National Atlantic Holdings Q4 2007 Earnings Call Transcript

| About: National Atlantic (NAHC)

National Atlantic Holdings Corporation (NAHC) Q4 2007 Earnings Call March 17, 2008 10:00 AM ET

Executives

James V. Gorman - Chairman and Chief Executive Officer

Frank Prudente - Chief Financial Officer

Bruce Bassman - Chief Operating and Actuary Officer

Dough Wheeler - General Counsel

Analysts

David Merkel - Finacorp Securities

Sam Kidston - North and Webster

Operator

Good morning everyone and welcome to the National Atlantic Holdings fourth quarter and year end 2007 financial results conference call. This call is being recorded and will include forward-looking statements. The forward-looking statements are subject to a number of risks and uncertainties that could cause actual results to differ materially. For more detailed discussions of these risks and uncertainties see the text under the heading quantitative and qualitative disclosures about market risks and the company’s most recent Form 10-Q. The statements made during this conference call are made only as of the date of the call and the company undertakes no obligation to update the forward-looking statements to reflect subsequent events or circumstances. At this time, I would like to turn the call over to the Chairman and Chief Executive Officer Mr. James V. Gorman Please go ahead sir.

James V. Gorman

Thank you operator. Good morning ladies and gentlemen and thank you for joining us. With me on today’s calls are Chief Financial Officer Frank Prudente, Chief Operating and Actuarial Officer Bruce Bassman and our General Council Douglas Wheeler. We are here today to discuss with you our financial results for the fourth quarter and full year ending December 31 2007, as well as Thursday’s announcement that we have entered into a definitive merger agreement to be acquired by a subsidiary of Palisades Safety and insurance association. Palisades is a New Jersey license insurance exchange. After a comprehensive process of reviewing the company’s strategic alternatives the management and board of directors of National Atlantic has determined that our merger with Palisade is in the best interest of shareholders and offers the best possible future for our partner agents, their policy holders and our employees.

We believe that the combination of our company with Palisades will produce a financially stronger, more competitive and more efficient operation. We expect the transaction to occur in the third quarter of 2008 subject to the approval of National Atlantic shareholders, certain regulatory approvals and the satisfaction or waiver of other closing conditions. Until then both companies will be operating independently and as competitors in the market place. Moreover federal antitrust laws including the Hart-Scott- Rodino Act plays limitation on the type of public disclosures and business changes that a buyer and seller can make prior to the closing of the merger. As a result long-term marketing strategies, competition, and other issues cannot be addressed at this time, but more information will be released as it becomes available.

Now turning to our financials, our results for the fourth quarter and full year ended December 31 2007 reflect in part the issue we identified in our BI claims operations in last year’s third quarter and which we discussed during our last quarterly conference call.

Since our initial public offering in April of 2005, the company has experienced quarterly earnings volatility related to changes in reserves for third-party auto liability claims. To address this issue in 2006, we began implementing changes in our auto liability claims reserving methodology which were to be fully effective by the third quarter of 2007.

However, there was inconsistent application of these new reserving practices which has led to the reporting of higher than expected losses on a calendar year basis in the later half of 2007. A substantial portion of these losses were factored in to our third quarter results, but some of the impact continued in to our fourth quarter and partially contributed to the net loss of $2.1 million or $0.19 per share fully diluted for the quarter and a loss of 6.2 million or $0.56 per share diluted for the full year ending December 31 2007.

Our financial results for the year suffered significantly as a result of this problem and we have been focused upon our primary goal to restore profitability rapidly. Our financial results for 2007 also reflected difficult pricing environment experienced by the property casualty industry as a whole during the year both nationally and here in New Jersey. Auto and new homes sales have been on the decline and auto accident frequencies have increased in each and every quarter during 2007.

In support of our profitability goal, we have filed for auto rate increases to allow us to restore profitability more quickly. We believe that we have recognized the need for and achieved the rate increases earlier than our competitors, and believe that others in the industry are taking similar actions.

On a more positive note, our other lines of business continue to perform well in the fourth quarter both in terms of top line growth and profitability.

For the full year 2007, our homeowners business was up 27.2% and our commercial lines business was up 21.5% in terms of direct written premiums. Our loss ratios were 54.9 for homeowners and 57.3 for commercial lines for the year. Workers comp is off to a good conservative start and this line also ended up at a profitable level for the year. I would now like to ask our Chief Financial Officer, Frank Prudente to review the quarterly financials. Frank?

Frank Prudente

Thank you, Jim. As we stated in our press release that we issued earlier this morning, our net loss for the three months ended December 31 2007 was 2.1 million or $0.19 a share diluted compared with net income of 3 million or $0.26 a share diluted for the same period in 2006. Net losses for the full year ended December 31, 2007 were 6.2 million or $0.56 a share diluted compared with net income of 14.4 million or $1.26 per share diluted for the same period in 2006.

Book value per share decreased to 3.5% to $13.10 as of December 31, 2007 from $13.57 as of December 31 2006 and our tangible book value per share was $11.38 as of December, 31 2007 down from $11.89 as of December 31 2006.

In addition, our press release outlines our weighted average common shares outstanding for the quarter and for the year. Total revenues for the three months ending December 31, 2007 increased by 2 million or 4.4% to 47.2 million from 45.2 million for the three months ending December 31, 2006. Total revenues for the year ending December 31, 2007 increased by 8.4 million, or 4.8% to 184.3 million from 175.9 million for the year ending December 31, 2006. For the three months ended December 31, 2007 our direct written premiums increased by 1.9 million or 5.3% to 37.5 million from 35.6 million in the comparable period in 2006.

For the three months ending December 31, 2007 the increase is primarily due to the following: New business generated by our partner agents decreased by $0.07 million to 4.8 million from 5.2 million in the comparable 2006 period including new business from our BlueStar auto insurance product and the amount of 3.1 million. This was offset by attrition of existing business of 4.1 million and 2.5 million respectfully as well as 1.2 million increase in premiums as a result of increases in renewal premiums during the period. Direct written premiums for the year ended December 31, 2007 increased by 7.6 million or 4.4% to 178.7 million from 171.1 million in the comparable 2006 period.

For the year ended December 31, 2007 the increase is due primarily to the following. New business generated by our partner and agents increased by 3 million to 34.4 million from 31.4 million in the comparable 2006 period including new business from our BlueStar car insurance product and the amount of 8.7 million. This was offset by attrition of existing business of 9.5 million and 7.3 million respectfully as well as a 17.3 million decrease in premium as a result of decreases in renewal premiums during the period and a reduction in closed agents business.

Net written premiums for the three months ended December 31, 2007, increased by 1.5 million or 4.5% to 34.7 million from 33.2 million in the comparable 2006 period. Ceded premiums as a percentage of direct written premiums for the year ended December 31, 2007, was 7.9% as compared to 7.2% in the same period in the prior year. The increase in net written premiums for the three months ended December 31, 2007, was due to the increase in direct written premiums for the same period.

Net written premiums for the year ended December 31, 2007, increased by 5.1 million or 3.2% to 166.2 million from 161.1 million in the comparable 2006 period. Ceded premiums as a percentage of direct written premiums for the year ended December 31, 2007, was 7.2% as compared to 6.5% in the same period in the prior year. The increase in net written premiums for the year ended December 31, 2007, was due to the increase in direct written premiums for that same period.

Net earned premiums for the three months ended December 31, 2007, increased by 2.2 million or 5.4% to 42.6 million from 40.4 million in the comparable 2006 period. Net written premiums for the year ended December 31, 2007, increased by 7.8 million or 5% to 165.2 million from 157.4 million in the comparable 2006 period.

Investment income for the three months ended December 31, 2007, increased by 0.2 million or 4.8% to 4.4 million from 4.2 million in the comparable 2006 period. Investment income for the full year December 31, 2007, increased by 1.2 million or 7.5% to 17.3 million from 16.1 million in the comparable 2006 period. This increase was primarily due to an increase in invested assets. Average invested assets for the year ended December 31, 2007, increased to 11.6 million or 3.7% to 323.1 million from 311.4 million in the comparable 2006 period.

Loss and loss adjustment expenses incurred for the three months ended December 31, 2007, increased by 13.3 million were 47.7% to 41.2 million from 27.9 million in the comparable 2006 period. This increase can be attributed to an increasing claims frequency and private passenger automobile coverage and strengthening of prior reserves by 7.6 million. As a percentage of net earned premiums, loss, and loss adjust expenses incurred for the 3 month ended December 31, 2007, were 96.7% as compared to 69.1% for the 3 month ended December 31, 2006. The ratio of net incurred losses excluding loss adjustment expenses and net earned premiums during the 3 months ended December 31, 2007, was 88.5% compared to 53.0% in the comparable 2006 period.

Loss and loss adjustment expenses incurred for the year ended December 31, 2007, increased by 41.3 million or 39.8% to 145.1 million from 103.8 million in the comparable 2006 period. This increase can be attributed to an increasing claims frequency and private passenger automobile coverage and strengthening of prior reserves by 19.6 million. As a percentage of net earned premiums, loss and loss adjustment expenses incurred for the year ended December 31, 2007, are 87.8% compared to 66.0% for the year ended December 31, 2006.

The ratio of net incurred losses excluding loss adjustment expenses to net earned premiums during 2007 were 76.3% compared to 61.5% for the comparable 2006 period. For the 3 month ended December 31, 2007, we increased results for prior years by 7.6 millions. This increase was primarily due to adverse development and the auto liability line including bodily injury and no-fault for the year ended December 31, 2007, we increased reserves for prior years by 19.6 million. This increase was primarily due to increases in prior year reserves for oral bodily injury coverage, which increased by 22.2 million. This increase was due to an inconsistent implementation of a revised claim reserving policy that was uncovered during the third quarter of 2007. Prior year reserves for other liability line increased by 3.6 million, which was offset by favorable development of 4.6 million in no-fault coverages and 1.6 million in commercial auto liability. For the 12 months ended December 31, 2007, our statutory combined ratio 117.31% as compared with 96.09% for the 12 months ended December 31, 2006. To break out the ratios for the period, our statutory loss ratio was 90.34% as compared to 69.16% in the full year of ’06. Our statutory expense ratio was 26.97% for the full year ’07 compared to 26.93% for the full year of 2006.

I would also like to report on the status of our ongoing share repurchase program which was initiated in early July of 2006 subsequent to the end of the second quarter. The board of directors authorized on July 5, 2006. The repurchase of the minimum of 200,000 shares and a maximum of 1 million shares of capital stock of the corporation within a 12 month period.

On May 24, 2007, the Board of Directors authorized a one year extension to our buyback program. As of December 31, 2007, the company had repurchased 418,303 shares at an average price of $10.26. I would now like to turn the call over to Bruce Bassman our Chief Operating Officer.

Bruce Bassman

Thank you Frank. First I will comment on our loss reserves. Reserves for prior years was strengthened by an additional 7.6 million in the fourth quarter. Of this amount, 4.5 million was due to the strengthening of our direct reserves. While an additional 3.1 million was due to reduction in ceded loss estimates recoverable from our re-insurance. Most of the strengthening occurred in auto liability as a result of the complete file review conducted in the fourth quarter by our client staff with the assistance of outside client consultants. Our external auditors performed a comprehensive independent actuarial review of the company’s reserves, and provided further validation that the company has taken the appropriate actions. In addition, the loss and allocated expense ratio for accident year 2007 increased slightly from 72.7% as of the third quarter to 72.9% at year end 2007.

Increases in private passenger liability and commercial property were partially offset by reductions in homeowners and commercial causality lines. Pricing activity has accelerated in the fourth quarter and in to 2008, we are currently seeing increases of 6% to 8% in our auto renewals and this will increase further with the most recent approval of an additional 10% effective later this month. Retention of our business has declined modestly, but is better than projected. In homeowners we received approval for an additional 7% rate increase focused on properties in wind-prone areas, where rates are increasing more than 25%. Modest reductions continue in commercial lines, but are supported by profit margins that we are achieving in these lines.

In our third quarter call, I highlighted the Claim Department issues that led to the reserve problem in auto bodily injury. Today, I can report that the recommendations made by our outside claim consultants have all been implemented and all claim files have been reviewed and dairies updated by our adjusters and supervisors. In addition, we hired Tom Glowacki as Vice President of Claims in January. Tom has spent virtually all of his carrier in the New Jersey Claims Arena and his impact is already being felt. Our accelerated bodily injured claim settlement activity which began in the third quarter increased further in the fourth quarter.

Late in the fourth quarter 2007, we outsourced property damaged liability and bodily injury claims in order to stabilize the workloads of our claim staff. Overall nearly 800 property damage files and approximately 500 bodily injured files were outsourced. This has resulted in more timely settlements of auto liability claims. We are confident that the new procedures and practices in the Claim Department will have a favorable impact on average claim costs.

I’ll now turn the call back to Jim.

James Gorman

Thanks Bruce. I would like to reiterate that our main focus in 2008 is to restore profitability as quickly as possible. Management has developed a profitability improvement plan which was implemented in January and we are optimistic that we will begin to see the results of that plan in the very near future. We believe that the rate increases in our auto line they became effective in March will expedite our return to profitability. The higher rates may costs us some top line growth in the short-term, but our primary focus is to steadily improve our bottom line in the second, third, and fourth quarters of 2008. We continue to monitor all of our lines of business and improve pricing on all products when possible. We have reduced staff in other operational costs to help reduce expense ratio. We are disappointed with the losses for the quarter in the year, and we are cautiously encouraged by the improvements made throughout our organization and are focused upon a significantly better 2008.

Operator, I will now open up the floor to questions.

Question-and-Answer Session

Operator

Thank you, sir. Today’s question-and-answer session will be conducted electronically. (Operator Instructions). We’ll go first to David Merkel of Finacorp Securities.

David Merkel - Finacorp Securities

Hi, Hello.

James V. Gorman

Good morning, David.

David Merkel - Finacorp Securities

Very good. I wanted to ask a little bit about the, you had a number of parties go over your reserves, three and all I believe and how, I would assume at this point you are rather certain that you have been able to clean up most of reserving problems particularly given what was happening in your claim department prior to, I guess September 2007? Can you walk us through that one more time?

James V. Gorman

Yes, we have taken a very hard look at the claim review process, within the claim department. We have modified the procedures, we have updated our diaries. And when you go through a change like this, your historical information and your typical loss development patterns are no longer appropriate to use.

David Merkel - Finacorp Securities

Right.

James V. Gorman

In estimating alternates. So, we had to rely heavily on projecting the open, ultimate number of claims that will be paid and the severity associated with those clients. And I think our review that was done as well as that done by our external auditors have focused on looking at average claim cost as opposed to looking at normal loss development methods.

We continue to look very closely, as part of our quality control process to make sure that the adjusters are in fact keeping claims up to date that we are managing them affectively and that we are in fact putting in place an aggressive settlement policy to move these claims off of our balance sheet. So, we are cautiously optimistic that we have our arms around, our ultimate liabilities. But, obviously there is no guarantee but we have scrubbed this thing it from many different angles.

David Merkel - Finacorp Securities

Great, well that’s good. The re-insurance recoverable change, it was $3.1 million or something like that? What was that about?

James V. Gorman

While we project our direct loses, we also project how much is going to commend in ceded loses and you know based upon our current retention as a company we’ve retained the first 500,000 of loss the emergence of ceded losses is very slow to develop.

David Merkel - Finacorp Securities

Right.

James V. Gorman

And we have looked more carefully at our projected reinsurance recoverables and determined that we are not going to be in a position to collect as much as we had previously thought. This is not connected at all to any reinsurance recoverable on paid clients.

David Merkel - Finacorp Securities

Yes got it.

James V. Gorman

This is based on projected losses.

David Merkel - Finacorp Securities

Okay. Last question, do you have side of your balance sheet, you know, there is a decent amount of turmoil out there now, with respect to various types of AAA structured product and I know you didn’t do that much with subprime or anything like that. But, what are you experiencing if anything on the asset side of your portfolio at present, I assume that it’s just ordinary payments of cash flows from your mortgage bonds and other assets, because you have a fairly high quality portfolio we use the way the rating agencies rate them. Are you experiencing any difficulties there at all?

James V. Gorman

Well, I’ll start that answering your question David and then I’ll turn it to Frank, but from the investments, I would like to just further assure our investors that we have absolutely no subprime exposure. In addition, any bond that we have is A or better on its own merits without the effective any MBIA or AM backed insurance less to the rating, further we have no equities in our portfolio. So, on the investment side, I think that we are pretty planned and pretty solid and we had a great yield in ’07 given all of the decrease in interest, average interest rates. Frank can you add anything to that on the balance sheet.

Frank Prudente

I think you well covered it I may I think we felt for a long time, we have a conservative portfolio and with a disruption we’ve seen in the market it’s evident it’s conservatism by us not having any issues.

David Merkel - Finacorp Securities

Well, thank you gentlemen. I appreciate it and I will be looking forward to any releases that described the logic for the $6 in a quarter purchase price. So, I thank you both.

James V. Gorman

Thank you, David.

David Merkel - Finacorp Securities

Take care.

Operator:

We will take our next question from Sam Kidston of North and Webster.

Sam Kidston - North and Webster

Yeah, hi guys. I may have missed earlier but, do you have a date, when you plan on getting a proxy out?

James V Gorman

Proxy is crawling under development and we will be placing it out once approved. That’s about all I can tell you.

Sam Kidston - North and Webster

Thank you.

Operator

And Mr. Gorman, there are no further questions at this time. So, I will turn the call back over to you for any additional or closing remarks.

James V Gorman

Thank you, Operator. And thank you to all of our shareholders and this will conclude our call today. Thank you and goodbye.

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