Meadowbrook Insurance Group's CEO Discusses Q4 2013 Results - Earnings Call Transcript

Feb.19.14 | About: Meadowbrook Insurance (MIG)

Meadowbrook Insurance Group, Inc. (NYSE:MIG)

Q4 2013 Earnings Conference Call

February 19, 2014 09:00 ET

Executives

Bob Cubbin - President and Chief Executive Officer

Karen Spaun - Chief Financial Officer

Analysts

Randy Binner - FBR Capital Markets

Bijan Moazami - Guggenheim

Ken Billingsley - Compass Point

Bob Farnam - Keefe, Bruyette & Woods

Doug Ruth - Lenox

Ron Bobman - Capital Returns Management

Operator

Greetings, and welcome to the Meadowbrook Insurance Group Incorporated Fourth Quarter 2013 Earnings 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.

I would now like to turn the conference over to your host, Ms. Karen Spaun, Chief Financial Officer for Meadowbrook. Thank you, Ms. Spaun. You may begin.

Karen Spaun

Thank you, and welcome to Meadowbrook Insurance Group’s fourth quarter 2013 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 2014 outlook and overall capital position. 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 e-mail a copy to you.

Now, with the results. For the fourth quarter, we had a net loss of $11.9 million, or $0.24 per share and a net operating loss of $14.8 million, or $0.30 per share. The net loss, excluding the impact of the Swiss Re quota share treaty, was $10.9 million, or $0.22 per share. While the net operating loss excluding the impact of the Swiss Re quota share was $13.8 million, or $0.28 per share. Since we have eliminated the Swiss Re quota share on an ongoing basis, I will discuss the results excluding the impact of the treaty.

Our GAAP combined ratio, excluding the impact of the Swiss Re quota share treaty, was 121.0%, and our accident year combined ratio was 104.7% for the fourth quarter of 2013. Our expense ratio, excluding the impact of the Swiss Re quota share treaty, for the fourth quarter was 35.6% compared to 31.1% in the fourth quarter of 2012. This increase reflects a higher level of fixed cost as a percentage of net earned premium as we reduced premium and an increase in commission ratio, reflecting a shift of our mix of business. Lastly, there was a 1.4 percentage point impact from the use of a non-affiliated A rated insurance company for policy issuance purposes so called front fees. We expect this impact to be approximately 2 percentage points on the expense ratio on a go forward basis.

Net investment income remained flat at $11.9 million in the fourth quarter 2013, compared to 2012. Pretax profit from net commission and fee revenue in the fourth quarter 2013 increased to $4 million from $3.1 million in the fourth quarter of 2012. Lastly general, corporate, amortization and interest expenses were $5.3 million for the fourth quarter 2013 compared to $6 million in 2012. This decrease reflects a decrease in amortization expense and partially offset by an increase in interest expense associated with the convertible debt securities issued in the first quarter of 2013.

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

Bob Cubbin

Thanks Karen and good morning everyone. This past year we were presented with many challenges and our team responded with the implementation of strong remedial measures to correct the unacceptable results we have experienced that fortify our surplus to terminate and runoff underperforming areas of our business and to maintain the strong partnerships that we have created with our customers, clients and distribution partners. We ended the year with approximately $488 million of statutory surplus in our insurance company and reduced our net premium written by almost 14% and a conservative effort to eliminate the more volatile segments of business that had not performed up to our underwriting standards.

Our commission and fee income remained strong and net investment income performed in line with expectations even in a prolonged low interest rate environment. Importantly, our loss reserves and workers’ compensation were stabilized in 2013 and apart from the one isolated territory within California, which we dramatically downsized in 2012 we saw slightly favorable reserve results over the last five quarters. Cumulatively in California work comp, we have achieved in excess of 50% rate increases since 2010 and in 2013 rate increases remained robust at over 20%.

Regarding the auto liability line of business, overall for the year, we did had some unfavorable development mostly in 2011 and 2012 accident years, about half of which was from the discontinued programs we exited in 2012. The run-off of the premium in the discontinued business went quickly with unearned premium at near zero by year end 2013. The dedicated claims team managing the run-off is taking the necessary actions to expeditiously run-off the remainder of the claims and has accelerated the process of reserving and closing claims. After experiencing favorable development in calendar years 2009, ‘10 and ‘11 on over accident years, the liability line of business in our excess and surplus lines division experienced unfavorable development in 2012 and again in 2013 primarily in the accident years 2010, 2011 and 2012. The over accident years in the excess and surplus line business appear to be stable.

The apparent shift in the historic incurred loss patterns that were identified in 2012 were in part caused by the previous year’s persistent stock market pricing conditions and competitive pressures from traditional admitted carriers in accident years 2009 through 2011. During that period of time, rates were decreasing and the performance risk characteristics of the pool of available mainstream excess and surplus lines business was changing as it was shrinking due to standard admitted market intrusions in the business traditionally written down in the (indiscernible) basis.

Beginning in 2012, we noted changes in claims activity and other performance metrics of the business. One notable difference was the divergence of industry published loss cost data from our own loss trends. This first became evident through our price monitoring work. Changes began immediately. The changes accelerated as performance trends became more pronounced. Ultimately, we achieved the 9% average rate increase in 2012 greatly increased minimum premiums in problem sub-classes, tightened coverage forms and affected the intentional exit from problem sub-classes of business within our various underwriting units. Our underwriting and pricing adjustments had accelerated through 2013 when we achieved a 16% rate increase and further reduced our exposure to underperforming areas of the business.

At this time, 2014 has proven that the market will continue to accept the changes and we have determined that necessary to bring the E&S book performance and predictability in line with our expectation. The liability lines in our traditional program business have not had the same adverse development and remain profitable. Public Entity Excess run-off efforts did result in slightly higher than expected emergence this year and we have increased our ultimate there, primarily on old accident years 2008 and prior. However, we believe that long tail line of business should start to show the signs of stabilization expected as it entered the second full year of run-off.

In summary, as we had indicated on previous occasions, we have for many years experienced an overall history of favorable or stable reserve indication up to 2011. In 2012, we noticed a shift in the historic claim pattern, particularly in accident years 2009 through 2011. Our previous actuarial collections on those accident years turned out to be wrong. In 2012, the increased reserves were recognized this identified shift and the strength in our overall reserve position. As we entered 2013, we did see a slowdown in the emergence of loss experience and accepted the impact of the isolated territory within California and the unusual arbitration award both in the second quarter of 2013, reserves in all our workers’ compensation reserve categories showed stabilization.

Reduction in premium volume in the underperforming segments of the business and significant rate increases give us optimism for the future. The policy issuing relationship we entered into in August is working well in the areas of the business that are most rating sensitive. And a significant portion of our business, the rating is less critical and we have retained a vast majority of the business we were seeking to retain. We attribute the stabilization in our production sources to longstanding relationships and the trust and commitment from our agents and brokers, many of whom have done business with us for well in excess of 10 years.

With the strong balance sheet and a commitment to return to profitability along with the ability to obtain rate increases and tightened terms and conditions, we are confident that 2014 will be a much better year than 2013. For 2014, we expect gross written premium to be between $775 million and $800 million. We expect the combined ratio to be between 99 and 100 with the expense ratio to increase approximately two percentage points relating to the cost of the policy issuance carrier. While we have initiated various expense management efforts, we expect the expense ratio will also increase as a result of a higher level of fixed costs in relation to earn premium and slightly higher other underwriting expenses related to a shift in the mix of business. This increase in expenses will be partially offset by an improvement in the loss ratio as we earn the rate increases achieved in the 2013 and 2014.

In addition, the full year impact of the business terminated in 2012 will improve the loss ratio. At these levels we expect net operating income to be between $25 million and $35 million or $0.50 to $0.70 per share. As we anticipate further planned reductions in premium volume, we should continue to experience improving and lower leverage ratio. As our business continues to stabilize and our calendar year and our accident year combined ratios proved to be profitable, we will then have the opportunity to manage our capital from a position of strength.

Our management team and our Board continued to diligently explore all strategic alternatives to enhance shareholder value. The remedial actions that we have taken over the last 18 months are having an effect. It does take time for these initiatives to manifest themselves and to turnaround the results. The challenges that we have faced are solvable and the efforts of our associates and our partners has been unparalleled. We are grateful to have such a strong loyal and committed team working together to return our company to profitability.

To further strengthen that team, we announced yesterday that Roger Walleck had been promoted to Chief Underwriting Officer. Roger brings a wealth of experience to the role and his appointment is an important step in our continued efforts to improve underwriting performance. During his career and particularly here at Meadowbrook, Roger has a proven track record of delivering profitable results. We look forward to benefitting from Roger’s experience, expertise and disciplined approach across the entire company.

With that operator will open the call to questions.

Question-and-Answer Session

Operator

Thank you. We will now be conducting question-and-answer session. (Operator Instructions) Thank you. Our first question comes from the line of Randy Binner of FBR Capital Markets. Please go ahead with your question.

Randy Binner - FBR Capital Markets

Thanks. Good morning. I wanted to follow up on this E&S reserve charge, I guess a couple of questions. One, can you quantify for us where the accident year loss ratios are now being held for those problematic years, so excuse me, I think you are saying that it was accident year ‘10 to ‘12 where these charges were taken in the fourth quarter. Can you give us a sense of where those loss ratios are being held? And also I am wondering what kind of product types in particular is related, so I understand that it’s E&S liability, but a little bit more granularity on the product types would be helpful as well?

Bob Cubbin

Yes, sure. The 2011 loss ratio was booked at 54.4%, that’s excluding the unallocated loss adjustment expense, which is roughly 3.5%. The 2012 is at little under 62%. And if you go backward, the 2010 was actually a pretty good year just was not as good as we thought, it was at 53.4%. That was an exceptional year. So the specific product classes, where we have been attacking problem areas has been habitational and restaurant bars and taverns specifically and so many of the actions that have been taken were in those two areas.

Randy Binner - FBR Capital Markets

Do you mention that your experience (indiscernible) of the industry, in general, I don’t think we heard of a lot of E&S development some of that figures. Do you have a sense of where those accident year loss ratios your own reference, were being held relative to the industry?

Bob Cubbin

I do think that the E&S business did experience higher loss ratios in the ‘09, ‘10, ‘11 accident years. I don’t have that specific industry information right in front of me, Randy but I can get that for you. I would say in general though that I think what really happened there was that the original actuarial selections were based upon the ‘07, ‘08, ‘09 accident years, which have been performing very, very well. So ‘10, ‘11, and ‘12 did perform much differently than the previous accident years. We had, had favorable development in those older years. And what happened is that as the pool of available insured became lower as the admitted markets were taking some of that business. I think we were getting a lower class, if you will, of business and prices were still dropping. We didn’t get price increases in the commercial multi-peril and particularly in the liability line until the beginning of 2012. So it’s still down in ‘10/11 from a pricing standpoint, but I think more than that, were some of the terms and conditions that had to be tightened up. So I think that was really more of an issue than just the pricing.

Randy Binner - FBR Capital Markets

Just one more, I just wasn’t clear in the press release, I think you have said that there was $26.8 million of development from E&S for the year. Was all of that in the fourth quarter or was some of that in the other quarters?

Bob Cubbin

No, that was over all three quarters, actually the second quarter, third quarter and fourth quarter.

Randy Binner - FBR Capital Markets

And how much of that was in the fourth quarter, the $26.8 million?

Bob Cubbin

That was above $12 million.

Randy Binner - FBR Capital Markets

Okay, thank you.

Operator

Thank you. Our next question comes from the line of Bijan Moazami of Guggenheim. Please proceed with your question.

Bijan Moazami - Guggenheim

Good morning. I have couple of questions. First, Bob, a while ago you guys engaged well as to be looking at strategic options for you guys, is Willis still engaged with Meadowbrook? If they are, is it an active or passive engagement? And if they have an active engagement, what kind of services they are providing to Meadowbrook? And then I have the follow-up questions on E&S.

Bob Cubbin

Willis is still actively engaged with Meadowbrook and really not as we discussed non-public aspects of our review process, but as I said, the management and the board are working diligently to explore all of its potential alternatives to increase shareholder value. So there is nothing that isn’t being explored.

Bijan Moazami - Guggenheim

On the E&S side, follow-up to Randy’s question, I wouldn’t provide that the E&S business you guys write as permanent E&S stuff that doesn’t move to the regular market. I guess my question is that how peak was that E&S business when you bought it with the ProCentury transaction? How big was it in 2010? And how big is it right now? In other words, did that business grow into something beyond the focus of ProCentury during your ownership?

Bob Cubbin

No, actually it’s been shrinking again – if not – I don’t think there is anything that’s permanently in the E&S business. You do see the pool of available insured does drop as the admitted markets right there. So yes the Century business I believe when we acquired it was around $240 million or so not only that specific number, but it was tracking down and we’re projecting for next year somewhere between $170 million and $190 million of premium. So they’re definitely being shrinked the business since we acquired it.

Bijan Moazami - Guggenheim

Perfect. And just one last question probably for Karen of the goodwill left how much of the goodwill is associated with ProCentury?

Karen Spaun

None.

Bijan Moazami - Guggenheim

Perfect. Thank you.

Operator

Thank you. (Operator Instructions) The next question comes from the line of Ken Billingsley, Compass Point. Please go ahead with your question.

Ken Billingsley - Compass Point

Okay. Good morning. Just want to obviously following up on the reserve charge fee. How much of the $31 million is run-off associated with run-off business?

Bob Cubbin

On a year-to-date basis, it’s about 60%, in the fourth quarter it’s probably a third.

Ken Billingsley - Compass Point

Third and you had talked about some of the problems just at least the current quarter was lower pricing and there’s obviously a change in claims activity. If there was a divergence in loss cost trends from the industry, I would imagine that obviously that’s going to impact customer selection as well as the terms and conditions. Can you talk about what major changes that you made that were different from industry norm so you could keep the business when you’re writing it from 2010 to 2012?

Bob Cubbin

I don’t think it was necessarily keeping the business because in the E&S business there was always a lot of new business being written. It tends to have a much lower retention ratio. So you see the mix of business shifts over time and I think that’s what the team notice was that the mix of business was shifting to classes of business or sub-classes of business that were not as attractive to us. So when they did identify that to their price monitoring and their data analytics they immediately responded by either changing the minimum premium, adding endorsements to exclude certain exposures that they weren’t comfortable with and raising prices. So I think it was a combination of all of those things, Ken.

Ken Billingsley - Compass Point

But I imagine at some point you had included endorsements, was it endorsements that…

Bob Cubbin

No, they really weren’t – they weren’t losing enough to terms and conditions. I think that they were just risk characteristic to the business that, that was being written that weren’t necessarily identified as having a negative impact none that overall loss ratio. So when those risk characteristics became apparent that the team then started to exclude that either class of business or to raise prices dramatically in that particular sub-class of business. So it’s really a very micro level review of the risk characteristics of the business that was being written.

Ken Billingsley - Compass Point

With – given the pass-throughs of charges and the rating downgrade I know you have a (front-in) agreement in place but how has that affected the marketing of products? Could you talk about what made the percentage change and distribution has occurred maybe over the last three quarters?

Bob Cubbin

Sure. I mean there obviously has an impact from that. It has changed since the initial announcement of that back in August. I think it settled down a bit, but it’s – the specific quantification of it is very difficult because people don’t always tell you why they’re not doing something or why they do something. Our view is that it has had an effect on our premium writings in the areas that are more rating-sensitive, but a lot of our business is not as rating-sensitive and a lot of the business that we have today has been with us for a long time. So with the strong commitment of our agents and brokers and our customers and clients we’ve been able to retain a very significant amount of the premium that we’re seeking to keep. As it had an effect on new business yes, I’m sure that we’re not seeing as many new applications as we otherwise might have, but we’re going to – as we’re looking at premium volume in 2014, we will see a drop as we indicated by our guidance. But we are pretty comfortable with that projection based upon all of these discussions and strategic planning we have done with our production stores. So I think we are pretty confident that premium volumes that we are projecting for 2014 should be attainable.

Ken Billingsley - Compass Point

The new Chief Underwriter, Roger Walleck, what statements has he been operating within Meadowbrook since 2005?

Bob Cubbin

He has been involved in a lot of our traditional program business. It includes all lines of business. Workers’ comp obviously is a big part of what we do, but also multi-peril.

Ken Billingsley - Compass Point

And last question, you obviously kept your guidance the same as what had previously been put out there given the – and always we are surprised reserve charges just continue to come through, I believe, nine quarters at least of some kind of reserve – net reserve addition in a row. How do you get confident that there is not another supply? Is there a segment that you guys have not reviewed, that you have not – that is there another segment that is showing some signs of difference versus industry trends that you have not yet made adjustments too?

Bob Cubbin

No, Ken, that’s a great question. We have been very aggressively running off the discontinued operations and a significant amount of the reserve development this year over 60% came from the discontinued operations. The balance of the reserve categories other than the GL, have been performing very well. So, we do believe that with the stabilization and the workers’ comp phase, which is a big percentage of our business today as a result of all the changes that we have made and the increase in pricing and tightening of terms in the 2012 and 2013 accident years, on the liability line that we have taken remedial steps necessary to stabilize the most current accident years, particularly ‘12 and ‘13 and to also look at 2013 accident year with a much more conservative view on what we have booked at it. So we do think that we do have a much more stable position. The reserves that have been developing in the intermediate term are now much mature. And so with the conservative 2013 accident year loss ratio fix and the maturity of those over accident years in the reserve side, we do believe we have the opportunity to see at year end which we have limited to know reserve development in 2014.

Having said that, I am sure that there is a high degree of skepticism surrounding that given the immediate past history, but we are booking to what we think is an ultimate that should represent the final take on that. Believe me, I am just as disappointed as everybody else in these reserve changes and it’s been very difficult and challenging to oversee that and to manage our way to the other side, but we are resolved to make that happen. The rate increases certainly are helping and we do think that the strong reaction that we have taken when we see it, we book it and unlike sometimes when people when ignore it, it gets even larger. So I know it doesn’t sound like this is a small amount, because it’s not, but as we see it we booked it and that’s really all I can tell you, Ken.

Ken Billingsley - Compass Point

Thank you for taking my questions.

Operator

The next question is from the line of Bob Farnam of Keefe, Bruyette & Woods. Please go ahead with your question.

Bob Farnam - Keefe, Bruyette & Woods

Yes, hi, there. Good morning. One more question on the guidance, just to close on that, so the combined ratio guidance you are giving at 99 or 100, I just want to confirm that has no reserve development baked into that number, we are expecting (indiscernible) zero in terms of prior year development in that?

Bob Cubbin

No, as we expected more development, we would have booked it in the fourth quarter.

Bob Farnam - Keefe, Bruyette & Woods

Okay. And Karen, do you happen to have what the net loss reserves where at year end?

Karen Spaun

Yes.

Bob Farnam - Keefe, Bruyette & Woods

And as you look that up, I can ask another question. So in the second quarter, you had a big reserve charge and I was kind of surprised by the A.M. Best downgrade. So, here is another charge, what should we think about the potential for another downgrade from A.M. Best?

Bob Cubbin

Well, you have to make your own determination, but our capital and surplus position today is very strong. The concerns that I think many people had with the California workers’ comp book of business should be alleviated. We have reduced our premium volume as we had projected though. Our leverage ratios are dramatically reduced. I think we are down to 1.4% to 1% on a net basis. We have reduced the growth of the business obviously by shrinking it. While most of the tankers that one would look at looking at capital adequacy, we should get a very high level relative to where we are today.

Bob Farnam - Keefe, Bruyette & Woods

Alright. And if it does come to tax that you are downgraded again, is it – what kind of impact did that have in your business, I mean, you have already separated kind of the big one down from A minus,. so would there still be a negative impact if there was an additional downgrade?

Bob Cubbin

Yes, there would be a negative impact.

Bob Farnam - Keefe, Bruyette & Woods

Okay, that’s it from me. Thanks.

Karen Spaun

Okay. The gross reserves or the GAAP reserves of $1.6 billion on the net side or statutory side, it’s $1.1 billion and that difference is the reinsurance recoverable on unpaid losses.

Bob Farnam - Keefe, Bruyette & Woods

Right, okay. Thanks.

Operator

Thank you. The next question comes from the line of (indiscernible). Please go ahead with your question.

Unidentified Analyst

Yes, thank you. What is the plan and the timing for getting back the A.M. Best A minus rating?

Bob Cubbin

Well, the plan is the same as our business plan, which is to produce profitable underwriting orders consecutively. The timing of it is really not something that we control obviously the faster we return to profitability and the more stable our balance sheet is, the quicker that would happen, but there was no specific timeframe to that.

Unidentified Analyst

Thank you.

Operator

(Operator Instructions) The next question is from the line of Doug Ruth with Lenox. Please proceed with your question.

Doug Ruth - Lenox

Hi. Thank you for answering the question about the reserves and I am adding to the group that we are just disappointed with the one-time charges and the fact it’s all statistically inexpensive, it’s trading at like 78% of book value. If you could just give us one quarter without some charges, I think that, that would really rally and I think you can really show your support and your belief in the company if you – as the two of the you and maybe some of the board members would step up and buy some additional shares in the company?

Bob Cubbin

Doug, I appreciate that. And management has purchased shares in the past. We obviously have to be cognizant of the windows of opportunity for us to do that, but they are limited, but I appreciate your sentiment and thank you for your comments.

Doug Ruth - Lenox

Okay. Well, I am hoping that we just want candid – we would like candid answers and if there is anymore charges, please tell us as quickly as possible and that will be very helpful.

Bob Cubbin

We will do that.

Doug Ruth - Lenox

Okay, thank you very much.

Operator

The next question comes from the line of Ron Bobman of Capital Returns Management. Please go ahead with your question.

Ron Bobman - Capital Returns Management

Hi, Bob. Hi, Karen. Good morning.

Karen Spaun

Good morning.

Bob Cubbin

Good morning.

Ron Bobman - Capital Returns Management

I have a few questions. First, were there any outside actuaries engaged to sort of performance review sort of on an off-cycle basis that sort of helped to accomplish the final adjustment or I don’t know final, but at least as far as adjustment is concerned for this quarter?

Bob Cubbin

Yes, Ron. We did a deep dive full actuarial review internally and independent external review was also conducted.

Ron Bobman - Capital Returns Management

Okay. And then the promotion of this gentleman to Chief Underwriting Officer, so I assume obviously – I assume you are replacing someone else who is leaving the company. In essence, if I am right about that is it’s not a coincidence I assume that this was (indiscernible) or is it unrelated?

Bob Cubbin

Well, it’s not related to this reserve addition, it’s related to the overall performance over the last couple of accident years. So we just felt that was necessary to make some additional organizational changes in order to assure ourselves that everything is being uncovered in that. All aspects of the business are being looked at very carefully.

Ron Bobman - Capital Returns Management

Okay. And then finally, is the reserve addition for this quarter largely centered in Century Insurance and if so or if not are you going to have to put anymore capital to any of the deriving entities and the regulated entities?

Bob Cubbin

The risk-based capital in all of the underlying insurance companies is very high. So, additional capital in those subsidiaries is not necessary.

Ron Bobman - Capital Returns Management

Okay, thanks and best of luck.

Bob Cubbin

Thank you.

Operator

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

Bob Cubbin

Thank you all very much. We appreciate your attention and we will talk to you soon.

Operator

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

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Meadowbrook Insurance Group Inc. (MIG): Q4 EPS of -$0.24 Revenue of $196.6M (-34.4% Y/Y) beats by $7.55M.