Employers Holdings Q3 2007 Earnings Call Transcript

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 |  About: Employers Holdings, Inc. (EIG)
by: SA Transcripts

EmployersHoldings, Inc. (EIC) Q32007 Earnings Call November 14, 2007 1:30 PM ET

Executives

VickiEricson – VP

Douglas Dirks – CEO

RickYocke – CFO

MartinWelch – Pres. & COO

Analysts

WilliamWilt – Morgan Stanley & Co. Inc.

DanielSchlemmer – Cochran Caronia Waller

SamHoffman – Foley & Lardner

Operator

Goodday ladies and gentlemen and welcome to the Employers Holdings, Inc. thirdquarter 2007 earnings conference call. (Operator Instructions) I will now liketo turn the call over to Miss Vicki Ericson, Vice President of InvestorRelations. Please proceed.

Vicki Ericson

Thankyou and welcome everyone to the third quarter 2007 earnings call for EmployersHoldings, Inc. After the close of market yesterday, we announced our thirdquarter 2007 earnings results and filed our form 10Q with the Securities andExchange Commission. These materials are available on the company’s website at www.employers.com. Today’s call is beingrecorded and webcast from the Investor Relations section of our website wherereplay will be available following the call.

Representingthe company on the call today are Doug Dirks, our Chief Executive Officer, RickYocke our Chief Financial Officer and Marty Welch, the President and ChiefOperating Officer of our insurance subsidiaries.

BeforeI turn the call over to Doug for opening remarks, I would like to remindeveryone that statements made during this conference call that are not based onhistorical facts, are considered forward-looking statements. These statementsare made in reliance on the safe harbor provisions of the Private SecuritiesLitigation Reform Act of 1995. So we belief the expectations expressed in ourforward-looking statements are reasonable, risks and uncertainties could causeactual results to be materially different from our expectations including therisks set forth in our filings with the Securities and Exchange Commission.

I’dalso like to remind you that we use a non-GAAP metric that excludes the impactof the 1999 loss portfolio transfer or LPT. This metric is defined in ourearnings press release available on our website. Now I will turn the call overto Doug.

Douglas Dirks

Thankyou Vicki and welcome everyone. Our solid performance in the third quarter isevidenced by strong net income, in line with first and second quarter 2007results. Positive impacts from favorable development on prior period losses, stronggrowth in policy count, continued evidence of prudent risk selection and agrowing contribution from investment income. I would to preface my review ofthe third quarter results by noting that our year-over-year comparisons forthis quarter are uniquely unfavorable largely because of timing adjustments toour loss and LAE estimates.

Whilewe were a private mutual company, we recognized $81.7 million in favorablereserve development in the first nine months of 2006. With $68.9 million, or84% recognized in the third quarter. In the first nine months of this year, andsince our conversion and initial public offering, favorable prior perioddevelopment of $43.4 million has been recognized with $15.6 million, $20.4million and $7.4 million recognized in the first, second and third quartersrespectively.

Wecontinue to see benefits from previously enacted reforms in California, although at lowerlevels than we recognized last year. Our third quarter 2007 GAAP net income was$29.9 million, or $25.3 million before the LPT, compared to third quarter 2006GAAP net income of $77 million or $72 million before the LPT. Looking at thenine months GAAP net income, through September 30, 2007 was $88.5 million,$74.8 million before the LPT, compared to GAAP net income for the first ninemonths of 2006 of $116.5 million, $101.9 million before the LPT.

Againthe change was largely the result of greater favorable prior period developmentlast year. We continue to operate profitably despite continuing, thoughmoderating rate declines in our largest market, California. Despite thisenvironment, California still presents us withattractive opportunities and remains a significant part of our growth plan.While California rates have declined inrecent years, the October filing by the Workers’ Compensation Insurance RatingBureau, were recommended an average 5.2% increase in advisory pure premiumrates to be affective on policies incepting on or after January 1, 2008.

Therecommended increase is based on the Bureau’s analysis of loss and lossadjustment expense data as of June 30, 2007 and takes into considerationadditional expected lost costs resulting from the passage of Assembly Bill 338.This legislation was signed by Governor Schwarzenegger in October, and extendsthe period of time during which temporary disability payments may be awarded.

Thecurrent filing by the WCIRB is the first recommended increase since October 1,2003 and suggests that rate decreases may be abating. However, the CaliforniaDepartment of Insurance has not yet adopted and published its advisory purepremium rates for 2008. As we have stated in previous calls, in making anydecision to change our filed rate, we analyze our current and anticipated California loss trends by classand determine what changes, if any, are necessary.

Inour new markets we continue to focus on establishing relationships to supportour recent expansion. While our geographic expansion is in the early stages, itis yielding positive results with increases in premiums written, policy countand the addition of our new strategic partner, Intego.

Wealso continue to focus on our existing markets including our recently announcedexclusive relationship with the California Restaurant Association. I want tostress that as we evaluate new business opportunities in both new and existingmarkets, we adhere to our strict underwriting standards. And while this mayaffect how quickly we add premium, we believe it helps to ensure that incrementalgrowth is profitable. Now Rick will cover our financial results. Rick.

Rick Yocke

Thankyou Doug. Historically our premium has come primarily from California and Nevada, and California remains our largeststate representing about 70% of total direct premiums written as of September30 of this year. Our rates in California have declined 38.1%since January of 2006 leading to a 7.8% decline in net premiums earned quarter-over-quarter,and a 12.6% decline in the first nine months of 2007 compared to the sameperiod in 2006.

I’dlike to point out that in this declining rate environment, net earned premiumshave increased in the third quarter relative to the second quarter of thisyear. That reflects strong retention as well as new policy growth that Martywill discuss later.

Ourthird quarter 2007 loss and loss adjustment expense ratio was 46.2% and 51.3%before the LPT. Third quarter losses in LAE were higher than last year due tothe amount and timing of favorable prior accident year development, which Doughas already discussed, and a downward adjustment in the current accident yearloss and loss adjustment expense estimate in the third quarter of 2006.

Additionally,in the third quarter of 2007 our loss and LAE estimates increased $1.6 millionrelated to the commutation of an excess of loss agreement with GLOBALReinsurance Corporation of America. Our loss and lossadjustment expense ratio for the nine months ended September 30, 2007 was 42.4%and 47.6% before the LPT. For the nine months ended September 30, 2007 lossesand LAE increased 16.3% over the same period in 2006 largely as a result of thefavorable development last year.

Ourcommission expense ratio was 14% in the third quarter and 13.6% for the ninemonths ended September 30, 2007. There was a slight increase in the thirdquarter 2007 commission expenses due to a July, 2006 increase in the commissionrates and an agency incentive commission plan adopted in 2007.

Ourthird quarter 2007 total underwriting expense ratio was 24.5% compared with23.6% for the same period last year. Our nine months ended September 30, 2007underwriting expense ratio was 25.8% compared to 19.7% for the same period in2006. The nine month ratio reflects lower net premiums earned and an increaseof $8.6 million primarily consisting of additional staffing and relatedoperating expenses required for a public company, and higher technology andmaintenance expenses.

Underwritingand other operating expense declined slightly compared to the first and secondquarters of this year.

Incometaxes in the third quarter and the first nine months in 2007, decreasedcompared to the corresponding periods in 2006 due to lower pre-tax income andlower effective tax rates. The effective tax rates declined because the ratioof tax exempt interest and dividends to pre-tax income increased as the resultof the portfolio reallocation in the fourth quarter of 2006 and in the thirdquarter of this year, we reversed a $5.8 million liability for previouslyunrecognized tax benefits including interest.

Theeffective tax rates were 11.5% in the third quarter and 19.3% in the ninemonths ending September 30, 2007.

Inthe third quarter of 2007, our GAAP combined ratio was 84.7% and before theLPT, it was 89.9%. For the first nine months in 2007, our combined ratio was81.9% and before the LPT it was 87.1%.

Netincome from investments increased in the third quarter and the nine monthsended September 30, 2007 compared to the same periods in 2006, principally dueto an increase in invested assets, a portfolio reallocation in the fourth quarterof 2006 that increased our book yield, and interest income on net proceedsrelated to the IPO.

Inthe nine months ended September 30, 2007 we sold $55 million of fixedmaturities for our stock repurchase program. And in October, we completed thatprogram and have repurchased 3,911,272 shares of common stock for a total ofapproximately $75 million.

Thefair value of our investment portfolio was $1.7 billion at September 30, 2007.Approximately 94% of our portfolio was comprised of fixed maturities of which93% had an average rating of AA or better, and 51.3% of the portfolio was investedin tax exempt municipals. The duration of the portfolio was 5.72 with a bookyield of 4.4% and a tax equivalent yield of 5.35%.

Ourinvestment portfolio includes less than 3/100 of 1% of sub prime mortgage debtor derivative securities. Our total exposure in the financial sector isapproximately $98 million or 5.7% of our total portfolio of $1.7 billion.

Insummary, in the third quarter the Company continued to be financially strong asreflected in our AM Best rating of A minus with a positive outlook; ourconservative investment portfolio with solid returns, our sound andconservative reserving practices and our long term attention to capitalmanagement. With that, I’ll turn the call over to Marty.

Martin Welch

Thankyou Rick. To update you on our operations I will begin by talking our directwritten premiums and our continuing strong growth in policy count. Startingwith policy count, we continue to grow our business at a very healthy rate. Wehave increased in-force policies by 12.7% since September 30, 2006. Our California in-force policy countincreased 17.4& year-over-year at September 30, while in Nevada we experienced a 7.2%decline in policies over the past 12 months.

ThisNevada result is expected aswe encounter continuing competitive pressures, maintain adherence to ourunderwriting guidelines and manage our book of business within targeted riskprofiles. We continue to emphasize growth in our new states, evidenced by totalpolicy count growth of 33% in states other than California and Nevada since September 30,2006.

AsRick indicated earlier, written premium continues to be impacted by falling California rates though we areexperiencing improvement in that premium trend. On a state by state basis, forthe nine months ended September 30, 2007 California represented about 70%of the total direct premium and Nevada was about 19%. Ournewest states, Arizona, Oregon, Florida, Illinois and Texas, grew about $3.5million to 1.3% of total direct premiums written. Illinois is gaining traction aswe appoint additional independent agents in that state, and Florida continues to be atwo-pronged market approach utilizing ADP and independent agent producers.

Ourrelationship with ADP continues to be strong though they have made somestructural and leadership changes within their sales and insurance operationsin recent months. We believe these changes will actually produce additionalopportunities going forward due to the renewed emphasis being placed on ourjoint sales efforts.

Wecontinue to execute our strategy including growth in our new states and thepursuit of additional strategic partners. We were very pleased to recentlyannounce our new strategic partnership with Intego Insurance Services LLC.Intego is a distributor of web based property and casualty insurance products.Beginning in December, this new partnership will enable us to offer ourWorkers’ Compensation product, combined with small business payroll processingservices through the use of Intego’s online payroll product.

Thispartnership will initially focus on Illinois, Florida and Texas. While Intego willafford us meaningful growth opportunity as we expand, our initial expectationsfor 2008 are a few hundred policies.

Additionally,this month we announced our relationship with the California RestaurantAssociation as a Workers’ Compensation provider of choice for their members.CRA is the largest trade association in the United States and while theirrelationship does not guarantee additional business, the CRA is the voice formore than 88,000 eating and drinking establishments in California, of which 22,000 areCRA members today.

Restaurantsrepresent the single largest class of business that we write, well over 3,000of our policy holders and we do expect this relationship to further strengthenour retention of restaurant business as well as produce more new restaurantpolicy holders in the future.

Overall,our insurance operations continue to successfully execute our strategy ofgrowing profitably in both new and existing markets. With those comments, Iwill turn the call back over to Doug.

Douglas Dirks

ThanksMarty. In closing as always, we remain committed to underwriting disciplined, profitabilityand the focus on specific markets within our targeted classes of business thatwe believe provide greater opportunities for profitable returns. Thank you forjoining us for our third quarter earnings call covering our financial andoperating results. That concludes our formal remarks and operator if you wouldplease, open the line to questions.

Question-and-AnswerSession

Operator

Youhave a question from the line of William Wilt – Morgan Stanley

William Wilt – MorganStanley

Goodafternoon, looking at the WCIRB data, I think you alluded to this Doug in your preparedremarks, looked like there was a bit of an inflection point in the frequencyand severity of losses, frequency being less negatives then it had been andseverity ticking up. Is that consistent with what you’re observing?

Douglas Dirks

Billit’s a little early right now to predict and inflection point based on that oneobservation, although I would have to say it doesn’t surprise us that we’re nowfour years into reform and you would expect at some point that all of thereform benefit will emerge. So again we’re not surprised by it, but I wouldreally be looking to see that next data point to confirm that that was in factthe inflection point.

William Wilt – MorganStanley

Sure,thanks for that. Two others if I may. The accident year loss ratio at 59.7% ifI did the math correctly is several points lower than it has been at precedingfew quarters, I don’t know if you could comment on whether that’s a new view onthe appropriate accrual going forward, whether there was some noise in thequarter, something unusual, any observations would be great.

Rick Yocke

Wedid make an adjustment of our current accident year provision rate in the thirdquarter so it’s not background noise as we looked at the emerging data for 2007;we lowered our provision rates slightly.

William Wilt – MorganStanley

Okay,that’s helpful and then the third if I could, I’m forgetting the name of the courtcase, but there was a case recently, settled between or adjudicated between thestate comp insurance fund, WellPoint I think, one of the big health insurers ina hospital. I guess the thrust of it was that the Workers’ Comp carrier hadbeen getting discounts, so the heart of the dispute was that the Workers’ Compcarrier seemed to be getting discounts for hospital services, physicianservices, etc. that arguably that they shouldn’t have been, irrelative to the,related to the PPO. Is that anything that you can comment on, I mean, are yourclaims subject to PPO discounts, do you have direct relationships with oragreements with hospitals and other medical providers to garner discounts?

Douglas Dirks

Youknow Bill, I am familiar with the case, I believe if it’s the one I’m recallingcorrectly it was settled in a way that it doesn’t represent any precedent interms of how companies might interact with individual providers. So from thatstand point, I don’t know that it has legal meaning to us. It is something thatwe’ll monitor; at least as we understand it today, don’t believe it presents aproblem for us.

William Wilt – MorganStanley

Isthere any way, and then I’ll turn it over to others, is there any way toquantify or add color to the extent to which employers benefits from volume discountsor PPO discounts in the relative to paying say full freight for hospital andphysician services, you know, across the totality of your claims?

Douglas Dirks

Notthat I have in front of me at the moment, you know, we could probably developsome type of estimate as to what that might represent, but to tell you thetruth, right now I just couldn’t even give you an estimate of what that is.

William Wilt – MorganStanley

Okay,thanks very much.

Operator

Yournext question comes from the line of Matt Carletti – Cochran Caronia Waller

Daniel Schlemmer –Cochran Caronia Waller

Hi,actually it’s Dan Schlemmer, I’m using Matt’s line, going back to, you had thequestion about the accident year loss ratio, I just want to make sure it’sclear. You haven’t changed your policy of where you book relative to the projections,is that right, I think 8% is your normal margin there and you haven’t changedthat?

Rick Yocke

Nowe have not changed our position relative to our actuarial consultants at all.

Daniel Schlemmer –Cochran Caronia Waller

Andthe change in the accident year loss ratio then is purely experience based, Imean is that a fair way to say it?

Rick Yocke

Askyour question again please?

Daniel Schlemmer –Cochran Caronia Waller

Isit fair to say your change in your accident year loss ratio was purely based ona change you saw in the experience?

Rick Yocke

That’scorrect.

Daniel Schlemmer –Cochran Caronia Waller

Okay.On the commutation, can you sort of clarify I guess in general, when you see acommutation usually there’s actually a benefit that comes out of it, not anadverse amount, can you sort of give us the background on the transaction?

Rick Yocke

WellI’ll summarize it. We have a situation where the reinsurers trying to wind uptheir affairs had approached us with a proposal to commute the agreement. As welook at it on a present value basis, we believe that it was a good businessdecision to commute the agreement, however when you look at it on a GAAP bookbasis, we do not discount our reserves. Consequently since many of, the largepart of the liability remained unpaid, you end up with what appears to be a,well it is a write-down, but it disguises the economics of the actualarrangement.

Daniel Schlemmer –Cochran Caronia Waller

Okay,do you know, I hate to put you on the spot too much, but do you know what theimpact would have been if you did take the benefit of that discounting?

Rick Yocke

AsI said, we viewed the arrangement to be a good business deal. We would haveviewed this to be a profitable arrangement between ourselves and the reinsurer.

Daniel Schlemmer –Cochran Caronia Waller

Understood,thank you. Last question, just the two relationships you went through in thecomments, Intego and the California Restaurant Association, do you have adollar amount expectation of any kind that you can share with us just overallhow much you’re thinking that can add over the next year?

Martin Welch

We’refar too early in these relationships to be putting up premium expectations. Wecertainly are pleased with both of those relationships and think that they willinure a benefit to us in the future as we go forward but at this point, Iwouldn’t want to throw a dollar out there for what it would mean to 2008.

Daniel Schlemmer –Cochran Caronia Waller

Alrightthank you.

Operator

Yournext question comes from the line of Sam Hoffman – Foley & Lardner

Sam Hoffman – Foley& Lardner

Hi,can you comment on the expected level of price competition in the generalpricing environment going into 2008 irrespective of the bureau’srecommendations, how much price competition are you expecting?

Douglas Dirks

I’mnot sure how we quantify that in terms of are we expecting reductions in ourrates overall based on competitive pressures or are you looking for what wethink the market will go down in general?

Sam Hoffman – Foley& Lardner

Iguess I’m looking for what you think will happen in the market and then whatwill happen with your renewal book?

Martin Welch

TheCalifornia market has become morecompetitive obviously over the last few years. It’s not sustained competitionfrom the same competitors consistently. It varies by region within the state;it varies by particular classes of business. So I think overall we would expectto see the market continue to be competitive as carriers look for the bestrisks in the market. What we’ve been focusing on is increasing the amount ofsubmittals that we get to our marketing and sales efforts so that we have anopportunity to see more good business and be able to compete that way. Drivethe top line and the bottom line results by seeing more of the types ofaccounts we would like to write.

Sam Hoffman – Foley& Lardner

Sowhat do you think the overall pricing change will be in the market next year,best guess and what do you think is going to happen to your overall pricing asa result of the initiatives you just talked about?

Martin Welch

Idon’t know what the overall market pricing will be in California. I wish I knew. Itwould make our setting of strategy a little bit easier. Again I think themarket continues to be competitive. I don’t think we’re seeing underlyingresults in California that are going to drivecompetitors out of the market place. I still think from our stand point, it’san attractive market. I would expect it presents similar opportunities toothers. What impact the commissioner’s ruling if any will have on rate levelsremains to be seen. But at this point, and I’ll go back to Bill’s firstquestion, it’s beginning to appear that we may have seen the inflection pointin the market, but again it’s a little too early to be predicting that.

Sam Hoffman – Foley& Lardner

Justtwo other detailed questions, your commission ratio increased from 12.4% to14%, year-over-year, is that something that we should expect, continuedincrease going forward or were there one-time items in the quarter?

Rick Yocke

WellI think what that’s primarily a reflection of is, one year ago we increased ourcommission rate to 12.5% primarily in California. And that has workedits way through the entire book of business now as we got to the third quarterof 2007. At this point in time, we are, we have not other decisions that wehave made or will make regarding our commission rates as we go into 2008.

Sam Hoffman – Foley& Lardner

Okay,and final question is what is your investment yield and what’s your new moneyyield?

Rick Yocke

Ourtax equivalent yield is 5.35%.

Sam Hoffman – Foley& Lardner

Andit’s the same on new money.

Rick Yocke

Approximately.

Sam Hoffman – Foley& Lardner

Okaythank you.

Operator

Wehave a follow up question for the line of William Wilt – Morgan Stanley.

William Wilt – MorganStanley

Thankyou for taking the follow up. Two, one numbers one first. Revisiting the 59.7%loss ratio in the third quarter, is it possible to parse that between thecatch-up from the first half of the year that presumably is benefiting thethird quarter and then the underlying third quarter run rate accrual?

Rick Yocke

Thetotal adjustment through nine months resulting from the change in provisionrate was approximately $6 million.

William Wilt – MorganStanley

Okay,I’ll work it out from there, thanks. And the more general question, on AssemblyBill 338, I guess the Workers’ Comp Bureau weighed in that it would increaserates 3% or you can tell me it’s some small positive increment as I recall, isit your sense that that Bill will be essentially cost-neutral or only increasecosts slightly? And I guess I’ve observed, and you can react to this howeveryou see fit, that increasing or extending the temporary disability benefits inthe face of potentially slowing economy could, has some attendant risks and Ididn’t know if you wanted to react to that observation or not.

Douglas Dirks

TheBureau did amend its rate filing and added an additional 1% as a result of 338,and 338 extends the period of time that an individual can collect temporarydisability from 104 weeks over two years, to 104 over four years. I think theway you present it, there is a possibility that that increased period of timecould lead to greater utilization of that benefit. But I think the Bureau’snumber probably has incorporated that. We would tend to agree with them, thatif it has an impact, it will likely be minimal.

William Wilt – MorganStanley

Great,thank you.

Operator

Thereare no further questions at this time.

Douglas Dirks

Thankyou everyone for joining us today and we look forward to speaking with youagain to cover our 2007 year end results. Thank you.

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