Earnings Call Transcript - UFCS Q2 2021

Operator, Operator

Good morning. My name is Chuck, and I'll be your conference operator today. I would like to welcome everyone to the UFG Insurance Second Quarter 2021 Financial Results Conference Call. Please note 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, sir.

Randy Patten, Assistant Vice President and Controller

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; 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, and welcome to our second quarter 2021 conference call. We are very pleased to report our most profitable second quarter in six years with net income of $0.54 and adjusted operating income of $0.35 per diluted share. The improvement in profitability is primarily due to a decrease in frequency and severity of commercial auto liability losses and below average catastrophe losses. During the second quarter of 2021, we reported a commercial auto net loss ratio of 67%, an improvement of 11.7 percentage points compared to the second quarter of 2020. We are pleased with this improvement and believe it is a direct result of our strategic initiatives. Throughout 2020 and the first half of 2021, our focus has been on reducing the size of our commercial auto portfolio by nonrenewing underperforming accounts and reducing the number of exposure units. Slide 6 in our presentation on our website highlights the progress we are making with our strategic initiative of portfolio diversification through rebalancing our mix of business. Commercial auto now makes up only 21% of our new business premium for the first half of 2021 as compared to 33% in 2019. Also, we are achieving growth in our more profitable lines of business with general liability increasing from 21% to 24%, commercial property increasing from 11% to over 18%, and inland marine growing from 9% to 15% from 2019 to 2021. We are also seeing growth in our surety, specialty, and assumed reinsurance lines of business, which contributed to our improved profitability in the second quarter of 2021. The decline of new commercial auto business, especially in targeted classes and jurisdictions, coupled with the growth of our more profitable lines, will allow us to continue to achieve greater diversification, reducing our vulnerability to commercial auto claims. Also contributing to the improvement in profitability in the second quarter of 2021 were below-average catastrophe losses. Catastrophe losses added 9.6 points to the combined ratio in the second quarter of 2021 compared to 19.2 percentage points in the second quarter of 2020. Our 10-year historical average for the second quarter is 10.6 points. The largest catastrophic event in the second quarter of 2021 was a $4 million convective storm in early April in the state of Texas. During the second quarter of 2021, we also saw improvement in our core loss ratio. This improvement occurred while we also strategically established reserves earlier in the claims cycle with greater pessimism. Slide 12 in our presentation shows that our core loss ratio improved 3.5 percentage points in the second quarter of 2021 as compared to the same period in 2020. If we take into consideration the recovery of $15.4 million in the second quarter of 2020 under our all-lines aggregate reinsurance program, our core loss ratio improved 9.3 percentage points in the second quarter of 2021 as compared to the second quarter of 2020. While we are encouraged by the improvement in our core loss ratio, we remain cautiously optimistic heading into the third quarter, which is historically our second highest quarter for catastrophe losses. Before I turn the call over to Mike, I am pleased to report that our new online quoting platform which we began piloting in mid-April have now been rolled out in select states. The amount of premium written on the platform as of today is not material, but we believe this platform will propel our growth in the small commercial market, delivering straight-through processing and policies and growth in our profitable BOP line of business. I will now turn the call over to Mike Wilkins.

Michael Wilkins, CFO

Thanks, Randy, and good morning, everyone. As Randy mentioned, we are pleased with the progress shown in our second quarter results. We believe that we are on the correct course to improving our profitability. Now more than ever, we remain focused on executing the three pillars of our One UFG boldly forward strategic plan: long-term profitability, diversified growth, and continuous innovation. Our focus on reducing the size of our commercial auto portfolio by nonrenewing underperforming accounts and reducing the number of exposure units continued to show progress in the second quarter of 2021. Through our strategic efforts, I'm pleased to report that exposure units decreased 23% over the past 12 months from 247,000 units in June of 2020 to approximately 190,000 units in June of 2021. Commercial auto claims frequency, expressed in claims for insured units, also continues to decrease with the 12-month moving average declining again in the second quarter of 2021, down to 4.48% from 5.01% in the second quarter of 2020. This decline is summarized on Slide 7 in our earnings call presentation on our website. It is important to note that the decline in frequency began prior to the pandemic and continues to decline despite an increase in miles driven in the second quarter of 2021. We believe this continued decline is a direct result of our strategic underwriting actions. Slides 9 and 10 provide a three-year view of our claims counts by major commercial casualty lines of business. For example, on commercial auto, bodily injury and property damage claim counts are down 22% in the first half of 2021 as compared to the same period in 2020. We have also provided commercial general liability, BOP liability, and workers' compensation claims counts on these slides as all are down in the first half of 2021, which is a positive sign of our strategic efforts. We remain disciplined in our pricing and focused on pricing adequacy in our commercial auto, property, and umbrella books of business. Year-to-date, the overall renewal pricing increase was 6.4%. Excluding the workers' compensation line of business, the overall average renewal pricing increase was 7.8%. The increase in pricing was driven by our commercial auto and commercial property lines of business. Year-to-date, the commercial auto average renewal rate increase was 9.9%. The commercial property average renewal rate increase was 8.4%. We continue to believe there is an opportunity with our commercial property book to be more aggressive with rate increases and reducing undesirable exposures. Before I turn the call over to Dawn, I will wrap up my portion of the call today with a reminder of our claims initiatives, which also remain a focus and key to improving profitability for UFG. Similar to the first quarter of 2021, in the second quarter, our claims metrics trended positively with improvements in litigation expenses. This is a result of declining claims frequency as well as our strategic initiatives to embed analytics into our claims triage process, set reserves early in the claims cycle, and shorten the length of the claims cycle. With that, I'll turn the discussion over to Dawn Jaffray.

Dawn Jaffray, CFO

Thanks, Mike, and good morning, everyone. In the second quarter, we reported consolidated net income of $13.8 million compared to net income of $6 million in the same period of 2020. Year-to-date, we reported consolidated net income of $32.5 million compared to a net loss of $66.6 million year-to-date 2020. As Randy mentioned, the improvement in profitability in the second quarter of 2021 was driven by a decrease in frequency and severity of commercial auto liability losses along with below average catastrophe losses. Also contributing to net income reported in the second quarter and year-to-date 2021 was an increase in investment income and net realized investment gains. Net investment income was $13.8 million and $30.9 million in the second quarter and year-to-date 2021 as compared to $12.7 million and $15.1 million in the same period of 2020. The increase in both periods was primarily due to the change in the fair value of our bank fund LLPs. These bank funds increased in value by $2.5 million in the second quarter and $9.5 million year-to-date 2021 compared to an increase of $1 million and a decrease of $9.1 million in the same period of 2020. We reported net realized investment gains of $6 million in the second quarter of 2021 compared to $15.8 million in the second quarter of 2020, and $30.5 million year-to-date versus net investment losses of $77.6 million in the comparable 2020, six months year-to-date. The majority of the change between the two periods was driven by a change in the fair value of our equity security investments, which I refer to as phantom gains. The remaining change was primarily driven by actual sales of equity holdings. Moving on to operating metrics. For the quarter, we reported a combined ratio of 100.8% compared to 111.4% last year. Year-to-date, we reported a combined ratio of 104.3% compared to 108.2% last year. Favorable prior accident year reserve development contributed about 1 point and 3.1 points during the second quarter year-to-date 2021 as compared to 3.8 points and 4.5 points in the same period of 2020. As mentioned during last quarter's call, we expect improvement in the expense ratio in 2021 because of previously announced changes to our retiree medical plan in managing long-term escalating personnel expenses. The majority of the benefit impacted both expense and loss adjustment expense ratios in the first quarter of 2021, with a smaller ongoing benefit recognized throughout 2021 and into 2022. For the second quarter of 2021, we reported an expense ratio of 33.1% as compared to 33.6% in the same period of 2020. Year-to-date, we reported an expense ratio of 30.2% in 2021 compared to 34.7% year-to-date of 2020. We still anticipate the resulting impact for the 2021 year will be approximately 2 points of improvement on the expense ratio associated with this change. Also benefiting the expense ratio in the second quarter and year-to-date 2021 was a decrease in the acceleration of the amortization of our deferred acquisition costs due to improved profitability in our commercial auto line of business. At June 30, 2021, as a result of having year-to-date net income of $33 million for GAAP and $54 million for statutory reporting, both our GAAP equity and statutory surplus continue to support our strong balance sheet. During the second quarter, we declared and paid a $0.15 per share cash dividend to shareholders of record as of June 4, 2021, marking our 213th consecutive quarter of consistently paying dividends dating back to March of 1968. Lastly, during the quarter, we repurchased just over 31,000 shares of our common stock. As a reminder, we remain authorized by our Board of Directors to purchase an additional 1.8 million shares 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

The first question will come from Marla Backer with Sidoti.

Marla Backer, Analyst

So your strategy to reduce commercial auto is obviously showing strong results. What are you seeing, if you could step back and just take a look at what you're seeing industry-wide. Are you still seeing the same kind of social inflation pressures that you've talked about in prior quarters, but not affecting you as much because of your proactive strategy?

Randy Ramlo, CEO

Marla, this is Randy. We're not declaring victory on commercial auto just yet. We have observed a continued decrease in frequency, which is encouraging, especially since some other carriers have seen frequency increase as the economy has started to open. This indicates that our efforts in reducing problematic units have contributed to the ongoing decrease in frequency. Additionally, severity has become more manageable, which is a positive development. We believe that our approach to handling claims—by staying out of court and settling them quickly—has contributed to this situation. However, we are still encountering cases of traumatic brain injuries, post-traumatic stress syndrome, and more claims than we have seen in the past. While we aim to avoid court, plaintiffs have found ways to enhance claims even in low-impact incidents. Consequently, we want to reduce our auto writing going forward. While we can't completely avoid this line of business, we can manage our offerings. We're also adjusting the limits we can provide, particularly for umbrellas, to reduce the risk of large severity losses. Although we haven't mentioned social inflation in this call, it's still very much present. There have been some legislative changes in Texas that could help, but we are doing everything on our side through rate adjustment and reducing exposure and limits. However, it's too soon to say we are seeing a significant decrease in the core issues that make commercial auto a challenging line of business.

Marla Backer, Analyst

Okay. In terms of the commercial auto category, you've reduced your overall exposure significantly. How far along do you think you are in the process of removing the riskiest policies from that category?

Randy Ramlo, CEO

This is Randy again. I think we mentioned that we're getting closer to having about 25% of our overall book in commercial auto, but I believe that number should ideally be around 20% long-term, or even lower. This would still place us above many of our competitors in terms of commercial auto percentage. We've discussed our goal of diversifying our business overall, and it's clear that we want to reduce our focus on commercial auto while increasing our presence in other areas.

Marla Backer, Analyst

Okay, and for my last question, switching topics, can you provide us with a general overview of the roadmap or timeline for rolling out the online quoting system platform?

Randy Ramlo, CEO

Yes. So I'll maybe turn a little bit over to Mike. We kind of mentioned that the premium volume was insignificant so far, and we're only offering it in a select number of states. But what I really like is we get high marks for the experience that agents go through in quoting business. The system is fast. I think our average quote time is under 8 minutes, which is terrific. What we have found is we still have work to do on our rates, and that's very correctable. So I'm kind of thrilled with the program. It has translated into a lot of premium yet, and that is solely because of competitiveness, and we can get that fixed in a fairly short period of time. Mike, do you have more on the timeline?

Michael Wilkins, CFO

Just on the timeline, no specifics that we would share, but we will be rolling out additional states on a regular basis every quarter or so. We'll be rolling out another state or a few states as we build momentum for that process of rolling out the states. Maybe one addition to the comments Randy made on how excited we are about the system. One of the other key things that we've seen is a pretty high percentage of our risks are able to go through the process straight to issue without involving an underwriter on our side. So our analytics is able to make the call on acceptability and pricing without underwriter involvement. That's part of what's speeding up the process. Now as Randy said, we're disappointed with the buying rate, and that's based on just our rates not being where they need to be. We implemented a lot of new analytics into our pricing process, and that's difficult to get right out of the gate. So we have some adjusting to do there in some states, in particular. But with the system itself and the process, we're very excited about how that's gone so far.

Paul Newsome, Analyst

Could you discuss the property lines of fire and allied lines and the actions you're taking in that area? It appears that you're experiencing growth, possibly primarily driven by rate increases. However, the loss ratio remains challenging and seems to be worse than that of the auto business year-to-date. Could you elaborate on what measures you're implementing in this regard?

Michael Wilkins, CFO

Yes, Paul, this is Mike. I'll address that. First, our property loss ratio has been challenging, mainly due to the Texas winter storm earlier this year, which has significantly impacted us. In recent years, storms have had an exaggerated effect on our property business, and we are actively working to improve this situation. While our primary focus remains on auto, we are currently prioritizing enhancements to our property line because we are dissatisfied with its performance. We just completed a Request for Proposals process, exploring different reinsurance options for catastrophes. Insights from several industry experts indicate that storm patterns have changed, affecting areas where UFG is particularly vulnerable. Therefore, we will likely develop strategies to lessen our exposure in certain regions. We are pushing for higher rates, as you may have noticed our property rates have been rising each quarter. We believe there is still room to increase rates, especially in certain states and jurisdictions. Furthermore, we are tightening our underwriting process and enhancing risk control measures. We are reviewing our current accounts to improve the quality of our portfolio moving forward.

Paul Newsome, Analyst

Is the idea that the recent years of catastrophe losses are considered normal and you will adjust pricing accordingly? Or should I be viewing this from a different perspective?

Michael Wilkins, CFO

We believe that the models used in the industry underestimate the effects of severe convective storms. Over the past decade, we have effectively reduced our exposure to hurricanes along the coast. However, we have increased our presence in the Midwest, where there is a higher risk of severe convective storms. Although we have experienced fewer significant losses recently, we did encounter the derecho. We still face occasional major losses, and while there has been a decrease in large claims, we are observing an increase in smaller catastrophic events. This accumulation of losses from severe convective storms has introduced some volatility in our financial results, which we are actively working to manage.

Operator, Operator

This concludes our question-and-answer session. I would like to turn the conference back over to Randy Patten for any closing remarks. Please go ahead, sir.

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.