Employers Holdings, Inc. (NYSE:EIG) Q3 2018 Earnings Conference Call October 25, 2018 11:30 AM ET
Lori Brown - SVP & Deputy General Counsel
Douglas Dirks - CEO & Director
Michael Paquette - EVP, CFO & Treasurer
Stephen Festa - President & COO
Mark Hughes - SunTrust Robinson Humphrey
Cliff Gallant - Philadelphia Financial
Robert Farnam - Boenning and Scattergood
Good day, ladies and gentlemen, and welcome to the Q3 2018 Employers Holdings, Inc. Earnings Conference Call. [Operator Instructions]. As a reminder, this conference is being recorded. I would now like to introduce your host for today's conference, Ms. Lori Brown, SVP, Deputy and General Counsel. You may begin.
Thank you, Tiffany. Good morning, and welcome, everyone, to the third quarter 2018 earnings call for Employers. 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. With me today on the call are Doug Dirks, our Chief Executive Officer; Mike Paquette, our Chief Financial Officer; and Steve Festa, our Chief Operating Officer.
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 provisions of the Private Securities Litigation Reform Act of 1995. Although 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. All remarks made during the call are current at the time of the call and will not be updated to reflect subsequent developments.
In our earnings press release and in our remarks or responses to questions, we may use non-GAAP financial metrics, including those that exclude the impact of the 1999 loss portfolio transfer or LPT. Reconciliations of these non-GAAP metrics are included in our financial supplement as an attachment to our earnings press release, our investor presentation and any other materials available in the Investors section on our website.
Now I will turn the call over to Doug.
Thank you, Lori. Good morning, everyone, and thank you for joining us on our call today. We had a strong third quarter and have posted outstanding performance for the first 9 months of 2018. Yesterday, we reported third quarter net income of $47.6 million, net income before the impact of the LPT of $45 million and adjusted net income of $32.7 million. Our third quarter adjusted net income was up 51% from a year ago, and our underwriting income increased 66% to $22.7 million. Our combined ratio before the impact of the LPT of 89.6% improved by 4.4 percentage points versus that of a year ago, and our net investment income was up 9%.
In the third quarter, we saw a continuing solid new business growth, but our top line continues to be challenged by declining rates on renewal business stemming principally from falling loss costs. We experienced an average premium renewal decrease of 7.4% during the third quarter with an average renewal rate decline of 14.1%. For the same period 1 year ago, our average renewal rate declined by 4.4%. Our book value per share, including the deferred gain at September 30, 2018, was $34.86, an increase of 3.4% from June 30, 2018, including dividends. And our adjusted return on equity for the third quarter was 2.9% or 11.4% annualized.
With that, I'll turn the call over to Mike for a further discussion of our financial results. Mike?
Thank you, Doug. Net premiums written and earned for the third quarter each increased from a year ago, which Steve will address in his remarks. Our third quarter loss and the LAE ratio before the impact of the LPT of 56.6% was 7 percentage points lower than a year ago. Six percentage points of that improvement resulted from $12 million of favorable prior period loss reserve development, relating primarily to accident years 2014 through 2017. The favorable development was largely the result of our key business initiatives, including accelerated claim settlements, geographic diversification and the use of data analytics.
Our third quarter commission expense ratio of 12.9% was slightly higher than a year ago. Increases in projected 2018 agency incentives and then the percentage of business produced by our higher commissions alternative distribution channels resulted in the higher commission ratio in the current period. Our third quarter underwriting and other operating expense ratio of 20% was 2.1 percentage points higher than a year ago. The increase was primarily the result of our aggressive development and implementation of new digital technologies and capabilities.
Net investment income for the third quarter was $20.2 million, up 9% from a year ago. Our pretax book yield on the portfolio was 3.3% during the quarter versus 3.1% a year ago. Our effective income tax rate for the third quarter was 18% versus 24% a year ago. The reduction in the effective tax rate was largely the result of the 2017 Tax Cuts and Jobs Act, partially offset by a higher proportion of fully taxable income experienced during the current quarter.
As of September 30, 2018, our fixed maturities had a duration of 4.4 and an average credit quality of A-, and our equity securities represented 8% of the total investment portfolio. Recent increases in interest rates, which have and will continue to benefit our net investment income, have resulted in year-to-date after-tax unrealized investment losses of $56 million. Note that fluctuations in unrealized investment gain and losses do not impact how we manage our investment portfolio since we typically hold our fixed income investments to maturity. Further, the quality of these fixed income investments remain very high, and the unrealized investment losses that we have incurred to date have had very little impact on our statutory surplus or regulatory capital requirements.
And now I'll turn the call over to Steve.
Thank you, Mike, and good morning. Net written premiums for the quarter of $187.3 million were up $9.7 million or 5.5% from the third quarter of 2017. The primary driver of this increase was new business growth, which increased $13.6 million over the comparable period in 2017. The new business growth rate of 33.4% was a result of year-over-year increases of submissions, quotes and bound policies. Double-digit new business revenue was achieved in both our core as well as alternative distribution channels. The second quarter of this year exhibited 25.7% new business growth over the comparable period in 2017, so the third quarter exhibited acceleration over the prior quarter trend. It is difficult to estimate future trends as we continue to see heightened competition in the states we operate in. This competition is evident in both the small business space as well as the middle market.
With respect to renewals for the quarter, we continue to see high policy unit retention rates. On a year-to-date basis, our unit retention rates are up over the comparable period in 2017 with continued improvement in the third quarter. This strong retention result was offset by an overall renewal rate decrease of 14.1% for the third quarter versus the rate level in effect on those policies a year earlier. This is driven by declining loss costs in virtually all of the states we do business in. Almost 50% of the states we do business in have had approved rate filings in 2018 that reflected double-digit decreases, once again, driven by declining loss costs. We expect this declining rate trend to continue in 2019 as evidenced by 2019 proposed or approved rate filings in many of our existing states. We do continue to see strong payroll pickup during the final audit process, a reflection of the strong economy and the fact that our policyholders continue to hire additional staff as well as increasing the pay and number of hours worked from existing staff. We have not seen any slowing down of these trends and don't expect to in the near future.
We continue to make progress in our objective to develop a national platform. During the quarter, we entered the state of Rhode Island. We now write business in 43 states as well as the District of Columbia. We plan on entering the remaining three states that are not monopolistic states over the course of the next few months, which will complete our national footprint initiative.
We continue to move forward with our previously discussed investments in technology as well as data and analytics capabilities. We expect to see the return on these investments in several areas to include improved customer experience, mitigation of loss costs through predictive analytics as well as improved efficiency and scalability.
And now I will turn the call back to Doug.
Thanks, Steve. As we progress into the fourth quarter of 2018, our overall accident year results continue to be in line with expectation. New premium growth remains strong, although the steady headwind continues to be declining average premium renewal rates compounded by competitive pressures. Offsetting some of the impact of declining rates are higher-than-expected payrolls on renewal business and stronger-than-expected new business growth.
We continue to make good progress as we aggressively develop and implement a variety of strategic technology and analytic capabilities, which lead to improving underwriting and claims results and sustainable operating efficiencies. Though many of these initiatives are multiyear in nature, our implementation plans allow us to roll out new capabilities centered on customer and agent experience as they are developed, consequently allowing us to realize financial and operational benefits sooner.
That concludes our prepared comments. With that, operator, we'll turn the call over for questions.
[Operator Instructions]. Our first question here comes from Mark Hughes with SunTrust.
The 14.1%, what was the distinction you're making there between that and, I think, 7.4%? What are those two numbers?
The 14.1% reduction, Mark, is the reduction in the rate -- the renewal rate of the policies that we renewed this quarter versus those policies rate at the third quarter of last year. The revenue reference is the revenue impact on that.
So the revenue impact was -- on the renewal was minus 7.4%...
Okay. The exposure being the difference.
Okay. Mike, the underwriting, other expenses in the quarter, 20% of premiums earned. You've been running kind of 22%, 23%. I know 3Q historically has had a kind of a lower seasonal expense load. With this quarter, was is just that seasonality? Or was there a little less of the investments spending this quarter?
It's the latter. So we announced that we would be deploying about 6 points, which is kind of low $40 million, and we would do that over an extended period of time. That has been -- we're comfortable with where the spend is right now, and we're very pleased with where we are, but the expense is emerging in a slightly different manner than we had anticipated based on accounting rules, the expense type and all of that. So we owe you a recast of that 4 and 2 points. And we're in the process right now of developing our 2019 plan, and we'll get that out to you so that you can tweak your models as soon as it's available. But I do want to just assure you that we're very comfortable with the spend. It's just that the expense is emerging a little bit differently than we had envisioned, which was almost a year ago.
Understood. Steve, the new business initiatives that are driving the growth in premium, can you talk about the -- how much momentum you've got? How much follow-through we might see in coming quarters? When do you lap kind of these -- this uptick in submissions and quotes, et cetera? How much -- maybe what's driving it? And how much more is in the pipeline?
So I would say, in my response, Mark, will be probably over the next couple of quarters because it's difficult to project too much further beyond that. But some of the initiatives that you're -- that are reflected in this very nice increase in new business growth still have some momentum behind them. And at least in the short term, I would expect to continue to see strong new business growth. The competition continues to get stronger. And we're seeing in the market, even from this quarter to the -- from the prior quarter to this quarter, we're starting to see even accelerated competition in certain states, California being one of them. So that's one of the headwinds we're going to see, which I think will be stronger over the next couple of quarters than they have been the prior 2 or 3 quarters. But we still haven't leveraged the full momentum from some of those initiatives that are driving the new business growth we've seen at this point.
Then final question. What years did the favorable development come from? Did you -- could you give that? What accident years?
Mark, it's predominantly from 2014 to 2017.
At this time, I'm showing no questions in queue. I'd like to turn the call back over to Douglas Dirks for further remarks. Pardon me, there's another one. We have a question here from Cliff Gallant with Philadelphia Financial.
Just a couple of small questions. The partner acquisition, is there any update on that? Is it -- is that -- see any benefit from that?
Not as of yet, but we're still awaiting regulatory approval, and we hope to receive that soon.
Okay. And then in terms -- I know maybe this is too early to ask as well, but the sort of the benefits of the technology initiatives, I think, was -- probably started about a year ago now or maybe 2 or 3 quarters. Are you seeing any benefit yet? Or is it too early to say?
We are, but it's still relatively early. And Cliff, maybe I'll take this opportunity to call out maybe a little more specific information on some of the things that we're working on. So for example, we have started an initiative that is focused on eliminating unnecessary touch points for our customers during the policy life cycle and improving the customer experience as a result of that. Much of this is focused on using technology to automate or eliminate many of the touch points that don't add value to our customers today. It'll also allow for greater internal efficiency and scalability within the organization. That's one example of an initiative that we're in the early stages of. We've launched some aspects of that already where we're seeing the benefit, but it'll take a few more months into next year before we start seeing the full impact of that. We're also investing heavily in predictive analytics to help us make better risk and pricing decisions and be more aggressive in terms of claims management and then several investments in the digital area. The most recent one that we launched was a new website for our customers and stakeholders. So those are some specifics that we're working on that we think are going to have a very clear impact on both top line as well as our bottom line results in the future.
And I'm going to jump in there quick and just give a little example of the magnitude of what some of these initiatives will be. We have one process where 100% of the transactions were being touched through this initiative. We've reduced that to 1% being touched. And that really is the power in terms of the improved experience and the efficiency that we're going to be achieving in some of these initiatives. So it's a very large magnitude gain.
While I have you on the line, it's been sort of general market worries, economic worries that we're starting to perhaps see any sort of signs of economic slowdown. I'm just curious from what you're seeing among your customers. Is there any sign of that here?
Cliff, not at all. We're still seeing very strong audit pickup. The third quarter, we didn't see any relaxation of that trend, and so we're not seeing any evidence of that at all.
And our next question comes from Bob Farnam with Boenning and Scattergood.
So I just have one question on the accident year loss ratio going forward. I'm just trying to engage whether the renewal rate declines of 14%, how are they tracking with the actual loss cost trends that have been filed by the states?
So we're comfortable with that 14.1% reduction, Bob. We feel it's justified based on the improving loss environments that we're seeing in the states that we do business in. We've talked about that in the past. I mean, our largest state, obviously, is California. The WCIRB continues to see it the same way with respect to California. However, what I would say is, and we said this previously, we're very focused on retaining our profitable business, but we'll not hesitate to walk away from business where we can achieve the profit goals that we've established. So we have and will continue to walk away from business where we feel like the price doesn't match our profit expectations.
What do you -- I mean, can you tell us what your expectations are for profitability?
I can't. I cannot.
And we have a follow-up here from Mark Hughes with SunTrust.
Yes, I thought I would just ask again on share repurchases. The -- obviously very strong profitability. I guess the stock is -- or maybe I'll just ask you your view on share repurchases at this point.
I'll take that one, Mark. We view share repurchases as a very attractive option for us. We consider it all of the time. But simply stated, we've had competing uses for our available cash in recent periods. Examples would be we have a growing top line. We've had -- our dividend has more than doubled over the last just few years. We've got our ongoing digital initiatives that we're funding on a daily basis, and we also are holding some cash for our pending acquisitions. But again, we view it as very attractive, and we will be optimistic in that regard, but we've had competing uses as of recent.
And I am currently showing no questions in queue. I'd like to turn the call back over to Douglas Dirks for further remarks.
Very good. Thank you, operator. Thank you, everyone, for joining us on the call today. We appreciate your participation and your interest and support. We look forward to speaking with you again next February as we report year-end results for 2018. Thank you, and have a great day.
Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program. You may now disconnect. Everyone, have a great day.