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Operator
Good morning, everyone, and welcome to ProAssurance's conference call to discuss the company's second quarter 2021 results. These results are reported in a news release issued on August 5th, 2021. Please review that document. 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 August 6, 2021, and except as required by law or regulation, ProAssurance will not undertake and expressly disclaims any obligations to update or alter information disclosed as part of the 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. Now, as I turn the call over to Mr. Ken McEwen, I would like to remind you that the call is being recorded, and there will be a time for questions at the conclusion of the prepared remarks. Mr. McEwen, please go ahead.
Ken McEwen
Thank you, Sean, and good morning, everyone. On our call today, we have Ned Rand, President and CEO, Dana Hendricks, Chief Financial Officer, Mike Bogusky, President of our Specialty Property and Casualty Lines, and Kevin Shook, President of our Workers' Compensation Insurance Operations. Ned, the floor is yours.
Ned Rand
Thanks, Kim. I want to start off this morning with a thank you to everyone at ProAssurance. This has been an exciting quarter on many fronts, thanks to their efforts. We closed the NorCal transaction on May 5, roughly halfway through the reporting period. And the financial teams of our newly combined organization did a great job getting everything ready to report our results. We've made excellent early progress on our integration plan. And already, NorCal is proving its value as we expand our operating model to a truly national platform. As I said in the release yesterday, closing the NorCal transaction was a transformative event for Pro Assurance, and the combined companies are off to a strong beginning. As you will hear from both Mike and Kevin, the strategic changes we've made over the past two years are beginning to show through, and I'm very encouraged by the results of the second quarter. We remain in an uncertain environment due to the continuing effects the pandemic has had on our healthcare and civil court systems, and as workplaces navigate the return to work to an office environment. In spite of these uncertainties, I am confident we have the right team in place, especially as we add in our colleagues from NorCal, to succeed as we move forward. Now I'd like to turn the call over to Dana so she can lead us into the results for the quarter. Dana?
Kim
Thanks, Ned. The NorCal acquisition was, of course, the most impactful item in the quarter. And we'll get to that in a moment. But first, I think it's important to answer the question of excluding the noise from the transaction. How did we do this quarter? In short, it was a good quarter. We expected significant improvement year over year just by nature of the adverse events booked in the year-ago period. And we saw that improvement and then some. Our specialty P&C business continues to show improvement with strong rate gains, solid retention, and top line growth. Lloyd's turned in an excellent result at a little over $4 million. Our workers' compensation insurance and segregated portfolio sale reinsurance businesses both produced underwriting income in a very challenging marketplace. With their expense ratios benefiting from the restructuring completed last year, Finally, we saw excellent returns from our investments in LPs and LLCs driven by the market increase in the first quarter. Recall, those investments are typically reported on a quarter lag. All told, a solid result as we continue to execute strategies that drive steady, incremental improvement. Now for the results of the quarter. We will be filing our 10-Q on or before Monday, which will provide a great look into exactly how NorCal contributed to the quarter and the effects of transaction accounting. I'll address certain of those impacts throughout my remarks today. At the consolidated level, we've reported net income of $92.1 million in the second quarter, or $1.70 per diluted share. driven by a gain on bargain purchase of $74.4 million related to the NorCal acquisition, partially offset by $20.3 million of pre-tax transaction-related costs. Because these one-time items are unique and unusual in nature and not indicative of regular operations, they are excluded from operating earnings and segment reporting. We reported non-GAAP operating income of $26.6 million, or 49 cents per share. Again, driven by strong performance from our LP and LLC investment portfolio and meaningful year-over-year improvement in our underwriting results. All segments contributed to our profitability this quarter. Consolidated gross premiums written increased nearly 13% year-over-year driven primarily by the addition of NorCal's premium to our specialty P&C results, as well as $14 million of new business written in the quarter from our core operating segment. Our consolidated current accident year net loss ratio was 81.9%, a year-over-year improvement of 28.1 points, primarily attributable to the adverse effect of losses associated with significant events in the second quarter of last year in specialty P&C. More importantly, that improvement also reflects the continued benefits of our re-underwriting efforts. We recognized net favorable development of $13.8 million in the current quarter, driven largely by the specialty P&C segment, which included $2.1 million related to the amortization of the purchase accounting fair value adjustment on NorCal's assumed reserve. Our consolidated underwriting expense ratio increased in the quarter to 32.3%, driven by the pre-tax transaction costs associated with our acquisition of NorCal. Excluding those transaction costs, the expense ratio in the quarter was 23.8%, reflecting the continued impact of restructuring efforts, but also included the impact of certain purchase accounting adjustments. As a part of purchase accounting, we wrote off NorCal's capitalized DPAC asset on the acquisition date. As a result, DPAC amortization expense for NorCal in the second quarter was only $900,000 and represented expenses capitalized and subsequently amortized since the acquisition. This amount is approximately $6.3 million lower than would be considered normal. In our Form 10-Q, we will provide a detailed breakout of the various items affecting our expense ratio in the quarter to help our readers arrive at a run rate. From an investment perspective, our consolidated net investment result increased year-over-year to $29.3 million, driven by $11.9 million of income from our unconsolidated subsidiaries, which were driven by the results of our investments in LPs and LLCs, as previously discussed. Consolidated net investment income was $17.4 million in the quarter, down slightly from the year-ago period, primarily due to lower yields from our short-term investments in corporate debt securities due to the current low interest rate environment. This decrease was partially offset by $2.7 million of net investment income from additional invested assets that came over from the NorCal acquisition. I'll conclude by thanking our accounting and financial reporting team for their extraordinary efforts in getting the NorCal financial results integrated with our consolidated results in such a short timeframe. They've done a great job. Ken?
Ken McEwen
Thanks, Dana. Mike, congratulations on a significant improvement in specialty P&C this quarter. What can you tell us about the results?
Dana
Thanks, Ken. I want to start by extending congratulations to the specialty P&C team for the continuing turnaround of our operating results over the past two years to achieve an operating profit, the close of the transaction with NorCal, and the great start to integration of the companies. We are proud of all that has been accomplished and look forward to a bright future with our new team members and business partners at NorCal. The significant year-over-year improvement in the segment's results was driven by several components. primarily the comprehensive business strategy executed since 2019 to address our operating and underwriting results and the resulting re-underwriting and rate strengthening efforts in our legacy HCPL business. We recorded improvement in operating metrics for all lines of business in the segment, including higher premium retention, continued rate gains, a reduced expense ratio, and a lower current accident year loss ratio. Most material to the improved results of the quarter was the impact of certain adverse events recorded in the second quarter of 2020. However, we recorded improvement in the current accident year net loss ratio, even excluding those adverse events, a direct result of the continued benefits of our HCPO re-underwriting efforts. Also contributing to profitability in the quarter was $10.5 million of net favorable reserve development, spread relatively evenly across lines of business within the segment. Just a brief aside before we move on from the loss ratio. The reduction in HCPL claims frequency observed in 2020 has continued into 2021 thus far, as courts and jury trials in most places have yet to return to normal schedules. We remain cautious in recognizing these favorable frequency trends in our current accident year loss pick due to the long-tailed nature of our lines of business and the high degree of continuing uncertainty that COVID-19 has introduced into operating conditions. We continue to carefully monitor pandemic-related claim activity, and no adjustments have been made to the COVID-19 IBNR reserves booked in the second quarter of 2020. Moving on to our top line, gross premiums written during the second quarter increased by over 30%, or approximately $35 million. We benefited from $22.4 million delivered by the NorCal team and growth in our legacy business of 6.9%. We achieved this growth with focus on underwriting discipline, and we will continue to manage the segment's top line as necessary to achieve our long-term profit objectives. Premium retention for the segment was 86% in the quarter, driven by retention rates that either improved or remained flat in all lines of business. Furthermore, we achieved average renewal price increases of 10% in the segment this quarter, driven by 11% in standard physicians and 10% in specialty healthcare. Although not reflected directly in our rates or pricing, we continue to strengthen rate adequacy through adjustments to product structure, terms, and conditions. Our small business unit and medical technology liability business also achieved increased rate gains of 6% and 8%, respectively. New business written in the quarter totaled $7.2 million, an increase of $2.6 million from the year-ago quarter and primarily driven by $3.7 million written in our HCPL specialty business. The specialty property and casualty segment reported an expense ratio of 17.1% for the first quarter, for the second quarter, an improvement of 2.8 points from the year-ago quarter, driven by significantly higher earned premiums, the impact of transaction accounting, and benefits from prior organizational restructuring efforts. This was partially offset by a slight increase in technology costs. To conclude, we are pleased with the results of a re-underwriting restructuring, expense management, and operational improvements in our legacy specialty P&C business over the past two years. We are extremely excited about the strategic value of the NorCal transaction and the bright future ahead. We have made excellent progress on our integration plan during the quarter, and we are well on our way to building our future business model on a national basis with the goal of enhanced and sustainable performance through all economic and insurance cycles. Ken?
Ken McEwen
Thanks, Mike, and congratulations again to you and the team. Kevin, workers' compensation insurance and the segregated portfolio cell reinsurance segments have solid results to report as well. Can you walk us through those?
Mike
Sure, Ken. The workers' compensation insurance segment produced income of $1.1 million and a combined ratio of 99.6% in the second quarter of 2021 compared to 98.7% in 2020. The increase in the combined ratio year-over-year reflects a higher accident year loss ratio in 2021, partially offset by an improvement in the underwriting expense ratio. During the quarter, the segment booked $57.8 million of gross premiums written, an increase of 1.1% year-over-year, despite negative audit premium. Renewal price decreases in our traditional book of business were 3% in the second quarter of 2021, and premium renewal retention was 85%. Traditional new business writings increased by $300,000 to $6.1 million in the quarter. Audit premium in our traditional book of business decreased $1.3 million year over year, reflecting the economic conditions associated with the COVID-19 pandemic and its impact on final audits of policyholder payrolls. The increase in the calendar year loss ratio to 68.3% in 2020 run reflects an increase in the current accident year loss ratio, partially offset by prior year favorable development of $1.9 million in 2021 compared to $1.5 million in 2020. The increase in the full year 2021 accident year loss ratio during the quarter reflects our response to observed higher claim activity as workers return to full employment with the easing of pandemic-related restrictions in our operating territories. The trend in higher claim activity was concentrated in our historically profitable small business unit, most notably in restaurant, hospitality, and small construction market segments, and was from accounts within our renewal policyholder base. We booked a current accident-year loss ratio of 73% for the second quarter of 2021, which brings the ratio for the six months ended June 30th to 72%. Despite the increase in claim activity in our small business unit, overall frequency continues to be below pre-pandemic levels, albeit higher than 2020. The claims operation closed 15.4% of 2020 and prior claims during the 2021 quarter, consistent with second quarter historical trends. Reported COVID claims continued to decrease during the second quarter of 2021. Of note is the fact that there are no currently reported COVID claims with accident dates in the month of June. However, there was a slight increase in reported COVID claims during July. We continue to monitor legislative attempts to broaden workers' compensation coverage in our underwriting territories, but observed minimal movement during the second quarter. The 2021 underwriting expense ratio decreased to 31.3%, primarily due to the restructuring initiatives implemented in August of 2020, partially offset by a decrease in net premiums earned. Other underwriting and operating expenses were $8.3 million in the quarter, a decrease of 7%, or approximately $700,000. The segregated portfolio cell reinsurance segment produced income of $955,000 and a combined ratio of 84.4% for the second quarter of 2021. Premium trends in the SPC resegment were largely consistent with those in the workers' compensation insurance segment. We renewed all of the captive programs that were available for renewal during the current quarter. The SPC-RE calendar year loss ratio increased from 45.9% in 2020 to 51.9% in 2021. The 2021 accident year loss ratio was 62.9%, up from 57% in 2020, and reflects both the continuation of intense price competition in the workers' compensation business and the impact of higher claim activity as workers return to employment. Favorable loss reserve development was $1.8 million in the second quarter of 2021 compared to $1.9 million in 2020. In all, another solid quarter in a very competitive marketplace. Ken?
Ken McEwen
Thanks, Kevin. Ned, can you give us just a quick look at the lowest results before closing comments?
Ned Rand
Yeah, happy to do so, Ken. As you know, for the 2021 underwriting year, we reduced our participation in Syndicate 1729 from 29 percent to 5 percent, and our participation in Syndicate 6131 from 100 percent to 50 percent. The gross premiums written in the segment this quarter reflect that change. As a result of these reductions, we received a return of capital of $24.5 million. Despite the reduced participation, results improved meaningly from the year-ago period to $4.3 million. Before we get to questions, I want to reiterate how pleased we are to deliver improved results after an exceptionally challenging year. While we still have much to do in pursuit of our long-term profit objectives, I believe our progress from a year ago speaks for itself. I look forward to seeing what we can accomplish in the second half of the year. Ken?
Ken McEwen
Thank you, Ned. Sean, that concludes our prepared remarks. We are ready for questions.
Operator
Thank you. We will now begin the question and answer session. If you would like to ask a question, please press star, then 1 on your touchtone phone. If you are using a speakerphone, please pick up your handset before pressing the keys. If at any time your question has been addressed and you would like to withdraw your question, please press star, then 2. The first question today will come from Paul Newsom with Piper Sandler. Please go ahead.
Piper Sandler
Good morning. Congratulations on the quarter. Maybe a few words on whether or not the medical malpractice and other liability, especially businesses, if the competitive environment has changed materially over the last quarter, and if it's getting a little bit easier or harder.
Ned Rand
Great. Paul, thanks. Mike, do you want to take that?
Dana
Sure, Ned. Thank you. Good morning, Paul. What we've really seen over the last, really just over the last two years, is that it still remains fairly competitive in our HCPL standard physicians business, particularly in some of our core states. In our HCPL specialty business, there was definitely an opportunity to to underwrite and strengthen rates, terms, product structure, and conditions. In general, that's continued. I think the only thing that I'd say that's been pretty interesting is that with the reduction of frequency in the industry as a result of COVID, that's maybe slowed down the pricing trends going forward as people are taking a look at that frequency reduction. I will say this, extremely pleased with our our rate trends in the quarter, double digits in standard and double digits in our HCPL specialty business, and a really good result across the segment.
Ned Rand
Thanks, Mike. Paul, I might add on the frequency reduction that Mike referred to. We remain very, very cautious both in how we're reserving because of that frequency reduction and also how we're pricing because of that frequency reduction. We don't know all the driver's of the frequency reduction and whether or not there's just a pinch in the pipe because of the court systems being slowed down. So we remain very cautious in recognizing some of those potential benefits. I'd say that maybe some others in the industry are being a little more aggressive in how they're recognizing it.
Piper Sandler
My second question, the piece that I have the hardest time modeling, probably no surprise, is the unconsolidated earnings piece. And I was wondering if you could, you know, give us some thoughts as to how we might view that piece. And, you know, I'm guessing that there was a benefit from the very strong financial markets. But maybe some words on that, that gives us a little bit better sense of how to think about the prospects going forward.
Ned Rand
Yeah, Paul, and I'll let Dana answer that. But yeah, it is, we recognize that it's a challenge. It's a volatile earnings component that over the longer term, we're very confident is producing outsized returns for us. There's two components to that. One is the tax credits. And we give some information in our 10-Q that shows how that part, which actually is a reduction to that line, is expected to earn out. And then the other component is how the LPs and other investments perform and very much driven by kind of the economic backdrop for those investments. But Dana can probably elaborate a bit.
Kim
Yeah, I think actually, Ned, you've hit on the primary components, certainly. What I'd tell you, Paul, is that one thing to consider in those investments is they're typically reported to us on a one-quarter lag. So, for our second quarter, you really have to kind of be thinking about how the market was responding in the first quarter of 2021. And that's going to be what's going to come through in our second quarter. So, really, that's how you ought to be thinking about it. In terms of the tax credits that Ned mentioned, we do provide a schedule of the anticipated tax credit portion. on our website, and so you can take a look at that as well to get sort of the two component pieces.
Piper Sandler
Fantastic. Thank you, guys.
Operator
The next question today will come from Mark Hughes with Truist. Please go ahead.
Mark Hughes
Yeah, thank you. Good morning. You mentioned how the courts being closed may be impacting frequency. I assume the trial attorneys are still out there doing their thing and they would still be looking for cases that they think they can profit from. You would still get notice in that way. Is that correct? You don't have to necessarily be going to court or is that often when you get notices some aspect of the court logistical process.
Ned Rand
Yeah, so Mark, you're right. The mere fact that the court systems have shut down may or may not be the total driver there. And that's why we kind of remain cautious if we don't know what all the drivers are. We do believe that there are probably plaintiff lawyers that are sitting on lawsuits waiting to file them until the court systems open back up. just because they don't necessarily want to start off in a position where you're negotiating to settle without the prospect of being able to litigate. And so we think there is some impact. We don't know exactly what that impact is, and that's why we remain cautious. Mike, I don't know if you'd add anything to that.
Dana
No, no, that's spot on. Thank you.
Mark Hughes
Then Mike says, I think you probably covered some of this ground, but your pricing looks like it accelerated in the quarter. As you pointed out, it was up double digits, both on position and specialty. But then you mentioned some slowdown in pricing trends related to this continuing decline in frequency. Has that slowdown been more recently, or are you reflecting on the first half in total?
Dana
Yeah, good morning, Mark. Good question. You know, one of the things to keep in mind in the second quarter, and I think this is terrific news, as you're well aware, we added the NorCal results into our premium. It's $22.4 million. And we did have some benefit from rate gain there. They produced about 16 points of rate from that May 5th to June 30th timeframe. So that was helpful. I think the slowdown was just from last year to the first couple of quarters of this year. I think the other thing to keep in mind is that we've been re-underwriting for a couple of years to get to the rate structures and adequacy that we think can produce a long-term underwriting profit. That does slow down as you get into the second year of re-underwriting. Those frequency trends, it is state by state. So, you know, there are some competitors, state competitors that are maybe being more aggressive as we look at competitive pressures resulting from the claims, the potential claims frequency reductions.
Mark Hughes
Understood. And if we think back, you know, three, four years ago, you were obviously early in spotting some of these social inflation trends. When you think of some of those earlier accident years, is it fair to say those, and particularly, you know, 2020 is probably distorting all of this, but is it fair to say that the inflation, the in the older claims is more in line with what you might have expected at the time rather than kind of what the concern was about an acceleration?
Dana
Yeah, I think as Ned stated, obviously the slowdown in the court systems has impact on that. But I think just in general, severity trend, it again is very much a state-by-state, and it's kind of hanging in there around 3%. as you look at our kind of 2020 and 2021 results.
Ken McEwen
Thank you.
Operator
Welcome. The next question today will come from Jeffrey Ransom with Dowling and Partners. Please go ahead.
Jeffrey Ransom
Sorry, it's Gary Ransom. Yeah, I had a couple questions on NorCal. Is there anything that you... know of now that might distort quarters in the future? Are there any expenses or anything else that just weren't booked in the second quarter but might have an unusual effect at some point in the future?
Ned Rand
Yeah, Gary. Dana can kind of give you some highlights of some of those details. There will be a lot more detail in our 10-Q as well. Dana?
Kim
Yeah, sure. So as you think about you know, the impact of NorCal on the second quarter, I think that there are a few component pieces. One in particular that you will want to be thinking about is, and I mentioned this in my opening remarks, around deferred policy acquisition costs. And that is an expense that we'll be building over time, over the course of the next year. So when you think about, you know, the capitalized policy acquisition costs that were written off, right, at the time of the acquisition, then what happens is the building of DAC begins again. And corresponding amortization essentially starts over day one after the acquisition. So the impact in the second quarter for us was very significant because we had the benefit of the earned premium with very little associated deferred policy acquisition costs. So if we were at a full run rate for DAC amortization expense, expenses would have been higher by about $6 million, which is about 3.8 points in the specialty P&C segment two and a half points if you're thinking about it from a consolidated perspective. So thinking about future quarters, as you look at deferred policy acquisition costs and the building of that amortization, you can expect it to increase expense each quarter until that amortization reaches its normal run rate, which it will reach that normal run rate in the second quarter of 2022. So I'd expect that increase on a quarterly basis to be around $3 million. And that's the biggest piece that I would say that's sort of kind of missing from second quarter that you need to be thinking about for the future.
Jeffrey Ransom
Okay, that's helpful. And maybe a little bit more strategically, can you help us understand how the strategy improves either top-line or profitability as you go through this integration? Are there things about distribution we should be thinking about or product that sells across the two books of business? Maybe if you can just help us understand how the integration helps top-line specifically and or bottom-line over time.
Ned Rand
Yeah, I'll let Mike get into the details, maybe just a couple of high-level thoughts. One, aside from the premium growth that we'll see, is the investment income growth. So we brought in an additional $1 billion in invested assets beyond the purchase price that will help drive investment earnings as we move forward. As we've spoken about previously, we expect to bring in or to reduce overall expenses between the combined organizations in excess of $18 million as a part of those integration efforts. So those are some things to keep in mind at a pretty high level. Mike, do you want to talk to some of the specifics around other integration impacts?
Dana
Sure, Ned. Thank you. First of all, the integration plan is meticulous, and it It's well thought out. And we're just getting some very nice early integration wins. And what I mean by that is we've already announced our HCPL national structure with five regions. And again, that will put us really close to the customer and agents as we look for revenue synergy wins. We do think that the revenue synergy wins There's a tremendous opportunity there because as you look at bringing NorCal into the company, we have geographic expansion. We also, for NorCal, have the addition of our life sciences products, our workers' comp products, our ANOVA captive facilities. there's a really great opportunity to do some cross-marketing, and that's a big part of our strategic planning process this fall. So we're pretty excited about that. But when you just look at it from an overall integration plan perspective, we think we'll have a much more diverse book of business, national platform, a reduced expense structure, best-of-breed talent, And we feel confident that it's going to bring some really nice strategic value to us over the next insurance cycle. We're excited about it.
Jeffrey Ransom
Thank you very much.
Operator
Again, if you would like to ask a question, please press star, then 1. The next question will come from Matt Carletti with JMP. Please go ahead.
Matt Carletti
hey thanks good morning um first question just circling back on on the expense reduction conversation there annette i think i heard you say kind of the combined um expecting about 18 million in expense synergies um just trying to kind of can you help us a little bit with just kind of pairing that up with the expense number we saw in the quarter i mean i caught dana's comments of course about the dac and how it's going to build over the next year just trying to get a feel for kind if you have a rough timing on that $18 million and if we're already seeing any of it in the current quarter or if that's all kind of yet in future quarters.
Ned Rand
Yeah, so, you know, the largest component of that will be driven by personnel changes that we make. Some of those happen day one with the departure of the most senior management at NorCal as well as the board at NorCal. During the quarter, we had our first reduction in force that reduced staffing as well. We would expect that that will continue over the next 18 to 24 months as we continue to integrate the organizations. There will probably be some lumpiness and expenses as a result of those actions, but But I would say that we've got a good start just because of those kind of early day one changes. But it will be about two years before we see the full benefit of that. Mike, anything you'd add?
Dana
Yes, Ned. I would just say this. In the second quarter, it was approximately $10 million. And we would project roughly $5 million in the third quarter. So I think To Ned's point earlier, we did get an early run at that. And it goes, the personnel obviously drives that, but you also have some other areas that are helpful to that reinsurance consolidation, IT consolidation, and those types of early wins. So I think the good news on the overall plan is we'll be substantially to the number that we publicly stated pretty early in the process.
Matt Carletti
Great. Thanks for the color, and congrats on getting the deal closed, and it sounds like you're off to a good start.
Operator
Thank you. This will conclude today's question and answer session. I would now like to turn the conference back over to Ken McEwen for any closing remarks.
Ken McEwen
Thank you, Sean, and thank you to everybody who joined us today. Please stay safe and healthy, and we'll look forward to speaking with you again in November. Thank you.
Operator
This will conclude today's question and answer session around today's conference. Thank you for attending the presentation, and you may now disconnect.
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