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Employers Holdings (NYSE:EIG)
Q3 2019 Earnings Call
Oct 24, 2019, 11:30 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:


Operator

Ladies and gentlemen, thank you for standing by, and welcome to the Q3 2019 Employers Holdings Inc. earnings conference call. [Operator instructions] Please be advised that today's conference is being recorded. [Operator instructions] I would now like to hand the conference over to our speaker today, Lori Brown, general counsel.

Thank you. Please go ahead.

Lori Brown -- General Counsel

Thank you, Jimmy. Good morning, and welcome, everyone, to the third-quarter 2019 earnings call for Employers. Today's call is being recorded and webcast from the Investors section of our website, where a replay will be available following the call. With me today on the call are Doug Dirks, our chief executive officer; Steve Festa, our chief operating officer; and Mike Paquette, our chief financial officer.

Statements made during this conference call that are not based on historical fact 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 development.

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 Investors section of our website. Now I will turn the call over to Doug.

Doug Dirks -- Chief Executive Officer

Thank you, Lori, and thank you all for joining us today. Our third-quarter and year-to-date results were highly favorable, and the accident-year results were broadly in line with our expectations. Within property and casualty insurance, workers' compensation continues to be on a relative basis a much more attractive line of business and consequently remains highly competitive. Notably, we are finding that the smaller end of the middle market is prone to the most aggressive pricing behaviors.

Our business model focuses on small low-hazard accounts. Compared to the middle market, this business is characterized by less competition, less price sensitivity and higher persistency, and therefore is more resilient to pricing changes. This is confirmed with the high unit and premium retention rates we are achieving in California on our smaller accounts despite our recent rate actions. We remain focused on alleviating or eliminating friction in the sales process, be it for our agency partners or through the Cerity, direct-to-consumer platform.

Cerity is currently open for business in 24 states in the District of Columbia and is rapidly expanding nationally. We continue to execute on our plan of accelerated development and implementation of digital IT capabilities that benefit and support both our agency force, as well as our direct customers. During the quarter, we delivered a 9.3% annualized return on adjusted equity. We also maintained our current accident-year loss ratio at 65.5%, delivered a combined ratio before the impact of the LPT of 92.4% and grew our book value per share, including the deferred gain, by 3.8%.

Our top line was negatively impacted by the meaningful rate increases we recently undertook in California to address of what we considered to be generally unfavorable pricing trends in the market. The decrease in new business premiums was expected and we are committed to remaining proactive in terms of ensuring rate adequacy, while remaining competitive in the marketplace. We have and will continue to protect the margins, even if that requires actions that have unfavorable impact on the top line and the expense ratio. And now I'll turn the call over to Steve for additional detail on our new business strategy.

Steve Festa -- Chief Operating Officer

Thank you, Doug, and good morning. Net written premium for the quarter of $165 million was down $22 million or 11.9% from the third quarter of 2018. The quarter over decline in net written premium is principally the result of decreases in premium related to final audits and a decrease in new business writings in California due to our increased rates, which were effective for new and renewal business as of July 1, 2019. With respect to the decrease in final audit premium, we continue to see payroll growth on existing policies, but at a slower rate this quarter relative to last year's third-quarter growth.

Our results for the quarter appear to be in line with the observations outlined in the September ADP National Employment Report, which noted that average monthly job growth for the past three months is down 32% from the same period last year. New premium decreased quarter over quarter by $9.5 million. This decrease is directly related to our July 1 rate filing that increased pricing in California, our largest state. Excluding California, new business grew by $2.2 million quarter over quarter.

Importantly, we believe that workers' compensation loss trends remained favorable, but significant pricing headwinds persist. Renewal premium continues to be strong as evidenced by an $8.8 million increase for the quarter. Our unit retention also improved. Our current unit retention rate is at 95.3%, which is up from 93.5% in the prior-year period.

At this point, our renewal retention rate continues to be strong in California as well, especially in our small business book. The strong persistency, as well as the increased rates in California have been key contributors to our renewal premium growth. Overall, on a year-over-year basis, we grew our in-force policy count by 7.4%. During the quarter, we entered the state of Hawaii.

As a result, we have now completed our national footprint. This footprint now allows us to capitalize our new business opportunities and partnerships that were not previously available to us. With that, I'll turn the call over to Mike for a further discussion of our financial results.

Mike Paquette -- Chief Financial Officer

Thank you, Steve. Our third-quarter loss and LAE ratio before the impact of the LPT of 54.2% was 2.4 points lower than a year ago. During the quarter, we recognized $20 million of favorable prior-year loss reserve development relating to nearly all prior accident years versus $12 million of favorable development recognized a year ago. Our third-quarter commission expense ratio of 12.5% was 0.4 percentage points lower than a year ago, primarily as a result of a decrease in projected 2019 agency incentive commissions, which were directly impacted by reductions in premiums written.

Our third-quarter underwriting and other operating expense ratio of 25.8% was meaningfully higher than a year ago. The reduction in earned premium for the quarter represented 2.4% of the 5.8 percentage point increase, with the balance representing expenses associated with the accelerated development and implementation of our digital technologies and capabilities, including those of Cerity. As discussed in the past, we have worked to accelerate these expenses into a tighter period, and so far we are pleased with the results. We expect to have greater clarity into our anticipated expense ratio for future years as we move forward into the fourth quarter and early 2020.

Moving to investments. Net investment income for the quarter was $22.3 million, up 10% from a year ago. Our pre-tax book yield on the portfolio was 3.4% for the quarter versus 3.3% a year ago. At quarter-end, our fixed maturities had a duration of 3.6 and an average credit quality of A+ and our equity securities and other investments represented 11% of the total investment portfolio.

Our current duration is lower than the 4.4 reported a year ago due to recent investments we've made in variable rate bank loans, as well as changes in prepayment speed assumptions affecting our mortgage-backed securities. During the first nine months of 2019, we benefited from $134 million of pre-tax investment gains. Our portfolio of fixed maturities increased in value by $104 million, which is reflected on our balance sheet, and our equities and other investments increased in value by $30 million which is reflected on our income statement. These investment gains were the primary driver of our 16.5% year-to-date increase in book value per share, including the deferred gain.

And finally, during the quarter, we repurchased $4.7 million of our common stock at an average for price of $42.22 per share, and our remaining share repurchase authority currently stands at $48 million. And with that I'll turn it back to Doug for his final remarks.

Doug Dirks -- Chief Executive Officer

Thanks, Mike. As we move through this segment of the cycle, our favorable view of the broad workers' compensation environment remains unchanged. Frequency and severity continue to be stable to falling, and general economic conditions continue to support growth, albeit currently at a slower pace than in recent period. As a nimble mono-line insurer, we have experience, data, tools and a perspective that allows us to closely monitor changes in the market and to react quickly to changing conditions.

And with that operator, we'll open the call up to questions, please.

Questions & Answers:


Operator

[Operator instructions] Our first question comes from Matthew Carletti with JMP Securities. Your line is now open.

Matthew Carletti -- JMP Securities -- Analyst

Hey, good morning. I just had a few questions. Maybe first might be for Steve or Doug. Regarding the growth, can you break apart hopefully both kind of renewal retention and new business production California versus ex California, so we can get an idea of kind of what the newer states are doing versus the rate actions in California?

Steve Festa -- Chief Operating Officer

Sure, Matt. This is Steve. I'll take that. So for the new business production for the quarter, quarter over quarter, California was down $11.7 million over the prior comparable period last year, and we saw a $2.2 million increase in premium in the other states.

We also saw in the other states, quarter over quarter, a 17% increase in policy count in those states. So the policy count percentage obviously is higher than the premium growth percentage because of the rate declines we've seen in those other states. From a unit retention standpoint, at renewal, the California, since we implemented the July rate hikes, the retention rates have held up very steady, especially, in particular, on our accounts 25,000 and below. We've seen a little bit of slippage on those above 25,000.

But the accounts that were sticking, which were the majority of our accounts, they're getting that higher rate attached to it. So in California, for the third quarter, we actually grew our renewal premium in California more so that we had the prior two quarters of the year.

Matthew Carletti -- JMP Securities -- Analyst

OK, great. Very helpful. And then maybe one more number just so we can kind of get the comparables going forward. Do you have kind of what the audit premium impact was a year ago, Q4 and then maybe even Q1 this year as we think about that...

Steve Festa -- Chief Operating Officer

No, no. What I do know is that the audit impact to quarter over quarter was a $16.7 million decrease. About 60% of that came through the -- even though we're still seeing payroll growth, the slower growth, about 60% of that number came from that. And about 40% of that came from a process change that we implemented, that elevated the audit numbers in the third quarter of last year and they declined this year, with some of that moving into premium renewal because through endorsement processes.

Matthew Carletti -- JMP Securities -- Analyst

OK, got it. So it sounds like the year ago was maybe a little bit tougher comp because of that process than otherwise would have been.

Steve Festa -- Chief Operating Officer

Yes, that's true. And then we'd expect to see a little bit of that residual carrying over into the fourth quarter, but we expect that to normalize by next year.

Matthew Carletti -- JMP Securities -- Analyst

OK, great. And then just one another question, this one probably for Mike, just on net investment income. Can you give us kind of your expectation going forward -- I know we have a bank loan portfolio now. It's largely variable rate, has been movements in interest rates lately.

Has that kind of all been captured in what we're seeing already? Or do we need to think about kind of how that flows through in the next few quarters in terms of NII run rate?

Mike Paquette -- Chief Financial Officer

So Matt, so as you can see, we had a big increase in our net investing income this quarter and a lot of that is because of the change in allocation in the roughly $200 million of bank loans as you mentioned. So whereas we are higher than we were a year ago, I'm not entirely sure how much higher we go from here where rates sit where they currently do. I do think we're probably at a decent run rate for this quarter. But I wouldn't expect a lot of inflation from here until things change.

Matthew Carletti -- JMP Securities -- Analyst

All right. Great. Thanks a lot for the answers.

Operator

Thank you. And our next question comes from Mark Hughes from SunTrust. Your line is now open.

Mark Hughes -- SunTrust Robinson Humphrey -- Analyst

Yes, thank you. The audit decreased. Steve, did you say $16.7 million was the magnitude of the decrease?

Steve Festa -- Chief Operating Officer

Yes, Mark, quarter over quarter, that's the amount, $16.7 million.

Mark Hughes -- SunTrust Robinson Humphrey -- Analyst

And how much was that technical change, did you say that was 40% of that?

Steve Festa -- Chief Operating Officer

40% of that is due to that.

Mark Hughes -- SunTrust Robinson Humphrey -- Analyst

OK. And you say that is sort of this quarter and next quarter, but then it normalizes...

Steve Festa -- Chief Operating Officer

Yes, that will normalize because we worked our way through the year-over-year process change. That normalizes as we move into 2020. But the 60% of that figure came from -- as I said before, we're still seeing payroll growth, just so I want to make that very clear, but the rate of that growth has slowed and that seems to be in line with some of the other reports that came out in September, I referenced at least one of those already.

Mark Hughes -- SunTrust Robinson Humphrey -- Analyst

Yes. And did you -- I think you gave a number. I'm not sure if I wrote it down. The renewal premium growth overall.

Steve Festa -- Chief Operating Officer

Oh, yes, the renewal premium for the quarter over quarter was up $8.8 million, including growth in California.

Mark Hughes -- SunTrust Robinson Humphrey -- Analyst

Right. And when you calculate the renewal premium, that's just your existing book of business, the 94% or so that you retain, 95.3% unit retention. You calculate the renewal change and on that cohort is up $8.8 million?

Steve Festa -- Chief Operating Officer

Right. So that renewal growth is really -- we have a higher base because of the growth we had last year to start with. We saw rate increase on our renewable book in California and then increasing our retention rate. So all three of those characteristics lead to the $8.8 million increase in renewal production, despite declining rate environments in all the other states we do business in.

Mark Hughes -- SunTrust Robinson Humphrey -- Analyst

Right. So when we think about it, it's really the audit decrease that's the kind of the key issue here. Your renewal premium is up. Your new business is down about the same amount.

So it's the audit premium and 40% of that is the process change. Am I looking at that properly?

Steve Festa -- Chief Operating Officer

Yes. If you look at the renewal production being up $8.8 million and the new production being down $9.5 million, but outside of California up $2.2 million, it's the audit. That's the primary driver this quarter. And audit can be volatile.

We don't necessarily extrapolate what's happening this quarter to the next quarter. The other thing that I would call out on the new business production, for the final month of the quarter, September, we actually saw some growth in new business production, driven by the states outside California.

Mark Hughes -- SunTrust Robinson Humphrey -- Analyst

So you're saying net growth in new business production.

Steve Festa -- Chief Operating Officer

In the month of September.

Mark Hughes -- SunTrust Robinson Humphrey -- Analyst

Is that year over year or is that...

Steve Festa -- Chief Operating Officer

Yes, that's comparing -- yes, year over year. September over this year to September prior, we grew.

Mark Hughes -- SunTrust Robinson Humphrey -- Analyst

OK. I don't think you gave the average rate or average pricing. I think you've done that in the past in California or otherwise. Anything you can share this time around?

Steve Festa -- Chief Operating Officer

Well, for the company as a whole, the average rate decrease on renewals which we talked about in the past for the quarter over quarter was 8.4% and year over year was 11.8%.

Mark Hughes -- SunTrust Robinson Humphrey -- Analyst

So 11.8% versus 3Q last year.

Steve Festa -- Chief Operating Officer

11.8% on the year on year and then 8.4% on the quarter on quarter.

Mark Hughes -- SunTrust Robinson Humphrey -- Analyst

OK. In California, I think you have said you need to increase rate because of the rate competition. How are loss trends in California? I would assume that it's your need for rate is going to be driven by your loss outlook rather than the price competition. Am I thinking about that properly? And what is your outlook for losses, roughly speaking?

Steve Festa -- Chief Operating Officer

Well, we said this before, Mark, and our prospective hasn't changed even with three months more worth of data. The loss environment in California still seems to be very favorable to us. Any industry as a whole, we're seeing, as Doug alluded to earlier on the call, frequency and severity appears to be very stable. The reforms are still holding up very, very well in California.

But I think we call this out on the last earnings call, if you look at the industry, the average charged rate, not filed rate, but charged rate in California since 2015 is down 33% and it's the lowest charged rate since 1976 and that data comes from the WCIRB. So as we said before, we just feel like the pricing decreases have reached the inflection point, where the need was justified for us to do the rate hikes that we made in California effective July 1. So it's not a deteriorating loss environment. It's just that we feel that the pricing has declined so much, the rate has declined so much over the course of the past several years that there will be deterioration in loss ratio if the pricing doesn't change.

Mark Hughes -- SunTrust Robinson Humphrey -- Analyst

Did you overshoot on the downside. Is that what you're saying?

Steve Festa -- Chief Operating Officer

I don't think so. I wouldn't say that. I would just say that we're noticing trends that we think are very appropriate visual into the future that now is the time to make that change. Even though we're taking that move without seeing much in that way from a competitive standpoint, we think it's the time to do it now based on the rate decreases that have occurred, that were justified in the past.

But we think it's time to make the rate increase that we did for July.

Mark Hughes -- SunTrust Robinson Humphrey -- Analyst

And then I'll ask one more, and I apologize to ask so many. But Doug, on Cerity, could you give us some updated thoughts kind of how you're seeing your marketing strategy, distribution strategy evolve? Are you still anticipating breaking out any financials or operating metrics in the K on Cerity?

Doug Dirks -- Chief Executive Officer

At this point, Mark, we're not breaking out any detail. It wouldn't be material to the results. We're really focused on getting the company stood up as quickly as we can. So getting the licenses in place, getting rate and form filings done.

As I indicated, we're now in 24 states in D.C. So we've made very good progress over the last quarter. Within the last day or two, we just added five more states to that. So they are starting to roll in fairly quickly.

In terms of marketing, there's still quite a bit of testing going on in terms of what is the best approach. We're still trying to identify where the customers are and how we get to them. There are a number of things that are ongoing, some of which I'm just not prepared to comment on yet, but certainly we're working very diligently to build that market out. As we've said, this isn't going to happen overnight, but we think it's inevitable.

It is taking different shapes than maybe we expected. We're finding different customers than we initially had planned. But that's not surprising either as the market is developing as rapidly as this one is. So we continue to be optimistic, but it will be sometime before this has a meaningful impact on the overall results.

Mark Hughes -- SunTrust Robinson Humphrey -- Analyst

Thank you.

Operator

Thank you. And our next question comes from Bob Farnam with Boenning and Scattergood. Your line is now open.

Bob Farnam -- Boenning and Scattergood, Inc. -- Analyst

Yes, thanks, and good morning. I guess a follow-up question on the Cerity comments. Do you plan on using Cerity, the insurance company, as another pricing tier for your independent agent business? Or are you not going to be able to use Cerity in that fashion going forward?

Doug Dirks -- Chief Executive Officer

Yes, we don't think of it as another pricing tier for our agents. We're certainly aware of other companies that are doing that. And at this point, we're not planning that. It has a unique rate filing.

It is separate from all of the other Employers companies. There are different customers. It is a different channel, but there are different channels in pursuit of different customers. And we think that's a significant distinction.

Bob Farnam -- Boenning and Scattergood, Inc. -- Analyst

OK. And did you -- pardon me if I missed it, but did you have any -- the amount of the rate increase you charged in California effective 7/1, how much did the rates go up?

Steve Festa -- Chief Operating Officer

Yes, it went up. So it depended upon the territory. We have four territories that we price in California. The net for the state as a whole is about 8%.

Bob Farnam -- Boenning and Scattergood, Inc. -- Analyst

OK. And more -- I assume -- it seems like the Los Angeles County always seems to be the kind of a more litigious environment, so more -- high rates down there and lower rates the rest of the state?

Steve Festa -- Chief Operating Officer

Bob, you're exactly right. Yes, the rate is higher in L.A. -- the rate increases higher in L.A. than the rest of the state.

Bob Farnam -- Boenning and Scattergood, Inc. -- Analyst

OK. And have you seen any competitors following suit? Or is this still kind of you guys standing on your own?

Steve Festa -- Chief Operating Officer

Well, we haven't seen any competitors raise their rates yet, not just yet. But what we have seen very recently is what I'll call noticeable moderation in some of their recent filings when compared to previous filings. So I would call that out as a movement that we're noticing.

Bob Farnam -- Boenning and Scattergood, Inc. -- Analyst

OK, great. I think that's all I had for questions remaining. So thanks.

Steve Festa -- Chief Operating Officer

You're welcome.

Operator

Thank you. [Operator instructions] Our next question comes from Ronald Bobman with Capital Returns. Your line is now open.

Ronald Bobman -- Capital Returns -- Analyst

Hi. Thanks a lot. And I applaud your rate action in -- it's tough to zig when everyone else is zagging. So it's quite impressive.

Could you expand on that last point that you had referred to about competitor action. I think you sort of saying sort of moderating, could you expand on that with a little bit more specifics?

Steve Festa -- Chief Operating Officer

Sure. We have access to some data that calls out what companies in California are doing with respect to their filings. And when I say that we noticed noticeable moderation, what I -- if you would have looked back the last three to four years, you'd see some pretty large rate decreases in the filings. The moderation comes into play when you look at the recent filings, and you see that at least in the case of one company, it recently saw filing where it was flat, not up, but -- at this point but flat and several other companies where it called out a much lower a decrease percentage than we've historically seen.

So when I say noticeable moderation, that's what I'm referring to.

Ronald Bobman -- Capital Returns -- Analyst

OK. And I think in the past, over many years of following the company, you sort of educated us that all the companies have a fair bit of latitude on offering sort of credits and debits to sort of filed rates. And so when you speak to sort of -- when you speak about rate filings here, that action that I should think that sort of dwarfs flexibility that companies could otherwise effect by way of issuing or not issuing credits?

Steve Festa -- Chief Operating Officer

That's correct.

Ronald Bobman -- Capital Returns -- Analyst

OK.

Steve Festa -- Chief Operating Officer

That is correct.

Ronald Bobman -- Capital Returns -- Analyst

All right. Thanks a lot, gentlemen, and again, well done.

Steve Festa -- Chief Operating Officer

Thank you.

Operator

Thank you. And I'm showing no further questions in the queue at this time. I'd like to turn the call back to Doug Dirks for any closing remarks.

Doug Dirks -- Chief Executive Officer

Very good. Thank you, everyone, for your participation today. Again, we're very pleased with the results for the quarter. We continue to have a very strong conviction that what we're doing in California is the right move and we will continue to pursue the strategy.

It's doing exactly what we thought it would. Thank you all, again, for participating. And we look forward to speaking to you early next year with our year-end results. Thanks.

Have a great day.

Operator

[Operator signoff]

Duration: 31 minutes

Call participants:

Lori Brown -- General Counsel

Doug Dirks -- Chief Executive Officer

Steve Festa -- Chief Operating Officer

Mike Paquette -- Chief Financial Officer

Matthew Carletti -- JMP Securities -- Analyst

Mark Hughes -- SunTrust Robinson Humphrey -- Analyst

Bob Farnam -- Boenning and Scattergood, Inc. -- Analyst

Ronald Bobman -- Capital Returns -- Analyst

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