American Physicians Capital Q3 2007 Earnings Call Transcript

Oct.26.07 | About: American Physicans (ACAP)

AmericanPhysicians Capital, Inc (ACAP) Q32007 Earnings Call October 26, 2007 10:00 AM ET

Executives

AnnStorberg - Vice President of Investor Relations

R.Kevin Clinton - President and Chief Executive Officer

FrankFreund – Executive Vice President and Chief Financial Officer

Analysts

RonBobman - Capital Returns

AmitKumar - Fox-Pitt Kelton

WalterSchenker - Titan Capital

BethMalone - Keybanc Capital Markets

Operator

Goodday, ladies and gentlemen and welcome to the third quarter 2007 APCapital Inc.Earnings Conference Call. My name is Eric and I will be your coordinator fortoday. At this time, all participants are in a listen-only mode. We willfacilitate a question-and-answer session toward the end of the conference(Operator Instructions). As a reminder, the conference is being recorded forreplay purposes.

Iwould now like to turn your presentation over to your host for today's call,Ms. Ann Storberg, Vice President of Investor Relations.

Ann Storberg

Thankyou, Eric. Good morning to everyone. Thank you for your interest in AmericanPhysicians Capital as we discuss our third quarter 2007 financial results. Asalways, this call is being webcast live on our corporate website atwww.apcapital.com and you can listen to a webcast replay of this call latertoday, which will also be available on our website.

Ourthird quarter earnings release is posted on our website located in the For Investorssection under press releases. Also for your convenience, a complete transcriptof this call will be posted on our website in the For Investors section underwebcast as soon as it is available.

Asalways, I need to remind our listeners that during today's discussion of ourfinancial results, management may make certain forward-looking statements underthe meaning of the Private Securities Litigation Reform Act of 1995. When weuse words such as will, should, believe, expect, anticipates, estimates orsimilar expressions, we are making forward-looking statements.

Whilewe believe any forward-looking statements made today are reasonable, they'resubject to risks and uncertainties, which could cause our actual results todiffer materially. For a complete discussion of these risks and uncertainties,please refer to today's press release or the company's latest Securities &Exchange Commission filings.

Participatingin today's call is R. Kevin Clinton, our President and Chief Executive Officer,and Frank Freund, our Chief Financial Officer. Kevin and Frank will begin thecall with their prepared remarks and then we are going to open it up to aQ&A session. Now I'm going to turn the call over to Kevin.

R. Kevin Clinton

Goodmorning everyone. Thank you for joining us. APCapital is pleased to announceour third quarter 2007 results. The third quarter was another excellent quarterfor APCapital. Net income for the quarter was $13.3 million or $1.21 perdiluted share, compared to net income of $11 million or $0.91 per share for thethird quarter of 2006.

WhatI’d like to do is highlight and review some of the highlights of the quarterwith you. First, this quarter highlighted our strong reserve position. Duringthe quarter we observed that our prior projections of losses proved to be toohigh and we released $8 million of prior year professional liabilities reservesinto income, and despite this favorable experience, we added $12.3 million toour total professional liability IBNR during the quarter.

Duringthe quarter we also reduced the number of professional liability open claimcount by 10% from 2,124 open claims at the end of the second quarter to 1,913open claims at the end of the third quarter. So, in summary, if you look at ourthird quarter, we have less open claims, more IBNR and a favorable runoff ofprior year reserves.

Thesecond highlight is our reported claim count has decrease. We had just 191professional liability claims reported this quarter. That is 36% less than thethird quarter of 2006 and 29% less than just last quarter. I can't explain whythe reported count was so low, but I'm pleased to report the resultsnonetheless.

Thethird highlight of the quarter is that we're retaining our insured doctors.Despite strong competition, our insured doctor count is down just 1.5% fromyear-end 2006. Our premium is down because our pricing is lower and we'recomfortable with the rate decreases we've taken because that very same datathat's indicating a release of prior year reserves is also indicating that wecan reduce our pricing and still meet our profit objectives.

Thefourth highlight during the quarter is our capital management. During the thirdquarter, while our stocks showed some signs of weakness, we were aggressivebuyers, repurchasing about 500,000 shares of stock, which represented 4.5% ofour company's total shares outstanding.

Andas you see from the press release, we have $47 million of prior authorizedbuybacks remaining. We believe our stock buybacks have been a positive for ourshareholders. While the rate decreases have resulted in a 6.2% reduction intotal revenues from third quarter 2006, our stock repurchase program hasresulted in a 2.8% increase in the total revenues per share over the same timeperiod.

Onceagain, I’d like to thank you all for your continued interest and commitment toour company and I would like to turn it over to Frank.

Frank Freund

Thankyou, Kevin. And good morning, everyone. As Kevin highlighted, APCapital hadanother very good quarter, generating income of $13.3 million in the thirdquarter of 2007, a 20.5% increase from the third quarter of 2006.This represents net income of $1.21 per share, which is up 31.9% from the thirdquarter '06.

Year-to-date,APCapital has generated net income of $40.1 million, up 31.1% from this time ayear ago, and earnings per share of $3.54, which is up 43.3% over the first ofnine months of 2006. Through September, the company has produced an annualizedreturn on beginning equity of 19.9% and at September 30, 2007, our book value per share is $25.61, an increaseof 10.1% since the start of the year.

Ouroperating results in the third quarter have followed recent trends. Although wehave retained a relatively stable number of insured positions with a retentionratio of 86%, our directorate and premiums are down 12.7% in the quarter and13% year-to-date. This is due to selective rate decreases and increased use ofscheduled credits due to price competition.

Thishas been necessary to retain many of our insured accounts. However, we remaindisciplined in our overall underwriting and pricing practices. Net writtenpremiums are down only 9.7% for the quarter and 10% year-to-date due to our2007 reinsurance program, which increased our retention but significantlylowered our ceded premium.

Investmentincome is down slightly from 2006 at $10.7 million for the quarter compared to$11.3 for the third quarter of 2006. Year-to-date investment income is $33.1million compared to $34 million at this time last year.

Ourpretax average return on investment is 5.05% in 2007 compared to 5.33% lastyear. This decline in yield is a result of corporate bond maturities and ourreallocation of the portfolio into tax-exempt securities. We have incurred nolosses or impairments due to subprime mortgage exposure.

AsKevin mentioned, while premiums are down in 2007, our careful management ofcapital through share repurchases has resulted in an increase of total revenueper weighted average share from $12.02 at this point in '06 to $12.25 per shareso far in 2007. Moving from revenues on to losses and expenses, we continue tosee very favorable trends in loss and loss adjustment expense.

In2007, the year-to-date accident year loss ratio remains very good at 74.5%,which is down slightly from the 75.8% ratio for 2006. Due to declines infrequency and stable loss severity, we've been able to recognize $25.1 millionof positive prior development this year, including another $8 million thisquarter. This compares to $8.1 million for the entire first nine months of2006.

Thislarge positive development was a result of several factors. As I noted andKevin mentioned, our claim frequency continues to decline. Reported claims inthe third quarter are down 36% from the third quarter of 2006. Year-to-date,we've had 707 new claims reported in 2007 as compared to 901 at this time in 2006, a 21.5% decrease.

Severityremains very stable and we continue to settle claims for significantly lessthan recorded case reserves. Our reported professional liability losses, whichequals paid losses plus changes in case reserves, was only 13.7% of net earnedpremiums this quarter and is only 22.5% of net earned premiums year-to-date.

Despitethese reserve releases, we continue to be cautious with our overall reserveposition. We added another $12.3 million to medical professional liability IBNRreserves this quarter. That brings the year-to-date IBNR increase to $27.9million. Our relationship of IBNR reserves to case reserves has gone from 77.5%at the start of the year to now 97.5% at September 30, 2007.

Year-to-dateunderwriting expenses are up as a percentage of net earned premium from 20.2%in 2006 to 21.1% in 2007. As a result of the lower premium, our fixed costs areincreasing as a percentage of our premium, hence the increase in ourunderwriting ratio. However, our other expense categories have remainedrelatively stable. Our effective tax rate is 32.2%, reflecting our movementinto tax-exempt securities.

Froma balance sheet perspective, we continue to maintain a conservative, buteffective investment portfolio. Our average rating is AA+ with only 4.3% of ourbonds rated BBB. We keep 64.1% of our bonds in the held to maturity categoryand we have no sub-prime exposure. We have 31.5% of our cash in investments intax-exempt securities and we have $81.5 million of cash in the system, which isapproximately 9.4% of our portfolio.

Capitalmanagement and shareholder value continue to be key focii for the company. Wepaid our first shareholder dividend this quarter and yesterday the Boardapproved a $0.10 per share fourth quarter dividend. During the third quarter,we’ve repurchased 506,400 shares at an average cost of $37.12 per share.Year-to-date, we have repurchased 995,600 shares at an average cost of $37.48. Wehave $25.5 million remaining from the discretionary Board authorizations andanother $21.4 million in our 10b5-1 plan.

AtSeptember 30, 2007, we have $61.2million of cash and short-term securities at the holding company to fund ourcapital initiatives, yet we’ve remain flexible with our capital as our currentwritings represent only 0.66 of our 206 million statutory surplus.

Thatconcludes my remarks on the quarter. Kevin, back to you.

Kevin Clinton

I'llopen it up for questions.

Question-and-Answer Session

Operator

(OperatorInstructions) Your first question comes from the line of Ron Bobman withCapital Returns.

Ron Bobman - Capital Returns

Iknow you sort of begged off in the commentary as to why the number is down, butwhat are at least the better reasons you've heard people comment as to whyclaim counts are down at ACap and industry wide or at least in the states youare operating in?

Kevin Clinton

Well,I can tell you my theory. I can't explain why they were down so much thisquarter. I mean that's a significant drop from last quarter and from a yearago. So, I guess the magnitude I can't explain.

Ithink one of the reasons, you take our state of Michigan, we’ve had the same tort environment, the sametort law since 1994. So, nothing has changed as far as that goes. But if youlook at the gatekeepers, the plaintiff attorneys, they determine what claims gointo the system and what claims don't. So, I don't think they're making anymoney at this.

It’sgetting more and more costly for them to bring a case to trial. They have tospend a lot of money on expert witnesses, pay them a huge hourly rate. Theyhave to depose our expert witnesses. This is all coming out of the attorney'spocket, if they don't lose.

Andwe have taken a much stronger stance in all of our states in taking things totrial. We're not settling cases easy anymore. At the end of the trial when theyjust want to settle it for their costs, we aren't doing it. So, I think that itis the attorneys who are weeding this out of the system. I think a lot of ithas to do with we're getting a lot more tough on what we take to trial.

We'renot taking bad claims to trial. As you can see, we've won about 88% of ourcases we take. We're not taking bad ones but the nuisance ones and the onesthat we should win, we're taking them right to the mat.

Ron Bobman - Capital Returns

Okay.Thanks. And then I had an investments question. Other invested assets - what'sthat include?

Frank Freund

Wehave one strategic equity investment. We have a little bit of development landthat we've had for several years that we just sell off over time. And thenthere is a note receivable related to when we exited the Florida market.

Wehelped the group who used to work with us start their own company. And they'vebeen paying on that regularly and that's been performing well for us.

Ron Bobman - Capital Returns

Andwhat's the note in the land carrying amounts?

Frank Freund

Thenote is, I believe, about $2.5 million and the land is about $3.5 million.

Ron Bobman - Capital Returns

Okay.And so, at the beginning of the year, at 12/31/06, the $6.5 was largely the note and the land, Iassume?

Frank Freund

Yes.

Ron Bobman - Capital Returns

Thosenumbers, I guess, don't change that much.

Frank Freund

Right.And then the strategic equity investment has developed over the year.

Operator

Yournext question comes from the line of Amit Kumar with Fox-Pitt Kelton.

Amit Kumar - Fox-Pitt Kelton

Juststarting with market conditions, could you perhaps go through all of your corestates and talk about what you're seeing in those states?

Kevin Clinton

Ithink competition, in my opinion, has leveled off. I think we're in a nice,competitive environment. Probably wasn't what it was about three or four yearsago. Obviously, in Michigan, we've been the number one writer of physiciansfor many, many years, same as New Mexico. And we're doing very solid growing in those states.

Ithink we're the market force to be dealt with in those two states. Ohio, I think we're holding our own. We've comethrough with some strategic rate decreases there and we're hoping to grow thebusiness this year.

Illinois has been probably the toughest state where we'vegotten the most competition. We've taken rate decreases because I think theirtort law has been very positive, although, unfortunately, I don't think weexpect that to continue. But I think we're having a more difficult time growingin Illinois because of the competition but we tend to holdour own in our renewals.

Amit Kumar - Fox-Pitt Kelton

Yes.I guess that leads to the next question in terms of acquisitions. Do you seeany new opportunities for you in some new states or maybe on the coast?

Kevin Clinton

Thecompany is interested in expanding our lines into other states. We're keepingtrack of the competition there and we're always interested in looking atacquisitions. I'm not sure you're going to see real huge acquisition activity,maybe over the next year, but I think it will heat up.

Companiesare doing well right now. And a lot of the boards sit back and say ‘well, whydo I need anything? Why do I need the change?’ But we're developing ourrelationships and I'm very encouraged that we can do something in the future.

Amit Kumar - Fox-Pitt Kelton

Isthat a change in tone when you say you are encouraged that you'll do somethingin the future?

Kevin Clinton

No,I don't think it is a change in tone of anything we've said over the pastseveral months, or several years.

Amit Kumar - Fox-Pitt Kelton

Interms of just moving on to the Standstill Agreement, can you just give somemore color as to the termination of the Standstill Agreement with Joe[Stilwell]?

Kevin Clinton

Sure.The Standstill Agreement was due to expire next month. And if we did nothing,there was a provision in the agreement that if we did nothing, if we didn'tterminate it the way we did, the board could have called for the resignationsof Mr. Stilwell and Mr. Schneider.

So,I think what you're seeing there in the termination is a strong statement fromour board, acknowledging the contributions of Mr. Stilwell and Mr. Schneider tothe overall success of this company. They want to retain them on the board andthey see no need to have any type of Standstill Agreement in place.

Amit Kumar - Fox-Pitt Kelton

Andfinal question just in terms of the cycle. Do you have any thoughts as to whendo you see the cycles reversing over the next several years?

Kevin Clinton

Yes.I haven't seen things get significantly worse, I'm encouraged by that. And Ithink things will start to turn around. We've gotten opportunities to bid onseveral accounts. I won't mention because some of them are in progress rightnow.

Butwe've had the opportunity to bid on several large accounts, hospital programsthat are coming back from being employed physicians to employed physicians atthe hospital into our marketplace. We've had recently an offshore company thatdecides they don't want to be offshore company anymore and their doctors arecoming back into the market place.

Actually,we did grab a few of those doctors. It was about a 60-person group and we thinkwe grabbed 15 to 20 of the doctors. And we're actually bidding on a lossportfolio transfer. It is not going to be an enormous thing on the loss portfoliotransfer but I just bring that up because the opportunities have presentedthemselves in recent months.

Operator

Yournext question comes from the line of Walter Schenker with Titan Capital.

Walter Schenker - Titan Capital

Justto make sure I understand what you said, as we saw on the way up, rate pricingtakes a while to flow through the actual reported results. I believe there wasa 6% figure. That is the effect on the quarter and therefore the question is onan apples-to-apples basis, what sort of rate changes have you seen?

Kevin Clinton

I'mtrying to understand the 6%. I'm not sure I understood.

Walter Schenker - Titan Capital

Imay have misunderstood the presentation. Let me ask the question directlyinstead of anything else. When fully implemented, current rates across theportfolio are how much lower than they were a year ago?

Kevin Clinton

I'mgoing to estimate. It’s probably in the area of about let's say 8% or somethinglike that. And it will vary by market. That's just an estimate. I don't haveanything directly in front of me.

We'vetaken rate decreases in most of our major states. We took a 14% rate decreasein Illinois effective March of this year. We took a 5%decrease in January of 2006 in Michigan. We took a 7% decrease this year in Ohio.

Andwhat we're finding is that the trends have not followed past practices. Thetrends in frequency, in particular, are much lower than they have been in thepast. And that justifies the rate decrease. But it doesn't mean that we can'tmeet our profit projections, because the claims are coming down, as you sawfrom this quarter.

Walter Schenker - Titan Capital

Okay.And obviously looking at your retention, one might conclude that the ratedecreases have been sufficient to maintain your position in the market place.

Kevin Clinton

Yes.When you take a rate decrease, you certainly take the desire for the doctornecessarily to go shop that insurance. They're kind of pleased they got a ratedecrease and they don't shop as much.

So,we're pleased with our retention and I think it is the same for all companies.Retention is up and it makes it a little bit more difficult for them to takeour business and for us to take their business.

Whatwe've been doing on that is getting a lot more aggressive in assigning peopleon the street, assigning new agents and to shake the bushes and knock on doorsand show them that even though they may have gotten a rate decrease from one oftheir carriers, our rates may even be better.

Operator

(OperatorInstructions) Your next question comes from the line of Beth Malone with KeybancCapital Markets.

BethMalone - Keybanc Capital Markets

Ihad a question about the experience you're seeing in your books of business. Canyou really figure out whether that’s due to the fact that you have reallypulled back from the more challenging or less attractive markets and that someof this trend is due to the fact that you're more concentrated in fewermarkets?

Kevin Clinton

Iwill attribute it to maybe three things. One is the environment. You see a lotof companies having to decrease [inaudible]. I think ours has beensubstantially better than most companies and I would attribute our own internaldecrease to our underwriting, which has been a lot more strict, let's say, inthe past four or five years and it is going through.

Ithink we have an excellent underwriting department. They're doing a very goodjob. We got out of the high-risk specialties and the high-risk areas, whichwere producing significant losses for us in the past. Those were not producinga profit.

Theother things we've done, as I said, we've been a lot more aggressive on theclaims end of it. I think that's helping to reduce our claim frequency. If theyrealize that they are going to be in a big fight on kind of a nuisance claim, Idon't think the attorneys are going to bring those.

Beth Malone - Keybanc

Doyou think that that new strategy, is that somewhat supported by the fact thatyou're a little bit better capitalized now and you have a little moreconfidence that you can spend the money up-front to make sure these claimsdon't end up costing you real development?

Kevin Clinton

Yes,we have a new person in charge of claims, who took over two to three years ago.We've been instituting this new strategy in most of our states. And it takessome time. But I tell you what, because of the decrease in the number ofclaims, we have a lot of defense attorneys knocking on the door looking forbusiness now because the business for them has kind of dried up.

So,what we've done internally is we've picked out the very, very best attorneys.We have a great stable of attorneys and we're not afraid to go to court withsome of these attorneys. They're great defense attorneys.

We'regiving our doctors a wonderful service, something they're paying us for and wewould rather pay the attorney $50,000, the defense attorney, than theplaintiff's attorney $50,000.

Beth Malone - Keybanc

Yes.Okay. And can you just talk about what do you think of the SCPIE acquisition and the price and were you involved and if so - I meanmaybe it is still in play, I don't know.

Kevin Clinton

Idon’t think I'll comment on that one. I think if you want information on the SCPIE bid, you'll just have to read it in their proxy statement when it comes out.

Beth Malone - Keybanc

Okay.It sounds like acquisitions are always going to be challenging. It is adifficult market even in this environment. Do you see organic growth given thesuccess you've had in these markets as being a viable thing? Can you now lookat some of the states that you find more attractive and apply some of thesestrategies to those states?

Kevin Clinton

Yes.I do. I don't know if you want any more comment.

Beth Malone - Keybanc

Iwould like to know what states?

Kevin Clinton

Wecan grow internally.

Beth Malone - Keybanc

Doyou want to comment on what states you think are more attractive than others ornot?

Kevin Clinton

Idon't know if we filed for rates in Michigan, but when we took a rate decrease in Michigan two years ago, we found we got, I think it was $8million of new business coming in.

Wehave concentrated in Michigan because we know it. We're the market leader here. We're reviewingour rates for January of '08 and I think, we're going to take some strategicrate decreases and we're going to work with our agents to hit the areas wherewe see some real good opportunities. So, we're look forward to it.

Operator

Itappears we have no more questions in queue. I would like to turn the call overto Kevin Clinton for closing remarks.

Kevin Clinton

Idon't have any more closing remarks, but I wanted to thank everybody forjoining us on the conference call. And we will talk to you next quarter.

Operator

Thankyou for your participation in today's conference. This concludes ourpresentation.

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