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Navigators Group (NASDAQ:NAVG)

Q2 2013 Earnings Call

August 08, 2013 8:30 am ET

Executives

Stanley A. Galanski - Chief Executive Officer, Director, Member of Underwriting Advisory Committee and Chairman of Navigators Insurance Company

Ciro M. DeFalco - Chief Financial Officer, Senior Vice President and Member of Enterprise Risk Management Steering Committee

Analysts

Max Zormelo - Evercore Partners Inc., Research Division

Robert Paun - Sidoti & Company, LLC

Operator

Good day, ladies and gentlemen, and welcome to the Navigators Group Second Quarter 2013 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded.

We remind everyone that today's call includes forward-looking statements made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. These statements concern future business conditions, expectations and the outlook for the company based on currently available information that involves risks and uncertainties. The company's actual results could differ materially from those anticipated in the forward-looking statements. We refer you to the company's most recent Forms 10-K and 10-Q for a description of the important factors that may affect the company's business. The forward-looking statements on this call and any transcript of this call are only made as of this date and the company undertakes no obligation to publicly update the forward-looking statements to reflect subsequent events or circumstances, except as required by law.

I would now turn the call over to Stan Galanski, President and Chief Executive Officer; and Ciro DeFalco, Chief Financial Officer. You may begin your conference.

Stanley A. Galanski

Thank you, and good morning. I'd like to welcome you to the second quarter earnings conference call of the Navigators Group Inc. Yesterday, we reported net income of $13.9 million for the second quarter of 2013 and $27.8 million for the first 6 months of the year. We were pleased to report profitable underwriting results, with the combined ratio for the quarter at 97.7% and 97.8% for the first half of the year, which compared favorably to 98.1% and 99% through the same period in 2012.

Our Lloyd's operation continued to lead the way in profitable performance, with the combined ratio of 90.8% for the quarter and 91.2% for the first half of the year. We did a good job of controlling expenses during the quarter, the largest component of which, of course, are staff-related. Non-commission operating expenses were up 2.2% compared to the second quarter of 2012, while net earned premium was up 5%. Our expense ratio for the quarter was 34%, which compares favorably to 35.1% for the second quarter of 2012 and 36.4% for the second quarter of 2011.

From a revenue standpoint, gross written premium was up 2.8% and net written premium was up 4% for the quarter, compared to the second quarter of 2012. While these are well below our premium growth rates in recent quarters, the quarterly growth rates were constrained by several factors. First, Navigators Re premium growth for the quarter was actually down 24%, largely as a result of the timing of the significant renewal that moved in to the third quarter. On a year-to-date basis, Navigators Re's growth was 12%. In addition, we are re-underwriting portions of our U.S. Inland Marine book and limit our exposure to both motor truck cargo and the static coastal exposures in the portfolio.

We continue to experience strong double-digit growth in Navigators Specialty, international D&O, U.S. Excess Casualty and our environmental business. Ciro DeFalco will take you through the details of our financials in a few minutes. But first, I would like to comment briefly on our business unit performance.

Navigators Specialty, our business unit focused on the U.S. wholesale and E&S market, generated $110 million or 33% of our gross written premium for the quarter and produced a combined ratio of 96.8%.

Within Navigators Specialty, the Primary Casualty unit grew 32% with strong new business production in our California, Texas and Chicago regional offices. We are benefiting from an upturn in both commercial and residential construction activity, including construction wrap ups, as well as by the continuing movement of real estate exposures out of standard lines insurers and into the EMS market.

Renewal rates showed an average increase of 4.5% for the quarter. Specialty Excess Casualty premium was up 22% for the quarter, with solid renewal retention and average renewal rate increase of around 4% and strong new business production. Technical pricing remains very strong in the E&S market.

During the quarter, we transitioned the management responsibility for our U.S. Professional Liability business into Navigator Specialty. The Professional Liability unit contributed a small underwriting profit for the quarter. Renewal pricing increased 2.5%. We will be transitioning the U.S. Lawyers Professional Liability business to a new insurer effective September 1, which will have a modest impact on our top line as we refocus our underwriting in Professional Liability toward the miscellaneous Professional Liability segment.

Marine business represented $88 million or 27% of our global gross written premium for the quarter, and on a global basis generated a combined ratio of 96.1%. Gross written premium for the U.S. Marine business was up 1% for the quarter.

Over the last few years, the industry has experienced increased frequency of large Marine Liability claims. As a market leader in Marine Liability, our underwriters are pushing hard for renewal price increases and achieved a 7% increase in the Marine Liability renewal rates during the quarter, which pushed our overall Marine renewal rate increases to 6.3% for the quarter.

Marine premium volume was down 4% at Lloyd's, with reduced writings in Marine and Energy Liability, offset by strong growth in cargo and in our Marine assumed reinsurance account. The Marine excess of loss reinsurance account has experienced 8 consecutive quarters of rate increase, and achieved a 16.5% rate increase in the quarter.

There's a lot of talk in the industry about the increased cost of work removal for the Costa Concordia due to the challenges presented by the Italian Government in approving the removal plans that have been presented. From our perspective, any deterioration in the ultimate cost of the removal is expected to have limited financial impact to Navigators and will be limited to a modest reinsurance reinstatement premium.

On a global basis, NavTech, our first party energy and engineering unit, represented 19% of our total group gross written premium for the quarter. Premium volume is down 8% from the second quarter of 2012 as market conditions continue to show gradual deterioration for Offshore Energy.

A number of large Offshore Energy renewals achieved rate reductions in the 10% range. Although this was difficult to observe, as in many cases the actual premium dollars increased, as a result of either higher insured values or increased E&P activity.

Ensuring energy risk is, by its nature, a volatile business, as 1 or 2 loses can impact the profitability in a quarter quite substantially. NavTech's underwriting results for the quarter were about breakeven, impacted by our participation on 2 onshore energy losses outside of the U.S. On a 6-month basis, however, they have a very respectable 85% combined ratio.

Our global D&O business generated $23.2 million of gross written premium for the quarter, with a combined ratio of 55.1%, with exceptionally strong underwriting results from our international D&O book underwritten at Lloyd's, which benefited from favorable loss emergence from prior underwriting years.

The international D&O book grew by 21% during the quarter. We are having a lot of success in writing both Side A and high-excess coverage for non-U.S. listed companies, particularly those listed in the U.K. and in Scandinavia.

The renewal rate change for international D&O was down 1% for the quarter, reflecting the competitive market for that business. Our U.S. D&O business produced the $2 million underwriting loss for the quarter, largely due to the impact of a single claim. We continue to closely monitor and remain encouraged with the loss emergence patterns for the 2011 and 2012 underwriting years.

U.S. D&O renewal rates increased a modest 2.5% for the quarter compared to 13% during the first quarter, but this was due to the limited amount of primary business that we had renewing in the quarter, as rates for the excess layers continue to be more competitive.

Navigators Re had a slight underwriting loss for the quarter, due to $4.5 million of large loss activity in the Accident and Health reinsurance portion of the portfolio. Our Latin American treaty book had another profitable quarter and grew 4% in a relatively flat pricing environment. The Professional Liability unit continue to gain traction during the quarter, with gross written premium doubling from a relatively small base that we had in the second quarter of last year. Next month, we will be adding an international property treaty underwriter to our London team, who will focus on developing Navigators Re's property portfolio outside of the Americas.

During the quarter, we made the decision to exit the U.S. commercial surety product line. We had difficulty gaining traction and achieving critical mass in this niche product line, and found that we were competing with a larger-than-anticipated number of new entrants, in what had already been perceived to be a crowded market. While we like the product itself, it became apparent that our resources would be better deployed in another specialty niche over the next 2 to 3 years.

On the other hand, we write a fair amount of surety treaty business in Navigators Re's Latin American operation, which is both profitable and evidences continued growth potential. Overall, we are pleased with the underwriting results for the quarter and proud of the performance of our underwriting and claims professional.

With that, I'll turn the call over to Ciro for a more detailed review of our financial performance.

Ciro M. DeFalco

Thank you, Stan. Good morning, everyone. Our second quarter net income of $13.9 million or $0.97 per share reported yesterday after market close includes net operating income of $11.8 million or $0.82 per share, and net realized gains after tax of $2.2 million or $0.15 per share. There were no OTTI losses during the quarter.

Second quarter's combined ratio of 97.7% includes a reported loss in LAE ratio of 63.7% and an all-in expense ratio of 34%, split between net commission expenses of 13.8% and other operating expense of 20.2%. The quarterly consolidated results includes $4.7 million of underwriting profit, with $4.5 million of that profit coming from the Lloyd's syndicate.

Net investment income of $14.2 million increased $600,000 in the quarter or 4.4%, and decreased $1.5 million when compared to last year, same period, due to lower investment yields. Our net realized gains were $3.3 million pretax or $2.2 million after-tax. These realized gains were generated as part of the normal active management of our investment portfolio.

Our portfolio of unrealized gain position decreased $58 million pretax or $37.7 million after-tax in the quarter, due to the interest rate spike in June following comments made by the Fed Chairman. The investment portfolio value as of June 30, 2013, however, remained flat, helped by positive operating cash flows with an annualized book yield of 2.41%, up from 2.33% in the first quarter of this year, fell down from 2.81% for the same period last year. Our market yield, on the yield-to-worse basis, at the end of the second quarter was 2.22% versus 2.02% for the same period last year and up from 1.71% in the first quarter.

And the rolling 12-month total return for the portfolio was 1.05%, down from 4.07% in the first quarter, and down from 6.47% for the same period last year. As I mentioned, as a function of the change in the unrealized -- the decrease in the unrealized gain position of our portfolio.

However, our investment portfolio has maintained its AA average credit quality for the duration of 4 years, which compares to 3.9 years duration for the same period last year. Our GAAP shareholders' equity at June 30, 2013, was $874 million, decreasing modestly from $879.5 million at year end 2012, so increasing on a year-over-year basis from $841.8 million at June 2012.

Our book value per share decreased by $1.63 or 2.6% in the quarter to $61.83, driven by the decrease in net unrealized investment gains of $2.67 per share, partially offset by net income per share of $0.99. On the year-over-year basis, our book value per share has increased by $1.75 or 2.9%. Finally, net cash flow from operations was a positive $44.2 million in the quarter.

And with that, we can open it up for questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from Max Zormelo with Evercore.

Max Zormelo - Evercore Partners Inc., Research Division

My first question is about the margin improvement in this quarter, it's quite meaningful. I'm looking at the accident year loss ratio x cash is down about 5.7 points year-on-year. So first question is were there any one timers in there? Secondly, is this a level of improvement that we can trend to future quarters? And then I have a follow-up.

Ciro M. DeFalco

Well, I think from the standpoint of the key things impacting numbers, I think we saw some improvement in the prior underwriting years, particularly in coming out of our international D&O business in London. And obviously, that would impact the way we think about the current underwriting years as well. But in general, I don't think there was a fundamental change in our loss picks for the 2013 underwriting year. You may have seen a little bit of a different shift in the mix of business impacting that during the quarter.

Stanley A. Galanski

And I would add, exactly, right in line with the change in mix of business and just the continuation of improvements in general operating performance. So there's no onetime item in the results. This is a good general indication of how the business is running on improving path.

Max Zormelo - Evercore Partners Inc., Research Division

Okay. That's helpful. Second one is on the investment yield. I know that you said the yield is 2.41% this quarter. It's actually gone up from last quarter. What bring -- what drove that? If [indiscernible] drive as well?

Ciro M. DeFalco

Yes. A couple of things. We have increased our allocation to equities with the purchase of a mutual fund in the second quarter, which was a modest amount, a $25 million purchase. And that's one of the items. It generates investment income -- dividends and the performance of our equity portfolio through dividend income and growth has done a very good job, as you probably know. So I would say that, that's the primary driver.

Stanley A. Galanski

Yes. Just to elaborate that a little further. I think, while we have a very limited amount of equities in our portfolio, what we focused on is high-quality dividend payings that make contributions to income. And I think we had a benefit of that from a good performance in that fund during the quarter.

Max Zormelo - Evercore Partners Inc., Research Division

Okay. That's helpful. And do you expect to add to that going forward?

Stanley A. Galanski

I don't think that we're talking about a fundamental shift in our investment philosophy. We continue to have a relatively conservative, we think, outlook. And despite the interest rate environment and the amount of bonds in our portfolio, we're reasonably pleased with the way things turned out. Having said that, I think there's room for a little bit more equity participation without radically altering what our investment portfolio looks like. And again, it would be in the areas that we've discussed with you, high quality, tend to be blue chip-type companies that have good dividend paying track records and growing dividends.

Ciro M. DeFalco

I would just simply add that we continue to search for those attractive opportunities as Stan said. But we are unwilling to diminish the quality of our overall portfolio. So high quality and conservatism will still be hallmarks of our strategy.

Max Zormelo - Evercore Partners Inc., Research Division

Okay. That's helpful. One more, if I may. Just a numbers question, I think for Ciro. The expense ratio for Property Casualty was quite low this quarter, and it's fairly low in the first quarter too. Just wondering is that a trend we should expect in the second half of the year or maybe even into 2014?

Ciro M. DeFalco

Yes. I think it's probably reasonable. I wouldn't certainly give you an indication that there's some straight line trend, but it's a function of change in mix of business. And I think Stan started the call commenting on we're focused on controlling the cost in a meaningful and prudent way. But we're focused on quality underwriting, not expense control. So we should just [indiscernible] there.

Stanley A. Galanski

We do benefit from a significant quota share that we buy on our NavTech Offshore Energy business, which flows through that number. And to the extent that you probably have a little bit higher impact of net earned premiums coming from the 2012 underwriting year of NavTech this quarter, it might have given a little bit more of a bump, and that's why it stands out here. But in general, there's a fair amount of quota share on a couple of the treaties there, and the seating commissions can have a positive impact on the expense ratio, particularly in a quarter where we don't have a big RPP impact.

Operator

[Operator Instructions] Our next question comes from Robert Paun with Sidoti & Company.

Robert Paun - Sidoti & Company, LLC

Stan, in your prepared comments, you talked about the uptick in loss severity in the Marine business over the past several quarters, and I think you said rates were up 7% in the quarter. Can you just talk a little bit more about the competitive environment in that Marine business? And maybe you can drill down and talk about what segments within Marine are showing some attractive pricing trends right now.

Stanley A. Galanski

Well, whether it's an attractive pricing trend or not, I'd stop short of saying that. But I do think that the -- look, Marine Liability is our core product line within Marine. It's our largest area of specialization and we're market leaders in that business, both in the U.S. and at Lloyd's. Frankly, there's been a lot of large loss activity in Marine Liability, and it's not just the obvious things that you read about in the paper, the deepwater horizon. But we think there's also increasing environmental awareness on the part of governments around the country -- around the world, rather, not just in our country. And that the exposures whether they have actually manifested themselves in losses today, are simply greater than I think what a lot of Marine underwriters are thinking about. We know that with the Marine Liability business, which we're specialists in, needs more rate and our underwriters are pushing hard to achieve that rate, and it's not easy in the market. Having said that, as a market leader, I think we are recognized because these are capacity risks that require a number of insurers in order to supply the limits that are required by the insured. So I think -- fortunately, we have the benefit of working with very good professional Marine brokers who understand the importance of getting rate adequacy and looking at the risk management needs of their clients over the long haul. And I think that's what's contributing to our success in achieving that rate increase. But make no mistake about it, in our view, more is needed. In general, I think we view the Marine market as probably less volatile in terms of its pricing over the last 3 years than it might have been. But again, you can fall asleep, you can get comfortable with the fact that maybe benign loss activities in certain areas. Cargo, I think there is opportunity to push rates a little bit harder there. We don't have a significant cargo book in the U.S, obviously, we're leaders in that business at Lloyd's. And while we were not hit hard by Sandy losses, I think others in the market were. So I think that's contributing to a favorable rate environment in that line. The final comment I'd make on Marine is the Bluewater Hull, although we had an okay quarter in Hull, it continues to be a business that we think needs rate. And so our appetite is a very cautious there. Many of the U.S. insurers have dropped out of that market. We remain one of the few U.S. issuers capable of leading a Bluewater Hull program. And we aim to continue that expertise and that capability.

Robert Paun - Sidoti & Company, LLC

Okay. That was helpful. Also, it seems like international D&O performed well in the quarter again. Can you just comment on how the U.S. D&O market is performing right now?

Stanley A. Galanski

I would say okay. And I think that -- we bifurcate our business by saying we really work very hard to position our portfolio, I'd say beginning with the 2010 underwriting year to much more of an excess position because we were concerned about the tactics of the plaintiff bar on low level or primary business and particularly, anything that had any kind of security issuance or M&A activity. So I guess, in my view, while there are well-underwritten and high quality primary risks there that we will continue to write in our portfolio, our preference is to participate on an excess basis. And that's where that business is. So in terms of the excess pricing, I think we feel okay about it. We think there is certainly opportunity to do better. But our focus is really on risk selection #1 and #2 on getting the layer right, getting the layer right. And obviously, we have technical pricing models and we've got some flexibility in how we look at the pricing per layer. But I think there's still a significant amount of improvement needed on the primary side in the U.S. At international D&O business, we feel very, very good about, particularly our portfolio, with its focus on Side A and excess D&O, particularly in London and Scandinavia.

Operator

I'm currently showing no further questions at this time. I will turn the call back over to management for closing remarks.

Stanley A. Galanski

You guys are pretty easy today. Thanks for your time, thanks for your interest in the company. We'll talk to you next quarter. Thanks.

Ciro M. DeFalco

We look forward to next quarter. Thank you, folks.

Operator

Thank you, ladies and gentlemen. That does conclude today's conference. You may all disconnect, and have a wonderful day.

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