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Edited Transcript of PRA presentation 8-Mar-17 4:35pm GMT

ProAssurance Corp at Raymond James Institutional Investors Conference

Orlando Apr 10, 2018 (Thomson StreetEvents) -- Edited Transcript of ProAssurance Corp presentation Wednesday, March 8, 2017 at 4:35:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Stan Starnes

ProAssurance Corporation - Chairman and CEO

* Ned Rand

ProAssurance Corporation - CFO

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Presentation

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Unidentified Participant [1]

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Good morning, everyone. Continuing on with our morning schedule, it's an honor to introduce our next company, ProAssurance. I've been following ProAssurance for a long, long time, and it has grown and evolved into one of the premier specialty insurance companies in the marketplace. And they've been very good to the shareholders along the way. In recent years, along with growth in their business, they've rewarded shareholders with dividends and special dividends.

And in fact just in January, paid out a special dividend of $4.69. So I'm sure there's a lot of happy shareholders out there.

So from management, we have Frank O'Neil, who serves in their Investor Relations function, and Ned Rand, who is the Chief Financial Officer and Stan Starnes, who is the Chairman and CEO. So let me turn it over to Stan.

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Stan Starnes, ProAssurance Corporation - Chairman and CEO [2]

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Thank you, Greg. And thank you for joining us this morning to hear just a bit about ProAssurance. I'm going to spend a few minutes talking with you about the strategy, how it evolved, where it has taken us and how we got there, and then Ned will talk to you about the recent financial results and a few more details about the operations of the organization. When the present senior management team at ProAssurance came together in the third quarter of 2007, we took a hard look at healthcare in the United States and what was likely to happen to healthcare as we move forward, because as a medical professional liability carrier, we obviously are greatly affected by the healthcare system in the country.

And we realized then that the healthcare system was going to have to change and would undergo substantial change over the next few years. And the reason was the cost of care, we cannot afford the healthcare system we have in the United States. If you look at the chart that Frank has put forward, you'll see the red line is the United States, and this is healthcare spending as a percentage of gross domestic product. And the red line is significantly above the other lines on the page, which represent a number of industrialized country, similar to the United States ranging from Canada to Great Britain, to Australia and then we have the global line, and you'll see that we spend in excess of 17% of the gross domestic product of this country on healthcare.

Everybody else is down no more than about 12%. Now you might say to yourself, well, what's wrong with that. There are several things wrong with it. One is the trend line and trajectory it has. The second thing that's wrong with it is we get less favorable outcomes for our healthcare spending than other countries do even though we spend more. In any number of areas, countries produce better health care outcomes than the United States produces even though we are spending more. This is simply unsustainable. If you look at the demographics of our country, as my generation ages and healthcare spending begins to go up further, that number can go as high as 25% in the next 10 years and nobody pretends that's sustainable. No country can maintain a robust state of economic health when it's spending 25% of its GDP on healthcare. It's in ways the equivalent of Benjamin Franklin's lament that we can't grow if all we're doing is cutting each other's hair.

And so the point of it is that we've got to do better as we go forward. From that slide, we concluded two things. We concluded that more and more healthcare was going to have to be delivered by lower and lower provider levels in order to reduce the cost. That is healthcare that was provided in 2007 by a physician would in many instances in 2017 be provided by a nurse. And that realization has fueled most of our acquisitions over the last 10 years in order to acquire lower provider levels that are in our insurance base. The second thing we realized is that more and more healthcare in this country was going to be delivered by a larger and larger integrated organizations, and that too has come to pass. If you look at the chart there, you'll see that back in 2008, 62% of the physicians in the United States practiced independently. That is either in solo practice or as part of smaller groups. When I started practicing law in 1972, that 62% would have been plus 90%.

So the trend has been going for a long time, but it began to accelerate in 2008. And you can see today, the number of independent physicians by this estimate is somewhere around 33% and shrinking. Physicians are going inside larger and larger organizations as the healthcare world sort of morphs into a different system. Providers are becoming payers, payers are becoming providers, and the healthcare system is changing greatly. If you look at what ProAssurance has done since 2007 in terms of acquisitions, it has put us in a position to ensure these larger and larger organizations. We have transitioned ourselves from being a physician-centric healthcare liability insurer to being a healthcare-centric liability insurer. We have insured hospitals since 1985, but today they make up a greater part of the customer mix for ProAssurance, and larger and large organizations make up a greater part of the customer risk for ProAssurance.

You'll see on the bubble chart here that most of the competitors in the MPL space are active in a fairly small number of states and they don't have a lot of capital. And the people congregated down at the lower left hand area of this chart are people who are the good companies, they do a lot of work in one state or two states, or on a small regional basis. But they're not situated to really ensuring compete for the larger risk, which are beginning to occupy greater and greater part of the healthcare landscape. The companies big enough with the geographic reach to do that are in the upper right-hand corner, and you'll see that ProAssurance fits squarely in that space.

We write business of one type or another in all 50 states, as well as outside of the United States. So we realized in 2008 that we were at a fork in the road and that we had to either shrink and ensure just small group and solo practitioners that we had done since 1977, or we had to transform the Company to make it as relevant to the healthcare system that was up on us as we had been to the healthcare system of the past. And we chose the latter course. And everything we've done since then has been designed to take us there. A good example of the sorts of things we have done is reflected in the Certitude program.

Ascension is the largest Catholic healthcare system in the world. They're the largest non-profit in the United States. They're the second largest of any type in the United States with revenues exceeding $22 billion a year. A number of years ago, Ascension came to us to partner with them to start a program whereby they would together with us would ensure physicians who are not employed by Ascension, but who had staff privileges at Ascension hospitals around the country.

And the program started at about 2010, and today it includes over 2,400 insured physicians and about $25 million in enforced premium. The total program premium in that program since its inception exceeds $100 million. The important part of that program is represented by the following facts. First of all, Ascension didn't need ProAssurance from a financial standpoint. They're bigger than we are. They have huge towers of liability programs, they maintain a working layer that exceeds $10 million, but they didn't need us for our balance sheet. What they needed us for was our expertise in handling medical professional liability claims. And we obviously were pleased to serve that purpose, but we wanted to make certain that the financial incentives of the program and the financial risk of the program were aligned between ProAssurance and Ascension.

And we set out to do that, and aligning those risk was very important to us because we did not want there to be a winner or a loser. We wanted there to be winners, or both be losers. And the program is designed in that fashion. So that everyone we ensure in that program, Ascension reinsurers part of that risk, on roughly a 50-50 basis depending on what state you're in and where the physician had been insured before he became part of the Certitude program. That then developed from there to where now ProAssurance insurers along with Ascension, the employed physicians at the hospitals as well as participation to working layer of the Ascension overall total risk program. We point this problem out because one, it's been very successful, but it also is important because I think it represents the types of things that we will be doing more and more of in the future is healthcare is practiced by these bigger and bigger organizations.

Now I quickly add that we don't intend to abandon the small group or solo practitioners. We'll be just as important to them and they to us has always been the case, but there'll just be fewer of them. And so we have to tailor our organization to serve not only their needs, but the needs of the bigger group. Another example of a program like that is CAPAssurance in California. It's not as big as Certitude, but it's a mechanism by which ProAssurance can enable cap in California to ensure groups and hospitals and organizations that otherwise would not be able to insure. That program is newer, it's not quite as big yet as Certitude is, but it continues to do well. The important thing of this is -- the next slide will illustrate to you, is that we continue to do what we've always done, but we have broad our expertise and broadened our base, so that we're able to ensure the larger risk as well as to provide alternative risk solutions to those in the healthcare area.

One of the things that we did to enable us to do that was acquire Eastern Insurance a number of years ago. Eastern is a boutique provider workers comp insurance. It's been quite profitable, roughly 20% of their risk are healthcare risk. And we felt like if we had Eastern so that we could book in the workers' comp program on one hand and the medical profession liability on the other hand, we added an organic D&O product in the middle, so that we now can provide the basis liability insurance products that any healthcare organization needs. The workers comp is not particularly important to the solo practitioner. It is very, very important to the multi-specialty clinic or the hospital or the other large organizations. So putting ourselves in a position to do that, we have seen success in cross-selling between the products.

Now let me add we underwrite them separately. Workers comp is not a loss leader for ProAssurance as it is for some. And we price them separately. But just the ease of doing business and your ability to get those two very expensive and very difficult-to-place insurance products from one source has helped us as we have spread out in those areas. The other thing Eastern brought to us is our ability to do alternative risk through single-cell captives through our Cayman Islands operation and that has been very successful for us in recent years. In 2016, and Ned will speak to this in a minute, our coordinating marketing efforts doubled the premium that they provided in 2015. And we think it will continue to grow in this area.

Couple of other points I should touch on. We started ProAssurance Risk Solutions, is headquartered in Hartford, Connecticut, and we have a team there that looks at a variety of potential specialty and one-off transactions. It was responsible for $11 million innovation premium, which was written and earned in the fourth quarter of 2016. They look at lots of things, it's a lumpy business. Some things, they hit on; some things, they don't. But it does provide us with the means of developing insurance products and solutions that will come more and more important as you see a continuing integration of healthcare systems. ProAssurance Complex Medicine brought us the ability to underwrite and evaluating in price, ever increasing self-insured groups that which take on things of increasing experience, increasing the complexity and the proprietary analytics right program were provided through our partnership with [Copper and Grey].

Syndicate 1729 at Lloyd's is something we're very proud of. Part of our strategic overlook in 2009 included creating the basis by which in the fullness of time, we'll be able to write an increasing amount of international business, and Syndicate 1729 will service that platform. Today, we look at it very much as an investment. We provide 58% of the capital. Duncan Dale runs that operation at 1729. He is a highly expected Lloyd's underwriter. Our efforts there have been profitable. Always is a difficult competitive spot today as you know, but Duncan navigates that with skill. And we've been very pleased with what he's done there. And again the fullness of time, that will serve as the platform for our international exploration.

Medmarc is another acquisition we made in recent years. It's a life sciences company. It operates out of Chantilly, Virginia. It brings to us the ability to ensure medical products, medical devices, genetic, therapeutics, clinical trials, things that we think we need to have expertise in if we're going to be the healthcare-centric organization that we desire to be.

And finally, ProAssurance Mid-Continent underwriters, that came to us in 2010. And it's specializes in underwriting and aggregating home healthcare workers. There is going to be an ever-increasing need for home healthcare workers and other ancillary healthcare providers, as we move down the path toward re-routing our healthcare system. And the reason for that is they're cheaper. It's less expensive to take care of somebody at home than it is to take care of them in the hospital. And we'll see more and more of that done overreached in the coming years. And we felt it was important to have that capability to underwrite and aggregate the home healthcare workers, and we do that at our Houston office and it too has been very successful in recent years.

Ned will give you the details of the fourth quarter, but let me just say to you, he comes up -- what was great about the fourth quarter in my mind, it was not just the numbers although the numbers were good, what was great about it was that it serve to validate this strategy I've have been describing to you for the last few minutes. And we think that's the right strategy to take us forward. Ned? And Ned's got a great voice today, you want to pay special attention.

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Ned Rand, ProAssurance Corporation - CFO [3]

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Good afternoon, everybody. I'm suffering from a little bit of laryngitis, so apologies in advance and hopefully you can hear me through my recipe voice. I'll do the best I can and Frank has promised that if the voice completely goes, he is going to jump up here and rescue me.

I want to start where Stan left off, which is the fourth quarter really did demonstrate what it looks like when our strategy really all comes together. And we were talking in an earlier meeting with an investor about the fact that we -- on the seven or eight different components of that strategy that you can look at. We really hit on all of them in the fourth quarter. And the reality is that every quarter, we're not going to hit on all seven or eight of those things. And so, our growth in particular going into the future is going to be lumpy, Stan used that term as well, lumpy. And I think that's right. As the business that we go after -- we still keep that core physician business and our core workers' comp business. As we go after these larger integrated healthcare systems and facilities, we're going to have wins and we're going to have times that we don't win and that's going to add lumpiness to the quarter-to-quarter topline results for the organization. We're confident the strategy that we're putting in place over a longer term trajectory is going to show growth, which is different than what we've seen over the last number of years in our healthcare professional liability business, but it definitely is going to be lumpy. And it's all going to be governed by the underwriting strategy. And the underwriting discipline that we have throughout our entire organization and that doesn't matter if you're talking about our healthcare professional liability business, our life science business, comp and the discipline that Duncan Dale puts to work within the Lloyd's marketplace, really foundational for us.

Just to go through some highlights for the year, $96 million in new business for us. That was a record for the organization, driven by a record amount of new business within our healthcare professional liability business. Stan mentioned the coordinated sales successes $13 million, $14 million in successes there. While we think those successes is really being where we marry up in some form or fashion, expertise within our comp business and our healthcare professional liability business, we do foresee in the future opportunities to bring together the healthcare professional liability business and the life science business or some of the capacity and underwriting expertise we have at Lloyd's and the international NPL space and the expertise we have within our traditional healthcare professional liability space.

An example of that with our life science [business is in tests] kits, diagnostic test kits where the producers of those test kits are becoming the readers of those test kits and you marry up a product liability and professional liability for both those. We were solidly profitable in the year, with a 91.4% combined ratio. We're going to talk about some more details of that as well as our premium to surplus leverage, which improved to 0.5 to 1. We'll go into some more details about that. And very important to what Stan was talking about is that we are seeing more submissions coming out of the brokerage market. Net brokerage market really is what controls the larger healthcare space, those facilities and other large healthcare providers.

If we take a quick look at the income statement, it's going to flash up here in a -- I'm not going to go through the different line items. I do want to just point to one thing that's important to think about as you think about ProAssurance and that's our investment returns. And our returns continue to decline. They're declining for very valid and very good reasons. One is that we've been aggressive in returning capital to our shareholders. Greg led off by talking about the $4.69 special dividend in January. So that shrinks the investment portfolio. And so as a result, investment income is going down. Two other important things to think about with that is in spite of some marginal improvements in interest rates, we are still investing new money and maturing money out of the portfolio at lower rates than the overall yield on the portfolio. I think the overall yield on the portfolio [is neighborhood of] 3.8%. And so, as we're putting new money to work, it's typically going to work at a lower rate. And so, that continues that downward trend.

And then lastly, embedded in this investment result, we call investment result and not investment income is that we've got some unconsolidated subsidiaries that we invest in and amongst those are tax credits. And the tax credits impact our investment results through the amortization of those credits and the benefit on those tax credits show up in our tax line. And the amount of amortization coming off of those tax credits has been increasing, and will continue to increase for the next couple of years, which will actually bring down investment income. We'll see a benefit in the tax line, not in the materials we have here, but we have in the materials from the meetings today, which are available I think online. There is some more detail about that and exactly kind of where the benefits come in and the amortization. But that amortization is going to bring investment income down over the next couple of years. I think that's important to keep in mind.

We talked about the 91.4% combined ratio that we have. We're very proud of that, but it is up over the last several years. Most of this trend that you see here in the combined ratio going up is being driven by a lower level of favorable development -- still favorable development coming out of our specialty P&C segment in particular and largely our healthcare professional liability business, but this is coming out at lower levels. A couple of things I think important to think about there as well. When you go back to these years in 2011 and 2012 where we had extremely large amounts of development, those were coming off years where expected years five, six years and then prior to that. So go back 10 years, where our expected trend in severity kind of where do we think inflation costs relative to our claims environment were going, we're closer to 8% or more. In reality, they've come in closer to 4% and less. And so by cutting that severity trend in half going from 8% to 4%, you get 4 points of compression that benefit favorable reserve development. One more [recent years our trend has been] 4%, 3%, we're seeing a 2% trend. And so if you cut that in half, your compression is only 2 points. And so, you've got less compression to add to the favorable development. We continue to reserve in the same conservative manner in which we always have, and that is putting 8 points to 10 points above our pricing objectives on the reserves we established for our healthcare professional liability business, but kind of that potential for even more favorable development to come out severity going from 8% to 4% is lessened because we've got severity at 3%. And our belief is that you're unlikely ever to see where severity goes into a truly negative number.

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Questions and Answers

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Unidentified Participant [1]

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(inaudible - microphone inaccessible)

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Ned Rand, ProAssurance Corporation - CFO [2]

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If you go to our pricing 10 years to 15 years ago, the severity trend embedded in our pricing was 8% or more. And today, the severity trend is 3%. And the other thing that we've reflected in the pricing that drove a good bit of this is dramatic decline in frequency that occurred. Over the last four years to five years, that frequency has been stable. But leading up to that, we saw frequency dropped dramatically and we've benefited from that as well.

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Unidentified Participant [3]

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(inaudible - microphone inaccessible)

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Ned Rand, ProAssurance Corporation - CFO [4]

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Greg, we still had a $130 million, $140 million of favorable development that helped with that. In a steady run state, go back to that 8 points to 10 points about pricing, it's more like a $50 million run rate on unfavorable development. So we're still benefiting from some of that compression and severity and other things today. So it's harder to know into the future, but I think there's just -- if we're being honest, there's less opportunity for that compression to occur.

Kind of in line with that a little bit if you followed the Company for a while going to the next slide, we have changed our ROE targets. Historically, we look at a static ROE target. And as we've kind of grappled with the challenges in the marketplace and in particular the low interest rate environment that we plan, we decided that a more dynamic ROE target was warranted. And so we're targeting 700 basis points above a risk-free rate, which was a 10-year treasury rate equates to about a 9.5% target today. I mean obviously if that 10-year yield rises, our targets will rise with it. If you look at kind of the components of ROE over the last couple of years, we've come short of that, and largely that's driven by the fact that we hold a good bit of excess capital.

I'm going to mess Frank up here a little bit. I'm going to ask him to jump ahead to slide 22 to talk a little bit about our capital position and where we stand today. Sorry about that, Frank. Alright, so there we are. So we're at a 0.5 to 1 premium to surplus ratio and while that's up, it's still low. And so, to achieve those ROE objectives we're putting out for ourselves, really will require that we become more efficient with our capital. And we think over the long term, we need to be closer to [0.75 to 1 or 1 to 1] somewhere in that range with the capital that we hold. We'd love to grow into that, but we recognize the challenges of growing in the marketplace. And so, we'll continue to evaluate with our Board every quarter what the appropriate capital for the organization is. So a question we get a lot is, okay, well that's year view, why not just hand it all back today. So I'm going to get Frank to back up a slide actually, and mess with him a little further. And so, one of the governors on our ability to pay dividends is where the capital actually sits. And the majority of the capital we hold in the Company is in our regulated insurance companies. And the way we get liquidity up to the holding company is through dividends from those subsidiaries and the ability to pay those dividends is regulated.

Basically two types of dividends that you can get from your insurance companies. There's an ordinary dividend. And those are pretty prescriptive. Every state -- and so the states in which we're domiciled have a prescription that says you can dividend up the money you made last year or 10% of surplus, the lesser or greater of those numbers in each state has a slightly different formula for. So we have the ability in 2017. Based on those formulas to dividend up $174 million from our subsidiaries. Unlikely, they will do all of that $174 million because it sits in different subsidiaries. Some of them that are better leveraging their capital than others. As an example, our workers' comp companies are better utilizing their capital they hold, while they do have the ability to pay dividends unlikely to take the dividends out. And while those are prescriptive and you don't have to seek formal regulatory approval to [pay down] the regulators do have the opportunity to say no. So you don't have to get their approval. But you have to not get their disapproval and kind of typical regulatory speak.

In addition to that, we have the opportunity to go to our regulators and request extraordinary dividends. And you can see on the slides, we've done that over the last number of years and we likely will continue to do that as we try to bring capital out of the subsidiaries. But there is a limit on what a regulator is realistically going to approve. So we've done $160 million in 2015, $150 million last year and we'll continue to look at that, but that's a regulator and our ability to return capital to deploy capital in any form is the fact that it's trapped in these regulatory entities. I mean that can make the timing of such distributions to kind of drive the timing of its distribution. Frank, if you go back two more slides to slide 19, just talk about what we have done, Stan alluded this a little bit, but we have returned $1.7 billion to our shareholders since Stan took over as the CEO of the Company, and we're proud of that. We think that as Stan likes to say, the past is prologue. We will continue to try to be good stewards of the capital that you have all entrusted to us.

My voice is about to give out, so I'm going to get Frank now to just kind of jump to 23, which just looks at what does that really mean in practice, what does that mean for our shareholders. You've got two slides here, total return and stock price. And really not a lot to say there, other than we're very proud of what we have achieved for our shareholders. We think the strategy that we've put in place will permit us to continue to produce superior results and hopefully superior returns. I don't know where we are in timelines. If we've got time for questions here, we're going downstairs and we can take questions down there.

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Unidentified Participant [5]

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We're out of time. So we're going downstairs.

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Ned Rand, ProAssurance Corporation - CFO [6]

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Great, thank you all very much.