Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)

Delphi Financial Group, Inc. (NYSE:DFG)

Q2 2010 Earnings Conference Call

July 28, 2010 11:00 AM ET

Executives

Robert Rosenkranz – Chairman and CEO

Bernie Kilkelly – VP, IR

Don Sherman – President and COO

Mark Wilhelm – EVP, Safety National Casualty Corporation

Duane Hercules – EVP, Business Development and CFO, Safety National Casualty Corporation

Tom Burghart – SVP and Treasurer

Larry Daurelle – President and CEO, Reliance Standard Life

Analysts

Randy Binner – FBR Capital

Ryan Krueger – KBW

Mark Finkelstein – Macquarie

Paul Newsome – Sandler O’Neill

Beth Malone – Wunderlich Securities

Alec Ofsevit – Credit Suisse

Mike Grasher – Piper Jaffray

Sean Dargan – Wells Fargo Securities

Eric Berg – Barclays Capital

Sam Hoffman – Lincoln Square Capital

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the second quarter 2010 earnings conference call. At this time all participants are in a listen-only mode. Later we will conduct a question-and-answer session with instructions given at that time. (Operator instructions). And as reminder the conference is being recorded.

I would now like to turn the conference call over to our host, Chairman, Mr. Robert Rosenkranz. Please, go ahead.

Robert Rosenkranz

Thank you. Welcome to Delphi Financial second quarter 2010 conference call. Our earnings release for the quarter was distributed last evening and has been posted on the company’s website along with the second quarter financial supplement. This call is also being broadcast live on our web site www.delphifin.com.

Participating in the call this morning with me are Don Sherman, Delphi’s President and Chief Operating Officer, Nita Savage, Vice President of Finance, Rich Waldis, Vice President, Investments, Bernie Kilkelly, Vice President of Investor Relations, and our colleagues at Reliance Standard Life, Safety National and Matrix.

At this point I’m going to ask Bernie to read the Safe Harbor statement.

Bernie Kilkelly

Thanks Bob and good morning, everyone. For those listening to a replay of this call that is being held on July 28, 2010. It contains time sensitive information that is current only as of this date. Statements made in this call relating to the future operations, performance goals, and expectations of the company, as opposed to historical facts are forward-looking statements under the Federal Securities laws.

These statements are based on assumptions and estimates by the Company that are subject to various uncertainties and contingencies. Discussions of these risk factors can be found in our second quarter 2010 earnings release yesterday, first quarter Form 10-K and our 2009 Form 10-K.

These factors could cause the company’s actual results to differ materially from those expressed in any forward-looking statements made during this call and should be considered carefully. The company specifically disclaims any duty to update forward-looking statements made in this call.

In addition, certain non-GAAP financial measures will be discussed on this call. The comparable GAAP financial measures, along with reconciliations to such measures are contained in our second quarter earnings release and financial supplement accessible on the company’s website.

Now, I’ll turn the call back to Bob.

Robert Rosenkranz

Thank you Bernie. Moving to overview, Delphi had an excellent second quarter and a good first half of 2010 with solid operating earnings and record high levels of shareholders equity and book value per share. Book value per share increased 10% since the end of 2009 to reach $26.74 at June 30. Operating earnings in the second quarter benefited from strong underwriting profits across our insurance businesses.

We also had positive sales trends in all of our insurance lines with good production growth at Reliance Standard and favorable results in the July renewal season at Safety National. Based on these trends we remained comfortable about meeting our financial targets in the remainder of 2010.

This morning we’re going to cover four main topics. First, I’m going to ask Don to review the performance of our insurance and asset accumulation businesses during the quarter. Second, I’ll discuss our investment performance. Third, we’ll be reviewing our balance sheet and capital positioning. And finally, discussing our outlook for the second half of 2010 and longer term.

After our remarks we’ll be glad to answer your questions. And at this point I would like to turn it over to Don.

Don Sherman

Thanks, Bob and good morning, everyone. Second quarter underwriting margins in our insurance operations were in line with our expectations in our employee combined ratio in the second quarters was 93.5%, that was up slightly from the 93.1 in last year’s quarter but down from the 94.1% in the first quarter of this year.

Our loss ratio continued to improve in the second quarter declining a 140 basis points from last year’s second quarter and declined to 67.6%. Loss ratios at Reliance Standard Life improved and we have not seen any impact from the recession on disability claims incidence, severity or termination rates. I want to make a couple of comments on this topic since I know it is top of mind after higher disability claims incidence was reported by one of our competitors.

We’ve done extensive analysis on this topic as part of our overall enterprise risk management effort. This analysis indicates that there is no significant correlation between a change in gross domestic products and our loss ratios including disability loss ratios. We’ve also analyzed the correlations between our loss ratios and ADP payroll data and Federal unemployment data. This analysis again showed no significant correlations. We believe there are three main reasons for this. First, the conventional belief that disability claims are more prevalent in times of rising employment has never been actually validated in the private group benefits market.

We believe this theory may have emerged from behavior seen in individual disability market in the past, but in the group disability markets it has not been the reality. Contracts have strict elimination period than a claimant must be employed to be eligible for disability coverage. Second, the attractiveness of going out on disability is greatly diminished in this recession when many employees are struggling with high levels of household debts.

These employees need to earn their full salary to make needs particularly if there is no second income in the household. In addition to these factors our particular customer base is focused on smaller companies which tend to perform better in a recession, almost half of RSL’s premium come from customers with 500 or fewer employees.

On a case comp basis, over 90% of RSL’s customers have 500 or fewer employees. For these reasons we have not seen any impact on disability claims from the recession and do not expect to see any impact in the future. Turning back to our group benefit combined ratio, the expense ratio for the quarter increased to 25.9% from 24.1%. This is mostly due to the impact of lower premiums in the quarter at RSL as well as somewhat due to investments we made in growth initiatives at Safety National.

We continued to believe that the combined ratio level in the 93% range is sustainable for the foreseeable future. Turning now to premiums, Delphi’s core employee benefit premiums in the second quarter were essentially unchanged from last year at $338 million. Core premiums at Safety National increased 7% in the quarter, this was driven by a 41% increase in our assumed workers compensation and casualty reinsurance premiums which grew to $12 million.

Pricing in this line remains firm and we were pleased with the 3D (ph) opportunities we saw in this line in the recent July renewal period. Turning now to Safety’s largest product line excess workers’ compensation, premiums rose modestly in the quarter to $71 million and production in the quarter was in line with our expectations for this quarter which is typically one of Safety’s slowest sales quarters.

More importantly we were encouraged by the positive trends in the July 1 renewal period which of course are not reflected in the second quarter results. July renewals are the second most important period for Safety in which we typically write about 25% of the business. For July Safety had near record high renewal ratios and robust new sales at about $11 million which was online with a very strong quarter last year. We believe this reflects continued expansion of Safety’s leading market share position.

While average rates decreased about 1%, this was offset by about 1% increase in the self insured retention level, as you know this is the point where risk shifts from the employer to us. Our average retention level or attachment point is now over $520,000. For these reasons we continue to feel very good about the business we are writing and we continue to see no signs that the market will soften significantly any time soon.

In the second quarter Safety continued to rollout our large casualty program in which auto liability and general liability coverage’s are bundled with our large deductible workers compensation products. We’ve only written a small amount of bundled product to-date but we’ve seen a positive impact on sales of the large deductible product as a result of our offering these other product lines in the bundled package.

We do not expect this initiative to have material results in 2010, but we continue to believe it will represent an attractive long-term opportunity for Safety. Let me turn now to Reliance Standard Life where core premiums declined 3% in the second quarter which was an improvement over the 6% decline we saw in the first quarter. We are pleased that Reliance Standard achieved a 15% increase in production in the quarter while continuing to hit our pricing targets.

We saw some modest easing of the competitive environment in our small case niche in the quarter and quoting activity remained steady. We are encouraged by the recent ADP payroll data that showed modest growth in employment in a key target market for RSL that being the Safety – I’m sorry, service providing companies with less than 500 employees.

Reliance Standard achieved a 5% premium growth in the second quarter from voluntary products which remained attractive to employers as they continue to seek cost control. This growth was boosted by premiums of our limited benefit healthcare product Basic Care which rose 31% $10.1 million. Basic Care is our only product that is directly impacted by the Healthcare Reform Legislation passed in March. While agency regulations are still being implemented – issued to implement the legislation, we’ve concluded that this product can continue to be marketed through at least 2013 and possibly beyond with a fixed indemnity benefit structure.

We anticipate that beginning this September, all new and renewal Basic Care policies will have to structure. We already have regulatory approvals for this product structure in the majority of states in which Basic Care is now being sold and we are in the process of seeking those approvals in the remaining states. In our larger case business at our cell insurance sales through our integrated employee benefits program increased over last year’s second quarter.

We continue to have a competitive advantage with the value added services we offer with our Matrix subsidiary. We’re also getting strong interest in our new product offering Reliance One which adds employee wellness components through a partnership with AllOne Health, a national leader in workforce health and productivity management. We are rolling out this product this year and expected to help us to continue competing effectively in the larger case market.

Before I turn the call back to Bob, I’ll also review the results in our asset accumulation segment at Reliance Standard Life. Second quarter operating profits in this segment were $11.3 million which was down from last year’s second quarter as we had slightly lower investment income as Bob will discuss in a moment. In the phase of tighter investment spreads and high cash balances that we’ve seen in our investment portfolio, we did not see the need to push for annuity sales. And annuity sales were at $78 million for the quarter down from $115 in the second quarter of last year.

Funds under management in this segment increased modestly from the year end to reach $1.5 billion at June 30. Now I will turn the call back to Bob to talk about our investment results.

Robert Rosenkranz

Thank you Don. Investment income in the quarter was in line with our expectations which was a gratifying outcome in what was a volatile quarter. The year-over-year comparison was difficult as last year’s second quarter was boosted by exceptionally high returns from our alternative investments.

Our fixed income yields continue to be constrained by a high cash position. 6% of invested assets were in short term investments at the end of the second quarter, frankly it’s a challenge to find appealing investments when interest rates are lows and spreads are tight.

Despite this challenging environment we did put about $300 million cash to work longer term during the second quarter and achieved average new money yields in the 5.5% to 6% range on a tax equivalent basis. We continue to put new money to work in our traditional asset classes such as high quality municipals, corporates and mortgage backed securities. I want to spend a minute on our muni bond investments which have been top of mind for investors in recent weeks.

Muni’s have been an attractive asset class for Delphi for us because Safety National is a property casualty company can take full advantage of the tax benefit. And second, since Safety has some of the longest tail liabilities of any insurance company, we’re natural buyer of long dated muni’s which continue to have very attractive tax equivalent yields particularly compared to corporates.

About two-thirds of our muni bonds have maturities of 15 years or more. At the end of the second quarter, we had about $2 billion of municipals, that portfolio is well diversified by type of bond and geography with no state making up more than 10% of the portfolio. Roughly 20% of this portfolio, some 400 million of bonds are guaranteed in some form by Federal government or agency collateral.

Another 25% consist of general obligation bonds and the remainder is made up of revenue bonds and all others. While we don’t depend on ratings for investment decisions, the issuer ratings of our portfolio is in our financial supplement are generally better than the ratings of municipal market indices. On an individual bond rating basis the comparison is that 95% of our bonds are rated A or higher versus 87% for the Merrill Lynch Municipal Master Index.

We use outside managers with specialized expertise in this sector to help manage the majority of our municipal bond holdings. In the current environment we’re working very closely with them to review and monitor every one of our holdings. Based on our current portfolio and our historical track record we remain confident that this asset class will continually achieve attractive tax equivalent yields with minimal risk.

Alternate investments at the end of the quarter were about $265 million or 4% of invested assets. Those assets had an annualized return of about 4% in the second quarter and for the first half of the year an annualized return of about 8% over the north of 8. we’re committed to maintaining our allocation to this asset class around 4% or 5% of invested assets and our objective here remains to reduce overall portfolio volatility while providing enhanced investment income.

Turning now to realized losses in the second quarter, we had after tax realized losses of $9 million which was down from the first quarter of 2010 and was the lowest in the last nine quarters. After tax losses from other than temporary impairments also decreased sequentially from the first quarter this year. These declines support our belief that the turnaround in economic activity and normalization of capital markets will continue to reduce our OTTI write-downs.

We also have sharply lower balances in several of the asset classes where past write (inaudible) occurred including home loan (ph) mortgages and the high yield corporate loans in our managed account with For Trust (ph) which is in runoff. For these reasons we believe future write-downs should not be a source of stress.

I’d like now to turn to our balance sheet and capital position. Both have continued to improve shareholders equity and book value per share up 10% as I mentioned since the end of 2009. Our shareholders equity touched the $1.5 billion market June 30 and book value per share rose to a record high of $26.74. Our debt-to-capital ratio was 19% with no short term debt and holding company financial resources at a comfortable $96 million.

We continue to take actions to enhance our financial flexibility and reduce interest expense by retiring some of our higher interest rate debt. We partially called our 8% senior debt – senior notes and that was completed in July and together with some note repurchases has resulted in overtime and if that $25 million of these notes, this will result in annual savings of about $2 million in interest expense.

We’re pleased that in June Moody’s raised its outlook stable for Delphi and our operating companies recognizing that our improved financial flexibility in regulatory capital. We don’t anticipate the need for any additional capital contributions to our insurance subsidiaries and currently we have more than sufficient financial flexibility to support our growth.

The final topic I want to discuss our outlook for the remainder of 2010. In February we gave operating earnings per share guidance in the range of $3.20 to $3.50. Our strong performance in the first half of the year puts us in track to mid to upper end of that range, but we’re not changing the range because while operating performance of our insurance businesses has been strong, we continue to be cautious in our outlook for employment growth and for the availability of attractive investments.

Looking beyond 2010, assuming that unemployment trends improve, we believe Delphi’s operating EPS growth going to return to historical levels which have been in the range of 10% to 12%. We expect RSL to benefit as the economy improves by capitalizing on its leading market position in the very profitable small case niche while also growing profitably in large case in voluntary markets.

We also expect Safety National to continue building on its leadership position and excess workers’ comp and to achieve growing contributions from its new product initiatives. So, in closing, we’re very pleased with our excellent financial performance in the second quarter and first half as well as balance sheet and capital position. We remain optimistic about our outlook.

And at this point, I would be very happy to take any questions. Operator?

Question-and-Answer Session

Operator

(Operator Instructions) And first we will go to the line of Randy Binner with FBR Capital. Please go ahead.

Randy Binner – FBR Capital

Hi great, thanks. This is for Bob Rosenkranz, I think but just on the cash redeployment, is there a target short term assets to total assets, total invested assets that we should think about versus the current 6%?

Robert Rosenkranz

Well I would say that there is no particular reason for us to have more than 1% or 2% of our portfolio in cash and we have repo lines, we have (inaudible) lines. So the cash is really a default holding which reflects a kind of growth of a good investment opportunities in an environment with very low interest rates and generally tight spreads, that got a little bit better in spreads lightened out during the second quarter and we did take advantage of that but that’s really what we think about the cash holdings.

Randy Binner – FBR Capital

And yes I mean I guess just from a broader perspective, I mean what I couldn’t tell from your comments exactly if you – if muni is in potentially there are still places where you’re finding kind of good risk adjusted returns but I guess there is some insurance companies that have more of the fully invested approach and some who are more selectively and clearly you are most selective, I mean what would you be waiting for the 10 year to go up or is it more that you think credit spreads could blow out again because if it’s kind of a flat 10 year environment, we could be waiting a while, I’m just trying to get a sense of kind of what’s good now and what you’re looking for as far as the benchmarks for redeploying more of the cash.

Robert Rosenkranz

So we’re at a size now and when you’re talking about redeploying $200 million or $300 million or $400 million, if we can find niches were we can put a $100 million to work and look for a couple of things maybe that the market has overlooked or that seemed to represent really good relative value for one reason or another that’s really the way we’re trying to build this portfolio. We’re not waiting – we’re not sitting around trying to time but interest rate movements or even spread movement, it’s more a quest for those niches, I mean much larger companies of course can’t do that, I mean I have to kind of because the niches are not going to make a difference but in our size, we sort of feel like we can find a special niche opportunities and have historically been quite successful in doing that.

Operator

Next we will go to the line of Ryan Krueger with KBW.

Ryan Krueger – KBW

As Safety production levels have held up quite well despite the weak economy, is that your sense that the overall market for excess worker comp has continued to expand at this point or would you attribute the growth more to market share gains?

Robert Rosenkranz

I think the primary driver, frankly has been market share gains but I will turn it over to more colleagues in Saint Louis if they would like to add some more color.

Mark Wilhelm

Yes, Ryan, this is Mark Wilhelm at Safety. There are a number of reasons for our success but the market itself hasn’t grown, we have seen additional self insurers but overall with the payroll reductions in other areas, it’s stayed pretty flat. We are achieving our success because of different initiatives that we have mentioned over time, taking advantage of our leadership position and just being more visible and using the services to attract new customers. There hasn’t been any irresponsible competition, that’s one of the best factors I can point to that we haven’t had to deal with too much of a soft market mentality in our sector.

Ryan Krueger – KBW

My last question is on the ROE goal, you talked in the recent past about 13% to 14% ROE goal on beginning equity and I am wondering if that would change at all, if interest rates remain at these really low levels for an extended period of time, do you think you could still achieve an ROE in that range and that’s an area should we be thinking about slightly lower target if interest rates remain at these low levels.

Robert Rosenkranz

Well, for some extent when interest rates declines the equity increases on a mark to market basis and yet the earnings of your bond portfolio is the same as they were. So you are right, it becomes a challenge to, when the equity number balances around as it does but I am sorry, not about to back away from that target. I think it’s achievable.

Operator

And next we will go to the line of Mark Finkelstein with Macquarie.

Mark Finkelstein – Macquarie

A couple of questions. One – very helpful comments on the disability loss ratio at RSL. I know you don’t like splitting kind of RSL and Safety out. But you did actually have a sequential decline in the overall group employee benefits loss ratio, and I was curious if you would be willing to say whether that same trend occurred specifically at RSL versus the overall platform. Just to kind of further reaffirm the comment you made on incidence levels.

Don Sherman

Yes, Mark, this is Don. We did see a decline at RSL on the loss ratio.

Mark Finkelstein – Macquarie

Also wanted to explore the interest rate question but perhaps from a little bit of a different angle. I think I have a pretty good handle on the impact on reserves at RSL. But I think maybe a little bit of an education on the Safety side. Obviously, it’s an excess indemnity based reserve, and there’s a fair amount of discount in that. When you think about interest rates at these levels, are there any impacts from where bonds are trading right now on the overall portfolio or does it really only impact what you reserve the new claims at?

Don Sherman

I think the primary impact on the interest rate moves on discounting, we would be looking at what you do for the new claims, not the existing.

Robert Rosenkranz

To put a little color on that, I mean we try to be pretty well matched on a cash flow basis. So our comment about owning very long dated munis, that’s a way of being sure that with these interest rates don’t impair our ability to meet claims that might come between (ph) 15, 20 years from now.

Mark Finkelstein – Macquarie

So on a statutory basis, it’s a promulgated standard and as I understand it, you wouldn’t be in a position of actually having to lower that rate, which would spring up the reserves and cause some kind of a capital implication at Safety.

Don Sherman

I think that’s right, I could turn that over to our colleagues at

Duane Hercules

Hi, Mark, it’s Duane Hercules. On a statutory basis, we discount the tabular reserves by 3.5%, so the investment yield is well north of that. We are not concerned about that risk.

Mark Finkelstein – Macquarie

The comments on the limited benefit A&H product, I think you talked about through 2013. I know a lot of stuff happens in 2014. Does the product become a problem when you get out into 2014 or do you think it’s still a sellable product or is it still up in the air?

Don Sherman

We feel confident about getting to 2013 and through that, we think beyond it, there is still a chance but at this point we don’t have as much clarity as we would like about how all of these regulations are going to be implemented. So we have to be a little more cautious about saying what happens in 2014. We think there is a prospect that we could continue selling it, but it’s not as clear now as we would like it to be.

Operator

Next we will go to the line of Paul Newsome with Sandler O’Neill.

Paul Newsome – Sandler O’Neill

I’m having a little trouble getting the effective tax rate going forward. I was wondering if you could just give us a couple of comments, maybe a little bit of a thought as to how we should think about it.

Don Sherman

Tom, would you like to take a shot on the effective tax rate?

Tom Burghart

For the current quarter on the operating side, the effective tax rate was 25% and then in our budgeting we are thinking of tax rate in that neighborhood makes sense.

Paul Newsome – Sandler O’Neill

Do you have any thoughts on SeaBright’s little surprise with – I believe they had some issues with their workers comp business in California.

Don Sherman

What we know about SeaBright’s book is what one would read, we think in the primary level markets, there may be some issues going on in California and perhaps, Mark, you want to provide more color on that from a Safety perspective?

Mark Wilhelm

The California market, the rates have gone down, and now they are down and now they are starting to go back the other direction. And that sort of rate decline overtime is probably catching up.

Paul Newsome – Sandler O’Neill

Any updates on your M&A thoughts?

Robert Rosenkranz

We continue to cast a wide net and examine a lot of fish but there is really nothing in M&As.

Operator

Next we will go to the line of Beth Malone with Wunderlich Securities.

Beth Malone – Wunderlich Securities

On the bundled product you are now offering, where does that show up in the premiums? Is it in excess workers comp?

Robert Rosenkranz

Almost all of the premiums that have been generated are excess comp, large deductible premiums. The amount of order liability or general liabilities have been pretty de minimus but the mere ability to offer this package, I think has helped us get in front of a lot of clients who – we would not have seen without that.

Beth Malone – Wunderlich Securities

On the alternative investments, is there a breakout or some way we see the contribution from the change in the value of alternative investments to earnings year over year?

Robert Rosenkranz

Not really, it’s just included as part of investment income.

Beth Malone – Wunderlich Securities

Investment income was down year-over-year. So I’m assuming that’s not necessarily because of alternative investment was down but because yields on the returns are down.

Robert Rosenkranz

Well, the second quarter last year was an exceptionally strong quarter in alternatives. As we said the time, that second quarter result last year was way, way about trend line.

Beth Malone – Wunderlich Securities

Now in the past you have kind of given some color on the alternatives as to the kind of targeted or the anticipated return on those. Are you feeling generous about providing some information on that at this point?

Robert Rosenkranz

I did indicate that for the first half was sort of at run rate of something north of 8%, which is certainly higher than the figures behind our guidance but probably somewhat lower than our long-term – actually quite a bit lower than we have achieved in this longer term and historically.

Beth Malone – Wunderlich Securities

On the assumed workers comp, the numbers on that are pretty impressive in terms of the growth that you had in the renewal ratios. And I’m curious, is that due to the fact that it’s a relatively new product, so we’re getting, it’s not such a tough comparison or is this product really working well with the marketplace?

Robert Rosenkranz

I would like to encourage our colleagues in Saint Louis to respond.

Mark Wilhelm

As I mentioned in the last call, this is a product that started around year 2000 and we have been gradually building momentum over time and we are really beginning to see the benefit from the fruits of our labors there. It really starts with our expertise in excess workers compensation that we can apply to this assumed reinsurance players, and that along with the addition of a very respected reinsurance underwriter last year in conjunction with our improved financials and stable outlook and a little bit of market dislocation, we have been able to take full advantage of that. So it’s a good spot for us, and it should be for the foreseeable future.

Beth Malone – Wunderlich Securities

You said it because of your experience in the excess workers comp. Is it a different underwriting approach or are you able to leverage that? I know the information that you get on excess workers comp is kind of unique, which gives you barriers to entry, an advantage. Is there something similar to that on this assumed?

Mark Wilhelm

Yes, exactly. The large majority of reinsurance sold for workers compensation is above $10 million and usually requires a 2% warranty, which means 2 people have to be involved in the loss. Most of the reinsurers you hear about every day are involved in those higher level layers. We focus a little bit more on the $2 million to $10 million layer, which we have a significant amount of proprietary data that we can apply and also a lot of underwriting expertise that we can apply.

Beth Malone – Wunderlich Securities

Your customers, are they companies that are exclusively writing workers comp or are you providing the reinsurance for the workers comp for a more comprehensive or a regional property-casualty company that might have a book?

Mark Wilhelm

More the latter where workers compensation is just one of their products. And so we probably have more expertise than them in a lot of respects and we have a lot of loss mitigation tools that we can tell our reinsurance buyers about. So that also attractive to them.

Beth Malone – Wunderlich Securities

Is the growth coming from greater penetration of your existing new customers or is it new customers?

Mark Wilhelm

It’s a combination of both but to have this kind of growth, it definitely has to come from new customers and we have been able to position ourselves as a respected and credible reinsurer in those layers we have been talking about.

Operator

Next we will go to the line of Alec Ofsevit with Credit Suisse.

Alec Ofsevit – Credit Suisse

First, do you think you could just break down the general obligation portfolio between state and local governments, between those two? The second question is, you described the correlations you ran between different economic variables. Have you looked at the correlation with social security disability claims and your own disability claims? The third and my last question is, on the bundled large casualty program, I know sales haven’t been a lot very recently but have most of your sales with that product has been for the whole package or just specific pieces of the package?

Don Sherman

On your first question with regard to the breakout on the muni portfolio, I don’t have at my fingertips the breakout between state versus smaller locality geo. We can try to get that for you if you have a continuing interest in that.

On the second question on correlation, we have not tested the correlations to social security losses. We suspect that some of the common opinions about claims being correlated may come out of the social security experience as well as out of the individual market experience as we indicated in our comments. But we have really focused our analysis on our claims rates and our other factors that are impacting our book versus trends in employment, unemployment, GDP, etcetera and try to address our correlation to the economy. We haven’t looked at the social security numbers in any great detail. On the package products, I think we have sold more, we have actually had more impact on our large deductible in workers compensation coverages than we have had on selling the entire package, but maybe I should turn that to Mark to see if I am recalling that correctly.

Mark Wilhelm

Your are absolutely right, Don. Our work comp LD submissions are up about 65% this year, which is a direct impact of the ability to write the other lines. Our new work comp LD premium this year has already more than doubled our total ‘09 output. So the new ability is definitely impacting the large deductible writings. We haven’t written that much in the way of the other lines but that’s okay with us especially given the softness of the AL and GL market. But it is allowing us to pick up new opportunities that we wouldn’t have seen before. These are typically coming in the larger account area. We have also seen impact in our excess workers compensation from the ability to have these other lines. It’s opened some doors in that area as well.

Alec Ofsevit – Credit Suisse

Just one follow-up on the social security disability claims, just why wouldn’t you run it versus that or why would that not be a relevant thing to look at when you’re considering claims experience?

Don Sherman

We don’t think that the social security claimant requirements and the purposes of the program and how it’s really – we distribute ours through a group contract. We don’t really think there is enough good data to be gained out of that because there is not that much connection between how one can either get a claim or not on social security versus –

Robert Rosenkranz

Also, it’s a dependant variable. I mean social security claims might be driven by the economy or might be driven by other factors but social security claims are certainly not going to be the drivers of our business. So we are looking of the things that might drive us and trying to figure out, as Don said earlier, whether there are any things that are going on in the general economy that might correlate with our experience and there just frankly doesn’t seem to be.

Don Sherman

Our interest in the social security information is more at the microlevel in terms of understanding the ability that we have for utilizing the social security offset language in our contracts and doing that appropriately as opposed to the macro level of what the aggregate social security claims are.

Robert Rosenkranz

And frankly, we have tried over the years to use the social security database as a guide perhaps for underwriting and pricing because obviously it’s a huge database compared to with any individual company would have. But it turns out not to be hugely useful to be honest.

Operator

Next we will go to the line of Mike Grasher with Piper Jaffray.

Mike Grasher – Piper Jaffray

Don, I thought your comment was interesting. You were talking about RSL, a 15% increase, and you had noticed in the small case environment the competition had eased. Just wondering if you could pay some attribute to that or give us some thoughts around why that might be the case.

Don Sherman

Well, I would like to say that people can only be in same for so long and then they have to own up to normal standards but maybe I could get more color for you if we ask Larry at Reliance Standard to take a pass with that question.

Larry Daurelle

I think that this is a relationship business and we have seen code activity hanging in there year-over-year and we just believe that some of the plan designs that we are writing and I think some of the selling that our sales reps do with the brokers has been very effective along – we are not always the lowest on the spreadsheets. So it’s been good business for the past couple of months and it looks nice right now and I think it’s just a matter of us versus the competition and we are being in the right place at the right time. And again, just same what Don said, maintaining our pricing disciplines.

Mike Grasher – Piper Jaffray

Bob, you spoke a little bit about the outlook for the company and commenting a little bit about jobs and that. I would like to get your perspective, your thoughts around the outlook for the macroeconomic environment and just where you see jobs headed, inflation, the impact on things, if you could.

Robert Rosenkranz

Okay, that’s a tall order actually. I mean I think the economy clearly has some real uncertainties associated with it. I think if you talk to economists and as we do a tot, it is simply not clear whether we are facing a great danger of inflation or a great danger of deflation. And not only is there a divided opinion about that, but I would say most observers are actually uncertain and don’t want to express an opinion at all. So it’s a very tricky environment. You had the experience in Japan, which people are becoming more and more cognizant of very high fiscal deficits, run over a hugely long period of time with no impact whatsoever on interest rates or inflation. In fact 20 years into and they are still battling deflation in Japan.

So there is certainly a model if you have had a, what I would like to call a balance sheet recession that, in the Japanese case for example, you can go on for long, long period of time with low prices. Now, that being said, I don’t really think that that’s terribly likely to occur in the United States. I think in Japan’s balance sheet recession was really driven by corporate problems, corporations had borrowed heavily primarily to invest in real estate and they were deeply, deeply underwater. So corporate Japan needed to rebuild their balance sheets. They were not in the business of maximizing profits, they are in the business of restoring their balance sheet and it took a long, long time.

That is not true about corporate America at all. Corporate America has huge cash balances, is in very strong financial position. The kind of people who can’t pay their debts in the American economy are basically people in homes that they could not afford it in the first place. We have big problems still to be resolved in the household sector but in the corporate sector, I would say American financial strength is pretty high. I have seen surveys in the last week or so that companies are finding that they actually do have some pricing power.

The notion, the idea the Chinese currency is probably going to float upwards a little bit. They have been big exporters of deflation. In fact that company seemed to have some pricing power. The employment market in specialized segments is pretty tight. I mean we found, just its anecdotal, but our matrix subsidiary is finding it hard to get qualified people in the Phoenix market is pretty intense competition for the kind of folks that they hire.

So, I mean, personally I think the outlook is a little more for on the expansionary side than on the deflationary side but I think we’re going to have sluggish growth in this economy for quite a while.

Mike Grasher – Piper Jaffray

So just tying that into payrolls and unemployment going lower –

Robert Rosenkranz

I think it’ll drift lower but we’re not anticipating any short-term reductions, any meaningful short term reductions in unemployment. We expect it to drift lower but it’s going to be a drift and not a particularly vigorous move.

Operator

Next we will go the line of Sean Dargan with Wells Fargo Securities.

Sean Dargan – Wells Fargo Securities

I have a couple of questions about RSL. You said that the loss ratio in RSL was down year-over-year. Given the comments from one of your competitors, can you just describe your exposure to the education market and your view of that market in the public sector in general?

Don Sherman

Hi Sean, it’s Don Sherman. Traditionally education segment has been a small piece of our business, certainly not in double digits, I think it’s in single digits, and so it’s not been a big driver for us. And Larry, maybe you want to give some more color about how that fits in our overall book.

Larry Daurelle

I think Don’s right, it’s been a small part of our business but if you just look at the education business, this business being public business tends to be big business and therefore very, very price sensitive. I guess as such we tend not to be competitive on your average public education group for that reason, therefore not having it be a big piece of our portfolio.

Sean Dargan – Wells Fargo Securities

You had very strong production numbers in life but that experience is not mirrored in disability. Can you just talk about the dynamics of the two products and the relative competitiveness of the marketplace?

Don Sherman

Yes, Sean, if you look at the comparison for the production increase, it shows a little more dramatic of a trend than it might overall typically are disability our life tend to run in about a 60-40 mix or something like that and we actually had, we’re comparing this quarter with a little bit stronger mix, a little more light than disability than perhaps normal, we’re comparing it to a quarter that was very weak on the life side.

So the percentage increases look a little unusual. We think the second quarter of this year is probably within the range of normal maybe it has a little bit more life than disability, if you look out over the whole book but what really makes that discrepancy look large is comparing to a ‘09 quarter where for a variety of competitive reasons and maybe accidents of history, our life numbers were small in relation to disability.

Operator

Next we will go to the line of Eric Berg of Barclays Capital.

Eric Berg – Barclays Capital

I have a number of questions regarding the Safety business. First, why would an employer choose a high deductible policy over an excess comp policy? Are they one and the same or are they sufficiently different that an employer might go for one over the other?

Don Sherman

I mean economically they’re quite similar but from a regulatory and administrative point of view, they can be quite a bit different. The employer has to be approved by the state insurance department or some version of the state regulatory environment to become self insured, and they have to maintain their program and work with a TPA etc. that maintain that self insured environment. And often times if you have an employer who is multi-state, they may be large enough to benefit from high deductible or self insurance but they don’t want to go to a whole variety of state insurance regulatory bodies to get approval and they may find a single high deductible program much more cost effective from their point of view, and they may be interested in rolling it into the package type environment that we were talking about earlier.

So economically the results can be similar but administratively and the processes that go underneath it the two policies can be quite different.

Eric Berg – Barclays Capital

When you in your prepared remarks referenced the renewal ratio. I’m going to guess that this is defined as the percentage of premium that was up for renewal that actually did renewal or is the ratio calculated differently?

Don Sherman

Duane, do you want to be sure we have that right for Eric?

Duane Hercules

You’re correct and it’s the percentage of the premium that was up for renewal that was renewed. It takes into account any changes in payroll as well as any changes in rate.

Eric Berg – Barclays Capital

Okay, it sort of normalizes or adjusts for that?

Duane Hercules

Yes, it also takes into account if there’s an increase in the SIR or deductible. So if the deductible or SIR goes up considerably you would expect the premium to go down generally speaking.

Eric Berg – Barclays Capital

My final question will bring you folks back to the conversation we had earlier in this call, which is, why are certain aspects of this business, I know you have already provided an answer but I hope you can build on the answers you’ve already provided. As we think about the three corners of this workers comp business in which you compete assumed reinsurance, excess, and high deductible all similar but not identical businesses, all somewhat different from the next one, why are some doing better than others, if they are so similar?

Don Sherman

Eric, this is Don again. My high level view on that is we have had a long standing major share in the excess comp market and we’ve certainly been building on that. Some of the other areas like assumed treaty reinsurance for worker’s compensation, while we’ve been doing it since 2000 to be sure we had it right, we’ve only been pushing more aggressively on that more recently. So I think some of it may be the level at which we have decades of experience and market traction in the excess comp market versus pushing more recently in the assumed worker’s comp reinsurance business.

Eric Berg – Barclays Capital

I would think too it has something to do with just the size of the numbers. It’s going to be easier to show growth in the assumed and high deductible businesses because they’re much smaller than your excess business.

Robert Rosenkranz

That’s absolutely another way of putting it.

Don Sherman

That’s very fair, Eric. I think the assumed treaty book is on track to head toward $45 million to $50 million annual premium range and the large deductible business has generally been a little bit smaller than that for us and you compare that to the excess comp market, that’s several hundred million a premium. So a $5 million production number looks much bigger in those newer segments where we’re more recently been pushing or emphasizing the thrust around that program.

Eric Berg – Barclays Capital

Yes, it looks like the excess comp is probably, what five or six times the size of your high deductible and assumed reinsurance business. Is that roughly correct?

Don Sherman

It sounds like the right zip code, yes.

Operator

Our final question comes from the line of Sam Hoffman with Lincoln Square Capital.

Sam Hoffman – Lincoln Square Capital

I just had two questions on expenses and capital. The first is how you mentioned that your expense ratio grew to 26% and it seems like the other operating expense line continues to tick upwards this year and you guys have made significant investments in preparation for growing the business over the last few years.

So my question is is the growth in the other operating expense line basically finished at this point? If so, when premiums do grow, as you mentioned they should next year, will there be significant operating leverage in the expense ratio?

Don Sherman

Sam, I think from the perspective of growth I mean we’re always hopeful that we’ll be finding additional new opportunities that would justify us building the business. So I hate to say it’s finished but I think from the perspective of our near-term game plan, yes, much more the increases in place than would come ahead. So we do think there’s leverage on the expense ratio side as we see success out of some these programs we’ve been working on.

Sam Hoffman – Lincoln Square Capital

Can you give the amount of holding company cash that you had at the end of the quarter as well as the excess capital approximately that you had at the insurance companies, and then talk about the priorities and timing for the redeployment of that capital. You mentioned that M&A was not imminent.

Don Sherman

I think we ended the quarter with 90 some million of financial assets at the holding company and excess capital is always a touchy subject because different people will have different definitions of excess but we feel very good about the capital positions of our insurance companies and would think that there is a number that order of magnitude or more in the aggregate available for the growth of the insurance businesses given capital versus the size of their reserves and premiums right now.

I think in terms of the deployment of that, well, as Bob said, we cast a wide net, we haven’t gotten anything in the net that is so exciting and imminent that we have to talk about it. We do still think about that as a possibility. We also think that there is a real opportunity in some of these insurance lines that we’re pursing perhaps in this current environment somewhat more so at Safety but we also have thoughts about things to do it ourself.

So we’re thinking that capital position gives us good flexibility to look at growth of the business whether that’s M&A or organic. We’ll remain mindful of what the best use of those capital dollars are including the possibility that if that’s not well used from a growth perspective looking at things like the dividend or stock buyback etc. We don’t have any particular plans in those areas that we’re ready to talk about but we would never rule those things out.

Sam Hoffman – Lincoln Square Capital

Do you have any buyback authorization at this point and how do you view a potential buyback? A lot of companies have talked about the fact that they’re waiting for the rating agencies to universally declare the life sector to be stable and then once all the ratings are stable that that would be a good time to restart their buybacks.

Don Sherman

I think we do have a remaining buyback authorization. We’re very mindful of the rating agency’s opinions in this environment. And so I think that would definitely be one of the considerations that would auger for us to be prudent and not hasty in what we decide to do.

Robert Rosenkranz

Well, I wanted to thank you for participating. This was one of the largest groups that we’ve had on the call, so I appreciate all of you taking the time to get up to speed with our company. Thank you and bye.

Operator

Ladies and gentlemen, that does conclude our conference for today. Thank you for your participation and for using AT&T Executive Teleconference Services. You may now disconnect.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY’S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY’S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY’S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Delphi Financial Group, Inc. Q2 2010 Earnings Call Transcript
This Transcript
All Transcripts