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NATL > SEC Filings for NATL > Form 10-Q on 2-Nov-2012All Recent SEC Filings

Show all filings for NATIONAL INTERSTATE CORP

Form 10-Q for NATIONAL INTERSTATE CORP


2-Nov-2012

Quarterly Report


ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

Forward-Looking Statements

This document, including information incorporated by reference, contains "forward-looking statements" (within the meaning of the Private Securities Litigation Reform Act of 1995). All statements, trend analyses and other information contained in this Form 10-Q relative to markets for our products and trends in our operations or financial results, as well as other statements including words such as "may," "target," "anticipate," "believe," "plan," "estimate," "expect," "intend," "project," and other similar expressions, constitute forward-looking statements. We made these statements based on our plans and current analyses of our business and the insurance industry as a whole. We caution that these statements may and often do vary from actual results and the differences between these statements and actual results can be material. Factors that could contribute to these differences include, among other things:

general economic conditions, weakness of the financial markets and other factors, including prevailing interest rate levels and stock and credit market performance, which may affect or continue to affect (among other things) our ability to sell our products and to collect amounts due to us, our ability to access capital resources and the costs associated with such access to capital and the market value of our investments;

our ability to manage our growth strategy;

customer response to new products and marketing initiatives;

tax law and accounting changes;

increasing competition in the sale of our insurance products and services and the retention of existing customers;

changes in legal environment;

regulatory changes or actions, including those relating to the regulation of the sale, underwriting and pricing of insurance products and services and capital requirements;

levels of natural catastrophes, terrorist events, incidents of war and other major losses;

adequacy of insurance reserves; and

availability of reinsurance and ability of reinsurers to pay their obligations.

The forward-looking statements herein are made only as of the date of this report. We assume no obligation to publicly update any forward-looking statements.

General

We underwrite and sell traditional and alternative risk transfer ("ART") property and casualty insurance products primarily to the passenger transportation industry, the trucking industry and moving and storage transportation companies, general commercial


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insurance to small businesses in Hawaii and Alaska and personal insurance to owners of recreational vehicles and commercial vehicles throughout the United States.

Effective July 1, 2010, we and our principal insurance subsidiary, National Interstate Insurance Company ("NIIC"), completed the acquisition of Vanliner Group, Inc. ("Vanliner") from UniGroup, Inc. ("UniGroup") whereby NIIC acquired all of the issued and outstanding capital stock of Vanliner and we acquired certain information technology assets. As part of this acquisition, UniGroup agreed to provide us with comprehensive financial guarantees, including a four and a half-year balance sheet guaranty whereby both favorable and unfavorable balance sheet developments inure to UniGroup. Through the acquisition of Vanliner, NIIC acquired Vanliner Insurance Company ("VIC"), a market leader in providing insurance for the moving and storage industry. Obtaining a presence in this industry was our primary strategic objective associated with the acquisition.

We have five property and casualty insurance subsidiaries: NIIC, VIC, National Interstate Insurance Company of Hawaii, Inc. ("NIIC-HI"), Triumphe Casualty Company ("TCC") and Hudson Indemnity, Ltd. ("HIL") and five active agency and service subsidiaries. We write our insurance policies on a direct basis through NIIC, VIC, NIIC-HI and TCC. NIIC and VIC are licensed in all 50 states and the District of Columbia. NIIC-HI is licensed in Ohio, Hawaii, Michigan and New Jersey. TCC holds licenses for multiple lines of authority, including auto-related lines, in 29 states and the District of Columbia. HIL is domiciled in the Cayman Islands and provides reinsurance for NIIC, VIC, NIIC-HI and TCC, primarily for the ART component. Insurance products are marketed through multiple distribution channels, including independent agents and brokers, program administrators, affiliated agencies and agent internet initiatives. We use our five active agency and service subsidiaries to sell and service our insurance business.

As of September 30, 2012, Great American Insurance Company ("Great American") owned 52.2% of our outstanding common shares. Great American is a wholly-owned subsidiary of American Financial Group, Inc.

Results of Operations

Overview

Through the operations of our subsidiaries, we are engaged in property and casualty insurance operations. We generate underwriting profits by providing what we view as specialized insurance products, services and programs not generally available in the marketplace. We focus on niche insurance markets where we offer insurance products designed to meet the unique needs of targeted insurance buyers that we believe are underserved by the insurance industry.

We derive our revenues primarily from premiums generated by our insurance policies and income from our investment portfolio. Our expenses consist primarily of losses and loss adjustment expenses ("LAE"), commissions and other underwriting expenses and other operating and general expenses.

Our net income, determined in accordance with GAAP, includes items that may not be indicative of our ongoing operations. The following table identifies such items and reconciles net income to net income from operations, a non-GAAP financial measure that we believe is a useful tool for investors and analysts in analyzing ongoing operating trends.

                                                            Three Months Ended September 30,
                                                          2012                            2011(1)
                                                Amount           Per Share       Amount         Per Share
                                                     (Dollars in thousands, except per share data)
Net income from operations                    $    8,460        $      0.43      $ 5,912       $      0.31
After-tax net realized gain from
investments                                          571               0.03          279              0.01
After-tax impact from balance sheet
guaranty for Vanliner                                (12 )             0.00         (362 )           (0.02 )

Net income                                    $    9,019        $      0.46      $ 5,829       $      0.30

                                                           Nine Months Ended September 30,
                                                         2012                           2011(1)
                                               Amount          Per Share        Amount         Per Share
                                                    (Dollars in thousands, except per share data)
Net income from operations                   $   23,975       $      1.23      $ 23,483       $      1.21
After-tax net realized gain from
investments                                       1,977              0.10         1,914              0.10
After-tax impact from balance sheet
guaranty for Vanliner                                78              0.00        (2,091 )           (0.11 )

Net income                                   $   26,030       $      1.33      $ 23,306       $      1.20

(1) 2011 results have been retrospectively adjusted for the changes to accounting for deferred policy acquisition costs required under Accounting Standards Update No. 2010-26 ("ASU 2010-26").


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Our net income for the three months ended September 30, 2012 was $9.0 million ($0.46 per share diluted) compared to $5.8 million ($0.30 per share diluted) for the same period in 2011, driven by improved underwriting results, as our loss and LAE ratio decreased 1.1 percentage point to 73.4% for the third quarter of 2012 from 74.5% in the third quarter of 2011. The favorable claims results were primarily attributable to improvement in several products which we previously reported as having performed poorly in recent periods, including recreational vehicle and the ART program where we took significant underwriting actions in 2011. The decrease in the loss and LAE ratio was also impacted by favorable loss experience in our higher limit passenger transportation business where we are experiencing fewer large claims, partially offset by the continued higher than average claims severity experienced in one of the historically profitable products within our Hawaii and Alaska component. Also contributing to the growth in net income for the third quarter of 2012 compared to the same period in 2011 was an increase in net investment income, mainly attributable to a shift into higher-yielding state and local government obligations and mortgage-backed securities that was concentrated in the second half of 2011.

Net income for the nine months ended September 30, 2012 was $26.0 million ($1.33 per share diluted) compared to $23.3 million ($1.20 per share diluted) for the same period in 2011. This increase was driven by the growth in net investment income due to increased net income resulting from the same factors discussed above for the three month period, partially offset by elevated claims results as our loss and LAE ratio for the nine months ended September 30, 2012 increased 0.6 percentage points to 73.7% compared to 73.1% for the same period in 2011. The increase in the loss ratio for the first nine months of 2012 was primarily attributable to higher than average claims severity experienced in two historically profitable products, one in our Hawaii and Alaska component and one in our ART transportation component, as well as adverse claim development from prior years' loss reserves. We expect that these products' results in future periods will be more consistent with our historical results.

UniGroup provided us with comprehensive financial guarantees related to the runoff of Vanliner's final balance sheet whereby both favorable and unfavorable balance sheet development inures to the seller. In accordance with purchase accounting requirements we were required to determine the fair value of the future economic benefit of the financial guarantees and acquired loss reserves as of the date of acquisition, despite the fact that certain gains and losses related to the financial guaranty would be reflected in operations as they are incurred in future periods. As a result, the recognition of the revenues and expenses associated with the guaranteed runoff business will not occur in the same period and will result in combined ratios which are inconsistent with the negotiated combined ratio which was to approximate 100% for the Vanliner guaranteed business. As such, the after-tax impact from the runoff business guaranteed by the seller for the three and nine months ended September 30, 2012 and 2011 have been removed in determining net income from operations to reflect only those results of our ongoing business.

Our net income from operations for the three and nine months ended September 30, 2012 was $8.5 million ($0.43 per share diluted) and $24.0 million ($1.23 per share diluted), respectively, compared to $5.9 million ($0.31 per share diluted) and $23.5 million ($1.21 per share diluted) for the same periods in 2011. For the three and nine months ended September 30, 2012, the loss and LAE ratios from ongoing operations, which exclude the impact from the runoff of the guaranteed Vanliner business, were 73.4% and 73.8%, respectively, compared to 74.4% and 71.4% for the same periods in 2011. The primary drivers for these period-over-period fluctuations are the same as those discussed above for the changes in net income for the respective periods.

We recorded after-tax net realized gains from investments of $0.6 million ($0.03 per share diluted) and $2.0 million ($0.10 per share diluted) for the third quarter and first nine months of 2012, respectively, compared to $0.3 million ($0.01 per share diluted) and $1.9 million ($0.10 per share diluted) for the comparative periods in 2011. Our after-tax net realized gains for both the three and nine months ended September 30, 2012 were primarily generated by sales or redemptions of securities and net gains associated with equity partnership investments, while the after-tax net realized gains for the comparable periods in 2011 related primarily to sales or redemptions of securities, partially offset by net losses associated with equity partnership investments.


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Gross Premiums Written

We operate our business as one segment, property and casualty insurance. We
manage this segment through a product management structure. The following table
sets forth an analysis of gross premiums written by business component during
the periods indicated:



                                            Three Months Ended September 30,
                                            2012                        2011
                                    Amount       Percent        Amount       Percent
                                                 (Dollars in thousands)
       Alternative Risk Transfer   $  55,745         44.1 %    $  53,365         44.2 %
       Transportation                 49,712         39.4 %       46,093         38.1 %
       Specialty Personal Lines       12,471          9.9 %       13,295         11.0 %
       Hawaii and Alaska               6,375          5.0 %        6,479          5.4 %
       Other                           1,971          1.6 %        1,629          1.3 %

       Gross premiums written      $ 126,274        100.0 %    $ 120,861        100.0 %

                                            Nine Months Ended September 30,
                                            2012                        2011
                                    Amount       Percent        Amount       Percent
                                                 (Dollars in thousands)
       Alternative Risk Transfer   $ 224,189         53.9 %    $ 222,810         54.1 %
       Transportation                132,650         31.8 %      126,512         30.7 %
       Specialty Personal Lines       39,673          9.5 %       43,085         10.5 %
       Hawaii and Alaska              14,964          3.6 %       14,672          3.6 %
       Other                           5,153          1.2 %        4,580          1.1 %

       Gross premiums written      $ 416,629        100.0 %    $ 411,659        100.0 %

Three months ended September 30, 2012 compared to September 30, 2011. Gross premiums written includes both direct and assumed premium. During the third quarter of 2012, our gross premiums written increased $5.4 million, or 4.5%, compared to the same period in 2011, primarily attributable to the growth experienced in our transportation and ART components. Gross premiums written in our transportation component increased by $3.6 million, or 7.9%, in the third quarter of 2012 compared to the same period in 2011, primarily due to growth in our trucking transportation product, which saw increases in both rates and exposures, as well as the impact from capitalizing on new business opportunities in the gradually improving commercial insurance market. Our ART component's gross premiums written increased $2.4 million, or 4.5%, during the third quarter of 2012 compared to the same period in 2011 due to growth in existing ART programs, including the addition of two new customers to our large account ART product, the addition of new customers in many of our other ART programs and an increase in exposures on renewal business. Additionally, we continued to experience near 100% member retention in group ART programs renewing during the period. The ART growth was partially offset by reductions in premium primarily associated with the impact from our previously reported 2011 termination of one of the products in the program business portion of our ART component. This program comprised 7.8% of our gross premiums written during the third quarter of 2011. The decrease of $0.8 million, or 6.2%, in our specialty personal lines component was primarily related to the decline in our recreational vehicle product due to the continued trend toward recreational vehicle owners going directly to insurance companies for quotes versus using an agent.

Nine months ended September 30, 2012 compared to September 30, 2011. During the first nine months of 2012, our gross premiums written increased $5.0 million, or 1.2%, compared to the same period in 2011, primarily attributable to our transportation and ART components. Gross premiums written in our transportation component increased $6.1 million, or 4.9%, mainly due to the trucking transportation product, as noted above for the three month period, as well as Vanliner's moving and storage products which grew due to a combination of rate increases and the addition of new customers during the period. Our ART component's gross premiums written increased $1.4 million, or 0.6%, due to the same factors discussed above for the three month period, as well as increased rates on renewal business. Partially offsetting this growth was the impact of the previously noted program terminated in 2011. This program comprised 6.2% of our gross premiums written for the first nine months of 2011. Gross premiums written in our specialty personal lines component decreased $3.4 million, or 7.9%, for the nine months ended September 30, 2012 compared to the same period in 2011 due to the decline in our recreational vehicle product as discussed above for the three month period, as well as the impact of the previously reported ongoing pricing and underwriting actions associated with our commercial vehicle product which have continued into 2012.

Our group ART programs, which focus on specialty or niche businesses, provide various services and coverages tailored to meet specific requirements of defined client groups and their members. These services include risk management consulting, claims administration and handling, loss control and prevention and reinsurance placement, along with providing various types of property and casualty insurance coverage. Insurance coverage is provided primarily to companies with similar risk profiles and to specified classes of business of our agent partners.


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As part of our ART programs, we have analyzed, on a quarterly basis, members' loss performance on a policy year basis to determine if there would be a premium assessment to participants or if there would be a return of premium to participants as a result of less-than-expected losses. Assessment premium and return of premium are recorded as adjustments to premiums written (assessments increase premiums written; returns of premium reduce premiums written). For the third quarter of 2012 and 2011, we recorded a $0.7 premium assessment and a $2.2 million return of premium, respectively. For the first nine months of 2012 and 2011, we recorded a $1.2 million premium assessment and a $0.5 million return of premium, respectively.

Premiums Earned

Three months ended September 30, 2012 compared to September 30, 2011. The
following table shows premiums earned summarized by the broader business
component description, which were determined based primarily on similar economic
characteristics, products and services:



                                           Three Months Ended September 30,                  Change
                                              2012                   2011             Amount        Percent
                                                               (Dollars in thousands)
Premiums earned:
Alternative Risk Transfer               $         60,273       $         52,430      $  7,843           15.0 %
Transportation                                    37,576                 36,966           610            1.7 %
Specialty Personal Lines                          11,830                 13,297        (1,467 )        (11.0 %)
Hawaii and Alaska                                  3,692                  3,686             6            0.2 %
Other                                              1,712                  1,568           144            9.2 %

Total premiums earned                   $        115,083       $        107,947      $  7,136            6.6 %

Our premiums earned increased $7.1 million, or 6.6%, to $115.1 million during the three months ended September 30, 2012 compared to $107.9 million for the same period in 2011. The increase is primarily attributable to our ART component, which grew $7.8 million, or 15.0%, over 2011 mainly due to the gross premiums written growth from existing and new programs experienced throughout 2011 and the first nine months of 2012. Partially offsetting this growth was a decrease in our specialty personal lines component of $1.5 million, or 11.0%, due to the decline in premiums written in our recreational vehicle and commercial vehicle products experienced throughout 2011 and the first nine months of 2012, as discussed above. Premiums earned in our transportation component were relatively flat, increasing $0.6 million, or 1.7%, during the three months ended September 30, 2012 as compared to the same period in 2011. However, included in this period-over-period change is a $1.8 million decrease related to the runoff of Vanliner's premiums earned associated with the business covered by the balance sheet guaranty. The remaining $2.4 million, or 6.7%, increase in the transportation component was driven by the gross premiums written growth experienced in our trucking transportation product during the first nine months of 2012 and in our moving and storage products throughout 2011.

Nine months ended September 30, 2012 compared to September 30, 2011. The following table shows premiums earned summarized by the broader business component description, which were determined based primarily on similar economic characteristics, products and services:

                                            Nine Months Ended September 30,                  Change
                                              2012                   2011             Amount        Percent
                                                               (Dollars in thousands)
Premiums earned:
Alternative Risk Transfer               $        176,429       $        148,047      $ 28,382           19.2 %
Transportation                                   108,792                115,574        (6,782 )         (5.9 %)
Specialty Personal Lines                          35,433                 40,710        (5,277 )        (13.0 %)
Hawaii and Alaska                                 10,587                 10,540            47            0.4 %
Other                                              4,833                  4,679           154            3.3 %

Total premiums earned                   $        336,074       $        319,550      $ 16,524            5.2 %

Our premiums earned increased $16.5 million, or 5.2%, to $336.1 million during the nine months ended September 30, 2012 compared to $319.6 million for the same period in 2011. The increase is primarily attributable to our ART component, which grew $28.4 million, or 19.2%, over 2011 due to the same factors discussed above for the three month period. Partially offsetting this increase were decreases in our transportation and specialty personal lines components of $6.8 million, or 5.9%, and $5.3 million, or 13.0%, respectively. The $6.8 million decline in our transportation component was driven by a $25.1 million decrease related to the runoff of Vanliner's premiums earned associated with the business covered by the balance sheet guaranty, which was partially offset by growth experienced in our trucking transportation and moving and storage products, as discussed above for the three month period. The decrease in our specialty personal lines component was due to the same factors discussed above for the three month period.


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Underwriting and Loss Ratio Analysis

Underwriting profitability, as opposed to overall profitability or net earnings, is measured by the combined ratio. The combined ratio is the sum of the loss and LAE ratio and the underwriting expense ratio. A combined ratio under 100% is indicative of an underwriting profit.

Losses and LAE are a function of the amount and type of insurance contracts we write and of the loss experience of the underlying risks. We seek to establish case reserves at the maximum probable exposure based on our historical claims experience. Our ability to accurately estimate losses and LAE at the time of pricing our contracts is a critical factor in determining our profitability. The amount reported under losses and LAE in any period includes payments in the period net of the change in reserves for unpaid losses and LAE between the beginning and the end of the period.

Our underwriting expense ratio includes commissions and other underwriting expenses and other operating and general expenses, offset by other income. Commissions and other underwriting expenses consist principally of brokerage and agent commissions reduced by ceding commissions received from assuming reinsurers, and vary depending upon the amount and types of contracts written and, to a lesser extent, premium taxes.

Our underwriting approach is to price our products to achieve an underwriting profit even if we forgo volume as a result. After several years of modest single digit decreases in rate levels on our renewal business as a whole, beginning in 2011 and continuing through the first nine months of 2012, we saw rate levels begin to stabilize on renewal business, with a number of our products experiencing single digit rate level increases on renewal business.

The table below presents our net premiums earned and combined ratios for the periods indicated:

                                          Three Months Ended September 30,               Nine Months Ended September 30,
                                            2012                    2011                  2012                    2011
                                               (Dollars in thousands)                        (Dollars in thousands)
Gross premiums written                 $       126,274         $       120,861       $       416,629         $       411,659
Ceded reinsurance                              (14,057 )               (19,120 )             (61,942 )               (65,924 )

Net premiums written                           112,217                 101,741               354,687                 345,735
Change in unearned premiums, net of
ceded                                            2,866                   6,206               (18,613 )               (26,185 )

Total premiums earned                  $       115,083         $       107,947       $       336,074         $       319,550

. . .
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