EMC Insurance Group, Inc. (NASDAQ:EMCI)
Q4 2015 Earnings Conference Call
February 12, 2016, 12:00 ET
Steve Walsh - Director, IR
Bruce Kelley - President & CEO
Scott Jean - EVP, Finance & Analytics
Mark Reese - SVP & CFO
Kevin Hovick - EVP & COO
Arash Soleimani - KBW
Paul Newsome - Sandler O'Neill Asset Management
Edward Williams - Capital Returns Management
Welcome to EMC Insurance Group's 2015 Fourth Quarter Earnings Conference Call. [Operator Instructions]. It is now my pleasure to introduce your host, Mr. Steve Walsh, Director of Investor Relations. Thank you, sir. You may begin.
Thank you, Michelle. Good day, everyone and welcome to EMC Insurance Group's 2015 fourth quarter and year-end earnings call. A copy of the press release is available on the investor relations page of our website which can be found at www.emcins.com/ir. The webcast will be available on this site for replay purposes until May 12, 2016. The transcript of the webcast will be available for one year.
This presentation includes some forward-looking statements about our expectations for our future performance. Actual results could differ materially from those suggested by our comments today. Additional information about factors that could affect future results is addressed in our SEC filings including Forms S-1, 10-K, 10-Q and 8-K.
Any information provided today should be read in conjunction with the 2015 fourth quarter and year-end earnings release with accompanying financial tables issued earlier today. Certain non-GAAP terms may be used during today's discussion. Please refer to the company's press release and SEC filings for a description and reconciliation of these terms.
Speaking today will be Bruce Kelley, President and Chief Executive Officer; Scott Jean, Executive Vice President for Finance and Analytics; and Mark Reese, Senior Vice President and Chief Financial Officer. They will be available to answer questions following the prepared remarks. At this time, it's my pleasure to introduce the company's President and CEO, Bruce Kelley.
Thank you, Steve. And welcome to those joining us today. Earlier today, we reported operating income of $0.65 per share and net income of $0.45 per share for the fourth quarter compared to operating income of $0.76 per share and net income of $0.80 per share in 2014. The GAAP combined ratio for the quarter was 94.1%, up from 92.5% last year. Although fourth quarter operating results were down slightly when compared with the good results you achieved in 2014, they were better than we expected. This was primarily attributed to the reinsurance segment which experienced a considerable amount of favorable development on prior-year accident reserves and low level of large losses.
This strong finish to the year resulted in $2.24 per share of operating income for the year, a superb year and best operating result since 2006. In addition, the improvement in our operating return on equity for the year is remarkable, driven by our strong underwriting results. The underwriting profit in the property and casualty insurance segment for 2015 is no accident.
The improved premium rate adequacy made it happen. In late 2010, we sensed the market was starting to harden. We realized we must achieve better rate adequacy given the prospect of declining investment income.
Since then, we have consistently obtained rate level increases that have exceeded industry averages on retained business while maintaining outstanding retention levels. This success is a testament to the results that can be achieved through the collaborative efforts of our local branch offices and our independent agents. They have been empowered by our proprietary rate compare system and analytical tools which focus our efforts on effectively targeting specific accounts for needed rate changes.
Premium income increased 4.3% for the quarter. In the property and casualty insurance segment, premiums earned increased 3.9% with the majority of the increase attributable to rate level increases on renewal business and growth in new commercial lines business. In our reinsurance segment, premiums earned increased 5.6%. However, premium adjustments made in the fourth quarter of 2015 and 2014 are impacting this percentage increase. In the fourth quarter of 2015, we booked a negative premium adjustment of $7.2 million reported by the ceding company in our offshore energy and liability proportional account to reduce the ultimate amount of premiums expected to be earned for underwriting years 2012 through 2014.
In the fourth quarter of 2014, an $8.7 million reduction earned but not reported premiums was recognized on pro rata contracts. Without these adjustments, earned premiums in our reinsurance segment would have declined approximately 0.2% in the fourth quarter. The premium adjustments made in the fourth quarters of 2015 and 2014 did not have a material impact on net income because corresponding adjustments were made to incurred but not reported loss reserves, commission expense reserves and the cost of the excess of loss reinsurance protection.
Net written premiums in the reinsurance segment were relatively flat compared to the prior-year quarter, due to the premium adjustments previously noted. Net written premium grew 2.7% for the property and casualty insurance segment. Net written premiums were up 4.3% in commercial lines but were down 9.7% in personal lines.
Personal lines new business premium was down as we continued to focus on our new strategy which will provide greater accountability and improve the quality of our book of business. New accounts are being selected very carefully as new business policy counts were down 5.4% in commercial lines and 13.7% in personal lines for the year. Retention levels remain strong at 86.5% with commercial lines retention slightly higher than personal lines.
One of the many factors that contributes to a high retention level is outstanding claims service. In 2015, our claims customer service score which is based on questions asked of our customers and outside adjustors about professionalism, courtesy and timeliness, rose slightly to 4.72 out of 5, a 94% satisfaction rate, our highest score to date.
Personalized renewal rates were flat for the year, while commercial lines increased approximately 2.3%, exceeding the modest rate level declines the industry is reporting. The commercial auto and business owners lines of business which reported rate level increases of approximately 4% and 5% respectively, remain the lines requiring the largest rate increases due to their elevated loss ratios. We expect to obtain an overall rate level increase in the low-single digits in our commercial lines of business during 2016, continuing our ability to outpace the industry.
We're starting to see more aggressive pricing by our competitors in their quest for new business and we must compete on rate to a certain extent. However, we will only accept risks that provide an opportunity to earn an adequate return. Our reinsurance business has not been immune to pricing pressures arising from an influx of nontraditional capital and the relatively low level of insured catastrophe activity during the past few years.
During the January 1 renewal season in which approximately 70% of our business renews, we saw a continuation of the trend experienced during our 2015 renewals with continued pressure on rates, especially in the more commoditized reinsurance products where there is excess capacity. In a few cases, we were not able to justify the terms offered and therefore had to pass on opportunities we might otherwise have welcomed.
In other cases, particularly with renewals where we had some prior success, we remained on the account but are monitoring for action if pricing deteriorates further. We currently expect premiums earned in the reinsurance segment to grow in the low- to mid-single digits in 2016 compared to 2015.
Before I turn the call over to Scott Jean, I am proud to note that for the fourth consecutive year, EMC Insurance company is listed as one of the 40 best public companies for leaders by Chief Executive magazine. EMC ranks second in 2016, moving up from fourth in 2015. According to the magazine, EMC finished just a fraction below General Electric and was ranked higher than some other companies such as IBM, Verizon and 3M.
This annual ranking is based on a worldwide survey of organizations conducted by the magazine and validates our investment in professional development throughout our organization. This enables us to fill a majority of open management positions with internal candidates. For example, when we restructured and expanded the executive management team at the beginning of last year, we tapped our deep bench strength of senior executives to fill these roles.
So with that, it gives me great pleasure to turn the call over to Scott Jean, Executive Vice President for Finance and Analytics.
Thank you, Bruce and good afternoon, everyone. The company's loss and settlement expense ratio increased to 63.9% in the fourth quarter from 62.1% in the prior year. This was partially due to an increase in the severity of losses experienced in the property and casualty insurance segment, partially offset by lower claim frequency.
However, we did see some variance by line of business. After adjusting for an increase in exposures, the overall loss trend increased slightly in 2015, approximating our renewal rate increases. The commercial and personal auto lines remained challenging with both frequency and severity at persistently high levels.
As we have discussed on previous calls, personal lines operations is focused on rolling out a new personal auto product that should improve profitability and the commercial auto task force remains hard at work concentrating on more aggressive underwriting and pricing, proper classification of risks and review of driver qualifications and class of business restrictions, among others. We will continue to monitor and scrutinize these lines until results improve as the success of these initiatives is of utmost important in the increasingly competitive marketplace.
Workers' compensation has performed well for us in recent years and 2015 was no different. However, we did have one large workers' compensation claim that negatively impacted the fourth quarter loss and the settlement expense ratio.
The loss and settlement expense ratio in the reinsurance segment was relatively flat but it also had some variance by line of business. The negative premium adjustments of $7.2 million and $8.7 million recorded in the fourth quarters of 2015 and 2014 respectively and their corresponding adjustments to incurred but not reported loss reserves are impacting the loss and settlement expense ratios reported for several lines of business.
Fourth quarter catastrophe and storm losses accounted for 2.6 percentage points of the combined ratio which is below the company's most recent 10-year average for this period of 3.4 percentage points and the 3.3 percentage points experienced in the fourth quarter of 2014. While we benefited from the lower level of catastrophe and storm losses this year, we recognize that weather related events are unpredictable.
That is why we have robust ceded reinsurance programs tied to our enterprise risk management framework that protects us not only from weather related events but also from other catastrophic losses. Effective January 1, 2016, the reinsurance agreements that provide protection to the pool and each of its participants, including for protection against losses arising from catastrophic events, were renewed with increased multiple line blending achieving efficiencies, expanded coverages and limits and better pricing terms.
The notable changes include increase in the top limit of the property cat program from $200 million in 2015 to $215 million for 2016 and increasing the maximum amount our reinsurers will pay for any one employee for a workers' compensation claim from $10 million in 2015 to $80 million in 2016 so that we can more efficiently write larger property accounts. In addition, top limit of the property risk program was expanded from $65 million in 2015 to $80 million in 2016 so that we can more efficiently write larger property accounts. Despite the additional limits and expanded coverage terms, we project the ceded deposit premiums for our 2016 excess and loss reinsurance coverage will be significantly less than 2015.
The new intercompany reinsurance agreement between the company's three property and casualty insurance subsidiaries and Employers Mutual will provide additional protection against catastrophe and storm losses. This reinsurance program is intended to reduce the volatility of the company's quarterly results caused by excessive catastrophe and storm losses.
In addition, the per occurrence and aggregate cash fee excessive loss reinsurance agreements between Employers Mutual and the reinsurance subsidiary should also provide enhanced protection from both the frequency and severity of catastrophe and storm losses. With that, I'll turn the call over to Mark Reese, Senior Vice President and Chief Financial Officer.
Thank you, Scott. Good afternoon, everyone. Both the reinsurance segment and the property and casualty insurance segment had development on prior years reserves that resulted solely from the reallocation of reserves between the current and prior accident years during 2015.
This type of development is mechanical in nature and has no impact on earnings. In the reinsurance segment, the reallocation of reserves generated approximately $1.5 million of favorable development in the fourth quarter and approximately $1 million of adverse development for the year. There was no comparable reallocation of reserves in the reinsurance segment in 2014.
In the property and casualty insurance segment, the reallocation of reserves generated approximately $423,000 and $2.2 million of favorable development in the fourth quarter and year ended 2015 and 2014 respectively. It is important to understand the difference between the reported development amounts and the implied amounts of development that have an impact on earnings because the implied amounts may lead to a different answer when calculating normalized earnings.
The consolidated statements of income contained in the press release show how the implied amounts of development that have an impact on earnings are calculated. Development amounts can vary significantly from quarter to quarter and year to year depending on a number of factors, including the number of claims settled and settlement terms.
Net investment income declined 3.3% in the fourth quarter and 1.9% for the year as portfolio growth wasn't able to offset the full impact of the low interest rate environment. The yield on new fixed maturity investments remains below the average book yield of the fixed maturity portfolio. The effective duration of the fixed maturity portfolio, excluding interest only securities, remained constant at 4.6%.
Total return on the equity portfolio was 6.6% for the quarter and 1.1% year to date, compared to 7% and 1.4% for the S&P 500. Book value increased 2.2% to $25.26 per share from $24.72 per share at December 31, 2014, driven primarily by growth in net income which was partially offset by a reduction in unrealized gains in the investment portfolio. Book value, excluding accumulated other comprehensive income, increased 8.5% to $22.45 per share from $20.70 per share at year end.
As previously reported, the Board of Directors recently approved a change in the metrics used to make decisions regarding repurchases of the company's common stock. The new metrics continue to focus on the rate of return that can be achieved through the repurchase of stock compared to other alternatives but are intended to give management more discretion in stock repurchase decisions.
No shares were repurchased under the company's $15 million stock repurchase program during the fourth quarter. However, approximately $380,000 was used to repurchase EMCI common stock during the month of January. Additional detail regarding the first quarter stock repurchase activity will be reported in the first quarter Form 10-Q.
We accomplished a lot in 2015 including the achievement of our best combined ratio since 2006. Our strong balance sheet and excellent operating results provided us with the opportunity to reward our shareholders with a 14% increase in the quarterly cash dividend. Looking ahead to 2016, we must continue to execute the strategies that led to this year's success as we navigate the increasingly competitive market.
As the market continues to soften, successful execution of the initiatives undertaken to improve the performance of the personal and commercial auto lines of business will become even more important. We remain committed to rewarding our shareholders with an attractive return on their investment by writing profitable business and wisely investing our assets. So with that, we're now ready to open up the call for questions.
[Operator Instructions]. Our first question comes from the line of Arash Soleimani with KBW. Please proceed with your question.
I had a few questions. Can you talk a little bit about the buybacks? I know you said that there's a new -- or that the new terms are a bit more flexible. Just given again that the parent company or that Mutual owns a large percentage of the shares of the public company, why are buybacks I guess more attractive to you at this point in time, given the potential liquidity constraint in the shares?
That is the primary concern is that we do have a limited amount of public float out there. So our method of repurchasing common stock has always been somewhat defensive in nature. We don't have a goal each year to buy back so much stock. We're more interested when it gets down to a certain level and it can provide attractive return to the company. That's when we want to buy the stock. So you'll see us continue to monitor where the stock levels are and if it gets down to the point where we can get an attractive return, we will be in the marketplace.
Can you remind us, you said in January there was how much?
And then I guess you spoke a little bit about the personal lines initiative and I think on the last call you had mentioned that 2016 is the year that you expect that to really be launched, that initiative. Can you just talk a bit about your expectations for the next year on the personal lines side? It looks like -- do you want to shrink there a little bit first before you grow or I guess what's the exact strategy?
I think Kevin, you can say a few words on that, the personal lines initiative. Kevin Hovick.
Yes, on that personal lines, for 2016, it's kind of a standalone profit center. That's a big change we made for this year. We're rolling out our new MyAuto and MyHome products which are going to make it more attractive for the types of business that we're going after. But you are correct, it is going to probably maybe shrink a little bit more before we start getting some traction. A lot of us travel around to our branch offices, talk to a lot of agents.
There is a strong desire for a lot of our independent agents to place personal lines with us, but the product and the pricing has to be in the ballpark. And so that's what we're trying to do is kind of -- as we roll out the new MyHome and MyAuto, we'll be able to give them a better idea of the types of business that we will be able to target and will give them a chance.
It's going to really -- we're making the filings in the states and in the territories, takes a little bit of time. We'll see quite a bit of that happen in 2016. But the plan is to have 2017 to see some stabilizing and some growth in 2017.
And there's been some talk about a potentially expanding into other states. Can you maybe talk about that which lines you're looking to do that in and if that's still part of the strategy?
Are you talking personal lines still?
Just across the company.
Well, yes, we're taking a -- kind of a cautious look. Right now, we operate in about 42 states. We want to make sure that we have the branch office territories to be able to handle that in some of those states. We're not heavily represented I think in the State of Washington and there's a few East Coast states that we're kind of taking a look at. We don't expect to have a major rollout of additional states. There might be a couple that are strategic for us, but we continue to look at opportunities.
Now, in personal lines, we don't operate in all 42 of those states. So we're going to be reassessing some of the states where we could maybe expand the personal lines into. That's something we plan to do as we go into 2016 and early 2017.
Thanks for that. And lastly, I just wanted to touch a bit on the commentary on rates and then how that relates to lost cost trends. I think you mentioned in the prepared remarks that you expect to still be able to raise rates on the commercial line side. So again, just wanted to see how that relates to the loss cost trends you're seeing and then what that implies for the underwriting margins.
We're still expecting to see to get very low level of rate level increases through 2016. What we saw in 2015 was the rate level increases that we got after adjusting for exposure trends, those rate increases fairly closely followed the loss trend or what we're getting in rates. The two are fairly well aligned.
In 2016, I still see that as a good possibility, although the -- we may see that loss ratio start to creep up a little bit because we're -- that loss trend may slightly exceed what we get for rate, but I don't think it's going to have a significant impact on 2016 results. What the industry, from what we've seen, the expectations are that rates will continue to slide down in 2016 which is going to put a lot more pressure on those combined ratios across the industry. And with our targets and current retention levels, we think we can still get a slight amount of rate this year which will at least come close to what that overall loss trend is.
And is commercial auto, is that still challenging or are you starting to I guess feel better about that line?
This is Scott again. I would not say that we feel better about commercial auto as far as the results that we have seen so far. However, we have taken a lot of initiative and have a lot of things going right now to address that.
I'm very confident that we're going to start to see improvement beginning in 2016, into 2017. We're seeing increased frequency and severity trends in commercial auto. I think part of that has to do with just increased number of miles being driven as oil prices are low, as we see the economy, more people being hired and potentially hiring drivers that don't have the necessary experience, but there are things we can do from an underwriting perspective, a pricing perspective to improve those results and we're being very proactive in addressing that.
I am confident we're going to see improvement starting very soon and then looking forward to the future. We just have not seen that up to this point. So that probably is the line of business that provides the most concern for us right now.
This is Bruce Kelley. Just wanted to add that we're working every day to improve the commercial auto results from Des Moines all out to our branches in relationship with our agents. I was at an agent function yesterday and the agents are looking at their book of businesses that we have and they're going through it almost account by account. So, it definitely has our attention. It's an industry-wide problem and we're going to be on top of it.
Our next question comes from the line of Paul Newsome with Sandler O'Neill. Please proceed with your question.
I was hoping you could give us a little bit more color on the earnings guidance. In particular, I'm looking at the combined ratio guidance. It looks like 1.5 points or so of that deterioration that you're expecting is catastrophe losses. Could you talk about the remainder of that deterioration? Is it mostly in reinsurance?
Is it mostly in property and casualty and why that's happening? It sounds like from your previous comments that you think you're making rate -- your rate adequacy -- you're increasing prices at about loss cost trend on the property casualty side and I guess that suggests that all the deterioration is on the reinsurance. Is that right? And just back to -- could you talk about sort of where the deterioration sources are, in your view, located?
Sure, Paul, I'll speak to that. This is Scott again. Part of that is the catastrophe ratio. We had a very good year in 2015 from the catastrophe and storm perspective.
And so building in a more normalized catastrophe and storm year would push that up a little bit with the reinsurance, internal reinsurance we put in place also; that comes at a cost with some additional premium. And so it does have a positive impact on the catastrophe and storm load but we're still paying for the catastrophes over a longer period of time with that reinsurance protection. That is part of it.
The other side, what you did I think address, is the assumed reinsurance piece or the reinsurance subsidiary. They had a very good, phenomenal year in 2015 and we expect that to return to more normal levels in 2016. So I suppose it's deterioration from one year to another, but it's still getting back to a profitable result in 2016, just not as profitable as it was in 2015.
Are you looking for the property casualty business to maintain its profitability ex-cat over the course of the year?
[Operator Instructions]. Our next question comes from the line of Edward Williams with Capital Returns Management. Please proceed with your question.
Firstly, I'd just like to commend you for taking the action to improve Management's flexibility regarding share repurchases. And then for the buybacks that took place during January, were these discretionary transactions executed in the open market or have you put a 10b5-1 plan in place?
We have a 10b5-1 plan in place.
And then quickly, I missed your earlier update of where you currently stand in terms of remaining authorization.
Our current authorization is $15 million and as I noted we spent $380,000. So the majority of that still remains.
And then just going forward, if buybacks were to continue and the authorization were to decline, how should we be thinking about frequency of renewing the authorization? Is that something that the Board will consider annually or semiannually?
It's something that is considered each year. We haven't had any activity for the past few years, so we haven't had to have those types of discussions with the Board. If we were to have a lot of activity, if that level was reduced down to the point where we're concerned about running out, we would certainly have those conversations with the Board.
There are no further questions at this time. I would like to turn the floor back over to Management for closing comments.
Thank you, ladies and gentlemen. This concludes today's conference call. I would like to remind you that a webcast of this call will be available on the company's Investor Relations page of the company's website at www.emcins.com/ir until May 12 of 2016 and a transcript of this call will be available for one year which can also be accessed from our IR page. We appreciate your interest in EMC Insurance Group and have a great day.
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