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Edited Transcript of UFCS earnings conference call or presentation 8-Aug-18 2:00pm GMT

Q2 2018 United Fire Group Inc Earnings Call

Cedar Rapids Aug 22, 2018 (Thomson StreetEvents) -- Edited Transcript of United Fire Group Inc earnings conference call or presentation Wednesday, August 8, 2018 at 2:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Barrie Willian Ernst

United Fire Group, Inc. - VP & CIO

* Dawn Michele Jaffray

United Fire Group, Inc. - Senior VP & CFO

* Michael Todd Wilkins

United Fire Group, Inc. - Executive VP & COO

* Randy Allen Ramlo

United Fire Group, Inc. - President, CEO & Director

* Randy L. Patten

United Fire Group, Inc. - Assistant VP of Finance & IR

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Conference Call Participants

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* 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 morning. My name is Steven, and I'll be your conference operator today. At this time, I would like to welcome everyone to the UFG Insurance Second Quarter 2018 Financial Results Conference Call. (Operator Instructions)

I will now turn the call over to Randy Patten, AVP of Finance and Investor Relations.

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Randy L. Patten, United Fire Group, Inc. - Assistant VP of Finance & IR [2]

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

Please note that our presentation today may include forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. Company cautions investors that any forward-looking statements include risks and uncertainties and are not a guarantee of future performance. These forward-looking statements are based on management's current expectations, and we assume no obligation to update them. The actual results may differ materially due to a variety of factors, which are described in our press release and SEC filings.

Please also note that in our discussion today, we may use some non-GAAP financial measures. Reconciliations of these measures to the most comparable GAAP measures are also available in our press release and SEC filings.

At this time, I'm pleased to present Mr. Randy Ramlo, CEO of UFG Insurance.

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Randy Allen Ramlo, United Fire Group, Inc. - President, CEO & Director [3]

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Thanks, Randy. Good morning, everyone, and welcome to the UFG Insurance Second Quarter 2018 Conference Call. Earlier this morning, we reported consolidated net income of $0.01 per diluted share and adjusted operating loss of $0.03 per diluted share and a GAAP combined ratio of 107.9% for the second quarter of 2018. This compares with net income of $0.12 per diluted share, adjusted operating income of $0.05 per diluted share and a GAAP combined ratio of 107.2% for the second quarter of 2017.

Looking at just our property and casualty insurance operations, although our second quarter 2018 net income was comparable to second quarter last year, with both periods earning $0.01 per diluted share, we know we need to continue our efforts at improving our core results. In both periods, we had an elevated level of losses. However, the composition of these losses in each period is different. In the second quarter of 2018, losses were driven by an increase in severity of noncatastrophe losses as compared to the same period of 2017, which experienced catastrophe losses above our historical averages. Mike will discuss our operational results in more detail in a few minutes.

Moving on to expenses. Our expense ratio was higher at 34.3% in the second quarter of 2018 as compared to 30.3% in the second quarter of 2017. As we mentioned in previous conference calls, the increase in the expense ratio is primarily split between 2 items. First, we have invested in our multiyear OASIS Project to upgrade our underwriting technology platform, to modernize our analytics capabilities and enhance decisions and productivity. As a reminder, we anticipate the OASIS Project will add approximately 1 to 2 points to the expense ratio annually for the duration of the project.

Second, since our commercial and personal auto lines have had heightened loss experience, we are required to accelerate the timing of our deferred acquisition costs or simply immediately expense those costs against net income. Our calculation uses a view of experience based on the prior quarter-end. So as we see improvement in future quarters in our auto lines of business, the acceleration of these costs through immediate expensing will decrease.

During our first quarter earnings conference call, I mentioned that we were pursuing regulatory approval for a special cash dividend. As you may be aware, our Board of Directors declared a special cash dividend for $3 per share, which we previously announced in a press release on July 24, 2018. The dividend is payable on August 20, 2018, to shareholders of record as of August 3, 2018.

We remain confident that our decision to sell United Life was in the best interest of our shareholders, agents, employees and UFG. We are now pleased to share the profits from this sale with our shareholders, returning a majority of the statutory gain from the sale through this special cash dividend.

The special cash dividend benefits our shareholders while allowing UFG to continue building upon the success of our property and casualty operations, together with the future strategic opportunities, share repurchases and capital initiatives. It is also important to note the significance of the special cash dividend in our recent history. With this dividend, UFG has returned over $250 million to shareholders through regular, quarterly and special dividends and share repurchases since 2013.

With that, I will turn over the discussion to Mike Wilkins. Mike?

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Michael Todd Wilkins, United Fire Group, Inc. - Executive VP & COO [4]

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Thanks, Randy, good morning, everyone. As Randy mentioned our second quarter 2018 results were impacted by an increase in severity of noncatastrophe losses, which we define as losses greater than $500,000. This increase in severity of losses was primarily in other liability and workers' compensation lines of business, of which a number of these were commercial auto liability related claims. We've had some improvement in our commercial auto loss ratio in the first half of 2018 compared to prior year, but we remain unsatisfied with the level of our improvement. On a positive note, we are seeing a decrease in frequency of claims in our commercial auto book and a decrease in our exposure units. However, the improvement is somewhat muted by an increase in severity of bodily injury claims overall.

We remain committed to risk-control initiatives to improve the performance of our commercial auto book. As we have discussed the past few quarters, we continue to focus on profit-driven strategies, targeted at improving the risk we underwrite, including expanding our reach with risk-control requirements, stricter underwriting guidelines and ensuring we are targeting adequate rates for the exposure. Our enterprise and analytics team continues to refine models designed to provide more insights in the underperforming commercial auto accounts and where rates increases are needed.

In 2018, catastrophe losses for the second quarter and year-to-date were below our historical averages. During the second quarter, we experienced catastrophe losses of $15.1 million or 5.9 percentage points of the combined ratio as compared to our historical averages of 10.8 percentage points of the combined ratio. Year-to-date, catastrophe losses were $18.5 million or 3.7 percentage points of the combined ratio.

Looking forward to third quarter, we know we have exposure to 2 catastrophe events, the California Carr wildfire and the July 19 tornadoes in Central Iowa. Our early loss estimates appear limited in these events and are less than $5 million at this point.

Moving on to market conditions. During the second quarter of 2018, the average renewal price change for commercial lines decreased slightly from the first quarter of 2018, with the average rate increases remaining in the mid-single digits.

Filed commercial lines pricing increased from the first quarter 2018, with pricing varying depending on the region and size of account. The increase in filed rates during the second quarter 2018 was primarily driven by an increase in commercial auto pricing. Filed commercial auto rate increases processed during the quarter averaged in the high single digits. Consistent with the past several quarters of 2018, much like many of our peers have reported, workers' compensation line remains very competitive with filed workers' compensation rates continuing to decrease. Our expectation moving forward is that our workers' compensation premiums will continue to decrease due to pricing and underwriting decisions, including walking away from unprofitable accounts.

Our workers' compensation continues to perform within our expectations with the year-to-date net loss ratio in the low 60s, which is comparable to same period in the prior year.

Our personal lines renewal pricing increased during the quarter, with average percentage increases in the mid-single digits. We continue to aggressively address our poor performing accounts across the country through nonrenewal or significant rate increases. Our premium retention and policy retention remained strong at 84% and 81%, respectively, during the second quarter of 2018.

With that, I'd let Dawn Jaffray to discuss our second quarter financials. Dawn?

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Dawn Michele Jaffray, United Fire Group, Inc. - Senior VP & CFO [5]

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Thanks, Mike, and good morning, everyone. For the second quarter of 2018, consolidated net income was $157,000 compared to $3 million in the second quarter of 2017, which included net income from our discontinued Life business of $2.9 million. Year-to-date, consolidated net income was $45.9 million compared to $22.9 million year-to-date in 2017. As a reminder, the year-to-date consolidated net income includes a onetime after-tax gain of $27.3 million associated with the sale of United Life Insurance Company and the first quarter net loss of $1.9 million from our discontinued Life business.

Looking at only property and casualty insurance operations results. For the second quarter of 2018, net income was comparable to the second quarter of 2017 with $157,000 of net income compared to $109,000 reported in the second quarter of 2017. Year-to-date in 2018, net income increased to $20.5 million compared to $18.7 million year-to-date in 2017. In both periods, in the second quarter and year-to-date in 2018, our net premiums earned increased 4.7% and 4.2%, respectively, compared with 2017. As mentioned previously, with our continued focus on profitable growth initiatives and achieving rate increases, we estimate our growth and premiums for 2018 will be in the low end of the range of our guidance of 4% to 6% growth.

Net investment income increased 42% to $17 million in the second quarter of 2018 and increased 24% year-to-date 2018 to $31 million compared to the same periods in 2017. The increase in net investment income for the quarter and year-to-date was driven by an increase in invested assets and the change in value of our investments in limited-liability partnerships and not due to a change in our investment philosophy. The valuation of these investments in limited-liability partnerships varies from period to period due to current equity market conditions, specifically related to financial institutions.

We reported net realized investment gains of $1.3 million and net realized investment losses of $6.6 million, respectively, in second quarter and year-to-date 2018 compared with net realized investment gains of $1.1 million and $3.3 million in the same periods in 2017. Included in net realized investment gains and losses in 2018 is the change in value of equity securities, which are now recognized in the income statement due to new accounting requirements adopted at the beginning of 2018. For the second quarter of 2018, the change in value of equity securities resulted in a gain of $300,000, and for the first 6 months of 2018, a loss of $8.9 million.

Moving on to reserve development. We experienced favorable reserve development of $10.3 million in the second quarter of 2018 compared to $16.3 million of favorable development in the second quarter of 2017. Year-to-date in 2018, we experienced favorable development of $48.4 million compared to $41.2 million in the same period of 2017. The impact on that income for the second quarter and year-to-date in 2018 was $0.32 and $1.49 per diluted share compared to $0.41 and $1.04 per diluted share in the same periods of 2017.

Expanding further on reserve development. During the second quarter of 2018, the biggest driver of our favorable development was in our workers' compensation line of business, followed by assumed reinsurance. Our second quarter 2018 reserve development of 4 percentage points of the combined ratio was below the 6.6 percentage points of reserve development we reported in second quarter of 2017.

On a year-to-date basis, reserve development was primarily driven by 3 lines of business: other liability, commercial auto and workers' compensation. The impact to the combined ratio was 9.6 percentage points in the first 6 months of 2018 compared to 8.6 percentage points in the same period in 2017. As a reminder, we continue to have a conservative reserving philosophy, with annual favorable development every year since 2009. At June 30, 2018, total reserves remained within our actuarial estimates.

The combined ratio in the second quarter and year-to-date in 2018 was 107.9% and 100.9%, respectively, compared to 107.2% and 102% for the same periods in 2017.

Removing the impact of catastrophe losses and reserve development, our core loss ratio in 2018 was flat compared with second quarter and year-to-date in 2017.

Referring to Slide 9 in the slide deck on our website. We've provided a detailed reconciliation of the impact of catastrophe and development on the combined ratio.

Annualized return on equity was 6.9% during the first 6 months of 2018 compared to 4.8% in the same period in 2017.

I will end my portion of our prepared remarks today with a discussion on capital-management activity. During the second quarter, we declared and paid a $0.31 per share cash dividend to shareholders of record as of June 1, 2018. Also, as Randy mentioned, we also announced a special cash dividend, the first in the company's history I might add, of $3 per share to shareholders of record as of August 3. Including the regular quarterly dividend, special cash dividend and share repurchases, we've returned over $95 million to shareholders so far during 2018. Also of note during the first 6 months of 2018, we've repurchased 120,372 shares of common stock at an average price of $44.90, which totaled $5.4 million.

We purchase United Fire common stock from time to time on the open market or through privately negotiated transactions as the opportunity arises. As always, the amount and timing of any purchases will remain within management's discretion and depends on a number of factors, including the share price, general economic and market conditions and corporate and regulatory requirements, including SEC rules on restricting the amount of any purchases associated with the available float when purchasing in the open market. We are authorized by the Board of Directors to purchase an additional 2.1 million shares of common stock under our share repurchase program.

And with that, I will now open the lines for questions. Operator?

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Questions and Answers

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Operator [1]

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(Operator Instructions) And our first question comes 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 [2]

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I was hoping -- and apologies a little bit ahead of time. I was having some phone problems here, so I may have cut out a few times and missed some things. But I was hoping you could talk a little bit more about the products and -- and lines of business that deteriorate on a year-over-year basis outside of the commercial auto insurance business. It looks like there was a net improvement in commercial auto. So that -- at least a year-over-year basis, so that would suggest to me that most of the year-over-year deterioration, especially if we exclude catastrophe losses, is someplace outside of that book of business. Is that fair? And could you talk about those products?

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Michael Todd Wilkins, United Fire Group, Inc. - Executive VP & COO [3]

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Paul, this is Mike Wilkins. I'll take a shot at that. If you look at the exhibit in our press release on the back, it has the results by line, and you'll see most of the lines of business year-to-date have shown some improvement. The one that hasn't is general liability. And we've had some -- I think we mentioned in the -- in our comments that we've seen some severity there, a few large claims. The other thing is last year, if you look at our loss ratio, it was in the 20s, both for the 3-month and 6-month periods. This year, we're in the -- we were in the 50% -- we were 50.5% for the 3 months ended June 30, and we're 42.0% for the year. So still not a disaster, but a big increase from a year ago. And that's primarily what drove the lack of progress in our core loss ratio. I think we were -- you said we deteriorated, I think we were about flat in the core loss ratio this year to last year.

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Jon Paul Newsome, Sandler O'Neill + Partners, L.P., Research Division - MD of Equity Research & Senior Insurance Analyst [4]

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The large losses, is there anything that suggests that they are unusual in nature or not unusual in nature?

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Michael Todd Wilkins, United Fire Group, Inc. - Executive VP & COO [5]

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Well, I would say that they were random. They weren't any 1 class or region. We did note that we saw several of those that were commercial auto related. So even though they maybe were impacting other lines of business, the root of the loss was a commercial auto accident.

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Randy Allen Ramlo, United Fire Group, Inc. - President, CEO & Director [6]

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Paul, this is Randy. One other area we seem to be seeing more and more of is adverse court decisions. The -- a lot of the -- we've had -- a couple of the large auto losses had kind of a distracted driver element to them, and those don't do very well if they end up going to court.

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Jon Paul Newsome, Sandler O'Neill + Partners, L.P., Research Division - MD of Equity Research & Senior Insurance Analyst [7]

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Okay. The -- I know you touched on the investment income increase. Is this a fair run rate as we sit? Was there some further investing going to happen because of the cash flow from the Life operation? Or is -- if you -- obviously, alternatives bumped that around. Should we think of the NII, the net investments in the quarter as a reasonable run rate?

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Barrie Willian Ernst, United Fire Group, Inc. - VP & CIO [8]

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Yes, I believe that it's a reasonable run rate. This is Barrie. The increase in the invested assets with the sales of the Life Company and our LLCs did a lot better this quarter too, as Dawn pointed out. And we haven't changed our investment philosophy with that. So I think this is pretty normal.

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Operator [9]

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(Operator Instructions) And our next question comes from [Eric Leeson] with [Eric Leeson Associates].

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Unidentified Analyst, [10]

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This question is for Randy. He mentioned the OASIS Project and the increased expenses related to that project. So my question is, what is the anticipated duration of this project? And what are the anticipated long-term benefits that will be derived from this?

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Randy Allen Ramlo, United Fire Group, Inc. - President, CEO & Director [11]

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So I may defer a little bit of this to Mike Wilkins. He is a lot more familiar with this than I am. But it kind of -- overall, it's a 5-year project. We have 4 left. We actually had our -- one of our benchmarking people come in earlier this week. And these major legacy systems usually take 5 to 7 years, so ours is at the low end of that, which we're thankful for. It's moving along, as we expected. Our past policy-processing system was probably 25 years old. So it had a bit of baling wire and duct tape on it. And the new system, and Mike can kind of add to this, but a lot more streamlined. We can add a lot more analytics features. So underwriters will have information right at their fingertips. On a policy level, better management of data. Mike, you got any more comments on that?

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Michael Todd Wilkins, United Fire Group, Inc. - Executive VP & COO [12]

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Yes, just expanding on what Randy said, I think the big advantage for us -- we use analytics today, but our analytics today isn't integrated into our policy-processing system. So the underwriters, it's a separate operation for them to go get the analytics information and then incorporate it into their underwriting process. The new system will tie it all together and provide guideposts for them on pricing and attractiveness of the business, quality of the business as they go through the process. Of course, productivity is another big area that we look to improve, underwriting policy-processing expenses, underwriting expenses, things like that. So it's a big project, and probably overdue that we tackled that.

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Operator [13]

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(Operator Instructions) And showing no further questions, this concludes our question-and-answer session. I'd like to turn the conference back over to Randy Patten for any closing remarks.

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Randy L. Patten, United Fire Group, Inc. - Assistant VP of Finance & IR [14]

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This now concludes our conference call. Thank you for joining us, and have a great day.

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Operator [15]

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