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FPIC Insurance Group Inc. (NASDAQ:FPIC)

Q2 2009 Earnings Call

August 6, 2009 11:00 am ET

Executives

John R. Byers – Chief Executive Officer and President

Charles Divita III – Chief Financial Officer and Principal Accounting Officer

Robert White, Jr. – President of First Professionals and President of Insurance

T. Malcolm Graham – Secretary and General Counsel

Pamela Deyo Harvey – Vice President and Controller

Analysts

Paul Newsome – Sandler O'Neill & Partners

Joe DeMarino – Piper Jaffray

[Jack Church] – SunTrust Robinson Humphrey

Amit Kumar – Fox-Pitt Kelton

John McCarden – John D. Williams Company

Operator

At this time, I would like to welcome everyone to the FPIC Insurance Group' second quarter 2009 conference call. (Operator Instructions). We're now ready to begin the call.

[Pamela Deyo Harvey]

Good morning, everyone and thank you for joining the FPIC Insurance Group quarterly conference call. The call this morning will include a brief presentation followed by an opportunity for questions and answers. Please be reminded that the call today is being recorded and a replay will be available this afternoon at 2:30 pm. A Webcast replay will also be available.

Today's presentation and the discussion that follows may include statements about expected future events and future financial results that are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are not guarantees of future performance and actual results may differ materially as a result of risk and uncertainties that we describe more fully in our earnings release and in documents that we file with the Securities and Exchange Commission.

Our earnings release can be found in the Investor Relations section of our Website at fpic.com. We do not undertake to revise forward-looking statements, whether as a result of new information, future events or otherwise except as required by law.

Today's presentation may also include certain non-GAAP financial measures, which we explain more fully in our earnings release, including a reconciliation of reported non-GAAP measures to the most directly comparable GAAP measure.

Now let me introduce our participants this morning. We have John Byers, President and Chief Executive Officer, Chuck Divita, Chief Financial Officer and Bob White, President of our Insurance subsidiaries. We are now ready for our presentation. Here is John Byers.

John R. Byers

Thanks. Good morning. We're pleased to report strong second quarter results. We'll also take the opportunity today to discuss our recently announced agreement to acquire Advocate MD Financial Group.

Let me begin with our results. We achieved operating earnings per diluted share of $1.09 for the second quarter, which reflects the continuation of our strong underwriting results and overall favorable claims trends, together with our solid investment results and our capital management initiatives.

Another highlight of the quarter was our very strong book value per share growth, fueled by our profitability and the increased valuation of our investment portfolio arising from the second quarter recovery in the financial market. As of the end of the quarter, our book value per share stood at $37.04, an 11% increase over our year-end 2008 book value per share.

Our retention rate for existing business for the quarter was excellent at 96% in Florida and 95% nationally, which reflects our established market positions and close relationship with our customer base. We also continued to achieve policyholder growth during the quarter.

Our overall policyholder account, excluding policyholders under alternative risk arrangements increased 5% from the end of second quarter 2008 to the second quarter of this year. This includes growth in our core Florida, Georgia and Arkansas markets, as well as in our recently added South Carolina market. Approximately half of this growth was in physicians with the remainder from dentists and other healthcare professionals.

As anticipated, written premiums for the quarter declined compared to second quarter 2008, reflecting moderating rates in recent years arising from sustained strong claims trends. While we systematically assess and seek to take advantage of opportunities for premium growth that make sense for us, our ultimate focus is on sound underwriting and pricing, which are the essentials to sustainable success.

And two other matters of note for the second quarter, first, overall claims trends remain solid, most notably continued low claims frequencies. And secondly, our investment portfolio continued its solid performance. All in, we're very pleased with our second quarter results.

Let me now discuss our contemplated acquisition. As you know, last Thursday we reported that we've entered into a definitive agreement to acquire Advocate MD Financial Group and its subsidiaries. For a number of reasons, we're very excited with the prospect of Advocate joining our organization.

Advocate is the fourth largest writer of medical professional liability insurance in Texas and also writes business in Mississippi. The acquisition will provide us with a significant presence in the large attractive Texas market.

It will also provide us with additional premiums in an overall market environment of declining premiums arising from the strong claims trends of recent years. As to its corporate culture, including its strong focus on customer service and organizational excellence is classed similar to ours.

Financially, the price and pricing structure of the acquisition makes sense for both organizations. We expect the acquisition will immediately upon its consummation be accretive to our earnings. We anticipate closing to occur prior to year-end subject to obtaining the required regulatory and Advocate shareholder approvals and satisfaction of the other closing conditions.

Chuck will further discuss the acquisition in his remarks and we'll be happy to answer any questions you may have regarding the acquisition in the question and answer portion of the call. With that, I'll now turn the discussion over the Chuck to review our second quarter results in detail.

Charles Divita III

Thanks, good morning, everyone. I'll start with the highlights of our second quarter results and then touch on our agreement with Advocate MD. In many ways our results this quarter and most of the first six months of 2009, reflect three significant themes.

First we continue to achieve solid bottom line results due to our focus on retaining and growing a preferred book of business. Our operating earnings per diluted share for the quarter is $1.09 and demonstrates the overall profitability of our business and the effectiveness of our capital management initiatives.

On an annualized basis, our results for the first six months of 2009 translate into a return on equity of approximately 13%. As John mentioned, we continue to achieve excellent business retention levels, which have been in the mid-90s for several years now and have achieved overall net growth in our policyholder base this year. This underlying growth in our business should bode well for our results going forward.

Secondly, favorable claims trends continue to impact our results. Since our rates are ultimately determined by loss costs, our top line measures continued to moderate downward in the quarter with direct written premiums and consolidated revenues declining 13% to 9% respectively compared to the prior year's quarter. The decline in net premiums written were somewhat greater at 15%, primarily due to our new South Carolina program, which has a different reinsurance structure.

While lower loss costs have resulted in lower premium rates for our customers, they also continue to drive good underwriting results for us. Claims frequency, when adjusted to reflect the composition of our book, remains near historic lows and for the first six months of 2009 appears to be in line with 2008 levels.

Additionally, overall payment severity measures remain within our expectation. As a result of the continuation of favorable claims results, we recognized $5 million in favorable reserve development during the quarter, primarily from accident years 2005 to 2007.

Excluding this favorable development, our loss ratio was 71% for the quarter compared to 68% for the prior year's quarter. The increase in the ratio is reflective of the lower premium rate environment and our commitment to establishing an appropriate loss provision.

Our expense ratio also continued to be impacted by a lower rate, with our underlying operating cost structure remaining efficient and stable. As a result, the ratio for the quarter increased to 27% from 22% for the prior year's quarter. The winding down of recoveries of a prior guarantee fund assessment also contributed to the increase in the ratio.

And the third significant theme of our result is one of continued financial strength, as evidenced throughout our balance sheet. Our cash and investment portfolio has an average quality rating of AA and continues to perform well. And as John said, we've seen significant growth in the portfolio's market value since year-end 2008.

Our reserve position remains appropriately conservative and continues to develop favorably in the quarter. Excluding incidents our claim inventory is 10% lower than the second quarter 2008 and 4% lower than year-end 2008.

And finally, we have substantial capital to support our business in key initiatives. Our book value per share has grown 11% since year-end 2008 and our insurance subsidiaries are currently writing at a net premiums written-to-surplus ratio of approximately 0.6 to 1.

Our strong capital position also continued to provide opportunities to repurchase shares at a meaningful level. We repurchased 829,000 shares of our common stock this year through July 31 for an average price of $33.53 per share. As of that date we've had 623.000 shares available under our current share repurchase authorization from our board of directors.

Now let me briefly comment on Advocate MD. We're certainly excited about the transaction and we look forward to working with Advocate MD as part of the combined organization. In 2008 Advocate MD through its subsidiary insurer grossed $25.4 million in direct written premium, approximately $23.5 million in Texas and $1.9 million in Mississippi.

The insurance subsidiary is well capitalized and as of June 30, 2009 was writing at a net premiums written-to-surplus ratio of approximately 0.9 to 1. The company currently serves approximately 2,500 physicians and has achieved very good retention levels for existing business.

Advocate MD has also achieved good underwriting results since its conception and has been effective at resolving claims in an expedited manner and with good overall results. The Texas market changed dramatically with the passage of tort reform measures in 2003, and Advocate MD has done a good job of taking advantage of the improved market conditions.

The transaction requires the approval of the Texas Insurance Commissioner and the shareholders of Advocate MD and work to obtain those approvals is already under way. Subject to their approval we would expect to close the transaction by year end. Once completed, we believe the transaction will be immediately accretive to our earnings and be positive in many other respects as well.

On a pro forma basis Texas will become our second largest market and based on 2008 data would have represented approximately 11% of the total direct written premiums of the companies combined. Florida will certainly remain our largest market but will decline as a percentage of our overall total direct written premiums.

The purchase price is comprised of $33.6 million in cash at closing at up to $12 million in additional cash consideration based on the performance of the business over a two-year period following closing in three key areas: the level of direct written premium, the combined ratio and the level of underwriting profit.

Under the transaction structure as Advocate MD achieves higher levels of performance the amount of total purchase price consideration increases as does the return on investment for FPIC. The structure and other key provisions of the deal provide substantial alignment of interest and are geared toward the long term success of the business.

Again, we're pleased with our results for the quarter and with the pending transaction with Advocate MD. With that we're now ready for questions.

Question-and-Answer Session

Operator

(Operator Instructions). Your first question comes from Paul Newsome – Sandler O'Neill and Company.

Paul Newsome – Sandler O'Neil & Partners

I wanted to ask about the expense ratio and it seems to be ticking up. I would imagine that's ticking up in part of because the premium is falling and do you essentially have kind of a situation where if frequency remains stable and therefore rates remain at low levels, a scale issue that's created by the frequency benefits? And does that – is there an issue there? Are you put at a competitive disadvantage and to what expect does Advocate separately help you with that operating expense situation?

Charles Divita III

Sure, well let me give some perspective on the underlying expense structure. We've had a very stable fixed cost structure for several years now, and n fact in 2009 the underlying fixed cost structure of the organization was very consistent with 2008.

What you're really seeing in the expense is a couple of things, primarily the winding down of the recoveries of a prior guaranteed fund assessment. In 2008 it was basically doubled what it's going to be in 2009. So you're seeing that lift in the expenses because of that recovery going away.

Last year we averaged about $9.5 million in other underwriting expenses per quarter excluding the FIGA recoveries last year I think was around $10 million and we're averaging on that same basis this year around $10 million. So the underlying expenses are very stable, but the ratio itself is a combination of the lower earned premium and the winding down if you will of the FIGA guarantee recoveries.

In terms of going forward I would expect that ratio to continue around that same level that 26% to 27%, again, it's reflective of the rate environment in Florida but we don't believe that puts us at any disadvantage in the market place.

In terms of Advocate MD and its impact once the transaction is consummated they have an expense ratio that's been around in that 27%, 28% range as well and given the size of that company versus our company I don't really see that materially impacting the ratio.

John R. Byers

I would just add to that, this is John, I mean we have taken substantial expense out of the company over the last several years but we're really geared strategically for the longer term and we want to be able to take advantage of growth opportunities that we see and we have grown our policyholder accounts and we want to continue to be positioned well to do that. So we certainly haven't cut expenses to the bone because we have a longer term view.

Operator

Our next question comes from Joe DeMarino – Piper Jaffray.

Joe DeMarino – Piper Jaffray

Last quarter I think you mentioned how some doctors who were self insuring had not yet made the leap over to your market is that similar this quarter?

Charles Divita III

Yes, Joe, things really haven't changed in that regard. Physicians who were self insured or bare a year ago are still pretty much self insured or bare right now.

Joe DeMarino – Piper Jaffray

I think you took a 12% or 12.1% rate decrease at the beginning of the year. Are you're comfortable with your rate level right now in Florida?

John R. Byers

Let me hit that at the high level and then I'll turn it over to Bob if he'd like to add something to it. We did. It was a 12% effective rate increase and yes, we are comfortable with our rate level. We think we're still driving good margins, appropriate margins for both actuarially and for driving appropriate return for our shareholders. So we are comfortable with the rate level. Bob?

Robert White, Jr.

And Joe, once we finish with our statuary filings with the state we'll undertake a rate review. We do it every year based on June 30 data and so we're about to undertake a rate review primarily of our Florida book of business. But I would say from my perspective I would be very surprised if there was anything that would come out of that review other than to suggest that our rates are adequate at their current level.

Joe DeMarino – Piper Jaffray

And then the increase in policyholders, what market is that I guess either year-over-year or for the quarter sequentially where is that coming from outside of Florida?

John R. Byers

Well it's really from our all – we're seeing growth – we've seen growth in Florida, Arkansas and Georgia as well this quarter, this last quarter second quarter from our New South Carolina market. The physician growth has been primarily in Arkansas and Georgia.

Joe DeMarino – Piper Jaffray

And how would you characterize the rate adequacy outside of Florida in your markets outside of Florida right now?

Robert White, Jr.

We just finished a rate review last year of all our rates, Joe, and in markets outside of Florida and we were very comfortable with the adequacy of our rates.

Joe DeMarino – Piper Jaffray

And then one last question here your risk-to-capital I think you said is 0.6 to 1 how high can that go in this type of market, rate market?

John R. Byers

Well, I mean I guess there's two issues. There's certainty in this market there's no pressure on the capital and so there is a lot of room there but in terms of where we're comfortable operating, we're certainly comfortable operating at a higher ratio. We're comfortable operating at or at least near one to one. In the past we've been much higher than that. We've been 1.2, 1.5 to 1, I don't see it going to there, but certainly our comfort level and I think certainly the regulators and the rating agencies we could see it move some higher up closer to one to one. Where it actually does go it just depends on the growth opportunities that present themselves.

Joe DeMarino – Piper Jaffray

Okay, but at some point don't you have to take into account the severity of this soft market and the fact that these rates on a per risk or per exposure basis may not be as similar or comparable to what they were in the last soft market.

John R. Byers

Well, I mean we'll continue to watch our rates. If the claims trends move, I think I'm answering the question, if the frequency of claims or the severity of claims moves that would get reflected in the rates. As I said before we're comfortable with our rates now.

We're closely monitoring where things stand. I think competitors in this industry ten 10 ago or so in a very soft market probably didn't have the discipline we have now and I think loss costs did get in front of them a little bit, or another way of saying it is they got behind in their rates. I'm very comfortable that we measure all these metrics monthly if not more often, so I'm not concerned that the claim trends are moving away from us. We understand the claims trend.

Robert White, Jr.

And Joe I would add – this is White – that the class of physician we insure today is much lower than in terms of its risk profile, the class of physician we insured in the last soft market. There's been an appreciable change in how risky our book of business is over the course of the last four or five years.

Operator

Our next question comes from [Jack Church] – SunTrust Robinson Humphrey.

[Jack Church] – SunTrust Robinson Humphrey

Just to make sure I heard this correctly, did you say claims were down about 10% year-over-year?

Charles Divita III

Yes, the inventory of the open claims excluding incidents was down 10% versus 6/30/08.

[Jack Church] – SunTrust Robinson Humphrey

Okay, and then just in terms of the competitive environment, have you seen any change there in Florida or any other markets?

Robert White, Jr.

No, Jack, things are pretty much exactly as they were in the first quarter for the second quarter.

[Jack Church] – SunTrust Robinson Humphrey

Okay, and then just moving on to the Texas market you mentioned the 2,500 physicians for Advocate, did you also say the policyholder accounts?

John R. Byers

It's the same. That's on a per physician basis so it's about 2,500 policyholders.

[Jack Church] – SunTrust Robinson Humphrey

Okay, and then just finally how about the retention rate for Advocate, how does that compare to you guys?

Charles Divita III

Yes, their retention has been in the high '80s, to low '90s for at least the last couple of years, so I would say it's around that 90% mark and so it's been a very good retention level.

Operator

Your next question comes from Amit Kumar – Fox-Pitt Kelton

Amit Kumar – Fox-Pitt Kelton

Maybe just staying on the acquisition, if you look at the top line, can you sort of talk about if there is any seasonality to the premiums? I think it's at $26 million book. Is it equally distributed or is there other than timing issues to that?

Charles Divita III

Hi, Amit. It was $25 million so I noticed you put an extra million on there, good analyst. There is some seasonality to their book. At least last year just from a percentage standpoint, the fourth quarter, which is probably the one you're most thinking about, was about 25% or 26% of their total written.

Their first quarter has been around 15%. Their largest quarter tends to be the third quarter, at least historically, and that's been in the 30% to 40% range, but so there is some seasonality although it's less – in talking with them, it's less than it used to be. You see more business distributed throughout the year as opposed to the normal renewal periods of 1/1, and 7/1.

Amit Kumar – Fox-Pitt Kelton

And you said that this will close at the end of fourth quarter, right or in fourth quarter?

John r. Byers

We believe it will close somewhere near or in the fourth quarter, probably towards the end of the year. It will close once the closing conditions are met, which there are two primary ones. There's typical closing conditions in the agreement, but we have to get approval by the Texas Department of Insurance, and then the Advocate shareholders will have to approve it.

So once those approvals are obtained we would go ahead and close. Just on historically the length of time it takes to get approval from a state insurance department we estimate that will be towards the end of the year, or perhaps right on the end of the year. That is what we think.

Amit Kumar – Fox-Pitt Kelton

Okay, so probably should not include any benefit in the Q4 numbers?

Charles Divita III

Yes, I mean just I think the more significant impact obviously is going to be 2010. To the extent that it impacts 2009 I think it's going to be modest, particularly if we're right about that sort of November/December timeframe.

Amit Kumar – Fox-Pitt Kelton

That's very helpful. In terms of maybe going back to the discussion in pricing and I know several questions were asked, is it fair to say that your December filings would probably be flat compared to '09 rate filings?

John R. Byers

I mean that's what we think, and assuming claims trends don't change and they haven't changed through the first six months of the year. We believe that you would see a flattening of those and maybe perhaps totally flat, and the reason we say that is because we at this point believe that all the benefits from the improved claims trends we've seen in Florida of the year are now fully reflected in the rates. So if that doesn't change you would expect the rates to stay about the same.

Amit Kumar – Fox-Pitt Kelton

Okay, that's helpful, and then maybe just moving on in terms of the tort reform. I know you've previously talked about the challenge and oral arguments being heard in July, can you sort of give an update on that?

Robert White, Jr.

Well the hearing took place in the fourth district court of appeals on July 7th. We expect that probably by the end of October they will issue an opinion on this case and this particular case in the Fourth District deals with emergency room cap on non-economic damage, and it remains to be seen how the court is going to rule. But the arguments went well from the medical community's perspective and we like the chance we have in this court.

John R. Byers

And then beyond that, as we've said in the past, if it went, as we would expect, either way it would go up to the Supreme Court and we would expect just based on historic looks at these things that 18 to 24 months after that we'd have a Supreme Court decision.

Amit Kumar – Fox-Pitt Kelton

And I guess based on your book and policy limits, even if it swings in the other direction it wouldn't be that material as it is, right?

Robert White, Jr.

I meant we had to bake in 5% for tort reform when it passed in 2003, and so the only influence on our rates is what we require to reflect back when the statutes passed. In other words there's a 5% benefit baked into our rate, or what the department actuary determined was the benefit of the tort reform. So if the tort reform went away, you would expect the rates to immediately then take off that 5% benefit, or in other words go up by 5%.

Amit Kumar – Fox-Pitt Kelton

Okay, and then I guess just one final question, in terms of your geographic expansion, do you feel that your distribution is sort of set for now, or would there be, again without being too specific, any other set of regions you might think about down the road?

John R. Byers

We're looking. I mean we continue to look and we have, as I mentioned a little earlier, we have grown a policyholder account in Arkansas, Georgia, obviously we anticipate picking up Texas. We have picked up some business in South Carolina in the second quarter.

We'll continue to look at other markets. We have programs out there that really haven't borne fruit yet, but we would go ahead and look at some other markets too. We wouldn't stop where we are. I mean to the extent that there are opportunities we have the capital to grow and we have the expertise that is right for business. So I don't necessarily – we're not stopping to look at good new markets, we'll continue to do that.

Operator

(Operator Instructions) Your next question comes from John McCarden – John D. Williams Company

John McCarden – John D. Williams Company

Just a quick question, we have been dealing with Advocate MD here in Texas for a little over a year and I was just wondering if after the deal closes will the named Advocate MD go away or will it be retained just for name recognition?

John R. Byers

I mean we would, as of the closing it would still be Advocate MD. It will still be a separate subsidiary of ours. We have more insurance subsidiaries now and that would become our self insurance subsidiary. I think there's some benefit there. I think the change you'll see in Texas is really just the added financial capital that you're going to see and you're going to have the sense of an established company behind Advocate MD. There's a lot about Advocate MD we like. We think they've got a solid staff. We think they've made great progress in the six years or so that they've been around, so no, it will remain.

Operator

Since there are no further questions, I'll turn the call back over to John for his closing remarks.

John R. Byers

Thanks. The second quarter was another solid quarter for us, and we believe we are well positioned for the future. We are also obviously excited with the prospect of Advocate MD joining our organizations, providing us a significant presence in the attractive Texas market.

Looking ahead we'll remain true to the business principles that brought us to this point, in which are the essentials for sustainable success. These include strict underwriting, disciplined pricing, aggressive, effective claims management and systematically seeking out and taking advantage of opportunities that make sense for our organization and create value for our shareholders.

With that we'll close. As always thanks for your support. We look forward to speaking with you again on our next call.

Operator

Our conference will be available for replay beginning at 2:30 pm today and will run through Thursday, August 13th. Callers in the U.S. and Canada may access the replay by dialing 800-642-1687, and international callers may dial 706-645-9291. The access code for both U.S. and international callers is 19993657. A replay of the conference call Webcast will also be available on our corporate website fpic.com beginning at 2:30 pm today.

That concludes our call for today. Thank you for joining us. We hope you'll join us again next quarter. You may now disconnect.

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