Good day, ladies and gentlemen, and welcome to the Quarter 1 2014 Employers Holdings Inc. Earnings Conference Call. My name is Patrick, and I will be your moderator for today. [Operator Instructions] As a reminder, this conference is being recorded for replay purposes. I would now like to turn the conference over to Ms.

Vicki Mills, Vice President, Investor Relations. Please proceed. .

Thank you, Patrick, and welcome, everyone, to the first quarter 2014 earnings call for Employers. Yesterday, we announced our earnings results, and today we expect to file our Form 10-Q with the Securities and Exchange Commission. These materials may be accessed from the company's website at employers.com and are accessible through the Investors link.

Today's call is being recorded and webcast from the Investor Relations 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; and Rick [ph] Yocke, 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 developments. .

We use a non-GAAP metric that excludes the impact of the 1999 Loss Portfolio Transfer, or LPT. This metric is defined in our earnings press release available on our website..

Now I will turn the call over to Doug. .

Thank you, Vicki. Welcome, and thank you for joining us today. Our results in the first quarter of this year were strong. Before the LPT, we recorded a year-over-year increase of $0.09 per diluted share in earnings and a 2-percentage-point improvement in the combined ratio.

Our book value per share, adjusted for the LPT, increased 1.6% in the first 3 months of this year..

In the first quarter, our net premiums earned was 13% higher than the same period last year as we increased pricing and grew both the number and size of our in-force policies. Policy count growth of 4.8% was more modest than in recent periods, while the average policy size increased 7.3% relative to last year's first quarter..

We are seeing benefits from our continuing increases in pricing as our aggregate net rate increased 6.5% over last year's first quarter..

In California, which represents 60% of our in-force premium, we slowed policy count growth to 3% while policy size grew 10.7%. And our year-over-year pricing increased 9.8%, 6.7 percentage points higher than all of our combined states excluding California..

Our underwriting results improved in the first quarter of this year relative to last year's first quarter, primarily due to increases in premium and our ability to continue to contain the underwriting costs that don't vary with premium. Our losses and loss expenses as a percent of net earned premiums were flat year-over-year..

You will recall that in the fourth quarter of last year, we experienced a significant increase in litigated claims concentrated in Southern California.

From January 1 through September 30, 2013, our open litigated indemnity claims as a percent of total indemnity claims in Southern California increased 6 percentage points, or an average of 2 points per quarter. From September 30 to December 31, the increase was 8 points..

We're pleased to report that in the first quarter of this year, the number of open litigated indemnity claims as a percent of total indemnity claims in Southern California grew less than 1 percentage point since December 31 of last year..

Our actuarial analysis of ultimate losses indicated a decrease in the frequency of indemnity claims in the first quarter year-over-year, while our loss experience indicated upward trends in medical and indemnity cost per claim that are reflected in our current accident year loss estimate..

Adjustments made in the fourth quarter of 2013 resulted in an annual loss provision rate of 77%. In the first quarter of this year, we reduced our loss provision rate to 74.7%. The decrease in our current accident year loss estimate was primarily the result of net rate increases, which more than offset anticipated increases in loss costs..

As I indicated during the last earnings call, we don't see anything on the immediate horizon that suggests a reversal of general loss trends in California. We believe the factors reported by the WCIRB, which we have previously discussed, including increased benefits associated with the passage of Senate Bill 863, continued to impact loss costs.

We have stated in the past that we have not factored any savings related to SB 863 into our California rates. That continues to be the case. And in fact, with impending challenges to medical lien reform and judicial decisions related to independent medical review boards, we do not anticipate any cost savings associated with this legislative reform..

First, we are currently quoting policies, effective June 1, utilizing 3 operating companies with new rates and territorial multipliers; second, we are non-renewing poor performers, which represent a small percentage of our California policies; third, we are increasing prices for chronically underperforming class codes; and fourth, we are targeting attractive classes of business both within and outside of California..

In the third quarter of last year, we announced an operational restructuring. We are currently staffing a more centralized operational structure and will continue to announce key appointments as they are made. Throughout the remainder of 2014, we will continue our focus on pricing, cost containment and service improvement..

With that, now I'll turn the call over to Rick for more details about the quarter. .

Thank you, Doug, and good morning. Our first quarter 2014 net income, before the LPT, nearly doubled at $0.20 per diluted share compared with $0.11 per diluted share in 2013. The increase in our invested assets led to a 3.5% year-over-year increase in net investment income during the first quarter..

Average book yields continued to decline slightly as investments matured. The first quarter average pretax book yield on invested assets was 3.3% and 4% on a tax equivalent basis.

Net realized gains on investments were $3.3 million in the first quarter, and investment income remains pressured for both the industry and for us in light of continuing historically low yields..

Our revenues grew 13% in the first quarter of this year compared to the same period in 2013 and our expenses, excluding the LPT, increased 11%, primarily attributable to a nearly 13% increase in loss and loss adjustment expense driven largely by premium growth.

Our recognition of prior rate increases in combination with the year-over-year decline in indemnity claim frequency allowed us to reduce our current year provision rate to 74.7%, a 2.3-percentage-point reduction from our effective provision rate of 77% at year-end 2013..

This is a 40 point -- or basis points lower than the rate in the first quarter of last year. We believe our current-year accident year loss estimate is adequate. The minor -- prior accident year loss development reflected in the combined ratio table in our earnings release is related to assigned risk business.

As we've indicated in the past, due to the late reporting by the states, the adverse loss development related to assigned risk pools will generally be for prior periods..

Our first quarter loss ratio was 1/10 of 1 percentage point lower than the same quarter last year, while our combined ratio before the LPT improved 2 percentage points largely due to improvements in our underwriting expense ratio..

We have limited increases in underwriting and other operating expenses to 5.6% with cost increases consisting largely of premium taxes and assessments related to premium growth and nonrecurring IT expenses of $700,000. Our underwriting expense ratio declined 130 basis points in the quarter and our commission expense ratio declined 40 basis points..

Our income tax expense was $1.3 million in the first quarter compared with a tax benefit of $200,000 in the first quarter last year. The increased tax expense was primarily the result of a reduction in tax-exempt income relative to pretax net income and an increase in year-over-year projected annual net income before taxes..

Please see Note 4 in the Form 10-Q, which will be filed after the call. This note provides reconciliations from the corporate tax rate of 35% to our effective tax rates of 10.9% and negative 3.1% for the first quarters of 2014 and 2013, respectively..

We know that modeling our tax rates is not easy and we hope the tax note is helpful. The estimated fair value of our portfolio was $2.4 billion at March 31, an increase of 1.3% since December 31, 2013..

Approximately 93% was fixed maturity securities with a duration of 4.2. Equities represented 7% of our total portfolio at the end of the first quarter with a continued focus on dividend-yielding equities..

At March 31, we had approximately $170 million in cash and securities at the holding company based on market value. Approximately $85 million of the securities were restrictive.

The principal uses of capital in recent years have been investments, supported the growth in financial ratings of our operating subsidiaries and the payment of dividends to shareholders. We continue to evaluate and consider other uses of capital as well, including acquisitions and share repurchases.

Although at this time, we have no plans or authorizations for these other options..

In conclusion, we're confident in our underwriting actions, our reserving practices and in the availability of capital for operations..

With that, I'll turn it back to Doug. .

Thanks, Rick. We reported a strong start to this year. Workers' Compensation insurance is a volatile business, but as a mono-line specialist company, we have the ability to recognize issues quickly and deal with them. We are monitoring and handling issues related to loss trends in California.

Our first quarter results reflect our significant progress in strengthening our financial and operating performance. .

And with that, operator, we're ready to take questions. .

[Operator Instructions] And our first question comes from the line of Mark Hughes with SunTrust. .

I'm sorry, I missed the first few minutes of the call, but Doug, if you talk about your thoughts about top line strategy going forward, I know around 4Q, you were talking about being very careful and being more selective in your underwriting and that was translated into the little slower top line this quarter.

How are you feeling about the opportunity versus the risks going forward?.

Let's start with opportunity and risk. We have identified, again, both within and outside of California, classes of business that we believe present very good opportunities. That will offset some, if not all, of the business that we expect to lose, principally in Southern California as a result of our nonrenewal activities.

Also, as we implement the tiered strategy in California with the territorial modifiers, that will likely have an impact on our new business production in Southern California. But again, we are seeing rates strengthening, particularly in California but in other parts of the country as well. The market continues to be competitive.

And we see, particularly new business production challenges because of the pricing levels in the market and we're prepared to miss on that business if we can't get the price we've set. .

And so when you put all that together, how do you think that, that shapes out over the next couple of quarters? Is it more balanced in favor of a little more top line growth? Or is this -- do you think this is what we ought to expect, a little more modest top line expansion?.

Yes. Relative to prior periods, the top line growth will be slower because the ability to get rate is more challenged now than it was 1 year and 2 years ago. The unknown is what the impact our pricing activity will have in Southern California.

There is certainly business in Southern California that we're prepared to write, but only if we can get our price. If we're unable to get our price, and if the renewal activity falls off, the top line could go down. That is not our expectation as we sit here today, but it's certainly possible. .

And you may have done some of this at the start of the call, but could you reflect on kind of what you saw in the fourth quarter? In your experience, have you seen spikes like this? The short periods where you get a sharp acceleration and then it flattens out.

How does this episode, as it's playing out, compare to your experience?.

I have seen these periods before where you might have a single quarter that is outside of expectations. When I look at the fourth quarter of last year, what occurred was not expected. And look at the first quarter of this year, the results were in line with our expectations.

It's a little early yet to say that things will return to normal in Southern California for the market as a whole, those litigation rates may just stay at those levels for a while. The underwriting actions we're taking, we expect, will bring that down.

If you look at what was driving the litigation rates, the things that those claims had in common is that they were cumulative trauma claims. In a lot of cases, they were late-reported and they seem to be concentrated in a handful of classes of business. The plan we put in place deals with all of those.

And so we would expect that our litigation rates could fall. Whether or not they ever go back to historical levels, I don't know. At this point, we're not even certain what caused that spike in the fourth quarter.

We'll have more industry data, probably in the next 6 to 8 weeks, that might give us a little bit more insight as to whether or not what we experienced was reflective of the entire market. We just -- it's just a little too early to know yet. .

Your next question comes from the line of Amit Kumar with Macquarie. .

Just a few follow-ups on the opening comments. First of all, just going back to the discussion, I guess, on the increase in litigated claims. You mentioned it's gone down to less than 1%.

Was there sort of a monthly trend line which you could share with us in terms of how Jan, Feb, and March looked? And I don't you know if you have any early view for April on that trend line?.

I don't have an early view on April yet, given where we are, on the first of May. So if I had it, I'd certainly be happy to share it with you, I just simply don't. In terms of where that sell -- I'm just looking to see if in my notes I have it by month. Let's see, I've got this in front of me. The movements are very slow.

I mean, they're tenths of a point up and down. So they're just -- there's really no trend there. .

Okay. The other question I had was just the discussion I guess on bank expense initiatives. I recall on the last call, you talked about reductions and the expense ratio. I was wondering if you could expand a bit further on that discussion from last call. .

Yes. As I indicated earlier, we are embarking on a restructuring of our organization. Some of the staffing of which has already occurred, some of which has yet to come. I guess the best way to describe it is, we've reached a point where we believe the company will benefit from centralizing a lot of what had previously been regional operations.

And we think by doing that, we will be able to drive much greater efficiencies as well as consistency in the operation. And I expect you'll see more of that as we go through the year. Again, it's still in the process of being staffed and there are many decisions yet to be made in terms of how we will ultimately structure the operation.

But the key idea is to drive centralization and greater efficiency and consistency. .

Okay. The last question, and we got a lot of questions on the loss pick discussion. You pointed out in your opening comments what you thought about the loss provision.

I guess going forward, could there be a possibility that you could have overshot in Q4 and hence, over time, there could in fact be a possibility that we could see some reserve takedowns? Or how do you think about 2013?.

Well, I would say that we believe there's an equal opportunity for it to go up or down. We've picked our best estimate for that quarter.

So we didn't -- when we picked the number, it wasn't, "Well, let's pick a high one, and maybe it'll come down." I think the best way to think about the fourth quarter is, what was driving that? It was an uptick in the number of litigated claims. And once those claims go into litigation, they're not going away.

And if it costs 7x more than the average indemnity claim, it seems unlikely to me that, that's going to just suddenly improve. There's something structural about those claims, and that's why we reacted the way we did in the fourth quarter. We just don't see them going away. And consequently, we had to provide for them accordingly.

Now is there a possibility that we went too far and things will be better than we expect? Well, I would certainly hope that's the case. But I can't tell you that we expect that. If we expected that, we'd be booking another number. .

Got it. And finally, is there any update on the 3 companies discussion we had last quarter? I know it starts from June 1. I think in it was in the press that those people have already received notices.

Can you just give us a quick update on where we stand in the process?.

Yes, we are quoting June 1 business with the 3 company strategy, with the territorial multipliers. Given the lag business comes on the books and the fact that a lot of it comes near the end of the quarter, particularly June 30 in our case, which is a large renewal date, it's too early for us to tell you what the implications of that might be.

We'll probably have a better feel for that in maybe 6 weeks, and certainly the 2 weeks following the middle of June. We'll have a pretty good idea of what the impact's going to be. I just -- the notices have gone out. People have an understanding of what's coming, but it's too early yet for June 1 business. .

Your next question comes from the line of Matt Carletti with JMP Securities. .

First question, probably for Rick, just a numbers question. An apology if I missed it in the prepared remarks.

Can you give us the moving pieces behind the very minimal amount of adverse development net in the quarter, which actual years generally went plus or minus?.

The entirety of that number is assigned risk pools. And as we've mentioned before, those, just by their very nature, reported late to us, they're reporting on the historical developments of the pools and they hit our statements as prior period development. We have no other prior period development other than the assigned risk. .

Great. And then second question might be for Doug, just on the improvement in the accident year.

It's nice to see, and I thought it would be coming maybe a little earlier than what I thought, given I think your comments on the last call in response to somebody's question about, if the litigated claims slow down maybe in a quarter or 2, we could bring down the loss ratio a few points.

And I think you essentially said, "It's a possibility but we're going to be a lot slower in taking it down than we were last time around." Can you just maybe give a little color on what you saw that led you to believe that you'd do that now instead of maybe wait a quarter or 2?.

Sure. Where -- if you look at where we're providing for right now, it's essentially at the same level we were providing for a year ago. And so if you would have taken where we were last year and the fact that year loss trends and rate expectations, I think you would've expected to see our loss ratio a bit lower right now than where it is.

So we're pretty much flat to last year. Again, I'm looking at the fourth quarter now more as it may have been an anomaly. It's real. We've responded to it and I think where the loss provision right now is appropriate to what we were seeing in first quarter.

Again, there was a slight decline in frequency, fairly modest increases in the medical and indemnity trends. So it has a sense of being back on track to where we thought things were. Doesn't mean that we can't have some other unexpected event, but you can always have an unexpected event.

Things are kind of right as we anticipated they would be as we put together our plan for 2014. .

[Operator Instructions] Your next question comes from the line of Heather Takahashi with Three Bridges Capital. .

I just had some questions on the claims trends. You mentioned that you saw decreasing frequency but increasing severity. And I'm wondering if you had any sense of what was driving the changes in each? And also, I'm wondering if you think there isn't any seasonality involved in what you saw in the fourth quarter. .

Let's start with the second part of that. In terms of seasonality, I don't expect so. That's something we look for. I just look at data historically. For some reason, September tends to be a quiet month. Something about back-to-school, I suspect. But I didn't see any seasonality in the fourth quarter.

Now if you look at some of our first quarter results at a claim level, and these aren't significant, but if you look at the largest claims in the quarter, I think 4 of the top 10 were weather-related. They were in the East, they were slips and falls.

So you can, once in a while -- it's not predictable, but once in a while, you can see some seasonality related to the way claims come in. Again, that was not significant at all to the quarter, but responsive to your question. In terms of causes of changes in frequency in the loss trend on medical indemnity. Frequency, I don't know.

I can't attribute a particular cause to the change in frequency. It was modest. In terms of the medical and indemnity trends, nothing out of the ordinary there, just normal kind of inflationary impacts. Certainly in California, we've seen increasing medical severity related to increased medical utilization.

And I think a lot of that has to do with the impact of the SB 863 reforms. And again, that's not changing, it's just kind of a continuation of what we've seen. .

And I'm just wondering about the change in the loss picks from the fourth quarter to the first quarter.

How much was driven by what you've actually seen in terms of reported claims versus what you or, I guess, the anticipated benefits from the remedial options that you've taken already?.

We're not building in expected benefit from actions that we're taking. It's more a question of what we're seeing in real time in terms of paid and incurred data. .

Okay, okay. And then the change in -- I guess, it's not a change really, it's more stabilization of the legal representation in the claims or the proportion of represented claims.

Do you have any sense of what drove that spike in the fourth quarter last year? Have you had any more insights on what drove that? Or how -- why it would reverse going forward?.

We've segmented this a number of different ways and trying to develop a better understanding of what's driving it. And every time we take a different approach in terms of the segmentation, we come back with the same answer, which is -- seems to be, principally, cumulative trauma claims.

And they have the commonality of higher litigation rates and higher costs. And in our case, it was principally related to particular geography and more common in a number of classes. And again, we've taken a number of stabs at this trying to see if there isn't some other explanation for it.

And every time we look at it, we come up with that same commonality. Where that may have come from is just the increase in permanent disability awards coming out of 863. And frankly, the amount of the awards going up makes it more attractive to litigate and more attractive to be an applicant's attorney. And it may be nothing more than that.

But that's just -- that's our view of what we're seeing. It's going to take some time to really understand it, if there's some other alternative explanation. That's our best guess at this point. .

And so just to clarify, then.

So what you've said in the press release was the 1%, that is just a lower delta versus the prior quarter versus an absolute reduction, a proportion of litigated claims? So the proportion of litigated claims continued to increase but just at a lower rate, if that's correct?.

Yes, at a lower rate than we'd seen in any of the previous 4 quarters. And again, in response to Amit's question, it was moving around slightly up and down, tenths of a point. So to the extent that 3 months means anything and certainly, we felt it did last quarter. This quarter, it appears to be relatively stable.

Although again, mathematically, it's up but it doesn't seem to have a trend, whereas the previous 12 months, there was a trend. .

So I was wondering about them. So if the proportion of litigated claims actually continued to rise and litigated claims tend to be more extensive, why would your loss pick have come down so much? I was just -- I just was wondering about that. .

So we're seeing a decline in frequency and we saw the medical and indemnity loss trends in line with expectations. .

And we're seeing the continuing -- earning again, if you will, of previously charged rates that we spoke about in 2013. So as those rates realize themselves as earned premium, and they are effectively higher rate on the policies, they express themselves as a lower loss ratio. .

Okay.

So you're saying then, it's the earning of the higher rates, and the lower general frequency offsets the impact of the increased represented claims, is that correct?.

That's correct. .

Your next question comes from the line of Robert Paun with Sidoti & Company. .

I believe you said the average policy size was up about 11%.

Was this mostly due to the rates? Or was there any movement in the buckets of hazard groups and classes of business that might have moved that policy size higher?.

Yes. It's mostly rate. I -- there's very little movement in terms of the book from hazard group or class. It's been relatively stable. There's not a lot of business mix moving to the book. And Robert, let me just expand on that a little bit. As we move production more outside of California, you're going to see some impacts there as well.

So it is very difficult to define that at a very precise level. I mean, there isn't business mix in terms of hazard groups but it should start moving in around the states, you can have an impact. .

Right. And just to follow up on the new operating companies in California.

Are there any material expenses associated with creating the additional companies that we might see in the second quarter?.

No. .

There are no additional questions at this time. I would now like to turn the call back over to Doug Dirks for any closing remarks. .

Thank you, everyone, for joining us today. We appreciate your questions and we look forward to speaking with you again with our second quarter results. Thank you. .

Ladies and gentlemen, that concludes today's conference. Thank you for your participation. You may now disconnect. Have a great day..