United Fire Group, Inc. (UFCS) Q4 2014 Earnings Report, Transcript and Summary

Good morning. My name is Christine and I will be your conference operator for today. At this time, I would like to welcome everyone to the United Fire Group 2014 Fourth Quarter and Year End Financial Results Conference Call. 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. Thank you. I will now turn the call over to Anita Novak, Director of Investor Relations.

Good morning, everyone and thank you for joining this call. Earlier today, we issued a news release on our results. To find a copy of this document, please visit our website at www.unitedfiregroup.com. Press releases in slides are located under the Investor Relations tab. Our speakers today are Mike Wilkins, Executive Vice President and Chief Operating Officer and Kevin Helbing, Interim Principal Financial Officer, Assistant Vice President and Controller. Our President and Chief Executive Officer, Randy Ramlo is traveling today, but is expected to join the call when possible. Other members of our executive team are also available for the question-and-answer session that will follow our prepared remarks. Please note that our presentation today may include forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. The company cautions investors that any forward-looking statements include risks and uncertainties and are not a guarantee of future performance. These forward-looking statements are based on management’s current expectations and we assume no obligation to update them. The actual results may differ materially due to a variety of factors, which are described in our press release and SEC filings. Please also note that in our discussion today, we may use some non-GAAP financial measures. Reconciliations of these measures to the most comparable GAAP measures are also available in our press release and SEC filings. At this time, I am pleased to present to Mr. Mike Wilkins, Executive Vice President and Chief Operating Officer of United Fire Group.

Thanks, Anita. Good morning, everyone and welcome to United Fire’s 2014 fourth quarter and year end conference call. Randy Ramlo is traveling today, but he has joined us via conference call and hopefully he will remain connected for the Q&A portion of the call. We are pleased to report operating income of $1.34 per share and GAAP combined ratio of 83.6% for the quarter. For the year, operating income was $2.13 per share, our GAAP combined ratio was 97.8%, our book value was $32.67 per share, and our return on equity was 7.4%. We continue to benefit from modest rate increases during fourth quarter as well as the lack of significant catastrophic events, favorable claims activity and favorable reserve development on prior accident year claims. Competitive market conditions during the quarter increased on renewals while persisting on new business. Commercial lines renewal pricing varied by region with average percentage increases in the mid single-digits on most small and mid-market accounts. Larger accounts remain more competitive with only small increases obtainable. This is the 13th consecutive quarter of commercial lines pricing increases. Personal auto renewal pricing increases during the quarter remained modest and in the low single-digits. The homeowners pricing experienced average percentage increases in the mid to high single-digits during the quarter. Overall, personal lines renewal pricing increased slightly during the fourth quarter. Written premium from new business remained strong up from the prior quarter as well as the same quarter a year ago. Our success ratio on quoted accounts increased slightly and remained strong. New business discretionary pricing was unchanged. We believe current rate increases are exceeding the lost cost trends and lost cost trends will remain low levels in 2015. However, we do expect the gap between lost cost and rate increases to shrink as 2015 progresses. Policy retention remained strong at 83% increasing slightly from the prior quarter for the group in most regions. Premium retention was down slightly from the previous quarter to 86%, but remains strong. Policies in force remained flat as new policies written were sufficient to offset policies lost or non-renewed. The U.S. economy continues to grow at a slow rate, premium from endorsements and premium audit continued positive trends, up from the same quarter a year ago. During the fourth quarter premiums written increased 11.3%, 3% is attributed to new business, 0.6% is attributed to endorsements and 7.7% attributed to rate change and policy revisions. Our expectations for 2015, our premium rate increases in the mid single-digit range at the beginning of the year, but tapering to low single-digits by the end of the year. Our specialty division business continued to expand in the fourth quarter. During the year the line operated in four Western states. During 2015, the division is expected to expand into at least two additional states. The division will create in the admitted and the non-admitted option in each of the active states, we expect strong premium growth for this division in 2015 but it will not be material to overall operations. Kevin will cover the details of our catastrophe loss activity for 2014 which was near what we budgeted for the year. Catastrophe losses were within our expectations for the year. However, we did see an uptick in large losses during 2014. During the first quarter we reported a large loss due to an East Coast condominium fire that affected multiple units. As an update we continued to expect favorable subrogation recovery on this claim. However, we do not anticipate subrogation efforts to occur before 2016. During the second quarter we reported a large loss due to fire which destroyed an entire city block. This claim is still in the investigative stages. During the second and third quarters of 2014 we reported an increase in the number of property lines claims. While storms caused some of these losses, the big driver was large fires. Though we see events in most quarters, there seem to be a greater concentration in the second and especially the third quarter this year. As a result we have initiated detailed loss studies, conducted underwriting audits and ask region to include tactics for improving the property line of business in their 2015 regional plans. In the commercial line, these plans include stronger pricing on tougher accounts and the stronger focus on risk selection and loss control compliance. We fully expect that recent loss studies will also help determine the appropriate accounts to target in order to improve results in these lines of business. In our personal lines our continued focus will be on our signature premier homes which are homes valued between $400,000 and $2 million. Our reinsurance program for 2015 remained essentially the same with a few minor tweaks. The most important one being that we expanded the hours clause to our catastrophe program from 96 hours to 120 hours. The catastrophe program experienced favorable pricing with rate levels down approximately 10% and pricing on the core program was flat. For the life company sales of our single premium whole life policies have lagged behind annuity sales due to our efforts to maintain price diligence on our single premium whole life products in order to achieve adequate rate spreads. As a result net income for the life insurance segment has declined approximately 22% for the year. Losses and loss settlement expenses increased $5 million for the year due to corresponding fluctuations in death benefits paid. Fluctuations in the timing of the death benefits occur from year-to-year. The increase in liability for future policy benefits improved during the year due to a decrease in sales of life insurance products. Interest credit had decreased $4.9 million for the year due to net annuity withdrawals decreasing the base on which interest is paid along with periodic reduction in the interest rate credited on annuity products throughout 2014. Deferred annuity deposits increased for the year. Guaranteed interest rates of our products increased in the second half of 2013 and in the first quarter of 2014 resulting in more favorable retention of maturing deferred annuity deposits as opposed to lapse of policies due to maturity and increased deposits due to additional annuity sales for the year. As Randy mentioned in the press release earlier today, book value growth is very important to us, equally important is obtaining an appropriate return on equity. Kevin will address the issue of book value in a moment, but I would like to take a moment to discuss return on equity. We make strategic decisions based on the double-digit return on equity and that has not changed even though the current investment environment is challenging. We will continue to focus on underwriting results rather than rely on investment portfolio returns to achieve double digit returns on equity. Over the last few years we have based our strategic plan on this premise. We have addressed our elevated expense ratio. We have developed our program business and increased our coverage of program associations. We have expanded our product offerings including the specialty division and we have continued to successfully achieve rate increases. Obtaining double-digit returns on equity remains the primary objective in our 2020 vision strategic plan. These are all actions designed to improve underwriting results and to bolster our return on equity. With that, I will turn the financial discussion over to Kevin Helbing.

Thanks Mike. Consolidated net income, including net realized investment gains and losses, was $34.8 million or $1.38 per share for the quarter compared to $26.5 million or $1.04 per share last year. For the full year, consolidated net income, including net realized investment gains and losses, was $59.1 million or $2.32 per share compared to $76.1 million or $2.98 per share in 2013. Losses and loss settlement expenses increased by $4.2 million or 3.8% during the fourth quarter compared to the fourth quarter of 2013 and $77.4 million or 16.9% for the full year. As Mike mentioned earlier, 2014 losses and loss settlement expenses were unusually impacted by large losses, which is beginning to look like a trend. For the quarter, however, was more consistent with expectations in these lines of business. Nonetheless, management continues to aggressively pursue actions to mitigate future concerns. As Mike mentioned earlier, our emphasis is primarily on a regional basis, but does include some home office scrutiny as well. Pre-tax catastrophe losses for the quarter totaled $2.5 million or $0.06 per share after tax compared to $3 million or $0.08 per share after tax. Both losses added 1.2 percentage points on the combined ratio. For the year, catastrophe losses totaled $49.7 million or $1.27 per share after tax and added 6.5 percentage points on the combined ratio. Our expectation for catastrophe losses in any given year is 6 percentage points on the combined ratio. It’s important to note, however, that our book of business remains primarily in regions of the country that are susceptible to seasonal weather events such as winter and spring convector storms, which will likely result in volatility in our results from quarter-to-quarter. As a company, we don’t get too excited about volatility since our final analysis is based on annual results. Favorable reserve development for fourth quarter was $24.2 million compared to $8.5 million in the fourth quarter of 2013. The positive impact on net income for the quarter was $0.62 per share compared to $0.22 per share in 2013. For the full year, favorable reserve development was $56.7 million or $1.45 per share compared to $57.5 million or $1.46 per share. As we have stated on many occasions, reserve development will vary from quarter-to-quarter and year-to-year due to a number of claims settled in the settlement terms. During the fourth quarter, the increase in favorable reserve development is attributable to the timing of paid claims as well as decreases in our IBNR reserves related to commercial liability lines of business. For the full year, prior year reserve development was consistent with long-term average releases. I will remind our audience that we have historically reserved on a conservative basis and continued to do so. At December 31, 2014, our total reserves remained relatively flat and within our actuarial estimates. Consolidated net investment income was $27.4 million for the quarter, which was a decrease of 8.8% as compared to $30 million in the fourth quarter of 2013. For the year, consolidated net investment income was $104.6 million, a decrease of 7.3% as compared to net income of $112.8 million for 2013. The year-to-date decreases are primarily due to changes in the value of our investments in limited liability partnerships, which are heavily weighted in bank funds and are recorded on the equity method of accounting. Because the equity method of accounting is based on changing market conditions, these results can be volatile from period to period. We continue to feel the impact of lower investment yields on majority of our investment portfolio and we expect a continuation of low interest rates into 2015. The weighted average effective duration of our fixed maturity securities portfolio at December 31, 2014 and 2013 was 5 years. Our overall portfolio yield was 3.3%. Consolidated net realized investment gains for the quarter were $1.5 million compared to net realized investment gains of $1.4 million in 2013. For the year, consolidated net realized investment gains were $7.3 million compared to $8.7 million in 2013. Consolidated net unrealized investment gains net of tax totaled $149.6 million as of December 31, 2014, which is an increase of $33 million or 28.3% from December 31, 2013. The majority of the increase in net unrealized gains is as a result of an increase in the fair value of the fixed maturity investment portfolio due to the interest rate declines. The expense ratio for the fourth quarter was 31.3 percentage points compared to 31.4 percentage points for fourth quarter of 2013. For the full year the expense ratio decreased to 31.4 percentage points as compared to 31.8 percentage points in 2013. The expense ratio continues to gradually improve as we indicated in our earnings release this morning. 2015 was the year that we expected we would finally reach our target of 30%. However, the learning low interest rate environment continues to impact our retirement benefit obligations which was somewhat offset by the anticipated savings in 2015 from other sources. During 2015 many of the added expenses associated with the Mercer Insurance integration project will be eliminated. However, those savings will likely be offset by amortization costs associated with the retirement benefit obligations. This might be a good time to discuss the change in the valuation of our retirement benefit obligations because of the impact these changes will have on the expense ratio and book value. In 2014, the declining interest rate environment and to a lesser extent the adoption of new mortality tables created significant changes in the valuation of our retirement benefit plans. The impact of the book value in 2014 was a $1.14 per share which is a balance sheet only impact. However, there will be an income statement impact in 2015 due to the amortization of increases in our benefit obligation liability as mentioned before. Our stockholders’ equity increased 4.4% to 817.4 million at December 31, 2014 from 782.8 million at December 31, 2013. The increase was primarily attributable to net income of $59.1 million and an increase in net unrealized investment gains of $33 million net of tax. These increases were offset by a change in valuation of our retirement benefit obligation of $29 million, shareholder dividends of $19.7 million and share repurchases of $12.9 million. At December 31, 2014 the book value per share of our common stock was $32.67 compared to $30.87 at December 31, 2013. During the fourth quarter we declared and paid $0.20 per share cash dividend to shareholders of record on December 1, 2014. For the full year we declared and paid dividends of $0.78 per share. In addition, during the fourth quarter we purchased 60,316 shares of United Fire common stock at an average price of $28.07 per share. For the year we repurchased 461,835 shares of our common stock for a total cash expenditure of $12.9 million at an average cost per share of $28.02. As a reminder under our current share repurchase program we may repurchase shares of United Fire common stock on the open market or through privately negotiated transactions. The amount and timing of any purchases will be at management’s discretion and will depend upon a number of factors including the share price, general economic and market conditions and corporate and regulatory requirements. We are authorized by the Board of Directors to purchase an additional 1.6 million shares of common stock under the new program which expires August 31, 2016. With that I will open the lines for questions.

Thank you. [Operator Instructions] Our first question comes from the line of Vincent DeAugustino with KBW. Please proceed with your question.

Good morning everyone.

Good morning.

Just to start, maybe a question for Kevin, just to your comments on the 2015 income statement impact, any sense of the ballpark drag from that pension side, either in terms of dollars or on the expense ratio?

It will be approximately $7 million addition on the expense ratio, $7 million.

Okay, great. And then…

Vincent, this is Mike, if I can just add to that. We don’t anticipate the expense ratio moving much in 2015. We have got other initiatives that we think will offset that increased expense. The disappointing thing to us is just we expect it to make good inroads into our expense ratio on 2015 and that will be more difficult now with the impact of the pension obligation.

Okay, makes sense there. So, I guess the other question would be here kind on the premium growth, so the volume here has just been kind of much better than I have been expecting here over the last couple of quarters. And so frankly, I am starting to wonder if I fail to fully appreciate some of your comments around just being a little bit more aggressive on new business growth plans embedded within your 2020 plan? And so I just wanted to touch on any specific targets that are in that 2020 plan and then the split between kind of exposure of new business and rate looking kind of further out to that 2020 mark?

Vincent, this is Mike again. I will start with some generalities and then if you want me to drill down, I can try to do that. We look at our growth carefully each quarter and make sure that we are comfortable with it. A lot of the growth as you know has been driven by rate increases, which we think is a very positive thing, but in addition to that, we have added the specialty unit which we have been talking a little bit about. Now, that added over 1 point of our growth this year. We also have had material reinsurance reductions over the last three years, which were ceding less premiums. So, that’s helpful on our growth. Now, the economy has improved. So, we are seeing better endorsement premium as people add exposures back and also a better audit premium. So, our new business growth is good and we feel good about that, but it’s not the primary driver of our overall growth.

Okay, but I guess just to make sure I am not missing anything there is no specific external target for growth?

We have some targets, but they are not anything we disclose.

Okay, alright. Fair enough. And then just on the reserve side, in the press release there was a mention of normal reallocation reserves following the comment on 2013 accident year IBNR releases. And so I was just kind of hoping you might be able to define kind of what the implication is for the reallocation process? I just want to make sure I understood that.

As you go forward in time, as you build out your current accident year, you shift your IBNR from the previous accident year into the new accident year and that’s what that comment reflected.

Okay, alright. Thank you for that. And just one last question maybe it’s probably best for Randy if he is connected or we can follow-up next quarter or maybe we get a release before then, but the question goes to just kind of getting an update on how the CFO search is going if you guys could comment on that or I would also understand if it is a bit too early?

No. Can you hear me, Vincent?

I can, thank you, loud and clear.

Okay, good. Yes, we had a very strong pool of interest. I think we had a total of 25 applicants initially. The search firm narrowed that group down to 12. Mike Wilkins and myself kind of picked the top 5 out of that group. And we have narrowed that tentatively right now to a group of 2. And then our plans are to have those two come back and do a more extensive interview with not only members of staff, but also with some of our Board of Directors. So, we had a very strong pool from the outside and internally and we are very excited.

Alright, thank you very much. Best of luck guys.

Thank you.

[Operator Instructions] Our next question comes from the line of Paul Newsome with Sandler O’Neill. Please proceed with your question.

Good morning and congratulations on the call. I want to ask about the cat load assumption, are you using about a 6% load for your pricing of your product?

Paul, yes, we are using a 6% budget number, assumption number estimated impact on an annual basis. I think our 10-year average has been 7, but we have done – we have combined the actual 10-year average with modeling results to come up with the 6. And we think our 10-year average is a little higher than we would anticipate going forward.

Are you assuming that the underlying level of catastrophe risk in general is a positive slope in other words that there is an increasing level of activity in general or it sounds like you are assuming the opposite?

Yes, I think we have spent a lot of effort trying to mitigate our exposure to cat losses. We have reduced exposure and concentrated areas, especially costal and our belief is that we have moved the needle in the right direction. Also with the Mercer acquisition, the business that we acquired in the two new locations, East Coast and West Coast is less susceptible to catastrophe losses than our Midwest business. So, we think that also should bring our average down.

Okay. Just a quick accounting question, did I hear right that you do not allocate IBNR reserves on an accident year basis?

We do. And as you move forward in time, that accident year allocation changes as you add the exposure for the current year.

But the individual IBNR buckets would just change on their own, right?

Correct.

Okay, that’s it. Thank you, guys. Appreciate it.

Thanks, Paul.

Thank you. It appears we have no further questions at this time. I would now like to turn the floor back over to management for closing comments.

Thank you, Christine. This now concludes our conference call. As a reminder, a transcript of this call will be available on the company website at www.unitedfiregroup.com. On behalf of the management of United Fire Group, I wish all of you a pleasant day.

Thank you. Ladies and gentlemen, this concludes today’s program. You may disconnect your lines at this time.