EXHIBIT 99
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EMC INSURANCE GROUP
Fourth Quarter 2004 Adverse Development Conf. Call
February 11, 2005
11:00 am EST
>>Operator: Good morning, ladies and gentlemen. Welcome to the EMC
Insurance Group Fourth Quarter 2004 Adverse Development Conference Call. At
this time, all parties are in a listen-only mode and a brief
question-and-answer session will follow the brief presentation. If anyone
should require operator assistance during the conference, press star zero on
your telephone keypad. As a reminder, this conference is being recorded.
It's my pleasure to introduce miss Anita Novac, Director of Investor
Relations.
>>Anita Novak - Dir. Investor Relations: Good morning. Welcome to this
morning's conference call. At this time, I would like to introduce those who
will be available for questions and/or discussion during today's conference
call. Mr. Bruce Kelley, President and CEO of EMC Insurance
Group; Mr. William Murray, Executive Vice President and COO of EMC Insurance
Group; Mark Reese, Senior Vice President and CFO of EMC Insurance Group;
Steve Peck, Senior Vice President, Actuary, and myself. At this time, I
would like to emphasize that the Private Securities Litigation Reform Act of
1995 provides issuers the opportunity to make cautionary statements regarding
forward-looking statements. Accordingly, any forward-looking statements
contained in this conference call are based on management's current beliefs,
assumptions and expectations of the company's future performance, taking into
account all information currently available to management. These, beliefs,
assumptions and expectations can change as a result of many possible events
or factors not all of which are known to management. If a change occurs, the
company's business, financial condition, liquidity, results of operation,
plans, and objectives may vary materially from those expressed in the
forward-looking statements. The risks and uncertainties that may affect the
actual results of the company include, but are not limited to the following:
Catastrophic events and the occurrence of significant severe weather
conditions, the adequacy of loss of settlement expense reserves, state and
federal legislation and regulations, changes in our industry, interest rate
or the performance of financial markets and the general economy, rating
agency actions and other risks and uncertainties inherent to the company's
business. When we use the words believe, expect, anticipate, estimate or
similar expressions, we intend to identify forward-looking statements. You
should not place undue reliance on these forward-looking statements. At this
time, I would like to turn the conference over to Mr. Bruce Kelly.
>>Bruce Kelley - Pres., CEO: Thank you, Anita. Welcome. The purpose of this
call is to briefly discuss the 8K filing made earlier today. As you know, an
8K was filed on January 25 responding to an announcement made by our parent
company regarding the 2004 consolidated statutory combined trade ratio for
the EMC Insurance Groups. At that time, we announced that EMC Insurance
Group Inc.'s statutory combined ratio for 2004 was 104.2. On February 1, we
filed an 8K announcing a change in the executive management of our claims
department effective March 1, 2005. Today's 8K filing and this conference
call will expand on the information provided in those earlier filings.
During the fourth quarter of 2004, we experienced approximately $15.4 million
of adverse development in our loss and settlement expense reserves which will
reduce fourth quarter earnings by approximately $10 million, or 76 cents per
share on an after-tax basis. This adverse development represents
approximately 3.8% of our total loss and settlement expense reserves at
September 30, 2004. The company has a conservative reserving philosophy and
is dedicated to maintaining a consistent level of reserve adequacy. Internal
actuarial evaluations completed in early February 2005 indicate the loss
expense and settlement expense reserves carried by the property and casualty
insurance segment at December 31, 2004 are at the high end of range of
actuarial indications. The fourth quarter adverse development occurred
primarily in the property and casualty insurance segment and as you might
expect was largely concentrated in the workers' compensation line of
business. Let me give you some context to this adverse development. For
many years, we have required every branch to conduct a comprehensive fourth
quarter inventory and review of their case reserves. Although the branch
offices are responsible for keeping their case reserves current at all times
throughout the year, there were indications during 2003 that this process was
not receiving an appropriate level of attention. After emphasizing the need
to perform better in this area, our quarterly internal actuarial reviews
indicated that very good progress was being made during 2004 to improve the
adequacy of the branch office case reserves. In fact, at September 30, 2004,
our internal actuarial reviews indicated that total reserves, including bulk
reserves established in 2003 and 2004, were adequate. However, we found that
during the 2004 fourth quarter review process, the branch offices were
especially diligent in their efforts to review and reevaluate their
individual claim exposures, which resulted in the large increase in case
reserves, particularly for the workers' compensation line of business. I am
pleased that the branch offices used the care and diligence they should have
during the fourth quarter review process. However, I am disappointed that
the case reserve deficiencies were not identified and corrected earlier. As
a result, I have made some definitive changes to the operating procedures and
reporting relationships in the claims department to make sure that the same
level of care is used throughout the year. Recognizing the need to maintain
adequate case reserves, beginning in 2005 the branch offices will be required
to perform the inventory and review process semiannually. This change is
designed to implement necessary reserve adjustments on a timely basis. I
want to stress that EMC has always maintained what we feel is a very
conservative reserving philosophy and that we are, and always have been,
dedicated to maintaining a consistent level of reserve adequacy. Obviously,
we have stumbled recently, but we have taken necessary corrective actions to,
one, increase our case reserves, two, make operational changes to our claims
review process, and three, enhance the oversight of the claim function. I am
pleased that Mr. Richard Shulz, the Claim Manager at the Chicago branch
office, will assume the position of Senior Claims Executive Officer effective
March 1, and I am also pleased to announce that Mr. Shulz will be reporting
to our Executive Vice President and Chief Operating Officer, Bill Murray.
This change in reporting will betterh align the oversight of our branch
operations. We are confident that our decentralized branch structure is the
best way for us to operate and fully expect that the corrective actions that
we have taken will serve us well in the future. As regards to 2004's fourth
quarter development, here's some information that I would like to share with
you. For all lines of business, case reserves increased $34 million,
approximately 23% in 2004 with approximately 50% of the increase occurring in
the fourth quarter. For the workers compensation line of business, case
reserves increased $17 million. That's approximately 29% in 2004 with
approximately 53% of the increase occurring in the fourth quarter. These
case reserve increases reflect a substantial amount of case reserve
strengthening. Case reserve strengthening in the fourth quarter of 2004 is
estimated to be approximately $9 million with approximately $7 million (78%),
occurring in the workers compensation line of business. As of September 30,
2004, case reserves, including bulk reserves were estimated to be redundant
by approximately 5%. At December 31, 2004, the estimated redundancy had
increased to approximately 10%. Now, for the workers compensation line of
business, we estimate that case reserves, including bulk reserves were
redundant by approximately 6% at September 30, 2004, and approximately 13% at
December 31, 2004. At this time, we'd like to take questions from the
audience.
>>Operator: Thank you, sir. Ladies and gentlemen, at this time, we will be
conducting the question and answer session. If you would like to ask a
question, please press star one on your telephone keypad. A confirmation
tone will indicate your line is in the question queue. You may press star
two if you would like to remove your question from the queue. For
participants using speaker equipment, it may be necessary to pick up your
handset before pressing the star keys. Once again, if you do have a question
at this time, you may press star one on your telephone keypad. Our first
question will be coming from Kelly Nash of Keybank Capital Markets.
Q. Good morning. I just had two questions for you. One, when was the last
time you had an outside actuarial review of your book of business?
When might you consider doing that on an ongoing basis?
A. We usually have an outside actuarial review connected with the Minnesota
filing. I will let Steve answer that because he would have had to deal
closely with them. We did have an outside actuarial review done of our
asbestos reserves and that resulted in us increasing our asbestos reserves in
March 2003. In response, I will let Steve answer that question.
A. We have a review of our reserves by Earnst & Young, our auditors,
annually. I think the last time we had a review other than somebody besides
the auditors was either year-end 1999 or 2000. We are currently having a
review done of our 2003 year-end reserves. That's in conjunction with the
financial exam conducted by the Iowa Insurance Department. Looking forward,
we do not have specific plans at this point to have outside reviews other
than, of course, the review that will be conducted by Earnst & Young.
Q. Okay, and can you talk a little bit more about what some of the issues
that you're seeing in the workers comp that's causing the reserve additions?
A. Well, we identified a lot of these issues in the workers comp area over
the last two years, and that was a big part of the work that was done by our
home office claim department to provide information to the branch offices
about this. I'll let Bill Murray talk about that because he has been
involved in overseeing the branches and the kind of information that they
need in order to properly handle workers compensation cases.
A. First of all, the job of the workers compensation adjuster's pretty
difficult at best. When the claims first reported, or at day one, the claim
is reported and all the adjuster knows is there's been an injury or an
illness reported that's supposed to be work related. They have no idea of
the serious nature of the injury. They have no idea of the health of the
individual before the injury. They have no knowledge of what the prescribed
course of treatment may be. They have no idea how that individual responds
to that treatment. They have no idea of whether this individual will return
to work if at all. And yet, they're asked to make an estimate of what the
final payments may be for that workers compensation injury. Now, they go
ahead and they make that estimate, but it's always made more difficult
because recently of the increased medical costs that have occurred, the
increased benefits, indemnity benefits that are prescribed often by state
law, they have seen many changes in the legislation and the case law changes
that have occurred in various states. Just to give you an example of some of
the things that they're dealing with in trying to project what future medical
cost may be, things like expensive medical technology, like morphine pumped
implants, computerized prosthetic devices. Very recently, we saw a case
where an artificial disk replacement can be done by only a top echelon of
specialists, and the surgery can be done at a cost of $30,000, $40,000.
Today, medical technology, they can provide wonderful benefits, but they're
oftentimes expensive. So I think the sum is that there are many of these
issues that are certainly affecting workers compensation today. We believe
that the answer to this is better information, which we're obtaining, better
training for our people that we're putting out into the branch offices and
with that better information and more current information, they'll be able to
make better decisions going forward.
Q. Finally, what really drove the increase in the redundancy? Do you
believe at this point then that your reserves are in good shape and you don't
anticipate additional reserve of adverse development?
A. I think that what we've said this morning about the fact that our
reserves were adequate at the end of September and now, based on actuarial
opinions by our staff, they're more adequate. We believe that we have
reserves that are in an adequate situation. Now, as I said before, we've
identified this problem in the workers comp area, and we've made a number of
changes in the home office and the branch offs have been working diligently
to make changes in the reserve levels of the case reserves. You saw that in
the fourth quarter, and I think that we believe that this level of redundancy
should have a favorable impact going forward with the company when we make
our pool change on the first of January and recognizing that the company
would be taking 30% of those reserves. You know that we're going to be
transferring cash from Florida's Mutual Casual Company to the subsidiary of
EMC Insurance Group, Inc. and that cash represents the reserves. I think,
Miss Nash, we've been working very hard on this, and we've let everybody
involved present their information on each case, and what you're seeing is a
higher level of adequacy.
Q. Thank you. Thank you for having the conference call to go over these
details.
A. You're welcome, Kelly.
>>Operator: If you do have a question, press star one on your telephone key
pad to answer the question queue. If would you like to remove your question
from the question queue, press star two. If you are using speaker equipment,
you should pick up your handset before pressing the star keys. Our next
question is coming from Paul Newsome of A.G. Edwards.
Q. Good morning. I was hoping you could give us a couple additional
comments and maybe some explanation on how confident we can feel that now
that you've got the case reserves presumably set at an appropriate level that
that's not going to feed into your calculations for bulk reserves and IBNR?
My understanding is how much of the analysis works is that you essentially
begin with case reserves and a development of case reserves and work your way
up to giving yourself an IBNR estimate based upon what the development of the
case reserves. If you're getting the case reserves wrong, then does that
call into question the bulk reserves?
A. Paul, thank you very much for the question. I'll turn it over to Steve
Peck, our Chief Actuary, to discuss how the case reserves and the bulk
reserves interrelate.
A. We have a few different bulk reserves. First, the workers compensation
case bulk reserve, which we first put up in 2003 recognizing at that time
that there did appear to be shortages in the case reserves. We refined the
methodology this year and the methodology uses paid losses only and so the
indication of the case reserve adequacy is not affected by the adequacy of
the case reserves themselves. The second reserve that we have up of the bulk
nature is the IBNR reserve, and here, we do take a look at reported IBNR
losses, historically reported IBNR losses compared to a premium base and then
project that forward. So you're absolutely right about that, and yes, you
have a point there that the adequacy of the case reserves does affect that
IBNR estimate based on that methodology. However, we need to keep in mind
that we're looking at IBNR claims that have emerged for all accident years
after a given point in time, all prior accident years, so a lot of those
cases have been settled and therefore, the reserve doesn't come into play,
but to some extent, certainly, the adequacy of the case reserve does affect
that IBNR estimate. I might also mention that is the approach we use for
establishing the IBNR reserve. In evaluating the overall reserve levels, we
use standard methodologies based on paid losses and incurred losses. Paid
losses, obviously, the adequacy of the case reserves is not going to affect
those projections. The incurred projections are definitely affected by
changes in adequacy over time. Actually, at this point, we believe that our
incurred projections are probably too high because our numbers suggest very
strongly that case reserves were more adequate than they have been for, well,
much more adequate than they were at the beginning of the year for sure, and
really a lot more adequate than they've been for a few years. Therefore, the
development factors that we are applying, although we've made some
adjustments, but I think the development factors that we are applying to
those incurred losses, which have been strengthened because of the strength
in the case reserves, those development factors are probably too high, and so
we're applying factors that are a bit too high to stronger reserves and we're
probably, we don't know for sure, obviously, but we're probably overshooting
the target a bit. The paid projections that we are obtaining right now are
giving us, generally speaking, a lower estimate of the ultimate losses than
the incurred projections, and when we look at our selected range, we have
really two ranges, a full range of projections and a selected range where we
think the right answer most likely lies. Our carried reserves at the end of
2004 were actually slightly above the selected range for both the incurred
projections and the paid projections. We're pretty comfortable with our
reserve levels while recognizing the problem that you mentioned in terms of
estimating IBNR.
Q. Do the IBNR reserves as they stand today for year-end incorporate the
impact of the fourth quarter charge in the projections?
A. Historically, -- the short answer is no. Historically, and by that I
mean, historically, we have set our -- I'm sorry. We have done our IBNR
review during the third quarter, so we have not done any projections using
the strengthened case reserves that occurred during the fourth quarter. Is
that the point you are getting at?
Q. Yeah. I think the concern is that we'll go into next year and that the
impact of the increase in case reserves in the fourth quarter will be
included in your next, I guess, third quarter study requiring you to increase
your IBNR reserves based on what's happening today.
Q. Yes, I've given that some thought myself. One tempering factor there
will be that a lot of the strengthening was in workers compensation, and as
you know, IBNR is not a huge issue in workers comp. Those claims get
reported fairly quickly, but to the extent that we have strengthening in some
of the other long-tail lines, like other liability, that's definitely
something that we're going to have to take into account when we do our next
review. It's a good point.
Q. Okay, thank you.
>> Thank you very much, Mr. Newsome.
>>Operator: At this time, ladies and gentlemen, if you would like to enter
the question queue, press star one on your telephone keypad. Please keep in
mind if you are using speaker equipment, you should pick up your handset
before pressing the star keys.
Our next question is coming from Brian Roman of Weiss, Pack & Greer.
Q. Good morning. Just an observation. I mean, I don't understand
everything because I don't have the tremendous level of expertise as, let's
say, Kelly or Paul does -- do, excuse me, but you say you review your IBNR
once a year. You haven't had an outside actuarial review in five years, and
you say that you didn't review the cases coming from your outside -- your
regional offices except for once a year, but now you're, what, about 47% or
43% owned by the public. I'm not sure that's adequate enough review for
public stockholders, and this is just the sort of thing that can happen.
Q. Well, Mr. Roman, I would like to make a couple comments on that. That's
good insight. First of all, we spend a tremendous amount of money here on an
actuarial department, so we're able to do things that a lot of companies are
not able to do because we have a professional actuary department, and that's
going to undergird all of these decisions that Steve referred to. He's
making those changes, and based on his staff that are underneath him looking
at the various aspects of our business, so that's the first point I'd like to
make. The second point I'd like to make is the issue of the claims oversight
in the branch offices, and we have Greg Bird here, who is from the home
office claims department, and there have been a number of changes in the
branches and so he may be able to talk about the relationship between home
office and the branches.
Q. These are claims changes that have been made when?
A. Well, back in 2003, we were very interested in getting a handle on our
workers comp problems, but we've also had some improvements in our systems
that have allowed us to get closer to the branches.
Q. But they did not enable you to miss this problem, correct?
Q. Just in the last few years, we developed a claims system that is a system
that allows our home office claims staff to gain more information than we had
in the past on individual claims files, and that, in turn, allows home office
claim personnel to provide -- push down and provide more information to the
branches in regard claims handling reserves.
Q. So, in other words, I guess this maybe didn't come out on the roadshow,
but in other words, there's sort of a shifting level of our economy here that
to date, the branch offices have had a relatively high degree of autonomy in
terms of underwriting, in terms of claims management is that my understanding
here?
Q. The branches have a high level of autonomy, and they will continue to
have a high level of autonomy. What we're doing by the change in the
executive reporting level is to increase that going forward.
Q. Increase autonomy?
A. No, working with the branches on operations because now you'll have the
branch -- now you'll have the home office claims executive reporting to Bill
Murray, who is -- who oversees the branch office operations. Where, in the
past, it was outside of that. The person reported to me not Bill. There
wasn't a -- there wasn't a holistic approach to the branch autonomy. You
know, each branch --.
Q. Bill is the new executive mentioned earlier on.
A. Richard Shulz is the new executive handling the claims and he will start
March 1, and he will be reporting to Bill Murray, who has been, for over four
years, handling the branch offices.
Q. But, you know, there's two levels. We're talking where it comes out the
back. Isn't there an issue of what comes out of the front which is also
underwriting?
Q. I'll let Bill respond to that question.
Q. Well, you're certainly right that there is certainly a relationship
between the business that's written and the results that we can expect to
have on that business when it comes to the claims because the claims
adjusters, once they get it, will do the best that they can with the claim
file, but the idea is to try to avoid losses in the beginning.
Q. Right.
A. The thing where it makes it difficult is, if, in fact, if we had a few
issues with reserves, what that means is that some of the decisions that
we've made over time need to be reviewed in terms of the business that's
written because actually, some of the results that we saw earlier on may not
have been as good as we thought they were. So that means that we're
constantly now reviewing the business that is to be written for workers
compensation, and we think that we can certainly get a handle on the pricing
if we can get ahead of the curve on this. In addition, you know, workers
compensation is a very, very important line to us from a marketing standpoint
of our commercial business that represents just a little less than 20% of the
business that's to be written. So number one, workers compensation is an
important line of business for us to write. Two, it adds a lot of stability
to the accounts that we write, so we want find some answers to some of these
issues, but we have the expertise. We have a risk improvement department
that can help us control the losses and work closely with our commercial
insurance to mitigate or avoid loss situations going forward. So we have
developed specifically in these -- in the Midwestern states where we write a
good bit of workers compensation coverage, we have reviewed our action plans
that were already in place and made them even more stringent in terms of the
business that's to be written because we, really, the controls from an
underwriting standpoint, you need to have an adequate price in place, or you
need to become more restrictive in the business that you accept.
Q. I guess I want to get back to this issue that I raised at the very
beginning. If nobody looked at this and no actuary outside of the firm
looked at your review, your reserves since '99 and you say or create friction
inside the company, look this is a country built on checks and balances.
Shouldn't there be that natural internal friction, that natural friction?
You know, all of us as investors look at companies that are always having
outsiders look at their companies. Wouldn't this have been picked up a long
time ago? In fact, before you would raise $70 million that between raising
the $70 million and reporting a faux pas like this might this not have been
picked up?
A. I appreciate your comment about outside reviews, and that's something we
may want to take a closer look at, but --.
Q. I mean, it sounds a little bit like you take a personal afront to the
fact that you don't get more periodic outside review on the company, that all
you do is get an auditor to come in.
A. I certainly didn't myself intend to give that impression. This has not
historically been the practice of the company to do that, as far as I know.
As I say, certainly that's something we may want to take a closer look at.
However, as far as the outside review that is currently done, my
understanding is that the reserve work we do is sent to the auditors' actuary
in Chicago. I believe there is actually an actuarial look at our reserve
levels on an annual basis. Now, how does that compare to a ground-up review?
It's different. They're reviewing our work, but it is looked at by an
actuary. I also want to clarify another point. I did comment that we look
specifically at the IBNR reserves on an annual basis. However, we do reviews
of total reserves in case IBNR, loss and adjust, both direct and assume. We
do that on a quarterly basis, and we have two reserve committees that meet
quarterly and review the results of my work. What comes out, has come out of
those reviews over the last few years is a set of actuarial indications over
time which indicated the need to increase bulk reserves. Based on those
quarterly reviews, I make recommendations to those two reserve committees and
the committee evaluates the recommendation and makes a decision. As a result
of the quarterly reviews, we have rather dramatically increased our bulk
reserves over the last four years. On the direct book, the overall four-year
increase is somewhere in the neighborhood of 50%. That is, we've
strengthened bulk reserves by about 50 to 55%. So I didn't want to leave the
impression that, you know, we did just an annual internal review. It is done
- -- it is done on a quarterly basis. The other thing I might just mention to
help address your concern, we are in the process of beefing up the portion of
our actuarial staff devote to the loss reserve function, and we're in our
second year of that process.
>>Operator: Our next question will be coming from Jason Russell of KBW.
Q. Good morning. On the workers comp side, did you have a problem in a few
particular states that was across the board?
A. We don't write workers compensation in every state. So there were
certain of our branch offices, the book of business is not very large, but
I'll let Bill Murray respond to that question on the various branches were
there was a problem, or I guess Steve.
A. We have looked at the case reserve development by branch and -- for
workers comp and it's pretty widespread. All but about two branches that
write any amount of workers compensation did have upward development during
2004.
Q. This is a general issue?
This wasn't a state issue?
A. This is not a specific state issue.
Q. Okay. The guidance of '05 from $2.15 to $2.40, and I think somebody else
asked about the review that's scheduled for the third quarter, is that kind
of information captured in your range for '05?
A. Our range is predicated upon projected combined ratios that the actuarial
department helps us come up with and has taken a lot of issues into
consideration. So I don't know specifically whether that review process is
brought into those factors, but it is projecting out over the year what we
expect the combined ratio to be for our various segments.
Q. So the actuarial department will project a combined ratio following the
recognition of what may or may not need to happen throughout the year?
So after these actions had taken place, these projections were put up?
A. That's correct. Our projections have always included explicit
recognition of expected bulk reserve strengthening, both on the IBNR side and
the loss adjustment expense side. We have not made explicit assumptions
about what will happen to case reserves. Obviously, because of what happened
with the case reserves this year which we in a way would have incorporated,
we were well off of the target.
A. I'd like to emphasize also that the actuarial department does pricing in
conjunction with the branch offices, so the pricing information they have is
also used when they're making their estimates for projected year-end combined
ratio.
Q. Okay. I'm not sure if you mentioned the exiting years that were impacted
by this case reserve action.
A. On workers compensation, about two-thirds of the adverse development came
from the latest three accident years, I believe, but there was another third
that came from accident years prior to 2001, and you can look at the string
of accident years back to about 1970 and virtually all of them are showing
some adverse development. Fairly insignificant, obviously, on some of the
earliest years, but the strengthening is pretty much across the board in
terms of accident year.
Q. Okay. So I guess the last question I have, does this action at all
impact any of the agency profit commissions you would have paid out in '03 or
excuse me, '04?
A. I imagine it would because they're done on year-end basis. I will let
Bill Murray answer that specifically. He handles that.
A. Was the question that we paid out in 2004?
Q. That you will pay out.
A. That we will pay out. To the extent, subject to the provisions of the
agency profit sharing agreement, it impacts their loss ratio.
Q. Okay, so they could share in this as well?
A. Very definitely.
A. Yes.
Q. Okay, thank you.
>>Bruce Kelley- Pres., CEO: We here in Des Moines appreciate your interest
in our group. We will answer more questions on our earnings conference call
on February 24th. We're in process of gathering data. Anita?
>>Anita Novak - Dir. Investor Relations: Thank you, ladies and gentlemen.
We would like to announce our next earnings conference call on February 24th.
It will be at 12:30 Central daylight time, and we look forward to talking to
you then. Thank you, operator.
>>Operator: Thank you. Ladies and gentlemen, at this time, the conference
has concluded. You may disconnect your lines and have a wonderful day.