ProAssurance Corporation (NYSE:PRA) Q1 2023 Earnings Call Transcript May 13, 2023

Jason Gingerich: Welcome to ProAssurance’s Conference Call to discuss the company’s First Quarter 2023 Results. These results were reported in a news release issued May 9, 2023 and in the company’s quarterly report on Form 10-Q, which was also filed on May 9, 2023. Included in those documents were cautionary statements about the significant risks, uncertainties and other factors that are out of the company’s control and could affect ProAssurance’s business and alter expected results. Please review those statements. Management expects to make statements on this call dealing with projections, estimates and expectations and explicitly identifies these as forward-looking statements within the meaning of the U.S. federal securities laws and subject to applicable Safe Harbor protections.

The content of this call is accurate only on May 10, 2023. And except as required by law or regulation, ProAssurance will not undertake and expressly disclaims any obligation to update or alter information disclosed as part of these forward-looking statements. The management team of ProAssurance also expects to reference non-GAAP items during today’s call. The company’s recent news release provides a reconciliation of these non-GAAP numbers to their GAAP counterparts. I would like to remind you that the call is being recorded, and there will be a time for questions after the conclusion of prepared remarks. This morning, we will discuss selected aspects of our quarterly results and remind investors that they should review our filing on Form 10-Q and accompanying press release for full and complete information.

Speakers on the call today will be Ned Rand, President and CEO; and Dana Hendricks, Chief Financial Officer. Also joining on the call today are executive leadership team members, Rob Francis; Kevin Shook; Ross Taubman and Karen Murphy. Ned, will you start us off, please?

Ned Rand: Thank you, Jason, and good morning. Today, Dana and I are looking forward to giving you some insight into the first quarter numbers that we released last night and outlining some of the challenges in the medical professional liability and workers’ compensation markets. I’ll talk about the market dynamics that we’re seeing, and then Dana will provide the consolidated results and key drivers are investment results and book value. We’d also like to welcome Rob, President of our Healthcare Professional Liability business; Ross, President of our Small Business Unit; and Karen, President of our Life Sciences business for the call today and to thank Kevin for his continued participation in this quarterly call. As we announced in February of this year, Mike Boguski will be retiring from his role as President of Specialty Property and Casualty on June 30 after carefully considering the leadership structure that will best serve ProAssurance going forward.

We decided to add Rob, Ross and Karen to the executive leadership team with each of them reporting directly to me. This decision reflects the excellent and conscientious guidance that these individuals have shown in managing their respective portions of our business. And any specific questions arise during the Q&A session that are better answered by one of them rather than by Dana or me, we will direct the questions to allow them to respond in their area of expertise. The results we released last night reflect what we see as a continuation of the challenging claims environment for medical professional liability carriers. The past 3 years has seen significant disruption and change, and as a consequence, increasing uncertainty. While COVID did not result in the increasing claims and initially concerned the industry, its effects were manifest in other ways.

The delay in jury trial outcomes resulted in changes to claim and reporting and payment patterns, which in turn impacted the actuarial process and increase the range of possible outcomes for our reserve estimates. As we’ve entered the post-pandemic period, trends we first saw prior to the pandemic, in particular, social inflation and an increased number of larger verdicts across the industry have returned and, in some instances, grown. We continue to be vigilant in monitoring the impact of these trends on our reserves. We have seen their effects in the broader claims environment as well, in some cases, specific to ProAssurance as I will detail shortly. With that background, I’ll walk you through the results reported in our key segments.

The Specialty P&C segment produced an operating loss in the first quarter of 2023, driven primarily by unfavorable prior accident year reserve adjustments. The current accident year loss ratio was 87.2%, essentially unchanged from last year after including the effects of purchase accounting adjustments. We recognized unfavorable prior accident year reserve development of $8 million in the quarter, in contrast to favorable development in the same period of 2022. This unfavorable development in the quarter is attributable to several excess verdicts and settlements that occurred during the quarter as well as recently observed loss severity trends. I want to take a moment to describe the claims environment that all NPL carriers are facing. After a pause in 2020, much of 2021, the number of excess verdicts being returned by juries against healthcare providers is back near or above all-time highs.

ProAssurance’s insureds largely avoided such verdicts last year as our policyholders received favorable verdicts and over 85% of the 229 cases we took the trial. In the first quarter of 2023, we and our insurers did not avoid them completely. We believe these outsized jury awards reflect a number of trends, including a level of underlying anger in the jury pools, a disconnect between proof of fault and the desire to compensate insured parties and the view that large awards have no consequences. All of these may lead juries to occasionally ignoring the facts regarding the care rendered in a given case. And assuming instead that if an unfavorable outcome occurs for the patient compensation should follow without first reliability. Such awards can also result from the view of insurance carriers as deep-pocketed targets rather than protecting our healthcare workers, allowing them to practice medicine without fear of financial ruin in a litigious society.

These issues won’t go away as a result of hope or wishful thinking. Rather, we must work to educate our lawmakers, regulators and the general public about the need for a robust and functioning professional liability market, and a jury system that fairly assigns liability where it is appropriate. It provides an indication where it is not. Looking at our top line, gross written premium decreased by 7% from a year ago as we faced competitive market conditions and continue to focus on underwriting efforts on achieving rate of retaining business. Premium retention for the segment was 85% in the quarter, an improvement over last year. Retention in both the standard physician and specialty healthcare books contributed to the improvement from 2022.

This was despite the loss of a large hospital account in our specialty book. Pricing increased by 6% in the quarter, and we were at $11 million of new business. In our expenses, we are seeing increases in acquisition costs and professional fees. With a base of lower earned premium this quarter, this exerts upward pressure on the expense ratio. This was offset by a $4 million payroll tax refund from the employer retention credit program and a decrease in NORCAL accrued contingent consideration, resulting in a segment expense ratio of 22.8%. Turning to the Workers’ Compensation Insurance segment, gross written premium increased by $1 million in the quarter, as we saw increases in audit premium and new business compared to last year. Top line growth continues to be a challenge in a highly competitive workers’ compensation market.

We were encouraged by the new business in our traditional book increasing to $6.6 million this year. In our traditional business, renewal pricing was down 6% and retention was 83% for the quarter, both reflecting the competition we are seeing in this market. Our strategies continue to focus on working with our valued distribution partners to secure quality new business opportunities and retain profitable accounts. Our current accident year loss ratio was 72.6% for the quarter, less than 1 point higher than last year. A portion of this increase was due to higher headcount and compensation costs, which flow into our loss ratio through unallocated loss adjustment expense. The increase in the calendar year loss ratio was primarily due to unfavorable prior year development of $1.2 million in contrast to favorable development last year.

The development was primarily on an older open claim from the 1997 accident year. The segment maintained discipline in our underwriting policy acquisition and operating expenses with these expenses coming in slightly lower in the quarter than a year ago. The expense ratio improved compared to last year due to the effect of higher audit premium this quarter. We may see an expense ratio increase in future quarters due to the timing of general expenses, which may not be evenly distributed throughout the calendar year. I’ll finish with the segregated portfolio sale reinsurance segment, which posted a profit of just under $1 million for the quarter in the Lloyd’s Syndicate segment, which also was profitable at a similar level, just below $1 million.

Now I’d like to turn the call over to Dana to share our consolidated results and some highlights from the balance sheet and investment returns. Dana?

Dana Hendricks: Thanks Ned and good morning everyone. For the first quarter, we reported a net loss of $6.2 million or $0.11 per share and an operating loss of $8 million or $0.15 per share. The main difference between the two is the impact of the change in fair value of investments and contingent consideration. The operating loss in the quarter reflected a challenging operating environment, which led to a modest increase in our current accident year loss ratio, coupled with unfavorable prior year development. Gross premiums written declined to $316 million, with most of the decline occurring in our Specialty P&C segment. Premium increased slightly in the Workers’ Compensation Insurance segment and Lloyd’s premium declined to $3.5 million.

Excluding the impact of purchase accounting and prior year transaction-related costs, our consolidated combined ratio increased 7 percentage points from the first quarter of 2022, driven mostly by the change in prior accident year reserve development. Investment results provided a 5-point benefit to the consolidated operating ratio. Therefore, the operating ratio increased 2 points from last year. Our consolidated current accident year net loss ratio after excluding the impact of purchase accounting and prior year ceded premium adjustments changed slightly compared to the first quarter of 2022. The primary driver behind the change in consolidated net loss ratio for the quarter was the change in prior year reserve development. In the first quarter of 2022, we recognized $5 million of favorable development.

As the result of the excess verdicts that Ned mentioned and a significant reserve increase on an older workers’ compensation client, we booked $7 million of unfavorable development in 2023. The unfavorable development was driven by a handful of claims, largely from what we feel were outsized verdicts based on the facts underlying the cases. These reserve increases primarily relate to older accident years, for which there was little IBNR to absorb the loss. Our consolidated expense ratio was pressured by a decrease in net premiums earned along with the impact of higher operating expenses, such as IT consulting fees and travel-related expense. These pressures were partially offset by a $4 million payroll tax refund available under the CARES Act and a $1 million reduction to the contingent consideration liability related to the NORCAL acquisition.

In total, the consolidated expense ratio increased 1.3 points to 28.3%. Net investment income grew nearly 50% to $30 million in the quarter as our reinvestment rate has exceeded that of the maturing assets in each of the last seven quarters and our floating rate assets reset higher yields as well. With the scale of our investment leverage, we see the significant positive impact this has on operating performance, and we expect the increases to continue in the coming quarters. In the first quarter, we reinvest in maturing bond that yields approximately 200 basis points higher than the portfolio’s average book yield. Results from our investment in LPs and LLCs, which are typically reported to us on a one-quarter lag, decreased to a loss of $1 million in the quarter, driven by the performance of one LP, which reflected lower market valuations during the fourth quarter of 2022.

This particular LP is a private equity fund and the decline in results was driven by the markdown to a single portfolio company due to the performance of its public company comps. Given the performance of those same public comps this quarter, we do not expect this fund to rebound next quarter. Further, to provide additional context on our entire LP and LLC portfolio, the results in the quarter excludes fourth quarter results of 8 funds due to the timing of when those funds report to us. The majority of these 8 funds are in private credit and private equity and based on market movements during the fourth quarter and first quarter, we would expect positive marks on most of those funds next quarter. Net investment gains, which are excluded from operating income and drive the difference between operating loss and net loss was $3 million in the quarter.

Unrealized holding gains resulting from changes in the fair value of our equity investments and convertible securities more than offset, almost $3 million of credit-related impairment losses, which were primarily on bond positions in Silicon Valley Bank and Signature Bank, resulting in the net investment gain. Other income declined $2 million in the quarter due to changes in foreign currency exchange rates and the impact of foreign currency denominated loss reserves in our Specialty P&C segment. This quarter, the effect of foreign currency movements was a loss of $1 million due to strengthening of the euro in the quarter compared to a gain of $1.3 million in the prior year period. We mitigate foreign exchange exposure by generally matching the currency and duration of associated investments to the corresponding loss reserves.

The impact of unrealized gains and losses on foreign currency-denominated investments flows directly to equity through other comprehensive income or loss, while the impact of changes in foreign currency exchange rates on loss reserves is reflected through our results as a component of other income. These items should roughly offset each other economically, so only the FX impact on the reserves flows through the income statement. Our book value per share at quarter end was $21.07, up 3% from year-end, driven by after-tax holding gains of $40 million on our fixed maturity portfolio, which flows directly to equity. Adjusted book value per share, which excludes $4.74 of accumulated other comprehensive loss, primarily from unrealized holding losses, is $25.81 as of March 31.

We consider these unrealized losses to be temporary as we have both the intent and ability to hold to maturity. Before I conclude, I will briefly touch on the refinance of our maturing senior notes due this November. As you may have seen, we filed an 8-K last week announcing the renegotiation and extension of our $250 million revolving credit agreement, which includes a $125 million delayed term loan – delayed draw term loan and the execution of two corresponding interest rate swap agreements. Our intent is to use the proceeds from the $125 million term loan plus a draw of $125 million on the revolver to retire the $250 million senior notes in November. The interest rate swaps effectively fixed the floating base rate on any borrowings under the revolver and term loan to roughly 3.2%.

However, there is also a margin component of the interest rate is based on our debt-to-cap ratio that will remain variable. Based on our current debt-to-cap ratio, the total interest rate for the revolver and term loan would be approximately 5.1% and 5.2%, respectively. In the current lending environment of considerably higher borrowing rates, and on the heels of the turmoil in the banking sector, we’re very pleased to have actually reduced our borrowing costs with these transactions. In summary, we continue to operate in a challenging environment; however, we did see a number of positives in the quarter, including rate gains and solid retention in our HCPL business along with increasing investment income and book value given our investment leverage and changes in the interest rate environment.

With that, I will turn it back over to Jason.

Jason Gingerich: Thank you, Dana. Glenn, that concludes our prepared remarks. We are ready for questions.

Q&A Session

Operator: Thank you. [Operator Instructions] Our first question comes from Greg Peters from Raymond James. Greg, your line is now open.

Operator: Thank you, Greg. Our next question comes from Mark Hughes from Truist. Mark, your line is now open.

Operator: Thank you, Mark. [Operator Instructions] Our next question comes from Paul Newsome from Piper Sandler. Paul, your line is open.

Operator: Thank you, Paul. [Operator Instructions] We have no further questions on the line.

Jason Gingerich: Thank you to everyone that joined us today. We look forward to speaking with you again on our next quarter’s conference call.

Operator: Thank you. Ladies and gentlemen, this concludes today’s call. Thank you for joining. You may now disconnect your lines.