United Fire Group Q2 2024 Earnings Call Transcript

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August 7, 2024

There are 8 speakers on the call.

Operator

Good day, and welcome to the United Fire Group Insurance 2024 Second Quarter Conference Call. All participants will be in a listen only mode. After today's presentation, Please note this event is being recorded. I would now like to turn the conference over to Tim Borsch, Vice President of Investor Relations. Please go ahead.

Speaker 1

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 atufginsurance.com. Press releases and slides are located under the Investors tab. Joining me today on the call are UFG President and Chief Executive Officer, Kevin Leidwanger Executive Vice President and Chief Operating Officer, Julie Stevenson and Executive Vice President and Chief Financial Officer, Eric Martin.

Speaker 1

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. Such forward looking statements are based on current expectations, estimates, forecasts and projections about the company, the industry in which we operate and beliefs and assumptions made by management. The company cautions investors that any forward looking statements include risks and uncertainties and are not a guarantee of future performance. Any forward looking statements made by us in this presentation is based only on information currently available to us and speaks only as of the date on which it is made.

Speaker 1

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 discussed specifically in our most recent annual report on Form 10 ks. 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.

Speaker 1

Kevin Leidwanger, CEO of UFG Insurance.

Speaker 2

Thank you, Tim. Good morning, everyone, and welcome to our Q2 conference call. I'll begin this morning by providing a high level overview of our results. Following my comments, Julie Stevenson will discuss our underwriting results and Eric Martin will discuss our financial results in more detail. Our Q2 results reflect continued progress in our efforts to deliver improved performance through the strategic execution of our business plan.

Speaker 2

We remain focused on engaging with our distribution partners in the pursuit of profitably growing our business, deepening expertise across the company, enhancing our capabilities and leveraging technology to improve efficiency. Net written premiums grew 9% to $326,100,000 led by ongoing growth in our core commercial and alternative distribution business units. Core commercial growth remains steady with average renewal premium increases of 12.3%, healthy retention and attractive new business opportunities reflecting our continued focus on profitability. Rate increases accelerated to 9.8 percent with all liability lines increasing in the Q2 and improving margins above loss cost trends. The 2nd quarter combined ratio of 105.6% improved significantly over prior year, primarily due to lower prior period reserve development, lower catastrophe losses and improvement in underlying combined ratios.

Speaker 2

Prior period reserve development in the Q2 was neutral overall. Consistent with the Q1, favorable emergence across several lines of business enabled us to further reinforce our position against the future inflationary uncertainty challenging our industry in certain liability lines. Loss emergence remains within our expectations and we believe these proactive steps are prudent measure to mitigate the impact of a potential further acceleration in severity trends. As you will recall, in the Q2 of 2023, we significantly strengthened loss reserves as a result of investments in our actuarial processes, as well as increased depth of analysis that provided a more informed understanding of our reserve position. Those investments also led to greater visibility into our underlying loss trends and we reacted quickly to recognize the increased levels of severity observed in our liability portfolio.

Speaker 2

For the last 4 quarters, we've been reflecting this elevated view of trend in our analysis as well as management decisions, which has fostered greater confidence in the strength of our reserve position. We remain committed to establishing a strong and stable reserve position, providing a solid foundation to grow our business. The 2nd quarter catastrophe loss ratio of 11.2% improved nearly 2 points over prior year and was below our historical 5 year and 10 year averages in a quarter of elevated industry losses. We continue to execute a broad range of actions to improve our property catastrophe risk profile. The Q2 underlying loss ratio of 58.9 percent improved 5.7 points from the prior year, reflecting strong earned rate achievement and continued disciplined underwriting.

Speaker 2

In addition, results in the Q2 of last year were impacted by elevated surety loss activity. Our intense focus on expense management has reduced our overall cost structure compared to last year. Efficiencies in non revenue generating functions have in talent and technology supporting our underwriting capabilities, shifting our cost structure toward the underwriting expense ratio. As a result, the underwriting expense ratio increased to 35.5 percent in the 2nd quarter, while reductions in loss adjustment expenses contributed to a lower loss ratio. We will continue to diligently manage the underwriting expense ratio down over time.

Speaker 2

The 2nd quarter underlying combined ratio of 94 0.4% improved 4.8 points over prior year as a result of successful execution of our ongoing actions to improve core margins, as well as normalizing surety loss activity that impacted prior year's results. Net investment income increased 59.2% from prior year to $18,000,000 on improving fixed maturity income along with higher valuations on alternative assets. Fixed maturity investment income increased 19% from prior year to $16,000,000 as we reposition portions of our fixed income portfolio to take advantage of the current attractive reinvestment rates and further support future earnings. Recently, we identified rating errors within our core commercial business and recorded a pre tax charge of $3,200,000 in anticipation of voluntarily issuing refunds to certain affected policyholders. We are committed to resolving this matter as expediently as possible and have begun working with state regulators to ensure resolution.

Speaker 2

This charge was recorded in the other income and loss line and does not impact any of this quarter's combined ratio metrics. The improvements in underlying profitability were sufficient to generate an operating profit in the Q2, excluding the impact of this rating error adjustment. We remain committed to continuing to drive improvements in our performance through strategic execution of our business plan during the second half of the year. I'll now turn the call over to Julie Stevenson, our Chief Operating Officer to discuss our underwriting results in more detail.

Speaker 3

Thank you, Kevin. Net written premium in our core commercial business grew 13% to $224,000,000 in the 2nd quarter compared to prior year, with Small Business, Middle Market and Construction all showing growth for the quarter. Renewal premium change in our core commercial business accelerated to 12.3% with rates up 9.8% and exceeding loss trends. Commercial property premium change continued to exceed 20%, while liability pricing accelerated from the Q1. As Kevin reminded everyone in his remarks, a year ago, our improved actuarial insights enabled us to more quickly recognize increased severities in our underlying loss trends.

Speaker 3

The elevated levels of trend we established at that time have been holding up over the past 4 quarters. We see loss trends in the mid single digits with some easing severity pressure in property observed along with ongoing frequency improvement across the portfolio. With overall rate achievement solidly exceeding loss trends, we remain confident in our ability to maintain improvement in underlying profitability. Core commercial new business production increased in the 2nd quarter with contributions across our portfolio of small business, middle market and construction. We remain pleased with the quality of accounts being added to the portfolio as we continue to improve alignment with our distribution partners and deliver additional capabilities to enhance our role as an account solution provider.

Speaker 3

Retention remained consistent and within expectations at 80% as we continue to refine our portfolio profile. Our alternative distribution portfolio continued to grow supported by increased rate and exposure on existing accounts and new business. We remain pleased with the continued opportunities offered in this space to contribute profitable and diversifying business to the UFG portfolio. We continue to manage this book to stay within a 25% share. Specialty excess and surplus lines net written premiums declined approximately $7,000,000 from prior year as we continued repositioning our portfolio to reflect a mix of business that will produce more sustainable consistent profitability.

Speaker 3

Surety net written premium increased approximately $3,000,000 compared to prior year, mostly as a result of the impact of reinsurance reinstatement premiums that depressed last year's results. We continue to take a measured approach to growth reinforcing our underwriting discipline and territory management to return the portfolio to our historic levels of profitability. The Q2 underlying loss ratio of 58.9 percent improved 5.7 points from the Q2 of 2023, continuing the momentum reflected in our Q1 results. We saw improvement across all major lines of business compared to the Q2 of 2023. Rate achievement over the last four quarters has generally exceeded our elevated but stable view of loss trends and now more fully earning into

Speaker 4

the

Speaker 3

to reposition the portfolio are producing further improvement in our frequency trends across all the major lines of business. Combined, these efforts are driving a longer term sustainable improvement in the loss ratio. Additionally, we have seen improved large loss activity in the quarter for property and surety lines. The large loss experience can be volatile from quarter to quarter. We have seen similar results in property in 2023 and current surety losses are emerging more consistent with historical profitable norms.

Speaker 3

These are early but positive signs we're building a portfolio that brings stability in our results. There are still some areas in the portfolio requiring further attention. Automobile continues to underperform relative to our expected levels of profitability but we're seeing gradual improvement as prior re underwriting and changes in portfolio mix continue to show decreased frequency, while rate is covering our severity trends. General liability rate achievement has lagged other lines recently, but a renewed focus on this effort in light of relentlessly elevated loss trends has resulted in an improved result this quarter. We will continue to focus on pricing for this line.

Speaker 3

In surety, we are optimistic this line is returning to historical profit levels. However, we are retaining a cautious position in our results until further evidence emerges. Prior period reserve development was flat overall in the Q2. Consistent with the Q1 of 2024, loss emergence was neutral to favorable across the portfolio. I'd like to take a step back and remind you of the actions we've taken to shore up our reserves.

Speaker 3

Beginning in the Q3 of 2022, we began responding to greater severity pressure observed in several liability lines. In 2023, we invested in additional XRail resources to increase the level of sophistication and analysis we bring to the reserving process and build a more comprehensive and stable framework. New insights have brought greater visibility into our true underlying exposure and emerging trends allowing us to take more proactive steps to establish strong reserve position. Since the Q3 of 2022, we have added nearly $90,000,000 to our reserves. $145,000,000 was concentrated in our general liability umbrella and excess casualty lines offset by some favorable movement in other lines.

Speaker 3

Much of this increase was attributable to accident years 2019 and prior. However, a full 40% of this figure was added to the more recent experience periods anticipating a continued escalation in severity will emerge. While initial increases were reactive in nature, we are now seeing opportunities to take more proactive steps to maintain a stable reserve position. For the 1st and second quarter of 2024, actuarial analysis indicated overall favorable development, including some favorable to neutral emergence relative to expectations in these pressured lines. Despite these positive indications, management has decided to continue to build a stronger reserve base for these liability lines that are sensitive to the future uncertainty inherent in the economic and social inflation environment.

Speaker 3

While we by no means claim victory, we are pleased with the progress made in our reserve position. Our 2nd quarter cat loss ratio of 11 point 2% was 1.8 points below prior year and below our 5 year and 10 year historical averages by 1.2 points and 0.3 points, respectively. While we could feel good about showing relative improvement in a quarter with elevated industry losses, we recognize results can be uneven for this exposure over short time horizons and we continue to execute multifaceted strategies to improve our property catastrophe risk profile. We are managing exposure to severe convective storms by geographically targeted concentration reduction actions while focusing growth in more diversifying areas supported by advanced analytical tools. We continue to reduce our exposure to hurricane PML risk with more restrictive risk profiles in our most exposed states and improving the fundamentals of risk selection, pricing and deductibles across the property portfolio.

Speaker 3

I will now turn the call over to Eric Martin to discuss the rest of our financial results.

Speaker 4

Thank you, Julie. Let me start by providing some additional perspective on the expense ratio. Since the beginning of 2023, we have made meaningful changes to the size and composition of the UFG team. Since last January, total headcount has come down significantly with a 20% reduction during that time. Included in that overall headcount change is a 35% reduction in the size of the claims team from process efficiencies and declining claims frequency.

Speaker 4

At the same time, we have made significant investments in technology and talent that will help us grow our business in a profitable way over the long term, and we are already seeing the benefits of blending these fresh perspectives with those of our long tenured UFG employees. This is having a meaningful shift in the geography of our overall expense base, which has increased for underwriting, but decreased for claims. It's easy to see part of the impact of this shift in our underwriting expense ratio remaining elevated. However, we are seeing larger benefits from the reduced costs in our claims organization that shows up in the loss adjusting expenses included in our loss ratio. So far this year, our combined underwriting and loss adjusting expense ratio has declined from 2023.

Speaker 4

Overall, we are making progress in reducing expenses. It's just not yet showing up in the underwriting expense ratio. We will continue to manage our overall cost structure down while making the necessary investments to achieve sustainable, profitable growth. Turning to the investment portfolio. Total invested assets and cash ended the 2nd quarter at $2,100,000,000 a high quality portfolio with an overall credit rating of AA- and a duration of approximately 4 years.

Speaker 4

The transition of fixed income portfolio management to our partners at New England Asset Management has already begun to show benefits. In the Q2, we began repositioning our portfolio away from its high allocation of tax exempt municipals into high quality fixed income assets offering more attractive tax equivalent yields in order to take advantage of the current elevated interest rate environment. In total, we invested approximately 20% of the fixed income portfolio in the 2nd quarter at an average yield of 5.6%, which is significantly higher than the total portfolio yield. This high volume of asset purchases at attractive yields will enhance shareholder returns for years to come. Net investment income was $18,000,000 in the 2nd quarter, up $6,700,000 or 59% compared to the Q2 of 2023.

Speaker 4

Increased valuation on limited partnership and alternative assets contributed $5,000,000 of the increase in investment income. Fixed maturity investment income increased nearly $3,000,000 or 19% from prior year to $16,000,000 in the 2nd quarter. With the portfolio repositioning I mentioned occurring throughout the quarter, this quarter's already improved results do not fully reflect the benefits of the actions that have been taken. There was approximately $1,000,000 of realized losses in the Q2 generated by this repositioning, which will be paid back very quickly. 2nd quarter net loss was 0 point 1 $1 per diluted share with a non GAAP adjusted operating loss of 0 resulted in book value per common share decreasing to $28.68 From a capital management perspective, during the Q2, we declared and paid a $0.16 per share cash dividend to shareholders of record as of May 31, 2024, continuing our 56 year history of paying dividends dating back to March 1968.

Speaker 4

At the end of May, we completed a debt transaction with Ares Management Credit Funds and 2 other partners that have provided us with $70,000,000 of regulatory and rating agency capital. We are pleased to support the company's growth on attractive terms, given the ability to reinvest these proceeds at an interest rate around 5.5%. This concludes our prepared remarks. I will now have the operator open the line for questions.

Operator

We will now begin the question and answer session. The first question today comes from Paul Newsome with Piper Sandler. Please go ahead.

Speaker 5

Good morning. Thanks for the call. I wanted to ask a little bit more on the expense line. If I plotted the LAE ratio and the expense ratio combined, would I see the total fall this quarter or recently? Or is it the combined still I mean, maybe just to ask the question, if I had the LAE ratio, would it be up or down

Speaker 6

in the quarter? Good morning, Paul. Sorry to interrupt. Good morning, Paul. This is Eric.

Speaker 6

Yes, you would. So if you plotted the LAE ratio from the first half of last year to the first half of this year or you looked at Q2 over Q2, you'd see that coming down a couple of points and that's a combination of expense ratio staying flat, up a little bit and claims costs coming down over that same time.

Speaker 5

Okay, that's great. Then maybe a little bit more on the ratings error situation. Obviously, it sounds like it's you just discovered it, so it's early days. But I've never seen anything like this before. So I really don't know how to begin in terms of thinking about implications or the size.

Speaker 5

It looks like a manageable number more of an earnings issue than a book value issue. But any thoughts in terms of maybe history of this or if we've seen anything like this before and just to give us a sense of the importance of it?

Speaker 7

Hi, good morning, Paul. It's Kevin. And so I can't really speak to the broader issue around rating errors. All I can speak to this morning is the fact that you're right, this is a relatively new issue to us identified in July. And so we're in the process of doing further investigation on both the umbrella and general liability product lines, as well as other lines to ensure that there are no further rating error issues in the portfolio.

Speaker 7

And obviously, we're in the process of having conversations with state regulators. And so at this point we've recorded an estimated liability based on the information we have available to us at this time. And as we indicated in the press release, that could change as more information becomes available to us. But we're diligently working through this issue and we don't have more to share as it becomes available to us.

Speaker 5

Maybe a related modeling question. Is it fair to say that the $3,200,000 was sort of what you overcharge those your customers last year. And so if we're looking at sort of a run rate for revenue, do we just take $3,200,000 and start with that as a base? Is that a good way to approach it? Or is it more complicated or different things than that?

Speaker 6

So I think as you look at the $3,200,000 that's included right now in the revenue section, but as other gain or loss. As we get this one time item behind us going forward, we don't think there's a significant premium impact from a run rate perspective after we get this one time impact past us.

Speaker 5

Okay. We'll take it offline. It doesn't make any sense to me, but I could be very confused. And anyway, those are the 2 big questions I have for you. Thank you.

Speaker 5

Appreciate the help as always.

Operator

This concludes our question and answer session. I would like to turn the conference back over to Kevin Leidwinger for any closing remarks.

Speaker 7

Well, thanks again for joining us this morning, and we'll talk to

Speaker 2

you next quarter. Thank you.

Operator

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

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United Fire Group Q2 2024
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