Earnings Call Transcript - EIG Q2 2021

Operator, Operator

Good day ladies and gentlemen, and welcome to the Second Quarter 2021 Employers Holdings, Inc. Earnings Conference Call. As a reminder, this conference call is being recorded. I would now like to turn the conference over to your host, Ms. Lori Brown, General Counsel.

Lori Brown, General Counsel

Thank you, Katrina. Good morning and welcome everyone, to the Second Quarter 2021 Earnings Call for Employers. Today's call is being recorded and webcast from the Investors section of our website, where a replay will be available following the call. Presenting today on the call will be Kathy Antonello, our Chief Executive Officer; and Mike Paquette, our Chief Financial Officer. Statements made during this conference call that are not based on historical facts are considered forward-looking statements. These statements are made in reliance on the safe harbor provision of the Private Securities Litigation Reform Act of 1995. Although we believe the expectations expressed in our forward-looking statements are reasonable, risks and uncertainties could cause actual results to be materially different from our expectations, including the risks set forth in our filings with the Securities and Exchange Commission. All remarks made during the call are current only at the time of the call and will not be updated to reflect subsequent developments. The company also uses its website as a means of disclosing material nonpublic information and for complying with disclosure obligations under SEC's regulation FD. Such disclosures will be included in the Investors section of the company's website. Accordingly, investors should monitor that portion of the company's website in addition to following the company's press releases, SEC filings, public conference calls, and webcasts. In our earnings press release and in our remarks or responses to questions, we may use non-GAAP financial metrics. Reconciliations of these non-GAAP metrics to our GAAP results are included in our financial supplement, as an attachment to our earnings press release, our investor presentation, and any other materials available in the Investors section on our website. Now I will turn the call over to Kathy.

Kathy Antonello, CEO

Thank you, Lori, and thanks to everyone for joining us today. On today's call, Mike and I will outline our financial results for the second quarter of 2021 and discuss our observations of the current workers compensation market. Employers continues to perform well, given the challenges faced by our policyholders throughout the pandemic. With businesses now reopened and restrictions largely lifted, we're experiencing year-over-year increases in new business submissions, quotes, and binds. We are encouraged by the rebound we experienced during the second quarter of 2021. Our second quarter gross written premiums were up 5% year-over-year, and we closed the period with yet another record number of policies in force. More than ever, we remain confident that rising payrolls and new business opportunities will bring further growth to our top line. Our year-over-year new business premium for the first half of 2021 is down slightly, driven by pandemic-related shutdowns in January and February. However, our second quarter new business premium was up over 40% relative to 2020, as both the labor force participation rate and unemployment rate continued to improve. The policy retention rate on our renewal book remains very strong at 94% year-to-date, although this strength was offset to some degree by lower average policy sizes and modest rate decreases. Overall, our year-over-year renewal premium was down 10% for the first half of 2021 and 8% for the second quarter. We continue to see declines in frequency for lost time claims and have maintained our current accident year loss and LAE ratio on voluntary business at 63.6%, down from 65.5% a year ago and 64.3% at year-end. While we experienced favorable loss reserve development of $10 million on accident years 2017 and prior, our second quarter results were tempered by $8 million of adverse loss reserve development associated with two catastrophic non-COVID claims that occurred in late 2020. Our second quarter expenses decreased by 21% from those of the first quarter of 2021 and are down 17% year-over-year, in line with our expectations. The decrease in our expenses was primarily a result of targeted expense savings, employee departures, and lower variable expenses that fluctuate directly with earned premium. With that, Mike will now provide a further discussion of our financial results, and then I will return to provide my closing remarks.

Mike Paquette, CFO

Thank you, Kathy. During the second quarter, we delivered a 3.8% annualized return on adjusted equity and the combined ratio of 98.8% within our largest operating segment, Employers. These modest operating results were largely the result of lower earned premium and net investment income, as well as two unusual prior year large loss adjustments. For the quarter, our net premiums earned were $137 million, a decrease of 10% year-over-year. While our written premiums for the first half were down 9%, our second quarter premium writings were up 5%, which demonstrates that our policyholders have endured the pandemic and small businesses are actively shopping for workers compensation coverage. Our losses and loss adjustment expenses were $84 million, an increase of 15%. We recognized $2 million of net favorable prior year loss reserve development on voluntary business during the current period versus $24 million a year ago. The increase in losses and loss adjustment expenses was primarily due to the two catastrophic non-COVID claims that we previously mentioned. Commission expenses were $18 million, a decrease of 6%. The decrease was primarily due to lower earned premiums. Underwriting and general administrative expenses were $37 million, a decrease of 17% year-over-year. Decreases in our fixed expenses, such as compensation and professional fees, resulted from targeted expense savings and employee reductions and departures, while decreases in our variable expenses, such as premium taxes, assessments, and bad debt expense, resulted from decreases in earned premium. From a reporting segment perspective, our Employer segment had underwriting income of $2 million for the quarter versus $18 million a year ago and its combined ratios were 98.8% and 88% respectively. Our Cerity segment had an underwriting loss of just over $2 million for the quarter, down from an underwriting loss of $4 million a year ago. We were enthusiastic about Cerity’s premium writings, which have consistently increased over the past several months. Turning to investments, our net investment income was $18 million for the quarter, consistent with that of the first quarter, but down 9% year-over-year. The decrease year-over-year was primarily due to lower interest rates impacting bond yields. At quarter end, our fixed maturities have a duration of 3.7 and an average credit quality of A+, and our equity securities and other investments represented 11% of the total investment portfolio. Our net income this quarter was favorably impacted by $11 million of net after-tax unrealized gains from equity securities and other investments, which reflected on our income statement and our stockholders' equity, and our book value per share this quarter were each favorably impacted by $10 million of after-tax unrealized gains from fixed maturity securities, which are reflected on our balance sheet. And finally, during the quarter, we repurchased $10 million of our common stock at an average price of $41.72 per share. On July 21, our Board authorized a new share repurchase authority in the amount of $50 million. And now I'll turn the call back to Kathy.

Kathy Antonello, CEO

Thanks, Mike. Our Cerity operating segment, which offers digital workers' compensation insurance solutions directly to consumers, continues to gather momentum and now has $1 million of in-force premium, all within our targeted low hazard groups A through D. We're encouraged by Cerity's success during the first half of 2021 and continue to believe that its technological and intellectual capabilities will support our future growth initiatives and provide direct access to workers’ compensation insurance for businesses seeking an online experience. For the remainder of the year, we will be focused on improving our economies of scale by capitalizing on emerging labor market improvements while continuing to maintain underwriting discipline and actively managing our expenses. Our balance sheet and capital position are very strong and are highly supportive of these key initiatives. As a monoline workers' compensation writer specializing in America's small businesses, we can react to the favorable trends we're seeing appropriately and efficiently and remain confident that we are well positioned for continued success. And with that, operator, we will now take questions.

Operator, Operator

Our first question is from Mark Hughes from Truist. Your line is open.

Mark Hughes, Analyst

Yes. Thank you very much. Hi, Kathy and Mike.

Kathy Antonello, CEO

Hi, Mark.

Mark Hughes, Analyst

The reserve development in the quarter, could you talk about what happened? What was just the general nature of those claims and how you in the first instance misjudged them?

Kathy Antonello, CEO

Yes. Can you just repeat the very last part? I didn’t catch it.

Mark Hughes, Analyst

Yes. And how you originally set the reserve, and then why it was too low? What was the reason for that?

Kathy Antonello, CEO

Okay. Yes, sure. Thanks for that question. So these were two very different and unrelated accidents that were not in any way related to COVID. They happened near the end of 2020 and with any claims of this nature and size, it does take time to analyze the claim and understand what the lifetime value of claims of this nature can be. I'll say that claims of this size for us are very infrequent. But when they do occur, we try to be very diligent in increasing our reserves as soon as possible, as soon as we have enough information to do that, to reflect the lifetime value of the claim. That way we're in a great position so that we don't expect any impact on future periods.

Mark Hughes, Analyst

Were these accounts, in hindsight, higher hazard than you might have expected, or were these just freak accidents?

Kathy Antonello, CEO

Not at all. These were, yes, I would use your words freak accidents. They were not expected. They were not work-from-home accidents as we've mentioned already, they're non-COVID related, very difficult to underwrite for these types of claims. You’re going to have to expect to see these occurrences every so often, but like I said, they're very infrequent.

Mark Hughes, Analyst

And then you can just talk about the new business definitely up year-over-year. How about on a two-year basis and how do you see that trajectory progressing from here? Is it continuing to get better or is there just a little body language there?

Kathy Antonello, CEO

No, it's definitely continuing to get better. Our in-force policy count grew during the second quarter by about 2.5% or 2,500 claims, and that's on a countrywide basis. We also saw an increase in California. I can tell you that the growth we saw in policies was across most policy size bands. We're also starting to see the average policy size increase. We're seeing growth across many states: Florida, Georgia, New Jersey, Illinois, California. So it's not so much in pockets anymore like we were seeing during the pandemic. We are very encouraged by the continued increase in policies and we're seeing some increases in average policy sizes.

Mark Hughes, Analyst

And then on frequency, you mentioned that frequency was still down. Could you give us some sense of how frequencies looking now versus earlier in the year versus last year, just roughly speaking?

Kathy Antonello, CEO

Yes. So last year frequency was sort of an anomaly, right, with the shutdowns that occurred. We saw some very significant frequency decreases. We're continuing to see frequency drop on both a premium and payroll basis, and I can tell you we've looked at it even relative to 2019 and it's down relative to 2019. So looking at it from that perspective, frequency is definitely continuing to drop.

Mark Hughes, Analyst

And then I followed that for going on, but I did want to get this in just regarding the expense run rate. You obviously had good improvement this quarter. Does this fully reflect the expense savings you anticipate? And then secondly, just some pricing in California – outside of California, what are you seeing there?

Kathy Antonello, CEO

Mike, do you want to take the expense question and then I'll jump back with the California?

Mike Paquette, CFO

So with the expenses, Mark, we're at $37 million for the quarter. The fixed aspect of that should be constant going forward for the balance of the year, but the variable component, which again includes premium taxes, policyholder dividends, bad debt assessments, will fluctuate with the level of earned premium. When you take a look at what happened from the first quarter of this year to the second, it was about a decrease of $9.7 million, of which about six of that was the decrease in fixed expenses, and $3.7 million was the decrease in variable due to that change in earned premium. The $37 million is an appropriate run rate at that level of earned premium that we had in the second quarter, but it will fluctuate a bit due to the variable expense.

Kathy Antonello, CEO

Yes. And in regard to California, California remains at about 45% of our book. On the last earnings call, I did mention that we reduced rates in California effective February 1st, and then again, in certain territories we made further reductions effective June 1st. The combination of the lower rates and the fewer restrictions on businesses that are happening in California has resulted in significant increases in our submissions, quotes, and binds. In the second quarter, California new business relative to the second quarter of 2020 was up by about 80%. So we're seeing some significant increases there in California.

Mark Hughes, Analyst

Thank you again.

Kathy Antonello, CEO

Thank you.

Operator, Operator

Our next question is from Bob Farnam with Boenning and Scattergood. Your line is open.

Bob Farnam, Analyst

Yes. Hi there and good morning. With the small business customers that you have, can you give us an idea of staffing, and what kind of – what percentage they're at relative to where they were at full run rate? Obviously, you hear a lot of anecdotes about small businesses having trouble hiring people. So I'm kind of curious what kind of payroll, percentage-wise, they've gotten back to relative to last year or the year before?

Kathy Antonello, CEO

Yes. So we're hearing all the same anecdotal information that you are. You can see it when you're out and about small businesses are having trouble hiring. You would expect that this would impact their payrolls in the short run. When it comes to what we're seeing from an audit perspective, our audit premiums are on average still coming in on average as returned premiums, which would indicate that our audits of small businesses indicate their payrolls are down relative to what we originally wrote the policy at. This would just be for those small businesses that were not in a position to endorse the policies down during the period, which a lot of them did. We would expect that with everything we are seeing, that is going to change; businesses are going to open up. We are hopeful that this fall small businesses will start to staff up and it's definitely not a hockey stick, but we are seeing improvements I would say month-over-month – it's getting better and better.

Bob Farnam, Analyst

Okay. And then related to that, loss trends. As the employees come back and you may have some less experienced employees getting hired, your current exiting loss rates are around 64%. What impact do you see going forward as the economy opens on that expense ratio – on that loss ratio?

Kathy Antonello, CEO

Yes. I mean, that has definitely been a concern coming out of prior recessions. We saw it back in 2009 and 2010 and we are incorporating that into our estimates. But right now we're not seeing anything that gives us pause or concern regarding frequency increasing as a result of new hires and so forth; but it's something that we're keeping an eye on.

Bob Farnam, Analyst

Okay. Fair enough. I have a couple of questions on Cerity. Now, given you're excited about the top line, I wanted to talk about the expenses at Cerity. You had about $15 million of expenses over the last 12 months for that $1 million or so of premium. With your original plan for Cerity, how long did you foresee this taking to break even?

Mike Paquette, CFO

So, Bob, I'll take that. Because Cerity is a new concept it's very difficult to accurately produce the break even, and you can see that in Insurtech today. I'm not aware of any Insurtech that has broken even in the few years in which they've operated, but we're seeing steady progress. We're staying in our lane. We're not reaching outside of the hazard classes that we seek. The amount of premium that we've written in the first six months is a big multiple of the inception-to-date premium we wrote through the beginning of this year. So, we're focused more on managing the expenses, not starving the engine, staying in our lane, and showing consistent stable growth that keeps a reasonable loss ratio; the expense ratio will fix itself in time. It's again very difficult to predict when that'll break even, but keep in mind, we did not go out and buy a $50 million, $75 million, $100 million Insurtech that would not have been perfect for our business; that would have required us to tweak that a little bit, and that also wouldn't have been profitable for some time. So, we're very enthused by what we see; we're going to stay the course. We're trying to make it as efficient as possible, but I don't have a current estimate as to breakeven.

Bob Farnam, Analyst

So how about in terms of the expenses? So the $15 million of expenses over the last 12 months, going forward how much – I'm trying to figure out how much of that is startup costs versus how much of that is kind of continuing fixed costs for the business? I understand you probably don't have a whole lot of variable costs in there right now because the premium is still somewhat small relative to the expense base, but just maybe give us an idea of what that expense – what type of expenses we should be looking for going forward as this thing starts to settle in?

Mike Paquette, CFO

Sure. And that's a difficult question. You're right on the variable expenses. There is not a lot, advertising and marketing are probably two of the ones that you could call kind of semi-variable because you get for what you give. But we have platform costs, and those will run out in just a couple of years. The true expense – and by the way, we're not running at $15 million right now on a run rate for 2021; it's much less than that. But it's difficult for us to do that. We may have an opportunity to plug Cerity into another entity to provide the easy workers' comp solution for that. That may mean more expense going forward. All I can say is we're being very diligent about our expense. A lot of that is fixed, not variable; some will run off in just a couple of years. We're not at $15 million currently; we're probably running at about $12 million for this year and that's down from last year.

Bob Farnam, Analyst

Okay. Yes. I'm just trying to figure out how long this is going to be a drag on earnings because it's – obviously you've gotten the premium up to $1 million, but still trying to cover the cost of $12 million coming up in the next – for this year; it’s a long way to go. So I'm just trying to get an idea of what you can tell shareholders in terms of – at some point, this has to start making money, or you're going to have to pull the plug on it. So I don't know if you've had thoughts on either – have you had thoughts on pulling the plug on it at all?

Mike Paquette, CFO

Right now, we're very encouraged by what we see; we knew this was not going to be an overnight thing. And as long as we have solid, consistent growth and we stay in our lane, we're enthused.

Operator, Operator

We have a follow-up from Mark Hughes from Truist. Your line is open.

Mark Hughes, Analyst

Yes. Thank you. The audit premium this quarter, can you say what that was? It sounds like it was a net return, and then I have a question on what it was in the first quarter?

Kathy Antonello, CEO

Yes. So just a little bit of background. In the first quarter of 2021, we reduced our audit accruals; it was at 0 and we brought it down to negative $2.6 million, $2.7 million. For the second quarter of 2021, we brought that accrual back up to 0, so that added $2.6 million in premiums written and earned during the quarter. As I mentioned earlier, we're continuing to see a mix of positive and negative audit pickups that are still weighted more towards audit returns. We feel pretty strongly that indications are this trend is going to reverse in the coming months as employment, wages, and payrolls increase. But in the second quarter of 2021, our audit pickup was about negative $6 million. I do want to point out too, that since the accrual represents the audit premium that's earned, there is going to be a lag between when the economy strengthens and then the increases that we see in both audit pickup and accrual.

Mark Hughes, Analyst

I'm sorry, I didn't quite follow the differentiation between the negative $6 million and the plus $2.6 million change in the accrual. Could you explain that again?

Kathy Antonello, CEO

Yes. So during the quarter we brought our audit accrual up from negative $2.6 million to 0. So that was a positive, and then our audit pickup was a negative $6 million.

Mark Hughes, Analyst

So that said, the net was what, $3.4 million – negative $3.4 million?

Kathy Antonello, CEO

Yes. That's right.

Mark Hughes, Analyst

Perfect. And then in Q1, if we look at it on a net basis as well, what was that number? You had those negative $2.6 million accrual, and then what was the, I guess, the underlying number?

Kathy Antonello, CEO

I don't have that in front of me, but we can get back to you on that.

Mark Hughes, Analyst

Okay. Yes, that's fine. And then Mike, you just mentioned in talking about Cerity as you might plug that in with another entity; what were you referring to there?

Mike Paquette, CFO

All I'm saying is that both Employers and Cerity can be the workers' comp solution with another carrier offering a full business suite, and that optionality exists within Cerity, as well as Employers.

Mark Hughes, Analyst

I take it there, you're talking about just the valuable platform as it builds and the idea of shutting it down. You wouldn't shut it down, and you might be able to offer that platform or sell that platform if it came to that, or that it would provide value in another way. Is that your point?

Mike Paquette, CFO

I'm not saying that at all. What I'm saying is that we have opportunities from time-to-time for Employers to provide the workers’ comp to another carrier’s full business offering. We absolutely have that optionality within Cerity as well. That has nothing to do with shutting it down, that has nothing to do with offering it for sale; it's providing the workers' comp solution to another carrier’s more fulsome offering.

Mark Hughes, Analyst

Yes, okay. All right. Thanks for that clarification. And then when you think about Q3, this may not be a fair question, but you've got comparable year-over-year growth numbers; you're looking at down 2021 in terms of written premium, this quarter your written premium is up about 5. You've mentioned that net headwind from audit premium. Any kind of direction you'd like to share for Q3? Do you think the growth will be similar in terms of written premium, a little faster, a little slower? How do you see it shaping up?

Mike Paquette, CFO

We can't predict that, Mark. What we see right now is very encouraging; California is now open for business, but we can't make those projections right now. We like what we see right now; the January and February new business opportunities this year were below our expectations, and we've been on a good trajectory since. We're very much hoping and expecting that continued trajectory for the balance of the year.

Mark Hughes, Analyst

Thank you.

Operator, Operator

I am showing no further questions at this time. I would now like to turn the conference back to Ms. Kathy Antonello, CEO.

Kathy Antonello, CEO

Thank you, Katrina. And thank you all for joining us this morning. Enjoy the weekend, and I look forward to meeting with you again next quarter.

Operator, Operator

Ladies and gentlemen, this concludes today's conference. Thank you for your participation and have a wonderful day. You may all disconnect.