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Edited Transcript of EMCI earnings conference call or presentation 7-Aug-18 4:00pm GMT

Q2 2018 EMC Insurance Group Inc Earnings Call

DES MOINES Aug 21, 2018 (Thomson StreetEvents) -- Edited Transcript of EMC Insurance Group Inc earnings conference call or presentation Tuesday, August 7, 2018 at 4:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Bruce Gunn Kelley

EMC Insurance Group Inc. - President, CEO, Treasurer & Director

* Mark Edward Reese

EMC Insurance Group Inc. - Senior VP & CFO

* Meyer T. Lehman

EMC Insurance Group Inc. - Senior VP & Chief Actuarial Officer

* Michael Alan Lovell

EMC Insurance Group Inc. - EVP of Operations

* Steve Walsh

EMC Insurance Group Inc. - Assistant VP & Director of IR

* Vicki Lynn Freese

EMC Insurance Group Inc. - VP of Reinsurance

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Conference Call Participants

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* Christopher Campbell

Keefe, Bruyette, & Woods, Inc., Research Division - Analyst

* John Eric Deysher

Bertolet Capital Trust - Pinnacle Value Fund - Portfolio Manager

* Jon Paul Newsome

Sandler O'Neill + Partners, L.P., Research Division - MD of Equity Research & Senior Insurance Analyst

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Presentation

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Operator [1]

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Good day, and welcome to the EMCI Second Quarter 2018 Earnings Conference Call. (Operator Instructions) Please note, this event is being recorded. I would now like to turn the conference over to Steve Walsh, Director of Investor Relations. Please go ahead.

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Steve Walsh, EMC Insurance Group Inc. - Assistant VP & Director of IR [2]

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Thank you, Austin. Good afternoon, everyone, and welcome to EMC Insurance Group's 2018 Second Quarter Earnings Conference Call. A copy of the news release is available on the Investor Relations page of our website, which can be found at investors.emcins.com. Archived audio webcast will be available for replay for approximately 90 days following the earnings call.

This presentation includes some forward-looking statements about our expectations for our future performance. These statements are not guarantees of future performance, and actual results could differ materially from those suggested by our comments today due to a variety of factors. Additional information about factors that could affect future results is addressed in our SEC filings, including Forms S-1, 10-K, 10-Q and 8-K. Any information provided today should be read in conjunction with the 2018 second quarter earnings release with accompanying financial tables issued earlier today.

Certain non-GAAP terms may be used during today's discussion. Please refer to the company's press release and SEC filings for a description and reconciliation of these terms.

Speaking today will be Bruce Kelley, President and Chief Executive Officer; Mark Reese, Senior Vice President and Chief Financial Officer; and Mick Lovell, Executive Vice President of Operations. They, along with other executive officers, will be available to answer questions following their prepared remarks.

And at this time, it's my pleasure to introduce the company's President and CEO, Bruce Kelley.

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Bruce Gunn Kelley, EMC Insurance Group Inc. - President, CEO, Treasurer & Director [3]

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Thank you, Steve, and welcome to those joining us today. Earlier today, we reported a net loss of $5 million for the second quarter of 2018 compared to net income of $5.5 million in the second quarter of 2017. Included in the net loss reported for the second quarter of 2018 is a $447,000 pretax decline in unrealized investment gains on our equity investments as required by updated accounting guidance that was adopted by the company at the beginning of 2018. Excluding this amount, the primary driver of the decline in net income for the second quarter is a high level of noncatastrophe losses in the property and casualty insurance segment, partially offset by strong operating results in the reinsurance segment. Also included in the net loss reported in the second quarter of 2018 is $5.4 million of pretax realized investment losses compared to $3.4 million of pretax realized investment gains included in net income in the second quarter of 2017.

Non-GAAP operating loss, which excludes the change in unrealized investment gains on equity investments as well as the realized investment losses, totaled $0.02 per share for the second quarter compared to non-GAAP operating income of $0.16 per share in the second quarter of 2017. The 109.8% GAAP combined ratio reported in the second quarter was not significantly higher than management's internal projection, but it was elevated enough to result in a reduction of our annual guidance. In addition, the composition of the results by segment and the drivers of those results were significantly different from management's projections as the property and casualty insurance segment reported a 115% GAAP combined ratio for the quarter, much higher than the projected, while the reinsurance segment reported a 92.2% GAAP combined ratio for the quarter, much lower than projected.

Based on actual results for the second quarter and expectations for the remainder of the year, we are now projecting 2018 non-GAAP operating income will be within a range of $0.95 to $1.15 per share. This guidance is based on a projected GAAP combined ratio of 103.6% for the year.

While second quarter results prompted a reduction in guidance, we remain focused on improving our underwriting results during the second half of the year. Book value per share declined approximately 6.2% to $26.39 per share from year-end 2017, primarily due to a decline in the value of the fixed maturity portfolio attributable to an increase in interest rates and, to a lesser extent, the $0.22 per share quarterly dividend that was paid to stockholders with no income to cover it.

For the second quarter, premiums earned and premiums written increased 5.4% and 5.1%, respectively. In the property and casualty insurance segment, premiums earned increased 4.6% and premiums written increased 3.6% in the second quarter. Rate levels for commercial lines of business were up low single digits, which is relatively consistent with first quarter. There continues to be significant variation by line of business. We achieved a high single digit rate level increases on the commercial auto lines of business, which still needs considerable rate given its recent underperformance. Workers' compensation levels declined by mid-single digits due to continued mandatory rate level decreases filed in many states, which has reduced rate adequacy over the past few years. We have been able to effectively manage these mandatory rate reductions as the rate declines reported by the National Council on Compensation Insurance have generally exceeded our rate declines. Appropriate placement within our various property and casualty insurance subsidiaries has played an important part in navigating these mandatory rate decreases as each subsidiary has deviated rating plans, which provide some flexibility for underwriters when evaluating the specific risk characteristics of each policy.

In addition, certain states allow for mandatory approval approved rates through the use of loss cost multipliers to increase or decrease mandatory rates. We will continue to closely monitor rating actions in the states in which we operate and review each new and renewal policy for profit potential at an account level.

Rate level increases in personal lines were up mid-single digits, with increases in homeowners in the high single digits and personal auto in the low to mid-single digits. Retention levels are consistent with 2017 and remain strong at approximately 87% for commercial lines and 84% for personal lines.

In the reinsurance segment, premiums earned were up 8.3% and premiums written were up 11.8% in the second quarter. As we noted in the first quarter, there was some disruption in the reinsurance market during the January 1 renewal season when approximately 70% of our reinsurance treaties renew. Brokers turn to our experienced team of underwriters who capitalized on these opportunities by increasing participation on some of our preferred existing accounts and also by adding some new business. The increase in premiums was partially offset by a continued decline in premiums from the Mutual Re underwriting association, formerly known as the Mutual Reinsurance Bureau, due to its withdrawal from nonstandard automobile business. Based on the growth experienced in the first half of the year and our expectations for the remainder of the year, premiums earned are expected to increase in the mid-single-digit range for the year.

Finally, A.M. Best Company recently affirmed the financial strength ratings of A excellent with a stable outlook for the pool members of EMC Insurance Companies and EMC Reinsurance Company. In addition, we received upgrades to the long-term issuer credit ratings, ICR, of the pool members of EMC Insurance Companies from a to a+ and EMC Insurance Group Inc. from bbb to bbb+. A.M. Best noted the long-term ICR upgrades are based on sustained improvement in our overall operations and strong capital formation and our robust level of risk-adjusted capital. They also recognized our predictive modeling tools and sophisticated monitoring systems as part of our overall risk management program, which have resulted in an improved ability to monitor risk concentrations as well as to quantify and track the quality of business over time. These tools are leveraged by our extensive regional branch office network and supported by longstanding agency relationships, which should enable us to more effectively manage our business through market cycles.

So with that, I'll turn the call over to Mark Reese, our Chief Financial Officer, for some additional comments on the quarter.

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Mark Edward Reese, EMC Insurance Group Inc. - Senior VP & CFO [4]

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Thank you, Bruce, and good afternoon, everyone. The property and casualty insurance segment reported a GAAP combined ratio of 115% in the second quarter of 2018, representing a 9.1 percentage point increase from the 105.9% reported in the second quarter of 2017. This was primarily driven by an increase in noncatastrophe losses in the workers' compensation line of business, which Mick will discuss in greater detail later on the call.

The high GAAP combined ratio reported by the property and casualty insurance segment was partially offset by a 9.5 percentage point improvement in the GAAP combined ratio in the reinsurance segment, which totaled 92.2% in 2018 compared to 101.7% in 2017. This improvement is primarily attributed to a significant reduction in catastrophe and storm losses.

Catastrophe and storm losses accounted for an unusually low 2.8 percentage points of the loss and settlement expense ratio for the second quarter of 2018 compared to 14.6 percentage points during the second quarter of 2017. The property and casualty insurance segment did not make any recoveries under the intercompany reinsurance treaty covering the first half of 2018. However, the recoveries received under the intercompany treaty during the second quarter of 2017 are impacting the comparison of catastrophe and storm loss amounts reported for the second quarters of 2018 and 2017. Despite the quarterly differences, catastrophe and storm losses in the property and casualty insurance segment totaled $20 million for the first 6 months of both 2018 and 2017.

The intercompany reinsurance program continues to operate as planned and provides additional stability and protection from excessive catastrophe and storm losses.

Earlier in the year, we stated that the acquisition expense ratio was expected to increase in 2018 as management is upgrading the company's systems and hiring additional team members with the skills necessary to remain competitive in this quickly changing market and achieve our goal of being a leader in innovation. So it should not be a great surprise to see the acquisition expense ratio for the property and casualty insurance segment increase to 37.4% in the second quarter from 35.7% in the second quarter of 2017. This increase is partially offset by a decline in the acquisition expense ratio in the reinsurance segment, which improved by 1.2 percentage points to 24.1% in the second quarter.

Net investment income increased 5.4% for the second quarter due to growth in the fixed maturity portfolio and higher interest rates. Pretax yields on new purchases were slightly higher than the existing book yield on the fixed income portfolio, which ended the second quarter at 3.5%. The effective duration of the fixed maturity portfolio excluding interest-only securities was 5.2 at June 30, 2018, up from 5.0 at the end of 2017.

Our equity portfolio increased in value by 1.1% during the second quarter of 2018 compared to 3.4% for the S&P 500. As a reminder, our equity portfolio has a higher allocation to value stocks compared to the S&P 500 and value underperformed growth in the most recent period.

I'll now turn the call over to Mick Lovell, Executive Vice President of Operations, for some additional comments on the performance of our workers' compensation line of business and closing remarks.

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Michael Alan Lovell, EMC Insurance Group Inc. - EVP of Operations [5]

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Thank you, Mark, and good afternoon, everyone. Contrary to the current term results, workers' compensation has been one of our best-performing lines of business over the past few years. In 2015, we implemented a multifaceted workers' compensation initiative to improve outcomes through both our underwriting and claims processes in an attempt to counteract mandatory reductions in rates set by the regulatory authorities in many of the states in which we operate. We have focused on providing robust loss control services to reduce the probability of a claim and providing programs such as our return to work and medical management programs designed to give an injured party the care and support necessary to get them back to work as quickly as medically possible. This has been instrumental in managing loss cost when an insured files a claim. We have had strong adoption of these programs on our larger accounts, with approximately 79% of the accounts having documented return to work programs and approximately 74% of the accounts are participating in medical management programs including our Select Provider for on-call nurse programs.

The on-call nurse program was recently implemented and is designed to improve the patient outcomes and lower the overall cost of care by quickly getting the injured party the appropriate medical attention. The on-call nurse can assist, assess the situation and refer the injured party to the most effective treatment plan from the start, which creates a more satisfactory outcome for all parties involved. Based on the recent performance of this line of business, it was a little surprising that the high level of noncatastrophe losses experienced in the property and casualty insurance segment was primarily attributed to the workers' compensation line of business.

During the second quarter, an adjustment was made to the first quarter 2018 ultimate loss and settlement expense ratio projection after it became apparent that we were experiencing unanticipated increases in both the frequency and severity of first quarter reported losses as claims emerged during the second quarter. The increase in frequency and severity experienced in the first quarter reported losses represents a significant departure from the recent activity, and management continues to analyze the underlying data to validate the adequacy of the revised ultimate loss and settlement expense ratio established for the first quarter of 2018 and will act on a timely basis if additional revisions are deemed necessary. Based on initial observations, reported losses from the second quarter 2018 claims appear to be much lower than what was experienced on first quarter claims.

While workers' compensation was the primary driver of the increase in noncatastrophe losses in the property and casualty insurance segment, I would be remiss if I did not mention the loss and settlement expense ratios in some of the other lines of business, such as commercial auto and personal lines, remain elevated. We will continue to provide updates on the initiatives we're undertaking to return these underperforming lines of business to profitability on future calls.

I also want to provide a quick update on our stock repurchase program. During the second quarter, approximately $652,000 was used to repurchase 25,300 shares of the company's common stock, which leaves approximately $14 million remaining under the $15 million authorization. As a reminder, our general rule is that we only repurchase stock at or below book value, subject to a number of additional factors including general market conditions, the economic environment and the rate of return that can be achieved on the repurchases.

Before we open up the call for questions, there are 2 recent recognitions I would like to mention. First, we received the Best Practices Award of Excellence from the Independent Insurance Agents & Brokers of America, also known as the Big "I." EMC Insurance was 1 of only 6 companies in the nation to receive this award, which recognizes imaginative, outstanding and unique contributions in advocating best practices philosophies that enhance the independent agency system. Our success is directly tied to the success of our independent agents, and we remain dedicated to providing valuable resources to help them develop their business.

We were also named a 5-star insurance carrier in a report issued by Insurance Business America, a leading business magazine for commercial insurance brokers and agents. Out of the 95 carriers mentioned in the brokers ratings, only 24 received 5-star ratings. EMC earned the 5-star ratings in the categories of reputation and financial security, claims processing, the range of products and the commitment to the broker channel. These ratings affirm our commitment as being a carrier that agents and brokers can count on as we continue to develop innovative products and services that will help our partners achieve greater success.

So with that, we are now ready to open the call for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) And our first question today will come from Christopher Campbell with KBW.

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Christopher Campbell, Keefe, Bruyette, & Woods, Inc., Research Division - Analyst [2]

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I guess, my first question is on the core loss ratio. We saw this quarter was up about 480 bps. So I'm just trying to wonder about how much of this was like noncat related versus underlying deterioration? And also with the increased workers' compensation loss picks, did that imply any potential benefit for reduced policyholder dividends and/or agent commission?

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Meyer T. Lehman, EMC Insurance Group Inc. - Senior VP & Chief Actuarial Officer [3]

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Chris, this is Meyer Lehman, Chief Actuarial Officer. So it's a great question. In terms of the work comp line of business in particular, we do expect that there'll be some downstream benefits later on as we pay out policyholder dividends due to the increase in the loss pick for that line.

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Christopher Campbell, Keefe, Bruyette, & Woods, Inc., Research Division - Analyst [4]

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Got it. And what are you -- is that all severity? It sounded like severity from the press release. Are you seeing any frequency trends since we've seen a few competitors have noted that there's been a little bit higher of frequency in the first half of '18?

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Michael Alan Lovell, EMC Insurance Group Inc. - EVP of Operations [5]

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Yes. Chris, this is Mick Lovell. We've seen an increase in frequency as well, and it's mostly attributable to an increase in slips and falls and, again, attributable, the slips and falls, to increase on snow and ice. So the cold weather that persisted in the early part of 2018 and into even the second quarter in many parts of the U.S. and dipped much further south than typically happens, we did see an increase in snow and ice accumulation, and therefore, an increase in the slips and falls. And that's what we found on the frequency side.

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Christopher Campbell, Keefe, Bruyette, & Woods, Inc., Research Division - Analyst [6]

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Okay. And that's just workers' comp? Are you seeing that kind of bleed over into any of your liability, like commercial liability and the GL stuff?

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Michael Alan Lovell, EMC Insurance Group Inc. - EVP of Operations [7]

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We haven't seen it there on the liability side a great deal. We've seen a little bit of an uptick there but nothing compared to the way work comp has seen that increase.

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Christopher Campbell, Keefe, Bruyette, & Woods, Inc., Research Division - Analyst [8]

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Okay, got it. And then just what's driving the year-over-year increase in underwriting? Like what are you investing in on the other underwriting expenses? It's about like $3.6 million. And how long should we kind of expect this investment cycle to continue?

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Michael Alan Lovell, EMC Insurance Group Inc. - EVP of Operations [9]

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This is Mick again. So the increase in the underwriting expenses are mostly associated with salary change, both in the merit side as well as onetime bonus provided in the early part of the year to all team members. We are also seeing an increase in headcount as we gear up our operations to migrate our legacy systems to a more robust and future-forward platform. We are seeing some change there. Quite a bit of that is centered in the IT arena. But in a modernization such as we're undertaking, you have to prepare the business side and other areas of the company as well. So we're seeing an increase in headcount and an increase in salary, and that's mostly what's driving that underwriting expense.

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Christopher Campbell, Keefe, Bruyette, & Woods, Inc., Research Division - Analyst [10]

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Okay. And is like 34.4% this quarter, is that a good run rate going forward?

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Michael Alan Lovell, EMC Insurance Group Inc. - EVP of Operations [11]

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For the second quarter, it would probably ...

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Christopher Campbell, Keefe, Bruyette, & Woods, Inc., Research Division - Analyst [12]

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Is there capital in there, like we wouldn't want to factor in if we're using this because it does have your increased investments and things like that in there?

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Michael Alan Lovell, EMC Insurance Group Inc. - EVP of Operations [13]

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For the short term, we would expect that, that remains somewhat elevated. Long term, as we move through the migration of our systems, we would anticipate that we're able to move back to a more normalized salary expense, certainly focused in the IT area.

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Christopher Campbell, Keefe, Bruyette, & Woods, Inc., Research Division - Analyst [14]

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Okay. And then just one more on the reinsurance adverse development. Can we get some color on what caused you to boost the liability excess of loss reserves?

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Bruce Gunn Kelley, EMC Insurance Group Inc. - President, CEO, Treasurer & Director [15]

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This is -- Vicki Freese is going to take that. She's the President of our reinsurance company.

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Vicki Lynn Freese, EMC Insurance Group Inc. - VP of Reinsurance [16]

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Thanks, Chris. We have seen some development in some of our casualty excess contracts, and we have been monitoring that very, very closely as that is where most of that adverse development has been seen. So -- and some of that, similar to the direct side, has been on work comp losses and some other liability losses.

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Christopher Campbell, Keefe, Bruyette, & Woods, Inc., Research Division - Analyst [17]

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Got it. And is that more -- is that kind of like more legal -- like I guess, more driven by the plaintiff's bar? Or what is -- I'm just trying -- is it more frequency, severity of losses, like what's driving that?

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Vicki Lynn Freese, EMC Insurance Group Inc. - VP of Reinsurance [18]

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Well, I would think it's somewhat severity, and there may be some legal cases that have been settled recently that have increased that.

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Christopher Campbell, Keefe, Bruyette, & Woods, Inc., Research Division - Analyst [19]

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Okay. But any underlying pattern you're seeing in that, that would cause you to kind of want to increase those loss picks?

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Vicki Lynn Freese, EMC Insurance Group Inc. - VP of Reinsurance [20]

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No.

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Operator [21]

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

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Jon Paul Newsome, Sandler O'Neill + Partners, L.P., Research Division - MD of Equity Research & Senior Insurance Analyst [22]

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First question, just to ask a little bit more about the expense ratio. When you say that there's going to be an elevated level of costs in the short term, I think does that actually mean the long term from an investor perspective? Should we be essentially modeling that out to 2019 and 2020?

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Michael Alan Lovell, EMC Insurance Group Inc. - EVP of Operations [23]

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Paul, this is Mick Lovell. Yes, we would anticipate that -- when I speak of short term, you would anticipate at least over the next 3 years as we work to retool skills and resources available. As we begin to move through migration and years beyond that, I would expect that to drop back down as we cease needing the current skill sets that we have and we have that either people retrained or attrition out of the operation.

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Jon Paul Newsome, Sandler O'Neill + Partners, L.P., Research Division - MD of Equity Research & Senior Insurance Analyst [24]

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What's the cycle on something like this? I mean, it seems to me that technology changes really every year or 2, actually probably faster than that. So wouldn't that suggest that if you -- that 3 years from now, you'd have to redo a whole another migration again, and therefore, you're really just looking at an expense ratio that's going to be permanently a couple of points higher?

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Michael Alan Lovell, EMC Insurance Group Inc. - EVP of Operations [25]

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This is Mick again, Paul. And I guess, I would have to focus that question in a couple of different arenas. Does technology change rapidly? Absolutely. And are we constantly adapting to that change in technology? Yes. But the depth at which we are going in a overall legacy system migration is not something you're going to undertake on a 2- or 4-year periodic basis. You hope to position for at least 7 to 10 years in that update and being able to make consistent changes until an even larger technology change happens down the road. We're talking about a pretty big chassis up restoration of the legacy systems. And so that's something that we will not undertake on an every 12- to 24-month basis.

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Jon Paul Newsome, Sandler O'Neill + Partners, L.P., Research Division - MD of Equity Research & Senior Insurance Analyst [26]

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All right. And I guess, a little bit of follow-up. I think just not so -- as well on the workers' comp, but in general -- obviously, the reinsurance business is well priced. But the primary business, generally speaking, is underpriced by probably 15% or so. What sort of rate do you think you're capable of pushing through at this point? And what levers do you think you have from a rate perspective? Workers' comp, I would suggest -- I suspect you're going to have limited ability given the sort of regulatory situation. But if you can just kind of talk about sort of the ability to push through rate to get to an adequate return at some point.

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Michael Alan Lovell, EMC Insurance Group Inc. - EVP of Operations [27]

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That's a good -- great question, Paul. And traditionally, over the last -- say, over the last 5 to 7 years, our rate change has outperformed that of the industry on multiple measures. At present, we would like to see our branches move in a 2% to 4%-type rate change on the nonwork comp lines of business. And if we can work to hold our workers' compensation from flat to down a few percentage points based on the push that we're getting from regulatory bodies to move those rates down, we'd like to hold that in that type of a range. As we -- if you look at overall rates in workers' compensation in the core states we write business in, our 10 largest states, we've had large rate reductions over the last 10 years. And our underwriters have worked to mitigate quite a bit of that. And it's been effective until this last half of the year. So we hope to be able to push in that low single digit-type rate increase on the nonworkers' compensation line and hold the line on workers' compensation as much as possible in the marketplace.

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Jon Paul Newsome, Sandler O'Neill + Partners, L.P., Research Division - MD of Equity Research & Senior Insurance Analyst [28]

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So if we ignore workers' comp, what do you think the spread is between what you think you can get on rate and what the underlying claim cost inflation is?

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Meyer T. Lehman, EMC Insurance Group Inc. - Senior VP & Chief Actuarial Officer [29]

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This is Meyer again. So right now, in terms of our expectations, we're thinking in total for all of our P&C segment that the underlying trend is about 2%, and we like to believe that we can continue to get rate that exceeds that force of inflation. As Mick said, on the nonwork comp lines of business, if we can get somewhere between 3% and 5% in total, that would be great. But obviously, we're being strategic about where we get that, in particular, focusing our attention on commercial auto.

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Jon Paul Newsome, Sandler O'Neill + Partners, L.P., Research Division - MD of Equity Research & Senior Insurance Analyst [30]

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So simple math, 1 point or 2 of underlying leverage?

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Meyer T. Lehman, EMC Insurance Group Inc. - Senior VP & Chief Actuarial Officer [31]

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Correct. Recognize again, of course, that rate is not the only tool we have in our toolbelt.

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Bruce Gunn Kelley, EMC Insurance Group Inc. - President, CEO, Treasurer & Director [32]

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Paul, this is Bruce Kelley. I just wanted to point out that the second quarter is not our strongest quarter. And as far as premium volume, we have more premium volume in quarters later in the year, so that elevated expense ratio. As Mick said, may be a short-term situation for just that quarter. And if you model the whole year, it will have lower expense ratios because of more premium coming in.

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Operator [33]

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(Operator Instructions) And our next question comes from John Deysher with Pinnacle.

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John Eric Deysher, Bertolet Capital Trust - Pinnacle Value Fund - Portfolio Manager [34]

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I just have a follow-up question on the workers' comp. I think you addressed the frequency issue, an increase in slips and falls due to bad weather. But what caused the increase in severity during the first quarter?

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Meyer T. Lehman, EMC Insurance Group Inc. - Senior VP & Chief Actuarial Officer [35]

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That's a great question. We've been looking into that. And we cannot find a single smoking gun for that. I'd like to believe from an actuarial perspective, it's just a bit of a statistical anomaly. So we'll continue to watch the line and see if we can't find any emerging patterns that should provide us a direction in terms of how to change how we're running our company.

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John Eric Deysher, Bertolet Capital Trust - Pinnacle Value Fund - Portfolio Manager [36]

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Okay. And was it more pronounced in one industry versus other industries for both frequency and the severity? Did any particular industry stand out there?

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Michael Alan Lovell, EMC Insurance Group Inc. - EVP of Operations [37]

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John, this is Mick Lovell. And as you may be aware, EMC rates a considerable book of school business across the Midwest in many of our states. Because of the size of the school book, and we write considerable amount of workers' compensation on that, the slips and falls that we did incur were a great deal centered in that school book. So -- and the interesting part about that is, as mentioned before, we didn't see that carry over into the liability segment, in retail or other service type areas. We even write a great deal of municipality business, and we didn't see that slip and fall trend continue on the liability side in municipality or workers' comp. So it was not solely centered but quite a bit centered in the school book of business.

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John Eric Deysher, Bertolet Capital Trust - Pinnacle Value Fund - Portfolio Manager [38]

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Okay. And if I understand you correctly, quarter 2 is showing improvement versus quarter 1 on the workers' comp book?

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Michael Alan Lovell, EMC Insurance Group Inc. - EVP of Operations [39]

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That is correct.

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John Eric Deysher, Bertolet Capital Trust - Pinnacle Value Fund - Portfolio Manager [40]

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Okay, good. And I guess, the final question is the release indicates that commercial auto and personal lines continue to underperform expectations. I'm just wondering what the board is doing to fix these particular segments. This has been ongoing for many quarters, and I'm just wondering specifically what the board is doing and what kind of benchmarks you can put out there in terms of indicating to shareholders that there's actually being progress made since it doesn't appear you're getting much traction.

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Michael Alan Lovell, EMC Insurance Group Inc. - EVP of Operations [41]

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Yes. John, that's a very good question. I will say that the performance, especially in commercial auto, is troubling. From a management standpoint, we continue to move multiple levers. We've got a greater-than-average increase in our worker -- on our auto book of business rate. We have been reunderwriting books of business especially in our Southwest and Southeast parts of the United States where we experienced the worst auto experience. We've dialed back the amount of trucking business we were writing because that is an area that has caused us concern. And in some territories, we've ceased writing some trucking or hauling type risks because it did cause so much problem. We have developed and implemented models within our agency plan to identify those agents that struggled with auto business. And we've worked with those agents, in some cases, canceling contracts. And so we're taking a lot of action that just has not presented itself yet in the results. So it remains a concern to management. It's not out of step with the industry. But quite honestly, that's not our biggest concern. Our biggest concern is in-house. It's not operating as we want it to.

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John Eric Deysher, Bertolet Capital Trust - Pinnacle Value Fund - Portfolio Manager [42]

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Okay, and that's commercial auto. What about the personal line side? What are you doing there to get this back on track?

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Michael Alan Lovell, EMC Insurance Group Inc. - EVP of Operations [43]

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From the personal lines standpoint, over the last 3 years, we've implemented new products in both home and auto that are more granular rating. So we can get more adequate rate for each one -- each of the risks. And we've implemented that in all of our writing territories in the last 18 months. During that time, we achieved significant rate increases especially in the homeowners line of business. In many of the territories that we're underrated, we've been able to achieve and get accepted increased rates in those territories. The attritional loss ratio in personal lines is actually running just slightly feverish compared to what the expectation would be by maybe 2 percentage points. The catastrophe impact to personal line's about 17 points. And we look at that as being somewhat elevated in the second quarter in a quarter that was relatively quiet. So again, commercial auto, we're working on a lot of reunderwriting rates and trying to move the levers there, books -- agents and our book of business. On the personal lines side, we've updated the products. There's still -- much of that premium volume is still rolling through on the upgraded products as well as the rate changes that we've taken. That just finalized in the early first quarter of this year.

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John Eric Deysher, Bertolet Capital Trust - Pinnacle Value Fund - Portfolio Manager [44]

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Okay. So when do you think we should start to see some improvements in both those segments?

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Michael Alan Lovell, EMC Insurance Group Inc. - EVP of Operations [45]

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That's a very good question. My crystal ball has not had the clarity on that I'd like to have. I would expect that the -- in the attritional side of the personal lines, as we see the rate flow through that we've been able to get, we would expect that attritional loss ratio will continue to drop in the personal lines side. It's still very heavily affected by convective storm. And we'll be impacted by that, but we do expect that the attritional will continue to get better as those rates flow through. On the auto side, we're really working to balance the marketing impact of the underwriting changes we're making with the overall profitability impact. Again, much of the book of business that has caused this trouble will continue to roll off. The auto loss ratio was impacted by prior year reserve change. We have a small increase in the current term losses on auto, but it is commensurate with the increase in policy count. So when will that be? I'm not trying to avoid the question, it is something I have no solid answer to say it will be September 14. It's too specific to be able to do that. We would expect that it continues to improve on the personal lines side. On the attritional and commercial auto, we would hope that the underwriting changes we have we'll see over the next 18 to 24 months.

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John Eric Deysher, Bertolet Capital Trust - Pinnacle Value Fund - Portfolio Manager [46]

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Okay, fine. I guess, the only other comment I'll make is I hope the Board of Directors is engaged here in terms of moving this forward and that there's a sense of urgency in terms of improving these operations so shareholders should benefit.

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Bruce Gunn Kelley, EMC Insurance Group Inc. - President, CEO, Treasurer & Director [47]

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Yes. John, this is Bruce Kelley. We're having a board meeting in a couple of weeks, and these topics will be discussed at that meeting. And know that the board is concerned with those 2 issues.

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Operator [48]

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And this will conclude our question-and-answer session. I would like to turn the conference back over to Steve Walsh for any closing remarks.

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Steve Walsh, EMC Insurance Group Inc. - Assistant VP & Director of IR [49]

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I'd like to thank you all for joining us today. We appreciate your interest in EMC Insurance Group and look forward to speaking with you again on our third quarter earnings conference call. Have a great day.

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Operator [50]

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