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National General Holdings Corp (NASDAQ:NGHC)
Q3 2019 Earnings Call
Oct 31, 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 3Q 2019 Quarterly Earnings Conference Call. [Operator Instructions]

It is now my pleasure to turn the floor over to your host, Paul Anderson. Sir, the floor is yours.

Paul Anderson -- Director of Investor Relations

Thank you. Good morning, and welcome to the National General Holdings Corp. third quarter 2019 earnings conference call. My name is Paul Anderson, Director of Investor Relations. 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 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. 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 third quarter 2019 earnings, which is available in the Investor Relations section of our website at 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, Paul. Good morning and thank you for joining our third quarter earnings conference call. While our overall combined ratio came in inline this quarter, our P&C segment underperformed while our A&H segment outperformed.

Diving into the issues that caused our P&C underperformance. We realized prior year adverse development of $14.9 million during the quarter related to small business auto and driven primarily by higher jury verdict and what we believe was increased litigation financing and higher limit policies. In response to that, we are taking the underwriting actions that include cutting out high limit policies for certain business, classes and territories. There are a host of other actions that we will be taking which I won't review on this call, but we believe we have taken the appropriate actions with respect to this product line. Our lower limit business remains profitable. Also contributing to our P&C results were elevated non-CAT weather claims in the Midwest during the quarter, which had a $4 million net impact on our property book. We also had prior quarters CAT development, which had an approximate impact of $5 million.

Lastly, we added some significant new accounts for our lender-placed product. Within LPI, we start tracking the loans on day one, but first policy is in place until 100 days out and accounts doesn't reach a mature level until one year out. Given our recent account additions, loans tracked increased by 45% in the last year, which leads to an expense increase without a meaningful offset from revenue. This product line is performing well in accordance with our expectations.

Our personal auto product is performing extremely well. While our total personal vehicles gross written premium increased by 6.7% year-over-year, our direct-to-consumer business, which now comprises roughly 19% of our total personal auto business has increased by 17% year-over-year with strong margins. Contributing factors are: we just completed a rebrand of our direct auto business; we have taken an extremely analytic approach to targeting customers based on their likelihood of converting, retaining and performing well from loss ratio standpoint, which is starting to pay dividends; we're in the process of revamping our online, e-com experience, which we expect to significantly increase our core completion and conversion rates; and we're just now starting to enter states where we have great product on the independent agency channel and leveraging that for our direct-to-auto brands.

A special thanks to our direct marketing team for their amazing work. While our growth on the independent agency channel is more muted, based on pure premium trends that we see, we believe the market softness should begin to subside. As I'm sure many of you have read that industry pure premium is increasing with it being up year-over-year by roughly 2.8% as of Q2, driven primarily by BI severity, while vehicle consumer price index has been increasing by 1.6%. We've been staying out in front of that trend by taking rate equal to loss costs. When the industry catches up to pure premium trends, our independent agency business should be a primary beneficiary of that.

Turning to Accident and Health. Our team has been able to produce spectacular player. Our small group stop-loss business continues its strong growth with solid margins. Our individual products, which is comprised of our short-term medical and supplemental products grew at 9.4%.

We recently launched our new short-term medical product, which adds a lot more segmentation. From the beginning of September, when we launched the product, until about a week ago, our gross written premium from those states experienced a 44% year-over-year increase that is the value -- this is the value that we're able to bring to additional lines of business with the power of analytics segmentation.

Using additional data points, we have the insight into additional segments that performed well, but were being overpriced and we focused our product accordingly. I would caution you against expecting top line growth of 44% as there were offsetting factors in other states, but it's an exciting data point.

We also launched our Avera Health, direct-to-consumer short-term medical brand. We would expect Avera to be contributor to growth during this open enrollment period as well. You'll notice, our third-party fee income increased by 60% year-over-year to $26 million. This is comprised primarily of our agency and technology businesses.

One of our agency businesses that I'd like to call out is HealthCompare or HCI. When we acquired HCI in January of 2017, the top line was about $5 million annually. HCI posted revenue of $5.6 million during this quarter. We've acquired various marketing assets including the Medicare.org domain that should continue to enhance fee revenue at a -- at strong margins. Our technology product posted revenue of $11 million during the quarter. Services provided under our technology assets include a lead marketplace, comparative rating, full CRM capabilities, and data integration services for carriers with data providers and lead generators.

We acquired our CRM capabilities and added further enhancements and integrated within our other services to offer agencies a full turnkey solution. One of our clients utilizing our CRM functionality purchased the license to our CRM, which resulted in proceeds to the Company of $5.75 million. While it's not our normal course of business to pursue such arrangements, we feel extremely excited about the longer-term values that we're building and it's indicative of the value that we thus far created.

We're looking forward to closing on the sale of Euro Accident during Q1. In summary, despite the headwinds that we faced this quarter, given our diversified platform, we experienced an all-in combined ratio of 92.5%. We have a lot of exciting initiatives which we believe will continue to expand our top and bottom line.

I'd like to now turn the call over to Mike for further review of our financial results.

Michael Weiner -- Chief Financial Officer

Thank you, Barry. Third quarter 2019 net income was $63.3 million compared to net income of $60.5 million in the third quarter of 2018. Operating earnings were $68.2 million versus $70.8 million in the prior year quarter. Operating diluted EPS was $0.59 compared to $0.65 in the prior year quarter. Our results in the quarter were impacted by $11.5 million of weather losses, which compares to $35 million of losses in the prior year quarter. Catastrophic losses were lower than prior year, but we saw higher non-catastrophic weather losses. And development in our 2019 cats, which are not included in the $11.5 million number.

Third quarter 2019 included $3.9 million of net favorable prior year development versus $6 million of net favorable prior year development in the prior year quarter for the Company in total. Trailing 12-month operating return on equity was 14.5% as of September 30th, 2019. Our fully diluted book value per share grew at 19.1% from December 31st, 2018 to $18.16.

Now I'd like to give some additional details about our two operating segments. Within the Property and Casualty segment, gross written premium grew 5.9% to $1.2 billion, driven by organic growth of 3.1% and the additional premium from the acquisitions of National Farmers Union Insurance. Personal auto grew 4% organically, reflecting continued investments in our direct-to-consumer distribution. Service and fee income grew 1.4% to $115.6 million, driven by growth in personal auto.

The P&C combined ratio was 97% versus the prior year quarter at 94.4%, excluding amortization of intangible assets. The year-to-date combined ratio was 93.3%. The loss ratio in the quarter was 75.8% compared to 73.5% in the prior year quarter, reflecting unfavorable prior year development primarily in the small business auto. Liability of $14.9 million versus $7.2 million of unfavorable in the prior year quarter.

The expense ratio was 21.2% compared to 20.9% in the prior year quarter, primarily reflecting a decrease in ceding commissions on the auto quota share and lower ceding commission income. Overall, our monoline auto book net trend, defined as loss trend divided by premium trend is moderately favorable, thereby helping the year-over-year accident year results on our monoline auto. We attribute this to continued favorable frequency trends reflecting from our pricing segmentation and better risk selection from our RAD 5.0 product and our new RAD 6.0 product as well as continued mix shift within our business. Severity trends are moderately better than industry, which we attribute to mix shift and continued claims initiatives.

Within our -- now within our Accident and Health segment. Gross written premium grew $12.9 million to $162.5 million, which benefited from strong growth in our domestic group and individual products. Service and fee income grew 41.2% to $63.7 million versus $46.5 million in the prior year quarter. The growth was driven prior primarily by group -- group administration fees, third-party agency distribution and technology fees, which included the previous mentioned $5.75 million pre-tax -- sale of software licenses in the -- to a third-party in the quarter. The Accident and Health combined ratio was 70.2% versus 77% in the prior year quarter, excluding non-cash amortization of intangible assets. The loss ratio was 41.8% versus 46.8% in the prior year quarter. The loss ratio reflects continued improvement in the current accident year loss ratio for both small group self-funded and individual products.

We also had continued favorable prior year development of $18.8 million versus $13.2 million favorable development in the prior year quarter, continue reflecting strong recent accident year trends in 2018, in both our individual and group business. The expense ratio was 28.4% versus 30.2% in the prior year quarter, reflecting the increased growth in fees and third-party commission revenue in our domestic business.

Now I'd like to turn the call over to the moderator for questions.

Questions and Answers:

Operator

Thank you. Ladies and gentlemen, the floor is now open for questions. [Operator Instructions] Your first question for today is coming from Randy Binner. Please announce your affiliation, then pose your question.

Randy Binner -- B. Riley FBR -- Analyst

Hi, good morning. I'm with B. Riley FBR. And I have two questions. One, I think you mentioned in the prepared remarks that there was a new lender-placed account. I just wanted to get some more color on that if I heard that correctly?

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

Yeah, there were actually three new lender-placed accounts. We won't go into names. But they're sizable financial institutions that had the impact of increasing our track loans year-over-year by 45% and it's definitely exciting to be able to grow that business.

Michael Weiner -- Chief Financial Officer

Yeah. And also I add on to that Randy, as Barry alluded to in his prepared remarks. When we [Technical Issues] in onboarding the tracking of it, so we have an accelerated expense associated with that. And the premium on track loans where it needs to be place comes in on a delayed basis. So we have a higher expense load early on on it.

Randy Binner -- B. Riley FBR -- Analyst

Yeah, is that -- is the book of business -- is the penetration rate on the book increasing, meaning, there's more folks who are being placed into the insurance or is it just -- when you say track loans are increasing, do you mean because you're out of the accounts or because of the penetration rate on that book is increasing?

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

The loans that we actually track are increasing, but the penetration rate is stable.

Randy Binner -- B. Riley FBR -- Analyst

Yeah, it's still stable, OK. That's what I thought. And then just on the Accident and Health. Clearly, there is good result. I just kind of thinking ahead though, can you give us an update on, kind of, the initiatives around open enrollment and kind of expectations as we get -- very close to that period of time when you sell a lot of your product?

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

I can't give a specific guidance as to what's going to happen with top line. However, just based on the initiatives we mentioned in the prepared remarks that we introduced new products with increased segmentation that we're really excited about. We have -- we're launching our Avera Health brand for the AEP period. We feel really, really excited about our position within the medicare industry as a whole. So I'm excited about the near and longer-term prospect of our Accident and Health segment as a whole.

Michael Weiner -- Chief Financial Officer

And we've also allocated some resources in Head of OEP which will manifest itself when it opens up and start selling those. So have some early expenses we put through associated with it.

Randy Binner -- B. Riley FBR -- Analyst

And that would be -- like call it -- like having agent in place to fill the calls?

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

That would be the sales center staffs.

Randy Binner -- B. Riley FBR -- Analyst

Very good. Thank you.

Operator

Your next question is coming from Matt Carletti. Please announce your affiliation, then pose your question.

Matthew Carletti -- JMP Securities -- Analyst

Sure, thanks. Matt Carletti with JMP. Barry, you touched on kind of non-standard auto market conditions in your opening comments. Just hoping you might be able to dig in a little bit further just in terms of what -- what you're seeing in kind of frequency and severity in your book, as well as what you're seeing competitively and what you expect kind of over the next call it 6 months to 12 months?

Michael Weiner -- Chief Financial Officer

Yeah. So, let me dig in. I'll deal a little on the frequency and severity on that, Matt. It's Mike. So on our monoline auto book, what we've seen is frequency declining slightly, industry declining as well, so we're roughly in line with that. Severity is up for the industry noticeably and up for us at a fractional rate of what we were doing. And again, we attribute a lot of that to some of the works we're doing and the -- and our business as a whole.

I think Barry did a -- Barry called out a few numbers earlier when he talked about loss trend. So one of the ways we're kind of thinking about it is, we talked about is -- CPI or consumer price on insurance is up about 1.6%, but loss trends are up about 2.8%. We're taking loss trends. So by definition, we still continue to feel that there's going to be some catch-up associated with the industry and we're well positioned to take advantage of that by maintaining our stable monoline underwriting.

Matthew Carletti -- JMP Securities -- Analyst

And then, what are you seeing competitively in the market. I mean, it sounds like from your comments, Barry, that maybe you -- it sounded like you expect more rational competition to emerge as kind of the competition maybe realizes that growing gap in the coming months. Did I interpret that correctly?

Michael Weiner -- Chief Financial Officer

Yeah, so -- I'll toss back to Barry in one sec. Yeah, and that's what we've seen. If you think about what we've seen and we played out this trend two or three years ago associated but by maintaining that underwriting discipline, right, and we've been that steady Eddie producer. I think it's going to revert back, you know we talk about that gap between loss trends and where the industry is. It's going to catch up, but remember, these are six month policies. We've also seen a number of sales incentives out there in the industry, which are somewhat uneconomical. But, Barry, if you want to add on to that?

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

There -- there you'll still be able to see carriers taking rate decreases in certain markets coming -- giving agents aggressive commission plans, cash wrap plans, etc. So within the independent agency market, it's quite competitive right now and that's what Mike alluded to, within obviously having a strong direct-to-consumer business during the market conditions like this is extremely helpful. And as -- as the industry reverts back to the, meaning, with having the CPI catch up with pure premium trends, again, we should be in a prime position to be able to cannibalize on that and realize some negative growth returning to our independent agency channel.

Matthew Carletti -- JMP Securities -- Analyst

Great. Thanks. And one more if I could. I noticed the -- you guys announced the sale of the Swedish A&H business in the quarter. And just, if you could just provide a little color on that. Was there just something specific to that business or should we think about it more in a -- more holistic view, kind of, getting back to, say, that the core of National General a more domestic business. And if it is the latter, are there any other kind of pieces that we could think about in terms of continuing to shrink to the core or is that really kind of the one outlier?

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

Sure. So the business was a -- was a stand-alone business. So being able to exit that business will allow us to focus on the domestic operation that we have. That being said, we were able to leverage some of our core capabilities to add value to that business, namely introducing segmentation, that is something that never really happen in the Swedish marketplace. So we added some value to the business and found a good home for the business going forward.

As far as our business, I mean, we believe that we -- all of our businesses are -- core touch they have. Great growth prospects to them going forward and don't have any other such businesses that we would think about selling at this point.

Michael Weiner -- Chief Financial Officer

Matt, I actually get on to that -- I think we're relatively good at being prudent allocators of capital throughout the company where you get the best returns on the business, right. So with the -- if you look at the interest rate environment that you -- hits you domestically to actually think about what it is in some areas like Sweden where potentially there's negative interest rates, to earn our return there is going to be increasingly challenging for us in that space. We found a good home for it. We'll take that capital and redeploy it back, where you can get an adequate amount of return on it. And again -- but we had -- one thing I do take away from it, we had a lot of nice learnings and synergies throughout the organization which we're going to be able to leverage in the years to come.

Matthew Carletti -- JMP Securities -- Analyst

Thank you for the answers and continue. Best of luck.

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

Thank you.

Michael Weiner -- Chief Financial Officer

Thank you.

Operator

The next question is coming from Jeff Schmitt. Please announce your affiliation, then pose your question.

Jeff Schmitt -- William Blair -- Analyst

Hi. Jeff Schmitt with William Blair. Question on the P&C segment, looking at the expense ratio at 21%. As you ramp up more, I guess, in some of that direct-to-consumer business here, going forward, where do you think that can go, I mean, what level improvements do you expect there? I mean, can that reasonably go under 20% over time?

Michael Weiner -- Chief Financial Officer

Hi. This is Mike Weiner talking. Well, I think the biggest driver of that, when you're looking at that number in our disclosure, it takes into account some of the ceding commission income we have on the changing of the quota shares, right, as well as the mix of our business. The impact for us is relatively muted in terms of what we're spending on the direct-to-consumer side from that. So I think -- if you think about the level it is now, the 20.5% to 21% is probably a good number on a go-forward basis for us.

Jeff Schmitt -- William Blair -- Analyst

Okay. And then I may have missed it, but where did you say in the A&H business, where is that favorable development coming from and what accident years is that?

Michael Weiner -- Chief Financial Officer

Yeah, it's great question. So it's roughly, roughly split 50%-50% between our group business as well as our individual business, and it's coming from 2018. But I actually, when I think about it, it's not just coming from last year 2018, it's coming from third and fourth quarter of 2018. When people think about the business, we don't write all one, one effective dates on our business. So theoretically if we wrote a policy at this time a year ago, right, and that policy gets more credible from an action to expected basis when it comes to, you know its annual pay -- annual number that prior year that couple -- that development pattern shows up in our disclosure as prior year development. So it's very short-tail business. So it's all 2018 second half.

Jeff Schmitt -- William Blair -- Analyst

Okay, great. Thank you.

Operator

The next question is coming from Sean Reitenbach. Please announce your affiliation, then pose your question.

Sean Reitenbach -- KBW -- Analyst

Good morning. Sean Reitenbach, KBW. How much of the P&C loss ratio was a true up for 1Q and 2Q this year?

Michael Weiner -- Chief Financial Officer

So we haven't -- we gave it out in dollars on a net basis which is $5 million. And you're talking on the cat development from 1Q and 2Q?

Sean Reitenbach -- KBW -- Analyst

Well, I guess I should say, is there any true-up to the small commercial stuff within the P&C loss ratio?

Michael Weiner -- Chief Financial Officer

The P&C loss ratio, if you want to think about it from that perspective, not really a true up. We've had prior year development in there for some prior accident years of the number we disclosed the $14 million or some odd million.

Sean Reitenbach -- KBW -- Analyst

So was there any accident year --

Michael Weiner -- Chief Financial Officer

There wasn't any accident year catch-up if you will. I think we've been reserving for that adequately.

Sean Reitenbach -- KBW -- Analyst

All right. Perfect. Thank you. In terms of Texas and -- or the homeowners book in Texas, I know you guys have taken some underwriting actions in California, some growth in Texas. How material different is the exposure there from the end of 2018 and specifically thinking about the Dallas area weather events that are -- I'm assuming too soon for any loss estimates?

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

Sure. I mean, where we've done the most of our reduction in terms of our exposure is really been out in California, but if you're thinking about the update in terms of the Texas tornadoes, I presume that's what you are alluding to, it's not going to having a -- it wasn't a material hit for us thus far. We're still a few weeks out of it. So relatively green, but that wasn't a large event for us.

Sean Reitenbach -- KBW -- Analyst

Okay. And finally, can you guys give an update on how the high net worth book is been doing year-to-date?

Michael Weiner -- Chief Financial Officer

Sure. It's been doing well. Obviously, given the reunderwriting of our California book we are -- that had a sizable presence in the state. So a good amount of that business was not renewed along with other policies in the State of California. And outside of California, the business is growing at a moderate rate.

Sean Reitenbach -- KBW -- Analyst

Thank you.

Operator

The next question is coming from Yaron Kinar. Please announce your affiliation, then pose your question.

Robert Cox -- Goldman Sachs -- Analyst

Hey, this is actually Rob Cox filling in for Yaron Kinar, Goldman Sachs. I was just wondering if you could elaborate on the PYD and small business auto, talk a little bit about the litigation environment and what accident years caused the development?

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

So the accident years that caused the development, '15 through '17 primarily and the litigation environment is one we are -- as I mentioned, both the juries are handing out a larger verdict, and due to a lot of litigation funding, some of the cases have longer staying power, which has definitely had an impact on our development triangles. So we believe that the 14.9% is definitely reflective of where reserves need to be, and we've taken on a go-forward basis underwriting and pricing actions to be able to return the book to profitability.

Robert Cox -- Goldman Sachs -- Analyst

Okay, great. Thank you.

Operator

There are no further questions in queue at this time.

Paul Anderson -- Director of Investor Relations

Okay. Thank you very much everyone. We'll end the call here.

Operator

[Operator Closing Remarks].

Duration: 30 minutes

Call participants:

Paul Anderson -- Director of Investor Relations

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

Michael Weiner -- Chief Financial Officer

Randy Binner -- B. Riley FBR -- Analyst

Matthew Carletti -- JMP Securities -- Analyst

Jeff Schmitt -- William Blair -- Analyst

Sean Reitenbach -- KBW -- Analyst

Robert Cox -- Goldman Sachs -- Analyst

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