United Fire Group, Inc. — Q2 2016 Form 10-Q
Reporting period: Three and six months ended June 30, 2016. Financial statements are unaudited and were reviewed, not audited, by Ernst & Young LLP. Unless noted otherwise, amounts below are USD millions.
Business context and performance
UFG writes property and casualty (P&C) and life insurance and sells annuities through independent agencies. P&C generated about 91.5% of first-half net premiums earned. The filing reports operations in two segments: P&C and life insurance.
| Metric | Q2 2016 | Q2 2015 | Six months 2016 | Six months 2015 |
|---|---|---|---|---|
| Net premiums earned | $253.5 | $229.2 | $494.8 | $442.4 |
| Total revenues | $279.8 | $255.9 | $545.5 | $494.4 |
| Income before taxes | $0.9 | $19.5 | $29.6 | $51.4 |
| Net income | $3.1 | $15.0 | $25.5 | $38.7 |
| Diluted earnings per share | $0.12 | $0.59 | $1.00 | $1.54 |
| Net investment income | $24.5 | $25.8 | $46.7 | $50.2 |
Financial condition, cash flow and capital
- Balance sheet: At June 30, total assets were $4,105.8 million, total liabilities $3,144.8 million and shareholders’ equity $961.0 million, versus $3,890.4 million, $3,011.5 million and $878.9 million, respectively, at December 31, 2015. Book value per share was $37.85, up from $34.94.
- Cash flow: First-half operating cash flow was $81.1 million, compared with $91.3 million in 2015. Investing activities used $25.5 million and financing activities used $42.3 million; cash and cash equivalents increased $13.3 million to $119.7 million.
- Investments and OCI: Invested assets totaled $3,271.4 million, up $128.6 million from year-end. Net unrealized investment gains were $187.4 million, up $59.1 million after tax since year-end, primarily reflecting lower interest rates. This uplift flowed through other comprehensive income and equity, not net income.
- Debt and liquidity: No credit-facility borrowings were outstanding at June 30. A new $50 million unsecured revolving facility matures February 2, 2020; the company reported covenant compliance. Cash, operating cash generation and investment maturities are principal liquidity sources. About $0.9 billion, or 30.4% of fixed maturities, is scheduled to mature within five years.
- Capital returns and commitments: First-half common dividends were $11.9 million ($0.47 per share); no shares were repurchased. The company had $9.9 million of potential capital contributions to a limited-liability-partnership investment through 2023. Its direct insurance subsidiary could pay up to $67.6 million in dividends without prior regulatory approval, subject to applicable restrictions.
Material changes and segment results
- Premium growth reflected organic expansion and geographic growth, but earnings declined: Q2 net income fell 79.3% and first-half net income fell 34.0% year over year. Management attributed the decline mainly to higher catastrophe losses and increased deferred acquisition cost amortization associated with growth.
- P&C premiums earned grew 11.0% in Q2 and 10.5% year to date. The P&C combined ratio rose to 104.8% from 97.7% in Q2, and to 98.7% from 93.8% for the first half. A ratio above 100% generally indicates an underwriting loss.
- Pre-tax catastrophe losses were $35.5 million in Q2 and $39.9 million for the first half, versus $20.2 million and $20.4 million in the comparable 2015 periods. Hail and wind, mainly in Texas and the Midwest, affected commercial and personal lines.
- P&C reported pre-tax income of $1.4 million for Q2 and $29.5 million for the first half. Prior-accident-year reserves developed favorably by $2.5 million in Q2 and $26.4 million year to date; management said total reserves were within actuarial estimates. Favorable development is variable and may not recur.
- The life segment had a Q2 pre-tax loss of $0.5 million and first-half pre-tax income of $0.1 million, down from $2.7 million and $3.5 million, respectively. Higher single-premium whole-life sales increased earned premiums and future policy-benefit liabilities; lower investment income also weighed on results. Deferred-annuity deposits declined, while management said it was prioritizing profitability over market share in the low-rate environment.
- Investment income declined 5.0% in Q2 and 6.8% year to date, reflecting lower limited-partnership investment results and a low interest-rate environment. No other-than-temporary investment impairment write-downs were reported for the periods.
Outlook, risks and other disclosures
The filing provides no specific earnings or premium guidance. Management describes continued premium growth and a strategy of maintaining annuity profitability rather than pursuing market share. Results remain exposed to catastrophe frequency and severity, reserve adequacy, underwriting and pricing, geographic concentration, interest rates and investment values, reinsurer strength and recoveries, competition, regulation, litigation, and cyber and operational risks. Management noted that catastrophe losses and reserve estimates can make results volatile. Pending legal proceedings were characterized as ordinary and routine, with no expected material adverse effect. Disclosure controls were judged effective; no material change in internal control over financial reporting was reported.
Important facts for investors to verify
- Whether elevated catastrophe claims, especially in commercial and personal property and auto lines, persist and how much is recovered through reinsurance.
- Whether P&C pricing and underwriting performance offset claims and acquisition-cost pressure; track combined ratios by quarter and line of business.
- How sustainable favorable prior-year reserve development is, given the uncertainty in long-tail claims and management’s reserve estimates.
- Whether lower rates or investment-market movements affect recurring investment income, investment valuations, and the unusually large unrealized-gain contribution to equity.
- Trends in life policy sales, annuity withdrawals and deposits, and the profitability and liquidity implications of the company’s product strategy.
- Compliance with revolving-credit covenants, insurance-subsidiary dividend restrictions, and the $9.9 million potential investment funding commitment.