Good day, ladies and gentlemen, and welcome to the Third Quarter 2012 Employers Holdings, Inc. Earnings Conference Call. My name is Jody, and I will be your operator for today. [Operator Instructions] As a reminder, this conference is being recorded for replay purposes. I would now like to turn the conference over to your host for today, Ms. Vicki Erickson Mills, Vice President, Investor Relations. Please proceed.

Thank you, Jody, and welcome, everyone, to the Third Quarter 2012 Earnings Call for Employers Holdings. First, let me say that we hope all of you and yours have not been significantly impacted by recent weather events. Our thoughts go out to those that have been. Yesterday, we announced our earnings results, and after the call, we will file our Form 10-Q with the Securities and Exchange Commission. Our press release and Form 10-Q may be accessed on the company's website at employers.com and are accessible through the Investors link. Today's call is being recorded and webcast from the Investors 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; and Ric Yocke, our Chief Financial Officer. Statements made during this conference call that are not based on historical fact are considered forward-looking statements. These statements are made in reliance on the Safe Harbor Provision 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. We use the non-GAAP metric that excludes the impact of the deferred gain from the 1999 Loss Portfolio Transfer or LPT. This metric is defined in our earnings press release available on our website. Additionally, the Financial Accounting Standards Board issued guidance that beginning in 2012, changed the definition of policy acquisition costs, which may be capitalized. During the third quarter of 2012, we recorded a $1.3 million increase to underwriting and other operating expense as a result of our prospective adoption of the FASB change in accounting methods for deferred acquisition costs or DAC. Please see the earnings announcement for reconciliations of results, which illustrate the impact of the change in DAC accounting. As has been our practice, a list of our portfolio securities by CUSIP is available in the Investors Section of our website under Calendar of Events, third quarter earnings call. Now I will turn the call over to Doug.

Thank you, Vicki. Welcome, everyone, and thank you for joining us today. We are pleased with our performance in the third quarter, during which we increased revenue, decreased our combined ratio and increased book value per share. Since the end of last year, our book value per share, including the LPT deferred gain, has grown 5.8% to $26.52 at September 30. We again reported strong revenue, up 34% compared to the third quarter of 2011. We added over 19,600 policies year-over-year at September 30, increasing policy count 35%, and in force premium, 39%. At the end of the third quarter, our overall net rate increased 7.4% year-over-year, up significantly from the year-over-year increases of 0.6%, and 3.8% in the first and second quarters of this year, respectively. The improvement was led by California, with a positive year-over-year net rate change of 14.6%. This is the third consecutive quarter in which overall net rate has increased year-over-year, evidencing the continuing improvement in pricing in our markets. Because of our recent growth in premium and the actions we took 2 years ago to reduce costs, we've been successful in regaining much of the business scale lost during the last recession. Consequently, the underwriting expense ratio, component of our combined ratio, has improved substantially. Yesterday, we reported a third quarter combined ratio before the LPT of $111.5 million compared with $116.5 million in the second quarter of 2012 and $117.4 in the third quarter of last year. This represents a substantial improvement of 5 percentage points relative to the second quarter and 5.9 points in the third quarter year-over-year. We indicated early in the year that one of our main areas of focus throughout 2012 would be pricing. This year, we filed rate increases in a number of our states, notably California, Florida…

Thank you, Doug. As Doug mentioned, in the third quarter, we continue to report strong growth in premiums, written and revenue. Our combined ratio before the LPT was $111.5 million, nearly a 6-point improvement compared to last year's third quarter. The decrease was primarily related to substantial improvement in the underwriting and other operating expense ratio. The GAAP underwriting and other operating expense ratio declined 5.2 points year-over-year, largely driven by the increase in net premiums earned and previously implemented cost controls. The loss ratio before the LPT was stable year-over-year. Our provision rate for the current accident year losses in the third quarter of this year was 77.2%. We believe that our 2012 provision rate remains adequate. Further, we had no adverse development in overall reserves from voluntary business in the third quarter. Our prior period reserves in the aggregate continue to be adequate, and our current year provision rates appropriately reflects our expectation for ultimate losses at this time. Our analysis of total reserves for prior periods continued to show modest adverse development for accident years 2009 through 2011, offset by aggregate favorable development in accident years preceding 2008. As in past quarters, all recorded unfavorable development was entirely attributable to our assigned risk business. As a reminder, assigned risk business is coverage for businesses that cannot obtain policies in the voluntary market. We do not establish a reserve until the coverage is assigned to us through mechanisms adopted by state regulators. Our commission expense ratio of 11.3% was slightly lower than last year's third quarter, while total commission expense increased 36% relative to the same quarter last year. This increase was entirely related to higher net premiums earned in the quarter. Our third quarter net investment income declined to $17.5 million from $19.6 million in the third quarter of 2011 due to a slight decrease in yield. Our investment portfolio continues to perform well despite historically low yields in continuing volatile markets. The average book yield of the portfolio was 3.6%, and the tax equivalent yield was 4.7% at the end of the current quarter. The duration of the fixed maturities in the portfolio was relatively short at 4.1%. The portfolio is weighted towards short- and intermediate-term bonds to minimize interest rate risk, however, our investment strategy balances consideration of duration, yield and credit risk. Equities represented 6.3% of our total portfolio at the end of the third quarter. With that, I'll turn it back to Doug.

Thanks, Rick. Over the past year, we have been highly successful in rebuilding scale and in substantially reducing our expense ratio. We also succeeded in building a pipeline that continues to produce new business opportunities that are squarely within our underwriting appetite. And recently, we announced a new strategic partnership with Paychex. Now in combination with ADP, we have strategic partnerships with the leaders in payable outsourcing services. We expect to complete the rollout of this new partnership by the middle of next year. Our focus throughout the remainder of 2012 and into next year is to continue to grow our business into an improving market and to incrementally capture more rate on new and existing business, thereby, improving our loss ratio, achieving more scale on our expense ratio and driving a better operating margin. Clearly, our focus on pricing is yielding a higher net rate. Additionally, it appears that the current trends in rates continue to exceed the trends in our losses. We believe that we have correctly provided for ultimate losses and appropriately priced our products. Consequently, we have not had the strength in reserves -- overall reserves for prior periods. While our loss provision rate remains in the high 70s at the end of the third quarter, if the more positive rate trends continue to exceed our loss trends, we will incrementally lower the loss provision rate throughout 2013. And with that, operator, we'll now take questions.

[Operator Instructions] And your first question comes from the line of Mark Hughes from SunTrust.

The pricing environment -- this quarter, you seem to do a much better in terms of pricing. How much of that was a deliberate shift on your part to be more aggressive and try to capture more rate? Or did you get -- do you feel like the overall market kind of strengthened enough that you benefited proportionately?

It's a combination of both of those, Mark. We have had a strategy of pushing rates as much as we could and try to get more rate where the market would give it. And what we've seen in the most recent quarter is that there were more opportunities to get that rate. And so it's not just our initiative, although there is a very serious initiative on our part to move the rates up, but it's also the market beginning to firm up really across the country.

Now was your initiative more in this quarter than it had been in prior quarters?

Mark, it was really a gauging of where we thought we could get more rate. As I've indicated in the past, this is a constant testing of the market. Where you go in, renewal business, new business, trying to see what the best rate you can get. And conditions have improved. The market has still got a fair amount of volatility. We continue to see a very strong pipeline in terms of new business submittals. We're seeing an opportunity to be successful on accounts that previously we weren't able to get our rate for and consequently lost. And so I think that's an indication of the firming of the market and our discipline to walk it a way from the business when we couldn't get our price.

And so I think you spoke in your prepared comments about you'll continue to push on rates and see how successful you'll be. So far, your persistency has been steady. So the more aggressiveness on rates have not translated into policy losses. So should we expect those of your pricing aggressiveness to ramp up in future periods? Or are you going to take the approach that you have in the last -- in more recently, let's say?

Well, we would be expecting to see if we push rate harder than the market's willing to give it, that we see a drop in our hit ratio and our retention rates. But given where they are, the high levels they're at today, that would be an acceptable outcome for us. Let me describe the various levers we have at our disposal in terms of pushing rate. We've taken a number of actions that will begin to take impact here in the fourth quarter and then moving into 2013 on increasing minimum premiums, increasing loss cost multipliers, pulling back credits in states where credits are an important part of the pricing. So there are a variety of different things we are doing now and will continue to do going into 2013 that we believe will allow us to get more rate. All of those sit on top of the rate increases that are being approved by the regulators as well.

Your next question comes from the line of Ken Billingsley from BGB Securities.

I just wanted to follow up on the expense ratio. I know that's been a strategy you've been focused on, on keeping that -- getting that lower. It was obviously significantly lower this quarter in general. Is that something that you believe is going to be sustainable going forward? And I ask just more from an operating expense, it was about 15% growth from a total dollar amount year-over-year, while your premiums grew 40%. How long can you maintain that kind of relationship so the expense ratio -- the operating expense ratio stays where it is?

We expect that as the business continues to grow as we add policies, and as those policies generate claims, then we'll have to adjust staffing accordingly. We don't expect to see improvement in our expense ratio by reductions in our staffing. Rather, we look to improvements in process, improvements in technology and the scaling we get from growing the top line that will allow the expense ratio to continue to drift down. I wouldn't expect it will be as dramatic going forward as it has been recently. But clearly, our focus is on making sure that we can be as efficient as possible and let the scaling of the business show through on the expense ratio.

And so when you're saying about obviously -- I understand as you grow, you're going to still have to add some people. But from a leverage standpoint, is the 22% a good working starting point? Or it's somewhere between that 22% and 28%?

When I think about a very strong pricing environment with strong growth in premium, we target something between an 18% to 22%, so that's an aspirational goal in the right market conditions. We believe we should be able to achieve that.

Okay. And then on the...

And that's -- by the way, that's excluding the commission element of the other underwriting expense, the way we break it out on a GAAP basis, not on the statutory.

Okay. And then on the acquisition expense ratio as reported on the GAAP basis, it seems for the last 2 years the third quarters have been a bit lower than the other quarters, and it was quite a bit lower than the second quarter 2012. And I understand there could be differences from some seasonality. Could you talk about maybe what's going on, maybe why the third quarter may historically stay lower going forward? Or what's different in the mix that causes the third quarter to be lower? And is that a good run rate as we look forward as well?

If you look at the acquisition expense generally, our objective right now is to try to push that down, that if the market hardens that, we are able to lower our commission expense. It's not going to change dramatically, but that's the objective as we move into this part of the cycle. There are a couple of things that impact the commission level. One for us has been the LPT contingent profit commission, to the extent that the LPT outperforms the expectation that was drafted into the contract in 1999. Those flow through as a reduction in commission expense. So there's some of that element in this quarter as well as there was in the third quarter of last year. Also, that number that can impact that quarter-to-quarter is the accruals that we have for our agency incentive agreements. But other than those 2 elements, the commission expense in the amount we actually pay out to agents remains relatively flat.

And you said that as pricing gets stronger, you're looking to obviously not pay as much to the brokers where you can't. What kind of pushback are you getting to them -- from them on that considering obviously they weren't necessarily making as much when pricing was lower and they're hoping to -- obviously they're hoping to recoup some as pricing goes up as well?

Well, their business, their revenue stream is the commission we pay them. So obviously, it isn't a matter of simply saying we're going to reduce the commission. But where there are opportunities to do that, we will push for that. Also, the change we are seeing right now in the market is we have had more opportunity to quote larger-account business; not large accounts, but larger for us. And then those larger accounts, there traditionally is more opportunity to negotiate what the commission levels will be. Unlike what you would see in our straight-through business where there's a fed commission and we pay that amount. As we quote the larger accounts, they are frequently reflecting a negotiated commission level below what we would normally pay on other business.

Last question, and you may have said this on the comments. I didn't kind of catch it if you did. Can you just sum up audit premiums and the direction in what you're seeing there with your -- obviously, with your current customer base?

Certainly. In terms of the audit premium, just looking at it broadly, it was up in the third quarter of this year over what it was in the third quarter of last year. Year-to-date, those numbers were about the same. So just to share with you what that is for the quarter, the audit accrual was $3.1 million, that's compared to $1.2 million a year ago. And year-to-date, it was $8.7 million. It was the same last year, year-to-date.

And have your clients given you any indication of expectations in 2013 because I realized that sometimes they will be giving you an idea of where they think their employment will be.

That's really reflected in what the estimated annual premium is. So when we quote a policy, it's based on an assumption around what payrolls are going to be. I really can't tell you that we're seeing enough in there that it gives us an indication as to what the broader economic conditions are likely to be. I think the most notable thing is we continue to see a very strong pipeline of new business opportunities.

[Operator Instructions] And your next question comes from the line of Amit Kumar from Macquarie Capital.

Just I guess a few follow-up questions to the earlier questions. First of all, just going back to the discussion on pricing, I'm not sure if I missed this, can you give some flavor as to what sort of additional rate filings might be in the pipeline for the next few months?

Well the one I've not referenced and obviously of critical importance to us is California. And part of our plan there is to get a better view as to what regulations get adopted around the new reforms and what impact they are likely to have. And once we have a little better view on that, we can incorporate that into our filing. We do expect there to be a filing in California next year, but we've not come to any conclusion yet as to how much that would be or when. The balance of the states are generally 1:1 rate filings, although that's not consistently true across the country. But a lot of the activity I've described in terms of pricing are rate filings that have already occurred or will be effective January 1.

Got it, that's very helpful. The other question I had was in the opening remarks. You were talking about lowering the loss provision going forward. And then, I'm curious as to the pace, is that more of a modest tweak in the first few quarters and perhaps the bigger change coming after the year-end reserve review? How do you sort of think about that in terms of timing?

The timing will be dependent on what we see in terms of the trends. It will include timing around the rate filings and again, particularly California, given that it's a substantial part of our book of business. As we come to a determination as to what, if any, rate actions we might take in California, that ultimately will have an impact on what we think the provision rate should be. And so as we think about what could occur in 2013, we don't have a predetermined amount by which we will change the provision rate quarter-by-quarter through the year. Our expectation is, given what's happening on rates, what we believe could happen in terms of additional rate filings next year with the favorable trend, that we expect to see a reduction in the provision rate throughout the year. But there isn't a predetermined plan as we sit here today as to how much or when.

Fair enough. Final question on Paychex. In terms of their partners, I see that they have other partners including Travelers and Hartford, they have 100,000-or-so clients. I'm sort of wondering, how should we think about the impact to earnings for the second half of 2013? I do realize it's too early, but maybe just give us some more color as to where do you stand in terms of the scheme of things compared to other partners?

Thank you. I can't provide you any guidance as to where we see the premium coming on the books and at what rate during 2013. Obviously, this is an important relationship to us. We believe it has much potential going forward as do our other partners. The reason we like this business is it has less price sensitivity and has very strong persistency. And our ability to write very clearly and our appetite into these partnerships is important. So we think as we ramp this up through 2013, it provides a nice opportunity to grow the book going forward. But I can't provide you any guidance as to what we expect that to be or what impacts that might have on earnings in 2013.

And then do you know how many partners do they have?

They have multiple partners. These are not exclusive relationships. And again, when we enter into the partnerships, we want to make certain that our partner is able to bring us business that's within our appetite. Because as you well know, we have a very focused appetite, and there are a large number of classes that were not interested in writing. And consequently, that's why it's critical that our partners have other markets because it's not our intent to change our underwriting strategy to provide a market for business that isn't otherwise part of what we do.

Got it. You know what, that just reminded me, on Hurricane Sandy -- and we're talking about the broader industry. And I know, you don't have any exposure per se. I'm sort of curious, and this is a big-picture question, as the other carriers deal with Hurricane Sandy, do you think as they look at their books and look at their sort of segmentation, does this create an opportunity for you in some new states where you're saying that, "Wow, these guys have been hit hard, they will probably recalibrate their book and there's an opportunity for us." I mean, does that have any sort of benefit for you, or I mean it's completely sort of mutually exclusive right now?

I would want to get a better understanding of what the ultimate losses are for the industry. Obviously, the workers' compensation losses are likely going to be relatively light, given the fact that there's advance warning. Obviously, the recovery efforts, are likely to generate some workers' compensation claims. We think our exposure in that regard is very small. To the extent that it distracts competitors, it may create opportunity for us, but it's way too early to speculate on that.

[Operator Instructions] And at the present time, you have no further questions. I want to take this time to turn the call back over to Doug Dirks for closing remarks.

Thank you, operator. Thank you, everyone, for joining us today. We appreciate your attendance and your questions. We look forward to meeting with you again to report on our fourth quarter 2012 results early next year. Thank you.

Ladies and gentlemen, that concludes today's conference. Thank you for your participation. You may now disconnect. Have a wonderful day.