Meadowbrook Insurance Group Inc. Q1 2010 Earnings Call Transcript

May. 4.10 | About: Meadowbrook Insurance (MIG)

Meadowbrook Insurance Group Inc. (NYSE:MIG)

Q1 2010 Earnings Call

May 4, 2010 9:00 AM ET

Executives

Karen Spaun – Chief Financial Officer

Bob Cubbin – President and CEO

Analysts

Bijan Moazami – FBR Capital Markets

Doug Mewhirter – RBC Capital Markets

Beth Malone – Wunderlich Securities

Tom Shapiro – Shapiro Capital Management

Operator

Greetings. And welcome to the Meadowbrook Insurance Group Incorporated First Quarter 2010 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, Karen Spaun, Chief Financial Officer for Meadowbrook Insurance Group Incorporated. Thank you, Ms. Spaun, you may begin.

Karen Spaun

Thank you. And welcome to Meadowbrook’s first quarter 2010 earnings conference call. I will lead off today’s call with a review of our financial results. Bob Cubbin, our President and CEO will then follow with a review of our financial outlook and current market conditions. The call will conclude with a question-and-answer session.

During this call, we may make certain statements relating to future results and expectations. These statements constitute forward-looking statements as defined under the Private Securities Litigation Reform Act of 1995. We therefore must state that actual results may differ materially from those projected and may involve risk and uncertainties that are outlined in our Forms 10-K and 10-Q that are filed with the SEC.

Please note Meadowbrook undertakes no obligation to update or revise any forward-looking statement. If you have not received a copy of our earnings release, it is currently available on our website, meadowbrook.com or you may give me a call and I will be happy to email a copy to you.

Before reviewing our results, I will take a few moments to discuss some changes we made to the presentation of expense line items on our income statement. We are excited about these changes because we can not report consolidated results in a manner that will enable you to calculate our combined ratio from the face of the consolidated income statement.

In 2010, we completed an in-depth cost allocation study and made refinements to our process to track these costs on a functional basis. The purpose of the study was to align our internal expenses with key areas of activity, such as underwriting and related policy administration, claims administration or otherwise referred to as ULAE, general, selling, and administration costs assisted with the production and management of net commission and fee revenue and general corporate expenses.

Upon completion of the study, we have the information to better define our inter-company fees and to treat these fees as an inter-company cost reimbursement for financial reporting purposes.

This enabled us to align the consolidated results with the underlying nature or function of the internal activities and expenses. Previously, we used estimations based on an overall cost study that focused on inter-company fees in total and the reasonableness of the allocation between claims administration and other underwriting activities.

The previously disclosed salaries and benefit expense line item and the other administration expense line item are now included in one of the following four line items, based on the function to which they relate, net loss and LAE, policy acquisition and other underwriting expenses, general, selling, and administrative expenses and general corporate expenses. This reclassification of expense is for presentation purposes only. No expense has changed and the bottom line does not change.

Last evening, we filed a Form 8-K as a supplement that illustrated a summary of this reclassification. Hopefully these changes will improve transparency and make it simpler for everyone to calculate our expense ratio, our loss and LAE ratio and combined ratio from the face of our consolidated income statement.

Now with the results, first quarter 2010 net operating income increased by $484,000 to $16.8 million or $0.30 per share, compared to $16.3 million or $0.28 per share for the first quarter of 2009.

Net income for the first quarter of 2010 increased by $2.9 million to $16.4 million, or $0.30 per share, compared to $13.5 million or $0.24 per share for the first quarter of 2009.

Revenues increased $24.6 million or 16.4% from $149.6 million in the first quarter of 2009 to $174.2 million in 2010. This increase reflects growth in net earned premiums of $22.4 million from the business we implemented in the second half of 2009.

Our 2010 first quarter GAAP combined ratio was 92.1%, compared to 88.2% for the first quarter of 2009. Our 2010 first quarter expense ratio was 34.3%, compared to 30.2% for the same period in 2009.

The increase in expense ratio reflects an increase in commission expenses as a result of a shift in the mix of business and growth in business where the agent handles policy processing and certain underwriting functions.

Also, the first quarter 2009 expense ratio was favorably impacted by lower insurance assessments related to premium tax credits, which were – which impact in the 2009 expense ratio by reducing it 1.3 percentage points.

In addition, as a result of the above mentioned cost allocation study, we refined the actual split between internal costs associated with claims administration and other underwriting expenses, resulting in less cost assigned to claims administration and more cost assigned to other underwriting expenses.

Consequently, in 2010 as compared to 2009, the expense ratio reflects approximately 1 percentage point more of internal costs and the loss in LAE ratio reflects 1 percentage point less of internal costs.

The first quarter of 2010 loss and loss adjustment expense ratio was 57.8%, compared to 58% in 2009. The accident year loss and LAE ratio was 64.2%, compared to 64.5% for 2009.

As mentioned, the accident year net loss and LAE ratio for 2010, as compared to 2009 reflects 1 percentage point less of internal costs. This decrease was offset by the impact of winter storm activity in 2010.

General, selling, and administrative expenses decreased $2.3 million from $8.2 million in 2009, to $5.9 million in 2010. This decrease reflects our ability to leverage internal fixed cost and expense savings in technology, travel and other administrative expenses.

During the first quarter of 2010, net investment income increased 5.6% to $13 million, compared to $12.3 million for the first quarter of 2009. The increase is primarily due to higher average invested assets and continued positive cash flow from operations.

The pre-tax book yield was 4.4% at March 31, 2010, which is unchanged compared to the last year. The effective duration of our fixed income portfolio is 5.2 years, compared to 4.6 years at March 31, 2009. The duration of our reserves is 2.9 years.

In 2009, we made a minority investment in an insurance company an affiliated agency with whom we do substantial business. For the first quarter of 2010, the after-tax equity earnings on the investment was $522,000.

Book value per share at March 31, 2010, increased to $9.43 per share, compared to $9.06 per share at December 31, 2009. Book value per share, excluding unrealized gains, increased $0.28 per share to $8.87 per share at March 31, 2010 from $8.59 per share at December 31, 2009.

We repurchased 1.5 million shares at an average cost of $7.51 per share, those repurchases increased book value per share by $0.05.

Tangible book value per share, which excludes goodwill and other intangible assets, increased by 5.3% to $6.50 per share, compared to $6.17 per share at December 31, 2009. Please refer to our earnings release for further details and a line-by-line analysis of our first quarter consolidated income statement.

With that, I will turn the call over to Bob Cubbin, our Chief Executive Officer. Bob?

Bob Cubbin

Thanks, Karen, and good morning, everyone. We are off to a good start in 2010 with gross written premium up by almost 30%, our combined ratio at 92.1% and net operating income at $0.30 per share.

Our revenue growth in the first quarter is primarily the result of new initiatives that were launched in the second half of 2009. And while we have generated strong growth, we continue to focus on adequately priced business. Our underwriting discipline continues to hold up and our accident year loss ratio improved slightly over last year.

As we have grown, we have done so in order to create geographic and product diversification, which has enhanced our ability to manage through this prolonged soft market and most of our growth is from the rollover of existing proven business.

While there has been meaningful growth in our programs in admitted business, the market for excess and surplus lines insurance has remained competitive. But even in a soft market we continue to focus on disciplined underwriting.

Overall rates increased modestly in the first quarter of 2010. Our workers comp rates were up by nearly 4% due largely to our ability to take rate increases on rollover business we acquired in 2009 in California and the Midwest. Rates in admitted programs on lines other than workers comp increased a little over 1%. Our E&S rates were down by about 4%.

We continue to work from a strong capital position and we repurchased approximately 1.5 million shares during the quarter. Our goal is to continue to efficiently manage our capital while positioning ourselves for future growth and protecting our liquidity.

Based on our underwriting results for the first quarter and the impact of our share repurchase plan, we are increasing our 2010 guidance. We have increased our range for expected net operating income to $50 to $55 million or $0.90 to $1 per share. We have also lowered the range of expectations for our combined ratio to 94.5% to 96%.

On the topline, we continue to expect gross written premium between $790 million and $815 million. These goals, as usual, do not consider any additional favorable or unfavorable prior year reserve development and we only include product and program opportunities that have been clearly identified and implemented in 2009 for 2010. To the extent that new opportunities emerge or a shift in the market conditions occurs, we could exceed those goals.

Thank you for your interest in Meadowbrook and we will now open the call to questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) Our first question is from the line of Bijan Moazami with FBR Capital Markets. Please go ahead with your question.

Bijan Moazami – FBR Capital Markets

Good morning. I have a number of questions. First of all, if you could elaborate on the decrease on the accident year loss ratio, in particular what are the lines of business that are seeing an improvement?

Bob Cubbin

Yeah. Bijan, one point of that improvement as Karen mentioned was the ULAE side. But for the most part we’re seeing improvement in workers compensation, professional liability, auto liability and general liability. Those are the main areas.

Other lines of business are pretty much as we would have expected. The short-term lines in the first quarter, we did have a little bit more loss in the accident year because of the winter storms. But other than that all lines performed pretty well.

Bijan Moazami – FBR Capital Markets

Okay. Can you guys maintain this rapid level of growth rates and do share buyback at the same time, at what point the rating agency will start getting worried?

Bob Cubbin

Yeah. That’s a good question. You know, we’re -- our number one priority is to make sure that we have adequate liquidity and that we don’t over lever ourselves. So when you look at the way that we bring the business on, it’s almost exclusively rollover business that has a long, proven track record. So that makes it much more predictable in terms of bringing that business on.

Relative to capacity, the high-end of our range for 2010 is $815 million and if you just take our statutory surplus at $352 million or so, we can go up to 2.5 or 2.75 with no problem and still have capacity or cushion beyond that.

And then when you add on top of that our statutory earnings for the year, we really have plenty of capacity at this point to continue to repurchase shares. We have 3.5 million left in that repurchase plan. We have plenty of liquidity and we’ve got a very good matching between our assets and liabilities.

And we’ve also built in servicing our debt. So our discussions with our rating agency go well and we are telling them exactly what we expect to see happen and fortunately what we’ve told them has come true. So I don’t think, we’ll have any pressure on that side.

Bijan Moazami – FBR Capital Markets

When you guys are looking at the pipeline of new products and new programs and I realize that you provide topline guidance. Could you elaborate a little bit in terms of what you are seeing and whether the pace of 2008, 2009 new programs can be continued?

Bob Cubbin

Well, that is a good question, Bijan. With the market continuing to be soft, we have to be very selective about who we do business with. But for the most part what we see is a continuing good pipeline of new business opportunities. But we can afford to be selective. You’re going to have some fluctuation quarter-to-quarter and year-to-year, so it’s not all that predictable, which is one of the reasons why we don’t build new unidentified business into our forecast.

So, we’re really today working on what we see for 2011 and 2012. It takes time to get through the due diligence. It takes time to build the relationship, get the program in a position where we can start rolling the business over. So that gives us a little bit more predictability on topline growth because we’re not factoring in new unidentified business. And as we’ve said for many, many years, we really are bottom line focused. And if we, for some reason don’t find enough business that’s suitable, then we’re willing to not grow.

Bijan Moazami – FBR Capital Markets

Thank you.

Bob Cubbin

Thank you, Bijan.

Operator

Our next question is from the line of Doug Mewhirter with RBC Capital Markets. Please proceed with your question.

Doug Mewhirter – RBC Capital Markets

Hi. Good morning. Two pretty quick questions. First, can you elaborate on the sources of your favorable development this quarter either from a business line or accident year perspective?

Bob Cubbin

Sure, I can do both. The accident years 2007 and 2008, and 2006 all had favorable development kind of in that order in terms of the order of magnitude. In the lines of business, we’ve continued to see favorable development in workers compensation overall, including residual market. Professional liability, auto liability and general liability kind of led the way. So we really have seen pretty good development in the older accident years in most every line of business.

You know, short tail lines obviously don’t necessarily develop favorably or unfavorably, particularly because we don’t have a lot of catastrophe exposure. So it makes it a little easier for us to predict that.

Doug Mewhirter – RBC Capital Markets

Okay. Great. Second question, maybe for Karen, do you have an operating cash flow figure for this quarter?

Karen Spaun

Yeah. I do.

Bob Cubbin

You probably lost it.

Karen Spaun

I figured that. I wasn’t going to just, I wanted to verify my memory there. Operating cash flow for the first quarter of 2010 was $44.7 million.

Doug Mewhirter – RBC Capital Markets

Great. And the last question. Bob, we’ve seen this from other companies commentary as well, that the E&S market seems to really be struggling, yet the admitted market in various areas seems to be holding up fairly well, I mean, actually getting some small rate increases.

I guess the first part would be, given that E&S generally prices a lot harder than admitted, just because of the nature of the business. How would you rate the general adequacy of the E&S despite the softness versus the admitted? And also is there any, I guess, explanation for the relative strength of admitted versus E&S right now?

Bob Cubbin

Well, I think, maybe I’ll try to answer that in reverse order. I think the strength on the admitted side is more so on the older accident years. Other than a few companies like us, where the current accident years continue to perform pretty well, I think a lot of companies, whether they’re regional or standard admitted markets are seeing deterioration in their more current accident years. And they’re really propping up the overall calendar year results with older accident year favorable development.

So I think the industry in general is probably going to start to see those current accident years be their calendar year results, as their older accident year favorable development either declines or ends.

The E&S business really for the most part over the last year or so has bottomed out I would say. And you’ve seen maybe a slight glimmer of hope on the horizon that when the economy improves and employment improves that new startup businesses will emerge, which are really good for the E&S side. And in general, I think, that pricing there has remained, okay, at least on our business it hasn’t deteriorated all that much.

So we still feel pretty good about the business that we’re writing on a surplus lines basis, particularly the specialty lines. The main street E&S business I think has probably been a little bit more hard hit.

Doug Mewhirter – RBC Capital Markets

Okay. And just to clarify, you’re describing the current poor, excuse me, current accident year is also a lot of the admitting carriers. Are you saying that that possibly was a catalyst, they’re maybe taking some slight, I guess, preemptive single-digit rate increases as a way to head that off?

Bob Cubbin

I would hope so, because loss cost inflation continues regardless of anything else, even if we’re in a low overall inflation neutral position in the economy, there still is medical cost inflation that needs to be considered when you’re looking at the changes in the accident years. So I would hope that companies would be taking some rate increases just to even offset that.

Doug Mewhirter – RBC Capital Markets

Okay. Thanks. That’s all my questions.

Bob Cubbin

Thank you, Doug.

Operator

Thank you. (Operator Instructions) Our next question is from the line of Beth Malone, Wunderlich Securities. Please proceed with your questions.

Beth Malone – Wunderlich Securities

Hi. Thank you. Good morning. Congratulations on the quarter.

Bob Cubbin

Thanks, Beth.

Beth Malone – Wunderlich Securities

A couple of questions, on, as you look at your mix of business and the success you have had at growing the topline, are you seeing, going into the second quarter, some momentum from the first in terms of demand and a pickup in the economy?

Bob Cubbin

Yeah. That’s a good question. I mean, there are certain areas where that certainly is the case. But I would say in general the pickup in the economy really hasn’t helped us at all yet, because most of that has been a jobless recovery. So I think that there is a lot of capacity out there. So businesses that are growing their revenues aren’t necessarily adding people.

So, the payroll side is what really drives workers comp, which is 35% or so of our business. So that hasn’t really seen an uplift yet and I think, we will start to see that when we start seeing job growth. So the growth that we’ve had has really come from multiyear initiatives to rollover existing proven books of business. And fortunately, we’ve been able to get a little bit of rate increase on top of that. So that’s primarily where the growth is coming from.

Beth Malone – Wunderlich Securities

And the programs, the new programs you’re putting on, do they represent larger businesses than the small commercial businesses that your programs had represented in the past?

Bob Cubbin

No, not really. Most of our business is still the small average premium size. So, we continue to like that type of business and that’s really where most of it’s coming from, obviously, it’s also not coming from construction or building because there is not much of that going on yet. So it has really been from the non-construction, small average premium kind of retail type of policyholder.

Beth Malone – Wunderlich Securities

No. On the E&S business that you acquired from with ProCentury, are we assume that the 29% increase in the topline gross written premiums you reported in the first quarter. Is that really more significant when you look at the program business because written premiums are declining in the E&S business?

Bob Cubbin

Yeah. The overall E&S business though did have a little bit of growth year-over-year, very small amount. So it’s not like it’s dragging us down. But, the $47 – little over $47 million of growth primarily came from admitted programs.

We’re holding our own on the specialty E&S business and slipping a little bit on the general agency E&S business. So overall, that’s really, what we’ve been trying to do is to be able to manage through these cycles with the various mix of business that we’re able to do.

Beth Malone – Wunderlich Securities

Okay. And then a last question on acquisition activity. Are you seeing more reasonable valuation metrics and is there an opportunity? Do you see greater opportunities to come in and support your MGAs or distribution as kind of a way to make kind of stealth acquisitions of books of business?

Bob Cubbin

You know, the acquisition side, I still think that there is disconnect between what buyers want to pay and what sellers want for their businesses. So it really has still been I think relatively modest acquisition opportunities. We’ve looked at a lot of things and we get a look at a lot of things. But you have got to make sure that they are properly priced and that they fit.

In terms of us continuing to support the program administrators and general agents and that sort of thing, that is a very, very important part of our strategy long-term. And so we do continue to help support that side of the business, sometimes putting capital into it with the opportunity to later on potentially acquire the entire business when it’s appropriate.

Beth Malone – Wunderlich Securities

Okay. All right. Thank you.

Bob Cubbin

Thanks Beth.

Operator

Our next question is from [Tom Shapiro with Shapiro] Capital Management. Please go ahead ask your question.

Tom Shapiro – Shapiro Capital Management

Good morning.

Bob Cubbin

Hi, Tom. How are you?

Tom Shapiro – Shapiro Capital Management

Okay. A couple of questions. Number one, the healthcare legislation that was recently passed down in Washington, Bob, have you had a chance to think about what impact, if any it may have on the workers comp business?

Bob Cubbin

Well, a little bit, I think it is more anecdotal than anything else because obviously the devil is in the details and it remains to be seen exactly what impact it’s going to have on healthcare insurance in general.

But I would say that if you have more people who have health insurance, there’re going to be fewer potential fraudulent claims where somebody doesn’t have health insurance, they come to work on Monday, they hurt their back moving their brother-in-law’s piano over the weekend and they file a comp claim. So, I think in general, it probably is not going to hurt the workers comp business.

I hope that eventually what we really focus on is trying to get the costs of healthcare under control, which because of the huge impact that has on loss costs, should be beneficial if we get around to focusing on the right thing, which is controlling those healthcare costs.

Tom Shapiro – Shapiro Capital Management

Thanks. That’s helpful, Bob. Secondly, the subject of reinsurance, anything there of note in the quarter, did we renew any treaties during the quarter and what is the status of the market these days?

Bob Cubbin

Yeah. The reinsurance market has remained, I would say, fairly conservative. We haven’t seen huge decreases. But then again, our results have been positive, so our long-term trading partners take that into consideration as they price the current treaty years. So we’ve continued to do okay on reinsurance purchasing.

As we’ve said for many, many years, we don’t ask for the lowest prices in a soft market and we don’t expect to get hit with the highest prices in a hard market. So maintaining those long-term trading relationships are important to us. And we have, I’m pleased to say, very good, long standing relationships on the reinsurance side.

Tom Shapiro – Shapiro Capital Management

That’s great. And lastly, on the investment portfolio if memory serves, I think the duration of our portfolio has been creeping up a little bit over the last few quarters. And I was, if I’m right, I was just curious what our strategy is there in an environment where it is tough to earn anything.

Bob Cubbin

Yeah. It is tough. We still are relatively short on the duration. There have been a few opportunities that go out a little bit longer on the duration as our loss reserve duration has stretched out a little bit with the excess business and workers comp is a little bit longer-tail line.

So we have seen some better spreads on investment grade corporates that are little longer duration. But we are not going to go out very far and risk interest rate changes impacting the portfolio. But as you also have heard from us in the past, we do hold to maturity in almost every situation. And, we do see some potential change in the interest rate environment going forward, I don’t think it’s going to stay this low forever. So in general I don’t think we are taking any extra risk by going out a little bit further.

Tom Shapiro – Shapiro Capital Management

The difference now between the duration of the assets and liabilities is a little over two years, as I recall. Is that there sort of that about where you want to keep it?

Karen Spaun

Yeah. That would probably be about where you would want to keep that relationship.

Tom Shapiro – Shapiro Capital Management

Okay. Thank you much.

Bob Cubbin

Thanks Tom.

Operator

Thank you. There are no further questions at this time. I would like to turn the floor back over to management for closing comments.

Bob Cubbin

Thank you very much. We appreciate your interest in Meadowbrook and if you do have any further questions, we’d be happy to feel them. Karen and I will be available after the call for those questions. Thanks a lot.

Operator

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

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