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National General Holdings Corp (NGHCP)
Q4Â 2018 Earnings Conference Call
Feb. 26, 2019, 9:30 a.m. ET
Contents:
- Prepared Remarks
- Questions and Answers
- Call Participants
See all our earnings call transcripts.
Prepared Remarks:
Operator
Good morning, ladies and gentlemen, and welcome to the Fourth Quarter 2018 Earnings Conference Call. At this time, all participants have been placed on a listen-only mode and we will open the floor for your questions and comments after the presentation. It is now my pleasure to turn the floor over to your host, Christine Worley. Ma'am, the floor is yours.
Christine Worley -- Director of Investor Relations
Thank you. Good morning, and welcome to the National General Holdings Corp Fourth Quarter 2018 Earnings Conference Call. My name is Christine Worley, and I'm the Director of Investor Relations at National General. With me this morning are Barry Karfunkel, Chief Executive Officer and Mike Weiner, Chief Financial Officer. Before Mr. Karfunkel and Mr. Weiner review our results, please note the following with respect to forward-looking statements.
Members of our management team may include statements other than historical facts in their remarks. Such statements may include the plans and objectives of management for future operations, including those relating to future changes in the Company's business activities and earnings results or potential. These statements are based on current expectations and involve assumptions that are difficult or impossible to predict accurately, many of which are beyond our control.
There can be no assurance that actual developments will be consistent with these assumptions. Actual results may differ materially from those expressed or implied in these statements as a result of significant risks and uncertainties, including the factors set forth in our filings with the Securities and Exchange Commission. The projections and statements in this presentation speak only as of the date of this presentation, as we undertake no obligation to update or revise any forward-looking statement, whether as a result of new information, future developments, or otherwise, except as may be required by law.
Our management will refer to financial measures that are not derived from generally accepted accounting principles or GAAP. Reconciliation of these non-GAAP financial measures to the most directly comparable GAAP measures and related information is provided in the press release for our fourth quarter 2018 earnings, which is available in the Investor Relations section of our Web-site at www.nationalgeneral.com.
It is now my pleasure to turn the call over to our CEO, Mr. Barry Karfunkel.
Barry Karfunkel -- Chief Executive Officer and Co-Chairman of the Board
Good morning, and thank you for joining our fourth quarter earnings conference call. I'd like to provide some added color around the performance of our various lines of business, as well as provide some outlook for how we're thinking about them for 2019.
Our personal auto has had a tremendous year in 2018 in terms of operating results and growth. Top line growth slowed in the second half of the year and we expect gross written premium growth to remain in the mid- to high-single digits for 2019.
We've also reduced our quota share from 15% to 7% on the auto line, allowing us to retain more of the strong reperforming business. The heart of market and REIT dislocation that drove outstanding organic growth levels during 2017 has subsided. In the current environment, we refuse to chase growth and engage in a rational behavior to the detriment of our bottom line. We will, however, expect to realize elevated growth rates from our direct-to-consumer channels.
During the softening markets, having the direct channel is extremely helpful as we continue to experience elevated conversion and retention rates vis-a-vis the independent agency channel.
Our homeowners book experienced strong top line growth in 2018, which enabled us to get to the scale where we can introduce sophisticated product segmentation. We expect our homeowner books growth to slow to the upper single-digit rate, as we retrench in California. In the heightened cash-free environment that we've experienced over the past two years, our underwriting has shown through with our losses below our market share and impacted areas.
We continue to gain traction with our lender placed business as we onboard new accounts and have a larger pipeline today than we've ever had since acquiring the business. We expect positive impact from new clients to benefit the Company in the second half of the year, as the business takes time to ramp up.
Our accident and health segment was one of the breakout stories for -- of National General in 2018, earning over $100 million in underwriting income for the year. This strategic approach that we took in assembling our various health assets and our control of both distribution and product positions us well in the changing healthcare market.
We're one of the top providers of short-term medical and while the emergence of the product during its opening enrollment period didn't materialize to the magnitude that we -- that was expected, we do think the product will become more accepted as a major medical alternative due to changing regulations. We expect demand for that product continue increasing and our rolling out additional segmentation in that product to enhance our position moving forward.
We believe our niche small group stop loss line will also be a source of growth in the coming years as the value proposition we bring to small groups is in an interactive alternative to more expensive fully insured product.
Overall, I think this was a strong year for National General, and I'm proud of the earnings firepower that we were able to demonstrate. The maturity of both our property and casualty in each segment has provided National General with the high-quality stable earnings stream from short-tail niche business lines that are flourishing under our shared infrastructure platform.
With that, it is my pleasure to turn the call over to Mike Weiner for a more detailed review of our financial results.
Michael Weiner -- Chief Financial Officer
Thank you, Barry. Fourth quarter 2018 net income was $17.3 million, that compared to a net loss of $9.9 million in the fourth quarter of 2017. Operating earnings were $33.6 million versus $30 million in last year's quarter and $231.5 million for the full year, growing significantly over $118.1 million recorded in 2017.
Operating EPS was $0.30 compared to $0.28 in the prior year quarter. The fourth quarter included the following. Disproportionate impacted by taxes with an effective tax rate of 32.5% for the quarter and 21.6% for the year. The tax rate was impacted by a handful of fixed items that were magnified due to the lower-than-anticipated pre-tax income for the quarter and finalization of the impacts of the change in tax law. Our results in the quarter were impacted by $59 million of losses related to Hurricane Michael and the California Wildfires. This is in line with our pre-announced large loss activity in the quarter.
We also announced in management estimates the probable net pre-tax impact to the Company to resolve class action lawsuit related to our collateral protection business is estimated to be $10 million. We continue to believe that the Company's actions were at all times in compliance with applicable requirements and that the Company has a meritorious defense in litigation.
We completed a secondary share offering in the quarter. We raised net proceeds of $132 million. We raised these funds in parts support our pending acquisition of National Farmers Union Insurance, which we announced concurrently with the capital raise as well as to reduce the amount of ceded auto insurance quota share.
I'm pleased to announce that effective January 1, we have reduced the ceded -- on our ceded auto quota share, from 7% to 15% -- from 15% to 7%. We expect return on capital to fall within the low- to mid-teen range and we target that for the overall company. We believe profitable growth opportunities such as these remain strong for National General and we appreciate the flexibility that our access to public capital markets provide us.
On February 25, 2019, we entered into a new credit agreement with a $340 million base revolving credit facility. This replaces the previous $245 million is revolving credit facility. Details of the new credit facility were filed last night and can be accessed on our website. Our fully diluted book value grew 4% sequentially to $15.25 as of December 31, 2018.
Now I'd like to give some additional detail about our two operating segments. The property and casualty segment. Gross written premium grew 8.8% to $1 billion, driven by organic growth in our homeowners' product of 17.8% and our personal auto product of 7.8%. Service and fee income grew 11.6% to $110.8 million, driven by underlying premium growth.
The P&C combined ratio was 100.5%, that's versus fourth quarter 2017 of 98.2%, excluding the amortization of intangible assets. The loss ratio was 79.6% compared to 76.9% in 4Q '17. The loss ratio reflects the aforementioned losses from Hurricane Michael and the California Wildfires of $59 million, which compared to $52.9 million in the prior year quarter. The P&C loss ratio was also impacted by $8.5 million in adverse development compared to $8.1 million in adverse development in 4Q 2017. The adverse development in this quarter was driven by a small uptick in losses from the accident years 2016 and prior, relating to liabilities in both our small business and personal auto products. The expense ratio was 20.9% compared to 21.3% in 4Q '17.
Overall in our order book, we continue to see moderately to-better loss trends than the industry, primarily in frequency. We attribute this to better-than-industry results to pricing segmentation, better risk selection from our RAD 5.0 product, which we began to implement roughly two years ago, and to a lesser extent mix shift.
Within our accident and health segment, gross written premium grew 19.2% to $163.5 million, which benefited from strong growth across the domestic book. Service and fee income grew $51.4 million versus $46.8 million in the fourth quarter of 2017. The accident and health combined ratio was 73.6% (ph), that's versus 89.9% in 4Q '17 excluding non-cash amortization of intangible assets. The loss ratio was 45.7% versus 59.9% in the prior year quarter. The loss ratio reflects continued improvement in our view of the current accident year of loss ratio for both the small group self-funded book as well as the individual products. The expense ratio was 27.9% and that's versus 30% in the prior year quarter.
I'd like to echo Barry's excitement in strength about our diversified platform that we demonstrated throughout this year, despite the heightened large loss activity.
I'd now like to turn the call over to moderator for questions.
Questions and Answers:
Operator
(Operator Instructions) And your first question is coming from Randy Binner. Randy, your line is live. Please announce your affiliation and pose your question.
Randy Binner -- FBR Capital Markets & Co. -- Analyst
Hi, good morning -- B. Riley, FBR. I wanted to talk about the litigation settlement. To the extent that you all are able to and just kind of understand how this would fit in to comparing it to ongoing legal spend if this settlement is potentially global in nature and would protect you from further class actions regarding the Wells Fargo situation. Any color you can provide there will be helpful.
Michael Weiner -- Chief Financial Officer
Yeah, hey, Randy, it's Mike. Unfortunately, we can't really comment on pending litigation of the settlement discussions. Based on the information currently available to us, the company, we believe that the probable net pre-tax impact of the Company to resolve this matter is $10 million. I think at this point, that's all we can really say.
Randy Binner -- FBR Capital Markets & Co. -- Analyst
Okay. And then on -- I think Barry mentioned in his opening commentary that there were some new opportunities in lender placed. Can you elaborate on that, please?
Barry Karfunkel -- Chief Executive Officer and Co-Chairman of the Board
Yes. We've got a robust pipeline. We are performing well and we see that as potentially being a decent growth area for us starting toward the end of the year.
Michael Weiner -- Chief Financial Officer
Is there...
Randy Binner -- FBR Capital Markets & Co. -- Analyst
Yes -- sorry, go ahead, Mike.
Michael Weiner -- Chief Financial Officer
No, I just wanted to say we grew the business about 9.3%. And as Barry alluded to in his comments, we start onboard some new clients that we won -- we won in addition to the pipeline. There is a time lag associated with when you onboard those clients and when the premium ramps up. So, we feel quite bullish about the growth opportunities, but I cut you off. I apologize.
Randy Binner -- FBR Capital Markets & Co. -- Analyst
No, I mean, yeah, it sounds like you're adding new clients. And is there -- so lender placed insurance is a counter-cyclical business, is there -- are you seeing better penetration of that book as folks maybe don't make auto payments or other payments that are due or is this more just kind of just general activity where you're seeing the opportunity.
Michael Weiner -- Chief Financial Officer
Yeah, I would -- classify more in the general activity area. Penetration rates still remain at historical low for us, and I believe for the industry as a whole. So we're growing this business kind of bootstrapping it, which is getting new clients to track and getting their associated premium at that. We haven't seen that big of change at all associated with the general health of the economy, and I think you're alluding to perhaps some of the press release reports of an uptick in auto delinquencies that potentially will affect the homeowners book. We haven't seen that yet. Again, we don't disclose penetration rates, but they still remain at a very low level.
Randy Binner -- FBR Capital Markets & Co. -- Analyst
Okay, I'll leave it there. Perfect, thank you.
Operator
Thank you. And your next question is coming from Matthew Carletti. Matthew, your line is live, please announce your affiliation and pose your question.
Matthew Carletti -- JMP Securities -- Analyst
Sure. Matt Carletti, JMP Securities. Good morning. Just had a few questions. Barry, I was hoping you might be able to comment a little bit on the short-term medical business and specifically, we saw the kind of the framework and then rules around that product change last year. What have you seen if anything thus far in terms of increased flow and what are your expectations as we progress into 2019 in that regard.
Barry Karfunkel -- Chief Executive Officer and Co-Chairman of the Board
Sure. As mentioned, the new business increase year-over-year was definitely less than what we had expected, but -- and is there a various actions by various states to -- perhaps curtailed the limit of the duration of these products. However, going forward overall, the product and the bulk of the states could be sold as a 12-month policy with three renewals and this is for a segment of the population. It's definitely a solid alternative for them and we expect the business to be able to grow at a pretty healthy clip over the next couple of years.
Matthew Carletti -- JMP Securities -- Analyst
Okay, great. And then, maybe shifting to M&A a little bit, just a twofold question. First part, just can you update us on your view of the overall environment kind of your M&A pipeline and your appetite for further M&A. And then secondly, just if there's any update on the timing around the NFU acquisition if there's anything to note in terms of the timing of the closing?
Barry Karfunkel -- Chief Executive Officer and Co-Chairman of the Board
With respect to the NFU acquisition, we would hope to close sometime in the second quarter. And as far as M&A pipeline, we remain engaged and we're constantly looking for opportunities for the year, provided that those opportunities fit within our approach of being able to -- be strategic fit with our current business. So, as we've always been having our ear to the ground with respect to opportunities, doesn't mean that something is going to happen. We're always talking to people.
Matthew Carletti -- JMP Securities -- Analyst
Okay. And then one last numbers one, probably for Mike. Just want to make sure I heard you right -- you commented on the tax rate, sound like it was just a little higher because of the kind of a mix in the quarter just less underwriting income and some other, I think you referred to them as fixed items. Is that basically a kind of just a mix issue?
Michael Weiner -- Chief Financial Officer
Yeah, it's more rate volume than anything else, so we had some discrete solid items on a smaller base. So for the year in totality, we came out a little over 21% tax rate for the Company on a full year basis. So, yeah.
Matthew Carletti -- JMP Securities -- Analyst
Okay, great. Thanks a lot, and best of luck in 2019.
Michael Weiner -- Chief Financial Officer
Thanks, Matthew (ph).
Operator
Thank you. And the next question is coming from Yaron Kinar. Yaron, your line is live. Please announce your affiliation and pose your question.
Yaron Kinar -- Goldman Sachs -- Analyst
Hi, good morning. Yaron Kinar with Goldman Sachs. I have two questions on A&H, and then one on P&C. So, in A&H, can you maybe give a little more color as to what exactly has helped the loss ratio on both the group and individual business?
Barry Karfunkel -- Chief Executive Officer and Co-Chairman of the Board
Sure, Yaron. I'll take that one. So in the A&H business, it's really two large groupings of different products. So the small group self-funded product has come in much better than we anticipated, really just reflecting the actual performance of the business from late last year through this year, as well as on the individual products, which is performing better. Our enhanced segmentation and underwriting really are flowing through in those products that we're offering there.
Yaron Kinar -- Goldman Sachs -- Analyst
Okay. So, are the numbers we saw in this four quarter, it goes representative of what we should expect going forward or those really better than expected and we should think of higher numbers as a run rate?
Barry Karfunkel -- Chief Executive Officer and Co-Chairman of the Board
Listen, there are certainly wonderful numbers, but I think we price for numbers that are a bit higher. So I would anticipate that business not to run at that in the future.
Yaron Kinar -- Goldman Sachs -- Analyst
Okay. And then on the short-term medical. So it sounds like, maybe, you faced a little bit of hurdles from states who enacted some regulation that made it a little more difficult or a little enhancing to buy this product. I'm just trying to understand what would get from the point or what you saw as of now to the future growth that you expect going forward? Won't you see the same hurdles manifest themselves and then nearer or longer-term future?
Barry Karfunkel -- Chief Executive Officer and Co-Chairman of the Board
Sure. So it wasn't really affected much by states impacting limits on duration of the policies. The bulk was that consumer demand and quote activity was just lower than we had anticipated, out of the gate. Keep in mind, even though new business is lower where we are now selling longer duration policies, then have been sold in the past. And I think as the population learns about the product over time that will help for awareness of this product to grow and for this policy to be more accepted overall, but the bulk of it was just -- it was not really a state regulation. It was just quote activity was lower than we had expected.
Yaron Kinar -- Goldman Sachs -- Analyst
Okay. Got it. And then finally in P&C. I saw you still have very strong growth in the homeowners, clearly still ramping up that business. I guess, my one question there would be, if I look at some of your competitors, they have seen higher loss ratios in homeowners due to higher frequency, and seems like they are repricing at this point. So I guess, how do you not get adversely selected against in this environment as you're growing and they're may be pulling back a better, trying to raise prices?
Michael Weiner -- Chief Financial Officer
Sure. Well, we are raising prices. And as Barry alluded to, we are pulling back a bit predominantly on the West Coast on that. It's also better enhance underwriting and product segmentation. So I don't think that's a large concern of ours. We have seen, as the industry has an uptick in noncat losses, we're responding to accordingly, primarily those who are on water-related losses, and we have some enhanced underwriting things that we're doing in terms of prior water losses, water shutoff, age of home, a little bit different underwriting approaches that we're taking to this uptick in noncat exposure. But I don't think that's a big concern of us, and we're taking rate where we can.
Yaron Kinar -- Goldman Sachs -- Analyst
Okay. Thank you very much.
Operator
Thank you. And the next question is coming from Meyer Shields. Meyer, your line is live. Please announce your affiliation and pose your question.
Meyer Shields -- Keefe, Bruyette & Woods -- Analyst
Great, thanks. KBW, and good morning all. So Barry and Mike, you both mentioned a -- I guess, Barry termed it a retrenchment in California. I was hoping you could explain that. Is that just exposure accumulation? Or are there other factors?
Barry Karfunkel -- Chief Executive Officer and Co-Chairman of the Board
It's really conservatism with respect to modeling our exposure to wildfire, that has led us to pull back a bit.
Meyer Shields -- Keefe, Bruyette & Woods -- Analyst
Okay. That makes sense. And a couple of quick numbers questions. Can you disclose the ceding commission as of January 1 on the auto quota share?
Michael Weiner -- Chief Financial Officer
It hasn't changed. So...
Meyer Shields -- Keefe, Bruyette & Woods -- Analyst
Okay. That's fine. That's all I need...
Michael Weiner -- Chief Financial Officer
I can get it to you. I apologize.
Meyer Shields -- Keefe, Bruyette & Woods -- Analyst
No, I have the old one, that's fine. And is 21% or so, the tax rate for 2019?
Michael Weiner -- Chief Financial Officer
Yeah, it is, so we will revert back to the statutory tax rate for both the federal and the combined where we do have some state taxes, 21% is a good rate to use.
Meyer Shields -- Keefe, Bruyette & Woods -- Analyst
Okay. And then finally, within investment income there was great number, was there anything unusual in there?
Michael Weiner -- Chief Financial Officer
Yeah, I think in the investment income, we had some -- we still own a small bit of third party managed life settlement portfolio. So there was relatively small, but enough of the percentage needle, a little nice income we had in the fourth quarter associated with that.
Meyer Shields -- Keefe, Bruyette & Woods -- Analyst
Okay. Is there anyway breaking that out?
Michael Weiner -- Chief Financial Officer
I can get back to you on that. I think it was $3 million or $4 million.
Meyer Shields -- Keefe, Bruyette & Woods -- Analyst
Okay. Perfect. Thank you.
Operator
Thank you. And the next question is coming from Mike Phillips. Mike, your line is live. Please announce your affiliation and pose your question.
Michael Phillips -- Morgan Stanley -- Analyst
Thank you. Good morning, everybody. Mike Phillips from Morgan Stanley. A question on the P&C core loss ratio up a bit. And Mike Weiner, I assume it's from your one of your earlier answers on the noncat weather water you have referred to. Is that what kind of drove the P&C core loss ratio up?
Michael Weiner -- Chief Financial Officer
Yes. So there's really two things that -- when you look at that. We had some -- while we had favorable development for the year, we had a little unfavorable development on the -- in the business of about $8.5 million. So I think that's one component of it. And then as well as -- when you strip out the cats, that noncat, for lack of a better term, attritional or water loss ratio penalty that we've had is probably the other driver of that. So it's really two things that drove it up a little.
Michael Phillips -- Morgan Stanley -- Analyst
Okay, great. And you also mentioned a small business in personal auto for accident years is -- in '16 and prior for the reserve development. We're hearing from competitors as well, I guess, maybe a little more color on what type of losses they are. And then, I guess, it sounds like you didn't mention '17 and '18 accident year, so you're not seeing them in the recent -- in the current book of business.
Michael Weiner -- Chief Financial Officer
That's correct. So again, for the year in totality, we had -- and for development in total, it's about a $6 million favorable, but $8.5 million unfavorable. A lot of that, if not all of that is really driven in the auto business, and that's really bifurcated by the small business as well as our regular auto business and that's really in accident years 2016 below. We've seen some small movements there. We've taken some relatively aggressive actions about that by recognizing those losses and increasing our proportion of IBNR in those years. So, I think it really sets us up moving -- going forward in a strong position.
Michael Phillips -- Morgan Stanley -- Analyst
So you -- on those losses, you're actually seeing -- I mean are there fatality losses that you're seeing or certain types of losses that you have you seen? Or is it something anticipating from just from what you're hearing from competitors.
Michael Weiner -- Chief Financial Officer
No, I wouldn't say to -- well, it's always interesting what competitors look at what really our own data and what that really tells us about it. We have seen an uptick in litigation associated with these on the small business these (inaudible) policies in certain states. So I would really attribute it to that.
Michael Phillips -- Morgan Stanley -- Analyst
Okay.
Michael Weiner -- Chief Financial Officer
And I would also say, though, that in the current period, meaning this year and the more current accident years, we're seeing a noticeably lower claims frequency of actual claims that have come into us, which we're attributing to our better risk selection. We rolled out our RAD 5.0 product about two years ago, and we are really seeing the benefits of that associated with the most current accident years.
Michael Phillips -- Morgan Stanley -- Analyst
And you're referring there to auto rates, small business and personal auto?
Michael Weiner -- Chief Financial Officer
Yes. I apologize. Yes.
Michael Phillips -- Morgan Stanley -- Analyst
Okay. Great. Thank you very much, Mike.
Operator
Thank you. And the next question is coming from Andre Summer (ph). Andre, your line is live. Please announce your affiliation and pose your question.
Andre Summer -- -- Analyst
Hi, I'm Andre Summer, working at Sersi (ph). Solid quarter. Thanks for taking the call. So I just wanted to come out you little bit from the perspective of the fixed income side. So while the stock has done well in the last quarter, preferred holders haven't exactly. So possibly due to what has been happening at neighboring companies. I just want to ask if you have other -- any further clarifying remarks on what's happening on the preferred side. Do you view the preferred also has an important constituent of your company, as an important part of your growth and M&A story?
Michael Weiner -- Chief Financial Officer
Yeah, so, well, let me take it from it from two parts. One is that, I think, what you're alluding to is we certainly enjoy our access to the capital markets. I think we've actually demonstrated that in the current quarter with our capital raise that we did, and I think it was in November of this year. As for the management of the company, we're focused on underwriting every day and building shareholder value for everybody in our capital stack. So we really don't make any kind of differentiation between anybody in doing that. We continue to run our business with thinking we have a very good use of proceeds. And we continue to keep our capital stack in line to -- into what we do and I think you've seen the benefit of us doing that with an actual capital raise in the fourth quarter. So I don't know if that answers it for you, but that's really how we think of the business.
Andre Summer -- -- Analyst
Okay. Thank you.
Michael Weiner -- Chief Financial Officer
All right. Thank you.
Operator
Thank you. And there were no further questions on the lines.
Christine Worley -- Director of Investor Relations
Thank you very much and we look forward to discussing our next quarter results with you on our next earnings call. Thank you.
Operator
Thank you, ladies and gentlemen. This does conclude today's conference call. You may disconnect your phone lines at this time and have a wonderful day. Thank you for your participation.
Duration: 30 minutes
Call participants:
Christine Worley -- Director of Investor Relations
Barry Karfunkel -- Chief Executive Officer and Co-Chairman of the Board
Michael Weiner -- Chief Financial Officer
Randy Binner -- FBR Capital Markets & Co. -- Analyst
Matthew Carletti -- JMP Securities -- Analyst
Yaron Kinar -- Goldman Sachs -- Analyst
Meyer Shields -- Keefe, Bruyette & Woods -- Analyst
Michael Phillips -- Morgan Stanley -- Analyst
Andre Summer -- -- Analyst
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