Earnings Call Transcript - UFCS Q4 2022

Operator, Operator

Good morning, and welcome to the UFG Full Year and Fourth Quarter 2022 Results Conference Call. Please note this event is being recorded. I would now like to turn the conference over to UFG, Senior Vice President and Chief Financial Officer, Eric Martin. Please go ahead, sir.

Eric Martin, CFO

Good morning, and thank you for joining this call. Yesterday afternoon, we issued a press 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 Investors tab. Joining me today on the call is UFG President and Chief Executive Officer, Kevin Leidwinger. Before I turn the call over to Kevin, a couple of reminders. First, 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. Also, please 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 will turn the call over to Mr. Kevin Leidwinger, CEO of UFG Insurance.

Kevin Leidwinger, CEO

Thanks, Eric. Good morning, everyone, and welcome to our fourth quarter conference call. I'll begin this morning by providing insight into the fourth quarter results, then provide an overview of our full year performance. First, let me say I'm pleased with the progress I've seen since joining UFG in August. We continue to position our company for superior financial and operational performance. Over the past year, we have further diversified our portfolio, improved its underlying fundamentals and intensified our focus on reducing the expense ratio. I'm proud of the work our team has done in executing our strategic plan. Turning now to fourth quarter results. We're pleased to report net written premium increased 6.3% to $235 million compared to $221 million in the fourth quarter of 2021. This marks the third consecutive quarter of net written premium growth as the business gains momentum following the re-underwriting exercise of the last several years. Growth was driven by our specialty, surety and assumed reinsurance businesses. Our core commercial business, including construction, middle market, small business and Marine was down slightly. However, we are encouraged by the improved retention ratios and increased new business production we saw in the quarter. The momentum continued into January, and we expect the core commercial business to return to profitable growth in the coming quarters. The combined ratio was 103.6% in the fourth quarter and was impacted by 5 points of catastrophe loss activity and 5 points of adverse development. The adverse development in the quarter was the result of the more granular analysis of the construction defect portfolio. The underlying combined ratio for the fourth quarter was 93.8%. As mentioned last quarter, we remain intensely focused on lowering our expense ratio, which fell to 33.8% in the fourth quarter of 2022 as early benefits of our expense management actions began to take effect. Turning now to our full year results. Net written premium increased 4.6% to $984 million compared to $941 million in 2021. As with our most recent quarters, growth was driven by our specialty, surety and assumed reinsurance businesses, while our core commercial business continues to recover. The combined ratio for full year 2022 was 101.4%, a slight deterioration over full year 2021. The combined ratio was impacted by 7.7 points of catastrophe loss activity and prior period development was neutral. The underlying combined ratio was 93.6% for full year 2022, a 3.4 point improvement over the previous year. The underlying loss ratio improved 5.2 points to 59.2%, our best underlying loss ratio in the last 10 years. The improvement in our underlying loss ratio was the result of significant actions taken over the past several years to improve profitability, diversify our portfolio, strengthen underwriting governance and reduce volatility. With respect to reinsurance, I'm pleased to share that we successfully renewed our multiline and catastrophe programs on January 1. Although we experienced increased costs and modest terms and conditions changes, they were consistent with the broader market. With the increased cost of reinsurance, we will continue pursuing property rate increases. We also made the strategic decision to add a variable quota-share treaty to support growth and reduce volatility in our specialty portfolio. Despite the many challenges we face as an industry, I'm confident the actions we are taking today will put our company in a strong position to deliver consistent superior financial and operational performance for the benefit of all of the UFG stakeholders. Finally, I'd like to welcome Julie Stephenson to UFG. Julie joined UFG at the end of January as Executive Vice President and Chief Operating Officer. Julie is an accomplished leader who brings a wealth of operational, underwriting and portfolio management experience to our company. We are thrilled to have her onboard as we continue to execute our strategic plan and position UFG for long-term success. I'll now turn the call over to our Chief Financial Officer, Eric Martin, for a detailed discussion of the fourth quarter and full year results.

Eric Martin, CFO

Thanks, Kevin, and good morning again. In the fourth quarter, we reported net income of $0.79 per diluted share and non-GAAP adjusted operating income of $0.18 per diluted share. Net written premiums increased 6.3% in the fourth quarter compared to the prior year. Our core commercial lines premiums are stabilizing with the slowing rate of decline, driven by average renewal premium change of 8.3% for the quarter and increasing levels of premium retention and new business. This reflects our transition from re-underwriting actions to positioning the core commercial portfolio for profitable growth. Notably, new business in the fourth quarter increased 55% and retention was 7 points higher than the fourth quarter of 2021. From a profitability perspective, our fourth quarter combined ratio was 103.6%, which includes 4.9 points of catastrophe losses and 4.9 points of prior year reserve strengthening. The catastrophe losses of $12 million in the fourth quarter were primarily driven by Winter Storm Elliott. With the resulting catastrophe loss ratio of 4.9% within historical ranges of performance for the fourth quarter at 1 point above our 10-year average catastrophe loss ratio and 1 point below our 5-year average catastrophe loss ratio. In the fourth quarter, we strengthened prior year reserves by $12 million or 4.9 points of combined ratio impact, focusing on our construction defect business in accident years 2015 through 2019, where a combination of deeper analytical insights and emerging claims experience has increased our view of potential exposure and aligned with long reporting lags. Since we've had 2 consecutive quarters of reserve strengthening, I'm going to address our results for the full year at this time. For the full year, our prior year reserve actions have had a neutral effect on our combined ratio and reflect 2 different themes playing out across the year. In the first 2 quarters, we experienced favorable reserve releases in our commercial auto line of business that continued in the third and fourth quarters. This favorable emergence resulted from strong case reserving and reduced claim handling costs, facilitated by our specialized claims operating model. In the third and fourth quarters, these reserve releases were offset by strengthening in our commercial liability portfolio, where a deeper view of our data has given us new perspectives and lines of business where the most uncertainty exists. The third quarter strengthening focused on excess umbrella where social and economic inflationary pressures are increasing the propensity for claims to pierce the excess layers, in line with what others in the industry are reporting. We've also experienced healthy growth in our specialty excess and surplus business that writes excess layer coverage. While our results have historically been superior to the industry, we felt prudent to take a cautious approach here, to enable continuation of our historic track record to continue to create financial benefits. The same theme continued in the fourth quarter with the actions focused on construction defect claims that I just described. Turning to investment results. Net investment income benefited from strategically positioning our fixed maturity portfolio toward a shorter duration profile that facilitates reinvesting at higher interest rates. As a result, fourth quarter investment income from fixed maturity assets increased by $2 million or 19% compared to last year. This increase in fixed maturity income was offset by lower valuations in our long-term investment portfolio, resulting in net investment income of $12.9 million in the fourth quarter, relatively flat compared to the fourth quarter of 2021. In the fourth quarter, both our equity and fixed income portfolios outperformed our market benchmarks. Our equity portfolio generated $20 million in investment gains and the unrealized fixed income loss on our balance sheet decreased by $24 million during the quarter. This improvement in equity and fixed income asset values drove a 5.5% increase in book value from Q3 to Q4. Our investment portfolio balance was $1.8 billion of invested assets in the fourth quarter, of which 84% is allocated to a high-quality fixed income book. For the full year, net income per diluted share was $0.59, and non-GAAP adjusted operating income per diluted share was $1.09. For the full year, net written premiums increased 4.6%. Within our core commercial business, the average renewal premium change was 8.3% for the year, with rate increases of 5.2% and exposure increases of 3.1% as we continue to focus on adequate property valuation considering today's inflationary environment. Both new business and retention improved on a full year basis as our core commercial book transitioned out of re-underwriting actions. Our full year combined ratio of 101.4% includes an expense ratio of 34.4%. This is higher than 2021 by 1.8 points, due to one-time impacts from changes in post-employee benefits that favorably impacted the 2021 expense ratio. Excluding the impact of those one-time items, the 2022 full year expense ratio would have been 0.3 points lower than 2021, building positive momentum into 2023 as we seek to aggressively improve our expense ratio. The full year catastrophe loss ratio of 7.7% is a 2.5 point improvement compared to our experience in 2021. As described earlier, prior year reserve development had a neutral impact on our full year loss ratio as releases in the first 2 quarters, focused on commercial auto were offset by strengthening in the third and fourth quarters in excess umbrella and construction defect coverages. Full year net investment income of $45 million was down $11 million from 2021, as a result of lower long-term partnership valuations in the first half of the year that decreased investment income by $17 million. This more than offset the increased earnings power of reinvesting at higher interest rates that began improving net investment income in the second half of the year and increased fixed maturity income by $5.5 million for the year. During the quarter, we declared and paid a $0.16 per share cash dividend to shareholders of record as of December 2, 2022, continuing our 54-year history of paying dividends dating back to March 1968. This concludes our prepared remarks. I will now open the line for questions.

Operator, Operator

Our first question comes from Paul Newsome with Piper Sandler.

Paul Newsome, Analyst

I would like to get more details about the reserve development over the past couple of quarters. Did anything change from a philosophical standpoint, or was there a thorough review of the reserves during this time? It's common for new management to adopt a different approach or reevaluate things. Did anything like that occur in the last quarter? Or is this simply the emergence that has appeared over the last six months?

Eric Martin, CFO

Thank you for joining us and for your question. It's a really good one. In general, we have not changed our philosophy. Historically, over the past couple of years, we have addressed some issues within our commercial auto book. Looking back over the last four quarters, we experienced favorable development of about $23 million in the first half of the year, followed by the same amount of unfavorable development in the second half. With new management coming in, while our philosophy remains unchanged, we aimed for a deeper segmentation and more analysis on some of our longer tail businesses. These issues appear in our other liability line, including excess umbrella coverage, products liability, and construction defects. We took the opportunity for a more detailed examination of these aspects, particularly in the current inflationary environment and as courts have reopened. We wanted to have a clear understanding of our exposure regarding these longer-tailed lines. As a result, we might respond more quickly to negative developments while possibly taking longer to react to positive news.

Paul Newsome, Analyst

Do you think the process of taking a more detailed approach is complete for the other liability book? Or do you believe this approach will also be applied to other areas of the business?

Eric Martin, CFO

I believe these are the areas where we have long tail lines. We've made significant progress in commercial auto recently. Some of our other lines, particularly surety and workers' comp, aren't very large at the moment, but we aim to continue growing them. While I can't say we're completely done with any of these areas, I think the actions we've taken will allow us to maintain that detailed insight, and we've focused on the lines with long tails.

Kevin Leidwinger, CEO

Paul, it's Kevin. Just an additional observation. I mean, it's our intent to use all the tools available to us to gain as much insight as we possibly can. And of course, then we'll take the appropriate level of action relative to the insights that are provided back through those analyses. And I think Eric's point about being prudent and taking action more quickly on negative trends and perhaps a little more slowly on positive trends is exactly spot on.

Paul Newsome, Analyst

Makes sense. UFG has a strong track record of managing reserves. I would also like to inquire about reinsurance and its impact both in terms of costs and on the assumed basis. Could you elaborate on those two aspects and discuss their effects on the business and the bottom line? I expect there will be an increase in reinsurance costs this year as a buyer. Additionally, please share any changes you have observed in the assumed reinsurance portfolio.

Kevin Leidwinger, CEO

Sure. Let me provide you with more details on the reinsurance program. As noted in our prepared remarks, all of our reinsurance renewals occur on January 1st. Like many others, we experienced pricing increases across our portfolio, along with some changes in terms. To give you context, the property catastrophe excess of loss premium increased by about 54% on a risk-adjusted basis. We observed around a 40% increase in our earthquake quota-share program. The rate increase for the pillared occurrence program was approximately 20%, but this was somewhat less pronounced compared to the cat program due to structural changes with the annual aggregate deductible. Our core multiline working program saw a rate increase of just over 30%. This pricing trend reflects the overall market circumstances. Regarding retentions, our property cat excess of loss retention increased from $15 million to $20 million. We also saw an increase in co-participation on the first layer to 28.5%. Our earthquake quota-share limit was reduced by about $10 million, now at $170 million, but it still offers coverage exceeding 1 in 250 probable maximum loss. In our new pillared occurrence program established in 2022, we saw an increase in placement from 66.5% in 2022 to 90% in 2023, which we see as a success given the current market conditions. The overall limit there increased from $25 million to $30 million, although the retention also went up from $5 million to $6 million and the annual aggregate deductible increased from $5 million to $10 million. Consequently, we expect additional debt exposure in both the property cat excess of loss and the pillared occurrence. For our core property casualty program, we applied a $5 million annual aggregate deductible this year and maintained our $3 million retention. Aside from the annual aggregate deductible, there were no changes to the layers or structure, and that program is fully placed. Overall, we additionally witnessed premium increases and retention adjustments across our entire program. We recognize the necessity of pushing for higher property rate increases, especially in catastrophe-exposed areas of our portfolio. This effort is already in progress, and we anticipate improved pricing on the property side over the next year to offset the increased reinsurance costs. I’ll pause here and see if you have any questions about this, otherwise, I’ll turn it back to you soon.

Paul Newsome, Analyst

I mean just to simplify it for folks like me where market price bumps over, essentially, it looks like maybe all things being equal, a little bit more cat load because of the higher retention and then maybe a little bit of overall pressure on the underwriting margins. This is the total excess of loss cost goes up a bit. Is that a fair amount of...

Kevin Leidwinger, CEO

I think we'll probably have to spend a little bit more time on that issue. So while it's all an increase in the retention under the cat program, the pillared occurrence is really designed to help manage the frequency of small cat events that have to accumulate losses inside of the cat XOL program. And so we saw an increase in placement on the pillared occurrence program. So we're still working through what we think the overall additional exposure to company. But I think there's an offsetting component based on the pillared occurrence increased participation to the overall net increase on the cat XOL. So those 2 things are interrelated.

Paul Newsome, Analyst

Okay, that makes sense. Okay.

Kevin Leidwinger, CEO

And then turning now to the assumed reinsurance business. We certainly were the beneficiary of the other side of the market. Clearly, as you saw on our ceded program, there were increases, obviously, on the assumed reinsurance component of the portfolio. We certainly got the benefit of increased pricing. And where that came through for us was certainly on the standard treaty. So we had a significant amount of opportunity for participation on regional carrier treaty reinsurance as other carriers were reducing their participation, those opportunities were presented to us. And so we saw some significant benefit to participate opportunistically on some treaty standard treaty business in this cycle, and so we were quite pleased with that participation.

Paul Newsome, Analyst

Is there some sort of target or goal for the reinsurance book relative to the rest of the book? Is it a percent of premium or something along those lines?

Kevin Leidwinger, CEO

Yes, we are currently targeting about 25% for the portfolio, and we are slightly below that at the moment. While we plan to maintain this target as our overall portfolio expands, the associated premium will naturally increase. However, we will also take advantage of favorable market conditions, like we recently did during the renewal cycle. Therefore, even though we expect to stay around 25%, there may be times when we exceed that percentage if opportunities arise that allow us to diversify our portfolio and achieve substantial underwriting profits.

Operator, Operator

This concludes our question-and-answer session. I would like to turn the call over to Kevin Leidwinger, President and CEO, for any closing remarks.

Kevin Leidwinger, CEO

Thanks for joining us for this quarter, and we look forward to talking with you again next quarter.

Operator, Operator

The conference is now concluded. Thank you for attending today's presentation. You may all now disconnect.