Protective Insurance Corporation (NASDAQ:PTVCA) Q1 2019 Results Conference Call May 8, 2019 11:00 AM ET
Han Huie - IR
Jay Nichols - Interim CEO
William Vens - CFO
Conference Call Participants
Brett Reiss - Janney Montgomery Scott
Greetings, ladies and gentlemen, and welcome to Protective Insurance Corporation First Quarter 2019 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions]
It is now my pleasure to introduce your host, Ms. Han Huie. Thank you. You may begin.
Thank you. Thank you all for joining us this morning for the Protective Insurance Corporation First Quarter 2019 Conference Call. If you did not receive the copy of the press release, you may access it online at the company's website, along with an investor presentation to accompany today's call and earnings release, which is available at www.protectiveinsurance.com. I would like to remind everyone that we are hosting a live webcast for the call, which may be accessed at the company's website as well.
At this time, management would like me to inform you that certain statements made 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 Protective Insurance Corporation believes the expectations reflected in any forward-looking statements are based on reasonable assumptions, it can give no assurances that expectations will be obtained. Factors and risks that could cause actual results to differ materially from expectations are detailed in the press release and are included from time to time with the company's filings with the SEC.
Now I would like to introduce Jay Nichols, interim CEO of Protective Insurance Corporation, and turn the call over to him. Please go ahead.
Thank you, Han, and good morning, everyone. I'm proud to report that book value per share grew by 2.8% in the first quarter of 2019 and total return after the payment of the quarterly dividend was 3.3%. Our much of the gain in the quarter was the result of total return on investment portfolio. We have made significant progress in our underwriting operations in the past 6 months. This progress will position us well for success in the future. The total return on our investment portfolio was 2.6% for the quarter, some of which was a recovery from the fourth quarter.
We have thoughtfully shifted our investment portfolio in the past 2 years. And we're very well positioned to create value with our investment results. Our investment leverage is 2.5x our equity. Our portfolio has a very short duration, has high credit quality and 88% of our assets are in fixed income securities. This portfolio should create a solid base of earnings contributing to growth in book value in the future. Our insurance results improved to a 108% combined ratio from the 112% reported in the fourth quarter. While this is still not acceptable, we are on the right track.
During the quarter, we held our loss picks relatively stable from the fourth quarter of 2018. The lack of material prior year development and a slight change in mix contributed to the 4 point improvement over the fourth quarter. In the first quarter of 2019, we did see severity return closer to our expectations after seeing an increase in both incurred and reported severity in the fourth quarter of 2018. Our expense ratio is consistent with the ratio reported for 2018 as we remain disciplined.
During the quarter, we achieved rate increases close to 20% on product lines that have been underperforming in our commercial automobile agency business. Our stated purpose is to consistently get rate in excess of trend. Commercial auto makes up 67% of our gross premium. And the liability component of this has been in a multiyear challenging environment. While this rate achievement is a positive outcome, our renewal retention ratio did decrease as a result of our underwriting discipline.
The remainder of our insurance business, primarily workers' compensation, continues to perform within expectations. The four initiatives in our underwriting operations: get rate, manage volatility, manage expenses and engage in digital partnerships are all moving along well. In addition to the rate activity mentioned above, the initiative to manage volatility is also on track. And we are placing facultative reinsurance on most agency-produced commercial auto risk in our book in excess of $2 million. We are refining our process and have created relationships with very strong and responsive reinsurance partners to support our efforts to provide consistent capacity to our clients.
Our initiative to manage expenses is working well but in the early stages. We will have to continue to manage expenses as the construction of our books shifts. And we intend to stay ahead of the curve to ensure that our expenses are appropriate for our premium volume. Our team is actively working to reengineer processes internally and externally to ensure that we are achieving savings in our operations by ensuring that the right people are doing the right thing for the right reason at the right time.
This is linked with our digital partnership initiative. I'm very excited about our partnership to build a digital insurance platform, beginning with our underwriting operations and moving through the rest of our insurance operations. This initiative will better prepare our platform for the future, which is already here now, by the way, and elevate the skills and tools that our people have to do their jobs. We are also teaming up with a partner to process the abundant telematics data to use in our pricing engine and to partner with our producers and our customers to provide information on their commercial auto operations.
We have been distilling signals from telematics and claims data for years to inform our underwriting approach. But we intend to take this to the next level and create a much more dimensionalized view of data to inform our underwriting and enhance our value proposition to our producers and clients. We have also had the opportunity to repurchase shares, which is immediately and significantly accretive to book value per share. We intend to continue to repurchase shares in the future. As long as the market continues to undervalue our shares, this gives us a third lever to increase the value creation for our long-term shareholders.
Regarding loss development, during the quarter, we had net favorable development in our claims reserves comprised of slightly adverse development on our commercial auto book, which was more than offset by favorable development in our workers' comp and other lines. This net favorable claims development was offset by increased contingent reinsurance premiums ceded due to the development in older accident years, resulting in adverse development of $0.5 million or $500,000 in the quarter.
While it has been a tumultuous time at Protective and in the broader commercial auto insurance industry, we are on a great track. We believe that our initiatives are gaining traction and should manifest themselves in improved profitability in our underwriting operations in the future. We have a great opportunity to continue enhancing our position in the market by enabling commerce with our products and services, providing recovery for people and property as a result of unfortunate events and aspirationally saving lives by serving as a strong partner in the transportation safety ecosystem. We have made great progress supported by a solid balance sheet and a solid franchise, although we have, as Robert Frost wrote, "Miles to go before we sleep."
In closing, I would like to thank our people for their commitment and dedication to our mission. I would also like to recognize Nate Shapiro on the 40th anniversary of his election to our Board. Nate is a great man, and it is with great pride and humility that I can refer to him as my partner in this endeavor. I and all of Protective thank him for his dedication.
With that, I thank you for your support. And I will now turn the call over to William. And I look forward to your questions following William's comments.
[Technical difficulty] was $2.7 million or $0.18 per share, which compares to net income of $0.3 million or $0.02 per share for the prior year's first quarter.
Gross premiums written for the current quarter were effectively flat at $148.9 million compared to $148.8 million during the first quarter of 2018. Net premiums earned for the current quarter increased to $110 million, up 4.3% compared to the prior year period. The increase was attributable to changes in our reinsurance structure for commercial automobile coverages. Our operations produced an underwriting loss of $8.7 million, resulting in a combined ratio for the first quarter on 108%. This compares to a combined ratio of 99.8% for the first quarter of 2018.
The increase from the combined ratio during the first quarter of 2019 compared to the first quarter of 2018 reflects an increase in the current accident year loss ratio. We continue to maintain current accident year loss ratios at a level consistent with rising severity expectations in the commercial automobile sector. As more time passes and we learn more about the ultimate performance of the current accident year, we'll adjust our loss picks accordingly, either down or up. But for now, we continue to maintain current accident year loss ratios at a relatively steady level as we observe the impact of our rate achievement relative to trend. First quarter net investment income increased 34.4% compared to the first quarter of 2018.
The increase in net investment income reflects an increase in average funds invested resulting from positive cash flow as well as a reallocation from equity investments held in limited partnerships into short-duration, high-quality bonds. While we expect future increases in net investment income to be more modest, we do continue to expect further increases due to higher invested assets resulting from expected future positive cash flows. Over the past year, our fixed income portfolio duration including cash has remained relatively level at an effective duration of approximately 2.4. Our high-quality fixed income portfolio has a weighted average rating including cash of AA-.
During the first quarter of 2019, we reallocated approximately $31.1 million of equity investments, including distributions from limited partnerships into short-duration fixed income securities. This reallocation is consistent with our actions throughout 2018, where approximately $122 million of equity investments were reallocated into short-duration fixed income securities. Proceeds from these sales as well as the limited partnership distributions were reinvested into high-quality, short-duration fixed income securities, further shifting our investment portfolio to a still more conservative posture.
Operating cash flow is once again positive during the first quarter, resulting in $11.4 million of positive operating cash flow for the quarter ended March 31, 2019. As we noted last quarter and as Jay further discussed earlier, our operating initiatives are supported by a very strong balance sheet. Our investment portfolio assets are high-quality. Half of our reserve liabilities are mitigated by our reinsurance treaties with stop-loss protection. The significant remainder of our reserves are for workers' compensation and occupational accident coverages, which are performing within expectations. As a reminder, we've posted our press release, quarterly financial statements and a brief presentation reviewing our first quarter results on our website at protectiveinsurance.com.
This concludes our formal commentary. At this time, we'd be happy to take questions.
[Operator instructions] Our first question is from the line of Brett Reiss with Janney Montgomery Scott.
We were late in addressing risk selection and pricing. The drop from the combined ratio from 112% to 108%, I mean, it's heading in the right direction. But is that an indication that we're successfully playing catch-up? Or would you liked to have seen the combined ratio even come in somewhat lower?
I would always like to see it come in lower, but we're absolutely heading in the right direction. It's -- we've held our loss picks very consistent. So if you look at the quarter, we didn't take into our loss picks the rate achievement that we have in the quarter because we're basically holding our loss picks for those underwriting years. And while we achieved very significant rate, and I would tell you rate in excess of trend in the books that are having a difficult time producing profits, we didn't bring that in until we're convinced that, that's going to come through to the results. So I think we're on the right trend and there's -- and while we are achieving rate and we are jettisoning business that is significantly unprofitable, including some of the public trans business, while we're on the right trend, we're -- I believe we're being conservative in the establishment of our loss picks, waiting for empirical information to come through that allows us to take those down.
Right. How many quarters do you think it will be before we see that combined ratio dip below 100%, where historically it's been?
I wish I had a crystal ball. But you can look at the renewal cycle of the business, so a very -- a large percentage of it comes in the second and third quarter. It takes a while for that. So even though it comes in second, third and fourth quarter, it then takes a while for that to earn in. So we've got 9 more months of rate to get in the portfolio, and not across everything but across the troubled lines. And as those 9 months earn in, which starts in the sort of 4 to 21 months that it takes to earn that premium fully in, we will hopefully see the impact of those rate increases as well as the underwriting shifts and the mix shift start to contribute incrementally over that period of time.
Right. Now a fairly new phenomenon is the impact of distracted drivers with the legalization of marijuana. With your new underwriting discipline and the new digital platform, can you just give us some color on -- this is a new possible impact on losses for the industry, how you'll be out in front of assessing risk and pricing for this kind of new normal in our country?
We think that new normal has existed for a couple of years, at least for a few years on distracted driving for sure and the new normal on the litigation environment. So we are pricing for what we have sort of seen as the new normal. And we try to stay ahead of trends like that. We also try to help our customers in ways that they can improve their safety environment through driver selection and their operating environment. So I would say that we're more aware of the new normal now. And we are doing all we can to get a 360-degree view of the risk. And there will be emerging risks as we go through this. But the distracted driving issue has been around for a while and is, it does impact the results. And I think those results or those impacts are considered in our pricing.
Right. One or two last ones and then I'll drop back into queue. The 108% combined ratio, did that come about from a lot of little things or just a couple of big verdicts that just didn't go our way?
Well, the 108%, the way we set our loss picks to be a component of the combined ratio is not an event-based establishment of the loss picks. So the 108% is not that we just had a couple of big claims or things like that. It's the expectation of what that book will run to ultimate. And because if we just reserve for the singular events that happened in the quarter, it would be much more volatile. So what we try to do is reserve for the expected outcome. We stay with pricing until we've got data to take us away from it. And we also, we will take our loss picks down as we get empirical information that the book has performed better than our loss picks. So it's not as linear as we had an event and that event goes into it. We try to forecast what the ultimate outcome is based on both the pricing and the incurred frequency and severity.
Okay. And then the last question is the strategic initiatives question. Are we in a period where the marching orders are fix the ship, right the ship and then at some point in time, be more proactive in the strategic initiatives? And is there any kind of time line you can share with us?
I can't show a specific time line, but I can confirm that we are singularly focused on improving our underwriting operations to return the company's underwriting operations to profitability as soon as possible. And the entire firm is singularly focused on that. And that, I can share with you.
Ladies and gentlemen, at this time, there are no further questions. I'd like to turn the floor back to management for closing comments.
All right. Well, I have no further comments. But I would like to thank everybody for their support. And I look forward to sharing our results for the second quarter. Thank you very much.
Thank you. Ladies and gentlemen, this concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.