Meadowbrook Insurance Group's (MIG) CEO Bob Cubbin on Q1 2014 Results - Earnings Call Transcript

May. 8.14 | About: Meadowbrook Insurance (MIG)

Meadowbrook Insurance Group, Inc. (NYSE:MIG)

Q1 2014 Earnings Conference Call

May 7, 2014 09:00 AM ET

Executives

Karen Spaun - SVP and CFO

Bob Cubbin - President and CEO

Analysts

Ken Billingsley - Compass Point

Randy Binner - FBR

Mark Dwelle - RBC Capital Markets

Bob Farnam – KBW

Operator

Greetings, and welcome to the Meadowbrook Insurance Group First Quarter 2014 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, Thank you. You may begin.

Karen Spaun

Thank you, and welcome to Meadowbrook Insurance Group’s first quarter 2014 earnings conference call. Bob Cubbin, our President and CEO, will lead off the call with a review of our 2014 outlook and overall capital position. I will then follow with a review of our financial results. The call will then 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, I’ll turn the call over to CEO Bob Cubbin to provide some perspective on the quarter and our outlook for the year. I’ll then come back and provide you with some more detail on the results. Bob?

Bob Cubbin

Thanks Karen and good morning everyone. On our last call I discussed the actions we have been taking to improve our underwriting performance and drive overall profitability going forward. Our first quarter results reflect the impact of those actions. For the first quarter, we recorded modest favorable reserve development, increased statutory surplus and increases in both net income and net operating income on both the year-over-year a sequential basis. While we still have work to do, our results for the quarter combined with our outlook for the year give us confidence that we remain on track to deliver on the 2014 guidance. We remain focused on our key priorities, including improving our risk profile, attaining stability in our loss reserves, strengthening our capital position and continuing to serve our customers and support our partners and agents.

Our accident year combined ratio excluding the impact of the policy issuance fee was 98.3%. Based on the cumulative impact of the actions we have taken to achieve rate increases, improve our underwriting and terminating underperforming business, our accident year loss and LAE ratio improved 5.4 percentage points to 63.9% compared to the first quarter of last year. While this improvement in the 2014 accident year loss ratio was tempered by a more conservative selection within the standard actuarial methods, it represents an initial indicator that our efforts are having the desired impact, a return to underwriting profitability. Specifically our workers compensation book experienced a modest favorable reserve development led by the California business segments.

The 2013 accident year reserves for all lines also showed favorable signs, as the accident year continues to mature in more favorable reserve indications reflect the effectiveness of rate changes, underwriting improvements and determination of underperforming box [ph] of business that we began in 2012. The 2014 accident year reserve indications reflect additional measurable improvement beyond the 2013 accident year. Reserves on the terminated business remained stable in the quarter. Our gross written premium was in line with our expectations at $201.7 million for the quarter, down from $267.7 million in 2013. We are gratified by the loyalty exhibited by our production partners. This loyalty has resulted in our ability to stabilize our premium flow, secure additional rate increases where needed and continue to see new business in mature, proven programs and segments. Yet we remain willing to walk away from business where appropriate.

Our statutory surplus continued to strengthen as we recorded approximately $496 million statutory surpluses in our insurance company subsidiaries at the end of the quarter. We also reduced our gross and net premium leverage ratios from 1.8 to 1.0 and 1.3 to 1.0, respectively. Our commission in fee income remains strong and net investment income performed in line with our expectations, even in a prolonged low interest rate environment.

As indicated, we remain confident with the previously provided guidance for the full year 2014. To reiterate 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 including 2 percentage points related to the cost of the non-affiliated policy issuance carrier.

This increase in expenses will be partially offset by an improvement in the loss ratio as the earned rate increases achieved in 2013 and 2014 which are expected to be approximately 8% on net earned premium for the full year 2014. This is in excess of expected loss ratio trend of about 2% for the full year. In addition the full year impact of the business terminated in 2012 will improve our loss ratio in 2014 by about 2.4 percentage points.

At these levels we expect net operating income to be between $25 million and $35 million, or between $0.50 and $0.70 per share for all 2014. The remedial actions that we have taken over the last 18 months are having the designed effect and we expect to continue to benefit from those actions in the coming quarters. The challenges that we have faced are solvable and the efforts of our associates and our partners have been unparalleled. We are grateful to have such a strong loyal and committed team working together to return our company to profitability.

With that I’ll turn the call back over to Karen to walk you through some of the details on the quarter.

Karen Spaun

Thanks Bob. As Bob mentioned Q1 results reflect the impact of the actions we’ve undertaken over the past several quarters. As you saw in our release, we generated net income of $10.4 million or $0.21 per share and net operating income of $8.4 million of $0.17 per share.

Our GAAP combined ratio was 99.9% and our accident year combined ratio was 100.3% for the period. The GAAP loss LAE ratio was 63.5% for the first quarter of 2014, compared to 71.4% in 2013. As Bob mentioned the accident year loss and LAE ratio was 63.9% for the first quarter of 2014, an improvement of 5.4 percentage points compared to 69.3% in the first quarter of 2013.

Excluding the impact of the Swiss Re Quota Share Reinsurance Treaty, which was mutually terminated as of October 1, 2013, the accident year loss and LAE ratio improved 3.3 percentage points to 62.7% for 2014 from 66% in 2013.

Let me provide you with a bit more color on the drivers behind the improvement. This reflects a 4.8 percentage point improvement relating to earn rate increases of 10.7% which are approximately 9 percentage points in excess of loss ratio trends. Also, approximately 1 point improvement from underwriting actions and a 2.4 percentage point improvement from the cessation of earned premium from the run off terminated business. These cumulative implied improvements were tempered by a more conservative loss ratio selection for the 2014 accident year. This selection was within our standard actuarial methods and based on the inherent risk associated with a less mature accident year.

Consistent with our expectations, the expense ratio increased to 36.4% for the first quarter 2014, compared to 29.7% in the first quarter of 2013. Excluding the impact of the previously terminated Swiss Re Quota Share Reinsurance Treaty, the expense ratio was 36.9% in 2014 compared to 31.6% in the same period of 2013, or an increase of 5.3 percentage points.

This increase largely reflects the impact of non-recurring severance cost of approximately 1 percentage point on the combined ratio. In addition, the expense associated with the use of an unaffiliated A rated insurance company for policy issuance added 1.8 percentage points and the impact of the planned decrease in earned premium associated with our actions to exit underperforming business was approximately 2 points. Finally the remaining 0.5 point increase related to a shift in the mix of business.

Net investment income was slight up at $11.3 million in the first quarter of 2014 compared to $11.1 million in 2013. Pre-tax profit from net commissions and fees in the first quarter 2014 was flat at $3.6 million from the -- compared to the first quarter of 2013.

Lastly, general corporate amortization and interest expense were $6.1 million in the first quarter of 2014, compared to $4.8 million in 2013. This increase reflects the increase in interest expense associated with convertible debt securities issued at the end of the first quarter of 2013.

With that we will open the call to questions.

Bob Cubbin

Operator?

Question-And-Answer Session

Operator

Thank you. We will now be conducting a question-and-answer session. (Operator Instructions). And our first question comes from the line of Ken Billingsley with Compass Point. Please proceed with your question.

Ken Billingsley - Compass Point

I wanted to just follow up on the reserve release. I know it was pretty small but can you specifically say again where did they come from and more importantly could you talk about were there any further deficiencies and lines that have been problematic in the past year or two?

Bob Cubbin

Yeah, thanks Ken. The reserves overall as we indicated were slightly better than what we have booked at year end but only modestly so. On the terminated business, it was overall very neutral. Auto liability which -- the transportation program that we terminated was up slightly. The commercial multi-peril GL [ph] aspects were neutral and some of the discontinued work comp, primarily the one territory in California was actually favorable slightly. On the ongoing business, reserves came down slightly. We saw a modest improvement in the auto line. We saw a modest unfavorable movement in the general liability line and workers’ comp actually favorable in the quarter. Again just modestly so.

Some of the movement between accident years is kind of normal, just mostly normal adjustments as claims emergence occurs. So there wasn’t any major trends that we saw one way or another, just some geography movement and a little bit of movement here and there between some accident years but that’s really normal based upon claims emergency.

Ken Billingsley - Compass Point

And just on the terminated business the auto liability specifically, what kind of tail is on that or timing are we looking for?

Bob Cubbin

The tail on the transportation is actually relatively short in terms of when you are notified of the claim. Usually when trucks and cars get in accidents you know about it pretty quickly. We have some -- I think there is around 500 claims left open on discontinued auto and we have seen that coming down. So the tail for reporting is probably less than two years from the end of the policy period and then you’re going to see a kind of a normal litigated -- a lot of them will be in litigation if you don’t settle them quickly. So you probably have another two to three years. But the movement that we saw was not significant.

Ken Billingsley - Compass Point

Okay. The ratio of premiums net to gross was higher this quarter than we’ve seen in the past. Can you talk about what you kind of change and what’s driving that?

Karen Spaun

Are you talking about the earned premium?

Ken Billingsley - Compass Point

No, net premiums written to gross premiums written, [indiscernible] was about 80% than it’s historically been -- it rose in the fourth quarter of last year but has been in the mid to low 70s.

Karen Spaun

It’s been, if you exclude the quota share, it’s been typically about 80%, between 80% and 85%. So where you would expect it to be.

Bob Cubbin

So it’s different year-over-year relating to the quota share.

Karen Spaun

Correct.

Ken Billingsley - Compass Point

So with it excluded -- with that excluded we should expect to see that rise back up into the mid-80s again?

Karen Spaun

Correct.

Ken Billingsley - Compass Point

Okay. The other question I had is, what was your renewal rate with your policy holders? You talked about your agents a little bit in your prepared comments? Can you talk about what the renewal rate is with the policyholders at Century and can you core Meadowbrook business?

Bob Cubbin

Yes. First on the Century side, we have seen a marked improvement over the second half of last year in the retention of the business. So that on the Century side that’s improving but not too much. It’s more in line with kind of more the historic before the fronting relationship occurred. On the traditional Meadowbrook side, it’s remained fairly strong throughout this entire process. So the retention of customers has been good. I would say new business in both areas was probably not as robust as it had been previously, but our ability to get rate kind of remains the same as we mentioned. Rate increases on a written basis are still going up, and for the first quarter they were up little under 7% at 6.8%. So I think overall the production side has settled down and we’re seeing some improvement there.

Ken Billingsley - Compass Point

Would you say it’s still in the 80s or the following quarters?

Bob Cubbin

Well, on the traditional Meadowbrook program business, it definitely is in that area depending on how you’re measuring it. If you measure it by what we quote on renewals and what we get, then yes. On the Century side, they’re dominated by the excess and surplus lines business which does not have the same kind of retention that the traditional [indiscernible] does. So their retention ratios are going to be more in the 50s and low 60s rather than in the 80s.

Ken Billingsley - Compass Point

Just one more question before I let somebody else ask. But on the commission fee side were there any -- is there anything developed in there that maybe one time or non-recurring in nature in this quarter based on some of the movements you’ve had with some of the reinsurance agreements or is this number pretty solid?

Karen Spaun

The number is pretty consistent and there is no unusual item. There is really nothing from the reinsurance side that impacts the net commissions and fees. That is strictly from fee for service business, not affiliated with our insurance companies.

Operator

Thank you. And our next question comes from the line of Randy Binner with FBR. Please proceed with your question.

Randy Binner - FBR

A couple, really I guess kind of the broader question is your guidance is obviously kind of near 100 on the combined. And the fronting fee kind of hurts that on the margin. But there were some severance charges in the quarter. And so to get to a more competitive combined ratio, assuming that you run with a B++ rating, I’d be interested to hear how you might do better maybe on the expense ratio going forward to try and get the combined to a more competitive level because kind of tether into a 100 probably isn’t sustainable?

Bob Cubbin

Yes, our goal is not to be between 99 and 100 longer term. On a current run year -- on a run rate basis for the current year the policy issuance fee and the severance in the quarter was almost 3 points. So, we do expect to see our accident year loss ratios moved down to allow us to generate a run rate combined ratio that’s closer to our target of 95. We still have some work to do on the expense side and we are -- we've taken some initiatives there. Otherwise we would have had a higher expense ratio this quarter. And we do think that there are some ways and initiatives that we can accomplish to bring that expense ratio down over say the next three or four quarters.

So we are definitely focused on that. As you might understand, we have been very much focused on getting the rate increases that we needed and the risk profile that we expect to return to a more stable position. So, we’re not ignoring the expense ratio obviously but we have had more attention paid to the loss ratio side. So as we move through the year, we do think that some of our initiatives will be a benefit to the expense as well. So we’re going to continue to push Randy to get that combined ratio, not counting the front fee down closer to our longer term target as we approach the end of the year.

Randy Binner - FBR

So what is -- is that IT initiatives, is that real estate locations, is that headcount or is it a combination of all three. Just kind of curious kind of what levers you have to pull in the organization to accomplish that?

Bob Cubbin

Yes, it’s all of the above. It’s also looking at some of our variable expenses and how we can manage that more effective. About two thirds of our expense is variable expense. So we’re looking at all of those things. And as we work together with our partners to present a long term underwriting profitability profile that’s acceptable, everybody has to come to the table and help with that. And we certainly have some initiatives that we think will in the intermediate and longer term allow us to get more -- back to a more competitive position on that.

Randy Binner - FBR

All right. And then just on the board, the Board seat that changed over with Wendy Becker. So it’s kind of -- I think it’s welcome to see some change there. And is that something we can expect to see more of? I think that -- and maybe you could just kind of walk us through the thought process there, kind of what that adds to the Board and if there may be an expectation to the other important board seats turnover over the next year?

Bob Cubbin

Yes, good question. We’re very pleased to have Wendy join the board if she’s elected at the shareholder meeting. It’s up to the shareholders. And as I believe we have indicated in our proxy materials, the Board is looking at adding additional industry experienced people to the Board over the coming period of time. So we do expect to see the succession planning process for the Board and the diversification of the Board continue over the course of the next period of time. So more to come.

Randy Binner - FBR

That’s great. And then so does that help kind of in the strategic alternative discussion because I assume that that kind of continues to go on in the background. Is it with more industry expertise? Is that the main goal that you’d accomplish by adding folks with more industry background to the Board?

Bob Cubbin

I don’t think it’s specifically geared towards any specific alternative. It really is to look at skill sets that needs to be added and industry specific skill sets and background and experience in the property casualty area was something that the board was looking to add. And so I think it’s more specific to the person and the skill sets than to any specific strategic initiative.

Operator

And our next question comes from the line of [indiscernible]. Please proceed with your question.

Unidentified Analyst

With the quarterly run rate, are you comfortable now in the higher end of your $0.50 to $0.70 guidance for the year, is there any reason net earnings -- the earnings run rate would sort of step down over the next couple of quarters?

Bob Cubbin

There is no specific reason at this point. We’re just trying to be a little more cautious about what we set as an expectation. So we have one quarter in a row with no adverse development on the reserve side. So I think we’re just trying to be cautious in that regard. I don’t know of anything specifically that would push that run rate that we accomplished in the first quarter higher. I think there are some things that we are trying to do that we hope will ultimately bring it down. So we’re not in any hurry to declare victory. We have a lot more work to do.

Unidentified Analyst

Okay. And then could you repeat or maybe expand on what you said about the commercial auto book and you’re feeling about the ultimate sort of accident year performance for like 2012 and 2013?

Bob Cubbin

Sure. The auto line of business, which is not a huge part of our premium volumes, mostly I was commenting on the discontinued transportation business. And there we did see a slight uptick in the older accident years, not older -- not too old but particularly ’10 or ‘11 accident years. But we do see that kind of stabilizing and don’t expect additional development there. In terms of the 2012, 2013, 2014; 2012 appears to be pretty much where it needs to be, 2013 and 2014 have more favorable indications than what we’re booking than that. But due to the fact that they are less mature accident years we’ve opted to book a more conservative position, still within the standard actuarial methods but slightly more conservative look at that than otherwise might be implied by the risk characteristics.

Unidentified Analyst

Okay, great. And finally can you tell us if the Willis Group is still engaged with the Board in terms of the expiration of strategic alternatives?

Bob Cubbin

Yes, we continue to support strategic alternatives and we haven’t terminated anybody. As reported in our proxy, our Board did assign a committee that analyze the available options for the company and our advisors have and will continue to contact potentially interested parties. But other than that we really don’t have anything more to report at this time.

Operator

Thank you (Operator Instructions) Our next question comes from the line of Mark Dwelle with RBC. Please proceed with your question.

Mark Dwelle - RBC Capital Markets

A couple of questions. Anything you describe as catastrophe losses in the quarter? Any unusual non-cat weather related losses in the quarter?

Bob Cubbin

No, not really.

Mark Dwelle - RBC Capital Markets

Okay. To the extent that -- I guess on the commissions and fees line, the growth there; is that primarily an increase in MGA activities or is it actually the old brokering operations that is driving the growth there?

Karen Spaun

Mark, if you recall, in the third quarter of last year when we started writing business and using the front fee or the front carrier, some of our business that we issued, we at as the agent or as MGA. So those fees used to be eliminated. They are not. So if you look at year-over-year $2.1 million of the growth year-over-year is related to those fees that previously were eliminated. There is a corresponding gross up in the general selling and administrative expenses of 2.1. So there is no impact on the bottom line there. So if you exclude that gross up, our net commissions and fees were up just about $0.5 million a little bit light than that, and that’s really from our Michigan agencies. And there’s really been no change in that business at all.

Bob Cubbin

And the net process is about the same.

Mark Dwelle - RBC Capital Markets

Okay, that’s exactly the detail I was looking for. To the extent that you are employing fronting, are there particular lines of business that are being fronted more commonly than others or is it kind of just case by case and kind of across the board?

Bob Cubbin

It’s primarily in the excess and surplus lines area, and where there are contractor related requirements. Those are the two primary areas.

Mark Dwelle - RBC Capital Markets

Okay. You commented little bit on the pricing environment in the press release. Anymore detail that can provided there? We still see kind of upper single digits on the workers’ comp and lower on some of the others or is that, has it all compressed a little bit?

Bob Cubbin

That’s a good question. On the comp, it’s about 7.5% year-to-date. The GO, commercial multi-peril line is up a little over 8%, and auto is up around 7.5%. Those are all slightly down from the full year 2013. So yeah they’ve all compressed a little bit. But we have been last year 2013 we had over 12%. We certainly didn’t expect to see that continue into 2014 but at almost 7% we’re pretty happy with that. And then on an earned basis, the rates that we earned last year, that we rolled last year that at 12% in outcome and through in the earned premium this year. So the earned side is much better in 2014 by a 1.5 point or so but the written is down about 5 points.

Mark Dwelle - RBC Capital Markets

Okay, that’s helpful. One last question, when is your next normal scheduled A.M. Best rating review?

Bob Cubbin

We generally meet with them once a year and unless there is something in between. So we had talked to them previously kind of on a quarterly basis. But we would expect to meet with them sometime this year and talk about what we’ve accomplished and what our go forward plan is.

Operator

And our next question comes from the line of Bob Farnam with KBW. Please go ahead with your question.

Bob Farnam – KBW

Yes. Most of my questions have already been answered, but I just had one. So for the terminated business I just wanted to know roughly how much of your next reserves is related to that business?

Bob Cubbin

It’s about $275 million of case reserves in the IBNR.

Operator

And we have no further questions at this time. I’d like to turn the floor back over to management for closing remarks.

Bob Cubbin

Thank you very much. Karen and I will be here the rest of the day if anybody has any additional questions. Thank you very much and look forward to speaking to you again soon.

Operator

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

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