EMC Insurance Group Inc. Q2 2008 Earnings Call Transcript

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 |  About: EMC Insurance Group, Inc. (EMCI)
by: SA Transcripts

Operator

Greetings and welcome to the EMC Insurance Group Inc. second quarter 2008 earnings results call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. (Operator instructions) As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Ms. Anita Novak. Thank you, Ms. Novak, you may begin.

Anita Novak

Thank you, Melissa. Good morning, everyone and welcome to EMC Insurance Group’s 2008 second quarter earnings call. A supplemental investor packet is available on the Investor Relations page of our web site, which can be found at www.emcinsurance.com. The webcast for replay purposes is also available at this site until October 24. 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 suggested by our comments today. Additional information about factors that could affect future results is addressed in our SEC filings, including forms S-1, 10-K, 10-Q, and 8-K. Any information provided today should be read in conjunction with the 2008 second 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 Financial Officer; Mr. William Murray, Executive Vice President and Chief Operating Officer; Mr. Ron Jean, Executive Vice President for Corporate Development; Mr. Steven Peck, Senior Vice President, Actuary; Mr. Rich Schulz, Senior Vice President, Claims; Mr. Ray Davis, Senior Vice President, Investments and Treasurer; and 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

Thank you, Anita.

We reported a net operating loss of $0.09 per share this morning for the second quarter of 2008 and a second quarter combined ratio of 116. While that is high, it is important to note that our underlying book of business is performing reasonably well and consistent with expectations, given the competitive state of the insurance buying market.

When comparing this quarter to prior quarters, we noticed some interesting details. We have been reporting financial results for 106 quarters. Of those 106 quarters, only 13 have produced operating losses, with four of those quarters being second quarters. Given that we are headquartered in the Midwest, it’s not surprising that all four of those second quarter losses, including second quarter 2008, have resulted from heightened Midwestern storm activity. Second quarter 2008 is somewhat unique, however, in that the record $1.12 per share of storm losses we incurred was 65% higher than the previous record of $0.68 per share incurred in the second quarter of '01.

In recent weeks, we have released quite a bit about the 2008 storms and we have responded to numerous questions as well. It seems to be a topic on most peoples’ minds. Therefore, I would like to speak briefly about some of those issues.

Parkersburg, Iowa and other severe storms: The most significant weather event of the quarter occurred on May 25, 2008. An EF5 tornado struck the southern half of the small community of Parkersburg, Iowa, killing eight people and destroying or damaging hundreds of homes, businesses and other personal properties. EMC insured the Aplington-Parkersburg High School, which suffered a direct hit by the tornado resulting in a total loss. The company received nearly 1,600 claims associated with the storm system that produced the Parkersburg tornado. We are proud to report that all of the claims associated with this storm system have been adjusted and 90% of those claims have been paid, many within days of the event. Losses from this storm system totaled $0.41 per share. Since all claims have been adjusted, we do not expect any further development associated with this event.

There were many other Midwest storms during the quarter, some of which had a significant impact on second quarter results; however, none of those events were of the magnitude of the storm system that hit Parkersburg. These storms were in Colorado, Nebraska, Kansas, Minnesota, Missouri, Oklahoma and Arkansas. An additional 1,900 claims were submitted as a result of these storms. As was the case with the storm system that devastated Parkersburg, 90% or better of the claims have been paid. The cumulative impact of these storms was approximately $0.44 per share. All other catastrophe and storm losses, including those associated with our reinsurance segment, accounted for an additional $0.27 per share.

Iowa Flooding: Given the global media coverage associated with the devastating Iowa floods this year, it is logical to question whether the company had a direct exposure to these events. Generally speaking, the company does not insure flood damage, although a few of our products do offer a limited amount of flood protection. Most of our exposure is associated with sewer backup and sump pump failure. We did receive a number of claims associated with these types of losses. Our total flood related losses amounted to less than $800,000.

California Wildfires: The company does not have significant exposures in California and therefore considers the wildfires to be a non-event for the company.

As we mentioned in our press release earlier today, catastrophe and storm losses added 24.3 percentage points to our combined ratio for the second quarter. Over the course of the last decade, catastrophe and storm losses have annually averaged 5.4% of earned premiums. Assuming normal storm activity for the remainder of the year, we are currently projecting that catastrophe and storm losses will approximate 11.5% of earned premiums.

Diversification: The question one might ask is whether or not we have overly concentrated our book of business in any one geographic region. The answer is, no, we have not. Midwestern storms occurred over a very wide geographic region and have affected several of our branch offices. As with many insurance companies this year, we have simply seen a significant increase in wide-spread storm activity.

I would like to mention that of our 16 branches, nine have not been significantly impacted by second quarter storms and in each of those instances the branch’s combined ratio reflects a profitable result. Bottom line, the second quarter saw heavy storm losses.

With that, I will call on Mark Reese, Senior Vice President and Chief Financial Officer, to discuss the financials for the quarter. After that, we would be happy to answer any questions.

Mark Reese

Thank you, Bruce.

Record storm losses during the second quarter resulted in a second quarter operating loss of $1.2 million compared to the record second quarter operating income of $13.8 million reported in the second quarter of 2007. Net loss for the second quarter totaled $940,000 compared to net income of $14 million in 2007.

In addition to the record storm losses, the operating and net loss for the second quarter reflect an expected decline in the amount of favorable development experienced on prior years’ reserves, and a moderate, but steady, decline in overall premium rate levels. In addition, the net loss reflects $1.7 million of other-than-temporary investment impairment losses recognized on seven securities in the company’s equity portfolio. These impairment losses were recognized because the company’s equity manager indicated that these securities, which were in an unrealized loss position, would likely be sold before they could recover to their cost basis. As a result, the intent to hold these securities to recovery did not exist.

Net written premiums decreased 2.8% to $187.8 in the first six months of this year. This decrease reflects declines of approximately 2.9% in both the commercial lines and personal lines of business in the property and casualty insurance segment and a 2.4% decline in the reinsurance segment. The decline in the reinsurance segment was primarily driven by premium rate declines and the loss of a few accounts. For the first six months of 2008, new business premium was down 10.3% in commercial lines and up 11.8% in personal lines, with much of the increase in the personal lines coming in select territories with greater profit potential.

Catastrophe and storm losses in the second quarter more than doubled to a record $23.5 million or $1.12 per share from the $9.8 million or $0.46 per share in 2007. The previous record for catastrophe and storm losses occurred in the second quarter of 2001, when Midwest storms generated $11.7 million or $0.68 per share of losses. Over a third of the second quarter storm losses were generated by the powerful storm system that devastated Parkersburg, Iowa. For the first six months of 2008, catastrophe and storm losses totaled $1.39 per share compared to $0.58 per share in 2007.

Investment income increased 3% to $12.0 million for the second quarter and 1.3% to $23.9 million for the first six months of the year. These increases are primarily due to higher average invested asset balances.

The total rate of return on our equity portfolio for the first six months of 2008 was negative 7.39%, which compares favorably to the negative 11.91% generated by the S&P 500. During the second quarter, our equity portfolio returned 3.19% compared to negative 2.73% for the S&P 500. The current annualized yield on our bond portfolio in cash is 5.27% and the effective duration is 5.11 years, which is up from 4.76 years at March 31, 2008.

Based on actual results for the first six months of 2008 and our expectations for the remainder of the year, management is reaffirming the 2008 annual operating income guidance of $1.20 per share to $1.45 per share that was announced on July 3.

On March 10 of this year, the company’s Board of Directors authorized a $15 million stock repurchase program. This program became effective immediately and does not have an expiration date. The timing and terms of the purchases are determined by management based on market conditions and are conducted in accordance with the applicable rules of the SEC. Common stock purchased under this program is being retired by the company. As of June 30, approximately 255,000 shares of stock had been repurchased at a cost of $7 million. Additional repurchases have been made during the month of July, bringing the total as of July 16 to approximately 325,000 shares at a cost of $8.7 million. Employers Mutual has about $4.5 million remaining in its $15 million stock purchase program. This program will remain dormant while the company’s repurchase program is active.

At this time, I would like to open the phones for questions.

Question-and-Answer Session

Operator

Thank you. We will now be conducting a question-and-answer session. (Operator instructions) Our first question comes from Mr. Bob Barnum with KBW. Please proceed with your question.

Bob Barnum – KBW

Thank you and good morning. I have a couple questions more on the competitive landscape, you have the two accounts or few accounts on the reinsurance side that you lost. Can you give more details as to what type of accounts those were and where they went?

Bruce Kelley

Bob, you are talking about the reinsurance?

Bob Barnum – KBW

The reinsurance, right.

Bruce Kelley

Okay. Ron?

Ron Jean

I don't have the specifics with me right now, but my general recollection is that those accounts were, in a couple of cases, were companies that were acquired by another company and so the reinsurance was moved to the –

Bob Barnum – KBW

Existing.

Ron Jean

To the existing programs.

Bob Barnum – KBW

Okay. And in terms of just the general property/casualty landscape out there, are you seeing rates stabilize? Are they still going down? Can you give us more flavor as to what the rate environment looks like?

William Murray

Bob, this is Bill Murray. I don't know that we have seen significant changes in the pricing landscape. Even though, for example, we have had significant Midwestern storms, it seems to be fairly competitive in the Midwest, as it has been. Through our Branch office structure, obviously we continue to monitor that competitive landscape and hopefully we are responding appropriately if that changes going forward.

Bob Barnum – KBW

Okay. And do you see new players coming into the market at all or has that pretty much subsided at this point?

William Murray

We still continue to see what we had viewed in the past to be primarily regional companies doing business in maybe a limited number of states. We continue to see those particularly in some of the higher growth areas in the West, and that adds to the competition of course that we were already experiencing.

Bob Barnum – KBW

Okay. That's it for me right now. I will get back to you if I have more. Thanks.

Operator

(Operator instructions) There are no further questions at this time.

Anita Novak

Thank you, Melissa. 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 website at www.emcinsurance.com until August 7 and a transcript of this conference call will be available until July 2009. We appreciate your interest in EMC Insurance Group and all of us wish you an enjoyable day.

Operator

This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.

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