Employers Holdings Inc. Q4 2007 Earnings Call Transcript

Mar.10.08 | About: Employers Holdings, (EIG)

Employers Holdings Inc. (NYSE:EIG)

Q4 2007 Earnings Call

February 27, 2008 10:00 am ET


Douglas Dirks – Chief Executive Officer, President and Director

William Yocke – Chief Financial Officer and Executive Vice President

Martin Welch – President and Chief Operating Officer

Vicki Erickson – Vice President of Investor Relations


Adnan Alum - ADAR Investment Management

Robert Farnam - KBW


Good day, ladies and gentlemen, and welcome to the Fourth Quarter and Full Year 2007 Employers Holdings, Incorporated Earnings Conference Call. My name is Eric. I will be your coordinator for today. At this time, all participants are in a listen-only mode.

We will facilitate the question and answer session towards the end of the conference. (Operator Instructions). I would now like to turn your presentation over to your host for today’s call Ms. Vicki Erickson, Vice President, Investor Relations.

Vicki Erickson

Thank you, Eric. And welcome everyone to the fourth quarter and full year 2007 earnings call for Employers Holdings, Inc. After the close of market yesterday, we announced our fourth quarter and full year 2007 earnings results. The press release is available on the company’s website at www.employers.com.

Today’s call is being recorded and webcast from the Investor Relations section of our website where a replay will be available following the call. Representing the company on the call today are Doug Dirks, our Chief Executive Officer; Ric Yocke, our Chief Financial Officer; and Marty Welch, the President and Chief Operating Officer of our insurance subsidiaries.

Before I turn the call over to Doug for opening remarks, I would like to remind everyone that 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.

Though 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.

There are additional risk factors concerning our acquisition of AmCOMP Incorporated. For example the following factors, among others, could cause or contribute to such material differences:

Failure to satisfy any of the conditions of closing, including the failure to obtain AmCOMP stockholder approval or any required regulatory approvals;

The risks that the businesses of Employers and AmCOMP will not be integrated successfully;

The risk that Employers and AmCOMP will not realize estimated cost savings and synergies and cost relating to the proposed transaction.

All remarks made during the call are current at the time of the call and will not be updated to reflect subsequent material development. I would also like to remind you that we use a non-GAAP metric that excludes the impact of the 1999 Loss Portfolio Transfer or LPT. This metric is defined in our earnings press release available on our website.

Now I will turn the call over to Doug.

Douglas D. Dirks

Thank you, Vicki. While 2007 was a year of challenges in the insurance industry and in the financial markets, we were able to execute our strategies and achieve profitable results throughout the year.

Our 2007 net income was $120.3 million compared to $171.6 million in 2006, which I might add was a record year for Employers. Our net income before the impact of the LPT was $102.2 million in 2007 and $152.2 million in 2006.

The decrease in our net income was largely the result of an investment gain from the portfolio reallocation in the fourth quarter of 2006 and differences in our adjustments for reserve development. In 2006, we recognized $107.1 million in favorable reserve development. In 2007, we recognized favorable prior period development of $61.6 million.

In California, our largest market, gains from declining loss trends continued in 2007 although impacts from prior reforms appear to be moderating both in terms of reductions in loss costs and rate declines.

Although the national economy is showing many signs of economic slowdown, we did not observe a similar trend in California. We continue to observe strong persistency in our renewal book of California business, but are monitoring both our independent agent book and our strategic partner business for signs of economic slowdown.

In our California independent agent book of business renewals and new business submittals continue to be strong. However, our success in increasing top line revenue in California is challenged by declining rate levels on our existing book of business and by irrational pricing by some competitors who appear to be buying top line revenue or who are defending existing books of business by decreasing premium levels below where we believe profit can be realized.

We also find that in California we are increasingly challenged by competitors who understand the profitability of our book and who now specifically target our geographies and classes of business.

We remain committed to writing business at price levels that support profitability, and consequently, we will be uncompetitive with those who seek top line growth at the expense of bottom line profitability.

In our second largest market, Nevada, we are beginning to be impacted by the significant decline in residential construction, principally in Southern Nevada. In our Nevada renewal book of business, we are seeing indications of decreases in estimated annual premium, which signals an expected decrease in 2008 payrolls and consequently a decrease in total premium.

Despite the more challenging economic and competitive conditions, we achieved strong in-force policy account growth of 13.3% in 2007, an indication of the success of our sales efforts.

At December 31, 2007, our year-over-year average in-force policy premium declined to $10,275 from $13,200 primarily due to rate decreases in California. We will continue to focus on establishing new relationships to support profitable growth.

In 2007, we added a new strategic partner Intego to our distribution pipeline and established an exclusive relationship with California Restaurant Association. Restaurants are our largest class of business.

Organic growth in our high quality book of business has supported our state expansion, but as we have indicated over the past year, opportunistic transactions are an important part of our overall strategy.

Our acquisition of AmCOMP announced last month, will provide us with new growth opportunities and financial and operating benefits in the coming years. When the transaction closes, Employers will have a larger and more diversified earnings base that extends beyond our current Western Region focus, and an enhanced team in terms of talent and experience and a total of 26 states in which we can profitability grow our business.

In terms of our progress on the acquisition, we have filed our Form A with the Florida Office of Insurance Regulation. On February 19, we were granted an early termination of the waiting period under the Hart-Scott-Rodino Antitrust Act, and AmCOMP is completing its proxy statement for shareholder vote. We anticipate we will close this transaction in the second quarter of this year.

Our capital position continues to be strong and we intend to manage our capital prudently. In 2007, we repurchased $75 million or 3.9 million shares of our common stock at an average price of $19.18 per share leaving 49.6 million shares outstanding at the end of December.

Through share repurchases and the three quarterly dividends in 2007, we returned 82.5% of our 2007 net income before the LPT to shareholders, demonstrating our ongoing commitment to stockholders and our proactive capital management.

We will continue to actively manage our capital. In addition to our acquisition of AmCOMP, which will include a cash component in the financing, yesterday, we announced an additional stock repurchase program and we’ll now have authorization to purchase up to $100 million of our common stock through June 30, 2009. We also announced the declaration of a dividend of $0.06 per share.

We continue to be under-leveraged in terms of premium to surplus relative to the workers’ compensation industry as a whole. However, as we have consistently stated, it is not our intention to solve the leverage issue by use of a single device; rather we will continue to pursue three objectives to fully optimize our capital structure.

Our first objective is to invest in our business model in pursuit of organic growth, now an enhanced opportunity because of the AmCOMP acquisition. Second, we will continue to pursue opportunistic acquisitions. Although, we will be fully engaged integrating AmCOMP into our operations and are committed to the success of that endeavor, we will not be blind to other opportunities should they present themselves.

And finally capital management through share repurchases and dividends remain important elements in our capital strategy. We are pleased with our 2007 performance and our position in the insurance market and will continue work to improve that performance in 2008.

Now Ric will discuss our financial results.

William E. Yocke

Thank you, Doug, and good morning to everyone. First I will cover our fourth quarter results. Our combined ratio was 75.9% on a GAAP basis and 81.1% before the LPT. That compares favorably with 80% and 85.1% before the LPT in the fourth quarter of 2006.

The four-percentage point improvement in the combined ratios reflects our continued strong underwriting results as our loss in LAE ratios were 37.9% on a GAAP basis and 43% before the LPT.

Consistent with past quarters, we saw a favorable prior accident year development and in the fourth quarter of 2007 this favorable development represented 19.7% of the combined ratio.

Our run rate for underwriting and other operating expenses was 28%. Underlying the lower expense ratio were decreases in professional and consulting fees in the fourth quarter of 2007.

Fourth quarter 2006 consulting fees were linked largely to our conversion to a public company, strategic planning, and implementation of our underwriting systems.

For the full year 2007, our combined ratio was 80.4% on a GAAP basis and 85.6% before the LPT. Our combined ratio increased compared with last year because we recognized favorable prior accident year development at higher levels in 2006 than in 2007.

Our underwriting and other operating expenses were 4.1% or $3.6 million higher than last year. The effect of favorable prior accident year developments in 2007 net of third quarter computation was 17.3 percentage points on the full year combined ratio.

In 2007, California and Nevada generated 72% and 17% of direct premiums written respectively. Our earned premium declined 11.7% as past rate decreases in California continued to roll through the book of business.

Our filed California rates on new business and renewals were 14% lower than December 31, 2006. Additionally, our 2007 written premiums declined in Nevada as a result of adherence to our underwriting guidelines, competition, and slowing economic activities, particularly in the residential construction industry.

We adopted approved loss costs for new and renewal policies effective March 1, 2008 with a revised loss cost modifier, which we expect to produce an average decrease of 5% on our Nevada book of business in 2008.

Overall, our average policy premium declined to $10,275 compared with $13,200 at year-end 2006. The decline in premiums written was partially offset by our strong 13.3% increase in policy count that Doug mentioned earlier.

Net income from investments increased 15.3% in 2007 primarily due to an increase in invested assets; portfolio reallocation in the fourth quarter of 2006 that increased our book yield, and interest income on net proceeds related to the IPO.

Income taxes in the fourth quarter and the full year 2007 decreased compared to the corresponding periods in 2006 due to lower pre-tax income and lower effective tax rate. The effective tax rate was 20.3% in the 12 months ending December 31, 2007.

Financial markets in 2007 were characterized by concerns over subprime investments and financial guarantors’ credit risk. Within this volatile environment, the fair value of our investment portfolio was stable at $1.7 billion at December 31, 2007.

There has been no substantive change in the asset allocation of our portfolio, which continues to emphasize asset quality and maximize economic value through dynamic asset and liability management. Equities represented 6.2% of our total portfolio at December 31, 2007.

The majority of our portfolio consists of fixed maturities and the average credit ratings for our fixed maturities using ratings assigned by Standard & Poor’s was AA+ at the end of last year.

51.9% of the portfolio was invested in tax-exempt municipals. 93% of the carrying value of our investment portfolio was rated AA or better. The portfolio duration was 5.82 with a book yield of 4.37% and a tax equivalent yield of 5.37%.

Our investment portfolio includes less than 300ths of 1% of subprime mortgage or derivative securities. Our total exposure in the financial sector is approximately $98 million or 5.7% of our total portfolio.

We do intend to issue senior unsecured debt in connection with the acquisition of AmCOMP with an expected debt to capital ratio of just under 20%. We are also negotiating a commitment for a $50 million senior secured revolving credit facility from Wells Fargo for general corporate purposes.

We do not expect our debt to capital ratio to exceed 25% during the upcoming year. In 2008, we have the ability to upstream $200 million in approved extraordinary dividends. Overall 2007 was another solid year for us.

With that I will turn the call over to Marty.

Martin J. Welch

Thank you, Ric. To update you on our operations, I will begin by providing some details about our 2007 written premium. While we have experienced and continue to experience a decrease in written premium due to falling California rates and an increasingly competitive marketplace, we continue to grow our business profitably.

Our healthy growth in policy count is coming as a result of our continued focus on customers within lower hazard businesses. The four lowest industry defined hazard groups, A through D comprised 83.3% of our total base direct premiums written in 2007. This compares to 82% in these categories in 2006.

Our top ten classes of business continue to reflect these lower hazard groups and represent 33% of our base direct premiums written and 42% of our in-force policies.

For those of you who may not be aware, these top ten classes include restaurants, physicians’ offices, wholesale and retail stores, colleges, machine shops, clothing manufacturers, dentists’ office, and automobile dealerships, and repair centers.

Further, our policy growth in these top ten classes was consistent with our company-wide policy growth rate of 13.3%.

Our policy count growth was strong in California with an increase of 3,627 in-force policies for an annual growth rate of 17% since December 31, 2006. Nevada experienced a decrease in policy count of 376 or 5.8% due to increasing rate competition and our adherence to underwriting guidelines.

In states other than California and Nevada, we increased in-force policies by 706, a very healthy growth rate of 38%. Independent agents and brokers generated 69.5% of base direct written premiums in 2007, while our strategic partnerships generated 28.5%.

At year-end, we are contracted with over 950 agencies, earning an average policy commission of 10% to 12.5%. Our retention rates continue to be high, in the mid 80s to low 90s depending on the region. We continue to execute our strategy including growth in our new states and the pursuit of additional strategic partners.

In our last call, we announced our relationship with the California Restaurant Association as the workers’ compensation provider of choice for their members. CRA is the largest trade association in the United States, making them the voice for more than 88,000 eating and drinking establishments in California. Restaurants represent the single largest class of business that Employers writes, over $22 million of premium.

This month we are pleased to announce the sponsorship of Employers by the California Medical Association as the source for its members’ workers’ compensation coverage. Physicians’ offices represent the second largest class of business we write, over $20 million of premium. The support of these two associations in our two largest classes further validates our business focus and our strong market position.

As Doug mentioned, we anticipate closing our acquisition of AmCOMP sometime in the second quarter. In the meantime, we are engaged in integration planning and are excited about the growth and profitability potential of our new larger and more geographically diverse organization.

In addition to increasing our scale, the acquisition of AmCOMP will bring with it strong agency relationships, a successful track record of profitable growth and expansion, and a staff of experienced insurance professionals.

In summary, our insurance operations continue to drive a profitable result, derived from a quality book of business that we are growing selectively and strategically in our new and existing markets.

With those comments, I will turn the call back over to Doug.

Douglas D. Dirks

Thanks, Marty. Looking ahead the economic conditions in which we will operate in 2008 are uncertain. Ultimately, we sell a product the price of which is derivative of total payroll. A slowing economy or a reduction in employment will have a direct impact on workers’ compensation premiums, although we believe less so in our book of business.

We carefully monitor our book of business, as well as macroeconomic conditions for any signs that might indicate a change in business conditions.

Throughout 2008, we will continue to drive profitable growth by executing the strategies put in place over the past year. That is, our focus on selected markets with our targeted classes of business that we believe will provide greater opportunities for profitable returns.

We will continue to focus on disciplined underwriting, on maintaining a strong balance sheet, and on operating within the core values that have withstood the challenges of a changing market throughout this past year.

Thank you for joining us this morning. And now I will turn the call over to Eric to take your questions.

Question-and-Answer Session


(Operators Instructions). Your first question comes from the line of Robert Farnam - KBW.

Robert Farnam - KBW

One question on the California Restaurant Association, any progress on policies coming through that program yet?

Martin Welch

We just started that. That was late fourth quarter that announcement; we are seeing activity there, obviously it’s not huge numbers at this point in time and we are reporting on fourth quarter numbers. So, I really don’t have a whole lot to report there but we are pleased with the relationship and we do have activity.

Robert Farnam - KBW

Okay, I just was curious if it was going according to plan or not. But the second question, can you just remind us in terms of your capital position what type of premiums or surplus you are comfortable writing at?

William Yocke

If you look at the industry as a whole it’s drifted down given some of the reductions in rates across the country and profitability. And so it’s drifted to something more like to one to one which I think is historically low for the workers’ compensation line. We seek to be more industry-like and don’t think at one-to-one we would in any way be stretched or over levered.

Robert Farnam - KBW

Right. And third question, with the AmCOMP deal now that you maybe had a better chance to take a look at the policies; how much of that type book of business do you think fits into your underwriting profile and how much do you expect to renew going forward?

Martin Welch

We have looked into that. We did that as part of the due diligence, Bob, and we continue to do integration planning with AmCOMP. They have a book of business that is somewhat different than ours from a class selection standpoint, and it really has a little bit to do, I think, with the geographic nature of their book as well. We have no intention of taking their book of business and trying to make it look exactly like ours.

One of the attractions of this was that it does help us broaden our organization both geographically and from an appetite in what our book of business will look like. So there is no intention here to not continue with classes of business that AmCOMP has written successfully that perhaps we have chosen not to write in the past.

Robert Farnam - KBW

Okay. So if I were to characterize it, I’d say in taking a look at what they produced in the past might be, a good portion of that would probably hit your books in the second half of 2008?

Martin Welch

I think that would be a fair assumption.


Next question comes from the line of Adnan Alum - ADAR Investment Management.

Adnan Alum - ADAR Investment Management

I had a couple of quick questions. One was, was there any reserve releases or changes from that first three quarters of this year?

William Yocke

Yes there was: $40, $45 million; we had totaled $61 for the year, $16 of which is in the fourth quarter. So we had ratable reserve releases over the course of the year.

Adnan Alum - ADAR Investment Management

No, I actually meant in terms of the fourth quarter, were there any recognition of any changes from business written in the first three quarters?

William Yocke


Adnan Alum - ADAR Investment Management

There wasn’t? Okay, and also like your premium per policy that fell and I was just trying to get a handle as to how much of that do you think was due to mix versus rates and what was the mix shift?

Martin Welch

If I understand your question, you are trying to understand the reasons that our average policy size has fallen in 2007, is that correct?

Adnan Alum - ADAR Investment Management

Yes I am.

Martin Welch

That is partly driven by rate level, certainly in California which in 2007 was over 70% of our book; that has increased, that is decreasing our average policy size for the same customers we had the year before, and our focus on small just continues to drive more of that business into our book.

I don’t know that we can say that economically, yet, we are seeing the payroll impacts, impact that average policy size. It may have started a little bit in the fourth quarter, but it’s too soon to say absolutely we are certain of that.

Adnan Alum - ADAR Investment Management

And are you seeing less competition in the smaller accounts that you are targeting or is it still the same?

Martin Welch

We are seeing more competitions than we have in the past. But our contention has always been that in the small business market space that we target that we believe there is less competition and less rate sensitivity on that end of the spectrum than there is a middle market and larger.


(Operator Instructions) It appears we have no more audio questions at this time. I’d like to turn the call over for closing remarks.

Douglas D. Dirks

Thank you, Eric. Once again thank you everyone for joining us on our call this morning and we look forward to talking to you again at the end of the first quarter. Good morning.


Thank you for your participation in today’s conference. This concludes our presentation, and you may now disconnect. Have a good day.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.


If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!