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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Greetings, and welcome to the Hallmark Financial Services 2019 Third Quarter Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions]. These instructions will be given again prior to the question-and-answer session. [Operator Instructions]. As a reminder, this conference is being recorded.
It is now my pleasure to introduce your host, David Webb, Senior Vice President, Corporate Development and Strategy at Hallmark. Thank you, sir. You may begin.
Thank you, and welcome to the Hallmark Financial’s third quarter 2019 earnings call. This is our second earnings call and we anticipate continuing these on a quarterly basis going forward.
Joining me on the call today are Naveen Anand, President and CEO; and Jeff Passmore, Chief Financial Officer.
During the call, we will be making forward-looking statements. These statements may reflect certain assumptions, expectations, beliefs, and intentions which are subject to various risks and uncertainties. Investors are cautioned that actual results may differ materially from such forward-looking statements.
Please refer to our most recent Form 10-K and other filings made with the SEC for additional details on some of the Risk Factors that may materially affect our results. We may also reference certain non-GAAP financial measures in the call today. A copy of the press release containing a reconciliation of GAAP to these measures and an updated quarterly investor presentation are available on the Company's website at www.hallmarkgrp.com.
We will begin the call today with a brief overview of the quarter, Jeff will follow with some comments on the quarter’s financial results, and then, Naveen, will discuss market conditions and our results.
With that, I will turn the call over to Naveen.
Thank you, David, and good morning, everyone.
I'm pleased to report that through the third quarter Hallmark Financial continues to produce returns in excess of 10%. Operating earnings were $0.35 per share for the quarter, a 52% increase over the same period previous year and $1.07 per share on a year-to-date basis, producing an annualized operating return on beginning equity of 10.2%.
Net income was $0.29 per share for the quarter, and $1.82 on a year-to-date basis, which translates to an annualized return on beginning equity of 17.4%. These results highlight the positive impact that the transformative actions taken by the company over the last few years, which has touched every facet of this organization, and has laid the foundation for the company to take advantage of the current favorable market opportunities particularly for specialty insurers.
The company is focused on building the talent base, market presence to firmly establish ourselves as a specialty company, with a diversified portfolio of specialty products. Our timing is good. We’re well-positioned to take advantage of the opportunity created by the market dislocation in the specialty space. We have been focused on expanding our specialty business which now comprises 77% of our total premiums and generated a combined ratio of 87.7% in the third quarter and a combined ratio of 91% year-to-date.
Most of our specialty products are seeing significant rate increases, while at the same time, deploying smaller limits and improving terms and conditions. The combination of these three components, rates, limits, and terms and conditions is critical to building and sustaining a profitable portfolio of business in an environment where claim severity is increasing.
I'll now turn the call over to Jeff Passmore for a review of our financial results, and then come back in with some views on our segments.
Thank you, Naveen, and good morning.
For the third quarter of 2019, we reported net income of $5.3 million. This compares to $9.7 million the same quarter last year. Removing the impact of unrealized changes in the market value of equity securities, our operating earnings for the third quarter of 2019 were $6.3 million compared to $4.2 million in the same quarter last year.
Gross premium written increased 33% to $224 million during the quarter compared to $169 million the same quarter last year. This improvement relative to last year is attributable primarily to growth in our specialty businesses driven in large part by the favorable rate increases, we are achieving in this portfolio. Year-to-date, our Specialty Commercial segment represented 77% of our portfolio with our Standard Commercial segment at 11% and our Personal segment at 12%.
Net premium written increased 45% to $128 million for the quarter compared to $88 million in the same quarter last year. While much of this is related to the growth in gross premiums, the higher rate of increase is being driven by the changes we made to our reinsurance program starting in October 2018 led by the consolidation of our casualty business into a single treaty structure.
For certain of our specialty lines of business, session rates in previous treaties were higher which has resulted in a larger portion of the business being retained by the company translating to a larger growth rate in net premiums. These changes to the reinsurance structure allow us to retain a larger amount of the specialty business that we write. At the same time the structure also provides protection against claim severity, as we have more reinsurance coverage on claims in excess of $1 million.
Going forward, we currently expect that the net premiums will continue to increase at a slightly higher rate than gross premiums, but those rates should be much closer than they had been over the past four quarters.
Cash flow from operations was a positive $16.2 million inflow for the quarter and a $22.9 million inflow year-to-date, a $41.9 million increase over the first three quarters of 2018.
The net cash outflows that company experienced in 2018 were a direct and deliberate result of the improvements made in the claim organization seeking to close claims more quickly than the company has historically. That dynamic has now normalized and we anticipate the current trend will continue. The expense ratio was 26% for the quarter and 25.8% on a year-to-date basis.
We continue to emphasize our expense ratio as a competitive advantage relative to our peers, which we believe is achieved by our careful management of expenses, intelligent usage of technology, and external resources, and our mix of business. We generally target an expense ratio that is 28% or lower.
Net investment income increased 4% to $5.1 million during the quarter as compared to $4.9 million in the same period the prior year. Net investment losses were $1.3 million for the quarter resulting from a $1.5 million reduction in net unrealized gains.
In August, we issued $50 million of a 10-year senior unsecured note in the public market with a 6.25% coupon. We used $30 million of these proceeds to repay an existing bank revolving credit facility and the remainder was contributed to our insurance subsidiaries to support additional premium growth as we see opportunity in the current market to achieve returns in excess of our target.
Total cash and investments increased 9% since year-end to $730 million or $40.26 per share. Improved operating cash flows driven by both increased premium production and stabilization in claim payments, proceeds from our senior unsecured note offering during the quarter, and a year-to-date increase in the valuation of our investment portfolio are the main drivers of this increase.
Stockholders equity for the Group ended the quarter at $296 million, up $41 million since year-end 2018.
Our book value per share has increased 15.5% since year-end to $16.36 per share as compared to $14.17. This is not an annualized number and reflects the actual change in book value per share over the nine-month timeframe.
And with that, I'd like to turn it back over to Naveen.
Thanks Jeff.
I’d like to spend a few minutes on the company's core results alone and then we'll discuss our performance at a segment level. Our combined ratio for the quarter of 2019 was 95.8% compared to 98.1% in the same period prior year. Year-to-date, the combined ratio was 95.6% as compared to 97.5% an improvement of almost two points. We continue to make progress toward our target of sub-95 combined ratios.
Well, there's been much discussion in the market recently over the CAT events, which have been primarily driven by Hurricane Dorian and Typhoon Faxai, Hallmark Financial has had a relatively quiet CAT year owing to minimal impacts from many major weather events. CAT losses were 0.5 point in the quarter and 1.5 point for the year, which is below our historical average of between two and four points.
Also as noted in our earnings release, the recent storms in the Dallas area were impactful to our community and colleagues, is not expected to be a meaningful CAT event for Hallmark.
We've been mentioning increased intent severity impacting our casualty lines in particularly commercial auto for the last two years and we've been aggressive in addressing this trend. In response to this, we've taken steps to improve pricing, risk selection, and claims management. Company experienced an increase in prior year development in the quarter driven by increased claims severity in our commercial auto line, above what was previously anticipated with unfavorable development in the quarter of 5.7 or 2.4 points year-to-date.
Claim management has been an important part of our strategy sought to close claims quicker and reduce our exposure to increasing claim costs associated with longer timeframes and litigation. It is clearly evident in our commercial auto book where the company has been diligent and working to close claims from earlier accident years and have closed at this point 99.1% of all primary commercial auto claims reported for accident years 2012 through 2017, as illustrated on Slide 12 of our Investor Presentation if you'd like to review.
We’ve also been very focused on addressing the issue on the pricing side of our auto book. Over the past year, the impact of the underwriting decisions and rate increases in our primary trucking portfolio has been notable. Since 2015, we have reduced in-force customer count by 53%, while premiums are only down 4%. On a more recent comparison since just year-end 2018, policy counts were down 9% while premiums were up 9% -- policy accounts are down 16% while premiums were up 9%.
Our underlying actions, supported by improved risk collection, predictive models, restructured claim efforts, seek to fast track new claims to closure will position the company for long-term success in this line.
Overall, our Specialty Commercial segment is performing very well. In the third quarter, the segment produced a combined ratio of 87.7% and for the year, the segment generated a combined ratio of 91% or 85.5% on an accident year basis. In addition, we continue to see great rate momentum in this segment with the rates increasing over the course of the year. In the third quarter, average rate increase across this portfolio was in excess of 15%, which is helping to drive improved underwriting margin into the business. This is particularly evident in our E&S property book, in our professional liability segments, as well as in our commercial auto product line.
We're in a very good position to capitalize on the current market conditions which in our view have shifted from broad headwinds to tailwinds and are particularly in our core specialty lines.
As I mentioned earlier, compressing limits is a critical part of our strategy and reducing the impact of claim severity in the market. At this point, nearly 90% of our liability policies are one million or less in limits in both our Specialty Commercial and in our Standard Commercial segments, which greatly minimizes our exposure to claim severity.
In terms of our other segments, while the company's overall CAT experience for the quarter was good, personal lines segment saw an uptick in both PCS and non-PCs weather-related claims, resulting in a loss ratio of 80.8%, a five point increase over the same quarter last year. Year-to-date, this book is generating a combined ratio of 96.9% which is an improvement over the 101.7% combined ratio over the same period of last year.
Our Standard Commercial business also experienced an increase in attritional loss activity in the quarter. This includes some non -- small non-CAT property losses as well as some CAT loss activity from severe conduct insurance. This resulted in a combined ratio of 107.5% for the quarter and 99.4% year-to-date.
Overall, I'm pleased with how we’re positioned in 2020, and we're benefiting from all the work that we've done over the past few years, and we're able to take advantage of the favorable market conditions in the specialty lines of business that Hallmark prides. With the right people in place, the balanced growth, also maintaining and driving pricing discipline.
With that, operator, let's open it up for questions.
Thank you. Ladies and gentlemen, we will now be conducting the question-and-answer session. [Operator Instructions].
Thank you. Our first question comes from Greg Peters with Raymond James. Please proceed with your question.
Hi, good morning. This is Marcus Aiello for Greg. You guys been talking about market dislocations for a couple of quarters now and I was hoping you could spend a minute and give us an update where this dynamic is more pronounced in the marketplace right now?
Good morning, Marcus. So overall, we're seeing a couple of things that are taking place in the market. We are seeing some of those Standard Line carriers move out of the E&S lines and so certainly more businesses coming into the E&S lines and overall, through six months, from a segment perspective E&S has grown, it’s growing at about 15% to 16%. E&S didn't see that type of dislocation or growth, I think the last time the E&S lines saw that type of dislocation was back in 2001, 2002. We're seeing it in our E&S property line, where we're seeing much more syndication of limits. So many more carriers required to fill a tower and a program. And as a result, we’re in some cases seeing sort of inverted towers, in some cases where pricing is higher as you get up the ladder, which is kind of opposite of what you would expect.
We're seeing it in our Professional Liability segments, both in our healthcare as well as our financial lines segment and we're much more of a small business small, small customer lighter in those segments. We're seeing it also in our commercial auto, as well as our casualty segments, both on the primary and the excess but much -- more so on the excess.
Now, this is a combination of changes that are being driven by as I mentioned earlier the Standard Lines markets kind of moving out of lines and more business coming back into the E&S segment. That's probably the biggest impact.
Second is changes at Lloyds particularly as Lloyds has walked away from smaller binding authorities and those individual risks are now coming into the market as individual risk versus they were in sort of program situations with Lloyds.
And then to a certain extent some of the changes that AIG and others that are making in terms of their limits in loan profiles. That’s little less impactful for us only because we don't necessarily focus on that sort of large national global account market from an overall standpoint.
Got it. Thank you for that color. My next question is on Slide 11. And you have your combined ratio broken down here and you can see a remarkable improvement in expense ratio and you're near your 95% target year-to-date, but that seems like in Florida have an average CAT year, you would be running a little higher. So I guess, maybe you can give us some perspective of where you'd see your expense and core loss ratio heading towards so in order for you to hit that target?
Yes. So we see -- as we continue to add rate into our portfolio the terms, conditions and the changes that are going in the marketplace, we expect that and our mix of business as that evolves, we see our accident ratio, accident loss ratio continue to improve. I think from an expense standpoint, we're in the range of 25, 26, 25.5 to 26 at this point and we'll see some more further improvement as -- from a growth as we continue to grow and benefit from the growth capacity expense ratio.
We don't have any sort of major projects and things like that, from a CapEx perspective that are on the horizon, that's going to necessarily impact a lot of that work has been done over the course of the last four years. So it's going to come from a combination of continued improvement in margin and accident year loss ratio perspective and a little bit from the expense ratio with even with a normalized CAT scenario, which has been around leading to three points over the last two years.
Got it. Thank you for that. I guess just my last question would be on capital. And I guess it's a good opportunity for you guys to comment on your perspective on the balance of capital and growth, you’re seeing some pretty staggering growth numbers there. And then maybe you can talk about your excess capital position if there is any intention to come back to the market and repurchase shares?
Yes. And so we generally target a leverage ratio between 1.4 times to 1.5 times, well little above that right now at 1.6, but not really far out of that range. And we feel fairly comfortable with the capital that we have. The company in the past has been quite a bit higher in terms of leverage ratios, but my comfort level is kind of stays within this range.
At this point, we're adequately capitalized, as Jeff noted, we did add $20 million recently from a public debt offering into our insurance companies, and based on our projections of profitability, resulting from kind of what we will generate from a CAT capital perspective, it meets our expectations to keep the net premium leverage within that range of the 1.4, 1.6 range at this point.
The -- we did file a Universal Shelf, as you may recall back in May at $150 million, we pull down $100 million of it, $50 million of it, I’m sorry as we have $100 million available at this point. So we do have some optionality. We choose to do something down the road. But at this point, we feel like we're generating enough from a step profitability perspective and step capital perspective to support our growth ambitions based on we see as the outlook of the market.
Thank you. [Operator Instructions].
Our next question comes from Bob Farnam with Boenning and Scattergood. Please proceed with your question.
Hey, there, good morning. I'd like to see if I can tether maybe a little bit more detail on commercial auto reserves. So you say that 99.1% of the claims have been closed from accident years 27 and prior, about how many claims are we talking now that are still open? I don't need an exact number just kind of ballpark, how many claims are still open from that era? How much does that 0.9% represent?
So, kind of address that question in two parts, Bob. So 2015 and prior which was kind of the area where we saw the most dislocation and drove primarily the reserved charges in the past were less than 50 claims open in terms of all those accident years at this point. And an adequate used case reserve from our perspective. We have little over couple hundred claims open between 2017 and 2016 from an overall claim perspective, but the key point is, we feel case reserve, from a case reserve perspective are probably at the highest level, we've seen in our company, in our history, and we feel they're adequately reserved.
But as we get kind of closer to closing out the claims, we do get some volatility. And we thought it was prudent to add to our reserves on that basis, based on some of the volatility we're seeing as we continue the pace of closing out the claims that we have.
And these claims are predominantly have, are they on policies that have a $1 million limit on them is that the key?
Yes, that is all primary. That's correct.
Okay.
A $1 million limit.
And so, again, I'm sorry, you may not have the details there, but so in terms of the 150, so it sounds like 150 so remaining claims around that area, do you know what percentage that they are reserved at in terms of at a -- percentage of the limit as how much is -- how much potential is there for going up to the limit on those claims?
Yes. So again it’s case-by-case basis, but those, there's quite a few that are at limits losses already, so they're not going to develop anymore. But on average -- at a case reserve basis, we feel pretty adequate in terms of what the case reserves are in terms of that, I don't have a specific information in terms of what that average case reserves does. But I'm happy to provide that as a follow-on.
Sorry, I didn't mean to hammer you with like a little minutia detailed stuff there. But I was just curious about the commercial auto stuff just because of the adverse development again this quarter. But it looks like 2018 has developed favorably thus far, is that basically lower than expected severity or frequency or like what's been driving the improvement in 2018 accident year?
Now, a couple of things. Obviously all of the changes we've made are coming through started making a lot of changes in 2016 and 2017 in terms of our portfolio both from pricing, risk selection improvement standpoint we put on our second-generation of our predictive model and capability. But also this has been a large reduction in just exposure base in the company.
So when you look at 2018 and on Page 12 of our Investor Deck, we give you some reference points on policies enforced reduction just share policies portion rate that has been put on the policies driving the continued improvement in the portfolio from a portfolio standpoint and that improvement continues into 2019 as well.
Is there a specific type of claim you've been trying to policy I mean, not claim but policy. You have called quite a bit of your enforced policies, what has been the more problematic type of policy that you've been getting rid of?
A couple of things. So we're looking at a lot of variables in terms of risk quality in our models to give us better and deeper insight on risk profile and risk quality. And through that process in general terms, we noted that some of the newer venture type truckers are problematic and so that's been a big part of the exit.
Some classes of flatbed trucking are problematic; it's down to kind of specific type of goods hauled and areas hauled. Some of the regional truckers have been problematic and some of the regions that they travel in where we've seen high performance of activity, and that's all coming through some of our modeling activity that we've done to really understand the portfolio.
So and then, broadly speaking, we've also exited two states that we think are really challenging and were unprofitable for us, which were Louisiana and Mississippi and we exited those, stop providing new business in those states in 2016, and in 2017, we completed the exit out of those states from a renewal standpoint.
Thank you. Our next question comes from Sam Hoffman with Lincoln Square. Please proceed with your question.
Hey, my question surround to the ongoing nature or the one-time nature of some of the events that happened in the quarter. So my first question is on personal lines, what was the entire excess of the loss ratio in the quarter due to CAT and non-CAT weather? And do you expect the combined ratio to be sort of in the 95% or below range as it had been given the prior four quarters going forward?
So we had a higher preponderance of losses related to weather in the quarter that that was the biggest part of the impact. There was also a little bit of movement, higher increase on the expense ratio by a couple of points. I think that sort of goes up to ebbs and flows in terms of kind of a quarterly impact. But I do expect the portfolio to come more in line and be on target -- to our 95% target for that portfolio on a run rate basis.
Terrific. And then on the commercial auto, which accident years was the prior-year developments coming from because we've seen some companies like Travelers take strengthenings on their more recent years. It sounds like this is coming from older years. And it would be implied since you've closed more of your claims we could view this as being more one-time. But I just wanted to get your commentary on where exactly it came from?
So it was actually, we added to the reserves in the more recent years of 2016 and 2017, which is where we're -- which is what's leftover of the claims that we're closing out. And 2015 and prior, as I said earlier, based on the number of claims that are open, pretty much settled out at this point. But we did again, those are the years that you have the leftover claims, if you will, and those are the ones that we're focused on at this point closing out, and that's where we saw some volatility, which we thought was prudent to put some more reserve additions on onto those years on that basis.
Okay. But you didn't have 2018 or 2019 in the quarter?
No, that is correct.
Okay, terrific. And then last question is, do you still believe that 10% return on equity, and the 95% combined ratio is achievable for 2019 and beyond?
So we don't generally give kind of broad guidance on that basis. But our view is based on kind of if you look at our metrics of the organization from a balance sheet standpoint, we're targeting generally 95% or better combined ratio, based on our kind of leverage ratios, both in terms of our net premium leverage or asset leverage, current financing rate, as well as debt leverage, and walk through all of that, the ability for us to sustain a 10% or better is relatively good. And we feel good about being in a position to do that on the current year as well go-forward basis.
Thank you. [Operator Instructions].
Our next question comes from Andrew Boord with Fenimore. Please proceed with your question.
Thank you. Good morning, guys, obviously is a good quarter. So congratulations. And thanks for all the good data you guys are putting out these days. It really helps. My question which you may have already hit, I apologize if I missed something here but on the Standard Commercial segment, I was little surprised down it is down in the $15 million range for net premiums earned, is anything is pulling out of there or anything changing there that would explain that. And I'm not sure it's a risk or anything. I'm just trying to get my arms around it. Thank you.
Yes, so Andrew, good morning, it's primarily driven by the changes we made in the reinsurance treaty. So, as we restructured our broad casualty treaty last year, we see that some of the liability and the portfolio that we have not been seeding before and that's and so we -- and we were retaining more some of the more specialty risks. And so it's really been about capital allocation, and optimizing our capital allocation perspective to optimize our returns from that standpoint. So this is really on that basis that's driving that change.
Thank you. It appears we have no additional questions at this time. So I'd like to pass the floor back over to Mr. Anand for any additional concluding comments.
Great. Well just thank you again everyone for your participation this morning. We appreciate your time and interest in Hallmark and we look forward to speaking with you again next quarter. Thank you.
Ladies and gentlemen, this does conclude today's teleconference. Again we thank you for your participation and you may disconnect your lines at this time.