EMC Insurance Group, Inc. (NASDAQ:EMCI)
Q4 2007 Earnings Call
February 28, 2008 11:00 am ET
Anita Novak - Director of Investor Relations
Bruce Kelley - President and Chief Executive Officer
Ron Jean - Executive Vice President for Corporate Development
Steven Peck - Senior Vice President, Actuarial
Rich Schulz - Senior Vice President, Claims
Ray Davis - Senior Vice President, Investments and Treasurer
Kevin Hovick - Senior Vice President, Business Development
Mark Reese - Senior Vice President and Chief Financial Officer
Bob Farnam - Keefe Bruyette & Woods
John Szabo - Flintridge Capital
Greetings and welcome to the EMC Insurance Group Incorporated Fourth Quarter 2007 Earnings Results Call. At this time, all participants are in listen-only mode. And a brief question-and-answer session will follow the formal presentation. (Operator Instructions). As a reminder, this conference is being record.
It is now my pleasure to introduce to your host Ms. Anita Novak, Director of Investor Relations for EMC Insurance Group Incorporated. Thank you. Ms. Novak, you may now begin.
Anita Novak - Director of Investor Relations
Thank you, Jackie. Good morning everyone and welcome to EMC Insurance Group 2007 fourth quarter earnings call. The supplemental investor packet is available on the Investor Relations page of our website, which can be found at www.emcnsurance.com. The webcast for reply purposes is also available at the site until May 28. 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 adjusted by our comments today. Additional information about factors that could affect future results is addressed in our SEC including Forms S-1, 10-K, 10-Q and 8-K.
Any information provided today should be read in conjunction with the 2007 fourth quarter earnings release with accompanying financial tables issued earlier today.
With us today are several members of EMC Insurance Group's Executive Management Team. They are Mr. Bruce Kelley, President and Chief Executive Officer; Mr. Ron Jean, Executive Vice President for Corporate Development; Mr. Steven Peck, Senior Vice President, Actuarial; Mr. Rich Schulz, Senior Vice President, Claims; Mr. Ray Davis, Senior Vice President, Investments and Treasurer; Mr. Kevin Hovick, Senior Vice President, Business Development and Mr. Mark Reese, Senior Vice President and Chief Financial Officer.
At this time, it is my pleasure to introduce EMC’s Chief Executive Officer, Bruce Kelley.
Bruce Kelley - President and Chief Executive Officer
Thank you, Ms. Anita and good morning everyone. Last year was a very successful year for EMC Insurance Group Inc. Fourth quarter results were consistent with our expectations.
We are pleased to report an operating income for the quarter was $0.39 per share and net income was $0.51 per share. For the year operating income was $2.91 per share and net income was $3.09 per share.
At December 31 book value was $26.15 per share an increase of 16.5%. Our average return on equity remained within our 2007 objectives and was 12.7%. Our statuary surplus as regards policy holders was $344.6 million, an increase of 11.1% for the year. Our GAAP combined ratio was 97.6.
Net written premium growth for 2007 nearly met our corporate goal of 2%. Actual growth excluding adjustments associated with change in our participation in Mutual Reinsurance Bureau Pool was 1.4%. We experienced premium growth in most lines of business with the exception of personal auto and personal property.
Again in 2007, we concentrated on increasing the effectiveness of our employee. Our Internal Education Department offered 6,237 course hours of employee development, which involved 2088 employees. The company administered 239 IIA CTCU exams, 69 additional industry designations were earned in 2007 by our employees and incidentally our employees currently hold 1272 industry designations.
Our stock price declined 30% in 2007 closing at $23.67 per share due to general economic conditions and the fact that financial services stocks were out of favor for much of the year.
Rate competitiveness was more changed from the third quarter, but overall premium rates were down approximately 4.9% as compared to one year ago. We are seeing declines in all lines of business, but they have not been as significant for our company as the industry averages might suggest. We fully expect the rate completion will continue this year in 2008, but we will continue our disciplined approach to premium growth and will only write, good, well priced, properly diversified business.
We continue to see a lot of new business applications. We are pricing a bit more aggressively. But we are not undermining our underwriting discipline by any means. We believe that that lesson was well learned during the last soft market. We continue to use underwriting tools to more adequately priced new business. Our easy billing business also helps since agents' timely and excellent coding, writing, and monitoring accounts.
Policy account for the company increased in 2007 by more than 6000 commercial lines policies or 2.7%. As we mentioned during our last call, the company introduced the EMC Choice Equipment Dealer Programs in 38 states in late October, which contributed new accounts and felt with written premium growth.
One major catastrophe affected the company in 2007. The devastating F-5 tornado had struck Greensburg Cantus last May. We insured the school and municipalities as well as some personal properties. We insured accounts. We insured the schools and counties, as well as some personal property. The effect of this particular loss on the company was $0.31. All claims have been adjusted and have received payments. A few files remained open, pending reinsurance adjustments, but for the most part these claims are now settled.
Our 2007, catastrophe and storm season was a little more serious than the normal storm season, but was comparable to 2008. Retention levels increased somewhat as compared to 2006 and were approximately 87% for commercial policies and 86% for personal policies. Claims frequency was up 1.3% in 2007 due partially to an unusual number of small weather related causality claims reported during the first quarters and an increase in home owner's claims. At year end, the largest frequency increases when the auto physical damage and home owners lines of business.
Claim severity for reported losses excluding bulk reserve adjustment was down 3.4% in 2007 due to the large number of small storm related casualty claims, which involves in the first quarter and a moderate reduction in case reserves adequacy indicated during the year.
However, its important to note that by our two main actuarial measures. Actuarial analysis indicates that one, case reserves remained adequate and two, total carried reserves remained in the upper quartile of actuarial reserve indication.
The company continues to receive accolades for our leadership in technology. We have been constantly creating easier ways of doing business for our agency partners. Previous awards include Accord's, Download Company of the year for greatest download increases in percent of growth. (AFC&S) ease of doing business in both personal lines and commercial lines, and last year Applied Systems industry leadership, and innovation award for outstanding achievement in the early adopter implementation of claims download. Each of these awards was presented to the company based on our download capability and the functionality of our website in regard to agency services. We continue to be very, very aggressive in these areas knowing that easier it is for agents to facilitate quality holder information the more likely agents are to recommend our products and services.
With that let’s turn to Mark Reese, Senior Vice President and Chief Financial Officer.
Mark Reese – Senior Vice President and Chief Financial Officer
Thank you, Bruce. Operating income for the fourth quarter was $5.4 million which is down from the record $10.7 million reported in the fourth quarter of 2006. For the year operating income was $40.1 million which is also down from the record $50.8 million reported in 2006.
Net income for the fourth quarter and the year was $7.1 million and $42.5 million respectively compared to $11.5 million and $53.5 million for the same period in 2006. The declines in 2007 operating income and net income are attributed to an increase in both large losses and catastrophe and storm losses, a decrease in the amount of favorable development on prior reserves and a moderate but steady decline in overall premium rate levels.
Debt premiums written increased 3.5% to $90.7 million in the fourth quarter and 2.3%, $395.3 million for the year. However, it should be noted that the increase for the year reflects a negative $3.4 million for full year adjustment recorded in the first quarter of 2006 in the reinsurance segment in connection with employee's mutual reduced participation in the MRB pool. Excluding this adjustment written premiums increased 1.4% in 2007.
Commercial line net written premiums increased 7.6% in the fourth quarter and 2.1% for the year as new business premium was sufficient to offset premium loss through declining premium rates and business not renewed. Personal Alliance net written premiums increased 4.5% in the fourth quarter but declined 3.3% for the year.
For the year new commercial lines premium was up 4.4% over a year ago and new personal lines premiums was up 4.7% with much of that coming in selected territories with a greater profit potential.
Catastrophe and storm losses totaled $0.10 per share in the fourth quarter of 2007, compared to $0.08 per share in 2006. For the year, catastrophe and storm losses totaled $1.02 per share compared to $0.69 per share in 2006. The amount reported for calendar year 2007 includes $0.31 per share of losses associated with the May tornado that devastated Greensburg, Kansas.
Investment income increased 5.7% in the fourth quarter and 3.8% for the year as a result of higher average invested asset balances and a small increase in the yield of fixed maturity securities.
Total rate of return on our equity portfolio for 2007 was 11.87% which compares very favorably to the 5.49% for the S&P 500. The current annualized yield on our bond portfolio is 5.41% and the effective duration is 3.75 years which is down from 3.91 years at year-end 2006.
Management has not identified any sub-prime mortgage exposures requiring any other than temporary impairment considerations.
The company's fourth quarter actuarial analysis indicates that total credit reserves as of December 31, 2007 remained in the upper quartile of the range of actuarial reserves indication.
During the fourth quarter, our reinsurance subsidiary redeemed all $11 million of surplus notes, statutory, Employers Mutual, plus accrued interest. The $25 million of surplus notes issued by our property and causality insurance subsidiaries remain outstanding and the interest rate of those notes was increased from 3.09% to 3.6% effective February 1, 2008 pending regulatory approval.
Management expects 2008 operating income to be within a range of $2.10 per share and $2.35 per share. The assessment is based on our projected GAAP combined ratio of 101.8% and management expectations of continued rate competition in both the property and casualty insurance market place and the reinsurance market place.
At this time, I would like to open the phones for questions.
Thank you. We'll now be conduction a question-and-answer session. (Operator Instructions). Thank you. Our first question is coming from Bob Farnam of Keefe Bruyette & Woods.
Hi, Good morning. Just a few questions, is there a drop in reinsurance premium in the fourth quarter versus the prior three quarters? Is there any reason for that because it's not changing the MRB or any or anything is it?
This is Bruce Kelley. Ron Jean oversees the reinsurance department and talks with Ron Hallenbeck who can't be with us today. Ron, do you have any comment on that?
There is nothing significant to change in the fourth quarter. Our written premium in the reinsurance operation do vary by quarter as does the earned has to do with the line of the businesses book and I know crop hail business as I look in the fourth quarter and saw 100% earnings same time. So, there are some fluctuations by quarters, but the pattern has been consistent with prior year's demand and change, so I don’t there is anything significant there.
Okay, nothing funky going on.
Alright. For the guidance for '08, can you give us an idea what you're expecting in terms of catastrophe loss, expectations, or favorable or adverse reserve development?
Bob, this is Bruce Kelley. I'll start off on that and then I'll pass it on to Mark Reese on the reserve development, but as to the catastrophes, when we think our guidance for the year we figure a normal catastrophe year, somewhat less than it was last year, but somewhat greater than it was in 2006. As to the development, Mark?
I think Steve Peck is going to talk about the load that he has in the projections for 2008.
Yeah, the catastrophe load is 6.9% (technical difficulty). The only development exquisitely built into the projection is on the case reserves and I've assumed downward development equal to 2% of premium.
Okay. So, that's 2% favorable development on case reserves.
And, you said 6.9 of catastrophes going into that.
Okay. On the investment side you did mention you didn't have any other (Inaudible) information in sub-primes. Can you just give an idea of what is considered sub-prime in your portfolio as the percentage of the total investments?
Yes. We'll turn this over to Ray Davis, our Chief Investment Officer.
Yes. We really feel like we have any direct exposure to sub prime. We don't have any CDOs. We don't do anything in sub prime area.
The only exposure would be maybe indirect through some equity investments that we have, but nothing significant or material that I think we can really specify and be concerned about.
We were able to price almost all of our investments I hear some companies are having a problem with a large percentage of their investments 10% or so. We were able to price almost everything that’s because most of what we have is very marketable.
Okay. And in terms of your municipal bonds, have you looked into credit quality of those underlying versus those with the credit enhancement?
Yeah, we feel really good about our municipal bonds quality, mostly GOs and AA GOs is what we normally buy and whether they – when we buy municipals, we buy it looking at the underlying rating first and we do get insurance at just a small cause. The quality of our municipal portfolio is holding very, very low.
Okay. That's all I have for now. Thanks.
(Operator Instructions). Our next question is coming from John Szabo of Flintridge Capital Investments.
Hello, good morning. Thanks for taking the question. I was just trying to understand your commentary a little bit more around the favorable reserve development. You mentioned that it was not as favorable in ’07, as it was previous to that. As a result, did you make any changes in the way you were reserving for cases in 2007? So, in other words, did that sort of change the trajectory of where you were reserving during the course of 2007?
I think Rich Schulz will start out with this being our Chief Claims officer on whether there have been any changes in our method of reserving these cases.
We had excellent favorable development last year, it was only down compared to the record year that we had in 2006. But in terms of pricing on our direct case reserves there were no changes whatsoever. We instituted some reserving policies in 2005 some guidelines for pricing our direct cases, and those have been heavily enforced and our continuing to be enforced so that we have a consistent way of pricing our cases.
Okay I think what I'm hearing to say is no real change in the methodology. Is that right?
Not in terms of pricing the direct case reserve.
This is Steve Peck speaking from my actuarial perspective. We believe we saw some decline in the adequacy of the case reserves at the end of 2007. But a large part of that, at least a majority of that has been offset with the establishment of a bulk case reserve.
This is Ron Jean I have to make one additional comment on that too. That the point here is that case reserves remain adequate that that’s based on to the level inadequacy. It's just that the level of adequacy has declined some. And we have a methodology in place where we analyze the actual case reserve adequacy and would try to maintain a reasonable risk margin in those case reserves until we basically supplement whatever level of case reserve adequacy we have with the bulk reserve if necessary to stay within that newer range. So, no major changes in the approach.
Okay. So, no changes in the approach, but you did increase the bulk reserves to I guess buttress the decline in the case reserves?
It was a pretty marginal increase, yes.
Okay, all right. And so, I guess what I am getting at here is if you sort of supplement those bulk reserves and you remain in the upper quarter of your range. What would make you think that the amount of favorable development would be lower going forward? I mean if you sort of increase the bulk you are using the same methodology all those being equal when you sort of get about the same result in ’08?
Right. What I was speaking to specifically was the individual case reserves, because of the decline in the adequacy of the individual case reserves. I think there will be a smaller amount of individual case reserves development, downward development in 2008. But that is the only explicit assumption regarding reserve development that is built into the projections.
Okay. So, you are seeing 2%, right?
For ’08, that’s what you are expecting?
Okay. And, what was it for’07?
It turned to be somewhere in the neighborhood of 7.5 to 8%.
Okay. So that’s a very…
Of earned premium, yeah.
Of earned premiums, okay. So, that’s a big difference.
This is Ron Jean again. Steve was referring to the explicit assumption you built there on case reserve development. Some of the favorable development that occurred in ’07, look to the IBNR reserve we have setup. That was the merged IBNR reserve, our merged IBNR activity wasn’t by the side we had established and we really haven’t that change the level of adequacy, there maybe some additional emergence base savings on the IBNR side, but that condition is pushing of having them.
Okay. And that was all on ’07 then?
Okay great. Okay, thanks. That’s helpful. Just one other the question; you know, you sort of mentioned the soft pricing environment you guys have strong balance sheet now, stock is trading well below book value. What are the thoughts at the board level or either, at the company or at the enterprise level about how capital will be deployed over the next 12 to 18 months?
Well this is Bruce Kelley. To start out the answer to this question, we are taking enterprise risk management very seriously as a company and are basically doing a lot of activities involved in identifying our risks. As to the capital position that we have and the allocation of it we are also studying that within the organization. One way we are going to be involved with managing capital is in our stock buyback program that continues with Employers Mutual Casualty Company buying stock or taking a hard look at that on how we want to use that going forward. So we are very aware that as the surplus continues to mount up we want to make sure that our leverage ratios are appropriate.
Hi Mike this is Ronald. One thing I would like to add to that is that, one thing is also that you kind of add as a strategy going to soft market we want to make sure that we maintain really strong surplus levels because it’s not a time when you want to grow necessarily and as you can really get good business at a good price. But we want to come out of the soft markets in a very, very strong surplus position. So at that point in time as you can get better quality business at better price that’s when we want to grow and want to have the surplus for that growth. So, we are kind of stockpiling to a certain extent in anticipation of when the market turns, we want to be in a position to take advantage of it.
Well how long do you think that’s going to take?
That I don’t know, several industry opinions that I have heard indicate that they don’t expect that this cycle may be quite as deep or quite as long as previous soft market cycle for a variety of reasons. First of all we have much lower incur investment return environment right now with lower interest rates, volatile stock markets and so forth. And so that certainly puts more pressure on the underwriting side and discipline in pricing, and there is a lot of people looking over our shoulders in addition to analysts and shareholders; you've got the rating agencies that are really scrutinizing returns very closely and putting pressure on ratings if they see companies growing and in situations where it shouldn’t be. So there is a lot of factors in place to indicate that it might not last as long as previous soft market, but at this point in time, we are expecting at least couple of more years for things to turn around.
Okay. And so I guess, it's a couple of more years and if you think that based on your guidance the company is going to make an excess of $2 a share in ’08, that would put the stock at pretty close to three-quarters of book value. I don’t know how good it's going to be on the other side, but I can imagine that is going to be better than buying something at three-quarters of book, which personally I think is understated but well just help me out with that?
It's not an area that we are currently evaluating, I guess, as to what the future actions we should look at there.
Okay. So maybe, we'll hear more about that at some point this year?
Once some decision will be made, yes.
Okay, thanks. Just one last question, just going back to the cycle question, you gave the sense that some of the uncertainty that’s currently facing the financial services industry regarding remarks on investments and some of the issues around the value of investments that are held by insurance companies or broker dealers, I mean you gave a sense that that could have an effect on pricing at all is that going that in much more faster at this point?
Well, John this is Bruce Kelley. I just want to talk a little bit about that and then I will turn it over to Kevin Hovick who is in charge of business development for our branches, but the insurance cycle as we understand it is not really that impacted by investment problems. It's more a supply and demand issue and there's a lot of supply of capital out there, and we don’t see it being diminished by the problems that some companies are having with their investment portfolio. So I think that there’s going to be a lot of fuel there, but going forward I think those who think kind of the market is going to continue to be competitive.
Yes, all indications so far point that they will need to be competitive and there is been some indication that there might be not increasingly as competitive as it was maybe just a few months ago, but again keep in mind it’s still competitive. We continue to work on some the advantages that we think we have in the market to introduce new products, new tools for the underwriters, and monitoring techniques to make sure that we are staying within our stated guidelines.
So basically what you're saying is that there hasn’t been enough destruction of capital through the investment portfolios to have a material impact on pricing, is that a fair characterization?
That’s a fair characterization. The last stock market ended when a lot of companies destroyed their capital by under pricing business and when they and when the world trade center catastrophe occurred.
Right, okay, so that’s obviously the more that’s the more traditional way capital would get destroyed within this business.
It generally gets destroyed by underwriting, but that's generally what happens. You are right on John.
Okay, fine. Alright, thanks very much. I appreciate the time.
Thank you. (Operator Instructions). Thank you. There are no further questions at this time. I’d like to hand the call back over to management for any closing comments.
Thanks Jackie. Thank you ladies and gentlemen. This now concludes this conference call. I would like to remind you that a playback of this call will be available on the company’s web site at www.emcinsurance.com until May 28th. And the transcript of this conference call will be available until February of 2009, which can be accessed from our web site later today. We appreciate your interest in EMC Insurance Group, and all of us wish you an enjoyable day.
This concludes today’s teleconference. You may disconnect your lines at this time. Thank you for your participation.
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