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Employers Holdings Inc  (NYSE:EIG)
Q4 2018 Earnings Conference Call
Feb. 21, 2019, 11:30 a.m. ET

Contents:

Prepared Remarks:

Operator

Good day, ladies and gentlemen and welcome to the Q4 2018 Employers Holdings Incorporated Earnings Conference Call. At this time, all participants are in a listen-only mode. Following management's prepared remarks, we will have a question-and-answer session and instructions will be given at that time. (Operator Instructions) As a reminder today's conference will be recorded for replay purposes.

It is now my pleasure to turn the conference over to your host, Doug Dirks, Chief Executive Officer. Please go ahead.

Douglas D. Dirks -- President and Chief Executive Officer

Good morning everyone, thank you for joining us today on our fourth quarter 2018 earnings call for Employers Holdings. Today's call is being recorded and webcast from the Investor section of our website where a replay will be available following the call. With me today on the call are Mike Paquette, our Chief Financial Officer and Steve Festa, our Chief Operating Officer.

Statements made during this conference call, that are not based on historical facts are considered forward-looking statements. These statements are made in reliance on the safe harbor provision of the Private Securities Litigation Reform Act of 1995. Although we believe the expectations expressed in our forward-looking statements are reasonable, risks and uncertainties could cause actual results to be materially different from our expectations, including the risks set forth in our filings with the Securities and Exchange Commission. All remarks made during the call are current at the time of the call and will not be updated to reflect subsequent developments.

In our earnings press release and in our remarks or responses to questions, we may use non-GAAP financial metrics, including those that exclude the impact of the 1999 loss portfolio transfer, or LPT. Reconciliations of these non-GAAP metrics are included in our financial supplement as an attachment to our earnings press release, our investor presentation and any other materials available in the Investor section of our website.

And with that, I'm now prepared to move on to our commentary. The fourth quarter marked a strong end to an exceptional year for Employers. During the year, we grew written premiums by 3%, despite industry wide pricing headwinds, grew new business writings by 29% over 2017 and maintained our current accident year loss ratio. Our fourth quarter adjusted net income increased 24% or $0.25 per share, and our underwriting income increased 4% as our combined ratio before the impact of the LPT of 82.2%, improved by eight-tenth of a percentage point.

Our full year adjusted net income increased 43% or $1.22 per share and our underwriting income increased 50%, as our combined ratio before the impact of the LPT of 88.1% improved by 4 percentage points. Throughout the year, we generated solid new business growth by actively pursuing opportunities, that met our underwriting and pricing requirements. Despite the strong growth in new business, our top line continues to be challenged by declining rates on renewal business, stemming principally from falling loss cost.

We experienced an average premium renewal decrease of 11.4% during the fourth quarter, with an average renewal rate decline of 13.4%. For the same period a year ago, our average renewal rate declined by 4.6%. Our book value per share including the Deferred Gain at December 31, 2018 was $35.64, an increase of 6.9% for the year including dividends and our adjusted rate -- adjusted return on equity for the year was 12.5%. As a mono-line workers compensation writer, we believe that we possess deep knowledge of our markets, allowing us to quickly react to rapidly changing conditions. We have demonstrated this ability over the years, across many economic and market cycles.

Looking forward, we believe that our in-depth industry knowledge coupled with existing and planned technological innovations, provides a significant competitive advantage for our Company.

With that, I'll turn the call over to Mike for a further discussion of our financial results. Mike?

Michael S. Paquette -- Executive Vice President, Chief Financial Officer

Thank you, Doug. Our fourth quarter loss in LAE ratio before the impact of the LPT of 48.7% was highly consistent with that of a year ago. During the current quarter, we recognized $25.4 million of favorable prior period loss reserve development relating primarily to accident years 2014 through 2017. For the year, our loss in LAE ratio before the impact of the LPT of 53.5% was 6.3 percentage points lower than a year ago.

Our fourth quarter commission expense ratio of 11.5% was 2.1 percentage points lower than a year ago. Decreases in agency incentives drove the reduction in the commission ratio in the current period. For the year, our commission ratio of 12.9% was highly consistent with that of 2017. Our fourth quarter underwriting and other operating expense ratio of 22% was 1.2 percentage points higher than a year ago. The increase was primarily the result of our aggressive development and implementation of new digital technologies and capabilities.

For the year, our underwriting expense ratio of 21.7% was 2.2 percentage points higher than that of 2017, which Doug will speak to in his further remarks. Net investment income for the fourth quarter was $21.3 million, up 12% from a year ago. Our pre-tax book yield on the portfolio was 3.4% during the quarter versus 3.1% a year ago. Net investment income for the year was $81.2 million, up 9% from a year ago. Our effective income tax rate for the fourth quarter was 16% versus 41% a year ago. When eliminating the transitional effects of the 2017 Tax Cuts and Jobs Act, the effective income tax rates for the fourth quarter of 2018 and 2017 were 17% and 28%, respectively.

At year-end, our fixed maturities had a duration of 4.1 and an average credit quality of AA-, and our equity securities represented 7% of the total investment portfolio. Recent increases in interest rates, which have benefited our net investment income have resulted in $47 million of after-tax unrealized losses on fixed maturities being recognized throughout 2018. Note that fluctuations in these unrealized investment gains and losses do not impact how we manage our investment portfolio, since we typically hold our fixed income investments to maturity.

During the quarter, we repurchased $4.2 million of our common stock at an average price per share of $41.06, and thus far in 2019, we have repurchased a further $2.1 million of our common stock at an average price of $41.69. Our remaining share repurchase authority currently stands at $43 million.

And now, I'll turn the call over to Steve.

Stephen V. Festa -- Executive Vice President, Chief Operating Officer

Thank you, Mike, and good morning. Net written premiums for the year of $743 million, were up $19 million from those written in 2017. This growth occurred despite a market environment that is extremely competitive, as well as a declining rate environment in virtually all of the states in which we do business. Despite this market environment, we grew our new business revenue $48 million year-over-year, a 29% increase. For every month during 2018, we had increases in submissions, quotes, and bound policies over the comparable month in 2017.

On a year-over-year basis, we increased our policies in-force by 7%. A significant amount of our new business growth came from our targeted classes of business, which historically have been our most profitable. We grew new business not only in the more recent states we have entered, but also in states that we have had a long-term presence. This growth came from both new partnerships, as well as from long-term partnerships. This growth was equally strong in both our core business distribution channels, as well as our alternative distribution channels.

With respect to renewals in 2018, we continue to see high policy unit retention rate throughout the year. In fact, our retention rate improved over 2017 results. We have been successful at retaining the business that has positively impacted our bottom line results, and this focus is particularly important in a softening market cycle like we are currently experiencing. As we have mentioned throughout the year, we have not observed any retraction in the market from the aggressive pricing, in particular with middle market renewals. We expect this to continue into 2019.

Wage growth continues to be strong within our book of business, as evidenced by increasing payrolls. In their 2018 fourth quarter economics briefing report, NCCI has projected average weekly wage growth to be up 3.3% for 2018 and 4.5% in 2019. And we do not see any evidence to counter this optimistic growth forecast. Consistent with our geographic diversification strategy, during the fourth quarter we entered the State of Delaware, the seventh new state we entered in 2018. We now operate in every state within the continental US, with the exception of the four monopolistic states. This footprint allows us to capitalize on multi-state opportunities that in the past we were not able to write.

And now I will turn the call back to Doug.

Douglas D. Dirks -- President and Chief Executive Officer

Thank you, Steve. During 2018, we initiated a plan of aggressive development and implementation of new technologies and capabilities that we believe will fundamentally transform and enhance the digital experience of our customers. Last month, we further define these ongoing initiatives to include continued investments in new technology, data analytics and process improvement capabilities, focused on improving the agent experience and enhancing agent efficiency and introducing Cerity, a subsidiary separate from our other insurance businesses, which offers digital direct-to-customer workers' compensation insurance solutions. We launched Cerity in Illinois in January of this year and now extended its reach to Arizona and Utah.

Our plans for Cerity are to expand both its geographical reach and its underwriting appetite throughout 2019. Subject to necessary regulatory approvals, we will build out the Cerity direct-to-customer platform to meet the insurance needs of small businesses nationwide. The development and implementation of these key initiatives including costs associated with the launch of Cerity, served to increase our 2018 underwriting and other operating expense ratio by approximately 2 percentage points.

For 2019, assuming a consistent level of earned premium to that of 2018, we expect that our underwriting and other operating expense ratio will be approximately 4 percentage points higher than that experienced in 2018, as a result of these initiatives. However, in the future periods, we expect that our underwriting and other operating expense ratio will gradually return to a normalized level as we generate in premium writings and operational efficiency gains.

With that operator, we'll turn the call over to questions.

Questions and Answers:

Operator

Thank you. (Operator Instructions) Our first question comes from Mark Hughes of SunTrust. Your line is now open.

Mark Hughes -- SunTrust Robinson Humphrey -- Analyst

Thank you. Good morning.

Douglas D. Dirks -- President and Chief Executive Officer

Good morning.

Mark Hughes -- SunTrust Robinson Humphrey -- Analyst

The four points higher in 2018, just to be clear the -- that's on top of the extra two points last year that came from these initiatives. So if we go back a couple of years, it would be six points cumulatively?

Michael S. Paquette -- Executive Vice President, Chief Financial Officer

That's right. The six points from 2017, Mark, but four points from where we were for 2018. That's our best estimate today.

Mark Hughes -- SunTrust Robinson Humphrey -- Analyst

And then previously, you had used a formulation, I think it might have been the six points spread over multiple years. I think this is clearly higher than that. Would you expect that cost structure would return at some point to that prior level or does this represents something of a permanent increase?

Michael S. Paquette -- Executive Vice President, Chief Financial Officer

We don't believe it's going to be permanent. But it's very difficult for us to project beyond 2019, at this time, because it's largely dependent upon the premium writings that we achieve from these two initiatives.

Douglas D. Dirks -- President and Chief Executive Officer

But I'll add to that, Mark, that you heard us reference in the past that we think speed is critical right now. This market is evolving very rapidly. And so, we are moving as quickly as we can to deploy both the initiatives on the agent side of our business, as well as launching Cerity. And so, when you think about where we expect it to be versus where we actually are, a big part of that is the speed with which we are deploying these initiatives. Now, we fully expect that as fully deployed, they will drive much greater efficiencies. Ultimately, we're just returning the expense ratio back to where we were in 2017, we wouldn't consider to be a great success. The objective here is actually to drive a lower longer-term expense ratio thereby making us more competitive. Exactly when this hits the income statement is difficult to project, but the objective is absolutely to reduce our historical expense ratio below what it was prior to the launch of these initiatives.

Mark Hughes -- SunTrust Robinson Humphrey -- Analyst

And can you talk about sort of early experience in Illinois, what's the strategy, and is that a -- with your go-to-market, how do you reach those small business owners?

Douglas D. Dirks -- President and Chief Executive Officer

What I saw, a variety of marketing techniques that we're utilizing, it is entirely digital. So if you think about a typical digital marketing strategy, it is directed at those people who are either likely to be your expressed an interest in being a direct buyer of workers compensation. That we've initially rolled it out in a small number of classes, and again initially it was in Illinois, we are now in Utah and Arizona, as well. And as I indicated in my comments, the expectation would be that, we'll build this out nationwide and increase the number of classes of business that we can offer. But again, it will be a digital marketing campaign, we are building knowledge, we are building a database. So we will be constantly refining it in a way that we can really direct that marketing spend, that part of the market that we believe is most likely to be amenable to buying direct.

Mark Hughes -- SunTrust Robinson Humphrey -- Analyst

I'll ask one more, and then I'll get back in line. But the -- when you think about loss pick for 2019, you've obviously had a lot of movement on rate, you've maintained your loss picks this year through that. How should we think about the 2019 when you consider price trends, loss trends, how will that show up in the loss pick?

Douglas D. Dirks -- President and Chief Executive Officer

Let me address that from a couple of perspectives. We are in a competitive environment, and so there is a lot of pressure on pricing. So I would say that, would likely have a negative impact on the margin, principally coming to the loss ratio, but there is also an impact on the expense ratio in a declining rate environment. Offsetting that are a number of initiatives that we've deployed, the underwriting algorithm that's maturing now, a couple of initiatives on the claims side that we think will have positive impacts on the loss ratio. After that, the fact that this experience of declining rates is the result of declining frequency and defining the loss cost, virtually everywhere in the country. And so net-net, I can't give you a number, I'm not going to give you a guidance on what we expect the 2019 loss ratio to be -- there are quite a few moving parts here. But to the extent that we're able to continue to deploy initiatives that have a favorable impact on our loss ratio, we hope to offset what we're experiencing in terms of the competitive marketplace.

Mark Hughes -- SunTrust Robinson Humphrey -- Analyst

Thank you.

Operator

Thank you. (Operator Instructions) Our next question comes from Bob Farnam of Boenning & Scattergood. Your line is now open.

Robert Farnam -- Boenning & Scattergood -- Analyst

Yeah, hi there and good morning. So with the new Cerity platform, have you gotten much pushback from your independent agents going direct?

Stephen V. Festa -- Executive Vice President, Chief Operating Officer

Bob, this is Steve, I'll answer that question, because we've spent a lot of time since the announcement out in front of our agents, speaking to them about this. And the bottom line answer to your question is, we have not, there is an understanding there, that there are going to be buyers of workers compensation today and in the future, that for their own personal reasons bypass the independent agent channel. And so, as we said to the agents, if they're not going to get that opportunity, there is an opportunity for us to generate some business as a result of that. And the fact that we've been very transparent with the agents and talk to them specifically about the Cerity launch, as soon as we were able to do that. And the fact that we're investing quite a bit of money over the course of the next two to three years in the independent agent channel has resonated very well with them.

Douglas D. Dirks -- President and Chief Executive Officer

These are separate businesses, they don't share data for marketing purposes. We expect that they will be -- these channels will represent different customers, not to say that there won't ever be a customer that moves from one channel to the other, but we don't expect them to be actively competing against each other, because we think they're going after differ buyers.

Robert Farnam -- Boenning & Scattergood -- Analyst

The size of the accounts in the Cerity, it sounds like you're really going to be focusing mostly on small business, I mean, what, like how many employees are you, are you looking kind of on average -- in that type of book?

Douglas D. Dirks -- President and Chief Executive Officer

No, it's difficult to define, but clearly these are micro accounts. These are the accounts that we think agents would not likely see in their normal channels. It's not to say that, obviously, we're small business writer, we seek to enable agents to write all the small businesses, they can, but these are small accounts. If you look at the initial launch, these are small professional offices and professional services companies. They're not going to be large accounts. We've not drawn a line in terms of premium because there is so much variation across the country in terms of what rates are by class. But again, they're micro accounts.

Robert Farnam -- Boenning & Scattergood -- Analyst

Alright. Okay. And one just kind of switching gears a bit, on the reserve development, I don't know if you have details in front of you, but kind of what are the recent accident year loss ratios developed to, like in 2017, 2016 kind of relative to where you're booking your initial estimate for 2018 and 2019?

Michael S. Paquette -- Executive Vice President, Chief Financial Officer

We don't have that information in front of us, Bob.

Robert Farnam -- Boenning & Scattergood -- Analyst

Okay.

Michael S. Paquette -- Executive Vice President, Chief Financial Officer

What we're continuing to see is strong favorable development, particularly in the years from 2014 to 2017. And as you could see, we took those movements in each of the four quarters of last year. So it's been a bit of a moving target, but we certainly like what we see thus far.

Robert Farnam -- Boenning & Scattergood -- Analyst

Alright. Okay. Thanks.

Operator

Thank you. And at this time, I'm showing no further questions. I would like to turn the call back over to Doug for any closing comments.

Douglas D. Dirks -- President and Chief Executive Officer

Perfect. Thank you for joining us, everybody. We'll be back together again in a couple of months, as we release the first quarter 2019 results. We thank you for your participation and your questions.

Operator

Ladies and gentlemen, thank you for participating in today's conference. This concludes today's program and you may now disconnect. Everyone have a great day.

Duration: 25 minutes

Call participants:

Douglas D. Dirks -- President and Chief Executive Officer

Michael S. Paquette -- Executive Vice President, Chief Financial Officer

Stephen V. Festa -- Executive Vice President, Chief Operating Officer

Mark Hughes -- SunTrust Robinson Humphrey -- Analyst

Robert Farnam -- Boenning & Scattergood -- Analyst

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