Earnings Call Transcript - EIG Q2 2022

Operator, Operator

Good day and thank you for standing by. Welcome to today's Second Quarter 2022 Employers Holdings, Inc. Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. Please be advised that today's call is being recorded. I would now like to hand the conference over to your speaker today, Ms. Lori Brown, General Counsel. Please go ahead.

Lori Brown, General Counsel

Thank you, Carmen. Good morning and welcome everyone to the second 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 non-public information and for complying with disclosure obligations under the 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.

Katherine 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 2022 and discuss our observations of the current workers' compensation market. We are executing extremely well on our business plan. Consistent with the momentum we have experienced in recent quarters, our written and earned premiums increased significantly year-over-year. This growth resulted from strong new and renewal business writings within our Employers segment, strong new business writings within our Cerity security segment, and further audit premium recognition. As a result, our gross premiums written during the quarter and first half are up 22% and 19% respectively versus those of a year ago. Our appetite expansion into new markets such as landscaping, residential, janitorial, and several artisan contracting classes was a solid driver of this growth. Cerity's enforced premium at quarter end was $2.7 million, which represents an increase of 250% over the last four quarters and was supported by its recent collaboration with Intuit's QuickBooks. Cerity continues to develop additional strategic opportunities which will support our growth initiatives by attracting an untapped segment of our target market. We once again ended the quarter with a record number of policies in force. Our consistent growth in policy count has positioned us well and will continue to generate premium growth as wages rise. Since the pandemic, lower wage workers, especially in our focus industry of leisure and hospitality, have seen the sharpest increase in wages, up 15% for the first quarter of 2022 relative to the prior year, which has led to robust audit premium recognition. With payroll as the exposure base and indemnity benefits automatically linked to state average weekly wages, the workers' compensation line of business adjusts nicely to changes in wage inflation. We maintained our current accident year loss and LAE ratio on voluntary business at 64%, largely consistent with the 63.5% we recorded throughout 2021. We also performed our routine midyear full reserve study and recognized $10 million of net favorable prior year loss reserve development from our voluntary business. We'll complete our next full reserve study at year-end. Our underwriting and general and administrative expenses of $39 million were $2 million higher than a year ago. The increase can be attributed to premium taxes, assessments, and a provision for bad debt, each of which vary with our earned premium. Our fixed expenses, those that are within our control and do not tend to vary with our earned premium were down $1 million from a year ago. The combined impact of lower fixed expenses and higher earned premiums led to a consolidated underwriting and general and administrative expense ratio of 23.8% this quarter, a year-over-year reduction of 320 basis points. This is the lowest consolidated underwriting and G&A expense ratio in 14 quarters and is a direct result of our focus on productivity and efficiency as we grow our top line. While we continue to diligently manage our expenses, we are also committed to technology and digital investments that improve both our customer and workforce experience and position us to scale the business. With that, Mike will now provide a further discussion of our financial results and then I will return to provide my closing remarks.

Michael Paquette, CFO

Thank you, Kathy. Gross premiums written were $179 million versus $147 million a year ago, an increase of 22%. That increase was primarily due to higher new and renewal premiums and higher final audit premiums. Net premiums earned were $165 million versus $137 million a year ago, an increase of 21%. Our losses and loss adjustment expenses were $93 million versus $84 million a year ago. The increase was due to higher earned premiums, partially offset by an increase in net favorable prior accident year loss reserve development. We recognized $10 million of favorable development during the quarter versus just $2 million of favorable development a year ago. Commission expenses were $24 million versus $18 million a year ago. The increase was primarily due to higher earned premiums and higher agency incentives. Our current commission ratio of 14% within our Employer segment is expected to decrease during the second half of 2022 as a result of a reduction in certain renewal commissions that went into effect on July 1st. Underwriting and general administrative expenses were $39 million versus $37 million a year ago. As Kathy mentioned, the increase was a result of higher variable expenses, namely premium taxes, assessments, and bad debt provisions. From a reporting segment perspective, our Employer segment had an underwriting income of $13 million versus $2 million a year ago, and its results in calendar year combined ratios were 92% and 99%, respectively. Our Cerity segment had an underwriting loss of $3 million for the quarter consistent with its underwriting loss of a year ago. 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 $20 million a year ago is $18 million a year ago. The sizable increase was due to higher bond yields and a higher invested asset balance, resulting from our Federal Home Loan Bank leveraged investment strategy. Pursuant to this strategy, our insurance subsidiaries have received advances of $126 million from the Federal Home Loan Bank through June 30th, and the proceeds of these advances were used to purchase an equivalent amount of high-quality collateralized loan obligation securities. Our fixed maturities currently have a duration of 4.1 and an average credit quality of A Plus, and our equity securities and other investments represent 13% of our total investment portfolio. Our weighted average ending book yield was 3.3% at quarter end. Our net income this quarter was unfavorably impacted by $33 million of net after-tax unrealized losses from our equity securities and other investments, which are reflected on our income statement, and our stockholders' equity and book value per share this quarter were each unfavorably impacted by $74 million of after-tax unrealized losses from our fixed maturity securities, which are reflected on our balance sheet. Finally, during the quarter, we repurchased $15 million of our common stock at an average price of $39.81 per share, and we have repurchased a further $4 million of our common stock at an average price of $40.89 since quarter end. Our remaining share repurchase authority stands at $53 million. With that, I'll turn the call back to Kathy.

Katherine Antonello, CEO

Thank you, Mike, and reiterating where you left off. During the quarter, in total, we returned $50 million of capital to our shareholders comprised of the $15 million of share repurchases that Mike just mentioned and an additional $35 million in dividends. I also want to reiterate that the sharp increases in market interest rates occurring throughout the first six months of 2022 have benefited our net investment income, which increased 7% year-to-date versus a year ago. While those same market interest rates generated unrealized investment losses on our fixed maturity portfolio, our adjusted book value per share dropped by only 2%, a direct result of unrealized losses from our equities and other investments, which flow through our income statement. Our balance sheet and underwriting capital remain very strong and are highly supportive of our continued growth and success. As a specialist in small business workers' compensation, we are well-positioned to react to the favorable trends, initiatives, and opportunities that we're seeing, and we remain highly confident in our continued success. With that, operator, we will now take questions.

Operator, Operator

Thank you. Our first question comes from Mark Hughes with Truist. Your line is open. Please go ahead.

Mark Hughes, Analyst

Yes, thank you very much. Good morning.

Katherine Antonello, CEO

Good morning, Mark.

Mark Hughes, Analyst

Kathy, could you talk about what's going on in California just in terms of pricing? The Rating Bureau has suggested an increase in the pure premium rate, I think it was around 7.5%, but it's not clear how much the market is going to follow that. Just kind of give us the pricing and competitive dynamic in the state.

Katherine Antonello, CEO

Sure. So, California remains at about 45% of our total book. It's been a little over a year since we adjusted our pricing in California and sort of changed our strategy there. The combination of lower rates, appetite expansion and the improved economy has increased in California our submissions, quotes, and binds, which has led to about a 13% increase in the second quarter of 2022 California new business premium relative to what we saw in the second quarter of 2021. To your point about rates, the WCIRB recently filed for a pure premium increase of about 7.5%. However, Commissioner Laura adopted no change in the advisory benchmark rates. That said, in the announcement, they noted that the average industry filed rates are currently about 18% higher than the Commissioner's advisory rate. The point being there is that companies have the flexibility they need to reflect the risk, whatever risk they're taking in California. We are in the process of analyzing our own data in that regard and deciding how we will respond to the recent filing from the WCIRB. Overall, the market, I would say, country-wide still remains competitive. We are not seeing too much of a change there. It's still a soft market for workers' compensation, but rates are decreasing at a slower pace than we've seen in the past.

Mark Hughes, Analyst

Okay, thank you. And then you mentioned a 15% increase in wages in the first quarter. I think you were talking in broad aggregates within leisure. Is there a number you can share for your book, kind of, what you're seeing on renewals in terms of wage gains or payroll gains?

Katherine Antonello, CEO

Yes, so we've seen on our renewal book we are seeing very slight decreases in the renewal rates there. Most of that is attributed to, even though loss costs are decreasing, like I said a minute ago, that's being more than offset by wage and payroll increases. So, we're seeing overall increases in our renewal book year-over-year.

Mark Hughes, Analyst

Okay. So, that sounds like it's wages, mostly offsetting declining loss. Is that fair?

Katherine Antonello, CEO

Yes, both wages and just increases in hiring and employment levels are more than offsetting the decreases that we're seeing in rates.

Mark Hughes, Analyst

And then the audit premium trend, is it fair to think that'll continue if we're dealing with policyholders that have underestimated their payrolls? Would this continue to be a tailwind, do you think?

Katherine Antonello, CEO

It wouldn't surprise me if it continues to be a tailwind for several quarters. The increase that we saw this quarter had a couple of things going on. For the second quarter, we did increase our audit accrual from $13.3 million at the end of Q1 to $18.8 million, which flowed through. Audit pickups were also really strong this quarter, totaling about $7.7 million. We are continuing to see that trend into July, and it's been an amazing turnaround in that space. For the first six months of 2021, we returned about $9 million of audit premium; in contrast, for the first six months of 2022, we've picked up about $12 million. This is all going back to what I was saying before about the wage increases and strong employment, especially in some of our target industries, which has had a really positive impact on these numbers.

Mark Hughes, Analyst

Then a final question for me, the inflation in medical costs, any commentary there?

Katherine Antonello, CEO

We are not seeing any impact on our book of business from medical inflation. Medical inflation has been relatively tame compared to a lot of the other sectors. I believe that workers' compensation has done a nice job over the last decade of implementing a lot of medical cost containment measures, and even if inflation starts to tick up in the medical sector of the market, those containment measures will start to mitigate the potential impact of medical inflation. Of course, the best hedge against inflation on the medical side is just solid reserving philosophy, along with prudent claim settlement practices, and I feel like we have both of these in place. So, the short answer is we're currently not seeing an impact from medical inflation. It doesn't mean it won't come through, but it is certainly lacking right now.

Mark Hughes, Analyst

Thank you very much.

Operator, Operator

Thank you. We have a question from Paul Newsome with Piper Sandler. Please go ahead.

Paul Newsome, Analyst

Just a quick follow-up on the medical cost inflation. Hartford was talking this morning about 5% medical costs inflation over the long term. Is that consistent with how you think of it as well? Or do you peg it higher or lower than what they are thinking about?

Katherine Antonello, CEO

Let me just talk a little bit about how we are reflecting the potential for medical inflation in our reserves. We have always included a provision for inflation in our reserves, primarily medical inflation, which can impact our reserves. Our current provision recognizes the possibility of an increase in the implicit inflation that's buried in our reserve triangles. Rather than pick one point for where we think inflation is going to go, we look at several scenarios and increase that implicit inflation over a defined number of years, which is reflected in our booked reserves. So, that's how we try to reflect it. I would say the number that you're stating is not too different from some of the scenarios that we have reflected.

Paul Newsome, Analyst

Right. Thank you. That's very helpful.

Katherine Antonello, CEO

Thank you.

Operator, Operator

Thank you. And we have a follow-up for Mark Hughes with Truist. Please go ahead.

Mark Hughes, Analyst

Yes, Mike, I was just going to ask about the expenses. The fixed expenses were down $1 million year-over-year. Is there any plan to bring those down further? Or alternatively, to the extent that you maintain more top-line growth? How much of an increase should you see in those expenses? How sensitive may they be to inflation? I'm just trying to get a sense of what you might anticipate.

Michael Paquette, CFO

Sure thing, Mark. Kathy and I are pretty dedicated to trying to hold our fixed expenses as flat as possible. The one thing that is very difficult for us to control in that regard right now is salaries and wages, which we try to build something in there and try to save expenses elsewhere to offset that. On the variable expense side, there is not much we can do; premium taxes, dividends, and assessments are largely outside of our control. Despite the fact that we've been growing premium quite a bit, we've been able to hold, if not reduce slightly, our fixed expenses. That's going to be a little bit of a challenge going forward, but we're going to try to hold that as best as we can.

Mark Hughes, Analyst

Understood. And when you think about some of the impact of the steps you've taken, you mentioned California's increased appetite, a better economy, and the price adjustment. Is there a point at which you lapped some of those things, and growth becomes more challenging? Or would you anticipate that those factors continue to impact the business? I'm just trying to understand whether a lot of these things were implemented at a specific point in time, and therefore, you comp against that and it's not as much of a tailwind?

Katherine Antonello, CEO

Mark, maybe I can add a little bit of color around where we're seeing some of our larger growth. One area we haven't discussed yet is our digital distribution area that uses APIs to take in our submissions, quotes, and binds on small business, and that's really taken off over the last couple of years. We have over 40 digital API integrations, which have produced a year-over-year increase in new business policies. For this quarter, it increased about 76% for policies, and premium increased about 64%. Year-to-date, we've written about $22 million of new and renewal business in that digital space, which is up 90% year-over-year. Some of that, yes, is coming from the appetite expansion we've discussed. In the first year alone, we've written about $27 million of new business in our expansion classes. We will continue to look at new ways to increase our market opportunity, whether it be in digital, appetite expansion, or through partnerships with Cerity. We're quite optimistic that we can continue to increase the top line to some extent for a period of time.

Mark Hughes, Analyst

Very good. Thanks.

Operator, Operator

Thank you. I am not showing any further questions in the queue. I will turn the call back to Kathy Antonello for her final thoughts.

Katherine Antonello, CEO

Okay, thank you, Carmen, and thank you all for joining us this morning. We look forward to meeting with you again in October.

Operator, Operator

Thank you. And this concludes today's conference call. Thank you for participating, and you may now disconnect.