AMERISAFE, Inc. (AMSF) Q4 2012 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the AMERISAFE, Inc. Fourth Quarter Earnings Conference Call. [Operator Instructions] As a reminder, today's conference is being recorded. I would now like to introduce your host for this conference call, Ms. Janelle Frost. You may begin, ma'am.

Good morning. Welcome to the AMERISAFE fourth quarter 2012 investor call. If you have not received the earnings release, this 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, Form 10-Qs 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.

Good morning, ladies and gentlemen, and thank you for joining us for this morning's fourth quarter 2012 earnings call. With me this morning is Geoff Banta and Janelle Frost, who'll be covering the operational and financial performance of AMERISAFE for the fourth quarter. Before I turn the call over to Jeff, I want to make a few general comments. The workers' compensation market continues to harden. Improvements in work activities have occurred but they've been slow, therefore, the demand for our product has not been overly robust. However, the number of carriers willing to write high hazard compensation risk is contracting. This change in underwriting appetite appears to be fairly widespread. I suspect, due to our focus on high hazard risks, we note these changes perhaps a little bit more rapidly than those ensurers covering just mainstream exposures. On February 4, A.M. Best released a report on the domestic P&C industry. In that report, Best estimated that 2012 calendar year combined ratio for the workers' compensation line to be 117.3%, the third year in a row of that approximate combined ratio. Their projection for the workers' compensation line for 2014 was only slightly improved to 115%. Naturally, pricing is rising. The most recent quarterly pricing survey released by The Council of Insurance Agents & Brokers on February 5, indicated 81% of survey respondents reported rate increases on workers' compensation accounts nationally. In the southeastern region of the country, an area where we have a lot of business, 90% of the respondents reported workers' compensation rates -- rate increases with half of those respondents reporting increases of greater than 10%. Loss costs are beginning to rise but only gradually. At the same time, investment yields continue to contract and remain at exceptionally low levels, putting greater pressure on underwriting to produce margin. Based upon the factors I have mentioned above, The CIAB survey of insurance agent and brokers, best estimate and projection of the 2012 and 2013 calendar year results for workers' compensation and the sustained period of low investment returns. I believe that it's reasonable to conclude that both loss cost and the actual pricing on workers' compensation risk will continue a gradual increase for the next 2 years. With that, I'm going to turn it over to Geoff, our Chief Operating Officer, to discuss the company's operational performance.

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. From an operating standpoint, we had a solid fourth quarter, generating a combined ratio of 92.6% versus a combined of 98.4% in last year's fourth quarter. For the entire year, we also saw improvement, generating a combined ratio of 97.5% versus a 100.4% combined in 2011. In terms of more detailed operating results, in the fourth quarter of 2012, we increased our gross premiums written year-over-year by a strong 30.6%, the eighth straight quarter in which our top line has grown by double digits. For the entire year, our gross premiums written grew 20.8% to $329 million from $272 million in 2011. As has been the case throughout 2012, the fourth quarter increase was due to 2 factors. First, we showed a historic 25% year-over-year increase in what we refer to as our debt sheet premium, that is premium for voluntary policies written during the quarter. Even more encouraging, the premium increase occurred during a period of increases in our pricing, continued evidence that our segment of the workers' comp market is hardening. The second factor in the increase in our gross premiums was a more than 100% increase in payroll audits and related premium adjustments to $7.9 million in the fourth quarter of 2012 from $3.8 million in Q4 '11. Regarding payroll audits, specifically, we experienced a 60% increase over the year-ago quarter. For several quarters now, we have stated that we expect an end to these year-over-year increases in audit premium but we were obviously premature in this prediction and our audit premium increases have been a welcome, if surprising boost to our top line. In terms of pricing, our effective loss cost multiplier for voluntary workers' comp written in the fourth quarter was 1.69 or 169% of the approved loss cost in the states that use this mechanism for pricing. This pricing represents a healthy year-over-year increase over our fourth quarter 2011 effective LCM of 1.56. Our increased pricing, along with a second straight year of aggregate increases in state-mandated loss cost, has contributed to an increase of 19.9% in our average renewal premium. In turn, this has led to a strong increase in our fourth quarter premium retention to 96.4% in the fourth quarter of 2012 from 91.2% in Q4 '11. Regarding losses, we saw a continuation of positive signs that began in the third quarter, including: decreased claim frequency, both payroll and premium based; decreased reported indemnity claims; and increased closure rates. On the other hand, our claims severities were up, reflecting the complex and unpredictable nature of the claims environment in which we operate. Taking the above into consideration and given the fact that 2012 accident year is still very green, we maintained our net current accident year loss and LAE ratio at 76.5%. Relative to prior accident years, we experienced stabilizing development in the fourth quarter, resulting in a lowering of our overall ultimate loss in LAE estimate, for these prior years, by $2.7 million in the aggregate. In her comments, Janelle will provide further color around our loss ratio and its components. Finally, in terms of expenses. Our total underwriting expenses increased by only 1% in 2012 while our net premiums earned increased 15.8%. We pride ourselves in strong expense management and in the intelligent application of technology for efficiency gains. And these factors, along with our top line growth, yield an -- yielded an excellent expense ratio of 21.1% in the 2012 calendar year. With that, I will turn to Janelle to present details on our financials.

Thank you, Geoff. For the fourth quarter of 2012, AMERISAFE reported a net income of $9.2 million or $0.50 per share compared to $8.1 million or $0.44 per share in the fourth quarter of 2011. Gross premiums written rose 30.6% from the year-ago quarter, attributable to $14.3 million growth in policies written in the quarter, and over $4 million of growth in positive audit and related adjustments. Net premiums earned increased 18.9% from the year-ago quarter. Our net investment income totaled $6.7 million for the fourth quarter of 2012, a slight decrease from the fourth quarter of 2011. The tax equivalent yield on our investment portfolio was 4.3% from the fourth quarter of 2012 down 0.2% (sic) [0.3%] from the fourth quarter of 2011. In total, revenue for the fourth quarter of 2012 was $85.6 million, up 14.3% from the year-ago period. Our current accident year loss ratio for the quarter was 76.5%, compared to 78.2% a year ago. Our incurred loss and loss adjustment expenses totaled $57.5 million for the quarter, which included $2.7 million of favorable prior-year development. This compares to loss and loss adjustment expenses of $49.6 million in last year's fourth quarter which included $2.2 million of favorable prior-year development. In total, our net loss ratio for the fourth quarter of 2012 was 73%, compared to 75% for the fourth quarter of 2011. Total underwriting and other expenses decreased 0.9% to $14.9 million compared to $15 million in the fourth quarter of 2011. The 2012 fourth quarter expense components included $5.7 million of salaries and benefits, $6.1 million of commissions and $3.1 million of underwriting and other costs. The expense ratio decreased to 18.9% from 23.7% in the same quarter a year ago. In total, our combined ratio was 92.6% for the fourth quarter versus 98.4% for the same period in 2011. Return on average equity for the fourth quarter of 2012 was 9.8% compared to 9.4% for the fourth quarter of 2011. Book value per share at December 31, 2012, was $20.88, an increase of 8.5% from 2011. And our statutory surplus was $323.9 million at year end. Finally, we had strong cash flows from operations of $81 million in 2012, compared to $43.7 million in 2011. To that end, we initiated our first quarterly dividend of $0.08 per share. That concludes my prepared remarks from the financials. We'll now turn the call back to Allen.

Thanks, Janelle. The fourth quarter was a very strong quarter indeed. I want to comment briefly on 2 other matters. First, as Janelle mentioned, we have initiated our first shareholder dividend. For some time, our board has taken several actions to manage our capital. First, we retired our convertible preferred shares and have cost of about $26 million. Subsequently, we entered into a stock repurchase program and redeemed approximately 1.2 million shares, at an average cost of $17.87. Next, we retired all of our outstanding debt at AMERISAFE. Now, our board has decided to initiate a common shareholder dividend of $0.08 per quarter -- per share per quarter. This decision was based on a number of factors, including but not limited to: the clarification of national tax policy toward dividend income; our having adequate capital at our operational entities to support appropriate growth in gross premiums written and our book value; and appropriate capital and surplus to maintain our A rating from A.M. Best. We believe the initiation of this dividend is a positive development for our shareholders. Finally, before I open the call for questions, I want to comment on an 8-K we issued yesterday after the release of our earnings announcement. Sean Traynor joined AMERISAFE's Board of Directors in April of 2001. Sean was a General Partner at Welsh, Carson, Anderson & Stowe, our principal shareholder at the time. Sean remained a member of our board even after Welsh, Carson liquidated its position in 2006 as part of our secondary offering. Sean's contributions to this company for the last 12 years have been numerous and invaluable. Sean's commitments to his family and his business have now led him to the decision to not stand for reelection to our Board of Directors. The Board of Directors and management team of AMERISAFE wish to express our sincere appreciation to Sean for his many years of dedicated service. We shall miss him very much. With that, let's open the call for questions.

[Operator Instructions] Our first question comes from Mark Hughes of SunTrust.

The claims improvement in the quarter, you're continuing the trend that you've seen previously. Could you talk about what may be driving that? Is that some difference in the underwriting? Some change in the broader climate? What's behind that?

It's a great question, Mark, and I'd like to say we have all the answers to the driver. It seems to be quite widespread. It started in 2012. We've seen a, I think, a 4% drop in reported claims this year, which is, of course, very nice when your earned premium is moving the other way. I'm not going to say that it's -- I'd like to say it's very tough underwriting and better underwriting and better claims, better safety but we don't know that for sure. It's going to take time for us to analyze that and all I can say is, it's welcome, it's widespread amongst our industries and we're very pleased with it.

Yes. Any comparison you can draw with the last cycle, perhaps, when construction activity started to pick back up, people have things to do, they're less likely to get hurt, let's say. Is that a possibility?

I think there's a couple of things. This is Allen. You should recall, we announced that we have launched a number of underwriting initiatives in late 2010 and 2011, and the results in 2012 start reflecting those changes. So some of it is clearly underwriting, not writing particular types of accounts, we analyze where we were having problems, we were having frequency and tried to drill down to those. And you don't see the results of that decision until that's fully implemented and it's in place. But the other thing is, I think when people have an opportunity for full work, they're more likely to want to return to work or perhaps the hiring of employees now is involving hiring more skillful employees or more experienced employees, but I think one of the things you're seeing now, people are probably working longer weeks. So if you got skilled people working longer weeks, they're having better payroll and those sort of things. I'll tell you one other thing and I call it sort of jailhouse religion, I've got a way of putting funny names on things, I guess -- but workers' compensation costs are going up. And when it costs an employer more, they pay more attention to it. If the cost is easy, if a risk is easy to transfer for a minimum cost, you probably won't pay as much as attention to it and we find that employers are more mindful of a safe workplace.

Right, when you say they're probably working longer weeks, is that to say that the skilled people are unlikely to be injured are getting paid more, thus more premium but no increased risk of injury?

Well, there is -- it's -- our exposure base is payroll, so obviously [ph] we get more premium. But it's not like there's a bunch of really new hires on the job. These are existing workers. I don't know, as Geoff says, we're going to have to look at it more closely. Yet, actually we've been experiencing a claims and frequency decline for a pretty good while but the fourth quarter particularly was remarkable, and as Geoff pointed out in his comments, a 15% rise in earned premium and an actual -- the number of claims reported actually decreased 4%. I don't -- and earned premium basis, I mean, the pure number of claims, and that was pretty remarkable.

I guess one more thing, Mark, to add to Allen's comments. In our underwriting initiatives that he pointed out, we have, in the last couple of years, I'll say, gotten tougher on new businesses that may not have as much experience as some of our -- some of the businesses that may generate better claims frequency and I think that plays a part in our falling claim numbers as well.

I agree.

The -- and then one final question. The retention was quite good, 96% retention, a nice jump with 20% average renewal premium increases is an interesting combination. Do you -- how much flexibility does that give you to maybe back off on the retention a little bit then keep pushing the pricing, could you talk about that dynamic?

Well I'll suggest you -- we're going to push the pricing. We'll follow along behind whichever way he goes, but you don't want to get above the market but if you don't know where the market is, that's a concern. We see loss cost rising but only gradually. So when I made the comment about we see loss cost increasing, as well as actual pricing, actual pricing is the discretionary components within the pricing unit beyond just the loss cost, and that's the LCM part, the scheduled debits and credits. And so, we're looking to achieve, based upon our own data, certain rates or certain exposures and we're going to try to achieve those and right now, those metrics all seem to be going in the right direction. The retentions are there, and I think part of that is because there's not a lot of choices. And number two, the new business applications are continuing to flow in at a rapid pace and we have a lot more opportunities. So we intend to increase our market penetration in our current jurisdictions.

And, Mark, just as it's obvious in this environment, as Allen pointed out, you have loss cost. Loss costs have turned the corner in terms of what the states are mandating. There's more states that are raising loss costs now than 2010 and prior. So number one, your base goes up and, number two, we are continuing to, as Allen pointed out, to raise prices, so we get sort of a double -- a multiplicative effect and that -- which obviously raises our average premium, if all other things being equal.

Our next question comes from Christine Worley with JMP Securities.

I have just a couple of numbers questions. To start off with, the premium momentum that you saw in the fourth quarter, did that sustain into January and February?

Well, we don't like to give the forward numbers but I don't think the turning of the calendar changes these sorts of things. If you look back on our commentary and you look back in the start of the fourth quarter of 2010, we noted subtle changes in the markets that were causing pricing to rise and volume to begin to increase. Those comments continue in every quarter since then, and in every quarter since then on a year-over-year basis we've increased premium. And as I've said in my opening remarks, I expect this to continue on for a couple of more years in terms of the rising pricing. Now all of my comments are predicated on the economy not falling off the cliff somewhere, and I guess I don't worry about being politically correct on the fiscal cliff, because I'm just saying, if the national economy were to stop or to slow down dramatically, that could change it. But assuming that the gradual improvement continues, I see the rates continuing to rise and if we're going to have a 1.15 combined, next year, there's going to be very few insurers that are going to be in a really big hurry to jump into that.

Okay. Great. And then turning to margins. Given the continued strong pricing that you're talking about and somewhat stabilizing loss cost trends, would it be logical to assume that we're going to see the accident year loss ratio come down a little bit next year?

Okay. We just about had an over/under bid on how long it would take for that question. Janelle?

I would expect the loss ratio to improve. And obviously, we don't give forward-looking guidance but if you recall 2010, we ended the accident year at 81.8% and unfortunately, that developed to a 95% at -- currently. 2011, we ended at 78.2% and it has developed to 79.5%. We were very prudent about our 76.5% this year, and as you know, we have been getting rate increases since then, so I would expect improvement.

Okay. Great. That's seems fair, and I know you don't give forward guidance, but would you say the -- that full year expense ratio that we saw in 2012 would at least be a good jumping-off point for the coming year?

We are starting to see efficiencies in our expense ratio with our fixed costs because we've been able to keep them at a level that we're benefiting from the additional earned premium. So, yes, I mean there are some pressure there but I would expect the expense ratio to be pretty steady.

[Operator Instructions] Our next question comes from Randy Binner with FBR.

This is Dan Altscher, on for Randy. A quick question on the new dividend policy. I think, Allen, you talked a little bit more higher-level, what the, I guess, the inputs were, but can you maybe go into a little more detail as to how the board thought about $0.08 or about, I guess a 1.1% yield versus maybe something a little bit higher given that the surplus is still very substantial?

Our head of sales and marketing would refer to it as a Christmas turkey. Once you start giving it, you never go back. We wanted to make sure it's a sustainable number, we modeled it against a number of companies, the 1%, or something above the 1% range was a -- seemed to be in the median range of those companies that we'd looked at and it seemed to be a good starting point. We clearly do have excess capital. We -- on a GAAP basis, I think we're levered it 0.8:1. On a stat, I think it's closer to 1:1, something like 0.96. So we have some room to grow with that. This dividend would be basically $6 million -- between $6 and $7 million dollars a year. If things improve, opportunities come, we'll be -- we may increase it. But that would be left up to the board and we wanted to start the process and we wanted to start at a reasonable number but not something that we couldn't build on.

Sure. That makes sense. And I guess also related to capital. You had all indicated that 2012 was not going to be a year of share buybacks as kind of taken care of the remaining debt, which is true. But how do you think about that now going to '13 on buybacks, in consideration with the new dividend?

Well we are still interested in buybacks. The question of dilution is a bit of a concern for us. And...

On a book value basis, you mean?

Right. There -- and we would buy back something above book value if we feel like we can reasonably reach that number in a relatively short period of time. But just to say, we're going to spend x million -- $20 million this year on stock repurchases regardless of what the price of the stock is, is not something we will pursue.

Okay. And then maybe just one other higher-level question since -- and I guess this has been the theme that competition or -- yes, competition has really pulled back and really left the market but at what point do you think that folks come in and say, "Hey, look, these guys are getting 20% rate increase and maybe there's something here for us to get back into now."

It will happen. It will happen. I don't think it's going to happen over the next 2 years and here's why: we write the most hazardous risk, that's what we specialize in, in the industry. That is the last place carriers get during a soft market, that's the last place they enter into the market during a soft market and it is the first place they exit when the market turns. Therefore, the period in the cycle, you'll understand, from trough-to-trough or peak-to-peak, is longer on the high hazard side, the way -- it's longer on the upside and it's shorter on the below -- on the soft side. So, people have, over the last 24, 27 months, have been exiting very, very slowly, that is accelerating. And you basically need 4 things to turn a market, the first one of which is long periods of unsustainable combined ratios, and we have had that. And so I think people will back away from it, they'll look to see where this line is going, that's why A.M. Best projection of a 1.15 for 2013 is a very important number. I don't think people are going to be jumping at that number to get into it. And you'll also understand, Daniel, that -- I mean, this is a patchwork quilt sort of market out there, it varies from state to state, from industry to industry, it is -- it can be pretty complex. Sometimes people look and say, "Oh, California, look at California." Well California is a unique market, just like Illinois is just a unique market, like Louisiana or Maryland. Any state is unique and they have to be measured and considered on their own.

I'm not showing any further questions at this time. I'd like to turn the conference back over to Allen Bradley for closing remarks.

Thank you, ladies and gentlemen, for joining us for our call this morning. I'll just reiterate that over several years, you have heard this management team talk about the soft market in terms of lower loss costs, shrinking payroll and excess capacity that was leading to irrational pricing. Over the last 9 quarters, we have started turning that conversation back to considerations that involve rising payrolls, gradually rising underlying loss costs and a renewed underwriting discipline. We think the fourth quarter is probably the best example of those positive trends that have come back into the marketplace and we see a reasonable expectation of that continuing for the next 12, 24, perhaps even longer, in terms of months. Thanks for being with us today.

Ladies and gentlemen, this does concludes today's presentation. You may now disconnect and have a wonderful day.