Employers Holdings, Inc. (NYSE:EIG)
Q1 2016 Earnings Conference Call
April 28, 2016 11:30 am ET
Vicki Mills - VP, IR
Doug Dirks - President, CEO
Terry Eleftheriou - EVP, CFO
Steve Festa - EVP, COO
Amit Kumar - Macquarie
Mark Hughes - SunTrust
Good day, ladies and gentlemen, and welcome to the Q1 2016 Employers Holdings Incorporated Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will be given at that time. [Operator Instructions] As a reminder, this conference is being recorded.
I would now like to turn the call over to Ms. Vicki Mills, Vice President; Investor Relations. Ma'am, you may begin your conference.
Thank you, Chelsea.
Good morning and welcome everyone to the first quarter 2016 earnings call for Employers. Yesterday, we announced our earnings results and today we expect to file our Form 10-Q with the Securities and Exchange Commission. These materials may be accessed on the company's Web site at employers.com and are accessible through the Investors link. Today's call is being recorded and webcast from the Investor Relations section of our Web site, where a replay will be available following the call.
With me today on the call are Doug Dirks, our Chief Executive Officer; Steve Festa our Chief Operating Officer; and our Chief Financial Officer, Terry Eleftheriou.
Statements made during this conference call that are not based on historical facts are considered forward-looking statements. These statements are made in reliance on the Safe Harbor provision of the Private Securities Litigation Reform Act of 1995.
Although, we believe the expectations expressed in our forward-looking statements are reasonable, risks and uncertainties could cause actual results to be materially different from our expectations, including the risks set forth in our filings with the Securities and Exchange Commission. All remarks made during the call are current at the time of the call and will not be updated to reflect subsequent developments.
We use non-GAAP metrics that exclude the impact of the 1999 Loss Portfolio Transfer, or LPT. These metrics are defined in our earnings press release available on our Web site.
Now, I will turn the call over to Doug.
Thank you, Vicki and thank you all for joining us on our call today. Our first quarter results compared to the first quarter of 2015 reflect a strong start to the year. Total revenues were up 8%. Net income before the LPT increased $0.20 per diluted share and operating income increased $0.21 per diluted share. Our operating return on equity increased 2.7 percentage points to 7.8%, our combined ratio before the LPT improved 4.8 percentage points and book value per share increased 3% in the quarter and 6% year-over-year.
We are executing upon our previously announced an authorized two-year share repurchase program. In the quarter, we repurchased 37,331 of our common shares at an average price of $27.88 totaling $1 million. The Board of Directors declared a dividend on our common stock at $0.09 per share for the second quarter.
Our first quarter results continued to be favorably impacted by the successful execution of our strategic underwriting, pricing and claims initiatives. These initiatives includes the uses of the -- of three company pricing territorial multipliers in California, non-renewal or increasing prices on underperforming business, accelerating claim settlement and pursuit of attractive classes of business in and outside of California.
Our initiatives have resulted in the following positive trends, favorable shifts in business mix by state and territory, improved pricing particularly in California, non-renewal underperforming business particularly in Southern California, case reserve salvage from accelerated claim settlement and growth in inforce policy and premium in attractive classes outside of California and more recently in California markets other than the LA Basin.
In response to these positive trends we lowered our provision rate for losses by 3.6 percentage points in the first quarter of this year relative to last year. This in-turn drove ongoing improvements in our loss ratio to combined ratio and operating income. Higher revenue in the quarter was driven by increased return and earned premium related to final audits, our targeted growth in profitable classes across all of our markets and a slightly higher investment income related to higher yields from equity security.
The increase in final audit billings was related to increases in our insureds number of worked and employee headcount. An advisory rate filing in April by the rating bureau in California indicates an average pure premium rate decrease, which is 5% lower than the industry average filed pure premium rate and 10.4% less than the approved average advisory pure premium rate as of January 1, 2015.
We are adjusting our filed rates and territorial multipliers in California effective June of this year. These rate actions will result in an average overall declining rates of 3.4% in California. Outside of California loss cost and rates are declining in the majority of the other 32 states in which we do business. Currently filed MCCI changes for rates and loss cost indicate rate declines in two thirds of the states and either rather slightly increasing rate in the remaining third.
In our book of business, our overall loss trends have been stable. While our business plan for 2016 is focused on increasing policy counts and premium in all of our states. Overall, we expect flat to slight declines in net rate modest growth in policy count and continuing increased competition. This plan includes expanding our distribution channel of partners and agents focused on small business. We entered Michigan in late 2015 and New York in the first quarter of this year. Our ultimate goal remains to be writing business in all of the continental United States. Additionally, we are actively engaged in multiple technology and predictive analytics initiatives as well as the multiyear replacement of our policy administration.
And with that, I'll turn the call over to Terry. Terry?
Thank you, Doug, and good morning everyone.
We continue to deliver improved operating results. Our operating income increased $0.21 per diluted share or 68% in the first quarter due largely to improvements in our combined ratio. Our operating return on equity increased 2.7 percentage points to 7.8% for the current quarter. Our first quarter combined ratio before the LPT improved 4.8 percentage points year-over-year to 96.8% for an underwriting income of $5.6 million.
We lowered our provision rate for current accident year losses by 3.6 percentage points year-over-year as a result of the success of our strategic business initiatives. The provision rate for the current accident year was 64.1%. Excluding impacts related to the LPT, our loss ratio declined 4.7 percentage points year-over-year largely due to the low provision rates of losses compared with the first quarter of 2015.
While our indemnity claim frequency decreased year-over-year, our loss experience indicated a slight upward movement in medical and indemnity cost for claim which is reflected in the current accident year loss estimate.
Net written premium increased 9.8% and net earned premium increased 8.6% year-over-year in the quarter. These increases were driven by a $13.5 million increase in final audit premiums year-over-year as a result of changes in that internal processes as well as continued payroll growth. Additionally, we saw growth in premiums driven by our efforts to diversify our risk exposure and target profitable classes of business across all of our markets.
Net investment income in the first quarter increased $0.9 million relative to the first quarter of 2015 reflecting a slight increase in yield. Pre-tax book and tax equivalent yields were 3.2% and 3.8% respectively. Net realized gains of $1.5 million resulted primarily from the sale of equity securities as part of our regular rebalancing of our high dividend equity investment portfolio and to meet cash needs of the holding company.
Grocery life gains of $6.8 million were offset by other than [tempering] [ph] payment of $5.3 million in equity securities primarily related to investments in the energy sector. Our underwriting and other operating expenses for the quarter was $36.3 million an increase of 8.4% relative to the first quarter of 2015. This increase was driven by higher compensation related expenses and increased premium taxes and assessments inline with our higher written premiums in the quarter. Our underwriting expense ratio of 21% was 10 basis points lower than the prior year's quarter.
Income tax expense increased $2.6 million in the quarter largely due to a year-over-year increase and projected annual net income before taxes. Our effective tax rate for the quarter of 24.2% reflects the improvement in our operating results. We continue to actively manage our capital and our balance sheet remains strong. The market value of our investment portfolio was $2.5 billion at the end of the quarter, an increase of 1.3% since December 31 of 2015. The average credit quality of the fixed income portfolio was unchanged at AA- with a duration of 4.2. Equity securities represented 8.2% of our investment portfolio.
At the holding company at the end of the first quarter, we had $85.6 million in cash and securities. Finally, we are currently working with AM Best in evaluating the impact of its new Stochastic Capital Adequacy Model that is expected to become effective in 2017. Our preliminary analysis using 2014 data indicates a level of capital adequacy that remains strong.
And now, I will turn the Steve Festa, our Chief Operating Officer.
Thank you, Terry, and good morning.
Doug referenced earlier both our top-line growth as well as our improved combined ratio results for the quarter. Total revenues are up 8% quarter-over-quarter. This has occurred despite a very competitive environment in the states we do business in as well as declining rates in the majority of those states. Several of our larger targeted states including Florida, Pennsylvania and New Jersey exhibited double-digit premium growth over the first quarter of 2015.
Similar results were achieved in territories within the state of California outside the Los Angeles basin. This has occurred despite rate decreases in many of the states we do business in as well as heightened mark-in competition for the type of business we focus on writing. These results are inline with our objectives linked to growth in several of the larger comp markets or our market share is small, but our results from a profitability standpoint had been attractive.
We increased our in-force policies in states outside of California by 6.6%. In addition retention rates on existing business continued to be higher than traditional norms. This trend was started in the second half of last year as continued through the first quarter. Despite this progress, we continue to see headwinds on future growth due to continuing rate decreases in many states along with strong competition from both regional and national competitors.
As referenced earlier, we started writing business in the State of New York during the first quarter of this year. We have leveraged longstanding national distribution partnerships as we entered that state because we know these partners have a clear understanding of our risk appetite. As we have mentioned previously our vision for the future is to be writing business in all of the continental United States with the exception of the monopolistic states.
Finally, with respect to our continued improvement in our operating results we have discussed over the last several earning calls, the specifics pertaining to our pricing and underwriting initiatives. These initiatives which were implemented in 2014 and 2015 have had a substantial impact on our improved profitability. In addition, we have had significant success in 2015 and through the first quarter of this year with several claim management initiatives particularly the closure of many aged and higher exposure claims as well as using analytics to determine which medical providers generate the best claim outcomes. We will continue to make the necessary investments in our core competency of claims management in order to continue to maintain our improved loss ratio.
And now, I will turn the call back to Doug.
We again delivered solid results in the current quarter. We continue to remain focused on creating value for both our customers and our shareholders.
So with that operator, we'll open the call up for questions.
[Operator Instructions] And our first question comes from the line of Amit Kumar with Macquarie. Your line is now open.
Thanks and good morning, and congrats on another strong quarter. Maybe just two quick questions, the first is regarding the growth in new states, can you sort of help us better understand why at this stage of the cycle would customers be switching to Employers?
This is Steve. Let me answer that question. There are several reasons, but I want to point out a couple specifically that we know we can tie to the increased revenue opportunities we're seeing in those other states. First of all, we over the past year and a half almost two years have spent substantial amount of our time looking at our distribution channels and over the past year and a half specifically we have added more partnerships that have proven to be very productive for us. And then, we've also had quite a bit of success in enhancing some of the existing partnerships that we've had.
So the distribution channel has been in large in terms of new partnerships over the past 18 months and we're starting to see the dividends of those investments at this point. And the other thing that we've done in the past 18 months is we've added new sales staff in many of the targeted states that we have look at to grow and those are starting to pay dividends as well at this point.
Got it. That's fair enough. The other question I had someone remarked about increasing competition from regionals and nationals. I'm sort of curious is that coming to a point where now when you look out towards the horizon you say to yourselves, this is coming at a much faster pace than what I initially anticipated and hence it could pressure margin sooner or is this sort of inline with, I know you've been talking about it for a few quarters, may be just help us understand the longer term outlook and if that has changed in a manner based on the competition? Thanks.
And this is Steve again. We haven't really seen over the past several quarters any changes. We talked about this heightened competition over the past several earnings calls and I still see that similar to what we've talked about in the past. As you know comp at this point is a very attractive product and from a profitability standpoint. So we continue to see our competitors being as aggressive as they have been in the past couple of quarters. I don't see that anticipating at least through the remainder of this year. I'm not going to comment any further than that, but clearly not only are they more aggressively targeting comp, but a lot of their focus is on some of the same classes of business that we have been focused on because they're more profitable classes of business. So, I think there really hasn't been a change in the market in terms of competition since the last time we spoke. And I don't expect that to change in the near future as well.
Got it. That's actually very helpful. That's all I have for now. Thanks for the answers and good luck for the future.
[Operator Instructions] And our next question comes from the line of Mark Hughes with SunTrust. Your line is now open.
Thank you. The audit changes that you made improvement in the processes to -- that have I guess have spurred the up tick for the last few quarters. When do you lap that? Do we still expect that for another quarter or two?
Bob, this is Terry. Yes, I think we talked in the past the process changes that we made to drive greater compliance with expiring policies, which is subject to final audit. What we are seeing are two things first, we continue to see final audit billings being higher than as for traditional norms and that's driven by growth in our insured payrolls both in terms of high headcount and high wages.
But also, in terms of our process, we talked about this in the prior two earnings calls, what we did in the mid-part of last year was to improve how we drive credit compliance with final audit in the -- un-expiring policies and that process improvement or reengineering of the process we saw significant great compliance in the third and fourth quarter of last year. And in last part, we've seen that stabilize now. So we -- difficult to predict the future in terms of final audit, but its particularly in terms of payroll growth. But I think the process improvements have worked their way through the system as it were.
Right. So the -- this nice bump in the first quarter you might still get some related to underlying payroll growth, but not necessarily the change in processes at their end?
And could you characterize of the increase how much was just better payroll growth?
Mark, our sense -- I can't give you a precise number, but our sense is that the bulk of it was driven by payroll growth.
Okay. So mostly payroll growth rather than the enhanced process?
Yes. And I would also point out that if we're comparing quarter-on-quarter, the first quarter of last year we were making these changes and the final audit premium in the first quarter of last year was significantly lower than what we've experienced here. So that process fess depressed final audit premium in the first quarter of last year. So the $13.5 million difficult to sort of use that as a benchmark going forward.
Okay. The lower loss pick in the quarter you mentioned a number of drivers on that, can you say how much of it was say mixed business may be just a shift of lower cost locales versus the combination of premium and pricing still getting an attractive spread?
Mark, this is Doug. I can't answer that one specifically, I will address it generally. To the extent that we get the rate that we're demanding in Southern California, it improves the margin to the extent that we don't get it, we lose the business, it improves the margin. We are conceding some margin in other parts of California and other parts of the country on our most profitable business to retain it. But I can't really break it down specifically state-by-state or territory-by-territory.
And then the technology rollout, what should we anticipate in terms of financial impact say over the next year or two?
There will be obviously a cost associated with it. We'll start seeing some of that in the second half of this year. I think generally it will be modest relative to our overall results and some of it will be current expense, but will be capitalized, so to be spread over a longer period of time. But I wouldn't expect it would materially change the financials.
And is there benefit that you would anticipate in the next couple of years?
Well, over the longer term, we fully expect to realize efficiency benefits from this. It's not simply a matter of replacing one technology platform with another although certainly we're doing that, a major part of this is a reengineering of many of the processes that are conducted within the company around policy, everything from submittal of an application to the final audit premium. And as we reengineer all of that and provide a different and more efficient technology platform we do expect some lift on the expense side, but that will occur over a period of time and none of it will be immediate.
Understood. Thank you.
Thank you. [Operator Instructions] And I'm not showing any further questions at this time. I would now like to turn the call back to Mr. Doug Dirks for closing remarks.
Thank you very much. Thank you everyone for joining us today. We appreciate your participation and your question. And we look forward to speaking with you again in July after we release our second quarter results. Thank you all very much.
Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program and you may all disconnect. Everyone, have a great day.
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