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Baldwin & Lyons, Inc. (NASDAQ:BWINB)

Q2 2008 Earnings Call

July 31, 2008 11:00 am ET

Executives

Scott Epstein – Financial Relations Board

Gary W. Miller – Chief Executive Officer

Joseph J. Devito – President and Chief Operating Officer

G. Patrick Corydon – Chief Financial Officer

Analysts

John Quinn – Morgan Keegan

Operator

Welcome to the Baldwin & Lyons, Inc. second quarter 2008 earnings conference call. (Operator Instructions) At this time for opening remarks and introductions I would like to turn the call over Scott Epstein of the Financial Relations Board.

Scott Epstein

If you did not receive a copy of the press release, you may access it online at the company's website, which is www.baldwinandlyons.com. I would like to remind everyone that we are hosting a live webcast for the call, which may be accessed on the company's website as well.

At this time, management would like me to inform you that certain statements during this conference call and in the press release which are not historical may be deemed forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Although Baldwin & Lyons believes the expectations reflected in any forward-looking statements are based on reasonable assumptions, it can give no assurance that its expectations will be obtained. Factors and risks that could cause actual results to differ materially from expectations are detailed in the press release and from time to time within the company's filings with the SEC.

And now I'd like to introduce Gary Miller, Chairman and Chief Executive Officer of Baldwin & Lyons, and turn the call over to him.

Gary W. Miller

Joining me on the call this morning are Joe Devito, President and Chief Operating Officer of the company, and Pat Corydon, Executive Vice President and Chief Financial Officer.

We have changed the format of this call a bit from the manner we have handled calls in the past, that will allow you to get better acquainted with Joe Devito, our President. This morning I will give a short and very broad view of the just completed quarter’s results. Joe will expand on that and provide details on our operating results by product line, some restructuring changes we have made and what we might expect for the rest of the year and beyond. Pat will then go into more detail regarding our investment results and present some of the ratios and numbers you normally expect to hear. As always, the three of us will be happy to entertain any questions you might have at the end of our presentations.

Increased premium volume and a stellar consolidated combined ratio of 86.2%, or 84.9% if fee income is considered, offset an expected decline in investment income and allowed us to register the second best quarterly results from operations in the company’s history. From operations we made $8.2 million after tax, or $0.54 per share, for the second quarter.

Net income was reduced to $6.3 million, or $0.41 per share, where we had net investment losses of nearly $2.0 million, or $0.13 per share. As you will recall, those net investment losses include actual realized losses in our investment portfolio plus realized and unrealized losses in our limited partnership holdings.

You may also recall that we had a tough first quarter with underwriting results being less than we normally expect and a large investment decline that further hurt our income statement. So as our six-month figures include those first quarter results we are reporting just $0.11 per share in net income for the six months, although operating income was $0.82 per share for the six-month period.

Our gross from our net investment losses are $2.0 million for the quarter. In addition, our decline in unrealized gains was a tax-affected $5.2 million reflecting our inability to avoid the overall market decline for the quarter. Because those losses and value decline were not offset by the quarter’s income, book value per share declined by $0.14 for the quarter and at June 30, 2008, stood at $24.09 per share.

During the quarter we were active in buying treasury stock and purchased 198 shares at an average price $21.35 per share. Since we bought for under book value, that actually added to book value by $0.05 per share. We have approximately 2.8 million shares still authorized for purchase under the Board’s current authorization.

Joe will give you further details regarding our expansion of products and expansion of volumes in certain lines. Pat will fill in details on the financials.

I would mention we have reached a handshake deal on the purchase of a small trucking insurance agency that does about $20.0 million in premium volume. We believe the agency should be a profit center for us, continuing as an agency. We also see some synergies in that some of the business written by the agency might be placed with our insurance companies. Due diligence is in process and we will provide further details, if the transaction goes to completion, in our next conference call.

We continue to look for expansion opportunities through internal growth of existing lines, new lines, and acquisitions. We will have more to say on those items in future calls.

And now I will turn the call over to Joe Devito for more details on our insurance operations.

Joseph J. Devito

Before I review the details of our insurance operations I will briefly review the realignment of management that has taken place over the last 18 months. During prior conference calls I have mentioned that our strategy over that period of time has been to expand the breadth of product offerings so that we might better position ourselves to manage through cycles instead of around them.

Our intent is to do so via a combination of acquisitions, internal growth, expansion of existing partnerships, and the development of new ones at both the distribution and risk-taking levels. Therefore, in order to expand the organization horizontally it became necessary to realign the management structure vertically.

Historically we have developed a structure around operating units rather than functional areas. Basically, we had management at the product level with the parent providing a variety of services, usually finance, accounting, HR, and IT. Maintaining that structure became less relevant and efficient as our offerings grew. Today the integration is complete and we now have a more effective, flexible, and nimble organization with officers and executives responsible for each functional area at the parent company level including all companies and product lines.

This structure allows us greater opportunities to grow our company, distribute our products, leverage expenses, allocate resources, and maximize profits. I would be more than happy to expand on this high-level outline during the Q&A session.

Turning to the insurance operations, our fleet transportation business performed very well this quarter. Direct written premium was up 24% from the second quarter of 2007 and 35 over the first quarter of 2008. That growth was concentrated in the independent contractor programs which grew 41% year-over-year and 7% from the prior quarter. The higher volume came mainly from additional premium and participation from existing customers but did include the addition of a few accounts as a result of our newly launched IC2 product.

The combined ratio in the second quarter for fleet transportation, which now includes public transportation, was 86%, almost exactly level with the second quarter of 2007 and 22 points better when compared to the 108% reported for the first quarter of 2008, mainly due to a reduction in loss ratios related to our independent contractor programs from 81.5% to 62%. The components shifted a bit with the loss ratio increasing slightly when compared to the same period last year, 56% to 52% but the expense ratio declined from 34% to 30%.

Regarding this segment’s insurance market conditions, competition remains strong and pricing is soft. Our strategy to continue to add value via the addition of new products and continuing the enhancement of our risk management, safety, loss prevention, and claims services, allows us to retain our core accounts and provides us an opportunity to expand despite the continuing pricing pressures and competitive environment.

Relating to the trucking industry in general, the overall climate reflects both a weak freight environment and continued economic uncertainty. In comparing year-to-date revenues for those customers reporting on that basis, revenues are up 4.3% year-over-year. If you exclude the largest five accounts revenues are down 3.7%. There is, of course, a variance based upon size, sector, focus, and geography. However, we consider our accounts to be among the most stable, financially sound in the industry and they should be better prepared to endure the current survival-of-the-fittest environment.

An ancillary benefit to us may be that in general there are more drivers available and the best ones should be attracted to the best operators.

Reinsurance assume, which now reports through our finance department and Pat Corydon, who was named Executive Vice President in addition to this role as CFO in February, also experienced solid growth.

Direct written premiums were up 23% over the second quarter in 2007 and 14% in comparison the first quarter of 2008. The loss in LAE ratio of 50.5% compares to a similar 49% in the same period last year. Combined ratio for the quarter was 71%. The year-to-date combined ratio of 62% is a six point improvement over last year’s 68%, mainly due to a 7 point improvement in the year-to-date loss ratio.

Upon completion of our prepared remarks Pat Corydon can answer any questions related specifically to the results of this line of business.

The personal and commercial insurance products currently written by Sagamore Insurance Company remain under significant volume pressure due to continued soft market conditions. Rate cutting, direct marketing, and ever-increasing advertising expenditures by competitors create an extremely difficult environment.

Despite continued increased promotions and marketing efforts, including selective rate adjustment and the development of new products and programs, volume declines continue. Overall volume is down 30% over the same period last year and 38% from the first quarter of 2008. The second to first quarter drop is somewhat consistent with other years due to seasonal fluctuations associated with the business. Overall, year-to-date direct premiums are down 33%.

The overall Sagamore moss in LAE ratio for the second quarter improved from 64% to 61% but that gain was exchanged for a 4 point increase in the expense ratio from 35% to 39% resulting in a combined ratio of 99.8% compared to 98.6% in the second quarter of 2007, before consideration of fee income. Including fees, this quarter’s combined ratio of 94.6% is almost identical to last year’s 94.3%. The year-to-date combined ratio before fees is 102% versus last year’s 97%, almost the entire difference being a 4% increase in the expense ratio from 36% to 40%. Adjusted for fees, the six months of 2008 has produced a combined ratio of 96.4% compared to 92.9% last year.

We continue to make every effort to stem the loss of volume be recognize the difficulty of doing so in the current environment. We will, and do, remain committed to profitability as we navigate through these difficult market conditions.

The restructuring that I mentioned in my opening should allow us to spread certain resources among products more efficiently and thereby utilize our infrastructures, systems, and talent where we find growth opportunities. On an ongoing basis these lines of our business are also impacted by external economic forces.

Regarding personal auto, gasoline prices definitely appear to have impacted miles driven, especially relating to our book of current insurance. Frequency and overall loss costs may be trending downward. Severity continues to slowly tick upward, but nothing dramatic. As to small fleet, new volume business is down and cancellations are up, definitely being impacted by the general decrease in freight volume which impacts the small fleet first and hardest and the aforementioned increase in fuel prices.

At this point I should note a potential future change in reporting. Due to the nature of the restructuring and complete integration of all departments, starting with the third quarter of 2008 we may no longer be reporting combined ratios for all products on an individual basis. The underwriting, marketing, and claims departments of all divisions have been absorbed into B&L’s overall operations. Therefore, it may no longer be efficient, necessary, or relevant to report in that manner. We will, however, continue to report loss ratios for these lines of business as we have in the past.

Overall, on a consolidated basis, direct written premiums for all of the Baldwin Company’s was up 15% quarter-over-quarter and 9% year-over-year. The consolidated loss ratio for the second quarter of 2008 is 56.4%, up slightly from the 2007 second quarter of 54.7% and is 60.8% for the six months compared to 57.7% last year. This quarter’s loss ratio is a 9 point improvement from the first quarter’s 65.3%.

Consolidated expense ratios for the 2008 periods are comparable to the prior year, producing a combined ratio of 86.2% for the second quarter of 2008 and 92.2% for the year-to-date. These results compare with combined ratios of 86.2% in the second quarter of 2007 and 87.2% year-to-date. Fee income would reduce all of the above combined ratios by about 1.5 points.

Again, our strategy for profitable, premium growth is working, although not yet at the pace that we would like to see, mainly due to extremely difficult insurance market and overall economic conditions. Our fleet transportation segment is strong, with the independent contractor programs growing and receiving great market acceptance. The reinsurance assumed business is performing well and most likely we will continue to expand current relationships and seek new ones. The Sagamore products continue to be a challenge but the overall loss ratios are acceptable and our new management alignment should allow us to control and perhaps reduce expense ratios as we continuously seek opportunities to scale up to higher premium volumes.

Finally, I will report on some exciting new developments. Our public transportation product now has approximately 2.0 million premium in force consisting of about a half a dozen accounts. We have completed licensing and capitalization for protective specialty in access and surplus lines insurance company domiciled in Indiana. We have formed B&L Brokerage, which is generating revenues by providing risk management services to both trucking and public transportation fleets in the areas of technology, safety, and claims.

As Gary mentioned, we have signed a letter of intent to purchase a Midwestern insurance agency specializing in transportation risks. This may be a platform for us to continue to acquire additional agents and/or brokers providing opportunities for both commission and perhaps premium income.

At this time I will turn it over to pay Corydon, our Executive Vice President and CFO, who will report on investments and investment-related activities.

G. Patrick Corydon

Pre-tax investment income for the second quarter is identical to the first quarter total of $4.2 million. The individual components of investment income changed slightly as short-term interest rates declined significantly from the first quarter but redeployment of assets generated higher income to offset the lower short-term rates. After-tax investment income was similarly level quarter-to-quarter.

Compared to the prior year, pre-tax investment income is down 14% for both the second quarter and six-month period. The primary components of this decrease are the significant declines in short-term interest rates and redeployment of assets into tax-exempt bonds and new investment vehicles, including Maritan, which generate less current income with the expectation of long-term gains. After-tax investment income decreased only 9% for the quarter, at 8% year-to-date, on essentially level average invested assets reflecting the impact of municipal bonds.

There were no significant changes to our average duration or contractual life of our bond portfolio since year end. Yields on our bond portfolio have declined much more modestly since year end, however, bonds purchased this quarter produced a 27 basis point lower after-tax yield than those maturing or sold during the quarter, continuing a trend experienced over the past year.

The second component of investment operations includes gains and losses generated by equity securities trading and investment in limited partnerships. Our equity investments are managed for overall appreciation and in general subscribe to a buy-and-hold philosophy. As such, equity trading gains are generally not a large component of this income statement category, with gains of $2.0 million this quarter comparing to $1.1 million for the second quarter of 2007 and year-to-date gains this year of $0.5 million comparing to $1.5 million last year.

A larger component of investment gains and losses is limited partnership activity, which includes both realized and unrealized changes as required by generally accepted accounting principles. Limited partnerships generated total losses this quarter of $4.7 million compared to $7.7 million in gains during the same period last year. For the six months, limited partnership losses of $16.7 million compared to $6.8 million in gains in 2007.

As most of the partnerships in which we participate engage in the trading of equity securities, the general decline in domestic and foreign stock markets during 2008 are reflected in their operations and hence, in our income. Our investment in the Indian stock market has been the most volatile this year, declining in value by 37%, in line with the major Indian indices after increasing 63% during 2007.

While our inception to date average annual yield on this investment is still near 20% we expect continued quarter to quarter volatility for the Indian Limited Partnership for the near term. In total, investment losses for the quarter were $1.9 million after tax, or $0.13 per share, compared to gains of $5.7 million, or $0.38 per share, last year. Year-to-date 2008 losses of $0.71 per share compared to gains of $0.40 per share last year.

The third component of investment operations is a change in fair value of non-limited partner investments owned. This quarter both the equity security and fixed income markets experienced holding losses, which are reflected in our portfolio, generating an after-tax decline in unrealized gains of $5.2 million. For the six months, declines in unrealized gains totaled $8.0 million.

On June 30, 2008, the market value of the company’s equity security portfolio remains more than $45.0 million above cost and the value of the bond portfolio is essentially equal to cost. The company’s total pre-tax return on direct equity security trading for the quarter was a negative 0.9% compared to the S&P 500 negative 2.7%.

Cash flow from operations this quarter was negative $3.5 million, including an increase in insurance recoverable of $3.2 million. Last year’s second quarter produced $8.8 million of cash flow. The difference is primarily attributable to higher loss payments this quarter associated with the closing of several large trucking claims. Year-to-date negative cash flow from operations of $9.7 million compares to $17.5 million cash flow last year. In addition to the higher loss settlements noted this quarter, the majority of the difference relates to the timing of reinsurance premium and loss recovery payments and federal tax deposits as well as the lower operating income.

Reinsurance recoverable unpaid losses increased from $134.0 million at December 31, 2007, to $144.0 million this quarter, reflecting an increased utilization of reinsurance over the past year. Reinsurance recoverable on paid losses totals $5.9 million at quarter end, all of which is current.

The consolidated prior year reserve savings on direct business for the quarter was approximately $900,000, bringing the year-to-date savings to a little over $2.0 million, while reinsurance assumed has developed a deficiency of $1.2 million for the six-month period.

I will remind listeners that we posted a full set of quarterly financial statements, including product level revenue and combined ratio data on our website at www.baldwinandlyons.com. Click on our Investor Relations page and select Presentations from the drop-down menu. From this page select the latest financial supplement, which can be downloaded using Adobe Acrobat or printed for your use. Also, the additional financial tables included in the Investor Relations section of our website have been updated to include the current quarter information.

This concludes our formal presentation. At this time we would be happy to answer any questions listeners may have.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of John Quinn with Morgan Keegan.

John Quinn – Morgan Keegan

Pat, could you give me the development number again for the quarter?

G. Patrick Corydon

On our direct business we had about a $900,000 savings for the quarter.

John Quinn – Morgan Keegan

That’s versus a much bigger number last year, right?

G. Patrick Corydon

Yes, the number last year was, I believe, a little over $5.0 million.

John Quinn – Morgan Keegan

And, Pat, has your repurchase activity, does the authorization specify the B shares or is it all classes?

G. Patrick Corydon

The authorization is not specific to the B shares, it would be any combination.

John Quinn – Morgan Keegan

Pat, on your assumed reinsurance book, congratulations by the way, but on the assumed book, with the Paladin element I’m surprised that it did so well during the quarter. Do you have any comment there?

G. Patrick Corydon

The Paladin piece of the business this quarter was certainly had a higher loss ratio than the overall. Fortunately, we’ve managed to create a well-diversified book reinsurance assumed business. Paladin comprises currently about 40% to 45% of that book. The remainder of the book is spread over the entire world at levels that, this quarter, didn’t generate any losses. We are very fortunate in that regard. So the overall book was able to come in at what we also consider to be a good level. But you’re right, the Paladin business did suffer the expected amount of losses this quarter.

John Quinn – Morgan Keegan

And, Joe, on the loss ratio in your small fleet trucking, during the second quarter there was a pretty good spike. Is that Severity?

Joseph J. Devito

Yes, that’s exactly what it was, John. And you know that business is fairly volatile relative to Severity even though our retention is not very high and with declining premium and that expected volatility, it tends to impact quarter-by-quarter loss ratios.

John Quinn – Morgan Keegan

Joe, were there any major changes to, or material changes to your reinsurance program during the quarter?

Joseph J. Devito

The reinsurance programs report through Pat, but I would say essentially no. We massaged them a little bit, a little bit less net than we had been last year but a fairly seamless, easy, no major change renewal.

John Quinn – Morgan Keegan

And just so I have this straight in my mind, this possible agency acquisition, did Gary say its 20.0 million of premium?

Gary W. Miller

That’s correct, John.

John Quinn – Morgan Keegan

And it’s primarily transportation risk?

Gary W. Miller

It’s 95% transportation risk.

John Quinn – Morgan Keegan

Public transportation?

Gary W. Miller

No.

John Quinn – Morgan Keegan

In your public transportation book, did you say there’s about $2.0 million now? Are we talking about buses, limos, and taxis or?

Gary W. Miller

Not limos and taxis, John. Primarily buses, both school buses and for-hire, but no municipalities. Nothing less than $50,000 in premium right now and fairly restricted geographic areas.

John Quinn – Morgan Keegan

Also, to clarify, the E&S that you set up in Indiana, is that stacked under Protective?

Gary W. Miller

It’s a subsidiary of Protective. Although it’s not really capitalized at this point in time and it’s expected to essentially run on its own.

Operator

It appears we have no further questions.

Gary W. Miller

We appreciate you joining us this morning and look forward to reporting good results in three more months. Thank you.

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Source: Baldwin & Lyons, Inc. Q2 2008 Earnings Call Transcript
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