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NATL > SEC Filings for NATL > Form 10-Q on 2-Aug-2013All Recent SEC Filings

Show all filings for NATIONAL INTERSTATE CORP

Form 10-Q for NATIONAL INTERSTATE CORP


2-Aug-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;


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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 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 32 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 June 30, 2013, Great American Insurance Company ("Great American") owned 51.7% 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 (loss) income, determined in accordance with U.S. generally accepted accounting principles ("GAAP"), includes after-tax net realized gains from investments that may not be indicative of our ongoing operations. The following table reconciles net (loss) income to net (loss) income from operations, a non-GAAP financial measure that we believe is a useful tool for investors and analysts in analyzing ongoing operating trends.


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                                                                  Three Months Ended June 30,
                                                             2013                              2012
                                                   Amount           Per Share         Amount        Per Share
                                                         (Dollars in thousands, except per share data)
Net (loss) income from operations                $   (7,927 )      $     (0.40 )     $  6,991      $      0.36
After-tax net realized gains from investments         1,647               0.08            274             0.01

Net (loss) income                                $   (6,280 )      $     (0.32 )     $  7,265      $      0.37


                                                                   Six Months Ended June 30,
                                                             2013                              2012
                                                   Amount           Per Share         Amount        Per Share
                                                         (Dollars in thousands, except per share data)
Net (loss) income from operations                $     (915 )      $     (0.05 )     $ 15,605      $      0.79
After-tax net realized gains from investments         2,652               0.14          1,406             0.08

Net income                                       $    1,737        $      0.09       $ 17,011      $      0.87

We recorded a net loss for the three months ended June 30, 2013 of $6.3 million ($0.32 per share diluted) and net income for the first half of 2013 of $1.7 million ($0.09 per share diluted), compared to net income of $7.3 million ($0.37 per share diluted) and $17.0 million ($0.87 per share diluted) for the three and six months ended June 30, 2012. These decreases were driven by the elevated loss and LAE ratios for the three and six months ended June 30, 2013 of 92.3% and 84.3%, respectively, as compared to 74.7% and 73.9% for the same periods in 2012. The loss ratio increases for the second quarter and first six months of 2013 were driven by uncharacteristically high claims severity and unfavorable development from prior years' loss reserves. Three claims occurring in the second quarter, two in our traditional passenger transportation business and one in our moving and storage business, represented a significant portion of the severe claims activity in accident year 2013. All three of these claims were related to long-term insureds with historically favorable loss histories. Included in the unfavorable development from prior years' loss reserves was $6.0 million related to reserve strengthening in our accident year 2011 commercial auto liability line. Also contributing to the decline in net income for the three and six months ended June 30, 2013 compared to the same periods 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 six months 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 $1.6 million ($0.08 per share diluted) and $2.7 million ($0.14 per share diluted) for the second quarter and first six months of 2013, respectively, compared to $0.3 million ($0.01 per share diluted) and $1.4 million ($0.08 per share diluted) for the comparative periods in 2012. Our after-tax net realized gains for the three and six months ended June 30, 2013 were primarily generated by net gains associate with sales of securities. The after tax net gains for the second quarter of 2012 were generated by sales of securities partially offset by net losses associated with equity partnership investments, while the after-tax net realized gains for the first half of 2012 were driven by sales of securities.

Our net loss from operations for the three and six months ended June 30, 2013 was $7.9 million ($0.40 per share diluted) and $0.9 million ($0.05 per share diluted), respectively, compared to net income of $7.0 million ($0.36 per share diluted) and $15.6 million ($0.79 per share diluted) for the same periods in 2012. The primary drivers for the period-over-period fluctuations are the same as those discussed above for the change in net income for the respective periods.

Gross Premiums Written

2013 compared to 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 June 30,
                                            2013                        2012
                                    Amount       Percent        Amount       Percent
                                                 (Dollars in thousands)
       Alternative Risk Transfer   $  84,920         50.2 %    $  92,006         57.5 %
       Transportation                 62,395         36.9 %       47,731         29.8 %
       Specialty Personal Lines       13,857          8.2 %       14,149          8.8 %
       Hawaii and Alaska               5,029          3.0 %        4,709          2.9 %
       Other                           2,815          1.7 %        1,535          1.0 %

       Gross premiums written      $ 169,016        100.0 %    $ 160,130        100.0 %


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                                               Six Months Ended June 30,
                                            2013                        2012
                                    Amount       Percent        Amount       Percent
                                                 (Dollars in thousands)
       Alternative Risk Transfer   $ 170,488         53.2 %    $ 168,444         57.9 %
       Transportation                109,165         34.0 %       82,938         28.6 %
       Specialty Personal Lines       27,399          8.5 %       27,202          9.4 %
       Hawaii and Alaska               8,919          2.8 %        8,589          3.0 %
       Other                           4,913          1.5 %        3,182          1.1 %

       Gross premiums written      $ 320,884        100.0 %    $ 290,355        100.0 %

Three months ended June 30, 2013 compared to June 30, 2012. Gross premiums written includes both direct and assumed premium. During the second quarter of 2013, our gross premiums written increased $8.9 million, or 5.5%, compared to the same period in 2012, primarily attributable to the growth experienced in our transportation component. Gross premiums written in our transportation component increased $14.7 million, or 30.7%, during the second quarter of 2013 compared to the same period in 2012 primarily due to a combination of the continued growth of our trucking product extension introduced in 2012 and premiums generated by the waste operations and energy distribution insurance products which were rolled out in the first quarter of 2013. Vanliner's moving and storage products also contributed to the transportation component's growth during the second quarter of 2013 as compared to the same period in 2012 due to a combination of rate increases, growth in the exposure base among its existing customers and the addition of new customers. Our ART component's gross premiums written decreased $7.1 million, or 7.7%, for the three months ended June 30, 2013 as compared to the same period in 2012, primarily due to non-renewing or "pricing away" the accounts of two customers within our large account ART product, as well as the impact of ending the business relationship with the agent for one of the products within the program business portion of our ART component, as previously reported. These two large account ART customers and the program business ART product comprised 11.9% of our gross premiums written during the second quarter of 2012. Partially offsetting these decreases within the ART component was the addition of a new customer to our large account ART product, rate increases and growth in exposures on renewal business. Additionally, we continued to experience high levels of member retention in group ART programs renewing during the period. The Other component, which is comprised of assigned risk policies that we receive from involuntary state insurance plans typically based on written premiums in that state and over which we have no control, increased $1.3 million, or 83.4%, compared to the same period in 2012.

Six months ended June 30, 2013 compared to June 30, 2012. During the first six months of 2013, our gross premiums written increased $30.5 million, or 10.5%, compared to the same period in 2012, primarily due to the growth experienced in our transportation component. Gross premiums written in our transportation component grew by $26.2 million, or 31.6%, driven by our trucking product extension, the new waste operations and energy distribution products and Vanliner's moving and storage products, as discussed above for the three month period. Also contributing to the transportation component's growth were rate increases on all transportation component products and high renewal retention in our traditional passenger transportation business. Gross premiums written in our ART component increased $2.0 million, or 1.2%, for the six months ended June 30, 2013 compared to the same period in 2012. The ART component increase was primarily due to the addition of two new customers to our large account ART product and growth within our group ART programs resulting from the same factors as discussed above for the three month period. This growth was largely offset by no longer writing the accounts of the two large account ART customers and ending the business relationship with an agent within the program business portion of our ART component, as discussed above for the three month period. These two large account ART customers and the program business ART product comprised 8.6% of our gross premiums written during the first six months of 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.

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 second quarter of 2013 and 2012, we recorded a $1.7 million premium assessment and a $1.0 million return of premium, respectively. For the first six months of 2013 and 2012, we recorded premium assessments of $4.9 million and $0.5 million, respectively.


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Premiums Earned

Three months ended June 30, 2013 compared to June 30, 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 June 30,                 Change
                                 2013                 2012           Amount        Percent
                                                (Dollars in thousands)
Premiums earned:
Alternative Risk Transfer   $       68,857       $       57,946     $ 10,911           18.8 %
Transportation                      42,403               36,079        6,324           17.5 %
Specialty Personal Lines            11,457               11,786         (329 )         (2.8 %)
Hawaii and Alaska                    3,787                3,511          276            7.9 %
Other                                2,362                1,544          818           53.0 %

Total premiums earned       $      128,866       $      110,866     $ 18,000           16.2 %

Our premiums earned increased $18.0 million, or 16.2%, to $128.9 million during the three months ended June 30, 2013 compared to $110.9 million for the same period in 2012. The increase is primarily attributable to our ART component, which grew $10.9 million, or 18.8%, over 2012 mainly due to the gross premiums written growth from new and existing programs experienced throughout 2012. Our transportation component increased $6.3 million, or 17.5%, during the second quarter of 2013 compared to the same period in 2012 mainly due to the gross premiums written growth in our traditional trucking business in 2012 and the growth among Vanliner's moving and storage products throughout 2012 and the first six months of 2013. The increase in the transportation component's premiums earned was also impacted by the addition of new products, rate increases and high renewal retention in our traditional transportation business during the first six months of 2013, as previously discussed.

Six months ended June 30, 2013 compared to June 30, 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:

                                 Six Months Ended June 30,                Change
                                   2013               2012         Amount        Percent
                                                 (Dollars in thousands)
   Premiums earned:
   Alternative Risk Transfer   $     140,165       $  116,156     $ 24,009           20.7 %
   Transportation                     81,035           71,216        9,819           13.8 %
   Specialty Personal Lines           22,788           23,603         (815 )         (3.5 %)
   Hawaii and Alaska                   7,348            6,895          453            6.6 %
   Other                               4,437            3,121        1,316           42.2 %

   Total premiums earned       $     255,773       $  220,991     $ 34,782           15.7 %

Our premiums earned increased $34.8 million, or 15.7%, to $255.8 million during the six months ended June 30, 2013 compared to $221.0 million for the same period in 2012. The increase is primarily attributable to our ART component, which grew $24.0 million, or 20.7%, over 2012 mainly due to the same factors discussed above for the three month period. Our transportation component increased $9.8 million, or 13.8%, over 2012 primarily due to the same factors as discussed above for the three month period.

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.


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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 six months of 2013, with many of our products taking rate increases of over 5% and, in some instances, exceeding 10%.

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

                                          Three Months Ended June 30,             Six Months Ended June 30,
                                           2013                 2012                2013               2012
                                             (Dollars in thousands)                 (Dollars in thousands)
Gross premiums written                 $     169,016        $     160,130       $     320,884        $ 290,355
Ceded reinsurance                            (29,798 )            (24,375 )           (56,909 )        (47,885 )

Net premiums written                         139,218              135,755             263,975          242,470
Change in unearned premiums, net of
ceded                                        (10,352 )            (24,889 )            (8,202 )        (21,479 )

Total premiums earned                  $     128,866        $     110,866       $     255,773        $ 220,991

Combined Ratios:
Loss and LAE ratio (1)                          92.3 %               74.7 %              84.3 %           73.9 %
Underwriting expense ratio (2)                  21.6 %               23.8 %              21.6 %           23.6 %

Combined ratio                                 113.9 %               98.5 %             105.9 %           97.5 %

(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 June 30, 2013 compared to June 30, 2012. Our loss and LAE ratio for the second quarter of 2013 increased 17.6 percentage points to 92.3% compared to 74.7% in the same period in 2012. This increase over the prior period is primarily attributable to a combination of uncharacteristically high claims severity and unfavorable development in prior years' loss reserves. Three claims, two in our traditional passenger transportation business and one in our moving and storage business, which represented a significant portion of the severe claim activity in accident year 2013, were related to long-term insureds with historically favorable loss histories. For the second quarter of 2013, we had unfavorable development from prior years' loss reserves of $8.4 million, or 6.5 percentage points, of which $6.0 million was related to reserve strengthening in our accident year 2011 commercial auto liability line. This compares to favorable development of $0.2 million, or 0.2 percentage points, in the second quarter of 2012. The accident year 2011 reserve strengthening is predominately related to products now in runoff within the program portion of our ART component, as well as our commercial vehicle product, which is part of our specialty personal lines component. We have experienced higher than initially anticipated frequency and severity levels in accident year 2011, and though in 2011 adjustments to our pricing and reserving practices were made and underwriting actions were implemented to stem such adverse results and improve the claim frequency, our severity experience has not improved as rapidly as anticipated. As such it was deemed necessary by management to bring loss reserves into an adequate position relative to our most recent actuarial ultimate loss projections. The remaining unfavorable development primarily related to settlements above the established case reserves and revisions to our estimated future settlements on an individual case by case basis.

In addition to the aforementioned renewal rate increases that we have continued to realize, we have also, during the first six months of 2013, responded to the deterioration in our underwriting margins by taking additional rate increases in certain of our loss layers and by non-renewing or "pricing away" approximately $34.9 million of renewal business. Such accounts were across all components of our business. We will continue to respond with rate increases, non-renewals or other corrective actions, as necessary.

The underwriting expense ratio for the second quarter of 2013 decreased 2.2 percentage points to 21.6% compared to 23.8% for the same period in 2012, which was primarily attributable to leveraging our fixed operating costs while increasing our premium base in the second 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 second quarter of 2013 as compared to the second quarter of 2012.

Six months ended June 30, 2013 compared to June 30, 2012. Our loss and LAE ratio for the six months ended June 30, 2013 increased 10.4 percentage points to 84.3% compared to 73.9% in the same period in 2012. This increase over the prior period is

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