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NATL > SEC Filings for NATL > Form 10-Q on 3-May-2013All Recent SEC Filings

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Form 10-Q for NATIONAL INTERSTATE CORP


3-May-2013

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;

performance of securities markets;

our ability to attract and retain independent agents and brokers;

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.


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

We have five property and casualty insurance subsidiaries: National Interstate Insurance Company ("NIIC"), Vanliner Insurance Company ("VIC" or "Vanliner"), 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 31 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 March 31, 2013, Great American Insurance Company ("Great American") owned 51.8% 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 after-tax net realized gains from investments that may not be indicative of our ongoing operations. The following table 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 March 31,
                                                              2013                             2012
                                                  Amount           Per Share         Amount        Per Share
                                                        (Dollars in thousands, except per share data)
Net income from operations                       $   7,012       $         0.36      $ 8,614      $      0.44
After-tax net realized gains from investments        1,005                 0.05        1,132             0.06

Net income                                       $   8,017       $         0.41      $ 9,746      $      0.50

Our net income for the three months ended March 31, 2013 was $8.0 million ($0.41 per share diluted) compared to $9.7 million ($0.50 per share diluted) for the same period in 2012. This decrease was driven by the higher loss and LAE ratio of 76.1% for the three months ended March 31, 2013 as compared to 73.1% for the same period in 2012. This 3.0 percentage point increase was primarily attributable to elevated claim severity in certain of our ART products during the three months ended March 31, 2013, partially offset by improvement in the loss and LAE results of two products which we have previously reported as having underperformed in recent periods, one of our Hawaii and Alaska products and our recreational vehicle product. Also contributing to the decline in net income for the first quarter of 2013 compared to the same period in 2012 was a decrease in net investment income, as yields available in the financial markets on fixed maturity securities have generally declined in recent years, placing downward pressure on our investment portfolio yield. Net investment income was also impacted by our average invested asset balances being slightly lower in the first quarter of 2013 as compared to the same period in 2012 due to our one-time special dividend payment in December 2012.

We recorded after-tax net realized gains from investments of $1.0 million ($0.05 per share diluted) for the first quarter of 2013, compared to $1.1 million ($0.06 per share diluted) for the comparative period in 2012. Our after-tax net realized gains for the three months ended March 31, 2013 were primarily generated by net gains associated with equity partnership investments and


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sales or redemptions of securities, while the after-tax net realized gains for the comparable period in 2012 related primarily to net gains associated with equity partnership investments.

Our net income from operations for the three months ended March 31, 2013 was $7.0 million ($0.36 per share diluted) compared to $8.6 million ($0.44 per share diluted) for the same periods in 2012. The primary drivers for this period-over-period fluctuation are the same as those discussed above for the change in net income for the respective periods.

Gross Premiums Written

Three months ended March 31, 2013 compared to March 31, 2012. 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 March 31,
                                            2013                        2012
                                    Amount       Percent        Amount       Percent
                                                 (Dollars in thousands)
       Alternative Risk Transfer   $  85,568         56.3 %    $  76,438         58.7 %
       Transportation                 46,770         30.8 %       35,207         27.0 %
       Specialty Personal Lines       13,542          8.9 %       13,053         10.0 %
       Hawaii and Alaska               3,890          2.6 %        3,880          3.0 %
       Other                           2,098          1.4 %        1,647          1.3 %

       Gross premiums written      $ 151,868        100.0 %    $ 130,225        100.0 %

Gross premiums written includes both direct and assumed premium. During the first quarter of 2013, our gross premiums written increased $21.6 million, or 16.6%, compared to the same period in 2012, primarily attributable to the growth experienced in our transportation and ART components. Gross premiums written in our transportation component increased by $11.6 million, or 32.8%, in the first quarter of 2013 compared to the same period in 2012, primarily driven by Vanliner's moving and storage products, which grew due to a combination of new customers, rate increases and growth in the exposure base among its existing customers. Also contributing to the transportation component's growth was the impact of premiums produced by the trucking product extension introduced in 2012, as well as rate increases on all transportation component products and high renewal retention in our traditional passenger transportation business. Our ART component's gross premiums written increased $9.1 million, or 11.9%, during the first quarter of 2013 compared to the same period in 2012 due to growth in existing ART programs including the addition of a new customer to our large account ART product, rate increases, growth in exposures on renewal business and the addition of new customers in many of our other ART programs. Additionally, we continued to experience high levels of 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 of ending the business relationship with the agent for one of the products in the program business portion of our ART component. This product, which is in runoff, comprised 4.7% of our gross premiums written during the first quarter of 2012. The increase of $0.5 million, or 3.7%, in our specialty personal lines component was primarily related to the growth in our commercial vehicle product, which is mainly attributable to the impact of having appointed hundreds of new independent agents over the past several months and increased rates. This growth was partially offset by a decline in our recreational vehicle product primarily driven by the impact on quote volume and conversion rates associated with significantly increasing our premium rates.

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.

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 first quarter of 2013 and 2012, we recorded premium assessments of $3.2 and $1.5 million premium, respectively.


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Premiums Earned

Three months ended March 31, 2013 compared to March 31, 2012. 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 March 31,                 Change
                                 2013                 2012           Amount        Percent
                                                (Dollars in thousands)
Premiums earned:
Alternative Risk Transfer   $       71,308       $       58,210     $ 13,098           22.5 %
Transportation                      38,632               35,137        3,495            9.9 %
Specialty Personal Lines            11,331               11,817         (486 )         (4.1 %)
Hawaii and Alaska                    3,561                3,384          177            5.2 %
Other                                2,075                1,577          498           31.6 %

Total premiums earned       $      126,907       $      110,125     $ 16,782           15.2 %

Our premiums earned increased $16.8 million, or 15.2%, to $126.9 million during the three months ended March 31, 2013 compared to $110.1 million for the same period in 2012. The increase is primarily attributable to our ART component, which grew $13.1 million, or 22.5%, over 2012 mainly due to the gross premiums written growth from new and existing programs experienced throughout 2012. Our transportation component increased $3.5 million, or 9.9%, during the first quarter of 2013 compared to the same period in 2012 mainly due to the gross premiums written growth in 2012 among Vanliner's moving and storage products and our traditional trucking business. Partially offsetting these increases was a decrease in our specialty personal lines component of $0.5 million, or 4.1%, due to the decline in premiums written in our recreational vehicle product experienced throughout 2012.

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, since 2011 we have seen rate levels gradually stabilize on renewal business, with a number of our products experiencing single digit rate level increases on renewal business. This positive trend has continued into the first quarter of 2013, with many of our products taking rate increases of over 5% and, in some instances, exceeding 10%.


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

                                                  Three Months Ended March 31,
                                                   2013                  2012
                                                     (Dollars in thousands)
  Gross premiums written                      $      151,868        $      130,225
  Ceded reinsurance                                  (27,111 )             (23,510 )

  Net premiums written                               124,757               106,715
  Change in unearned premiums, net of ceded            2,150                 3,410

  Total premiums earned                       $      126,907        $      110,125

  Combined Ratios:
  Loss and LAE ratio (1)                                76.1 %                73.1 %
  Underwriting expense ratio (2)                        21.7 %                23.3 %

  Combined ratio                                        97.8 %                96.4 %

(1) The ratio of losses and LAE to premiums earned.

(2) The ratio of the sum of commissions and other underwriting expenses, other operating expenses less other income to premiums earned.

Three months ended March 31, 2013 compared to March 31, 2012. Our loss and LAE ratio for the first quarter of 2013 increased 3.0 percentage points to 76.1% compared to 73.1% for the same period in 2012. This increase over the prior period is primarily attributable to higher claim severity in certain of our ART products during the three months ended March 31, 2013. Accordingly, we have non-renewed certain underperforming accounts and have increased rate levels, as previously discussed. Partially offsetting this increased claim severity was improvement in the loss and LAE results of two products which we have previously reported as having underperformed in recent periods, one of our Hawaii and Alaska products and our recreational vehicle product. For the first quarter of 2013, we had unfavorable development from prior years' loss reserves of $2.4 million, or 1.9 percentage points compared to unfavorable development of $1.9 million, or 1.8 percentage points, in the first quarter of 2012. This unfavorable development was primarily related to settlements above the established case reserves and revisions to our estimated future settlements on an individual case by case basis. The prior years' loss reserve development is not considered to be unusual or significant to prior years' reserves based on the history of our business and the timing of events in the claims adjustment process.

The underwriting expense ratio for the first quarter of 2013 decreased 1.6 percentage points to 21.7% compared to 23.3% for the same period in 2012, which was primarily attributable to leveraging our fixed operating costs while increasing our premium base in the first quarter of 2013 compared to the same period in the prior year. Specifically, operating costs associated with our insurance operations, such as product management, underwriting, sales and marketing costs, have remained flat during the first three months of 2013 as compared to the first three months of 2012.

Net Investment Income

Three months ended March 31, 2013 compared to March 31, 2012. Net investment income decreased $1.2 million, or 13.3%, to $8.0 million in the first quarter of 2013 compared to the same period in 2012. Yields available in the financial markets on fixed maturity securities remain low, placing downward pressure on our net investment income. While we have normally had higher average invested assets period over period to help offset the declining yields, average fixed income holdings were slightly lower in the first quarter of 2013 as compared to the same period in 2012 primarily due to our one-time special shareholder dividend paid in December 2012.

Net Realized Gains on Investments

Three months ended March 31, 2013 compared to March 31, 2012. Net realized gains on investments were $1.5 million for the first quarter of 2013 compared to $1.7 million for the first quarter of 2012. The net realized gains for the three months ended March 31, 2013 were primarily generated from net realized gains associated with equity partnerships totaling $0.8 million and sales or redemptions of securities, which produced net gains of $0.7 million. The net realized gains for the first quarter of 2012 were primarily generated from net gains associated with equity partnership investments of $1.4 million and net realized gains associated with sales of securities totaling $0.4 million.

Commissions and Other Underwriting Expenses

Three months ended March 31, 2013 compared to March 31, 2012. During the first quarter of 2013, commissions and other underwriting expenses of $22.9 million increased $1.4 million, or 6.2%, from $21.5 million in the comparable period in 2012. As a percentage of premiums earned, commissions and other underwriting expenses decreased to 18.0% for the three months ended


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March 31, 2013 as compared to 19.6% for the same period in 2012, primarily attributable to increasing our premium base while maintaining relatively flat fixed operating costs associated with our insurance operations.

Other Operating and General Expenses

Three months ended March 31, 2013 compared to March 31, 2012. Other operating and general expenses increased $0.5 million, or 10.0%, to $5.4 million during the quarter ended March 31, 2013 compared to $4.9 million for the same period in 2012, primarily due to growth in our employee headcount and other expenses necessary to support the growth in our business. As a percentage of premiums earned, such expenses were relatively flat at 4.3% and 4.5% for the three months ended March 2013 and 2012, respectively.

Income Taxes

Three months ended March 31, 2013 compared to March 31, 2012. The effective tax rate of 27.6% for the three month period ended March 31, 2013 decreased 1.6 percentage points, from 29.2%, as compared to the same period in 2012, primarily attributable to the impact of tax-exempt investment income. While our tax-exempt investment income was relatively flat in the first quarter of 2013 as compared to the same period in 2012, its impact on our effective tax rate was greater in the first quarter of 2013 due to having lower income before income taxes as compared to the prior period.

Financial Condition

Investments

At March 31, 2013, our investment portfolio contained $962.5 million in fixed maturity securities and $38.1 million in equity securities, all carried at fair value, with unrealized gains and losses reported as a separate component of shareholders' equity, and $38.4 million in other investments, which are limited partnership investments accounted for in accordance with the equity method. At March 31, 2013, we had pre-tax net unrealized gains of $45.8 million on fixed maturities and $6.9 million on equity securities. Our investment portfolio allocation is based on diversification among primarily high quality fixed maturity investments and guidelines in our investment policy.

At March 31, 2013, 90.1% of the fixed maturities in our portfolio were rated "investment grade" (credit rating of AAA to BBB-) by nationally recognized rating agencies. Investment grade securities generally bear lower degrees of risk and corresponding lower yields than those that are unrated or non-investment grade.

State and local government obligations represented approximately 37.1% of our fixed maturity portfolio at March 31, 2013, with approximately $281.8 million, or 79.0%, of our state and local government obligations held in special revenue obligations, and the remaining amount held in general obligations. Our state and local government obligations portfolio is high quality, as 99.5% of such securities were rated investment grade at March 31, 2013. We had no state and local government obligations for any state, municipality or political subdivision that comprised 10% or more of the total amortized cost or fair value of such obligations at March 31, 2013.


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Summary information for securities with unrealized gains or losses at March 31, 2013 is shown in the following table. Approximately $1.0 million of fixed maturities and $27 thousand of equity securities had no unrealized gains or losses at March 31, 2013.

                                                 Securities with               Securities with
                                                Unrealized Gains              Unrealized Losses
                                                             (Dollars in thousands)
Fixed Maturities:
Fair value of securities                        $         885,680            $            75,813
Amortized cost of securities                              838,293                         77,406
Gross unrealized gain or (loss)                 $          47,387            $            (1,593 )
Fair value as a % of amortized cost                         105.7 %                         97.9 %
Number of security positions held                             714                             50
Number individually exceeding $50,000
gain or (loss)                                                284                              6
Concentration of gains or losses by
type or industry:
U.S. Government and government agencies         $           6,610            $                (7 )
Foreign governments                                            49                             -
State, municipalities and political
subdivisions                                               16,186                           (246 )
Residential mortgage-backed securities                      9,646                         (1,195 )
Commercial mortgage-backed securities                       2,056                             -
Other debt obligations                                        281                            (15 )
Financial institutions, insurance and
real estate                                                 4,133                            (49 )
Industrial and other                                        8,426                            (81 )
Percent rated investment grade (a)                           90.7 %                         83.1 %
Equity Securities:
. . .
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