NAVG
#Good day, ladies and gentlemen, and welcome to the Q2 2016 Navigators Group Inc earnings conference call.
(Operator Instructions) We remind everyone that today's call includes forward-looking statements made pursuant to the Safe Harbor Provisions of the Private Securities Litigation Reform Act of 1995.
These statements concern future business condition, expectations and the outlook for the Company based on currently available information that involves risk and uncertainties.
The Company's actual results could differ materially from those anticipated in the forward-looking statements.
We refer you to the Company's most recent forms 10-K and 10-Q for the description of the important factors that may affect the Company's business.
The forward-looking statements made on this call and any transcript of this call are only made as of this date, and the Company undertakes no obligation to publicly update the forward-looking statements to reflect subsequent events or circumstances, except as required by law.
I would now like to introduce your host for today's conference <UNK> <UNK>, President and and Chief Executive Officer.
Please go ahead.
Thanks, Dan.
Good day, everyone.
Our second-quarter net income of $16.2 million, or $1.08 per share reported yesterday after the market closed includes net operating earnings after tax of $12.2 million, or $0.81 a share, net realized gains after tax of $1.3 million, or 0.09 per share, less after tax OTTI of just $97,000, or minus $0.01 cent a share, and after tax foreign exchange transaction gains of $2.8 million, or $0.19 per share.
The second-quarter's combined ratio of 99.6% includes a reported loss and LAE ratio of 62.4% and an and all-in expense ratio of 37.2% comprised of net commission expenses of 15.2% and other operating expenses of 22%.
Our quarterly consolidated results include $1.1 million of underwriting profit with $10.8 million of that profit coming from the US insurance segment, $300,000 of profit from the Global Reinsurance segment, offset by $10.1 million of loss from the International Insurance segment, as <UNK> just shared with you.
The quarterly results were impacted by $18.3 million of natural catastrophe events, including $16.4 million of net catastrophe losses and $1.9 million of reinsurance reinstatement premiums, mostly related to the Alberta wildfires, and to a lesser extent the Ecuador earthquake.
Net investment income of $19.9 million increased $3.3 million, or 19.8% as compared to the same period last year.
The increase in investment income was primarily driven by growth in the overall portfolio, with an increased allocation to higher-yielding preferred stock and an increase in tax-exempt municipals.
Net realized gains of $2 million pretax, or $1.3 million after-tax, were the result of normal active portfolio management.
In our overall investment portfolios unrealized gain position increase in the quarter by $37.7 million pretax, or $24.5 million after-tax due to the increase of interest rates and a rally in equity market.
The investment portfolio value as of June 30, 2016 increased by $151.7 million to $3.23 billion with a book yield of 2.6%, down 6 basis points from 2.66% in the first quarter, but up 21 basis points from 2.39% for the same period last year.
Total return on a trailing 12-month basis was 4.92%, up 245 basis points from 2.47% in the first quarter and up 335 basis points from 1.57% to the same period last year.
Importantly our investment portfolio has maintained its AA-minus average quality with a duration of 3.9 years.
Looking at our overall balance sheet, our GAAP shareholders equity at June 30, 2016 was $1.182 billion, up from $1.144 billion at March 31, or 3.3%, and up from $1.096 billion at December 31, 2015, an increase of 7.8%.
On a year-over-year basis, book value has increased 12.1%.
Book value per share was $81.24 compared to $78.72 at March and $75.96 at December.
Our annualized ROE is 7.1%.
And net cash flow from operations was a positive $78 million in the quarter and $115 million for the year.
With that, we'll turn it over to the operator for calls.
Questions.
(Operator Instructions) <UNK> <UNK>, William Blair.
Hello.
Good morning, everyone.
Good morning.
The professional liability book in both the US and internationally obviously looks a lot better, but the combined ---+ compared to recent years, but the combined still up around pretty close to 100%.
Do have a sense on where you think the combined ratio can go in both the US and internationally there.
Let me just say this.
I think when we look at the economic returns generated by both the professional liability business in the US segment and in the International segment, we see a marked improvement in the most recent three underwriting years compared to, say, five years or so on.
In other words, we went through a path of improving the performance of that book.
And we are very encouraged by the most recent three underwriting years, which would be 2015, 2014, 2013 going backwards.
At the same time, I think it's important to not prematurely declare a victory.
It's a claims made business.
But it takes a while for even reported claims to develop.
So maintaining a prudent reserving philosophy, particularly in the area of IBNR is pretty critical to us.
So we like the business.
We like our teams.
We like where we've got the portfolio position.
There's always a desire to bob and weave and grow one sector of the business, and maybe reduce or even exit other little micro niches of E&O or a geography.
But a reasonably healthy business.
And we are very optimistic for improved underwriting results.
One thing that will help that is that, as we were transitioning that portfolio over the last couple of years in the US, we had purchased a quota share reinsurance program.
And the elimination of that program I think will give some benefit on the expense ratio side of that business in coming years, as the new premium earns through on a different basis than the current previously written business.
So, yes.
I think the prognosis looks pretty good for that business.
But we don't really throw out future combined ratios for our competitors.
Okay.
And that makes sense with the quarter share going away.
Because it looks retention's moved up quite a bit there, around 75% in both the US and internationally for professional liability.
Is that the right sort of run rate going forward.
Yes.
That was a little hard to talk about sitting here in our London boardroom without our reinsurance data and stuff like that in front of us.
But what I would say in general is that we would expect to see that portfolio probably look like a ---+ maybe actually an improved operating expense number.
The commission number could actually move up because you have less ceding commission, but more premium to offset the operating expenses ---+ the noncommissioned operating expenses.
So clearly it's going to have a favorable impact on the business, not the least of which is more net premiums sticking to your ribs on a portfolio that you believe to be profitable.
And, frankly, it's in line with our capital size.
And we think it is rightsized to the organization of today.
<UNK> [<UNK>], KBW.
Hello, good morning.
Thank you for taking my questions.
Morning.
There's some premium growth this quarter in marine and International P&C, lines that appear to be priced ---+ to have pricing pressures from commentary that we've heard and from trade publications that we've read about.
Is this more of an anomaly, or what kind of opportunities are you seeing here.
Go ahead, <UNK>.
I didn't hear the question.
Neither one of us actually clearly heard your question.
It was about an international component of our business, but I'm afraid we're not sure what your comment was.
<UNK>, could you repeat it, please.
Yes.
There was premium growth this quarter in the marines and the International P&C side.
And these are lines that appear to have pricing pressures from commentary that we've heard from the past and from trade publications.
Is this more of an anomaly or what kind of opportunities are you seeing here.
Well, I think if you look back on what we've told you on prior earnings calls, and you may recall that in 2015 in particular, we said we have two exciting new products in the London market: property and casualty.
And we might be the only company in the world that could have said that because, as a specialty company, our London business, and particularly our Lloyd's business, was built around marine, energy, and professional liability/D&O.
So I think it's very natural for us to expect to grow an international property business that we entered into last year.
As an underwriting guy for the last 35 years of my life, if I saw a mature business growing at a rate of 110%, I'd be sending in my underwriting auditors to look at it.
But in a startup you're able to achieve these things.
So $20 million worth of premium production in an $8 billion market is very much in line with the expectations we made when we entered that business.
Now, like anything, what you underwrite, how you price your business, where you attach on it, how much capacity you allocate to it, and how you buy your reinsurance all affects net underwriting result.
So, we spent a fair amount of time with our teams.
We have a high degree of confidence in the capability of our underwriters to achieve an underwriting profit across the cycle.
Can't add anything to that.
We have made investments in businesses.
And we are seeing the benefit of it in the premium.
So it's very well-controlled growth.
And the last thing I would add, <UNK>, is simply that we are a specialty insurance company, inside and out.
And I think what you see here is ---+ what you hear in general terms when you read trade press may, in fact, may not be the full story when you are a niche-oriented specialist, underwriting-focused company.
But just to reiterate for you, newer initiatives in our London and in our International Insurance segment in terms of products include both the International property, political violence and terrorism, and a trio of casualty products including, as we underwrite in the US segment, environmental business, life science business, and excess casualty.
So these are significant markets on a global basis.
Today we see most of that in London.
But you'll also remember that we are only two years into our three newer Continental European offices in Rotterdam, Milan, and Paris, all of which contribute growth.
So we embarked on a journey to expand our International business, certainly cognizant of market conditions.
And I think you know our culture is not one where we beat people up for premium growth.
We encourage them to make prudent decisions and to walk away from under-priced business, always focused on the bottom line.
And if we are a little short of what our premium expectations are, we are much happier to explain an expense ratio that's higher than you might have expected than any kind of loss problems in the portfolio.
Great.
Thanks.
That's helpful.
And, sorry, I may have missed this one.
I was hoping you can make it clear.
But going back to the expense ratio that was up 2.5% year over year.
And it looks like most of it was coming from commissions all across the board.
What's driving the higher expenses and what are you seeing ---+ are you seeing more pressure on ceding commissions.
Yes, it's a combination of factors, <UNK>.
At the very high level, what we have is a change in mix of business.
So that's first.
We have an introduction of property that's been listed before.
That certainly adds something to the equation.
And then, you also would've heard that on the last question from our analyst at William Blair basically asking about the way the portfolio's positioned in terms of net retention.
So I think, as we retain more business, obviously we have lower ceding commissions offsetting some of the commissions.
So it's a combination of higher net retention, so lower ceding commissions, and generally mix of business.
And those two factors combined are, we think, are the prime drivers.
Great, thanks.
I will return back to the queue.
Well, that's a difficult question.
As you know, over the last 15 years, we have significantly expanded the office network of this Company.
And we have significantly expanded the product breadth of the Company from a company that was 95% marine to today, which is much more of a broader specialty insurance offering.
And all of that has been done with organic growth, not through acquisition.
When we bring a new business on, we don't expect them to be accretive in year one.
But we certainly expect them to be accretive by year three.
So I think there's a balance of how you measure the performance of that unit.
In a modestly mature business, meaning something we've been in, in that three-, five-, six-year category, certainly we expect that business to achieve a double-digit return on allocated capital.
Now, again, then it [gets back] to our job to make sure we manage the amount of capital.
And if you carry excess capital, that might not translate to a double-digit bottom-line number.
But we try to think about getting those businesses there over time.
But in a true start-up product line, to assess them that way I think would potentially lead to some false assumptions.
You just don't turn on the light switch.
You want them to do it in a thoughtful, deliberative, and profitable manner.
<UNK>, let me start with that one.
A couple of things going on there, right.
So, on the pure noncommissioned expenses, the true operating expenses, I think I shared this with the audience on last quarter's call.
Operating expenses are actually leveling ---+ the second quarter, pure OpEx is approximately $59 million; in the first quarter it was almost $61 million; in the fourth quarter it was $59 million ---+ as we talked about making investments in the teams over time.
So there's a normalization that's already happening.
One of the things that amplifies the expense ratio, certainly in a quarter where there are probably five natural cat events, are reinstatement reinsurance premiums, which obviously increase ---+ decrease your net earned premium as you have to pay for those reinstatements.
And while they weren't usually sizable, there's 1.5 points of expense that <UNK> mentioned in his prepared remarks.
So there's 1.5%.
And that's a commission-driven item.
So there's one component of it.
I think as the year normalizes you will start to see both the commission come more in line.
And one of the big drivers of the improvement will be, as the premium growth that you're seeing on the gross and net premium lines start to earn through on the net earned premium.
Because our growth in net earned premium for the group is approximately 10%.
And our net written premium growth is somewhere closer to 15%.
As the earn-through of the premium comes through the rest of the year, that will give it a natural normalization.
Plus there are certain expense initiatives that we have undertaken over the last year or two to make sure that our operating expenses remain within tolerance of our expectations.
Yes, I just want to add just a quick comment to that, <UNK>.
I think our US insurance segment, led by Vince Tizzio, has done a super job on that.
It's never easy.
And I believe their expense ratio for the quarter, inclusive of commissions, is 31.6% and year to date, 31.7%.
And that number got pushed up, remember, because of the reduction in the amount of quota share.
So I think that is a very strong performance.
And their cost management has been superb.
The level of net written premium that we have in the Company is at a level that is very, very strong and much above historical levels.
So that's a lot of ceding commission that benefited our expense ratio that's gone out the door.
And we're happy for that.
But the optics of it, it does put pressure on pushing up the commission ratio.
Is it the right answer.
Of course it is.
But I would particular give credit to our US segment, who I think have done a super job on it.
The largest plus, <UNK> ---+ and thank you for asking about OPUS.
Just as a refresher, OPUS is an acronym that we've used in the organization.
It stands for Outstanding People, Underwriting and Service.
And really reflects our desire to create an excellent customer experience for our policyholders and our brokers.
The short-term impact ---+ and we conducted lot of OPUS training during the second quarter on customer service excellence, which is just not issuing a policy on time, it's about every touch that one has with a customer.
The greatest impact has been on the morale of our team, who I'm just so pleased with the way they have embraced it.
We see it in e-mails they share with their colleagues, we see it in our trip reports of documentations of their meetings with brokers and policyholders, of really creating a value-added transaction in every exchange they have with customers.
So, the most immediate impact is one of ---+ not to use an odd term, but consciousness, to raise awareness and to the enthusiasm that's associated with it.
And I've got to tell you, on that it's been a 10 plus on a 1-to-10 scale.
Now, embedding that into our culture and creating more things in terms of touch points, that's the journey over the next two or three years.
But, absolutely, we are excited with the way our team has embraced it.
And it's a bottom-up strategy.
And that's always been one of the strengths of this Company, is our people in the field.
Thank you.
Well, we very much appreciate you joining the call today.
Thanks for your interest and support of the Company.
Have a great weekend.
Thank you.
