United Fire Group, Inc. (UFCS) Q4 2016 Earnings Report, Transcript and Summary

Welcome to the United Fire Group, Inc. 2016 Fourth Quarter and Year End Earnings Conference Call. [Operator Instructions]. I would now like to turn the conference over to Mr. Randy Patten, Assistant Vice President of Finance and Investor Relations. Please go ahead.

Good morning everyone and thank you for joining this call. Earlier today we issued a new release on our results. To find a copy of this document please visit our website at ufginsurance.com. Press releases and slides are located under the Investor Relations tab. Our speakers today are Chief Executive Officer, Randy Ramlo. Michael Wilkins our Chief Operating Officer. And Dawn Jaffray, Chief Financial Officer. 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'm pleased to present Mr. Randy Ramlo, Chief Executive Officer of United Fire Group.

Thanks Randy good morning everyone and welcome to UFG Insurance fourth quarter and year end 2016 conference call. Earlier this morning we reported net income and operating income of $0.46 per diluted share. And a GAAP combined ratio of 102.6% for the fourth quarter 2016. This compares with net income and operating income of $1.21 per diluted share. And a GAAP combined ratio of 86.8% in the fourth quarter of 2015. For the year 2016, net income was $1.93 per diluted share operating income $1.78 per diluted share. And our GAAP combined ratio was 100.3%. This compares to prior year net income of $3.50 per diluted share. Operating income of $3.46 per diluted share. And a GAAP combined ratio of 92%. Don will address the quarterly and full-year financial results in a few minutes. The full-year of 2016 were primarily impacted by two items. First, an increase in catastrophe losses as compared to 2015. 2015 was a quiet year for catastrophe losses only adding 3.8 percentage points to the combined ratio as compared to 2016, when catastrophe losses added 6.5 percentage points to the combined ratio. The level catastrophe losses in 2016 is within our expectations. And is normally what we would expect in a given year. Aligning closely with our 10 year historical average of 6.7 percentage points on the combined ratio. The second item impacted our 2016 results was a deterioration in our core loss ratio. A portion of this deterioration was driven by an increase of large losses which we defined as losses greater than $500,000. The large losses were primarily in our commercial automobile and commercial property lines. In a few moments, Mike will go over into more detail regarding these losses. And the strategies we have put in place or will be put in place to adjust this deterioration. Last year at this time, we announced a milestone of $1 billion in total revenue in the first time in Company history. Again in 2016, we achieved another milestone. Earning $1 billion in net premiums. This milestone included a 9.9 % increase in net premiums earned in 2016 as compared to 2015. Although we're proud of this milestone, looking ahead to 2017 and where we're in the current softening market cycle, we believe that the pace of our premium growth will slow moderately compared to the level of growth we have experienced since the beginning of 2014. As we have discussed all year, 2016 was a challenging year for our life segment. For the year 2016, we had a net income of $786,000 as compared to $3.8 million in 2015. As we mentioned in our third quarter call, beginning on January 1, 2017 we implemented a number of strategies to improve the profitability of the life segment. The changes are already implemented include product pricing adjustments and restructuring of our commissions. We're also looking at our current product mix and exploring opportunities to expand our product offerings in a state we currently write business. We believe these strategies are positive steps to approve profitability our life insurance segment. Since the second quarter of 2016, our expense ratio has been at or below 30.3 percentage points. We're satisfied with the progress we have made this year to reduce our expenses and maintain an expense ratio near 30 percentage points. We will always continue to look for efficiencies, but we believe we have achieved an acceptable operating expense level. 2016 proved to be another year of milestone and accomplishments for UFG. In addition to the premium milestone we accomplished this year we also recognized our 70th year in business our 45th year as a publicly held company and our 30th year will be listed on the NASDAQ. Which we celebrated by bring ringing the NASDAQ opening bell in April. Besides these milestones UFG also received several outstanding recognitions. Including being named to Forbes America's Topmost Trustworthy Financial Companies list for the third year in a row. And being selected as a top workplace by the Des Moines Register. While we're proud of the accomplishments in 2016, we're disappointed with the deterioration in our core loss ratio. In response to this, we're reviewing and working on implementing more rigorous loss control efforts, stricter underwriting guidelines, rate increases and new analytics tools. Which Mike Wilkins will now discuss in more detail. Mike?

Thanks Randy. Good morning everyone. As Randy indicated, one of the items impacting our results in 2016 was an increase in catastrophe losses as compared to an exceptionally low cat year in 2015. This is catastrophe losses are in line with our expectations for any given year. Adding 6.5 points to the combined ratio. Which aligns with our 10 year historical average of 6.7 of the combined ratio. The majority of this year's catastrophe losses occurred in the second and third quarters primarily due to related to weather-related events. The second item which was impacted our results in 2016 was a deterioration in our core loss ratio. Impacted by an increase in large losses, primarily in our commercial automobile and commercial property lines. During 2016, large losses totaled $108 million compared to $86 million in 2015. As we discussed during last quarter's call, the majority of large commercial property losses occurred in the third quarter. When we incurred five large commercial fire losses, for a total of $9.6 million. His spies were geographically spread out with no recurring patterns. However, we have implemented many loss control initiatives to reduce commercial fire losses. Including more emphasis on electrical systems, HVAC and other systems especially in older buildings. And buildings in unprotected area. Strict compliance loss control recommendation and expanded use of technologies such as infrared thermography. For commercial auto, losses continue to deteriorate in the fourth quarter of 2016 due to an increase in the severity of claims. We're currently asking for and receiving rate increases between 3% and 10% depending on the region for new business and renewal premiums. Along with implementing these rate increases, we have already implemented many loss control initiatives to reduce commercial auto losses. Including enforcement of vehicle use policies, required driver training, vehicle maintenance programs and reducing umbrella and excess limits in certain regions. Further loss control initiatives, including implementing predicting analytics in our underwriting process in mid-2017. For personal auto we're achieving rate increases the mid to upper single digit range and we continue to expand the use of telematics in the use of analytics. As compared to exceptional results in 2015, our loss ratio on workers' compensation deteriorated in the fourth quarter. In the fourth quarter, our loss ratio on workers' compensations increased to 35 points over the fourth quarter of 2015. We attribute this change to increase in severity of claims over $100,000. Workers' compensation losses can be volatile quarter over quarter. Therefore, we will continue to monitor this line of business. During the fourth quarter, we saw an increase in competition and a further softening of the market. Which was most evident in our Midwest region. Overall, commercial lines renewal pricing for the group was flat to a slight increase. Pricing varied by region and size of account. Commercial auto and commercial property rate increases continue to be in the mid to upper single digits. Other casualty lines and workers' compensation rate increases are flat or slightly negative. We believe that loss cost trends are approximately 3%. Personal lines renewal pricing increase with average percentage increases in the low to mid-single digits primarily in homeowners and personal auto. Premium and policy retention remains strong at 84% and 82% respectively. With changes from prior quarter of approximately 1%. Our success ratio on quoted accounts was up 4% from the prior quarter remaining at an acceptable level. During the fourth quarter, property and casualty premiums written increased 4% as compared fourth quarter of 2015. 2% is attributed to new business and 4% is attributable to endorsement and audits. Both of these are partially offset by a 2% decline and rate and exposure changes. For the year 2016, property casually written premiums increase 9% as compared to 2015. 3% is attributable to new business and the remaining increase is due to rate changes, endorsements, audits and exposure increases. With that I will turn financial discussion over to Dawn Jaffray.

Thanks Mike and good morning. For the fourth quarter of 2016, we reported consolidated net income of $12 million or $0.46 and per diluted share. Compared to $30.9 million or $1.21 per diluted share in the fourth quarter of 2015. For the year 2016, consolidated net income was $49.9 million and $1.93 per diluted share. Compared to $89.1 million and $3.53 per diluted share in 2015. The decrease in net income in the fourth quarter and full-year 2016 as compared to 2015, is primarily due to an increase of in catastrophe losses and a deterioration in our core loss ratio. A portion of which was due to an increase in large losses. Previously discussed by Randy and Mike. Our shareholders equity increased 7% to $942 million at December 31, 2016 from $879 million as December 31, 2015. Book value increased $2.10 to $37.04 at December 31 2016 from $34.94 at December 31, 2015. The increases in shareholders' equity and book value are primarily due to net income of $49.9 million. An increase in unrealized investment gains of $5.5 million to $134 million. A change benefits and valuation of our post retirement obligations. Which contributed $23 million all partially offset by a payment of shareholders dividends of $24.6 million. On a positive note, the changes we implemented to take effect at the beginning of 2017 will result in an estimated $5 million net decrease in future expense for our postretirement benefit plan. Return on equity was 5.5% for 2016 compared to 10.5% for 2015. The decrease in ROE, as compared to the same quarter last year, was primarily due to combination of decrease in net income and increase in shareholders' equity. Our return on equity excluding unrealized investment gains was 6.4% for 2016. Losses and loss settlement expenses increased by $57 million. Or 45% during the fourth quarter 2016, compared to the fourth quarter of 2015. For the year 2016 losses and loss settlement expenses increased by $135 million or 25% when compared to 2015. Again, the primary driver of the increases in 2016 were large losses and catastrophe losses. As we discussed. Favorable reserve development for the fourth quarter of 2016 was $4.2 million compared to $16.3 million in fourth quarter 2015. The impact on net income for the fourth quarter in 2016 was $0.10 per diluted share. Compared to $0.41 per diluted share in the fourth quarter of 2015. For the 2016 year favorable reserve development totaled $31.2 million, compared to $40.4 million in 2015. The impact on net income in 2016 was $0.79 per diluted share. Compared to $1.04 per diluted share in 2015. For the fourth quarter 2016, the majority of the favorable development came from two lines. Commercial liability with $9 million unfavorable development. And personal fire with $2.3 million. The favorable development was offset by reserver strengthening in commercial auto with $6.7 million in assumed reinsurance with $2.9 million of adverse development. For the year 2016, the majority of favorable development came from two lines. Commercial liability with $25.4 million and workers' compensation with $12.2 million. The favorable development was offset by a reserve strengthening in commercial property lines was $6.4 million and commercial auto with $5.5 million of adverse development. The combined ratio the fourth quarter of 2016 was 102.6% and a 100.3% for the year 2016. 2016 comparatives were 86.8% for the fourth quarter and 92% for the year. Removing the impact of catastrophe losses and reserved development, our core loss ratio deteriorated 11.7 points in the fourth quarter and 4.6 points for the year. When compared with 2015. The primary drivers of the deterioration in the core loss ratio are an increase in large commercial property and commercial auto losses. As well as workers' compensation losses. Referring to slide nine in our slide deck, on our website, we have provided a detailed reconciliation of the impact of catastrophes and development on the combined ratio. Now moving to investments, consolidated net investment income was $33.4 million for the fourth quarter 2016. Or a 26% increase as compared to $26.6 million in the fourth quarter 2015. Year-to-date 2016 consolidated net investment income was $106.8 million. Which represented a 6% increase when compared to 2015. The increase in net investment income for the fourth quarter and full year was primarily driven by the change in value of our investments limited liability partnerships. As compared to the same period in 2015 and not due to a change in our investment philosophy. This resulted in an increase of $7.1 million and $7.5 million respectively. In investment income during the fourth quarter and full-year 2016 as compared to the same periods of 2015. With respect to capital management activity, during the fourth quarter, we declared and paid a $0.25 per share cash dividend to stockholders of record on December 1st 2016. We have paid a quarterly dividend every quarters since March 1968. Under our share repurchase program, we may purchase United Fire Common Stock from time to time on the open market or through private re-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. During the fourth quarter, we purchased 22,923 shares of our common stock at an average price of $38.32 for total cost of $0.9 million. For the year 2016 we purchased 90,450 shares of our common stock at an average price of $41.43 with a total cost of $3.8 million. We're authorized by the Board of Directors to purchase an additional 2,938,471 shares of common stock under our share repurchase program which expires in August 2018. And with that I will now open the line for questions. Operator?

[Operator Instructions]. The first question comes from Paul Newsome of Sandler O'Neill. Please go ahead.

Could you talk perhaps just a little bit more about what the results would have been if you pulled out the large losses themselves? Was are also deterioration in the underwriting if you just pull out those large losses?

Paul this is Mike Wilkins answer would be yes. There was deterioration if you pull out the large losses. The large losses probably if you look at that quarter deterioration made up a little over a third of the deterioration. The rest of the deterioration was just you know core deterioration.

Any notable patterns in that core deterioration?

Well, I would say it was in auto and property lines that we have talked about and also work comp. The issue with work comp is the results we had in 2016 we still are pleased with. It was just 2015 was such a good year that the difference between the two led to some of the deterioration in the difference between our loss ratio numbers between the two years.

The non-workers' comp, what's going on with that deterioration? Ex the big cat, the big losses.

I'm not sure I understand your question.

I think he's just probably this is Randy. Paul we have probably been talking about commercial auto for a while. And we all know the usual suspects mileages is up qualified drivers are difficult to find. We see a lot of evidence of distracted driving. We're going to be as we mentioned, raising rates fairly aggressively on this line. And walking away from business if we have to. The commercial auto line rates will help that for us. But that can not be the only answer. We have a lot of loss control initiatives trying to help our insured people to just to be better drivers. And then on the property, if I had to characterize anything it is probably having to do with a little bit older properties. And then the catastrophic losses that we did have in 2016 was another area where some of those property lines came from. We had some notable activity in the Gatlinburg, Tennessee wildfires. We normally don't have a lot of exposure to wildfires as we don't write a lot of property out west. That happened in the fourth quarter. Which normally our fourth quarter is a pretty quiet cat quarter. But this time that contributed a little bit to that as well. Those are the main areas we're seeing. Commercial auto on the severity side and on the property side as well.

Two quick ones. I think you said that I missed the cost savings from the pension change, what would that be in 2017?

It will be $5 million per year.

And then it looked like there was a very good quarter for investment income, anything that was unusual in the quarter?

Well, the financials were up strong in the fourth quarter and we have some large investments in the financial areas in our LLCs. This is Barrie. So I think that was the cause of most of the increase in investment income and that flows through to the investment income.

The next question comes from Quentin McMillan of KBW.

I just wanted to talk about the growth initiatives that you guys have in their in the press release for 2017. You said that the growth was slow moderately. Could you give a little more color? You have grown double digits consistently over the past couple years, so obviously it's pretty impressive what is moderate mean? Are we still looking for growth and any kind of range would be helpful.

This is Randy. We're still looking to grow in 2017. The past, as you said, we probably been growing around 10% or a hair more. And I would say we hope to be able to grow at about half pace. So we the 4% to 6% range will be pretty satisfactory in this market cycle I think.

Okay great. And then you talked about the profitability initiatives in there in the life insurance operation. Previously also dividend some of the capital from the life back to the PMC. Did you do any of that this year? And would that also be part of a plan of the PMC operations are earning a little bit better than what the life are currently?

A we did not dividend this year Quinton. Our plans are sometime in the very new features of to continue that

And then I just Dawn, a numbers question. I think that you said in your remarks AOCI finished the year at $134 million. I do not have the number in the press release but that would be flat with the third quarter. Is that actually right? Because that would indicate unrealized losses in the quarter?

It down slightly.

Okay. So there was some degree of book value hit associated with a loss in AOCI as everybody else saw obviously right?

Year over year it was less. There was a significant drop in the quarter to fourth quarter. But year-over-year it was down about I believe it was $5 million.

Okay. Thanks very much and then just one last quick question. In terms of the commercial auto book, obviously you have talked about some the initiatives that you're taking and obviously getting a lot of price and a lot of rate is going to be a good thing that will earn in over time. But do you have an indication as to what you target the loss ratio of that book to be or qualitatively where you need it to be to make sense for you to write that?

Quentin, this is Mike. We will probably look at account loss ratio more than individual lines. But we expect all the lines to stand on their own as well. So we look at an overall basis by line. But an individual account, sometimes the auto pricing we can have some flexibility with. We're probably 10 points from where we'd like that line to be on a loss ratio basis.

[Operator Instructions]. This concludes our question-and-answer session. I would like to turn the conference back over to Randy Patten for any closing remarks.

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

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.