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EMC Insurance Group, Inc. (NASDAQ:EMCI)

Q1 2009 Earnings Call

April 23, 2009 02:00 pm ET

Executives

Anita Novak - Director, IR

Bruce Kelley - President and CEO

Mark Reese - SVP and CFO

Ron Jean - EVP Corporate Development

Steven Peck - SVP Actuarial

Analysts

Paul Newsome - Sandler O’Neill & Partners

Bob Barnum - KBW

Operator

Greetings and welcome to the EMC Insurance Group First Quarter 2009 Earnings Results 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 Ms. Anita Novak, Director of Investor Relations for EMC Insurance Group Incorporated. Thank you. Ms. Novak, you may begin.

Anita Novak

Thank you, Manny. Good morning, everyone and welcome to EMC Insurance Group’s 2009 first quarter earnings call. A supplemental investor packet is available on the Investor Relations page of our web site, which can be found at www.emcins.com/IR. The webcast for replay purposes is also available at this site until February 23, 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 2009 first quarter earnings release with accompanying financial table 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 Executive 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. Rich Schulz, Senior Vice President, Claims; Mr. Kevin Hovick, Senior Vice President for 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. From an overall perspective first quarter 2009 ended with a solid result. Net operating income was $0.86 per share and the GAAP combined ratio was 96. Our underlying book of business remains sound despite the fact that overall rate levels on a written basis declined 4.2% year-over-year. Premium rates are showing signs of stabilization and we expect them to be begin firming somewhat during the second-half of 2009 in light of reduced capital levels and continuing uncertainty on the investment side. The lagging effect of previous rate level reductions, however reduced rate levels by approximately 3.5%.

Policy counts were up slightly in commercial lines and a little more significantly in personal lines. Average premium per policy is trending downward reflecting lower rate levels. Frequency is down slightly and severity is up 2.2 percentage points. Retention remains strong at approximately 86% for both commercial and personal lines.

Net written premium declined 2.3% in the first quarter with regard to commercial lines written premium was down for auto and liability but up for property and workers compensation lines as well as surety bonds.

For personal lines, written premiums increased for auto but declined for property and liability. It is important to note that some of the decline in personal lines written premium is a result of strategic decisions to reduce our presence in certain territories. We continue to redirect personal lines marketing initiatives and resources to characterize which we believe offer greater potential for growth and profit.

Personal lines, especially home owners are also being affected by ongoing efforts to mange exposure to catastrophic events. You may recall for example, that we previously decided to reduce our Rhode Island homers exposure by one-third, that process continues as we work to maintain a balance between geographic diversification and focus marketing initiatives in selected territories.

Catastrophe in the storm losses added 4 percentage points to our combined ratio in the first quarter compared to 6 percentage points in the first quarter of 2008. Development on prior years reserves continuous to be favorable. For the first quarter of 2009 favorable development totaled $21.1 million compared to $15.9 million for the same period in 2008, a reflection of consistent and conservative reserving practices.

Reserves are reviewed by our actuaries on a quarterly basis and both reserve adjustments are made as appropriate to maintain a consistent level of reserve adequacy. This methodology creates a transparent view of our actual reserve position and it is our intention to continue this methodology.

Underwriting reserves are very important and we take them very seriously. Our corporate objectives are based on profitable underwriting initiatives. We continue to expand our use of modeling tools, to enhance the value of prediction underwriting approaches and to improve the effectiveness of our selection and pricing decisions. We maintain a brand structure so that our underwriting staff is strategically located throughout our marketing territories and so that underwriters are well versed in the local marketing environment. However, underwriting is only one of the elements of our profit potential. As with most financial services organizations we strategize for profitability and our investment portfolio as well. And like most financial services organizations we continue to feel the effects of the global financial crisis especially in the evaluation of assets.

Investment income in the first quarter increased 2.8% as compared to the same period a year ago. However, as reported in our press release earlier today we recorded other than temporary investment impairment losses totaling $8.4 million or $0.41 per share after-tax on 24 equity securities and one fixed maturity security in the first quarter of 2009. Clearly, asset impairment continues to have a significant effect on net income. Even so we remained financially strong and we believe that our conservative investment philosophy has served us well during the financial crisis.

Current speculation suggest that financial market conditions could begin to improve by year-end regardless, we will continue to adhere to our long-term strategy which consists of investing in high grade securities as opportunities present themselves and avoid riskier investments that we do not understand and have created such serious problems for so many others.

With that I will turn the discussion over to our Chief Financial Officer, Mark Reese. Mark?

Mark Reese

Thank you, Bruce. Operating income for the first quarter was $11.4 million which is an increase of 12.9% from the $10.1 million reported in the first quarter of 2008. Operating income for the first quarter of 2009 reflects a more normal level of catastrophe and storm losses and moderate to steady decline in overall premium rate levels and an increase in amount of favorable development experience on prior year reserves.

Net income for the first quarter was $5.8 million compared to $8.2 million in the first quarter of 2008. Results for the first quarter were negatively impacted by $8.4 million of other than temporary investment impairment losses.

This is more than 2.5 times the $2.9 million of other than temporary impairment recognized in the first quarter of 2008. And includes $2.2 million recognized on fixed maturity securities issued by Great Lakes Chemical Corporation, now known as Chemtura Corporation as a result of its chapter 11 bankruptcy filings.

Net written premiums decreased 2.3% in the first quarter. In the property and casualty insurance segment, net written premiums declined 3.5% in the commercial lines of business and 1% in the personnel lines of business.

In the reinsurance segment net written premiums increased to 1.3%. For the quarter new business premium was up 5.3% reflecting an 18.8% increase in personnel lines and a 4.1% increase in commercial lines.

Investment income increased 2.8% to $12.3 million for the quarter due to the purchase of high quality commercial and residential mortgage backed securities and the redeployment of over $165 million of proceeds from called US Government Agency Security into a higher yielding corporate securities during 2008.

The total rate of return on our equity portfolio by the first quarter of 2009 was a negative 8.91% which compares favorably to the negative 11.01% in total return generated by the S&P 500. The current annualized yield on our bond portfolio is 5.36% and the effective duration is 5.47 years which is down slightly from 5.6 years at year-end 2008.

The net book value of the company's stock at March 31 was $21.62 per share, an increase of 1.4% from $21.32 at December 31. Consolidated assets totaled $1.1 billion including $947.9 million in the investment portfolio and stockholders equity was $286.2 million an increase of 1.2% from year-end 2008.

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 thetiming in terms of the purchases are determined by management, based on market conditions and applicable rules of the SEC. As of March 31, 601,119 shares have been repurchased at cost of approximately $15 million, leaving approximately $10 million available for the purchase of additional shares.

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

Question-and-Answer Session

Operator

Thank you. (Operator Instructions). Our first question comes from the line of Paul Newsome with Sandler O’Neill & Partners. Please go ahead.

Paul Newsome - Sandler O’Neill & Partners

Good afternoon.

Bruce Kelley

Good afternoon, Paul.

Paul Newsome - Sandler O’Neill & Partners

Could you talk a little bit about the generally large reserve release in the first quarter. Was there anything in there that was unusual and perhaps talk about the timing as well. It seems to be recurring pattern it’s a pretty sizable release in this quarter. Although this is (inaudible).

Bruce Kelley

We will let Steven Peck to address that.

Steven Peck

Downward reserve development is somewhat greater than it was a year ago and through March. Lot of that increase is coming from case reserves and all of that development is on closed clients. The increase in the case reserves a good deal of that increase is coming from storm claims, as you know we had a very unhappy storm season in 2008. And lot of those claims were paid, an unusual numbers of storm claims were paid during the first quarter. So the numbers are a bit higher but it has to do with the distribution and claims.

Paul Newsome - Sandler O’Neill & Partners

What active year's are the reserve (inaudible).

Steven Peck

Case reserve development, about 87% of that is coming from 2004 to 2008. Making specific lines (inaudible) 70% of the (inaudible) development was [2000] in those buybacks in years 77% of the other liability, so relatively reasonable. And of course most of the property would have been from active year 2008.

Paul Newsome - Sandler O’Neill & Partners

Now, I will put myself in the queue and let some other folks ask questions.

Operator

Thank you. Our next question is from line of Bob Barnum with KBW. Please go ahead.

Bob Barnum - KBW

Yes, thanks, good afternoon

Bruce Kelley

Good morning.

Bob Barnum - KBW

I am curious about where the reserves are in the range, just to kind of extending on Paul’s questions. I know historically even in the upper quartile is the just the case?

Bruce Kelley

Yes, storm we have a quartile, I believe at the end of 2008 on a consolidated basis it was in the neighborhood of the 92% percentile, something like that.

Bob Barnum - KBW

Okay, another question on it looks like the property and casualty piece the expense ratio was a bit higher in the first quarter, specifically the dividend ratio, anything going on there that is abnormal?

Bruce Kelley

Well in the increase in the dividend ratio is coming from, let me back up a step. There are two types of dividends. One is for safety dividend group. The other type is dividends on individual workers compensation policies. The ratio is up a bit and that’s coming entirely from the workers compensation type of dividend, the increases. I am not aware of exactly where that is coming from, but the dollars are not increases is not here.

Bob Barnum - KBW

Okay but these are related to policies from 2008 basically and the, how they ended profitable, they are more profitable?

Mark Resse

Yeah, could have been some from early 2008 and later part of 2007.

Bob Barnum - KBW

Okay, in terms of the re-insurance piece, we hear from others that one-to-one renewals were, there were increases in rates there, do you have any idea to quantify if you did get rate increases in those reinsurance piece at one?

Ron Jean

This is Ron Jean, I can address I am not sure if I have the numbers but we did get some increase on renewals in the January renewals. And I think the April renewals, some of those were coming in at even higher so we may see more impact going forward. I don't think the increases were surprising and they were kind of expected and mostly increases came on, on accounts that have been generating some loss activity other renewals are maybe a little bit flatter.

Bob Barnum - KBW

Thanks and last question before I jump back in the queue, looking at the taking out the catastrophes is probably question more for Steve again the in year ’09 combined ratios out of 1.15 or so I understand that has a cushion in there, or typically does, can you kind of quantify where you think that might ultimately end up?

Steven Peck

I would point out as a preface to your specific question that, we were at approximately the same combined ratio at the end of the first quarter of 2008 and had we had a normal storm year, the combined would have come in the neighborhood of 103.

Bob Barnum - KBW

Okay.

Steven Peck

That is the, the ultimate projection, projected combined ratio.

Bob Barnum - KBW

Do you saying it's consistent with you had in year '08?

Steven Peck

Yes, it's very consistent with actually --

Bob Barnum - KBW

Where you think the ultimate acting '08 is going to go?

Steven Peck

I think the ultimate actually '09 is going to come in the neighborhood, this is a statutory number in the neighborhood of 106.

Bob Barnum - KBW

Okay. That's for me. Thanks.

Operator

Our next question comes from line of Paul Newsome. Please go ahead.

Paul Newsome - Sandler O’Neill & Partners

Could you talk a little bit about the OTTI write downs and what were the specific triggers in this quarter versus why we did not see them in the last quarter for example?

Bruce Kelly

I will let Mark Reese.

Mark Resse

Hey Paul. Obviously the $2.2 million is related to one of our fixed maturity securities that went into bankruptcy. We did kind of pre-announce that when we did an 8-K filing back in March. And that stock has been trading in the $0.26 on the $1 and that's what we ended up parring it down to at the end of the first quarter. We do ultimately expect our recovery to be higher than that but the accounting rules are required to write that down to the current market value at the end of the quarter.

On the equity side its really result of the continuation of the significant decline in the equity markets, once security passed a certain timeline of being under water for six months or nine months or forced with the accounting rules to really look at those for impairments. Even though ultimately we expect the value of those to come back. It is deemed other than temporary.

So that’s really where we got in to in the first quarter was with the 24 securities that we ended up writing down regarding those which has been under water for a longer period of time where we kind of forced in to the impairment.

Paul Newsome - Sandler O’Neill & Partners

I guess what I am asking for, is to better understand what long enough means and far enough means we have a specific rule that you are using or even it's in rough guidelines?

Mark Resse

Rough guidelines, its something, that’s been under water for six consecutive months, we have to look at it pretty hard for impairments. And our guidelines test if there is such a thing. But even though security does meet those guidelines, we do look at each security individually. We determine if there is compelling evidence why should not impair it. Something pointing that we might see a recovery in the near future.

So the rules kind of put you in a bad position when you are in a prolonged market where securities are just beat down those severely and for so long. If you can get an increase in the overall market we should see a significant reduction in impairment losses but if it continues to go down or even stay at this level we are going to be seen hopefully not at this level but additional impairment losses going forward.

Paul Newsome - Sandler O’Neill & Partners

Back to the comments on where we focusing the ultimate action year is. If we are still looking price decline around 2.5%. does that mean that '10 is really what we somewhere around [109] combined ratio?

Mark Resse

Most of the decline in rate levels that we mentioned few minutes ago are coming from rate reductions implemented in 2008 and with the lag impact than they have their effect in 2009 or much of the effect. Actually we are tempted to get an increase overall increase in manual rates in 2009 whether that happens depends obviously on the market but that's our intention. I think that there will be relatively little further downward pressure in 2010, at least that is our hope.

Paul Newsome - Sandler O’Neill & Partners

So, I guess sort of follow-on thought is should we be concerned and if the reserve releases go away during the eventually do. You are looking at a company thats currently not profitable?

Mark Resse

Okay, I am glad raise that question because I wanted to follow-up on my previous answer. With regard to reserve development. In our reserving process the downward reserve development does not mean that we are deliberately releasing reserves. All we are doing is reallocating, for the bulk reserves all we are doing is reallocating between active years. That's not to say that the bulk reserves might not go up or down but the downward development itself does not imply releasing any reserves.

So the overall effect on the calendar year basis of reserve development is in the neighborhood of zero. Now the one exception to that statement is on case reserves, but in effect that is release and does affect the bottom line. But keep in mind what I said about those that all of these downward development of case reserves is coming from claims that are closed. It's not that we are reducing an aggregate case reserves on open claims it is just that claims are settling out at a lower level than they were reserved.

And as long as case reserves continue to be established at the same level of adequacy as they were in recent years then that downward development would continue every year theoretically.

Bruce Kelly

I would like to add something to that also. I think it's important to keep in mind that we had cases reserves strengthening that cut back in 2004 since that point in time we have maintained a very persistent level of reserve adequacy and that’s by design. And so to say that reserve releases are going to go away. I think it is probably inaccurate because we intend to maintain that same level of adequacy going forward. So let us not say there might not be some variation from year-to-year but overall we are intended to maintain a very conservative reserve position.

Paul Newsome - Sandler O’Neill & Partners

I think we may have a different on what is GAAP but that’s a preliminary discussion. But I mean the issue I think folks have is that all of your profits are based upon reserve theoretically reserve redundancies that are in the case reserves and I think that’s what we are basically looking at for the next year today, is that an accurate statement?

Bruce Kelly

Well I'm not projecting on an action year basis I'm not projecting we will have an underlying profit. But I would point out if you go back from beginning in 2006, maybe 2007 I'm not sure go back five or six years. You will find five or six years in a row with active year combined ratios are less than a 100 and we had more downward reserve development in those years than we are having now. And that reserve development of course has no effect on the action year results.

We do not know for sure they are going to settle out below a 100 but that is the projection that’s where they are right now.

Paul Newsome - Sandler O’Neill & Partners

Fair enough thanks.

Operator

(Operator Instructions). We will take a follow-up from Paul Newsome, please go ahead.

Paul Newsome - Sandler O’Neill & Partners

Please keep my line open. There was no mention I did not see you mention of earnings guidance. Any changes from the fourth quarter to the first quarter results, is that a deliberate choice, any comments?

Mark Reese

Yeah Paul its Mark again, we deliberately did not change our guidance even though we had what we consider to be a strong first quarter, we recognized that there has been in recent years a lot of volatility in our cat and storm numbers. As we head into second and third quarters. So at this point we are kind of waiting out to see how the second quarter plays out and we will readdress guidance at that point.

Bruce Kelly

Yes Paul this is Bruce Kelly, I agree with Mark that we are looking at this very closely but we are not able to make the change at this point, we are waiting to see more, see how the months go ahead, so we are looking at it very closely.

Paul Newsome - Sandler O’Neill & Partners

Thank you.

Operator

We have no further question in the queue at this time.

Anita Novak

Thank you ladies and gentlemen, this now concludes this conference call. I would like to remind you that a playback of this call will be available on the company’s Investor Relations page of the company's website at wwe.emcins.com/ir until May 7, 2009. And a transcript of this conference call will be available until April 23, 2010, which can also be accessed from our Investor Relations page later today. We appreciate your interest in EMC Insurance Group and all of us wish you an enjoyable day.

Operator

Ladies and gentlemen this concludes today’s teleconference. You may disconnect your lines at this time. Thank you for your participation.

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