Earnings Call Transcript - UFCS Q1 2021

Operator, Operator

Good morning, my name is Kate and I’ll be your conference operator today. At this time, I would like to welcome everybody to UFG Insurance First Quarter 2021 Financial Results Conference Call. All participants will be in a listen-only mode. Please note that this event is being recorded. I would now like to turn the conference over to Randy Patten, Assistant Vice President and Controller. Please go ahead.

Randy Patten, Assistant Vice President and Controller

Good morning, everyone, and thank you for joining this call. Earlier today, we showed 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; Mike Wilkins, 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, the 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. 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.

Randy Ramlo, CEO

Thanks, Randy. Good morning, everyone. Welcome to our first-quarter 2021 conference call. I will start off today's call by saying there are a lot of moving parts in our earnings for this quarter. Mike, Dawn, and I will do our best to walk you through the reported numbers in detail. This morning, we reported net income of $0.74 per diluted share for the first quarter of 2021. This was driven by net realized investment gains and higher net investment income from an increase in the valuation of our investments in equity securities and limited liability partnerships. Also contributing to our net income in the first quarter was a decrease in expenses due to a change in the design of our employee post-retirement health plan. Dawn will provide more details on the impact of this change later in the call. Offsetting these positive items was an increase in both catastrophe losses and the severity of commercial auto losses. Catastrophe losses added 11.3 points to the combined ratio compared to our 10-year historical average for the first quarter of 4 points. The increase in catastrophe losses was primarily due to the winter storm freeze event, Uri, mostly occurring in the state of Texas. This catastrophic event was a full retention loss, with losses in excess of our stated reinsurance retention of $20 million. Excluding this event, catastrophe losses in the first quarter of 2021 were in line with our expectations for the first quarter. In the first quarter of 2021, we continued to see a decrease in the frequency of commercial auto claims and a decrease in the number of commercial auto exposure units, both positive signs of progress in our strategic initiatives. There was an increase in the severity of commercial auto losses, involving bodily injury during the quarter, which increased our core loss ratio and is summarized on slide 12 in our presentation on our website. This deterioration comes on the heels of three consecutive quarters of improvement in our core loss ratio. This increase in severity is the result of current year case reserves being set higher and earlier in the claim cycle through the use of analytics. While this increased our core loss ratio in the first quarter of 2021, we ultimately believe this will lead to less unfavorable reserve accident year reserve development in the future. It will also have the benefit of assisting our underwriters with pricing at the time of policy renewal. In executing our strategic plan, we know the key to improving profitability at UFG lies in addressing commercial auto losses, reserve development, and portfolio diversification. All of our strategic initiatives are important to our success and work in concert to remove the variability in our underwriting execution. To achieve more consistent, profitable results, our top priority, and the focus of my portion of today's call is surrounding diversification of our book of business. During the first quarter of 2021, commercial auto made up 27% of the written premium in our portfolio, down from 31% for the full year of 2019. Slide 6 in our presentation summarizes new business. This slide shows that new commercial auto business has dropped to almost 20% in the first quarter of 2021 compared to 32% in 2019. We are also pleased to report the growth in Inland Marine, Property, General Liability, ENS, Shuri, assumed Reinsurance along with the addition of our investment in Lloyd's syndicates in the first quarter of 2021. The decline of our new commercial auto business, especially in targeted classes and jurisdictions, coupled with the growth in our profitable lines such as assumed reinsurance, will allow us to achieve greater diversification. We do see our vulnerability to commercial auto claims and are reducing our exposure in geographically exposed areas to catastrophe. Also, part of portfolio diversification is a clearly defined and consistent selection of appropriate risks, markets, and partners. Moving forward for UFG, we are working closely with our agency partners to ensure they are aligned with our strategic vision and confirming there is a clear path to profitability. Finally, part of our portfolio diversification plans include the launch of a new online quoting platform. In April, we began a pilot program with a few agents and have plans to roll out this in select states starting in mid-2021. We are confident that this platform will propel our growth in the small commercial market, delivering straight-through processing of policies and growth in our profitable BOP lines of business. I will now turn the call over to Mike Wilkins. Mike?

Mike Wilkins, COO

Thanks, Randy. Good morning, everyone. For my portion of the call today, I will discuss the progress of our strategic plan, focusing on positive outcomes during the first quarter of 2021. First, as discussed throughout 2020, our focus has been on reducing the size of our commercial auto portfolio and non-renewing underperforming accounts while reducing the number of exposure units. During the first quarter of 2021, we continued these efforts and are pleased to report that the exposure units decreased 23% over the past 12 months, from 265,000 units in March 2020 to approximately 203,000 units in March 2021. Commercial auto frequency, expressed in claims per insured units, also continues to decrease, with the 12-month moving average declining slightly in the first quarter of 2021 to 4.53% from 4.56% in the fourth quarter of 2020. This decline is summarized on Slide 7 in our earnings call presentation on our website. In addition, Slides 9 and 10 provide a three-year view of our claim counts by our major commercial casualty lines of business. For example, our commercial auto bodily injury and property damage claim counts are down 33% in the first quarter of 2021 compared to the same period in 2020. We've also provided commercial general liability, both liability and workers' compensation claim counts on these slides. All are down notably in the first quarter of 2021, which are positive signs of our strategic efforts. We remain disciplined in our pricing strategy and continue to embed analytics-driven technical pricing into our underwriting processes across all major lines of business. In particular, we're focused on pricing adequacy in our commercial auto, property, and umbrella books of business. Commercial auto average renewal rate increase remained in the double digits at 10.8% in the first quarter of 2021, up from 10.4% in the fourth quarter of 2020. The commercial auto average 12-month rate increases have been in the low double digits since the beginning of 2020. Commercial property pricing also improved in the first quarter, with average renewal rate increases now at 7.9%, up from 7.4% in the fourth quarter. As we stated last quarter, we believe there's an opportunity with our commercial property growth to be more aggressive with rate increases in reducing undesirable exposures, as we see signs in the market hardening. Our claims initiatives also remain a focus and key to improving profitability for UFG. In the first quarter of 2021, our claims metrics trended positively with improvements in litigation expenses, which are the result of declining claims frequency and strategic initiatives to embed analytics into the claims triage process, set reserves in the claim cycle early, and shorten the length of the cycle time. I will wrap up my portion of the call today by expanding on some of our growth strategies that Randy mentioned. During the first quarter of 2021, we added several new assumed reinsurance programs. We believe these new programs will further diversify our direct book of business and improve our profitability, as assumed reinsurance has historically been a profitable segment for UFG. Also, another addition in the first quarter of 2021 was UFG's investment in five Lloyd's of London syndicates. We recorded $14.5 million of net premiums written in the first quarter of 2021 with this new participation. This new program will also help diversify our direct book of business. With that, I'll turn the discussion over to Dawn Jaffray. Dawn?

Dawn Jaffray, CFO

Thanks, Mike. Good morning, everyone. In the first quarter, we reported consolidated net income of $18.7 million compared to a net loss of $72.5 million in the same period of 2020. As Randy mentioned, net income reported in the first quarter of 2021 was driven by net realized investment gains and an increase in net investment income, offset by higher catastrophe losses and an increase in loss severity of commercial auto. We reported net realized investment gains of $24.5 million in the first quarter of 2021 compared to net realized investment losses of $93.4 million in the same period in 2020. $20.6 million of the net realized investment gains were driven by a change in the fair value of our equity security investments, what I refer to as phantom gains; the remaining $3.9 million of gains were primarily driven by the actual sales of equity holdings. Net investment income was $17.1 million in the first quarter of 2021 compared to $2.4 million in the same period of 2020. The increase of $14.7 million was primarily due to the change in the fair value of our bank funds. These bank fund LLPs increased in value by $6.6 million in the first quarter of 2021, compared to a decrease of $11.1 million in the same period in 2020. Moving on to operating metrics for the quarter comparison, we reported a combined ratio of 107.2% compared to 105.2% last year. Favorable prior accident year reserve development contributed 5.1 points during the first quarter of 2021 and was flat compared to the first quarter of 2020. As I mentioned during our fourth-quarter earnings call, we announced we were making changes to our pension and retiree medical plan in managing long-term escalating personnel expenses. Changes in the traditional pension plan structure to a cash balance plan are made to mitigate long-term liability and volatility. Changes in the retiree medical plan to a participant-funded plan had both an immediate first-quarter and will have a longer-term cost-saving impact. The required accounting for this change had a much more significant impact on operating results in the first quarter. Both the expense and loss adjustment expense ratio benefitted from this change, with approximately $22 million in total recaptured into income and recorded in the first quarter. This aggregate change provided about 8 points of reduction to the combined ratio during the first quarter of 2021. Note that the beneficial impact on the combined ratio in the first quarter will taper off as the year progresses as premiums are earned, or the denominator of the ratio grows throughout the balance of the year. We anticipate the resulting impact for the 2021 year will be approximately 2 points of improvement on the expense ratio. Including these changes, our expense ratio was 27.6% for the first quarter of 2021 compared to 35.8% for the first quarter of 2020. Moving on to capital, as of March 31, 2021, our balance sheet remains strong and statutory surplus increased approximately 3% during the quarter. During the first quarter, we declared and paid a $0.15 per share cash dividend to shareholders of record as of March 5, 2021, marking our 212th consecutive quarter of consistently paying dividends, dating back to March of 1968. Lastly, during the quarter, we restarted our share repurchase program, buying a small amount of shares. The amount and timing of any purchases are at management's discretion and depend on a number of factors, including the share price, general economic and market conditions, and corporate and regulatory requirements. As a reminder, we remain authorized by our Board of Directors to purchase an additional 1.8 million shares of common stock under our share repurchase program, which will expire at the end of August 2022. And with the closing of our prepared remarks, I will now open the line for questions.

Operator, Operator

Our first question is from Paul Newsome from Piper Sandler.

Paul Newsome, Analyst

I wanted to ask about how you feel regarding the balance between your rates and the underlying claims inflation, and what you think the current situation of improvement might be.

Randy Ramlo, CEO

Paul, this is Randy. I'll take a shot at that one and maybe Michael has something to add. We feel pretty good about where we are on commercial auto right now on rate versus loss costs. We think we can do a little bit better, especially in some of the parts of the country that have had storms. Mike went over what our overall rate increase is, which was I think up to 7.9% across the board, and we think that should be north of 10%. We believe there are more opportunities there. Workers' comp has kind of moved to flat, which is better than it's been in the past. General liability has kind of been one of our more profitable lines and I think there's some opportunities there as well. In the umbrella, we're getting some rate there, but I think we can probably do more there. I think some of the nationwide statistics we've seen on the umbrella business and excess coverage show pretty severe rate increases. We believe we have to do a little bit better there, even though loss ratio-wise; that's been one of our more profitable lines, but I think we need to be a little more opportunistic in that area. That's really an area that—I'll try not to mention social inflation as much anymore, but it relates to court costs that are attracting the plaintiff's bar. Mike, you've got anything more to add?

Mike Wilkins, COO

Maybe just to add, I think on an overall basis, we're confident that our rate increases exceed the loss cost inflation in the environment that we operate. In the short term, with analytics providing guidance for our reserve setting, we're setting our case reserves earlier in the process and closer to ultimate. This is increasing our severity in the quarterly results, but in the long term, that should be a positive.

Paul Newsome, Analyst

A little help, just clarifying my understanding of the pension impact on expenses. Is it as simple as there was a $21 million true-up in the first quarter, and then there'll be an ongoing benefit that helps the expense ratio by about 2 points prospectively? You also mentioned there was something about reserve earning over time, so maybe you could clarify what we should think about that as we're looking at over the course of the year. Is the true-up done? Or are there more true-ups that come up through the course of the year, and then it hits a run rate? How's the accounting working?

Dawn Jaffray, CFO

Paul, this is Dawn. You're correct, we did recapture the liability in the first quarter that we had previously set up. There will be a small amount of ongoing recapture throughout the year, and that's where we arrive at approximately 2 points associated with the overall improvement for the total year. Relative to the expense ratio specifically, I mentioned 8 points overall; about 6 points of that is expenses, and about 2 points on the loss adjustment expense side. Understand that there are factors in the underwriting components of the calculation, and then there are some offsetting expenses. As Randy indicated earlier, there are many moving parts. We continue to invest in additional technical talent and analytics, our risk office, and assumed reinsurance team. We continue to invest in technology, our online quoting platform, and analytics. As a result, there's some fluctuation as the fixed expenses and the level of earned premiums will vary over time. So I would anticipate that our run rate in 2021 will be somewhere in the range of about 32 to 32.5 roughly. We're expecting about a 0.5 point improvement from the medical plan and the pension plan, offset by some interest costs on the surplus note.

Paul Newsome, Analyst

Okay. I guess I misunderstood. The 2 points you were referring to is what you expect the expense ratio to benefit for the full year 2021 and then run rate into 2022 was about 0.5 point. Is that right?

Dawn Jaffray, CFO

Yes, I would expect 0.5 point. Again, how much the denominator or premium changes, opportunistically, there could be some additional savings, but right now, I would suggest about 0.5 point going forward beyond 2021.

Paul Newsome, Analyst

That's great. I was hoping you could talk a little bit on a different topic about these voids of wanting business and maybe the reinsurance businesses as well as they become more important. How should we think about your participation as businesses? Is it property exposures? The kind of exposures you were talking about? Where do you think United Fire's edge is in these kinds of businesses? What's the strategic piece that you think United Fire brings to these businesses?

Robert Cataldo, Speaker

Paul, this is Bob Cataldo. When we consider the funds at Lloyd's as an investment in the investment portfolio, we monitor the size accordingly within our investment policy, but we've established a member company in which we've invested in five syndicates as we disclosed. We look at it as a complement to our assumed reinsurance strategy, which is intended to further diversify our existing book of business. As we look at the opportunities and underwrite the individual syndicates, we keep in mind our need to expand our book and diversify ourselves away from social inflation, severe Midwestern convective storms, and similar risks. We'll probably continue to look at further investments, or at least maintain our share of the investments we've made. But again, we monitor and govern the size of this exposure vis-a-vis our investment policy statement.

Paul Newsome, Analyst

So are these property exposures outside the U.S.? Or different types of casualty exposures that are outside the U.S.? Or how does the different specification work?

Mike Wilkins, COO

Paul, this is Mike. I'll take that one. We do look to write property exposures in places where we don't write it on the direct side, so that could be outside the U.S. For example, we write a fair amount in Japan, Europe, and other places. Or it could be in the United States in areas where we don't write direct business, for example, the far Northeast or the Southeast, Carolinas, Georgia, etc. I'll also look to fill out lines where we're underweight. We've targeted some workers' compensation business, where we are underweight as a company and a segment that's currently been very profitable. Really just trying to smooth out the sharp corners that we have in our current portfolio. We hired a Chief Risk Officer, a fellow by the name of Micah Woolstenhulme. You asked, what is UFG's advantage here? Micah brought a lot of past relationships; a lot of the programs that we got on have been long established, and we wouldn't have been invited to get on a lot of these programs without those connections. Obviously, we underwrite all of the programs, but Micah has really introduced us to a lot of opportunities that we wouldn't have otherwise had. That's kind of where we have a little bit of an advantage over just anybody doing all their internal underwriting on their own.

Operator, Operator

At this time, we have no more questions. This concludes our question-and-answer session. I will turn the conference back over to Randy Patten for closing remarks.

Randy Patten, Assistant Vice President and Controller

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

Operator, Operator

The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.