Good day, ladies and gentlemen, and welcome to the Employers Holdings Incorporated Q4 2016 earnings conference call. At this time, all participants are in the listen-only mode. Later, we will conduct a question-and-answer session, and instructions will follow at that time. If anyone should require assistance during the conference, please press star then zero on your touch-tone telephone. As a reminder, this conference is being recorded. I would like to introduce your host for today's conference, Ms. Vicki Mills, Vice President of Investor Relations. Ma'am, you may begin.
Thank you, Bruce. Good morning, and welcome everyone to the fourth quarter and full year 2016 earnings call for Employers. This morning, we announced our earnings results, and later this week, we expect to file our Form 10-K with the Securities and Exchange Commission. These materials may be accessed on the company's website at employers.com and are accessible through the investor's 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, Mike Paquette, our Chief Financial Officer, and Steve Festa, our Chief Operating 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 certain non-GAAP metrics that exclude the impact of the 1999 loss portfolio transfer, or LPT, and other items. These metrics focus on operating income and operating equity and are defined in our earnings press release available on our website. Now, I will turn the call over to Doug.
Thank you, Vicki, and thank you all for joining us for our fourth quarter and full year call. Our reported results for the quarter and the full year 2016 are some of the strongest in our history as a public company. In the fourth quarter, we achieved double-digit returns on equity and reported historically low combined ratio. Our annualized return on equity was 16.8%, with an annualized operating return on equity of 13.5% for the quarter. Our operating return on equity was 2.6 percentage points lower than the fourth quarter of 2015, driven largely by higher taxes on income. Higher taxes in 2016 as compared to 2015 were the result of a significant tax benefit from the reallocation of pre-privatization reserves recorded in the fourth quarter of 2015.
Our combined ratio before the impact of the LPT was 85.6%, 7.4 percentage points lower than in the fourth quarter of 2015, driven mainly by lower loss and expense ratios. We lowered loss reserves in the fourth quarter by $16.9 million due to favorable development. Our accident year combined ratio, which excludes impacts of the LPT and favorable development, was 95.4%, reflecting our disciplined underwriting philosophy and prudent reserving practices. Our book value, which includes the LPT deferred gain and dividends, increased 8% year-over-year to $31.61 per share. AM Best recently affirmed our A-minus excellent rating, citing our excellent risk-adjusted capitalization, our rapidly improving operating earnings, and our significant market expertise operating as a workers' compensation writer. Our outlook is stable.
Given our continued strong financial position and our improved underwriting results, we are pleased to announce that the board of directors increased our first quarter shareholder dividend to $0.15 per common share, up from $0.09. This significant increase reflects our continued confidence in the operating performance of the company. Our capital strategy remains focused on supporting our business operations and sustaining a level of financial flexibility to prudently manage our business through insurance and economic cycles, while allowing us to take advantage of investment opportunities when they arise. Our strong financial and operating results reflect our continuing focus on pricing and data-driven strategies, accelerated claims settlement, and our success in targeting profitable classes of business nationally. By successfully implementing our business strategies, we have delivered increased profitability in the fourth quarter and the full year 2016.
Headwinds to our top line in 2017 will be similar to those in the recent past. Ongoing competition for our small business customers across our markets, and generally improving loss costs, which are driving lower rates. Throughout 2017, we will work to retain our best business and seek new business opportunities that meet our desired return objectives by continuing to focus on disciplined risk selection and pricing across all of our markets. With that, I'll turn the call over to Mike for a discussion of our operating results. Mike?
Thank you, Doug. We delivered solid operating earnings in the current quarter, in line with our expectations. Net written premiums declined by $8 million in the current quarter, driven largely by lower final audit premiums recognized a year ago. The higher audit premium in the fourth quarter of 2015 was attributable to increased payrolls on expired policies and an improved premium audit process. Net written premiums for the full year were largely unchanged from those in 2015. Net investment income for the fourth quarter and full year 2016 increased period over period, reflecting an increase in the average size of our investment portfolio. Yields at year-end were slightly lower than a year ago, with an average pre-tax book yield of 3.1% and a tax-equivalent book yield of 3.6%.
Net realized gains for the fourth quarter and full year 2016 increased period over period, primarily due to $17 million of other than temporary impairments recognized in the fourth quarter of 2015. The impairments taken during the fourth quarter of 2015 related primarily to equity securities that were affected by a downturn in the energy sector. Our fourth quarter and full year 2016 loss ratios before the LPT were each lower period over period, driven largely by a lower current accident year loss provision rate and an increase in favorable prior period loss reserve development. Consistent with our experience in recent quarters, the decrease in our current accident year loss provision rate during the 2016 periods was the result of a decrease in the frequency of indemnity claims, as well as rate changes, loss trends, changes in business mix, and our strategic underwriting initiatives.
During the fourth quarter of 2016, we recognized $17 million of favorable prior year loss development on our voluntary risk business. During the fourth quarter of 2015, we recognized $9 million of favorable developments on our voluntary risk business. These favorable prior year loss reserve movements reflect favorable paid loss trends due to cost savings associated with the accelerated claims settlement activity that began in 2014 and has continued through 2016. Our commission expenses and associated ratios for the fourth quarter and full year 2016 were each lower period over period. The decrease in our commission expenses during the 2016 periods compared to the 2015 periods was primarily due to lower agency performance incentives. Our underwriting and other operating expenses and associated ratios for the fourth quarter were also lower than a year ago. The decrease was driven by lower bad debt expense, premium taxes, and assessments.
Our underwriting and other operating expenses and associated ratios for the full year were consistent with those from a year ago. Our effective tax rate was 27% in the fourth quarter and 24% for the full year 2016. Our effective tax rates during the comparable 2015 periods were significantly lower than those in the current periods due to fourth quarter 2015 reallocation of loss reserves from non-taxable pre-privatization years to more recent taxable years. As of year-end 2016, the market value of our investment portfolio was $2.6 billion, an increase of 3% from a year ago. At year-end, our fixed maturities had a duration of 4.4 years, with an average credit quality of double A-minus, and our equity securities represented 7.5% of our investment portfolio. We intend to continue to actively manage our capital through common stock dividends, and when feasible, common stock repurchases.
During the fourth quarter of 2016, we repurchased $2.5 million of our common stock at an average price per share of $30.39. Now I'll turn the call over to Steve.
Thank you, Mike, and good morning. Net written premiums for the year of $694.6 million were up $5.3 million from 2015. This top-line growth occurred despite a reduction in our book of business in Southern California. In addition, as stated on prior calls, the market environment is extremely competitive, and the majority of the states we do business in have been subject to a declining rate environment. New premium growth year-over-year for the quarter was 7.8%. New business growth for the year was 3% greater than 2015. Outside of Southern California, the increase for the year was greater than 7%. In the past, we have discussed our opportunities within the alternative distribution channels and the fact that we have dedicated resources to grow our business with both existing partnerships and with new partners. In 2016, our new business revenue within this channel grew 25.6% year-over-year.
We will continue to place a strong emphasis on these partnerships in the future. With respect to renewals in 2016, we continue to see much higher retention rates throughout the year when compared to prior years. We have been focused on retaining the business that has positively impacted our bottom-line results, and these efforts have led to the success we have seen in 2016. This emphasis is particularly important in a softening market cycle like we are currently experiencing. As a result of our success on both new and renewal business opportunities, our policies in force increased year-over-year, led by a 5.6% increase outside of the state of California. This growth was achieved due to both our entry into new states in 2016, as well as growth in many of our existing states.
Consistent with our geographic diversification strategy, during the fourth quarter, we entered the states of Connecticut and Nebraska. This follows our entrance into Massachusetts in the prior quarter. We now write business in 36 states as well as the District of Columbia. Finally, we believe it is important to emphasize that in order for us to continue to improve upon the overall strong results in 2016, we have placed a significant emphasis on investing in technology initiatives, as well as continuing to improve our use of data to make better business decisions. We believe that these investments will reduce transaction costs over time and allow us to become more efficient as an organization. In addition, we know this emphasis will have a positive impact on our customers' experience, which has positive implications for top-line opportunities. Now I will turn the call back to Doug.
Thanks, Steve. Once again, we are pleased to announce a two-thirds increase in our first quarter dividend, which will provide the means to supplement our return to shareholders. Throughout 2017, we will continue to remain focused on creating value for our customers and for our shareholders. With that operator, we'll now turn the call over for questions.
Ladies and gentlemen, at this time, if you have a question, please press star then one on your touch tone telephone. If your question has been answered or you wish to remove yourself from the queue, please press the pound key. Again, that's star then one on your touch tone telephone. Our first question comes from Mark Hughes from SunTrust. Your line is now open.
Yeah, thank you. Good morning. The favorable development in the quarter really was a striking number. You'd been kind of a little bit of a plus or minus in prior quarters. How should we think about this? Is this kind of give a full effect to your trend in claims closure, that sort of thing? Or is this kind of the, if the favorable trends continue, then one might expect additional favorable development and you wouldn't have enough confidence to say so yet, but if you make a sustained progress that favorable development might continue in the future. How to think about it?
I'll take that question, Mark. I'd be reluctant to forecast where this might go. We look at reserves on a quarterly basis. It is our best estimate at that point in time. If you look at where the development was principally coming from, the bulk of it was coming from 2013 and 2014, and we attribute a fair amount of that to the accelerated settlement activity that we've discussed just previously. That certainly has had a very positive impact on losses. Again, I think seeing it in '13 and '14 is significant. You'll recall that when we did the reserve strengthening several years ago, we had an increase in our provision rate for 2013 in the fourth quarter of 2013. It was at the time what we felt was necessary.
I think what you're seeing here now with that favorable development in '13 and '14 is that our initiatives are having a positive impact. Again, I can't forecast that out. That would be inappropriate, I believe, at this point, but certainly we will continue the initiatives that we think will drive better cost containment loss control.
Right. I guess another way to say it is I know you've provided some statistics in your presentation showing how your claims costs were substantially lower than peers. I think it wasn't fully reflected in your loss numbers yet because you didn't have all the credibility or all the full experience you might have wanted. Does this now reflect a full catch-up? Or if you saw more credibility with numbers that continue to outperform, then you might have a more favorable development in the future?
Well-
Asking the same question.
I guess the approach there, Mark, is we'll take it when we see it. We don't take it anticipating that there's more to come. It's reflective of what we're seeing at the point in time in which we do the loss evaluation. Now, you referenced some of the improved performance we've had relative to the industry, and specifically, I believe that's a reference to our experience in California. Relying on the data of the Workers Compensation Research Institute, we consistently outperform the industry in terms of average medical costs. I think what you're seeing in the reserve release is in fact reflective of the outcomes-based network that we put in place in California and across the country. I think that will be supportive of generally better than industry average results going forward.
You had talked about part of the reason for lower commissions was lower agency performance incentives. Presumably, that wasn't because of the profitability of the business, which seems like it's continued to be good. Just a little less emphasis on growth. Did that hamper the written premium in the quarter? I know the audit premium, aside from the change in audit premium, are relatively stable. Could you have gotten some growth if you'd have kept some of those incentives in place?
Yeah, let me turn that over to Steve.
Yep. Mark, in terms of the commission results that we reflected earlier, as you would expect, our commission arrangements in terms of our agency incentive agreements with some of our key agents reflect both growth goals as well as profitability goals, loss ratio goals. Some of our agents did not meet both of those criteria, and some of them didn't meet the growth criteria. As a result of that, the payments to those agents specifically were lower than we would've anticipated.
When we think about loss picks for 2017, you had touched on sounds like frequency and severity trends continue to be favorable. Pricing down a little bit less than a point. With the mix, with those moving parts, how should we think about the loss picks just directionally as we look at 2017?
Well, I referenced that a little bit at the end of my comments, Mark. I think as we look at 2017, we expect that there's going to be continuing pressure on the top line because of declining loss costs, falling rates, and a very competitive marketplace everywhere. Our focus will remain on retaining the outstanding business that's on the books today, and then very selectively pursuing growth opportunities where we can get the appropriate return. In terms of what we expect to see on the loss side, I think the declining frequency trend is likely to continue. I think there are some shifts in the economy that have been occurring for many years that will continue going forward. I would expect to see frequency continuing to be supportive of declining loss costs.
Offsetting that, maybe this is where the uncertainty is, will be what happens on the severity side and specifically what might happen on the medical side. We've been through a fairly sustained period of very stable medical inflation, and really below expectation and workers' compensation medical inflation being below CPI medical inflation. Given the uncertainty around what could happen with the Affordable Care Act and whether or not any of that has an impact on workers' compensation costs is an unknown. It's not something that we're worried about, but it is something that we'll be carefully monitoring, because we could see an uptick in medical severity. Again, I am not forecasting that, but it's something that we're watching for.
One final question. Any movement on the small business side, smaller restaurants, any of this broader economic momentum show up in your book of business?
Yeah, Steve, do you want to take that one?
Sure. One of the things, Mark, that we continue to see is when we evaluate our payroll at final audit relative to the payroll estimated at the inception of the policy, which is generally 15 months after the policy was incepted, we continue to see payroll growth. As you know, a big part of our business is the restaurant class, and that's consistent within that class as well. We continue to see increases in payroll overall. That hasn't deteriorated over the year. In fact, it's been pretty stable. It's clearly reflecting of the fact that the employers that we write are actually hiring more employees, and in some cases, just adding hours to existing employees. We have not seen that deteriorate throughout the year. I don't know what that means for the future. Clearly, we haven't seen any deterioration over the past year. Thank you.
Our next question comes from Cliff Gallant from Philadelphia Financial. Your line is now open.
Thank you. Great quarter, guys. Great year.
Thanks.
I saw you guys were buying back stock in the quarter, but you also announced a nice increase in the dividend. I was curious if that signals any change in your thinking about capital return and maybe just the parameters you use in terms of the form.
Yeah, I don't know that it's reflective of a change in our thinking. We have been looking to increase the yield through the dividend. Obviously, the declining activity in share purchases is connected to the rapid increase we saw in our share price in the fourth quarter. We've always viewed share purchases as a very powerful tool to return capital to shareholders, but we've been very opportunistic in the way we do that. On a quarterly basis, we consider all of the tools that are available to us to return capital that we believe is excess of what's necessary in the business.
Okay, thank you. As a follow-up, in terms of growth in new states, are there any states in particular which are showing strong receptivity to your plans? Out of the, was it 36 out of 44 you're now in, what's the goal for 2017 of how many states you want to be in?
Yeah, I'll let Steve answer that. Sure. Cliff, clearly one of the contributors to our new business growth has been the new states that we've gone into in 2016. New York has driven a lot of our strong growth. Even some of the existing states that we've been in, particularly in the Northeast territories, Pennsylvania, New Jersey, down in the Southeast, Florida, we've seen significant growth in Florida as well. In California. We've talked a lot about Southern California and what's been happening there, but in the Bay Area and other parts of the state, we saw significant growth in 2016 as well. Those are some of the larger contributors to the new business growth we've seen in 2016 over 2015.
Okay. Actually, I need to ask, in terms of the Los Angeles area, do you feel like you're getting towards it being right-sized?
I think we are. In fact, in the fourth quarter for Los Angeles, we actually grew our new business for the first time in a while. I think we've plateaued there. It still is our largest territory. It's the largest market. We obviously are still very interested in writing business that's profitable for us in that territory. We saw a turn in the fourth quarter that I think bodes well for us in that territory in the future.
Okay, great. Thank you very much.
You're welcome.
Our next question comes from Amit Kumar from Macquarie. Your line is now open.
Thanks, and good morning. Just a few follow-up questions. Number 1, just going back to the discussion on the reserve releases, did you talk about the time period where these releases came from? What years?
I'll take that, Amit. That was principally coming from 2013 and 2014.
Okay. That's helpful. The second question, I guess, goes back to what everyone has been asking. Obviously, you're benefiting a lot from the environment and some of the trends. At the same time, some of the other competitors have talked about worsening sort of environment, if you will. I'm curious, why shouldn't we be a bit worried by the pace of reserve releases as well as the direction of your underlying loss picks? Just because we've seen how these things can turn fairly quickly. What gives you confidence that we are at a steady state point where things will not rapidly inflect with an improving economy?
Well, let's take a look at what some of the drivers are here. I referenced in a response to one of Mark's questions some of the initiatives in particular in California, but also nationwide in terms of the outcomes-based medical network we have in place. That continues to drive much better results, and there's no reason to believe that that's likely to change. The accelerated claims settlement activity was really directed at a body of claims related to specific years. That will continue going forward, and we have
Every reason to believe that that will continue to drive better outcomes than we've had in the more recent past. Clearly, we will hit some point where the market plateaus. We believe that those initiatives, along with the things we're doing in terms of better analytics around claims management, will continue to support a stable, if not improving, loss environment.
Got it. The final question I have is obviously on the AM Best change. How do you think about, is there a way to put a range around the potential capital flexibility it adds, or does it not add anything? Is it more sort of a headline thing? Maybe just talk about that, because I know previously we used to discuss that a lot in terms of an overhang.
Yeah. It really isn't a consideration to, or a principal consideration to capital management for us. Clearly, we have been able to build a much stronger capital position from the standpoint of the AM Best rating. If you'll recall, we had some fairly significant growth that occurred in 2011 and 2012 that was creating a growth penalty or a capital charge relative to our AM Best rating. As that charge ran off over about a three-year period of time, it really allowed that capital to come back in from a rating standpoint. Couple that with the increased profitability we've seen over the last several years, and it's really completely rebuilt our capital base from a rating standpoint. Is it a consideration? Well, certainly it's always a consideration, but I don't view it as being a constraint in any way.
Got it. Thanks for the answers, good luck for the future.
Thank you.
We have a follow-up question from Mark Hughes from SunTrust. Your line is now open.
Yeah, I was just going to ask sort of tongue in cheek, so as we look back, the 2013 strengthening, all that volatility, is it the case that in the fullness of time, maybe it didn't have to happen?
I thought about that, Mark, and I actually went back and had looked at those numbers. I said this before, and I'm still comfortable saying it. I think we got 2013 pretty close to right. We made that adjustment in the fourth quarter because of the trends we were seeing in that quarter. Those were real claims. They didn't go away. Fortunately, many of them are now being settled. I think in the end, 2013 will prove to have been about the right call with the adjustment we made in that fourth quarter.
Okay. Very good. Thank you.
Once again, ladies and gentlemen, if you have a question at this time, please press star, then one on your touch-tone telephone. At this time, I'm showing no further questions. I'd like to turn the call back over to Doug.
Very good. Thank you. Thank you everyone for joining us today. A very strong quarter and a very strong year. We think we're heading into 2017 with a very good foundation. I appreciate your participation today and your questions. We look forward to speaking with you again in a couple of months to report the first quarter results. Thanks everyone, and have a great day.
Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the program. You may now all disconnect. Everyone, have a great day.