Executives
Julie McGraw - VP & CFO
David Michelson - President & CEO
Analysts
Alison Jacobowitz - Banc of America
Vincent D'Agostino - Stifel Nicolaus
Robert Paun - Sidoti & Company
Meyer Shields - Stifel Nicolaus
Ron Bobman - Capital Returns
National Interstate Corporation (NATL) Q1 2010 Earnings Call May 6, 2010 10:00 AM ET
Operator
Good day, ladies and gentlemen and welcome to National Interstate Corporation's 2010 First Quarter Conference Call. My name is Steve and I'll be your coordinator for today. At this time all participants are in a listen only mode. We will conduct a question and answer period following the Company's prepared statements. (Operator Instructions). As a reminder, this call is being recorded for replay purposes.
Your hosts for today's call are Mr. David Michelson, President and Chief Executive Officer; Ms. Julie McGraw, Vice President and Chief Financial Officer and Mr. Gary Monda, Vice President and Chief Investment Officer.
I would now like to turn the call over to Ms. McGraw to begin the presentation.
Julie McGraw
Thank you Steve. Certain statements made during this call are not historical facts and may be considered forward-looking statements and are based on estimates, assumptions and projections, which management believes are reasonable, but by their nature subject to risks and uncertainties. The Private Securities Litigation Reform Act of 1995 provides a Safe Harbor for forward-looking statements.
The factors which could cause actual results to differ materially from those suggested by such forward-looking statements include but are not limited to those discussed or identified from time to time in National Interstate's filings with the Securities and Exchange Commission including the annual report on Form 10-K and quarterly reports on Form 10-Q. We do not promise to update such forward-looking statements to reflect actual results or changes in assumptions or other factors that could affect these statements.
Net earnings from operations is a non-GAAP financial measure which sets aside items that are generally not considered to be a part of ongoing operations such as realized gains or losses on investments. We believe this non-GAAP measure to be a useful tool for analysts and investors in analyzing ongoing operating trends. As such it will be discussed for various financial periods during this call. A reconciliation of net earnings from net earnings from operations from net income is included in our earnings release.
I'd like to now pass the call to Mr. Michelson.
David Michelson
Thank you Julie and thank you for joining our 2010 first quarter earnings conference call. This morning I'll provide comments on the first quarter results, as well as our recently announced pending acquisition of Vanliner Insurance Company from their parent company UniGroup Inc.
We posted solid results for the 2010 first quarter with net income of $0.55 per share, a book value per share increase of 4.6% and a return on equity of 15.2%. This quarters numbers, both topline and earnings require a deeper analysis than usual when coming to last year.
In regard to earnings, we are faced with a difficult task of comparing a very good 2010 first quarter to an exceptional 2009 first quarter. 2010 first quarter earnings from operations of $9.2 million or $0.48 were below the 2009 first quarter but consistent with our expectations. Our operating earnings last year were favorably impacted by unusually low claims activity as well as low underwriting expenses. In contrast, the 2010 first quarter experienced more typical claims results and slightly elevated expenses.
The net operating earnings variance was primarily driven by underwriting results. Our combined ratio for the 2010 first quarter of 86.5% was 7.5 percentage points higher than the 2009 first quarter but consistent with expectations and with recent quarters. The first quarter of last years with its 79% combined ratio was unusual due to both claims and underwriting expenses falling below the average run rate.
The 2010 first quarter loss and LAE ratio was 61.4%, reflecting both frequency and severity within the normal ranges. The 2010 first quarter expenses were up slightly, in part due to the mix of business written which can cause variances in the quarter to quarter underwriting expenses. In addition, first quarter expenses were higher due to legal and professional costs associated with the Vanliner acquisition and other product development efforts.
Net investment income, the other component of operating earnings was in line for the 2010 first quarter in comparison to the first quarter of 2009. Like other investors, one of our major challenges in 2010 related to investment income would be to maintain yield without sacrificing quality or extending the portfolio as we invest maturing fixed holdings and operating cash flows.
To help maintain yield and diversify the portfolio during the quarter we focused our purchases in corporate debt which now comprises approximately 12% of the portfolio. Also contributing to the net income for the 2010 first quarter was the elimination of the remaining valuation allowance on our deferred tax assets related to the net capital losses. The tax valuation allowance was recorded in 2008 during the financial crisis when the investment portfolio value dropped and impairment charged occurred.
Throughout 2009 and into the 2010 first quarter, as the portfolio recovered, the valuation allowance decreased, lowering the effective tax rate for those quarters. We do not expect further impacted related to the valuation allowance which was reduced to zero at quarter end. Also throughout 2009 and continuing into 2010, we have been successful in generating net realized gains from our investments. We will continue to respond to market opportunities to generate capital gains to supplement recurring investment income.
Our topline performance for the 2010 first quarter also requires some analysis and explanation. The basic comparison reflects a decrease in gross premiums written when comparing to last year. However there were two non recurring items related to the alternative risk transfer component which skews this comparison. The 2010 first quarter would have been approximately 7% above last year after adjusting for these two items.
Our ART gross premiums for the first quarter were impacted by a customer who requested change in the renewal rate for their captive program. The program moved from a first quarter to a third quarter renewal date. As a result approximately $11 million of written premium that was recorded in the 2009 first quarter will not hit 2010 until the third quarter.
The other item affecting the ART period over period comparison related to the residual impact of a decision made in late 2008 to reduce lines of coverage in one of our captive programs. Approximately $9 million of the premium variance in the first quarter was attributable to this action which will not have a comparable impact on the remaining quarter-over-quarter comparisons in 2010.
Adjusting for these two non recurring items, ART premium would have been up approximately 9% for the first quarter. We continue to experience a near 100% renewal rate in our group captive programs and we added new customers in several of our programs including the 70 programs written in 2009. We continue to have a flow of new opportunities in this component.
Specialty Personal Lines again grew in the first quarter by approximately 5%. The growth in this component continues to come from our commercial vehicle product. During the quarter we began offering the product in two additional states, Georgia and Alabama, bringing the total to five states that the commercial vehicle product is now being offered. We plan to continue to expand distribution for this product.
The exiting story for the first quarter was the growth in the transportation component which we have not experienced for several quarters. We continue to feel the soft market conditions but the negative effect of the dollar economy on our insurance appears to have somewhat settled down. In addition, in recent months, we stepped up our marketing efforts in this component. Some examples include geographic expansion of our paratransit product. We added distribution sources particularly for the traditional truck product and are increasing our focus on top tier passage or transportation and truck accounts.
In wrapping up my prepared comments, I want to share a few thoughts on the Vanliner acquisition. We've been working on this deal for quite a while and it is appealing to us in several regards. We looked at the moving and storage insurance business several years ago and felt that would be an attractive niche for us but it would be difficult to start it up from scratch.
When this opportunity came up, we reacted favorably because Vanliner is a well established and well respected insurance company for the moving and storage industry. We saw the chance to enter a business that was ideally suited for our successful business model with people that we felt were cultural fit and with a partner that will continue to promote the Vanliner name with in the affiliated moving and storage networking.
Being our first major acquisition and faced with a challenge of understanding the balance sheet that we were assuming as well as running the business going forward, we approach the situation with caution. Agreeing on financial guarantees significantly reduced our balance sheet risk but more significantly will allow us to place our focus on the future business prospects. We are pleased that as part of the deal, we will enter into a 5 year agreement whereby Vanliner will remain the exclusively endorsed insurance provider of United Van Lines and Mayflower moving and storage companies throughout the United States.
At this time Julie, Gary and I will be happy to answer any questions you may have regarding the pending acquisition or the first quarter results.
Question-and-Answer Session
Operator
(Operator Instructions). And your first question comes from the line of Alison Jacobowitz with Banc of America.
Alison Jacobowitz - Banc of America
So I was wondering, on the acquisition, I don't know if you can give any of this yet, but if you could talk some about maybe the premium base that you're acquiring from Vanliner. Have you had any initial thoughts on it yet? I know it's soon, but what percentage might look desirable that you think you might keep or anything like that? Have you had a chance to go through it that you could share?
David Michelson
Well we've been fluid to some degree with some onsite diligence and your right, it's a little premature to be too specific although in our press release we did announce that a little under 60% of their overall business is moving and storage premium and clearly, what drew us to Vanliner Insurance Company was the new moving and storage niche. I can say that from an underwriting results standpoint, and we've had questions from others relative to the underwriting results and how there are some differences at least on the surface relative to our historic results. I will tell you that from our view we think that the predominant issues relative to the underwriting results are in businesses that not the moving and storage business which is the other 38% to 40% of their premium base.
Alison Jacobowitz - Banc of America
So then, as a follow-up of your answer there, I don't think I've seen it. There is nowhere where there's published results of their business by segment, or can you share then, because obviously the combined ratio for them is running high and the accident-year combined ratio is even higher. Is there anything you could share as far as the performance for the segment you find most desirable?
David Michelson
No I really don't want to share specific numbers. Again I would say to you that the non moving and storage business, again there are many good accounts in that segment. It's trucking. To I don't want to apply that every single account in that business is problematic. By no means is that the case. But the underwriting results in the trucking business, the non moving and storage, those results aren't as strong as the moving and storage business results.
Operator
(Operator Instructions). Your next question comes from the line of Vincent D'Agostino with Stifel Nicolaus.
Vincent D'Agostino - Stifel Nicolaus
I just wanted to follow up on the Vanliner question from a moment ago. Since we're not going to dive into the segment, is there any way you may be able to share the overall results from 1Q '10 in terms of maybe net written premium and underwriting results?
David Michelson
Yeah, quite honestly, I don't have them to share. We're working towards a close that looks like its going to be around the end of the second quarter but no; I don't have the specific results to share at this juncture.
Vincent D'Agostino - Stifel Nicolaus
Okay. Just two other follow-ups real quick. With the timing impact in the ART segment, should we look for any impact to earned premiums or commissions as a result of that shifting to 3Q?
David Michelson
Okay. Well $11 million of ART premium that will renew in the third quarter, like most of our ART business does have a lower acquisition cost associated with it. I cant tell you because I cant project what our third quarter mix of business is going to be because again we're growing the personal lines business too and that business includes commercial vehicle and that business has traditionally with us and in the marketplace a higher acquisition cost. So it really just kind of depends upon what the rest of our business mix is in the third quarter in terms of how it's going to impact expense ratio.
Vincent D'Agostino - Stifel Nicolaus
And just lastly, why was interest expense so low in the quarter compared to year-ago numbers?
Julie McGraw
This is Julie. We had a favorable non-recurring adjustment that impacted the normal interest expense that's on our line of credit.
Operator
(Operator Instructions). Your next question comes from the line of Robert Paun with Sidoti & Company.
Robert Paun - Sidoti & Company
Just on the acquisition again of Vanliner, do you expect any cost savings to come through later this year?
David Michelson
It's hard to project any cost savings in particular for 2010. I will tell you that one of the many things that was appealing to us regarding Vanliner, when you look at their historic public statutory results is that they wanted a very nice low expense ratio historically, very similar to what you might see in the National Interstate published results, again in part due to the acquisition cost platform they have on the moving and storage business. But I don't know that I could project any material savings in 2010 at all.
Julie McGraw
2010 will probably be more like a stub period to us because we won't be taking control until mid…
David Michelson
Right, we're going to be taking control in the third and fourth quarter and again we're going to have non recurring expense items. They are going to a part of our 2010 expense ration but won't be there in 2011.
Robert Paun - Sidoti & Company
And just a broader macro question. Have you see any impact from the economic recovery in any of your business lines? Is it too early to tell, or have you seen any pickup in demand from your customers?
David Michelson
Its interesting, I just talked to one of our larger customers a little before I came on the call and he indicated to me -- and this is a trucking account -- that he's starting to see a pickup in his business after what he described as obviously a pretty awful 2009. But then he characterized it with at least I survived and I think a lot of our accounts really kind of characterize 2009 as a year of survival.
We've always prided ourselves on going after top quartile risks in our captive accounts, both from an underwriting performance standpoint and strong financials. So whereas a number of companies didn't make it, at least the vast majority of our customers did and they're going to come out a bit strong than their competition. We do monitor truck cargo moving and also by rail and I'm seeing some modest pick up in trends in terms of month-over-month and quarter-over-quarter trends.
So I think that there is a little bit of an uptick from an economic standpoint. We're not seeing any kind of a favorable change relative to the insurance market competitive landscape but relative to economic indicators, maybe a little bit of an uptick but nothing that I would called dramatically improved but some modest improvements.
Operator
And your next question comes from the line of Meyer Shields with Stifel Nicolaus.
Meyer Shields - Stifel Nicolaus
Quick question just on the -- and I apologize if I missed this -- on the reserve release in the quarter. Can you break that down by line of business or/and accident year?
Julie McGraw
This is Julie. Truly, it was across multiple accident years. I didn't just come from like one or two and just I'll say it again. I know Alan said this multiple webcasts ago but we don't do true reserve releases that you might normally put quotes around keeping in mind that we consistently apply a methodology that realizes historical payment patterns to determine the IBNR load for each accident year. So just kind of wanted to go back and revisit that because it's been a while.
Operator
(Operator Instructions). And your question from the line of Ron Bobman with Capital Returns.
Ron Bobman - Capital Returns
I was taking a look at the Vanliner stats statement. There's about a half a dozen segmented lines, commercial auto, other liability, work comp. And I'm wondering if the two main lines that you described earlier, sort of the moving business as compared to the commercial auto business. Where are they represented in the stats statement as far as premium volume? Or is it all commingled?
David Michelson
It's all commingled. Again in both the moving and storage business as well as their truck business, in both of those areas, similar to ours, commercial auto is the dominant line and workers comp is then the second largest line. But the results are commingled.
Ron Bobman - Capital Returns
So when I'm a customer of Van Lines and I buy the insurance, that's not a property cover, is it? It's actually; I'm buying a liability cover?
David Michelson
Right. Most of their premium, the commercial auto, there is physical damage coverage insuring the values of the vehicles but the majority of the commercial auto premium is commercial auto liability, third party liability and then obviously workers comp is a liability coverage for employees.
Operator
And that concludes the Q&A session for today's call. I'd like to turn the presentation back over to Mr. David Michelson for closing remarks.
David Michelson
Thank you. So far 2010 is shaping up to be an exiting year for us. We're maintaining our focus on profits and we're seeing strong signs that our top line will continue to improve. Of course the Vanliner acquisition was a huge deal for us. We are very exited about the terms of the purchase and the business we are taking on. More important, we feel good about our new customers, business partners and employees that will soon be part of National Interstate. We appreciate your support and look forward to updating you throughout the year. Thank you.
Operator
Thank you for your participation in today's conference. That concludes the presentation you may now disconnect. Good day.
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