United Fire Group, Inc. (UFCS) Q4 2017 Earnings Report, Transcript and Summary

Good morning. My name is Brandon, and I'll be your conference operator today. At this time, I would like to welcome everyone to the United Fire Group Fourth Quarter and Full Year 2017 Financial Results Conference Call. [Operator Instructions]. Please note this event is being recorded. I would now like to 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 the 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 on 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 Fourth Quarter and Full Year 2017 Conference Call. Earlier this morning, we reported consolidated net income of $1.81 per diluted share, adjusted operating income of $1.78 per diluted share and a GAAP combined ratio of 93.8% for the fourth quarter of 2017. This compares with net income of $0.46 per diluted share, adjusted operating income of $0.46 per diluted share and a GAAP combined ratio of 102.6% for the fourth quarter of 2016. For the full year 2017, we reported net income of $1.99 per diluted share, adjusted operating income of $1.79 per share and a GAAP combined ratio of 104%. This compares with full year 2016 net income of $1.93 per diluted share, adjusted operating income of $1.78 per diluted share and a GAAP combined ratio of 100.3%. Our fourth quarter and year-end 2017 results benefited from the Tax Cuts and Jobs Act, which passed into law on December 22, 2017. The impact of this change added $0.86 per diluted share to adjusted operating earnings in the fourth quarter. Removing the impact of the tax law change, adjusted operating earnings were $0.92 per diluted share for the fourth quarter, which is an increase of $0.46 per diluted share compared to the fourth quarter of 2016. Dawn will be providing additional details on the financial impact of the tax changes later in this conference call. During the fourth quarter 2017, we began to see improvement in our core loss ratio, including a decrease in our commercial auto and commercial property losses. As a company, we have several initiatives in place to return our auto line of business to the acceptable level of profitability, which includes continuing to aggressively increase pricing on our auto business. We believe we are gaining traction in our auto lines and we'll continue our initiatives to improve profitability going forward. During the fourth quarter of 2017, catastrophes were manageable, with cats adding 2 percentage points to the combined ratio compared to 3.6 percentage points in the fourth quarter of 2016. The cat load for the fourth quarter 2017 is lower than our 10-year historical average of 6 percentage points. For the full year 2017, cats added 7.4 percentage points to the combined ratio, up from 6.5 percentage points in 2016. The 10-year historical average for cats has been 7.3 percentage points, so 2017 was right in line with our historical performance. For the full year 2017, the hurricanes during the third quarter had the most significant impact, accounting for $22 million or approximately 30% of our total 2017 cat losses. The wildfires in California accounted for $2 million of our cat losses in 2017. Moving on to expenses. Our expense ratio increased to 33.3% in the fourth quarter of 2017 as compared to 30.2% in the fourth quarter of 2016. This increase is primarily due to the deterioration in profitability of our auto lines of business, which accelerates the amortization of our deferred acquisition costs. For the year, our expense ratio was 31.2% compared to 30.6% in 2016. So despite the increase in the fourth quarter, our full year 2017 expense ratio continues to meet our expectations at around 31 percentage points. 2017 was a year that definitely had its ups and downs. UFG, like the industry overall, continue to battle a deterioration in performance in our commercial and personal auto lines of business. We expect to return these lines back to our desired level of profitability with aggressive rate increases and other initiatives. In 2017, UFG also incurred losses from 3 powerful hurricanes and devastating wildfires in California. The diligent and proactive efforts of our claims staff allowed us to minimize the impact on our policyholders and agents and return them to a sense of normalcy as quickly as possible. In addition to these large catastrophes, in 2017, the industry endured the second most costly severe convective storm season in the U.S. in a decade. UFG was no different than the industry. The majority of our remaining catastrophe losses in 2017 were from severe convective storms. I believe it is worth noting that in both these cases, our selective underwriting minimized our losses from any individual cat event. Finally, signs of improvement in our underlying core loss ratio in our commercial auto and commercial property lines has us headed in the right direction. Looking forward to 2018, we are still on track to close our previously announced sale of our life insurance business in the first half of 2018. As we stated previously, the proceeds from the sale will be used for various capital initiatives, which may include share repurchases, regular and extraordinary dividends and potential future acquisitions. With that, I will turn over the discussion to Mike Wilkins. Mike?

Thanks, Randy, and good morning, everyone. As Randy indicated, we had some improvement in our core loss ratio in the fourth quarter of 2017, driven by a decrease in severity in our commercial auto and commercial property lines of business. We are making progress in our ongoing efforts to improve profitability in our commercial and personal auto lines of business with the initiatives we've been discussing all year, and we will continue to push rate increases while keeping a close eye on these lines during 2018. All of our regions will also be reviewing our underperforming accounts and taking appropriate rate and underwriting actions necessary to return these lines to profitability. In the fourth quarter of 2017, we had 18 large commercial auto claims compared to 24 large commercial auto claims in the fourth quarter of 2016. For the full year, we had 63 large commercial auto claims compared to 45 large claims in 2016. This reduction in frequency of large losses during the fourth quarter is encouraging, and we look forward to seeing the benefits of our auto initiatives carry on into 2018. On Slide 10 of our slide deck, we have provided a breakdown of the geographic distribution of the large commercial auto claims received for the full year 2017. Our risk control representatives are continuing to focus their efforts on accounts with significant auto exposure. These efforts include ensuring that our commercial policyholders have acceptable hiring practices, driving -- excuse me, driver screening practices, vehicle use policies and vehicle maintenance policies in place and that they are being enforced. Also recently, we began working with the selected automobile accounts to implement a net-based telematic solution to monitor and prevent distracted driving practices by insured drivers. The new app will provide information on miles driven, hours driven, number of drives, drive times a day, drive durations, drive locations, routes, mobile distractions and also provide data on hard stops, acceleration and speed. We are also continuing to grow our enterprise analytics department and look forward to the additional capabilities this department will provide to our underwriting teams in both risk selection and pricing. Enterprise analytics is also directly involved in our OASIS initiative, which is a multiyear project to modernize our policy processing system and transform the way we do business, allowing us to incorporate data and analytics into our daily decision-making. The initial phase of this project is complete, and we expect to make substantial progress in the year ahead with support and guidance from over 50 employees serving on the OASIS team. For commercial property, similar to our commercial auto initiatives, we implemented several strategies in 2016 to address our underperforming commercial property book. In the fourth quarter of 2017, we began to see some improvement in this line due to these initiatives. In particular, we have seen significant reduction in fire losses during 2017 as compared to 2016. We believe that fire results are benefiting from an increased focus on lost control on this line, including the use of infrared imaging technology. Additionally, there has been an increased focus on underwriting discipline for older buildings and certain classes of business. Moving on to market conditions. During the fourth quarter of 2017, market conditions were competitive on both renewal and new business across all regions. The average renewal pricing change for commercial lines increased by low single digits, primarily driven by an increase in commercial auto pricing. Filed commercial auto rate increases processed during the quarter averaged in the low double digits and commercial property increases averaged in the mid-single digits. Filed workers' compensation rate decreases averaged in the mid-single digits. Personal lines renewal pricing also increased with average percentage increases in the low single digits and filed rate increases processed during the quarter averaged in the upper single digits. All regions continue to aggressively address our poor-performing accounts through nonrenewal or significant rate increases. During the fourth quarter of 2017, premium and policy retention remained strong at 84% and 81%, respectively. Our success ratio on quoted accounts decreased 1 percentage point from the prior quarter to 27%. This decrease, similar to the third quarter, was largely driven by a significant drop in the success rate of our specialty division, resulting from a large increase in quote request for this division again in the fourth quarter. As we continue to address the deterioration in our 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 Jaffray.

Thanks, Mike, and good morning. For the fourth quarter of 2017, we reported consolidated net income of $46 million compared to $12 million in the fourth quarter of 2016. For the year ended 2017, consolidated net income was $51 million compared to $49.9 million in 2016. The increase in net income in the fourth quarter and full year over the comparable period is due to prior year favorable reserve development, improvement in our core loss ratio, as Randy and Mike have discussed, and changes in the corporate tax rate, resulting in a onetime adjustment to net income. UFG realized a tax benefit of $21.9 million associated with remeasuring our deferred tax liability under the new lower corporate rates that will be in effect in 2018 and beyond. In simple terms, the deferred tax asset on the balance sheet reflects an opportunity for our future tax deduction and our deferred tax liability reflects the future taxable income amount. However, I note it is not as simple as just applying a rate change from 35% to 21% as various other tax rules create permanent and temporary timing differences between accounting for income taxes and actual corporate income tax payments. UFG's effective rate, which can vary as a function of the amount of pretax income or loss, has historically been in the range of 21%. Although subject to variability in any year, we anticipate our effective tax rate will approximate 15% to 17% on average under the new tax code. One of the more significant items potentially impacting property and casualty companies will be the requirement to discount loss reserves based solely on IRS factors and using company payment patterns will no longer be permitted. With bonus depreciation being increased to 100% writeoff for assets with a depreciable life of 20 years or less, we may see capital investments increase across our commercial client base. So in analyzing the impact of the new tax bill, we view it as a positive development for UFG as well as for our commercial policyholders. We will continue to refine our calculations as more definitive guidance is issued. Moving on to premiums. Consolidated net premiums earned increased 2.6% in the fourth quarter 2017 as compared to 2016, while total revenues were flat. Year-to-date consolidated net premiums earned increased 3.5%. Total revenues increased 2.8% as compared to 2016, with the resulting increases in property and casualty continuing operations premium being offset by decreases in discontinued life insurance business premium. Consolidated net investment income was $25.1 million for the fourth quarter 2017, a decrease compared to fourth quarter 2016 with $33.4 million. For the full year 2017, investment income was $100.9 million or a 5.5% decrease over 2016. The decrease in net investment income in the fourth quarter and full year 2017 was primarily driven by the change in value of our investments and limited liability partnerships as compared to the same period in 2016 and not due to a change in our investment philosophy. And looking at only our property and casualty insurance business or our continuing operations, we reported consolidated net income of $1.78 per diluted share and $1.75 per diluted share in the fourth quarter and full year 2017, respectively, as compared to net income of $0.46 per diluted share and $1.90 per diluted share in the same periods of 2016. Net premiums earned from our continuing P&C operations grew by 6.5% and 6.6% in the fourth quarter and full year 2017 as compared to the same period in 2016. As we have discussed in our previous conference calls, our expectation for premium growth in 2017 was 4% to 6%. We will emphasize profitable growth initiatives along with continued rate increases, expecting year-over-year growth rate to remain in a similar range for 2018. We experienced favorable reserve development of $16.3 million in the fourth quarter of 2017 compared to $4.2 million of favorable development in the fourth quarter of 2016. For the full year 2017, favorable reserve development was $54.3 million compared to $31.2 million for the same period in 2016. The impact on net income for the fourth quarter and full year in 2017 was an increase of $0.42 and $1.38 per diluted share compared to an increase of $0.10 and $0.79 per diluted share in the same period of 2016. To expand further on our reserve development in the fourth quarter of 2017, the biggest driver was favorable development in our fire and allied line of business. For the full year 2017, a majority of the favorable development was from other liability lines and workers' compensation, partially offset by reserves strengthening in our assumed reinsurance lines. Our full year reserve development of 5.4 percentage points of the combined ratio is slightly below our 5-year and 10-year averages of 5.8 and 5.7 percentage points. At December 31, 2017, total reserves were within our actual estimates. The combined ratio in the fourth quarter 2017 was 93.8% compared to 102.6% for the fourth quarter 2016. For the full year 2017, combined ratio was 104% compared to 100.3% for the same period in 2016. Removing the impact of catastrophe losses in reserve development, our core loss ratio improved by 0.7 percentage points in the fourth quarter and deteriorated 4.3 percentage points for the full year of 2017 as compared with 2016. The primary driver of the deterioration in the core loss ratio is an increase in the number of severe commercial auto losses in the first 3 quarters of 2017, as previously discussed. Referring to Slide 9 and the slide deck on our website, we provided a detailed reconciliation of the impact of catastrophes and development on the combined ratio. Return on equity was 5.3% in 2017 compared to 5.5% in 2016. Even though net income was slightly higher in 2017 compared to 2016, the decrease in ROE is attributed to a higher denominator equity base. During the fourth quarter, we declared and paid a $0.28 per share cash dividend to stockholders of record on December 1, 2017. We have paid quarterly dividends every quarter since March of 1968. During the fourth quarter, we did not repurchase any shares of our common stock. For the full year 2017, we repurchased 701,899 shares of our common stock for a total cost of $29.8 million. We purchased United Fire common stock from time to time on the open market or through privately negotiated transactions as the opportunity arises. The amount and timing of any purchases is at management's discretion and depends on 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 2.2 million 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]. Our first question comes from Brian Hollenden with Sidoti.

The commercial auto, the large losses from commercial auto by region, any -- I guess, why is the West Coast and Great Lakes region so much worse than, let's say, the East Coast and Gulf Coast? Can there be anything done there to improve those results? What's going on particularly in the West Coast?

Well, maybe I'll let Mike answer in more detail, but I think there's kind of a lot of factors to a little bit the type of looks of business differs slightly by the branches. I mean, a little bit of it's underwriting. Some of it is a little bit more heavy vehicles written. And then court jurisdictions are part of the fact or 2. Mike, do you have some things to add to that maybe?

Yes. Brian, one thing I would say is there is -- for a lot of these regions, correlations are based on how much premium they write. So for example, Great Lakes is our second largest auto region and East Coast is by far smallest. So that's part of the reason of the difference there. The one outlier would be West Coast office and a couple of things playing into that. One, they tend to write more heavy wheel exposures, which tend to generate more severe losses. And then the second thing, as Randy mentioned, is jurisdiction and just that state, if you look at national statistics, there's been a lot more auto issues in that state, a lot of congestion, just tend to see higher frequency and severity in the state of California than a lot of the other states.

And then just by segment, I mean, fire and allied lines and workers' comp, there's pretty significant improvement in the net loss ratio. Anything in particular that you guys are doing different on the underwriting side to generate those good -- significant improvements?

I think on the property, probably the biggest thing is age of building. We've kind of become a lot more strict on older buildings. And then on the work comp, we're down in that line. I think if anything else, that as premiums are going down in that line, we've probably walked away from more business as the pricing goes down. Mike, you got anything to want to add?

Yes. Property, in particular, has been a line of focus for us, and we're probably most pleased with the reduction in fire loss ratio between 2017 and 2016. Our storm losses were up quite a bit in the year but still had some improvement in the line, so we feel good about that. On the work comp side, the only other thing I'd throw in there is we've got analytics at play there, which I think is helping. So we try to focus on reducing the severity within that book, and I think we're making some progress.

And then last one for me, just to confirm. Dawn, did you -- you mentioned premium growth in '18 of 4% to 6% and effective tax rate between 15% and 17%. Did I hear that correctly?

Yes, Brian, that is correct.

Our next question comes from Paul Newsome with Sandler O'Neill.

Could you talk a little bit more about capital management and as we approach the big sale of the life operation, the mechanics of how you'll go about that and maybe some of the specific statistics of how you look at buyback versus special dividend, et cetera?

Yes. Sure, Paul. So I think we've mentioned in the past we've assembled a Capital Committee as part of our board. We've chosen to kind of wait until after the sale to decide what the best use of the proceeds are going to be. We've listed in the conference call some of the areas that we'll consider. I think we've told you in the past, we're maybe not as looking for acquisitions as we have in the past a little bit, focusing more on organic growth. But we still list that as not full use. And we continue to look for M&A opportunities still. Our stock price will kind of depend. The share buybacks are a function of where our stock is trading, so we'll use that more heavily, obviously, if our share price stays a little bit lower. And special dividends is something we have not traditionally done, but I know that's something else that we're going to be talking about going into the future. And then we're kind of continuing to refine our capital analysis and A.M. Best has a new -- kind of new BCAR system that we would also like to take a look at that to see exactly where we stand capital wise from a minimum required capital and that will help us make some of our judgments as well.

And then separately, the question sort of -- of 2018 is regulatory clawback of rates sort of related to the benefits of the corporate tax reform. Could you give us your thoughts as to whether or not you think they will materially impact your rate filings, and particularly, the issue, I guess, is in California more than other places as well, which is obviously a problem state?

Yes, I probably should've looked up. Obviously, when we file rates, you're -- you have to load in for your tax rates. So that -- I don't know if it's a 1-year or if it's a 3-year rolling, but that tax cut will be passed on to our policyholders, certainly within 2 or 3 years. It could be quicker than that, but I think there will be some benefit maybe in the shorter run. But as we continue to file new rates, that new tax rate is going to be reflected in there. So I know California has talked about mandating that the tax cut be returned to the policyholders, but I think the market is going to kind of ensure that, that happens relatively quickly.

Paul, this is Mike. I would add a couple of points there. I think there'll be more pressure from the regulatory bodies on personal auto, which is 3% of our book than on the commercial side. And the second thing I would say is with the auto results that we've had, when you look at our indicated rate calculations, the tax will be a very small part of that and I'm confident we will still have justification for increased auto premiums going forward until we get the numbers back in line with where we want them to be.

[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. Thank you for joining us, and have a great day.