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National General Holdings Corp (NASDAQ:NGHC)
Q2 2019 Earnings Call
Jul 30, 2019, 9:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good morning, ladies and gentlemen, and welcome to the National General Holdings 2Q 2019 Quarterly Earnings Call. [Operator Instructions] It is now my pleasure to turn the floor over to your host, Salisha Hurtz [Phonetic]. Ma'am, the floor is yours.

Unidentified Speaker

Thank you. Good morning, and welcome to National General Holdings Corp's Second Quarter 2019 Earnings Conference Call. My name is Salisha Hurtz, Financial Analyst at National General. With me this morning are Barry Karfunkel, Chief Executive Officer; and Mike Weiner, Chief Financial Officer. Before Mr. Karfunkel, 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 speaks only as of the date of this presentation. We undertake no obligation to update or revise any forward-looking statements, 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. Reconciliations of these non-GAAP financial measures to the most directly comparable GAAP measures and related information is provided in the press release for our second quarter 2019 earnings, available on the Investor Relations section of our website, 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

Thank you. Good morning, and thank you for joining our second quarter earnings conference call. I'm pleased with our solid year-over-year earnings growth, driven by strong combined ratios across our Property & Casualty and Accident & Health operating segments. Diving into provide a little more color on our various lines of business, our personal auto line experienced a 3.3% year-over-year gross written premium decrease. As we mentioned last quarter, we're experiencing a soft market within this line of business, which is causing many carriers to take rate decreases, which in turn is lowering shopping activity, having the greatest impacts on smaller independent agencies. The sense that we've always taken across all of our lines of business is to never get caught being behind on rates. As focused onto writers, we seek a balanced approach to growth and profitability across the full market cycle.

Also contributing to the year-over-year decrease are actions taken to terminate some unprofitable MGA relationships and some significant new business boosts in the prior year's quarter, relating to the Nationwide renewal rights transaction and a competitor seizing to operations. I am pleased to note that our direct-to-consumer generated business, which currently stands at roughly 18% of our total auto line, did experience 8% year-over-year growth, and we look forward to seeing further growth as we continue to invest in our direct-to-consumer platform. Turning to our homeowners line of business. Our gross written premium fell 0.4%. The key driver of this was nonrenewals on our wildfire exposed areas in California, along with stricter underwriting rules. Ex-California, our gross written premium increased by 11%, and we're pleased with the overall performance of the book. I would expect to see continued slight decrease of our top line within this line of business. We renewed our quota share for our auto and homeowners lines of business.

While our quota share renewal on our auto business reflects a solid margins and strong expertise, there are many things that contributed to our lower property ceding commission. Our homeowner line experienced strong top line growth of over 22% in 2018, which brings a new business penalty with it. Secondly, we were negatively impacted by prior year's cat activity, including wildfires, which has caused the market to increase its cat load. And lastly, we have seen an uptick in our attritional loss ratio due to water loss activity and non-cat weather losses in line with the industry. Our lender-placed business experienced a 27% decline. Under half of the decrease is due to a client that was terminated as a result of being acquired. The remaining premium was due to termination of unprofitable accounts. We are pleased with our growth initiatives in the lender-placed insurance line of business.

While our new accounts haven't started earning premium yet, as of today, our tracked home loans have grown over 47% from the second quarter of 2018. I wouldn't guide you to expecting written premium growth to reflect track loan growth, as some of the clients that have been onboarded experienced lower penetration rates, but we are making significant progress. To wrap up, our Property & Casualty segment, while our premium growth was a bit disappointing relative to past quarters and years, our #1 focus is to be prudent underwriters, while earning an acceptable return on equity and growing our book value per share across all business cycles. Turning to A&H. Our small group stop-loss business continues to perform extremely well. While overall industry quotes for individual short-term medical has been lower than expected, we believe we're well positioned to grow and continue to grow in this space with a wonderful product and distribution, including our internal call center agency and direct-to-consumer marketing assets. Our third-party fee income continues to grow, driven by our agency sales of third-party individual health and Medicare products as well as our software technology sales comprised of our LeadCloud's quoted and AgentCubed's products.

Our international group supplemental business has seen a decrease to a gross written premium, driven by a rollout of new pricing segmentation as well as some impacts from foreign exchange rates. Lastly, as we continue to grow our book value through earnings and exhibit strong returns, our Board has decided that it's appropriate to increase our quarterly dividend to $0.05 per share. We're extremely excited with the platforms that we've built and its ability to produce strong top line growth at above industry margins.

With that, it's my pleasure to turn the call over to our CFO, Mike Weiner, to provide additional color on our financial performance.

Michael Weiner -- Chief Financial Officer

Thank you, Barry. Second quarter 2019 net income was $69 million compared to net income of $36.7 million in the second quarter of 2018. Operating earnings were $78.1 million versus $59.5 million in last year's quarter, up approximately 31%. Operating diluted EPS was $0.67 compared to $0.54 in the prior year quarter. Our results in the quarter were impacted by $18.4 million of weather losses, that compares to $20.5 million of losses in the prior year quarter. Catastrophic losses were lower than prior, but we saw higher non-cat weather-related losses in the quarter. Second quarter 2019 included $2.3 million of unfavorable prior year development versus $13.4 million favorable development in the prior year's quarter. Our trailing 12-month operating return on equity was 15.2% as of June 30, 2019. Our fully diluted book value per share grew 14.6% from December 31, 2018, to $17.48. As highlighted in our earnings release and our Form 10-Q, effective July 1, 2019, we renewed our auto quota share insurance agreement for a 2-year time period. We will see 10% of net liabilities under in-force new and renewal business at a 31.2% provisional ceding commission.

Also, effective July 1, 2019, we renewed our homeowners' quota share reinsurance agreement for a 1-year term, and we'll see 40% of net liabilities under new and renewal business at a 36% ceding commission. Additionally, a proportion of the in-force business will run off under the prior agreements, resulting in a weighted average ceding commission for all in-force new and renewal business of 37.5%. The net effect of these changes to both our auto and our home quota share are expected to have a small impact on our earnings as we continue to provide volatility, protection and surplus relief that are in line with our expectations. Now I'd like to give you some additional detail on our 2 operating segments. Within Property & Casualty, gross written premium declined 4.2% to $1 billion, driven by lender-placed insurance and personal auto. Service and fee income grew 7.6% to $113.1 million driven by personal auto. The P&C combined ratio was 92.6% versus 92.9%, excluding amortization of intangible assets. The loss ratio was 72.6% compared to 73.5% in the prior year quarter, reflecting lower accident year loss ratios primarily in our monoline auto book, offset by unfavorable prior year development, primarily in auto liability of $10.4 million.

The expense ratio was 20%, which compares to 19.4% in 2Q '18. Overall, in our auto book, net trend, defined as loss trend divided by premium trend, are moderately favorable, thereby helping our year-over-year accident year results. We attribute this to continual favorable frequency trends, reflecting pricing segmentation and better risk selection from our RAD 5.0 product and our new RAD 6.0 product as well as mix shift within our portfolio. Severity trends are moderately better than industry trends, which we attribute to mix shift and continued claims initiatives. Now within our Accident & Health segment. Gross written premium grew 9.5% to $171.7 million, which benefited from strong growth in our group and individual products. Service and fee income grew 23.3% to $52.9 million versus $42.9 million in the prior year quarter. The growth was driven by group administration fees, third-party agency distribution and technology fees. The Accident & Health combined ratio was 82.6% versus 88.6% in the prior year quarter, excluding noncash amortization of intangible assets. The loss ratio was 52% versus 56.6% in the prior year quarter.

The loss ratio reflects continued improvement in the current accident year loss ratios for both the small group self-funded and individual products. We also had continued favorable prior year development of $8.1 million. The expense ratio was 30.6% versus 32% in the prior year quarter. I'd like to echo Barry's excitement about the strong growth in earnings resulted this quarter and really demonstrating the power of National General.

I'd now like to turn the call over to moderator to open up the call for questions.

Questions and Answers:

Operator

[Operator Instructions] And the first question is coming from Matt Carletti. Your line is live.

Matthew Carletti -- JMP Securities -- Analyst

Thanks Matt Carletti with JMP Securities. Just a couple of questions. I think I'll start with -- if you could expand a little on your comments on auto in terms of competition? Can you talk a little bit about what you're seeing there? You mentioned some competitors that are getting aggressive and kind of slowing down the shopping cycle. Are there particular geographies you're seeing it more than others? And kind of how has that evolved over, say, the past few months? Is it intensifying? Does it seem to be kind of a second quarter phenomenon, and you're seeing less of it in July? Any color you could give there?

Barry Karfunkel -- Chief Executive Officer and Co-Chairman of the Board

Yes, we are -- it's mostly -- it's definitely Q1 and into Q2, as we discussed. We do not see it intensifying. It's very much on a state-by-state basis. So in a couple of states, it is a soft market and quite competitive in other states. We don't see that. So that is -- it's very much on state-by-state basis.

Michael Weiner -- Chief Financial Officer

Matt, I think I'd like to just add one thing to that. One thing that we do look at here in many different ways is we look at both frequency and severity trends, us versus the industry, in multiple different dimensions of looking at it. As I alluded to earlier, though, if you look at the frequency trends, we continue to do better than the industry in a decreasing frequency environment. But severity has picked up both sequentially in all of the other measures, year-over-year, rolling 4 quarter, 8 quarter, 12 quarter so on. So -- and we continue to do better at -- so our severity is going up at a lower rate. But when you ultimately look at it, the industry is just not keeping up, in our opinion, with pure premium trends. And we're not just seeing -- we're not seeing the corresponding rate actions. In some cases, you're seeing the opposite.

So I would attribute what we're seeing in the market now to what has happened, probably about 2, 2.5 years ago, where a lot of competitors took that growth, really underpriced the business and then had to pull back in the preceding quarters. As Barry alluded to in his comments, we're not going to chase that business, we're just going to focus on our underwriting margin, and we'll go the ups and downs in the cycle.

Matthew Carletti -- JMP Securities -- Analyst

All right. And then just one more question related to the changes in the quota share reinsurance programs. Specifically, can you talk a little bit about if there are any implications in terms of your capital needs or excess capital off of that? And if I recall, when they were put in place, the big reason was because they were just really kind of superior forms of capital to other forms of capital you could get. Do the changes in ceding commission change that materially, not at this moment in time, but just as you think out longer term?

Barry Karfunkel -- Chief Executive Officer and Co-Chairman of the Board

No, not at all. Actually, if -- our auto margin has decreased. So that means the capital associated with our auto business, which we were ceding about 10%, has become more favorable for it. We obviously have the ability to adjust these up and down within the terms of the contract. But the other piece that we like, and it also benefits us from our cataracts' loss reinsurance, is the sideways protection on volatility we get in the property space that served us well over the last 2 years. So it's really a combination of surplus relief and volatility protection. So we made the ultimate decision on what we feel comfortable with, with the most de minimis impact to our earnings going forward. So if you were just to kind of roll forward what these financial impacts are going to be for us, it's a de minimis, something like, a 0.3% combined ratio impact for us going forward for the next 12 months.

Matthew Carletti -- JMP Securities -- Analyst

Thank you very much.

Barry Karfunkel -- Chief Executive Officer and Co-Chairman of the Board

thank you.

Operator

And the next question is coming from Randy Binner. Your line is live.

Randy Benner -- Randy Benner -- Analyst

Oh hi I'm with B. Riley. And the first question I have is just on the reserve changes in the quarter for prior year development. So in auto, I think, you all mentioned that part of it was from the nationwide renewal book, but was there another piece that drove it? And overall, I think, it's all related to auto liability. Can you expand on what are the other pieces and confirm it from the liability side?

Michael Weiner -- Chief Financial Officer

Sure. Actually, it's nothing to do with Nationwide, the PPD. So we had about -- PYD, I should say, I apologize. So we had about $10 million of unfavorable P&C activity. We have about $5 million, planned $5.5 million to be exact, favorable. So on a year-to-date basis, it's about $4.9 million unfavorable. All of that came from auto liability, with the vast majority of it came from small business auto. Specifically, we're seeing higher volume of tort cases with attorney rep claims, pretty much the same as everybody else is seeing in the industry. What we do here now is just a little different than others potentially in the industries, we do a full reserve study every single quarter, we view a $10 million movement as just normal variations in any quarterly movement. And it's really our best view at this point. What I'll point to, as I alluded to earlier, is that $4.9 million unfavorable PYD, P&C, but total for the -- for both -- for the year, we're about 14.1% favorable when you take into account the A&H business.

Randy Benner -- Randy Benner -- Analyst

Yes. And there -- was that development in stop loss? Or was it another area of their products there?

Barry Karfunkel -- Chief Executive Officer and Co-Chairman of the Board

The vast majority of it was in stop-loss. And again, this is very, very short-tail business. So if you think about it, just the definition of what prior year development is, not all of our policies are written on 1:1 to 1:1. So you could have development in quarter 3 and quarter 4 of a policy that you've written in the third quarter of last year that shows up as prior year development, but we continue to see a very favorable trend in that business. I would not consider that favorable development to continue going forward, but it's been good for us.

Randy Benner -- Randy Benner -- Analyst

And then just one more on A&H. Can you share kind of any progress or updates on initiatives that you've put in place to potentially see better selling and top line results in the open enrollment period, which will be the fourth quarter?

Michael Weiner -- Chief Financial Officer

Yes, sure. So we do a solid job of staffing up our internal agencies. We are in the process of -- we're going to be rolling out our new segmented product in the coming months in advance of open enrollment period, which should really bring a degree of rating sophistication to the lines of business that does not currently exist in the marketplace. And we've been working on a couple of our marketing assets, launching our new branded product in advanced -- direct-to-consumer product in advance of open enrollment period as well as acquiring a couple of domain names and being less dependent on the external lead generation space for business and quotes to drive our direct-to-consumer operations going forward.

Randy Benner -- Randy Benner -- Analyst

All right.

Michael Weiner -- Chief Financial Officer

Thanks for that thank you.

Operator

Next question is coming from Christopher Conlon [Phonetic]. your line is live.

Chris Campbell -- ANALYST

Yes. So it's Chris Campbell from KBW. Congrats on the quarter. I guess, my first question is just a small one on the reserves. So on the auto, it sounds like most of the auto liability was coming from commercial auto. What accident years was that?

Barry Karfunkel -- Chief Executive Officer and Co-Chairman of the Board

It's pretty much spread over a few accident periods. I think it's probably '15, '16 and '17. '18 and '19 continue to be a little bit better.

Chris Campbell -- ANALYST

Okay. Great. And then just kind of moving to the personal line side, what rates are you guys seeing in your personal auto, homeowners and then the RV books?

Michael Weiner -- Chief Financial Officer

We -- we're taking rates in line with trends. Yes, we're taking rates equal to what our peer premium trend is. So I think our overall rate environment is probably 2% or 3% in the business. And that's really blended by both our direct-to-consumer, our independent agent, our standard and our standard preferred as well as the RV. So each one is going to differ, and obviously, the geographic nature of it's going to be. But the most important for us, and I'll reiterate again, is that we are taking rate not below our peer premium trends. We don't get caught behind the curve.

Chris Campbell -- ANALYST

Got it. So the 2% to 3% that you're taking on an aggregate level would basically equal what you're seeing in terms of your loss cost inflation. Is that the way -- is that's the right way to think about it?

Michael Weiner -- Chief Financial Officer

Correct, correct. And the average loss cost inflation industry is about that as well. But again, we look at it specifically in our book.

Chris Campbell -- ANALYST

Okay. Got it. And then I was just looking at the commercial auto premium, which was down, like, 1.4%. Now I would have expected that to increase, just kind of all the color on what everybody is taking in commercial auto. So like, what's the rate environment that you're seeing there? And then just how much of, like, the overall growth is rates versus exposure changes?

Michael Weiner -- Chief Financial Officer

The vast majority of that decrease is going to be exposure changes, but you used the word commercial vehicle a minute ago. This is really small business auto, so it's hard for us and while there are larger limits for NatGen, there are by no means large limits in the industry. We're writing small artisan fleets of contractors. So I think that's a bit of a difference between us and the industry. I would say, though, the vast majority of that is we're -- I would say, we're pulling back, but particular areas like New York and some other areas where we've seen just these higher tort cases. We're just going to pull back capacity and sign our underwriting guidelines where we can.

Chris Campbell -- ANALYST

Okay. Got it. That's very helpful. And then just kind of a last one on LPI. So I guess, like, just -- can you walk us through some of the dynamics of what you're seeing there? I think Barry had mentioned increasing tracked loans. So I guess how many loans are you currently tracking? What's your market share? And then how is your reinsurance designed for that product line?

Michael Weiner -- Chief Financial Officer

Sure. Let me kick it off and throw it over to you, Barry. We don't actually disclose our loan growth, and that we're probably arguably a distant second in terms of the industry. But the dynamics of, and Barry alluded to it when he made the comment, that the tracking volume of being up 40-something percent isn't going to drive 40-something percent of gross written premium. Again, it goes by penetration rates. You track these loans, the higher quality loans have a lower penetration rate than potentially some of the more non-standard or sub-prime loans, and we continue to onboard a higher quality client portfolio from that perspective. And as far as reinsurance goes, it goes into our property cat or "home treaties" for that. So we get that sideways protection as well as we get the top-of-the-house protection through our access loss policies.

Chris Campbell -- ANALYST

Got it. And do you get, like, separate pricing on that? Because, I mean, the way I think of LPI is just a strip down homeowner's policy with less coverage and it's kind of more expensive, just in general. So I mean, do -- that seems like it would be more attractive for the reinsurers. So do you get like a higher ceding commission on that?

Michael Weiner -- Chief Financial Officer

Absolutely. So that's a great, great question. So we actually -- the quota share that we're running off right now, we got to the new one, our initial quota shares that -- which we published was at a 42.5%, and then we redid it. We expanded it to 38% about the second quarter of last year. The vast majority of that decrease was that we had less lender-placed premium. We can't control that. And that lender-placed premium -- if that disproportionately goes higher, that will make the ceding commission on our property business go higher. So it's more attractive to the reinsurers in that perspective. But unfortunately, for us, is that we don't control penetration rates, right, the market as a whole does. So if penetration goes higher and that mix shifts, we could see a better ceding commission moving forward in our portfolio in total, again, market conditions aside.

Chris Campbell -- ANALYST

Thanks.

Michael Weiner -- Chief Financial Officer

Thank you.

Operator

And the next question is coming from Jeff Schmitt. Your line is live.

Jeff Schmiditt

Good morning Jeff Schmitt with William Blair. Question on the personal auto growth, obviously, coming down, but it sounds like you're still getting rate at 2% or 3% in line with loss cost trends. What about the nonstandard auto book, in particular? How does that -- how do the competitive levels look there compared to the standard?

Barry Karfunkel -- Chief Executive Officer and Co-Chairman of the Board

It is the same. Mike's earlier comment reflects -- they're centered on the total auto book.

Jeff Schmiditt

Okay. And could we get a sense on -- I know you said you had terminated some MGA relationships. Could we get a sense on the size of that?

Barry Karfunkel -- Chief Executive Officer and Co-Chairman of the Board

It's -- ex those determinated relationships as well as the boosts that we would have -- we received in the 2018 Q2 to our top line. If you would remove those items, we would have been marginally up year-over-year.

Jeff Schmiditt

Okay. And just looking at the ceding commission, actually, on the A&H side it has bounced around, I guess, quite a bit. It's almost $4 million in the quarter, $2.5 million last quarter. How should we think about that going forward?

Michael Weiner -- Chief Financial Officer

Yes. Well, the vast majority, we retained pretty much all of our business in our Accident & Health business from a quota share perspective, with the exception of our EuroAccident business or our European business, which we have on one of our large products there, but a 90% quota share. So their mix of business changes. So a lot of that business from a gross written perspective is written in the first quarter; the other business comes through on that. So I think for the remaining piece of the year, you'd want to keep that gross to net on a steady-state basis in A&H. Keep in mind also, though, that the other A&H of the domestic business is growing at a much faster rate than our European business.

Jeff Schmiditt

Thank you.

Michael Weiner -- Chief Financial Officer

Thank you.

Operator

And the next question is coming from Yaron Kinar. Your line is live.

Unidentified Participant

Hey thanks This is Rob for Yaron at Goldman Sachs. I was wondering if you could talk about how the repricing and reunderwriting of the homeowners business is coming along? And if you expect any impact from the utilities wildfire fund legislation which caps subrogation?

Barry Karfunkel -- Chief Executive Officer and Co-Chairman of the Board

I'll let you talk to the subrogation, but in terms of California, we're working to be able to underwriting again the nonrenewing the wildfire exposed areas as we've discussed. And as far as all other states, we're taking great increases in the line with our rate indication and pure premium trends, overall. Mike, on the subrogation?

Michael Weiner -- Chief Financial Officer

Yes. It's a very fluid situation out there in California. We've been talking to a lot of representatives out there as well as our claims staff. I don't actually have a great opinion on what that's ultimately going to mean for us and as far as the subrogation or claims rights against the utility.

Unidentified Participant

Okay. And just a second question. Aside from the terminated client in the lender-placed business, just thoughts on premium trend there?

Barry Karfunkel -- Chief Executive Officer and Co-Chairman of the Board

Well, the premium trend there, I think, is going to pick up. So we talked about that client that left us last quarter and that's called a flat cancellation. So all that premium kind of goes off at that period of time. We started in July, in earnest, onboarding some new clients. Those client premium, while we're tracking day 1, those premiums going to earn in over a period of time as we place new business on that. So it's going to take a year or so for the steady state environment. So if you kind of look at our business in totality, I think we'll get back to a run rate basis early in next year where we were in 2018, that $80-ish million range.

Operator

And there were no further questions from the lines at this time.

Unidentified Speaker

Thank you all for joining. We look forward to speaking to you next quarter.

Barry Karfunkel -- Chief Executive Officer and Co-Chairman of the Board

Thank you.

Operator

[Operator Closing Remarks]

Duration: 31 minutes

Call participants:

Unidentified Speaker

Barry Karfunkel -- Chief Executive Officer and Co-Chairman of the Board

Michael Weiner -- Chief Financial Officer

Matthew Carletti -- JMP Securities -- Analyst

Randy Benner -- Randy Benner -- Analyst

Chris Campbell -- ANALYST

Jeff Schmiditt

Unidentified Participant

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