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EMC Insurance Group Inc  (NASDAQ:EMCI)
Q4 2018 Earnings Conference Call
Feb. 07, 2019, 12:00 p.m. ET


Prepared Remarks:


Good day, and welcome to the EMC Insurance Group Fourth Quarter 2018 Earnings Conference Call. All participants will be in listen-only mode. (Operator Instructions) Please note, this event is being recorded.

I would now like to turn the conference over to Steve Walsh, Director of Investor Relations. Please go ahead.

Steven T. Walsh -- Assistant Vice President-Director of Investor Relations

Thank you, Carrie. Good afternoon, everyone, and welcome to EMC Insurance Group's 2018 fourth quarter earnings conference call. Copy of the news release is available on the Investor Relations page of our website, which can be found at investors.emcins.com. The archived audio webcast will be available for replay for approximately 90 days following our earnings call.

This presentation includes some forward-looking statements about our expectations for our future performance. These statements are not guarantees of future performance and actual results could differ materially from those suggested by our comments today due to a variety of factors. Additional information about factors that could affect future results is addressed in our SEC filings, including Forms S-1, 10-K, 10-Q, and 8-K. Any information provided today should be read in conjunction with the 2018 fourth quarter earnings release with accompanying financial tables issued earlier today.

Certain non-GAAP terms may be used during today's discussion. Please refer to the Company's press release and SEC filings for a description and reconciliation of these terms.

Before we get started, I'd like to note that we will not have a question-and-answer session following our prepared remarks today due to the pending non-binding indicative proposal submitted by EMC Insurance Group's parent company Employers Mutual Casualty Company or Employers Mutual on November 15, 2018 to purchase all the outstanding common stock of EMC Insurance Group it does not already own.

Speaking today will be Bruce Kelley, President and Chief Executive Officer; Mick Lovell, Executive Vice President of Operations; and Mark Reese, Senior Vice President and Chief Financial Officer.

At this time, it's my pleasure to introduce the Company's President and CEO, Bruce Kelley.

Bruce G. Kelley -- President-Chief Executive Officer and Treasurer

Thank you, Steve. And welcome to those joining us today. This morning we reported a net loss of $21.5 million for the fourth quarter of 2018 compared to net income of $26.2 million in the fourth quarter of 2017. The net loss amount includes a record $18.5 million of catastrophe and storm losses in the Reinsurance segment, which was partially offset by a $10 million underwriting gain in the Property and Casualty Insurance segment.

In addition, the net loss amount includes a $28 million pre-tax decrease in unrealized investment gains on equity investments. The Company adopted updated accounting guidance at the beginning of 2018 that requires a change in unrealized gain/loss in equity investments to be recognized in net income, whereas previously this change was recognized in accumulated other comprehensive income.

Also contributing to the net loss is $13.1 million of pre-tax realized investment losses. These losses were recognized to take advantage of a 14% tax differential that could be realized by carrying them back to a previous tax year subject to the prior 35% tax rate. This resulted in a $1.7 million tax benefit for the Company. We were then able to reinvest the money from the sale into fixed maturity securities with similar characteristics at a higher book yield. Included in the $26.2 million of net income reported for the fourth quarter of 2017 is a one-time $9.1 million deferred income tax benefit that resulted from the enactment of the Tax Cuts and Jobs Act, TCJA, in December 2017 and $4.4 million of pre-tax realized investment gains.

Non-GAAP operating income, which excludes the change in unrealized investment gains on equity investments as well as realized investment gain/losses, totaled $0.43 per share for the fourth quarter and $1.09 per share for the year, compared to $0.67 per share and $1.22 per share for the same periods in 2017. Due to the one-time nature of this event, the 2017 amounts also exclude the deferred income tax benefit that resulted from the enactment of the TCJA in the fourth quarter of 2017.

The GAAP combined ratio increased to 102% for the quarter compared to 95% in the fourth quarter of 2017. This increase was driven by the Reinsurance segment, which reported a GAAP combined ratio of 134.6% for the quarter due to the occurrence of a significant amount of catastrophe and storm losses, compared to 100.6% in the fourth quarter of 2017. No recoveries were made under the Reinsurance segment's intercompany reinsurance program with Employers Mutual during the fourth quarter compared to $8 million of recoveries in the fourth quarter of 2017.

The Property and Casualty Insurance segment reported a GAAP combined ratio of 92.3% for the quarter, which is a slight improvement from the 93.4% reported in the fourth quarter of 2017. Book value per share declined approximately 7% to $26.18 per share from $28.14 per share at year-end 2017. This decline is attributed to a net loss reported for 2018, a decline in unrealized investment gains on the fixed maturity portfolio and the $0.89 per share cash dividend paid to stockholders.

For the fourth quarter, premiums earned increased 6.4% and premiums written increased 8.4%. In the Property and Casualty Insurance segment, premiums earned increased 5.8% and premiums written increased 7.5%. Rate levels for commercial lines of business were up low-single digits, although there continues to be variation by line of business. Retention remained strong at approximately 87%. In the Reinsurance segment, premiums earned increased 8.6% and premiums written increased 10.8%.

As we have noted previously, our experienced team of reinsurance underwriters capitalized on some disruption in the marketplace during 2018 by increasing participation in some of our preferred existing accounts and also by adding some new business. This was partially offset by the continued decline in premiums from Mutual Re, formerly known as Mutual Reinsurance Bureau underwriting association, due to its withdrawal from non-standard automobile business.

During the January 1 renewal season, when approximately 70% of our treaties renew, reinsurance pricing was mixed. Continued development on 2017 catastrophe events, large losses in the second half of 2018, and reduced capacity in the insurance-linked securities and retrocession reinsurance markets led to rate increases on accounts that sustained losses in 2018.

Programs with wildfire losses received the largest rate increase -- rate level increases as more focus was placed on this peril (ph) upon renewal. Most accounts across our domestic and international regions that were loss free renewed with rates that were flat or down slightly. We currently expect earned premium growth in the low-single digits in our Reinsurance segment for 2019.

Management is projecting 2019 GAAP -- non-GAAP operating income guidance will be within a range of $1.35 to $1.55 per share. This guidance is based on a projected GAAP combined ratio of 102.2% for the year and includes a load of nine points for catastrophe and storm losses. The guidance assumes a mid-single digit increase in investment income and an effective tax rate in the mid-teens. It also includes the expected financial impact from the transition out of personal lines, which we provided on the third quarter earnings conference call.

So with that, I'll turn the call over to Mick Lovell, Executive Vice President of Operations, for an update regarding this transition.

Mick A. Lovell -- Executive Vice President-Operations

Thank you, Bruce, and good afternoon, everyone. The strategic decision to transition out of personal lines business is now under way and will continue through the first quarter of 2020. This strategic decision to focus our resources on commercial lines was made to maximize our profit and growth potential and further strengthen our position as a diversified market leader in commercial lines. At the time of the announcement, EMC actively wrote personal lines in 22 states through independent agent.

These independent agents can determine where they want to move their personal lines business. However, EMC provided an option allowing consenting agents to easily renew their book into Safeco Insurance with a price matching option. And 76% of our personal lines agents opted to move their personal lines business to Safeco. This represents over 81% of our personal lines premiums written. Of the agents who opted out, the most cited reason for this decision was that the agent had a small policy count with EMC and they believed they could more easily move the business on their own.

Our agents' reaction to this decision was impacted by the size of their book of business and the associated workload to move their insured customers. Initially, many agents that have had strong long-term relationships with EMC were disappointed that they could no longer write their accounts with us. With few exceptions, they understood why the action was being taken and respected the Company for making the strategic decision. And for the most part, they appreciated the transition option we provided, which made their transition process easier as demonstrated by the high opt-in result.

We continue to believe the impact on our commercial lines of business will be minor and that any loss of business will primarily come from smaller books of business managed by agencies who primarily wrote personal lines business. This was expected based on our comprehensive market analysis we completed prior to making this decision.

Regrettably, this decision impacts 121 of our team members in Des Moines and our branch offices. All impacted team members are receiving job placement assistance and have opportunities to apply for open positions within the Company. Severance packages will be provided to those who have not found employment by their separation date.

February 1, 2019, was the first of five pre-established dates over the next year that personal lines positions will be eliminated. To date, approximately 35% of the 121 team members have found a safe landing. Many of them have filled business needs within EMC and our affiliate, EMC National Life, while others have found employment outside of EMC or announced their intention to retire at the separation date. In summary, we are pleased with the progress we have made on the transition process, which is proceeding according to plan.

So with that, I'll turn the call over to Mark Reese, our Chief Financial Officer, for some additional comments on the quarter.

Mark E. Reese -- Senior Vice President-Chief Financial Officer

Thank you, Mick, and good afternoon, everyone. The underwriting loss for the fourth quarter was driven by the Reinsurance segment due to the significant amount of catastrophic losses, partially offset by an underwriting profitability in the Property and Casualty Insurance segment.

In the Reinsurance segment, only catastrophic events with total losses greater than $500,000 are subject to the terms of the intercompany annual aggregate excess of loss treaty. In 2018 such losses did not exceed the $20 million retention amount. As a result, no recoveries were made under this treaty and the entire $18.5 million of catastrophe and storm losses incurred in the fourth quarter were retained.

In 2017, having already filled the retention amount under the intercompany reinsurance program, the Reinsurance segment recovered $8 million of the $10.2 million of catastrophe and storm losses incurred in the fourth quarter. This brought total recoveries under the program to $16.9 million for 2017.

As a reminder, the intercompany reinsurance programs were renewed for 2019 at the existing terms. These intercompany reinsurance programs are in addition to the ceded reinsurance agreements that provide protection to all parties through the reinsurance pooling agreement with Employers Mutual, including protection against losses arising from catastrophic events.

Effective January 1, 2019, the external reinsurance agreements were renewed with similar coverages and limits as the prior year. The notable changes include increase in the placement of the first and second layers of the pool's property catastrophe program and increased limits in our property per risk and workers' compensation catastrophe program.

Based on past loss experience under these treaties, marginal changes to coverages and limits, and an increase in exposures, we project the ceded deposit premiums for our 2019 excess of loss reinsurance coverage will increase by high-single digits to low-double digits compared to 2018.

The Property and Casualty Insurance segment reported a slight improvement in fourth quarter underwriting profitability due primarily to an increase in favorable development. The Property and Casualty Insurance segment's underwriting loss and settlement expense ratio, which excludes the impact of catastrophe and storm losses and development on prior years' reserves, was 59.3% in the fourth quarters of both 2018 and 2017. However, some differences remain across the various lines of business. In workers' compensation, mandatory rate reductions that have been implemented in many of the states in which we operate over the past several years have reduced rate adequacy and contributed to an increase in the loss of settlement expense ratio.

Commercial automobile has shown some improvement for the year but still remains unprofitable. We are expecting mid-single digit rate level increases in commercial auto in 2019 to help combat these headwinds. Net investment income increased 6.2% for the fourth quarter and 4.7% for the year due to an increase in the fixed maturity portfolio book yield and to a lesser extent growth in the fixed maturity portfolio.

Pre-tax yields on new purchases were slightly higher than the existing book yield on the fixed income portfolio, which ended the fourth quarter at 3.7%. Effective duration of the fixed maturity portfolio, excluding interest-only securities, was 4.9% at December 31, 2018, down slightly from 5% at the end of 2017. Unrealized investment gains in the fixed maturity portfolio increased $21.1 million after-tax in the fourth quarter, but declined $9.5 million after-tax for the year.

So with that, I'll turn the call back to Steve Walsh for closing remarks.

Steven T. Walsh -- Assistant Vice President-Director of Investor Relations

I'd like to thank you all for joining us today. We appreciate your interest in EMC Insurance Group. Look forward to speaking with you again on our first quarter earnings conference call. Have a great day.


Conference has now concluded. Thank you for attending today's presentation. You may now disconnect your lines. Have a great day.

Duration: 18 minutes

Call participants:

Steven T. Walsh -- Assistant Vice President-Director of Investor Relations

Bruce G. Kelley -- President-Chief Executive Officer and Treasurer

Mick A. Lovell -- Executive Vice President-Operations

Mark E. Reese -- Senior Vice President-Chief Financial Officer

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