United Fire Group, Inc. (UFCS) Q3 2017 Earnings Report, Transcript and Summary

Good morning, my name is Nicole, and I’ll be your conference operator today. At this time, I would like to welcome everyone to the United Fire Group Third Quarter 2017 Financial Results Conference Call. All participants will be in a listen-only mode. [Operator Instructions] After today’s presentation there will be an opportunity to ask questions. [Operator Instructions] And please note, this event is being recorded. Thank you. And I will now turn the call over to Randy Patten, AVP of Finance and Investor Relations. Please go ahead.

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 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 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 result 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 UFG.

Thanks Randy. Good morning everyone and welcome to the UFG Insurance third quarter 2017 conference call. Earlier this morning, we reported a net loss of $0.72 per diluted share, operating loss of $0.73 per share and a GAAP combined ratio of 118.1% for the third quarter of 2017. This compares with net income of $0.48 per diluted share, operating income of $0.41 per diluted share and a GAAP combined ratio of 100.9% in the third quarter of 2016. The third quarter results were impacted by three powerful hurricanes that cause devastation in Texas, Florida and Puerto Rico. These storms cause much more than economic damage, they displace families and cause tremendous stress and uncertainty for everyone effected and we hope for a speedy recovery for all those impacted by Harvey, Irma and Maria. I’d also like to thank our catastrophe claim teams that were in Texas and Florida before the storms made landfall, ready to assist our policyholders. Their quick response and the ability to handle these claims in a timely fashion, help our insurers get back in business or get back to the sense of normalcy, which is appreciated during times like this. Along with elevated CAT losses during the third quarter, results were also impacted by an increase in the number of large commercial auto claims, which we define as those above $500,000. We are disappointed in the continued poor results in our commercial auto line, but we are not alone. We believe this is an industry-wide issue, commercial auto loss ratios have been increasing for the past couple of years. In the October 2017, Best’s Review, insurance magazine, it shows the average adjusted loss ratio for U.S. commercial auto writers increased from 63.9% at the end of 2014 to 69% at the end of 2016 or an increase of 5.1 percentage points. We have a number of initiatives that we are putting in place to address this issue, which we have discussed the past few quarters in our conference calls. One of our responses to our – and the industry’s continued issues with commercial auto is to address distracted driving. In the third quarter, we launched a new distracted driving campaign. This campaign which we are calling worth it, is a is a comprehensive educational and marketing program to remind drivers their life is worth it, driving distracted is not. This collection of resources is designed to teach and engage. It can be used by any business owner, insurance agents, educators or individuals, basically anyone interested in helping fight the epidemic of distracted driving. Another initiative which we continue to work on is rate increases on our commercial auto line. We initially set out with an aggressive plan for rate increases, but in reality we did not execute it across all regions. So we need to refocus on execution of our plan. Moving forward we will further reinforce the importance of rate adequacy given the exposure. We think it will take sometime before we see improvement in the results, but with the rate increases along with other ongoing initiatives, we are confident we can return this line to profitability. Mike will discuss the initiatives we are putting in place to improve our underwriting performance in this line in more detail. Moving onto catastrophe losses, cats added 12 percentage points to the combined ratio in the third quarter of 2017 compared to 5.2 percentage points in the third quarter of 2016. The cat load for the third quarter of 2017 is higher than our 10-year historical average of 8.9 percentage points. The increase in cats this quarter is the result of the three hurricanes, which I previously discussed. During the quarter $10 million of the $30.7 million of cat losses occurred on assumed reinsurance for these hurricanes. Our expense ratio continues to meet our expectations but was up to 30.8% for the third quarter of 2017, which is slightly higher then the third quarter 2016 at 30.2%. The increase in the three month period ended September 30, 2017 was due to two items. First, the deterioration and the profitability of the commercial and personal auto lines of business, which accelerates the amortization of our deferred acquisition costs. Second, we are investing in a new multi-year project to upgrade our technology platform to enhance core underwriting decisions and productivity. These were both partially offset by a decrease in the post-retirement benefit expenses, and a decrease in contingent commission expenses. As many of you are aware, we issued a press release on September 19, announcing we had reached a definitive agreement with Kuvare US Holdings to sell our life insurance subsidiary, United Life Insurance Company. The decision to sell our life subsidiary to Kuvare was made in the best interest of UFG, its shareholders and United Life from both a business perspective and a personal perspective. By selling United Life to Kuvare, we have established a solid future for our life insurance employees, insurance agents and customers, while allowing us to continue to build on the success of our property and casualty operations. The closing of this sale is currently expected to occur in the first half of 2018, subject to customary conditions and regulatory approval. Finally, to wrap up my portion of the discussion, during the third quarter A. M. Best affirmed our rating of A Excellent, as we expected. With that I will turn the discussion over to Mike Wilkins. Mike?

Thanks, Randy and good morning everyone. As Randy indicated, we had further deterioration in our core loss ratio in the third quarter of 2017 driven by an increase in the number of large losses in our commercial auto line of business. Much of this deterioration between the second and third quarter of 2017 is due to strengthening our prior year reserves. This reserve strengthening is partially due to bodily injury loss inflation that we and the industry are experiencing. There were also a number of catastrophe claims from the three hurricanes in the third quarter, which contributed to the increase in the commercial auto loss ratio. In the third quarter of 2017, we had 17 large commercial auto claims compared to 10 large commercial auto claims in the third quarter of 2016. Year-to-date, we have 45 large commercial auto claims as compared to 21 large claims in the prior year-to-date. This increase in the number of severe commercial auto losses is the primary reason for the deterioration in the core loss ratio. Many of these commercial auto losses occurred on policies with umbrella coverage, which increased our loss ratio on our other liability line of business this quarter as well. On Slide 10 of our deck, we have provided a breakdown of the geographic distribution of the large commercial auto claims received year-to-date. As Randy also touched on, we have not been diligent enough in all regions pushing the approved rate increases in our commercial auto line of business. Moving forward all of our regions and branches will be more aggressive with our rate increases for this line, especially on our marginally performing accounts. They will also continue to review and non-renew our underperforming accounts. Some other initiatives, we continue to work on include having our loss control reps focus their efforts on accounts with significant auto exposure, these efforts include ensuring that insurers have acceptable hiring practices, driver screen practices, vehicle use policies and vehicle maintenance policies and ensuring that they are being followed and enforce. Our new analytics department also continues to assist us by providing pricing and acceptability guidance on our commercial auto book as well as business intelligence insights to assist underwriters and making better acceptability and pricing decisions. We are confident that with continued rate increases in these initiatives we will return our commercial auto book back to our desired level of profitability. Moving onto market conditions, we continue to experience competitive market conditions during the quarter for both renewal and new business. Renewal pricing on larger accounts is flat to down slightly, and pricing on smaller accounts is flat to a small percentage increase. Overall average renewal pricing change for commercial lines increase slightly, driven by commercial auto with pricing varying depending on the region and size of account. Commercial auto and commercial property rate increases continue to be in the mid to upper single-digits with negative rate changes for our workers compensation line of business. Overall average renewal pricing increase slightly for personal lines but it increases in the low single digits. All regions continue to aggressively address our poor performing accounts through non-renewal or large pricing increases. Premium and policy retention remains strong at 84% and 81% respectively during the third quarter of 2017. Our success ratio on quoted accounts decreased 5% from the prior quarter to 28%. This decrease was largely driven by a significant drop in the success rate of our specialty division due to a large increase in quote request for this division in September. As we continue to address the deterioration in our auto book of business, our expectation is that premium and policy retention may be negatively impacted. With that, I’ll turn the financial discussion over to Dawn Jeffrey.

Thanks Mike and good morning. For the third quarter of 2017 we reported a consolidated net loss of $17.9 million or $0.72 per diluted share compared to consolidated net income of $12.4 million or $0.48 per diluted share in the third quarter of 2016. Through nine-months 2017 year-to-date consolidated net income was $5 million or $0.20 per diluted share compared to $37.9 million or $1.47 per diluted share in the same period of 2016. The decrease in quarter-over-quarter and year-over-year net income is primarily due to deterioration in our core loss ratio and elevated catastrophe losses previously discussed by Randy and Mike. Consolidated net premiums earned increased 3.8% in the third quarter of 2017 as compared with 2016 and total revenues increased 2.5%. Year-to-date consolidated net premiums earned and total revenues both increased 3.8% as compared with 2016. As Randy mentioned, during the third quarter, we reached a definitive agreement to sell our life subsidiary. Throughout our press release and 10-Q this quarter, we have classified the results from our life subsidiary as discontinued operations and the results from our P&C business as continuing operations as required by accounting guidance. Just looking at continuing operations, we reported a consolidated net loss of $0.77 per diluted share and $0.01 per diluted share in the third quarter and year-to-date 2017 respectively as compared to net income of $0.45 per diluted share and $1.45 per diluted share in the same period of 2016. Net premiums earned from our continuing operations grew by 6.8% and 6.6% respectively in the third quarter and year-to-date 2017 as compared to the same periods in 2016. As we’ve discussed in our prior conference calls, our expectation for premium growth in 2017 is 46% with the initiatives that we are aggressively pursuing in our commercial auto line of business. We expect our premium growth will slow in the fourth quarter of 2017. And as a result, we meet these expectations. We experienced unfavorable reserve development of $3.2 million in the quarter compared with $700,000 of favorable development in the third quarter of 2016. Year-to-date in 2017 favorable reserve development was $38 million compared to $27.1 million in the first nine months of 2016. The development impact on net income for the third quarter and year-to-date in 2017 was a decrease of $0.08 and an increase of $0.96 per diluted share respectively compared to an increase of $0.02 and $0.68 per diluted share in the same periods of 2016. Looking at reserve development in more detail, in the third quarter of 2017 the majority of the unfavorable development was from two lines other liability and commercial auto, which was partially offset by favorable development in workers compensation. Year-to-date 2017, the majority of the favorable development is from other liability lines and workers compensation partially offset by reserves strengthening in our commercial fire and allied and commercial auto lines. The combined ratio in the third quarter of 2017 was 118.1% compared to 100.9% for the third quarter of 2016. Year-to-date 2017, the combined ratio was 107.6% compared to 99.5% for the same period of 2016. Removing the impact of catastrophe losses and reserve development our core loss ratio deteriorated 8.1 percentage points in the third quarter and 7.7 percentage points year-to-date 2017 as compared to 2016. The primary driver of the deterioration in the core loss ratio is an increase in the number of severe commercial auto losses as previously discussed. Referring to Slide 9 in our slide deck on our website, we’ve provided a detailed reconciliation of the impact of catastrophes and development on the combined ratio. Return on equity was 0.7% year-to-date 2017, compared to 5.5% in 2016. The decrease in return on equity as compared to the same quarter last year was primarily due to the net loss for the quarter. Our return on equity excluding unrealized investments gains was 0.9% for 2017. During the third quarter, we declared and paid a $0.28 per share cash dividend to stockholders of record on September 1, 2017. We have paid a quarterly dividend every quarter since March of 1968. Also during third quarter of 2017, we remained active with our share repurchase program. During the third quarter, we repurchased 205,291 shares of our common stock at an average price of $41.89 at a total cost of $8.6 million. And year-to-date through September, we’ve repurchased 701,899 shares of our common stock for a total cost of $29.8 million. We purchase United Fire common stock from time-to-time on the open market and/or through privately negotiated transactions as the opportunity arises. The amount and timing of any purchases will be at management’s discretion and will depend on a number of factors including the share price, general economic and market conditions and corporate and regulatory requirements. We are authorized by our Board of Directors to purchase an additional 2.2 shares of common stock under our share repurchase program, which expires in August of 2018. And with that I will now open the line for question. Operator?

Thank you. We will now begin the question-and-answer session. [Operator Instructions] And our first question comes from Paul Newsome of Sandler O’Neill. Please go ahead.

Good morning. Thanks for the call. Could you tell me or give us a sense of how many years of profit were overtaken by the loss in the assumed reinsurance business? I’m just trying to think about sort of the payback period of time for that kind of business.

Take that Mike.

Yes. Paul good morning this is Mike Wilkins. Yesterday, we’re looking at a 10-year total for the results of the assumed business, including this year, and I think our – I don’t have it with me, but I think our underwriting profit on that business for the last 10 years was around $60 million. So it’s been very profitable. It’s our most profitable segment but it does have a lot of volatility to it. So when you have years like this year or the year of the Japan earthquake and tsunami, you have bad result in those years. But over the long run, it’s definitely a good segment to be in.

Great. And then do you have any sense about the implementation time for the rates on the commercial auto business? Are you actually raising rates at the moment, and you’ve been doing it for a while? Obviously, I mean, rate is really what’s going to fix this thing. So just curious as to how fast you’re getting rate through the commercial auto business. And I’d also like to know your willingness just to let business go in that line?

Yes. This is Mike again, Paul. We’re gaining momentum. I think Randy’s comments, he said that maybe not all regions are on board, but I think we’ve corrected that in the last quarter. Some – our analytics group has done a nice job of getting us solid metrics on what we’re achieving on commercial auto rate. Going back to the last three months, July, this is overall rate increases across all regions. July was 4.8%, August was 6.0%, September was 8.0%. So nice momentum being gained there as everybody is getting on board with those rate increases. I think market continues to firm. So I don’t think we’re at the top yet, I think we can get north of 10% in that line going forward, so that’s encouraging. The other thing I would say is rate will certainly help, and probably the fastest thing we can do to improve the loss ratio, but we have to do more than that to get it to where we wanted. So we continue to work on the other areas that we mentioned as well. One thing that’s really going to help, in our slide deck, we showed breakdown of large losses by region, and you can see our West Coast is really contributing more than their fair share of large losses. We did get a fairly large rate approval through the California Insurance Department this quarter, so that will help things out there as we go forward as well. And I think some positives finally coming through and some trends that are encouraging.

Paul, this is Randy Ramlo. I just wanted to kind of reiterate one of the things Mike said that for UFG, rate alone will not cure this. We know we have to let some of our poor-performing accounts go. So all of our regions absolutely have the message that we’re not looking to grow in this area and we have to – price something up, and you lose it, that’s a win.

And, Paul, maybe one more comment along those lines. So our policy account in auto is up, but our unit count is down. And one of the things that we’ve found with our analytics business intelligence and some of our larger accounts, the accounts with larger fleets, were our most unprofitable accounts. And I just think there’s a tendency on those large accounts to over credit them from an underwriting perspective. Bigger accounts tend to get more credits. A lot of times on the auto, there’s not good fundamental reasons why those credits should be applied. It’s just – they’re larger accounts just because they have more units, not because they have – they’re not better accounts because they don’t necessarily have safety programs or driver training or better driver screening. So those are the types of things you really have to look at when applying credits and not size of the account. And I think, unfortunately, in the past, some of those large accounts got credit just because they’re large accounts. So I think we’re making progress there, too, as we tend to focus more on the accounts with fewer units but more profitable, more adequately priced. More adequately correct.

Thank you. Great. Thank you very much. Operator

Thank you, Paul.

Our next question comes from Brian Hollenden of Sidoti. Please go ahead.

Good morning and thanks for taking my questions. Can you talk about the likely uses of capital from the life insurance segment sale, given the challenges in the core business?

This is Randy Ramlo. We’ve kind of mentioned before, we developed a capital committee as part of our board, and we’ll obviously just have to wait for our life insurance deal to close, which we hope we’ll do sometime early in 2018. And at that time, our capital committee will, I think will look at – we continue to look at outside acquisitions, but maybe slightly less aggressively than we have in the past. Dawn mentioned our track record of paying dividends. We would consider even a special dividend, more share repurchases depending on kind of where our stock price is. So I think we’ll take a multipronged approach to putting those funds to use or returning some to the shareholders.

Thanks. And then can you talk a little bit about your direct or perhaps your reinsurance exposure to the California wildfires?

I’ll let Mike handle that one.

Yes. This is Mike Wilkins. I would say it’s too early to know the impact yet. I don’t think it would be anywhere near as significant as the Harvey, Irma, Maria exposure. But as a fourth quarter event, and we have not gotten updates from the reinsurer – the companies that we reinsure yet to have a good feel for that.

In general, we try to, I guess, minimalize reinsurance exposure to U.S. cats because we have that exposure on the primary side. So Maria would came mostly from our Puerto Rican exposure, which we don’t have any on the primary side. So not to say that we won’t have any, but we do try to kind of watch U.S. exposure to any kind of cat business because we have it on the primary side already.

And this quarter marks sort of the first unfavorable reserve development in a number of quarters. Would you expect additional unfavorable reserve developments?

That’s a tough one. I hope not. We always think that we’ve been diligent in getting caught up, but a lot of this came, obviously, from the commercial auto line. So we’ll – more to follow, but we hope that we’ve got everything in the third quarter that belongs there.

And then the last one for me, just the new technology platform that you’re implementing. Can you just talk about perhaps the new features that this platform has that your old platform did not? Just any additional capabilities.

This is Mike Wilkins. I’ll try to tackle that one. And I think probably the big transformational pieces that we think will come with this is just better analytics, insight, better access to data from our underwriters and decision-making. Of course, we think productivity gains will come. There’ll be more things automated, less manual entry, more straight through process. But while we really think the advantages will come to UFG, the things that will really help transform our business are the ability to make better underwriting decisions and improve the profitability through better use of data.

That’s helpful. I mean, any way to kind of quantify that in terms of impact to combined ratio, all else equal?

I don’t think that’s probably anything that we’re willing to talk about at this time. It’s probably a long timeframe on this project. We would not expect to implement the first states for a couple of years. And probably, by the time the whole project is wrapped up, it’ll be more like five year timeframe. Part of the – it’s not just the policy processing. So it’s also the data structure, analytics and access to that data for the underwriters. So I don’t think it’s anything that we’d want to talk about quantifiable numbers yet.

Thank you.

[Operator Instructions] And as we have no further questions, 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 the UFG, I hope you all have a great day.

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