t have a whole lot to add to what Mark had said on that. We easy to see a fairly start inflow of new business into our branches during the fourth quarter and during the year last year, it wasn’t quite as strong as it was in 2007, our personal lines continue to stay fairly strong and our renewal retention continues to stay pretty strong. Again, I think it’s some of a reflection of the continuing fairly soft market place out there.

Bob Farnam - Keefe Bruyette & Woods

What was the renewal retention in that business, do you have that number?

Kevin Hovick

Its about 86% on commercial lines and about 87% on the personal.

Bruce Kelly

Remember Bob, we are doing some re-underwriting on some of our coastal exposures. So are getting of business that we don’t want to have long-term.

Bob Farnam - Keefe Bruyette & Woods

Then second question is more of a number question too, your effective tax rate I think kind of screwed up the second half of the year. So I have been assuming 25% tax rate looked forwarded, does that still sound reasonable?

Mark Reese

Well, yes we have movements of fluctuation this year and that’s really due to fact that we have quite a bit of our investment income is tax exempt and our book income has been fluctuating pretty dramatically through the year as a result of the high level of cat and storm losses and the impairment losses that we’ve been recording. On going forward basis, our assumption is that our effective rate for 2009 is going to be 14.6%.

Bob Farnam - Keefe Bruyette & Woods

14.6%?

Mark Reese

A little bit less than the 25 that you have been using.

Operator

At this time there is no further questions, I would like to turn the call back over to speakers for any closing comments.

Anita Novak

Thank you, Sherry. Thank you ladies and gentleman. This now concludes this conference call. I would like to remind you that the playback of this call will be available on the company’s website at www.emcinsurance.com until March 12, 2009 and a transcript of this conference call will be available until February, 2010 which can be accessed from our website as well. We appreciate your interest in EMC Insurance Group and all of us wish you an enjoyable day.

Operator

Thank you. This does conclude today’s teleconference. You may disconnect your lines at this time. Thank you for your participation.

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Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

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