Earnings Call Transcript - EIG Q4 2022

Operator, Operator

Thank you for standing by and welcome to the Employers Holdings Fourth Quarter 2022 Earnings Conference Call. As a reminder, today's program is being recorded. And now I'd like to introduce your host for today's program, Lori Brown, Executive Vice President, General Counsel. Please go ahead.

Lori Brown, Executive Vice President, General Counsel

Thank you, Jonathan. Good morning and welcome, everyone, to the fourth quarter 2022 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 webcast. 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.

Katherine Antonello, CEO

Thank you, Lori. Good morning to everyone and thank you for joining us today. To start the discussion, I'll provide some insights into our fourth quarter and full year 2022 financial results. And then I'll hand it over to Mike for more details on our financials. Prior to the Q&A, I'll share some insights into the current workers' compensation market and then talk a little about our focus for 2023. I am really pleased with what we achieved in 2022. We closed the year with strong revenue growth driven by sharp increases in both premium writings and net investment income. Our written premiums were up 22% for the quarter and 21% for the year. The strong growth was the result of higher new renewal and final audit premiums, our thoughtful and disciplined expansion within the low-to-medium hazard group classes, increased submissions, quotes and binds across most of the states where we operate and was the primary driver of new business premium growth. We also increased our final audit premium accruals and recognized strong audit premium pickup as our payroll exposure grew with the strong labor market and rising wages. Finally, our renewal premium benefited from continued solid retention rates throughout the year. We wrote $707 million of net written premium in 2022, higher than any other year since 2018 and the third highest in our history as a publicly traded company. Our net investment income was up 53% for the quarter and 24% for the year. The sharp increase was primarily due to higher market interest rates impacting bond yields and higher invested balances of fixed maturity securities. We earned $90 million of net investment income in 2022, higher than any other year since 2009 and the second highest in our history as a publicly traded company. With respect to losses, Employers and Cerity each maintained a current accident year loss and LAE ratio on voluntary business of 64% versus the 63.5% recorded throughout 2021. During the quarter, Employers and Cerity each recognized net favorable prior year loss reserve development which amounted to $23 million in the aggregate. Diligent fixed expense management helped to lower our consolidated underwriting and general and administrative expense ratio to 24.7% for the year which was far lower than any other year since 2018. Cerity, which we launched in 2019, increased its premium writings by 350% this year from $1.5 million a year ago to $6.7 million. Cerity continues to develop additional partnership opportunities to attract small business customers seeking an online experience when purchasing workers' compensation. Finally, I want to thank our dedicated employees for an outstanding 2022. The unwavering service you provide our agents, our policyholders, and their injured workers drive our continued success. With that, Mike will now provide a further discussion of our financial results and then I'll return to provide my closing remarks.

Michael Paquette, CFO

Thank you, Kathy. Gross premiums written were $174 million versus $142 million a year ago, an increase of 22%. The increase was due to higher new and renewal premiums and higher final audit premiums. Net premiums earned were $181 million versus $156 million a year ago, an increase of 16%. Our losses and loss adjustment expenses were $91 million versus $71 million a year ago. The increase was due to our higher earned premium and lower favorable prior year loss reserve development. We recognized $23 million of favorable prior year loss reserve development during the current quarter, predominantly related to accident years 2017 and prior versus $24 million a year ago. Commission expenses were $26 million versus $21 million a year ago. The increase was primarily due to higher earned premiums, higher 2022 agency incentive accruals, and an increase in new business writings which are generally subject to higher commission rates. Underwriting and general and administrative expenses were $47 million versus $39 million a year ago. The increase was primarily due to higher premium taxes, assessments, and bad debt expense, each of which vary with our earned premium. Income tax expense was $9 million, a 16% effective rate versus $14 million a year ago or a 20% effective rate. The effective rates in each of those periods included tax benefits and exclusions associated with our tax-advantaged investment income and LPT deferred gain amortization. From a reporting segment perspective, our Employers segment had underwriting income of $24 million versus underwriting income of $28 million a year ago and its resulting calendar year combined ratios were 87% and 82%, respectively. Our Cerity segment had an underwriting loss of $3 million for the quarter, consistent with its underwriting loss of a year ago. As Kathy mentioned, we remain very enthusiastic about Cerity's premium writings which have significantly increased over the past several quarters. Turning to investments. Our net investment income was $27 million for the quarter versus $18 million a year ago, an increase of more than 50%. The increase was due to higher bond yields and higher invested asset balances as measured by amortized cost, largely resulting from our Federal Home Loan Bank leveraged investment strategy. Pursuant to this strategy, our insurance subsidiaries have received advances of $183 million from the Federal Home Loan Bank and the proceeds from those advances were used to purchase a similar amount of high-quality, collateralized loan obligation securities. Our fixed maturities currently have a duration of 3.9 and an average credit quality of A. Our weighted average ending book yield was 3.9% at year-end which is up sharply from the 3% a year ago and our new money rate today is near 6%. Our net income this quarter was favorably impacted by $11 million of net after-tax unrealized gains from equity securities and other investments. Those are reflected on our income statement. And our stockholders' equity and book value per share further benefited from $20 million of net after-tax unrealized gains from fixed maturity securities which are reflected on our balance sheet. And finally, during the quarter, we repurchased $1.7 million of our common stock at an average price of $42.15 per share. And since year-end, we have bought a further $4.2 million of our stock at an average price of $42.75 per share. Our remaining share repurchase authority currently stands at $43.2 million. And now I'll turn the call back to Kathy.

Katherine Antonello, CEO

Thanks, Mike. We expanded our capital management strategy in 2022 to include the proactive return of excess capital to our shareholders via special dividends. During 2022, we returned over $120 million of capital to our shareholders, comprised of $30 million of share repurchases, $29 million of regular quarterly dividends and $62 million of special dividends. As a unique specialist in small business workers' compensation, we are both well-positioned and well-capitalized to further react to the favorable trends and opportunities that we're seeing. While workers' compensation pricing remains competitive, the line also remains profitable. Tailwinds from increasing hiring and wages, especially in the leisure and hospitality industry, where we've always had a strong presence, are benefiting workers' comp and medical inflation has remained moderate relative to other categories. Throughout 2023, our focus will be on continuing to identify new and profitable segments of the workers' compensation market to grow our top line while maintaining our fixed expense structure. We're investing in improvements to both our workforce and customer experience which will yield efficiencies and delight our growing customer base. We remain highly confident in our continued success. And with that, operator, we will now take questions.

Operator, Operator

Our first question comes from Mark Hughes from Truist.

Mark Hughes, Analyst

Kathy, the capital situation as it stands today, your top line opportunities seem to be pretty good that you've got something to do with your capital. But presumably, your leverage is still moderate. How do you see that? Is there still opportunity for capital return with what you've got in front of you?

Katherine Antonello, CEO

Yes, I do believe so. I will let Mike discuss more of the details. But I'd just say that we've always been and will continue to be committed to managing our capital in a way that's in the best interest of the company and its shareholders. And to do that, we're going to use every tool in our toolbox, which is what we did in 2022. We do feel the company is in a very strong capital position. And it's highly supportive of our growth and the technology initiatives that I mentioned earlier and we do not see that changing. And yes, I do feel like we have more potential going forward but I will let Mike give you some more details on that.

Michael Paquette, CFO

So great question, Mark. And one of the reasons why we were able to affect $62 million of special dividends this year is we did extract in a special distribution $120 million from one of our larger insurance companies. That still leaves about $100 million at the parent today which is in a good place. But the result of that special dividend was very helpful to us because it helps serve to increase our premium to surplus ratio from about 54% at the end of 2021 to 75% where we stand today. And that's a function both of reducing the underwriting capital and the premium growth that we saw this year. I think Kathy and I would both like to see that number even higher than the 75% it's at right now, perhaps to the low to mid-90s. So we're on our way towards more efficiency in that regard. With respect to further special dividends, we'll make a determination in the second half of this year as to whether that's appropriate for 2023 or not. We'll make that determination based on where our capital at the insurance company stands, what our capital position at the holding company looks like and what our opportunities for 2024 look like. There's no guarantees but we won't be able to make that determination until that time but it is important for you to understand that we are comfortable in making special dividends when they're appropriate.

Mark Hughes, Analyst

Yes. I appreciate those details. Cerity really had a good fourth quarter for written premiums. Is anything in particular going on there? Is there some seasonal component to it? Is this a new run rate that you'll look to build on?

Katherine Antonello, CEO

Yes. I do think that Cerity will continue to grow at a strong clip. For the fourth quarter, Cerity increased its premium year-over-year by about 275%. I'd like to see a continued growth of that size, somewhere between 200% and 300% in the future. We're pretty cautious with the direct-to-consumer space and don't want to grow too fast. We're obviously very focused on profitability also and always have been and that's why we've been cautious in that area. The appetite expansion has helped Cerity and enhancing some of their back-end capabilities and some of the partnerships that we announced in 2022 are also adding to that growth and we fully expect more partnerships in the future.

Mark Hughes, Analyst

And then your broader push to expand, I think you talked about low-to-mid hazard, median hazard classes driving submissions, et cetera. How much more is there to go would you say? How far along in that process are you?

Katherine Antonello, CEO

It’s an ongoing process, and I am not sure when we will finish. However, since we started our appetite expansion a little over 18 months ago, we've written around $50 million in premium within those expanded class codes. That team is still working and looking for profitable growth opportunities, so we haven't stopped that expansion. We plan to continue pursuing growth in the future, as there is still plenty of opportunity available.

Mark Hughes, Analyst

Yes. If I could just slip in a couple more. Current accident year outlook? Any reason for that to be higher or lower in 2023?

Katherine Antonello, CEO

I don't expect a material change in the current accident year. We're 45 days in but we didn't see anything that would cause alarm when we were looking at 2023 and trying to project what that might be. So I think it will be very similar to what you've seen in the prior two accident years.

Mark Hughes, Analyst

I would like to know if you have any general comments about the potential for reserve development. Given the size of the reserve and how much you have from some of these accident years that have been more promising, what are your high-level thoughts? This has clearly been a favorable period for you. What can we anticipate moving forward?

Katherine Antonello, CEO

Yes. So as you know, about a year ago, we decided to do full studies of reserves twice a year. And so that will continue into 2023. The one area where we've spent a lot of time looking at our reserves is in regard to inflation. And our reserves have always included a provision for inflation. But our current booked reserves recognized the possibility of an increase in over the inflation that has always been buried in our reserve triangles. So we did do a deep dive where we looked at several scenarios and increased our booking to reflect something over and above the implicit inflation. And so I feel like we're in a good spot. There's nothing that I'm seeing that is concerning about our reserves. As you know, we recognized $23 million of favorable prior year reserve development that came predominantly from accident years 2017 and prior. Our reserve philosophy tends to hold on the more current accident years until there's a compelling reason to adjust those. And at the moment, we have not felt that there was a need to do that.

Operator, Operator

Our next question comes from Paul Newsome from AOL.com.

Paul Newsome, Analyst

It's from Piper Sandler. Congratulations on the year. I didn't hear anything about the competitive environment in general. Are there any indications that things are changing from a competitive standpoint?

Katherine Antonello, CEO

Not in a significant way. For the business sectors and the premium sizes that we are writing, I would continue to characterize the environment as competitive. There have been pockets that I've heard chatter about where the insurtechs are either pulling out or kind of tightening their pricing to achieve some profitability. That could be opening up some opportunities for us to participate in areas where we felt like pricing was somewhat inadequate before. For our renewal book, when we adjust for changes in exposure, I can tell you that our Q4 2022 average pricing did show the smallest year-over-year rate decrease that we've seen in many, many years. It's almost approaching flat. But I would say kind of, in a nutshell, it's still not a hard market but there could be some fundamental changes going on.

Paul Newsome, Analyst

So what might be the drivers of that? Is it just simply less frequency benefit? Or is there something else that you think is maybe helping us out a little bit on the margin?

Katherine Antonello, CEO

I don't believe there are any issues with frequency. To elaborate, when we assess frequency, we're looking at the current accident year, which I'm referring to as accident year 2022. By comparing it to accident year 2019, we can eliminate any temporary distortions caused by the pandemic. So far, the frequency for accident year 2022 is emerging significantly lower than that of accident year 2019, indicating a notable reduction in frequency. On the severity front, we need to monitor that closely. I don't see medical inflation as a current concern. However, there is a slight increase in severity, but it's still early for accident year 2022 to determine its final impact. So far, I'm not seeing anything alarming.

Operator, Operator

And our next question is a follow-up from Mark Hughes at Truist.

Mark Hughes, Analyst

Kathy, I just wanted to clarify when you said the frequency is down. Would you say on a premium basis, so not necessarily on the closure but relative to premium?

Katherine Antonello, CEO

Yes. We like to analyze frequency in relation to on-level premium to ensure we're comparing all years equally, allowing us to accurately gauge the decline in frequency. We are indeed observing significant decreases in frequency in our compensation book.

Mark Hughes, Analyst

No, I'm sorry, I interrupted you. What I was going to mention is considering it in terms of exposures with new developments.

Katherine Antonello, CEO

Yes, we're seeing a decrease across the line, whether you look at it on an exposure basis, on a not on-level premium basis or on an on-level premium basis. So yes, versus payroll or premium, it's decreasing.

Mark Hughes, Analyst

Yes. What's the latest you're seeing, if you look at the state data on like NCCI loss costs? Is there a particular trend in what they're putting out in the market?

Katherine Antonello, CEO

Loss costs are continuing to decline in most of the NCCI states. In California, the WCIRB filed for a pure premium increase of 7.6% last fall but the commissioner approved no change. I guess I would say I'm a little surprised at some of the sizable decreases that are being filed but these are just the loss costs and every carrier can file what is appropriate for them. And it's good that carriers have that flexibility. I have a lot of faith in our team of actuaries and feel like they're best-in-class and we always complete our own analysis and make filings that represent what we feel is appropriate rate adequacy for both Employers and Cerity. But yes, that's kind of the overall trend I'm seeing is WCIRB tends to be seeing some upward pressure in California, NCCI states are still drifting down for the most part.

Mark Hughes, Analyst

Mike, the Federal Home Loan Bank strategy you've used has been seemingly very successful. When does that taper? What's the impact of potential movement in that over the next six to twelve months?

Michael Paquette, CFO

So that trade is probably going to end in the third, maybe fourth quarter of this year. And the reason for that is that the CLOs track LIBOR today that will change when LIBOR goes away July 1 and the Federal Home Loan Bank borrowings are done at SOFR. And it's the difference between those two rates that's helping us with the arbitrage today. To put it into perspective with respect to our activities in 2022, we had about a $6.3 million net investment impact increase as a result of that trade and that is just the yield on the additional CLOs. But also going the other way was $3 million worth of interest. So that trade had a $3.3 million pretax benefit to us in 2022 and we'll have to wait to see what that effect is going to be into 2023. But we'll continue to have some benefit from that but it will be dwindling as the year goes by.

Mark Hughes, Analyst

That's a modest number, I believe. Regarding the expense ratio, commissions increased slightly, but your growth has been quite robust, which is understandable. Do you have any insights on the overall expense ratio for 2023?

Michael Paquette, CFO

Keep in mind that the expense ratio for the fourth quarter has increased slightly, primarily due to our success with net investment income and the adjustments we made. This required us to modify some compensation accruals, which affected the entire year. Therefore, the fourth quarter appears somewhat unusual because of the extra revenue we experienced. Moving into next year, Kathy and I are striving to maintain our fixed expenses. As you're aware, variable expenses are largely beyond our control since they fluctuate with our premiums and cannot be mitigated. We are unlikely to achieve a significant reduction in fixed expenses like we have since the first quarter of 2021, but ongoing premium growth and aligning earned income with written income will help improve that ratio as long as we can manage our fixed expenses.

Mark Hughes, Analyst

Can you say roughly what the comp expense the accrual catch-up was? What that impact was in the fourth quarter?

Michael Paquette, CFO

It's tough for me to say we're talking short term, long term, this, that but it was a few million dollars, let's say $3 million.

Operator, Operator

This does conclude the question-and-answer session of today's program. I'd like to hand the program back to Kathy Antonello for any further remarks.

Katherine Antonello, CEO

So, thank you all for joining us this morning. I look forward to meeting with you again in April and thank you, Jonathan. Have a great weekend.

Operator, Operator

Thank you. And thank you, ladies and gentlemen, for your participation in today's conference. This does conclude the program. You may now disconnect. Good day.