AMERISAFE, Inc. (AMSF) Q2 2012 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen. Welcome to Amerisafe's Second Quarter Earnings Call. [Operator Instructions]. As a reminder, this conference call is being recorded. Now, I'll turn the conference over to Janelle Frost, CFO. Please begin.

Good morning. Welcome to the Amerisafe's Second Quarter 2012 Investor Call. If you have not received the earnings release, it is available on our website at amerisafe.com. This call is being recorded. A replay of today's call will be available. Details on how to access the replay are in the earnings release. During this call, we will be making forward-looking statements. These statements are based on current expectations and assumptions that are subject to various risks and uncertainties. Actual results could materially differ because of factors discussed in today's earnings release and the comments made during this call, and in the Risk Factors section of our Form 10-K, Forms 10-Q and other reports and filings with the Securities and Exchange Commission. We do not undertake any duty to update any forward-looking statements. I will now turn the call over to Allen Bradley, Amerisafe's Chairman and CEO.

Thanks, Janelle. Good morning, ladies and gentlemen, and thank you for joining our second quarter 2012 earnings call. As usual, I will make a few remarks and then turn the call over to Geoff Banta and Janelle Frost for more details. During the second quarter, the workers' compensation market continued to exhibit signs of increasing demand and pricing. Consistent with public comments, a number of large carriers have made good on their stated diminished capacity or appetite for workers' compensation exposures. And we have commented earlier, it appears high hazard risks are among the first to be jettisoned by carriers. Previous doubters of a turn in the workers' compensation market, have now shifted their focus to the length or severity of the cycle, rather than the occurrence of the turn. Seasoned observers of the workers' compensation market saw residual market volumes expand approximately 89% during the first half of 2012, as compared to the same period in 2011, according to the NCCI's latest report. That increase is an unmistakable indication of a troubled marketplace. Published market surveys indicate workers' compensation pricing is increasing. In the hazardous industries, that trend is even more pronounced, as Geoff will discuss with you shortly. The demand for workers' compensation has improved. For Amerisafe, applications for new business continued to skyrocket, as customers react to the change in underwriting appetite and price increases. Nationally, we expect to see the country's premium increase in 2012 over 2011, reflecting both increases in exposures, as well as the increases in rates. Now, I will turn it over to Geoff Banta for details on our operations.

Thank you, Allen, and good morning, everyone. I'll make a few comments about our operational performance and trends, before turning things over to Janelle to present a summary of our financials. So second quarter was a disappointing one for us, one in which we experienced unfavorable prior loss year development for the first quarter since we went public in 2005. In the second quarter, we saw unexpected levels of case development and accident years 2010 and 2011. In the 2010 accident year, most of our second quarter development came from our trucking subsegment and most due to issues related to return-to-work. In the 2011 accident year, our case loss ratio is much improved over that of our 2010 year, but the second quarter case development we experienced in 2011 was higher-than-expected and caused us to increase our 2011 ultimate loss ratio selection. Both the 2010 and 2011 accident years have been problematic for us and for the industry at large. Medical cost inflation, increased medical and prescription drug utilization and difficulties in returning claimants to work have all led to increased claims duration. Our claims organization has made adjustments to this new reality, and we firmly believe that the actions we have taken in our claims management and product pricing, will bode well for our future performance. But make no mistake, the hangover -- the overhang from accident years 2010 and 2011 continues to test our historical assumptions on loss development. On the positive side, we grew growth premiums written 17.2% in the second quarter, year-over-year, and year-to-date, our top line is up 18.1%. As in the first quarter, the increase was due to 2 factors: First, a 9.4% increase in premium from policies written during the quarter, what we refer to as deck sheet premium, and secondly, a strong year-over-year increase in payroll audits and related premium adjustments. Our deck sheet premium has now grown for 6 straight quarters, and we've had 7 straight quarters of year-over-year increases in premium adjustments. Importantly, our organic growth occurred while we were continuing to increase our pricing. Clear confirmation that the overall work comp market is hardening. In another positive turn, our second quarter premium retention was 99.2% versus 85.8% in quarter 2 '11, a substantial increase and one, due mainly to a 16% increase in average renewal premium. Our policy retention, meanwhile, was a very respectable 91.3% in the second quarter, just slightly lower than Q2 '11, when we retained 92.1% of our policies. Our average premium was due to our continued pricing moves, as well as increased payrolls. In the second quarter, our effective LCM for voluntary work comp was 1.63 or 163% of the approved loss cost, in the state that used this mechanism for pricing. This pricing has an increase of almost 9% year-over-year, and is the highest pricing level we have had in a decade. We are encouraged by the fact that we are growing organically, even while significantly strengthening our pricing. That concludes my remarks, and I will now turn to Janelle to discuss our financial performance.

Thank you, Geoff. In the second quarter of 2012, Amerisafe reported a net income of $3.4 million or $0.19 per share, compared to $4.6 million or $0.24 per share in the second quarter of 2011. Gross premiums written grew 17.2% from the year ago quarter, attributable to 8.9% growth in policies written in the quarter, and over $4 million in positive audit and related adjustments. Net premiums earned increased 15.7% from the year ago quarter. Our net investment income totaled $6.6 million in the second quarter of 2012, a slight increase from the second quarter of 2011. Average invested assets were $873 million, compared to an average of $829 million in the second quarter of 2011. The tax equivalent yield on the investment portfolio was 4.5% in both the second quarter of 2011 and '12. In total, revenue for the second quarter of 2012 was $76.6 million, up 14.3% from the year ago period. Our current accident year loss ratio for the quarter was 76.5%, compared to 79.3% a year ago. Our incurred loss and loss adjustment expenses totaled $56.7 million for the quarter, which included $3.4 million of unfavorable prior year development, attributable to unfavorable development of $5.3 million for accident years 2010 and '11 in the quarter, and favorable development in accident years prior to 2010 of $1.9 million. This compares to loss and loss adjustment expenses of $46.6 million in last year's second quarter, which included $1.2 million of favorable prior year development. In total, our net loss ratio for the second quarter of 2012 was 81.3%, compared to 77.3% for the second quarter of 2011. Total underwriting and other expenses increased 3% to $15.3 million, compared to $14.9 million in the second quarter of 2011. The 2012 second quarter expense components, included $5 million of salaries and benefits, $5.4 million of commissions, and $4.9 million of underwriting and other costs. The expense ratio decreased to 22% from 24.7% in the same quarter a year ago. In total, our combined ratio was 103.8% for the second quarter versus 102.6% for the same period in 2011. Return on average equity for the second quarter of 2012 was 3.8% compared to 5.5% for the second quarter of 2011. Book value per share at June 30, 2012 was $19.98, an increase of 8% from the same period in 2011. And our statutory surplus was $305 million. One last comment, cash flow from operation, was $42 million for the first 6 months of 2012, compared to $5 million in the same period in 2011. We keep our cash at the holding company for our share repurchase program, retiring debt or future acquisition. As previously announced, we will be retiring our remaining $12.9 million of debt in August. That concludes my prepared remarks on the financials. I will now turn the discussion back to Allen.

Thank you, Janelle. Unfortunately, AMERISAFE recorded its first aggregate prior year unfavorable claims development, as a public company, during the second quarter of 2012. Macro factors certainly have exacerbated the claims closure process, lengthening claims' duration and impacting claims cost. But quite frankly, that's not an excuse. All companies operate in the same dynamic and complex environment, and must deal with those factors. Despite the relatively small amount of unfavorable development, we are deeply disappointed with the outcome, but it was the right thing to do. We believe that most shareholders care deeply about a company's long-term value and at the same time, measure its current performance against the same period in the prior year. For the past 26 quarters, we have consistently produced results that generally met or exceeded both expectations, retrospectively and prospectively. We did not achieve both results during this quarter. However, we believe our actions in posting this reserve will promote the company's long-term value. And with that, I'd like to open the call for questions.

[Operator Instructions] We have a question from Matt Carletti of JMP Securities.

I just had a couple of questions on the development. I know it isn't a big number but by any sense, I just wanted to drill a little deeper on it. Can you give us a little more color, just kind of, a guidance around looking at what was allocated to '11 versus -- I know 2010 has been a bit of an enigma over the past several quarters, and maybe, how '11 versus '10, why you think you have grasp on it here versus '10, which seem to be a little bit more of a headache for a little longer period?

Sure, Matt. This is Janelle. I'll start with just telling you what the numbers were. Of the $5.3 million, $3.3 million of that was 2011 and $2 million was 2010.

Partially offset with about $1.9 million in 2009 and prior. Geoff, you want to...

Maybe, I'll get down a little bit into the weeds. We talked about the claims management change in assumptions, change in perspective on the environment. And then I'll say, actually, in 2009, we started seeing some changes whereby, historical assumptions about claimants who were -- who we were -- who had been injured, obviously, and let's say they were mostly soft tissue injuries in the $100,000 to $500,000 range. And we -- of course, our claims people, varied by state, have certain assumptions about how quickly they could return these folks to work. How quickly they could get them to -- through temporary total disability and to maximum medical improvement. Those assumptions for whatever reasons, macro, is what I certainly believe, it's macro reasons. We started seeing those with the same best efforts, those -- the duration to maximum medical improvement elongating. And with each claims professional, they start -- while we were starting to see development at an aggregate level, they were starting to see greater movement, not huge, but greater movement in terms of getting folks through TTD, through maximum medical improvement, and back to work. You can just imagine how difficult it might be for a trucker who has hurt his or her back, who has a fifth grade education, and whose company has no light duty for that person to return to because of the recession, we were forced to deal with some of those realities. And so, on a micro level, our claims adjusters have been moving, ever so gradually, but certainly moving, toward increasing the move to maximum medical improvement, the elongation to temporary total disability, which we've talked about on other conference calls. And we've tried to take that into account as we look at aggregate case development and then set our IBNR. That might be a long- winded explanation, but hopefully, that gives some more color to that.

Now, that's very helpful. And then, I mean, is there any kind of color or guidance you can give on, as we sit here and look at say, where 2011 stands today, and where 2010 does? The difference's, to the extent there are any and where, say, average claim duration expectations are? How -- where are you taking '11 to versus where maybe '10 is now or where '10 came from?

Let me take a stab at that on a couple of points, Matt. The frequency of claims is down, which is good. So therefore, and we're seeing, in fact, in the more recent last half of 2011 and 2012, sort of a mix shift of mixed back to more medical-only type claims, or smaller claims, which are less problematic. Although, the improvement to the economy may not have been what all of us had wished, it clearly has had somewhat of a softening effect. And the other thing that you need to keep in mind and there's been much written about this in the industry, but the return-to-work problems largely seem to be focused around some key issues. One of which was companies going out of business. It's going to be real hard to return this trucker that Geoff is talking about, when the trucking company is no longer in business. And A number of business failures in 2009, for the policies that were reported in '09 and '10, or earned out in '09 and '10, accelerated significantly. So we hope some of that's behind us. We believe some of that is behind us, and that the companies that we're now ensuring have survived those rather difficult times, and we're seeing a growth in exposures, meaning their payrolls are expanding. But there are problems that still remain. And Geoff outlined a couple of them in his comments, but I want to go back to one in particular and that is the use of prescription medications, of opioid schedule II narcotics. And what studies from a high-level have indicated are problems with respect to those sort of treatments, and the impact they have on duration. Duration increases the cost of claims. People stay out longer, they have to see the doctor more, they take more medications, and they get more indemnity payments, and that shows up more in this level of claims that Geoff is talking about. We think that will be less a factor in the later claims, in the more recent claims than it was in that time period where the businesses were going out of -- the companies were going out of business and there was no opportunity to return to work.

And Matt, there are some real headwinds in terms of the third-parties that we deal with that we've also seen in 2010 and 2011. One is and Al mentioned, is the propensity of physicians to prescribe and sometimes, dispense more drugs and actually enable a -- an injured worker to continue to be disabled and not return to work. And there are some very tough states in terms of the administrative law rulings that seem to favor claimants when there is a question, and a qualitative, more than a quantitative question, about whether they're really able to return to work even where there is a job. So there are some forces out there that are fighting that. What I can say is, that we're taking a much more aggressive stance in dealing with those and trying to settle claims in pushing back on pain management therapy and that sort of thing.

And also remember, Matt, that it's not the very large claims that we're running into a problem now. It is not those 7-digit claims. It's not the paraplegic claims, quadriplegic, closed-head injuries, burn claims, as a general rule.

That's really helpful. And I know it's not a big number but nonetheless, I think it's helpful to get our hands around it and get some color. And one other question if I could, and I'll get out of the way. It's just on capital. You guys are writing at less than 1:1 premium-to-surplus leverage. And then, I think in the past, you've mentioned, kind of ballpark 1.5x leverage as being ideal or what you feel you could take it to and not have any -- too much scrutiny from A.M. Best. There's no dividend being paid currently. I know given the shares -- of where the shares are in evaluation, and not a buyback, what's your view on capital return at this point? Or do you see the cycle unfolding in that you could, I mean, it's -- if I kind of keep the current growth rate for this year, we'll call it rough numbers, $300 million a premium, and 1.5x on your current equity, suggests something north of $500 million, is that a number you feel you could can you grow the business to over the next several years? And you want to hold on to that capital?

Well, that's -- it's very interesting you bring that up. That is the question of returning capital to shareholders via some form of dividend, continues to be a topic that our Board is monitoring and is engaging in. No final decision has been made, so I wouldn't be in a position to say that. I do think that's something that's under active consideration. And one of the things that you can't get out of the discussions, but one of the things that you've got to understand in that is that, of course, is what do you need to support the business to grow? That's kind of the starting point. And so, we intend to expand the business, so long as we can underwrite it profitably and it appears that, that it is clearly happening at this point. So, we're going to first do that, but I do think, and certainly considering the current tax environment, that the dividend is certainly a possibility. It's not mine to say, that belongs to the Board of Directors. Additionally, we have increased the leverage just a bit. I mean, a very small one -- with 0.8 to 0.8 from 0.78. Hey, that's a 14% move. But we do intend to expand that, regardless of other capital measures, capital management measures. So of course, M&A is a possibility, but there's nothing I have to report to you in any regard on that.

Our next question is from Jack Sherck of SunTrust.

You mentioned -- Geoff, you mentioned that pricing was at 9% year-over-year in the second quarter. Just from my memory, what was it in 1Q?

1Q is roughly the same thing. Yes, it was 8.7% and 8.6%, roughly about the same rate. Yes. It's actually a little higher this quarter, but it's against a higher bar.

Okay, and then Janelle, on the positive audit premiums, how long can we expect that to last?

I'll be completely honest with you, Jack, and say I was surprised this quarter as I was last quarter, that premium audits continued to come in on a positive year-over-year increase. I've been predicting for the last 2 quarters that, that would slow down because when you're comparing to the prior year, quarter-over-quarter, then the hurdle is getting higher and higher. So I would expect that to slowdown. But I will say, the cash coming in the door right now, year-over-year, is 10% to 11% higher than what we received last year at the same point in time.

And then, on my last question, it's just kind of a bigger picture question. With the passage of a new highway construction bill, in the past when those bills have passed, have you guys seen an uptick? Or what sort of a associate uptick have you seen in your business with that, if any?

We anticipated more of an uptick, Jack, than we saw. And so, we're not counting anything in regard to that. I will tell you that the oil and gas business, the frac-ing and some of the shale operations and related operations, have stirred economic activity. The offshore production has stirred manufacturing and trucking, and welding and fabrication, those sort of businesses significantly. We have -- as you can see from our past history, we've shifted more emphasis over to the agricultural side, which has been more resilient than the logging side. So there's been some support there. But what you're going to see in my estimation, Jack, is that you're going to see the underwriting loss cost rise, you're going to see the amount that carriers are willing to take these risks on rise, and you're going to see, almost an artificial contraction in the market. In other words, there's capital available, yes, but with the performance of the workers' comp, market as a whole, carriers are going to be reluctant to put that capital to work in that particular sector, unless they can get a number, unless they can get a rate that they feel like will reasonably produce a return, consistent with other lines of business.

[Operator Instructions] Our next question is from Randy Binner of FBR.

So I guess I'm going to try and kind of summarize if I could, just everything you covered with macro [indiscernible]. So with these charges, it sounds like it's not large cases, it's kind of a higher number of claims staying open longer and beyond putting a better high reserves against that, that the actual claim trend is mitigated by the fact that you're writing more businesses, better providing kind of the opportunity to return to work. Is that a fair way of kind of summarizing it in a couple of sentences?

Well, we see claims frequencies going down. Okay? And they go down -- they're going down in 2 areas, 2 particular metrics. They're shrinking as -- and correct me, Geoff, but they're shrinking as a -- as it relates to payroll, for a very good thing. And dramatically down as it relates to premium, because as premiums rise, the earned premium rises and therefore, it's going down even faster there than payroll. So those are both good, good metrics. That's why, I think, this lump of claims that Geoff was referring to, really, is of so much impacted by the macro factor, of the inability to return to work, largely because there's no employer out there to take them. Employer is not there.

Or there's no light duty.

There's no light duty, or if the employer is there -- if it's a new employer, that employer would rather not hire somebody that has a history of a loss. Although, it's not supposed to be a consideration, as a practical matter, it does. It is.

Yes. And so I guess, what I was trying to kind of drill down to, is if there's this kind of body of claims that are having a higher severity because they're not closing, so they're staying opened, as you mentioned for medical cost and indemnity. Is -- I guess I'm trying to figure out, is the light duty or the return-to-work environment improving in your book? Or is it just as bad as it was a year ago?

I'd say it is just as bad that we're throwing -- obviously, we're raising our prices. You have to price for moves like that. But I, personally, in our claims organization, I have not seen that, that is improving, is in the $100,000 to $500,000 K claims. It is still a tough slog, trying to get these guys back to work. I'll just say that all our claims adjusters have a heightened sensitivity to that, and to manage against that aggressively to settle a claim, to get them back to work, even in the face of some heavier resistance. But that's still a tough problem. And put that against the backdrop, Randy, on a run rate. The frequency of claims coming in is lower now than it was, but correct. And this is truly, much more difficult with respect to those claims. But the longer a person stays out, the more they begin to consider themselves as disabled.

Sure. And then, I guess I kind of segue -- I mean, this is dumb. I'm going to ask you a question on -- and many analysts have asked on some other calls, on talking to executives about the workers' comp. But I mean, what's your take, Allen, on the fact of healthcare reform and how people use comp. I mean, I think something we worry about as insurance analysts, is that whether it's the insured or their doctor or their lawyer, they find a way to make their worker's comp., or even their auto insurance, have been kind of the way that they access medical care, because they're not accessing it well, otherwise. Do you worry about that? Do you think that's a trend out there? And if so, is there anything that you do to try and mitigate that impact on AMERISAFE?

There's always been, in my estimation, a trend to put billing under workers' comp, as opposed to group health or other forms of healthcare. Because, and I can send you a dozen reports on this, but because the discounting, the amount a physician healthcare provider of any type gets paid under group health, is less, than they get paid under workers' comp. Workers' comp is the last bastion of fee-for-service business. And it is for that reason, there's an effort to make that push. But that's not new. Okay, what does the impact of a healthcare system do on that? And I think that's out -- and that substitutes a great amount of debate, whether it exacerbates the cost shifting, or whether or not, it actually improves the situation. My approach to that would be to plan for the worst and hope for the best. So consequently, we're pricing for that. We're pricing for cost shifting. We're pricing -- trying to price for this elongation and duration and the difficulty in closing claims. And we're also -- I'll add that we're also extremely aggressive on coverage confirmation issues because sometimes, employers will say -- or an employee will say, I was injured in the course and scope of employment, and maybe that's not the case. And so, we do very thorough investigations to make sure if we're on the risk, it was work-related.

[Operator Instructions] The next question is from Bob Farnam of KBW.

Just one question. There is no change to the accident year 2012 loss ratio and I was wondering if you considered moving in a higher base than what you saw on the prior 2 action years?

Let me put it this way, Bob. There would be absolutely no support for moving it higher at this point, okay? It's based upon the earned premium, and based upon the dollars paid, and based upon the change in frequency and reported claims. There would not be support. There just wouldn't be support for that. Why? The percentage of medical-only claims for example, is rising, which are -- our total medical-only claims as a percent of our total incurred amount is about 1%, 1.5%.

It's just the first time in about 4 years.

Yes -- well, the -- so I don't think there was any support for that. But that also has another implication. There's not any support in my mind based upon what's happened with 2011, for us to pull that down either. Despite increased pricing, despite all these other positive metrics, it is entirely too early to make any sort of judgment, to move that. And it is a, we believe at this point, a very cautious number.

There are no further questions at this time. I'd like to turn the call over to Mr. Allen Bradley for any closing remarks.

Thank you. Again, thank you, ladies and gentlemen, for joining us this morning. I want to reiterate one thing, that is that our view of the opportunity of the workers' compensation market, to provide a profitable expansion, still exists and exists even more robustly than before. We believe that there is a significant opportunity to expand our market presence in the coming years. And that AMERISAFE is well-positioned in all relevant aspects to take advantage of this opportunity on a go-forward basis. Thank you, ladies and gentlemen.

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program. You may now disconnect, and have a wonderful day. Thank you.